The Federal Reserve is refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral.

Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson said in September they would comply with congressional demands for transparency in a $700 billion bailout of the banking system. Two months later, as the Fed lends far more than that in separate rescue programs that didn't require approval by Congress, Americans have no idea where their money is going or what securities the banks are pledging in return.

It makes sense that us taxpayers should know, right?

"As a taxpayer, it is absolutely important that we know how they're lending money and who they're lending it to,"' said Lucy Dalglish, executive director of the Arlington, Virginia-based Reporters Committee for Freedom of the Press.

And yet, Congressman Barney Frank thinks that it's entirely copacetic that we're kept in the dark:

In an interview Nov. 6, House Financial Services Committee Chairman Barney Frank said the Fed's disclosure is sufficient and that the risk the central bank is taking on is appropriate in the current economic climate. Frank said he has discussed the program with Timothy F. Geithner, president and chief executive officer of the Federal Reserve Bank of New York and a possible candidate to succeed Paulson as Treasury secretary.

"I talk to Geithner and he was pretty sure that they're OK,'" said Frank, a Massachusetts Democrat. "If the risk is that the Fed takes a little bit of a haircut, well that's regrettable.'" Such losses would be acceptable, he said, if the program helps revive the economy.

Frank said the Fed shouldn't reveal the assets it holds or how it values them because of "delicacy with respect to pricing." He said such disclosure would "give people clues to what your pricing is and what they might be able to sell us and what your estimates are."' He wouldn't say why he thought that information would be problematic.

WTF!!??

Says Shiller,

Indeed, there has been a significant, decades-long trend toward greater inequality that needs to be corrected. The president-elect needs to seize the opportunity and to do something really effective to prevent inequality from getting much worse.

He then outlines various solutions that a President Obama can undertake to address this systemic problem:

The best way to battle gratuitous inequality is to make our financial institutions better embody the true principles of risk management. Financial theory is all about incentives for people to work effectively, and diversifying against random shocks by sharing them among many investors. At its essence, finance is really more about helping and sharing than "beating the market."

It may seem paradoxical to try to lessen inequality by relying on the institutions that are most blamed today, but it is only through these institutions that inequality reduction can really work well in a capitalist economy. Enhanced financial institutions could serve the real purpose that financial theory proposes: serving the people.

He lays out three steps we can take beginning in January:

1) To improve the information infrastructure, we need to subsidize financial advice for the common man. The crisis we are in is largely due to investor ignorance. Some emergency measures, like the Hope Now Alliance, have been set up essentially to offer such help, but these will presumably be dismantled after the crisis, and they are not well designed for serving investors’ broad needs. We need some permanent subsidies to get the full scope of financial advice out to the people.

2) Second, we need to broaden financial markets to improve risk management. We need sophisticated systems that will act as insurance plans against unexpected risks. The government could lead the way to a historic development of financial infrastructure.

3) Third, we need to change retail financial institutions, notably those that grant and service mortgages. Recent government policy has encouraged workouts for defaulting mortgages — again an impromptu, after-the-fact measure. These workouts should have been spelled out in the original of what I have called a "continuous workout mortgage." Then workouts could be systematic, automatic and free-market, with costs priced into the original mortgage rate.

Although these points are a bit general, it is encouraging to finally have a president in office who will listen to experts such as Robert Shiller. Bring back the experts!!

Some of the other economists with columns in today's Times (Sunday Business Section) can be read hear. Check 'em out!

"Chase recently received $25 billion in federal funding. What effect will that have on the business side and will it change our strategic lending policy?"

It was Oct. 17, just four days after JPMorgan Chase's chief executive, Jamie Dimon, agreed to take a $25 billion capital injection courtesy of the United States government, when a JPMorgan employee asked that question. It came toward the end of an employee-only conference call that had been largely devoted to meshing certain divisions of JPMorgan with its new acquisition, Washington Mutual.

The JPMorgan executive who was moderating the employee conference call didn't hesitate to answer a question that was pretty politically sensitive given the events of the previous few weeks.

What makes this exchange so interesting is that the JPMorgan official didn't know that the reporter was listening in to the exchange, and hence, was able to speak his mind truthfully:

In point of fact, the dirty little secret of the banking industry is that it has no intention of using the money to make new loans. But this executive was the first insider who’s been indiscreet enough to say it within earshot of a journalist.

(He didn’t mean to, of course, but I obtained the call-in number and listened to a recording.)

"Twenty-five billion dollars is obviously going to help the folks who are struggling more than Chase," he began. "What we do think it will help us do is perhaps be a little bit more active on the acquisition side or opportunistic side for some banks who are still struggling. And I would not assume that we are done on the acquisition side just because of the Washington Mutual and Bear Stearns mergers. I think there are going to be some great opportunities for us to grow in this environment, and I think we have an opportunity to use that $25 billion in that way and obviously depending on whether recession turns into depression or what happens in the future, you know, we have that as a backstop."

