Will Fools Rush In?

Earthside Comments: The stock market soars one day, then plummets the next. An investment bank fails and suddenly there are billions and billions of public dollars pumped-in to facilitate its take over by another bank. Gold hits a new high, gas hits a new high, then suddenly, they both plunge.

Volatility of this scale actual means panic, uncertainty, confusion.

Of course, the financial talking heads on the cable television channels are claiming that this shows the worst is over. But, they say that when exactly the opposite is happening, too.

The following articles remind us that the downturn is real. There are deadly tentacles of debt intertwined everywherei n our economy -- and billions and billions and billions of dollars being created out of thin air to try and save the situation.

Indeed, some fools (most with your 401K money) will rush in believing the propaganda. So, watch carefully.

Link: US Economist Calls Financial Crisis Worst Since 1930s | Economic Times

The current financial crisis is the worst the world has seen since the Great Depression of the 1930s and the US Federal Reserve move to cut interest rates will not make much difference, the Nobel Prize winning economist Joseph Stiglitz said on Wednesday.

"It will have some impact - it will do a little bit to stem the blood - but it's not addressing the fundamental problems underlying the collapse of the financial sector," Joseph said.

Stiglitz, who won the Nobel Prize in economics in 2001, is a former chief of the World Bank and chaired former US president Bill Clinton's council of economic advisers. He is in New Zealand on a lecture tour.

He said the Federal Reserve's move to cut its funds rate by three-quarters of a percentage point was "just trying to ease the economy down rather than try to address the underlying problems."

Stiglitz said the main problem was the fact that an estimated 2 million Americans were going to lose their homes because they could not repay mortgages which exceed the value of their property as house prices fell dramatically.

"As people walk away from their mortgages there will be more and more defaults - that undermines the whole financial system," he said.

Stiglitz said the Bush administration was bailing out banks, but accused it of refusing to do anything to help poor people stay in their homes which would stabilise the housing market.

"It's very easy to do something about it," he said, suggesting the administration could give assistance to write down mortgages to about 90 per cent of the value of a house which would enable people to stay in their properties.

However, the Bush administration has unveiled plans designed to help homeowners in danger of losing their homes by allowing holders of sub-prime mortgages to borrowers with poor credit to more easily apply for refinancing. The government will also send out tax rebate cheques in May.

Stiglitz said it was ironic that former Federal Reserve head Alan Greenspan had said it was the world's worst economic problem in the last 50 years, adding, "He is the source of much of the problem."

He said mismanagement by the Federal Reserve over the last seven years was one of the major factors underlying the current problem.

"They had the regulatory authority to prevent some of these bad practices that we are now paying for and he chose not to do it."

Stiglitz said the reason related in part to the war in Iraq and the very negative effect on the economy.

"They didn't want Americans to know exactly how bad the war was for the economy so they flooded it with liquidity, they looked the other way with regulations and they deliberately, I think, postponed the problem into the future and now we're paying the price."

Link: Making the Most of a Global Depression | Richard Heinberg/HopeDance Magazine

It’s becoming increasingly likely that 2008 will go down in history as the year the Second Great Depression began. The unraveling started with the subprime mortgage fiasco and is spreading fast. The total value of all US$-based mortgage bonds is $10.4 trillion, of which 30 percent is now expected to be lost in defaults and property devaluation. That’s $3.2 trillion in losses. Trillions more are likely to evaporate from the related derivatives markets. It’s true that the global economy is pretty big, and a few hundred billion get lost under sofa cushions from time to time (as happened during the savings and loan crisis of the 1990s), and still, life goes on. But when we’re discussing trillions of dollars (with a “T”), we’re talking real money.

Get ready for bank runs, a stock market collapse, and, perhaps, a money panic.

