Much has been heard in the press lately about the end of the great American dream of homeownership but what the press has missed is that what has really died in the crash is a perversion of the American dream. The perversion of getting rich exclusively through homeownership. That perversion really started in the 1970s and died in the great real estate crash that began in 2007.

Prior to the 1970s homeownership was regarded as a key asset in the accumulation of wealth but it was never considered the only asset. Real estate values rose too slowly to accomplish that mission. In fact it is surprising how little real estate values have risen over the long term. According to the economist Robert J. Shiller, the recognized economic expert on this matter from 1890 when accurate records began to the crash year of 2007 residential real estate rose only 3.44% a year. Far less than most people would assume. Then the rise in inflation rates changed everything.
In the decade of the 1970s inflation turbocharged real estate and values rose a blistering 8.12% a year, the greatest rise in history and in the 1980s values rose an additional handsome 5.86% a year. These two decades convinced millions of American homeowners that they could now get rich solely through homeownership.

Their home they were now convinced was the truth, the light and the way to getting rich.

People adore owning real estate. They lust for the stability and permanence of the land. They can roll around in the stuff and as the saying goes they are not making any more of it. What’s more everyone knows or rather knew that you can’t lose money in real estate. People have always had an exaggerated notion of how profitable an investment real estate has historically been. This opinion is based to a great extent on the enormous leverage that is common in homeownership. If your down payment is 5% you are employing leverage of 20:1. Wall street speculators would kill for this kind of leverage.

But there was more to it than that. By the 1970s the American people had changed. They were for the most part no longer willing to make the sacrifices that their parents and grandparents had made.

Scrimping and saving and living below your means was too tough for them. Instant self-gratification was in. What was attractive to them was blowing every dime they had on a big-beautiful home and get rich while they were wallowing in their big-beautiful home like a pig wallows in slop. Saving and sacrificing was for dummies. As for the stock market it was way, way to risky. They were far too smart for that crazy gamble. Risk taking was for dummies. Their home was the perfect investment it required zero risk and zero sacrifice. Which was just what they were looking for.

An interesting component of this belief was an amazing lack of interest in any real estate other than their home. When there was enough equity in their home to support an investment in any real estate other than their home for the most part they turned it down flat. After all any investment outside their home would require a sacrifice on their part. We couldn’t have that happening now could we? Instant self-gratification always comes first. The smart career move from their point of view was to shoot for the Mcmansion. Boy could they pig wallow in that baby.

In 2007 their big-beautiful homes imploded on their heads. It is hard to overstate the financial devastation that the housing crash has had on the American middle class. The unemployment rate that everyone is whining about is almost a side show. For millions of middle class, home owning Americans their home was their only financial asset. In a matter of months millions of home owning Americans went “upside down.” They went from having $100,000 to $250,000 or more in equity in their homes and often much more. To being that much or more underwater.

For those who have twenty years or more before they retire recovery is possible but for the millions who are approaching retirement there is very little hope. The statistics are so grim that many of them are hard to believe. According to the famous Case-Shiller Housing Index home values hit rock bottom in the depression year of 1933 with a decline of -30.5% from the 1920s peak boom period. As hard as it is to believe according to the latest Case-Shiller findings we have just broken that record in the 2nd quarter of 2011 with a decline of -32.7% from the 2006 market peak.

About one-third of all the homes in America are paid off and have no mortgage. The remaining two-thirds of all homes have mortgages. An amazing 25% of homes with mortgages are underwater. The outstanding mortgages exceed the value of these homes.

Then there is the seldom reported vacant housing crisis. There are 126 million housing units in this country or about one housing unit for every 2.38 Americans. That is an awful lot of housing for each American. The classic 3/2 American home is overkill if there is only 2.38 people rattling around in it.
The census figures tell the tale. When I first read these numbers they were so bad that I could not believe that they were true. The 1990 census reported that there were a staggering 10.3 million vacant homes in this country. It gets worse, in the 2000 census that figure had risen to 15 million vacant homes and in the 2010 census that figure had risen to 19 million vacant homes. About 15% of all the housing stock in America is vacant. You could level 19 million homes and there would still be housing for every American. This is not good! What were we thinking? We were thinking that you can’t lose money in real estate. Every new home is money in the bank.

The chickens have come home to roost. There will be no quick recovery. We are not only broke but we have a mountain of inventory hanging over our heads. It will take us years to work our way out of this mess.

Airline stocks were down broadly on concerns that a weak economy will drain travel demand and hit fares this autumn.

But American, seen financially as the weakest major carrier, saw the worst share losses on a percentage basis. The stock was down 15.9 percent, or 47 cents, at $2.49 on the New York Stock Exchange.

“When can they stop the bleeding of cash?” asked Basili Alukos, an equity analyst at Morningstar. The carrier had a second-quarter net loss of $286 million, while rivals showed profits.

“If it appears we’re coming into somewhat of a rough patch or slowdown, how is that going to fare for them?” Alukos said. “I don’t think very well, because they were unable to generate a profit kind of in the best of times for the airlines last year.”

Ray Neidl, a senior aerospace sector analyst with Maxim Group, said in a recent research note that: “Some believe that a prepackaged bankruptcy filing would be the best thing for AMR and the industry.”

