Cold Fusion Fact Or Fantasy?

Reports are out: Scientist Creates Cold Fusion For the First Time In Decades.

Yoshiaki Arata, a highly respected physicist in Japan, demonstrated a low-energy nuclear reaction at Osaka University on Thursday. In front of a live audience, including reporters from six major newspapers and two TV studios, Arata and a co-professor Yue-Chang Zhang, produced excess heat and helium atoms from deuterium gas.

Arata used pressure to force deuterium gas into an evacuated cell that contained a palladium and zirconium oxide mix (ZrO2-Pd). Arata said that the mix caused the deuterium's nuclei to fuse, raising the temperature in the cell and keeping the center of the cell warm for 50 hours.

Arata's experiment would mark the first time anyone has witnessed cold fusion since 1989, when Martin Fleishmann and Stanely Pons supposedly observed excess heat during electrolysis of heavy water with palladium electrodes. When they and other researchers were unable to make it work again, cold fusion became synonymous with bad science.

But the method Arata showed was "highly reproducible," according to eye witnesses of the event. If nobody calls this demonstration out as a sham, Arata might have finally found the holy grail of cheap and abundant energy—nuclear power, without its destructive heat.

Cold-fusion demonstration "a success"

PhysicsWorld is reporting Cold-fusion demonstration "a success".

These days the mainstream science media wouldn't touch cold-fusion experiments with a barge pole. They have learnt their lesson from 1989, and now treat "cold fusion" as a byword for bad science. Most scientists agree, and some even go so far as to brand cold fusion a "pathological science" — science that is plagued by falsehood but practiced nonetheless.

There is a reasonable chance that the naysayers are (to some extent) right and that cold fusion experiments in their current form will not amount to anything. But it's too easy to be drawn in by the crowd and overlook a genuine breakthrough, which is why I'd like to let you know that one of the handful of diligent cold-fusion practitioners has started waving his arms again. His name is Yoshiaki Arata, a retired (now emeritus) physics professor at Osaka University, Japan. Yesterday, Arata performed a demonstration at Osaka of one his cold-fusion experiments.

So, did this method work yesterday? Here's an email I received from Akito Takahashi, a colleague of Arata's, this morning:

"Arata's demonstration...was successfully done. There came about 60 people from universities and companies in Japan and few foreign people. Six major newspapers and two TV [stations] (Asahi, Nikkei, Mainichi, NHK, et al.) were there...Demonstrated live data looked just similar to the data they reported in [the] papers...This showed the method highly reproducible. Arata's lecture and Q&A were also attractive and active."

I also received a detailed account from Jed Rothwell, who is editor of the US site LENR (Low Energy Nuclear Reactions) and who has long thought that cold-fusion research shows promise. He said that, after Arata had started the injection of gas, the temperature rose to about 70 °C, which according to Arata was due to both chemical and nuclear reactions. When the gas was shut off, the temperature in the centre of the cell remained significantly warmer than the cell wall for 50 hours. This, according to Arata, was due solely to nuclear fusion.

Rothwell also pointed out that Arata performed three other control experiments: hydrogen with the ZrO2–Pd sample (no lasting heat); deuterium with no ZrO2–Pd sample (no heating at all); and hydrogen with no ZrO2–Pd sample (again, no heating). Nevertheless, Rothwell added that Arata neglected to mention certain details, such as the method of calibration.

Google Translation From Japanese

Here is a translation of the experiment held before a live audience.

Flashback to a Flashback

Dateline March 1, 1999

Whatever happened to cold fusion?

First announced ten years ago, cold fusion has been largely dismissed by the scientific community.

Most physicists can probably remember where they were when they first heard of Stanley Pons and Martin Fleischmann. On 23 March 1989 the two electrochemists grabbed the world's attention by announcing at a press conference in Salt Lake City, Utah, that they had observed controlled nuclear fusion in a glass jar. The excess heat measured in the experiment offered the promise of a new power source for the planet, as well as huge financial rewards.

However, it is clear that world energy production has not been affected in any way by cold fusion. No experiment has so far convinced the sceptics that cold fusion is real, and most of the big funding sources, which threw money at quick experiments in the early days of cold fusion, have pulled out. Retired particle physicist Douglas Morrison, one of the more persistent critics of cold fusion, says that after ten years there is "less science, fewer scientists, fewer funds, [although there are] more potential investors".

But cold fusion is not dead and buried. A dedicated circle of enthusiasts has kept the flame alive to varying degrees, carrying out jury-rigged experiments in garages and basements, and one or two more conventional institutions still have an interest. Although governments such as those of the US and Japan have officially pulled out, the cold-fusion faithful say that several government agencies are still giving money to the field, including the US Department of Defense. And the Italian and French governments are still supporting research in a small number of labs, according to one cold-fusion insider.

Cold fusion: the culture

Cold fusion may have been written off by the scientific community at large, but it has entered cultural consciousness in interesting ways. Hollywood embraced the subject in 1997 in the action movie The Saint.

Cold fusion has even been turned into a game. Trevor Pinch of the Science and Technology Studies Department at Cornell University created a hypertext game in which you pretend to be an experimenter trying to replicate the Pons and Fleischmann experiment. Depending on what choices you make, you end up either with your reputation intact or a career in tatters.

Cold fusion ten years on

What has become of the original protagonists? Martin Fleischmann apparently had a nasty falling out with Stanley Pons over the direction of research at IMRA and returned to Southampton in1995, where he is still working on theoretical models of cold fusion. In a recent phone interview, Fleischmann told Physics World that he just got fed up with his ideas being ignored.

Could This Device be a Real Mr. Fusion?

The Atomic Motor Blog is asking Could This Device be a Real Mr. Fusion?

As a nuclear engineer with a strong interest in nanotechnology for many years, there aren't many cold fusion devices that I've seen and read about over the years that excite me as much as the potential of Dr. Yoshiaki Arata's solid state fusion reactor which uses Palladium nanoparticles to help initiate his cold fusion reaction process, which creates He4, the gas found in children's balloons from Deuterium gas (a readily available hydrogen isotope). What is also released in the process is heat energy from fusion. No small accomplishment as any physicist would tell you, because this process should be impossible according to the known laws of nuclear physics and chemistry.

What is also significant besides excess heat generated [ awaiting confirmation according to latest news update], is that if his process could somehow be scaled up in large volumes, perhaps ...just perhaps it may be a way to replace Helium supplies someday, which according to the latest reports is becoming a scarce non-renewable resource, often times released to the atmosphere as natural gas is collected along with fossil fuels. The US strategic Helium reserves are also known to be a finite supply, and despite this are now being sold off to meet supply needs of the scientific and commercial sectors.

If any cold fusion fans have read Dr. Arata's earlier important papers on this device, first published in 2006 in a very reputable Italian journal found here, then you would probably agree that an announcement like this is significant from the standpoint that it shows for the first time his actual prototype laboratory device and that he is now demonstrating it in public as also reported here in an interview by New Energy Times.

The Atomic Motor would like to send out an atomic guitar hero award to Dr. Arata and other fellow scientists who diligently keep trying and making significant progress against all odds in keeping the clean energy cold fusion spirit alive.

There are some neat atomic diagrams that will appeal to scientific nerds in the above link. If nuclear engineers find this credible and someone of Arata's stature is willing to stick his neck on the line than I do not think it can be dismissed outright.

So.... Is this the real deal or another flash in the pan to be disgraced for 20 more years? Even if it is the real deal (and I hope it is), how long before there are practical applications to the technology? I do not pretend to know the answers. What I do know is that if is the real deal, at some point in the future there is likely to be incalculable benefits.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Repackaged Mortgage Garbage Is Still Garbage

Bloomberg is reporting Deutsche Bank Unit May Begin Repackaging Its Mortgage Bonds.

