I was reading these links today:
http://www.istockanalyst.com/article/viewarticle/articleid/3205941
"Zenn has moved because it is the only public way to participate in a privately held company called Eestor that is developing a new technology for energy storage - a sort of cross between a standard battery and an ultracapacitor. I’ve also written about Eestor in the past. Many people have opined that the company’s product is just vaporware, that it will never become real. Others have noted that if the product does work as advertised and can be produced in volume at a reasonable cost (which is part of Eestor’s business plan) it could be a game changer.
Eestor’s new battery would provide huge jolts of energy at a touch plus long length of storage plus very rapid re-charge time and (are you ready) virtually unlimited numbers of recharges. As you can easily imagine, it would be useful in huge numbers of devices, not least hybrid cars. If it is cheap enough, in fact, it might even make hybrid cars cheaper to buy than those with internal combustion engines - not to mention being a lot cheaper to operate.
If all that were to happen, companies that make other sorts of batteries or provide lithium, for example, might not be seen as quite so attractive. Or not. It’s not at all clear whether the Eestor battery would be sufficient by itself or would work in tandem with other energy storage devices."
EEstor is linked to Lockheed Martin
and:
http://www.euroinvestor.co.uk/news/shownewsstory.aspx?storyid=10348537
and:
Http://Www.Thestar.Com/Business/Article/623621
Saturday, April 25, 2009
Thursday, April 23, 2009
Crime of the Century and the Credit Crisis
As this crisis began in the US financial sector we would be best served by looking at the history of the US Federal Reserve. If money is the root of all evil the US Federal Reserve is the organic garden that cultivates and nourishes every
penny of it. For where else do we find the money tree (make that an entire forest!) that grows legally?
Yes it is the crime of the century, and sprouted roots in Washington DC on December 23 1913 when the Glass-Owen bill was signed into law. The US Federal Reserve Act was previously debated and contained forty points of contention as the fall session neared the Christmas recess. The US Congressmen prepared to leave Washington for the annual Christmas recess, assured that the Conference bill would not be brought up until the following year. Then creators of the bill pulled some political "sleight of hand" on the American public. In a single day, they ironed out all forty of the disputed points of contention in the bill and quickly brought it to a vote. On Monday, December 22, 1913, the bill was passed by the House 282-60 and the Senate 43-23. This meant that the single most important piece of legislation ever passed by the Senate was missing the votes of 27 Senators because it was passed just prior to the Christmas recess. President Wilson, at the urging of Bernard Baruch, signed the bill on December 23, 1913.
A few years later, President Wilson had second thoughts:
“I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the world–no longer a government of free opinion, no longer a government by conviction and vote of the majority, but a government by the opinion and duress of small groups of dominant men.”
Another critic was Rep. Charles Lindbergh Sr., the most vocal opponent of the bill and a member of the House Banking and Currency Committee, who on the day before the Federal Reserve Act was passed told Congress:
"This is the Aldrich bill in disguise…The worst legislative crime of the ages is perpetrated by this banking bill…The banks have been granted the special privilege of distributing the money, and they charge as much as they wish…This is the strangest, most dangerous advantage ever placed in the hands of a special privilege class by any Government that ever existed. The system is private...There should be no legal tender other than that issued by the government…The People are the Government. Therefore the Government should, as the Constitution provides, regulate the value of money." (Congressional Record, 1913-12-22)
My apologies for the US history lesson. Why is the history of the US Federal Reserve relevant here?
Simply put, the US Federal Reserve was created by the Federal Reserve Act of 1913 as a privately owned and interconnected system of national banks. Reference this court case for details: (Lewis vs. U.S., case #80-5905, 9th Circuit, June 24, 1982.)
It reads in part: "Examining the organization and function of the Federal Reserve Banks and applying the relevant factors, we conclude that the federal reserve are NOT federal instrumentalities . . . but are independent and privately owned and controlled corporations . . . federal reserve banks are listed neither as `wholly owned' government corporations [under 31 U.S.C. Section 846] nor as 'mixed ownership' corporations [under 31 U.S.C. Section 856] .
This becomes more clear when we look at the relationship between where the bailout money is coming from and where is it going. It is no mere coincidence that there is plenty of money to bail out financial institutions like banks but not so much money for automakers. The US Federal Reserve is now in "self-preservation mode" and will loan as much money as it deems necessary back into the US financial system (the same banks that own shares in the US Federal Reserve) at any cost to the US tax payer to rebuild the health and liquidity of the fractional reserve banking sector that currently exists in the US.
Many folks believe (or more correctly, have been led to believe) that the US Federal Reserve is United States Government institution. The Federal Reserve is not a government institution, department, or agency. It is a private credit monopoly which invents money out of thin air and lends it to the US Government through the US Treasury Department (at profit charging interest), for the benefit of these private bankers. It is a collection of 12 private credit monopolies (US Federal Reserve Banking districts ) that was deceitfully foisted upon the United States by the lobby of a powerful banking consortium in 1913. Not Coincidentally, this privately held banking consortium also determines the interest rate at which this money is loaned by determining the interest rates.
The Federal Reserve basically works like this: The government granted the power to create money to the Federal Reserve. They create money, then loan it back to the government charging interest. The government levies income taxes to pay the interest on the debt. On this point, it's interesting to note that the Federal Reserve Act and the sixteenth amendment, which gave Congress the power to collect income taxes, were both passed in 1913. The incredible power of the US Federal Reserve over the economy is universally admitted. Some people, especially in the banking and academic communities, even support it. (US Senator Ron Paul is the most vocal and outspoken critic of the US Federal Reserve.)
Why do we focus on the US Federal Reserve? Simply because that organization which
is not accountable to Congress controls the money supply and the interest rate.
The US Federal Reserve has never been audited its financial statements have never been publicly disclosed.
Notice also that US income tax came into existence in 1913. That income tax was only needed to pay interest to the bankers for the money that they loaned to the US government. Yes, you read that right, the Federal Reserve, mostly on paper and computer, creates money or pays the US Treasury a small printing fee for currency, and then loans this money to the US government. The taxes pay them interest on this loan that cost the Federal Reserve virtually nothing to make. What a sweetheart of a deal they have going for them. To be clear, this amounts to a license to print money, loan it out (at virtually no cost) , and charge interest on it.
This concept forms the basis of all of fractional reserve banking (loan money and charge interest on it). Fractional reserve banking combined with a fiat currency ( printed paper not backed by gold or any precious metal or physical item) is in the opinion of this author the real root of all evil.
Let's look at the collapse of the US investment bank Bears Sterns, and the buyout by J P Morgan Chase and the loan from the US Federal Reserve for a moment.
J P Morgan Chase owns an interest in the US Federal Reserve. They hold shares in it as do other banks like Bank of America, Citigroup, and HSBC. The CEO of J P Morgan (James Dimon) sits on the Board of the New York Federal Reserve. The US Federal Reserve (acting this time in the best interest of "insider" J P Morgan Chase) invented $55 billion out of thin air AND in an unusual (if not questionable or illegal) move lent it directly to J P Morgan it to "save" Bear Sterns in a buy out deal. No one is asking where the $55 billion came from in the first place? The US Federal Reserve grew it on their money trees and lent it directly to J P Morgan. Now let's look closely at who made these decisions. There should be no doubt this represents a conflict of interest of the highest order.
J.P.Morgan's CEO James Dimon
James Dimon of J P Morgan sits on the Board of Directors of the New York Federal Reserve Bank which made the decision to
extend $55 billion of loans to J P Morgan to buy Bear Stearns. Bear Stearns' CEO, Alan Schwartz, was not on the New York Federal Reserve Board. In fact, no one from Bear Stearns is on the Board.
James Dimon was at the luncheon on March 11, 2008 with Ben Bernanke, chairman of the US Federal Reserve,
Tim Geithner, president of the New York Federal Reserve bank, Thain of Merrill Lynch, and Schwarzman of the Blackstone Group and others.
Some claim that the meeting was about Bear Stearns and how to handle that situation. Bernanke, Dimon, and Geithner all testified before the U.S. Senate Committee on Banking April 4, that they first heard of liquidity problems at Bear Stearns on the evening of March 13, 2008. If they were talking about the solution to Bear Stearns at the March 11, 2008 luncheon, then their answers before the Senate Banking Committe were less than truthful.
Perhaps a felony. Alan Schwartz was not invited to the luncheon on March 11, 2008.
What is at issue here is the relationship between the US government and the US financial industry.
A very insightful article in the New York Times by By ANDREW ROSS SORKIN, PETER EDMONSTON
and JENNIFER DANIEL documents the relationship between the nation's bankers, their money their lobbying efforts,
political donations and how politicians make decisions. They write:
"Congress pushed and prodded with rules and regulations, and Wall Street pushed back. But lawmakers also gave tax breaks and eased some rules, allowing the money crowd more room to run. Behind the scenes, financiers sought support on Capitol Hill — usually with a campaign contribution in hand. With sweeping reforms coming, the Wall Street-Washington connection may be more important than ever, and political connections may be the new currency for deal makers."
***link:
http://dealbook.blogs.nytimes.com/2009/03/26/where-wall-street-trades-in-political-currency/?scp=1&sq=contribution&st=cse
(ignore)****
More recently, Paul Volcker, senior economic adviser to President Barack Obama and former chairman of the U.S. Federal Reserve, was quoted at Vanderbilt University in Nashville, Tennessee on April 18th. He said that a review of the Federal Reserve's role, something traditionally regarded as taboo, now seems inevitable given the fallout from the long-running financial crisis. "For better or worse, we are at a point where the Federal Reserve Act is going to be reviewed," said Volcker.
So what does all this actually mean? It simply means that the US Federal Reserve bank now finds itself with the perfect opportunity to make hundreds of billions of dollars of profitable loans for which they are charging the borrower (the US Government, through the US Treasury) a very low rate of interest. One might suggest as a shrewd lender, they don't really want their principal back, they just want to charge interest on the loans in perpetuity. But we must consider this is the same US Federal Reserve that is also legally responsible for setting the rate of interest and it would not be unrealistic to suggest we will see interest rates rise over the next several years as US economy recovers.
Capitalism and avarice drive the US economy in a way many Canadians cannot fully appreciate. Under the Bush administration this level of excessive greed spawned a very aggressive (and perhaps even fraudulent) subprime lending bonanza (loaning money to unworthy borrowers who could not afford to buy expensive real estate) that imploded into an adverse economic feedback loop of falling real estate prices, foreclosures, unemployment, and frozen credit markets. It would appear then the primary benefactor of this credit crisis is none other then the the bank owners and private equity stake holders of the US Federal Reserve as they bask in the once-in-a-generation opportunity to extend as much new debt as possible (also known as bail out loans to financial institutions). By controlling both the interest rate on that new debt, and the US money supply, the US Federal Reserve will surely profit from this crisis in ways that will never be fully understood. In summary the privately owned US Federal Reserve is not accountable to the US Congress or the President and has never been audited, they loan billions of US dollars, (they grow on their mythical forest of evergreen money trees) charge interest on it, and will make untold billions in profits from this period of economic crisis in the US. (If you noticed, the new head of the Treasury, Tim Geithner was an Obama political appointee, but the head of the US Federal Reserve, Ben Bernanke, was not replaced by Obama because the US Federal Reserve Act does not give the President of the United States or the US Congress the power or authority replace him.)
penny of it. For where else do we find the money tree (make that an entire forest!) that grows legally?
Yes it is the crime of the century, and sprouted roots in Washington DC on December 23 1913 when the Glass-Owen bill was signed into law. The US Federal Reserve Act was previously debated and contained forty points of contention as the fall session neared the Christmas recess. The US Congressmen prepared to leave Washington for the annual Christmas recess, assured that the Conference bill would not be brought up until the following year. Then creators of the bill pulled some political "sleight of hand" on the American public. In a single day, they ironed out all forty of the disputed points of contention in the bill and quickly brought it to a vote. On Monday, December 22, 1913, the bill was passed by the House 282-60 and the Senate 43-23. This meant that the single most important piece of legislation ever passed by the Senate was missing the votes of 27 Senators because it was passed just prior to the Christmas recess. President Wilson, at the urging of Bernard Baruch, signed the bill on December 23, 1913.
A few years later, President Wilson had second thoughts:
“I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the world–no longer a government of free opinion, no longer a government by conviction and vote of the majority, but a government by the opinion and duress of small groups of dominant men.”
Another critic was Rep. Charles Lindbergh Sr., the most vocal opponent of the bill and a member of the House Banking and Currency Committee, who on the day before the Federal Reserve Act was passed told Congress:
"This is the Aldrich bill in disguise…The worst legislative crime of the ages is perpetrated by this banking bill…The banks have been granted the special privilege of distributing the money, and they charge as much as they wish…This is the strangest, most dangerous advantage ever placed in the hands of a special privilege class by any Government that ever existed. The system is private...There should be no legal tender other than that issued by the government…The People are the Government. Therefore the Government should, as the Constitution provides, regulate the value of money." (Congressional Record, 1913-12-22)
My apologies for the US history lesson. Why is the history of the US Federal Reserve relevant here?
Simply put, the US Federal Reserve was created by the Federal Reserve Act of 1913 as a privately owned and interconnected system of national banks. Reference this court case for details: (Lewis vs. U.S., case #80-5905, 9th Circuit, June 24, 1982.)
It reads in part: "Examining the organization and function of the Federal Reserve Banks and applying the relevant factors, we conclude that the federal reserve are NOT federal instrumentalities . . . but are independent and privately owned and controlled corporations . . . federal reserve banks are listed neither as `wholly owned' government corporations [under 31 U.S.C. Section 846] nor as 'mixed ownership' corporations [under 31 U.S.C. Section 856] .
This becomes more clear when we look at the relationship between where the bailout money is coming from and where is it going. It is no mere coincidence that there is plenty of money to bail out financial institutions like banks but not so much money for automakers. The US Federal Reserve is now in "self-preservation mode" and will loan as much money as it deems necessary back into the US financial system (the same banks that own shares in the US Federal Reserve) at any cost to the US tax payer to rebuild the health and liquidity of the fractional reserve banking sector that currently exists in the US.
Many folks believe (or more correctly, have been led to believe) that the US Federal Reserve is United States Government institution. The Federal Reserve is not a government institution, department, or agency. It is a private credit monopoly which invents money out of thin air and lends it to the US Government through the US Treasury Department (at profit charging interest), for the benefit of these private bankers. It is a collection of 12 private credit monopolies (US Federal Reserve Banking districts ) that was deceitfully foisted upon the United States by the lobby of a powerful banking consortium in 1913. Not Coincidentally, this privately held banking consortium also determines the interest rate at which this money is loaned by determining the interest rates.
The Federal Reserve basically works like this: The government granted the power to create money to the Federal Reserve. They create money, then loan it back to the government charging interest. The government levies income taxes to pay the interest on the debt. On this point, it's interesting to note that the Federal Reserve Act and the sixteenth amendment, which gave Congress the power to collect income taxes, were both passed in 1913. The incredible power of the US Federal Reserve over the economy is universally admitted. Some people, especially in the banking and academic communities, even support it. (US Senator Ron Paul is the most vocal and outspoken critic of the US Federal Reserve.)
Why do we focus on the US Federal Reserve? Simply because that organization which
is not accountable to Congress controls the money supply and the interest rate.
The US Federal Reserve has never been audited its financial statements have never been publicly disclosed.
Notice also that US income tax came into existence in 1913. That income tax was only needed to pay interest to the bankers for the money that they loaned to the US government. Yes, you read that right, the Federal Reserve, mostly on paper and computer, creates money or pays the US Treasury a small printing fee for currency, and then loans this money to the US government. The taxes pay them interest on this loan that cost the Federal Reserve virtually nothing to make. What a sweetheart of a deal they have going for them. To be clear, this amounts to a license to print money, loan it out (at virtually no cost) , and charge interest on it.
This concept forms the basis of all of fractional reserve banking (loan money and charge interest on it). Fractional reserve banking combined with a fiat currency ( printed paper not backed by gold or any precious metal or physical item) is in the opinion of this author the real root of all evil.
Let's look at the collapse of the US investment bank Bears Sterns, and the buyout by J P Morgan Chase and the loan from the US Federal Reserve for a moment.