An AMR spokesman did not immediately respond to a request for a comment on the bankruptcy talk.

American is the only major carrier that did not restructure in Chapter 11 during the recent industry downturn. As a result the airline has operating costs — including labor — that are higher than competitors.

Meanwhile, experts warn that an economic downturn could hit travel demand just as airlines are beginning to recover.

The International Air Transport Association on Monday said airline traffic slowed in August compared with July, with the total passenger market down 1.6 percent.

Shares of United Continental Holdings (UAL.N) were down 9 percent at $17.64 on the New York Stock Exchange. Delta Air Lines’ (DAL.N) shares fell 7 percent to $6.99 on the NYSE.

BERLIN (Reuters) – Following a now-familiar script, Europe again averted disaster in its debt crisis when German deputies rallied behind Chancellor Angela Merkel to approve a stronger euro zone bailout fund on Thursday.

But bigger challenges lie ahead for the euro zone and markets are already demanding more far-reaching measures to prevent a crisis that began in Greece from spreading far beyond Europe and its banks.

The Bundestag (lower house) overwhelmingly approved new powers for the 440-billion-euro EFSF fund to make precautionary loans, help recapitalize banks and buy distressed countries’ bonds in the secondary market.

Despite a rebellion by 15 backbench Euroskeptics, Merkel won 315 votes from her own conservative-liberal coalition, enough to avoid the humiliation of having to rely on opposition Social Democrats and Greens to pass the plan.

“The result of the vote is a strong signal for Europe. The broad majority in parliament clearly shows that Germany is committed to the euro and to protecting our currency,” said Hermann Groehe, general secretary of her Christian Democratic party.

The measure was part of a July 21 agreement by euro zone leaders meant to solve the crisis by providing a second bailout for debt-stricken Greece, partly funded by private sector bondholders, and providing more firepower to prevent contagion engulfing bigger EU economies Spain and Italy.

But that deal failed to stop Italian and Spanish borrowing costs soaring, forcing the European Central Bank to intervene in August to buy their bonds, and may yet unravel in Greece, which has fallen behind again on its deficit reduction targets, pushing it closer to default.

“There is a growing realization, even among the more reticent, that the July 21 package is yesterday’s war, and we need to go further,” a senior EU official said, speaking on condition of anonymity.

The euro and European shares ticked up and safe-haven German bonds fell after the closely-watched vote in Europe’s pivotal power, where public opposition to further bailouts is rife.

But analysts said financial markets and outside powers still want a more comprehensive response from European Union policymakers to the debt crisis.

U.S. President Barack Obama kept up a barrage of criticism of the EU’s crisis management, saying on Wednesday: “In Europe, we haven’t seen them deal with their financial system and banking system as effectively as they need to.”

EU officials are already working on ways of leveraging up the rescue fund, but kept those legally and politically fraught ideas under wraps ahead of the German vote to avoid antagonizing waverers in the Bundestag.

The European Commission welcomed German approval of the EFSF boost and said it was confident the ratification process would be complete throughout the 17-nation currency area by mid-October.

Elsewhere in Europe, there was a sense of relief. French Finance Minister Francois Baroin said the Bundestag vote “confirms German determination to preserve the financial stability of the euro zone.”

So far 11 states have backed the new powers. Of the rest, only Slovakia’s endorsement appears politically difficult.

PAIN IN SPAIN, ITALY

Despite the German vote, developments in Spain and Italy highlighted the stark challenges still facing the euro zone in coping with the sovereign debt crisis.

Spain’s ruling Socialists abruptly shelved plans to boost public coffers by selling part of the state lottery for up to 9 billion euros ($12 billion), in the face of tough market conditions, political opposition and banks’ funding concerns.

The backtracking, a day before bookbuilding was supposed to begin on the public offering of 30 percent of Loterias, was a blow a few weeks before a November 20 election, which opinion polls show the center-right People’s Party sweeping.

Banks involved in the sale, Santander and BBVA, saw the Loterias flotation as a direct rival to their efforts to bolster their capital by enticing Spaniards to withdraw deposits to invest in lottery shares.

Italy meanwhile had to pay the highest yield on a 10-year bond since the introduction of the euro in 1999 at an auction on Thursday, the first long-term sale since Standard & Poor’s cut the country’s sovereign credit rating.

Rome’s funding costs remain under pressure despite ECB bond-buying and a pick-up in risk appetite due to expectations of a stronger euro zone rescue fund. Analysts say the government’s tentative crisis response has harmed investor confidence.

Italy sold 7.86 billion euros of long-term bonds, moving closer to an overall issuance target of 430 billion euros for the year, but the 10-year yield rose to 5.86 percent at the auction, up from 5.22 percent a month ago.

“That’s eye-watering yield levels,” said David Schnautz, a rate strategist at Commerzbank.

Senior officials of the troika of European Commission, ECB and International Monetary Fund resumed talks in Athens aimed at checking that Greece has met the terms of its international bailout program after adopting new austerity measures.

The government will run out of money to pay salaries and pensions in October unless it receives the next 8 billion euro installment of emergency loans. It pushed an unpopular new property tax through parliament this week despite public anger.