Read that answer as many times as you want -- you are not going to find a single word in there about making loans to help the American economy. On the contrary: at another point in the conference call, the same executive (who I’m not naming because he didn't know I would be listening in) explained that "loan dollars are down significantly." He added, "We would think that loan volume will continue to go down as we continue to tighten credit to fully reflect the high cost of pricing on the loan side." In other words JPMorgan has no intention of turning on the lending spigot.

And there you have it: these banks have no intention of increasing their lending, and there's nothing in the new legislation to force them to lend. How outrageous is that?

It is starting to appear as if one of Treasury's key rationales for the recapitalization program -- namely, that it will cause banks to start lending again -- is a fig leaf, Treasury's version of the weapons of mass destruction.

In fact, Treasury wants banks to acquire each other and is using its power to inject capital to force a new and wrenching round of bank consolidation. As Mark Landler reported in The New York Times earlier this week, "the government wants not only to stabilize the industry, but also to reshape it."

Friday delivered the first piece of evidence that this is, indeed, the plan. PNC announced that it was purchasing National City, an acquisition that will be greatly aided by the new tax break, which will allow it to immediately deduct any losses on National City's books.

Or as Nocera puts it: "I don’t know about you, but I’m starting to feel as if we’ve been sold a bill of goods."

For three decades we've artificially kept middle class wage increases far below the growth rate of the economy, and this trend has been even more pronounced over the past eight years. This has created an enormous pool of extra money that's been -- yes -- strip mined and redirected to the rich, and fixing this is Barack Obama's biggest and longest-term challenge. If we restore the normal growth of middle class wages, it provides a sustainable consumer base for the entire economy; it reduces the demand for endless credit card debt; it brings down income inequality naturally; and it goes a long way toward keeping the financial sector under control and reining in Wall Street salaries without putting in place a bunch of artificial (and probably fruitless) regulations.

He's really nailed the core problem with what's been going on in this country, and it's inception most likely dates back to 1980 and the Reagan revolution. This study, at the Center on Budget and Policy Priorities, shows that, indeed, the concentration of wealth in the top 1% hasn't been this extreme since 1929:

The jump in income concentration in 2005 brought the percentage of income going to the top 1 percent of households to its highest level since 1929. The top 1 percent of households (those with annual incomes above about $350,000 in 2005) garnered 47 percent -- nearly half -- of the total income gains in 2005. More than two thirds of total income gains accrued to those in the top decile (the highest-income 10 percent) of the income scale. Less than one third of total income gains went to the bottom 90 percent of households.

If the recession turns particularly nasty, we just might get that revolution everyone's been talking about, where Harlem invades The Upper East Side, for instance:

View Larger Map

Are they listening to the right guys, i.e. economists? These policy wonks spend their time trying to figure out solutions to great problems, so you'd think that the Washington policy-makers would be consulting them these days. Have they spoken with Luigi Zingales from the University of Chicago?

He's got a Plan B that makes a lot of sense:

After pointing a gun to the head of Congress, threatening a financial meltdown in case his plan was not approved, Treasury Secretary Hank Paulson has finally arrived at the only logical conclusion: his plan will not work.

Desperate for a Plan B, Paulson is slowly warming to the suggestion of many economists: inject some equity into the banking system. Unfortunately, it is too little and too late. The confidence crisis currently affecting the financial system is so severe that only a massive infusion of equity capital can reassure the market that the major banks will not fail, recreating the confidence for banks to lend to each other. The piecemeal approach of 100 billion today, 100 billion tomorrow used with AIG will not work. It will only eat up the money, without achieving the desired effect -- without reassuring the market that the worst is over. Simply stated, nothing short of a 5% increase in the equity capital of the banking system will do the trick. We are talking about 600 billion. Unfortunately, even if the government is willing to spend this kind of money, there are three problems.

He then discusses the three problems before focusing on the best solution:

We need a different solution: a Plan B. A plan that minimizes the money the Government uses in bailing out Wall Street and Main Street to save our precious dollars for a stimulus package, which will be essential to restarting the economy.

Suppose that you bought a house in California in 2006. You paid $400,000 with only 5% down. Unfortunately, during the last two years the value of your house dropped by 30%; thus, you now find yourself with a mortgage worth $380,000 and a house worth $280,000. Even if you can afford your monthly payment (and you probably cannot), why should you struggle to pay the mortgage when walking away will save you $100,000, more than most people can save in a lifetime? However, when the homeowner walks away, the mortgage holder does not recover $280,000. The foreclosure process takes some time during which the house is not properly maintained and further deteriorates in value. The recovery rate in standard mortgage foreclosures (which will not take place in the middle of the worst crisis since the Great Depression) is 50 cents per dollar of the mortgage. I am generous in estimating that under the current conditions it might recover 50 cents per dollar of the appraised value of the house; right now, it is only 37 cents per dollar of the mortgage, which given a house appraised at $280,000 equals only $140,000 for the mortgage holder. In other words, foreclosing is costly for both the borrower and the lender. The mortgage holder gains only half of what is lost by the homeowners, due to what we economists call underinvestment: the failure to maintain the house.