J P Morgan Chase owns an interest in the US Federal Reserve. They hold shares in it as do other banks like Bank of America, Citigroup, and HSBC. The CEO of J P Morgan (James Dimon) sits on the Board of the New York Federal Reserve. The US Federal Reserve (acting this time in the best interest of "insider" J P Morgan Chase) invented $55 billion out of thin air AND in an unusual (if not questionable or illegal) move lent it directly to J P Morgan it to "save" Bear Sterns in a buy out deal. No one is asking where the $55 billion came from in the first place? The US Federal Reserve grew it on their money trees and lent it directly to J P Morgan. Now let's look closely at who made these decisions. There should be no doubt this represents a conflict of interest of the highest order.
J.P.Morgan's CEO James Dimon
James Dimon of J P Morgan sits on the Board of Directors of the New York Federal Reserve Bank which made the decision to
extend $55 billion of loans to J P Morgan to buy Bear Stearns. Bear Stearns' CEO, Alan Schwartz, was not on the New York Federal Reserve Board. In fact, no one from Bear Stearns is on the Board.
James Dimon was at the luncheon on March 11, 2008 with Ben Bernanke, chairman of the US Federal Reserve,
Tim Geithner, president of the New York Federal Reserve bank, Thain of Merrill Lynch, and Schwarzman of the Blackstone Group and others.
Some claim that the meeting was about Bear Stearns and how to handle that situation. Bernanke, Dimon, and Geithner all testified before the U.S. Senate Committee on Banking April 4, that they first heard of liquidity problems at Bear Stearns on the evening of March 13, 2008. If they were talking about the solution to Bear Stearns at the March 11, 2008 luncheon, then their answers before the Senate Banking Committe were less than truthful.
Perhaps a felony. Alan Schwartz was not invited to the luncheon on March 11, 2008.
What is at issue here is the relationship between the US government and the US financial industry.
A very insightful article in the New York Times by By ANDREW ROSS SORKIN, PETER EDMONSTON
and JENNIFER DANIEL documents the relationship between the nation's bankers, their money their lobbying efforts,
political donations and how politicians make decisions. They write:
"Congress pushed and prodded with rules and regulations, and Wall Street pushed back. But lawmakers also gave tax breaks and eased some rules, allowing the money crowd more room to run. Behind the scenes, financiers sought support on Capitol Hill — usually with a campaign contribution in hand. With sweeping reforms coming, the Wall Street-Washington connection may be more important than ever, and political connections may be the new currency for deal makers."
***link:
http://dealbook.blogs.nytimes.com/2009/03/26/where-wall-street-trades-in-political-currency/?scp=1&sq=contribution&st=cse
(ignore)****
More recently, Paul Volcker, senior economic adviser to President Barack Obama and former chairman of the U.S. Federal Reserve, was quoted at Vanderbilt University in Nashville, Tennessee on April 18th. He said that a review of the Federal Reserve's role, something traditionally regarded as taboo, now seems inevitable given the fallout from the long-running financial crisis. "For better or worse, we are at a point where the Federal Reserve Act is going to be reviewed," said Volcker.
So what does all this actually mean? It simply means that the US Federal Reserve bank now finds itself with the perfect opportunity to make hundreds of billions of dollars of profitable loans for which they are charging the borrower (the US Government, through the US Treasury) a very low rate of interest. One might suggest as a shrewd lender, they don't really want their principal back, they just want to charge interest on the loans in perpetuity. But we must consider this is the same US Federal Reserve that is also legally responsible for setting the rate of interest and it would not be unrealistic to suggest we will see interest rates rise over the next several years as US economy recovers.
Capitalism and avarice drive the US economy in a way many Canadians cannot fully appreciate. Under the Bush administration this level of excessive greed spawned a very aggressive (and perhaps even fraudulent) subprime lending bonanza (loaning money to unworthy borrowers who could not afford to buy expensive real estate) that imploded into an adverse economic feedback loop of falling real estate prices, foreclosures, unemployment, and frozen credit markets. It would appear then the primary benefactor of this credit crisis is none other then the the bank owners and private equity stake holders of the US Federal Reserve as they bask in the once-in-a-generation opportunity to extend as much new debt as possible (also known as bail out loans to financial institutions). By controlling both the interest rate on that new debt, and the US money supply, the US Federal Reserve will surely profit from this crisis in ways that will never be fully understood. In summary the privately owned US Federal Reserve is not accountable to the US Congress or the President and has never been audited, they loan billions of US dollars, (they grow on their mythical forest of evergreen money trees) charge interest on it, and will make untold billions in profits from this period of economic crisis in the US. (If you noticed, the new head of the Treasury, Tim Geithner was an Obama political appointee, but the head of the US Federal Reserve, Ben Bernanke, was not replaced by Obama because the US Federal Reserve Act does not give the President of the United States or the US Congress the power or authority replace him.)
Thursday, April 2, 2009
Link to notes on Ex CIA Chip Tatum (Jack Baur story)
http://www.scribd.com/doc/504636/USA-vs-Chip-TatumCIPA-Briefing-Transcripts
Sounds like a the REAL life story of Jack Baur to me!
This is from a TRUE real life actual court document acquired through the freedom of information....
Quote
DESCRIPTION
This is the Classified Information Procedures Act (C.I.P.A.) briefing transcripts from the political trial against former CIA/black ops operative, Dois Gene 'Chip' Tatum. In this description of classified information, Tatum revealed under oath, (and was never accused, indicted, or tried for perjury), that Oliver North and others were guilty of importing illegal narcotics into the U.S. as a covert CIA operation, that Tatum had documented evidence of this that North and others wanted from him under threat of his life, and that former President Bush (H.W.) gave him the directive to 'neutralize' an American citizen in 1992. The citizen was Ross Perot and he was told to do this during the election campaign of 1992. Perot had first hand knowledge of Bush's criminal involvement in the drug trade and wanted him silenced. Tatum disappeared in the winter of 1998 and his tortured body was found washed up on a beach in Panama in early 2007
Sounds like a the REAL life story of Jack Baur to me!
This is from a TRUE real life actual court document acquired through the freedom of information....
Quote
DESCRIPTION
This is the Classified Information Procedures Act (C.I.P.A.) briefing transcripts from the political trial against former CIA/black ops operative, Dois Gene 'Chip' Tatum. In this description of classified information, Tatum revealed under oath, (and was never accused, indicted, or tried for perjury), that Oliver North and others were guilty of importing illegal narcotics into the U.S. as a covert CIA operation, that Tatum had documented evidence of this that North and others wanted from him under threat of his life, and that former President Bush (H.W.) gave him the directive to 'neutralize' an American citizen in 1992. The citizen was Ross Perot and he was told to do this during the election campaign of 1992. Perot had first hand knowledge of Bush's criminal involvement in the drug trade and wanted him silenced. Tatum disappeared in the winter of 1998 and his tortured body was found washed up on a beach in Panama in early 2007
Who is the real life (actual) Jack Bauer?
Who is Gene "Chip" Tatum is he the REAL Life Jack Baur
Google for Gene "Chip" Tatum to see for your self
Google for Gene "Chip" Tatum to see for your self
Where did your tax money to AIG go? (GM bond holders!)
The Truth Behind AIG:
Making Bernie Madoff Look Like
The Artful Dodger Since at Least 2005
Dear A-Letter Reader,
I knew something was fishy when I worked out the details on AIG’s “Securities Lending” program. It sucked the whole institution into a long bet on rising housing prices, in an irresponsibly unprotected position. My one-year-old nephew’s got better risk management than that. It just didn’t add up.
Well, dear friend…it turns out I had no idea.
“AIG was a Ponzi scheme plain and simple,” says a new report from Institutional Risk Analytics, “yet the Obama Administration still thinks of AIG as a real company that simply took excessive risks. No, to us what the fraud Bernard Madoff is to individual investors, AIG is to the global financial community.”
That’s right friend…our intuition was right on with this one. So grab yourself a cup of coffee, mute the television, and get ready to take a peek under the Emperor’s Kimono.
What we’re going to see truly might shock you…or…if you’re like me, it’ll just make your blood boil and wonder how you can “opt-out” of funding any more bailouts.
AIG…A Black Hole for Your Tax Money
So we’ll start with some of AIG’s less egregious sins. Namely selling Credit Default Swap contracts on GM bonds…and in doing so, indirectly driving GM into bankruptcy.
Here’s how that works…
If I understand it correctly, Obama gave GM sixty days to negotiate with its bondholders. Either they take a “haircut” on the value of their bonds, or a “debt-for-equity” swap. But neither seems likely at this point. Why?
Well…as it happens, GM’s bondholders bought CDS protection from AIG. And as the government’s made perfectly clear over the last few months, AIG counterparties can expect their CDS contracts to be paid out at 100 cents on the dollar. What’s more, bankruptcy recovery on bonds is rarely – if ever – zero. Lehman bonds were worth about ten cents on the dollar…even after the biggest bankruptcy in history.
So GM’s bondholders are staring down the barrel at two grossly different opportunities. On the one hand, they could do the right thing – at least in terms of taxpayer bailout money – and take a haircut on their assets. That would mean taking a serious hit on the value of their bonds…something that would be necessary just to make GM solvent.
But on the other hand, they’re looking at recovering 100%+ on the exact same bonds. Granted, through means of indirect taxpayer extortion, but nonetheless; a profit. And as we said yesterday, these guys are in the business because they love money, not because they feel a duty to their government or their people. (ed.: We could likely say the same thing about Washington at this point.)
And remember, President Obama vowed that the American auto industry would indeed survive…even if they’re forced into Chapter 11 bankruptcy. That means any money paid out by GM in the aforementioned recovery process would need to be replenished by taxpayer dollars in order to get the company back up to speed.
So effectively – thanks to AIG – the taxpayers could end up bailing out GM twice…on the hook for paying to make GM’s bondholders whole, but also indirectly paying for any recovery they make on those bonds post-bankruptcy.
Now…if your already steaming mad…and if you’re worried about your blood pressure…well, you might just want to skip this next session…
AIG: The Ponzi Scheme Laid Bare
Because this is the big one folks.
The proof that AIG was just one big Ponzi scheme…cooking the books for the whole global financial system. If AIG really was bailed out because of “systemic risk,” then it was bailed out because the system risked being exposed for how insolvent it truly was.
If the “systemic risk” was failure and a collapse in the global credit markets, then it holds that AIG was merely preventing an illusion…an incontrovertible fraud that disguised this ugly truth.
The major hat-tip here goes to the whistleblowers at Institutional Risk Analytics, and you can find their full report here.
Basically, they wanted to know why AIG would ditch the highly profitable business of writing Property and Casualty (P&C) insurance policies in favor of the highly risky CDS business. It just didn’t add up.
So they spent a few months, “interview[ing] a number of forensic experts, insurance regulators and members of the law enforcement community focused on financial fraud. The picture we have assembled is frightening and suggests that, far from just AIG, much of the insurance industry has been drawn into the world of financial engineering and has thus become part of the problem.”
It all started with reinsurance…and a form of communiqué known as “side letters”…
“In the regulatory world, a 'side letter' is perhaps the most insidious and destructive weapon in the white-collar criminal's arsenal. With the flick of a pen, underhanded executives can cook the books in enormous amounts and render a regulator helpless.”
Reinsurance is a common practice in the insurance industry…where one insurer will offset another insurer’s risk on his own books for a fee. But once side letters are involved, all bets are off.
At that point, reinsurance essentially becomes a show…a “window dressing” that helps keep accountants and regulators at bay while you get down to the business of making money – never mind those pesky safeguards.
Oh yeah, and it nullifies your CDS contracts…
“There are two basic problems with side letters,” says the IRA report, “First, they are a criminal act, a fraud that usually carries the full weight of an '“A'” felony in many jurisdictions. Second, once the side letter is discovered by a persistent auditor or regulator examining the buyer of protection, the transaction becomes worthless. You paid $6 million to AIG to shift risk via the reinsurance, but the side letter makes clear that the transaction is a fraud and you lose any benefit that the apparent risk shifting might have provided.”
Did this practice hit AIG’s CDS business? It’s highly, highly likely according to the report from the IRA…
“Indeed, our sources as well as press reports suggest that the CDS contracts written by AIG may have included side letters, often in the form of emails rather than formal letters, that essentially violated the ISDA agreements and show that the true, economic reality of these contracts was fraud plain and simple.”
But the evidence might be harder to come by…largely thanks to our government’s ham-fisted approach to the situation…, “Unfortunately, by not moving to seize AIG immediately last year when the scandal broke, the Fed and Treasury may have given the AIG managers time to destroy much of the evidence of criminal wrongdoing.”
As for a resolution…or perhaps a recovery following fraudulent conveyance…
“Only when we understand how AIG came to be involved in CDS and the fact that this seemingly illegal activity was simply an extension of the reinsurance/side letter shell game scam that AIG, Gen Re and others conducted for many years before will we understand what needs to be done with AIG, namely liquidation. Seen in this context, the payments made to AIG by the Fed and Treasury, which were then passed-through to dealers such as Goldman Sachs (NYSE:GS), can only be viewed as an illegal taking that must be reversed once the US Trustee for the Federal Bankruptcy Court for the Southern District of New York is in control of AIG’s operations.”
However Did We Get Here?
With US$200 Billion of our dollars already crammed down AIG’s craw, and more fraudulent “bailout” on the way before we even inspect the legality of AIG’s CDS contracts, I just want to know how the hell we got here in the first place.
This isn’t the kind of America they told me about when I was in school. And they’re not even covering it in the media. What happened? When did we become the United States of AIG?
But then I took a look at AIG’s campaign contributions over the last few years and it all became perfectly clear. I wish I had US$9 million kicking around to subsidize measures that would have prevented utter financial collapse, rather than provoking one.
Sadly, it’s often the culprits of financial collapse – the AIG's the Goldman's and the Madoff's – that have the money necessary to buy “democratic support” for their continued shenanigans. This stuff won’t be stopping any time soon, but I’m taking steps to make sure it doesn’t cost me a dime…are you?
Making Bernie Madoff Look Like
The Artful Dodger Since at Least 2005
Dear A-Letter Reader,
I knew something was fishy when I worked out the details on AIG’s “Securities Lending” program. It sucked the whole institution into a long bet on rising housing prices, in an irresponsibly unprotected position. My one-year-old nephew’s got better risk management than that. It just didn’t add up.
Well, dear friend…it turns out I had no idea.
“AIG was a Ponzi scheme plain and simple,” says a new report from Institutional Risk Analytics, “yet the Obama Administration still thinks of AIG as a real company that simply took excessive risks. No, to us what the fraud Bernard Madoff is to individual investors, AIG is to the global financial community.”
That’s right friend…our intuition was right on with this one. So grab yourself a cup of coffee, mute the television, and get ready to take a peek under the Emperor’s Kimono.
What we’re going to see truly might shock you…or…if you’re like me, it’ll just make your blood boil and wonder how you can “opt-out” of funding any more bailouts.
AIG…A Black Hole for Your Tax Money
So we’ll start with some of AIG’s less egregious sins. Namely selling Credit Default Swap contracts on GM bonds…and in doing so, indirectly driving GM into bankruptcy.
Here’s how that works…
If I understand it correctly, Obama gave GM sixty days to negotiate with its bondholders. Either they take a “haircut” on the value of their bonds, or a “debt-for-equity” swap. But neither seems likely at this point. Why?
Well…as it happens, GM’s bondholders bought CDS protection from AIG. And as the government’s made perfectly clear over the last few months, AIG counterparties can expect their CDS contracts to be paid out at 100 cents on the dollar. What’s more, bankruptcy recovery on bonds is rarely – if ever – zero. Lehman bonds were worth about ten cents on the dollar…even after the biggest bankruptcy in history.
So GM’s bondholders are staring down the barrel at two grossly different opportunities. On the one hand, they could do the right thing – at least in terms of taxpayer bailout money – and take a haircut on their assets. That would mean taking a serious hit on the value of their bonds…something that would be necessary just to make GM solvent.
But on the other hand, they’re looking at recovering 100%+ on the exact same bonds. Granted, through means of indirect taxpayer extortion, but nonetheless; a profit. And as we said yesterday, these guys are in the business because they love money, not because they feel a duty to their government or their people. (ed.: We could likely say the same thing about Washington at this point.)
And remember, President Obama vowed that the American auto industry would indeed survive…even if they’re forced into Chapter 11 bankruptcy. That means any money paid out by GM in the aforementioned recovery process would need to be replenished by taxpayer dollars in order to get the company back up to speed.