Such things have happened before (in 1833, 1837, 1857, 1907, 1920, and 1929), but this time it’s different. Now the problem is not just financial mismanagement; there is a deeper instability: the global economy is based on a fundamentally unsustainable exploitation of depleting natural resources, and that whole system is teetering. In his essay, “Barreling into Recession: How Oil Burst the American Bubble,” Michael Klare points out that “The economic bubble that lifted the stock market to dizzying heights was sustained as much by cheap oil as by cheap (often fraudulent) mortgages.” Veteran geologist Colin Campbell, in his ASPO Newsletter #86, steps back for an even broader overview:

“The Oil Age opened 150 years ago, releasing a flood of cheap energy, such that today’s production is equivalent in energy terms to 22 billion slaves working around the clock. The resulting economic prosperity allowed the banks to lend more than they had on deposit, confident that Tomorrow’s Expansion was collateral for To-day’s Debt. It sounds a rather dubious principle but worked well enough during the First Half of the Oil Age allowing at least some countries to reap great prosperity. The Second Half now dawns, and being characterized by falling supply, effectively removes the Collateral for debt. . . . Whereas the post-peak physical decline of oil . . . is only gradual, . . . the perception that past economic growth must now give way to contraction can come in an instant, prompting radical changes in the financial world.”

So, as the oil drains away, the view is all downhill from here. A Depression is, well, depressing even to think about, much less to live through.

But wait a moment. For anyone with an ecological sensibility, the prospect of economic contraction has a silver lining. In a recent e-mail message, UBC Professor of Human Ecology Bill Rees summed up our collective situation this way:

“To raise the human enterprise ever further from thermodynamic equilibrium, we must degrade and dissipate ever-greater quantities of available energy and material resources extracted from the ecosphere. We have passed the point where the ecosphere can provide sustainably all that we are extracting. Resources are depleted; entropy accumulates. In effect, techno-industrial society has become pathologically parasitic on nature.”

The implication is clear: if we hope to survive as a species, and if there is to be hope for millions of other creatures, we need to shrink the human enterprise. Economic contraction may be bitter medicine, but it’s part of the cure for what ails our planetary home.

However, we can manage this contraction either foolishly or intelligently.

A foolish management of economic contraction would entail burning the biosphere for alternative fuels; propping up the banks and other financial institutions that created the mortgage mess, without ever re-examining the wisdom of growth-based economics; and responding to human privation and misery with repression and war.

Intelligent management would start with an explicit commitment to redesign the global economy to run with less. We would assess ecosphere resources and identify a humane, equitable path toward gradual reduction in population and total consumption levels. We would focus on those aspects of life that bring us increasing satisfaction without requiring more inputs of energy and materials. We would re-acquaint ourselves with the values and virtues of community, self-sufficiency, and modesty. We would redesign our cities to eliminate cars, while developing renewable energy sources and educating a new generation of ecological farmers.

If we handle this well, the medicine of contraction will leave Nature intact and humanity in a state of greater happiness, equity, and peace.

We don’t have much choice regarding whether a Depression will ensue. But a great deal depends on how we respond. It’s not too soon to start that discussion.

Link: Why the Fed Cuts Won't Help You | Jon Markman/MSN Money

The Federal Reserve today [Tuesday] continued its attempt to get out in front of the worst financial crisis to hit the world banking system in five decades by slashing short-term interest rates by three-quarters of a percentage point, to 2.25%, the lowest level since 2004.

But the Fed's effort will have little effect on the ability of the average American to get a cheap loan for a new home, car or college education even as it has a large effect on U.S. banks' ability to fix their balance sheets by racking up fat profits.

If that sounds unfair, welcome to the latest episode of a brutal new American business ethic, in which the government bails out bad bets by risk-taking banking executives in New York with money that it borrows from middle-class families and foreign investors. The effort is gilded with fancy financial language and cloaked in the guise of a rescue that helps all citizens, but the reality is that Washington is essentially robbing the poor to help the rich.

It seems odd, but these are extraordinary times. Normally, when the Federal Reserve cuts the rate at which it lends money to U.S. banks, those banks in turn cut the rates at which they lend money to citizens and companies for personal and commercial use. Simple enough. Yet in the past few months, banks have made three important changes in their usual practice:

+ They have not been passing all of their interest-rate savings to customers.
+ They have restricted lending only to most creditworthy, documented applicants.
+ They have cut the total amount they're willing to lend.

