S&P on the Kill List: U.S. Government Seeking Vengeance for S&P Downgrade of U.S. Credit.

S&P On the Kill List By Douglas French Thanks to Douglas French and The Daily Reckoning

“Paybacks are a bitch,” as they say.What was Standard & Poor’s thinking back in August 2011, when the ratings agency took the Red, White, and Blue’s AAA rating away? A rating the most powerful government in the history of the world had held for 70 years. S&P downgraded long-term US debt to AA-plus. That score ranks lower than over a dozen governments, including Liechtenstein’s, and is level with Guernsey’s and France’s.McGraw-Hill Companies (S&P’s owner) may be a big corporation, but you don’t kick sand in Uncle Sam’s face like that and get away with it. Now the government, in the person of Attorney General Eric Holder, is kicking back. The US government is accusing the ratings agency of committing fraud by inflating the ratings of mortgage investments, which, of course, created the financial crisis.S&P, along with its competitors Fitch and Moody’s, famously rated the mortgage security goulash that Wall Street concocted AAA, thus allowing everyone everywhere to participate in America’s housing boom. And why not? According to computer models, housing prices never go down. Pension funds as far away as Reykjavik and Heerlan were gobbling up what Wall Street was serving because all three ratings agencies provided their stamp of approval. According to the government’s suit, S&P “knowingly and with the intent to defraud, devised, participated in, and executed a scheme to defraud investors.” Yep, in the minds of the government’s gumshoes, the clairvoyants at S&P knew these securities stunk to high heaven. They knew, or should have known, that the housing market was ready to crash any moment, but they were greedy capitalists who, while they were making a buck, created and carried out a diabolical plan to bring the financial world to its knees. Yeah sure, that’s what happened. S&P should be ashamed for maintaining that it ratings “were objective, independent, uninfluenced by any conflicts of interest,” the suit said. The suit centers around 40 collateralized debt obligations (CDOs) created from 2004-2007. The firm was paid $13 million for rating these securities. Giving these securities the highest rating must have been fraud, because everyone knew by that time that the market was toast. Right? After all, in 2004, the nation’s deposit insurer and bank regulator, the Federal Deposit Insurance Corporation (FDIC), published a paper on housing that concluded: “It is unlikely that home prices are poised to plunge nationwide, even when mortgage rates rise.” This is because “housing markets by nature are local, and significant price declines historically have been observed only in markets experiencing serious economic distress.” Plus, housing markets have “characteristics not inherent in other assets that temper speculative tendencies and generally mitigate against price collapse.” In conclusion, “it is highly unlikely that home prices would decline simultaneously and uniformly in different cities as a result of some shift, such as a rise in interest rates.” Whoops. Where’s the lawsuit against the FDIC?

14 FACTS OBAMA DOESN’T WANT YOU TO KNOW

FOURTEEN  FACTS OBAMA DOESN’T WANT YOU TO KNOW:

1. Prosecution For Financial Fraud Hit A 20-Year Low During The Obama Administration (There were more prosecutions during every year of George W. Bush’s presidency than during every year of Obama’s).
2. Income Inequality Is Worse Under Obama Than Under Bush (The gap between the rich and the poor was more pronounced under Obama’s presidency than under George W. Bush’s).
3. Obama Wants To Lower The Corporate Tax Rate (Obama proposed a tax overhaul that would cut the corporate tax rate from 35 percent to 28 percent).
4. Obamacare Won’t Make Health Care Cheaper For Most Americans (After Massachusetts enacted a similar health care plan in 2006, premiums for an individual plan in the state rose 18 percent over three years).
5. Obama’s Housing Programs Have Largely Been A Failure (In 2009, Obama announced the Home Affordable Mortgage Program, promising to help 3 to 4 million borrowers, but as of January — more than three years into the program — HAMP had only reached 1 million borrowers).
6. Homeowners Haven’t Seen Much Out Of That Huge Mortgage Deal (As part of the settlement, banks said they would offer at least $10 billion in loan forgiveness to homeowners. But months after the deal was inked, banks have been slow to hand out the money).
7. Democrats Have Received Lots Of Campaign Cash From Bain Employees (Democratic candidates and committees had actually netted double the amount of campaign cash from Bain workers as of May than their Republican counterparts since 2008, according to the Boston Globe).
8. Goldman And Other Wall St. Firms Have Largely Escaped Punishment For Their Role In The Financial Crisis (The announcement last month that the Justice Department wouldn’t be prosecuting Goldman Sachs over allegations surrounding the financial crisis was a reminder for many that the Obama Administration has largely let banks off the hook for their role in the meltdown).
9. The Wall Street “Revolving Door” Is Alive And Well In Obama Administration (Many current and former members of the Obama Administration have ties to Wall Street. The list includes the president’s current and former chiefs of staff — Jacob Lew and Bill Daley, respectively — as well as his former budget director, Peter Orszag, and others).
10. “Too Big To Fail” Banks Have Grown Under Obama (At the end of 2011, five big banks, including Bank of America and JPMorgan Chase, held 56 percent of the U.S. economy, according to Bloomberg, compared to 43 percent five years earlier. That’s right, the too-big-to-fail banks have actually gotten bigger).
11. The U.S. Has Gained A Lot Of Low-Wage Jobs During The Recovery (Most of the jobs lost during the recession paid middle wages, while most of those gained during the recovery were low-wage jobs, according to a recent study from the National Employment Law Project).
12. Incomes Declined More During The Recovery Than The Recession (Median household income fell 6.7 percent between June 2009, when the recession technically ended, and June 2011, according to a Census Bureau study cited by The New York Times. That’s more than the 3.2 percent incomes fell during the recession, between 2007 and 2009).
13. Payroll Tax Cut May Expire On Obama’s Watch (The White House won’t be pushing for another payroll tax cut extension this year).
14. Many Top Obama Donors Are Employees Of Major Corporations (Of the top 10 companies with employees donating money to Obama’s campaign, three are big banks: JPMorgan Chase, Citigroup and Goldman Sachs, according to the Center for Responsive Politics. Some of Obama’s other major contributors include employees from big companies such as Microsoft and Google).

