Do You Think The Economy Will Escape A Trump Meltdown?

From time to time I asked my financial advisor when she thinks the Trump Crash will come. She doesn't see one coming any time soon. I hope she's right. Do you know who Jim Rogers is? I used to see him on TV all the time when I watched financial news programs. Usually termed a "legendary investor," he was one of the founders of the Quantum Fund. He was just interviewed by Business Insider's Henry Blodget. He predicted "a market crash in the next few years, one that he says will rival anything he has seen in his lifetime." (He was born in 1942.)

He grabbed the first opportunity to make his prediction-- less than 30 seconds in: "Some stocks in America are turning into a bubble. The bubble’s gonna come. Then it’s gonna collapse and you should be very worried. But Henry, this is good for you. Because someone has to report it. So you have job security. You’re a lucky soul." Blodget, of course, asked when and why. Rogers said "Later this year or next... Write it down."

Well, it’s interesting because these things always start where we’re not looking. In 2007, Iceland went broke. People said, ‘Iceland? Is that a country? They have a market?’ And then Ireland went broke. And then Bear Stearns went broke. And Lehman Brothers went broke. They spiral like that. Always happens where we’re not looking. I don’t know. It could be an American pension plan that goes broke and many of them are broke, as you know. It could be some country we’re not watching. It could be all sorts of things. It could be war. Unlikely to be war but it’s going to be something. When you’re watching Business Insider and you see, ‘That’s so interesting. I didn’t know that company could go broke.’ It goes broke. Send me an email and then I’ll start watching.

So how bad will it be?

Rogers: It’s going to be the worst in your lifetime.

Blodget: I’ve had some pretty big ones in my lifetime.

Rogers: It’s going to be the biggest in my lifetime and I’m older than you. No, it’s going to be serious stuff. We’ve had financial problems in America-- let’s use America-- every four to seven years, since the beginning of the republic. Well, it’s been over eight since the last one. This is the longest or second longest in recorded history, so it’s coming. And the next time it comes-- you know, in 2008, we had a problem because of debt. Henry, the debt now-- that debt is nothing compared to what’s happening now. In 2008, the Chinese had a lot of money saved for a rainy day. It started raining. They started spending the money. Now, even the Chinese have debt and the debt is much higher. The federal reserves, the central bank in America, the balance sheet is up over five times, since 2008. It’s going to be the worst in your lifetime, my lifetime too. Be worried.

Blodget: I am worried.

Rogers: Good. Good.

Blodget:  Can anybody rescue us?

Rogers: They will try. What’s going to happen is they’re going to raise interest rates some more. Then when things start going really bad, people are going to call and say, ‘You must save me. It’s Western civilization. It’s going to collapse.’ And the Fed, who is made up of bureaucrats and politicians, will say, ‘Well, we better do something.’ And they’ll try but it won’t work. It’ll cause some rallies but it won’t work this time.

Blodget: And we are in a situation where Western civilization already seems to be possibly collapsing, even with the market going up all the time. Often when you do have a financial calamity, you get huge turmoil in the political system. What happens politically if that happens?

Rogers: Well, that’s why I moved to Asia. My children speak Mandarin because of what’s coming. You’re going to see governments fail. You’re going to see countries fail, this time around. Iceland failed last time. Other countries fail. You’re going to see more of that. You’re going to see parties disappear. You’re going to see institutions that have been around for a long time-- Lehman Brothers had been around over 150 years. Gone. Not even a memory for most people. You’re going to see a lot more of that next around, whether it’s museums or hospitals or universities or financial firms.

And not a whisper or even a hint about Trump causing anything. This morning, HuffPo's Zach Carter, writing about what Democrats can learn from Corbyn's big win in the U.K., was more insightful about the relationship between politics and financial (and economic) swings. "Financial crises," he wrote, "foment authoritarianism. This idea is not controversial in Europe, where authoritarian scars are still historically fresh. Stateside, many financial journalists intuitively grasp the connection between banking crashes and far-right politics, after witnessing the pattern in country after country... As Donald Trump surged in the Republican primaries, a flurry of academic papers began making the rounds highlighting the moderately high median incomes of his supporters. These are still trickling out. They continue to serve as feature fodder for centrist publications and continue to be largely irrelevant to the political landscape. It doesn’t matter how rich the authoritarians are. Their key feature is their authoritarianism."

We have had few financial crises in the United States since the Great Depression, and our political thinkers are accustomed to grappling with aristocratic conservatism, not authoritarianism. Aristocratic conservatism-- the type espoused by House Speaker Paul Ryan and establishment Republicans of the past 50 years-- seeks to protect the financial interests and social status of the wealthy. Banking elites want low capital gains taxes, but they are in many ways more protective of their position on top of the American social hierarchy. Even as he scuttled prosecutions for financial fraud and protected bonuses for bailed-out bankers, former President Barack Obama prompted hysterical denunciations from Wall Street by casually dismissing “fat cat bankers” in a single TV interview early in his first term.

The Democratic Party can sometimes defeat aristocratic conservatives by publicly shaming them as extremists. Aristocratic conservatives are sensitive to elite social pressure and respond to attacks on their dignity. This was a key plank of Hillary Clinton’s 2016 general election strategy, and in some ways, it worked: Clinton really did win over a big chunk of millionaires who had previously voted Republican.

But shame is a terrible strategy for defeating authoritarian candidates after a financial crisis. Banking meltdowns don’t unleash a wave of aristocratic sympathy. They cause widespread, unfair suffering and create tremendous uncertainty. People lose their jobs and homes through no fault of their own. Even working families who survived the 2008 crash relatively unscathed did not do so without having to confront new psychological strains. Millions of people who kept their jobs had to come to the aid of family members who did not. The prospect of economic ruin was always right around the corner.

Authoritarians exploit this uncertainty by promising stability, order and safety. This is not a mathematical equation guaranteeing higher incomes. It is a social rebellion against the governing aristocracy that has just failed and-- even in the most just and perfect bank rescue-- enjoyed the political prioritization of its own interests over the needs of the broader citizenry.

In the wake of a financial crisis, the public does not interpret centrist politics as an appeal to moderation or reasoned debate. It sees centrism as an attempt to rehabilitate the legitimacy of the aristocracy which has just pushed the country into disaster. “Countrymen, I have been approved by the finest minds of the old order as an eminently reasonable leader!” is a poor slogan when measured against “I will crush your enemies and restore your glory!”

A much better pitch? “I am on your team and will protect you.” This works very well with promises to expand and improve social welfare programs. “I will break the cheating aristocrats who did this to you” can also be effective. In 1932, Franklin Delano Roosevelt put the Democratic Party in power for only the third time since the Civil War by campaigning on a combination of both messages.

Whatever the slogan, anti-authoritarian politicians need to make a clean break with what failed and offer a psychological alternative to authoritarianism’s call for order through violence and suspension of civil liberties.

The specific policy agenda is important-- politicians need good ideas that people actually like. Corbyn appears to have significantly boosted the youth vote by promising to abolish college tuition fees entirely. But policy mostly functions as a guidepost for voters. A leader’s tone and presentation matter just as much-- the point is to project a sense of safety and community. Corbyn nailed that part, too. When May called the election, she and the Conservatives believed Corbyn’s left-wing priorities would alienate him from voters. His stump speeches did the exact opposite.

...Trump is the American strain of the authoritarian virus that has infected much of Europe. In France, its standard-bearer is Marine Le Pen. In Greece, it is the neo-Nazi Golden Dawn party. Finland has the True Finns; Hungary has Jobbik. In the U.K., this faction was represented by Nigel Farage and the U.K. Independence Party, which won 4 million parliamentary votes in 2015 and successfully mobilized a campaign to push their country out of the European Union by demonizing refugees and promising better health care for native Britons.

