Dana Blankenhorn

The Oil Standard

Think of this as Volume 11, Number 18 of A-Clue.com, the online newsletter I've written since 1997. Enjoy.

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I have long been intrigued by what stands for value. (Picture from The Zoo.)

Throughout the 19th century, gold was the standard of value.

The 1896 Crisis, the Cross of Gold speech, these were outgrowths of the 1895 gold loan by J.P. Morgan to the U.S. government in exchange for bonds, which Morgan then sold at the "usurious" interest rate of 4%. With gold as the standard of value, the value of other commodities (like wheat) withered. Farmers suffered, bankers gained. The farmers' uprising was called Populism, and it made Democrats dominant in the farm belt for decades.

Today we have a new standard of value. Oil. And the impact is much the same. For wheat read dollars, for farmers read Americans, and for J.P. Morgan read the Saudi sheikhs, Hugo Chavez and Vladimir Putin.

What makes a "strong" store of value is the fact that its supply is limited, that it doesn't inflate. It's stable. It's sound.

The U.S. dollar is no longer sound. It's being tossed out by Helicopter Ben the way farmers a century ago tossed wheat on the market, and the result is very predictable. The age of the "dollar standard" is over, and while the world seeks a new safe haven, oil will do nicely.

There can be only one response.

A Nation of Makers

At the heart of the economic component in our current crisis is this salient fact.

We are no longer a nation of makers. (A version of this iconic Norman Rockwell image is painted on the side of my car mechanic's workshop in Atlanta.)

In this last generation we have transformed ourselves from a nation of makers into a nation of takers. Most jobs don't really involve the making of anything. They involve either the recycling of money or the spending of it.

I'm proud to say that my lovely bride isn't part of this. One point of pride in her computer programming job has always been that the transaction processing programs she writes make money each time they run. (Another curiosity -- she's been at one employer for a quarter century.)

My son, on the other hand, wants to be a taker. A lawyer. Usually a prosecutor. Sometimes a trade negotiator. My problem with the law is that it doesn't make anything. It refines rules which take from one and give to the other. The plaintiff gets the defendant's money, or the state takes the defendant's liberty. Essential to security, but it doesn't add to GDP.

While the U.S. is still the world's manufacturing leader (believe it or not) our share of the world's value added through manufacturing has been declining throughout this decade. Changing this last fact is the key to a lasting economic turnaround.

Bias Doesn't Help

Having been a business reporter for 30 years this summer I understand the natural bias to identify with your subject.

The job of a journalist is to organize and advocate an industry, place or lifestyle. Thus, a certain bias favoring the political views held by the group you write about is natural.

But at some point your ideological blinders have to come off, or else you're doing your readers and viewers a disservice.

This has plainly happened with the financial press.

Media coverage of the Big Shitpile has ignored the Big Fact. This happened because unregulated markets were allowed to be created, to grow, to soak up much of the world's capital. When two brokers or hedge funds repackage mortgages or other things into new types of trading instruments, they are printing money, just as the Federal Reserve prints money. They're doing it in the same way, by declaring the existence of new paper, by putting a price on it, and making a market in it.

Anyone who does this has a fiduciary responsibility. You become the trustee of your investor's interest, which is supposed to trump your own. Ethical rules can police such a responsibility. So can laws and regulations.

What happened in this decade is entirely new markets and new instruments were allowed to be created, which lacked these controls.

Nothing I have seen, either from the Administration or the financial press, addresses this key point. Nothing I've seen endorsed from either is designed to control these markets. It's all window-dressing, pushing papers and organization charts around in the appearance of doing something while in fact doing nothing.

This guarantees the scandal will happen again, sooner rather than later.

Will you read this in Forbes? Will you see this on CNBC? No you won't. Jim Cramer won't tell you either. The ideological blinders of all these outlets cause them to hide from this simple truth.

We must regulate our markets, or we will lose them.