In the old days, when the mortgage was granted by your local bank, there was a simple solution to this tremendous inefficiency. The bank forgave part of your mortgage;let’s say 30%. This creates a small positive equity value—an incentive—for you to stay. Since you stay and maintain the house, the bank gets its $266,000 dollars of the new debt back, which trumps the $140,000 that it was getting through foreclosure.

Unfortunately, this win-win solution is not possible today. Your mortgage has been sold and repackaged in an asset-backed security pool and sold in tranches with different priorities. There is disagreement on who has the right to renegotiate and renegotiation might require the agreement of at least 60% of the debt holders, who are spread throughout the globe. This is not going to happen. Furthermore, unlike your local bank, distant debt holders cannot tell whether you are a good borrower who has been unlucky or somebody just trying to take advantage of the lender. In doubt, they do not want to cut the debt for fear that even the homeowners who can easily afford their mortgage will ask for debt forgiveness.

Here is where government intervention can help. Instead of pouring money to either side, the government should provide a standardized way to re-negotiate; one that is both fast and fair. Here is my proposal.

Congress should pass a law that makes a re-contracting option available to all homeowners living in a zip code where house prices dropped by more than 20% since the time they bought their property. Why? Because there is no reason to give a break to inhabitants of Charlotte, North Carolina, where house prices have risen 4% in the last two years.

And how is this implemented?

Thanks to two brilliant economists, Chip Case and Robert Shiller, we have reliable measures of house price changes at the zip code level. Thus, by using this real estate index, the re-contracting option will reduce the face value of the mortgage (and the corresponding interest payments) by the same percentage by which house prices have declined since the homeowner bought (or refinanced) his property. Exactly like in my hypothetical example above.

In exchange, however, the mortgage holder will receive some of the equity value of the house at the time it is sold. Until then, the homeowners will behave as if they own 100% of it. It is only at the time of sale that 50% of the difference between the selling price and the new value of the mortgage will be paid back to the mortgage holder. It seems a strange contract, but Stanford University successfully implemented a similar arrangement for its faculty: the university financed part of the house purchase in exchange for a fraction of the appreciation value at the time of exit.

The reason for this sharing of the benefits is twofold. On the one hand, it makes the renegotiation less appealing to the homeowners, making it unattractive to those not in need of it. For example, homeowners with a very large equity in their house (who do not need any restructuring because they are not at risk of default) will find it very costly to use this option because they will have to give up 50% of the value of their equity. Second, it reduces the cost of renegotiation for the lending institutions, which minimizes the problems in the financial system.

Since the option to renegotiate offered by the American Housing Rescue & Foreclosure Prevention Act does not seem to have been stimulus enough, this re­contracting will be forced on lenders, but it will be given as an option to homeowners, who will have to announce their intention in a relatively brief period of time.

The great benefit of this program is that provides relief to distressed homeowners at no cost to the Federal government and at the minimum possible cost for the mortgage holders. The other great benefit is that it will stop defaults on mortgages, eliminating the flood of houses on the market and thus reducing the downside pressure on real estate prices. By stabilizing the real estate market, this plan can help prevent further deterioration of financial institutions' balance sheets. But it will not resolve the problem of severe undercapitalization that these institutions are currently facing. For this we need the second part of the plan.

Let's hope that the guys in Washington are finally talking to these economists, because they are making a lot of sense right now...

Read the entire article...

The technical term for it is "negative feedback loop." The rest of us just call it a panic.

How else to explain yet another plunge in the stock market Tuesday that sent the Standard & Poor’s 500-stock index to its lowest level in five years -- particularly in the absence of another nasty surprise?

If anything, the markets should have been buoyed by the Federal Reserve saying it would shore up another troubled corner of finance by lending money directly to companies. Stocks did open higher, but then quickly tumbled as rumors swirled about the viability of big financial firms like Morgan Stanley and the Royal Bank of Scotland.

Indeed, the brain-stem instinct of "flight" - one half of the "fight-or-flight" instinct - is kicking in:

Fear is an immensely powerful force, perhaps more so than greed, said Andrew W. Lo, a professor at the Massachusetts Institute of Technology who has studied investor behavior.

Scientists who have studied the brain function have found that the amygdala, the part of the brain that controls fear, responds faster than the parts of the brain that handle cognitive functions, he said.

"Fear is a much stronger motivational force," Mr. Lo added. "The loss of $1,000 has a much bigger impact than the gain of a $1,000."

Read the entire fascinating article, and if you have investments, now is the absolute worst time to sell them (if you don't have to). And if you have some extra cash, it just might be a good time to start buying from all those poor souls who are being forced to sell - by their inner animal fleeing fear...

Washington Mutual, the giant lender that came to symbolize the excesses of the mortgage boom, was seized by federal regulators on Thursday night, in what is by far the largest bank failure in American history. Regulators simultaneously brokered an emergency sale of virtually all of Washington Mutual, the nation’s largest savings and loan, to JPMorgan Chase for $1.9 billion, averting another potentially huge taxpayer bill for the rescue of a failing institution.