So effectively – thanks to AIG – the taxpayers could end up bailing out GM twice…on the hook for paying to make GM’s bondholders whole, but also indirectly paying for any recovery they make on those bonds post-bankruptcy.
Now…if your already steaming mad…and if you’re worried about your blood pressure…well, you might just want to skip this next session…
AIG: The Ponzi Scheme Laid Bare
Because this is the big one folks.
The proof that AIG was just one big Ponzi scheme…cooking the books for the whole global financial system. If AIG really was bailed out because of “systemic risk,” then it was bailed out because the system risked being exposed for how insolvent it truly was.
If the “systemic risk” was failure and a collapse in the global credit markets, then it holds that AIG was merely preventing an illusion…an incontrovertible fraud that disguised this ugly truth.
The major hat-tip here goes to the whistleblowers at Institutional Risk Analytics, and you can find their full report here.
Basically, they wanted to know why AIG would ditch the highly profitable business of writing Property and Casualty (P&C) insurance policies in favor of the highly risky CDS business. It just didn’t add up.
So they spent a few months, “interview[ing] a number of forensic experts, insurance regulators and members of the law enforcement community focused on financial fraud. The picture we have assembled is frightening and suggests that, far from just AIG, much of the insurance industry has been drawn into the world of financial engineering and has thus become part of the problem.”
It all started with reinsurance…and a form of communiqué known as “side letters”…
“In the regulatory world, a 'side letter' is perhaps the most insidious and destructive weapon in the white-collar criminal's arsenal. With the flick of a pen, underhanded executives can cook the books in enormous amounts and render a regulator helpless.”
Reinsurance is a common practice in the insurance industry…where one insurer will offset another insurer’s risk on his own books for a fee. But once side letters are involved, all bets are off.
At that point, reinsurance essentially becomes a show…a “window dressing” that helps keep accountants and regulators at bay while you get down to the business of making money – never mind those pesky safeguards.
Oh yeah, and it nullifies your CDS contracts…
“There are two basic problems with side letters,” says the IRA report, “First, they are a criminal act, a fraud that usually carries the full weight of an '“A'” felony in many jurisdictions. Second, once the side letter is discovered by a persistent auditor or regulator examining the buyer of protection, the transaction becomes worthless. You paid $6 million to AIG to shift risk via the reinsurance, but the side letter makes clear that the transaction is a fraud and you lose any benefit that the apparent risk shifting might have provided.”
Did this practice hit AIG’s CDS business? It’s highly, highly likely according to the report from the IRA…
“Indeed, our sources as well as press reports suggest that the CDS contracts written by AIG may have included side letters, often in the form of emails rather than formal letters, that essentially violated the ISDA agreements and show that the true, economic reality of these contracts was fraud plain and simple.”
But the evidence might be harder to come by…largely thanks to our government’s ham-fisted approach to the situation…, “Unfortunately, by not moving to seize AIG immediately last year when the scandal broke, the Fed and Treasury may have given the AIG managers time to destroy much of the evidence of criminal wrongdoing.”
As for a resolution…or perhaps a recovery following fraudulent conveyance…
“Only when we understand how AIG came to be involved in CDS and the fact that this seemingly illegal activity was simply an extension of the reinsurance/side letter shell game scam that AIG, Gen Re and others conducted for many years before will we understand what needs to be done with AIG, namely liquidation. Seen in this context, the payments made to AIG by the Fed and Treasury, which were then passed-through to dealers such as Goldman Sachs (NYSE:GS), can only be viewed as an illegal taking that must be reversed once the US Trustee for the Federal Bankruptcy Court for the Southern District of New York is in control of AIG’s operations.”
However Did We Get Here?
With US$200 Billion of our dollars already crammed down AIG’s craw, and more fraudulent “bailout” on the way before we even inspect the legality of AIG’s CDS contracts, I just want to know how the hell we got here in the first place.
This isn’t the kind of America they told me about when I was in school. And they’re not even covering it in the media. What happened? When did we become the United States of AIG?
But then I took a look at AIG’s campaign contributions over the last few years and it all became perfectly clear. I wish I had US$9 million kicking around to subsidize measures that would have prevented utter financial collapse, rather than provoking one.
Sadly, it’s often the culprits of financial collapse – the AIG's the Goldman's and the Madoff's – that have the money necessary to buy “democratic support” for their continued shenanigans. This stuff won’t be stopping any time soon, but I’m taking steps to make sure it doesn’t cost me a dime…are you?
GM Bond holders insured by AIG at tax payer expense
AIG: Before Credit Default Swaps, There Was Reinsurance
April 2, 2009
"What do many corporate buyers of insurance have in common with American International Group? Perhaps more than they would like to admit. Like AIG, many companies in the past few years have bought finite insurance, which transfers a prescribed amount of risk for a particular liability. What regulators now want to know is, how many companies, like AIG, have used finite insurance to artificially inflate their financial results?"
Infinite Risk?
CFO Magazine
June 1, 2005
"In the regulatory world, a 'side letter' is perhaps the most insidious and destructive weapon in the white-collar criminal's arsenal. With the flick of a pen, underhanded executives can cook the books in enormous amounts and render a regulator helpless."
Fraud Magazine
July/August 2006
PRMIA Event: Market & Liquidity Risk Management for Financial Institutions
First, a housekeeping item. On Monday, May 4, 2009, in partnership with the Federal Deposit Insurance Corporation (FDIC) & the Office of Thrift Supervision (OTS), the Washington DC chapter of Professional Risk Managers' International Association (PRMIA) is presenting an important day-long conference on managing liquidity and market risk for financial institutions. Speakers include some of the leading risk practitioners, investors, researchers, bank executives and regulators in the US financial community. PRMIA free and sustaining members may register on the PRMIA web site. Members of the regulatory community may register via the FDIC University. IRA co-founder Christopher Whalen will participate in the conference and serve as MC. See the PRMIA web site for more information on the program and speakers. And yes, our favorite bank regulator is making the opening remarks. ;)
For some time now, we have been trying to reconcile the apparent paradox of American International Group (NYSE:AIG) walking away from the highly profitable, double-digit RAROC business of underwriting property and casualty (P&C) risk and diving into the rancid cesspool of credit default swaps ("CDS") contracts and other types of "high beta" risks, business lines that are highly correlated with the financial markets.
In our interview with Robert Arvanitis last year, "'Bailout: It's About Capital, Not Liquidity; Seeking Beta: Interview with Robert Arvanitis', September 29, 2008," we discussed the difference between high and low beta. We also learned from Arvanitis, who worked for AIG during much of the relevant period, that the decision by Hank Greenberg and the AIG board to enter the CDS market was, at best, chasing revenue. No rational examination of the business opportunity, assuming that Greenberg and his directors were acting based on a reasoned analysis, could have resulted in a favorable decision to pursue CDS and other "high beta" risks, at least from our perspective.
In an effort to resolve this conundrum, over the past several months The IRA has interviewed a number of forensic experts, insurance regulators and members of the law enforcement community focused on financial fraud. The picture we have assembled is frightening and suggests that, far from just AIG, much of the insurance industry has been drawn into the world of financial engineering and has thus become part of the problem. Below we present our preliminary findings and invite your comments.
One of the first things we learned about the insurance world is that the concept of "shifting risk" for a variety of business and regulatory reasons has been ongoing in the insurance world for decades. Finite insurance and other scams have been at least visible to the investment community for years and have been documented in the media, but what is less understood is that firms like AIG took the risk shifting shell game to a whole new level long before the firm's entry into the CDS market.
In fact, our investigation suggests that by the time AIG had entered the CDS fray in a serious way more than five years ago, the firm was already doomed. No longer able to prop up its earnings using reinsurance because of growing scrutiny from state insurance regulators and federal law enforcement agencies, AIG's foray into CDS was really the grand finale. AIG was a Ponzi scheme plain and simple, yet the Obama Administration still thinks of AIG as a real company that simply took excessive risks. No, to us what the fraud Bernard Madoff is to individual investors, AIG is to the global financial community.
As with the phony reinsurance contracts that AIG and other insurers wrote for decades, when AIG wrote hundreds of billions of dollars in CDS contracts, neither AIG nor the counterparties believed that the CDS would ever be paid. Indeed, one source with personal knowledge of the matter suggests that there may be emails and actual side letters between AIG and its counterparties that could prove conclusively that AIG never intended to pay out on any of its CDS contracts.
The significance of this for the US bailout of AIG is profound. If our surmise is correct, the position of Feb Chairman Ben Bernanke and Treasury Secretary Tim Geithner that the AIG credit default contracts are "valid legal contracts" is ridiculous and reveals a level of ignorance by the Fed and Treasury about the true goings on inside AIG and the reinsurance industry that is truly staggering.
Does Reinsurance + Side Letters = CDS?
One of the most widespread means of risk shifting is reinsurance, the act of paying an insurer to offset the risk on the books of a second insurer. This may sound pretty routine and plain vanilla, but what most people don't know is that often times when insurers would write reinsurance contracts with one another, they would enter into "side letters" whereby the parties would agree that the reinsurance contract was essentially a canard, a form of window dressing to make a company, bank or another insurer look better on paper, but where the seller of protection had no intention of ever paying out on the contract.
Let's say that an insurer needs to enhance its capital surplus by $100 million in order to meet regulatory capital requirements. They can enter into what appears to be a completely legitimate form of reinsurance contract, an agreement that appears to transfer the liability to the reinsurer. By doing so, the "ceding company" - an insurance company that transfers a risk to a reinsurance company - gets to drop that $100 million in liability and its regulatory surplus increases by $100 million.
The reinsurer assuming the risk does actually put up the $100 million in liability, but with the knowledge that they will never have to actually pay out on the contract. This is good for the reinsurer because they are paid a fee for this transaction, but it is bad for the ceding company, the insurer with the capital shortfall, because the transaction is actually a sham, a fraud meant to deceive regulators, counterparties and investors into thinking that the insurer has adequate capital. Typically the fee is 6% per year or what is called a "loan fee" in the insurance industry.
When it operates in this fashion, the whole reinsurance industry could be described as a "surplus rental" proposition, whereby an insurer literally loans another insurer capital in the form of risk cover, but with a secret understanding in the form of a side letter that the loan will be reversed without any recourse to the seller of protection. You give me $6 million in cash today, and I will give you a promise that we both know I will never honor.
Does this sound familiar? What our contacts in the insurance industry describe is almost a precise description of the CDS market, albeit one that evolved in the reinsurance industry literally decades ago and has been the cause of numerous insurance insolvencies and losses to insured parties. Or to put it another way, maybe the inspiration for the CDS market - at least within AIG and other insurers -- evolved from the reinsurance market over the past two decades.
As best as we can tell, the questionable practice of using side letters to mask the economic and business reality of reinsurance transactions started in the mid-1980s and continued until the middle of the current decade. This timeline just happens to track the creation and evolution of the OTC derivatives markets. In particular, the move by AIG into the CDS market coincides with the increased awareness of and attention to the use of side letters by insurance regulators and members of the state and federal law enforcement community.
Keep in mind that what we are talking about here are not questionable risk management policies but acts of deliberate and criminal fraud, acts that often result in jail time for those involved. As one senior forensic accountant who has practiced in the insurance sector for three decades told The IRA:
"In every major criminal fraud case in which I have worked, at the center of the investigation were these side letters. It was always very strange to me that on-site investigators and law enforcement officials consistently found that these side letters were being used to mask the true financial condition of an insurer, and yet none of the state regulators, the National Association of Insurance Commissioners (NAIC), nor federal law enforcement authorities ever publicly mentioned the practice. They certainly did not act like the use of side letters was a commonplace thing, but it was widespread in the industry."
It is important to understand that a side letter is a secret agreement, a document that is often hidden from internal and external auditors, regulators and even senior management of insurers and reinsurers. We doubt, for example, that Warren Buffet or Hank Greenberg knew the details of side letters, but they should have. Just as a rogue CDS trader at a large bank like Societe General (NYSE:SGE) might seek to hide losing trades, the underwriters of insurers would use sham transactions and side letters to enhance the revenue of the insurer, but without disclosing the true nature of the transaction.
There are two basic problems with side letters. First, they are a criminal act, a fraud that usually carries the full weight of an "A" felony in many jurisdictions. Second, once the side letter is discovered by a persistent auditor or regulator examining the buyer of protection, the transaction becomes worthless. You paid $6 million to AIG to shift risk via the reinsurance, but the side letter makes clear that the transaction is a fraud and you lose any benefit that the apparent risk shifting might have provided.
As the use of these secret side letters began to become more and more prevalent in the insurance industry, and these secret side deals were literally being stacked on top of one another at firms like AIG, the SEC began to investigate. And they began to find instances of fraud and to crack down on the practice. One of the first cases to come to the surface involved AIG helping Brightpoint (NASDAQ:CELL) commit accounting fraud, a case that eventually led the SEC to fine AIG $10 million in 2003.
Wayne M. Carlin, Regional Director of the SEC's Northeast Regional Office, said of the settlements: "In this case, AIG worked hand in hand with CELL personnel to custom-design a purported insurance policy that allowed CELL to overstate its earnings by a staggering 61 percent. This transaction was simply a 'round-trip' of cash from CELL to AIG and back to CELL. By disguising the money as 'insurance,' AIG enabled CELL to spread over several years a loss that should have been recognized immediately."
Another case involved PNC Financial (NYSE:PNC), which used various contracts with AIG to hide certain assets from regulators, even though the transaction amounted to the "rental" of capital and not a true risk transfer.
As the SEC noted in a 2004 statement: "The Commission's action arises out of the conduct of Defendant AIG, primarily through its wholly owned subsidiary AIG Financial Products Corp. ("AIG-FP"), (collectively referred to as "AIG") in developing, marketing, and entering into transactions that purported to enable a public company to remove certain assets from its balance sheet." Click here to see the SEC statement regarding the AIG transactions with PNC.
The SEC statement reads in part: "In its Complaint, filed in the United States District Court for the District of Columbia, the Commission alleged that from at least March 2001 through January 2002, Defendant AIG, primarily through AIG-FP, developed a product called a Contributed Guaranteed Alternative Investment Trust Security ("C-GAITS"), marketed that product to several public companies, and ultimately entered into three C-GAITS transactions with one such company, The PNC Financial Services Group, Inc. ("PNC"). For a fee, AIG offered to establish a special purpose entity ("SPE") to which the counter-party would transfer troubled or other potentially volatile assets. AIG represented that, under generally accepted accounting principles ("GAAP"), the SPE would not be consolidated on the counter-party's financial statements. The counter-party thus would be able to avoid charges to its income statement resulting from declines in the value of the assets transferred to the SPE. The transaction that AIG developed and marketed, however, did not satisfy the requirements of GAAP for nonconsolidation of SPEs."
In both cases, AIG was engaged in transactions that were meant not to reduce risk, but to hide the true nature of the risk in these companies from investors, regulators and the consumers who rely on these institutions for services. Keep in mind that while the SEC did act to address these issues, the parties involved received light punishments when you consider that these are all felonies that arguably would call for criminal prosecution for fraud, securities fraud, conspiracy and racketeering, among other things. Indeed, this is one of those rare cases where we believe AIG itself, as a corporate person, should be subject to criminal prosecution and liquidation.
Birds of a Feather: AIG & GenRe
Click here to see a June 6, 2005 press release from the SEC detailing criminal charges against John Houldsworth, a former senior executive of General Re Corporation ("GenRe"), a subsidiary of Berkshire Hathaway (NYSE:BRKA), for his role in aiding and abetting American International Group, Inc. in committing securities fraud.
The SEC noted: "In its complaint filed today in federal court in Manhattan, the Commission alleged that Houldsworth and others helped AIG structure two sham reinsurance transactions that had as their only purpose to allow AIG to add a total of $500 million in phony loss reserves to its balance sheet in the fourth quarter of 2000 and the first quarter of 2001. The transactions were initiated by AIG to quell criticism by analysts concerning a reduction in the company's loss reserves in the third quarter of 2000."
But the involvement of the BRKA unit GenRe in the AIG mess was not the first time that GenRe had been involved in the questionable use of reinsurance contracts and side letters.