Farage is still at it. During a Fox Business interview with Maria Bartiromo last week, he raised the prospect of mass “internment” of “thousands” of terror suspects. But under May, the chief vehicle for authoritarian politics in the U.K. has become the Conservative Party. She has embraced Farage’s Brexit cause and floated the repeal of human rights laws in the name of stability in opposition to Corbyn’s “weak” approach to terrorism. On Thursday night, UKIP was decimated, its vote split between the new ethno-nationalist haven in the Conservatives, and the populist alternative offered by Corbyn’s Labour party.

The same union of authoritarian insurgents and the aristocratic old guard is taking place in the United States. After campaigning as an authoritarian populist, Trump has filled his administration with Goldman Sachs alums and is embracing the aristocratic economic agenda of Paul Ryan’s Republican Party.

And the Republican aristocracy, with a few Never-Trumper exceptions, is reciprocating. Just ask Paul Ryan about James Comey’s Senate testimony. Then ask him about Dodd-Frank.

Corbyn made significant gains where nearly every political expert in Europe expected him to march off an electoral cliff. He did so by abandoning dyed-in-the-wool aristocratic Tory voters, energizing new, young Labour voters with policy, and making a direct psychological challenge to authoritarian appeals.

There’s a lesson there for the Democratic Party. It can be the party of the Good Aristocrats, or it can be the Anti-Authoritarian Party. But it can’t be both.

The Dying Fossil Fuel Industry

The classic shape of an economic bubble (source). Notice "New Paradigm" at the top, the point at which market participants decide "this can go forever." Big Oil CEOs think nothing can topple the technology that turns fossil fuel into energy — that unlike every other technology in history, their technology will never be replaced.

by Gaius Publius

Whom the gods would destroy, they first make mad.

—Sophocles (tr. Longfellow)

We've written before about the coming crisis in the fossil fuel industry, the one that extracts oil, gas and coal from deep in the earth so it can be burned as fuel. For example, this from December 13:

• Big Oil In Trouble, Enters "No Man’s Land" of Collapsing Balance Sheets

and this from March 16:

• Oil and Gas Price War Looms; Trump to Worsen It

Despite the stranglehold Big Oil has on energy production — to enhance their wealth and for no other reason — the industry is doomed to die. There are just three questions left unanswered:

• Will the industry die quickly or slowly?

• Will it be brought down in an orderly way, by government intervention, or by its own self-destructive internal forces?

• Will the industry fatally worsen climate change before it goes, or will humans escape the grip of Big Oil in time to prevent most of the preventable damage? 

Because, make no mistake, Big Oil has a fatal disease, two of them in fact, and either or both are going to end its life as an industry. (The companies may survive, but not as carbon extraction companies; I have an interesting fantasy, in fact, about an event that would instantly kickstart a U.S. return to global climate change leadership, but I'll save it for later.)

Disease One — Vulnerability to Climate Change Itself

The first of those diseases is the industry's vulnerability to the inevitable climate crisis. There are only two ways our current, business-as-usual climate behavior — where we pump gigatons of CO2 into the atmosphere each year and watch ocean and atmospheric temperatures relentlessly rise — will end:

1. The Chaotic climate-response scenario — Humans don't stop pumping carbon into the air until, as a species, we're pre-industrial or worse; we live through the all the chaos that devolution implies; we lose the technology and numbers to do further damage; then we watch the result play out for centuries, if we survive that long. In other words, our response is to allow whatever happens to happen and try to live through it.

A chaotic, multi-decade transition from where we are now to that point (note: multi-decade, not multi-century) will be the stuff of dystopian nightmares. That transition will be global in scope, obvious as to its cause, and will play out monstrously in full view of anyone who lives into the 2030s. That's not too many years away. In fact, the transition has started already in the Middle East and Europe. (For more, see "Climate Change in the Age of Trump".)

Keep in mind, systemic collapses don't always happen quickly, but many do.

2. The Voluntary climate-response scenario — Humans voluntarily and proactively end the extractive carbon industry because it's an existential threat to survival. Whether humans do this in time to avoid the worst of what's coming is another question. The point is that we play an effective proactive role, not a passive, reactive one, before the chaos mentioned in the Chaotic scenario overwhelms everyone.

Either of these outcomes spells the end of the fossil fuel industry. In the Chaotic scenario, the end comes when global chaos shrinks the industrial base of the planet, causing fuel prices to rocket upward because of supply shortages, then collapse because of shrinking demand. Societies in chaos don't buy new Toyotas at anything like their old rate of purchase, and increasing the number of societies in chaos decreases the global market for all manufactured goods.

Bottom line: Climate change itself will end the industry if disease number two doesn't do it first.

Disease Two — Vulnerability to Its Own Internal Instability

The second factor that could end this industry is described in the two pieces linked at the beginning of this one. Even in the absence of a climate crisis, the industry itself is a dinosaur, a thing of the past providing the energy source of the past. Its dominant market position is extremely unstable, since its profitability depends entirely on massive capital infusions via subsidies and on a compliant political atmosphere — and complicit politicians — to keep it afloat.

What's more, the industry sits on a mountain of debt that can never be repaid, will never be repaid, and it's poised between two bad pricing decisions — keep prices low, which will accelerate the industry bankruptcies caused by those debts (which will also bankrupt some banks); or raise prices higher, making the fossil fuel industry's debt service more sustainable in the short term while driving an even faster transition to renewables in the long term.

Neither of those alternatives — death by low prices or death by higher prices — is a prescription for long life, or life at all. One alternative underfunds the industry, ultimate fatally. The other overprices its product in the midst of a decades-long recession. (For this will be a "decades-long recession," see "America Cannot Recover from This Recession Until It Writes Down Debt to What Can Be Paid".)

Bottom line: Even without a climate chaos event, Big Oil cannot survive as an industry because it's critically hooked to a last-generation energy technology and has within it fatal financing flaws.

Big Oil's Price Dilemma

This gloomy outlook for the industry is supported by many knowledgeable insider sources. Former Guardian writer Nafeez Ahmed, an expert on the industry, and on climate change dynamics generally, recently reported on its price and debt problems for Motherboard, supporting the points I made above. Note his reference to this industry analysis, one of several he could have chosen:

We Need to Accept That Oil Is a Dying Industry

The future is not good for oil, no matter which way you look at it.

A new OPEC deal designed to return the global oil industry to profitability will fail to prevent its ongoing march toward trillion dollar debt defaults, according to a new report [pdf] published by a Washington group of senior global banking executives.

But the report also warns that the rise of renewable energy and climate policy agreements will rapidly make oil obsolete, whatever OPEC does in efforts to prolong its market share.

About Big Oil's pricing problem, he writes:

[A]ccording to Michael Bradshaw, Professor of Global Energy at Warwick Business School, a price hike would not solve OPEC's deeper problems. In fact, it could speed up the transition away from oil....

As oil gets more expensive again, there is more incentive to use alternative, cheaper forms of energy—like solar photovoltaics, which can now generate more energy than oil for every unit of energy invested....

"We are not in a business as usual world," Bradshaw said. "Higher prices for oil and gas will drive investment in efficiency and demand reduction and also substitution, so they may actually promote structural demand destruction."

Please do note the second paragraph above. Photovoltaics can now generate more energy per unit of energy invested than oil. The technology that produced energy from fossil fuel is a dinosaur, inefficient and getting more so every day compared to what's emerging. It's only the political grip of the kings of that industry, the Rex Tillersons and the David Kochs, that keep it viable.