Deutsche Bank AG's asset management business may join other firms in repackaging their home-loan bonds into new securities without creating collateralized debt obligations, which are being shunned by investors.

The unit of the Frankfurt-based bank has studied using the technique on bonds in the portfolios it oversees, Julian Evans, a director who helps manage insurer money at Deutsche Asset Management, said in an interview yesterday. Bankers including Goldman Sachs Group Inc. and JPMorgan Chase & Co. have created more than $5 billion of new home-loan securities called Re-REMICs out of existing ones this year, newsletter Inside MBS & ABS says.

By slicing up securities and creating new ones less exposed to loan defaults, the deals can raise the odds some of the debt will retain top ratings or appeal to buyers wary of downgrades or losses amid the U.S. housing slump. Securities firms are mostly repackaging their inventories rather than bonds held in outside funds, according to executives at Deutsche Asset Management.

"It's what financial engineering and securitization is all about: It's taking something nobody wants and creating something people will want, be able to finance, or able to hold,'' said James Grady, a managing director at the New York-based unit, which has $240 billion of fixed-income assets under management.

Re-REMIC issuance so far this year is near the pace that led to a record $25 billion in issuance last year. There have been no CDOs composed of mortgage bonds created this year, down from about $500 billion last year, according to JPMorgan Chase.

A "chief goal" of Re-REMIC deals this year has been to turn a portion of the underlying mortgage-bond balances into debt that won't suffer downgrades from the AAA ratings needed by some types of holders, UBS AG analysts said in a report earlier this month. Institutional Credit Partners LLC, a New York-based asset manager, has done six Re-REMIC deals in the past two months, according to Chief Executive Officer Thomas Priore.

Growth Potential

REMICs are real estate mortgage investment conduits, the tax-exempt vehicles used to turn mortgages into bonds by passing payments from the loans to different investors in varying orders of priority or at different times. Re-REMICs repackage some of those securities or a single class into new bonds in which payments are also directed in different ways.

More Financial Engineering

"It's what financial engineering and securitization is all about: It's taking something nobody wants and creating something people will want, be able to finance, or able to hold."

Excuse me for being cynical but isn't that what CDOs, CMOs, and arguably the Fed sponsored TAF, PDLF, TSLF swap-o-ramas were supposed to do? (See Fed Is Not King Midas for the Fed's non-solution to the problem). The misguided and now disproved theory on swap-o-ramas was that if the Fed was willing to take it someone else might too.

Furthermore, weren't the senior tranches of those CDOs supposed to be safe? Now we are taking existing garbage, and repackaging it as something called "Re-REMIC" and people are supposed to want to buy it? Perhaps they will but how many times can suckers be fooled with all this financial engineering?

Given that there was $500 billion of mortgage CDOs sold to fools last year, and none this year vs. a mere $25 billion in issuance of Re-REMICs, it does appear that there is a healthy bit skepticism towards this latest product. Rightfully so.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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S&L Crisis vs. Current Crisis

I have been talking about an expected wave of bank failures for quite some time, most recently in Too Late To Stop Bank Failures. Recently I was asked to compare the current crisis to the 1980's S&L Crisis in regards to to whether or not this crisis will be worse.

By sheer number of failures the S&L crisis will dwarf what's coming hands down. Here is a chart from MarketWatch that tells the story.

However, numbers alone are not the proper way to measure things.

A proper focus must include an analysis of the magnitude of the failures, who will be affected by those failures, and what actions the Fed might have at its disposal to handle the situation.

Let's start with a look at bank consolidations. Following is a history of just one bank, courtesy of Mr. Practical :

Roll Up

Here's an incomplete list of former financial institutions that now comprise what is known as JPMorgan (JPM):

• Bank One
• Chase Bank
• U.S. Trust
• Manufacturer's Hanover Trust
• Chemical Bank
• First Chicago
• National Bank of Detroit
• First U.S.A
• Bear Stearns (BSC)

Of course there are thousands of smaller financial institutions that have been rolled up into this behemoth. Many of us believe that the last and most famous "acquisition” was really a bail-out of JPMorgan, the deal in reality injecting some $50 billion of capital into this amalgamation of finance.

So what you say? Well I think as we watch bank after bank (Royal Bank of Scotland(RBS) this morning as an example) take recurring “one-time” write-offs we can begin to see just what a ponzi scheme this has been over the years. Banks book loans, mark them up in value, and show the difference in profits. They've done the same thing with the phantom book value these deals present when consummated. Over the last few decades banks have not really made any money; they have merely been a conduit for the Fed to create massive credit. The U.S. money supply is now over 99% debt.

The ponzi scheme is unwinding and investors continue to be gullible. Those that bought Citigroup (C) on its dilutive stock offering are now over 20% in the red. The implications are vast. Risk is high.

The failure of Bear Stearns alone is enough to counterbalance hundreds of what really amounts to branch failures during the S&L crisis.

From the MarketWatch article: "During the late 1980s, banks in Texas couldn't open a new branch in another county without forming a new commercial bank. That meant there were lots more lenders in the state when the S&L crisis struck. So when a bank failed, "40 of its other banks failed on the same day," Cassidy recalls."

Today there are some huge banks and brokers at risk. Wachovia (WB), Washington Mutual (WM), Lehman (LEH), Citigroup (C), Morgan Stanley (MS), Merrill Lynch (MER), Countrywide Financial (CFC) , Keycorp (KEY), Fifth Third (FITB), and Regions Financial (RF) for starters.

That list looks ominous if not preposterous. Yet two years ago if someone said Bear Stearns and Countrywide would fail and that Citigroup, Morgan Staley, Lehman and others would need repeated capital infusions from Dubai, Singapore, and China they would have been laughed off the street.

For more on regional bank failures please see Charge-Offs Hammer Banks.

The Fed will likely act to prevent Citigroup from going under, but I do not believe Citigroup will survive in its current form. I said that last summer while Chuck Prince was still a "dancing fool".

Not every bank and broker in the above list will fail, but I am quite sure that some of them will. Others will be rescued by "shotgun marriage" just as the Fed orchestrated a rescue of JPMorgan by allowing it to take over the Bear.

Who Is Affected

Looking back at the S&L crisis, I do not recall knowing anyone who was directly affected. This mortgage crisis (credit crisis really) runs far deeper. Ridiculous lending standards compounded by consumer greed and Fed micro-management of interest rates are causing millions of foreclosures.

In the wake, tens of thousands of self-employed real estate agents have not had any income for months on end, the originate to securitize model is dying, and mortgage rates are not dropping in spite of massive rate cuts by the Fed. Unemployment is poised to soar which means still more foreclosures are coming. REOs are piling up on bank books. What was largely an institutional crisis in the 1980's is now a huge consumer crisis as well as a huge institutional crisis.

Fed's Inability To Counteract Crisis

In the 1980's the consumer was not tapped out. Today's consumer is so tapped out that many are walking away from their homes. Others are voluntarily choosing bankruptcy. The Fed can add liquidity now, but it cannot dictate where it goes. This poses a huge problem for the serial bubble blowers at the Fed because from a jobs creation standpoint, housing was the bubble of last resort.

No matter what the Fed does now, it is not going to spur jobs creation. On the other hand, Fed action may further stimulate commodity speculation, the very last thing the Fed wants. I talked about this in Commodities Speculation Symptom Of Larger Problem.

Furthermore, what was a US crisis in the 1980's is now a global problem. Property bubbles are busting in the US, Spain, Ireland, Australia, Canada, and other places. What was a US S&L crisis before is now an international credit bubble crisis.