No big deal, right? These failures are a dime-a-dozen these days, so we're led to believe. But the truth is that WaMu was TEN times as large as the IndyBank failure of last month - 10 Times. $300 Billion Large.

That is huge.

But what is really huge is what the new CEO, Alan Fishman, will make off with. He's been on the job for THREE weeks. That's right...3 weeks. And his take home pay will be $19 million:

Mr. Fishman, who has been on the job for less than three weeks, is eligible for $11.6 million in cash severance and will get to keep his $7.5 million signing bonus, according to an analysis by James F. Reda and Associates.

Not only will this go down as the largest bank failure in history, but it's got to go down as the biggest heist of share holders by any CEO in the history of America. Remember, the shareholders are left with worthless pieces of paper - the stock is now at $0.00 - but this scumbag, Fishman, will take home $19 million.

That is beyond grotesque.

And yet in the three page summary that they sent Congress on Thursday it says this:

Section 8. Review: Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Is this the final looting of the U.S. Treasury before the Bush Reign of Error comes to an end?

Paul Krugman is worried:

Whoa -- it seems that Ben Bernanke ditched his prepared testimony and, instead, let the cat at least partly out of the bag.

"I believe that under the Treasury program, auctions and other mechanisms could be devised that will give the market good information on what the hold-to-maturity price is for a large class of mortgage-related assets. If the Treasury bids for and then buys assets at a price close to the hold-to-maturity price, there will be substantial benefits.

First, banks will have a basis for valuing those assets and will not have to use fire sale prices. Their capital will not be unreasonably marked down..."

As I wrote earlier this morning, the whole "take these assets off the balance sheets" line is fundamentally disingenuous; the key question is what price Treasury pays for the assets. And here we have Bernanke effectively saying that it's going to pay above-market prices -- prices that allegedly reflect "hold-to-maturity" value, but still more than private investors are willing to pay.

What is going on here?

The U.S. government will take control of Fannie Mae and Freddie Mac after the biggest surge in mortgage defaults in at least three decades threatened to bring down the companies making up almost half the U.S. home-loan market.

"We have determined that it is necessary to take action,"' Treasury Secretary Henry Paulson, who engineered the takeover along with Federal Housing Finance Agency Director James Lockhart, said in a statement today. "Our economy and our markets will not recover until the bulk of this housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner on housing."

Lockhart said his agency has placed Fannie Mae and Freddie Mac into conservatorship. This was because the companies "cannot continue to operate safely and soundly and fulfill their critical public mission without significant action to address our concerns," he said in a statement.

Why is this happening now? Well, it seems that the two quasi-public companies haven't been so forthcoming after all. Is that a surprise?

Last week, advisers from Morgan Stanley hired by the Treasury Department to scrutinize the companies came to a troubling conclusion: Freddie Mac's capital position was worse than initially imagined, according to people briefed on those findings. The company had made decisions that, while not necessarily in violation of accounting rules, had the effect of overstating the companies' capital resources and financial stability. One person briefed on the company's finances said Freddie Mac had made accounting decisions that pushed losses into the future and postponed a capital shortfall until the fourth quarter of this year, which would not need to be disclosed until early 2009.

The details are staggering:

Accusations of questionable accounting are not new for either company. Earlier this decade, both companies paid large fines and ousted their top executives after accounting scandals.

Freddie Mac's current chief executive and chairman, Richard F. Syron, joined the company in 2003 after the former managers revealed that they had manipulated earnings by almost $5 billion. The next year, Fannie Mae's chief executive, Daniel H. Mudd, was promoted to the top spot after that company was accused of accounting errors totaling $6.3 billion.

The accounting issues that brought so much urgency to the bailout appear to center on Freddie Mac’s capital cushion, the assets that regulators require them to keep on hand to cover losses.

The methods used to bolster that cushion have caused serious concerns among the companies' regulator, outside auditors and some investors. For example, while Freddie Mac's portfolio contains many securities backed by subprime loans, made to the riskiest borrowers, and alt-A loans, one step up on the risk ladder, the company has not written down the value of many of those loans to reflect current market prices.

Executives have said that they intend to hold the loans to maturity, meaning they will be worth more, and they need not write down their value. But other financial institutions have written down similar securities, to comply with "mark-to-market" accounting rules. Freddie Mac holds roughly twice as many of those securities as Fannie Mae.

And this accounting scam is particularly disgusting (why, exactly, is this legal?):

Freddie Mac and Fannie Mae have also inflated their financial positions by relying on deferred-tax assets -- credits accumulated over the years that can be used to offset future profits. Fannie maintains that its worth is increased by $36 billion through such credits, and Freddie argues that it has a $28 billion benefit.

But such credits have no value unless the companies generate profits. They have failed to do so over the last four quarters and seem increasingly unlikely to the next year. Moreover, even when the companies had soaring profits, such credits often could not be used. That is because the companies were already able to offset taxes with other credits for affordable housing.