Anti-austerity protesters blocked the entrances to several ministries before the start of the talks.

Around 200 finance ministry employees gathered in front of their ministry, shouting: “Take your bailout and leave.”

“The occupations are carried out today when the troika returns to our country and as we face new barbaric measures which were decided and are being decided for further wage reductions … new tax hikes and mass layoffs,” public sector ADEDY said in a statement.

There’s been word that the jobs will be cut in the U.S., but there is not confirmation of that today. The announcement simply refers to “layoffs,” with no mention of whether it’s globally or not.

However Moynihan said that layoffs would affect those areas under review in Phase 1 of Project New BAC.

That means these units are getting chopped: the consumer and small business banking, credit card, home loans, global tech and operations, and support areas.

The layoff plans were anticipated last week, as people familiar with BofA said it would cut from 30,000 to over 40,000 employees.

It sounds like a lot and it is, but here’s a bit of context. CEO Brian Moynihan said on a conference call this morning that BofA acquired 200,000 people through 6 deals in the past 5 years.

Check out the layoffs about to hit other Wall Street banks >

The announcement:

Bank of America’s Project New BAC is key to the company’s strategy of focusing all of its resources on serving individuals, companies, and institutional investors.

The first result of New BAC was the recently announced management reorganization, removing a layer of management and streamlining the company by aligning its businesses with the customer groups.

This reorganization follows on work that started in January 2010. The company continues to sell non-core business units and assets that don’t support its strategy, thereby strengthening the balance sheet, and improving capital and liquidity.

Bank of America is nearing the end of the first phase of a comprehensive review of its consumer businesses and support functions. As the company implements the thousands of decisions from Project New BAC over time, it intends to become a more focused, leaner, and more efficient company, providing all of its customers and clients with the best financial services, generating strong revenues, carefully managing expenses and risks, and delivering long-term value for shareholders.

Bank of America’s goal is not a given number of job reductions, but rather implementation of New BAC decisions. As the decisions are implemented, employment levels in the areas under review during Phase I are expected to be reduced by approximately 30,000 jobs over the next few years. The company expects that attrition and the elimination of appropriate unfilled roles will be a significant part of the anticipated decrease in jobs.

Full implementation of approved ideas in Phase I is expected to lead to net expense reductions of $5 billion per year by 2014, on a baseline of $27 billion in annual expenses for the areas the company reviewed.

New BAC Phase II is scheduled to begin in October and continue through March 2012, and cover those businesses and operations that were not reviewed in Phase I.

After spending much of last year’s meeting defending the industry and debating proposed rules, bankers plan to focus on wooing clients and winning business, according to executives at three Wall Street companies, who spoke anonymously because they weren’t authorized to comment publicly.

The bankers will be coming to Davos, Switzerland, with a renewed sense of confidence. JPMorgan Chase & Co.’s profits last year were the highest in the bank’s history, and Citigroup Inc. returned money to the U.S. Treasury and reported its first full- year profit since 2007. Governments have so far opted against breaking up or levying extra taxes on banks deemed too big to fail, and the Basel Committee on Banking Supervision, which sets global financial-regulatory guidelines, isn’t requiring lenders to meet new capital standards until 2015.

“It will feel less acute,” said Anne M. Finucane, Bank of America Corp.’s chief strategy and marketing officer, who attended with CEO Brian T. Moynihan for the first time last year and is returning this week. “The level of angst should have dissipated some given that there is movement in the economy.”

Goldman, Morgan Stanley

Two years ago, after the 2008 financial crisis, the CEOs of Bank of America, Citigroup and Morgan Stanley stayed away from the annual forum. This year the only major Wall Street banks that aren’t sending CEOs are Goldman Sachs Group Inc. and Morgan Stanley, instead represented by President Gary D. Cohn, 50, and Chairman John J. Mack, 66, respectively.

That means banks will be spending on parties. JPMorgan upgraded its cocktail reception to the Kirchner Museum from last year’s event at the Tonic Piano Bar at Hotel Europe Davos. Bank of America’s Moynihan and the firm’s other top executives will meet clients for drinks on Jan. 27 at the Steigenberger Grandhotel Belvedere — the same night Morgan Stanley’s Mack is hosting a private dinner at restaurant Gasthaus in den Islen. Standard Chartered Plc and Deutsche Bank AG are both hosting events at the Belvedere the following night.

Nomura Holdings Inc. is having a British journalist and a newspaper editor speak at a dinner for clients, the first such event the Tokyo-based bank has held in Davos, according to a person familiar with the planning. Barclays Plc will again hold its annual client dinner at the Hotel Schatzalp, and Credit Suisse Group AG is hosting two client lunches, one discussing financial regulation and the other focused on emerging markets.

‘Cup of Coffee’

As always, much of the action at Davos will happen at meetings and parties that aren’t on the official program.

“The most useful thing for us is really just to spend time with key clients over there, even if it’s just a cup of coffee for 20 minutes or so,” said William Vereker, the London-based joint global head of Nomura’s investment banking division.