And the popping of this bubble could not have happened at a worse time. Boomers are entering retirement en masse, and many have been counting on increases in the value of their home and the stock market to see them through. What boomers need is one thing, what they are going to get is another.

For more on the demographic problem, please see US and Canada Demographic Time Bomb and Pink Slips Hit Older Workers.

Finally, the Fed is facing additional problems of a falling US dollar, global wage arbitrage, and an economy at the mercy of hundreds of trillions of dollars worth of derivatives with suspect counterparties. Those derivatives dwarf the entire world's economy. This is all happening at a time when the world is increasingly less dependent on the US and is therefore less likely to bend to every whim of the Fed.

The Fed has attempted to counteract these problems with an alphabet soup of lending facilities. However, the Fed Is Not King Midas.

The root cause of this mess is the Fed itself and fractional reserve lending. The Fed created this mess, with help from Congress. If you prefer, Congress created this problem by creating the Fed. Whichever way you prefer it, the Fed and especially Bernanke are not going to fix it. Instead they are going to attempt to increase their power, disguised as a need for still more regulation. If you have not yet done so, please consider the Fed Uncertainty Principle.

Add it all up and the upcoming bank crisis is going to be far greater than what happened in the 1980's even though the number of failures will be far smaller.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Swap Traders Don't Trust Moody's, S&P

Bloomberg is reporting Moody's Implied Ratings Lab Reveals Ambac, MBIA Turning to Junk.

Moody's Investors Service has created a new unit that surprises even its own director.

The team from Moody's Analytics, which operates separately from Moody's ratings division, uses credit-default swap prices as an alternative system of grading debt. These so-called implied ratings often differ significantly from Moody's official grades.

The implied ratings frequently show that swap traders think debt is in more danger of defaulting than Moody's credit ratings signify. And here's the kicker: The swaps traders are usually right.

"When I first saw this product, my reaction was, 'Goodness gracious, Moody's has got a product that is basically publicizing where the market disagrees with Moody's,'" says David Munves, managing director for credit strategy research at Moody's Analytics.

Using the CDS market, Munves's unit rates both MBIA and Ambac Caa1. That's seven notches below junk and 15 below the official Moody's rating.

Swap traders see there's a huge risk that Ambac and MBIA will default, hedge fund adviser Tim Backshall says. He says swap traders don't trust S&P's and Moody's investment-grade ratings for the companies

"The only thing holding them at AAA is simply the model that the rating agencies claim they use to judge that capital and the fact they know that if they downgrade the companies, it'll push them into default," says Backshall, of Walnut Creek, California- based Credit Derivatives Research LLC.

The rating companies say their grades are correct.

"Moody's will not refrain from taking a credit rating action based on the potential effect of the action," says company spokesman Anthony Mirenda.

My Comment: There is hardly a person in the world that believe you Anthony. You have a severe credibility problem as well as a business model totally dependent on government sponsorship and based on conflicts of interest.

Munves says that over one year, the implied ratings have been a more accurate predictor of defaults than Moody's ratings. The Moody's unit reports that implied ratings for one year have a 91 percent accuracy ratio compared with an 82 percent ratio for Moody's official ratings.

"The Moody's accuracy ratio is consistently lower," he says.

The Surprising Thing

The surprising thing is that Moody's is surprised by their own findings.

Ambac (ABK) Daily Chart



click on chart for sharper image

MBIA (MBI) Daily Chart



click on chart for sharper image

Is there any explanation for maintaining AAA ratings of MBIA and Ambac through this debacle other than incompetence or corruption? If there is someone let me know what it is.

It's not just swap traders who do not trust the rating agencies, I do not think anyone does. How can they?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Bankruptcy Reform Act Finally Blows Sky High

The Debt Slave Act, better known as the Bankruptcy Reform Act of 2005 has at long last blown sky high. We will get to "how" in just a moment but first let's review some of the provisions of the bill. Lenders asked for and received everything on their wish list as follows:

Wish List

• A strict financial means test that may prohibit many debtors from filing a liquidation bankruptcy under Chapter 7;
• A requirement that all debtors must receive a briefing from an approved credit counseling agency at least six months before they can file their bankruptcy case; Note: Check with your local bankruptcy court to determine if they will waive the time restrictions in the beginning months.
• A requirement that debtors take an approved class on debt management techniques before they receive their bankruptcy discharge;
• A provision making it easier for a court to dismiss a bankruptcy case outright or to convert a Chapter 7 case to a Chapter 13 case; and
• A provision permitting a court to impose sanctions on attorneys, or even on debtors, for filing a Chapter 7 case that is dismissed or converted to a Chapter 13 case.

After the fairy godmother (Bush) signed the bill written by industry lobbyists and passed by Congress as "reform", banks and lending institutions went on a credit binge of previously unimaginable proportion. The most ridiculous abuse of common sense was the so called "Liar Loans" more commonly referred to as "Stated Income Loans".

In addition, much of the subprime mess and the HELOC (home equity) can be attributed to lending institutions behaving as if Sixteen Tons was the new state of being.

You load sixteen tons, what do you get
Another day older and deeper in debt
Saint Peter don't you call me 'cause I can't go
I owe my soul to the company store

Liar loans are now blowing up. I talked about this recently in Bring On The Alt-A Downgrades.

Liar Loans Discharged In Bankruptcy

Debt Slavery is now in reversal. Inquiring minds should consider this extremely significant ruling: BK Judge Rules Stated Income HELOC Debt Dischargeable.

Tanta writes:

This is a big deal, and will no doubt strike real fear in the hearts of stated-income lenders everywhere. Our own Uncle Festus sent me this decision, in which Judge Leslie Tchaikovsky ruled that a National City HELOC that had been "foreclosed out" would be discharged in the debtors' Chapter 7 bankruptcy. Nat City had argued that the debt should be non-dischargeable because the debtors made material false representations (namely, lying about their income) on which Nat City relied when it made the loan. The court agreed that the debtors had in fact lied to the bank, but it held that the bank did not "reasonably rely" on the misrepresentations.

I do not always agree with Tanta, but I would say that I do over 85% of the time. And I certainly agree with her post this time. She is correct on two counts:

1) This was an extremely significant ruling
2) This was the correct ruling

What is interesting to me was some of the comments, some of which defended the lenders. I have zero sympathy for the lenders and the following comments are in line with my thinking.

Tanta Writes:

Nat City gets zero sympathy for me on this one. Talk about a case of "fool me twice."

Jas Jain writes:

Tanta: “I argued some time ago that the whole point of stated income lending was to make the borrower the fall guy: the lender can make a dumb loan--knowing perfectly well that it is doing so--while shifting responsibility onto the borrower, who is the one "stating" the income and--in theory, at least--therefore liable for the misrepresentation.”

Bingo: And the reason this was carried to such an extreme was the debt slave act of 2005 in conjunction with absurd interest rate policy at the Fed, the Fed's direct sponsorship of ARMs and derivatives, and the "Ownership Society" of the Bush administration. All of which are also blowing sky high right now.

Uncle Festus writes:

A few random thoughts on things which have been raised in these comments:

1. I don't think that the lender will appeal this, because at this point it's not "binding" precedent on any other court (though it will be cited as "persuasive" precedent in future similar disputes). I think the lender will not appeal it because there is a real risk that the higher court (either the 9th Circuit itself or the Bankruptcy Appellate Panel) could affirm it and it would then become binding on the entire 9th Circuit, which encompasses the whole West Coast plus Arizona and Nevada. The money at risk in this individual case (if there is any at all) is minuscule compared to the risk of this becoming the law in the largest Circuit in the country.

Binding or not, the die is cast. Furthermore, under a Democratic Congress and Obama as president the entire bankruptcy reform act is likely to be rewritten.

