"In Politics, What Begins in Fear Usually Ends in Folly." (S.T. Coleridge:Table-Talk, Oct 10, 1830)

As a non-practicing CPA and Economist, I was astonished at the so called $700 Billion Bail-Out (Actually the bill past by Congress is $850 Billion thanks to “pork” additions like giving tax credits to makers of Puerto Rican Rums, and subsidizing manufactures of wooden arrows used in children’s toys). I was astonished as a CPA because to buy worthless Mortgages, the Government (us) must buy the Mortgages in excess of real value to create any benefit to the holder of toxic assets. To illustrate this simple accounting concept, assume Bank “A” below sells their bad assets on their books at $5 for $2 (not zero) to the Government:



Now Bank “A” is bankrupt by definition. The shortfall of protection on the Debt & Equity side of the balance sheet is what causes the run on the bank. The “before” balance sheet debt to equity ratio is 32.33 times (which is typical of most banks). By selling the worthless bad assets at any price below the “book value ($5 in this case) will not improve anything. Our Governments plan to buy bad assets must price these assets in excess of “carrying value”($5) to have any benefit to the bank and its creditors. This so called plan provides no profit to the taxpayers. It is interesting to note that the valuation process for “finding a fair market value” for Mortgages and Mortgage Pools is to be run by “Consultants” not the Feds. It just so happens that our Treasury Secretary was the CEO of Goldman Sachs, and surprisingly, Goldman Sachs is hired to run this scam.

This plan coupled with past and future bail outs will cost us close to an estimated $1.5 Trillion Dollars. The 2009 Federal Deficit could be close to $2 Trillion or 12.50% of our Gross Developed Product (GDP), more than twice the record of 6% set in 1983. The National Debt when the Bail-Out is finished will be equal to the annual GDP of the US which is $13 Trillion.

Warren Buffett showed us the proper way for the Fed’s to bail out Financial Institutions in his helping hand at Goldman Sachs. His company Berkshire Hathaway acquired a new issue of Preferred Stock yielding 10% into perpetuity, exchangeable into common stock at a discounted price. The taxpayers could make money on this sort of scheme. Friday the Government has talked about using this type of scheme. We all hope so! Also, Senator Shelby of Alabama(my new idol) who voted against the 1st bail out had a great idea. He proposed that the Fed’s should guarantee all bank deposits (the Government ended up guaranteeing only $250,000 in bank deposits.)

The stock market (as of 10/10/2008) has lost about $7.50 Trillion from the market high in 10/9/07. This loss exceeds the GDP of China and Japan and is 75% of our current National Debt (10.3 Trillion as of 10/12/08). This has got to hurt! I’m hanging onto Gold. To watch the clock on our National Debt go to the web site, http://www.zfacts.com/p/461/html. Your kids and grandkids will love it. They will love watching this more than “SpongeBob Square Pants.”

Several unintended consequence arose with the current panic cures. Among them, the Government guarantees of money market funds. After this was announced, investors flocked into money market funds by taking their money out of Banks. Aren’t we out to help Banks? To the extent that each Government action causes and equal (and seemingly negative) market reaction, you have to wonder what policy makers will do for an encore. Haven’t we seen this movie before-“The Fed’s create easy money, which inflates asset bubbles, then the Fed’s tighten money supply, which bursts the bubble, then the Feds run another easy money policy to offset the effects of the burst bubble, only to create another asset bubble.

Ladies and Gentlemen, make no mistake as to what just happened. We are abandoning Capitalism by Nationalizing the Banking and Financial System. Who’s to blame? Congress, the Federal Reserve and the President for encouraging no down payment, low interest rate mortgages. The people that bought houses with easy money mortgages they knew they could not pay. Wall Street, who smelled a kill and bundled this crap to sell to investors. The rating agencies that issued “Triple A” Ratings on this junk, and the American Population who spent money like there was no tomorrow. When you point your finger at someone you have three fingers pointing back at yourself. We all are to blame. The market in the short run will have some selling opportunities with “soda pop” rallies, only to be followed by new lows. I suspect the recession could last well into 2010.

