The Bush Bailout

Bush announced his subprime plan last Friday, which he hopes will limit the number of borrowers defaulting on home loans as rates on adjustable mortgages adjust higher.

What Dubya has proposed is to work with the Federal Housing Administration in letting homeowners (with good credit), who could be at risk to default on their loan, refinance into FHA-insured loans. Unfortunately, this proposal won’t do much to alleviate the bigger concerns in the credit market.

“By promising to absorb the $100 billion in subprime real-estate losses forecast by his top monetary wonk, Ben Bernanke, Bush is in effect doing what many small-town US banks did during the early stages of the ’30s Depression: Putting all the money where passers-by will see it, right there in the front window, just to prove that the money exists,” writes Adrian Ash in today’s guest essay. “That way, or so the logic runs, anxious depositors will see their money’s still there…and they’ll wait a while longer before forming a queue to empty the bank in a panic.

“The big difference this time – besides the sheer size of Bush’s bail-out – is that Washington is putting America’s credit out front, rather than hard cash. The US government doesn’t have any cash to put on display; instead, it owes the better part of $9 trillion already. George W. Bush is going to add the cost of subprime debt defaults on top – absorbing this summer’s crop of late-paying homebuyers, while establishing the expectation of unlimited future bailouts. These massive governmental rescue operations have a nasty way of exceeding initial forecasts. Today’s $100 billion bailout, therefore, might easily become tomorrow’s $200 billion bailout.

“As the scope of Bush’s intervention grows, what will become of international demand for Treasury bonds? Will foreigners continue to line up to buy American debt?”

Adrian Ash
September 4, 2007

Keep reading here:

The Bush Bailout

And we turn to Short Fuse, reporting from Tinseltown…


Views from the Fuse:

*** Here in the Golden State, where real estate is (or was) king, your editor has noticed something interesting on morning walks around the Hollywood Hills…

About a year ago, around every turn was a construction truck…people were gutting their homes (or their investment properties), installing granite countertops perhaps, or new hardwood flooring, and prepping their homes to be put on the market. So, slowly, the construction trucks were replaced by For Sale signs…and granted, more than a few have come down, so we can assume that they’ve sold.

However, there are some houses that have been sitting on the market, unsold, price reduced, for months now…and senior economist at the Center for Continuing Study of the California Economy, Stephen Levy is worried that the California housing cycle isn’t going to end well.

“There’s a limit to what people can afford,” he wrote in a recent Weekend Edition of the Wall Street Journal. And, as Bill pointed out above, Americans are learning to live within their means – or at least are beginning to realize what their means are.

But in California, living within your means was basically unheard of, as home prices were inflated to 80% more than the national average.

Unlike most of the mainstream press, Levy isn’t as worried about foreclosures in this market, although that is a definite problem. What concerns him most is “the spending behavior of those who aren’t going to lose their homes, but have seen their wealth evaporate.”

Think about the Baby Boomers who hope to sell their home – but run into a couple of problems. First, their house is worth less than they had been quoted when they refinanced, and now they are upside down in their mortgages, i.e., they owe more to the bank than their house is worth.

Or, secondly, buyers in California are becoming few and far between, because even though house prices may be declining slightly, they are still over-inflated – and there is no added ‘benefit’ of EZ credit.

This isn’t just happening in California…take a look at Vegas, Boston, Colorado and Florida – you’ll see a similar picture.

The California economy is an important one to keep your eye on, writes MarketWatch, “because accounts for 13% of the country’s gross domestic product or the total value of all goods and services produced nearly double the No. 2 contributor, New York. That means that what happens in California, home to such growth industries as high-tech, biotech, venture capital and film, doesn’t necessarily stay in California. The impact of slow economic growth, or even recession, in the state will ripple through the rest of the country.”

Make sure you aren’t affected.

*** Ah, the Information Superhighway. You can pay bills, chat with friends across time zones, even watch TV. Of course, on the flip side, your children could fall prey to online predators; your identity could be stolen, and now comes news that we can add “information warfare” to that list.

C.L. Staten, CEO and Sr. Analyst at the Emergency Response & Research Institute feels “that the critical computer infrastructures of many nations are increasingly becoming a center of gravity that will be attacked by various kinds of insurgent forces.”

Apparently, this is nothing new. In 1999, following the accidental bombing of the Chinese embassy by U.S. troops during the Kosovo conflict, Chinese hackers launched a coordinated attack against NATO computers…and possibly 1000 civilian Web sites. Additionally, at least four other U.S. government sites, including the Department of Energy were allegedly hacked by attacks originating from China.

