Financial Armageddon

Ensure You Are FDIC-Insured

Although I believe that FDIC insurance will ultimately prove worthless, that moment is probably some years away.

In the meantime, it makes no sense whatsoever to deposit more than the FDIC-insured limit in any one bank. That is just asking for trouble, especially given the fact that things are only going to get worse as far as banks are concerned.

For those who profess to be relaxed about such things, let the following post from the Bank Deals blog, "$400,000 of Deposits at a Failed Bank, First-Hand Experience at ANB Financial," be a warning.

One of this blog's readers was a depositor at the failed bank ANB Financial, and he has emailed me his experience to share. I reported on this bank failure Friday after the FDIC sent out its press release. He and his wife had opened a $400,000 CD last summer at this bank. He thought he was covered since he was careful to open the CD in the proper ownership category. However, when he read about the bank failure on Sunday, it did ruin his weekened. What if there was some esoteric mistake in the bank's documentation that put the money at risk?

The good news is that his diligence when he opened the CD paid off. The $400,000 was insured, and they were able to receive the funds on Monday after several nerve-racking hours at the bank. Here is how he described this time:

We spent 3 hours there inside the bank calling various phone numbers and being mostly told, "the information you have received is erroneous." No one took any responsibility for getting the money to us. Finally, one of the FDIC team members inside the bank decided to personally intervene on our behalf. Within about 45 minutes, we had correctly navigated the maze and wire transfer form had been fax'd to the correct location and authority to effect the transfer.

The bad news is that the interest earned was not covered. The CD had earned almost $15,000 in interest, and this put the total amount above $400,000. The FDIC claims agent told them that they'll receive a "receiver's certificate" within 30 days and that they may someday receive something back.

Why have over $100,000 in one bank? Sometimes this happens when people just forget, and the money keeps growing until it exceeds $100,000. However, in this case the reader was taking advantage of a 5.82% APY CD special. I had reported on this special last September.

If you're going to take advantage of similar deals with deposits over $100,000, you should be interested in what he has learned. I describe these lessons below along with some other potential issues that I've learned over the last few years from other readers.

Be Very Careful When You Go Above $100,000

It's not common knowledge, but you can have over $100,000 FDIC insurance for a non-retirement account at one bank. The FDIC defines many different ownership categories. An account that falls into one of these ownership categories can have more than $100,000 of coverage if the account meets the applicable requirements. You should be very careful to ensure these requirements are met, and you shouldn't assume that your bank is taking care of this.

The ownership category that the reader and his wife used was a revocable trust account. This FDIC page provides the formal definition of a revocable trust account. A subset of this account is a payable-on-death (POD) account. The owner of a POD account is insured up to $100,000 for each beneficiary if 3 specific requirements are met. This FDIC page describes these requirements.

Account Title Requirement

The first of these 3 requirements can be problematic. The requirement states that the account title must include a commonly accepted term such as "payable-on-death," "in trust for," "as trustee for" or similar language to indicate the existence of a trust relationship. The term may be abbreviated (for example "POD," "ITF" or "ATF").

The problem is that banks often do not include the POD or similar term in the account title. This almost happened to the reader. Here's what the reader reported:

Because of your FDIC insurance warnings and advice we were VERY hardnosed about correctly titling the accounts. In fact, the bank almost refused to correctly title the two POD's but we told them we would "walk" if they didn't. They finally relented and titled them exactly the way they were supposed to be titled.

This seems to be a common problem among banks. Last year another reader reported having problems with Countrywide Bank. He had applied for Countrywide's Savingslink account, and in the application, he listed two beneficiaries. The problem was that these beneficiaries were not officially added to the account titled as POD's. So if you are depending on POD's to extend your FDIC coverage over $100,000, make sure you verify the proper account title.

What Happens if a Beneficiary Dies

In addition to the account title, there are also other issues that could reduce your FDIC coverage. If the POD beneficiary dies, the coverage is reduced immediately. Example #18 of this FDIC page describes this.

Joint Accounts and Signature Cards

Thanks to an investigation by another reader, I just learned of another potential issue that could reduce your FDIC coverage. This one involves joint accounts. As described at this FDIC page, a joint account for a husband and wife can qualify for $200,000 in FDIC coverage. Note the three conditions listed at that FDIC page which must be met. One of the conditions that applies to savings accounts states "Each co-owner must personally sign the account signature card." This concerned the reader when he had applied for an Indymac money market account since it can take several weeks before you receive the signature card from Indymac. The reader recommended that you stay under $100,000 during this period. Below is what he received from the FDIC:

If the joint account is opended as a Market Market Deposit Account (MMDA), then it is important to have all owners of the deposit sign the signature card, otherwise if the bank were to fail the FDIC could make the determination the account is insured under the single ownership category in your name only for up to a total of $100,000.

He was also concerned about online banks that do not require a paper signature card. According to the FDIC representative, "the attachment or use of an electronic signature does satisfy the FDIC requirements for deposits including joint accounts." So you should be safe with online joint money market accounts that only have electronic signatures.

Make Sure You Consider the Accumulated Interest

Unfortunately, the reader with the ANB Financial CD may lose the interest he earned. He had let the interest be added back into the principal of the CD, and the total balance exceeded the $400,000 insured limit.

If you specify that interest payments are to be added to the principal, make sure the total amount will always remain under the insurance limit during the entire CD term. Most banks also allow you to withdraw interest without penalties. Another option is to specify that interest be paid to you by check or be transfered to another bank.

Monitor Your Banks

One more lesson the reader mentioned was to carefully monitor your bank's condition. This is a good idea, but I wouldn't recommend this as an alternative to maintaining deposits under the FDIC limits. The bank's financial data that is publicly available is often at least 3 months old. The safety ratings issued by Bankrate and BauerFinacial are even older than this. You may be able to pick up on other clues that show the bank is in trouble, but these signs can be easy to miss.

