Last Ditch

As we all know, this weekend brought about some big news: the U.S. government seized control of Fannie Mae and Freddie Mac. James Howard Kunstler sees this as an attempt to ‘paper over’ the United States’ growing black hole of debt.

Why do the big deals always happen over the weekends? So the big boyz in government and finance can take off their neckties when they bargain with each other? So the markets will be closed and unable to register a response one way or another? So the shrinking fraction of the U.S. public that pays attention to anything besides NASCAR and pornography won’t catch the news Saturday evening?

This weekend’s big deal was the U.S. government taking over the "government sponsored enterprises" (GSEs) Fannie Mae and Freddie Mac that guarantee trillions of dollars in mortgages. The "guarantee" is supposedly accomplished by converting bundles of mortgages from the banks and loan companies that originate them (that make the contracts with the buyers of houses) into bonds that can be sold downstream. Risk was theoretically dispersed among the holders of these bonds. This all seemed to work during the long stable period when our cheap oil economy was chugging along, and house prices maintained a consistent relationship with incomes, and people paid their mortgages dependably. The whole system ran like a reliable machine – like a Chrysler slant-six engine!

Until the cheap oil age came to an end. Then, all parts of the system shook apart. It was the end of cheap oil that catalyzed the housing collapse and, by extension, the current huge financial crisis. But the run up to it was like a bounce off a high diving board into an empty pool. The bounce came around 2001 when it became apparent that the U.S. standard-of-living could not be maintained on incomes in a post-cheap-oil economy. The trauma of 9/11 prompted a new and utterly insane consensus to form that the US standard of living could be switched over from income to massive debt. All the normal brakes against irresponsible lending and borrowing came off – embodied in Alan Greenspan’s absurd statement that it was a good time to assume an adjustable rate mortgage when interest rates were at a historic low – meaning they could only be adjusted upwards. Why hold Greenspan responsible? Because he was at the apex of the authority vested with establishing norms, and he shoved our behavior into the realm of the recklessly abnormal, and he should have known better.

The public went along with it because "free money" and high living are fun. Their behavior was reinforced by other authorities – for instance, President Bush, who told Americans to go shopping after the 9/11 attacks. (They went shopping with credit cards.) Things really wobbled in 2005 – which was, coincidentally, the year of all-time world-wide peak conventional oil production – with hurricanes Katrina and Rita ripping through the Gulf of Mexico oil rigs as a dramatic highlight. (It was also the year that The Long Emergency was published.)

Since then, the U.S. economy and the financial part of it that became a nine hundred pound tail wagging a thirty-pound dog, has been held together with baling wire, duct tape, and band-aids. All the debt run up by all parties – home-owners, credit-card holders, business, banks, hedge funds, government – is not being paid back reliably, and all the leveraged arrangements that depend on it being paid back are coming apart. Thus, capital disappears. The wealth of a nation disappears. All that remains is the pretense that we are still a wealthy society

Fannie and Freddie are near the center of this black hole of debt. So far, the black hole has been "papered over" by the old stage magician’s trick of diverting the audience’s attention. The systemic wound that Bear Stearns represented, was covered up with a band-aid applied by the Federal Reserve’s exchange of loans for worthless securities. In fact, the capital of Bear Stearns actually did disappear – a mere residue of it, a few cents on the dollar, was shifted to JP Morgan as payment for taking the wrapper off the band-aid. But, basically, the money is gone.

Now, the same thing has happened with Fannie and Freddie, except that the scale is an order of magnitude greater. This time, the U.S. Treasury Department is assuming worthless paper and paying out much larger loans to enterprises that are functionally bankrupt. The exact nature of the government’s chartered "sponsorship" has always been ambiguous. Professional opinion has generally held that government backing was implied rather than explicit – but that’s a ridiculous internal contradiction that went unchallenged for decades as Fannie and Freddie’s Ponzi-style operation lumbered on (and their executives made off with obscene payouts). Now the government’s role has suddenly been made explicit. It will probably only make things worse, since the enterprises are too big and over-scaled to work under any circumstances, let alone insolvency.

One thing this points to is a truth that is uniformly overlooked by kibitzers: that what we developed over the past decade in America was not an "information economy" or a "consumer economy" but a suburban sprawl building economy, meaning an economy dedicated to building a living arrangement with no future. The climax of the sprawl building economy occurred in absolute lockstep with the climax of peak oil. You can date it virtually to the month – May, 2005. After that, the future asserted itself and all the financial expectations bound up with sprawl-building went up in a vapor – including the value of mortgages on suburban houses. Everything that followed has been an attempt to cover up this basic reality: that the way we live in America can’t continue.

