Eventually, with a decades-long orgy of credit expansion unraveling fast; the meltdown of stock, bond, commodity, and other markets; a cratering economy; and more of the nation’s largest financial institutions precariously on the edge, the Federal Reserve and Washington as a whole will have reached a critical juncture. There will be widespread pressure, bordering perhaps on hysteria, for somebody, somewhere to take action and stem the rapidly rising tide of disaster.

Only then, after being unwilling to react quickly and forcefully enough early on, the Federal Reserve will abruptly shift gears, no longer fearing the consequences of an aggressive monetary response. In a sense, they will have nothing to lose. With immediate effect, they will give up their self-imposed yoke of restraint and move wholeheartedly into money-creation mode. That will mark the beginning of the second phase of the great unraveling.

Sound familiar? Here’s some more from Chapter 6 (”Systemic Crisis”)

No doubt a systemic meltdown will provoke a similar response. For the financial system and the markets, however, the fallout will likely be worse than any downturn in many decades, owing to a unique combination of modern developments and incendiary circumstances. The explosive growth of derivatives trading and leveraged hedge fund investing, hidden behind a shroud of lightly regulated secrecy, means that few people will have a handle on where dangerous risk is concentrated or overall levels of exposure — not until it’s too late…

-SNIP-

Simply put, people will find it difficult to react in timely, logical or focused fashion to the unfolding calamity…

-SNIP-

Despite increased levels of sophistication and the broad use of modern risk management systems, no one can be sure how new or exotic instruments and markets will behave when conditions take an ominous turn. The sheer scale of the unfolding financial crisis—in terms of the number of participants, firms, regulators, products, countries, and markets—will make it difficult to penetrate the problems…

-SNIP-

This time, however, a vast and efficient global communications network will ensure that destructive energies are rapidly transmitted to billions of people. So, too, will trading technology that facilitates and encourages traders and investors to act on their impulses. Many will find it too easy to shoot first — or point and click — and ask questions later in a 21st-century rush for the exits.. Not only will the fastest or sharpest operators look to get out. Firms that have come to depend on leverage, including hedge funds, brokers, and even banks, will also face immediate and rapidly growing pressure to scale back positions because of demands for additional cash collateral or reduced access to financing. Meanwhile, those who still have the wherewithal to initiate fresh positions or act independently will look to dive in and take advantage of the stampede.

-SNIP-

A constant global ripple effect will occur as positions are adjusted to take account of risk management strategies or cash-raising demands. The widespread use of flawed models will further aggravate the situation.

-SNIP-

By the time the systemic crisis is full-blown, there will almost certainly have been a domino-like collapse of more than a few large intermediaries and allegedly sophisticated global financial firms, including hedge funds, insurers, and brokers. As the number of failures grows, concerns over counterparty risk will take center stage. Lenders, investors, and risk managers will fret and gossip about which institution is next. Worries about fraud and chicanery will boost anxiety to a fever pitch. Even firms not in dire straits may suddenly find themselves at risk. In times of upheaval, a lack of information and concern about the ability of others to manage their exposure often spurs a self-fulfilling prophecy, where idle chatter alone leads to institutions being squeezed or cut off—just when they need access to financing most.

-SNIP-

Few areas of the financial system will be unaffected when the meltdown rages. In the insurance sector, for example, debt downgrades and defaults will occur at a quickening pace… At least some of the $2 trillion held in money market funds will anxiously flee to safer pastures as the prices of one or more pools fall below par — “breaks the buck” — because of shaky markets and holdings that turn out to be much riskier than expected.

Pretty much all of this has taken place over the last few weeks. Kudos to Michael Panzner for nailing all of this. And somehow I still have hope that much of the other stuff in the book is worst case scenario and won’t come to pass. But I’m losing hope by the day.

Post from: Trader Mike's Blog

Financial Armageddon is in Full Effect

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MOUNTAIN VIEW, Calif. — Many parts of America, long considered the breadbasket of the world, are now confronting a once unthinkable phenomenon: food rationing. Major retailers in New York, in areas of New England, and on the West Coast are limiting purchases of flour, rice, and cooking oil as demand outstrips supply. There are also anecdotal reports that some consumers are hoarding grain stocks.

