The Flipping Industry

Everyone breathed out a collective sigh of relief when the first quarter of 2008 ended. But Byron King wonders: are we out of the woods yet? Or are the bad times just beginning?

I am sure glad to see the first quarter of 2008 behind us. It seemed as if every couple of days there was more bad economic news. Each announcement was worse than the last. The banks, investment houses, hedge funds, etc. just pumped out the bilges with their financial gray, brown and black water. It didn’t matter if the tide was coming in or going out. The whole economic bay seemed to be polluted.

As the quarter unfolded, it became clear that the world’s credit system was drifting aimlessly, like a ship sailing with no wind. A lot of business that should have gotten done just did not happen, for lack of funding. Funding went away because risk aversion kicked in with a vengeance, and for a very real reason.

The last 12 months or so have been a time of repricing risk – and this occurred on a global scale. But the repricing was not orderly. The U.S. dollar was steadily drifting downward in value, and prices for most things were readjusting just on this monetary basis alone. Add to this some severe industrial disruptions, from power shortages in South Africa to floods in Australia to economy-stopping winter weather in China.

Closer to home, the downward repricing of risk rapidly became a collapse as flaws in the U.S. rating agency process bobbed to the surface. With so much distressed commercial paper floating around, many people were paranoid about risk. It was like the old game of "hot potato," except nobody could pass their potatoes onto the next guy down the line.

For example, in one major presentation, I heard General Electric CEO Jeff Immelt spend a large part of his discussion defending GE’s "triple-A credit rating." Normally, Immelt would be up there slapping the pointer against the screen and bragging about all the great products that GE makes and sells. Instead, he was busy trying to "prove a negative," that GE does not hold bad paper in its money operations. But Immelt believed he had to defend GE’s stock price by dispelling fears of a rating markdown.

And through it all, the resulting stock market gyrations were a reflection of investor confusion about the future. Are we at the end of something good? Are we at the beginning of something bad? Is this the beginning of the end? Or is it only the end of the beginning? Really, what comes next? Will credit markets liquefy? Or will they stay dried out? Can we do business? Or should we hold tight and sit on the cash?

Paul Krugman of The New York Times recently told Fortune, "Large parts of the financial system will have to be reinvented." And there’s no argument from me on that one. But so much of the financial system is broken that the question is where to even start.

It is apparent that much of the old way of doing business – particularly in the realm of lending money – was rotten to the core. In my view, it begins with the dollar itself. The dollar has been steadily deteriorating in value for decades, so inflationary expectations are part of the worldwide consciousness. That is, just because of the long-term decline in the value of the dollar, most people expect most things to go up in price most of the time.

So is it any wonder that people developed a "speculation expectation"? This fed into an entitlement mentality, as well, that tainted every rung of the credit ladder. A lot of people wanted to buy and flip, whether it was houses or stocks or commodities. So other people lent to people to enable buying and flipping. Flipping became a dominant, if not defining, element of the financial "industry," of sorts.

But what an industry! For example, in the past five years, many people just plain lied through their teeth on everything from credit card applications to mortgage applications to the lending documents for multibillion-dollar takeovers. It was pure and brazen fraud in many instances, verging on burglary in plain sight. The next level up the food chain – the brokers and loan officers – often just looked the other way and rubber-stamped the papers. "Hey, not my problem."

This kind of bad buck-passing went all the way to the top of some firms, many with familiar names. There in the ethereal reaches of the nice office buildings in Irvine, Calif., and Fort Lauderdale, Fla. – let alone Wall Street – the chief executives knew, or should have known, how risky the portfolios were becoming. (If I may say so, we’ve been writing about it at Agora Financial for at least the past four years.)

But these corporate worthies let it happen. The pressure to "make the numbers" was too much. The money was just too good. The bonuses were too sweet. And besides, there is always the old excuse that "Everybody does it this way." Yet it was not for nothing that the ancients defined greed as a deadly sin. At each step of the ladder of financial deceit, people just let it slide. They should have known better, and maybe they did know better.