Summary

In summary, the reader provided the following lessons learned which sums up many of the above details:

• Be a bulldog on FDIC requirements for account titling. Do NOT take the word of any CSR such as "Don't worry, it's OK." Make certain the accounts are titled exactly as required.
• Monitor your bank's evolving condition.
• Withdraw interest at every available opportunity and put it somewhere else. Whatever little pittance you might gain through compounding pales in comparison to the total loss of your interest!

For more information and links on FDIC coverage and on NCUA coverage for credit unions, please refer to my post from last year. I have a short list of important FDIC and NCUA links in this post.

Thanks to this reader who emailed me his experience with ANB Financial. Also, thanks to the reader who informed me about the Joint Account issue, and other readers who shared their experience on FDIC insurance issues.

Freddie Mac Freak Show

I've know I've spent a bit of time writing about government-sponsored enterprises lately, but yesterday's reaction to Freddie Mac's results was truly a sight to behold.

In my view, the fund managers who drove the stock higher should hand in their notices at the first opportunity, because they clearly have lost touch with reality.

Even if -- and I don't rule out this possibility -- the government eventually steps in and rescues either one or both of them, the odds that shareholders will survive unscathed must surely be close to nil.

Anyway, in "Freddie Mac Posts Quarterly Loss Tempered by Accounting Techniques," Charles Duhigg of the New York Times reports on yesterday's freak show [italics mine]:

Freddie Mac, one of the nation’s largest buyers of home loans, announced a fresh wave of bad news Wednesday, disclosing losses that were smaller than expected only because of accounting tactics that minimized the effects of bad loans.

Yet investors cheered the results anyway, and pushed the company’s shares up by more than 9 percent, to close at $27.25. The company’s regulator, which only a month ago chastised Freddie Mac for questionable accounting policies, also recognized the results by reducing the size of the company’s financial safety cushion.

Much like its rival Fannie Mae, whose share price rose last week after it reported enormous losses, Freddie Mac’s performance on Wednesday reinforced the idea that investors have become convinced that Freddie and Fannie are too important for either to fail.

Put another way, even bad news can be good, as long as the federal government needs to bolster an ailing housing market.

“Both these companies are clearly going to be insolvent by the end of the year, but everyone knows that Congress will do anything to keep them afloat, because if Fannie and Freddie go under, the entire global financial system will melt down,” said Christopher Whalen, a founder of Institutional Risk Analytics, an independent research firm. “These companies’ earnings don’t matter. Their accounting hardly matters. People buy the stock because they believe the federal government will bail them both out if things get really bad.”

Freddie Mac, which announced a first-quarter net loss of $151 million on Wednesday, disputes that it will become insolvent and argued that optimism was warranted because it is positioned to snap up the best and safest loans in the marketplace. (Fannie Mae made similar arguments last week.) Freddie Mac will seek $5.5 billion in fresh capital from investors, largely to pursue these opportunities, executives said.

“We are confident that the capital we are raising will both allow us to achieve our mission to both the public and to shareholders,” Freddie Mac’s chief executive, Richard Syron, said in a conference call with analysts. The chief financial officer, Buddy Piszel, said he expected the company’s credit guarantee business to grow by as much as 20 percent this year and other parts of Freddie Mac to grow by more than 30 percent.

But executives also said they expected housing prices to continue to decline, as well as combined credit losses of more than $6 billion through 2009 from borrowers who do not pay their mortgages on time. Moody’s Investors Service downgraded Freddie Mac’s financial strength rating on Wednesday, projecting that the company will have up to $7.5 billion in losses from bad mortgages over the next two years.

“It’s clear we have not yet hit bottom in the housing market,” Mr. Syron said.

Freddie Mac and Fannie Mae are essential lubricants in the housing marketplace. The companies buy more than 80 percent of all home loans made by banks and lenders, providing fresh financing for more home mortgages.

Because of their importance, the companies have traditionally received much more leniency than other banks and lenders. Their combined financial cushion — $83 billion at the end of 2007, underpinning $5 trillion in debt and other financial commitments — is much thinner than at other financial firms.

And some analysts say the cushion at Freddie Mac would be thinner still if it were not for accounting tactics. Executives explained on Wednesday that accounting techniques had allowed the company to reduce its credit losses by $1.3 billion. Other accounting methods let the company pick and choose which assets and liabilities to measure at market value, adding $1 billion to retained earnings.

A spokesman for the company, Michael L. Cosgrove, said those accounting methods were proper and withstood the scrutiny of multiple parties, including an auditor.

But last month, the company’s regulator, the Office of Federal Housing Enterprise Oversight, was critical of some of those accounting choices in a report to Congress. That regulator, however, is dependent upon Freddie Mac’s cooperation in helping to combat the unfolding housing crisis.

On Wednesday, the regulator said that it was decreasing the mandatory size of Freddie Mac’s financial cushion by 5 percent and that it would decrease it by another 5 percent in September as long as the company registers with the Securities and Exchange Commission and fulfills other basic requirements.

The company said it planned to register with the S.E.C. by August.

While Freddie Mac’s results seemed not to trouble Wall Street, it is likely they will cause some raised eyebrows in Congress, where lawmakers are debating wide-ranging reforms on how Freddie and Fannie are regulated. Legislation has already passed the House, and on Thursday the Senate Banking Committee is expected to vote on a reform bill.

What the Senate bill will contain, however, is still uncertain, according to people close to the negotiations, who spoke on the condition of anonymity to avoid upstaging their bosses. While Republicans are pushing for legislation that would allow regulators to rein in Freddie and Fannie for a multitude of reasons, Democrats are hoping to place greater restraints on the regulator’s powers.

As an added bonus, I've included a list (from Bloomberg) of the top 10 holders (based on the most recently available filing data) of Fannie Mae and Freddie Mac stock. I'd love to hear their explanations -- excuses? rationalizations? -- why they own so many shares of companies whose prospects are so poor (click on image to enlarge).