At a Costco Warehouse in Mountain View, Calif., yesterday, shoppers grew frustrated and occasionally uttered expletives as they searched in vain for the large sacks of rice they usually buy.

“Where’s the rice?” an engineer from Palo Alto, Calif., Yajun Liu, said. “You should be able to buy something like rice. This is ridiculous.”

[SNIP]

“You can’t eat this every day. It’s too heavy,” a health care executive from Palo Alto, Sharad Patel, grumbled as his son loaded two sacks of the Basmati into a shopping cart. “We only need one bag but I’m getting two in case a neighbor or a friend needs it,” the elder man said.

The Patels seemed headed for disappointment, as most Costco members were being allowed to buy only one bag. Moments earlier, a clerk dropped two sacks back on the stack after taking them from another customer who tried to exceed the one-bag cap.

“Due to the limited availability of rice, we are limiting rice purchases based on your prior purchasing history,” a sign above the dwindling supply said.

[SNIP]

An employee at the Costco store in Queens said there were no restrictions on rice buying, but limits were being imposed on purchases of oil and flour. Internet postings attributed some of the shortage at the retail level to bakery owners who flocked to warehouse stores when the price of flour from commercial suppliers doubled.

[SNIP]

The curbs and shortages are being tracked with concern by survivalists who view the phenomenon as a harbinger of more serious trouble to come.

“It’s sporadic. It’s not every store, but it’s becoming more commonplace,” the editor of SurvivalBlog.com, James Rawles, said. “The number of reports I’ve been getting from readers who have seen signs posted with limits has increased almost exponentially, I’d say in the last three to five weeks.”

But here’s the part that really gets me. We’ve got the same dynamic working as with gasoline. This reminds me so much of our little fake gas scare & mania here in Atlanta that I documented back in 2005, post-Katrina — when gas rose from sub $3 to over $5 in a matter of hours:

“There have been so many stories about worldwide shortages that it encourages people to stock up. What most people don’t realize is that supply chains have changed, so inventories are very short,” Mr. Rawles, a former Army intelligence officer, said. “Even if people increased their purchasing by 20%, all the store shelves would be wiped out.”

[SNIP]

An anonymous high-tech professional writing on an investment Web site, Seeking Alpha, said he recently bought 10 50-pound bags of rice at Costco. “I am concerned that when the news of rice shortage spreads, there will be panic buying and the shelves will be empty in no time. I do not intend to cause a panic, and I am not speculating on rice to make profit. I am just hoarding some for my own consumption,” he wrote.

Ah, the old I’ll just panic before everybody else panics solution! As Duru & I say to each other almost daily, “we live in interesting times”. Now where are those food ETFs trading…

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A Food Mania?

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Barry ‘Big Picture’ Ritholtz on WallStrip

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Mortgage Lenders Whistling Past the Sub-Prime Graveyard? — I just noticed this Countrywide (CFC) ad on my site. I wonder how much longer we’ll be seeing these.

Here’s the ad I was linking to:

It just seemed incredible to me that Countrywide, the biggest mortgage lender was apparently doing business as usual right after New Century went belly up. Then some weeks later I saw their CEO, Angelo Mozilo, co-hosting Squawk Box. He was all tanned (just off a nice vacation?) and kept talking about how everything was all good for the company despite what was going on in subprime land. I’m pretty sure he even talked about buying back stock (the stock is now about 05 lower). Well the real deal was revealed on July 24th when they released earnings. Here’s what Mr. Mozilo had to say:

“This is a huge battleship, and we’re headed in the wrong direction,” Chief Executive Angelo Mozilo said on an analyst conference call, referring to the housing environment.

He said it may be 2009 before the market recovers from oversupply, stagnant home prices, and increasingly lax lending standards that left many borrowers overstretched.

“Nobody saw this coming,” Mozilo, a 54-year mortgage industry veteran, said on the nearly three-hour call.