Source:    Huffington Post:

http://www.huffingtonpost.com/2012/11/15/fiscal-cliff-richard-trumka-unions_n_2134229.html?utm_hp_ref=politics#slide=more248394

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Commission Reports on Financial Crisis Causes

Washington, D.C. (January 27, 2011)
By Michael Cohn

The Financial Crisis Inquiry Commission delivered the results of its nearly two-year-long investigation into the causes of the financial and economic crisis on Thursday, but with dissenting views from some of the Republican members of the commission.

The commission concluded that the crisis was avoidable and was caused by a variety of factors:

• Widespread failures in financial regulation, including the Federal Reserve’s failure to stem the tide of toxic mortgages;
• Dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk;
• An explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis;
• Key policymakers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and,
• Systemic breaches in accountability and ethics at all levels.

“Despite the expressed view of many on Wall Street and in Washington that the crisis could not have been foreseen or avoided, there were warning signs,” said commission chairman Phil Angelides, a former California state treasurer, in a statement. “The greatest tragedy would be to accept the refrain that no one could have seen this coming and thus nothing could have been done. If we accept this notion, it will happen again.”

The commission’s report also offers conclusions about specific components of the financial system that contributed significantly to the financial meltdown. Here the commission concluded that collapsing mortgage-lending standards and the mortgage securitization pipeline lit and spread the flame of contagion and crisis, over-the-counter derivatives contributed significantly to this crisis, and the failures of credit rating agencies were essential cogs in the wheel of financial destruction.

Link to Full Article

Big Four Face Unlimited U.K. Negligence Claims

By Michael Cohn

September 29, 2009

The Big Four audit firms in the United Kingdom are worried that they could be facing huge payouts for negligence claims in the wake of the financial crisis and even the potential collapse of some firms.

The U.K. member firms of Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers have been pushing for a cap on payouts from negligence lawsuits, but did not receive the legal change they wanted from the U.K. government. They had been making their case to Business Secretary Lord Mandelson and the Department for Business, Innovation and Skills, according to Times Online.

Under current law, the audit firms can be held liable for the entire amount of losses when one of their business clients suffers a financial collapse, even if they’re only partially at fault. The firms are worried that lawsuits arising from audits of the Madoff feeder funds and companies like New Century Financial could even bankrupt them.

While Lord Mandelson is reportedly sympathetic to their concerns, his department apparently already considers a recent legal change to be enough of a help to the firms. The 2006 Companies Act gives company directors the ability to limit the liability of auditors if they get the approval of shareholders. However, this law does not go far enough from the audit firms’ perspective as no major companies to date have been willing to limit their audit firms’ liability.

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Mortgage market bound by major U.S. role

In the go-go years of the U.S. housing boom, virtually anybody could get a few hundred thousand dollars to buy a home, and private lenders flooded the market, aggressively pursuing borrowers no matter their means or financial history.

Now the pendulum has swung to the other extreme. Only one lender of consequence remains: the federal government, which undertook one of its earliest and most dramatic rescues of the financial crisis by seizing control a year ago of the two largest mortgage finance companies in the world, Fannie Mae and Freddie Mac.

While this made it possible for many borrowers to keep getting loans and helped protect the housing market from further damage, the government’s newly dominant role — nearly 90 percent of all new home loans are funded or guaranteed by taxpayers — has far-reaching consequences for prospective home buyers and taxpayers.