Big Oil's Debt Dilemma

About the industry's debt burden Ahmed writes:

It's not just OPEC that needs to be prepared. A report [pdf] published in October by the Group of 30 (G30), a Washington DC-based financial advisory group run by executives of the world's biggest banks, warns investors that the entire global oil industry has expanded on the basis of an unsustainable debt bubble....

The industry's long-term debts now total over $2 trillion, the report concludes, half of which "will never be repaid because the issuing firms comprehend neither how dramatically their industry has changed nor how these changes threaten to soon engulf them." [emphasis added]

A $2 trillion debt burden — with $1 trillion doomed never to be repaid — will kill even the largest industry once investors become convinced they'll never get their money back.

Collapses Can Come Quickly

I'll say again, collapses often happen quickly, especially collapses of investor confidence. And when they do, they don't give much warning. The price floor simply gives way, and look out below.

The example most familiar to Americans is the stock market crash of 1929. But it's by no means alone. As an earlier classic example, here's what happened to the price of tulip bulbs, which had at one time been bid up by investors in a way that resembles the recent housing market. Once investors decided they could never get back what they paid for them — because there was no more "next fool" to sell to — the price collapsed almost immediately, each panicked seller panicking the next one.

Shown alongside that chart is the fate of the South Seas Company, a less-familiar bubble-and-bust investment of the same era. Different market, same story.

(source)

And here's the NASDAQ price chart in the lead-up to the Dot-Com crash of 2002:

(source)

Price collapses often happen this suddenly, especially in an industry as fueled by "delusions" as this one is. See the article itself for a list of those delusions.

The Question for Americans — Not When But How

The only real question for us is not when the industry collapses, but how it collapses. It can collapse later, with global society collapsing at the same time — in other words, our Chaotic scenario above. Or it can collapse in a managed way — our Voluntary scenario above. Or finally, it can collapse relatively soon, a victim of its own economics, as outlined by Ahmed in the article, prior to the fatal rise of social chaos.

A sudden collapse that happens fairly quickly would also be chaotic, but that may not be bad, all things considered. Imagine what could happen in the country and the world if oil prices fall to, say, $25 per barrel from today's price of about $50 per barrel. Smaller fossil fuel companies would disappear as suddenly as firefly light on a hot summer evening. The industry would be in economic turmoil, desperate for funding.

You can almost hear the cries for even greater government subsidies, added to the already massive global subsidies it now receives, $1.82 trillion, or 3.8 percent of global GDP. This would amount to our next big national bailout after the Wall Street bailout of 2009, as before with taxpayer money.

Would Americans foot the bill for a second massive bailout, so soon after the first? Would they do it if Big Oil is the recipient? I think the political chaos surrounding that public discussion would be deadly to Big Oil all on its own.

A chaotic event as well, yes, but also very welcome from a climate change standpoint. One alternative to a hated, massive Big Oil bailout would be to provide the same money as a subsidy to the renewables industry, giving it a needed "putting a man on the moon" boost to replace Big Oil. If that were the outcome of a Big Oil industry collapse, I'd take it tomorrow.

GP
   

The Next Bubble to Burst: Will It Be Housing Again?

The modern world of bubbles (source; click to enlarge)

by Gaius Publius

I'm following a number of stories at the moment, including the possible further collapse in carbon (oil and gas) prices; the likely and casual ubiquity of election-stealing by both parties (which has interesting implications for the general election); and the next installment in our "Look Ahead" series, a peer into the future of American political life and governance from the conventions into the reign of the next administration.

But this one-off story deserves your attention. I want to put the existence of a new housing bubble on your radar. It certainly exists. Will it burst soon? There's no telling, but it's as big a bubble as the last one. In my locale (one of those illustrated below) the amount of construction is shocking, given the fact that nothing has structurally changed since the 2007-08 crash.

From Zero Hedge, with charts (emphasis in the original):

Housing Bubble 2.0 - Are You Ready For This?

The mind-numbing Case-Shiller regional charts below are presented without too much comment. As MHanson.com's Mark Hanson adds, the visual says it all.

Bottom line:

Q: If 2006/07 was the peak of the largest housing bubble in history with affordability never better vis a’ vis exotic loans; easy availability of credit; unemployment in the 4%’s; the total workforce at record highs; and growing wages, then what do you call “now” with house prices at or above 2006 levels; worse affordability; tighter credit; higher unemployment; a weakening total workforce; and shrinking wages?

A: Whatever you call it, it’s a greater thing than the Bubble 1.0 peak.

... If these key housing markets hit a wall they will take the rest of the nation with them; bubbles and busts don’t happen in “isolation”.

And now those charts:

Price charts from selected housing markets (click to enlarge).

A few comments from the site (my emphasis here):

• The bubblicious regions above all have one thing in common…STEM [the science-technology-engineering-math sector]. As such, if the tech and biotech sectors hit a wall, which some believe has already begun, so will these housing regions.

• If these key housing markets hit a wall they will take the rest of the nation with them; Bubbles and busts don’t happen in “isolation”.

• House prices have retaken Bubble 1.0 levels on the exact same drivers: easy/cheap/deep credit & liquidity that found its way to real estate. The only difference between both era’s [sic] is which cohorts controlled the credit and liquidity. In Bubble 1.0, end-users were in control. In this bubble, “professional”/private investors and foreigners are. But, they both drove demand and prices in the exact same manner. That is, as incremental buyers with easy/cheap/deep credit & liquidity, able to hit whatever the ask price was, and consequently — due to the US comparable sales appraisal process — pushed all house prices to levels far beyond what typical end-user, shelter-buyers can afford. Thus, the persistent, anemic demand.

• Bubble 2.0 has occurred without a corresponding demand surge just like peak Bubble 1.0. As such, it means something other than fundamental, end-user demand and economics is driving prices this time too.

• The end result of Bubble 2.0 will be the same as 1.0; a demand “mix-shift” and price “reset” back towards end-user fundamentals once the speculators finish up, or events force them to the “sidelines”. ...

And:

• Lastly, I am betting 2016 marks the high for house prices, as mortgage rates can’t go meaningfully lower, the unorthodox demand cohort is exhausted, and real affordability to end-user shelter-buyers has rarely been worse. In fact, I believe this is the year house prices go red yy [year-over-year].

The zero interest rate economy (ZIRP; the "P" stands for "policy"), which is so good for bankers since they "borrow" from the Fed for free, is terrible for us little people. (The central banks are also propping up the stock market, by the way, one of the places the CEO class parks their corporate "take.") All of which creates an economy that is, as Zero Hedge says, "bubblicious." The fact that we're in an economy buoyed by serial bubbles is structural, built-in. The economy will be this unstable until we reregulate and aggressively tax those with too much money and no productive place to invest it.

This is not good for the rest of us, not good at all. Pay attention, and if you can, protect yourself. At some point soon, the next housing crash will occur. And when the banks do need bailing out, watch what happens. The public, left and right, won't tolerate more flat gifts to bankers. So the Europeans are experimenting with something quite different:

According to The Economist, the magazine that coined the term "bail-in", a bail-in occurs when the borrower's creditors are forced to bear some of the burden by having a portion of their debt written off. For example, bondholders in Cyprus banks and depositors with more than 100,000 euros in their accounts were forced to write-off a portion of their holdings. This approach eliminates some of the risk for taxpayers by forcing other creditors to share in the pain and suffering.