Click here to see an example of a side letter that was made public in a civil litigation in Australia a decade ago. The faxed letter, which bears the ID number from the Australian Court, is from an insurance broker in London to Mr. Ajit Jain, a businessman who currently heads several reinsurance businesses for BRKA, regarding a reinsurance contract for FAI Insurance, an affiliate of HIH Insurance.
Notice that the letter states plainly the intent of the transaction is to bolster the apparent capital of FAI. Notice too that several times in the letter, the statement is made that "no claim will be made before the commutation date," which may be interpreted as being a warranty by the insured that no claims shall be made under the reinsurance policy. By no coincidence, HIH and FAI collapsed in a $5.3 billion dollar fiasco that ranks as Australia's biggest ever corporate failure.
Click here to read a March 9, 2009 article from The Age, one of Australia's leading business publications, regarding the collapse of HIH and FAI.
In 2003, an insurer named Reciprocal of America ("ROA") was seized by regulators and law enforcement officials. An investigation ensued for 3 years. According to civil lawsuits filed in the matter, GenRe provided finite insurance to ROA in order to make the troubled insurer look more solvent than it was in reality. Several regulators and law enforcement officials involved in that case tell The IRA that the ROA failure forced insurers like AIG and Gen Re to start looking for new ways to "cook the books" because the long-time practice of side letters was starting to come under real scrutiny.
"These reinsurance deals made ROA look better than it really was," one investigator with direct knowledge of the ROA matter tells The IRA. "They went into the ROA home office in VA with the state insurance regulators and law enforcement, and directed the employees away from the computers and records. During that three-year investigation, GenRe learned that local regulators and forensic examiners had put everything together and that we now understood the way the game was played. I believe the players in the industry realized that that they had to change the way in which they cooked the books. A sleight- of-hand trick that had worked for 25 years under the radar of regulators and investors was now revealed."
Several senior officials of ROA eventually were prosecuted, convicted of criminal fraud and imprisoned, but DOJ officials under the Bush Administration reportedly blocked prosecution of the actual managers and underwriters of ROA who were involved in these sham transactions, this even though state officials and federal prosecutors in VA were anxious to proceed with additional prosecutions.
AIG: From Reinsurance to CDS
While some reinsurers are large, well-capitalized entities that generally avoid these pitfalls, AIG was already a troubled company when it began to write more and more of these risk-shifting transactions more than a decade ago. It is easy to promise the moon when people think that they can deliver, but because AIG and their clients saw how easy it was to fool regulators and investors, the practice grew and most regulators did absolutely nothing to curtail the practice.
It was easy for AIG to become addicted to the use of side letters. The firm, which had already encountered serious financial problems in 2000-2001, reportedly saw the side letters as a way to mint free money and thereby help the insurer to look stronger than it really was. AIG not only helped banks and other companies distort and obfuscate their financial condition, but AIG was supplementing its income by writing more and more of these reinsurance deals and mitigating their perceived exposure via side letters.
A key figure in AIG's reinsurance schemes, according to several observers, was Joseph Cassano, head of AIG-FP. Whereas the traditional use of side letters was in reinsurance transactions between insurers, in the case of both CELL and PNC neither was an insurer! And in both cases, AIG used sham deals to make two non-insurers, including a regulated bank holding company, look better by manipulating their financial statements. Falsifying the financial statements of a bank or bank holding company is an felony.
AIG-FP was simply doing for non-insurers what was common practice inside the secretive precincts of the insurance world. The SEC did investigate and they did finally obtain a deferred prosecution agreement with AIG, which was buried in the settlement with then-New York AG Elliott Spitzer.
The key thing to understand is that if you look at many of these reinsurance contracts between ROA and Gen Re, they look perfect. They appear to transfer risk and seem to be completely in order. But, if you don't get to see the secret agreement, the side letter that basically says that the reinsurance contract is a form of window dressing, then you cannot understand the full implications of the transaction, the reinsurance agreement. Not, several experts speculate, can you understand why AIG decided to migrate away from reinsurance and side letters and into CDS as a mechanism for falsifying the balance sheets and earnings of non-insurers.
Several observers believe that at some point in the 2002-2004 period, Cassano and his colleagues at AIG began to realize that state insurance regulators and the FBI where on to the reinsurance/side letter scam. A number of experts had been speaking and writing about the issue within the accounting and fraud communities, and this attention apparently made AIG move most of its shell game into the world of CDS. By no coincidence, at around this time side letters began to disappear in the insurance industry, suggesting to many observers that the industry finally realized that the jig was up.
It appears to us that, seeing the heightened attention from regulators and federal law enforcement agencies such as the FBI on side letters, AIG began to move its shell game to the CDS markets, where it could continue to falsify the balance sheets and income statements of non-insurers all over the world, including banks and other financial institutions.
AIG's Cassano even managed to hide the activity in a bank subsidiary of AIG based in London and under the nominal supervision of the Office of Thrift Supervision in the US, this it is suggested to hide this ongoing activity from US insurance regulators. Even though AIG had been investigated and sanctioned by the SEC, Cassano and his colleagues at AIG apparently were recalcitrant and continued to build the CDS pyramid inside AIG, a financial pyramid that is now collapsing. The rest, as they say is history.
Now you know why the Fed and EU officials are so terrified about an AIG liquidation, because it will result in heavy losses to or even the insolvency of banks and other corporations around the globe. Notice that while German Chancellor Angela Merkel has been posturing and throwing barbs at President Obama, French President Nicolas Sarkozy has been conciliatory toward the US.
But for the bailout of AIG, you see, President Sarkozy would have been forced to bailout SGE for a second time in two years. So long as the Fed and Treasury can subsidize AIG's mounting operating losses, the EU will be spared a financial bloodbath. But this situation is unlikely to remain stable for long with members of the Congress demanding an investigation of the past bailout, a process that can only result in bankruptcy for AIG.
Are the CDS Contracts of AIG Really Valid?
The key point is that neither the public, the Fed nor the Treasury seem to understand is that the CDS contracts written by AIG with these various non-insurers around the world were shams - with no correlation between "fees" paid and the risk assumed. These were not valid contracts as Fed Chairman Ben Bernanke, Treasury Secretary Geithner and Economic policy guru Larry Summers claim, but rather acts of criminal fraud meant to manipulate the capital positions and earnings of financial companies around the world.
Indeed, our sources as well as press reports suggest that the CDS contracts written by AIG may have included side letters, often in the form of emails rather than formal letters, that essentially violated the ISDA agreements and show that the true, economic reality of these contracts was fraud plain and simple. Unfortunately, by not moving to seize AIG immediately last year when the scandal broke, the Fed and Treasury may have given the AIG managers time to destroy much of the evidence of criminal wrongdoing.
Only when we understand how AIG came to be involved in CDS and the fact that this seemingly illegal activity was simply an extension of the reinsurance/side letter shell game scam that AIG, Gen Re and others conducted for many years before will we understand what needs to be done with AIG, namely liquidation. Seen in this context, the payments made to AIG by the Fed and Treasury, which were then passed-through to dealers such as Goldman Sachs (NYSE:GS), can only be viewed as an illegal taking that must be reversed once the US Trustee for the Federal Bankruptcy Court for the Southern District of New York is in control of AIG's operations.
Editor's note: Officials of BRKA and GenRe did not respond to telephonic and email requests by The IRA seeking comment on this article. An official of AIG did respond but was not willing to comment on-the-record for this report. We shall be happy to publish any written comments that BRKA, AIG or GenRe have on this article.
April 2, 2009
"What do many corporate buyers of insurance have in common with American International Group? Perhaps more than they would like to admit. Like AIG, many companies in the past few years have bought finite insurance, which transfers a prescribed amount of risk for a particular liability. What regulators now want to know is, how many companies, like AIG, have used finite insurance to artificially inflate their financial results?"
Infinite Risk?
CFO Magazine
June 1, 2005
"In the regulatory world, a 'side letter' is perhaps the most insidious and destructive weapon in the white-collar criminal's arsenal. With the flick of a pen, underhanded executives can cook the books in enormous amounts and render a regulator helpless."
Fraud Magazine
July/August 2006
PRMIA Event: Market & Liquidity Risk Management for Financial Institutions
First, a housekeeping item. On Monday, May 4, 2009, in partnership with the Federal Deposit Insurance Corporation (FDIC) & the Office of Thrift Supervision (OTS), the Washington DC chapter of Professional Risk Managers' International Association (PRMIA) is presenting an important day-long conference on managing liquidity and market risk for financial institutions. Speakers include some of the leading risk practitioners, investors, researchers, bank executives and regulators in the US financial community. PRMIA free and sustaining members may register on the PRMIA web site. Members of the regulatory community may register via the FDIC University. IRA co-founder Christopher Whalen will participate in the conference and serve as MC. See the PRMIA web site for more information on the program and speakers. And yes, our favorite bank regulator is making the opening remarks. ;)
For some time now, we have been trying to reconcile the apparent paradox of American International Group (NYSE:AIG) walking away from the highly profitable, double-digit RAROC business of underwriting property and casualty (P&C) risk and diving into the rancid cesspool of credit default swaps ("CDS") contracts and other types of "high beta" risks, business lines that are highly correlated with the financial markets.
In our interview with Robert Arvanitis last year, "'Bailout: It's About Capital, Not Liquidity; Seeking Beta: Interview with Robert Arvanitis', September 29, 2008," we discussed the difference between high and low beta. We also learned from Arvanitis, who worked for AIG during much of the relevant period, that the decision by Hank Greenberg and the AIG board to enter the CDS market was, at best, chasing revenue. No rational examination of the business opportunity, assuming that Greenberg and his directors were acting based on a reasoned analysis, could have resulted in a favorable decision to pursue CDS and other "high beta" risks, at least from our perspective.
In an effort to resolve this conundrum, over the past several months The IRA has interviewed a number of forensic experts, insurance regulators and members of the law enforcement community focused on financial fraud. The picture we have assembled is frightening and suggests that, far from just AIG, much of the insurance industry has been drawn into the world of financial engineering and has thus become part of the problem. Below we present our preliminary findings and invite your comments.
One of the first things we learned about the insurance world is that the concept of "shifting risk" for a variety of business and regulatory reasons has been ongoing in the insurance world for decades. Finite insurance and other scams have been at least visible to the investment community for years and have been documented in the media, but what is less understood is that firms like AIG took the risk shifting shell game to a whole new level long before the firm's entry into the CDS market.
In fact, our investigation suggests that by the time AIG had entered the CDS fray in a serious way more than five years ago, the firm was already doomed. No longer able to prop up its earnings using reinsurance because of growing scrutiny from state insurance regulators and federal law enforcement agencies, AIG's foray into CDS was really the grand finale. AIG was a Ponzi scheme plain and simple, yet the Obama Administration still thinks of AIG as a real company that simply took excessive risks. No, to us what the fraud Bernard Madoff is to individual investors, AIG is to the global financial community.
As with the phony reinsurance contracts that AIG and other insurers wrote for decades, when AIG wrote hundreds of billions of dollars in CDS contracts, neither AIG nor the counterparties believed that the CDS would ever be paid. Indeed, one source with personal knowledge of the matter suggests that there may be emails and actual side letters between AIG and its counterparties that could prove conclusively that AIG never intended to pay out on any of its CDS contracts.
The significance of this for the US bailout of AIG is profound. If our surmise is correct, the position of Feb Chairman Ben Bernanke and Treasury Secretary Tim Geithner that the AIG credit default contracts are "valid legal contracts" is ridiculous and reveals a level of ignorance by the Fed and Treasury about the true goings on inside AIG and the reinsurance industry that is truly staggering.
Does Reinsurance + Side Letters = CDS?
One of the most widespread means of risk shifting is reinsurance, the act of paying an insurer to offset the risk on the books of a second insurer. This may sound pretty routine and plain vanilla, but what most people don't know is that often times when insurers would write reinsurance contracts with one another, they would enter into "side letters" whereby the parties would agree that the reinsurance contract was essentially a canard, a form of window dressing to make a company, bank or another insurer look better on paper, but where the seller of protection had no intention of ever paying out on the contract.
Let's say that an insurer needs to enhance its capital surplus by $100 million in order to meet regulatory capital requirements. They can enter into what appears to be a completely legitimate form of reinsurance contract, an agreement that appears to transfer the liability to the reinsurer. By doing so, the "ceding company" - an insurance company that transfers a risk to a reinsurance company - gets to drop that $100 million in liability and its regulatory surplus increases by $100 million.
The reinsurer assuming the risk does actually put up the $100 million in liability, but with the knowledge that they will never have to actually pay out on the contract. This is good for the reinsurer because they are paid a fee for this transaction, but it is bad for the ceding company, the insurer with the capital shortfall, because the transaction is actually a sham, a fraud meant to deceive regulators, counterparties and investors into thinking that the insurer has adequate capital. Typically the fee is 6% per year or what is called a "loan fee" in the insurance industry.
When it operates in this fashion, the whole reinsurance industry could be described as a "surplus rental" proposition, whereby an insurer literally loans another insurer capital in the form of risk cover, but with a secret understanding in the form of a side letter that the loan will be reversed without any recourse to the seller of protection. You give me $6 million in cash today, and I will give you a promise that we both know I will never honor.
Does this sound familiar? What our contacts in the insurance industry describe is almost a precise description of the CDS market, albeit one that evolved in the reinsurance industry literally decades ago and has been the cause of numerous insurance insolvencies and losses to insured parties. Or to put it another way, maybe the inspiration for the CDS market - at least within AIG and other insurers -- evolved from the reinsurance market over the past two decades.
As best as we can tell, the questionable practice of using side letters to mask the economic and business reality of reinsurance transactions started in the mid-1980s and continued until the middle of the current decade. This timeline just happens to track the creation and evolution of the OTC derivatives markets. In particular, the move by AIG into the CDS market coincides with the increased awareness of and attention to the use of side letters by insurance regulators and members of the state and federal law enforcement community.
Keep in mind that what we are talking about here are not questionable risk management policies but acts of deliberate and criminal fraud, acts that often result in jail time for those involved. As one senior forensic accountant who has practiced in the insurance sector for three decades told The IRA:
"In every major criminal fraud case in which I have worked, at the center of the investigation were these side letters. It was always very strange to me that on-site investigators and law enforcement officials consistently found that these side letters were being used to mask the true financial condition of an insurer, and yet none of the state regulators, the National Association of Insurance Commissioners (NAIC), nor federal law enforcement authorities ever publicly mentioned the practice. They certainly did not act like the use of side letters was a commonplace thing, but it was widespread in the industry."
It is important to understand that a side letter is a secret agreement, a document that is often hidden from internal and external auditors, regulators and even senior management of insurers and reinsurers. We doubt, for example, that Warren Buffet or Hank Greenberg knew the details of side letters, but they should have. Just as a rogue CDS trader at a large bank like Societe General (NYSE:SGE) might seek to hide losing trades, the underwriters of insurers would use sham transactions and side letters to enhance the revenue of the insurer, but without disclosing the true nature of the transaction.
There are two basic problems with side letters. First, they are a criminal act, a fraud that usually carries the full weight of an "A" felony in many jurisdictions. Second, once the side letter is discovered by a persistent auditor or regulator examining the buyer of protection, the transaction becomes worthless. You paid $6 million to AIG to shift risk via the reinsurance, but the side letter makes clear that the transaction is a fraud and you lose any benefit that the apparent risk shifting might have provided.
As the use of these secret side letters began to become more and more prevalent in the insurance industry, and these secret side deals were literally being stacked on top of one another at firms like AIG, the SEC began to investigate. And they began to find instances of fraud and to crack down on the practice. One of the first cases to come to the surface involved AIG helping Brightpoint (NASDAQ:CELL) commit accounting fraud, a case that eventually led the SEC to fine AIG $10 million in 2003.
Wayne M. Carlin, Regional Director of the SEC's Northeast Regional Office, said of the settlements: "In this case, AIG worked hand in hand with CELL personnel to custom-design a purported insurance policy that allowed CELL to overstate its earnings by a staggering 61 percent. This transaction was simply a 'round-trip' of cash from CELL to AIG and back to CELL. By disguising the money as 'insurance,' AIG enabled CELL to spread over several years a loss that should have been recognized immediately."
Another case involved PNC Financial (NYSE:PNC), which used various contracts with AIG to hide certain assets from regulators, even though the transaction amounted to the "rental" of capital and not a true risk transfer.