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It’s PRIME TIME: Stage 2 of the U.S. Collapse

Dave “Dave From Denver” Kranzler

To listen to our political leaders, the mainstream media and financial bubblevision t.v. programs, you would think that the financial crisis has stabilized and the housing market is bottoming. But if you un-spin the data fed to us by the Government and the media, the facts show that the financial system is on the precipice of another very large crisis. As the housing market collapse spreads into the prime-rated mortgage sector, a veritable avalanche of foreclosed middle to high-end homes will flood the market, triggering a much larger credit and economic crisis than what was experienced during the past 18 months.

The onset of the financial crisis in this country last year was largely precipitated by the inevitable bursting of the housing and mortgage bubble. In what was an unregulated multi-trillion dollar Ponzi scheme, the price of houses rose to unsustainably insane valuation levels, fueled by the reckless and tragic use of no-holds-barred mortgage financing. This “Stage 1″ of the financial collapse was triggered by an escalation in defaults and foreclosures primarily in the subprime and Alt-A mortgage sectors. The associated collateral damage from this reverberated into the implosion $100′s of billions of off-balance-sheet assets and derivatives, many of which were fraudulently rated by the rating agencies and recklessly pumped into investors by Wall Street. This took the Dow from 14,000 to 6,440 and was addressed by the Government/Fed with as much as $24 trillion in direct monetary injections and financial guarantees. During this Stage 1 we saw the Government takeover of Fannie Mae, Freddie Mac, the de facto Government takeover of AIG, the collapse of Bear Stearns, Lehman, Merrill Lynch, Countrywide, Washington Mutual, Wachovia; the U.S. auto industry, among many any other corporate failures and smaller regional bank collapses (64 smaller bank failures this year as of 7/24/09).

Stage 2 of the financial collapse of the U.S. is being triggered by the accelerating rates of default/foreclosure in the prime-rated mortgage market, as well as the collapse of commercial real estate. I am going to focus on the residential mortgage component, as it is three times as large as the commercial real estate mortgage market. Whereas the subprime and Alt-A mortgage markets are roughly $1.5 trillion combined, the prime-rate mortgage market is in excess of $10 trillion, depending on your source of data. For purposes of my analysis, I am using data presented by Mark Hanson of Field Check Group in his “7-19 Mortgage Default Crisis – Brutal Past Two-Months” article posted here (any housing/foreclosure data I use comes from this article):

http://www.fieldcheckgroup.com/2009/07/19/7-19-mortgage-default-crisis-brutal-past-two-months/

I have been asserting that the housing collapse would not end until prices fall enough to balance out the supply/demand equation. This includes the inventory of new and existing homes for sale, the inventory of foreclosed homes either on the market or being held by banks but not listed for sale AND the inventory of rental units. Data released this past week show that the rental unit vacancy rate surged to an all-time high. This will put downward pressure on rental rates, of which I am already seeing evidence in Denver. As rental rates decline, it becomes relatively more attractive to rent rather than to own, putting more downward pressure on the price buyers will be willing to pay to buy a home vs. rent.

The biggest problem, however, facing the housing market, is the impending surge in bank foreclosure inventory, fueled by the rapid increase in defaults and foreclosures in the $10 trillion prime mortgage sector of the market. Delinquencies surged in May and foreclosure inventories hit new highs. The May foreclosure rate hit 2.79% of all mortgages. This foreclosure rate increased from April to May by 6.2% and surged from May 2008 by 88.3%. Further troubling is the 5% spike in the rate of delinquencies from April to May. This compares to the April to May average increase in delinquencies over the past four years of 1.1%. The increase in delinquencies from May 2008 to May 2009 spiked up by 50%.

What’s most troubling about this data is that the main source of these horrific foreclosure/default numbers is the rapid increase in defaults in Prime-rated mortgages over the last six months. Once a mortgage defaults, it typically takes 12 to 18 months for the property to be foreclosed and either listed for sale for held in suspense by banks hoping for a miracle in the condition of the housing market.

The default/foreclosure statistics for Prime mortgages are starting to follow the same statistical path experienced in the subprime and Alt-A markets. Currently, over 12% of all subprime mortgages and 8% of all Alt-A mortgages have been foreclosed. Let’s assume that the total foreclosure rate for the prime mortgage market eventually hits 5%. I believe this is a conservative estimate given what has already occurred in subprime and Alt-A, the surging rate of delinquencies in the prime sector and the rapidly escalating rate of unemployment, which directly correlates to mortgage defaults. Assuming 5% means that $500 billion in prime mortgages will be foreclosed. This equates to the entire size of the subprime mortgage market. Imagine the damage this is going to cause to the entire financial system in this country. And my guesstimate may well be way too low (it is not too high, I can assure you of that).