The reason our energy debate is so hollow and idiotic is because we can’t face this basic reality. The fantasy-du-jour among both political parties is that we can become "energy independent." By this they mean we can keep on living the way we do by means other than oil. This is just not true. We have to make profound changes in everything we do from the way we inhabit the landscape to the way we produce our food. Lately, the only change we’ve shown any interest in is changing what our cars run on. But that is not going to rescue us, not even a little. Our inability to talk about anything else except the cars will drag us down into poverty and turmoil.

The housing market is not coming back. Ever. In the form that we knew it. The suburban project is over. That version of the American Dream is over. We’ll be a lot better off if we put aside dreaming altogether for a while and start focusing on reality instead – that part of the day when we’re awake and capable of actually doing things. We’ve got a lot to face and a lot to do.

The government takeover of Fannie and Freddie is just another papering-over of our fundamental problem – that until we embark on new ways of being a nation, of living differently and working differently on different things, the other nations of the world will not have confidence in us, or the paper we issue, and we will not really have confidence in ourselves.

I have believed all along – and said as much in The Long Emergency – that we would not get through this crisis without passing through a period of hardship. We’re entering it now. Even if the stock markets shoot up five hundred points today on the basis of the Fannie-Freddie deal (and the mistaken belief that our troubles are over), we are only at the beginning of a very painful workout. Personally, I think we’re in for financial carnage before the election. The Fannie-Freddie deal may be the place where the wheels really come off.


James Howard Kunstler
for The Daily Reckoning
September 10, 2008

James Kunstler has worked as a reporter and feature writer for a number of newspapers, and finally as a staff writer for Rolling Stone Magazine. In 1975, he dropped out to write books on a full-time basis.

His latest nonfiction book, The Long Emergency describes the changes that American society faces in the 21st century. Discerning an imminent future of protracted socioeconomic crisis, Kunstler foresees the progressive dilapidation of subdivisions and strip malls, the depopulation of the American Southwest, and, amid a world at war over oil, military invasions of the West Coast; when the convulsion subsides, Americans will live in smaller places and eat locally grown food.

Big tumble on Friday. Big rally on Monday. Big tumble on Tuesday.

Yesterday, the Dow fell 280 points, following a 289-point gain the day before.

We have a feeling the smart money is selling into this rally. Why? Because it is a bear market, and the smart money knows it…

The Daily Reckoning was right all along. At least, that’s the line we’re taking this morning. We said the stock market topped out in 2000 – and that it would be followed by a massive, long-term bear market. But for the past eight years, this bear market has been delayed…and disguised. It was delayed by the biggest tide of monetary and fiscal liquidity since The Flood. In a matter of months, the U.S. federal budget went from a couple hundred in surplus to several hundred in deficit – a stimulus of more than $700 billion.

Meanwhile, the Greenspan Fed cut rates to 1%…and only reluctantly increased them. In fact, they’re still lower than the inflation rate – 6 years later!

This boost of cash and credit held off a serious bear market decline. But it also brought about higher levels of consumer price inflation that disguised what was really going on. Though nominal prices remain more or less in line with where they were 8 to 10 years ago, inflation has knocked their real value down 25-30%.

Who noticed? And even now, people still believe they can get rich if they just hold "stocks for the long run." What they don’t realize is that the run can last longer than they can. The previous major peak in stock prices occurred in 1966. Investors then waited until 1982 – 16 years – for the next bull market to begin…and until 2000 for it to reach its apogee. Based on this arithmetic, the next bull market peak may not come until 2034.

What are we worried about? We just celebrated our 60th birthday. (About which, more below…) In 2034, we’ll be 86. We’ll just wait.

But if smart investors are selling stocks, what do they do with the money? Our advice has been to buy gold. From the looks of it, the smart money is not following that part of our advice. Yesterday, the price of gold fell $26 to $781.

The smart money is looking for safety. But it seems to think that it is better off in US Treasuries than in gold. Yesterday, while gold and stocks both dropped, Treasury bonds went up. The yield on the 10-year T-note fell below 3.6% (yields go down as prices go up). This makes us think the smart money is not as smart as it thinks. Our guess is that the credit of the world’s biggest debtor will prove less sure than they believe. The debts and financial obligations of the U.S. government continue to rise many times faster than the growth of the economy. Under the Bush administration, they’ve gone up faster than ever before in the history of the nation. We doubt that they will go up any more slowly if Obama is elected. Eventually, the United States will be recognized for what it is – a subprime borrower. And eventually, U.S. Treasury bonds will be looked upon as though they were Fannie Mae shares.

*** The U.S. government has just seized the mortgage lenders – Fannie and Freddie. How much that will add to the nation’s debts, we don’t know. No one knows. When the question was put to the man who should know – Hank Paulson – he replied: "We didn’t sit there and figure this out with a calculator."

