11/08/2002 125 Basis Points Left to Sustain the Unsustainable *

Wednesday afternoon’s growing conviction of a reinvigorated bull market faded into the reality of unresolved financial problems by week’s end. For the week, the Dow was slightly positive, while the S&P500 declined about 1%. The Morgan Stanley Cyclical index added 1%, and the Morgan Stanley Consumer index was about unchanged. Continued debt worries weighed on the Utilities, as the leading index dropped 3%. The broader market suffered from late week selling, as the small cap Russell 2000 declined 1% and the S&P400 Mid-Cap index slipped 2%. The technology sector was its usual volatile self, with the NASDAQ100 and Morgan Stanley High Tech indices ending the week down 1%. The Semiconductor rally was brought to an abrupt halt, with the index sinking 4% this week. The Street.com Internet and NASDAQ Telecommunication indices were largely unchanged. The Biotechs were also generally flat for the week. Curiously, the financial stocks were weak, with the Securities Broker/Dealer index declining 2% and the Banks 4%. With bullion up $2.50, the HUI Gold index jumped 5%.

The Credit market remains extraordinarily unsettled. For the week, the two-year Treasury yield rose six basis points to 1.80%. The five-year Treasury yield declined six basis points to 2.80%, while the 10-year note saw its yield drop 18 basis points to 3.83%. The volatility must have the mortgage players pulling their hair out. For the week, benchmark mortgage-back yields dropped 20 basis points, while implied yields on agency futures sank 17 basis points. There were some notable moves in the spread market, with agency and dollar swap spreads in retreat. For the week, the spread on Fannie’s 5 3/8% 2011 note narrowed 8 to 45, while the 10-year dollar swap spread declined 6.5 to 47.5. It would appear players may have been caught on the wrong side of these spreads in a general unstable environment. The week saw the December 3-month Eurodollar yield decline 8 basis points to 1.375%. The dollar took a turn for the worst, sinking 2% against the yen. The Euro traded above 101 for the first time since July, while the British pound went to a 2 ½ year high and the Norwegian Krone a 4-year high against the dollar. At the same time, the Mexican peso sank to a 3-year low against the greenback.

Broad money supply (M3) jumped $32.6 billion last week, the strongest weekly advance since August (and up about $62 billion over three weeks). While not keeping up with last year’s blistering pace, broad money supply has nonetheless expanded $337 billion, or at a 7.8% annualized rate, over the past 28 weeks. M3 has grown at a 6.1% rate so far this year ($480 billion increase). For the week, checkable deposits increased $19.1 billion, while Savings and Small Denominated Deposits decreased $3.1 billion. Retail Money Fund assets increased $6.5 billion, while Institutional Money Fund assets declined $7.7 billion. Large Time Deposits expanded $5.7 billion, while Repurchase Agreements resumed their growth by increasing $10.3 billion. Commercial Paper borrowings were actually unchanged. Bank Credit jumped $27 billion, with Securities Holdings up $30.9 billion (Treasuries up $7.7 billion and “other” up $23.3 billion). Loans and Leases declined $3.9 billion. Total bank assets increased $30.4 billion. Total bank assets have surged $493 billion over the past 28 weeks to almost $6.9 trillion, an annualized growth rate of 15.6%.

ABS (asset-backed security) issuance continues to be eye-opening as well. Year-to-date, total issuance of $299 billion is running 22.5% above year ago levels. While Credit card issuance of $54.5 billion is about unchanged y-o-y, auto-backed issuance is up 13.5% to $75 billion. The remarkable sector, however, remains home-equity-backed securities. Home Equity issuance of $122 billion is up 73% from last year’s record level. Student Loan issuance of $16.4 billion compares to $7.2 billion this time last year.

Consumer Credit expanded by $10 billion during September, a 6.9% annualized rate. Revolving Credit expanded at a 9.3% annualized rate during the month and 9.5% for the quarter (up from the second quarter’s 5% and first quarter’s 2% growth rates). The new auto loan data are interesting and indicative of ultra-easy Credit availability. For the quarter, the average interest rate was 2.72% for a 58.4 month loan at 96% loan-to-value. This compares to the first quarter’s 5.32% for 53.9 months at 90% loan to value. We are rapidly running out of room for easier auto Credit (0% interest, $0 down and, how about, 10 years to pay?)