Is It Any Wonder?

Investors keep hoping for a happy ending, but the facts suggest otherwise.

The nation's largest mortage lenders don't have nearly enough capital, they are heavily exposed to a housing market that remains in free fall, and they have a mission that is muddled by political, social and commercial interests.

Aside from that, they have grown to a size that has made them unwieldy and unstable.

Is it any wonder that we are seeing reports like the following, "Fannie and Freddie Capital Alert." from the Financial Times?

The government-backed mortgage companies that finance the bulk of new US home loans may not have enough capital to withstand the plunge in the country's housing market, according to one of Washington's most senior financial legislators.

In an interview with the Financial Times, Richard Shelby, the senior Republican on the Senate banking committee, said Fannie Mae and Freddie Mac were "thinly capitalised, highly leveraged and pose a systemic risk to taxpayers".

"I worry about the failure of the institutions," he said. "My interest ... is to try to make sure they are strong enough financially to withstand a real downturn in the housing market."

The two companies are perceived to have implicit government backing which investors believe would trigger a bail out in the event of collapse, but the government has never had to exercise the guarantee.

The comments by Mr Shelby come amid talks in Congress over new housing legislation and the future of Fannie Mae and Freddie Mac, which have experienced heavy losses amid the mortgage crisis.

Mr Shelby and Chris Dodd, the Democratic chairman of the banking committee, are working to hammer out a bipartisan bill that would expand the Federal Housing Administration, the government insurer for mortgages to those with low incomes.

The aim of the bill is to halt the wave of foreclosures by allowing the FHA to guarantee the refinancing of up to $400bn (€260bn, £205bn) in loans to reflect lower house prices, with lenders voluntarily agreeing to forgive a chunk of their loans.

The bill would also create a powerful new regulator for Fannie Mae and Freddie Mac, and Mr Shelby is pressing Democrats to grant the body a higher level of "discretion" to force the companies to raise their capital requirements.

"I just think that the capital today is so thin, considering the losses, that it is dangerous," he said.

The legislators must agree a text by Thursday morning, when the banking committee will vote on both measures. Mr Dodd released details of the bill on Monday, but has so far failed to garner Mr Shelby's backing.

"We are not there yet," Mr Shelby said shortly before Mr Dodd's announcement. Afterwards, a spokesman for Mr Shelby said "it remains to be seen whether an agreement can be reached."

The support of Republicans in the Senate is critical because 60 votes out of 100 are needed to advance legislation. The White House and many Republicans oppose the FHA plan on the grounds that it amounts to a bail out of speculators that puts taxpayer money at risk.

Mr Shelby said he worried the plan would raise "false hopes that it would take care of the housing crisis," but did not to rule it out.

Still Relevant After All These Years

Will Rogers was a popular actor, columnist and radio personality who died in a tragic plane crash more than 70 years ago. One of the things he was famous for was his homespun wisdom and pithy but often very insightful quips. After the 1929 stock market crash, for example, he remarked: "I am not so much concerned with the return on capital as I am with the return of capital."

In "Commentary: Needed For Our Times - Will Rogers," nationally syndicated humor columnist Tom Purcell takes a fresh look at insights that still seem quite relevant in today's world.

As the presidential campaign moves along and Americans take to arguing around water coolers and dinner tables, we ought to embrace the wit and wisdom of Will Rogers:

"The short memory of voters is what keeps our politicians in office."

"We've got the best politicians that money can buy."

"A fool and his money are soon elected."

Rogers spoke these words during the Great Depression, but they're just as true today. With 24-hour news channels, our memories are shorter than ever. And in the mass-media age, the politician who can afford the most television advertisements often does win.

"Things in our country run in spite of government, not by aid of it."

"Alexander Hamilton started the U.S. Treasury with nothing. That was the closest our country has ever been to being even."

"Be thankful we're not getting all the government we're paying for." Today, unfortunately, we're getting MORE government than we're paying for. We cover the difference by borrowing billions every year.

As the king of the velvet-tipped barb, Rogers never intended to be mean, but to bring us to our senses. One of his favorite subjects was to remind the political class that it worked for the average American, not the other way around.

"When Congress makes a joke it's a law, and when they make a law, it's a joke." "You can't hardly find a law school in the country that don't, through some inherent weakness, turn out a senator or congressman from time to time ... if their rating is real low, even a president." "The more you observe politics, the more you've got to admit that each party is worse than the other." That's for certain. I used to fault the Democrats for cronyism and reckless spending. But that was before Republicans gained power and showed us how cronyism and reckless spending are really done.

Rogers' thinking on American foreign policy hits home today: "Diplomacy is the art of saying 'Nice doggie' until you can find a rock." "Diplomats are just as essential to starting a war as soldiers are for finishing it. You take diplomacy out of war, and the thing would fall flat in a week."

"Liberty doesn't work as well in practice as it does in speeches."

Rogers was born and raised on a farm in Oklahoma. His wit reflected the heart of America -- the horse sense, square dealing and honesty that are the bedrock of our country's success.

"When a fellow ain't got much of a mind, it don't take him long to make it up."

"This country is not where it is today on account of any one man. It's here on account of the real common sense of the Big Normal Majority."

Franklin Roosevelt, a frequent target of Rogers' barbs, understood how valuable Rogers' sensibility was during the years of the Depression. Here's what Roosevelt said of Rogers:

"I doubt there is among us a more useful citizen than the one who holds the secret of banishing gloom ... of supplanting desolation and despair with hope and courage. Above all things ... Will Rogers brought his countrymen back to a sense of proportion."

A sense of proportion is a hard thing to maintain, and we need to get ours back.

Not long ago, we were attacked by people who hold an ideology we're still having trouble getting our arms around. At first we were united, but we've since stumbled and become divided.

We've got a rapidly aging population -- a Social Security and Medicare train wreck is just over the horizon -- and there is no shortage of other woes we must resolve if we expect the American experiment to keep on rolling.