To put this in perspective, Stage 1 of the financial collapse primarily affected the middle to lower income demographics who purchased a home using subprime and Alt-A financing. A lot of these properties are being purchased and turned into rentals, fueling the rental inventories. In what will be a much larger and more severe Stage 2, accelerating defaults in the prime mortgage sector will cause foreclosures to balloon in the upper-middle (think of overbuilt suburban McMansion developments or overvalued renovation homes in trendy urban areas) and high income neighborhoods. Anecdotally, as I drive through all the trendy renovated urban enclaves around Denver, I see “for sale” and “for rent” signs popping up like uncontrolled weeds as homeowners attempt to avoid foreclosure by selling or renting. It’s one thing for an investor to scoop up several low-priced homes and rent them out, hoping for future price recovery. But how will the housing market ever absorb a massive increase in larger, overvalued homes which would never have been built in the first place if a housing bubble never occurred?

As this prime mortgage-financed foreclosure inventory balloons, it is going to drive prices down to levels thought unimaginable. As the value of the collateral for the mortgages declines, banks and investors who own the associated mortgage and mortgage-related paper will suffer massive hits to the value of their assets. Even worse, we will see another round of derivative-related bank and insurance company implosions, some of which will vaporize into thin air the way Bear Stearns and Lehman did, and Countrywide, Wash Mutual, Wachovia and Merrill should have, were it not for the taxpayer financed bailouts of these firms. This Stage of the financial collapse will likely bring down several large State and corporate pension plans as well.

And finally, how will the Federal Reserve and Treasury deal with this impending financial explosion? If it took $24 trillion of direct and indirect financial support and monetary printing in order to “stabilize” the shock of Stage 1, how much money-printing will it take in order to hold the system together as Stage 2 materializes and engulfs our system with multiple financial disasters? It can be argued that the collapse of CIT is the first sign of Stage 2 hitting. It will be interesting to see which other financial firms hit the wall. We know that Bank of America – which sits on Countrywide and Merrill Lynch’s subprime mess, Wells Fargo – which sits perched on Wachovia’s $122 billion of explosive Pay-Option ARM paper, and GE Capital – a giant-sized CIT – are prime candidates to be vaporized by their nuclear balance sheets.

To conclude, based on the spin-free data presented above, a bottom to the housing market is nowhere in sight. In fact, I would argue that housing prices have at least another 30-40% to fall from where they are now. This is a guesstimate based on all of the above evidence. I don’t know what general level of valuation will mark the end of the housing market freefall. I do know that all the so-called experts (like Ben Bernanke et. al.) who said less than 18 months ago that the financial crisis would be contained to the subprime mortgage market and would top out at $200 billion were tragically wrong in their assessment. I also know that I am on record saying prices will revert to 1981 levels and that this crisis would end up costing $5-10 trillion. Looks like the jury is out on home prices and I was way too low on the dollar cost. I also know that, not only are we nowhere near a bottom, but that the worst is yet to occur.

Clearly, the above analysis means that investors should be taking advantage of this bear market stock rally to sell their stocks, sell all of their bonds except for maybe Treasury TIPS and start moving as much money as possible into physical gold, silver and mining stocks.

UK Economic Assessment Grim

Grim forecasts for British economy

By Jean Shaoul
28 May 2009

 Several reports published in the last few days testify to the increasingly serious impact the financial crisis is having on Britain’s financial institutions, the broader economy, public finances and the living conditions of working people. They portend the introduction of sweeping austerity measures, the likes of which have not been seen in the post war era and which the traditional organisations of working people will do nothing to oppose.

Last week, the IMF issued a stark assessment of the UK economy, explicitly criticising the budget and its optimistic assumptions announced by Chancellor of the Exchequer Alistair Darling just last month.

It forecast that the UK economy would shrink by 4.1 percent this year, the biggest peace time contraction since the Great Depression of the 1930s, and 0.4 percent in 2010. It warned that despite the government’s “bold and wide ranging” response to the banking crisis, the banks were still exposed to bad debt from the fallout of the financial crisis and insufficiently capitalised, making it difficult for them to lend on the scale required for economic recovery. Figures just out indicate that business investment has fallen by 8.4 percent in the first quarter of this year from that of a year ago.

Consumers, faced with high levels of household debt, falling house prices, a reduction in the value of their occupational and personal plans due to the fall on the world stock markets, rising unemployment and reduced access to cheap credit, are cutting back on spending.

The Council of Mortgage Lenders announced a 60 percent fall in home loan advances for April compared to last year. The Economist Intelligence Unit in its report noted that “This [the lack of household credit] in turn is aggravating a severe downturn in the housing market, which may not reach bottom until 2010 or 2011. Employment has also started to fall, and we expect the rate of unemployment to rise sharply to close at 11 percent by 2011”.

The IMF cautioned that the UK remained susceptible to shocks, in particular to the banks and financial institutions, and that the government should prepare contingency plans to bail out the banks again. It said that the authorities should “stand ready to provide further support where needed”. But that must lead to a further increase in government borrowing and contingent liabilities—the potential claims on public finances if the banks redeem the government’s guarantees. Standard and Poor’s, the credit ratings agency, believes that such claims will reach £100 to £145billion (between 7 and 10 percent of GDP).

