Gold at 1025

Bear Stearns rescued by Fed aka JPMorgan.

Time for a diversion...Remember the Maine, the Lusitania, or the Gulf of Tonkin.

Philip Berg,

I am convinced that no matter which mainstream candidate is elected to the presidency, government will continue on the same destructive course, fiscally and otherwise, that it is currently on. If you agree with my prediction, to what level do you believe the dollar will fall before things get better, if they get better. Also, do you believe the dollar will be replaced with another currency if continues to fall? I believe our government is trying to destroy the dollar so they can usher in a new currency linked to a North American Union between USA, Canada and Mexico. What are your thoughts on these issues?


Donald Fields

I believe that it was Napolean who said" Never attribute to malevolence what can be attributed to incompetance"

The financial system is taking water and listing in heavy seas. Twenty five years of continuous easy money hasbrought the level of debt to exceed the ability of the central banks to paper it over. The derivitive market as reported by the bank of international settlements is 600 Trillion dollars compared to a US GDP of 15 Trillion and a US money supply of the same amount 15 trillion.

No one knows how this will turn out, but the Weimer Republic is probably a good model. Just replace war reparations with over the counter derivitives. Warren Buffet warned about this years.ago.

The Amero may be used just to cove up the necessity to cut off a few zeros from the dollar, as isusual in a hyperinflationary economy.

Even hyperinflation may not be able to stave a deflationary collapse ofpaper based assets.

I made my biggest financial mistake of my life last by selling my months old position in Bear Stearns puts. It didn't cost me any money, but lost me chance for a hugh windfall. Do overestimate the abiity of the system to fix itself. This ha s realposssibility to descend into chaos.The answer will be a severe crackdown.

Don't believe me. Just ask Steve DeKoe\rte. a much more level headed guy.

On his blog he makes a conservative case for a ten trillion dollar pricetag just from the hedgefunds.

Sorry about the typos , my computer vice is acting up badly and won't shut up.

Philip Berg,

I believe you and I thank you for your reply to my questions. As you suggested, I will read Steve Dekorte's blog.

All the best,

Donald Fields

Philip Berg,

You said, "I believe that it was Napoleon who said, 'Never attribute to malevolence what can be attributed to incompetence.'" I've always tried to figure out whether government is stupid or evil. Unable to answer this question satisfactorily, I recently came to the the conclusion that the correct answer, from my point of view, is both: Depending on the issue, government can be either stupid or evil, or both. Please count me as a political atheist: I have no faith whatsoever in government or politicians.

All the best,

Don Fields

The WSJ reported that hedge funds are managing ~$2 trillion in client funds and a friend at a hedge fund suggested that the mean leverage for hedge funds is probably 5/1 so that's ~$8T in hedge fund debt. Many hedge funds are getting margin calls as the market goes down, which raises the question of how much of that $8T they'll be able to pay back as the weaker ones collapse. If they can't pay back even 1/8th of it ($1T) will the US banking system be able to withstand it?

But with today's collapse of the world's 5th largest financial institution, Bear Stearn, the stakes are higher. Stearns has notional/contract amounts of $13 trillion and $9 trillion. Lehman Brothers is rumored to also be in serious trouble and some are predicting it's collapse by the end of the week.

- Steve

There is certainly no lack of malevolence, but it takes a certain amount of competancy to be malevolent in a conspiratorial way, a degree of competance that is clearly waaay above the heads of the idiots running the show.

Bear was NOWHERE close to the world's 5th largest financial
institution, although it has been widely misreported as such by the
media. What they mean to say is that it was the 5th largest US-based
Investment bank (behind Goldman, Morgan, Merrill and Lehman).
However, even at its peak, Bear was still way smaller than many banks,
including my Swiss employer - UBS, in addition to Credit Suisse,
Barclays, JP Morgan, Citigroup, Bank of America, HSBC, ABN Amro, Wells
Fargo, Banco Santander, Mitsubishi, RBS, US Bancorp, and at least 10

It's important we keep Bear's failure in perspective. Calling it the
5th largest bank just serves to scare people.


Thanks Derek...while tending to be easily alarmed's an
even-keeled opinion although I can't argue for or against it.


Let's Get Real About Bear

I already have a slew of emails from people upset about what they see as
a bailout of a big bank, decrying the lack of "moral hazard." And I can
understand the sentiment, as it appears that tax-payer money may have
been used to bail out a big Wall Street bank that acted recklessly in
the subprime mortgage markets.

But that is not what has happened. This is not a bailout. The
shareholders at Bear have been essentially wiped out. Note that a third
of the shares of Bear were owned by Bear employees. Many of them have
seen a lifetime of work and savings wiped out, and their jobs may be at
risk, even if they had no connection with the actual events which caused
the crisis at Bear. Don't tell them there was no moral hazard.

For all intents and purposes, Bear would have been bankrupt this
morning. The $2 a share offer is simply to keep Bear from having to
declare bankruptcy which would mean a long, drawn out process and would
have precipitated a crisis of unimaginable proportions. Cue the lawyers.