Weekly bankruptcy claims of 31,508 were up 13% year-over-year. And while year-to-date bankruptcies are running up 4.6%, October filings were a troubling 14.8% above year ago levels. The ISI Non-Manufacturing index was almost a bright spot, with the reading of 53.1 (vs. September’s 53.9) slightly above expectations. The problem was that only the Prices component posted a month-over-month increase (54 vs. September’s 52.5 and October 2001’s 41.5). Orders dropped to 50.9 from 52.3, Employment 46.2 from 46.6, and the Export component 49 from 57.5. Let’s not get too carried away with the “deflation” talk.

This afternoon from Bloomberg: “National Century Financial Enterprises Inc. Chairman and Chief Executive Officer Lance Poulsen resigned, two weeks after the company had the credit ratings on about $3.35 billion of securities reduced. Poulsen also resigned his positions with National Premier Financial Services, and two units that issue securities backed by health-care receivables. National Century buys hospital bills due from patients and packages them into bonds for sale to investors.” The article quoted a lawyer: “There appear to be some irregularities that need to be explained.”

November 4 – Bloomberg: “The Securities and Exchange Commission plans two hearings this month on whether to increase oversight of credit rating companies and boost competition among the firms whose actions steer trillions of dollars in investments… The credit rating companies have come under fire, as have accountants, lawyers and top executive officers after accounting scandals at Enron Corp., WorldCom Inc and other companies.”

November 6 – American Banker: “Residential Funding Corp., a mortgage unit of…General Motors Acceptance Corp., said Monday that its third-quarter issuance of asset- and mortgage-backed securities reached $9.2 billion and pushed its volume for the first three quarters to a record $27.3 billion. It also broke company records in several areas. Alt-A products, which straddle the line between prime and subprime, generated $1.7 billion of closings for the quarter… The unit also securitized $1.8 billion of negotiated and high-loan-to-value first mortgages…”

November 8 – “Alt-A mortgage securitizations are anticipated to increase by approximately 50% over 2001’s volume and should reach a record-breaking $41 billion by the end of 2002, says Moody’s Investors Service… Alt-A mortgage loans are a credit quality notch below Prime quality Jumbo loans. These loans are so classified because of issues, such as weaker loan documentation, riskier property types, including multifamily homes and investor properties, lower FICO scores, and higher loan-to-value ratios (LTV) than Jumbo mortgage loans.”

November 5 Fitch – “The number of defaulted commercial mortgage-backed securitizations (CMBS) loans with losses will increase in 2002 by over 100% and the severity of these losses will increase by at least 50%, according to a new report published today by Fitch Ratings. As of year-end 2001, the loss severity increased to 34% from 19% as of year end 2000. These data come from the latest Fitch CMBS loss study, which considers a universe of 28,116 loans in conduit, large loan, and fusion CMBS transactions rated by Fitch as of year end 2001 but excludes single borrower transactions. ‘With fundamentals deteriorating in many real estate markets and a greater volume of loans in workout, Fitch expects losses will continue to rise during 2002.'”

Today from Countrywide Credit: “Average daily loan applications were $2.0 billion in October, up 72 percent over last year. Pipeline and funding volumes once again set new records. The mortgage loan pipeline reached a new milestone of $52 billion, an increase of 86 percent over last year. October fundings surpassed all previous company records reaching $34.7 billion, exceeding last month’s funding high of $25.3 billion by an impressive 37%. Given our pipeline activity and the Federal Reserve’s recent decision to cut interest rates by 50 basis points, we expect continued robust funding levels in the near term.” Total fundings were up 134% year-over-year, with purchase fundings up 84% to $9.4 billion and non-purchase (refi) fundings surging 159% to $25.3 billion. Total “e-Commerce fundings” were up 95% y-o-y to $13.9 billion. “Home Equity Fundings” jumped 73% to $1.1 billion and “Sub-prime Fundings” surged 74% $1.0 billion. It’s quite a mortgage finance Bubble…

November 8 - Dow Jones (Colleen DeBaise and Lingling Wei): “The Securities and Exchange Commission filed a civil complaint accusing Beacon Hill Asset Management LLC, one of the biggest hedge-fund managers in the bond business, of misleading investors about the value of its assets… In cases of hedge-fund fraud, the SEC typically looks at whether investment managers receive more fees than they should have because they were overstating the value of the assets… The complaint, filed Thursday in Manhattan federal court, says Beacon Hill disclosed ‘much greater losses than previously reported’ in October when it revealed that its… funds had dropped 54%, or more than $400 million, in September… The SEC said Beacon Hill also agreed to a preliminary injunction barring it from further violations of the federal Investment Advisers Act. The current court-ordered relief doesn’t affect Beacon Hill’s management of collateralized debt obligations, a business valued at $1 billion.”