The IMF noted that it was not just the public debt that was rising, but so were its contingent liabilities arising out of its guarantees to the financial institutions. In addition, there are the explicit and implicit support measures for the government’s public private partnerships and bailouts of failed privatisations, all of which are—Enron style—off the balance sheet.

The IMF warned that “the sharp increase in public sector borrowing and contingent government liabilities, together with continued financial sector fragility, are significant vulnerabilities. In these circumstances, a severe shock has the potential to disrupt domestic and external stability”.

It insisted that the key to shoring up the banks’ financial situation was to restore “fiscal sustainability”. Stripped of the bland language of such reports, the IMF was serving notice that the government’s projected debt level is unacceptable, and that the bank bailouts must be paid for through attacks on working people. The Brown government and its successors are being called upon to implement public expenditure cuts and reduce borrowing much faster than the chancellor had planned, i.e., in one five-year electoral term, not two or three.

Standard and Poor’s report expressed similar concerns last week, downgrading its outlook on British sovereign debt from “stable” to “negative”. It said that the UK’s triple-A rating was at risk unless government borrowing was cut sooner rather than later. It reaffirmed the UK’s actual credit rating, but said the outlook had deteriorated “at a faster rate than Standard and Poor’s had previously assumed”, because of the massive borrowing to deal with the banking crisis and the recession, which last month cut tax receipts by £2 billion while increasing benefit payouts by £1 billion, compared to a year ago.

The government may miss its own forecast of £175 billion in debt for 2009-10, itself a massive increase on last year’s £90 billion. Standard and Poor’s expects public debt to reach 100 percent of GDP by 2013. The UK’s gross debt, already 53 percent this year, is expected to breach the European Union’s Stability and Growth Pact limits of 60 percent by next year.

It is the first potential downgrade of UK public debt since the agency began rating government debt in 1978. A credit downgrade could make it more expensive for Britain to borrow. A higher cost of borrowing would increase government expenditure on debt servicing. Bringing down the total level of debt would mean drastic spending curbs and tax rises.

Standard and Poor’s warning is significant because it is not based upon new data but is consistent with all the public finance forecasts.

Much to the government’s annoyance, the Bank of England also confirmed these reports. The Bank has cut its growth forecast over the next two years and raised its estimate for inflation since February. It appears to be projecting a decline of about 3.9 percent this year and growth of about 1 percent in 2010. The Bank believes that inflation will fall to around 0.5 percent by the end of this year before picking up to around 1.2 percent in two years’ time—below the Bank’s target rate of 2 percent.

Mervyn King, the Governor of the Bank of England, said that the economy would take time to recover. “There are pretty solid reasons for supposing that there will be a recovery next year, but also pretty solid reasons for questioning if that will be sustained”, King said. “But in the light of the state of balance sheets particularly in the financial sector, the committee [the Monetary Policy Committee] judges that the risks are weighted towards a relatively slow and protracted recovery”.

Last month, the Bank agreed to expand its programme of “quantitative easing”—in effect printing money—by spending £50 billion of the remaining £75 billion authorised by the government to buy up the banks’ worthless toxic assets. This comes on top of £75 billion in March. The committee wanted the chancellor to increase the £150 billion limit “should economic conditions require it”. But the Bank said it was “too soon” to know whether the quantitative easing was working.

 

While the Labour government has bailed out banks and mortgage lenders on the point of collapse due to their own semi-criminal and reckless policies, it has done and will do nothing to assist the millions of working people struggling with mortgages, rising bills and debt. Instead, they face a catastrophic decline in their living standards.

Prime Minister Gordon Brown has made it clear that public sector workers will see their pay rise by no more than 2 percent even as prices rise. He has encouraged private employers to similarly limit their pay increases.

The Institute of Fiscal Studies concluded on the basis of last month’s budget that working people would have to face 10 years of austerity measures to bring public debt down to 40 percent of GDP.

A report from the financial services company PWC gives an indication of just what such austerity measures might entail if the government is to bring debt below 50 percent of GDP by 2018. It warns that additional tax hikes or public spending cuts building up to £115 and £133 billion a year by 2017-2018 will be needed, equivalent to £5,000 for every family in the country.

John Hawksworth, head of macroeconomics at PWC, says that the Treasury believes that public finances will come under control by 2017-18. But this is just when the impact of an aging population takes effect. He is calling for tax increases or spending cuts “sooner rather than later” in order to “avoid unduly large increases in the tax burden on future generations of workers to pay for the future pensions and healthcare costs of current generations of workers”.

The National Institute of Economic and Social Research estimated that the state pension age would have to be raised to 70 to cut the debt.

Nicholas Timmins, in a Financial Times article, looked at where the axe would have to fall in order to balance the books. Selling off the state’s assets would not provide the cash it yielded in the 1980s. “More controversially, it involves reducing the role of—and burden on—the state and increasing the role the individuals will play, where politicians believe that will be justified. For example, the introduction of university tuition fees, which look set to rise again after the election; the long term rise in the state pension age; or a reduction in the generosity of public sector pensions”.