Apparently, taking control of Mac and Mae was matter of national financial security, something you couldn’t put a price tag on. But the cost will be enormous. Sooner or later, someone is bound to get out a calculator.

As USA Today figured it, taxpayers are on the hook for trillions. You’d think you’d hear them squawking, with that kind of burden hoisted on their backs. But nobody really thinks he is going to pay for the housing bailout. Instead, the costs are expected to disappear – like the smell of cigarette smoke in a teenager’s room. Too bad, but the smell of debt lingers long after the money has been spent. Eventually, his mother opens the door.

"How will this end?" says Chris Mayer. "I suspect we [the U.S.] are on a path similar to that of Argentina. One day, we’ll have some major Argentine-style financial crisis. We’ll have Argentine inflation and a similar loss of faith in the banking system and the currency. The government will chew away and destroy a lot of wealth in the process.

"Hopefully, I won’t quote myself on that someday soon. In the meantime, though, I think one of the best things an investor can do is focus on buying useful and tangible assets that ought to hold their value against a depreciating paper currency. These assets include oil and gas, metals and minerals and land and water rights. The shares of the companies that own or find these assets ought to do well. Commodities will have their day in the sun once again."

*** Ouch. Lehman Bros. shares plunged to their lowest level in almost ten years yesterday, falling 45%. They reported a quarterly loss of $4 billion – their worst since going public, and second consecutive loss.

Clearly, the $7.8 billion in writedowns had a hand in pulling the investment bank down, but the execs are singing a different tune. They say that these numbers can be blamed on "attempts to shore up the company’s books." reports: "During the quarter, the company said it drastically slimmed down both its commercial and residential real estate holdings by [settling] billions of dollars worth of assets as part of a multi-prong restructuring plan."

Despite this ‘multi-prong’ plan, which includes moving the firm’s commercial real estate assets into its own separate entity and reducing its residential real estate holdings by half, fears in the marketplace have not been quelled. The question on everyone’s mind: Will the bank reach the fate as Bear Stearns?

"The situation is not a pretty one," say our friends at Strategic Investment. "The big banks keep on revealing even bigger losses. Remember the knockout punch delivered by the S&L crisis in the 1980s? This is bigger. More than 2,500 banks, thrifts, credit unions and mortgage companies wrote a combined $1.5 trillion in subprime loans during the peak of the boom.

"When George W. Bush’s dad threw $150 billion at the S&Ls, it helped spark a three-year recession. What happens when Washington tries to defuse a multitrillion dollar time bomb?"

*** Your editor celebrated his 60th birthday on Saturday night. Elizabeth recorded the occasion in a letter to our daughter, now in Hollywood, awaiting her big break:

(Daily Reckoning sufferers are advised that this has nothing to do with money or other trivial matters):

"Dear Maria,

"I thought I would write to you about Daddy’s 60th birthday celebration in Annapolis while it is still fresh in my mind. It was a worthy pendant to the party at Ouzilly, though the setting was less magically beautiful, and though we missed you and Edward very much, and though there was no dancing and Daddy and Jules did not sing. Because of the threatened hurricane, the venue was changed from the boat to Londontown Publick Gardens (where I had a birthday party for Sophia about 18 years ago, when Henry was a little baby.)

"Tout Agora was there – though not quite, as we were only about 115 guests and Agora has about 500 employees worldwide. But the key people had been invited and were there: Mark Ford, Myles Norin, Matt Turner, Porter Stansberry, Addison Wiggin, Julia Guth, Laura Davis, Bob Compton (our financial controller), Daryl Berver, Jenny Thompson (health publications). The up and coming, to many whom I barely know. There were foreign publishers, like Annabel Koffman from South Africa, Ajit Dayal from India, and Vicki Burrill from Manchester, Toby Bray from London, Dan Denning from Australia, Martina Dunphy from Ireland, Catherine Dourlens from France, Laura Aramburu from Spain and of, course, our foreign associates, like dear Norman Rentrop, who gallantly offered me his arm crossing the paving stones so I would not trip! (I took it, so as not to hurt his feelings), and Helmut Graff. And there were many old friends: Doug Casey, Adrian Day, Lee Euler, Brian Smith, Jim Davidson, Kathy Peddicord, and even John Mauldin (who said he would send a case of barbecue sauce before his next visit!).

"We were supposed to leave for to the party at 6pm; there was a big yellow school bus which took Dad (accompanied by Jean) and the Agora contingents down to Edgewater, and others followed in cars. The party started with mingling on a porch. We were served delicious seafood hors d’oeuvres, including great big fresh shrimp. As you can imagine, I had very little time to really talk to anyone…

"We sat down in due time…Jean, Dad, and I had worked on a seating plan, so everyone had an assigned table, which mostly went well, I think…Daddy and I, naturally, were at the head table, and Dad was wedged in between Mark and Norman, while I got to sit between two charmers, Mark and Doug. Doug and I had a lively theological conversation. I think he was disappointed to find out that I am not much of a Christian dogmatist and his disbelief in the Immaculate Conception and the resurrection does not shock me. He’s been taking a course on the historical Jesus. He is like a big wide-eyed eager student, and despite his mockery of the ‘cannibalistic’ religion, I think he is a seeker of truth, and of God. It is part of what gives him great charm.