Nobody saw it coming? Really? I call bullsh*t. A lot of people called it in March if not earlier than that. Anyway, the death spiral in this stock has been simply amazing to watch. I just hope we don’t start seeing these bank runs spread to other financial institutions.

P.S. It’s interesting to go back and see/hear what was being said about Countywide earlier this year. This CBS News report from May 29th is an example: “Why is Countrywide Financial, one of the country’s largest subprime mortgage lenders, doing so well despite the recent lending crisis? Geoff Colvin reports.”

Post from: Trader Mike's Blog

Countrywide, oh Countrywide…

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Many of these good looking girls are not high-class assets worth 100 cents on the dollar. And sorry Ben, but derivatives are a two-edged sword. Yes, they diversify risk and direct it away from the banking system into the eventual hands of unknown buyers, but they multiply leverage like the Andromeda strain. When interest rates go up, the Petri dish turns from a benign experiment in financial engineering to a destructive virus because the cost of that leverage ultimately reduces the price of assets. Houses anyone?

[SNIP]

Those that point to a crisis averted and a return to normalcy are really looking for contagion in all the wrong places. Because the problem lies not in a Bear Stearns hedge fund that can be papered over with 100 cents on the dollar marks. The flaw resides in the Summerlin suburbs of Las Vegas, Nevada, in the extended city limits of Chicago headed west towards Rockford, and yes, the naked (and empty) rows of multistoried condos in Miami, Florida. The flaw, dear readers, lies in the homes that were financed with cheap and in some cases gratuitous money in 2004, 2005, and 2006. Because while the Bear hedge funds are now primarily history, those millions and millions of homes are not. They’re not going anywhere…except for their mortgages that is. Mortgage payments are going up, up, and up…and so are delinquencies and defaults.

[SNIP]

The right places to look for contagion are therefore not in the white-washed Bear Stearns hedge funds, but in the subprime resets to come and the ultimate effect they will have on the prices of homes – the collateral that’s so critical in this asset-backed, and therefore interest-sensitive financed-based economy of 2007 and beyond. If delinquencies lead to defaults and then to lower home prices, then we have problems and the potential for an extended – not a 27-day Paris Hilton sentence.

[SNIP]

If subprime total losses hit 10% then even some single-A tranches face the grim reaper. AAA’s? Folks the point is that there are hundreds of billions of dollars of this toxic waste and whether or not they’re in CDOs or Bear Stearns hedge funds matters only to the extent of the timing of the unwind. To death and taxes you can add this to your list of inevitabilities: the subprime crisis is not an isolated event and it won’t be contained by a few days of headlines in The New York Times. And it will not remain confined to a neat little Petri dish in some mad financial derivative scientist’s laboratory. Ultimately through capital market arbitrage it will affect risk spreads in markets completely divorced from U.S. housing.

[SNIP]

Importantly, as well, and this point is neglected by most pundits, the willingness to extend credit in other areas – high yield, bank loans, and even certain segments of the AAA asset-backed commercial paper market should feel the cooling Arctic winds of a liquidity constriction.

If not taken too far – and there is no hint yet of a true “crisis” – these developments may be just what the Fed has been looking for: easy credit becoming less easy; excessive liquidity returning to more rational levels. Still, PIMCO looks for the Fed to issue an insurance policy in the form of lower Fed Funds at some point over the next 6 months…

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Subprime Crisis is Not an Isolated Event says Bill Gross

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12:02 MBA says U.S. MORTGAGE DELINQUENCY RATE 4.95 PCT IN Q4, UP FROM 4.67 PCT IN Q3 AND FROM 4.70 PCT IN Q4 2005

12:02 MBA says subprime borrowers more vulnerable to higher interest rates, slower home price gains or price drops

12:01 MBA pushes back forecast for housing market to regain footing to end of 2007 vs middle of year

12:01 MBA says delinquency rates rose in 49 states in Q4; foreclosure inventory rates grew in 44 states