But as Paul Johnson, a former director of public services at the Treasury, lamented, “Shrinking the state is terribly difficult. [Governments] don’t get far in reducing the size of the state without reducing the numbers working for it or reducing the amount they are paid”. This is a recipe for a slash and burn programme of job losses and real wage cuts.

Investment Suggestion – Agriculture

The Best Investment Opportunity of 2009
By Chris Mayer, editor of Mayer’s Special Situations

“Investing in agriculture today will be like investing in the oil sector in 2001-2002,” writes Mark McLornan in the May issue of Marc Faber’s Gloom Boom & Doom Report. McLornan runs a fund that invests in farmland. Some of his on-the-ground observations confirm many of the things I’ve been telling my readers for the past several years.

As for likening agriculture today to oil in 2001-2002, an investor’s pulse quickens. We all know the great run oil stocks had as the price of oil sprinted from under $30 to a peak of $143 per barrel. Investors made hundreds-of-percent gains – even thousands-of-percent gains. What most investors forget is that oil prices halved from 2000 to the bottom in 2001, just before the great run-up. The same sort of setup seems to be happening today in the agriculture sector. Most ag commodities fell more than 50% after hitting their June 2008 highs.

This is the pause that refreshes.

The biggest reason to get excited about agriculture is the fact that supplies are at multi-decade lows. In fact, as McLornan points out, “agriculture is one of the very few sectors globally that currently face supply shortages.”

The “stocks-to-use ratio” provides a helpful context. This ratio measures how much supply is on hand versus how much we use. High ratios imply a fully supplied market. Low ratios hint at possible shortages. You have to go back to the 1970s to find ratios in wheat and corn as low as they are today.

The kicker to all this is that last year, the world’s farmers produced a record wheat crop and the stocks-to-use ratio barely budged. There is no way we are going to top that harvest this year with all the drought hitting different parts of the world.

The International Grains Council (IGC) predicts a fall in total wheat output in 2009-10. The IGC predicts global wheat output of 650 million tons, down by 5% from the previous year. The largest declines are seen in the European Union, the U.S., China, Russia, and Ukraine. “Although conditions in the Northern Hemisphere are generally favorable,” the IGC says, “production is likely to fall sharply.”

McLornan says that global yields for wheat hit a plateau in the 1980s and “gene modification technology has been unable to improve what natural selection has achieved over the past centuries.” So we already have tight supplies. And they look to get tighter.

The financial crisis also threatens to reduce supplies. Farmers who cannot gain access to credit cannot put seeds in the ground. Thus, the twin forces of drought and financial crisis seem likely to exert a growing influence over the grain markets – depressing supplies and therefore, boosting prices.

We’ve seen this movie before…

In 1933, in the pit of the Great Depression, writer Sherwood Anderson took to America’s back roads to see how the country was making out. He wandered into coal towns and mill towns, farms and factories.

His account, published in 1935 as Puzzled America, gives us a peek at Depression-era days. As the title lets on, most Americans seemed not to know quite what to make of the Great Depression. “Puzzled” seems just the right word.

It was puzzling because a man was prosperous and then suddenly was not any longer. A common story in farm country during the Great Depression began something like this: There was a prosperous farmer with lots of land who grew wheat. He then went into debt to buy more land and plant more wheat. The price of wheat suddenly fell like a shot quail. And the farm went under. Just like that, our man was broke.

If the financial crisis didn’t take the farm, Mother Nature did. “It was a farm until he plowed it,” Anderson quotes one man as saying of his uncle’s place. Then the drought came. The dry soil swirled around like snow in a blizzard. The farm simply “blew away.”

The hot winds tore the bark right off the trees and burned crops to ash. Fences lay buried under dust drifts. Dust storms blackened the sky. Topsoil of thousands of acres blew away. Anderson describes a little church in North Dakota:

The boards of the church cracking and curling under the dry heat, the paint on the boards frying in the hot winds… and the dust of the fields sifting in through the cracks. Dust in the mouths of the people as they prayed for rain.

Commodity prices took a big tumble after the crash of 1929. That’s what bankrupted the once-prosperous farmers. Then you had fewer farmers farming. Then you also had drought. Supply fell and prices soon rallied hard off their bottoms. By 1937, most food commodities – corn, wheat, sugar – were as high, or higher, than their ’29 highs.

Today, we also have the dual threat of drought and financial crisis. Farmers across the southern plains report poor crop conditions, thanks to dry weather. We also have drought in many places in the world that usually grow a lot of food.

One example: China’s Ministry of Agriculture said that a third of its crop faces drought issues. The country’s stocks-to-use ratio will fall below 30% for the first time since 1971. As AgCapita, an investment fund specializing in farmland, notes in a recent letter, China will be a net importer of 12 million metric tons of wheat. By way of comparison, Canada’s entire annual wheat exports average around 15 million metric tons.