Good for banks, bad for you

Banks are taking these seemingly perverse steps in an effort to reverse the effects of the massive losses they have withstood for lending too broadly to consumers and companies with lousy credit over the past five years.

They're pulling a big 180, which is as confusing as it is disheartening. Rather than providing funds to prospective home buyers and business people with legitimate needs for moving into larger homes or expanding factory lines, records show the banks are hoarding the low-cost money they're borrowing from the Fed and investing it in Treasury bonds paying higher interest yields. They're then pocketing the windfall profits to repair their own ravaged balance sheets.

As if that's not bad enough, the Fed's swiftly conceived, unprecedented course of action harms the public in three other ways:

+ It boosts inflation by lifting the total number of dollars in circulation.
+ It undercuts the attractiveness of the U.S. dollar, which leads to higher food, energy and gold prices.
+ It cuts the yields of dividend-paying investments such as government bonds upon which retirees depend for steady income.

In other words, the Fed action helps imprudent bankers dig out of a hole by putting prudent citizens and foreigners in one. This gives big financial businesses a shot at staving off disaster at the risk of cutting the spending and earning power of everyone else.

Fed outwitted and outplayed

To be fair, the Federal Reserve never wanted to be in this position, and it told Congress as recently as a few months ago that the U.S. economy was in such great shape that it had no intention of lowering interest rates in a material way anytime soon. But the Fed's leaders, a dangerous mix of university professors and career bureaucrats, were drawn into a trap at amazing speed by dark forces in the global financing system that they now admit they scarcely understood.

How could this happen? Albert Wojnilower, who was chief economist at Credit Suisse First Boston for a quarter of a century, observes that the history of finance is rife with examples of financiers who successfully outwit their referees -- the accountants, auditors, rating agencies, bank examiners and government agencies that are assigned to create and enforce rules.

Wojnilower, now an adviser to Craig Drill Capital in New York, points out that just as in sports, some of these officials may be corrupt, indifferent, incompetent, or even hostile to the rules themselves, but they always fall behind the financiers. He notes that as soon as lenders are freed of constraints -- as they were in this case by Bush administration officials eager to deregulate the industry -- they are spurred by huge short-term rewards "to compete addictively with one another in taking bigger and bigger risks.” Wojnilower says that eventually havoc breaks loose, forcing responsible government authorities to halt the chaos by providing bailouts to participants considered too big to fail.

It's a bit ironic, and not a little sad, that government has come to believe it has to fight fire with fire. The Fed, whose leaders are appointed by the president, is essentially trying to battle problems created in an era of overly cheap money and loose lending by making money even cheaper and lending even more aggressively.

In just the past few weeks, it has broken all of its own rules by providing hundreds of billions of taxpayer funds to brokerages at special auctions, opening a bigger "discount" window to permit a wider range of financial institutions to beg at the government till and accepting weaker-than-normal collateral such as iffy mortgage-backed securities. The Fed has put the government in the position of being the payday lender of last resort.

The Fed's hamster wheel

Just to top it all off, the Fed this week announced plans to allow the twin titans of government-supported mortgage finance, Fannie Mae and Freddie Mac -- which have proved themselves horrible at managing risk -- to make even bigger loans than they had previously. And it is telling banks to let individuals facing foreclosure to stretch out their payments a little longer.

It is all a bit crazy, which is why many veteran financial advisers recommend that investors remain skeptical of rallies.

The market rallied before today's Fed action, expecting a full percentage-point cut, and reacted well initially even to the less aggressive action. But what you want to watch is the reaction of debt markets, not the equity markets. Credit investors, who are the real masters of the global economic system, believe that the Fed is like a hamster in a cage that has to run faster just to stay in place as events spin faster and faster out of its control.

To have had a chance at getting ahead, by making money so cheap that lenders would have abandoned their policy of distrust toward borrowers, the Fed should have cut rates by 1.25 percentage points today. As the Fed's effort fell short, the hamster will likely just go back on the wheel.