But instead of working to resolve our challenges, we snipe, point fingers and make silly accusations. We forget we're not Democrats or Republicans, but Americans.

What we need is the calm, clear perspective of Will Rogers. He offered some sound advice on how we can get started: "If stupidity got us into this mess, then why can't it get us out?"

The Same Old Bubble-Bursting Story

Now that the red ink is flowing fast, firms are closely scrutinizing deals they probably never thought twice about while the going was good.

They are also getting their lawyers involved, trying to figure out ways to turn bull market euphoria, dumb or innocent mistakes, and nebulous clauses into contract-negaters that can shift the losses -- and the blame -- onto somebody else.

Others are simply trying to milk those who are vulnerable or overwhelmed (e.g., the banks) for all they are worth.

It's the same old bubble-bursting story, I guess.

In "CDO Debt Could Pose Renewed Danger for Banks," the New York Post's Mark DeCambre details the latest chapter.

Just when Wall Street firms thought the worst of the credit crisis was over, investors in funky mortgage-tainted debt may unleash a fresh bout of pain for embattled banks like Citigroup, UBS, Lehman Brothers and Bank of America.

Investment managers, including GSC Group, which buy bonds in arcane securities known as asset-backed collateralized debt obligations, are looking to force Wall Street banks to take back onto their balance sheets a big chunk of the $380 billion in mortgage loans used to back these CDOs.

Mortgage lenders, including Countrywide Financial and Thornburg Mortgage, are also being targeted.

These investors are reviewing agreements tied to the arrangement of these mortgage securities to determine if the banks and lenders misrepresented the quality of the underlying collateral supporting these securities.

Due to the language embedded in many CDO deals, bondholders can return the securities to the so-called depositor or bank at 100 percent of their original investment if they can prove that there was fraud involved in originating the mortgage.

Investors are growing emboldened because fraud claims are becoming more prevalent over these loans as it's discovered that borrowers lied about their incomes or that lenders turned a blind eye.

Posing a sticky issue for those seeking to force their investments back onto the banks is the fact that many of these CDO offerings weren't created with clear-cut contractual language that stipulates under what conditions payouts would occur.

"It's not enough to prove that a defaulted loan was deficient in underwriting but you have to prove that the reason that it defaulted is tied to the deficiency," said Joshua Rosner, a financial consultant at Graham Fisher & Co.

It's rare for bondholders to take such action given the potential legal costs and the strain a move like this could have on an investor's relationship with a Wall Street bank.

However, many investment managers are facing billions in losses, and things are widely expected to get worse, one CDO manager told The Post.

Investors are said to be targeting specifically banks and mortgage firms that can pony up cash rather than going after struggling firms such as the now-bankrupt New Century Financial. "This is going to become a bigger and bigger problem," Rosner said.

'An Especially Rude Wake-Up Call'

Slowly but surely, the contractionary/deflationary tide is rolling in.

Rich and poor, male and female, young and old -- no matter which segment of the population you are talking about, attitudes are changing, by choice or, increasingly, out of necessity.

Gone are the care-free days and free-spending ways. Instead, there is soberness and austerity.

In "Survey: 1 in 10 Boomers Borrowing for Everyday Expenses," the Associated Press' Ellen Simon highlights a few of the new, less pleasant realities.

The economic downturn is hitting roughly one in 10 middle-aged and older Americans especially hard, compelling them to borrow money for everyday living expenses and to seek help from family, friends or charities, according to a survey released Tuesday by the AARP.

In the telephone survey of 1,002 adults 45 and older, nearly four in 10 said they had helped a child pay bills or expenses. Among retirees, one-third said they'd helped their children pay bills. Eight percent said they'd helped a parent pay bills or expenses. The survey's margin of sampling error was plus or minus 3 percentage points.

One-third of survey participants said they stopped putting money into their 401(k) or retirement account and 14 percent said they had cut back on their medications.

"We have patients coming in fewer times," said registered nurse Tucky Franz of Salisbury, Md. "They'll cut back because of the copay."

The majority of baby boomers said they were finding it more difficult to pay for essentials and utilities, and six in 10 said they had cut back on eating out and entertainment.

James Dyas, 75, of Sherman, Conn., said he and his wife go to their favorite Mexican restaurant about half as frequently as they used to. "About all the money we have goes to buying gasoline," he said.

While the survey doesn't show large numbers of people making radical changes -- taking second jobs or moving to a smaller home -- it did find that more than one-quarter of those surveyed are having trouble paying their mortgage or rent.

Compared with older people, a greater percentage of younger baby boomers, those 45 to 54, said they were cutting back on medications, prematurely withdrawing retirement funds and postponing paying bills.

"For the younger boomers, it's been an especially rude wake-up call," said Jim Dau, a spokesman for the AARP, a nonprofit that advocates Americans 50 and older.

Debra Koziol, a 48-year-old hospital finance worker in Rhode Island, said she's started carpooling to work with her sister a few times a week and packing lunch every day.

"The food is better," she said. "Some of this is creating better habits, not so much waste."

Both Sides of the 'Flation Aisle

Although I think I know how things are going to pan out, I admit I don't have a crystal ball. I also know that there are some pretty smart and experienced individuals out there whose views on the future are somewhat different than mine.

Many believe, for example, that the immediate threat before us is runaway inflation, rather than deflation (which is what I believe comes next). Given events of the recent past (e.g., the Fed throwing caution to the wind), I suppose it is possible that our government could fall in love with Zimbabwean economics at a far faster rate than I expected when I wrote my book.

Regardless, a post at the Prudens Speculari blog, "Observations and Thoughts," provides a helpful overview of where some of these people stand.