While both bail-ins and bail-outs are designed to keep the borrowing institution afloat, the two different methods of accomplishing the goal vary greatly. Bail-outs are designed to keep creditors happy and interest rates low, while bail-ins are ideal in situations where bail-outs are politically difficult or impossible, and creditors aren't keen on the idea of a liquidation event. The new approach became especially popular during the European Sovereign Debt crisis.

Otherwise known as asset confiscation, that is, preserving taxpayer money and helping a firm's bondholders not take the whole hit themselves by putting some of the cost of keeping an institution afloat ... on depositors. Wonder how that will make depositors feel as they're feeling the pinch of the next crisis.

Of course, the government could just let the profligate banks fail; but then, where would the next Treasury Secretary come from? It is a puzzlement.

GP
 

Junk Bonds Are in Worse Shape than Before Lehman Collapsed

Percentage of S&P junk bonds and leveraged loans considered "distressed" (click to enlarge)

by Gaius Publius

We know that there will be another economic "big one" like the crisis of 2008. All of the pieces are in place — Wall Street greed and literal pathology, the even greater size of too-big-to-fail institutions, a literal get-out-of-jail free card that almost blesses continued financial fraud, and the like. We just don't know when it will occur, or what will trigger it. Last time it was triggered by the collapse of the bubble-sized home mortgage market. The time before that, it was the bubble-sized tech stock valuations. Where's the bubble now, or the inverse bubble, the market hole that may be forming somewhere?

Many people are looking at collapsing oil prices and soaring supplies, which is causing the collapse of over-leveraged carbon companies of all types (coal, oil and methane), as a potential cause of the next crash. Others say that the collapsing price of oil is "contained" — unique and isolated — and is not contaminating other markets.

The following piece by Wolf Richter argues the opposite point — that the collapse in the carbon market is not contained at all, and that collapse is in danger of spreading via the increasing price of junk bonds. Is this a precursor to the next "big one"? See what you think.

Wolf Richter (my emphasis throughout):

Now It’s Even Worse Than it Was When Lehman Collapsed, But It’s “Contained”

“Distress” in Bonds Spirals into Financial Crisis Conditions

The pile of toxic corporate bonds in the US, euphemistically called “distressed” debt, ballooned 15% in the single month of February to $327.8 billion, up 265% from a year ago, according to S&P Capital IQ. The number of S&P rated US companies with distressed debt rose 9% in February to 353, up 128% from a year ago.

The last time the pile of distressed debt had soared to this level was in November 2008, and the last time the number of distressed issuers had shot up to these levels was in October 2008; Lehman had declared bankruptcy in September.

These “distressed” junk bonds sport yields that are at least 10 percentage points above US Treasury yields, according to S&P Capital IQ’s Distressed Debt Monitor. 

Note the definition in the final paragraph above. Bonds are considered "distressed" if they have to offer 10 points or more greater yield than U.S. Treasuries in order to attract buyers. Obviously, any company whose financing depends largely on these bonds is at risk of bankruptcy.

As a chart, the above data looks like this. Take a minute to study it.

The Y-axis is both number of issuers (bar graph) and billions of dollars issued (line graph). Click to enlarge.

Richter adds this about the S&P "distress ratio" for junk bonds and leveraged loans (see chart at the top):

The ratio hit the highest level since July 2009, when it was coming down from the Financial Crisis. But this is the spine-chilling part: Back in September 2008, before the Lehman bankruptcy had fully registered in the ratio, but when the Financial Crisis was already gaining a good amount of momentum, and when stocks were crashing left and right and prudent people were wearing hardhats while out on the sidewalk, the distress ratio was “only” 28.9[.]

Richter quotes the report he cites as saying that a rising ratio is “typically a precursor to more defaults.” If he's right, we could be headed into the same soup we took years getting out of. And this time, it will be a political soup as well, since the country, both left and right, is in zero mood for another massive government bailout.

Not Confined to Oil and Gas

Nor is the damage in these markets confined to the carbon sector. Richter again:

And it’s not just the oil-and-gas and the minerals-and-mining sectors that are getting crushed. Of the 607 distressed bond issues in the ratio, 172, or 28%, are oil-and-gas related and 80 bond issues, or 13%, are minerals-and-mining related. The remaining 59% are spread across other the spectrum.

“Spillover effect,” is what S&P Capital IQ calls this. It has contaminated “the speculative-grade spectrum as a whole.”

The article has more along these lines, including a list of sectors affected, how many billions of dollars in debt are distressed in those sectors, and the main companies affected in each sector. It's quite eye-opening.

Will Commodity Prices Cause the Next Collapse?

I've been personally watching all of this with interest. There is a bubble in commodities — especially those things that the very very wealthy are interested in (for example, Manhattan real estate and high-end art) — but really, in commodities in general. There's also a major crack in the commodities bubble connected to carbon products (coal, oil and methane). I've wondered before if collapsing oil prices would spark a collapse in other commodities (stocks, for example) via the highly leveraged, and therefore highly vulnerable, nature of many fracking companies in the U.S.

It's possible we'll get an answer soon ... or not. Still, this is worth watching. If you're interested, Richter's website, Wolfstreet.com, is worth checking on a regular basis.

GP

How the Very Rich Are Misusing Miami Beach

This painting sold in 2013 for $142 million (source). Are the very very wealthy driving an asset bubble? If so, how large a bubble?

by Gaius Publius

This is a follow-up to this piece, "Can Miami Beach Survive Global Warming?" about Miami Beach, south Florida, and climate change. There we talked about the disconnect between the pace of development, high land valuations, and inevitable sea level rise.

That disconnect flies in the face of an inevitable collapse. But I don't mean physical collapse (though at some point, that too is inevitable). I mean economic collapse, something less deadly perhaps, but for many, still very painful.

While I didn't make the point there (I have elsewhere), please keep in mind that sometimes economic collapse — a collapse in prices — precedes the event that causes it. That is, because we are an anticipatory species, a species that can anticipate events, we also act on anticipation. Thus, it may well be true that, as soon as the seed is planted that "you're going to lose money buying in Miami Beach," it may well follow that anticipation makes the future immediately present.

And frankly, once prices for any product collapse, the stampede is on — simply because there's a stampede. Many prices do recover over time. The price of Florida real estate, for example, recovered after the disastrous collapse in the mid-1920s. The difference now, however, is this — once it's over for the economy of south Florida, there won't be a recovery until people see the sea stop rising. Meaning, never.

The Very Rich and the Miami Beach Bubble

The problem in Miami Beach, unlike the general problem is south Florida, is that it's the playground of the very very wealthy, who have turned luxury condos and homes into the same kind of competitive "investments" that condos and homes in Manhattan and the very best parts of London have become. In other words, a massive asset bubble, the same kind of bubble that the fine art market has become, and one that only the very very wealthy can create:

A sale earlier this week of Post-War and contemporary art brought in more than $691 million, the largest haul in the history of the art market, according to the auction house Christie's.

The highlight was a painting [above] by Francis Bacon, "Three Studies of Lucian Freud," which went for over $142 million, the highest price ever for a piece of art sold at auction.

Over at Sotheby's (BID), a silk-screen painting by Andy Warhol sold Wednesday for $105 million.

The art market has heated up just as Wall Street has been setting records of its own. Stocks are holding near all-time highs. So there may be a spillover to the art market as the already wealthy grow now even richer. There are obvious spillovers into certain real estate markets as well.