12:01 Late payments rise for all loan types but driven mainly by subprime and FHA loans

12:00 According to MBA, Mississippi, Louisiana, Michigan had highest overall late payment rates across all loan types in Q4

12:00 U.S. Mortgage delinquencies, foreclosures rise in Q4 2006 vs prior quarter and year ago, according to MBA

Here’s an intraday shot of QQQQ with 15 minute bars. Note the volume on the big drop:

Post from: Trader Mike's Blog

I Think the Other Mortgage Lending Shoe(s) Just Dropped

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• Ed from Daily Dose of Optimism wrote an excellent critique of a recent MarketWatch article about ‘Wall Street Blogs‘. As Ed put it — “the author, David Weidner, spends most of his energy re-affirming the fact that pretty much the only reason to read Marketwatch is for Herb Greenberg.” Ouch!
• In case you haven’t noticed, Japan is in a red hot bull market after a long, excruciating bear market. Here are some ways to play the Japan trend if you believe there is still upside for the Japan market.
• Royalty trusts offer investors high yields and good returns. However, there are some important issues to analyze when considering an investment in a royalty trust.
• Loi writes about the importance of dividends.
• David of Pacesetter Mortgage takes a look at the slowing pace of mortgage pre-payments. He concludes that “if you plan to stay in your home for more than three years, and have an adjustable mortgage, you better get off the fence!”
• Jeffrey wrote about a very interesting concept which has just made it to the U.S. — person-to-person lending. While it could lead to a high return on investment it also (of course) carries a variety of risks. (Note, the New York Times has an article about Prosper.com in today’s edition.)
• Steven reveals that Sharp Corporation is actually an alternative energy play. Sharp is “the world’s largest producer of solar cells and systems and is in position to grab even more market share with recent favorable California state legislation to the solar industry.”
• Here’s a post that no homeowner should be able to pass over — “Do Neighbors Affect Property Value?”
• ‘Frank the Financially Savvy Atheist’ warns about the effects of the newly inverted yield curve.
• Has natural gas already peaked? “The Real Returns” wants to know if the price action is reminiscent of some historical market tops.
• The Consumer Electronics Stock Blog tries to figure out if Cisco is a growth or a value stock.
• “Retire at 30″ submits: “Since ROTH money is post-tax, each dollar in a ROTH account is actually more valueable than a dollar in a traditional retirement account, and you end up being able to contribute more value each year with roth than traditional accounts.”
• Jose provides a lesson on how to calculate the effective interest of an investment after taking into account taxes and inflation.
• Dan takes his local paper to task on their recent erroneous variable annuities article.
• ‘Five Cent Nickel’ thinks that PayPal may soon be meeting its match from Google’s Gbuy.
• Early Riser reveals how he’s reshuffling his portfolio in order to get more index fund exposure.
• On a related note, ‘Mighty Bargain Hunter’ says that rebalancing your portfolio should not replace thinking about your portfolio.
• Bill, playing off of a recent Sprint commercial, has an article about ’sticking it to the man’ by maxing out retirement plan contributions.
• ‘Big Cajun Man’ looks back on a specific Financial Planners advice to his Radio Audience in 2000 and then his about face in 2002.
• ‘Blueprint for Financial Prosperity’ has a glowing review of Phil Town’s blog.
• Free Money Finance made (another?) bet on Steve Jobs by buying Disney stock after it was announce that Steve Jobs is to become its largest shareholder and a director.

Next week’s Carnival of investing will be hosted by MyMoneyBlog

Post from: Trader Mike's Blog

Carnival of Investing, Issue 9

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As usual there are a lot of good articles submitted by bloggers on a variety of topics. I didn’t even attempt to categorize the articles, as many of them cross multiple topics. I did do a quick sorting of them, so the list below generally flows in this order: entrepreneurship, business, technology, blogging, marketing, internet, financial markets, economy and taxes. Enjoy…