I want throw my 2 cents in on the deflation/inflation argument. I am aware of the division on the street regarding this. There are many well traveled shrewd insightful analytical market minds on both sides it can be confusing. I am going to jump around on what many of them think and my thoughts on theirs. It may be a little haphazard, but that is how my mind works. It's ADD combined with hyperness, with a touch of caution as I always assume I am the sucker until I can prove otherwise. (I do so as it tends to save me money!)

Remember I am summarizing what I have read and followed about the mentioned market observers from recent memory. I am NOT quoting them and hopefully not misrepresenting what they think or have said, given that they may have modified or adjusted their positions which is their right. I welcome any feedback or clarification regarding their positions from my readers or even the people mentioned.

• Jim Rogers/inflationist- brilliant, no other way so say it I agree 95% with his outlooks on bullishness for commodities, I diverge with him on China's market, in that I truly believe the corruption and speculation there are endemic and need to be purged out something awful. The economy and the market can diverge significantly. He likes the yen, yuan and the Swiss Franc while hateing the US dollar which I agree with.

• Gary Shilling/deflationist- oozes wisdom no matter what the shallow pollyanas like Jerry Boyer on Kudlow say or think about him. He has forgotten more than lighweights like boyer could ever dream of knowing. Shilling thinks the dollar is done and loves the long bond. I agree with him mostly my exception is with his call on the long bond. I am petrified that foreigners, yeah those cats that buy all our paper are going to realise that we are bailing everyone out and the gig is up. The bonds will tank something awful. People forget that the bond market got obliterated in the deflationary depression of the early 30's. I have not blogged about the bonds in a while but there is not a day that goes by that I don't watch whats going on and contemplate and bond market massacre. I want to short the long bond via the proshares PST(10yr) and TBT(30yr) but have not and will wait on this, call me conflicted.

• Mike Shedlock and Mike Panzner/deflationists- excellent analytical minds with Mish being an analyst at my old firm BMO and Panzner the author of the prescient book Financial Armageddon, which is must reading, especially now that much of what he called is unfolding. Both believe credit is being destroyed faster than it is being created.

• Richard Russell/inflationist- his motto is that governments have 2 choices, inflate or die. I agree but I have to reconcile that with the credit destruction Mike,Mike and Gary are calling. I watch the St. Louis Fed adjusted monetary base chart and it is talking deflation to me. I must remain flexible but the chart is saying deflation unless it is wrong and I am highly skeptical of many government statistics. He is bullish on the equity markets now.

• Bill Fleckenstein/inflationist - He can be summed on with his web site motto, "In a social democracy with a fiat currency, all roads lead to inflation." Very bright analytical mind and a true contrarian. Some dismiss him at first glance but don't let the long hair fool you, wise beyond his appearance.

• Marc Faber/inflationist- believes money creation is full throttle ahead. like emerging economies like South Korea. Dr. Doom is a misnomer as he has been bullish on many markets when need be.

• Jim Sinclair/inflationist- believes the derivative situation is dire and we are heading to a Weimar republic situation. Calling for the $USD at 52 which I cannot disagree with and believe. He is looking for $1150 and then $1600 gold. I lifted the following from his web site Jim Sinclairs MineSet",There is no escape from a Global Weimar Experience as Central Banks monetize bankruptcy. Equity markets in the Weimar experience went to unimaginable levels on the upside." Given my disposition to being short this sits in the back of the mind on a constant basis and not in a good way.

This is a short list I may do another one with more shrewd cats I try to follow. So where does this leave us here at Prudens Speculari.

I believe we are experiencing unprecedented credit destruction and contraction and the banks retrench. Economically I am an Austrian at heart and inflation is everywhere and always a monetary phenomenon. I believe credit increases are inflationary not a rising oil or corn or what have you price, which is a reflection or symptom of the credit increase. I am watching the adjusted monetary base chart for clues.

To be blunt I am watching for things that the correlation, black box, intellectual thinkers believe cannot happen. Government remedies and intervention only exacerbate the issues. I am worried that things are so critical and so dysfunctional, and that as market participants try to adjust and feel their way around we can, are and will get temporary misleading signals as 'the market digests what is truly going on. Which I feel is a bursting of the mother of all bubbles, the credit bubble, whose ramifications are global, UK, continental Europe, and Australia. Its attendant effects on banks, credit creation and the consumer.

I sit sometimes thinking globally we are on the verge of a Daimler/Chrysler situation. Remember that, it was called a merger of equals but I remember an obscure analyst whose name I cannot recall who claimed that either Daimler came down to Chrysler's level or Chrysler came up to Daimlers'. As my wife is fond of saying, water finds its own level. Globally are we going to find the emerging markets economic level or are they rising to meet us. I think it is a combination of the 2 with them coming to us, slowly but surely but more problematically we falling faster to them.

Should we be long emerging markets short developed UK, US on a spread trade. Not a bad idea. I don't believe we can decouple. We consume like nothing else can and those hoping the Middle East and BRIC countries will replace us lockstep is fantasy. Our economy is 70+ % the consumer and it took us decades to get where we are, Should I believe they (BRIC) consumer will arrive at the same place overnight.

I am a peak oil believer. We are not in a bubble although speculation is present everywhere and always. Simply put easily accessible and plentiful suppy has all been found. Demand is rising, recession or no recesssion. Crude is still cheap compared to other goods. Gold is insurance but may very well become money, for as an Asia college buddies grandfather used to always say, "no trust paper!"

So where am I ? I am squarely in the deflationary camp, with the perogative to change my mind at any time !!!

My apologies for the lengthy post but I do this for me as well as my readers, buy mainly so I can go back and read over how stupid or wrong I was at any particular time in the past !

Wishing you continued success in all your endeavours and above all Good Speculating to you all !

More Fresh Air from Mr. Baker

Anyone who pays attention to what the mainstream business media is saying knows that there are plenty of ivory-tower economists, clueless "strategists," industry shills, delusional managers, and other misfits being quoted who are nevertheless described as "experts" on the current unraveling.

