Thursday, January 31, 2008

A Stock Market Bottom?

A Stock Market Bottom?

By Steve Saville | 31 January 2008

Below is an extract from a commentary originally posted at on 24th January 2008.

As noted in the email we sent to subscribers following Tuesday's (22nd January) dramatic US trading session:

"There were more than 1100 new lows on the NYSE on Tuesday, which is something that has only happened on four prior occasions over the past 40 years. It happened in May of 1973; it happened on the day of the 1987 stock market crash; it happened on 31st August 1998 (the day of the US stock market's bottom during the 1998 financial crisis); and it happened at the peak of last August's financial market panic."

We will now take a look at the situations mentioned above with the aid of charts from the excellent web site.

The first chart shows the most recent two occasions when the number of new lows on the NYSE exceeded 1100, including this week's event. Notice that the '1100+ new lows day' in August of last year was followed by a strong 2-month advance to a new all-time high, after which the market embarked on the downward trend that led to this week's selling climax. Last year's dramatic surge in new lows was actually the 'odd man out' in the historical record in that it wasn't followed, within three months, by a successful test of the bottom reached on the day of the selling climax.

Click Here, or on the image, to see a larger, undistorted image.

The next chart highlights the bottoming process during the 1998 financial crisis. For all intents and purposes the stock market reached its ultimate correction low on 31st August 1998— the day on which the number of new lows was greater than 1100. Notice, though, that the 31st August bottom was tested about 6 weeks later.

Click Here, or on the image, to see a larger, undistorted image.

Moving along to the famous 1987 selling climax depicted on the chart presented below, notice, again, that the NYSE Composite Index returned to test its panic low before a sustained advance got underway.

Click Here, or on the image, to see a larger, undistorted image.

Last, but certainly not least, we'll take a look at a chart showing the dramatic May-1973 surge in new lows and its aftermath. The chart displayed below reveals that the selling climax near the end of May-1973— as marked by new lows surging to more than 1100— was followed by a choppy rebound that lasted about 5 months. The market then returned to its downward path.

Click Here, or on the image, to see a larger, undistorted image.

Although the recent decline was much steeper than the one that led to the May-1973 selling climax, we think it makes the most sense to compare the current situation with 1973. The reason is that the May-1973 selling climax, like this week's selling climax, occurred in the midst of a secular (very long-term) bear market, whereas the 1987 and 1998 climaxes occurred within the context of a secular bull market.

As an aside, for the past seven years we've consistently maintained that US equities are mired in a secular bear market as defined by long-term downward trends in VALUATIONS (P/E ratios, etc.) and REAL prices (gold-denominated prices). In a high-inflation world it is very important to define the long-term trend in this way, rather than in terms of nominal dollar prices, because it is purchasing power and not monetary value that matters. For example, if the US stock market were rising at 5% per year while the US$ were losing purchasing power at the rate of 10% per year then it would not, in our opinion, be reasonable to claim that US stocks were in a bull market. What we would have, in that situation, is a bear market in the dollar as opposed to a bull market in equities. To say otherwise is to say, in effect, that a million dollars is a million dollars regardless of whether it can buy a beautiful house in the best part of town or an ice-cream cone.

In any case, even if we assume the bearish 1973 parallel, the historical record suggests that the stock market has just made a low that will not be decisively breached for at least 5 months.

Steve Saville



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Bank Reserves Go Negative

Mish's Global Economic Trend Analysis

By Mike "Mish" Shedlock | 31 January 2008

Bank Reserves Go Negative

I have been watching a chart of Borrowed Bank Reserves for several weeks. The action is unprecedented.

Borrowed Reserves of Depository Institutions

Click Here, or on the image, to see a larger, undistorted image.

The NFORBES Chart above is courtesy of St. Louis Fed.

Here's an interesting excerpt from the book Investing Public Funds by Girard Miller about borrowed reserves.

"Another useful indicator of the Federal Reserve's relative monetary policies can be found weekly in the Federal Reserve data. A key statistic is the net free reserves or net borrowed reserves line item. This statistic measures the degree to which depository institutions have found it necessary to obtain funds in the Fed Funds market and through the Fed discount window in order to obtain required reserves.

During periods of central bank credit-tightening operations, the depository sector might find it necessary to borrow funds to meet reserve requirements. This practice results in net borrowed reserves, which shows as a negative number. Conversely, if ample funds are available through the banking system to meet reserve requirements, banks can become net lenders of reserves through the Fed Funds markets"

Given that the Fed is certainly not in a credit tightening mode, we must look for another explanation. Here it is: Banks in aggregate have now burnt through all of their capital and are forced to borrow reserves from the Fed in order to keep lending.

[ Normxxx Here:  For the financially challenged, this means that the banks are technically insolvent— they owe more than they are owed.  ]

Detail comes from the Federal Reserve H3 Release.

Table 2 Not Seasonally Adjusted Reserves in Millions of Dollars

Click Here, or on the image, to see a larger, undistorted image.

Total Reserves for two weeks ending January 16th are $39.988 billion. Inquiring minds are no doubt wondering where that $40 Billion came from. It's a good question. The answer is the Term Auction Facility. You can see that figure in Table 1 of the H3 release (not shown).

Were it not for the Term Auction Facility, banks would have had to raise another $40 billion in capital by selling assets or some other means. We will look at "other means" in just a moment.

For now, the Fed is not disclosing who is borrowing under the Term Auction Facility, probably out of fear that people just might find out what banks are capital impaired and by how much.

January 29 TAF Auction

Forbes is reporting Fed's TAF auctions $30 bln 28-day loans at 3.123 pct.
The Federal Reserve's latest loan auction through its Term Auction Facility (TAF) produced the lowest interest rate, lowest bid-to-cover ratio and fewest bidders yet. The lower demand suggests an improved liquidity situation in financial markets.

Yesterday's auction of
$30 bln 28-day loans came in at a 3.123 pct interest rate, a 1.25 bid-to-cover ratio with 52 bidders. This was the fourth auction under the new TAF program designed to relieve pressure in the short-term, inter-bank funding market [[i.e., the banks are just rolling over the borrowed funds! : normxxx]].

The Role Of The Monolines

What Happens if Ambac (ABK) and MBIA (MBI) are downgraded? That too is a good question. Let's take a look.

MarketWatch is reporting Banks may need $143 billion in fresh capital.
If bond insurers are downgraded a lot, banks will need as much as $143 billion in fresh capital to absorb the impact, Barclays Capital estimated Friday. Citigroup Inc. (C), Merrill Lynch & Co. (MER) Bank of America Corp. (BAC), and Wachovia Corp. (WB) are among U.S. banks most exposed to bond insurers, or "monolines" as they're also known, Barclays Capital wrote to investors.

The Telegraph is reporting Banks 'face a further $300bn sub-prime hit'.
The world's financial institutions will have to write down a further $300bn (£152bn) of US sub-prime losses before the crisis is over, according to a study by consulting firm Oliver Wyman.

"While governments, central banks and regulators scramble to address the aftermath of the sub-prime fallout, several other crises are mounting."

Tumbling property prices— especially in the UK and Spain— a weakening dollar, a possible collapse in commodity prices, and a fall in Chinese and Indian stocks will
"disrupt" the global economy, the report claimed.

As noted in Banks Attempt To Freeze Balance Sheets “Large money center banks have virtually frozen their balance sheets, reluctant to lend even to good credit,” according to Scott Anderson, a senior economist at Wells Fargo.