In the interim I will stay in Gold and US Treasuries. Now is not the time to panic. Things will get better. Stay liquid, be safe, preserve Capital, stay out of debt, be nice to your family and friends, Vote on Tuesday, and wake me up when the DOW gets to 7500 (it closed Friday, 10/1008 at 8451.19).

Economics 101

In my opinion the US Recession started in December 2007. The dynamics of this recession poses some unusual circumstances that create an interesting dilemma for investors and the US Federal Reserve.

The continuing contraction of debt is by definition, deflationary, while the Government Bail Outs of various failed financial institutions is very inflationary. The US Gross Developed Product has not turned negative (yet) due in great part to Export growth. Currently the US Dollar has gained strength which means, US Exports will decline. Our current problem is that no matter what the Fed’s does, we will have a prolonged recession. I have attached some charts to illustrate the point.

This indicator leads the general activity of the US Economy by about six months. The shaded areas on the charts represent recessions. Note that since 1968, Recessions have occurred when the Leading Indicator has turned below -1 (as it has in the July 2008 data). The Coincidence Indicator is coincident with US Economic Activity. Since 1968, when this indicator is below Zero it represents a warning, and when it is below -1 (as it is now), it is in recession.

The Lagging Indicator lags the US Economy by about four to six months. This indicators typically peaks before a recession and then follows the indicators above down. The Lagging Indicator has peaked and starting down.

Ratio of Coincidence Indicators to Lagging Indicators: This ratio is also a very powerful leading indicator that tends to lead general economic activity by about 6 months. Since 1968, a recession has occurred when this Ratio goes below -1 (which is where it is now).

The unemployment rate inverted is a good coincidence indicator that turns below -1 in recessions. Inverted means as unemployment goes up, the indicator turns down.

This indicator is a very strong leading indicator that represents the psychology of the American People regarding the US Economy. If the consumer is worried about the future, he won’t spend money and the Economy will fill his expectations. Note that when this indicator goes below -1 a recession is underway.

This index presumably measures the Consumer Inflation Rate of the US Economy. The basis for this index was changed in the years, and in my opinion does not represent the real inflation rate of our Economy.

John Williams, the President of Shadow Government Statistics (http://www.shadowstats.com), computes the inflation rate under the method that was used prior to the Clinton years and computes the rate at almost 9.00% versus 5.39% of the new “official” rate.

Trade Weighted Dollar: This indicator measures the strength of the US Dollar against our largest trading partners. If this index goes lower, it indicates the purchasing power of the dollar is declining, and vice-versa. Note the large decline in our purchasing power.

S&P 500 Stock Index: This indicator is a leading indicator and when below -1 indicates a recession. In some cases there have been “Bear Markets” (indicator below -1) resulting from investment problems, not necessarily the US Economy. We are in a Bear Market.

Earnings per Share, S&P 500 Stock Index: Currently, there are Earnings Estimates made through December 2009. Stock Prices generally move with estimated earnings (not current earnings). Actually current earnings (reported Quarterly) are a lagging indicator. The accompanying chart shows increasing earnings starting in the 4th Quarter of this year (December 2008). In my opinion, this isn’t going to happen. I expect declining earnings through the 1st half of 2009.

Gold price: Gold represents fear. The more fear in any economy, the higher the price of Gold. Deflations pose a special problem for Gold. In the Depression, the black market price of Gold initially went up, but as the price level collapsed, Gold began to decline. In the current business environment, deflation is considered more likely than inflation and therefore Gold has started to decline. I think our wonderful Federal Reserve Chairman will not let a deflation happen, and therefore will pump up the money supply to save our “credit nation”.

Reuter Commodity Index: This index measures all commodities which includes, Gold, Oil, Foodstuffs, etc. In the beginning of a Business Cycle Expansion, this index normally starts to rise and levels off as the expansion matures. Because of the Global Expansion over the past 5 years, the commodity index has headed higher. Currently commodity prices are declining led by Oil, Gold, Copper, Aluminum etc. Generally in recessions, the Index is declining.

