Event Horizon

With all of the negative news coming from the banking industry this past week, it’s likely that we’re seeing yet another series of “risk events” that could send the American Dream, as James Howard Kunstler puts it, hurtling toward the event horizon of a black hole.

There’s a particular moment known to all Baby Boomers when Wile E. Coyote, in a rapture of over-reaching, has run past the edge of the mesa and, still licking his chops and rubbing his front paws in anticipation of fricasseed roadrunner, discovers that he is suspended in thin air by nothing more than momentum. Grin becomes chagrin. He turns a nauseating shade of green, and drops, whistling, back to earth thousands of feet below, with a distant, dismal, barely audible thud at the end of his journey. We are Wile E. Coyote Nation.

Is there anyone in the known universe who thinks that the U.S. financial system is not fifty feet beyond the edge of the mesa of credibility?

Nothing will avail now. Not even if Sirhan Sirhan were paroled at noon today and transported directly to the West Wing with a .44 magnum in each hand (and a taxi driven by the Devil waiting outside to take him to the U.S. Treasury and the offices of the Federal Reserve).

It’s hard to imagine what kind of melodramas were unspooling on the Hamptons lawns this weekend, while everybody else in America was watching Nascar, or plying the aisles of BJs Discount Warehouse for next week’s supply of mesquite-and-guacamole flavored Doritos, or having flames and chains tattooed on their necks, or lost in a haze of valium and methedrine.

With the death of the IndyMac Bank last week, and the GSEs Fannie Mae and Freddie Mac laying side-by-side in the EMT van on IV drips, headed for the Federal Reserve’s ever more crowded intensive care unit, there was a sense of the American Dream having passed through the event horizon that denotes the opening of a black hole.

What would happen if the U.S. government acted to bail out these feckless enterprises (and what if they don’t)? Either way, it’s not a pretty picture. If Mr. Bernanke does start shoveling loans into the GSE black hole, he’ll further undermine the soundness of his own outfit and do nothing, really, to repair Fannie and Freddie’s structural problem of having securitized too many loans that will never be paid back. If instead Fannie and Freddie are flat-out taken over entirely by the U.S. government (and remember the Federal Reserve is not the government), then the national debt will roughly double overnight – which will pound the U.S. dollar down a rat-hole.

Meanwhile, the foreign holders of those decrepitating dollars might not rush to the redemption window, but they certainly would use them to buy up every oil futures contract on God’s not-so-green Earth as fast as possible – they’d be dumb not to – which would leave American Happy Motorists with gasoline prices north of $5 a gallon, and possibly north of $10. (In that case, say goodbye to the airlines. In fact, say goodbye to what passes for the rest of the US economy, including especially the vaunted retail sector that supposedly counts for 70 percent of the action.)

If Fannie and Freddie are left to die out on the desert floor, say goodbye to the housing market, the major investment banks, countless regional banks, the retirement accounts of virtually everyone in America, the viability of all fifty states’ governments, and the day-to-day operating ability of all their municipalities – and very likely the current incarnation of the world banking system.

This process is really out of control now. The bottom line is the comprehensive bankruptcy of the United States. The Republican Party under George Bush will be known as the party that wrecked America (release 2.0). Painful as it is, Americans had better get a new “Dream” and fast. It better be a dream based on the way the universe actually works, which is to say an operating procedure run on earnest effort and truthfulness rather than merely trying to get something for nothing and wishing on stars. We might begin symbolically by evacuating Las Vegas and calling in an air strike on the loathsome place – to register our new reality-based attitude adjustment.

After that, we’ve got to get to work re-tooling all the everyday activities of life, including the way we grow our food, the way we raise and deploy capital, the way we do trade and manufacturing, the way we go from point A to point B, the way we educate children, the way we stay healthy, and the way we occupy the landscape. I know, it sounds like a lot, maybe too much. But grok this: we don’t have any choice if we want a plausible future on this portion of the North American continent.

Of course, none of that is likely to happen. Instead, and under the worst imaginable economic conditions, we’ll probably embark on a campaign to prop up the un-prop-up-able and sustain the unsustainable – that is, defend every status quo habit and behavior that we’re used to, whether it can be salvaged or not. Of course, this would be a fatal squandering of our dwindling resources, but it tends, historically, to be the last act of the melodrama in any faltering empire.