Here's what that looks like in Miami Beach, from the same Vanity Fair article quoted previously (my emphasis):

[Harold Wanless, chairman of the Department of Geological Sciences at the University of Miami], who is among the scientists whose work is cited in Hansen’s paper, told me that he and Hansen take issue with the current models for projected sea-level rise—most of which top out at around six feet as the absolute worst-case scenario for 2100—because they don’t account for how rapidly the world’s glaciers and ice sheets are going to melt in the decades to come. “If you ever fly over Greenland, which I’ve done, it’s unbelievable,” he said. “The ice sheet is already melting from global warming, and now it’s also dirty on top, because of dust and soot blowing in from other parts of the world.” The darkened ice absorbs heat more quickly than clean, white ice, hastening its melt rate. Given such factors, Wanless said, he predicts that Miami Beach will experience something in the range of 10 to 30 feet of sea-level rise by the end of the century. I was so stunned by these numbers that I asked him to repeat them, to make sure I had heard him right. He did.

A pause to think. If that is true (I personally think it is, given the many non-linearities — and the history of negative surprises — in the climate prediction world), then it follows that people will figure this out way ahead of time. That's the anticipation I mentioned above.

But that's for later, for after prices start falling. In the present there's no end of optimism, even among the local scientists:

I received a more optimistic take on South Florida’s future from Ben Kirtman, a climate-modeling expert at the University of Miami’s Rosenstiel School of Marine and Atmospheric Science. While not shying away from dire climatic trends or from the extraordinary measures that will be required to contend with them, he sounded a lot like Mayor Levine, believing that there remains time for human ingenuity to save the day. “I want to see Miami Beach survive,” he said. “When we acknowledge a problem, we diagnose the problem, and then we start to develop really good technology to fix the problem. I believe in that.”

And that optimism, plus more than a little greed, is driving a very hot real estate market:

It’s this sort of determination that allows [Mayor] Levine to believe that the current boom of building and buying, far from being a crazy bet on what’s destined to become Waterworld, makes perfect sense. “If you can show me the first owner of real estate who’s panicky, who would like to sell cheap, please let me know—because I’d like to be the buyer,” he said. “And I have about 100,000 people right behind me.”

The real-estate figures bear him out. Peter Zalewski, the founder of CraneSpotters.com, a Web site and consulting service that monitors the high-end condominium market in South Florida, told me that, while the pre-2008 real-estate boom was actually bigger in terms of units sold, “from a price perspective, this is the biggest boom by far. It’s triple or quadruple anything we’ve ever seen.” To wit, two years ago, Alex Rodriguez sold his mansion on North Bay Road, for which he had paid $7.4 million in 2010, for $30 million. In June, Phil Collins paid $33 million for a home, also on North Bay Road, that had once belonged to Jennifer Lopez—and which Lopez had sold, 10 years ago, for $14 million.

Two of the foremost brokers in this super-luxury market are Jill Eber and Jill Hertzberg, a pair of glamorous, mediagenic Coldwell Banker agents who bill themselves as The Jills®, and who, three years ago, bagged themselves what was then, pre-Faena House, the county record for a single-family dwelling, selling a mansion at 3 Indian Creek to a Russian buyer for $47 million. I met with Hertzberg at her office, where even she expressed surprise at what people are paying for properties nowadays—not just in desirable South Beach but in areas like the one where the Edition and the Faena properties are (“They’re calling it ‘Mid-Beach,’ but no one had a name for it before,” she said) and in the quiet town of Surfside, just north of Miami Beach proper, where the developer Nadim Ashi and the architect Richard Meier are making over the Surf Club, that toffs’ haunt from the 1930s, as a Four Seasons-branded hotel-and-residential complex. It won’t be completed until next year, yet Hertzberg has already sold one of its penthouses for $35 million.

Many of The Jills’ well-off buyers are from overseas and pay for their purchases in cash. For her foreign customers, Hertzberg explained, Miami Beach is precisely the opposite of a risky investment; rather, it’s a safe harbor in which to park their money (and often their extended families) when things get volatile at home. There is even a colorful real-estate term for the cash spent in this fashion: flight capital. Selling super-luxury real estate, Hertzberg said, has provided her and Eber with a continuing education in political unrest around the globe. “Years ago, when they started having all the kidnappings in Bogotá, and newspeople and judges were getting killed, we started to have Colombians coming in,” she said. More recently, she noted, there has been an influx of customers from troubled Argentina. With Miami Beach offering beautiful views, a temperate climate, a stable national political system (well, relative to other countries), and properties that seem to only appreciate in value, sea-level rise is not foremost among the considerations of today’s eight-figure buyer. In fact, when I asked Hertzberg how many of The Jills’ clients have even raised the subject, the answer was precise: one. And that client still proceeded with his purchase.

Which isn’t to say, Hertzberg hastened to add, that her customers are oblivious or delusional. “I don’t want to belittle my clients, because I think they’re very sophisticated, world-traveled, and well read,” she said. “What it is, I think, is that they have confidence that the city will figure it out.”

Zalewski, the condominium analyst, takes a more cynical view. “Rising sea levels are in the back of everyone’s minds, but it’s all about immediate gratification,” he said. “I would wager that less than 10 percent of these purchases are long-term investments. It’s more like ‘I will buy into that position, I will hold for three, five, seven years, and then I will exit that position.’ I like to say that in New York you trade stocks, in Chicago you trade commodities, and in South Florida you trade condos.”

The capstone — Miami Beach has status it doesn't want to surrender:

It’s an index of Miami Beach’s ascendant cultural status that it now sits alongside New York, London, St. Barth’s, Portofino, and Aspen on the circuit of the International Set—as the site of a “third, fourth, or fifth home,” in Zalewski’s words, that will sit unoccupied for the better part of the year.

Money chasing money chasing status and money. $30 million, $33 million, $47 million for one condo, one home — there are other markets like these but not many. Yet these men and women aren't the only property owners in Miami Beach or mainland Miami. They're just the trend-setters.

So what happens when trend-setting money flies off in a swarm?

There was a horrible collapse in real estate prices in Florida in the mid 1920s, a presage of the 1929 collapse that caused the Great Depression. I'm not predicting the second — a new great depression — but the first, a price collapse in Miami Beach that will last generations, is certain. Even if the ripples of that fall encompass only the rest of south Florida, the crisis may look to the nation like a wake-up call. I hope.

GP

Is the world economy headed into the dumper? One thing's sure, says Ian Welsh: Western elites are losing control of the global economic narrative

"[T]here is more pain to come, but there always was. The decision was made in 2008 and 2009 to not allow an actual recovery and to protect the rich at all costs. There was a cost; it has been paid for the last six years, and this is yet and simply another one of those costs. China, as an exporting power, cannot carry the world economy when the people to whom it exports insist on various levels of austerity (be clear, the US is in austerity too, just not as bad an austerity as Europe)."

-- Ian Welsh, in his post this evening, "As the Dow Jones Drops"

by Ken

I think Drew Harwell's late-afternoon washingtonpost.com report, "Global sell-off turns to chaos in rocky day for financial markets," is representative of at least the American coverage of the day's financial events. It begins (links onsite):

A worldwide selling frenzy on Monday bruised U.S. stocks and sent the Dow Jones Industrial Average plunging nearly 600 points, as investors worried over China’s slowing economy extended a global-market meltdown.

The Dow fell more than 1,000 points within six minutes, its largest single-day slump in history, before staggering back to close down 588 points, or 3.6 percent, its lowest point in 18 months. It marked the second straight day of a 500-point-or-more loss for the Dow, a blue-chip index of 30 large companies.

The Standard and Poor’s 500, a broader look at the market, and the Nasdaq Composite, a tech-heavy index, posted similarly dismal starts before swinging wildly then sinking again to losses of close to 4 percent.