For bankers like Vereker, in contrast with this year’s Davos theme of “Shared Norms for a New Reality,” the old reality is back.

“They’re out there to make money for shareholders and trying to do that the best way they can under a system they helped design,” said Simon Johnson, a professor at the Massachusetts Institute of Technology’s Sloan School of Management and a Bloomberg News columnist. “We’re just going through the same cycle again with pretty much the same incentives and power structures. Why would one expect anything different?”

Co-Chair Kochhar

One thing different this year is that none of the heads of big western banks is among the event’s six co-chairs. Chanda D. Kochhar, the 49-year-old CEO of ICICI Bank Ltd., India’s second- biggest lender, is replacing Deutsche Bank CEO Josef Ackermann and Standard Chartered CEO Peter A. Sands, who represented the industry last year.

Kochhar’s bank, unlike many of its western counterparts, remained profitable throughout the financial crisis and this week reported a record profit for the three months ending Dec. 31. Her salary, bonus, expenses and pension contributions for the year ending March 31, 2010, totaled 20.9 million rupees ($457,500), the Mumbai-based bank’s annual report showed, less than half the $1 million base salary paid to JPMorgan CEO Jamie Dimon, who is returning to Davos after skipping last year.

A survey released today by New York-based public relations firm Edelman showed the percentage of respondents in India who said they trusted banks rose to 87 percent, while in Germany, Ireland, the U.K. and U.S., trust in banks tumbled to 25 percent or less. In China, trust in banks soared to 90 percent, the study showed.

Lessons Learned

Finucane and other senior bankers said the lessons learned from the financial crisis aren’t forgotten. They also said the reform process isn’t finished. Many of the rules required by the U.S.’s Dodd-Frank financial legislation have yet to be written, and Basel still has to craft rules for too-big-to-fail banks and capital requirements for trading units.

“The way that Dodd-Frank is implemented is still up for grabs,” said Jane R. Gladstone, who leads the financial- services corporate advisory practice at New York-based investment bank Evercore Partners Inc. and is going to Davos for the third time. “There is a chance that we still have some important sessions and regulatory meetings at Davos.”

This year the discussion at Davos will probably move to different topics such as economic stimulus, monetary policy and the role played by emerging markets, Finucane said.

Geithner, Cantor

Timothy F. Geithner is scheduled to be in Davos, the first time in more than a decade that a sitting U.S. Treasury secretary has flown to Switzerland for the conference. The leaders of France, Germany and the U.K. will also appear, as will seven members of the U.S. Congress, including Republican Majority Leader Eric I. Cantor and Massachusetts Democratic Congressman Barney Frank.

None of the U.S.’s main financial regulators, such as Securities and Exchange Commission Chairman Mary L. Schapiro or U.S. Commodity Futures Trading Commission Chairman Gary Gensler are on the list of participants.

“Last year there were a lot of conversations about who to blame, how to blame them, and how to re-jigger the industry,” said Yury Spektorov, a Moscow-based partner in Bain & Co.’s mergers and acquisitions practice. “It’s not a hot topic anymore. Some people probably learned their lessons, some probably didn’t, but they will discuss how to move forward.”

Back on Track

Goldman Sachs’s Cohn and Standard Chartered’s Sands are scheduled to participate in one of the first panels tomorrow, discussing “The International Financial System: Back on Track?” The discussion will also include Liu Mingkang, chairman of the China Banking Regulatory Commission, as well as London- based lawyer David R. Childs and hedge-fund manager Frank P. Brosens. That session is closed to the press.

JPMorgan’s Dimon, 54, will make a more public appearance the following morning on a panel titled “The Next Shock: Are We Better Prepared?” Dimon is the only financial-industry participant in that discussion, which also includes Israeli President Shimon Peres and the leaders of consulting firm McKinsey & Co., Alcoa Inc. and Paris-based advertising company Publicis Groupe SA.

Pandit, Diamond

Other appearances by top bank executives are less likely to focus on Wall Street and regulation. Citigroup’s Vikram S. Pandit is on a panel about expanding financial services to the poor; Bank of America’s Moynihan will talk about currency devaluations; and Barclays’s Robert E. Diamond Jr. will discuss the global economy in a session that features World Bank President Robert B. Zoellick and the finance or economy ministers from three countries.

Jonathan Chenevix-Trench, who spent 23 years at Morgan Stanley and went to Davos in 2006 and 2007, said the event could be more useful than ever if executives used the time with politicians and regulators to address unsolved problems in the financial system.

“There will always be client meetings, that’s what they’re there to do, so absolutely they’ll be doing that,” said Chenevix-Trench, 59, who co-founded London-based African Century Group, which invests in sub-Saharan Africa. Still, “we’ve not solved this conundrum of bankers making hay when the times are good and taxpayers picking up the tab when times are bad, and that model, everyone’s got to look at it very carefully.”

The study, conducted by Boston College’s Center for Retirement Research, says savings have been squeezed by declines in stock and housing values.

The study was commissioned by Retirement USA, a coalition of organized labor and pension rights advocates that hopes to use the study to push for a more stable retirement system. The group plans to unveil the study at a news conference in Washington on Wednesday.