We also have cutbacks in supply, as farmers have a harder time getting financing to buy seed, fertilizer and machinery. As The Wall Street Journal reported recently:

Across the nation, farmers are making plans to cut their production of corn, wheat, rice, peanuts, beef, pork, poultry and milk… Also, some farmers plan to grow just one crop on land that normally produces two each year, and to let some land lie fallow throughout the year.

Production of meat in every category will fall for the first time since 1973. Meanwhile, consumption of grains keeps rising. Globally, wheat demand should rise 6% this year. No surprise that retail food prices rose nearly 6% last year. I think they could rise as much this year.

Ultimately, we’ll have to grow more food…somehow. So a forward- looking investor will want to invest in the ideas that help that process along. Fertilizers are one such idea. Like a prizefighter with a tough chin, fertilizer demand doesn’t stay down for long. The reasons are simple. Lower fertilizer use means lower crop yields. Lower crop yields tend to raise prices for food. These higher prices then provide an incentive to plant more, so fertilizer demand comes back.

I’m a fan of PotashCorp (POT:nyse), which benefits from these trends. It also owns more potash, a key fertilizer, than anybody else. As Barron’s recently noted: “Longer-term investors can take comfort in the knowledge that many crop-planting, potash-guzzling countries – like China, India, Brazil – all have growing economies.” And they have growing populations as well.

There are other ways to invest too. You can buy other ag-related businesses. You can also invest in the actual food commodities. I expect good moves on this stuff in the back half of the year after the fall harvest disappoints.

What about demand?

I think we’re getting close to the moment when the world’s meager supplies of grains become front-page news. We have another few months before the reality of a lousy fall harvest sets in. Agriculture investments should do very well from that point – for everything from fertilizer stocks to agricultural equipment makers to the grains themselves.

As always, I recommend buying assets like these before the crowd sees it on the 6:00 news.

The Economy – Global View – Protecting Yourself

What Are the Chinese Buying?
By Chris Mayer

The financial crisis is not over yet. The banks still need capital. And more credit losses are on the way — from commercial real estate to credit cards and everything in between. The Great Deleveraging is still under way, and that’s one reason — among many — that gold should do well.

The ripple effects of the financial crisis have been felt in all sectors, though. In the world of oil and gas, we see lots of production cutbacks and projects shuttered or delayed. Getting financing is tough. About the only people spending money are the Chinese.

One of the interesting bits of news this morning is how Brazil — looking for someone to help finance its massive oil projects — is turning to the China. Today, Brazil’s president, Lula da Silva, will arrive in Beijing to meet with Chinese president Hu Jintao.

The Chinese have lots of money. They sit on mountains of reserves and have been looking for ways to invest that money. So far, they’ve bought gold and put money toward infrastructure projects. They are also buying up natural resources around the globe — everything from rare earths to iron ore.

The Chinese want to seal a deal with Brazil in exchange for guaranteed oil shipments. See, the Chinese are looking out ahead. They know the massive urban migration going on in their borders. They know how much oil they’ll need to fuel their growth.

Brazil’s state-controlled oil company, Petrobras, wants to spend $174 billion over the next five years. That’s one of the largest capital spending plans in the world among the big oil companies. And China is a willing and able source of funds.

China’s government is looking for ways to further its long-term energy security goals. It wants diverse global supplies. It wants its own oil companies to have a foothold and be competitive on oil regions. Already, China has made $45 billion in commitments to Russia, Kazakhstan and several other countries.

By contrast, the U.S. government is too busy trying to figure out ways to hand dying automakers over to the unions. The U.S. government also has two wars to deal with, a massive deficit and a frightening debt load. Furthermore, the biggest states in the Union are in financial crisis. America’s politicians seem to spend most of their time trying to figure out how to fleece citizens and businesses of more cash.

These misguided ambitions and warped priorities are costing the U.S. dearly. “America has a problem,” complains Sergio Gabrielli, CEO of Petrobras, the state-controlled Brazilian oil company. “There isn’t someone in the U.S. government that we can sit down with and have the kinds of discussions we’re having with the Chinese. The U.S. economy cannot easily afford losing access to vast portions of the world’s energy supplies. But that’s a problem for another day.

Over in the agricultural markets, the financial crisis is also making its presence felt. Farmers have delayed or reduced their buying in fertilizers and equipment. Since we are already in a position where grain inventories are low, this is going to put a strain on the grain markets.

There is also a lot of government intervention here. For one thing, the whole biofuel industry probably would not be anywhere near the size it is today without the government support it receives the world over. This means more acreage devoted to producing alternative fuels, crowding out and raising the prices for food crops like wheat.