Let me put this in a way Cramer might understand. You have two casinos. One is regulated. The other is not. Where will you place your bets? Will you do it at a place where, if the casino plays 3-card monty on you they will be caught and punished? Or will you do it where the game is crooked and there's no cop on the beat?

Regulators are cops. When conservatives go on this knee-jerk "anti-regulation" jag they're arguing for lawlessness. Markets which can't guarantee transparency, which act as unregulated casinos, will over time be rejected in favor or markets where honesty is assured.

The growth of the U.S. financial industry over the last 80 years has been driven by its honesty, by its transparency, by the wealth of information on players and games which regulators of all types have imposed. Eliminating these regulations, or going around them, does not make markets more efficient. It makes them more crooked.

Law good. Lawlessness bad.

Halfway Through the Process

The first part of our national economic nightmare is over.

But only the first part. (Picture from Cashflowrollercoaster.com.)

What we've seen in stocks is a classic bear market. Prices fell roughly 20% from their highs, from over 14,000 to (briefly) under 12,000. They then re-traced about a quarter of that loss, and if they go higher still it's no all-clear signal. Most bear markets retrace half their initial loss.

What happens next is a test of the lows. This is just what happened nearly a decade ago in the dot-bomb. It's what happened in the "Asian contagion" of the late 1990s, and in nearly all previous bear markets. If the lows hold it's over.

But the lows don't always hold. That was true for Japan after 1987. It was true for Wall Street after 1930. And in this case there is real fear that the lows may not hold.

The reason is that under all this crap is the Big Shitpile, the mortgage derivatives created by unregulated markets over the last few years. Basically investment banks were creating money on their own, with no controls, by simply defining new securities based on these mortgages and selling them as though they were worth something. The ability to do this inflated home prices, because lenders didn't have to consider the risk a borrower wouldn't pay. The unregulated market was hungry for any new collateral.

Federal Reserve intervention staved off the first phase of panic, but there could easily be more to come. Millions of mortgages will re-set this year. Millions more are "underwater," more money owed than the value of the home. These are both opportunities for speculators to get-out, and since the bankruptcy law of 2005 made home debt less important than credit card debt (you have to pay the credit cards in bankruptcy now, but you can walk away from the home) there may be millions more foreclosures to deal with.

Each one of those foreclosures will have a ripple effect. Each mortgage is tied to other securities, all of which default or lose value when a homeowner walks away. How many are there? No one really knows.

So far home prices have dropped about 11%, and newspapers are saying this is a disaster, but it's really not a big deal. I think prices will fall by at least 20%, probably more, meaning lots more mortgages go underwater, as lenders tighten their standards, knowing they may have to hold the paper themselves for a while.

We have yet to see the second leg of this thing, in any market.

It's Not That They're Clueless

Think of this as Volume 11, Number 11 of A-Clue.com, the online newsletter I've written since 1997. Enjoy.

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My blog friend Oliver Willis calls those in charge of our financial house clueless.

That's an easy mistake to make.

In fact, it's in the nature of our economic system that you go right up to the line of legality in order to maximize profit. Anyone who doesn't do that is an economic loser, either in the short run or the long run.

You want to go right up to the line, peer down over the edge, and maybe move your toes back a bit. That's what your lawyers are there for, to move your toes back a bit.

This is fine so long as the law is reasonable. If the law is reasonable and cops are on the beat, walking right up to the line of legality and staring down into the canyon is both legitimate and good business. It's what makes markets efficient.

The problem in this case is the law was made unreasonable, and the cops chose to look the other way.

All the problems Bear Stearns caused were through the creation of new, "unregulated" markets. An unregulated market is a market that's looking for scandal. Because there is no reasonable line you can walk right up to, it's easy as heck to become Wile  E. Coyote in such a market -- everything is fine so long as you don't look down.

The defaults on sub-prime mortgages last year were when we started to look down.

A Bigger Crime Than Iraq

With very little fanfare, a bearded bureaucrat about my age recently committed a bigger crime than our entry into the Iraq War.