However, rising numbers of foreclosures are forcing assets back on to bank balance sheets in spite of that desire to freeze. It's no wonder banks are spooked by those walking away from debt. See 60 Minutes Legitimizes Walking Away for details.

Banks Raise ATM Fees To $3.00

One method of raising capital is to increase fees. $3 ATM Fees are one such method.

"They're looking for ways to make up for the losses and nickel and diming appears to be the only way they can do it," Consumer Affairs analyst Joseph Enoch said. Today, the average ATM fee is $1.78, while five years ago it cost a little more than a $1 to retrieve money from a bank with which you didn't have an account.

In some areas, JP Morgan Chase, Bank of America and Wachovia fees have hit $3 for non-customers. Some banks now charge their
own customers a fee for the convenience of using an ATM to the disdain of some.

Another way to raise cash (and a very expensive one at that) is to offer way above market rates on savings deposits and CDs. Let's take a look at some current offers on savings accounts.

Savings Deposit Rates

Click Here, or on the image, to see a larger, undistorted image.

Chart courtesy of Bankrate.Com.

Any bank paying those rates on savings accounts is desperate for cash. Those looking for candidate banks liable to go under need only look at the price banks are willing to pay for capital.

I cannot stress this enough: If you accept these offers, please make sure you never go above the FDIC limit.

$3.00 ATM Fees Will Backfire

As for banks charging $3.00 ATM fees, I think the strategy will backfire in several ways. Some customers will stop using anything but their own bank's ATMs. Instead of getting $1.50 banks will get nothing. Other customers will opt to max out the cash they take on each transaction to minimize the number of transaction fees.

Banks charging their own customers will find many switching banks out of resentment. In the grand scheme of things, $30 Billion or $40 billion is not a lot of money. However, when lack of reserves would otherwise prevent lending, it certainly is a lot of money. Imagine a major bank telling customers: "We have no cash reserves so we can't renew your loan." With that in mind, banks are scrambling to raise cash .

Borrowing reserves is expensive, paying 5% on CDs and Savings Deposits is expensive, and in the end, attempting to extract more blood out of consumers by raising ATM fees to $3.00 is going to prove expensive. There are simply no good ways to raise capital [[but it's why the Fed is desperately trying to steepen the interest rate curve (banks make money on the difference between short and long term rates): normxxx]]. And the problem is going to get far worse before it gets better.

A deepening recession, a falling stock market, plunging commercial real estate, and social acceptance of 'walking away' are all going to exacerbate the problems Bernanke and lending institutions face. A Crash Course For Bernanke on academic theory is coming. It will be interesting to watch how he reacts to it.

  M O R E. . .


The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Wednesday, January 30, 2008

RE Scams by Homeowners!

The Modern Psychology Of A Crashing Housing Market: Just Sending In Your Home Keys
Click here for a link to complete article:

By Dr. Housingbubble | 30 January 2008

Well it shouldn’t come as a surprise to you that the market was expecting new home sales to come in at 645,000 but the actual number came in at 604,000. Being off by 41,000 isn’t a big deal given how horrible the establishment is at predicting the will of the people. Just a few short months ago, it was almost a given that the front runners in the 2008 presidential race were going to be Hillary and Rudy. It was hard to see anyone else in the race (that is if you only listened to the 'scientific' pollsters). Yet, just these past few days, we just saw how frustrated the public is with the status quo and with following in the footsteps of the past. They gave a resounding vote to someone new (in S.C.) and someone utterly different (in Fla.). Yes, we’ve heard it a million times, but people do want change. Even Joe and Susie public realize that when they hear "tax cuts stimulate the economy" and watch corrupt corporation leaders walk off scot free, with massive severance packages to boot, they understand that that a trickle down "tax cut" (two weeks groceries?) does not translate to a healthier economy or better wages.

Many are becoming convinced that the country is devolving more and more into a plutocracy— and looking at wealth statistics, especially distributions, this belief seems well founded enough. Corporate welfare/bailout is alive and well (with a few crumbs for the masses [[and isn't it only fair that we share out the same amount among the upper 1% as among the remaining 99%— fair's fair! : normxxx]]). The housing bubble just went mainstream with a cover report on 60 Minutes called "House of Cards." You can click on the link and watch the clip if you did not watch it during the weekend. It is well worth your time and plays out like any bubble blogger post. Take a wild guess at what city was the main focus? Stockton, California! In fact, they were showing folks going on repo bus tours to buy homes.

Sort of like a Universal Studios tour except instead of Jaws coming out to eat you alive, you have overpriced McMansions waiting to sink their teeth into your wallet. For any of you who have taken trips to the Inland Empire to what are now defunct new subdivisions, this will not come to you as a surprise. The 60 Minutes' piece didn’t shed any new light in regard to numbers and economics that many 'housing blog' readers wouldn’t know, but it cemented the fact that, yes, housing is in a historical bubble everywhere in the nation. It is a good piece and well worth your time.

The thing that really hits home (pun intended) is how willing people are to game the system. Learning from the best on Wall Street, many recent American homebuyers are giving the middle finger to (often innocent) lenders (it was mostly the brokers and "loan originators" who did the scamming) and are willingly going into foreclosure. They show two couples that bought homes with exotic mortgages. One couple talked about buying another (less expensive) home in a better area and about not knowing or understanding the terms of their current note— that was their justification for not trying very hard to keep their home. Another couple added to our insight into the psychology of recent buyers, telling us they are allowing their foreclosure to happen because "the home isn’t appreciating" and therefore just isn’t worth it. If you think about the psychology behind this and dig deeper, we have a nationwide epidemic of people looking for free lunches. People from Wall Street to main street are expecting profits each and every time they take on any risk, whatever the odds of payoff; then when losses appear, they expect everyone else to bail them out.

A reader (Linda) sent in this piece about "Intentional Foreclosure" from CBS News in Sacramento:

"This is how it works. Bob paid $420,000 for his home. Then he notices the house across the street, with more upgrades, is selling for $315,000.

“So Bob, who has pretty good credit, decides to buy the cheaper house.
He can’t afford both; so then he walks away from his original home, letting it fall into foreclosure. That will hurt his credit, but he’s willing to take the hit for a more affordable home and some cash [[besides, in a measly 7 years, he's whole again!: normxxx]]

“Is it wrong to steal when you’re hungry (e.g., for a few staples, such as a 100" plasma TV)?

That’s an issue that a lot of people are trying to figure out right now,"
says Linda.

I imagine that this strategy will become more and more pervasive as the market declines. A large number of people try to build up good credit to have the ability to purchase a home. And for many this is the end-game of good credit. So if you can get out and buy another home while your credit is still good, lock in a good rate (thanks to Boom Boom Bernanke), move into your new place and simply try to sell your previous home or just let it foreclose, then you've succeeded. And you wonder why there is such an uproar for rate cuts. Suddenly that poor family being kicked out in the street is mixed in with a boatload of folks that speculated in real estate, got burned, and now want you to pick up the tab. No need to mince words, this is a bailout. You wouldn’t be receiving your $600 check in the mail (payoff?) and allowing those golden parachutes to greedy companies and recent 'buyers' else. How do you feel about raising mortgage caps to $625,500 now?

The Psychology Of Housing Greed

From Calculated Risk we get a glaring statistics summing up the current market:

“From the Fed’s Flow of Funds report, household real estate assets totaled $20.99 trillion at the end of Q3 2007. So a 30% decline in prices would reduce "housing wealth" by about $6 trillion (Merrill’s number).”