The result, pretty soon into that process, will be social breakdown and political upheaval. Every tattoo freak out there who has been prepping for his own starring role in some kind of comic book Armageddon will finally get his chance to shine. Lots of people will get hurt and starve. Property will change hands in a disorderly way. And at the end of this process an American corn-pone Hitler may be waiting to set everything and everyone straight.


James Howard Kunstler
for The Daily Reckoning
July 15, 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.

Give capitalism a chance…

Last night, we attended a birthday party for our old friend, Lord Rees-Mogg. Tout London was there – Maggie Thatcher and David Cameron, for example.

We had heard that Mrs. Thatcher had been unwell; but she looked spry…even sturdy. It was not the occasion to ask a serious question…but we wondered how she must feel. She, along with Ronald Reagan, did so much to set capitalism free. But now, it is being put back in a cage…

All the world’s major markets are in major declines. The worst hit so far are those in the Far East – which are falling again this morning. Among the Asian markets, only Vietnam seems to be on the mend. European markets are down 20%-25%. But Shanghai has lost 40%…and Vietnam has been trimmed more than 50%.

Not much action in the U.S. stock market yesterday. Fannie (NYSE:FNM) and Freddie (NYSE:FRE) kept treading water, with their heads barely above the waves. Oil stayed at $145.

“U.S. action on lenders calms tense markets,” says a headline on the International Herald Tribune. “Rescue of Fannie Mae and Freddie Mac has ripples around the globe.”

The Financial Times saw the situation differently: “US banks suffer as bail-out fails to calm nerves,” begins the cover story.

And that interpretation would be closest to the truth…at the open of the U.S. markets today, the Dow is down triple-digits.

“The Fed stepped in and tried to bail out Fannie Mae and Freddie Mac, but talk continued to circulate that there would be nothing left. Add the FDIC takeover of IndyMac and the focus of the market shifted to who would be the next to fold,” said Marc Pado, U.S. market strategist at Cantor Fitzgerald.

Despite the rescue of Fannie and Freddie, U.S. banks, such as Washington Mutual and Cleveland’s National City, are in full retreat following the collapse of IndyMac. WaMu went down 35%…National City plunged 27%.

And where’s that strong dollar that Bernanke and Paulson were talking about? It was supposed to go up…after U.S. officials announced a change of policy. Henceforth, the feds were going to fight inflation, remember? Henry Paulson said a strong dollar was in America’s interest…and that there would be no more hanky panky going on with the greenback. Honest. Cross my heart and hope to die.

Today, the dollar continues to slide. The euro (EUR) briefly hit a record against the U.S. dollar before falling back below $1.60. And yesterday, gold rose another 13 bucks, bringing it back to $973.

“God, guns and gold,” we explained to our French friends over the weekend, “are the three core values to a real American.”

Of course, we went on to explain that there weren’t many real Americans left. Most of them died with Eisenhower…or before. But that’s a long story.

We will try to stay “on message” this morning. But how can we? Everywhere we look, there are so many delicious distractions…so many exquisite ironies…so many feet in so many mouths. How can we help but laugh?

So we’re laughing at Henry Paulson today. As soon as the man is under a little pressure, he buckles to the forces of modern mobocratic government. It was all very well for the nation’s two biggest mortgage finance companies to be part of the ‘free enterprise’ sector – when the wind was at their backs. Fannie and Freddie were just important parts of the financial sector. They helped “allocate credit” to people who needed it. Mongering credit was good work since the ’80s. Since 2002, it was especially good work – up until about a year ago. So who could begrudge Daniel Mudd’s $13.4 million 2007 pay package as CEO of Fannie Mae? Or, who would be sour enough to complain about Dick Syron’s $18.3 million wage from Freddie Mac? These guys were just getting rewarded for good performance, right?

Well, not exactly. Syron’s pay went up 25% last year – even as the company went from a $2.3 billion profit in 2006 to a $3 billion loss in ’07. And Mr. Mudd got a 7% increase, while the company posted a $2.1 billion loss and shareholders took a 33% haircut.