There is overwhelming evidence we are currently in a Recession. Keep in mine the Bureau of Economic Research defines recessions, and always defines them after the fact. I think we are in for a prolonged recession that will try everyone’s patience. Until our Economy recovers, stay liquid and out of debt.

A Grim Fairytale

Once upon a time, there was Sovereignty that ruled the World. They owned all the Gold, had all the “good people” and most of the people were happy. (As you know you can make some of the people happy all the time, you can make all the people happy some of the time, but you can’t make all the people happy all the time). The Sovereignty had an abundance of natural resources (lots of Gold), had a high level of Unity, and was ruled by a benevolent King and Queen. Even the Knights were hard working, and were loved by the people.

All economic transactions were settled with the Gold Coins. The King minted the Coins and made a large profit by putting some of the Gold in his pocket. Over the years the Sovereignty prospered, built castles in the sky, created a culture that was second to none, and continuously created innovations in Transportation, Technology, Communication, and the Arts. Yes there were some issues with other Sovereignties but the “good peoples” Militia prevailed.

In the beginning of the new Debt Creation policy, the King used the money to build “peoples” assets such as Bridges, Dams, and Water and Sewer systems. This was good because it put people back to work, put money in their pockets, and created new business units. The people returned to normalcy and there was peace in the Kingdom.

Over the years, the King was creating debt as fast as he could, so that he could give the “money” to the people. The Hell with infrastructure! After all, the only way the King could keep his job was to give away money. By doing this the King kept the masses from revolting. Some mal-contents were unhappy because goods and services cost more every month and they were paying more and more in taxes. Soon other Sovereignties were buying the Kingdoms debt. After all, the Kingdom was the best, and who wouldn’t want the highest quality I.O.U on earth. This also helped keep the rate of inflation and interest rates down.

Eventually, the masses were tapped out. They did not have enough money to buy everything they wanted, and to make matters worse, the interest on the Kingdom Debt was sky-rocketing, and taxes to pay for the debt was very high. Again, the King started to worry about a possible be-heading. The King sought council. He found out that Keynes had passed away, but there was a new Wise Man named Greenspan. The King called in Greenspan.

Greenspan said, “We need to create credit cards for the masses so they can buy whatever they want, and create a special kind of debt for buying assets. We will issue a Credit Card to everyone in the kingdom, even newborns. They can charge their desires on the card and pay a small monthly payment. Let the issuer of the Card collect a high rate of interest. The common man won’t know it, but it will take him about 22 to 24 years to pay off one charge. Also, the Kingdom will loan money to the masses so they can buy their homes (even newborns). The loan will require no money down, and low rates of interest for 3 to 5 years. After 5 years, the interest will go up. By doing this, the people can get into a home with no money down and pay very little. By the time the interest rate on the home loan increases, the value of the home will be substantially higher and the Kingdom can loan them more money. Also let me run the Super Bank.” The King liked the fact that even newborns could buy things so he told Greenspan, “Make it happen!” And so he did.

The people loved the new credit facilities and again the Kingdom prospered. Debt expanded in the Kingdom exponentially. Everyone owned a house (even newborns), bought everything they ever wanted, and decided that saving money was for smucks. Meanwhile, the King was getting upset because the money he was receiving from the peoples Mortgage payments was not enough to fund his lifestyle. It is not good public policy to have the King not able to spend more money than the people. Again he called in Greenspan. The King told Greenspan, “I need more money. Taxes and cash flow from the Mortgages is not enough.” Greenspan said, “Sell the mortgages to the private sector and let them package the mortgages into bonds and sell them to the people. This method will liquefy your Mortgage holdings, and will also lower short term Interest Rates. This will tend to keep interest and inflation rates low. As long as the stupid Foreigners keep buying our debt, we will be fine.