Let's run a few scenarios to see potentially how much damage can occur:

Click Here, or on the image, to see a larger, undistorted image.

Merrill Lynch has already stated that it is very possible that we will see a decline of household real estate wealth by 30 percent. In Southern California we have already seen 10 to 20 percent drops in all counties. I would imagine simply by the sheer size of the homes and the extent of bubble prices, California will be a large percentage of that $6 trillion loss. Statistics! Go back to the presidential polls of a few months ago. The media and pollsters were utterly off and even [just before Iowa or S.C.], they were predicting Hillary losing by only a few percentage points (10 points at most) but things didn’t work out exactly as planned. And this was days before the vote!

Anyone using current housing prices is going to get burned because once you enter into a major bubble and you try to use peak prices to measure your decline, you are using artificially inflated price measures to predict the future. Did anyone see California housing going up nearly 200 percent in some regions over this decade? Of course not. Yet that is the definition of a bubble. Prices disconnect from reality and it becomes a question of "homeowner dreams", consumer behavior, and the frontiers of what is legal and/or moral. Add to this a semi-corrupt industry where the corruption and greed spread from speculators, banks, brokers, agents, Wall Street, politicians, to builders and even normally ultra-conservative foreign investors, and you realize that everyone wanted a free lunch. As the 60 Minutes piece highlighted, at each step of the process someone was getting a cut.

Now we have this pervasive mentality (of unrequited greed) where people are not only willing to let their homes be foreclosed on and walk away from their contracted debt obligations, but we have people that are prepared to do things (and self-justify them) that border on the criminal. In the piece cited above, we also read about people taking out "some equity" just before knowingly letting their homes go to foreclosure. Think about the mindset that occurs when this is happening. "Hey honey, we signed a contract, but so what? How about we tap into our HELOC and take out $50,000 and let this home go into foreclosure. By that time we'll have bought our new home and taken out some cash, so who cares what happens to our 'credit'. After all, Wall Street is just one crooked scam anyway and the lenders are more than willing to give us the money. Take that Wall Street!"

I assure you this conversation (or something very much like it) is happening at many households in the US as we speak. That is why fierce regulation and enforcement are utterly impotant. Rushing to raise caps is a knee-jerk reaction to the deeper and more profound problems with the economy and the psyche of many homeowners, who (often rightly) feel they have been scammed (by the 'system'). People are mostly willing to go to almost any lengths as long as they believe they can get away with it. All of these 'get rich quick books' cater to this free lunch mentality ('everybody's doing it!'). Once at the fringe of late night infomercials, now a majority of Americans think 'nothing down' is a birth right. Ben Bernanke was surprised that a trader in France was able to milk $7 billion from the markets. Why is that so shocking? If you allow people with no appreciable assets or income to take out $2 million loans in California, I assure you they will. When will the Fed and politicians stop to think: does this next move actually make any sense (especially long-term)? I guess that is a lot to ask in an election year.

Subprimed For Disaster: A blast heard 'round the world!
Irrational Housing: Insiders out Early and The Duesenberry effect.
Is Housing the Next Rocky Balboa? Only 2007/8 Will Tell…

  M O R E. . .


The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Monday, January 28, 2008

Reviews Of 'Supercapitalism'

Reviews Of Supercapitalism:
The Transformation Of Business, Democracy, And Everyday Life

By various | 28 January 2008

Supercapitalism: The Transformation of Business, Democracy, and Everyday Life"
by Robert B. Reich


Whether or not you agree with him, Robert Reich, former Secretary of Labor in the Clinton administration, opens up a dialogue on the joint problems of economics and social responsibility.

Reich makes a compelling argument that supercapitalism has robbed democracy of much of its power. supercapitalism by the definition presented in the book is simple— the consumer is king and prices always go down. What Reich looks at is the cost of such a narrow focus to companies, society, the individual, and its impact on the workings of democracy. Reich also points out the hidden costs and 'contributions' of the rise of well heeled, single-purposed, different lobbying groups (e.g., PACs) to politics and the political process, and to the process of globalization. This is hardly new. But it has become markedly more pronounced in recent years.

So how is democracy compromised? The 'great compromise' is not driven by some overarching conspiracy or hidden agenda— it is driven largely by the simple mechanics of Adam Smith's 'marketplace'— by simple consumption. Ultimately Reich argues that it robs the common citizen (the 'hoi polloi') of legitimate, effective, democratic control over his society. It's not surprising that this is a highly charged issue because the economics of what benefits society (or "the common good" as Reich calls it) often gets tangled up in the web of politics, history, and ethics. Reich also points out that the cost of supercompetitiveness and constantly falling prices is a loss to the economic and social health of America. Reich points out that everyone, of course, is driven to get the lowest price for a good or service as possible, but he suggests that we must balance that with our desire also to have decent wages and benefits— that the two are not necessarily complementary— and often at odds. He also points out that the move towards regulation was initiated by government and that companies/corporations went along because it tends to raise the bar for new competitors and guarantee a top and bottom for prices— i.e., stable prices. Regulation promised companies a profit without fear of prices so low that they might be put out of business— e.g., as the result of some new breakthrough technology or marketplace innovation— hence, most regulation does stifle novelty; every consumer 'protection' restricts the 'new'). And that companies/corporations fight tooth and nail against any regulations that would tend to 'open up' competition (especially to new companies or innovations promoted by 'new' companies) and for any regulations that would tend to 'close down' competition from new companies. And, of course, this should be considered the 'natural and necessary order' of things!

[ Normxxx Here:  It remains for us, the hoi polloi, to defend and protect our rights against regulations that constrict our choices to the benefit of established companies! It also should be noted, that this country was not always actually a democracy. Despite what the history books teach, democracy (little 'd') was hard won; first by the non-landed gentry and common folk, through many state and federal laws, then by the 14th Ammendment, and finally as late as the 19th Ammendment, well into the last, 20th, century. (Note the many remaining requirements, as in the ability of the 'supreme court' and no other to 'interpret' the constitution, as in the requirement for 'supermajorities' e.g., in congress for any substantive issue, such as overriding a veto or for impeachment, and among the states, for ratifying a congressional ammendment or a new constitution, to protect 'the few' from the 'wrath of the many'— 'mob rule'!) For the first third of our country's history, the U.S. was quite deliberately a republic (small 'r') NOT a democracy! Plato thought a republic, with an elite trained up to govern, was many times preferrable to a democracy, which in the words of our country's forefathers (who so carefully crafted the constitution) was prone to 'mob rule'. I sometimes agree, but then I believe everyone should have a say in how that republic is re-constructed.  ]

I should point out that this is a great oversimplification of Reich's points but it does capture some of the principal concepts. He also makes suggestions that should promote the free market without unduly undermining democracy and still allowing consumers to benefit from competitive pricing. Since this is economics we are discussing, politics is inextricably mixed in and will probably color whether or not you agree with his points or not— but try to give him a fair, unbiased reading before you make up your mind.

Reich's style is breezy for a book that looks at economics, democracy and the erosion of wages, benefits. Reich comes across as fair balanced and thoughtful even as he sells his take on what is undermining American society. Ultimately it's a worthwhile book to read simply because it opens up dialogue on the social cost of constantly lowering prices without regard to end effects, and how it impacts those who live next door to us.