Now looking ahead, we have a hell of a rocky road before us. And can we as a society really "regulate" our way out of that situation? Or is there a systemic problem with deeper roots? Really, what do the Furies have in store for us?


Bryon King
for The Daily Reckoning
April 08, 2008

P.S. I regret to say that I cannot solve all the world’s problems. All I can do is write about energy and scarcity and give you the best work that I can crank out. In other words, I cannot control the monetary environment or the economy or the ups and downs of the stock markets. I can only work to find the best kinds of investment opportunities in next-generation energy systems and resources that are getting scarce.

The rest of the world is going to have to sort itself out. And one way or another, I think that people in the future will want clean electricity and new ways to recover liquid hydrocarbons and technology made out of exotic metals and other substances.

Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. Byron is also co-editor of Outstanding Investments, and editor of Energy & Scarcity Investor.

Nothing much happened in the markets yesterday…so that is what we will write about, nothing much. Besides, we don’t have much time anyway…we’re headed out to the desert…out of range of the Internet.

While everyone else invested in corn, wheat or rice – all of which have been soaring – we put our money into cattle. Recently, you could barely give cattle away.

"People were getting rid of cattle," our old friend Doug Casey explained to us today. "They all wanted to get the cattle off the land so they could plant soybeans. But that killed the cattle market, of course. Don’t worry, though. Cattle will come back."

Okay. We weren’t worried anyway. Still, we’re headed up to the Andes, to see how our beef cattle are doing.

In the meantime, many people think the feds have done it. By aggressively cutting rates and pushing money out to the banks…and helping to save Bear Stearns…they’ve turned it around. It is as if they had diverted a giant meteor; the world is saved.


But what does it mean, anyway? Let’s say they were successful? What would that mean? Have they somehow erased Americans’ debts? Are all those upside down homeowners now flipped over so they’re sunny side up? And how about all that subprime debt…and all those leveraged loans for mergers, acquisitions and buyouts that didn’t quite work…and all those hedge funds who stretched so far to get into the most dangerous investments at the most dangerous time? Have all these mistakes somehow been wiped away?

Oh, dear, dear reader…we feel a religious experience coming on. Somehow, we have all been forgiven our sins…the slate has been washed clean…our errors have been pardoned by an authority more powerful than God himself – the feds.

Could it be?

If it is not…then what does it mean when they say the feds have ‘succeeded’ in averting a real crisis? What, exactly, have they averted? If they have not erased the mistakes, what have they done with them? If they have not prevented people from getting what they’ve got coming…who, then, is going to get what those people had coming?

Ah, there’s the rub…if the mistakes cannot be magically made to vanish…then someone will pay for them. Perhaps then, the ‘success’ is really in shifting them…from the people who deserve to pay to the people who don’t…that is, to the general public and the taxpayer?

Personally, we like mistakes. It is our mistakes that made us what we are. Yes, we would happily erase a few of them from the record, if we could. But inasmuch as all of them contributed to what we are, getting rid of any of them might have drastic consequences…causing the whole universe to slip into some kind of alternate reality. We might disappear too…why take the chance?

The feds must like mistakes too. As near as we can figure, ‘success’ – for them – must mean getting people to make more of them. That’s why they are lowering borrowing rates – so an over-indebted nation can borrow more. And that’s why they’ve given out tax ‘rebates,’ so that people who spend too much can spend more.

And if they spend and borrow more, what does that mean for the future? The next generation must spend and borrow less. That’s it, isn’t it? That’s what ‘success’ really means…

…robbing the next generation. Spending their money today so they will spend less tomorrow.

*** It looks like the end is near…for ethanol at least.

Take Basehor, Kansas-based ethanol plant, Ethenex Energy for example. This company opened its doors in the midst of the ethanol boom two years ago, when "Corn was the cheapest it had ever been and ethanol was skyrocketing," former Ethanex president and chief executive officer Al Knapp said. "There was a land rush for people to build ethanol plants."