Now, twice in three weeks, Chinese operatives have been accused of hacking into foreign government databases, reports Addison over at The 5 Min. Forecast.

“The Financial Times reported yesterday that the People’s Liberation Army hacked into Defense Secretary Robert Gates’ computer in June, which prompted American IT spooks to take down their network for a week.

“Coupled with last week’s revelation that PLA computer nerds hacked into German Chancellery systems, we surmise China is on the information offensive. A couple of years ago, we published a report detailing China’s penchant for what they call ‘total warfare’. Facets of that strategy include economic and IT strategies that require very long-range strategic vision. These news reports have prompted us to dig into the archives and recall our forecasts at the time. We’ll keep you posted on what we dig up…”

Yesterday was a holiday in America – Labor Day. In global markets the dollar went nowhere and oil went up. Oil is above $70 again…its most recent rise attributed to hurricane winds blowing towards the Gulf of Mexico.

The risk of recession is increasing, according to a Bloomberg report. Both business and personal spending are being curtailed by tightness in the credit channel. At the top end, some half a trillion dollars worth of deals are said to be stuck…unable to get financing. At the bottom, ordinary homeowners are facing up to ‘life without refinancing’. It’s not exactly that they are being forced to live within their means; instead, they are just discovering what their means are.

GDP in the United States is growing at a reasonable pace, but the growth is not showing up in paychecks. Our old friend, Scott Burns, reports that wages grew less than inflation during eight of the nine years between ’88 and ’96. Then, in the most recent 10 years, wages beat inflation in almost two of every three years. But the gain was so slight – just $10.61 per week for the whole period – that is was probably erased by rising health care premia. Incomes have been stagnant for at least a generation, says Scott.

Recession is inevitable. And with recession will come a lower dollar, say George and Helen Pardee, writing in the Financial Times.

“Now is the time to sell the dollar,” they say.

“One of the surest bets over the last 35 years was betting against the U.S. dollar,” wrote our old friend Gary Scott recently. Gary reminded us that he practically invented the carry trade; more than three decades ago, he began borrowing in one currency and putting the money on deposit in another, pocketing the difference. He called it the ‘multi-currency sandwich.’ He continues to do it today…using fairly low risk, long-term placements and working with a Danish bank. The way Gary does it, the ‘carry trade’ looks less like wild speculation and more like prudent money management.

Why would the dollar be an especially weak currency? “Because its issuer is especially strong,” is our answer. The dominant imperial power always has a financial advantage. In the modern world, it provides the reserve currency that is used for international trade and global banking. Oil is still (mostly) priced in dollars. So are gold and other key commodities. People use dollars like they use English, to get around in the world. Other nations have to support their own currencies. But the dollar gets much of its support from abroad. Foreigners use it to make billion-dollar multi-national LBOs…and to buy illegal drugs on the street corner.

Americans are also the biggest shoppers in the world…which gives every exporting economy on the planet an incentive to hold the dollar up against its own currency, lest a rival steal a march on it. There is a bias in favor of the dollar, in other words, that goes beyond its actual financial strength.

Our general rule here at The Daily Reckoning is that a man will always seek to hustle something for nothing – as long as he can get away with it. Having the world’s reserve currency permits the United States to get away with the grandest larceny in history. It has spread its paper all over the globe, and as the dollar goes down in value, the foreigners lose money. Too bad for them; they should have known better.

Charles de Gaulle, aided by his sharp economics advisor Jacques Reuff, did know better. Back in the ’60s he noted the ‘exorbitant privilege’ that the dollar enjoyed. He instructed his treasury officials to lug their dollars to Washington and ask for them to be redeemed in gold. This action by the French led to what looked to the Nixon Administration like a run on U.S. gold. On August 15th, 1971, the Nixon government effectively reneged on nearly two centuries of good faith and promises, refusing to honor its paper. Henceforth, it told the world – you’re on your own; your dollars are worth only what you can get for them on the international market.

For a while, it looked as though Americans wouldn’t be able to get away with much more inflation. The world was on to the scam. The dollar was falling sharply. But then Paul Volcker came along and restored faith in the greenback. Soon the coast was clear again.

Still, the dollar slips and slides. You could buy a euro, soon after it first came out, for just 88 cents. Now, it will cost you $1.36. A gallon of gas…a bushel of wheat…a year atYale…everything is rising against the dollar.

“Our government just flips a switch, and out pops more money,” says Strategic Investment’s Dan Amoss. “This kind of behavior is detrimental to our future financial stability.

“Who cares if you have a million dollars tomorrow, if you have to spend $5 to buy what cost $1 today?”