According to Robert Reich, there was a time when capitalism and democracy where almost perfectly balanced. This was the period of 1945 to 1975, which he calls the "Not Quite Golden Age." During this period there was a three-way social contract among big business, big labor, and big government. Each made sure that they as well as the other two received a fair share of the pie. Unions recieved their wages and benefits, business' and investors their profits, and regulatory agencies regulated to 'protect' consumers (e.g., from unsanatory and otherwise harmful products) and make sure everyone could compete fairly. It was also a time when the gap between the rich and the poor was the narrowest in our history. It was not quite the golden age because women and minorities were still second class citizens, but at least there was hope.

Fast forward to 2007, capitalism is thriving and democracy is sputtering. Why has capitlism become supercapitalism and democracy become enfeebled? Reich explains that it was a combination of things: unthinking deregulation, globe spanning computer networks, better transportation, etc. The changes were mainly a result of technological and social breakthroughs; unlike many left-leaning authors, he sees no 'great conspiracy,' only a transformational change and contest. The winner of this great transformation was the consumer/investor and the loser was the citizen/wage earner. Throughout the world, the consumer has more choices than ever before him and at reasonable prices. The investor has unprecedented opportunities to make profits, if only he is patient and wise. The citizens and the wage earners, however, are less well off. The average citizen does not have much voice— other than occasional (and sometimes 'fixed') voting— in the body politic. And the wage earner income has been stagnating for many years. The most salient illustration of this trend is Walmart. Walmart delivers the goods at low prices, but the trade-off is low wages and poor benefits for their employees [[in their defense, it must be argued that they give preference to ex-military and retirees of all stripes, who usually come with their own benefits: normxxx]]. We justify this dilemma, as Reich nicely puts it, because "The awkward truth is that most of us are of two minds."

Reich makes some startling pronouncements. For starters, stop treating corporations as 'human beings'. They are neither moral or immoral, they are merely "bundles of contracts." I couldn't agree more. Stop expecting corporations to be socially responsible, see them for what they are: profit-seeking institutions. Any socially responsible action they are likely to take (and remain in business) as a result of coercion is probably defensive (and half-hearted) anyway. Don't even encourage them to be socially responsible, because it may only hurt them and wrongly lead us to believe that they are solving problems when they are not. Corporations play by the rules of the 'market place' and the laws of the states that they operate under: these are their givens, and it is up to wage earners and other citizens, and their elected representatives, to change the rules of the playing field so that it is possible for all to play a fair game and benefit— 'win-win' NOT 'win-lose'.

This is no easy task in the age of supercapitalism. There are currently 38,000 registered lobbyists in Washington DC in a virtual arms race of spending with each other to buy favors from our so-called representatives. The only way citizens can compete with this is not by hiring more lobbyists but advocating through new media outlets such as the internet and cable tv. This, according to Reich, is currently the most effective way to make government more responsive.

As noted, during the "Not Quite Golden Age," the government was charged with ensuring a 'level playing field' for all and also as being the referee. He refers to this political-economic balancing act as "democratic-capitalism." But that accommodation rapidly unraveled starting in the mid-70s as advances in transportation, communications, and various other technologies permitted the globalization of production and the rise of more efficient, generally international firms that challenged the monoliths and that also undermined and decimated labor unions and the 'mom and pop' companies, who could not compete. An ideology of free-market, 'laissez-faire' capitalism was legitimized that discredited any regulation [[so the 'market place,' including that for labor, is today becoming one mad scramble, subject to the laws of no nation : normxxx]]. He suggests that Americans as consumers and investors have benefited greatly from this transformation of the economy, but as wage earner-citizens we no longer have the political will or power (as non-union or weakly unionized wage earner-citizens) to counter the social impacts of largely unchecked international corporations. In other words, democratic-capitalism has morphed into supercapitalism.

For an author accused of being left-leaning, this book is remarkably neutral, even benign, in its assessment of dynamic capitalism in its current form of globe-spanning corporations, massive layoffs and job shifting, extravagant CEO pay, and vast political influence by corporations in both local and national elections and even day-to-day affairs. In fact, in his view, corporations are doing no more than reacting positively to consumers/investors in their demands for advancing shareholder prices and their insistence on lowest possible pricing. He points to the stock market run-up over the last thirty years and the ability to produce consumer items relatively more cheaply. However, little notice is made of the considerable market manipulation and price setting in many areas of the economy, such as in energy and telecommunications [[as government regulation, abetted by those large, international hegemons, stifle legitimate competition. : normxxx]]

Any perceived social harmony in the post-WWII generation is more of an aberration than indicative of democracy in action. A combination of devastated economies across the globe and the containment of workers in no-strike, inflation adjustable contracts permitted the setting of stable, high prices by now dominant US corporations. Dissidents were painted with as Comm-simps (communist sympathizers) and purged from unions. The fact that corporations nevertheless had the power to quickly destroy any so-called accord demonstrates clearly that democratic effectiveness even in democratic-capitalism was minimal at best.

In the present, Reich insists that the very existence of Wal-mart is indicative of consumer empowerment, setting aside the fact that consumers are also workers who have had their wages squeezed by the likes of Wal-mart. Lumping consumers and investors is highly convenient. The mega-profits of global corporations have highly enriched the most knowledgeable and deeply invested— generally, the upper (managerial and owner) classes. It is somewhat cynical to hold that the lower prices and the holding of a few shares of stock have enriched or empowered the working classes nearly as much.

But the author takes issue with those who perceive a conspiracy of big business and politicians or the existence of class warfare to explain the takeover of government functions by the most affluent (including corporations). His argument that businesses (and business combines/lobbies) compete for favorable legislation in no way discredits those who recognize the exclusion of average Americans and their concerns from government. The commonality of corporate interests is readily seen in their united opposition to populist initiatives. The author does accept that the corporate "social responsibility" movement- codes of conduct, etc. is little more than a cynical defensive ploy to deflect concerns about the ramifications of corporate dominance undercutting the possibility of democratic actions.

The author assures us that we can have both a vibrant democracy and a vibrant capitalism. The spheres of consumption and citizenship are likewise to be kept distinct. His essential contention is that powerful corporations need to be severely limited or kept out of the political process. Beyond that, we must elevate our actions as citizens above our actions as consumers [[to which I append a completely cynical, "good luck!" : normxxx]]. One cannot simply ignore the consequences to one's community in making buying decisions; for example, by frequenting Wal-mart[!?!] Most of all, we need to reinvigorate the political process. Democracy requires citizen interaction and debate to set an agenda and carry it out. The town square is long gone; perhaps online communities can act as meeting places [[like the viewers/listeners of PBS? Fat chance! : normxxx]]. By contrast, markets need only aggregate individual, self-interested behavior [[and democracy must do the same— or perish in its present form: normxxx]]. The greater difficulty in conducting [[unrewarded: normxxx]] democratic action is certainly a factor in the ascendance of the marketplace in supercapitalism.

The book is best at describing the evolution of so-called supercapitalism. It is a stretch to maintain that the post-WWII period can be termed 'democratic-capitalism'. It is, perhaps, disingenuous to suggest that American consumers have become 'empowered' with globalization and the advent of Wal-mart. A vibrant democracy cannot be distinct from consumer/investor actions— the latter must be involved in the economy to ensure a positive impact on all communities and the greater society.

The question that remains, after reading this book, is to what degree will 'consumers' be willing to sacrifice their low prices to achieve their goals as 'citizens'. If the answer is that we currently ARE imbalanced in the direction of 'the marketplace' we must rebalance the choices between capitalism and democracy. If not, we are left to the increasingly autocratic and not so tender mercies of supercapitalism.