As the SEC noted in a 2004 statement: "The Commission's action arises out of the conduct of Defendant AIG, primarily through its wholly owned subsidiary AIG Financial Products Corp. ("AIG-FP"), (collectively referred to as "AIG") in developing, marketing, and entering into transactions that purported to enable a public company to remove certain assets from its balance sheet." Click here to see the SEC statement regarding the AIG transactions with PNC.
The SEC statement reads in part: "In its Complaint, filed in the United States District Court for the District of Columbia, the Commission alleged that from at least March 2001 through January 2002, Defendant AIG, primarily through AIG-FP, developed a product called a Contributed Guaranteed Alternative Investment Trust Security ("C-GAITS"), marketed that product to several public companies, and ultimately entered into three C-GAITS transactions with one such company, The PNC Financial Services Group, Inc. ("PNC"). For a fee, AIG offered to establish a special purpose entity ("SPE") to which the counter-party would transfer troubled or other potentially volatile assets. AIG represented that, under generally accepted accounting principles ("GAAP"), the SPE would not be consolidated on the counter-party's financial statements. The counter-party thus would be able to avoid charges to its income statement resulting from declines in the value of the assets transferred to the SPE. The transaction that AIG developed and marketed, however, did not satisfy the requirements of GAAP for nonconsolidation of SPEs."
In both cases, AIG was engaged in transactions that were meant not to reduce risk, but to hide the true nature of the risk in these companies from investors, regulators and the consumers who rely on these institutions for services. Keep in mind that while the SEC did act to address these issues, the parties involved received light punishments when you consider that these are all felonies that arguably would call for criminal prosecution for fraud, securities fraud, conspiracy and racketeering, among other things. Indeed, this is one of those rare cases where we believe AIG itself, as a corporate person, should be subject to criminal prosecution and liquidation.
Birds of a Feather: AIG & GenRe
Click here to see a June 6, 2005 press release from the SEC detailing criminal charges against John Houldsworth, a former senior executive of General Re Corporation ("GenRe"), a subsidiary of Berkshire Hathaway (NYSE:BRKA), for his role in aiding and abetting American International Group, Inc. in committing securities fraud.
The SEC noted: "In its complaint filed today in federal court in Manhattan, the Commission alleged that Houldsworth and others helped AIG structure two sham reinsurance transactions that had as their only purpose to allow AIG to add a total of $500 million in phony loss reserves to its balance sheet in the fourth quarter of 2000 and the first quarter of 2001. The transactions were initiated by AIG to quell criticism by analysts concerning a reduction in the company's loss reserves in the third quarter of 2000."
But the involvement of the BRKA unit GenRe in the AIG mess was not the first time that GenRe had been involved in the questionable use of reinsurance contracts and side letters.
Click here to see an example of a side letter that was made public in a civil litigation in Australia a decade ago. The faxed letter, which bears the ID number from the Australian Court, is from an insurance broker in London to Mr. Ajit Jain, a businessman who currently heads several reinsurance businesses for BRKA, regarding a reinsurance contract for FAI Insurance, an affiliate of HIH Insurance.
Notice that the letter states plainly the intent of the transaction is to bolster the apparent capital of FAI. Notice too that several times in the letter, the statement is made that "no claim will be made before the commutation date," which may be interpreted as being a warranty by the insured that no claims shall be made under the reinsurance policy. By no coincidence, HIH and FAI collapsed in a $5.3 billion dollar fiasco that ranks as Australia's biggest ever corporate failure.
Click here to read a March 9, 2009 article from The Age, one of Australia's leading business publications, regarding the collapse of HIH and FAI.
In 2003, an insurer named Reciprocal of America ("ROA") was seized by regulators and law enforcement officials. An investigation ensued for 3 years. According to civil lawsuits filed in the matter, GenRe provided finite insurance to ROA in order to make the troubled insurer look more solvent than it was in reality. Several regulators and law enforcement officials involved in that case tell The IRA that the ROA failure forced insurers like AIG and Gen Re to start looking for new ways to "cook the books" because the long-time practice of side letters was starting to come under real scrutiny.
"These reinsurance deals made ROA look better than it really was," one investigator with direct knowledge of the ROA matter tells The IRA. "They went into the ROA home office in VA with the state insurance regulators and law enforcement, and directed the employees away from the computers and records. During that three-year investigation, GenRe learned that local regulators and forensic examiners had put everything together and that we now understood the way the game was played. I believe the players in the industry realized that that they had to change the way in which they cooked the books. A sleight- of-hand trick that had worked for 25 years under the radar of regulators and investors was now revealed."
Several senior officials of ROA eventually were prosecuted, convicted of criminal fraud and imprisoned, but DOJ officials under the Bush Administration reportedly blocked prosecution of the actual managers and underwriters of ROA who were involved in these sham transactions, this even though state officials and federal prosecutors in VA were anxious to proceed with additional prosecutions.
AIG: From Reinsurance to CDS
While some reinsurers are large, well-capitalized entities that generally avoid these pitfalls, AIG was already a troubled company when it began to write more and more of these risk-shifting transactions more than a decade ago. It is easy to promise the moon when people think that they can deliver, but because AIG and their clients saw how easy it was to fool regulators and investors, the practice grew and most regulators did absolutely nothing to curtail the practice.
It was easy for AIG to become addicted to the use of side letters. The firm, which had already encountered serious financial problems in 2000-2001, reportedly saw the side letters as a way to mint free money and thereby help the insurer to look stronger than it really was. AIG not only helped banks and other companies distort and obfuscate their financial condition, but AIG was supplementing its income by writing more and more of these reinsurance deals and mitigating their perceived exposure via side letters.
A key figure in AIG's reinsurance schemes, according to several observers, was Joseph Cassano, head of AIG-FP. Whereas the traditional use of side letters was in reinsurance transactions between insurers, in the case of both CELL and PNC neither was an insurer! And in both cases, AIG used sham deals to make two non-insurers, including a regulated bank holding company, look better by manipulating their financial statements. Falsifying the financial statements of a bank or bank holding company is an felony.
AIG-FP was simply doing for non-insurers what was common practice inside the secretive precincts of the insurance world. The SEC did investigate and they did finally obtain a deferred prosecution agreement with AIG, which was buried in the settlement with then-New York AG Elliott Spitzer.
The key thing to understand is that if you look at many of these reinsurance contracts between ROA and Gen Re, they look perfect. They appear to transfer risk and seem to be completely in order. But, if you don't get to see the secret agreement, the side letter that basically says that the reinsurance contract is a form of window dressing, then you cannot understand the full implications of the transaction, the reinsurance agreement. Not, several experts speculate, can you understand why AIG decided to migrate away from reinsurance and side letters and into CDS as a mechanism for falsifying the balance sheets and earnings of non-insurers.
Several observers believe that at some point in the 2002-2004 period, Cassano and his colleagues at AIG began to realize that state insurance regulators and the FBI where on to the reinsurance/side letter scam. A number of experts had been speaking and writing about the issue within the accounting and fraud communities, and this attention apparently made AIG move most of its shell game into the world of CDS. By no coincidence, at around this time side letters began to disappear in the insurance industry, suggesting to many observers that the industry finally realized that the jig was up.
It appears to us that, seeing the heightened attention from regulators and federal law enforcement agencies such as the FBI on side letters, AIG began to move its shell game to the CDS markets, where it could continue to falsify the balance sheets and income statements of non-insurers all over the world, including banks and other financial institutions.
AIG's Cassano even managed to hide the activity in a bank subsidiary of AIG based in London and under the nominal supervision of the Office of Thrift Supervision in the US, this it is suggested to hide this ongoing activity from US insurance regulators. Even though AIG had been investigated and sanctioned by the SEC, Cassano and his colleagues at AIG apparently were recalcitrant and continued to build the CDS pyramid inside AIG, a financial pyramid that is now collapsing. The rest, as they say is history.
Now you know why the Fed and EU officials are so terrified about an AIG liquidation, because it will result in heavy losses to or even the insolvency of banks and other corporations around the globe. Notice that while German Chancellor Angela Merkel has been posturing and throwing barbs at President Obama, French President Nicolas Sarkozy has been conciliatory toward the US.
But for the bailout of AIG, you see, President Sarkozy would have been forced to bailout SGE for a second time in two years. So long as the Fed and Treasury can subsidize AIG's mounting operating losses, the EU will be spared a financial bloodbath. But this situation is unlikely to remain stable for long with members of the Congress demanding an investigation of the past bailout, a process that can only result in bankruptcy for AIG.
Are the CDS Contracts of AIG Really Valid?
The key point is that neither the public, the Fed nor the Treasury seem to understand is that the CDS contracts written by AIG with these various non-insurers around the world were shams - with no correlation between "fees" paid and the risk assumed. These were not valid contracts as Fed Chairman Ben Bernanke, Treasury Secretary Geithner and Economic policy guru Larry Summers claim, but rather acts of criminal fraud meant to manipulate the capital positions and earnings of financial companies around the world.
Indeed, our sources as well as press reports suggest that the CDS contracts written by AIG may have included side letters, often in the form of emails rather than formal letters, that essentially violated the ISDA agreements and show that the true, economic reality of these contracts was fraud plain and simple. Unfortunately, by not moving to seize AIG immediately last year when the scandal broke, the Fed and Treasury may have given the AIG managers time to destroy much of the evidence of criminal wrongdoing.
Only when we understand how AIG came to be involved in CDS and the fact that this seemingly illegal activity was simply an extension of the reinsurance/side letter shell game scam that AIG, Gen Re and others conducted for many years before will we understand what needs to be done with AIG, namely liquidation. Seen in this context, the payments made to AIG by the Fed and Treasury, which were then passed-through to dealers such as Goldman Sachs (NYSE:GS), can only be viewed as an illegal taking that must be reversed once the US Trustee for the Federal Bankruptcy Court for the Southern District of New York is in control of AIG's operations.
Editor's note: Officials of BRKA and GenRe did not respond to telephonic and email requests by The IRA seeking comment on this article. An official of AIG did respond but was not willing to comment on-the-record for this report. We shall be happy to publish any written comments that BRKA, AIG or GenRe have on this article.
Thursday, May 8, 2008
The new "bubble cycle" in decade long financial trends (for real)
http://www.youtube.com/watch?v=Ptzml1qQvZE&feature=related
or
Hello Investor Friends and Family,
I think there is about to be a "market correction" on the horizon so says Tom (just a prediction).
(10 days to 2 weeks or less)
I predict the TSE starts to get quite brittle (prone to a down turn) over about 14,650
it will be there tomorrow, today's close was: 14,607.99 (think about the down side "correction" risk at this time)
This article that follows is about the now yearly (decadely?) boom to bust "bubble cycle" (this is new term, look for it on the internet, I just coined it! :-) "the bubble cycle" may now replace the fictitious business cycle.
I suggest you read the whole thing I think it is right-on (seriously):
From the article:
"That the Internet (dot.com boom) and housing hyperinflations (Sub prime mortgage "boom") transpired within a period of ten years, each creating trillions of dollars in fake wealth".....
in a nut shell this is proposed to be the next big investment bubble:
"There is one industry that fits the bill: alternative energy, the development of more energy-efficient products, along with viable alternatives to oil, including wind, solar, and geothermal power, along with the use of nuclear energy to produce sustainable oil substitutes, such as liquefied hydrogen from water. Indeed, the next bubble is already being branded. Wired magazine, returning to its roots in boosterism, put ethanol on the cover of its October 2007 issue, advising its readers to forget oil; NBC had a “Green Week” in November 2007, with themed shows beating away at an ecological message and Al Gore making a guest appearance on the sitcom 30 Rock. Improbably, Gore threatens to become the poster boy for the new new new economy: he has joined the legendary venture-capital firm Kleiner Perkins Caufield & Byers, which assisted at the births of Amazon.com and Google, to oversee the “climate change solutions group,” thus providing a massive dose of Nobel Prize–winning credibility that will be most useful when its first alternative-energy investments are taken public before a credulous mob. Other ventures—Lazard Capital Markets, Generation Investment Management, Nth Power, EnerTech Capital, and Battery Ventures—are funding an array of startups working on improvements to solar cells, to biofuels production, to batteries, to “energy management” software, and so on."
from:
http://www.harpers.org/archive/2008/02/0081908
The next bubble:
Priming the markets for tomorrow's big crash
TYPE Article
BY Eric Janszen
PUBLISHED February 2008
VIEW PAGESPDF
A financial bubble11. I will use the familiar term “bubble” as a shorthand, but note that it confuses cause with effect. A better, if ungainly, descriptor would be “asset-price hyperinflation”—the huge spike in asset prices that results from a perverse self-reinforcing belief system, a fog that clouds the judgment of all but the most aware participants in the market. Asset hyperinflation starts at a certain stage of market development under just the right conditions. The bubble is the result of that financial madness, seen only when the fog rolls away. is a market aberration manufactured by government, finance, and industry, a shared speculative hallucination and then a crash, followed by depression. (or down turn, or recession). Bubbles were once very rare—one every hundred years or so was enough to motivate politicians, bearing the post-bubble ire of their newly destitute citizenry, to enact legislation that would prevent subsequent occurrences. After the dust settled from the 1720 crash of the South Sea Bubble, for instance, British Parliament passed the Bubble Act to forbid “raising or pretending to raise a transferable stock.” For a century this law did much to prevent the formation of new speculative swellings.
Nowadays we barely pause between such bouts of insanity. The dot-com crash of the early 2000s should have been followed by decades of soul-searching; instead, even before the old bubble had fully deflated, a new mania began to take hold on the foundation of our long-standing American faith that the wide expansion of home ownership can produce social harmony and national economic well-being. Spurred by the actions of the Federal Reserve, financed by exotic credit derivatives and debt securitiztion, an already massive real estate sales-and-marketing program expanded to include the desperate issuance of mortgages to the poor and feckless, compounding their troubles and ours.
Watch is and LAUGH if you have not seen it:
http://www.youtube.com/watch?v=SwRFoxgEcHc
(really)
That the Internet and housing hyperinflations transpired within a period of ten years, each creating trillions of dollars in fake wealth, is, I believe, only the beginning. There will and must be many more such booms, for without them the economy of the United States can no longer function. The bubble cycle has replaced the business cycle.
* * *
Such transformations do not take place overnight. After World War I, Wall Street wrote checks to finance new companies that were trying to turn wartime inventions, such as refrigeration and radio, into consumer products. The consumers of the rising middle class were ready to buy but lacked funds, so the banking system accommodated them with new forms of credit, notably the installment plan. Following a brief recession in 1921, federal policy accommodated progress by keeping interest rates below the rate of inflation. Pundits hailed a “new era” of prosperity until Black Tuesday, October 29, 1929.
The crash, the Great Depression, and World War II were a brutal education for government, academia, corporate America, Wall Street, and the press. For the next sixty years, that chastened generation managed to keep the fog of false hopes and bad credit at bay. Economist John Maynard Keynes emerged as the pied piper of a new school of economics that promised continuous economic growth without end. Keynes’s doctrine: When a business cycle peaks and starts its downward slide, one must increase federal spending, cut
taxes, and lower short-term interest rates to increase the money supply and expand credit. The demand stimulated by deficit spending and cheap money will thereby prevent a recession. In 1932 this set of economic gambits was dubbed “reflation.”
The first Keynesian reflation was botched. To be fair, it was perhaps impractical under the gold standard, for by the time the Federal Reserve made its attempt to ameliorate matters, debt was already out of control.22. Historians argue whether the Federal Reserve and Congress did enough soon enough to slow the rate of debt liquidation at the time. Most agree that once the inflation rate turned negative, monetary stimulus via short-term interest-rate management was ineffective, since the Fed could not lower short-term rates below zero percent. The Bank of Japan found itself in a similar predicament sixty years later.Banks failed, credit contracted, and GDP shrank. The economy was running in reverse and refused to respond to Keynesian inducements. In 1933, President Franklin D. Roosevelt called in gold and repriced it, hoping to test Keynes’s theory that monetary inflation stimulates demand. The economy began to expand. But it was World War II that brought real recovery, as a highly effective, demand-generating, deficit-and-debt-financed public-works project for the United States. The war did what a flawed application of Keynes’s theories could not.