The $6.6 trillion figure is based on projections of retirement and income for American workers ages 32-64. The study’s authors say they arrived at the amount using conservative assumptions, including a 3 percent rate of return on assets and no further cuts in pension coverage or increases in the Social Security retirement age.

“Using other assumptions, it could be much higher,” said Maria Freese, Director of Government Relations and Policy for the National Committee to Preserve Social Security and Medicare. For example, the study notes, if the rate of return matches the return on U.S. Treasury Inflation-Protected Securities (TIPS), currently 1.87 percent, the deficit balloons to $7.9 trillion.

This announcement comes on the heels of other sobering news: Milliman Inc., a Seattle-based actuarial and consulting firm, reported this week that the funded status of the 100 largest corporate defined benefit pension plans dropped by $108 billion during August 2010.

This comes amid recent reports indicating that a White House-created panel is considering proposals to cut Social Security benefits and raise the retirement age.

“The ‘Retirement Income Deficit’ should be a wake-up call to Americans everywhere,” Freese said.

Yes, we are one year removed from that column and Gold is up 25% in dollar terms at nearly $1000/ounce. Detractors will quickly point out Gold’s inability to land and stick above the $1000 level. In return, I will point at the Dollar’s failed rally to 90 as measured by the USDX. Detractors will point to a lack of interest and dividends from investing in Gold. I will point out that Gold is not an investment; it is money. However, for those who insist on comparing Gold to stocks, I will point out that in the year since the last article, Gold is up 25% while the Dow Jones Industrials are down 19%. Detractors will point out the new bull market in stocks. I’ll counter with the fact that stocks are merely in the middle of a countertrend rally within a bear market while Gold’s correction last year was a countertrend move within a bull market. Detractors will point to the save-haven status of the Dollar during times of economic distress. I’ll counter with the fact that Congress has ensured that the Dollar will die of nearly two trillion cuts – in FY 2009 alone. Must we really continue this?

So on the anniversary of the beginning of the first in extremis phase of the financial crisis, we’re going to look at two of the many developing situations that should give us pause when considering the stability of our financial structures despite all the positive rhetoric and hopefully compel us to consider how to adequately protect ourselves.

China’s stop-loss

Earlier this week, China released some rather earthshaking news that was barely reported by the diligent media here in the US. And where it was reported, the significance was completely glossed over or even ignored. The Chinese Government gave a directive to its state banks to cut their losses on commodity related derivatives, many of which are tied to NY and London banks. In doing so, the Chinese government is in essence saying it no longer respects the validity of these specific performance contracts, pointing out that without performance, there is nothing special about the contracts.

This is tantamount to a shot across the bow. The commodities portion of the total notional value of all OTC derivatives as of December 2008 is rather small at .75% of the total. Telling Wall Street to take a long walk off a short pier in this instance will probably not destroy the financial system in and of itself, but it will certainly give the bailout boys a hint of what could happen if the Chinese et al (think BRIC) start backing out of other more important areas such as interest rate swaps which were nearly 55% of the total notional value. (Data courtesy of BIS)

Even the most diehard of Keynesians, who have never seen a deficit they didn’t love, are aware of the fact that it is much more favorable to have foreign cooperation in your currency burying than to have to do it on your own with direct (or around the woodpile) monetization. In that regard, they still need the Chinese if for nothing else than maintaining the façade of vendor financing and the maintenance of the status quo.

Stock markets reacted poorly to the news on Tuesday with the DOW losing nearly 200 points on a day where there was a bevy of ‘green shoots’ economic news in the form of ISM manufacturing data, pending home sales, and motor vehicle sales. Financial stocks led the decline and we must wonder if the smart money had its eyes on the Chinese as the day progressed. On Wednesday, Gold broke out of its recent doldrums and immediately headed north. Granted the technical patterns had been predicting the breakout for the past few weeks, but it is rather coincidental and we have to ask if we are not beginning to see the first shockwave from the recent Chinese action? If so, Gold gets a big thumbs up, while paper assets get the boot.

FDIC: The paper tiger is going to need more paper

“We’ve all seen the good news that has come out on the economy in the past few weeks. While challenges remain, evidence is building that the American economy is starting to grow again. But no matter how challenging the environment … the FDIC has ample resources to continue protecting insured depositors as we have for the last 75 years. No insured depositor has ever lost a penny of insured deposits … and no one ever will.”

The above statement, made by FDIC boss Sheila Bair is overflowing with inaccuracies, but for the purposes of this article, I want to focus on the last sentence. The FDIC’s ‘trust fund’ is dry. At the beginning of 2008, the Deposit Insurance Fund (DIF) had a balance of approximately $52.8 Billion. By the end of 2008, the DIF had been drained to around $17.3 Billion on the back of just 25 bank failures. To date in 2009, there have been 81 failures, with the two largest failures of the recession coming in the last month. At the end of Q1 2009, the DIF balance had already been reduced to $13.1 Billion. In addition, the list of ‘troubled’ (read: dead) banks now stands at 416 as of the FDIC’s latest quarterly report.