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Sunday, January 27, 2008

Darker Days Ahead?

Darker Days Ahead?
Robert Reich Warns A Recession, Or Worse, Could Be Coming.

By Arlyn Tobias Gajilan, Newsweek | 27 January 2008

Think the last few days have been bad for Wall Street and the rest of the world's markets? Hang on, things are probably going to get worse, says Robert Reich, President Clinton's former secretary of Labor and author of the recent book

Supercapitalism: The Transformation of Business, Democracy, and Everyday Life"
by Robert B. Reich

According to Reich, who currently teaches public policy at the University of California, Berkeley, the United States might even be headed toward a depression.

NEWSWEEK's Arlyn Tobias Gajilan talked to Reich about the Fed's surprise rate cut Wednesday, the "D word," the growing criticism of Federal Reserve chairman Ben Bernanke and whether a stimulus package will include $500 check for each American. Excerpts:

NEWSWEEK: Many investors had hoped for an interest-rate cut, but this cut's size and timing took people by surprise. Were you taken aback by the Fed's three-quarter basis-point cut, the largest single-day reduction in the Fed's history? And do you think it's necessary?

Robert Reich: Yes and yes. The Fed is clearly becoming aware of the serious potential of an economic meltdown. The size of the cut is larger than anyone expected because the Fed usually moves in [increments of] .25 or .50 percentage points. But the danger of a cut this size is that it may panic the investors. They may conclude that the Fed has determined that the economy is even worse than assumed and that there is still a way to go before we hit bottom. Yet the Fed has to [cut]. Credit markets are still uncomfortably frozen, and the housing slump continues to worsen.

Unlike Ben Bernanke, Alan Greenspan had a habit of hinting at what his next move would be. While he kept investors on their toes, Greenspan rarely acted as unexpectedly as Bernanke did this week. Is it dangerous for a Fed chairman to surprise the market?

Yes, but I don't believe Bernanke wants to surprise the market as a general rule. This strikes me as a major exception to the relative transparency he's trying to achieve with regard to letting the market know where the Fed is going. It's a move that underscores the seriousness of the current economic problems.

Tuesday's rate cut initially caused a huge market swing, with the Dow, NASDAQ and the S&P 500 all hitting 14-, 15- and 16-month lows respectively. But by the end of the day, all three had bounced back considerably. Does that mean the cut is working?

The fact is that no one knows anything. Investors are flying blind. Even experienced Wall Street hands have no idea whether we're near the bottom. We can expect even more violent swings in the stock market. The reason for all the uncertainty is that the big banks and lenders simply have no idea how many bad loans they're holding. [During the housing bubble] credit markets evolved such complex ways of reselling and repackaging debt that even many top Wall Street professionals simply have no idea of the risks and costs they're involved with. The bottom line is there is a great deal of uncertainty out there, and the markets hate uncertainty.

Can we expect another rate cut at the Fed meeting next week?

Yes. I wouldn't be surprised if the Fed cut another quarter point. If it doesn't announce something at its meeting, it may cut .25 or even .50 within the next month or so. They are clearly worried. [And while lowering rates may cause] inflation, it is far less threatening now than a recession or perhaps— and I cringe at using the word— a depression.

You cringe, but you still used the D word. How far along are we on that particularly slippery slope?

Hopefully, not far. But several managing directors on the Street, whose opinions I trust, have said to me that the chances for a depression are 20 percent. That matches my sense. In other words, it's still low, but 20 percent is nonetheless far higher a probability than anyone should be comfortable with. Even absent a depression, it seems likely that the coming recession will be deeper than the last several.

There's a U.S. News & World Report blog item that was making the rounds on the NYSE floor Wednesday reporting that Bernanke has privately been much more negative about the economy than he publicly admits. From the indicators you've been watching, how bad do you think things are really going to get in the next six months to a year? Is a recession avoidable at this point?

It's going to be difficult to avoid a recession, defined as two consecutive quarters of economic contraction. Difficult because the scale of the problems is so much larger than any stimulus package or Fed rate cut can readily deal with. The stimulus package now being considered on the Hill is in the range of $140 [billion] to $150 billion. But at the rate housing prices are dropping, consumer purchases alone are likely to be hit by $360 [billion] to $400 billion. Similarly the Fed rate cuts, under normal circumstances, would free up money, but lenders are afraid of lending because they don't know how much risk of default they face, even at lower interest rates. It's a little like offering a lobster dinner to someone who is so constipated that they can't take in another mouthful.

Bernanke hasn't won many fans lately. Under his leadership, many on the Street think the Fed has moved too slowly to avoid recession and too ineffectively to prevent inflation. Is that fair criticism?

Probably not. Up until last week, Wall Street's assessment of Bernanke was quite positive. He was getting good press all around. He faces a very difficult balancing act under circumstances in which energy and food prices are rising, the dollar is falling and inflation is becoming more threatening. What should the Fed do? It is terribly unqualified to cope with speculative bubbles and their aftereffects. The housing bubble and the Wild West credit markets of the last few years came about not because the Fed kept interest rates too low, but because the treasury, the comptroller of the currency, and the Fed, in its regulatory capacity, failed miserably to use their authority to oversee credit markets and assure that they were not unduly exploiting those low interest rates with irresponsible lending practices. Now we have a mess on our hands. Bernanke has the only pooper-scooper in town, but it is too small for the job.

There's a theory that the global markets have matured past the point where they won't necessarily get slammed whenever the U.S. economy gets hammered. Do you buy into that thinking? Will our country's worsening economic situation infect the rest of the world economy?

The U.S. is not completely uncoupled from the rest of the global economy, but the good news is that consumers in Japan, China, India and Europe are now far better able to fill-in the gap when American consumers fail to do the job they have been doing for decades, which is to buy enough of the world's goods and services to keep the world out of recession. Remember American consumers have been the Energizer Bunnies of the global economy for some time. Now others around the world are wealthy enough to become Energizer Bunnies themselves.

The administration has called for a $140 billion economic stimulus package. There have been few details about the plan, but Treasury Secretary Henry Paulson and Congress have all hinted that taxpayers might soon receive checks of several hundred dollars or more. Can Americans expect those checks any time soon and will such a plan actually stimulate the economy?

Only relatively low-income people are likely to spend any extra money they get, since they need the extra money in order to maintain their living standards. So the first question is will the stimulus be targeted to them or will it be frittered away in tax breaks for the upper-middle class and for investors. Secondly, the money has to be in people's pockets right away, not eight or nine months from now in the form of a tax rebate from the IRS. The only surefire way to do that is to reduce withholding in payroll taxes, since 80 percent of Americans pay more in payroll tax than they do in income tax. Thirdly, the money has to be enough to change people's behavior. Five hundred dollars isn't likely to do the trick. I see far more politics in this than economics. Washington has to look like it's doing something, and so it will.

* * *


Since 1934, there have only been two years when no U.S. banks failed: 2005 and 2006, according to the Federal Deposit Insurance Corp.

During the savings-and-loan crisis of 1988-89, U.S. banks failed at a rate of more than two every business day.

Nearly 58% of Americans believe the globalization of the U.S. economy has been bad for the country, up from 48% 10 years ago, according to a December NBC News/WSJ poll.

Real-estate holdings accounted for 58% of total assets for U.S. banks in 2006, up from 45% in 2000, according to the FDIC.