As I understand this morning, JP Morgan will take a $6 billion write
down, which is essentially what they are paying for Bear. The Fed is
taking $30 billion dollars in a variety of assets. They may ultimately
take a loss of a few billion dollars over time, although they may
actually make a profit. When you look at the assets, much of it is in
paper that will likely get close to par over time, and the good paper
will pay premiums mitigating the potential loss. The problem is, as the
essays below point out, no one is prepared to take that risk today.

If it was 2005, Bear would have been allowed to collapse, as the system
back then could deal with it, as it did with REFCO. But it is not 2005.
We are in a credit crisis, a perfect storm, which is of unprecedented
proportions. If Bear had not been put into sounds hands and provided
solvency and liquidity, the credit markets would simply have frozen this
morning. As in ground to a halt. Hit the wall. The end of the world,
impossible to fathom how to get out of it type of event.

The stock market would have crashed by 20% or more, maybe a lot more. It
would have made Black Monday in 1987 look like a picnic. We would have
seen tens of trillions of dollars wiped out in equity holdings all over
the world.

As I have been writing, the Fed gets it. Their action today is actually
re-assuring. I have been writing for a long time that they would do
whatever it takes to keep the system intact. As one of the notes below
points out, this was the NY Fed stepping in, not the FOMC. The NY Fed is
responsible for market integrity, not monetary policy, and they did
their job. And you can count on other actions. They are going to change
the rules on how assets can be kept on the books of banks. Mortgage
bail-outs? Possibly. The list will grow.

Yes, tax-payers may eventually have to cover a few billion here or there
on the Bear action. But the time to worry about moral hazard was two
years ago when the various authorities allowed institutions to make
subprime loans to people with no jobs and no income and no means to
repay and then sold them to institutions all over the world as AAA
assets. And we can worry in the near future when we will need to do a
complete re-write of the rules to prevent this from happening again.

But for now, we need to bail the water out the boat and see if we can
plug the leaks. Allowing the boat to sink is not an option. And get
this. You are in the boat, whether you realize it or not. You and your
friends and neighbors and families. Whether you are in Europe or in
Asia, you would have been hurt by a failure to act by the Fed.
Everything is connected in a globalized world. Without the actions taken
by the Fed, the soft depression that many have thought would be the
eventual outcome of the huge build-up of debt would in fact become a
reality. And more quickly than you could imagine.

As I have repeatedly said, recessions are part of the business cycle.
There is nothing we can do to prevent them. But depressions are caused
by massive policy mistakes on the part of central banks and governments.
And it would have been a massive failure indeed to let Bear collapse. I
should note that this was not just a Fed action. Both President Bush and
Secretary Paulson signed off on this.

The Fed risking a few billion here and there to keep the boat afloat is
the best trade possible today. Their action saved trillions in losses
for investors all over the world. It is a relatively small price. If you
want to be outraged, think about the multiple billions in subsidies for
ethanol and the hundreds of billions of so-called earmarks over the past
few years to build bridges to nowhere. And think of the billions in lost
tax revenue that would result from the ensuing crisis. I repeat, this
was a good trade from almost any perspective, unless you are from the
hair-shirt, cut-your-nose-off-to-spite-your-face camp of economics.

The Fed is to be applauded for taking the actions they did. And they may
have to do it again, as there are rumors that another major investment
bank is on the ropes. I hope that is not the case, and will not add to
the rumors in print, but I am glad the Fed is there if we need them.

It is precisely because the Fed is willing to take such actions that I
am modestly optimistic that we will "only" go through a rather longish
recession and slow recovery and not the soft depression that would
happen otherwise.

I got a very sad letter today from a lady whose husband is in the
construction business an hour from Atlanta. He has had no work for four
months and they are rapidly going through their savings. The jobs he can
get require them to spend more in gas to drive to than he would make. He
is sadly part of the construction industry which everyone knows is
taking a major hit.

But without the Fed action, that story would have multiplied many times
over, as the contagion of the debt crisis would have spread to sectors
of the economy that so far have seen only a relatively small impact.
Unemployment would have sky-rocketed over the next year and many more
families would have been devastated like the family above. It would have
touched every corner of the US and the globe.

Bailing out the big guys? No, the Fed does not care about the big guys,
and only mildly pays attention to the stock market, despite what
conspiracy theorists think. In the last few years, I have had the
privilege of meeting at length with a number of Fed economists and those
who have their ear. They are far more focused on the economy, their
mandates for stable inflation and keeping unemployment as possible.

No one who owned Bear stock was protected. This was to protect the small
guys who don't even realize they were at risk. To decry this deal means
you just don't get how dire a mess we were almost in. It is all well and
good to be rich or a theoretical purist and talk about how the Fed
should let the system collapse so that we can have a "cathartic" pricing
event. Or that the Fed should just leave well enough alone. But the pain
to the little guy in the streets who did nothing wrong would simply be
too much. The Fed and other regulatory authorities leaving well enough
alone is part of the reason we are where we are. First, get the water
out of the boat and fix the leaks, and then make sure we never get here

And yes, I know there are lots of implications for the dollar,
commodities, markets, interest rates, etc. But we will get into that in
later letters.

For now, let's go to the essays from my friends and then a quick note
about the stock market.

John Mauldin, Editor
Outside the Box


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