November 8 – Bloomberg: “Swiss Reinsurance Co. lost its top rating from Moody’s Investors Service on concern about earnings prospects and capital level of the world’s second-largest reinsurer. The Zurich-based company’s long-term insurer financial
strength ratings were cut one level to Aa1 and its senior debt rating to Aa3…”

“Data released today by the BIS (Bank for International Settlements) on positions in the global over-the-counter (OTC) derivatives market at the end of June 2002 point to a further acceleration of activity in the first half of the year.” Total OTC derivative positions increased at a 30% annualized rate during the first half to $127.6 Trillion (up 83% since June 1998!). Interest rate derivatives expanded at a 32% rate to $90 Trillion (up 112% since 6/30/98), while currency derivatives increased at a 16% rate to $18.1 Trillion. Equity derivatives grew at a 35% rate to $1.9 Trillion, with gold derivatives increasing at a 42% rate to $279 billion.

Credit insurer MBIA reported earnings this week. The company saw “Net Premiums Written” jump 26% y-o-y (up 6% sequentially). Of the total $41.2 billion of gross “Par Value Insured” (new insurance written), $23.6 billion, or 57%, was insuring “Global Structured Finance.” MBIA saw “Net Debt Service Outstanding” (gross insurance written less risk ceded) increase $22 billion during the third quarter (12% annualized) to $764 billion. This compares to the second quarter’s $14.8 billion and last year’s third quarter growth of $1.4 billion. Interestingly, it was the company’s strongest growth since the (infamous) fourth quarter of 1998. When the financial markets falter and risk aversion escalates, it helps tremendously that MBIA and the Credit insures can step up to the plate and transform risky debt into palatable securities. This mechanism has, over time, developed into a key mechanism (along with GSE Credit creation and guarantees) to sustain Credit excess. The day these mechanisms don’t work…

It is simply difficult to fathom that MBIA’s “Net Debt Service Outstanding” is up more than 10-fold since 1987. It is also worth mentioning that MBIA saw total assets increase by $1.8 billion during the quarter, an annualized growth rate of 44%. Assets grew at a 26% rate during the second quarter and are up 16% y-o-y. Peddle to the metal, as if one drives fast enough they can outrun the storm. The company repurchased 1.7 million shares of stock during the quarter, increasing year-to-date purchases to 3.4 million shares.

Well, we no longer ponder how CDO issuance could remain so strong despite heightened Credit quality issues: MBIA (along with Ambac) is aggressively insuring CDO structures (turning water into wine). Year to date, MBIA has written insurance on $28.9 billion of CDO exposure. This compares to $13.6 billion last year, almost doubling total CDO exposure to $65.9 billion (MBIA ended 1999 with total CDO exposure of $2.3 billion). MBIA concluded the quarter with a “Global Structured Finance” “Insured Portfolio” of $167 billion. In addition to the CDO exposure, the company has insured about $35 billion of asset-backs (mostly Credit card and auto loan-backed), $21 billion of home equity loans, about $20 billion of other mortgage-backed, almost $20 billion “Pooled Corp. Obligations & Other, and $5 billion of other “Financial Risk.”

MBIA also provides a list of its “Insured Portfolio – 50 largest Structured Finance Credits.” Leading the list is Providian Gateway Master Trust at $2.8 billion, with Metris Master Trust number two at $2.5 billion. Included in its list of the “Top 25 Structured Finance Servicer Exposures” are the likes of Providian Financial Corp, Capital One Financial Corp., Union Acceptance Corp., AmeriCredit Corp., Household International, and Ocwen Financial Corp. The Credit insurers have developed into key players in the increasingly fragile Consumer Debt Bubble and, regrettably, critical business partners in subprime lending. The “financial guarantor” business has changed a great deal since the days of insuring municipal bonds. The risk profile of these companies – with the nature of Credits insured and recognizing we live at the very late stage of the Credit boom cycle – is not even recognizable compared to years past.