A few weeks after D-Day, the allies met at the Mount Washington Hotel in Bretton Woods, New Hampshire, to determine the future of the international monetary system. It wasn’t much of a negotiation. Western economies were in ruins, and the international monetary system had been in disarray since the start of the Great Depression. The United States, now the dominant economic and military power, successfully pushed to peg the currencies of member nations to the dollar and to make dollars redeemable in American gold.
Americans could now spend as wisely or foolishly as our government policy decreed and, regardless of the needs of other nations holding dollars as reserves, print as many dollars as desired. But by the second quarter of 1971, the U.S. balance of merchandise trade had run up a deficit of $3.8 billion (adjusted for inflation)—an admittedly tiny sum compared with the deficit of $204 billion in the second quarter of 2007, but until that time the United States had run only surpluses. Members of the Bretton Woods system, most famously French President General Charles de Gaulle, worried that the United States intended to repay the money borrowed to cover its trade gap with depreciated dollars. Opposed to the exercise of such “exorbitant privilege,” de Gaulle demanded payment in gold. With the balance of payments so greatly out of balance, newly elected President Richard Nixon faced a run on the U.S. gold supply, and his solution was novel: unilaterally end the U.S. legal obligation to redeem dollars with gold; in other words, default.
More than a decade of economic and financial-market chaos followed, as the dollar remained the international currency but traded without an absolute measure of value. Inflation rose not just in the United States but around the world, grinding down the worth of many securities and brokerage firms. The Federal Reserve pushed interest rates into double digits, setting off two global recessions, and new international standards and methods for measuring inflation and floating exchange rates were established to replace the gold standard. After 1975, the United States would never again post an annual merchandise trade surplus. Such high-value, finished-goods-producing industries as steel and automobiles were no longer dominant. The new economy belonged to finance, insurance, and real estate—FIRE.
* * *
FIRE is a credit-financed, asset-price-inflation machine organized around one tenet: that the value of one’s assets, which used to fluctuate in response to the business cycle and the financial markets, now goes in only one direction, up, with no more than occasional short-term reversals. With FIRE leading the way, the United States, free of the international gold standard’s limitations, now had great flexibility to finance its deficits with its own currency. This was “exorbitant privilege” on steroids. Massive external debts built up as trade partners to the United States, especially the oil-producing nations and Japan, balanced their trade surpluses with the purchase of U.S. financial assets.33. The motivation was in part political: the Saudis, Japanese, and Taiwanese hold a great portion of U.S. debt; not coincidentally, these nations receive military protection from the United States. The process of financing our deficit with private and public foreign funds became self-reinforcing, for if any of the largest holders of our debt reduced their holdings, the trade value of the dollar would fall—and with that, the value of their remaining holdings would be decreased. Worse, if not enough U.S. financial assets were purchased, the United States would be less able to finance its imports. It’s the old rule about bank debt, applied to international deficit finance: if you owe the banks $3 billion, the bank owns you. But if you owe the banks $10 trillion, you own the banks.
The FIRE sector’s power grew unchecked as the old manufacturing economy declined. The root of the 1920s bubble, it was believed, had been the conflicts of interest among banks and securities firms, but in the 1990s, under the leadership of Alan Greenspan at the Federal Reserve, banking and securities markets were deregulated. In 1999, the Glass-Steagall Act of 1933, which regulated banks and markets, was repealed, while a servile federal interest-rate policy helped move things along. As FIRE rose in power, so did a new generation of politicians, bankers, economists, and journalists willing to invent creative justifications for the system, as well as for the projects— ranging from the housing bubble to the Iraq war— that it financed. The high-water mark of such truckling might be the publication of the Cato Institute report “America’s Record Trade Deficit: A Symbol of Strength.” Freedom had become slavery; persistent deficits had become economic power.
* * *
The bubble machine often starts with a new invention or discovery. The Mosaic graphical Web browser, released in 1993, began to transform the Internet into a set of linked pages. Suddenly websites were easy to create and even easier to consume. Industry lobbyists stepped in, pushing for deregulation and special tax incentives. By 1995, the Internet had been thrown open to the profiteers; four years later a sales-tax moratorium was issued, opening the floodgates for e-commerce. Such legislation does not cause a bubble, but no bubble has ever occurred in its absence.
Total market value: NASDAQ. 11% annual growth derived from pre-bubble valuation (peak occurred March 10, 2000, when the NASDAQ traded as high as 5132.52 and closed the day at 5048.62)
I had a front-row seat to the Internet-stock mania of the late 1990s as managing director of Osborn Capital, a “seed stage” venture-capital firm founded by Jeffrey Osborn,44. Venture-capital firms are defined by when, not where, they place their investments; a “seed stage” firm usually puts the first money into very young firms and takes an active role in that investment. Jeffrey Osborn was a senior executive at commercial Internet provider UUNet before and after the legislation passed. Prior to the legislation, bookings were less than $4 million a year; a few years later they were greater than $2 billion.with positions on the boards of more than half a dozen technology companies. I observed otherwise rational men and women fall under the influence of a fast-flowing and, it was widely believed, risk-free flood of money. Logic and historical precedent were pushed aside. I remember a managing partner of one firm telling me with certainty that if the company in which we’d invested failed, at least it had “hard assets,” meaning the notoriously depreciation-prone computer equipment the company had received in exchange for stock. A year after the bubble collapsed, of course, the market was flooded with such hard assets.
Deregulation had built the church, and seed money was needed to grow the flock. The mechanics of financing vary with each bubble, but what matters is that the system be able to support astronomical flows of funds and generate trillions of dollars’ worth of new securities. For the Internet, the seed money came from venture capital. At first, Internet startups were merely one part of a spectrum of enterprise-software and other technology industries into which venture capitalists put their money. Then a few startups like Netscape went public, netting massive returns. Such liquidity events came faster and faster. A loop was formed: profits from IPO investments poured back into new venture funds, then into new start-ups, then back out again as IPOs, with the original investment multiplied many times over, then finally back into new venture-capital funds.
The media stood by cheering, carrying breathless profiles of wunderkinder in their early twenties who had just made their first hundred million dollars; business publications grew thick with advertisements. The media barely questioned the fine points of the new theology. Skeptics were occasionally interviewed by journalists, but in general the public was exposed to constant reiterations of the one true faith. Government stood back—after all, there was little incentive for lawmakers to intervene. Members of Congress, who influence the agencies that oversee market-regulation functions, have never been unfriendly to windfall tax revenues, and the FIRE sector has very deep pockets. According to the donation-tracking website opensecrets.org, FIRE gave $146 million in political donations for the 2008 election cycle alone, and since 1990 more than $1.9 billion—nearly double what lawyers and lobbyists have donated, and more than triple the donations from organized labor.
Part of my job was to watch for the end-time, to maximize gains and guard the firm against sudden losses when the bubble finally popped. In March 2000, the signal arrived. One of our companies was investigating the timing of an IPO; the management team was hoping for April 2000. The representatives of one of the investment banks we talked to gave us a surprisingly specific recommendation that ran counter to advice offered by banks during the IPO-driven cycle of the preceding five years: they warned the company not to go public in April. We took the advice in the context of other indicators as a clear sign of a top, and over the next few months we liquidated stocks in public companies that we held as a result of earlier IPOs. Shortly thereafter, millions of investors with unrealized gains in mutual funds sold stock to raise enough cash to pay taxes on their capital gains. The mass selling set off a panic, and the bubble popped.
In a bubble, fictitious value55. Fictitious value is the delta between historical-trend growth and growth brought on by asset hyperinflation. As an anonymous South Sea Bubble pamphleteer explained: “One added to one, by any rules of vulgar arithmetic, will never make three and a half; consequently, all the fictitious value must be a loss to some persons or other, first or last. The only way to prevent it to oneself must be to sell out betimes, and so let the Devil take the hindmost.”goes away when market participants lose faith in the religion—when their false beliefs are destroyed as quickly as they had been formed. Since the early 1980s, the free-market orthodoxy of the Chicago School has driven policy on the upward slope of an economic boom, but we’re all Keynesians on the way down: rate cuts by the Federal Reserve, tax cuts by Congress, deficit spending, and dollar depreciation are deployed in heroic proportions.
The technology industry represents only a small fraction of the U.S. economy, but the effects of layoffs, cutbacks, and the collapsing stock market rippled through the economy and produced a brief national recession in the early part of 2001, despite a concerted effort by the Federal Reserve and Congress to avoid it. This left in its wake a crucial dilemma: how to counter the loss of that $7 trillion in fictitious value built up during the bubble.
* * *
The Internet boom had been a matter of abstract electrons and monetized eyeballs—castles in the sky translated into rising share prices. The new boom was in McMansions on the ground—wood and nails, granite countertops. The price-inflation process was traditional as well: there was way too much mortgage money chasing not enough housing. At the bubble’s peak, $12 trillion in fictitious value had been created, a sum greater even than the national debt.
Total market value: Real estate. Actual market value from “Federal Reserve Flow of Funds Accounts of the United States.” Historical trend from Robert J. Schiller, Irrational Exuberance.
We certainly should have known better. Historically, the price of American homes has risen at a rate similar to the annual rate of inflation. As the Yale economist Robert Shiller has pointed out, since 1890, discounting the housing boom after World War II, that rate has been about 3.3 percent. Why, then, did housing prices suddenly begin to hyperinflate? Changes in the reserve requirements of U.S. banks, and the creation in 1994 of special “sweep” accounts, which link commercial checking and investment accounts, allowed banks greater liquidity—which meant that they could offer more credit. This was the formative stage of the bubble. Then, from 2001 to 2002, in the wake of the dot-com crash, the Federal Reserve Funds Rate was reduced from 6 percent to 1.24 percent, leading to similar cuts in the London Interbank Offered Rate that banks use to set some adjustable-rate mortgage (ARM) rates. These drastically lowered ARM rates meant that in the United States the monthly cost of a mortgage on a $500,000 home fell to roughly the monthly cost of a mortgage on a $250,000 home purchased two years earlier. Demand skyrocketed, though home builders would need years to gear up their production.
With more credit available than there was housing stock, prices predictably, and rapidly, rose. All that was needed for hypergrowth was a supply of new capital. For the Internet boom this money had been provided by the IPO system and the venture capitalists; for the housing bubble, starting around 2003, it came from securitized debt.
To “securitize” is to make a new security out of a pool of existing bonds, bringing together similar financial instruments, like loans or mortgages, in order to create something more predictable, less risk-laden, than the sum of its parts. Many such “pass-thru” securities, backed by mortgages, were set up to allow banks to serve almost purely as middlemen, so that if a few homeowners defaulted but the rest continued to pay, the bank that sold the security would itself suffer
little—or at least far less than if it held the mortgages directly. In theory, risks that used to concentrate on a bank’s balance sheet had been safely spread far and wide across the financial markets among well-financed and experienced institutional investors.66. As happens with most bubbles, a perfectly good idea is taken to an extreme. In the case of the housing bubble, the new securitized debt product that drove the final stage—which has come to be known as the “subprime meltdown”—was the collateralized debt obligation (CDO). A CDO is a class of instrument called a credit derivative; specifically, a derivative of a pool of asset-backed securities. Parts of pools of asset-backed securities that were, for example, rated at a moderately high risk of default—junk grade, such as BB—were modeled, packaged into CDOs, and rated at lower risk-investment grades, such as AAA. These were used to finance the more creative mortgages—stated-income or “liar loans”—which we now hear are not quite living up to the issuers’ hopes.
The U.S. mortgage crisis has been labeled a “subprime mortgage crisis,” but subprime mortgages were only a sideshow that appeared late, as the housing-bubble credit machine ran out of creditworthy borrowers. The main event was the hyperinflation of home prices. Risks are embedded in price and lurk as defaults. Even after the faith that supported a bubble recedes, false beliefs continue to obscure cause and effect as the crisis unfolds.
Consider the chemical industry of forty years ago, back when such pollutants as PCBs were dumped into the air and water with little or no regulation. For years, the mantra of the industry was “the solution to pollution is dilution.” Mixing toxins with vast quantities of air and water was supposed to neutralize them. Many decades later, with our plagues of hermaphrodite frogs, poisoned ground water, and mysterious cancers, the mistake in that logic is plain. Modern bankers, however, have carried this mistake into the world of finance. As more and more loans with a high risk of default were made from the late 1990s to the summer of 2007, the shared level of credit risk increased throughout the global financial system.
Think of that enormous risk as ecomonic poison. In theory, those risk pollutants have been diluted in the oceanic vastness of the world’s debt markets; thanks to the magic of securitization, they are made nontoxic and so pose no systemic risk. In reality, credit pollutants pose the same kind of threat to our economy as chemical toxins do to our environment. Like their chemical counterparts, they tend to concentrate in the weakest and most vulnerable parts of the financial system, and that’s where the toxic effects show up first: the subprime mortgage market collapse is essentially the Love Canal of our ongoing risk-pollution disaster.
* * *
Read the front page of any business publication today and you can see the mess bubbling up. In the United States, Merrill Lynch took a $7.9 billion hit from its mortgage investments and experienced its first quarterly loss since 2001; Morgan Stanley, Bear Stearns, Citigroup, along with many other U.S. banks, have all suffered major losses. The Royal Bank of
Scotland Group was forced to write down $3 billion on credit-related securities and leveraged loans, and Japan’s Norinchukin Bank suffered $357 million in subprime-related losses in the six months prior to September 2007. Even more of this pollution will become manifest as home prices continue to fall.
The metaphor is not lost on those touched by debt pollution. In December 2007, Chip Mason of Legg Mason, one of the world’s largest money managers, said that the U.S. Treasury should put $20 billion into a “structured investment vehicles superfund” to boost investor confidence.
As more and more risk pollution rises to the surface, credit will continue to contract, and the FIRE economy—which depends on the free flow of credit—will experience its first near-death experience since the sector rose to power in the early 1980s. Because all asset hyperinflations revert to the mean, we can expect housing prices to decline roughly 38 percent from their peak as they return to something closer to the historical rate of monetary inflation. If the rate of decline stabilizes at between 6 and 7 percent each year, the correction has about six years to go before things stabilize, leaving the FIRE economy in need of $12 trillion. Where will that money be found?
* * *
Bubbles are to the industries that host them what clear-cutting is to forest management. After several years of recession, the affected industry will eventually grow back, but slowly—the NASDAQ, for example, at 5,048 in March 2000, had recovered only half of its peak value going into 2007. When those trillions of dollars first die and go to money heaven, the whole economy grieves.
The housing bubble has left us in dire shape, worse than after the technology-stock bubble, when the Federal Reserve Funds Rate was 6 percent, the dollar was at a multi-decade peak, the federal government was running a surplus, and tax rates were relatively high, making reflation—interest-rate cuts, dollar depreciation, increased government spending, and tax cuts—relatively painless. Now the Funds Rate is only 4.5 percent, the dollar is at multi-decade lows, the federal budget is in deficit, and tax cuts are still in effect. The chronic trade deficit, the sudden depreciation of our currency, and the lack of foreign buyers willing to purchase its debt will require the United States government to print new money simply to fund its own operations and pay its 22 million employees.
Our economy is in serious trouble. Both the production-consumption sector and the FIRE sector know that a debt-deflation Armageddon is nigh, and both are praying for a timely miracle, a new bubble to keep the economy from slipping into a depression.
We have learned that the industry in any given bubble must support hundreds or thousands of separate firms financed by not billions but trillions of dollars in new securities that Wall Street will create and sell. Like housing in the late 1990s, this sector of the economy must already be formed and growing even as the previous bubble deflates. For those investing in that sector, legislation guaranteeing favorable tax treatment, along with other protections and advantages for investors, should already be in place or under review. Finally, the industry must be popular, its name on the lips of government policymakers and journalists. It should be familiar to those who watch television news or read newspapers.
There are a number of plausible candidates for the next bubble, but only a few meet all the criteria. Health care must expand to meet the needs of the aging baby boomers, but there is as yet no enabling government legislation to make way for a health-care bubble; the same holds true of the pharmaceutical industry, which could hyperinflate only if the Food and Drug Administration was gutted of its power. A second technology boom—under the rubric “Web 2.0”—is based on improvements to existing technology rather than any new discovery. The capital-intensive biotechnology industry will not inflate, as it requires too much specialized intelligence.