As ye sow so shall ye reap.

Banks and lending institutions are now bearing the fruits of their attempts to make debt slaves out of consumers. I salute the ruling of Judge Leslie Tchaikovsky.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Bring On The Alt-A Downgrades

HousingWire is reporting S&P Lowers the Boom on 1,326 Alt-A RMBS Classes.

Bring on the Alt-A downgrades: Standard & Poor’s Rating Services said Wednesday evening that it had slashed the ratings of 1,326 Alt-A residential mortgage-backed securities, after recent data is proving performance of Alt-A loans originated in 2006 and 2007 to be particularly problematic. The downgrades affect $33.95 billion in issuance value and affect Alt-A loan pools securitized in the first half of 2007 — roughly 14 percent of S&P’s entire Alt-A universe in that timeframe.

Perhaps more telling were an additional 567 other Alt-A classes put on negative credit watch by the ratings agency.

A review of affected securities by Housing Wire found that all of the classes put on watch for a pending downgrade are currently rated AAA, suggesting that S&P’s confidence in thin overcollateralization typical of most Alt-A deals is quickly waning. The total dollar of potential downgrades to the AAA classes in question would dwarf Wednesday’s downgrades, which affected only mezzanine and equity tranches.

Happy Birthday WMALT 2007-0C1

I have been tracking a particular Washington Mutual (WM) Alt-A mortgage pool for 5 months. The pool is known as WMALT 2007-OC1 A1. It is a securitized mortgage-backed security issued in May, 2007. It is also the poster child for what's wrong with Alt-A.

In Evidence of "Walking Away" In WaMu Mortgage Pool, I wrote about data January.
The February update was WaMu Alt-A Pool Revisited.
The March update was called WaMu Alt-A Pool Deteriorates Further.
The April update was WaMu's Suspect Mortgage Pool.

The pool is now one year old. Happy Birthday. Let's see how the pool is doing as we light one candle on the cake to celebrate.

WMALT 2007-0C1 May Picture



click on chart for sharper image

Facts and Figures

• The original pool size was $513,969,100.
  
• 92.6% of this cesspool was rated AAA.
  
• 22.89% of the whole pool is in foreclosure or REO status after 1 year.
  
• 31.17% of the pool is 60 days delinquent or worse

Chris Puplava at Financial Sense put together some additional charts to consider.

REOs vs. 60 Day Delinquencies or Worse



click on chart for sharper image

REOs (green) are the right scale, and 60 day delinquencies (red) are the left scale.
As expected REOs are following 60 day delinquencies with a lag. Over time well over 30% of this pool is going to fail.

Pool Balance vs. Foreclosures



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Foreclosures (green) are the right scale, and pool balance (red) is the left scale. No matter how you look at this data things are deteriorating rapidly.

I do not know about this pool in particular, but in general the ratings agencies are well behind the curve with downgrades. The S&P just now appears to be figuring out what some of us have known for a long time:

1) Pools from 2006-2007 are extremely suspect in quality
2) Confidence in Alt-A pools is unwarranted

S&P is still far behind the curve given those 1326 Alt-A downgrades have only hit the mezzanine and equity tranches, not the senior tranches. Many downgrades of those senior tranches are coming. The losses are going to be staggering.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Infighting At The Fed

Bloomberg is reporting Mishkin to Leave Fed in August, Return to Columbia.

Federal Reserve Governor Frederic Mishkin, a central-banking scholar and advocate of the longest run of interest-rate cuts since 2001, resigned to return to Columbia University.

Mishkin, 57, on a leave of absence from the New York school, will step down as of Aug. 31, the Fed said in a statement today, also releasing his letter of resignation to President George W. Bush. Mishkin will attend his final meeting of the rate-setting Federal Open Market Committee on Aug. 5.

The departure may create an unprecedented third vacancy on the seven-member Fed Board of Governors this year as the central bank tries to ease the credit crisis. The vacancies mean that a new U.S. president to be inaugurated in January may have an opportunity to influence monetary and regulatory policy by nominating new members to the board.

"It leaves the board in a challenging condition, with only four governors, one of which is unconfirmed," said Brian Sack, senior economist at Macroeconomic Advisers LLC in Washington and a former Fed research manager.

Bush may select a fourth nominee to fill Mishkin's seat. Should the Senate fail to approve a replacement or not allow Bush to appoint a temporary substitute, the Fed would have fewer than five governors in office for the first time since establishment of the bank's current structure in 1936.

Mishkin presented a paper at the Kansas City Fed's annual symposium in Jackson Hole, Wyoming, saying the Fed can be more successful by lowering rates "aggressively" in response to a deep slump in home prices. In another speech he said the financial turmoil posed an "important downside risk to economic activity" beyond housing.

"He was a pretty important supporter of the move toward aggressive rate-cutting this year," said Michael Feroli, an economist at JPMorgan Chase & Co. in New York, who used to work at the Fed.

Bies Frustrated Over Slow Progress On Capital Standards

Susan Schmidt Bies resigned effective March 30 2007. The interesting thing about Bies' resignation was that she was spearheading efforts to revise capital standards for banks but was frustrated by the slow progress. Here is an interesting flashback snip:

After a speech at the National Credit Union Administration's Risk Mitigation Summit in January, Bies told reporters that "I'm an impatient person. I clearly wish that things were going faster, but I'm very happy that we've got everything out for comment now."

On Wednesday, four major U.S. banks submitted a letter to the Federal Reserve and urged it to move away from certain Basel II proposals. JPMorgan Chase (JPM), Washington Mutual (WM), Wachovia (WB), and Citigroup (C) complained that the new rules would require U.S. banks to hold more minimum capital and would give foreign banks an advantage.

Ironically, three of the four banks complaining loudest about forthcoming capital requirements are in deep trouble being over leveraged and short of capital. Bies had it right.

Poole Retired In March, Critical Of Fed Ever Since

St. Louis Fed Governor William Poole retired in March and has been critical of Bernanke ever since. Please consider this May 2nd article Fed 'Rogue Operation' Spurs Further Bailout Calls

"It is appalling where we are right now," former St. Louis Fed President William Poole, who retired in March, said in an interview. The Fed has introduced "a backstop for the entire financial system."

Fisher Warns Of Rate Hikes

Fed Governor Fisher is warning Rate hikes could come sooner vs later.

The Federal Reserve would likely increase interest rates "sooner rather than later" if inflation worsens, even if the U.S. economy remains weak, Dallas Federal Reserve Bank President Richard Fisher said on Wednesday.

"If inflationary developments and, more important, inflation expectations, continue to worsen, I would expect a change of course in monetary policy to occur sooner rather than later, even in the face of an anemic economic scenario," Fisher said.

Fisher is one of the Fed's leading policy hawks, urging the central bank to focus more on the need to quell inflation, which he termed "a sinister beast." He has tallied three straight dissents against the Federal Open Market Committee's moves to lower benchmark lending rates.

"Growth cannot be sustained if markets are undermined by inflation," Fisher said. "Stable prices go hand in hand with achieving sustainable economic growth."

Who's Left On The Board?

• Ben Bernanke - Chairman
• Donald Kohn - Vice Chairman
• Kevin Warsh
• Randall Kroszner

Click here for more about the Fed Board of Governors.

Look Back At Mishkin

The Wall Street Journal has this Look Back At Mishkin.

Mr. Mishkin has been an important intellectual force at the Fed in his two years there, making several academically meaty speeches on issues such as how to deal with asset prices and cushion the economy from the housing market’s blow. That said, he isn’t considered one of the key architects of the Fed’s response to the credit crisis in the last year, and his speeches sometimes haven’t represented where Chairman Ben Bernanke’s own inclinations were.

