by Bill Holter

To all; we are now entering uncharted territory. The government seizure of FNM and FRE opens up the next and terrifying chapter of the credit crunch. As I have posited many times before, this has NOW ENDED UP IN THE LAP OF THE U.S. TREASURY! The Treasury is now the backstop to all things paper. This will be a real life “Atlas shrugged”. There are huge implications to this step. The Treasury will now have between $5-6 Trillion of mortgage loans added to its balance sheet. The Treasury is in a huge deficit already to the tune of $10 Trillion of funded liabilities and over $70 Trillion of unfunded future liabilities. It is over. The U.S. Treasury is broke. This will take the entire banking system with it. The banking system will need to writedown $36 Billion of Fannie and Freddie preferred stock that is carried as core capital. This means at a 6% reserve ratio, that another $500 Billion of credit must be withdwrawn to keep capital ratios from collapsing. The Treasury stimulus plan was $140 Billion [remember those $600 checks]. Now 3 times that amount will have to be withdrawn from the credit pool unless Treasury doesn’t magically credit these banks with $36 Billion.

There is no telling how much the carried loans are really worth in todays market as even prime loans are only fetching .80 cents on the Dollar. This will cost at least $1 Trillion at a minimum for starters. It will all be printed. The credit rating of the U.S. will be downgraded, the interest rates the Treasury will now have to pay will increase substantially. This is so Dollar negative it goes beyond words to describe it. The borrowing ability of the Treasury is now being hamstrung by the same credit crunch that we were assured last Sept. was “contained”. I’m sorry but the ruse is over. A government running a deficit can only do two things to cover the gap, borrow more or print. They can’t raise taxes because that will implode the economy even worse than it already is. They will find it more and more difficult to borrow the sums needed until the auctions begin to fail. Then the “black helicopters” will be out in full force spreading freshly printed Dollars. The dilutive effect to the Dollar will be astonishing. We are entering the Weimar Republic phase. The Treasury will be crushed under debt and the Dollar [Fed] will be crushed through overissuance of new currency used to buy the Treasury debt.
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by James McShirley

Now we know. The giant black hole of derivatives at JPM is about to become the size of Jupiter. With the utter failure of Fannie and Freddie (a culmination of what I predicted 12 years ago) Fannie and Freddie’s massive derivatives portfolios can now be hidden from public scrutiny. These trillions of derivatives, which in likelihood have already failed, can now be whitewashed with the able assistance of the US taxpayer. Also the true values of their mortgage portfolios gets deep-sixed. This is no doubt the single largest financial failure in the history of the world. The Fed had every reason to previously discontinue M-3 reporting. Can you imagine what is about to happen to the dollar supply once this catastrophe starts getting paid for? Look for wild market gyrations as these derivatives get dealt with by the insiders who will now know both sides of the trade. What a deal, the taxpayer backs you and you know both sides of the trade, how can you lose? The derivatives may now become hidden from view, but the inflationary implications will become VERY evident. Another ominous problem facing FNM and FRE is a collapse in their pension plans and retirement funds. Retirees and current employees holding FNM/FRE stock will get wiped out, however a pension fund collapse would mean open revolt. This is another side-bailout I see coming.

Since FNM/FRE’s gigantic derivatives allegedly hedged against rising interest rates I think it’s safe to say you won’t be seeing any Fed interest rate hikes coming soon. This government takeover of the largest financial entity in America has in one fell swoop put into question ANY guarantee of debt, sovereign or otherwise. With this news gold should be up hundreds, maybe a thousand dollars if free markets were allowed. They will need to throw the kitchen sink at paper gold to prevent it from revealing the truth of what just happened. US Treasury bond prices now look egregiously high. This time it might not work. Next up for the weekend-only government news release program? Bailouts for GM, Ford, the entire banking industry, and who knows, if I’m hearing Bill Gross correctly maybe even PIMCO.