The global whiplash underscored investors’ shaken confidence in China’s slowing economy and central bank. The world’s second-largest economy is now reeling over what China’s state media is calling “Black Monday,” during which its markets just recorded their biggest one-day nosedive in eight years.

WHEN LAST WE LOOKED AT CHINA'S PLUNGING EQUITY MARKETS --

in early July, Tufts professor Daniel Drezner, in the washingtonpost.com post "The politics of China's stock market collapse," was quoting he Financial Times's Tom Mitchell saying that "if anything, a three-week, 30 per cent correction after a 12-month, 150 per cent surge seemed like a welcome adjustment." Experienced watchers of the Chinese economy were pointing out that, given the size of the bubble that had inflated the Chinese markets, and in combination with news of the Chinese economy's slowdown, there was still a heckuva lot of bubble deflating to be done. So I don't think there should be any great surprise that the Chinese markets have done more plunging.

However, there was (and still is) much interest in the Chinese government's handling of the situation, notably the hardly precedented effort to appear to allow its currency to sort-of-float while simultaneously being seen making various quite conspicuous, even frantic efforts to maintain control (that's the control-freak PRC we're accustomed to) -- frantic and notoriously unsuccessful. In the less than two months since, the government's efforts to get control of the situation have mostly served to show how little actual control it has.

Nevertheless, as Ian Welsh points out in the post I've referenced at the top of this post, China retains the distinction of having an economy that's actually producing actual stuff,.

China is the key maker of goods. There are a few other countries that also make goods as the most important (not largest, most important) part of their economy. Everyone else is a commodity producer, a financier, or trying to sell intangibles (intellectual property, whether inventions or fiction or branding).

This means that China has to buy resources from somewhere to be able to make stuff and has to have markets where they can sell the stuff they make. So the Chinese economy, already in slowdown, has been further vulnerable to world increases in resource prices and to fall-off in consumer demand in its once-humming export markets.

During this period we had repeated currency devaluations in an attempt to increase the competitiveness of exports. These devaluations had marginal effect at best, didn’t work at least.

China’s growth had been slowing (thus the reduction in their demand for commodities), they encouraged a stock market bubble as consumers were proving reluctant to continue piling into real-estate. They printed vast amounts of money, at least twenty times as much as Europe, Japan, and the US combined, but exports were no longer leading growth. Regular Chinese and private firms have massive amounts of debt.

To put it simply, China had reached the point where export-led mercantilism was no longer working. They needed to shift to domestic consumer demand.  They chose to try and inflate bubbles instead.

Virtually every country in the world was either rolling off a cliff, or struggling to keep their head above water. Most of the South of Europe had never really recovered (Ireland is a partial exception). Latin America was diving, Turkey’s real-estate driven, neo-liberal growth was stalling, India’s “miracle” was always more of a paper tiger than most made out, being concentrated to a minority even as the average number of calories consumed in the country dived.

To Ian it's significant that the economic "contagion" started in China, "spread to emerging economies, money fled to the US and a few other safe havens, China’s economy continued to stall, its stock market fell despite radical attempts to keep it inflated, and that has now come home to New York." He points out that he has been saying for years that the next 1929-style crash "would start in China." Whether this is actually the new 1929 "we won't know for a while," Ian says -- "just as they did not know in 1929 that it was 1929."

"Welcome to the new world," says Ian.

The US and Europe put a LOT of effort into moving as much industrial production as possible to China. China just promised that a very few people would get very rich doing it, and those people made sure it happened. (Look up the profit margins on iPhones.)

I will note that there are still bubbles. Real-estate bubbles (Canada, Britain, a few important US cities, Australia, etc.) and a vast amount of highly leveraged derivatives have been pumped back out since the 2008 crash, since no one actually bothered to regulate or forbid them. And banks and financial companies are now larger and fewer, making the economy and financial markets both more subject to contagion.

The elites learned from 2008 that the important thing to do in a financial crisis is to just print enough money and relax enough accounting rules–extend and pretend. That will be the play again this time if this contagion turns truly serious. I would guess that it will work, sort of: More zombies will be created, they will need higher profits, the real economy will be even more stagnant. And people like Corbyn, Trump, Sanders, and so on will reap the rewards electorally.

Printing money is a viable strategy only as long as the elites control the regulatory apparatus (including prosecutors, finance departments/treasuries, and central banks), legislators, and executives. The reason people are screaming so loudly about Corbyn is not because he can’t win in England, it’s because if he did, and he’s serious about his policies, he will inevitably have to confront them. And an English PM with a majority he controls is pretty much a dictator.

"A LOT IS AT STAKE HERE," SAYS IAN

And he explains this stake in a way I don't think you'll be seeing in your regular infotainment nooze outlets:

Our elites are losing control over the electoral apparatus and the common narrative. In both cases, the signs aren’t terrible yet, but they are there; the rise of the old right and the old left is visible.

"So," Ian says, "there is more pain to come,"

but there always was. The decision was made in 2008 and 2009 to not allow an actual recovery and to protect the rich at all costs. There was a cost, it has been paid for the last six years, and this is yet and simply another one of those costs. China, as an exporting power, cannot carry the world economy when the people to whom it exports insist on various levels of austerity (be clear, the US is in austerity too, just not as bad an austerity as Europe).

Ian can't help but take note of "the way the Chinese are fumbling this crisis," which convinces him, he says, "that they are now past the point where enough competent people who remember poverty and fear remain in power."

Ian concludes: "We continue to live in interesting times."

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Nobel economist Robert Shiller seems to be saying: I'm right, they're wrong, but we can all be friends

Why not Nobel Prizes for one and all? says Professor Shiller -- "even if we sometimes seem to come from different planets."

"Actually, I do not completely oppose the efficient-markets theory. I have been calling it a half-truth. If the theory said nothing more than that it is unlikely that the average amateur investor can get rich quickly by trading in the markets based on publicly available information, the theory would be spot on. But the theory is commonly thought, at least by enthusiasts, to imply much more."

-- Nobel economist Robert Shiller, in a NYT "Economic View"
column, "Sharing Nobel Honors, and Agreeing to Disagree"

by Ken

A lot of us who aren't exactly close followers of the inner workings of the economics profession were fascinated by this year's three-pronged Nobel award to economists who have all done work relating to markets, but work that seems, at least in two of the cases, the University of Chicago's longtime free-market worshipper Eugene Fama and Yale's more real-world-oriented Robert Shiller, openly contradictory.

I was happy to turn to Paul Krugman, who declared in the blogpost "The Nobel" that he's "actually fine with the prize."

It's an old jibe against economics that it's the only field where two people can win the Nobel for saying exactly the opposite thing; even the people making that jibe, however, probably didn't envisage those two guys sharing the same prize, which is kind of what happened here.

But I am actually fine with the prize. Fama's work on efficient markets was essential in setting up the benchmark against which alternatives had to be tested; Shiller did more than anyone else to codify the ways the efficient market hypothesis fails in practice. If Fama has said some foolish things in recent years, no matter -- he did earn this honor, as did Shiller. As for Hansen, his work involves econometric methods on which I have no expertise at all, but I'll trust the experts who consider it great work.

So, all good -- and you actually have to admire the prize committee for finding a way to give Fama the long-expected honor without seeming as if they are completely out of touch with everything going on around them.

This worked for me. Fama was getting a Nobel to make up for the one he didn't get when the Nobel people were handing them out like door prizes to Chicago economists, a number of them less deserving, and he even contributed to Shiller's work by providing an up-to-date version of the theory Shiller earned his prize by discrediting.