Ms. Bair, in her statement alluded to the notion that the FDIC sets aside reserves for anticipated failures. The problem is that their estimates of the total impact of failures have been categorically low during the recent run of bank failures. In fact the actual losses have been nearly twice (1.94X) the estimates by FDIC. In the following graphic, used in Ms. Bair’s presentation, the FDIC has estimated the cost of failures to be $32 Billion. If recent history is any guide, the real cost is likely to be a tick over $62 Billion. Given that the balance of the DIF is now at $10.4 Billion, I’d say they have more than a small problem.

What is even more interesting is that Ms. Bair considers money borrowed from the Treasury (taxpayers) and thrown into a black hole to be an asset and her chart above fails to recognize that such a loan creates a liability as well. However, this is indicative of our new accounting paradigm. In addition, she asserts that the FDIC is entirely ‘industry-funded’. Not so when they’re tapping a Treasury credit line. While most folks are sniffing a bailout of FDIC, I wouldn’t count on it. So far, the vast majority of the bailout money has found its way to Wall Street, not Main Street.

So while the FDIC is bragging that no insured depositor has ever lost a penny and never will, it must be noted that it is incorrect to assume that Congress is under any type of mandate to bailout FDIC. When the DIF requires massive borrowing from the Treasury, bank premiums will be increased in a vain attempt cover the cost, which will mean higher borrowing costs for the real economy. And if Congress does step in and bailout FDIC, the amount will just get tacked onto the national debt. So while large banks gobble up smaller ones and consolidate on the back of TARP, TALF, TSLF and a dozen other ‘emergency’ Fed lending programs, everyday Americans will foot the bill in its entirety. How’s that for a guarantee?

The above items are just a sampling of where we stand a year later. The opportunity offered by precious metals is the opportunity rid oneself of counterparty risk. The Dollar is the ultimate example of counterparty risk as it relies on the responsible performance of government and monetary authorities to maintain its value. Since the two aforementioned entities have been absentee custodians of the Dollar for so long, its value has deteriorated dramatically. Precious metals have allowed individuals to compensate for that loss in purchasing power. Pundits will say that Gold is a lousy investment and they’re right. The problem with their thinking is that Gold is not an investment; it is sound money and should be regarded as such, not with contempt as is routinely the case in the mainstream press corps.

So as we begin another September, a time of year that seems to bring out the worst in our financial and banking system, I will say it again – Gold continues to be the opportunity of a lifetime.

Despite the calm appearance on the economic waters of late, there is quite a bit of turbulence building beneath the surface on a multitude of fronts. Several developments have emerged that fly directly in the face of the idea that we’re headed for a green shoots recovery. Even more surprising, when you take a deeper look at these issues, some rather remarkable inconsistencies emerge in that the methods being used in some critical areas virtually guarantee that they will not be successful. We’ll take a look at two of these areas, but first, let’s discuss maneuvering room.

A compressing timeline – less time for proactivity

Last week we presented a chart of the spread between 10 year and 2 year bonds and noted how with each interest rate ‘cycle’ that the spread is getting bigger. For reference, that chart is included below.

What is perhaps even more alarming than the increasing spread with each successive cycle is that the timelines are becoming compressed meaning that there is less time for recovery with each subsequent cycle. Such as has been the case in many other fiat systems when they begin to degrade. Volatility increases while the business cycle compresses. This is exactly what we’re seeing here. Firms and cohorts become reactive rather than proactive and it seems they’re always a day late and a dollar short. Not only do they have limited time to properly position for the next cycle, but with each subsequent cycle, they emerge with diminished resources as well.

No Green Shoots for Consumers?

Consumers are not far behind in this regard. As consumer prices continue to be on the increase due to the recent blowout in the monetary base (M1), expectations will switch from deflationary to inflationary.

However, there is a problem in this regard; the fuel for this inflation is not present. In order to see a meaningful inflation at the consumer level, money or credit has to find its way into the hands of consumers to monetize demand. Wages have been remarkably stagnant, with the most recent data suggesting that wages are increasing at a 1.2% annual rate. Consumer credit, which is another potential source of spending money, has been in a contractionary pattern over the past 4-6 months.

Fiscal stimulus by the federal government has largely left consumers out of the picture as the government has opted to try to initiate consumers to spend their own money instead of monetizing demand directly through rebates or other types of transfer payments. The shift from the direct stimulus method, which was used at the beginning of 2008 to the indirect method of using tax credits, has been important. Ostensibly, from a financial perspective it doesn’t really matter which means are used. The government will either spend money directly or lower future tax receipts as people take advantage of the credits.

The message here is clear. The government would prefer that people didn’t save, opting rather to borrow and consume in the present and avail themselves of a tax credit at the end of the year.

This is evidenced by the ever-growing list of tax credits that are available for doing various things like buying a home, putting in alternative energy systems, or installing energy saving devices. The problem is that in order to take advantage, consumers must have access to the money and/or credit to make the expenditure in the first place. This is probably the worst way to stimulate consumption in a cohort that is already grossly overextended. Consumers, to a certain degree have sniffed this out as is evidenced by increased savings rate in recent months. Job losses haven’t helped to encourage spending and certainly won’t do much for consumers’ willingness to borrow. If the government was interested purely in consumption, there are much better ways to stimulate it.