Recently, Mr. Mishkin was on the frontline of a debate over whether the Fed should work to prevent asset-price bubble. In a speech this month, he maintained the common central bank view against attempting to prick asset-price bubbles through monetary policy. His key reasons: bubbles can be hard to identify; using interest rates may not even restrain a bubble; and monetary policy, as a blunt instrument, would likely hit overall asset prices rather than those just in the bubble. That stance echoed comments he made last September as the credit crisis began coming to a head.

Earlier this year, he defended the Fed’s actions to stem the crisis. In a speech in January, he focused on the risks that financial market disruptions pose to the economy. He stressed the importance of responding preemptively with “decisive action” as a form of risk management, echoing comments from Mr. Bernanke.

He has been somewhat dovish on inflation, in March indicating an expectation for easing price pressures. He also played down the effects of dollar depreciation on inflation. However, he’s been a vocal proponent of a specific inflation target for the central bank.

Good Riddance

One look at that pathetic profile is enough to cheer Mishkin leaving. Inflation targeting is complete nonsense, and ironically Mishkin does not even practice what he preaches or he would be begging for interest rate hikes, not cuts.

Ignoring asset bubbles but proposing the Fed acting to prop up the markets when they bust causes serially bubble blowing. The latest example is the housing bubble brought about by a Fed acting in the wake of a dotcom bust.

What's interesting however is we are seeing frequent public displays of infighting and dissent, something that seldom if ever happened under Greenspan. Now if only Bernanke would resign.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Telling Rift Over Fed Lending Facility

In mid-September the Fed is placing new restrictions on the Primary Dealer Credit Facility, a swap-o-rama with broker dealers as opposed to banks.

The Financial Times picks up the story in Investment banks split over Fed loan facility.

Investment banks such as Goldman Sachs (GS) that have been less affected by the credit crisis are said to be leaning against accepting any significant new limits by the Fed, while those that have been somewhat more affected, such as Lehman Brothers, are seen as more eager to maintain access to the Fed facility even if it means new limits on risk-taking.

“Then you have people like Morgan Stanley (MS) in the middle saying everyone should just wait and see what the Fed comes up with” in terms of new regulation. None of the banks would comment officially, given the sensitivities and differences of opinion on what should be done.

The Fed initiative, spurred by the collapse of Bear Stearns, allows investment banks to pledge investment-grade securities, including mortgage-backed securities, in return for low-interest cash loans. The rationale for the facility was to ensure that none of the other banks would suffer the same kind of evaporation of short-term liquidity that sank Bear Stearns.

The big commercial banks have told regulators that the investment firms should be subject to the same tight requirements on debt and leverage and that no compromise should be allowed.

Leverage Got Banks In Trouble

It was leverage that got banks and broker dealers in trouble. Now banks are complaining that broker dealers get to use higher leverage than they do. Where would Citigroup, Wachovia, etc, be with higher leverage still?

One problem is the Fed should not be lending to broker dealers at all, regardless of leverage issues, not that the swap-o-rama should have a level play field. For more on this topic, please see Big Brother Monitors Investment Activity.

For a quick recap of the alphabet soup of lending facilities please see Fed Is Not King Midas.

Previously, the ECB Expressed Concerns Over Swap-O-Rama Exit Strategy, so perhaps restrictions are a sign the Fed is looking for an exit strategy. Then again, perhaps the Fed is simply seeking ways to exert more influence over broker dealers.

Goldman is resisting.

That Lehman is more willing to go along with new restrictions on lending is a telling indictment that Lehman is more desperate for liquidity than the other broker dealers.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Charge-Offs Hammer Banks

BusinessWeek is reporting KeyCorp plunges on charge-offs.

Shares of Keycorp tumbled Wednesday after the regional bank said it expects loan charge-offs in 2008 to be higher than previously anticipated.

Key said it now expects charge-offs, loans that will be written off as not being repaid, to range between 1 percent and 1.3 percent of total loans during the year, up from prior estimates of 0.65 percent and 0.9 percent. Charge-offs could be even higher during the second and third quarters, Key said in its filing with the Securities and Exchange Commission.

The company cited rising losses in the residential homebuilder, education and home improvement loan portfolios.

Worst Possible Business Model

Minyanville Professor Bennet Sedacca is writing about the business model of Keycorp and other banks. Let's tune in.

More on KEY and Others

What could be the worst possible model?

When a company pays out its entire EPS in dividends and then goes to market with a 9% preferred. Then it RAISES the common dividend. Come on!! Then it announces deteriorating fundamentals. Who is it?

Keycorp (KEY), Fifth Third (FITB), Regions Financial(RF) and Wachovia (WB).

What should they be doing?

Cut the dividend, lay people off and sell common equity while they can. If not, it could be curtains.

I pinged Sedacca with a question about the preferred rates and he clarified that Merrill Lynch (MER) did a deal at 8 5/8, Wachovia (WB) was at 8.409, and Citigroup (C) 8.3 and that preferreds are cratering.

KeyCorp Weekly



click on chart for sharper image

Keycorp is down about 12% on the day, and Wachovia and Fifth Third over 4% each. The latter two are making new 52 week lows. There is no way those dividends hold and the same applies to Citigroup.

Banking Confessional Is Open

In a second post on the BKX Banking Index, Sedacca went on to say...

If my suspicions are correct and Stage 2 of Stage 3 of the Credit Crisis has begun, then we all want to pay attention to the chart below. I mentioned yesterday that the BKX was at critical support around 75. With Keycorp (KEY) this morning, the confessionals about the consumer have now begun. Just look at how the Regional Bank HOLDRs (RKH) trades with Wachovia (WB), etc. getting hammered.

But if we take out 75, next stop is 60-65. If we take out 60, which I think happens in Wave 3 in 2009-2010? Well, my target is 40 or so.

My firm continues to focus on short opportunities in regionals and will avoid credit risk for the foreseeable future.

$BKX Banking Index Monthly Chart



click on chart for sharper image

RKH Regional Bank Holders Monthly



click on chart for sharper image

Do those charts look like a second half recovery is coming? I think not. And given that regional banks are in general more tied to commercial real estate and consumer loans than mortgages, the worst is yet to come for banks in general and regional banks in particular.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Commodities Speculation Symptom Of Larger Problem

With a tip of the hat to Michael Masters, it is possible to Quantify Commodities Speculation. Here is the key chart:

Commodity Index Investment vs. Spot Prices


Chart One shows Assets allocated to commodity index trading strategies have risen from $13 billion at the end of 2003 to $260 billion as of March 2008, and the prices of the 25 commodities that compose these indices have risen by an average of 183% in those five years!

What To Do About It?

If speculation is the problem, then the question is what to do about it. Masters proposes three solutions as follows:

Number One:
Congress has closely regulated pension funds, recognizing that they serve a public purpose. Congress should modify ERISA regulations to prohibit commodity index replication strategies as unsuitable pension investments because of the damage that they do to the commodities futures markets and to Americans as a whole.

Number Two:
Congress should act immediately to close the Swaps Loophole. Speculative position limits must “look-through” the swaps transaction to the ultimate counterparty and hold that counterparty to the speculative position limits. This would curtail Index Speculation and it would force ALL Speculators to face position limits.

Number Three:
Congress should further compel the CFTC to reclassify all the positions in the Commercial category of the Commitments of Traders Reports to distinguish those positions that are controlled by “Bona Fide” Physical Hedgers from those controlled by Wall Street banks. The positions of Wall Street banks should be further broken down based on their OTC swaps counter-party into “Bona Fide” Physical Hedgers and Speculators.