The “good people” understood how the system worked and were very much involved in same. There was a high degree of contentment among the people, and they were willing to do almost anything to preserve their way of life.

Then one day, the Kings Gold Mine was depleted. Some people started to hoard Gold, and their Free Market collapsed. Most people spent their Gold holdings on survival. There was nasty and prolonged depression in the Kingdom. The people suffered, the investors suffered, and the King was in a quandary as to what to do. He hired a “wise man” name Keynes to advise him. Keynes said “…the problem is that the people don’t have any more Gold. You have it all! You must print money so that the people, the Kingdom, and investors will survive.” The King queried, “How do we print money?” Keynes said, “The Kingdom must go into debt, and create a Super Bank that can buy the Kingdoms obligations. The Super Bank will print money with your picture on it. The Kingdom then borrows money (just printed) from the Super Bank. The Super Bank then holds the Kingdoms debt as an asset, and owes the Kingdom. Continue this process until everybody is happy. The Kingdom now has money to allocate through the Kingdom for the public good. In affect the Kingdom owes the people, and the people are the Kingdom. Don’t you see? The Kingdom Debt is owed to the people, and the people are the Kingdom, so it’s a wash, and the people will never understand how we did this little trick. We will then “tax” the people to pay for the debt. Of course, you the King will receive the tax. You can put some of the money in your pocket and the rest can service the debt. You must also ban the ownership of Gold, and make it illegal to use Gold as a settlement of debts. Only the new paper can be used for transactions.”

The King had no idea what the wise man said but liked the fact that is picture would be on money, he could keep his Gold, and he could put some money in his pocket. He told the wise man to proceed (like many leaders, he was willing to try anything to get the people off his back). There was no documentation or public vote on the creation of the Super Bank, but as you might get guess, the plan worked. Along the way Keynes conned the King into allowing the Super Bank to set short term interest rates.

Over time, home prices rose exponentially, the Mortgage market boomed and the people were big time happy. Soon, the Kingdom did not produce anything except compliancy. The Kingdom’s people moved their business to other Sovereignties that provided cheaper labor and materials. The Kingdoms principal business was spending on consumable goods provided by other Kingdoms. Their natural resources, Sprit de Corp, and respect for the King were depleted. The Kingdom continued to print money on a parabolic scale, but inflation was contained due to cheaper imported consumable goods. The Kingdoms money flooded the World Market. The Kingdoms excessive money printing policy soon started creating “bubbles”.

Then one day, housing prices stopped going up. Sadly at the same time, the low interest no down payment Mortgages were reset to higher interest rates. The people who have benefited from this give away program were now faced with losing their home. The Kingdoms economy was faced with a major meltdown. Some of the Kingdoms large businesses went broke on wild speculation schemes. The King was worried. Again, Greenspan came to the rescue. He told the King, “let the Super Bank bail them out”. The King was not sure what his advisor said, but decided (afraid of a riot) to grant Greenspan his wish. The Superbank (paid for by the people’s taxes) bailed the “bubbles” out. More money was printed.

The bottom line for the Kingdom was it transferred its wealth to foreign nations. In return it received cheap goods, cheap energy, and a higher standard of living. Now other Kingdoms were beginning to use the transferred wealth to improve their standards of living. They are competing with the Kingdom for basic commodities the Kingdom assumed would always be available. Not understanding why the Kingdom was collapsing, the King, the people and Greenspan continued to print money, stay complacent, and buy stuff.

The end of this tragic Fairy Tale is obvious: The Kingdom lived beyond their means far too long… The Piper has been paid with paper (printed money)…the Piper has been screwed. Now the Piper seeks his revenge with higher rates of inflation, and interest rates.

The moral of the story is: don’t print money exponentially, if you don’t understand the consequences.

Who's in Charge?