Okay…so maybe shareholders overpaid them a little. But that’s how compensation works in the free market; you get what you can get away with. So, bravo to them! Besides, they were helping the whole great machinery of capitalism make Americans rich. That’s why they gave out all those rich consulting contracts to former members of Congress. And that’s why they spent millions on lobbyists…angling the politicians to protect the mortgage market at all costs.

But what’s this? The wind has whipped around, and now blows a gale into the twin lenders’ faces. Now, we discover that these were “government sponsored enterprises” all along. They were part of America’s social welfare system, it turns out, not part of the free market. They were just performing a public service – helping make sure the poor plebes had roofs over their heads. And now that the two GSEs are having trouble, naturally, the full faith and credit of the United States of America has to be lined up to support them.

“Paulson Puts Treasury’s Weight Behind Fannie, Freddie,” says Bloomberg.

Everywhere we look, we see more evidence that post-Reagan Republicans and post-Thatcher Tories have given up on free enterprise. They have decided that the problems in the economy are too important to be left to business and Wall Street. Congress needs to intervene, say the meddlers, in order to guarantee the nation a smoothly-functioning financial system.

Everyone seems to feel the same way…the free marketers have had their chance. Now, it’s time for a little “adult supervision.” But adult supervision in this context – putting politicians in charge of the economy – is like adult entertainment; it is a salacious fantasy.

And so, it is all happening as we expected…and as we predicted in these pages. What can we do now, but buckle our seat belts…and prepare to enjoy the show? Well, you could try to make a little money…while everyone else is being swept away in the flood of failing financials.

As if the pretensions and conceits of the financial industry weren’t comic enough…we’re now going to see a hilarious farce. The same people who set up a government sponsored enterprise to jack up the mortgage market…and created the biggest housing bubble the world has ever seen…now come to the rescue when the bubble pops.

How, exactly, are they going to rescue America’s mortgage industry? Henry Paulson says they’re going to lend more money to Fannie and Freddie. And he wants the feds to buy their stock too. That should do it. Fannie and Freddie, in their heyday, put their hands on 80% of all the new mortgages in the entire country. Now, they have a book of business that includes more than $5 trillion in liabilities – an amount equal to about half the outstanding mortgages in the country…and a third of the nation’s total GDP.

In other words, Fannie and Freddie are probably the two most important businesses in the consumer economy. Now, nearly three decades after the Reagan Revolution, they will be nationalized. Is that progress…or what?

*** CNN reports that U.S. pension plans have lost about $280 billion.

“Since the credit crunch hit last fall, pension plans funded by S&P 1500 companies have lost about $280 billion in assets, according to an actuary at Mercer, a human resources consulting firm.

“On paper, the losses from last October tally $160 billion. However, according to Mercer actuary Adrian Hartshorn, the asset losses are closer to $280 billion when pension plan assets and liabilities are considered together. The assets, which totaled roughly $1.7 trillion at the end of October 2007, fell by 17%, leaving about $1.4 trillion in assets at the end of June.

“Companies should be concerned, he said, because – assuming no change in the market – a typical U.S. company can expect their pension expenses to increase between 20% and 30% in 2009. That’s due to the higher cost of servicing the pension plan’s debt and the smaller return from the plan’s assets.”

*** “The only things worth owning right now are the financials…and gold,” said a fund manager last night. “I think gold is only about half way to where it is going. And the financials – some of them – are so cheap that you can’t go too far wrong. We’re looking at major banks paying a dividend over 10%. These kind of opportunities don’t come along very often.

“Of course, you have to be prepared for a lot of bad news. We’re going to see more bankruptcies. We’re going to see more markdowns…and more panics…

“But if you’re a value investor…or, I guess I should say, if you’re a young value investor with plenty of time ahead of you…the banks look like good buys.”

Until tomorrow,

Bill Bonner
The Daily Reckoning

P.S. Gold has been the longest-standing store of real wealth – and those who have invested in it have been seeing some nice returns, as the price of gold continues to go to the moon. In case you haven’t padded your portfolio with the yellow metal yet, fear not. The price still has a ways to go – and we know of a way that you can get gold for just a penny per ounce.

The Daily Reckoning