• Dave Pollard of How to Save the World discusses Rule #1 for business start-ups — ‘find a need and fill it‘. This is a chapter from Dave’s upcoming book ‘Natural Enterprise’.
• Dr. Jeff Cornwall comments on the state of entrepreneurship in America by taking a look at the SBA’s 2004 Small Business Report. I’m with Jeff on obliterating apart the current tax code.
• Most people who’ve worked in organizations of any size recognize the underground organization - it is the informal and often unspoken (or at least spoken behind closed doors or softly around the coffee machine) network that defines the way challenges to the conventional “wisdom” are squelched or undermined. In this article Phillip Wilson offers three practical tips managers can use to implement double-loop learning in their organizations in order to surface the underground organization.
• Steve Rucinski discusses the importance of customer relationship management (CRM) and gives four key metrics to use to measure the effectiveness of CRM programs.
• Paul Noonan shares his observations of the consequences of running a business like a public utility. When customer satisfaction is not the focus, bad things happen. He uses the Chicago Transit Authority as an example and shows how they are apparently trying to encourage customers to get off the trains.
• Jay Allen, the Zero Boss, recounts a bad customer service experience with a Napster representative.
• Todd Sattersten explains why the lack of opportunities to do innovative work caused him to leave his job at GE.
• In part one of a four part series Brendon Connelly reveals the fine (and secret) art of managing your boss. The other articles in the series detail the three things that one needs to know in order to manage her boss effectively: 1) Understanding Yourself; 2) Understanding The Boss; 3) Understanding The Relationship.

  (As an aside, I’m glad to see that Brendon has been using David Allen’s “Getting Things Done” productivity system for four years. I just got turned on to it a few weeks ago and it’s already had a major impact on me.)

• Dave Foster puts a new spin on the old business parable about buggy-whip manufacturers and how they should have thought of themselves as being in “transportation” rather than “buggy-whips”
• Barry Ritholtz continues his excellent coverage of the music industry by asking if U2’s P2P release was a briliiant marketing ploy.
• On her RFID blog Anita Campbell takes a look at several emerging technologies (Wireless Local Area Networks (WLANs), Radio Frequency IDentification (RFID), smart cards, kiosks, biometrics, and electronic shelf labels) which are converging to change the face of the retail industry.
• Wayne Hurlbert of Blog Business World reports that support for creating a ‘Blog Chamber of Commerce’ is growing. After reading his article I’m all for it. He says that “dispelling the myth that all blogs are online diaries and personal journals is a great place to start.” I would add ‘political soap boxes’ to that as well.
• The blogosphere loves memetics theory and ‘The Tipping Point’. This article by Evelyn Rodriguez is the first in an exploratory series looking at why when we’re talking ideological warfare - certain memes don’t crossover but remain contained within their group. Within their group, the memes amplify and self-reinforce - but cross-over doesn’t happen. This has far-reaching implications for persuasion and evangelizing: from the selling of presidential candidates to understanding the deep loyalty inspired by brands such as Apple or Harley-Davidson. (But may not necessarily apply to more benign products and services such as tissue paper.)
• Yvonne DiVita gives us advice on how and why to utilize some old-fashioned marketing, like newspaper ads, along with your Internet marketing, to make sales this holiday season.
• Russell Buckley explores the future direction advertising might have to take in order to continue to work.
• Sparked by James Surowiecki’s recent article about the decline of brands largely due to reputation systems, Arnold Kling of EconLog wonders if the same can done to the “brand” of government licenses (e.g. health care providers).
• James Cherkoff, from across the pond in London, writes that “the organisational model behind open source (massive web base collaborations by individuals outside of private organisations) is starting to starting to drive innovation in other areas.” He gives several recent examples of how open source techniques are being used in the world of marketing.
• David Jackson lays out four emerging Internet trends which will propel the growth of small Web sites. Although the article discusses the implications for Internet investing it’s also highly relevant to bloggers and anyone in the business of e-commerce or Web publishing.
• In ‘Really Emerging Markets‘ Roger Nusbaum compares iShares South Africa (EZA) to the South Africa Fund (SOA) as a way to invest in Africa. Roger cites two investment themes — Africa as an emerging market and a gold rally lifting the Rand (South Africa’s Currency) and helping stocks work higher with a low correlation to the US. I love the charts of both of those equities, but man are they’re thinly traded.
• Oracle is threatening to give up its bid for PeopleSoft if 50% of PeopleSoft’s outstanding shares are not tendered by November 19. Frank Scavo at the Enterprise System Spectator speculates on what might happen to PeopleSoft if Oracle wins, or if it walks away.
• Rawdon Adams writes that “Ignorance is a vastly underrated quality when it comes to investing; and their counter-parts - arrogance and over-confidence - can prove devastating.” Truer words have never been written.
• Martin Lindeskog reports in from Hungary with a look at how globalization of the financial markets is evolving.
• Don Lloyd writes that contrary to conventional wisdom, high rates of return in the private sector will not save social security.
• Stephen Karlson discusses the assertation by Chicago Fed economist William A. Strauss that President Bush’s “Mission Accomplished” carrier landing signalled the end of major macroeconomic surprises at the beginning of the current economic recovery.
• Technofunk of the ‘Think Like Us‘ group blog takes a very interesting look at a possible effect of online banking and payment tools and what possible effect their increased usage may have on the economy, including personal savings and personal consumption.
• David Tufte does an excellent job of explaining one of the two reasons that Kydland and Prescott won the economics Nobel prize this year. He uses an analogy of traffic jams to explain how events propagate through the economy.
• M. Simon of Power and Control explores why profit is necessary and how it tends to drive down costs.
• Paul Asad of Truck and Barter provides us with his ideal armchair economics reading list. I know I could benefit from reading a few of those books.
• Brian Gongol says that contemporary economic development work by the public sector puts a lot of taxpayer resources to very inefficient use. He proposes that instead of providing special incentives to a small number of firms, states and communities should focus on creating a better organic environment for all businesses.
• Now that it’s year-end tax planning time, Mike Pechar reminds us that mortgage interest on second homes is tax deductible and a boat can easily qualify as a second home.
• Warren Meyer provides us with a roundup of the challenges of collecting and filing sales taxes, including some of the more egregious state practices he’s come across.
• Anita Campbell, at her Small Business Trends weblog, writes that “real estate investors trying to take advantage of 1031 exchanges are banding together into investor groups and overpaying for commercial real estate, just because of the tax advantage. This is a troubling trend that is inflating real estate values across the country.”