Ben Bernanke, whose title is Chairman of the Federal Reserve Board, is committing half your country's capital -- $400 billion -- against securities  he knows are bogus, home mortgages that should never have been made, collateral instruments that should never have been created.  He compounded this crime yesterday by explicitly bailing out Bear Stearns, the investment bank which more than any other created this Big Shitpile.

The excuse, given even by liberals like Paul Krugman, was that Bear is "too big to fail."

Bullshit.

The Buried Lede in the McCain-Lobbyist Story

I don't care if he shtupped her. I don't care if he saw her socially. I don't care about the why concerning anything he did. (Find the lobbyist on the page where this picture came from.)

This should not be about John McCain. It should not be about The New York Times.

This should be about us, all of us. Did John McCain serve us well, or serve us poorly?

The buried lede is John McCain's record, as chair of the Senate Commerce Committee, regarding telecommunications issues and media consolidation. The fact is he endorsed monopolization, every step of the way.

Why do you see no more local programming on your TeeVee? Why are all your radio stations canned and controlled in Corpus Christi? Why do you have, at most, two choices for Internet access? Why are your bills going up instead of down?

Media consolidation. And John McCain has endorsed it, enabled it, for a decade now. The why or how is really immaterial.

Why the Smart Guys are Panicky

The mood at the end of the annual Davos retreat of big moneybags was, in a word, scared. (Picture from Freakingnews.com.)
 

They're looking at the world economy the way New Orleanians looked at the TV weather shows a day before Katrina hit. They see the thing blossom before them, they're told it's headed right for them, but there are no freeways out of the money business. You gotta own something.

Why panic? The cataclysm has two components:

1. Big Shitpile, the corruption and greed which created the housing bubble; and
2. Stagflation, our dependence on oil and its suppliers' ability to manipulate the price.

History shows that whenever excess, a bubble, is found within the market, you can't turn things around until that excess is wrung completely out. Think about the dot-bomb. Some of the best companies lost half their value. Some lost 90%. Many went under completely. Now that the housing bubble is obvious that is what has to happen.

And the impact of making that happen is catastrophic. Think about it. You've got a $250,000 house. Before this is over it might be worth $125,000, it might be worth far less. Your buyer has to qualify for a fixed-rate mortgage, and put down a substantial down payment. Now how much do you owe on that house? I'd venture to say very few mortgages are half-paid off. And what happens to a loan when the value of the collateral falls below what you've borrowed? Well, on Wall Street they call that a margin call.

What we're seeing right now might be just the tip of the iceberg. Because all the excess has to be wrung out -- in home prices, in the mortgages underlying them, in the derivatives and other crap made with those mortgages.

Yet that's just half the problem.

Hershey Bars for Rich Kids in Harbour Green

Think of this as Volume 11, Number 4 of A-Clue.com, the online newsletter I've written since 1997. Enjoy.

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This is my Alex Baldwin story.

Not Alec. Alex. The father.

When I knew him, I was a toffee-nosed rat-faced git of 15, and he was running the summer camp program for the Massapequa Schools. The rest of the year he was a gym teacher at McKenna Jr. High.

We were coming back from some camp trip on a yellow school bus. (I think we'd harassed the gays on Fire Island or something.) We were full of brio (or our own youthful bullshit) and talking up doing a fundraiser. We had lots of ideas to raise money -- car washes, product sales, babysitting.

Mr. Baldwin brought up the question of what we were raising the money for. "Are you going to give Hershey Bars to all the rich kids in Harbour Green?" he asked. He wanted us to think of those less fortunate, rather than other privileged people, who he assumed could get their own Hershey Bars.

I thought this hysterical at the time, and I still get a chuckle out of it. But these days the joke's on us.

Getting an Economy Back

The financial collapse which began with the Big Shitpile continues apace. (Get Super Bubble Pop here.)