Most financial institutions are not allowed to count such credits as assets. The credits cannot be sold and would disappear in a receivership. Removing those credits from assets would probably push both companies’ capital below the regulatory requirements.

What exactly does this mean for those involved, from shareholders to bond holders to the U.S. taxpayer? It's not entirely clear, although you can bet that regular shareholders will be wiped out but foreign governments will get their money back - all courtesy of you and me:

Investors who own the companies’ common and preferred stock will suffer. Holders of debt, including many foreign central banks, are expected to receive government backing. Top executives of both companies will be pushed out, according to those briefed on the plan.

The cost of the government's intervention could rise into tens of billions of dollars and will probably be among the most expensive rescues ever financed by taxpayers.

But the repercussions across the economy aren't entirely known. Gretchen Morgenson, from the NY Times, has been following this issue diligently over the past year, and she points out one particular area which is likely to suffer:

The potential effects of a rescue become more complex for the holders of Fannie's and Freddie's $19 billion in subordinated debt, so-called because it ranks below other bonds in the companies' capital structures.

As UBS analysts point out, because Fannie's and Freddie's subordinated debt is used when they calculate capital -- the financial cushion regulators require to support the companies' operations -- interest payments on the debt may have to stop if a bailout occurs. Such a hiatus could last up to five years.

While this would hurt subordinated debt holders, a deferral of interest payments has even broader ramifications. Halting those payments would put the bonds into default and force payouts on credit insurance that has already been written. In the debt market, this is known as a "credit event."

Starting today, it looks like this "credit event" will now play itself out:

"If we reasonably assume that the Treasury would only intervene in the event that Fannie or Freddie is declared significantly under capitalized by its regulator," UBS analysts wrote, "then interest payments on the qualifying subordinated debt is automatically deferred for up to five years."

Because nonpayment of interest would be seen as a credit event, UBS added, entities that have bought protection on Fannie’s and Freddie's subordinated debt would be entitled to payment by the entities that wrote the insurance. This, even though taxpayers are standing behind Fannie's and Freddie's debt, not allowing it to fail. Talk about the laws of unintended consequences.

The problem now is that we don't know how far the ripple effect of losses will extend. And the reason we don't know that is because there are literally trillions of dollars of insurance issued to holders in case a credit event like this happens (they are called credit default swaps). But we don't know who owns what kind of securities, since most of the transactions are not publicly traded. That is, most of these gargantuan bets were made between investment houses and hedge funds that weren't required to reveal them to the public, since we live in a society that doesn't value regulation by the government. It seems like we're still paying the price for the Reagan Revolution from the '80's:

It is not clear how much insurance has been written on the subordinated debt. The actual holders of the debt very likely hedged their stakes with credit insurance, which is intended to protect buyers in the event of a default.

But speculators may have bought credit default swaps on the companies' subordinated debt even if they did not own any of the debt. A gutsier gamble than selling short Fannie or Freddie shares, buying credit insurance on the companies’ debt was essentially a bet against the implicit government guarantee that many felt was backing all the companies' obligations.

Because of the implied guarantee -- and the belief that it meant they would never have to pay out on the swaps -- sellers of credit insurance may have been overly eager to write contracts on Fannie's and Freddie's debt.

So the burning questions are these: Who wrote the insurance and do they have the money to pay those who bought it? If they don’t, what happens?

If the market for credit insurance were more transparent, we might know the answers. But these deals are private and largely hidden from view.

Finally, we have the scenario that the Federal Government will step in to make the parties unwind their positions, with one side getting off scott free and the other side taking massive losses:

It is possible, of course, that a Mac 'n' Mae bailout will be structured so as not to force credit default swap payouts. Or regulators could step in and require parties on both sides of the Fannie and Freddie credit insurance trade to unwind their stakes at heavily discounted levels. Such has been the nature of recent deals struck by financial guarantors like Ambac at the behest of the New York State Insurance Department. In one deal, the credit default swap buyer got just 13 cents on the dollar; in another deal, the buyer got 61 cents.

If regulators make such a move related to Fannie and Freddie, sellers of the insurance could escape dire financial problems associated with paying on the claims. But buyers of credit protection are apt to get far less than they think they are owed on the insurance. And if they have written the values of their holdings way up to reflect the increased likelihood of a default event, they will soon have to write them down again.

Remember, this is just one aspect of this bailout, where there are literally trillions of dollars at stake. It's indeed staggering.

Oh yeah, one other staggering part of this story: Richard Syron, Freddie Mac's CEO, has collected more than $38 million on compensation since he joined the company in 2003. $38 million.

Do you think he'll give any of it back?

Even though traders on the floor will tell you that commodities are driven by huge hedge fund speculators now, this much speculation is a shocker:

Regulators had long classified a private Swiss energy conglomerate called Vitol as a trader that primarily helped industrial firms that needed oil to run their businesses.

