Black Swans Everywhere

With all the up and downs in the markets lately, it seems as though a whole flock of black swan events is circling the sky over Financial-land and is about to blot out the sun. James Howard Kunstler explains…

After a one-day reprieve from total meltdown in the financial markets, news media cheerleaders for the most reckless gang of bankers in world history declared the crisis over on Good Friday (with the markets safely closed). Whew, that’s a relief. Problem solved. And just in time for baseball season, too, so none of the Banker Boyz have to sell their sky box leases.

What is meant by "meltdown," by the way, since the word is used so promiscuously by myself and others. I’d define it as the shock of recognition that many big institutions are worse than flat broke and are therefore powerless to conduct normal operations. By "worse than flat broke" I mean they are so deep in hock that all the accountants who ever lived, in the life of this universe and several others like it, using the fastest parallel processing computers ever built, could not keep up with their compounding accelerating losses (now approaching the speed of light).

The current vacation from reality on Wall Street may last a few more days, or even a couple weeks, but it seems as though a whole flock of black swan events is circling the sky over Financial-land and is about to blot out the sun. By black swan, I refer to the concept popularized by Nassim Nicholas Taleb in his recent book of that name, namely unexpected events of great power that tend to change the course of history.

For the moment, with the crisis "contained," and the Boyz getting ready to air out their Hampton villas for the coming season, we are once again primed to be blindsided by potent random events that nobody saw coming. The trouble is, there are enough potent potential fiascos already visible on the horizon.

The mortgage fiasco is still just gathering steam as it moves from the non-payment stage to the default and repossession level on the grand scale. Even the political wish to bail out feckless mortgage holders will stumble on the mammoth clerical task of administrating the process, especially since we’ve barely begun to sort out who actually holds the mortgages after they’ve been minced into a fine mirepoix of securities off-loaded onto countless dupe "investors" ranging from municipal funds in obscure corners of foreign nations to countless public employee retirement plans.

No matter how the authorities try to "nationalize" the sucking chest wound of bad mortgages, the body of finance will flat-line — and the American public will get stuck with the bill from the intensive care unit. Those who, for some weird reason, continue to pay their way and meet their obligations, will be none too pleased to pay for misdeeds of the deadbeats and their banker-lenders. This portends a taxpayer rebellion, which may translate into a voter rebellion.

It’s too bad the current presidential candidates have been unable to address the unfolding economic nightmare. Their collective silence on the matter suggests that they don’t have a clue what to say about it. As the nightmare plays out and black swans flock in to blot out the sun, and the hedge funds come a’tumbling down, and more big banks blunder into black holes, and businesses big and small across the land shutter up their operations, and the unemployment rolls swell, and families are thrown out of their houses even when bailouts are supposed to be saving them (but the bureaucracy can’t get the paperwork done in time) — well now, they are going to be one pissed off bunch of people. What will they do at the conventions? Our outside the conventions?

In the deeper background of all this is the all-important oil story that nobody in politics or the media wants to pay attention to. Notice that in the fervid unloading of assets this past week, as investors dumped their positions in the commodities markets, the price of oil remained stubbornly above $100-a-barrel when it was all over on Thursday afternoon. Well, maybe they’ll ratchet down a little further this week, but the trend line will prove to continue remorselessly upward in the months ahead.

Peak oil is for real. The supply can’t keep up with global demand, even if it dips in the USA. And more portentous sub-plots develop in the story every month. Export rates are falling at a steeper rate than depletion rates. The exporting nations are not only buying more cars and running more air-conditioners, they also need to use more energy to lift the oil they’ve got out of the ground.

Another sub-plot is the fact that the equipment used world-wide to drill for oil and recover oil and move oil around the planet — all that equipment is now so old and rusty that it can barely do the job, and it is going to start failing altogether unless investments are made to replace it, which nobody is making.

By the way, Americans blame the familiar private oil companies for all the trouble with oil in their lives — Exxon-Mobil, Shell, et al — but they don’t seem to know that oil nationalism is in the driver’s seat now. The old private "majors" are only producing five percent of the world’s oil. The rest is coming from the national companies — Aramco, Petrobras, Pemex, et blah blah — and the very operations of the oil markets are entering a phase of radical instability as they move away from auctioning their stuff on the futures markets and start making long-term favored customer contracts instead.

The bottom line is that high prices for oil is hardly the only thing America has to worry about. Pretty soon the US will have to worry about getting the oil at any price — meaning, we’re in for shortages and supply disruptions sooner rather than later.

Also unbeknownst to most of America, the financial markets reflect all this instability around the basic resource of oil because industrial economies like ours are set up in such a way that they can’t run without cheap and reliable supplies of the stuff. So the least little twitter in the reality-based world of peak oil means that everything to do with money and capital investment will naturally go crazy, since our expectations for increased wealth — i.e. "growth" — are predicated on the activities driven by oil.

It will be interesting to see what new machinations are unveiled this week. Whatever else this catastrophe is, it’s a good show from the cheap seats.

James Kunstler
for The Daily Reckoning
March 25, 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.

Yesterday, markets in Europe were closed.  But in America, they kept doing what they are supposed to do – separating fools from their money.

What is really remarkable – and entertaining – is that some of the biggest fools are the very same people who claimed to be Masters of the Universe, the hustlers who work for the financial industry.  That is to say, the separators are being separated from their money too.

And the more you look into it, the more you discover that they are not masters of the universe at all – but slaves to it; nothing but clowns in the great human circus…just like us.

