AP: Oil was just another bubble

From the Associated Press, via MSNBC:

As oil prices zoomed toward an unheard of $147 a barrel this summer, it seemed every analyst prediction that oil would approach $200 was a self-fulfilling prophecy, until suddenly it was not.

Instead of $200 oil, oil is now $80. Instead of going up, U.S. demand has fallen at the steepest rate since the oil-shocked 1970s. Americans have dramatically cut down on driving over the past year.

Soaring prices for oil and other commodities this summer have turned out to be nothing short of another classic bubble, and the bursting may not be over, one analyst said Monday.

"It's just amazing that the market gets suckered into this," said analyst Stephen Schork of the Schork Report, who called the idea of $150 a barrel oil "an obscene number, a perverted, illogical number." ...

"We clearly underestimated the depth and duration of the global financial crisis and its implications on economic growth and commodity demand," analyst Jeffrey Currie said in a report.

David Fyfe, an analyst with the International Energy Agency in Paris, was a bit less critical, avoiding the word "suckered." "To be fair, there is always a tendency in parts of the analyst community to look at short-turn trends and assume it's something that will continue in perpetuity," he said.

As recently as July the price of oil was rising based on strong global economic growth, especially in China and India. Now that the financial crisis is threatening to push the entire world into a recession, global economic weakness is likely a major cause of the drop in oil prices.

Also, $4 per gallon gasoline seems to have been the tipping point that encouraged many Americans to cut back on driving and stop buying SUVs. Americans consume roughly 25% of all the world's oil, despite the fact that we make up only about 5% of the world's population.

Now let's see when the gold bubble bursts.

Details on the banking equity injection

Bloomberg provides details on the Treasury's investment in U.S. banks:

The Bush administration will invest about $125 billion in nine of the biggest U.S. banks...

The proposed cash injections in exchange for preferred shares are part of a $700 billion rescue approved by Congress and follow similar moves by European leaders to unfreeze credit markets by helping beleaguered banks. ...

The purchases represent a new approach for Treasury Secretary Henry Paulson, who first promoted a bailout targeted at illiquid mortgage-related assets. The urgency for a more immediate infusion has grown as banks struggle to regain the confidence of investors, counterparties and clients after bad loans caused more than $635 billion of writedowns across the industry. Paulson will discuss his plan at a press conference at 8:30 a.m. today in Washington. ...

The Treasury plans to spend $25 billion each for stakes in Citigroup and JPMorgan, people said. Another $25 billion will be divided between Bank of America and Merrill, which agreed last month to be acquired by Bank of America. Wells Fargo is to get at least $20 billion, Goldman and Morgan Stanley will each get $10 billion, and State Street and Bank of New York will get about $3 billion each, people said.

The government will obtain its stakes with a type of security designed not to dilute the value of common shares.

None of the nine banks getting government money was given a choice about it, said people familiar with the plans. All of the banks involved will have to submit to compensation restrictions as mandated by Congress, people said.

I find the second to last sentence disturbing. Is America still a free country? Government has made a big grab for power under President Bush, starting with the Patriot Act. Now the government is forcing banks to sell parts of themselves. I wouldn't be as bothered if banks were voluntarily letting the government invest. But force? Does JPMorgan even need the money?

More details from The New York Times:

The preferred stock that each bank will have to issue will pay special dividends, at a 5 percent interest rate that will be increased to 9 percent after five years. The government will also receive warrants worth 15 percent of the face value of the preferred stock. For instance, if the government makes a $10 billion investment, then the government will receive $1.5 billion in warrants. If the stock goes up, taxpayers will share the benefits. If the stock goes down, the warrants will be worthless.

By comparison, the U.S. inflation rate over the past year has been 5.4%.

Warning: Big Government Ahead

David Brooks gives us forewarning.

WSJ on the history of stock behavior during recessions

The Wall Street Journal has an overview of how the stock market behaves before, during, and after a recession.

Warren Buffett wisdom

Stock market thoughts from the Sage of Omaha:

You know, five years from now, ten years from now, we'll look back on this period and we'll see that you could have made some extraordinary (stock market) buys. That doesn't mean it won't get more extraordinary a week or a month from now. I have no idea what the stock market is going to do next month or six months from now. I do know that the American economy, over a period of time, will do very well, and people who own a piece of it will do well.

Former FDIC chairman: Mark-to-market causing credit crunch

In a CNBC interview, a former FDIC chairman blamed mark-to-market accounting for the credit crunch:

Financial markets are frozen throughout the world, and former FDIC Chair William Isaac puts the blame squarely on the Securities and Exchange Commission and fair-value accounting—especially the accounting method's requirement that banks "mark to market" their assets.

"The SEC has destroyed $500 billion of bank capital by its senseless marking to market of these assets for which there is no market, and that has destroyed $5 trillion of bank lending," he said.

"That’s a major issue in the credit crunch we’re in right now. The banks just don’t have the capital to start lending right now, because of these horrendous markdowns that the SEC’s approach required."