This week fellow Credit insurer Ambac reported that it owns $175 million of National Century Financial Enterprises (NCFE) notes (NPF XII and NPF VI conduits). This is a troubling revelation. We would hope that a company with $525 billion of “Net Financial Guarantees in Force” would be diligent and conservative in its investment approach. But, as is too often the case when it comes to the U.S. financial sector, we hope for too much. With “Capital and Surplus” and its “Contingency Reserve” combining for $3.6 billion, there is scarcely little room for error (Ambac has expanded its insurance “guarantees” by $49 billion y-t-d - a 14% rate). Yet somehow there was one gaping hole in Ambac’s Credit “analysis.” And if they were incapable of identifying conspicuous shortcomings and Credit issues related to NCFE, how much confidence are we to have in the Credit analysis used to establish one-half trillion dollars of Credit insurance exposure?

On the other hand, perhaps it had nothing to do with Credit analysis, being instead simply a case of CSFirstBoston (NCFE’s investment banker) needing to unload some NCFE paper and looking for a “favor.” We hope Ambac management would not purchase such bonds in hopes of garnering more (structured finance) insurance business or a “buy” rating on its stock (CSFB downgraded Ambac’s stock Wednesday). Sometimes - when we’re in one of those moods – we recall the Milken junk bond cartel fiasco and contemplate the “possibilities” for similar shenanigans on a much grander scale in the asset-backed securities marketplace. Too much “money” sloshing around; enterprising rating agencies, bankers, brokers, and accountants; too many securities without legitimate market prices; and scant transparency… Somehow, the ABS market remains off the radar screen when it comes to discussing conflicts of interest between commercial and investment banking.

Profits are the driving force in Capitalistic systems. Historically, the quest for profits has revolved around business enterprise; more specifically, the goods-producing sector. It was Keynes who brilliantly differentiated between the “industrial sphere” and “financial sphere” in analyzing the Twenties boom that collapsed into the Great Depression. He thought in terms of a monetary economy and a financial sector/Wall Street paradigm. Minsky delved deeper and more clearly. There are particular extraordinary periods that beckon for careful analysis of the impact and ramifications from an overheated financial sphere. The Twenties was certainly one of those periods, as is today. Occasionally, the pursuit of “profits” in the financial sphere dominates. Importantly, this dominance does not arrive overnight. It takes years to develop the infrastructure and market psychology – a long period of inflating securities prices. It requires years of financial asset inflation to entice trillions of dollars into stock, bond and hedge fund vehicles. It also takes years of industrial hallowing to see capital goods profits become basically inconsequential. Let there be no doubt, the major financial operators are today’s “Captains of Industry.” Never has the financial sphere reigned so supreme as to overwhelm the real economy.

Many of our “Captains” today trumpet only looser money as the price-level, profit, financial market, and economic elixir. It’s tempting to aver the fact that the recent incapacity of easy money to work its magic only emboldens The Inflationists to cheer for heavier doses. It’s been a slippery slope to absolute monetary recklessness. But the financial players have enjoyed tremendous “profits,” although these gains are suddenly in clear jeopardy. So the specter of deflation is today’s evil villain to be eliminated with virtually free money (and greater financial windfall). If we can only elevate earnings and stock prices the boom can run indefinitely, they say. The Monetarists, “Keynesians,” and Kudlowdians clamor for more “liquidity” and “high powered money” in the face of an over-liquefied Credit market and endless non-bank Credit creation (“infinite multiplier”). This thinking is so flawed and dangerous. It is also interesting to note that much of today’s spurious analysis prefers the “Keynesian” label when it would be more aptly relegated “JohnLawsian Inflationism.”

I would like to add to this discussion the famous (and apropos) quote from Keynes; he would surely be repulsed by today’s “Keynesians” calling for only greater monetary fuel: “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism – which is not surprising, if I am right in thinking that the best brains of Wall Street have been in fact directed towards a different object. These tendencies are a scarcely avoidable outcome of our having successfully organized ‘liquid’ investment markets. It is usually agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of Stock Exchanges.” (What would Keynes think of the Credit default swap market and today’s boom in Credit insurance?)

Former Fed Governor Wayne Angell was providing the CNBC audience “color” on FOMC Wednesday. Within a steady flow of ridiculous bantering, he commented that the financial markets like “sound money” and that “the Fed has been too tight.” But the truth of the matter is very different and the ramifications profound: The U.S. financial system has grown severely dependent on unsound money, and the maladjusted system is only sustained by gravitating further and further away from any semblance of reasonable monetary management. Are our foreign-sourced investors/speculators looking increasingly askance at the rampant inflation of dollar claims?