Today the Google Bubble may have finally popped. We predicted that two months ago, giving you plenty of time to get out of the way. At its present price, Google still sells at 25 times next year's expected earnings. A reasonable level might be 20-25 times expected earnings, a nice premium over the 15x current earnings stocks are worth historically. Apple and other "momentum stocks" joined in the downturn, and that's good -- speculation needs to be driven out before we can go up again.

But instead of praying to the tape, or attacking those who got us here, how about a brief focus on some potential solutions to this mess? Everyone with a functioning brain cell (even Lou Dobbs) knows the present "rebate" proposal is nonsense. This means both parties, and all major politicians, are Clueless at this point.

So how about some ideas:

The Rough Justice of a Crash

Both political parties are rushing to bail-out the losers in the present economic crisis.

• Bail out my friends who insured the Big Shitpile, begs Jim Cramer.
• Bail out the rich, says George W. Bush.
• Bail out the poor, say the Democrats.

Unfortunately there's a sort of rough justice which takes place during these market crashes. I have seen it during every single crash I've ever covered, from the oil crash of 1981 through the dot-bomb of 2001 through today.

We don't want idiots bailed-out. Those of us with cash, or those who stayed on the sidelines, want the chance to pick through the wreckage at our leisure. Analysts claim there are two emotions, fear and greed, which determine where prices will go. There's really only greed and greed.

During a boom everyone wants to be venture capitalists.

During a bust everyone wants to be vulture capitalists.

Money Is Just Half The Problem

While unregulated financial markets are a big problem, they are not the entire problem with the U.S. economy.

Or the world economy, for that matter.

The problem for the world economy is a shortage of clean energy, a crying shortage of clean energy which has been 30 years in the making. All our incentives have favored hydrocarbons, and alternatives have been given no fair chance.

Whoever finds a way to supply this demand will get very, very rich. So the whole trick of the next few years must be to re-orient our government's financial incentives in favor of this new supply, and against older, unstable supplies.

In The Answer to All Fears I describe the economic process which must be set in motion, but below I'm going to give you the whole key to the thing.

Silly Season Comes Early

Silly season got here early.

With the conclusion apparently foregone, given the incredibly bad right track-wrong track numbers, we're already seeing some Democrats start serious 2009 policy discussions, even while others worry about how much worse 2008 might get.

The answer is, much worse. As with Texas a generation ago, America is about to lose its banks, with foreign operators coming in to take over. We are about to lose our financial sovereignty.

This will make it harder than ever to get America back on its feet after the coming recession. In the past, you just reflated the economy by pushing out new money. With no one wanting the new money, with the dollar already tanking before the recession starts, this solution becomes ridiculous, just as it has long been ridiculous throughout Latin America.

When Brazil or Argentina lets the books go out of balance, the currency is no get-out-of-jail-free card. The answer recommended by American bankers is to link their currency to ours, to fix an exchange rate which will enforce fiscal discipline. This delivers short-term stability, while drastically lowering local living standards, and in the long run it's asinine. I can't wait to read the Heritage Foundation press release first time someone suggests we tie the dollar to the Euro.

The Habit of Submission

Having just spent a week traveling by air, following several years of being away, I may have a unique perspective on the way the system has changed.

Whenever I was in an Airport, I was induced to conform. Watch what you read. Watch how you move. Watch your stuff. Be suspicious. Take off your shoes. Submit to inspection. Show us your papers.

This is the price we now routinely pay to travel by air. The people I saw in all the Airports I visited, both large and small, shared the same glass-eyed, vacant expressions. The same resignation.

In today's air system you have no rights. This was made clear to us when we arrived. Our non-stop flight was replaced by a one-stop, no notice, no apology, no nothing. The airline didn't even transfer the reservation correctly. We had to stand at a desk, helpless, for 40 minutes, while someone went into a back room to check, manually. We had arrived in plenty of time to have breakfast after getting through security, but this meant we could barely grab a single overpriced sandwich before being shuttled into our cramped seats.

And of course, the connection was two hours late.