The problem with Masters' solution is that commodity speculation is "A" problem, not "THE" problem. A still better way of looking at it is that commodities speculation is symptom of a much larger set of problems:

• Fractional Reserve Lending
• Past monetary inflation
• The Fed's willingness to blow bubble after bubble
• Loose lending standards by the Fed
• Carry trades in Japan
  
• Runaway spending by Congress

All of the above points pertain to other central bankers and foreign governments as well.

The Fed openly encouraged speculation in the wake of the dotcom crash. Greenspan was the biggest cheerleader for both derivatives and ARMs. The result was the biggest housing bubble the world has ever seen.

Although monetary inflation is benign now, the passthrough effects of past monetary inflation are still being felt.

The Fed's Role

The Fed can provide liquidity but not capital. That is a given. If you disagree, please see No Helicopter Drop For Failed Banks. More importantly, the Fed can only provide liquidity, it cannot dictate where the money goes, if indeed it goes anywhere at all.

If the Fed steps on the gas once again (monetary printing), it is highly doubtful that money finds its way into job creation or a recreation of the housing bubble (two places the Fed arguably would like it to go). Past experience shows that bursting bubbles do not get reinflated, and given there is rampant overcapacity in practically everything, liquidity is unlikely to foster job creation.

Instead the money will look for a new home, and that home may be the last place the Fed wants it to go: continued commodity speculation. Congress could intervene, but that will not address the root problem: Fractional Reserve Lending and the Fed itself.

By the way, if Congress does intervene, it does not guarantee that speculation in commodities will end, it might merely shift futures trading from one market to another.

Dubai Futures launch

Please consider Oil's tense trading scene may sway a move to Dubai.

A U.S. Senate panel listened to testimony on May 20 that said financial speculation by institutional investors and hedge funds in the commodity markets are contributing to energy and food inflation.

"The regulatory environment is becoming so undesirable to foreign and domestic funds that they have no choice but to go offshore," said Kevin Kerr, president of Kerr Trading International and editor of MarketWatch's Global Resources Trader.

"If Congress makes some laws that reign in speculation, it's possible that speculators will move out of the U.S. markets and into Dubai," said Phil Flynn, a vice president at Alaron Trading.

"Understaffed and overworked, the regulatory industry has decided to throw the baby out with the bathwater and meanwhile, legislators who are also fearing job loss have decided to blame the speculators and create some sort of witch hunt," said Kerr.

"Dubai is now the Middle East's recognized financial services hub and in a short period of time, has gained a solid reputation as a good place to do business and invest," said Mark O'Byrne, a director at Gold and Silver Investments Ltd. in Dublin, Ireland.

Gold futures have been traded on the DGCX since the exchange's inception. The launch of those contracts may have had a "marginal impact" on trading volumes on the Nymex/Comex, said O'Byrne.

"This is likely to be the case with an oil exchange in Dubai," especially if there is a "misguided attempt to regulate 'speculators' in Nymex and Comex," he said.

Congress cannot fix this problem by passing laws against speculation or by Insanity: Sue OPEC over Oil Prices.

Speculation will continue as long as conditions exist that foster speculation and/or until the whole mess blows sky high on some derivatives chain failure. The latter is increasingly likely. Timing it is of course the problem.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Quantifying Commodities Speculation

A debate has been raging as to exactly what percentage speculation is playing in the price of commodities. The Wall Street Journal is reporting Oil Is Up Because the Dollar Is Down.

Certainly energy prices have risen, regardless of what currency you use. In Europe, the price of oil has risen by 50 euros in the past five-and-a-half years. It now stands at about 75 euros per barrel, three times what it was then. But in the U.S., the price of oil has risen to over $120 per barrel, and is now almost five times what it was then.

The sole reason for this enormous difference is the incredible depreciation of the dollar against the euro. From one for one at the end of 2002, it now costs nearly $1.60 to buy a euro.

If the sole reason for higher oil prices was the falling US$ then oil would not be rising in every currency. Ironically, the author even mentions that the price of oil is going up in every currency.

[Added Comment: Some people pointed out that I may have misread the authors comment, in that "difference" pertained not to the rising price of oil itself (now vs. then) but rather the difference between the price of oil in Euros now vs. the price of oil in dollars now. It should go without saying that prices of anything will vary according to relative strength of currencies.]

Calculated Risk wrote about The Oil Speculation Debate, referring to Krugman's article More on oil and speculation.

One of the things I find puzzling about the whole oil market discussion is how complicated people seem to make it. They get all wrapped up in stuff about forward markets, hedge funds, etc., and lose sight of the fundamental fact that there are only two things you can do with the world’s oil production: consume it, or store it. If oil isn’t building up in inventories, there can’t be a bubble in the spot price.

Krugman Misses the Boat

There is a third thing one can do with oil, and that is continually roll over futures without ever taking delivery.

Michael W. Masters of Masters Capital Management, LLC spoke of Commodities Speculation before the Committee on Homeland Security and Governmental Affairs. Let's look at the highlights.

You have asked the question “Are Institutional Investors contributing to food and energy price inflation?” And my unequivocal answer is “YES.” In this testimony I will explain that Institutional Investors are one of, if not the primary, factors affecting commodities prices today. Clearly, there are many factors that contribute to price determination in the commodities markets; I am here to expose a fast-growing yet virtually unnoticed factor, and one that presents a problem that can be expediently corrected through legislative policy action.

What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets: Institutional Investors. Specifically, these are Corporate and Government Pension Funds, Sovereign Wealth Funds, University Endowments and other Institutional Investors. Collectively, these investors now account on average for a larger share of outstanding commodities futures contracts than any other market participant.

These parties, who I call Index Speculators, allocate a portion of their portfolios to “investments” in the commodities futures market, and behave very differently from the traditional speculators that have always existed in this marketplace. I refer to them as “Index” Speculators because of their investing strategy: they distribute their allocation of dollars across the 25 key commodities futures according to the popular indices – the Standard & Poors - Goldman Sachs Commodity Index and the Dow Jones - AIG Commodity Index.

Index Speculator Demand Is Driving Prices Higher

Today, Index Speculators are pouring billions of dollars into the commodities futures
markets, speculating that commodity prices will increase. Chart One shows Assets allocated to commodity index trading strategies have risen from $13 billion at the end of 2003 to $260 billion as of March 2008,5 and the prices of the 25 commodities that compose these indices have risen by an average of 183% in those five years!

Commodity Index Investment vs. Spot Prices


The next table looks at the commodity purchases that Index Speculators have made via the futures markets. These are huge numbers and they need to be put in perspective to be fully grasped.

In the popular press the explanation given most often for rising oil prices is the
increased demand for oil from China. According to the DOE, annual Chinese demand
for petroleum has increased over the last five years from 1.88 billion barrels to 2.8 billion barrels, an increase of 920 million barrels.8 Over the same five-year period, Index Speculatorsʼ demand for petroleum futures has increased by 848 million barrels. The increase in demand from Index Speculators is almost equal to the increase in demand from China!

Commodity Index Purchases Last 5 Years



Index Speculators have now stockpiled, via the futures market, the equivalent of 1.1 billion barrels of petroleum, effectively adding eight times as much oil to their own stockpile as the United States has added to the Strategic Petroleum Reserve over the last five years.

Index Speculator Demand Characteristics

Demand for futures contracts can only come from two sources: Physical Commodity
Consumers and Speculators. Speculators include the Traditional Speculators who have always existed in the market, as well as Index Speculators. Five years ago, Index Speculators were a tiny fraction of the commodities futures markets. Today, in many commodities futures markets, they are the single largest force.15 The huge growth in their demand has gone virtually undetected by classically-trained economists who almost never analyze demand in futures markets.