Next week’s edition will be hosted at SocialTwister Be sure to send entries to cotcmail-at-gmail-dot-com before next Sunday afternoon (the earlier the better — this is a lot of work!). Brian Gongol has set up a form to help facilitate CotC submissions. I think it would be very helpful to the hosts if people used that form.

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Carnival of the Capitalists Rolls Through Atlanta

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CNBC’s Wal-Mart Documentary

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What’s Next?

Readers ask us that question all the time. And we ask the people we write about the same thing. This first incarnation of the Fast Forward list is an attempt to capture what comes out of those conversations, to look around the corner and offer some insight into the ideas, people, and trends that will affect the way we work and live in 2005.

Perhaps the most thrilling part of putting together a list of 101 emerging ideas is seeing the innovation and optimism bubbling up in so many arenas, from packaged goods to biotech to security. In a stagnant business climate, it’s easy to get dejected about whether there are, in fact, any big ideas left to pursue. An Internet may not come along every year to transform our lives, but not every mountain has to be Everest. We can still get pretty excited about an advance in shopping-cart technology (see No. 74).

At the heart of each of the 101 items on the list lies an idea. It may be convenience or transparency or a new way to think about strategy. We think you’ll see ideas that will help you change the way you work or how your company does business. In some cases, you may just be able to adopt the concept itself. In others, you may be inspired by the soul of it.

Predicting the future, even the near future, is a perilous endeavor in our lightning-round business culture. Some of these items are sure things and others are long-shot gambles. That’s by design. For as you consider what you want to accomplish next year, the key to success may be a healthy mix of both. [read the rest]

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Fast Forward 2005

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