Ignored in the Big Shitpile

There are three big problems, laid on top of one another, in the financial mess known as the Big Shitpile:

1. Bad loans were mixed with good ones and sold as securities, even options.
2. Millions of adjustable rate mortgages are re-setting to higher rates over the next three years.
3. Homes are priced at twice their value.

There are a lot of "solutions" being proposed by both parties for the first two problems. (Picture from Bayareahousingbubble.)

No one is even talking about the third, because its implications are too massive to contemplate.

But this is the stark reality. What we're reading now, even the pessimists' argument, is not yet even realistic.

When any bubble bursts, the actual value of things gets cut in half. Usually it over-shoots this mark, then it resettles at the halfway line and starts proceeding upward again, slowly.

• This is what happened to the NASDAQ after the tech bubble burst. It fell from 5,000 to under 2,000, but now trades at around 2,600.
• This is what happened to the Japanese stock market after it peaked in 1987 at around 37,000. It now trades at about half that value, and investors are happy to be there.

This is also what happened in the 1970s, the last time we had a housing crash. Homebuilding stopped in most markets -- at least those outside the oil patch. The price you could get for an existing home fell to much less than its replacement cost, and stayed there. Renting made sense.

That is where the U.S. housing market is headed. That's where it has to be headed in order to regain free market equilibrium. That's the way markets operate.

But you'd never know that from the nonsense being proposed right now:

• Easing the pinch on some "sub-prime" borrowers does not make more credit available for new mortgages. 
• Enabling refinancing of adjustable-rate debt doesn't make the value of the underlying home any greater.
• Giving developers incentives to price some homes below-market is useless.
• A moratorium on foreclosures sounds nice, but it's just delaying the inevitable.

This Week's Clue: The New Mortgage Fraud is Political

Following is the essay you can designate as Volume 10, Number 49 of This Week's Clue, based on the e-mail newsletter I have produced since March, 1997. It would be the issue of December 10.

Enjoy.

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There's a new kind of mortgage fraud stalking the land, the quick political fix.

It's a game both parties can play, unfortunately. A moratorium on foreclosures bails out thieves who signed for loans they had no intention of repaying. The industry's "freezer-teaser" plan gives the impression of progress, but it's really just a way for lenders to pick through the rubble.

Jesse Jackson has proposed that the government take on the loans which are going bad, leaving you and I on the hook for bad loans. He misunderstands what the Depression-era RFC actually did, which was mainly micro-lending to good risks, at a profit.

Here are the plain facts:

1. Housing prices have to come down. That's the only way to make housing affordable.
2. Lending practices have to be tightened. No more teaser rates, no more interest-only except to investors, and simplified documents must become mandatory.
3. Incentives need to be adjusted, and responsibilities attached to everyone in the mortgage process.
4. The criminal law must be applied for fraud by both borrowers and lenders.

It's this last which is most essential. It's obvious a lot of fraud took place here on all sides.

1. Investment bankers created crap, mixing-and-matching bad loans with good.
2. Mortgage brokers pushed bad loans on poor people, and didn't tell them.
3. Many buyers grabbed cash with both hands.

Laws are going to have to be changed, and people with gazillions of dollars in the bank are going to have to face prosecution, not just here but in other countries as well.

Here are my own modest proposals:

What Housing Prices Should Be

The proposed bail-out of the sub-prime market is an attempt to postpone reality past the Bush term of office. (Picture from the Real Estate Bloggers.)

There will be a lot of talk from Democrats approving this about "home affordability" but it will be a lie.

An affordable home should be what it has always been:

A 30-year note in which one-fourth of your take-home income goes to pay off the mortgage.

Everything else is speculation.

We have subsidized housing so that you can't afford a home on this basis. That's the scandal. Allowing people to buy homes with no money down, or with teaser rates, or with balloon notes, or with negative amortization (the principal goes up even as you make payments) is nonsense. These kinds of loans make homes less affordable, not more. They drive up the prices of all homes, forcing more-and-more buyers into the trap of bogus loans.