The world's most-transparent state-run investment fund is New Zealand's, according to the Peterson Institute for International Economics, followed by the funds of Norway, Timor-Leste and Canada. The lowest-rated: the funds of the United Arab Emirates, Qatar and Singapore.

What's On The Horizon For The Banking Industry? Here's A Closer Look:

Points Of View

"Right now it's looking as if the U.S. banking system is on sale to the foreigners."
— Robert S. Patten, Morgan Keegan & Co.

Foreign investment is "a symbol of past mistakes but also of somebody's view of future potential."
— Alex J. Pollock, American Enterprise Institute

Chart: Bad Time for Banks
Review & Outlook: How the Credit Bubble Grew

Credit cards and consumer loans: Rising home prices allowed borrowers to refinance mortgages or take other loans to pay off credit-card bills and other loans, which prevented consumer-loan losses from rising. But that stopped in August, which has spurred a rise in loan and credit-card delinquencies since then.

Credit-card delinquencies and charge-offs increased by one percentage point to 6.83% last October from November 2006. But the figure jumped 0.8 percentage point just in in November 2007, to 7.63%. "That's the kind of jump you normally see after Christmas and not before," says Zach Gast, an analyst at RiskMetrics Group. Earnings reports this past week suggest that credit-card-debt repayment in December may have been as bad or worse. Moreover, losses stemming from delinquencies on holiday purchases won't show up until the summer, says Dennis Moroney, a bank-card analyst for TowerGroup.

Credit-default swaps: The sale of securitized loans using complex financial instruments can distribute risk broadly while democratizing credit, but the explosion of those complex investments may have gone too far because the "loan originators"— big banks, insurers and others— never knew [[or cared about: normxxx]] the real worth, or risk, these investments carried.

The market for credit-default swaps, which protect investors against borrowers defaulting on their loans, has soared in recent years to an estimated $43 trillion. If defaults in investment-grade or junk corporate bonds return to historical norms of 1.25% this year (from 0.5% last year), sellers of insurance on those loans could face losses of $250 billion, enough to match the losses some predict will result from subprime mortgages, says Bill Gross, chief investment officer at Allianz SE's Pacific Investment Management Co., or Pimco.

Loss reserves: Bank earnings could fall by as much as 20% over the next three years, suggests Mr. Gast, because they face a double whammy: Loan delinquencies are outpacing the capital reserves they are required to set aside, according to Mr. Moroney. As losses mount, banks have had to commit more of their revenue to loss reserves. Those low reserve levels, coupled with deteriorating credit, could force banks to increase their loan-loss provisions by $30 billion to $85 billion, according to Mr. Gast, which would put further pressure on earnings. Loss reserves fell to 1.28% of total loans in the third quarter of 2007, nearly half the 2.57% share reached in 1991.

Regulation: Bank deregulation in the 1970s and 1980s spurred the creation of larger banks, but it also fostered greater competition. Between 1970 and 2005, the number of banks fell to 7,500 from 13,500, but the number of banking locations nearly doubled to 80,300. Some argue that recent deregulation— such as a 1999 law that repealed the Depression-era Glass-Steagall Act separating investment- and commercial-banking activities— has made it too easy for banks to take bigger risks, even as they grow so large that the government can't allow them to fail.

But the problem may have more to do with management than regulation— indeed, top executives have been booted from the banks that posted the biggest losses. Banks have struggled to eliminate blind spots for risk, in part because banks have grown so large, says Guillermo Kopp, a former Citigroup information-technology head who is now TowerGroup's executive director. "Citi was supposed to be the quintessential diversified financial institution. But because it's so big, the leadership has been finding it hard to keep all of the pieces working together."

And regulation has its limits, says Alex J. Pollock, a resident fellow at the conservative American Enterprise Institute. "No matter what any regulator or legislator does, financial markets will create as much risk as they want."



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Stocks Plunge As Predicted!

Global Stock Markets Plunging As Predicted!

By Capital Multiplier | 27 January 2008

Clearly, we have now made several of the most spectacularly successful market calls of this decade as seen from the following:

1) Bank of America posted a 95% decline in quarterly profit after suffering a $5 Billion write down in the value of its mortgage holdings,

2) Wachovia Corp. announced a 98% decline in quarterly profit after taking a $1.7 Billion write down for loan losses,

3) E-Trade Financial reported a net loss in its latest quarter after losing $2.2 Billion on the sale of its portfolio of mortgage debt, and

4) After peaking last October, the Dow Jones World Index has been plunging lower reflecting the sharp drop in global stock markets. Indeed, according to a Bloomberg report, 43 of the world's biggest stock indexes fell into Bear market territory last week, representing a decline of at least 20% from their 2007 highs! Now you know why we repeatedly warned you not to believe Wall Street's nonsensical claims about 'global decoupling' and foreign markets being immune to a U.S. economic recession!

So how did U.S. policymakers respond to last week's global market plunge? The Federal Reserve resorted to an inter-meeting rate cut and slashed the Fed Funds rate by 75bps (the biggest interest rate cut in more than 2 decades)! And the U.S. Congress announced a $150 Billion 'economic stimulus' that would give most tax filers rebates of $600-$1,200 (and more for those with children) and raised the limits on Federal Housing Administration loans and home mortgages that Fannie Mae and Freddie Mac can purchase to as high as $725,000 in over-priced markets like NY and CA.

Global stock markets immediately bounced after the Fed's rate cut but there was no follow through and the S&P 500® rose just 0.4% last week. So now that U.S. policymakers have clearly shown that there is no limit to their stupidity and that they are willing to 'prop up' asset markets, Wall Street cheerleaders are once again declaring that stocks have 'bottomed'. Indeed, many analysts are calling for a significant market rally citing factors like good stock Values, Oversold Markets, and Investor Sentiment as probable catalysts.

We think they are wrong because: Values: Wall Street proponents of the 'Fed Model' are pointing to the 3.5% yield on 10-Year U.S. Treasuries as bullish for the stock market. However, our research shows that over the past several decades the Fed Model has proven to be a very unreliable tool for timing market tops and bottoms. Also, contrary to popular perception, we believe the stock market is currently overvalued based on most fundamental valuation metrics because Wall Street's 2008 earnings estimates for the S&P 500® are ridiculously over-optimistic. According to Wall Street consensus estimates, analysts are projecting S&P 500® earnings growth of nearly 15% this year ostensibly driven by very strong comebacks in the Consumer Discretionary and Financials sectors!

Given our expectations of: i) A global economic slowdown (possibly a global recession), ii) Further sharp declines in real estate prices in U.S., U.K., Spain and many other countries, iii) A significant correction in commodities, and iv) Further huge losses for global financial institutions at least this year and next, we think we will be lucky to see no significant losses in earnings.

Oversold Markets: In a Bear market, the market can get short-term 'oversold', bounce a little (and not even to as positive reading, e.g., Tuesday's market) and then market prices can continue to plunge through so-called 'support levels' without pausing!

Investor Sentiment: Recent surveys of individual investors have shown a huge jump in bearish sentiment which is considered bullish from a 'contrarian' standpoint since high readings of investor pessimism generally occur near market lows. However, given the fact that individuals account for a small percent of daily trading volumes these days, we believe their actions are likely to have only a marginal impact on market prices at best and their sentiment is not much reflected in today's 'computer driven program trading'. We have seen no signs of the 'panic' selling by institutional traders or individual investors that typically occurs near market bottoms (aka, the 'great washout').