Barney Frank and Christopher Dodd deserve blame for Fannie and Freddie

The Independent, a British newspaper, blames the Democrats for the failure of Fannie Mae and Freddie Mac:

What is the proximate cause of the collapse of confidence in the world's banks? Millions of improvident loans to American housebuyers. Which organisations were on their own responsible for guaranteeing half of this $12 trillion market? Freddie Mac and Fannie Mae, the so-called Government Sponsored Enterprises which last month were formally nationalised to prevent their immediate and catastrophic collapse. Now, who do you think were among the leading figures blocking all the earlier attempts by President Bush — and other Republicans — to bring these lending behemoths under greater regulatory control? Step forward, Barney Frank and Chris Dodd.

In September 2003 the Bush administration launched a measure to bring Fannie Mae and Freddie Mac under stricter regulatory control, after a report by outside investigators established that they were not adequately hedging against risks and that Fannie Mae in particular had scandalously mis-stated its accounts. In 2006, it was revealed that Fannie Mae had overstated its earnings — to which its senior executives' bonuses were linked — by a stunning $9.3billion. Between 1998 and 2003, Fannie Mae's executive chairman, Franklin Raines, picked up over $90m in bonuses and stock options.

Yet Barney Frank and his chums blocked all Bush's attempts to put a rein on Raines. During the House Financial Services Committee hearing following Bush's initiative, Frank declared: "The more people exaggerate a threat of safety and soundness [at Freddie Mac and Fannie Mae], the more people conjure up the possibility of serious financial losses to the Treasury which I do not see. I think we see entities that are fundamentally sound financially." His colleague on the committee, the California Democrat Maxine Walters, said: "There were nearly a dozen hearings where we were trying to fix something that wasn't broke. Mr Chairman, we do not have a crisis at Freddie Mac and particularly at Fannie Mae under the outstanding leadership of Mr Franklin Raines."

When Mr Raines himself was challenged by the Republican Christopher Shays, to the effect that his ratio of capital to assets (that is, mortgages) of 3 per cent was dangerously low, the Fannie Mae boss retorted that "our assets are so riskless, we could have a capital ratio of under 2 per cent".

Nobel laureate Gary Becker gives his thoughts on the financial crisis

Nobel Prize–winning economist Gary Becker says the current financial crisis is minor compared to the Great Depression:

The magnitude of this financial disturbance should be placed in perspective. Although it is the most severe financial crisis since the Great Depression of the 1930s, it is a far smaller crisis, especially in terms of the effects on output and employment. The United States had about 25% unemployment during most of the decade from 1931 until 1941, and sharp falls in GDP. Other countries experienced economic difficulties of a similar magnitude. So far, American GDP has not yet fallen, and unemployment has reached only a little over 6%. Both figures are likely to get quite a bit worse, but they will nowhere approach those of the 1930s.

He is not fond of government bailouts, but he has this to say about TARP:

Taxpayers may be stuck with hundreds of billions of dollars of losses from the various government insurance provisions and government purchases of assets. Although the media has made much of this possibility through headlines like "$700 Billion Bailout," such large losses are highly unlikely except in the low probability event that the economy falls into a sustained major depression. Indeed, with efficient auctions, the government may well make money on its actions, just as the Resolution Trust Corporation that took over many savings-and-loan banks during the 1980s crisis did not lose much, if any, money. By buying assets when they are depressed and waiting out the crisis, the government may have a profit on these assets when they are finally sold back to the private sector. Making money does not mean the government involvement is wise, but the likely losses to taxpayers are being greatly exaggerated.

Jeremy Siegel's take on the bailout

Wharton Business School finance professor Jeremy Siegel gives his thoughts on TARP:

It is possible that the plan can be a "win" for both taxpayers and banks. One of the central tenets of economics is that a trade often involves gains to both parties and this is no exception.

The collapse of the housing market has sharply lowered the price of real estate, so many of the mortgages and securities issued against homes are now "under water," or worth less than the value of the house. If a lender wrote a $300,000 mortgage on a house that is now worth only $150,000, the "intrinsic" or underlying value of the loan is now 50 cents on the dollar. ...

But in these stressed times, the lot for mortgage lenders is even worse. Because of the current illiquidity of the mortgage-backed security markets and the confusion of ownership rights of some of these complex securities, investors are willing to pay only 30 cents on the dollar or less for an asset with a 50 cent intrinsic value. It is in this situation where the government has an opportunity to improve the lot of the buyer and seller. The Treasury has the ability to hold these assets until the mortgage is restructured in order to realize the intrinsic value of the loan.

This does not mean a recovery of 100 cents on the dollar, but, if the government can buy the loan for 40 cents, it can still receive a good return on the investment if prices eventually rise to only 50 cents. In the meantime, the financial institution has swapped a distressed asset for a highly liquid security.

IMF: Major downturn ahead

From Bloomberg:

Global growth is headed for a "major downturn'' next year, as U.S. gross domestic product grinds close to a halt, the International Monetary Fund said in a staff report prepared for a Group of Seven meeting this week.

"The global economy is entering a major downturn,'' the fund said in the report, dated Oct. 4 and obtained by Bloomberg News. "Many advanced economies are now close to recession, while emerging economies are also slowing rapidly.''

Growth is slowing across the world as policy makers struggle to contain the worst financial crisis since the Great Depression. ...

"All the advanced economies are stagnant or in mild recession now,'' John Lipsky, the IMF's first deputy managing director, in a Bloomberg Television interview. The slowdown is removing "inflationary dangers,'' making it appropriate for central banks in some countries to respond with lower interest rates, he said.