"Mark was the masterful master of ceremonies, and gave the whole event un bon ton…amusing, intelligent, sharp and affectionate. He introduced the toasts. The first was Norman’s…long, worthy…a tribute to his German thoroughness and intelligence, and of his affection for Dad. He ended by saying that since the invitation had excluded gifts for Bill, he would like to give me tw one a champagne glass (engraved with the date, etc.) to toast Daddy on Monday on his behalf and the other, an engraved silver photo frame. He ended with the Irish blessing, and many were the voices that joined in: ‘May the road come up to meet you, may the sun shine warm upon your back…’ That toast was followed by the first course and then we had a raft of toasts from Agora people…Addison and then Porter, each speaking of how grateful he was for the opportunity to develop ‘outside the box’ and of Dad’s generous spirit…and of his often absentminded approach to business. Porter gave a great little imitation of Dad ruminating over a crazy idea Porter had announced, turning up his eyes and pressing his lips together and finally responding, ‘What does it mean?’ Julia Guth paid me a sweet little compliment…she credited me for having been hired by Dad, who told her, she said, that he was going to take her on Elizabeth Bonner’s recommendation…because he always listened to me!

"My favorite toasts were those by Uncle Jim, Will, Jim Davidson and Mark. Uncle Jim congratulated Dad on being a good husband and father and a very good son, and, recalling how their mother had advised, ‘Be more like Fezziwig and less like Scrooge,’ concluded that Agora’s success showed how well he had heeded her counsel. Will gave a short toast in which he thanked his father for being such a rock of reliability, and recalled how impressed he had been as a child by the long trips Dad made every other weekend to pick him and Sophia up in Virginia. I was very touched that he should remember that effort.

"Jim, however, gave the most affecting speech. He recalled the early days…youth, starting the National Taxpayers Union together, and then, with a tear in his eye and a tremble of the lips, told how he had called upon Bill to sit with his mother after Dennis died, until Jim could get back from New Zealand. ‘Bill is my family,’ he said, ‘and I love him dearly.’

"Mark’s speech elegantly balanced wit and sincere affection for Dad. I thought it was great…Mark looked very handsome and fit, and spoke with fluidity and spirit. It was upbeat, optimistic, heartfelt.

"And then Dad spoke. He thanked many people and told little anecdotes about them. But his main theme was how lucky he had been in his life, a life in which incompetence and errors seemed to lead to new opportunities, and to work out for the best! As a crowning example, he told the story of how he and I got to know each other so many years ago. He and Jim had bought at auction an old Bentley, an aluminum body on a wood frame which, unbeknownst to them, was irreparably rotten. The car was a disaster from start to finish, and had been sitting on blocks in Hartge’s boatyard for a few years while various ill-starred efforts were made to rescue it. Finally, they decided to sell it at auction in Atlanta, Georgia, and Bill was to drive it down on a flatbed trailer. Jim asked if he would mind taking his girlfriend along so that he could meet her in Atlanta. (An amused chuckle from the audience.) Dad described how he started driving more and more slowly, how he lost his way and drove to Florida instead of turning west for Atlanta, and how finally -thank heavens! – one of the trailer tires went flat in the middle of the night. We never did get to Atlanta, but we spent two whole days together talking and laughing and acting out little sketches and altogether having a wonderful time. And laying the foundations for, later, falling in love. He asked me to stand up so everyone could ‘get a look at you.’

"After the dinner, as you might imagine, there was a continuation of the party at the hotel bar. I stayed until 1am, when I suddenly thought that if I did not lie down, Matt, our lawyer, would have to carry me to my room. Feeling a little woozy, I nevertheless retired with good grace. But I was an exception! After the bar closed, Jean, Sophia, Jules and Henry and many others partied in one of the rooms until the hotel security threw them out at 3 am. Tiffani Mauldin went and bought MacDonald’s meals for the crowd, and Henry told me that he was surprised by so many adults that he had thought were so straight-laced! In conclusion, it would seem that everyone had a good time.

"Well, darling, it was an occasion that I will always remember. And though we all missed you, you were present in our thoughts and in the minds of many guests. You have your own goals and your own life, but you are part of us and your aspirations are also our dreams for you.

With much love,


That does it for us today. Until tomorrow,

Bill Bonner
The Daily Reckoning