Most investors seem to be as yet unaware that the eventual magnitude of capital losses suffered as a result of the U.S. housing and mortgage debt crisis alone by global financial institutions is likely to be several times that of the Savings & Loans crisis of 1990 (which, moreover, had little effect on homeowners, except that they were shielded from run-away interest rates during a period of run-away inflation— it was the S&Ls that went bankrupt). To make matters worse, it is only the tip of the iceberg, there are trillions of dollars in highly leverraged, high-risk LBO loans, ABCS, RMBS, CMBS, and a zoo of other paper 'assets' that have already started declining sharply in value, exposing global financial institutions to further huge losses this year! There are ABCBs which were rated triple-AAA for the highest rating that no longer even trade, i.e., their value has gone to zero!

Given that the relatively much smaller S&L crisis of the early '90s was enough to push stocks into a cyclical bear market, we really don't think it will be possible for the Federal Reserve and Wall Street to prevent a standard bear market decline of at least 20% in the S&P 500® by sometime this year (we are almost there already). That gives a minimum downside target for the S&P 500® of 1250. So we are not making any changes to our Model Portfolios at this stage. However, if you believe you are over-committed on the bearish side, we suggest taking appropriate precautions immediately, since we may be heading into a (limited) counter-rally around here.

Normxxx     ______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only. The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Saturday, January 26, 2008

$7.2 billion French Fraud?

Trader Kerviel Taken Into Custody

By AP | 26 January 2008

A rogue trader who cost France's Société Générale bank more than $7 billion by making bad stock market bets to the tune of $70 billion was taken into custody on Saturday for questioning, judicial officials said.

Financial police in Paris were to question Jerome Kerviel as part of a probe into Société Générale's announcement Thursday that the 31-year-old trader had put tens of billions of dollars at risk in one of history's biggest frauds, judicial officials said. They spoke on condition of anonymity because the investigation is ongoing.

Skeptics from Mr. Kerviel's neighbors to France's prime minister have questioned whether a single, junior futures trader could have managed such large sums. Adding to the mystery, the bank said Mr. Kerviel may not have made any personal gain from his unauthorized trades.

The bank said it "discovered the fraud" last weekend and unwound the trader's losing bets starting Monday, when world markets tumbled. Some analysts have questioned whether Société Générale exacerbated the fall and indirectly led to the U.S. Federal Reserve's subsequent decision to cut rates.

Judicial officials also confirmed police searched Mr. Kerviel's apartment in the Paris suburb of Neuilly-sur-Seine. They said police also went Friday night to the bank's headquarters, where they were provided with documents relating to the investigation, officials said. Paris prosecutors are conducting a preliminary investigation based on three complaints: one by the bank accusing Mr. Kerviel of fraud, and two by small shareholders. The bank maintains it was the biggest loser in the case, because of the timing of the discovery.

Mr. Kerviel had been investing the bank's money by hedging on European equity market indices. That means he made bets on how the markets would perform at a future date. Société Générale's chief executive, Daniel Bouton, said the trader had been betting throughout 2007 that markets would fall[!?!] But the bank says he had overstepped his authority and was wagering more money than he should have. Ultimately it took three days to close the positions, and the bank lost $7.2 billion.

French presidential aide Raymond Soubie said the trader had been dealing with more than $73.3 billion. That figure outstrips the bank's market capitalization of $52.6 billion, and is close to the annual GDP of entire nations such Slovakia, Qatar or Libya. It remains unclear whether Mr. Kerviel's actions, if proved, were out of malevolence, ambition or some other reason. Three union officials representing Société Générale employees said managers at the bank who briefed them about the fraud told them Mr. Kerviel was having family problems[!?!]

The debacle generated buzz at the World Economic Forum in Davos, Switzerland, and raised questions sector-wide about risk management. French Finance Minister Christine Lagarde, speaking Saturday in Davos, said she has been asked to compile a report on the fraud. Ms. Lagarde said her report will look at "the reality of facts based on real hard data," and "how and why the controls did not work" to prevent the fraud. Ms. Lagarde said the report, whose results are to be made public, will address "what additional controls should be put in place to stop it happening again."

Société Générale's shares have lost nearly half their value over the past six months. After an up-and-down day Friday, the shares closed down 2.5% at $108.62. The company, which also posted another $2.99 billion subprime-related loss, planned to raise $8.02 billion in new capital.

Société Générale's Damage Control
After Alleged Fraud, French Bank Strives To Save Reputation

By David Gauthier-Villars | 26 January 2008

PARIS— For 72 hours this past week, top executives at Société Générale scrambled to save their company. Now, after a massive fraud that the French bank said cost it €4.9 billion ($7.2 billion), management faces another tough task: saving the firm's reputation.

In a telephone interview yesterday, Jean-Pierre Mustier, the head of Société Générale's investment-banking arm, said supervisors of the 31-year-old employee allegedly responsible for fraudulent trading missed several opportunities to stop him.

Missed Opportunities: The company credits swift intervention with allowing it to limit losses. But a senior executive says the French bank missed several opportunities to stop the alleged illicit actions of the junior trader. The trader caught the attention of back-office supervisors several times in recent months with unusual positions, Mr. Mustier said. "In some cases, he would tell them that it was a mistake," he said. "He would convince them, for example, by canceling the positions." Mr. Mustier said initial evidence of repeated lack of supervisory oversight is emerging in an internal investigation that Société Générale started after top executives learned of the alleged irregularities on Jan. 18. The bank said it was dismissing four to five people.

In disclosing the world's biggest-ever trading loss Thursday, Société Générale blamed fraudulent trades by Jérôme Kerviel, a junior trader on the bank's futures-trading desk in Paris. According to people familiar with the matter, the bank's total exposure had reached €50 billion by Jan 18.

Paris prosecutors have launched a preliminary criminal investigation into Mr. Kerviel's actions, though no charges have been pressed. Shareholders also have launched a complaint with Paris prosecutors. Mr. Kerviel's lawyer couldn't be reached for comment yesterday. An associate attorney said on Thursday that the trader was ready to answer to French justice.

In his interview Friday, Mr. Mustier said that after discovering the problem, Société Générale on Monday introduced new control systems to the back office of the bank's trading desk. Nonetheless, if Société Générale's internal inquiry finds a serious breakdown in supervisory control, it would add to pressure on the bank's embattled top executives. "They were strong, independent and a bit cocky, and now this whole fiasco has made the bank and its management vulnerable," said Bruno Berry, an equity-fund manager at Morley Asset Management in London, who owns Société Générale stock.

Mr. Mustier said he first learned of problems in the bank's futures-trading unit at 10 p.m. on Jan. 18. Philippe Citerne, co-chief executive of Société Générale, said he was warned at about the same time. The two executives said it took them two days to grasp the scope of the problem and map out a strategy to unwind the estimated €50 billion exposure they said was built up by Mr.Kerviel.

According to accounts from Mr. Mustier and other Société Générale executives, Mr. Kerviel managed to circumvent the bank's high-priced and complex security system to make trades over the past several months. Bank executives said Mr. Kerviel's alleged subterfuge was fairly straightforward. He was making large bets that European stock indexes, such as the CAC in Paris and the DAX in Frankfurt, would rise, they said. But the markets began working against him earlier this year, and the trader began racking up huge losses. Mr. Kerviel, according to bank executives, covered up those losses by recording fictitious trades[!?!] that went in the opposite direction.