In general, I think we are in an age in which political risk is high. Increasingly, we’ll have to take into account what governments are doing. Most of them are broke. Most of them seem intent on bailing out banks and other failing businesses in favored industries. So that would mean the printing presses will run amok. That’s good for gold and commodities generally, which ought to preserve their purchasing power, as paper currencies lose theirs.

The Financial Crisis … The Problems Aren’t Over, Not By a Long Stretch

He Who Borrows the Most, Wins
by Niels Jensen

“Never in the history of the world has there been a situation so bad that the government can’t make it worse.” -Unknown

The stock market might bounce for a while, global currencies might stabilize for a while, but don’t be deceived, large problems remain…very large problems. And the price to fix these problems will run into the tens of trillions of dollars. That’s the kind of price tag that could ruin a national currency or two…even the world’s reserve currency.

While equities continue to go up and up, most of us are left scratching our heads. Is this the real thing or will it go down in history as ‘just’ another bear market rally? Not so long ago, the entire financial system stared Armageddon in the face. Now, only a few months later, equity markets behave as if all the worries of yesterday have been washed away.

The dangerous conclusion to draw from the experience of the past few weeks is that all is now well and dandy and it is time to load up on stocks again. I cannot emphasize it strongly enough: The bull market of March-April 2009 is almost certainly a bear market rally. As one of my partners pointed out the other day, NYSE saw four 20%+ rallies between 1929 and 1932. Bear market rallies can be extremely powerful and hence deceiving.

But the problems are not over yet. Not by a long stretch. It will take longer than 18 months to unwind the excesses of the past 25 years. Analysts at Morgan Stanley reckon that the 15 largest banks, which between them have shrunk their balance sheets by about $3.6 trillion so far in this crisis, will shed another $2 trillion in 2009. The US financial sector debt load (as a % of GDP) is now 117%. In the early days of the great bull market in 1982, the same number was 22%. Households are not much better off than the banks, with total household debt now at 96% of GDP vs. 47% in 1982.

The IMF reckons that both European and US banks – but in particular the European ones – are well behind the curve in terms of recognizing their credit crunch related losses. According to the IMF, there is at least another $1.5 trillion to come.

As the recession bites into the lives of ordinary people, banks will face losses not only on sub-prime mortgages but on all loan products. In fact, sub-prime is indeed a small fraction of the total loan book for the US banking sector. Prime and Alt-A mortgages, together with commercial real estate loans total about seven times the size of the subprime market.

Delinquencies are now on the rise on all mortgage products; however, whereas sub-prime started to deteriorate as early as 2007, it is only recently that delinquencies related to Alt-A mortgages have taken off, and prime and jumbo loans are only now starting to suffer.

These defaulting mortgages pose a very serious threat to the U.S. economy, but they are only part of the economic crisis worldwide. By far my biggest concern at the moment is the enormity of the debt problem facing most OECD countries. In the March issue of the Absolute Return Letter, I referred to an important study conducted by Carmen Reinhart and Kenneth Rogoff back in December of last year.

Reinhart and Rogoff studied every banking crisis of the past generation and made some startling observations. One in particular caught my attention. According to the authors, governments inevitably underestimate the ultimate cost of a banking crisis, because the indirect costs (such as falling tax revenue in subsequent years) end up much higher than predicted.

The IMF estimates that the cost of the current crisis to the United States will eventually reach 34% of GDP or close to $5 trillion. However, the Obama administration, through its various implicit and explicit guarantees, is already using a number close to $9 trillion. And Reinhart and Rogoff’s historical average of 86% of GDP implies an ultimate cost of over $12 trillion!

The true cost is important, because it has to be financed through new bond issuance, and it is my thesis that the sheer size of this tsunami will eventually overwhelm the world’s bond markets. Even using the relatively conservative IMF estimates, the twelve largest industrialized countries of the world will have to issue about $10 trillion worth of new bonds to cover the cost of the current crisis.

However, if you (like me) believe that IMF underestimates the true cost of this crisis, Reinhart and Rogoff offer a more realistic approach. Using their least costly case study (Malaysia 1997) as our best case scenario, the true cost comes to $15 trillion. If one uses the average of 86% instead, the cost jumps to a whopping $33 trillion. I didn’t even bother to produce a worst case scenario – it all got too depressing!

I need to put the $33 trillion into perspective. Total global savings (loosely adjusted for the big losses in 2008) are probably somewhere in the region of $100 trillion. In other words, financing this crisis could absorb one-third of total global savings.

Hence it comes down to the price at which governments can attract sufficient demand from people like you and me. One of two things may happen. Either this crisis will ignite such a bout of deflation that investors will happily own government bonds yielding 2-3% or the deflation scare goes away ultimately, the global economy recovers and bond investors demand much higher yields for taking sovereign risk. I am not yet sure which scenario will prevail, but I do know that both are quite bad for equities longer term.

There is a third route, of course. Governments could print money for themselves, which they could then use to purchase their own bonds. We call that process inflation…and it is already underway.