But today, with the price of corn hitting $6 a bushel and the price of ethanol falling, Ethanex was "definitely held captive by the capital market."

The company filed for Chapter 11 late last month. And more and more this sort of scenario is playing out for ethanol plants.

"I have gotten about ten emails like [the story above] from farmers in Illinois, MN, Iowa, Wisconsin and Indiana. Either ethanol plants under construction that have ceased or plants that are declaring Chap. 11. Looks like the ‘dream’ of the new gold rush in corn based ethanol is starting to unravel, and fast.

"I am headed out to Minnesota on the 17th and will be visiting a few farms and hog operations as well as a feedlot as well as an ethanol plant (under construction) in Janesville Minnesota. It will be interesting to get a sense of what the sentiment is now as compared to the last two years that I have talked to farmers. Somehow I think a lot of the euphoria is gone, corn at $6 will do that since it has made input costs skyrocket."

We know that long time DR-sufferers where never fooled by the great ethanol swindle. It was clear that the dream of this corn-based fuel was to be short-lived.

There is a way that America could get close to energy independence…and it has nothing to do with corn. Byron King recently discovered the only company that has the inside track on tapping a huge oil deposit within U.S. borders – one estimated to be triple the size of Saudi Arabia’s proven reserves.

In the latest report from Energy & Scarcity Investor, you’ll find out all about how the breakthrough technology that this company uses could put thousands of dollars in your pocket.

Right now, you can subscribe to Byron’s Energy & Scarcity Investor for the lowest price we’ve ever offered – but only for a limited time.

*** As we’ve been saying…there is no advantage so great that the authorities can’t waste it…

Colleague Garry White explains how the oil producers are squandering their windfall revenues:

"The latest data available on World Energy consumption is for 2003 from the World Resources Institute. The figures represent total energy consumption per capita in units of kilograms of oil equivalent (kgoe) per person.

US: 7,794.8
UK: 3,918.1
UAE: 10,538.7
Qatar: 21,395.8
Kuwait: 9,076.0
Bahrain: 10,250.5

"The U.S. is decried as the gas-guzzling capital of consumption…but this is only partly true. It is actually the residents of the Middle East who are the largest consumers of energy in the world. With a wealth and population explosion added to the mix, oil-rich countries are facing an unprecedented energy crunch.

"Middle East governments were more generous in subsidising oil products than governments anywhere else in the world during 2007, according to the IMF. While oil prices rose strongly through the year, governments in the Middle East passed on just 58% of the increase in the cost of importing petrol.

"Egyptians paid just $0.23 for a litre of kerosene at the end of 2006, compared with the $2.25 a litre paid by consumers in Turkey, which passed on more of the increase to consumers.

"The region’s governments also passed on an average of 67% of the increased cost of diesel to their consumers, a smaller amount than governments in any other part of the world. Yemen spent a staggering 9.3% of GDP on energy subsidies in 2006, the most of any country in the region."

And from Horacio Pozzo, our man here in Buenos Aires, comes word that you can fill your gas tank up in Venezuela for only $3. Still, the economy of Chavez’s country is a disaster. The shelves are empty, and the inflation rate and the murder rate are both at record highs.

*** And here is a name from the past:

"This week Japan’s former vice-minister of finance Eisuke Sakakibara predicted that fresh turbulence in the currency markets over the next six months is likely to see the yen ‘break 90 to the US dollar.’" writes colleague Manraaj Singh.

"Maybe you’ll remember Sakakibara from the late 1990’s when the financial media dubbed him ‘Mr. Yen’ for his ability to move global currency markets with his pronouncements. He’s predicting that the market turmoil triggered by the U.S. subprime crisis is unlikely to go away for ‘a year or two’ and that there may be more shocks to come from Europe over subprime exposure."

Until tomorrow,

Bill Bonner
The Daily Reckoning