How long will it continue? A lot longer is our guess. Most likely, the gentle slide of the dollar will be followed by a scarier decline. Before it is over, dollar holders will feel like passengers on a runaway bus…they’ll take the first opportunity to get off.

Incidentally, Dan has offered his Strategic Investment subscribers an exit to the runaway dollar bus…in fact, 7 exits. He’s rustled up 7 of the safest investment opportunities available in our current market environment.

Each wealth-protection investment is a powerful shield against the collapsing value of your dollar bills as Washington prints up more of the worthless greenbacks to cover their lies and keep our borrow-and-spend economy afloat.

The dollar may be falling…but the price of wheat is soaring…

“Wheat has gone up like a rocket,” said a farmer in France. “We used to sell it for less than 100 euros a tonne. That was just a few months ago. Now, it’s selling for 260 euros a tonne.

“I think the whole world is changing. You know, agriculture has suffered for many, many years. Who wants to be a farmer anymore? You have to work hard…and you have to risk your money…and sometimes you don’t even earn enough to live on. And here in France, maybe it is the same in the United States, I don’t know, you also have to put up with so much paperwork…environmental protections…employment rules. I work in the field all week. Then, on the weekend, I have to work in my office to keep up with the paperwork.

“But maybe our time is coming at last. Now, the Chinese need food. And they don’t have that much good land to grow it on. They have to get it from us. And everyone wants quality food. And you can’t just produce quality food overnight. It takes many years of careful preparation …especially if you’re raising animals.

“And they’re taking a lot of land out of food production in order to use it to produce fuel. It is probably crazy, because it is a negative-sum operation in terms of energy, but it is a fact. I take two things as given – that the price of fuel will continue to go up…and the price of food will go up.

“You know, in Argentina, they’re moving the cattle to more and more marginal land – in order to switch to growing cereals. Because they can make a lot more money a lot faster by growing grains. It’s easy to make the switch too. Then, when the price of cereals declines, they’ll want to switch back…but it’s hard to go in the other direction. You can add to the world’s grain supply pretty fast. But you can’t add to the world’s beef supply fast…at least not quality beef. It takes time to build up a herd…before you can begin selling in any quantity. That’s why I think I’m better off sticking with cows. They’re not as profitable as grains now, but as these Chinese people get more of a taste for meat…and the quality of Argentine beef goes down…they’re going to want our good French meat.”

We agree…people will always need to eat…and grains (and grain-fed animals) are more in demand than ever before in the Far East.

That’s why we tend to believe that this commodities boom is far from over – it may just be starting.

It isn’t just wheat and grains that have been skyrocketing…the price of gold is up (a weak dollar will certainly see to that) and oil is up as well, as we haven’t even seen the worst of the 2007 hurricane season.

Kevin Kerr’s Resource Trader Alert subscribers have been making some pretty major moolah in light of this recent surge in commodities prices…just on volatility in the resource sector, Kevin’s followers racked up a handsome 99% gain in five weeks on unleaded gas call options… another 119% gains in three weeks on crude oil calls… and a solid 178% gain in just four weeks using call options on heating oil.

Don’t be put off if this all sounds confusing – trust us, it isn’t. Kevin tells you exactly what to say and do.

In our travels, we often meet some very interesting people. And Englishmen are notoriously eccentric. But we met a fellow in Scotland who must have been waiting for a place in a mental hospital.

“Every license plate tells a story,” he told us.

British auto tags have collections of letters, rather than a group of numbers. The letters, he believes, have a meaning that he has to decipher. A personal meaning.

“Oh yes, sometimes they warn me about things that are coming…you know, tax audits…that kind of thing. Sometimes they tell me what the government is doing…or about some insidious plot concocted by my neighbors to kill my lilacs. Of course, you have to learn to read them. You get a license plate that says WOTAGTKY…for example, and you can interpret it many different ways. “Watch out, they are going to kill you,” is one interpretation. But it’s not necessarily the right one.

“In your business, you’re probably wondering if you can use license plates to find out about the movements of stock prices. I don’t know. I’ve never tried. But I’m not a financial guy. Maybe they do tell the financial story; maybe they don’t.”

Hmmm…now there’s a different approach to reading the markets…maybe this guy should write a newsletter for us…

Until tomorrow,

Bill Bonner
The Daily Reckoning

P.S. If you haven’t heard already, Chris Mayer has alerted his Mayer’s Special Situations readers to what he thinks is the next American energy miracle…and did so without the help of magical license plates, imagine that. This whole new resource could reinvent where we stand in world energy markets… but it could also make vast fortunes for early investors.

The Daily Reckoning