An article in the Sunday Telegraph ( 27 July, 2008) reveals that HM Treasury is planning to bail out U.K. mortgage lenders to the tune of amost £50 billion! The article explains that the Treasury would swap or exchange Gilt Edged Treasury paper for mortgage debt! Basically Gilt Edged Treasury paper is a euphemism for ripping off the taxpayer through the indirect tax called inflation. What else would one expect from a socialist governmet?
The Sunday Telegraph Article

This is President Nixon’s announcement of the end of gold convertibility for the American dollar. It is interesting to note that all the great things Mr Nixon predicted would happen like a stronger dollar, low inflation and a rebalancing of the trade deficit didn’t! In fact with the abandonment of gold as a monetary anchor the dollar has gone from just over 4 Swiss francs to almost parity today against the franc. Inflation was rampant in the 1970’s also as Mr Nixon closed the “gold window” and has remained rampant ever since and as a result created multiple bubbles of which the latest is the housing bubble. As for the trade deficit it has only gotten worse! America nowadays exports roughly $700 billion less than it imports from abroad! One also only needed $35 back in 1971 to buy one troy ounce of gold! The Austrian School of Economics was right that if the dollar was allowed to float versus gold the value of the dollar would plummet against the yellow metal! Milton Friedman and other mainstream economist were completely incorrect as they pointed out that the value of gold would drop precipitously once the gold standard was abandoned.

An Escape Route in a Time of Disaster

Darryl Robert Schoon
Jul 22, 2008

Only those who have gone too far know where the limits should have been.

Money served throughout history as a medium of exchange and as a storehouse of value. But when gold and silver coins were replaced by paper currencies, money no longer was the same. Paper money, no longer having intrinsic value, now functions only as a medium of exchange, a function that degrades over time.

The value of paper money continually loses value because the constant printing of paper money constantly dilutes the value of previously printed money. The more paper money printed, the less paper money is worth; and today, money is being printed at a faster rate than at any time in history.

In fiat paper money systems, today’s paper money will be worth less than tomorrow’s and will be worth less the day after ad infinitum. This constant degradation of paper money is known as inflation. When the process rapidly speeds up, it is known as hyperinflation. Remember that word.
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By John Browne, senior market advisor – Euro Pacific Capital

This week, we were treated to strong statements by both Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke about the desirability of a “strong dollar”, and the intention of policy makers to pursue strategies that will enhance its value. To the relief of many, the dollar responded to the moral support and managed a mild rally. The move is inconsequential. The harsh realities have not changed in the slightest, and the dollar is set to continue its overall decline.

Although some investors respond to such jawboning, the more sophisticated international players, who in large part determine the foreign exchange market, do not. Why the bearish sentiment despite the bullish talk from Washington?

First, the political situation is that both Paulson and Bernanke were handed a poisoned chalice by their predecessors. By consuming more than we have produced for decades, Americans are now confronting the reality of diminished living standards. These inevitable declines have been masked by a series of massive liquidity injections by former Fed Chairman Greenspan. This was done to avoid the political cost of the natural corrective medicine of recession. It fueled both the dot.com and the real estate booms. The current liquidity injections are now fueling inflation in food and energy.

The problem for policy makers is that large portions of the electorate are starting to realize that a weak dollar is not simply a problem for those who vacation in Paris. People innately understand that a falling dollar is adding to the cost of living. So there are very strong political reasons for the Fed and the Treasury to talk tough on the dollar. In his Congressional testimony, Bernanke noted that the strength of the dollar is “a top priority”. Notably, he did not say that it was “the” top priority.

The political reality of the continued erosion of American wealth, and the reluctance of officials to allow the public to fully comprehend the extent of the problem, has tied their hands and feet. However, their mouths still have the ability to move freely.

While inflation inflicts greater economic damage over the long term, recession causes more “political” damage over the short term. In an election year, it may come as no surprise that the short term problems will attract the lion’s share of attention. However, the rest of the world is not nearly as concerned with these political points, and instead favors combating inflation over recession.

Doubtless, Bernanke and Paulson see the acute danger of raising rates to combat inflation and to defend the U.S. dollar. The present recession is based on a housing collapse of gigantic proportions and could all too easily be pushed into a depression by an interest rate hike. With this terrifying prospect in view, it is little wonder that Bernanke and Paulson are keener to avoid depression.

Therefore, like a tackler in American Football or in Rugby, it pays not to look at what an opponent ‘says’ with his eyes or arms or mouth, but at what he ‘does’, with his feet! By ignoring the head fakes, and concentrating solely on the fundamentals, it’s easy to see that the Fed is pursuing a policy of inflation and dollar debasement. So, expect continued soft to neutral action on interest rates, accompanied by further overall weakness in the U.S. dollar.