But when the Commodity Futures Trading Commission examined Vitol's books last month, it found that the firm was in fact more of a speculator, holding oil contracts as a profit-making investment rather than a means of lining up the actual delivery of fuel. Even more surprising to the commodities markets was the massive size of Vitol's portfolio -- at one point in July, the firm held 11 percent of all the oil contracts on the regulated New York Mercantile Exchange.

The CFTC, which learned about the nature of Vitol's activities only after making an unusual request for data from the firm, now reports that financial firms speculating for their clients or for themselves account for about 81 percent of the oil contracts on NYMEX, a far bigger share than had previously been stated by the agency.

This article should reveal to all Americans that our system of unfettered markets has now officially screwed us all. It's a fascinating read, starting with this:

To build up the vast holdings this practice entails, some swap dealers have maneuvered behind the scenes, exploiting their political influence and gaps in oversight to gain exemptions from regulatory limits and permission to set up new, unregulated markets. Many big traders are active not only on NYMEX but also on private and overseas markets beyond the CFTC's purview. These openings have given the firms nearly unfettered access to the trading of vital goods, including oil, cotton and corn.

The commodities industry had long been regulated:

For most of the past century, regulators put limits on financial actors to prevent them from dominating commodity exchanges, which were much smaller than the bond or stock markets. Only commercial operations, such as farms, airlines, manufacturers and the middlemen that handle their trading activities, were allowed to buy nearly unlimited quantities. The goal was to allow these businesses to minimize the effect of price swings.

But something strange happened in 1991, then again in 2000:

The first major change to this regulatory framework occurred in 1991, when Goldman Sachs, through a subsidiary called J. Aron, argued that it should be granted the same exemption given to commercial traders because its business of buying commodities on behalf of investors was similar to the middlemen who broker commodity transactions for commercial firms.

The CFTC granted this request. More exemptions soon followed, including one to the Houston-based energy trader Enron.

A second turning point came when Congress passed the Commodity Futures Modernization Act of 2000. The law formally allowed investors to trade energy commodities on private electronic platforms outside the purview of regulators. Critics have called this piece of legislation the "Enron loophole," saying Enron played a role in crafting it.

In the months after the act was passed, private electronic trading platforms sprang up across the country, challenging the dominance of NYMEX.

And how much did this industry grow over the past five years? Can you say 2000%? It's absolutely stunning:

Using swap dealers as middlemen, investment funds have poured into the commodity markets, raising their holdings to $260 billion this year from $13 billion in 2003. During that same period, the price of crude oil rose unabated every year.

CFTC data show that at the end of July, just four swap dealers held one-third of all NYMEX oil contracts that bet prices would increase. Dealers make trades that forecast prices will either rise or fall. Energy analysts say these data are evidence of the concentration of power in the markets.

So now, with this article, it should be clear to every layman why he or she is spending record amounts at the pump: Our government, starting in 1991 and then again in 2000, sold out its traditional regulatory role to its rich Wall Street benefactors, at the expense of all of us. Coupled with the natural growth of the world population, you have a recipe for higher and higher prices:

In the coming years, commodity investments by funds could grow to $1 trillion, veteran hedge fund manager Michael Masters said in testimony before the Senate earlier this year. In an interview, he said this trend could raise commodity prices for everyone in the coming years and "have catastrophic economic effects on millions of already stressed U.S. consumers."

Just think of that every time you fill up at the gas station or buy that loaf of bread or bag of rice. And, most importantly, think about it when you enter that voting booth in November. If you think prices are high now, you can rest assured that they are guaranteed to go higher under a McCain presidency as he continues to reduce government regulation even beyond its minuscule role now...

The ant works hard all summer, socking away provisions for the winter; the grasshopper frolics away each day. The ant warns the grasshopper that he's being hedonistic and short-sighted. The grasshopper ignores the ant, and continues on his merry way -- only to perish when winter sets in.

It's a rather stern lesson about financial prudence, but there is a reason this tale has survived through the ages -- and still preoccupies many researchers who study the eccentricities of human economic behavior. Why do the grasshoppers of the world have such a hard time emulating the ants?

It's an old story that a few economists have tried to explain:

Yet economic research has demonstrated that most people find it hard to resist the siren song of "seize the day and spend what you have now" -- even though a lifestyle based on constant consumption doesn't enhance anyone's long-term store of happiness and often puts people on shaky financial ground.

This conundrum also bedevils those who work in the field of personal finance. Why do millions of Americans resist saving for their retirements? Why do so many carry thousands of dollars in credit card debt?

Indeed, the article uncovers research for some pretty plain and simple advice: focus on what makes you happy, since investing in your well-being and quality of life go a long way towards a more fulfilling life:

Tim Kasser, an associate professor of psychology at Knox College in Galesburg, Ill., studied 200 people who embraced Voluntary Simplicity, a movement focused "less on materialistic values -- like wanting money and possessions and status -- and more on what we called intrinsic values or goals," Professor Kasser said. The three main intrinsic values were being connected to family and friends, exploring one's interests or skills and "making the world a better place," he said.