Recent “debate” is increasingly reminiscent of the late 1920s and early 1930s, to the point of being eerie. Regrettably, the earlier wrangling about prices, markets, and monetary management was anything but satisfactorily resolved. In the end, the Monetarists won and history (and curriculums) was revised to blame the Depression on a shortage of money and liquidity. They got it absolutely wrong. Amazingly, virtually no one is today willing to admit that Federal Reserve policy has been an unmitigated disaster, with the meter still running (time and a half for overtime!). What we have today is so far removed from sound money, with the lunatics directing the governors of the asylum to pump in only stronger laughing gas.

There is today an overwhelming consensus that there are no costs associated with Fed rate cuts, thus every reason to aggressively cut to the bare bones and quickly. While our central bankers were determined to avoid learning lessons from the Japanese Bubble experience, they do appreciate that it is expedient to “learn” from their dismal post-Bubble struggle – the key is to move early and move aggressively. But the Fed is only feeding the gluttonous financial sphere to death.

The big problem we have with all of this is that our analysis convinces us that this is precisely the recipe that led to a hopelessly deranged financial sphere that was resolved with the 1930s financial collapse and Depression. It is my view that the post 9/11 aggressive rate cuts (and consequent blow-off in mortgage finance and Credit market speculative excess) were an even greater mistake than the post-Russia/LTCM cuts and “reliquefication” that fueled the fateful technology/stock market speculative blow-off. And, amazingly, no one will step up and admit we have set course for financial disaster. Sure, ultra-easy money stimulated unprecedented household borrowings, with a spike in home and auto sales. We will now pay the price for artificially inflating housing and auto demand. It was absolutely irresponsible monetary policy to actively stimulate consumer over-borrowing and spending in this manner – a desperate attempt to Sustain Unsustainable boom-time demand. It’s been little more than a dangerous monetary gamble with great risk and NO possibility for success.

Financial system and economic stability would have been dramatically less disturbed by major (“Keynesian”) deficit spending. But policy chose instead to do what should have been avoided at all cost: Further stimulation of the disturbed financial sphere.

Although apparently not obvious to the consensus, monetary policy has significantly exacerbated an already acutely fragile financial sector. We have seen money inundate the hedge fund community, adding an additional layer of leveraged speculation on top of an already egregiously overleveraged financial system. The repurchase agreement market grows only more rapidly to the moon. Money on the move has flooded into bond funds in a desperate search of yield. In response to heightened systemic Credit problems, we have witnessed an explosion in marketing and trading Credit default swaps, etc. We have seen Ambac, MBIA and the other Credit “guarantors” drastically increase their risk profile by diving headfirst into insuring against Credit losses throughout “structured finance.” And we have seen unprecedented creation of mortgage securities, the legacy of which will impair the financial sector for years to come. GSE risk exposure continues to mushroom into the peak of an historic mortgage Credit cycle. Importantly, unprecedented amounts of non-productive debt have been created of increasingly suspect quality, whose value is sustained only by additional non-productive Credit creation. Meanwhile, we have seen nary a trickle of finance go to sound investment.

“The control of finance is, indeed, a potent, though sometimes dangerous, method for regulating the rate of investment.” J. M. Keynes

The problem is that the “financial sphere” remains manically overheated as the U.S. “industrial sphere” suffers border-line depression. Throw shots of aggressive monetary ease in front of this Odd Couple and one should expect quite disparate reactions. One is a despondent teetotaler; the other an uncontrolled drunk. Further ease monetary conditions and the subdued “industrial sphere” will hardly take notice, although you had better be prepared for frenzied outbursts from the manic “financial sphere.” The dejected has given up on achieving economic profits, while the rabid opportunist salivates at the thought and talks speculative profits in his sleep. If the goal of the monetary authority is to stimulate the spiritless capital goods sector at all costs, the upshot will be a border-line deranged leveraged speculating community imparting gross distortions to the structure of the real economy. And that’s just the way it is – the terrible cost of financial and speculative excess being nurtured and shrouded for too many years. The impairment to system stability from overheated leveraged speculation is simply much too great. There were critical lessons not learned from the 1927-1929 experience and the Great Depression (and further motivation to fight historical revisionism “tooth and nail”).