From what I can tell, those who aren't in some sort of natural or drug-induced stupor are either looking to distort and dissemble so they can promote a hidden agenda, or they are shallow chameleons who have jumped on the crisis-unfolding bandwagon because that is getting all the attention nowadays.

There are exceptions, however. One genuine expert whose views I've noted before is Dean Baker, an economist (yes, it's true) and co-director of the Center for Economic and Policy Research in Washington. In a post at the U.K. Guardian's Comment Is Free... blog, "Wrong Then, Wrong Again," Mr. Baker offers up another round of insights that are, as in the past, like a breath of fresh (and very informative) air.

The same economists who failed to spot this year's financial meltdown are now predicting that everything will soon be fine

The economists are telling us that everything is going to be fine. It seems that the worst is behind us. The credit crunch is over, the tax rebate cheques are in the mail, the dollar will stop falling, and the economy is now expected to pick up in the second half of the year. That is what most economists have been saying.

Of course all the economists saying this completely missed the $8tn housing bubble and most of them probably missed the $10tn stock bubble also. In other words, knowledge of the economy is not the strong suit of the expert economists who are telling us that the economy will be fine.

Here is why they are wrong, yet again. The housing market is currently in a free fall. The latest data from the Case-Shiller 20 city house price index show real prices falling at an almost 30% annual rate. This rate of price decline implies a loss of almost $6tn of housing wealth by the end of the year - that's $80,000 for every homeowner in the country.

This stunning loss of wealth has two important implications for the near-term course of the US economy. First, consumption is certain to decline. For the vast majority of families, their house is their main source of wealth. Tens of millions of baby boomers are approaching retirement without a traditional pension and very little money accumulated in personal savings or a defined contribution pension. The one source of wealth that these people had been counting on in retirement, in addition to their Social Security, was the equity in their home.

This wealth is now disappearing with the collapse of the housing bubble. As baby boomers see the price of their homes drop from $400,000 to $300,000, a typical decline in many areas, they will suddenly find themselves with little or no equity. If they hope to have anything other than Social Security to sustain them in retirement, they will have to hugely increase their savings during their remaining working years.

In many cases the loss of equity will more directly lead to an increase in savings because it will prevent homeowners from borrowing any further against their home. At the peak of the bubble in 2006, homeowners withdrew more than $700bn in equity from their homes. As house prices plunge, tens of millions of homeowners will no longer have any equity against which to borrow. This will leave them no choice except cutting back their consumption.

Standard measures of the size of the wealth effect from housing imply that a loss of $6tn in wealth will reduce annual consumption by between $240bn to $360bn a year, between 2%-3% of GDP. This sort of plunge in consumption would imply a severe recession.

The other important effect of plunging house prices is an inevitable surge in default rates. For some bizarre reason, many economists continue to think that the mortgage crisis was caused by adjustable rate mortgages resetting to higher interest rates. While a reset could often be a trigger event forcing families to default, the underlying problem was that house prices had fallen so that people no longer had any equity in their homes.

Homeowners don't default on homes in which they have equity. They will either borrow against the equity to make their payments or they will sell the home and put money in their pocket. As house prices continue to fall, the number of homeowners with no equity will soar.

Even more importantly, many homeowners will find themselves deeper underwater making default a much more attractive mortgage. If you like your home, it may be worth paying off a $400,000 mortgage on a house that is currently worth $380,000. This sounds like a much worse deal if the mortgage is $400,000, but the home is worth $250,000, as will be the case in many of the former bubble markets.

This means that the default rates will surely be heading upward in the months ahead as will the write-off that banks will take on these mortgages. The $250bn or so that has already been written off by the banks is just a down-payment, the big hits are yet to come.

Of course, the economists who most of the media rely upon to inform the public don't see any of these problems ahead, just as they didn't see any problems ahead at this time last year. But those of us who learned our grade school arithmetic know that we can look forward to serious economic and financial troubles ahead.

The Other Retirement Nightmare

When most people think about retirement system nightmares, they tend to focus on screwed-up federal government programs like Social Security and Medicare, or on private-sector-related obligations, where plans are often underfunded or, as has increasingly been the case, investment and other risks have been shifted to the employees themselves.

However, one  time bomb that has been lurking in the shadows for a while now -- and which I also wrote about in Financial Armageddon -- has to do with the retirement-related obligations of federal and state governments. In "Growing Deficits Threaten Pensions," the Washington Post's David Cho explains just how bad things really are (especially for taxpayers).

Accounting Tactics Conceal a Crisis For Public Workers

The funds that pay pension and health benefits to police officers, teachers and millions of other public employees across the country are facing a shortfall that could soon run into trillions of dollars.

But the accounting techniques used by state and local governments to balance their pension books disguise the extent of the crisis facing these retirees and the taxpayers who may ultimately be called on to pay the freight, according to a growing number of leading financial analysts.

State governments alone have reported they are already confronting a deficit of at least $750 billion to cover the cost of the retirement benefits they have promised. But that figure likely underestimates the actual shortfall because of the range of methods they use to make their calculations, including practices that have been barred in the private sector for decades.

Local governments use these same techniques for their pension funds and face deficits that further contribute to what some investors and analysts say may be shaping up to be a massive breach of faith with a generation of public employees.

This gap is growing more yawning with the years. It has already presented taxpayers with a whopping bill that is eating up a vast portion of government budgets at the cost of other services. In Montgomery County, for instance, pension and retiree health care costs are already higher than the combined budgets for the departments of transportation and health and human services. Eventually, officials responsible for the funds will have to choose whether to continue paying out or renege on benefits promised to retirees.

By their own assessment, state and local governments acknowledge that their funds for retiree benefits are increasingly falling behind, with the number that are severely underfunded soaring to 40 percent in 2006, a five-fold increase from 2000, according to the U.S. Government Accountability Office.

But even these grim calculations are based on assumptions that some analysts consider too aggressive, including projections about how the investments of pension funds will fare and how long retirees will live.