It would seem possible that there are some ulterior motives at work here. Namely that the government would prefer that consumption remain tepid or even contract without them actually coming out and saying it. More on this a bit later.

Mortgage bond yields continue to rise

The Federal Reserve publicly plans to purchase $1.25 Trillion in mortgage bonds this year alone in an effort to keep mortgage rates down. However, rates have shot up from just under 4.8% to nearly 5.5% in just the past few weeks. One would wonder what exactly is going on here. How can this be, given that the Fed has pledged its undying support to this market? It would appear they have, at least for the meantime, reneged on their pledge. Consider the following:

As of April 30th, the Fed held a total of $367.728 Billion in mortgage backed securities. That number increased to $384.115 Billion on 5/14, $430.485 Billion on 5/21, and reached a peak of $430.902 Billion on 5/28. However, as of yesterday, Fed holdings of MBS actually fell to $427.612 Billion, meaning the Fed sold over $3 Billion of MBS during the past week.

So not only has the Fed slowed its support of this endeavor in the weeks leading up to 5/28, they are now contributing to higher mortgage rates by selling into an already weak market. I would contend that they never should have been buying MBS in the first place, but since they decided to monetize this market, why all of a sudden are they content to allow rates to jump nearly 15% in two weeks by withdrawing their support? Every piece of Fed testimony would lead one to believe they firmly attach the success of the housing market to the success of the overall economy. So why pull the plug on that support just when there seemed to be at least something of a bottom forming? No doubt the quick increase in rates will scare buyers away. A three quarter percent increase in rates will quickly eat up any tax credit the government is providing.

Again, similar to the issue with consumers, it would seem as though there is an attempt being made to throttle recovery without coming right out and admitting it.

One possible answer – The $100 Trillion consumption gap?

It has long been the view of this weekly editorial that our climbing debt levels would eventually be what sank the US as the premier economic world superpower. Even more than the debt itself is the impact such debt will have on future generations. Unfortunately, this is one angle that is rarely looked at. Most government reports reflect the national debt, trade, and budget deficits as a percentage of GDP. Using this measure, it is easy to look at the debt picture of the US in a rosy light. On a purely percentage basis, the debt looks manageable and is not out of line with other industrialized nations. The problem lies in the ability of both the economy, and the working class young to repay the debt. In other words, we never look at the impact of the debt, but rather choose focus on the size of it.

When one starts to examine the impact of our mounting debt and take into account generational and demographic factors affecting our population, it becomes immediately clear that not only is our current standard of living unsustainable, but it is downright foolish to expect that it can continue. This week on our Spin Cycle podcast, we talked with Professor Laurence Kotlikoff who can easily be considered an expert in the field of generational accounting. He pointed out during our discussion that there was more than a $100 Trillion gap between our ability to produce, and our appetite for consumption. Such studies are stretched out over many years with the future dollars being discounted to the present so we can compare apples with apples.

Certainly those in the upper levels of government and finance are aware of these realities and realize that there is simply no way we can continue to consume at our present rate, enjoy the same standard of living, and ever have any hope of paying for it without a massive hyperinflation and the resultant economic and social discord. Another contributing factor in this analysis is the growing likelihood that not only has global oil production peaked, but that our ability to procure ever-increasing amounts of other materials necessary for our standard of living has peaked along with it.

For more information about generational accounting and our current fiscal and consumption gap, listen to our interview with Professor Laurence Kotlikoff by visiting our podcast page: www.my2centsonline.com/radioshow.php and looking in the ‘Spin Cycle’ section. Next week we’ll conclude our cubic analysis with a discussion of energy and natural resources with Zapata George Blake. That podcast will be available on 6/10/2009 and may also be found at the above link under the same section.

It is the latter statement that causes me to reflect this week on the prospects for our return to prosperity. We have had the opportunity over the past year to listen to many speeches from Presidents to heads of Treasury and the Federal Reserve. Many men and women – bright men and women, have weighed in and opined on our current situation. They’ve spoken of stimulus, of consumer spending, government spending, bridges, roads, healthcare, energy, banks, and many other topics too numerous to count in this short space. However, what I haven’t heard nearly enough mention of is confidence even though the stated purpose and intent of these speeches has been to inspire the same.

The confidence of consumers

One report in particular has made some inroads in terms of getting coverage of the precipitous drop in overall consumer confidence. And in fact, the most recent release of the Conference Board’s measurement of consumer confidence was the worst in history since measurements began more than 40 years ago. Perhaps the worst part of this report was the expectations component, which absolutely fell off a cliff, plunging from a level of 42.5 to a 27.5 level. The jobs component of the report was no better. 47.3% of those surveyed expect there to be fewer jobs in the future with a mere 7.1% expecting more jobs. 4.4% thought jobs are easy get with nearly half (47.8%) opining that jobs are very hard to get. The chart below tells the awful story.

It is fairly easy to see how the lack of confidence has translated into overall drops in retail sales. Sure people are spending less for gasoline (a major component of retail sales) than they were a year ago, but they certainly aren’t buying anything else in its place either.