There is one industry that fits the bill: alternative energy, the development of more energy-efficient products, along with viable alternatives to oil, including wind, solar, and geothermal power, along with the use of nuclear energy to produce sustainable oil substitutes, such as liquefied hydrogen from water. Indeed, the next bubble is already being branded. Wired magazine, returning to its roots in boosterism, put ethanol on the cover of its October 2007 issue, advising its readers to forget oil; NBC had a “Green Week” in November 2007, with themed shows beating away at an ecological message and Al Gore making a guest appearance on the sitcom 30 Rock. Improbably, Gore threatens to become the poster boy for the new new new economy: he has joined the legendary venture-capital firm Kleiner Perkins Caufield & Byers, which assisted at the births of Amazon.com and Google, to oversee the “climate change solutions group,” thus providing a massive dose of Nobel Prize–winning credibility that will be most useful when its first alternative-energy investments are taken public before a credulous mob. Other ventures—Lazard Capital Markets, Generation Investment Management, Nth Power, EnerTech Capital, and Battery Ventures—are funding an array of startups working on improvements to solar cells, to biofuels production, to batteries, to “energy management” software, and so on.
Total market value: Alternative energy and infrastructure. Estimated fictitious value of next bubble compared with previous bubbles
The candidates for the 2008 presidential election, notably Obama, Clinton, Romney, and McCain, now invoke “energy security” in their stump speeches and on their websites. Previously, “energy independence” was more common, and perhaps this change in terminology is a hint that a portion of the Homeland Security budget will be allocated for alternative energy, a potential boon for startups and for FIRE.
More valuable than campaign rhetoric, however, is legislation. The Energy Policy Act of 2005, a massive bill known to morning commuters for extending daylight savings time, contained provisions guaranteeing loans for alternative-energy businesses, including nuclear-power technology. The bill authorizes $200 million annually for clean-coal initiatives, repeals the current 160-acre cap on coal leases, offers subsidies for wind energy and other alternative-energy producers, and promises $50 million annually, over the life of the bill, for a biomass grant program.
Loan guarantees for “innovative technologies” such as advanced nuclear-reactor designs are also at hand; a kindler, gentler nuclear industry appears to be imminent. The Price-Anderson Nuclear Industries Indemnity Act has been extended through 2025; the secretary of energy was ordered to implement the 2001 nuclear power “roadmap,” and $1.25 billion was set aside by the Department of Energy to develop a nuclear reactor that will generate both electricity and hydrogen. The future of transportation may be neither solar- nor ethanol-powered but instead rely on numerous small nuclear power plants generating electricity and, for local transportation, hydrogen. At the state and local levels, related bills have been passed or are under consideration.
Supporting this alternative-energy bubble will be a boom in infrastructure—transportation and communications systems, water, and power. In its 2005 report card, the American Society of Civil Engineers called for $1.6 trillion to be spent over five years to bring the United States back up to code, giving America a grade of “D.” Decades of neglect have put us trillions of dollars away from an “A.” After last August’s bridge collapse in Minnesota, it took only a week for libertarian Robert Poole, director of transportation studies for the Reason Foundation, to renew the call for “highway public-private partnerships funded by tolls,” and for Hillary Clinton to put forth a multibillion-dollar “Rebuild America” plan.
Of course, alternative energy and the improvement of our infrastructure are both necessary for our national well-being; and therein lies the danger: hyperinflations, in the long run, are always destructive. Since the 1970s, U.S. dependence on foreign energy supplies has become a major economic and security liability, and our superannuated roadways are the nation’s circulatory system. Without the efficient transit of gasoline-powered trucks laden with goods across our highways there would be no Wal-Mart, no other big-box stores, no morning FedEx deliveries. Without “energy security” and repairs to our “crumbling infrastructure,” our very competitiveness is at stake. Luckily, Al Gore will be making principled venture capital investments on our behalf.
The next bubble must be large enough to recover the losses from the housing bubble collapse. How bad will it be? Some rough calculations77. To create these valuations, I first examined the necessary market capitalization of existing companies; then, using the technology and housing bubbles as precedents, I estimated the number of companies needed to support the bubble. The model assumes the existence of nascent credit products that will eventually be deployed to fund the hyperinflation. While the range of error in this prediction is obviously huge, the antecedents—and more important, the necessity—for the bubble remain.: the gross market value of all enterprises needed to develop hydroelectric power, geothermal energy, nuclear energy, wind farms, solar power, and hydrogen-powered fuel-cell technology—and the infrastructure to support it—is somewhere between $2 trillion and $4 trillion; assuming the bubble can get started, the hyperinflated fictitious value could add another $12 trillion. In a hyperinflation, infrastructure upgrades will accelerate, with plenty of opportunity for big government contractors fleeing the declining market in Iraq. Thus, we can expect to see the creation of another $8 trillion in fictitious value, which gives us an estimate of $20 trillion in speculative wealth, money that inevitably will be employed to increase share prices rather than to deliver “energy security.” When the bubble finally bursts, we will be left to mop up after yet another devastated industry. FIRE, meanwhile, will already be engineering its next opportunity. Given the current state of our economy, the only thing worse than a new bubble would be its absence.
* * *
Eric Janszen is the founder and president of iTulip, Inc. He formerly served as managing director of the venture firm Osborn Capital, CEO of AutoCell, Inc. and Bluesocket, Inc., and entrepreneur-in-residence for Trident Capital.
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Hello Investor Friends and Family,
I think there is about to be a "market correction" on the horizon so says Tom (just a prediction).
(10 days to 2 weeks or less)
I predict the TSE starts to get quite brittle (prone to a down turn) over about 14,650
it will be there tomorrow, today's close was: 14,607.99 (think about the down side "correction" risk at this time)
This article that follows is about the now yearly (decadely?) boom to bust "bubble cycle" (this is new term, look for it on the internet, I just coined it! :-) "the bubble cycle" may now replace the fictitious business cycle.
I suggest you read the whole thing I think it is right-on (seriously):
From the article:
"That the Internet (dot.com boom) and housing hyperinflations (Sub prime mortgage "boom") transpired within a period of ten years, each creating trillions of dollars in fake wealth".....
in a nut shell this is proposed to be the next big investment bubble:
"There is one industry that fits the bill: alternative energy, the development of more energy-efficient products, along with viable alternatives to oil, including wind, solar, and geothermal power, along with the use of nuclear energy to produce sustainable oil substitutes, such as liquefied hydrogen from water. Indeed, the next bubble is already being branded. Wired magazine, returning to its roots in boosterism, put ethanol on the cover of its October 2007 issue, advising its readers to forget oil; NBC had a “Green Week” in November 2007, with themed shows beating away at an ecological message and Al Gore making a guest appearance on the sitcom 30 Rock. Improbably, Gore threatens to become the poster boy for the new new new economy: he has joined the legendary venture-capital firm Kleiner Perkins Caufield & Byers, which assisted at the births of Amazon.com and Google, to oversee the “climate change solutions group,” thus providing a massive dose of Nobel Prize–winning credibility that will be most useful when its first alternative-energy investments are taken public before a credulous mob. Other ventures—Lazard Capital Markets, Generation Investment Management, Nth Power, EnerTech Capital, and Battery Ventures—are funding an array of startups working on improvements to solar cells, to biofuels production, to batteries, to “energy management” software, and so on."
from:
http://www.harpers.org/archive/2008/02/0081908
The next bubble:
Priming the markets for tomorrow's big crash
TYPE Article
BY Eric Janszen
PUBLISHED February 2008
VIEW PAGESPDF
A financial bubble11. I will use the familiar term “bubble” as a shorthand, but note that it confuses cause with effect. A better, if ungainly, descriptor would be “asset-price hyperinflation”—the huge spike in asset prices that results from a perverse self-reinforcing belief system, a fog that clouds the judgment of all but the most aware participants in the market. Asset hyperinflation starts at a certain stage of market development under just the right conditions. The bubble is the result of that financial madness, seen only when the fog rolls away. is a market aberration manufactured by government, finance, and industry, a shared speculative hallucination and then a crash, followed by depression. (or down turn, or recession). Bubbles were once very rare—one every hundred years or so was enough to motivate politicians, bearing the post-bubble ire of their newly destitute citizenry, to enact legislation that would prevent subsequent occurrences. After the dust settled from the 1720 crash of the South Sea Bubble, for instance, British Parliament passed the Bubble Act to forbid “raising or pretending to raise a transferable stock.” For a century this law did much to prevent the formation of new speculative swellings.
Nowadays we barely pause between such bouts of insanity. The dot-com crash of the early 2000s should have been followed by decades of soul-searching; instead, even before the old bubble had fully deflated, a new mania began to take hold on the foundation of our long-standing American faith that the wide expansion of home ownership can produce social harmony and national economic well-being. Spurred by the actions of the Federal Reserve, financed by exotic credit derivatives and debt securitiztion, an already massive real estate sales-and-marketing program expanded to include the desperate issuance of mortgages to the poor and feckless, compounding their troubles and ours.
Watch is and LAUGH if you have not seen it:
http://www.youtube.com/watch?v=SwRFoxgEcHc
(really)
That the Internet and housing hyperinflations transpired within a period of ten years, each creating trillions of dollars in fake wealth, is, I believe, only the beginning. There will and must be many more such booms, for without them the economy of the United States can no longer function. The bubble cycle has replaced the business cycle.
* * *
Such transformations do not take place overnight. After World War I, Wall Street wrote checks to finance new companies that were trying to turn wartime inventions, such as refrigeration and radio, into consumer products. The consumers of the rising middle class were ready to buy but lacked funds, so the banking system accommodated them with new forms of credit, notably the installment plan. Following a brief recession in 1921, federal policy accommodated progress by keeping interest rates below the rate of inflation. Pundits hailed a “new era” of prosperity until Black Tuesday, October 29, 1929.
The crash, the Great Depression, and World War II were a brutal education for government, academia, corporate America, Wall Street, and the press. For the next sixty years, that chastened generation managed to keep the fog of false hopes and bad credit at bay. Economist John Maynard Keynes emerged as the pied piper of a new school of economics that promised continuous economic growth without end. Keynes’s doctrine: When a business cycle peaks and starts its downward slide, one must increase federal spending, cut
taxes, and lower short-term interest rates to increase the money supply and expand credit. The demand stimulated by deficit spending and cheap money will thereby prevent a recession. In 1932 this set of economic gambits was dubbed “reflation.”
The first Keynesian reflation was botched. To be fair, it was perhaps impractical under the gold standard, for by the time the Federal Reserve made its attempt to ameliorate matters, debt was already out of control.22. Historians argue whether the Federal Reserve and Congress did enough soon enough to slow the rate of debt liquidation at the time. Most agree that once the inflation rate turned negative, monetary stimulus via short-term interest-rate management was ineffective, since the Fed could not lower short-term rates below zero percent. The Bank of Japan found itself in a similar predicament sixty years later.Banks failed, credit contracted, and GDP shrank. The economy was running in reverse and refused to respond to Keynesian inducements. In 1933, President Franklin D. Roosevelt called in gold and repriced it, hoping to test Keynes’s theory that monetary inflation stimulates demand. The economy began to expand. But it was World War II that brought real recovery, as a highly effective, demand-generating, deficit-and-debt-financed public-works project for the United States. The war did what a flawed application of Keynes’s theories could not.
A few weeks after D-Day, the allies met at the Mount Washington Hotel in Bretton Woods, New Hampshire, to determine the future of the international monetary system. It wasn’t much of a negotiation. Western economies were in ruins, and the international monetary system had been in disarray since the start of the Great Depression. The United States, now the dominant economic and military power, successfully pushed to peg the currencies of member nations to the dollar and to make dollars redeemable in American gold.
Americans could now spend as wisely or foolishly as our government policy decreed and, regardless of the needs of other nations holding dollars as reserves, print as many dollars as desired. But by the second quarter of 1971, the U.S. balance of merchandise trade had run up a deficit of $3.8 billion (adjusted for inflation)—an admittedly tiny sum compared with the deficit of $204 billion in the second quarter of 2007, but until that time the United States had run only surpluses. Members of the Bretton Woods system, most famously French President General Charles de Gaulle, worried that the United States intended to repay the money borrowed to cover its trade gap with depreciated dollars. Opposed to the exercise of such “exorbitant privilege,” de Gaulle demanded payment in gold. With the balance of payments so greatly out of balance, newly elected President Richard Nixon faced a run on the U.S. gold supply, and his solution was novel: unilaterally end the U.S. legal obligation to redeem dollars with gold; in other words, default.
More than a decade of economic and financial-market chaos followed, as the dollar remained the international currency but traded without an absolute measure of value. Inflation rose not just in the United States but around the world, grinding down the worth of many securities and brokerage firms. The Federal Reserve pushed interest rates into double digits, setting off two global recessions, and new international standards and methods for measuring inflation and floating exchange rates were established to replace the gold standard. After 1975, the United States would never again post an annual merchandise trade surplus. Such high-value, finished-goods-producing industries as steel and automobiles were no longer dominant. The new economy belonged to finance, insurance, and real estate—FIRE.
* * *
FIRE is a credit-financed, asset-price-inflation machine organized around one tenet: that the value of one’s assets, which used to fluctuate in response to the business cycle and the financial markets, now goes in only one direction, up, with no more than occasional short-term reversals. With FIRE leading the way, the United States, free of the international gold standard’s limitations, now had great flexibility to finance its deficits with its own currency. This was “exorbitant privilege” on steroids. Massive external debts built up as trade partners to the United States, especially the oil-producing nations and Japan, balanced their trade surpluses with the purchase of U.S. financial assets.33. The motivation was in part political: the Saudis, Japanese, and Taiwanese hold a great portion of U.S. debt; not coincidentally, these nations receive military protection from the United States. The process of financing our deficit with private and public foreign funds became self-reinforcing, for if any of the largest holders of our debt reduced their holdings, the trade value of the dollar would fall—and with that, the value of their remaining holdings would be decreased. Worse, if not enough U.S. financial assets were purchased, the United States would be less able to finance its imports. It’s the old rule about bank debt, applied to international deficit finance: if you owe the banks $3 billion, the bank owns you. But if you owe the banks $10 trillion, you own the banks.
The FIRE sector’s power grew unchecked as the old manufacturing economy declined. The root of the 1920s bubble, it was believed, had been the conflicts of interest among banks and securities firms, but in the 1990s, under the leadership of Alan Greenspan at the Federal Reserve, banking and securities markets were deregulated. In 1999, the Glass-Steagall Act of 1933, which regulated banks and markets, was repealed, while a servile federal interest-rate policy helped move things along. As FIRE rose in power, so did a new generation of politicians, bankers, economists, and journalists willing to invent creative justifications for the system, as well as for the projects— ranging from the housing bubble to the Iraq war— that it financed. The high-water mark of such truckling might be the publication of the Cato Institute report “America’s Record Trade Deficit: A Symbol of Strength.” Freedom had become slavery; persistent deficits had become economic power.
* * *
The bubble machine often starts with a new invention or discovery. The Mosaic graphical Web browser, released in 1993, began to transform the Internet into a set of linked pages. Suddenly websites were easy to create and even easier to consume. Industry lobbyists stepped in, pushing for deregulation and special tax incentives. By 1995, the Internet had been thrown open to the profiteers; four years later a sales-tax moratorium was issued, opening the floodgates for e-commerce. Such legislation does not cause a bubble, but no bubble has ever occurred in its absence.
Total market value: NASDAQ. 11% annual growth derived from pre-bubble valuation (peak occurred March 10, 2000, when the NASDAQ traded as high as 5132.52 and closed the day at 5048.62)
I had a front-row seat to the Internet-stock mania of the late 1990s as managing director of Osborn Capital, a “seed stage” venture-capital firm founded by Jeffrey Osborn,44. Venture-capital firms are defined by when, not where, they place their investments; a “seed stage” firm usually puts the first money into very young firms and takes an active role in that investment. Jeffrey Osborn was a senior executive at commercial Internet provider UUNet before and after the legislation passed. Prior to the legislation, bookings were less than $4 million a year; a few years later they were greater than $2 billion.with positions on the boards of more than half a dozen technology companies. I observed otherwise rational men and women fall under the influence of a fast-flowing and, it was widely believed, risk-free flood of money. Logic and historical precedent were pushed aside. I remember a managing partner of one firm telling me with certainty that if the company in which we’d invested failed, at least it had “hard assets,” meaning the notoriously depreciation-prone computer equipment the company had received in exchange for stock. A year after the bubble collapsed, of course, the market was flooded with such hard assets.