"Very small shifts in actuarial assumptions can generate huge changes over time," said Susan Urahn of the Pew Center on the States, which has studied the issue. "It is not very transparent, and even where it is transparent not many people understand it."

Pension funds generate money from worker contributions, government payments and the returns from investing that money. These funds pay an annual pension salary and health benefits to retirees for as long as they live.

But with workers retiring earlier and living longer, governments have been struggling to keep up with the promises they made. Many are taking out loans to restock their pension funds, which is akin to using a credit card to cover monthly mortgage payments. Others are passing the bill to future generations by using sunny projections of what their investments will return, claiming they do not need to dedicate more money now to their pensions.

Such "accounting nonsense" has been "pushing the envelope -- or worse -- in its attempt to report the highest number possible" for their investment returns, wrote billionaire investor Warren E. Buffett in a recent letter analyzing pensions for shareholders of his company. Taxpayers ultimately will pay the price when these forecasts prove wrong.

"Because the fuse on this time bomb is long, politicians flinch from inflicting tax pain, given that problems will only become apparent long after these officials have departed," he wrote. "In a world where people are living longer and inflation is certain, those promises will be anything but easy to keep."

Public pensions have broad leeway in their accounting methods because, unlike their counterparts in the private sector, they have no federal oversight. Private pension funds were forced by regulators starting a generation ago to use far more conservative forecasts in their pension calculations and follow uniform guidelines set by the federal government. The move toward stricter regulation provided a clearer picture of pension costs, and many corporations are now switching their employees to 401(k) retirement plans, which offer far less generous benefits.

For public pension funds, a nonprofit body called the Governmental Accounting Standards Board sets guidelines but has no power to enforce them and little incentive to confront the states and localities that finance its budget. So some states, pension analysts said, have adopted accounting techniques motivated more by politics than prudent financial considerations.

Virginia, for instance, has been using an accounting method since 2005 that allowed the state to contribute about $300 million less into its pension funds each year than what its own pension board has recommended. Some pension actuaries called this "highly unusual" and "troubling."

Maryland adopted a funding formula in 2002 that prompted a sharp drop in pension funding levels, ignoring repeated requests by the state's pension board to amend this approach. In 2006, even as funding levels dropped, the state significantly raised the retirement benefits promised to teachers and other public employees.

The District's pension funds are among the healthiest in the region, according to figures provided by the governments. The District has determined that its pension liability is $4 billion this year, which means the funds are slightly overfunded. But if the District used more conservative methods common in the private sector for projecting assets and costs, it could instead face a shortfall of several billion dollars, analysts said.

In Montgomery County, which has promised to pay $3 billion in health-care benefits to retirees, government officials accepted the advice of consultants who urged the county to nearly quadruple the amount it sets aside to cover this commitment. But the county council voted to delay this full funding for five years. Now the council, which claims wide legal latitude, is considering whether to postpone it for another three years.

"The biggest issue is the lack of standards in regards to government pensions," said Timothy L. Firestine, Chief Administrative Officer in Montgomery County. "You can make up your assumptions as you go."

Of all the assumptions, among the most fateful is the figure chosen for how much money the fund will make on its investments. The better these investments fare, the more flush is the fund. And if a government projects a high rate of return, there is less need to tap taxpayer money to finance a shortfall.

Most public pension funds limit their contributions by assuming their investments will grow between 7.5 percent and 8.5 percent a year.

"While anything is possible, does anyone really believe this is the most likely outcome?" Buffett wrote in the most recent annual report his firm, Berkshire Hathaway. Buffett is also a Washington Post Co. director.

A growing number of leading investors are warning that the return rates used by state and local governments are unreasonably optimistic. Buffett, for one, has pointed out that over the 20th century -- when the Dow Jones Industrial Average soared from 60 points to 13,000 -- the stock market produced a 5.3 percent annual return for investors. Over the next century, the Dow would have to explode to 2.4 million to produce a similar rate of return.

Yet even that would be less than the rate of return commonly projected by public pension funds.

Many public pension managers say their projections are based on past experience. Moreover, they say they can take more risks than private companies because there's no chance of going out of business.

"There's been a government in our city since 1779," said Mark Jinks, chief financial officer for Alexandria. "You can't be sure that the promises made to private sector employees will outlive their company."

Another concern for public funds is demographic: We are living longer and more of us are getting old. By 2015, life expectancy is expected to reach 79.2 in the United States. By 2030, one out of five people will be over 65.

In addition, retiree costs are soaring. A study by California predicted its retiree health care costs would jump from $4 billion today to $27 billion by 2019.

Nor has the crisis in the housing and debt markets helped matters. Investment returns for most pension funds across the nation turned negative for the first part of this year. State and local governments are also facing budget deficits that are expected to top $30 billion next year, according to Standard & Poor's, making it tough for officials to find more funding for pensions.

Urahn, of the Pew Center, called the current environment "a perfect storm" and expressed a concern over whether governments may be tempted to cut their pension contributions. Yet most are loath to revise the benefits employees have traditionally been promised.

"The age of retirement was set when people did not live that long. It's very hard to change that now," she said. "People feel these pension obligations were a promise. And changing them feels like you are breaking a contractual promise, that you are changing the rules of the game. But the game has changed."

Financial Phenology

I received an email containing several interesting insights from regular visitor M'Liz Dupree, and I asked her if I could share them with other Financial Armageddon readers. Fortunately, she agreed, and here is what she had to say (with a few slight tweeks for clarity):

In the horticultural world, in which I work, the science of phenology tracks the relationship between natural events and plants and animals. I've been applying phenology lately to the economy. Observation is the key; little things that didn't register previously now offer insight to the future of the markets, individual stocks and trends.