Housing prices need to fall until they are below this level. They need to overshoot the target so that the inevitable bounce-back achieves parity with what people can afford.

This Week's Clue: Liberate Moore's Law

Following is the essay you can designate as Volume 10, Number 48 of This Week's Clue, based on the e-mail newsletter I have produced since March, 1997. It would be the issue of December 3.

Enjoy.

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When this newsletter launched in 1997 it was called A Clue...to Internet Commerce.

As Internet Commerce became commerce, and as the process of doing business online became standardized, I began looking at other areas to cover and settled upon Moore's Law.

At the start of this decade Moore's Law was racing along on every front, and it seemed there was no way to stop it. So I wrote in my 2002 book. (That's it to the right. The beard is whiter now, but I still have the suit and it fits.)
 

I was wrong. There was a force that could stop many elements of Moore's Law in their tracks.

Politics.

The Big Shitpile

I like Atrios' term for it, not because of Duncan Black's politics, but because it accurately describes what we're looking at. (Picture from The Fattys.)

The present financial crisis was caused by brokers combining so-called "sub-prime loans" (aka shit) with decent mortgages into securities and derivatives. This pile of capital was then traded like real securities, which worked fine until the shit started to stink, i.e. when the rates on those loans re-adjusted to what they should have been all along. The wave of defaults turned the whole pile of securities into something you couldn't price, because it would take enormous work to figure out which bad mortgages were in what jumbo instrument.

The idea was to make a pile on the shit, but the shit stunk up the whole pile. Thus, shitpile.

It gets worse. A lot of mortgage brokers deliberately inflated the price of homes, flipping them over-and-over until values went completely out of whack to reality. ($805,000 for North Massapequa? )

The brokers did this because they made money each time a house sold, and the pay-out rose as the price rose or the quality of the loan fell.

There was every incentive, in other words, to avoid regulation, there were a host of people involved who weren't regulated, and even those areas subject to regulation had regulators who were either asleep at the switch or actively participating. (Picture from Rising Hegemon.)

But wait, there's more. Much of the big shitpile was sold on international markets. It was bought by foreigners who were told they were getting gilt-edged, sometimes even government-backed securities. Which they weren't. They were getting piles of shit. Piles that are defaulting, losing their value. Leaving investors wondering about the credibility of all U.S. government debt (such as $9 trillion we owe as a people) and the word of any U.S. government (even though it was just one Administration, that Administration represents all of us, like it or not).

This sort of thing happened in the past. In the late 1970s Michiganders piled their property into cars and drove to Houston looking for work. A few years later, during the oil bust, Houstonians reversed the process. But we're talking about something that is going on across the country -- there is nowhere to move.

So what are the Bushies doing? Trying to blame liberals. Liberals like  New York Attorney General, Andrew Cuomo, who is trying to look inside the Big Shitpile. This is pure chutzpah, the thief  blaming the cop for the run on the bank caused by the thief's daring daylight robbery of it. Then there's the finger-pointing. This was the predictable result of greed hitting an unregulated market.

Enron? This makes Enron look like a break-in of a child's piggy bank. This is the biggest financial scandal of all time.

Mr. Bubble Admits The Truth

Next year's recession is already baked-into the market. And probably the next years'. And maybe the years' after that. (Picture by Daniel Guidera for iTulip.com ).

Alan Greenspan, the self-proclaimed genius whose silence in the face of frauds never-before imagined has as much to do with this as anything else, admits it. Secretary of the Treasury Henry Paulsen is waking up to it. Banks are trying to build a firewall, but it's too late, too small, the banking Katrina is in the Gulf and it's coming onshore.

The problem is not what you think. It's not the gross size of the debt. It's not the debt's quality. It's the way that debt was allowed to be used, the way it was mixed together, good debts with bad debts, into instruments and options. Now that some of those debts are going bad, no one knows who has them.