Deregulation had built the church, and seed money was needed to grow the flock. The mechanics of financing vary with each bubble, but what matters is that the system be able to support astronomical flows of funds and generate trillions of dollars’ worth of new securities. For the Internet, the seed money came from venture capital. At first, Internet startups were merely one part of a spectrum of enterprise-software and other technology industries into which venture capitalists put their money. Then a few startups like Netscape went public, netting massive returns. Such liquidity events came faster and faster. A loop was formed: profits from IPO investments poured back into new venture funds, then into new start-ups, then back out again as IPOs, with the original investment multiplied many times over, then finally back into new venture-capital funds.
The media stood by cheering, carrying breathless profiles of wunderkinder in their early twenties who had just made their first hundred million dollars; business publications grew thick with advertisements. The media barely questioned the fine points of the new theology. Skeptics were occasionally interviewed by journalists, but in general the public was exposed to constant reiterations of the one true faith. Government stood back—after all, there was little incentive for lawmakers to intervene. Members of Congress, who influence the agencies that oversee market-regulation functions, have never been unfriendly to windfall tax revenues, and the FIRE sector has very deep pockets. According to the donation-tracking website opensecrets.org, FIRE gave $146 million in political donations for the 2008 election cycle alone, and since 1990 more than $1.9 billion—nearly double what lawyers and lobbyists have donated, and more than triple the donations from organized labor.
Part of my job was to watch for the end-time, to maximize gains and guard the firm against sudden losses when the bubble finally popped. In March 2000, the signal arrived. One of our companies was investigating the timing of an IPO; the management team was hoping for April 2000. The representatives of one of the investment banks we talked to gave us a surprisingly specific recommendation that ran counter to advice offered by banks during the IPO-driven cycle of the preceding five years: they warned the company not to go public in April. We took the advice in the context of other indicators as a clear sign of a top, and over the next few months we liquidated stocks in public companies that we held as a result of earlier IPOs. Shortly thereafter, millions of investors with unrealized gains in mutual funds sold stock to raise enough cash to pay taxes on their capital gains. The mass selling set off a panic, and the bubble popped.
In a bubble, fictitious value55. Fictitious value is the delta between historical-trend growth and growth brought on by asset hyperinflation. As an anonymous South Sea Bubble pamphleteer explained: “One added to one, by any rules of vulgar arithmetic, will never make three and a half; consequently, all the fictitious value must be a loss to some persons or other, first or last. The only way to prevent it to oneself must be to sell out betimes, and so let the Devil take the hindmost.”goes away when market participants lose faith in the religion—when their false beliefs are destroyed as quickly as they had been formed. Since the early 1980s, the free-market orthodoxy of the Chicago School has driven policy on the upward slope of an economic boom, but we’re all Keynesians on the way down: rate cuts by the Federal Reserve, tax cuts by Congress, deficit spending, and dollar depreciation are deployed in heroic proportions.
The technology industry represents only a small fraction of the U.S. economy, but the effects of layoffs, cutbacks, and the collapsing stock market rippled through the economy and produced a brief national recession in the early part of 2001, despite a concerted effort by the Federal Reserve and Congress to avoid it. This left in its wake a crucial dilemma: how to counter the loss of that $7 trillion in fictitious value built up during the bubble.
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The Internet boom had been a matter of abstract electrons and monetized eyeballs—castles in the sky translated into rising share prices. The new boom was in McMansions on the ground—wood and nails, granite countertops. The price-inflation process was traditional as well: there was way too much mortgage money chasing not enough housing. At the bubble’s peak, $12 trillion in fictitious value had been created, a sum greater even than the national debt.
Total market value: Real estate. Actual market value from “Federal Reserve Flow of Funds Accounts of the United States.” Historical trend from Robert J. Schiller, Irrational Exuberance.
We certainly should have known better. Historically, the price of American homes has risen at a rate similar to the annual rate of inflation. As the Yale economist Robert Shiller has pointed out, since 1890, discounting the housing boom after World War II, that rate has been about 3.3 percent. Why, then, did housing prices suddenly begin to hyperinflate? Changes in the reserve requirements of U.S. banks, and the creation in 1994 of special “sweep” accounts, which link commercial checking and investment accounts, allowed banks greater liquidity—which meant that they could offer more credit. This was the formative stage of the bubble. Then, from 2001 to 2002, in the wake of the dot-com crash, the Federal Reserve Funds Rate was reduced from 6 percent to 1.24 percent, leading to similar cuts in the London Interbank Offered Rate that banks use to set some adjustable-rate mortgage (ARM) rates. These drastically lowered ARM rates meant that in the United States the monthly cost of a mortgage on a $500,000 home fell to roughly the monthly cost of a mortgage on a $250,000 home purchased two years earlier. Demand skyrocketed, though home builders would need years to gear up their production.
With more credit available than there was housing stock, prices predictably, and rapidly, rose. All that was needed for hypergrowth was a supply of new capital. For the Internet boom this money had been provided by the IPO system and the venture capitalists; for the housing bubble, starting around 2003, it came from securitized debt.
To “securitize” is to make a new security out of a pool of existing bonds, bringing together similar financial instruments, like loans or mortgages, in order to create something more predictable, less risk-laden, than the sum of its parts. Many such “pass-thru” securities, backed by mortgages, were set up to allow banks to serve almost purely as middlemen, so that if a few homeowners defaulted but the rest continued to pay, the bank that sold the security would itself suffer
little—or at least far less than if it held the mortgages directly. In theory, risks that used to concentrate on a bank’s balance sheet had been safely spread far and wide across the financial markets among well-financed and experienced institutional investors.66. As happens with most bubbles, a perfectly good idea is taken to an extreme. In the case of the housing bubble, the new securitized debt product that drove the final stage—which has come to be known as the “subprime meltdown”—was the collateralized debt obligation (CDO). A CDO is a class of instrument called a credit derivative; specifically, a derivative of a pool of asset-backed securities. Parts of pools of asset-backed securities that were, for example, rated at a moderately high risk of default—junk grade, such as BB—were modeled, packaged into CDOs, and rated at lower risk-investment grades, such as AAA. These were used to finance the more creative mortgages—stated-income or “liar loans”—which we now hear are not quite living up to the issuers’ hopes.
The U.S. mortgage crisis has been labeled a “subprime mortgage crisis,” but subprime mortgages were only a sideshow that appeared late, as the housing-bubble credit machine ran out of creditworthy borrowers. The main event was the hyperinflation of home prices. Risks are embedded in price and lurk as defaults. Even after the faith that supported a bubble recedes, false beliefs continue to obscure cause and effect as the crisis unfolds.
Consider the chemical industry of forty years ago, back when such pollutants as PCBs were dumped into the air and water with little or no regulation. For years, the mantra of the industry was “the solution to pollution is dilution.” Mixing toxins with vast quantities of air and water was supposed to neutralize them. Many decades later, with our plagues of hermaphrodite frogs, poisoned ground water, and mysterious cancers, the mistake in that logic is plain. Modern bankers, however, have carried this mistake into the world of finance. As more and more loans with a high risk of default were made from the late 1990s to the summer of 2007, the shared level of credit risk increased throughout the global financial system.
Think of that enormous risk as ecomonic poison. In theory, those risk pollutants have been diluted in the oceanic vastness of the world’s debt markets; thanks to the magic of securitization, they are made nontoxic and so pose no systemic risk. In reality, credit pollutants pose the same kind of threat to our economy as chemical toxins do to our environment. Like their chemical counterparts, they tend to concentrate in the weakest and most vulnerable parts of the financial system, and that’s where the toxic effects show up first: the subprime mortgage market collapse is essentially the Love Canal of our ongoing risk-pollution disaster.
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Read the front page of any business publication today and you can see the mess bubbling up. In the United States, Merrill Lynch took a $7.9 billion hit from its mortgage investments and experienced its first quarterly loss since 2001; Morgan Stanley, Bear Stearns, Citigroup, along with many other U.S. banks, have all suffered major losses. The Royal Bank of
Scotland Group was forced to write down $3 billion on credit-related securities and leveraged loans, and Japan’s Norinchukin Bank suffered $357 million in subprime-related losses in the six months prior to September 2007. Even more of this pollution will become manifest as home prices continue to fall.
The metaphor is not lost on those touched by debt pollution. In December 2007, Chip Mason of Legg Mason, one of the world’s largest money managers, said that the U.S. Treasury should put $20 billion into a “structured investment vehicles superfund” to boost investor confidence.
As more and more risk pollution rises to the surface, credit will continue to contract, and the FIRE economy—which depends on the free flow of credit—will experience its first near-death experience since the sector rose to power in the early 1980s. Because all asset hyperinflations revert to the mean, we can expect housing prices to decline roughly 38 percent from their peak as they return to something closer to the historical rate of monetary inflation. If the rate of decline stabilizes at between 6 and 7 percent each year, the correction has about six years to go before things stabilize, leaving the FIRE economy in need of $12 trillion. Where will that money be found?
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Bubbles are to the industries that host them what clear-cutting is to forest management. After several years of recession, the affected industry will eventually grow back, but slowly—the NASDAQ, for example, at 5,048 in March 2000, had recovered only half of its peak value going into 2007. When those trillions of dollars first die and go to money heaven, the whole economy grieves.
The housing bubble has left us in dire shape, worse than after the technology-stock bubble, when the Federal Reserve Funds Rate was 6 percent, the dollar was at a multi-decade peak, the federal government was running a surplus, and tax rates were relatively high, making reflation—interest-rate cuts, dollar depreciation, increased government spending, and tax cuts—relatively painless. Now the Funds Rate is only 4.5 percent, the dollar is at multi-decade lows, the federal budget is in deficit, and tax cuts are still in effect. The chronic trade deficit, the sudden depreciation of our currency, and the lack of foreign buyers willing to purchase its debt will require the United States government to print new money simply to fund its own operations and pay its 22 million employees.
Our economy is in serious trouble. Both the production-consumption sector and the FIRE sector know that a debt-deflation Armageddon is nigh, and both are praying for a timely miracle, a new bubble to keep the economy from slipping into a depression.
We have learned that the industry in any given bubble must support hundreds or thousands of separate firms financed by not billions but trillions of dollars in new securities that Wall Street will create and sell. Like housing in the late 1990s, this sector of the economy must already be formed and growing even as the previous bubble deflates. For those investing in that sector, legislation guaranteeing favorable tax treatment, along with other protections and advantages for investors, should already be in place or under review. Finally, the industry must be popular, its name on the lips of government policymakers and journalists. It should be familiar to those who watch television news or read newspapers.
There are a number of plausible candidates for the next bubble, but only a few meet all the criteria. Health care must expand to meet the needs of the aging baby boomers, but there is as yet no enabling government legislation to make way for a health-care bubble; the same holds true of the pharmaceutical industry, which could hyperinflate only if the Food and Drug Administration was gutted of its power. A second technology boom—under the rubric “Web 2.0”—is based on improvements to existing technology rather than any new discovery. The capital-intensive biotechnology industry will not inflate, as it requires too much specialized intelligence.
There is one industry that fits the bill: alternative energy, the development of more energy-efficient products, along with viable alternatives to oil, including wind, solar, and geothermal power, along with the use of nuclear energy to produce sustainable oil substitutes, such as liquefied hydrogen from water. Indeed, the next bubble is already being branded. Wired magazine, returning to its roots in boosterism, put ethanol on the cover of its October 2007 issue, advising its readers to forget oil; NBC had a “Green Week” in November 2007, with themed shows beating away at an ecological message and Al Gore making a guest appearance on the sitcom 30 Rock. Improbably, Gore threatens to become the poster boy for the new new new economy: he has joined the legendary venture-capital firm Kleiner Perkins Caufield & Byers, which assisted at the births of Amazon.com and Google, to oversee the “climate change solutions group,” thus providing a massive dose of Nobel Prize–winning credibility that will be most useful when its first alternative-energy investments are taken public before a credulous mob. Other ventures—Lazard Capital Markets, Generation Investment Management, Nth Power, EnerTech Capital, and Battery Ventures—are funding an array of startups working on improvements to solar cells, to biofuels production, to batteries, to “energy management” software, and so on.
Total market value: Alternative energy and infrastructure. Estimated fictitious value of next bubble compared with previous bubbles
The candidates for the 2008 presidential election, notably Obama, Clinton, Romney, and McCain, now invoke “energy security” in their stump speeches and on their websites. Previously, “energy independence” was more common, and perhaps this change in terminology is a hint that a portion of the Homeland Security budget will be allocated for alternative energy, a potential boon for startups and for FIRE.
More valuable than campaign rhetoric, however, is legislation. The Energy Policy Act of 2005, a massive bill known to morning commuters for extending daylight savings time, contained provisions guaranteeing loans for alternative-energy businesses, including nuclear-power technology. The bill authorizes $200 million annually for clean-coal initiatives, repeals the current 160-acre cap on coal leases, offers subsidies for wind energy and other alternative-energy producers, and promises $50 million annually, over the life of the bill, for a biomass grant program.
Loan guarantees for “innovative technologies” such as advanced nuclear-reactor designs are also at hand; a kindler, gentler nuclear industry appears to be imminent. The Price-Anderson Nuclear Industries Indemnity Act has been extended through 2025; the secretary of energy was ordered to implement the 2001 nuclear power “roadmap,” and $1.25 billion was set aside by the Department of Energy to develop a nuclear reactor that will generate both electricity and hydrogen. The future of transportation may be neither solar- nor ethanol-powered but instead rely on numerous small nuclear power plants generating electricity and, for local transportation, hydrogen. At the state and local levels, related bills have been passed or are under consideration.
Supporting this alternative-energy bubble will be a boom in infrastructure—transportation and communications systems, water, and power. In its 2005 report card, the American Society of Civil Engineers called for $1.6 trillion to be spent over five years to bring the United States back up to code, giving America a grade of “D.” Decades of neglect have put us trillions of dollars away from an “A.” After last August’s bridge collapse in Minnesota, it took only a week for libertarian Robert Poole, director of transportation studies for the Reason Foundation, to renew the call for “highway public-private partnerships funded by tolls,” and for Hillary Clinton to put forth a multibillion-dollar “Rebuild America” plan.
Of course, alternative energy and the improvement of our infrastructure are both necessary for our national well-being; and therein lies the danger: hyperinflations, in the long run, are always destructive. Since the 1970s, U.S. dependence on foreign energy supplies has become a major economic and security liability, and our superannuated roadways are the nation’s circulatory system. Without the efficient transit of gasoline-powered trucks laden with goods across our highways there would be no Wal-Mart, no other big-box stores, no morning FedEx deliveries. Without “energy security” and repairs to our “crumbling infrastructure,” our very competitiveness is at stake. Luckily, Al Gore will be making principled venture capital investments on our behalf.
The next bubble must be large enough to recover the losses from the housing bubble collapse. How bad will it be? Some rough calculations77. To create these valuations, I first examined the necessary market capitalization of existing companies; then, using the technology and housing bubbles as precedents, I estimated the number of companies needed to support the bubble. The model assumes the existence of nascent credit products that will eventually be deployed to fund the hyperinflation. While the range of error in this prediction is obviously huge, the antecedents—and more important, the necessity—for the bubble remain.: the gross market value of all enterprises needed to develop hydroelectric power, geothermal energy, nuclear energy, wind farms, solar power, and hydrogen-powered fuel-cell technology—and the infrastructure to support it—is somewhere between $2 trillion and $4 trillion; assuming the bubble can get started, the hyperinflated fictitious value could add another $12 trillion. In a hyperinflation, infrastructure upgrades will accelerate, with plenty of opportunity for big government contractors fleeing the declining market in Iraq. Thus, we can expect to see the creation of another $8 trillion in fictitious value, which gives us an estimate of $20 trillion in speculative wealth, money that inevitably will be employed to increase share prices rather than to deliver “energy security.” When the bubble finally bursts, we will be left to mop up after yet another devastated industry. FIRE, meanwhile, will already be engineering its next opportunity. Given the current state of our economy, the only thing worse than a new bubble would be its absence.
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Eric Janszen is the founder and president of iTulip, Inc. He formerly served as managing director of the venture firm Osborn Capital, CEO of AutoCell, Inc. and Bluesocket, Inc., and entrepreneur-in-residence for Trident Capital.
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