Index Speculator demand is distinctly different from Traditional Speculator demand; it arises purely from portfolio allocation decisions. When an Institutional Investor decides to allocate 2% to commodities futures, for example, they come to the market with a set amount of money. They are not concerned with the price per unit; they will buy as many futures contracts as they need, at whatever price is necessary, until all of their money has been “put to work.” Their insensitivity to price multiplies their impact on commodity markets.

Commodity Futures Market Size



As money pours into the markets, two things happen concurrently: the markets expand and prices rise. One particularly troubling aspect of Index Speculator demand is that it actually increases the more prices increase. This explains the accelerating rate at which commodity futures prices (and actual commodity prices) are increasing. Rising prices attract more Index Speculators, whose tendency is to increase their allocation as prices rise. So their profit-motivated demand for futures is the inverse of what you would expect from price-sensitive consumer behavior.

You can see from Chart Two that prices have increased the most dramatically in the first quarter of 2008. We calculate that Index Speculators flooded the markets with $55 billion in just the first 52 trading days of this year.19 That’s an increase in the dollar value of outstanding futures contracts of more than $1 billion per trading day. Doesn’t it seem likely that an increase in demand of this magnitude in the commodities futures markets could go a long way in explaining the extraordinary commodities price increases in the beginning of 2008?

There is a crucial distinction between Traditional Speculators and Index Speculators: Traditional Speculators provide liquidity by both buying and selling futures. Index Speculators buy futures and then roll their positions by buying calendar spreads. They never sell. Therefore, they consume liquidity and provide zero benefit to the futures markets.

Is this what Congress expected when it created the CFTC?

The CFTC Has Invited Increased Speculation

When Congress passed the Commodity Exchange Act in 1936, they did so with the understanding that speculators should not be allowed to dominate the commodities futures markets. Unfortunately, the CFTC has taken deliberate steps to allow certain speculators virtually unlimited access to the commodities futures markets.

The CFTC has granted Wall Street banks an exemption from speculative position limits when these banks hedge over-the-counter swaps transactions. This has effectively opened a loophole for unlimited speculation. When Index Speculators enter into commodity index swaps, which 85-90% of them do, they face no speculative position limits.

The really shocking thing about the Swaps Loophole is that Speculators of all stripes can use it to access the futures markets. So if a hedge fund wants a $500 million position in Wheat, which is way beyond position limits, they can enter into swap with a Wall Street bank and then the bank buys $500 million worth of Wheat futures.

In the CFTC’s classification scheme all Speculators accessing the futures markets through the Swaps Loophole are categorized as “Commercial” rather than “Non-Commercial.” The result is a gross distortion in data that effectively hides the full impact of Index Speculation.

Additionally, the CFTC has recently proposed that Index Speculators be exempt from all position limits, thereby throwing the door open for unlimited Index Speculator “investment.” The CFTC has even gone so far as to issue press releases on their website touting studies they commissioned showing that commodities futures make good additions to Institutional Investors’ portfolios.

Congress Should Eliminate The Practice Of Index Speculation

I would like to conclude my testimony today by outlining three steps that can be taken to immediately reduce Index Speculation.

Number One:
Congress has closely regulated pension funds, recognizing that they serve a public purpose. Congress should modify ERISA regulations to prohibit commodity index replication strategies as unsuitable pension investments because of the damage that they do to the commodities futures markets and to Americans as a whole.

Number Two:
Congress should act immediately to close the Swaps Loophole. Speculative position limits must “look-through” the swaps transaction to the ultimate counterparty and hold that counterparty to the speculative position limits. This would curtail Index Speculation and it would force ALL Speculators to face position limits.

Number Three:
Congress should further compel the CFTC to reclassify all the positions in the Commercial category of the Commitments of Traders Reports to distinguish those positions that are controlled by “Bona Fide” Physical Hedgers from those controlled by Wall Street banks. The positions of Wall Street banks should be further broken down based on their OTC swaps counter-party into “Bona Fide” Physical Hedgers and Speculators.

There are hundreds of billions of investment dollars poised to enter the commodities futures markets at this very moment. If immediate action is not taken, food and energy prices will rise higher still. This could have catastrophic economic effects on millions of already stressed U.S. consumers. It literally could mean starvation for millions of the world’s poor.

If Congress takes these steps, the structural integrity of the futures markets will be restored. Index Speculator demand will be virtually eliminated and it is likely that food and energy prices will come down sharply.

Forces At Play

1) The falling US Dollar
2) Commodities speculation by price insensitive index strategy players
3) Rules and regulations at the CTFC that have categorized as commercial hedgers, those who are in reality speculating in enormous size.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Alice-in-Wonderland Accounting

Banks and brokers have been scrambling like mad to raise capital in the wake of declining asset prices. In response, some top banks would prefer to pretend that problems do not not exist. For example, please consider Top banks call for relaxed writedown rules.

The world’s leading banks have stepped up pressure to relax controversial accounting rules with a new plan aimed at breaking the “downward spiral” of huge writedowns, emergency fundraisings and fire-sales of assets.

The proposals on “fair value” accounting by the Institute of International Finance (IIF), an alliance of 300-plus companies chaired by Josef Ackermann, Deutsche Bank’s chairman, would enable financial companies to cushion the blow of financial crises by valuing illiquid assets using historical, rather than market, prices.

Under the plan, which has been obtained by the Financial Times, banks that decided to keep assets on their balance sheet would also be freed from the requirement to hold them to maturity and would be able to sell them after two years.

The IIF’s proposals, which were sent to US and European central banks, governments and accounting watchdogs, underline financial groups’ view that the credit crunch will inflict long-lasting damage on their business.

The IIF’s paper says: “The writedowns required under current interpretations may be substantially in excess of any actual or reasonably probable loss on many instruments”.

“Often dramatic writedowns of sound investments required under the current implementation of fair-value accounting adversely affect market sentiment, in turn leading to further writedowns...in a downward spiral that may lead to large-scale fire sales of assets,” the IIF’s paper argues.

Goldman Sachs calls IIF Proposal "Alice-in-Wonderland Accounting"

The Financial Times is reporting Goldman set to sever IIF links.

Goldman Sachs said it was likely to sever its links with the Institute of International Finance after the association of leading banks and insurance companies called for a relaxation of controversial accounting rules on asset valuation.

Goldman, one of the IIF’s 370-plus members, said it did not agree with the IIF’s proposals, which have been circulated to regulators and politicians over the past month, and opposed any changes in “fair value” accounting.

“The proposals are extraordinary,” a Goldman official said on Thursday. “This is Alice-in-Wonderland accounting.”

He said that Goldman had a representative on the IIF’s committee responsible for the proposal but she was not directly involved in its drafting. Goldman would almost certainly leave the IIF following the report.

Under the IIF plan, revealed by the Financial Times this week, banks would be allowed to use historical, rather than market prices, to value illiquid assets – a change that could help to reduce the negative impact of the crisis on their strained balance sheets.

Historical Pricing

Here is an example of historical pricing: A house was valued at $1,000,000 two years ago. There are no bids on it today so let's keep it on the books at $1,000,000. Here is another one: There is no bid on various subprime or Alt-A derivatives so let's keep those on the books at historical values as well.

Level 3 Wonderland

Ironically, there is already an enormous amount of pretending going on, even at Goldman who opposes this rule change.

Inquiring minds may wish to consider Slow Motion Train Wreck, Deflation In A Fiat Regime? and The Moral Hazard Club by Professor Sedacca. Here is a snip from the latter:

When you add up all the Level II assets by just the eight largest holders in the U.S: JP Morgan (JPM), Citibank (C), Bank of America (BAC), Merrill Lynch (MER), Goldman Sachs (GS), Bear, Morgan Stanley (MS) and Lehman Brothers (LEH), it comes to a staggering $5 trillion - nearly half the size of the economy. Level III assets are nearly $600 billion.