This situation, however, goes way beyond some numbers reported every month. It goes to the very heart of the opening paragraph. Confidence is the key to a successful economy, particularly ours, which is so heavily dependent on the consumer taking on debt and spending money. In order to perpetuate this dynamic, the consumer needs to have utmost confidence. As last 2008’s failed stimulus package demonstrates, simply handing money to consumers who are not confident will result in the money being saved or used to pay off existing bills. No confidence, no spending. It’s as simple as that.

Collapse of retirement contributions a referendum on confidence in the financial system

Whether it is along with, beside, or because of consumer’s confidence, equity markets on a global scale have crashed in grand form over the past year. Sure, not all of that was caused by the little guy selling his 401(k)/IRA and going to cash. It is our opinion that the little guy actually represents a relatively small component of the overall money invested in the markets when leverage is factored in. However, the little guy’s actions have still had major ramifications. Consider the following:

• 529 plan contributions are down an average of 60% from 2007 according to a 529 plan representative who materialized at my office door a few weeks ago

• According to TD Ameritrade, 63% of people with retirement plans stopped contributing to them in 2008

• Only 21% of individuals surveyed in the above study had more than $50,000 in investable savings

• Unemployment (32%) and increases in health care premiums (25) were the leading reasons why people stopped contributing to retirement plans in 2008

• Nearly 25% of survey respondents in the 35-44 age group said they’d completely stopped contributing to retirement accounts in 2008. This more than any other group

While complete data for 2008 contributions is incomplete due to the fact that 4/15/09 is the deadline for 2008 IRA contributions, it is relatively clear that 2008 contributions will be down significantly. This problem is two-fold. The first is many people don’t have the funds to invest. The second is that they have lost confidence in the markets and their ability to protect (let alone grow) capital. This reality is unfolding at an unprecedented time in history – a time when people can least afford to be caught without savings.

Job loss – the ultimate confidence-killer

As now more than 600,000 Americans each week are realizing, the loss of a job is one of the most stressful events one can endure. There is an old adage that it is a recession when your neighbor loses his job, but it is a depression when you lose yours. This is not meant to trivialize the matter of unemployment in the least, but rather to underscore the effect that the loss of one’s livelihood has on confidence. As can be expected, consumer confidence has plunged as job losses continue to increase.

Next Friday’s unemployment report is likely to feature an unemployment rate well north of 8% not counting the thousands of workers who lost their jobs in late 2007 and early 2008 that have now fallen off the unemployment rolls and as such are no longer counted. By our count, there have been nearly 2.4 million first time claims for unemployment in the past 4 weeks alone and the trend shows no signs of slowing, at least not in the short term. While unemployment insurance lasts up to a year (depending on the state), it only covers a portion of lost earnings. A good average is probably around 60%. I don’t know about you, but I don’t know too many people who can maintain their current standard of living on 60% of their income – or are even willing to try.

Money – A True Crisis of Confidence

Confidence in the monetary system of the United States has been a true lagging indicator. Inflation at a rate of 5% or so per year has been institutionalized in the system for as long as anyone can remember. Keynesian economics teaches us that this inflation is a normal by-product of growth and should be accepted with glee, which is absolute nonsense. This is akin to welcoming a burglar into your home and offering him 5% of your belongings then chalking it up as a cost of living.

However, even the most regular of folks are starting to wonder where the trillions of dollars for their retirements, healthcare, financial system bailouts, various industry bailouts, state bailouts, government spending, and other pet political projects are going to come from. The fact is we’ve crossed the Rubicon in this regard. The world no longer creates enough savings to cover our massive balance of payments and fiscal deficits. And remember, one in three Americans have less than $50,000 in savings to deal with this. Everyday Americans are starting to wake up to the reality that this money doesn’t exist and must be created from nothing. That certainly doesn’t bode well for their confidence in the value of the currency they carry in their pockets. It can no longer be called money, because to call it money is to imply that it is a store of wealth and acts as a standard unit of exchange.

A real store of wealth holds its value and maintains purchasing power. The US dollar has lost around 96% of its purchasing power since the Fed was created in 1913. Other paper currencies are not far behind. This reality has driven record demand for gold and silver coins as the public awakens and attempts to diversify out of paper. This overall loss in confidence in paper assets is what drives mainstream columnists to attack gold as a ‘useless rock’ and float the false notion that people who bought stock after the 1929 crash got their money back in a few years when in fact it took a few decades. Remember, it is all about confidence.

In the end, the financial crisis of 2007-? will be summed up as a fairly simple process:

1) Confidence shaken

2) More debt accumulated to maintain confidence

3) Confidence further shaken

3) Even more debt accumulated

4) Confidence lost because of all the debt accumulated

For in fact during the early stages of the crisis, policymakers and pundits alike were busy talking about strong economic fundamentals and failing to address the root causes of the problem when it might have mattered. For nearly 9 months the current depression brewed before Fed head Bernanke and Treasury Secy. Paulson were even willing to admit that a problem existed outside the banking system. The entire sum total of their efforts was to maintain confidence. It was a dangerous gamble that has proven disastrous and they’re about to learn the hard way that while you might be able to create a bailout for big banks and big government, there is no bailout for confidence.

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Disclosures: Long GDX