Last week, Bear Stearns’ shareholders were separated from a lot of money; in a panic, they agreed to sell out for $2 a share.  We wondered how these accountants, lawyers and market-savvy traders could have been so wrong about what they had.  When the market closed on Friday they still had billions.  When it opened again on Monday, they had almost nothing.  How could it be?

Well, now the geniuses have had time to think; and they’ve come to the conclusion that they shouldn’t have sold so cheap.  And the buyers – JP Morgan Chase – apparently messed up too.  They thought they had closed the deal, only to find that they’d forgotten to get the key documents signed.  So when the sellers wanted to go back to the bargaining table, the buyers had no choice.  They had to up the ante by 400%.  Now, instead of paying $2 a share…they’re going to spend $10, or about a billion dollars more.

So, here is the same question we asked last week: how can such clever people be so clueless about what they’ve got in their own pockets?  Is it worth $2 a share?  Or $10?

Of course, it is worth what you can get for it.  But this is a financial institution.  Its assets are marketable.  It should be worth exactly the net value of those assets – plus the value of the operating business (typically determined by smoothing earnings over some period of years and multiplying times a capitalization factor – 5 to 20, depending on what kind of mood the buyer is in).

But in the strange new world we live in, however, it’s hard to know what those financial assets are really worth.  "Hence the billions of dollars sheltered off balance sheets in SIVs and conduits," explains the Economist.  But the magazine goes on:

"That game is now up….the counterparties no longer trust each other."

You wouldn’t know it from yesterday’s market new, however.  To hear the papers tell it, investors were greatly encouraged by higher-than-expected house sales and the news from Bear Stearns.

"US stages broad recovery as sentiment improves," is the headline in the Financial Times.  Stocks rose, bond yields fell…and the dollar worked its way higher.  The Dow went up 187 points.  Oil held right at $100.

‘Maybe things aren’t so bad after all,’ they said to themselves.

Or, maybe they are worse.

The reason house sales picked up might be because sellers are getting desperate.  There are still a lot of unsold houses – about twice the usual number.  Sales are a third down from their peak.  And building stocks are about two-thirds below their highs.  The stock market tends to follow the housing market, but with a lag of 20 months, says John Authers in the FT.  "If that were to continue, it [the stock market] could fall 60% by the end of next year."

Meanwhile, say a prayer for the poor people who labor in the fields of private equity.  Steve Rattner of the Quadrangle Group is in London this week.  "Since July," he writes in the FT, "not a single private equity deal has been hatched above $4 billion."  And deals just done before "the levers fell off the buyout machine" now threaten to sink their Frankensteinian creators.

The buyout firms had hoped to squeeze, re-structure, refinance and flip these deals quickly back onto the same public markets whence they came.  This was what the Economist describes as standard procedure in the heady last days of the great financial bubble.  Finance became a "game for fees and speculation," it says.

But now, the counter-parties no longer trust each other and no one is particularly eager to get stuck with these heavily-leveraged private equity deals.  So they end up as "zombies," says the FT – neither living nor dead – but still drawing breath, salaries and financing costs.  They are the equivalent to the "upside down" houses that are worth less than their mortgages; these companies are worth less than the loans taken out to buy them.    The Irish telecom – Eircon – is one of these companies.  The French builder – Kaufman and Broad – is another.  K&B was bought, with plenty of leverage of course, at the very peak.  Now, its shares have lost half their value  — which makes the business worth less than the debt it collateralizes.

All of which makes us think that reports of the end of the crisis may be premature.

*** Gold has been correcting.  When we looked on Friday, the price had dropped more than $100 from the top.

What to make of it? Has it seen its top?   Has it now found its bottom?  Or is there more correction to come?

We wish we knew.  We were hoping for a correction down to about $850.  "Buy the dips," we kept saying.  But there haven’t been many dips.  Now, at $918, is this the best offer we’re going to get?  Maybe.

Remember, we don’t buy gold to make money.  We buy it not to lose money.  And then, we only buy it when the risks from other forms of wealth outweigh the hope of profit.

What else are you gonna do with your money?  Buy stocks?  In real terms, U.S. stocks have been in a bear market since 2000.  This trend will probably last another 10 years or so.  Buy property?  Maybe…but you will have to choose very carefully.  Put it in CDs? You will get a low yield…inflation rates are going up…and you have the risk of a currency loss.

Gold is no sure thing, either.  It went down in price from 1980 to 1999.  But there are times when owning gold is safer than other things you might own.  This is probably one of those times.

Which is why we’ve decided to take this opportunity to launch our newest service, Gold & Options Trader . The first report from this publication details 5 unknown junior mining stocks that are set to soar. You can get this report free with your charter membership to Gold & Options Trader .

*** What’s a conservative to do?  Abstain.

There hasn’t been a true conservative candidate for president since the Eisenhower years.  One by one the old conservatives disappeared – caught up by the military machine, the Cold War hysteria, welfare state politics or the lure of modern macro-economics: "We are all Keynesians now," said Richard Nixon.

Occasionally, there were candidates who still called themselves ‘conservatives’…and many who tried to be conservative about this or that.  But they were all either big spenders, war mongers, or social engineers.

And now, John McCain — the best the Republicans could do – is a candidate who is all those things, and more.

"The US is the indispensable nation because we have proven to be the greatest force for good in human history… We have every intention of continuing to use our primacy in world affairs for humanity’s benefit."

Alas, John McCain is a world-improver of the worst sort.  If elected, he promises to use America’s military advantage and her credit as his predecessor has – until it is all used up.

Until tomorrow,
Bill Bonner
The Daily Reckoning

The Daily Reckoning