Dr. John P Hussman, (www.hussmanfunds.com), the great Economist noted that “…Monetary policy is effectively subordinate to fiscal policy. No amount of monetary discipline can offset an undisciplined fiscal policy”. The only US Government budget spending constraint is a simple accounting identity, namely Spending = Taxes Received + Treasury Bonds Issued to the public + Increase in the Monetary base. This is not a theory, but fact. We worry about inflation, and the growth of money supply but the real problem is the growth of US Government Spending, which is fueled by Debt Expansion.

National Debt on May 7, 2008 was $9.35 Trillion. Interest alone is now $500 Billion a year, which is equal to the cost of the Iraq War for five years. Since September 2006, debt has increased at an average of $1.46 Billion a day. From December 2002 the National Debt has expanded at a monthly compound rate (annualized rate) of 7.08%. This is Inflation. As I have discussed before, Our Government and Federal Reserve has a Paradox. Less Government, less spending, less debt, will lead the economy into a deep recession or even a depression. Thus the Government must spend and spend heavily. Of course the question is who is going to buy our debt? The answer—foreigners and investors at higher yields than offered today. That is, the dollar is going down further, and interest rates and inflation will rise.

Further good news: At the end of the first quarter of this year, US Households were worth a combined $56 trillion down $1.7 trillion from the previous quarter. Falling home prices accounted for $305 billion and declining stocks accounted for $965 billion, the rest of the difference ($ 43 billion) was due to other asset value declines.

Preserving Capital has trumped risk, as traditional asset values fall. Housing, Stocks, Bonds, are all falling. Risk seeking is on hold as investors crowd into T-Bills yielding 1.84% for 90 days. In my view, all traditional assets are overvalued. For example, the S&P 500 Index is currently trading at 1,320.80. The SP index yields 2.14%, and has a current price/earnings ratio of 18.20 for 2008 estimated earnings and 18.83 for 2009 estimated earnings. The current yields and PE’s might have been “cheap” in the easy money days, but in my opinion are not cheap in today’s environment. My value model prices the “Fair Value” of the SP to be 1214.80 (8%) below the current value. The 10 Year T-Bond provides a 4.11% yield. With the real inflation rate at 7.50% (as calculated by John Williams), who would buy T-Bonds? Mr. Williams calculates the inflation rate on the same basis the Government used pre Clinton. A 2600 square foot house has an asking price of $1,100,000 or $423 per square foot. Is this cheap? Where is value versus risk? The answer is---it currently does not exist. The good news however, is like all previous Economic and Investment downturns, proper risk/reward ratios will appear. The bad news, probably later than sooner. Gold, Cash and no debt is the ideal combination to stay out of trouble. I choose to follow that advise.

"There is Always an Easy Solution to Every Problem -- Neat, Plausible and Wrong." -H.L. Mencken

As the housing bubble and credit crisis accelerates, the Politicians, Federal Reserve, and the US Treasury wants to help fix the problem. The Federal Reserve in March “bailed out” Bear Sterns. The Fed agreed to provide a $30 Billion “non recourse loan” to J.P Morgan secured only by the worst tranche of Bear Sterns’ mortgage debt. This is not in fact a loan. If it were, J.P Morgan would be required to pay it back, but no such requirement (unless J.P. Morgan itself fails). Instead of a loan, this is a “put option” which protects J.P Morgan from losses on the collateral, regardless of J.P. Morgan’s own financial status. The effect of the Fed’s guarantee is not to protect the public, but to protect Bear Sterns’ bondholders.

The deal is being defended on the notion that the global financial system would have “failed” had Bear Sterns, not been rescued. But the orderly transfer, netting and settlement of financial contracts is precisely what Title IX of the Bankruptcy Act of 2005 was written to facilitate. In effect, the Federal Reserve and the Treasury decided to ignore existing law and provide a bailout to the benefit of Bear Sterns’ bondholders at public expense.