Essentially what they found was that a life focused on those three things is more fulfilling then a life of consumption:

The study found that when people invested more in intrinsic values, like relationships and quality of life, and less in consumption, it seemed to increase their happiness. And, the study suggested, there may be a financial gain to doing so. Those in the simplicity group were far more likely than the control group to say that they were careful about their spending, Professor Kasser said.

Live simply, save money, be happier. Indeed, one of the best bumper stickers ever made said, "The secret to happiness is keeping your expenses low."

Amen!

For more resources to explore, go to the Simplicity Forum and check out what they've got to say...

One particularly egregious example is in the Auction Rate Securities market. If you haven't heard of Auction Rate Securities, it's probably because you had no need for them. But this $200 billion market seized up earlier in the year when the credit crises hit, and millions of investors have been unable to retrieve their money from big banks across the nation even though they were told that the money was good as cash:

Beginning on Thursday, February 7th, 2008, auctions for these securities began to fail when investors declined to bid on the securities. The four largest investment banks who make a market in these securities (Citigroup, UBS AG, Morgan Stanley and Merrill Lynch) declined to act as bidders of last resort, as they had in the past. This was a result of the scope and size of the market failure, combined with these own firm's need to protect their capital during the 2008 financial crisis.[citation needed]

On February 13 (2008) 80% of auctions failed. On February 20th, 62% failed (395 out of 641 auctions). As a comparison, from 1984 until the end of 2007, there were a total of 44 failed auctions.

Essentially, what had been a normal market, where investors could redeem their money at any time turned into a nightmare because most of the banks that provided liquidity in the past decided not to provide that service anymore. Hence, the Attorney General of New York, Mario Cuomo, had to step in and sue Citigroup in order to make them cough up the dough:

Citigroup Inc. (C) (C) will buy back more than $7 billion in auction-rate securities and pay $100 million in fines as part of settlements with federal and state regulators announced Thursday.

Citigroup will buy back the securities from tens of thousands of investors nationwide under separate accords with the Securities and Exchange Commission, New York Attorney General Andrew Cuomo and other state regulators. The buybacks will have to be completed by November.

The nation's largest financial institution also will pay a $50 million civil penalty to New York state and a separate $50 million civil penalty to the North American Securities Administrators Association, which represents securities regulators in the 50 states and the District of Columbia.

The SEC also will consider levying a fine on Citigroup, the agency's enforcement director Linda Thomsen, said at a news conference.

So here we have an example of government stepping in to protect and retrieve the people's money, since there was no law that stated that Citigroup had to pony up the money to redeem the auction rate securities.

Thank god we have government on our side working for us, right?

Countless studies have addressed this question, and have concluded that very few managers have the ability to beat the market over the long term. Nevertheless, researchers have been unable to agree on how small that minority really is, and on whether it makes sense for investors to try to beat the market by buying shares of actively managed mutual funds.

Yet, there is a new study out that...

...builds on this research by applying a sensitive statistical test borrowed from outside the investment world. It comes to a rather sad conclusion: There was once a small number of fund managers with genuine market-beating abilities, as judged by having past performance so good that their records could not be attributed to luck alone. But virtually none remain today. Index funds are the only rational alternative for almost all mutual fund investors, according to the study's findings.

The study, "False Discoveries in Mutual Fund Performance: Measuring Luck in Estimating Alphas," has been circulating for over a year in academic circles. Its authors are Laurent Barras, a visiting researcher at Imperial College’s Tanaka Business School in London; Olivier Scaillet, a professor of financial econometrics at the University of Geneva and the Swiss Finance Institute; and Russ Wermers, a finance professor at the University of Maryland.

You can read the nitty gritty of the research, but the crux of the story is that fund managers used to be more successful picking stocks that beat the market but have since faded in their ability to beat the market. The reasons for this decline could be due to a number of factors:

Professor Wermers says he and his co-authors suspect various causes. One is high fees and expenses. The researchers' tests found that, on a pre-expense basis, 9.6 percent of mutual fund managers in 2006 showed genuine market-beating ability -- far higher than the 0.6 percent after expenses were taken into account. This suggests that one in 10 managers may still have market-beating ability. It's just that they can't come out ahead after all their funds' fees and expenses are paid.

Another possible factor is that many skilled managers have gone to the hedge fund world. Yet a third potential reason is that the market has become more efficient, so it's harder to identify undervalued or overvalued stocks. Whatever the causes, the investment implications of the study are the same: buy and hold an index fund benchmarked to the broad stock market.

And has this study affected the researchers use of mutual funds?

Professor Wermers says his advice has evolved significantly as a result of this study. Until now, he says, he wouldn't have tried to discourage a sophisticated investor from trying to pick a mutual fund that would outperform the market. Now, he says, "it seems almost hopeless."

Hopeless? Hmmm...just like the stock market feels these days...

The food industry pressured the Bush administration years ago to limit the paperwork companies would have to keep to help U.S. health investigators quickly trace produce that sickens consumers.