Now Shiller himself has gone public with his feelings about the "obvious incongruity" of this year's Economics prize, which he says harks back to 1974, when "the Nobel committee gave a joint prize to Gunnar Myrdal, a Social Democrat in Sweden and a proponent of the welfare state, and Friedrich Hayek, a conservative who believed that government should be minimal."

Eventually Shiller gets around to being diplomatic:

[L]ike Professor Hansen, Professor Fama is a first-class scholar who does careful research on the topics he focuses on.

We disagree on a number of important points, but there is nothing wrong with our sharing the prize. In fact, I am happy to share it with my co-recipients, even if we sometimes seem to come from different planets.

But in getting there, Shiller has what seems to me like some naughty fun. First, he deals with the third recipient, Lars Peter Hansen, yet another Chicago guy. He notes that Hansen "is well known for having rejected one form of the efficient-markets model," but says his heart still seems to be with what the Chicago markets fetishists call the "rational expectations" that make markets so wise and dependable.

With regard to the other winner, however:

Professor Fama is the father of the modern efficient-markets theory, which says financial prices efficiently incorporate all available information and are in that sense perfect. In contrast, I have argued that the theory makes little sense, except in fairly trivial ways. Of course, prices reflect available information. But they are far from perfect. Along with like-minded colleagues and former students, I emphasize the enormous role played in markets by human error, as documented in a now-established literature called behavioral finance.

As I've noted at the top of this post, Shiller says he doesn't "completely oppose" efficient-markets theory; he just considers it "a half-truth."

If the theory said nothing more than that it is unlikely that the average amateur investor can get rich quickly by trading in the markets based on publicly available information, the theory would be spot on. I personally believe this, and in my own investing I have avoided trading too much, and have a high level of skepticism about investing tips.

But the theory is commonly thought, at least by enthusiasts, to imply much more. Notably, it has been argued that regular movements in the markets reflect a wisdom that transcends the best understanding of even the top professionals, and that it is hopeless for an ordinary mortal, even with a lifetime of work and preparation, to question pricing. Market prices are esteemed as if they were oracles.

He doesn't make nice about this.

This view grew to dominate much professional thinking in economics, and its implications are dangerous. It is a substantial reason for the economic crisis we have been stuck in for the past five years, for it led authorities in the United States and elsewhere to be complacent about asset mispricing, about growing leverage in financial markets and about the instability of the global system. In fact, markets are not perfect, and really need regulation, much more than Professor Fama's theories would allow.

And now he's ready for his fun (links onsite):

It's interesting that Professor Fama is also the intellectual father and major adviser of an investment company that has, by many accounts, been beating the market. The company, Dimensional Fund Advisors, has impressed investors with its performance so much that its assets under management have grown to $296 billion, as of Aug. 31.

You see what he's done here, right? Normally it would be considered a feather in Fama's hat to be known for providing investment advice that beats the market. But how is this possible for a "rational expectations" maven? After all, according to believers of Fama's camp, financial prices efficiently incorporate all available information and are in that sense perfect.

Shiller turns to the DFA website and turns up some rather murky rational-expectations hemming and hawing, and points out that "he has ended up with an investing approach that looks, in some of its fundamental principles at least, a little like my own." He adds, "I can even recommend that people might consider investing in D.F.A."

I would not, however, recommend that monetary or fiscal authorities seek inspiration from his theories on how to stabilize the economy. He doubts the existence of any bubble before this crisis, and his philosophy would have let banks fail at the beginning of it.

And he concludes that both of the 2013 Chicago Two are "first-class scholars" doing "careful research" on their chosen subjects, and never mind that they're wrong. Okay, that last part is me, not Shiller, but isn't that what we means when he talks about the three of them "disagree[ing] on a number of important points" and "sometimes seem[ing] to come from different planets." That doesn't make them bad Nobel Prize recipients, does it?

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For a "Sunday Classics" fix anytime, visit the stand-alone "Sunday Classics with Ken."

The stock-market "boom" may not be a bubble, but that doesn't mean it's good news for most of us

"Today, there's a growing divide between the fortunes of corporate America and those of the majority of Americans. . . . The stock-market boom is real, but most Americans have been left on the outside looking in."

-- James Surowiecki, in his latest New Yorker
"Financial Page," "Boom or Bubble?"

by Ken

So what do you think, is this great stock-market boom really another in our recent series of stock-market bubbles?

I confess I haven't given the matter much thought. I'm not even sure I was aware that there is a stock-market boom. I've had, um, stuff on my mind. A stock-market boom doesn't figure heavily in my stuff. A stock-market bubble, however, might force itself on my attention, judging by that recent history of market bubbles, which somehow came crashing down on those of us who thought we were pretty remote from either tech or housing hysteria.

Not surprisingly, The New Yorker's financial columnist, James Surowiecki, has been paying attention.

With the stock market setting new highs on a nearly daily basis, even as the real economy just slogs along, there seems to be one question on everyone's mind: are we in the middle of yet another market bubble? For a growing chorus of money managers and market analysts, the answer is yes: the market is a house of cards, held up by easy money and investor delusion, and we are rushing all too blithely toward an inevitable crash. Given that we've recently lived through two huge asset bubbles, it's easy to see why they're worried. But in this case the delusion is theirs.

The bubble believers make their case with a blizzard of charts and historical analogies, all illustrating the same point: the future will look much like the past, and that means we're headed for trouble. Smithers & Company, a London market-research firm, says that, according to a number of market indicators, stocks are, by historical standards, forty to fifty per cent overvalued. The bears admit that corporate profits are high, which makes the market's price-to-earnings ratio look quite normal, but they insist that this isn't sustainable. They think that earnings will return to historical norms, and that, when they do, stock prices will be hit hard. Today, after-tax corporate profits are more than ten per cent of G.D.P., while their historical average is closer to six per cent. That's a vast gap, and it's why bears believe that the market is, in the words of the high-profile money manager John Hussman, "overvalued, overbought, overbullish."

As you may have guessed, Surowiecki isn't in the "bubble camp." He allows that "It's certainly unusual for corporate profits to soar during a slow recovery."

But the argument for a stock-market bubble is flawed: when it comes to the role that corporations play in the U.S. economy, the present looks very different from the past, which means that historical comparisons to the nineteen-fifties, let alone the thirties, tell us little. The four most dangerous words in investing may be "This time, it's different." But this time it is different.

Different how?

* Taxes. One reason to believe in today's corporate profits is that corporations now are paying so much less in taxes. "In 1951, corporations had to pay almost half of reported profits in taxes. In 1965, they had to pay more than thirty per cent. Today, they pay only around twenty per cent."

* Globalization. Another reason to believe: So much more of the corporate bottom line today comes from foreign earnings, which 'account for almost a third of corporate earnings," almost three times the case in 2000. "The global economy, even with its current woes, is projected to grow more briskly than the U.S. economy over the next decade, so corporations will continue to benefit."

* "Labor's share of the economy has fallen steeply." Unions have no power, and apart from some skilled workers, neither do workers. There may not be new profits to be racked up by squeezing the stuffing out of whipped-to-the-mat workers, "but keeping profits where they are doesn't look all that difficult."

Which brings us to what for me is the money quote, and we take it in whole.

It's still possible that investor hysteria could eventually inflate stock prices, or that investor panic could send them crashing, but there is no profit bubble and, for now, no stock-market bubble, either.