The clear historical role of the Federal Reserve has been to manage the composition of Federal liabilities (by varying the mix of Treasury securities and monetary base, currency and bank reserves-held by the public). The recent transaction is a dangerous break from that role, in which unelected bureaucrats are committing public funds to facilitate private business transactions and selectively defend the holders of corporate securities. Only Congress has the Constitutional right, by the representative will of the people, to commit public funds. The Bear Sterns deal is a dangerous precedent and a dilution of Congressional prerogative. Even worse, it indicates to risk seeking mismanaged financial institutions that they do not have to face the consequences of their erroneous acts.

Over the next six months there will be other financial institutions that will fail. Do the taxpayers bail out the whole mess (estimated to be $1 Trillion)?

Congress would like to have a Mortgage Rate Moratorium fixing interest rates for two years, and/or forgiving a portion of the principal on these sub-prime mortgages. Good idea. Let the taxpayers pay for this mess too. We now live in a world with high risk, without anyone taking responsibility stupidity and greed. Expect one thing next year - higher taxes, and higher rates of inflation.

I have attached 3 Graphs that indicate that we are clearly in a Recession and that Stock Market is in a Bear Market. Many pundits have expressed the belief that the worst is over for the Stock Market and Economy. I do not share this belief. The Market has had some rallies over the past two weeks which made headlines. Looking closer at these market advances indicate huge short covering, and very selective buying. Hardly the action required to end the Bear Market. The fact is, that selling pressure (supply), as measured by the Lowry Research Corporation (www.lowryondemand.com) is still very high. Selling pressure measures the supply of stock for sale. Historically there have been rallies in primary bear markets that can last 2 days to 3 months. It is my opinion that the market has lower to go.

The bear market will not end until stocks are undervalued. Currently in my opinion, stocks are still overvalued. The S&P 500 carries a PE Ratio of 20.71 times and a dividend yield of 2.02%. Does this valuation and yield sound like good value to you?

So we wait. The next six to twelve months probably will be very boring, with only unpleasant surprises coming. The good news is that the Olympics are coming this summer (assuming the US are allowed to go), the Baseball season has started.

"Two Things are Infinite: The Universe and Human Stupidity: and I'm Not Sure About the Universe." --Albert Einstein

“The Stock Market has reached a permanently high plateau.” Irving Fisher, Yale Economics Professor, September, 1929. The poor man was the leading Economist of his day, and was highly leveraged in the Stock Market before the great crash. After September 1929, Irving Fisher was financially wiped out.

Bear Sterns spokesmen Alan Schwartz CEO said on Tuesday March 11, 2008 that “Bear was not in trouble, and would withstand the Sub-Prime meltdown. On Friday March 14, 2008 “Bear” borrowed and unknown amount from the Federal Reserve to continue operations. The loan is for 28 days. Good luck! Read on.

In the mid 70’s, Continental Illinois Bank set out to become the largest Commercial and Industrial lender in the World. Between 1976 and 1981 the banks lending jumped form about $5 billion to more than $14 billion, while its total assets grew from $21.5 billion to $45 billion. A 1978 article in Dun’s Review pronounced the bank one of the top five companies in the nation. An analyst at First Boston Corp praised Continental, noting that it had “superior management at the top and its management are very deep”. In 1981 a Solomon Brothers analyst echoed this sentiment, calling Continental “one of the finest money-center banks going.” During late 1981 and early 1982 the stock market price of Continental was deteriorating (from a high of 42.00 to 6.50-a drop of 84%). However, Analysts continued to recommend purchase. Interestingly enough, Continental was offering 16% fixed rate loans with the Prime at 20%. Many bankers muttered, “I don’t know how they do it?”

In March 1982 Fitch Investors Service downgraded six large bank ratings, but retained its AAA rating on Continental. In May 1984, The Office of the Controller of the Currency departed from their policy of not commenting on individual banks, took the extraordinary step of issuing a statement denying the agency had sought assistance for Continental and noting the OCC was unaware “of any significant changes in the bank’s operations, as reflected by rumors.