I’ll admit to partaking in my usual extended ramblings, but please focus on a couple of critical questions: Why couldn’t more money boost prices and industrial profits during the late 1920s? And why would it have not been possible for the Fed to print money and keep the financial system solvent post-Roaring Twenties Bubble? While there is something to be said for the analysis that productivity improvements throughout the U.S. goods producing sector were keeping a lid on prices during the late Twenties, I would argue that the key issue was that the greatest Credit excesses were feeding a speculative mania in the U.S. stock market. The financial sphere had become the overwhelming source and destination (“Monetary Processes”) for created “money” and liquidity. The inflationary regime worked magically when financial asset prices were inflating and speculative juices were flowing, but buckled in inoperability in reverse.

Today, the key mechanism for both liquidity and speculation is the U.S. Credit market. And to the second question from above: Why would more money not have resolved the banking crisis? Apparently, banking system losses were in the neighborhood of $5 billion (which was about the banking system’s capital). Although the banks were technically insolvent, why couldn’t the government have printed $5 billion, made the banks whole, and preempted bank runs and financial collapse? Well, this is today The Big Question. And I do believe that the Fed is confident (especially after the early 1990s experience) that any banking system problem can be resolved by recapitalizing the industry (either directly or through cheap borrowings). And as long as the banking system remains solvent and extending new credits, there can be no major economic downturn. But the issue is not the level of bank capital, but the quality of system debt, distorted asset prices, and a maladjusted economy. Yes, the Fed could have printed money and replaced the banking system’s lost capital in the early Thirties. Yet the $5 billion would have quickly proved irrelevant and impotent in sustaining inflated asset prices, tens of billions of non-productive debt created during the manic stages of the boom, and the insatiable Credit appetite of a maladjusted economy. Yes, a recapitalized banking system could have fed the Bubble awhile longer, but there was no changing the harsh reality that it was a Bubble. No amount of “money” was going to right the system, only extend the wrong.

To return this discussion to the nuance of contemporary finance, when things begin to turn sour, why can’t the Fed simply journal some Fed funds/liquidity over to the likes of Ambac, MBIA, Fannie and Freddie? After all, as long as there is “capital” underpinning the trillions of dollars of securities they have guaranteed, these securities will remain “top rated” and, with Fed assurances, liquid. There will be no liquidity crisis, debt deflation or economic collapse. And, as is the case today, it really doesn’t take much “capital” to support unfathomable amounts of rated debt (as long as confidence holds).

Well, I would argue that the critical issue today is not the imminent losses to be suffered by our behemoth Credit insurers. The issue is, as it would have been had the banks been recapitalized in the early Thirties, that to sustain the boom requires unrelenting Credit creation. As we are witnessing, there is no turning off the Credit insurance engine; there is no possibility of a respite for the GSEs. The day the Credit insurers back away from writing new policies is the day they the are crushed by systemic Credit problems. Yes, the Fed could wire them a few billion, but they have today no alternative than to insure new debt in the tens of billions From Here On Out. The Fed could wire a few billion to Fannie and Freddie, but the issue is that the GSEs will have no alternative than to purchase and guarantee new mortgages to the tune of hundreds of billions annually From Here On Out.

As I wrote last week, the issue is not the little “billions” that the Fed can easily “print” but the Trillions that the U.S. financial sector must create From Here On Out. The Credit system has Bubble binge consumption (with $500 billion current account deficits) to sustain. The Credit system has inflated (in many cases, especially California, grossly inflated) real estate prices to keep levitated. The Credit system has unfathomable quantities of non-productive debt whose value rests on the continued issuance of massive quantities of non-productive debt. The Credit system has a wildly maladjusted monetary/service sector economy - that is an absolute Credit sponge - to maintain.

If, like the early Nineties, we were suffering merely from a credit crunch, Fed “reliquefication” could reinvigorate the Credit system. But today, additional vigor only feeds the out of control financial sphere and further distorts the structure of the real economy. Neither Credit crunch nor deflation is the issue today. The issue is that we have no alternative than to deal with faltering Credit, speculative, and Economic Bubbles of historic proportions. The issue is a massive Credit Bubble that has likely reached the point of being inoperable in reverse. There came a point when Nick Leeson’s losing trade spiraled completely out of control, and the marketplace figured out as much. We think we may be approaching a similar crossroads for the Fed’s trade – “The Great Experiment” - gone terribly awry. And to think the inflationists are giddy to continue betting as if the stakes were only an unlimited number of green chips.