For investors, that's obviously good news: there's nothing wrong with profits, and the rebound of the stock market has helped restore many Americans' battered finances. Still, it's unsettling that companies and investors are doing so well while the economy as a whole is stuck in the mud. Throughout the postwar era, high corporate profits were coupled with rising wages and strong economic growth. Today, there's a growing divide between the fortunes of corporate America and those of the majority of Americans. You might hope that people could make back as investors some of what they're not getting as workers, but in fact only about half of Americans have any money in the stock market, and most of those who do have only small sums. What's more, the crash of 2008 scared many ordinary investors out of the market, so they haven't benefitted from the recent profit boom at all. "There's a lot of residual shell shock at work, and that's made investors still pretty gun-shy," [Doug] Ramsey [chief investment officer for Leuthold Weeden Capital Management] said. The stock-market boom is real, but most Americans have been left on the outside looking in.

Once upon a time we heard some political chatter about "The Two Americas." Thank goodness we stopped hearing about that! The compact coterie of Americans Who Matter just don't want to hear about the rest of us, because, after all, by definition we don't matter.

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The race for Fed chairman is over, and it's . . . BEN BERNANKE in a landslide!

"Ben approached a financial system on the verge of collapse with calm and wisdom."

-- President Obama, announcing this morning at Oak Bluffs Elementary School on Martha's Vineyard that he is appointing Ben Bernanke to succeed himself when his term as chairman of the Federal Reserve expires in January

by Ken

That's right, Mr. President, our Ben approached the financial system in meltdown with the same calm and wisdom he had shown while it was preparing to go down the crapper. Say good night, Ben.

So President Obama has made it official: Chairman Ben gets another four-year term as Fed chairman, confirming our fearless forecast. We really went out on a limb with that one, since our Ben was competing in a cutthroat candidate field of one for the single vote being cast, the president's.

There is good news here -- and if there's anything I'm known for, it's finding the "good news" angle on any story. In this case the good news is that White House economic czar Larry Summers is reported to be interested in the job of Fed chairman. Sorry, Larry, the job's filled!

Or is this such good news? How much damage, after all, could Larry have caused at the Fed? Okay, I'm the one who always warns against putting questions like that in the form of a challenge -- you know, let's us just see how much damage he could cause! I mean, if you had played this game a few years ago, you could have asked, "How much trouble could our Larry get into as president of Harvard University?" Would your answer have come anywhere close to how much trouble he did get into?

The line of thinking, though, is that a Fed appointment would have gotten our Larry the hell out of the White House, or wherever the hell the office is from which he safeguards the interests of the nation's leading financiers. Of course, since the rest of the White House economic team was reportedly assembled according to our Larry's specifications, it's not as if that much change in policy would have been noticeable if he had been tapped for the Fed job, especially since all he needs is a cell phone to tell the president what to do from wherever he is.

Luckily, I do have a "backup good news angle" on this story: The president could have brought back Alan "Mumbles" Greenspan for an encore term as Fed chairman, with a shot at presiding over one last bubble before he leaves for that great economics council in the sky.

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'Tis the season for robbing banks, but for NABBING con guys. The Madoff scandal could have caused a nosedive. The reason it didn't isn't much comfort.

"In David Mamet's movie 'House of Games,' the grifter played by Joe Mantegna explains to a former mark, 'It's called a confidence game. Why? Because you give me your confidence? No. Because I give you mine.' So the bankers gave us their confidence, in the form of mortgages and other forms of credit, and we gave them ours. This culture of credulity did plenty of damage to the economy, but now it has given way to something even more corrosive; namely, endemic mistrust."

"Discovering what the crooks have been up to is disillusioning, but not as disillusioning as coming to terms with what the so-called honest people did."

-- James Surowiecki, in "Cheat, Pray, Love," the "Financial
Page" in this week's (January 12) New Yorker

by Ken

SEC Broadens Its Probe Of Failures in Madoff Case

By Zachary A. Goldfarb
Washington Post Staff Writer
Tuesday, January 6, 2009

The inspector general of the Securities and Exchange Commission said yesterday that he is broadening his investigation into the agency's failure to detect the alleged fraud committed by Bernard L. Madoff, examining whether the regulatory breakdown was isolated.

H. David Kotz, the SEC's inspector general, said he is looking to identify not only the officials who failed to uncover Madoff's activities, but also whether the agency is able to "to respond appropriately and effectively to complaints and detect fraud."

Kotz addressed outraged lawmakers on the House Financial Services Committee, who expressed bipartisan agreement that the Madoff scandal underscores the need to restructure the regulatory system.

And now, warns James Surowiecki (whose "Financial Page" has become one of my favorite things in The New Yorker), may be the time to hunt for more Bernie Madoffs:

Along with slashed payrolls, rising foreclosures, and plummeting stock prices, 2008 brought another unwelcome development: a surge in bank robberies, which were up more than fifty per cent in New York. This wasn't shocking: we typically expect property crimes to rise in hard economic times. There is, though, one crime against property which bucks this trend: defrauding investors. On Wall Street, fraudulent schemes tend to thrive during economic booms, and to blow up when times turn tough. While bank robbers are getting busier, the Bernard Madoffs are starting to get caught.

Madoff, says Surowiecki, "is just the latest in a long line of fraudsters who took advantage of investor euphoria. Time and again, as asset markets have become frothier, fraud has flourished," and he provides examples from "England's South Sea Bubble, in 1720," all the way through the last stock-market bubble and the fun and games of Enron, WorldCom, and their crooked kin.

Fraud is a boom-time crime because it feeds on the faith of investors, and during bubbles that faith is overflowing. So while robbing a bank seems to be a demand-driven crime, robbing bank shareholders is all about supply. . . . The same overconfidence that leads investors and lenders to underestimate the risks of legitimate investments also leads them to underestimate the likelihood of fraud. In Madoff's case, for instance, his propensity for delivering inexplicably consistent returns month after month should have been a warning sign to his investors. But in the past few years besotted investors were willing to believe lots of foolish things -- like the idea that housing prices would just keep going up.

Of course this can't go on forever, and "when the crash comes, and people get more cynical and cautious, the frauds are exposed." Surowiecki quotes Warren Buffett: "You only learn who's been swimming naked when the tide goes out.”

Did the share prices of Enron and WorldCom start plunging after their fraudulent actions came to light? Actually, it was the other way around: the financial mischief was exposed only after their stock prices tanked. In Madoff's case, the steep across-the-board decline in asset prices curbed investors' appetite for risk, so that many started to pull their money out. That effect may very well have forced Madoff to dispense more money than he could keep bringing in, especially since recruiting new investors, which you have to do to keep a Ponzi scheme going, would have become harder after the crash.

There is one small saving grace. With the unmasking of an investor ripoff on the scale of our Bernie's, there is a normal expectation of a sizable jolt to general investor confidence, and that didn't happen.

But the reason why it didn't happen isn't such good news. Surowiecki notes a couple of contributing factors:

* "A stock market that lost seven trillion dollars in value in 2008 knows how to take a fifty-billion-dollar loss in stride."

* "Madoff was running money largely for an élite clientele, which gained access to his services primarily through inside connections, limiting the market-wide impact of his malfeasance."

But the main reason that Madoff didn't destroy investor confidence is that it was already gone, thanks to a year when just about every institution that the market depends on -- rating agencies, accounting firms, regulators, Wall Street C.E.O.s. -- had messed up. The whole web of intermediaries and knowledge brokers that modern asset markets have come to rely on has become frayed. That helps explain the current credit crunch -- bank lending has dropped fifty-five per cent this year -- and the dismal state of the stock market. Discovering what the crooks have been up to is disillusioning, but not as disillusioning as coming to terms with what the so-called honest people did.

"If there's one thing worse than too much confidence," Surowiecki concludes, "it's not enough. Fraud impoverishes a few; fear impoverishes the many. As long as mistrust prevails, people will keeping pulling money out of the system -- sometimes even at gunpoint."

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