Is the Fed big enough to bail out all these assets? My best guess is probably not, and more firms will fail. If the loans and economy both don’t start performing, these failures will happen more quickly, which is why my firm continues to avoid credit risk. It's not hard to envision an acceleration of this process if the market starts to believe the special loan facilities and other funding processes artificially created to deal with this mess cease to work.

The Fed is slowly becoming the dumping ground for dealers and banks - members of the ‘Moral Hazard Club.’ It's is running out of capital, and quickly.

The problem assets (at least the ones we know about) are way too large for the Fed to completely absorb. It's waiting and hoping the economy and credit markets stabilize before it runs out of ammunition.

Citigroup (C), Goldman Sachs (GS), Morgan Stanley (MS), and JPMorgan (JPM) have staggering amounts of level three assets, no doubt kept on the books at fantasy prices. I am confident that the merger of Bank of America (BAC) and Countrywide Financial (CFC) will put Bank of America in the same spot (assuming the deal goes through but it may not). The shotgun marriage between JPMorgan and Bear Stearns (BSC) will add to the problem at JPMorgan.

For a description of what Level 1, Level 2, and level 3 mean please see Marked to Fantasy. Level 3 assets have actually been rising at many institutions. Why?

1) SIVs and other garbage that was kept off the balance sheets entirely are being brought back on the books as Level 3 assets.
2) Banks are not ready or willing to mark that garbage to market (it would be too capital impairing) so they are hiding out in "Level 3 Wonderland".

There's no need to change the rules when hiding out in Wonderland accomplishes the same thing.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

2 Homes For Price Of 1 Ripoff

Here's a new sucker twist on two for the price of one. Please consider Local Developer Offers 2 Homes For Price Of 1.

If you're looking for a bargain, the deals are out there. However, one particular deal takes the cake.

"We thought, 'Why does it just have to be on Pop Tarts and restaurants? Why not buy one home, get one free,'" said Dawn Berry of Michael Crews Development.

Michael Crews Development is offering new, 2000-square foot cityscape row-homes worth $400,000 in Escondido for free -- if you buy one Royal View Estate home in San Pasqual Valley starting at $1.6 million.

"You know it's a straight-up legit deal; no prices have been increased, there are no hidden costs. Michael is just giving away a free home for people that buy at Royal View," said Berry.

Adam Rossman of Michael Crews Development added, "People have been coming in saying, 'How can you do this?' Well, it's our way of dealing with current market conditions to move some inventory."

No News Here - This Is An Ad

There is no news here. This is a freaking ad disguised as news. Is this a paid infomercial by any chance? If not where is the news?

This deal is not 2 apples for the price of one. Rather, this deal is an apple and a raisin packaged as 2-for-1-price. What you are getting (supposedly) is $2 million worth of homes for a minimum of $1.6 Million. Big freaking deal. This is at most 20% off.

Is this really news? I think not. Now what I want to know is whether or not 10News.com can distinguish news from non-news or if this was a paid for ad disguised as news.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Too Late To Stop Bank Failures

Comptroller Dugan Tells Lenders that Unprecedented Home Equity Loan Losses Show Need for Higher Reserves.

Comptroller of the Currency John C. Dugan said today that accelerating losses in the home equity business show the need to build reserves and to return to the stronger underwriting standards of past years.

Home equity loans and lines of credit grew dramatically in recent years, more than doubling, to $1.1 trillion, since 2002. In part, that’s because of the rapid appreciation in house prices, the tax deductibility feature of home equity loans, and low interest rates.

“But another contributing factor was perhaps not so obvious: liberalized underwriting standards,” Mr. Dugan said, in a speech to the Financial Services Roundtable’s Housing Policy Council. “These relaxed standards helped more people to qualify for loans, and more people to qualify for significantly larger loans.”

These relaxed standards included limited verification of a borrower’s assets, employment, or income; higher debt to equity ratios; and the use of home equity loans as “piggyback” loans that helped borrowers qualify for first mortgages with low down payments and without mortgage insurance, resulting in ever-higher cumulative loan-to-value ratios.

“I can’t stress enough how crucial reserves will be in helping the industry manage its way through this situation,” he said. “At some banks, the portion of reserves attributable to home equity loans just barely covers 2007 chargeoffs. With losses accelerating, those reserves are simply not going to be adequate, and that’s why our examiners are encouraging more robust portfolio analysis and loss reserve levels.”

In assessing loan loss reserves for home equity loans, he said, banks need to recognize that they are in uncharted territory. “New product structures, relaxed underwriting, declining home prices, potential changes in consumer behavior – all of these factors make it difficult to predict future performance of home equity loans,” he said.

Circumstances have changed fundamentally, and historical trends have little relevance in estimating credit losses. As a result, qualitative factors such as environmental analysis and changing consumer behavior clearly should be factored into the reserve calculation. Likewise, lenders should take into account the very real possibilities that unemployment or interest rates will increase from their quite low current levels.

Too Late To Stop Bank Failures

MarketWatch is reporting Bank failures to surge in coming years.

"At this point in the crisis, you can't stop bank failures," said Joseph Mason, associate professor of finance at Drexel University's LeBow College of Business, who has studied past financial crises.

At least 150 banks will fail in the U.S. during the next two to three years, according to a projection by Gerard Cassidy and his colleagues at RBC Capital Markets.

If the current economic slowdown deteriorates into a recession on the scale of those from the 1980s and early 1990's, the number of failures will be much higher this time around -- probably as high as 300 of them, by RBC's reckoning.

Cassidy and his colleagues have developed an early-warning system for spotting future trouble at banks called the Texas Ratio.

The ratio is calculated by dividing a bank's non-performing loans, including those 90 days delinquent, by the company's tangible equity capital plus money set aside for future loan losses. The number basically measures credit problems as a percentage of the capital a lender has available to deal with them.

Cassidy came up with the idea after covering Texas banks in the 1980s. Until the recession hit that decade, many banks in the state were considered some of the best in the country. But as problem assets climbed, that view was cruelly challenged, Cassidy recalls.

The analyst noticed that when problem assets grew to more than 100% of capital, most of the Texas banks in that precarious position ended up going under. A similar pattern occurred in the New England banking sector during the recession of the early 1990s, Cassidy said.

The FDIC had highlighted 76 banks that it considered troubled at the end of 2007. That's up from 50 at the end of 2006, which was the lowest level for at least 25 years.

Texas Ratios from the article

• UCBH Holdings (UCBH) Texas Ratio jump to 31% at the end of the first quarter from 4.7% in 2006, according to RBC.
• Colonial BancGroup (CNB) Texas Ratio jumped from 1.5% in 2006 to 25% at the end of March.
• Sterling Financial Corp. (STSA) had a Texas ratio of 1.9% in 2006. It was nearly 24% at the end of the first quarter.
• National City Corp. (NCC) had a Texas Ratio of 40% at the end of March though the bank did raise $7 billion in new capital in April.
• IndyMac Bancorp (IMB) has a whopping Texas Ratio of 140%

Liquidity challenged banks offer some of the highest rates on CDs. IndyMac actually tops the list on one one year CDs according to the article. The irony is that money flows to the weakest banks taking the biggest risks instead of the strongest ones taking minimal risks, all because of government guarantees. This is one of the perverse "moral hazard" effects of FDIC.

If this was up to me, I would phase FDIC out over a period of time on CDs and savings accounts, keeping it only for checking accounts for which banks would be required to have 100% reserves. If people want guarantees they can buy US treasuries. Instead of having huge numbers of failures periodically, bank failures would be very widely scattered and people would care where they put their money instead of chasing the latest deal at banks that are destined to fail.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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