Optimism about Continental’s financial condition ended abruptly in July 1982, when Penn Square Bank, N.A. in Oklahoma failed. Penn Square had generated billions of dollars in extremely speculative oil and gas exploration loans, many of which were nearly worthless, and Continental had purchased a monumental $1 billion in participations from Penn Square. Depositor raids (pulling there money out) crippled the bank. Continental and other banks pressed regulators to find a way to prevent a deposit payoff of Penn Square, a course preferred by the Federal Reserve. The other large banks refused either to inject money into Penn Square or to waive their claims on the Bank. The refusal to waive their claims meant that the contingent liabilities of the Federal Deposit Insurance Corporation would have incurred payouts that were in excess of their funds. This presumably left only one course, namely, the Federal Reserve must “bail out” the bank. The bottom line was that the Fed’s “loaned” the bank the money (printed it) in the amount of $4.5 billion.

Technically the Federal Reserve purchased the banks bad loans. This “loan” was not paid back until 1993 (eleven years). All this going on while the CEO stated that the bank “had no intention of pulling in its
horns.” Does any of this sound familiar? Who really paid for the bailout? You did of course, through Income Taxes and Inflation. We pay for extraordinary speculation by others. A wonderful concept.

Last week my Wife called me and asked if I knew anything about Fremont Savings and Loan, a local Savings and Loan that has a branch across the street from Leisure World. I asked her why? and she said a friend of hers had gone to the bank prior to its opening to make a deposit and was greeted with a line a block long. The people in line told her the bank is going broke. I looked up the bank (Fremont General Corp) and discovered they were large originators of sub-prime loans. There problem was they had sold this crap into Mortgage backed bonds with the caveat that they would maintain a Net Worth at a minimum of $250 million. Woops, their net worth is presumably about $100 million. The bank on March 4, 2008 received a default notice on $3.15 billion. Maintaining a net worth level of at least $250 million was part of the agreement with investors who purchased the loans in March 2007 to support the bank’s obligation to repurchase any loans sold in the deal. To meet the sales terms, Fremont would need to put the amount of money required to make up the difference between its net worth and the agreed upon level in a reserve account or provide a letter of credit for that amount, and Fremont in a press release said that it is not in a position to do either. So far, Fremont has been asked to repurchase about $11 million of the loans sold under the deal. Not surprisingly, Fremont has not filed a Financial Statement since March of 2007.

The good news is that my Wife’s friend got her money, and as she left the bank, she noticed the line at the bank had expanded to about 3 city blocks. Good luck Fremont.

This “Financial Panic” as I have said cannot be averted with interest rates cuts. It’s a Credit Crisis for which the average Joe in the street has lost there trust in the Banks. The next chapter in this “speculative bubble” could be very painful for investors, and the general public. The Political and Social solution to all these mounting problems will be printing more money, Bail Out’s, and higher Income Taxes.

For those of you, who have CD’s at any Federally Insured Bank; remember that you are only insured up to $100,000 per account. It may be time to move money in excess of $100,000 into Treasury Obligations.

My solution is simple: over the next few weeks we will own US Treasury Bills and Notes, Gold, and some Silver. I will watch from the sidelines. Yield on Treasuries are very low, but remember, in the Depression (1932) 90 Day T-Bills traded at a negative yield because it was the only safe place to put “cash”. Now is not the time to panic, but defense, safety, risk aversion, and liquidity is currently the only strategy.

The Bailout

I hate to write about negative events and problems. I would prefer to write about happy things, like my Grandchildren, the joy of Italian Food, and NY Giants making the Super Bowl. I always have preferred a Bull Market to a Bear Market, and a healthy, and happy Economy. The problem I have is that we have big problems. We have some real Economic and Financial Problems that need to be addressed. No doubt, in time, all the problems will be resolved in the long run, but (as John Maynard Keynes said) we eat in the short run. Here are some of the problems we confront for this year:

In the past five years, Wall Street has created yet another derivative-namely, “Credit Rate Swaps”, whereby “bets” are placed between two parties that a given debt will default or make good. The market is about $45 Trillion, which is equal to all of the Deposit’s in the Banks around the World. A Party for a price assumes the value of an “insurance” contract that rises or falls with perceptions of risk. Some players buy them just to speculate. A financial institution, hedge fund, or other player can make unlimited bets on whether loans will either strengthen or go sour. If they default, everyone is supposed to settle up with each other. Even if there isn’t a default, if the market value of the debt changes, parties in the swap may be required to make large payment to each other. Many of the contracts are leveraged. Warrant Buffet says” you are essentially counting on the reliability of strangers to pay up on their contract. The rate swaps are largely unregulated, and the derivatives are off-balance sheet transactions. Who’s going to bail out these transactions? Taxpayers? Who’s watching the store, and what are these instruments worth? Nobody knows!

The lowering of the Fed Funds Rate twice in a matter of weeks excited Wall Street. Yet the Stock Market has not had any significant rally so far. Could it be that this is a credit crunch and not an interest rate problem? No doubt the lowering of interest rates will help the helpless, hapless Banking System and some Reset Mortgages coming due over the next 9 months, but remember, the Mortgage Obligor must now pay higher rates and at the same time make principal payments.

Mammoth infusions of Capital into the US Banking System from Foreign Soveirgn Wealth Funds (Saudi Arabia, Korea, and China) have bolstered Bank Capital, but the Banks are paying 15% to 18% interest on the “loans”. The US Dollar is recycled. We pay foreigners buying Oil and Consumer Goods, and now Foreigners give us the money back.

The US Dollar is in free fall. A nations currency value measures the wealth of a country. If a nation’s currency goes lower, it indicates the lower purchasing power of that currency for World Wide Goods and Services. The US Dollar versus all currencies was 121.29 in June 2001. It now stands at 74.48, a 38.50% decline in purchasing power. Factor in the inflation rate, and our populace has given up over 42% in value in 7 ½ years.

As our we go from “Bubble to Bubble”, The Federal Reserve and Congress keep bailing us out (we pay for it) by lowering interest rates and providing funds to prevent a Recession. In the Great Depression, this was a very good idea. However, in the current economic environment this strategy poises several major problems, namely:

1. Interest Rates cannot go to zero percent (can they?),
   
2. it takes greater and greater infusions of liquidity to prevent a Recession (inflationary). This process is very much like narcotics addiction. Each injection does not create the desired high, so the addict injects more narcotics trying to capture the original high. This process cannot go on,
   
3. the whole process assures a penalty free atmosphere for those that created irrational and inefficient processes, In fact, Wall Street calls this the “Federal Reserve Put”, meaning that any half-baked scheme will be “bailed out”.
   
4. We (taxpayers) pay for the mess made by others,
   
5. Our Economy goes from one bubble to another bubble. We already had the Dot.Com bubble, and the Housing bubble. With cheap money and borrowing rates at all time low’s, the tendency is for investors to borrow and bid asset prices up. The question is what asset class will investors buy next?
   
6. As other Foreign Currencies go up against the dollar, Foreign Central Banks are motivated to keep their trading advantage. To do this, they print more money to prop the US Dollar up (thus selling their currency). We then have an expansion of all Currencies that is inflationary for the World.

The Gold Reserves of the United States have not been full and independently audited for half a century. Our Gold Reserves are being used for the surreptitious manipulation of the international currency. The Treasury Department acknowledges that their Exchange Stabilization Fund has undertaken gold swaps. Barrick Gold Corp acknowledged that the mining company was the instrument of Central Banks in shorting the Gold Market. Now our Government is fooling with our Gold Reserves.

There are two opposing economic possibilities confronting the US Economy. Deflation or Inflation If the Credit crunch gets out of control, we will have a deflation (collapse of credit). If the Politicians and Federal Reserve keep up their advertised cures, we will have inflation. Either extreme is not satisfactory. My bet is we will have increasing levels of inflation, which makes Gold and precious metals viable candidate’s for the next Bubble. Cash is King and Gold glimmers.