The White House also killed a plan to require the industry to maintain electronic tracking records that could be reviewed easily during a crisis to search for an outbreak's source. Companies complained the proposals were too burdensome and costly, and warned they could disrupt the availability of consumers' favorite foods.

The apparent but unintended consequences of the lobbying success: a paper record-keeping system that has slowed investigators, with estimated business losses of $250 million. So far, nearly 1,300 people in 43 states, the District of Columbia and Canada have been sickened by salmonella since April.

How do we know that the FDA was bought off?

A former member of Bush's Cabinet and three former senior officials in the Food and Drug Administration told the AP that government food safety experts did not get the strong record-keeping and trace-back system originally proposed under a bioterrorism law to cope with a major foodborne illness.

"In retrospect, yes, if they (the regulations) had been broader and a bit more far-reaching, it could have helped with this," said Robert Brackett, senior vice president of the Grocery Manufacturers Association. "It wouldn't have hurt, for sure." Brackett formerly was a top safety official at the FDA.

Did you get that? The proposed system was part of a new bioterrorism law created to track attacks on this country by terrorists using food-borne illnesses. And our money-driven culture allowed Big Business to buy off our safety:

According to government records reviewed by the AP, business groups met at least 10 times with the White House between March 2003 and March 2004, as the FDA regulations were under debate. Food industry lobbyists successfully blunted proposals using arguments familiar in other regulatory debates: The government's plans would saddle business with unnecessary and costly regulations.

"The FDA's strong proposed bioterrorism rules were significantly watered down before they became final," said Caroline Smith DeWaal, food safety director at the Washington-based Center for Science in the Public Interest. The private advocacy group obtained the White House meeting records under the Freedom of Information Act and provided them to the AP.

Even then Health Secretary, Tommy Thompson, acknowledges that the government was bought off:

"We went in with the larger package but knew we had to compromise," Thompson told the AP. "I was satisfied with this being the first step. It's always better to be a Monday morning quarterback. We could have ended up with nothing. If we had more, would it help the situation now? Yes."

And why exactly did they have to compromise? Because the following food companies were buying off our officials so that they would dilute the new paperwork-tracking system, thereby saving these corporations money:

Participants in the meetings included companies and trade groups up and down the food chain, including Altria Group Inc. (MO) and Kraft Foods Inc. (KFT), when Altria was Kraft's parent; The Kroger Co. (KR); Safeway Inc. (SWY); ConAgra Foods Inc. (CAG); The Procter & Gamble Co. (PG); the American Forest and Paper Association; the Polystyrene Packaging Council; the Glass Packaging Institute; the Cocoa Merchants' Association of America; the World Shipping Council; and the Food Marketing Institute.

This story is just one of many that shows how our devotion to a profit-driven society can easily lead to our own destruction.

We're lucky that the current salmonella outbreak is not of a nefarious origin. We may not be as lucky next time.

In a capitalist economy, losers are expected to take losses and winners to gain. Private enterprise is best able to allocate capital efficiently and, where it fails to do so, markets make adjustments and capital is reallocated to efficient users. This basic tenet supports good and productive assets moving from the hands of weak players to stronger. Where this is not possible, the US system gives the government a hand in fostering that move through an efficient process called bankruptcy or reorganisation. This rule of markets and of law has always been the basis of our national supremacy in innovation and the reason ours was the world’s clear choice of a reserve currency. That was the world we lived in previously.

He goes on to detail the mission of Freddie and Fannie:

The core of the GSEs’ (Freddie and Fannie) mission is to purchase mortgages from mortgage originators, charge a guarantee fee to issuers to protect their ability to stand behind these loans, and securitise these mortgage-backed securities with assurances to MBS holders they would receive 100 per cent of their anticipated returns. To this end the GSEs have guaranteed $3.5 Trillion in mortgage-backed securities These securities are backed by real housing assets and there is little question that, assuming they are well serviced, there will be relatively little loss over a longer period.

So far so good. The problem is that the GSE's got in a little trouble when they started dabbling in businesses from which they should have stayed away:

Over the past decade the GSEs have increasingly used their portfolios to speculate in aircraft leasing, manufactured housing, interest-only mortgages and other securities they are specifically prohibited from buying as part of their mission. In recent years, through these portfolios they funded nearly 50 per cent of the riskier private label Alt-A mortgage market, invested in aircraft lease securities, manufactured housing and other assets that leveraged them into trouble. To achieve this speculative, hedge fund-like growth they issued almost $1.5 Trillion of senior corporate debt. By their investments, debt buyers supported speculation in non-mission-related activities and did so with a clear understanding they were funding non-mission-related activities. They also knew GSE debt was explicitly not an obligation of the US taxpayer and that was repeated constantly by the government and the companies.

And so now we have the U.S. taxpayer bailing out the same management team that is almost criminally culpable. It's called "privatizing the gains and socializing the losses." What comes after this is even more massive U.S. Government debt which means a further weakening of the dollar which will inevitably lead to $200/barrel oil and $10/gallon gasoline.

Look out below...