Saturday, March 1, 2008

All the President's Men....

Let's start with the most obvious: Ethanol and Iraq. Science News had this to say about ethanol in July of 2006:

Harvests of corn and other crops are likely to be drawn into a tug of war between people's need for food and their need for fuel, agricultural economists say....

The analysis found an emerging "competition between the 800 million people who own automobiles and the 2 billion low-income people, many of whom already spend over half their income on food," Brown says. Furthermore, he says, "taxpayers may be subsidizing a rise in their own food prices."

To encourage the use of alternative fuels, U.S. law subsidizes ethanol production at 51 cents per gallon and production of other so-called biofuels at up to $1 per gallon. Those incentives tempt farmers to sell crops to biofuel distilleries or, if they instead sell to food manufacturers, to demand higher prices than they otherwise would.

President Bush thought otherwise, and pushed ethanol in his 2007 State of the Union speech:

Which generated puzzled responses from journalists:

Of all the proposals in President Bush’s State of the Union speech, the call for massive increases in subsidized ethanol production stands the best chance of winning Congressional support. With the campaign season getting under way, both parties are eager to boost federal funds to the Farm Belt....

So the Bush administration has decided to more than double down its bet. The new target of 35 billion gallons a year by 2017 represents a five-fold increase in ethanol production. That would displace about 15 percent of U.S. gasoline demand.

Now Iraq. We know there were 700 inspections in Iraq for weapons of mass destruction. Nothing was found.

But President Bush, despite this, had this to say in his 2003 State of the Union address:

Twelve years ago, Saddam Hussein faced the prospect of being the last casualty in a war he had started and lost. To spare himself, he agreed to disarm of all weapons of mass destruction. For the next 12 years, he systematically violated that agreement. He pursued chemical, biological, and nuclear weapons, even while inspectors were in his country. Nothing to date has restrained him from his pursuit of these weapons -- not economic sanctions, not isolation from the civilized world, not even cruise missile strikes on his military facilities...

Year after year, Saddam Hussein has gone to elaborate lengths, spent enormous sums, taken great risks to build and keep weapons of mass destruction. But why? The only possible explanation, the only possible use he could have for those weapons, is to dominate, intimidate, or attack....

We Americans have faith in ourselves, but not in ourselves alone. We do not know -- we do not claim to know all the ways of Providence, yet we can trust in them, placing our confidence in the loving God behind all of life, and all of history. May He guide us now.

We know the the President's men behind the SIV sieve bailout that wasn't; the monoline bailout that didn't happen, and the homeowner bailout that Secretary Paulson now disavows.

Now to the subtle. The Federal Reserve chairman, Mr. Benarnke has learned from the administrations miscues. Here is his the text of his speech submitted before Congress on the 27th. I'll just go over the first couple of paragraphs:

His testimony, that the world hears:

"The economic situation has become distinctly less favorable since the time of our July report. Strains in financial markets, which first became evident late last summer, have persisted; and pressures on bank capital and the continued poor functioning of markets for securitized credit have led to tighter credit conditions for many households and businesses.

Many of the challenges now facing our economy stem from the continuing contraction of the U.S. housing market. In 2006, after a multiyear boom in residential construction and house prices, the housing market reversed course. Housing starts and sales of new homes are now less than half of their respective peaks, and house prices have flattened or declined in most areas. Changes in the availability of mortgage credit amplified the swings in the housing market."

And the actual report, which no-one reads:

"The U.S. economy has weakened considerably since last July, when the Federal Reserve Board submitted its previous Monetary Policy Report to the Congress. Substantial strains have emerged in financial markets here and abroad, and housing-related activity has continued to contract.

The turmoil in financial markets that emerged last summer was triggered by a sharp increase in delinquencies and defaults on subprime mortgages. That increase substantially impaired the functioning of the secondary markets for subprime and non-traditional residential mortgages, which in turn contributed to a reduction in the availability of such mortgages to households."

Now let's go back to the obvious. Warren Buffett, whose shareholder letter came out last night, said the party in insurance pricing is over. Two weeks ago, Father Warren offered to guarantee $800 billion of AAA municipal bonds. It was rejected. Now all hell is breaking loose in muni land.

February was the worst month for munis in five years. The $330 billion auction rate market is frozen. All the municipalities that financed long term debt with short term auctions, will soon need to issue bonds at longer maturity bonds with substantially higher rates. If you want a bid on a muni now, it can be 10-20% below your statement price. The leveraged funds in this market are blowing up as banks are demanding their capital back. They sell, depressing prices further, until Saint Gross, from Pimco, offers to buy their merchandise at a 20% haircut.

It is as obvious as ethanol and Iraq that everyone whom is leveraged, has gotten themselves in trouble. But the most leveraged instruments; commodities, are where the biggest bull market exists. Does anyone think that speculators aren't running amok in these markets?

And if the financial system is deleveraging, (and some are complaining of the "forced" nature of it) why don't they just raise the margin rates on commodities, and see what happens to prices?

I suspect the commodity buyers are just as real as all these bond buyers!

Why else would Calpers announce that they are increasing their exposure to commodities by 16 times. Who would advertise this before they would buy?

The California Public Employees' Retirement System, the largest U.S. pension fund, may increase its commodities investments 16-fold to $7.2 billion through 2010 as raw materials prices surge to records.

Do you think all these leveraged commodity players will be able to sell to Calpers and China?

We have a Federal Reserve Chairman, that nuances his speech and testimony, and the President's men, that come up with ill-conceived plans and then abandon them. And the only plans that they agree on, are the half-baked ones that are detrimental to this economy.

The Fed is finally getting with the program and cutting rates, and a .75 basis point cut in mid-March, will allow the economy to start to mend itself. But the higher commodity prices are spooking investors, who worry about acclerating inflation and decreasing profit margins resulting in stagflation with a chaser of housing deflation.

But it would be too obvious and easy to fix the run in commodities by substantially raising the margin requirements.

We have a laissez faire administration, that sees what isn't, only to miss that which is. I guess that what happens when you spend all your free time eavesdropping on telephone calls.

So we have to wait until the market does it itself.