With such a stance likely to be in place well into 2009, international faith in the U.S. dollar may fall to such depths that the special “reserve” status it enjoys may be challenged by the Euro. This possibility would move a step closer to a probability once the European Union becomes a sovereign state after January 1, 2009.

By Peter Schiff

This week, as the financial sector began to give way under the unbearable weight of bad mortgage debt, the Federal Reserve stepped in to save the day. At least that’s what it says in the script.

In a surprise move, the Federal Reserve announced its intention to swap $200 billion of treasury debt for $200 billion of potentially worthless mortgage-backed securities. The Fed may have been partially spurred to take the step as a result of the rapid collapse of Carlyle Capital Corp. a publicly traded private equity firm that is a subsidiary of the Carlyle Group. The Dutch firm could not meet margin calls on its depreciating collateral of AAA-rated mortgaged-backed securities guaranteed by Fannie Mae and Freddie Mac. On Friday, the Fed then took the unusual step of providing emergency “non-recourse” funding to Bear Stearns, collateralized by that firm’s similarly worthless mortgage debt. Apparently the Fed now stands willing to assume any mortgage-related risk that no other private entity would touch.

That the Fed would take such extreme measures, which would have been considered unthinkable even a few months ago, followed a few notable media events that may have affected their thinking. On Monday, Wall Street was rocked by an article in Barron’s that suggested that government sponsored lenders Fannie Mae and Freddie Mac lacked sufficient capital to cover the likely losses on the $5 trillion in mortgages they insure (a position that I have taken for years) and raised the possibility of either bankruptcy or a government bailout. On CNBC the next day, Paul McCulley, the managing director at Pimco, the world’s largest bond fund, publicly called for the Fed to use it balance sheet and its printing press to buy mortgages.

According to the Fed, its new plan does not amount to buying mortgages but simply accepting them as collateral for 28-day loans. However, will the Fed really return these ticking time bombs to their true owners in 28 days, inciting the very collapse its actions were originally designed to postpone? Why does the Fed believe that the mortgages will be marketable next month; or the month after that? Nor can we believe that such “loans” will be restricted to only $200 billion. Bear Stearns and Carlyle are certainly not alone in massive exposure to bad debt. Given the unprecedented leverage that many of the biggest financial firms used to play in this market, there will be many more failures to come. Does the Fed stand ready to bail out all comers? Based on this course of action, the Fed, or more precisely American citizens, will end up with trillions, not billions, of such securities on its books.

The problem with these mortgages (other than the borrowers lacking any means or desire to repay them) is that the underlying collateral is worth a fraction of the face amount. With recent foreclosure recovery rates amounting to less than 50 cents on the dollar, it is no wonder that no one wants them. The real estate bubble allowed borrowers to leverage themselves to the hilt using inflated home values as collateral. However, now that the bubble has burst, mortgage balances far exceed current property values. It is a trillion dollar time bomb that no one can possible defuse.

Paper dollars are technically Federal Reserve Notes, which means they are liabilities of the Fed. When it puts newly minted notes into circulation it does so by buying assets, usually U.S. treasuries, which it then holds on its balance sheet to offset that liability. By swapping treasuries for mortgages, the Fed effectively alters the compilation of its balance sheet and the backing of its notes.

However, backing paper money with mortgages is nothing new. The French tried it in the late 18th Century, and it lead to hyperinflation. Assignats, which were first issued in 1790 to help finance the French revolution, were backed by mortgages on confiscated church properties. Although the stolen underlying collateral did have some value, the revolutionaries saw no reason to limit how many Assignats were printed, which resulted in massive depreciation. Within three years, price controls were introduced and failure to accept Assignats, initially an offence subject to six years in prison, was made a capital crime. By 1799 the currency was completely worthless.

If even the threat of death could not prop up the Assignat, does anyone believe that the currency could have been saved if Robespierre had forcefully mouthed a “strong Assignat policy” as President Bush is now doing with the dollar? Rather than repeating the mistakes of history we should learn from them. Our own failed experiment with the Continental currency as well as the Great Depression should prove conclusively that it is Austrian, and not French, economics we should be following.

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