Bank executives said Mr. Kerviel was acting alone. Some in the financial world have expressed skepticism of that assertion, considering the layers of controls that banks have in place in order to keep tabs on their traders' activities; experts question how a junior trader was able to gain intimate knowledge of settlement procedures and schedules, for example. Banks are supposed keep those operations completely separate as a safety mechanism. Bank executives said Mr. Kerviel was deeply knowledgeable of procedures because he had worked in the bank's so-called back office for several years. Moreover, the trader had kept up friendships in that section of the bank, possibly allowing him to keep up with the latest security features, they said. Mr. Mustier said Mr. Kerviel may have used the login and password of some colleagues to enter some transactions into the computer.

Société Générale executives say that Mr. Kerviel knew when checks were conducted. To prevent the bank's supervisors from uncovering the fictitious positions, he would erase them right before the checks and rebuild new ones immediately after, to ensure that his real positions were properly offset and concealed. Mr. Kerviel further would offset real positions that triggered real margin calls with fictitious positions, such as bets on forwards, that didn't trigger margin calls, Mr. Mustier said.

The real positions were significantly beyond Mr. Kerviel's authorized limit— the trader's annual target was to earn between €10 million and €15 million for the bank— but well within Société Générale's overall daily volume of transactions. Since the real and fake transactions balanced each other out, "we could not see anything," said Mr. Mustier. After studying the trading irregularities all weekend with Mr. Mustier, Mr. Citerne took the lead in a three-day selling marathon to unwind the massive positions allegedly created by Mr. Kurvier, according to the bank's investment-banking chief.

Société Générale's market capitalization is currently about €34 billion— a figure far less than the losses it was facing. By keeping knowledge of the problem only to a tight circle of insiders, Mr. Citerne was able to act fast. This secrecy, however, has raised questions over how many people actually knew what was going on at Société Générale while its securities were trading. Société Générale Chairman Daniel Bouton said Thursday that although he has a duty to disclose information to shareholders, he acted in the interest of the bank.

Société Générale’s Sales May Have Incited Market Plunge

By Nelson D. Schwartz and Nicola Clark, NYT | 26 January 2008

PARIS— As panic swept European markets on Monday, word spread that a big hedge fund was in trouble and dumping stocks. Someone was selling, all right— Société Générale. The French bank was frantically unwinding an estimated $75 billion of bad bets on European stocks placed by a rogue trader, Jérôme Kerviel.

As the bank struggled on Friday to determine how Mr. Kerviel could have run up $7.2 billion in losses before anyone caught on, the scope— and global impact— of his fraud began to emerge. From his desk in the middle of the trading floor on the sixth floor of Société Générale’s Alicante building in the La Défense business district outside Paris, Mr. Kerviel, 31, took huge bullish positions on the Dow Jones Euro Stoxx 50 index and the German DAX in particular, according to a fellow trader still working there who insisted on anonymity.

Société Générale rushed to unwind those trades during Monday’s market plunge, and trading in those futures contracts soared to record levels. The bank’s abrupt reversal contributed to a decline that snowballed into an avalanche of sell orders around the world, some traders said. The ensuing turmoil helped prompt the Federal Reserve to orchestrate the surprise cut in interest rates announced Tuesday.

"I have little doubt that Société Générale’s unwinding of those positions absolutely pressured indexes worldwide," said Barry L. Ritholtz, chief executive of FusionIQ, a New York-based investment research and money management firm. "And wouldn’t it be embarrassing if the Fed had to make one of the biggest emergency rate cuts ever because of some rogue trader?"

Granted, fears of a recession in the United States and continuing worries about the spread of the subprime mortgage collapse were also responsible for the market downdraft in the last 10 days. But Mr. Ritholtz argued the rapid move by Société Générale to close out tens of billions in futures positions might have been a major factor in pushing an already nervous market into an outright panic. Mr. Ritholtz is not alone in his suspicions. "I definitely think there is a link," said Byron R. Wien, chief investment strategist at Pequot Capital Management and a 40-year Wall Street veteran. "This precipitous unwinding created the negative momentum that spread around the world."

Mr. Wien also singled out the Federal Reserve chairman, Ben S. Bernanke, for criticism. "Bernanke has been reacting to events, rather than anticipating them," he said. On Monday afternoon, with United States markets closed for Martin Luther King’s Birthday, Mr. Ritholtz said, many Wall Streeters were struggling to figure out just why Europe and Asian markets were off so steeply. "Instant messages were lighting up, and people were saying ‘This looks like a big European hedge fund blew up.’ " Indeed, there was little market-moving data before the plunge.

He was quick to add that the French bank’s rapid turnover of the positions assembled by Mr. Kerviel would not have been enough to push the German market down 7.2 percent Monday. But in today’s fast-paced markets, hedge funds and investment firms often pile on once the selling starts. "These things take on a momentum of their own," he said. On Tuesday, the volume on the DAX and Euro Stoxx 50 contracts was twice that of open futures contracts, suggesting that the bank was having to sell and then buy back contracts to cover leveraged positions. Ten percent of the volume on DAX futures on Tuesday alone was 9.2 billion euros.

On a typical day, the total open interest on the Dax futures market is roughly $50 billion, according to Hélyette Geman, a professor of mathematical finance at ESSEC business school in Paris. Although the exact positions are not known at this moment, she said, it was quite likely that Société Générale’s trades would have accounted for a major portion of DAX futures activity in recent weeks. She added that settling those positions might have created some downward pressure in the market.

A Société Générale trader said that Mr. Kerviel, a member of Société Générale’s Delta One team, frequently worked late into the night after other members of the group had gone home. He added that it appeared the pace of Mr. Kerviel’s trading picked up toward the close of 2007. Many of the trades were placed on near-term futures contracts, the trader said. Jean-Pierre Mustier, chief executive of Société Générale’s corporate and investment banking division, declined to identify which particular indexes formed the bulk of the specious trades, but insisted during an interview that closing the positions early in the week did not cause the steep plunge in markets across Europe.

Meanwhile, the legal noose appeared to tighten around Mr. Kerviel, as French police raided his apartment in the suburban Paris neighborhood of Neuilly-sur-Seine Friday evening. A spokeswoman for the Paris prosecutor’s office, which on Friday opened a preliminary investigation into the case, declined to comment on the raid. "An investigation is under way," said the spokeswoman, Isabelle Montagne. "We must let the police do their work." At the same time, French government authorities signaled growing frustration with Société Générale.

Indeed, Paris appeared to be putting pressure on Société Générale to come forward with a more detailed accounting of how Mr. Kerviel could have racked up the staggering losses by himself over the course of a year without raising any red flags among either his supervisors or the internal auditors of the bank. François Fillon, the French prime minister, expressed frustration Friday at having been kept in the dark about the unfolding crisis until Wednesday— four days after Société Générale’s chief executive, Daniel Bouton, informed the governor of the country’s central bank, Christian Noyer.

Speaking to reporters at a briefing in Luxembourg, Mr. Fillon conceded that as a private bank, Société Générale was not obliged to inform the French government. He said, however: "It’s an affair of such an importance for the French financial system, that maybe the government could have been informed earlier." Mr. Fillon said that he had asked the finance minister, Christine Lagarde, to conduct a separate inquiry into the affair and report back to him within eight days. A spokesman for Ms. Lagarde could not be reached for comment.

The bank, meanwhile, identified four other individuals, in addition to Mr. Kerviel, who had been dismissed in connection with the scandal and would face disciplinary action: Marc Breillout and Grégoire Varenne, co-heads of fixed-income trading; Christophe Mianné, global head of market activities; and Luc François, global head of equities and derivatives activities.



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