For instance, when General Motors (GM) announced deep cutbacks at their plants which manufacture SUVs, I saw "For Sale" signs on more than 60 percent of the rental units in Janesville, Wisconsin, where one of the affected plants is located. One shift was cut, but that wouldn't normally precipitate widespread rental vacancies. That is, unless you deduce that the Janesville plant will be shuttered by the end of 2008. Given GM's losses and the recent $200 million concession to American Axle, a supplier of truck and SUV parts, more plant closings are a distinct possibility.

Kroger (KR) announced last week that it would give a 10-percent bonus to customers who purchase Kroger gift cards with their tax rebate check. A $300 card would yield an additional $30 in credit, etc. The fine print reads that no personal checks will be accepted for the card purchase, only rebate checks. A quick trip through the local Kroger store during the past few days was an eye-opener. All prices were up from a week ago, from canned goods to meat to cleaning supplies, by about 8 percent. No free samples in the deli or bakery were offered. Usually, one can cruise those sections and munch enough for a small lunch. Goldman Sachs changed its rating of Kroger from "neutral" (based on fundamentals and recent underperformance) to a "buy." They noted the benefits from fiscal stimulus package as a reason for the upgrade.

Then we come to the 500-pound gorilla, oil. Goldman Sachs also said recently that oil may go to $200 a barrel. My ringing telephone verifies that prediction.  I inherited the mineral rights to three parcels in the Permian basin of West Texas and Oklahoma, both beehives of oil and natural gas production. Until, that is, the early part of this century. About 2002, before the election of George Bush, oil companies stripped out as much as they could and then shut down numerous wells rather than drill deeper. Middle Eastern assets were more profitable for them.

Hundreds of new wells have come online in the last 90 days, according to The Tulsa World's weekly drilling completion report. Played out fields are being drilled as deep as 19,000 feet to tap larger pools (as late as 1999, drillers in the Gulf of Mexico were hesitant to go more than 15,000 feet). It's worth the expense with the prospect of $200 oil. Leasing agents are giving you anything you want for your mineral rights now. You can name your cash bonus and easily negotiate 25 percent royalties. Two-hundred dollar oil may be conservative, if you read the financial phenology.

Lots More Consequences

It's the thing that many experts still don't understand: how interconnected everything is.

That is why they didn't realize that the subprime crisis would have implications for all lending markets. Or that upheaval in one credit trading arena would spread to others. Or that so many different types of financial institutions in various countries around the world would end up with rivers of red ink flowing out of their financial statements.

Or, as the following report from the New York Times, "Losing a Home, Then Losing All Out of Storage," might suggest, that the bursting housing bubble would continue to spawn plenty of (unexpected) consequences.

The foreclosure crisis is hitting yet another American locale: the self-storage center.

As they lose their homes, people are turning to these humble cinderblock and sheet-metal boxes to store their stuff. But some people cannot keep up with their storage bills any better than they could handle their mortgage payments, and storage companies are auctioning off their property for a pittance.

A cottage industry has developed to profit from these lost and abandoned items. The other day in this Chicago suburb, Stephanie Donahou and her son Marcus had only a moment to decide whether to bid on a unit in default. They could see a couch, a sewing machine, a fish tank, a washer and dryer, lots of Christmas wrapping paper, a television and other trappings of daily life.

“This is someone’s house,” Mrs. Donahou said. Her bid, for $160, was the highest. Mr. Donahou was not impressed. “Ma, you bought a junker,” he said, rooting through the material. They began to fill their U-Haul. Good material they would auction on eBay; middling stuff would go to yard sales.

The auctioneer, Blair Auction & Appraisal, has been conducting sales at self-storage facilities in the Midwest for more than a decade. “If a site used to have 10 auctions, these days it has 15 or 20,” said Wayne Blair, the owner. At one site in Detroit, he auctioned off the contents of 45 units.

Subprime mortgage loans had low “teaser” rates to lure borrowers. Many storage facilities offer the first month for free.

“You tell yourself, ‘I’m only going to put my things in for a short time,’ ” Mr. Blair said. “Before you know it, you’re behind. Then you have to pay penalties and interest. You owe $400 to $500. If you lost your job, you can’t come up with that, not if you want to feed your family.”

Nearly non-existent 35 years ago, self-storage has become ubiquitous, with 51,000 facilities nationwide. Even as the larger economy falters, the industry is flourishing. Executives say the mortgage crisis is one reason.

Dean Jernigan, chief executive of the U-Store-It chain, says people generally rely on storage when they are dealing with major milestones: marriage or divorce, a relative’s death, a job transfer or, in boom times, remodeling or building new homes.

Now he’s adding foreclosure to the list. “People are moving back down the property ladder,” Mr. Jernigan said.

Bill Martin, a 50-year-old former manager in the technology industry, lost his house in the Southern California community of Lake Forest last August. His local self-storage company sent a truck and driver to pick up his things, a service it offers all new customers.

“Storage has my hopes in it,” said Mr. Martin, who sleeps on a foldout bed in his mother’s guest room. “I don’t tell anyone this, but at least once a week I go over and look at my couch, my refrigerator, my TV stand, my mattress and realize I did have a life, and maybe there’s a way to go back to it.”

Investors agree that hard times for homeowners like Mr. Martin will yield good times for storage firms. U-Store-It’s stock is up 33 percent this year. Extra Space is up 18 percent. Public Storage is up 18 percent.

“People might lose their home but they’re not going to lose their things,” said Charles Ray Wilson of Self Storage Data Services, a research firm.

Yet some evidence suggests that is exactly what is happening. It is impossible to put precise numbers on the phenomenon, partly because the industry is highly fragmented — the majority of facilities are locally owned — and also because the topic is not one the industry cares to dwell on. But auctioneers who dispose of units in default, as well as the bidders who try to buy their contents, say they see increasing signs of strain. They note that more auctions involve people who appear to have had their homes foreclosed.

Fred Reger, an auctioneer in Washington and its suburbs, is seeing two trends, which he calls “matching luggage” and “residential units.”

The first means that he often sees a bunch of over-stuffed plastic bags when he opens a unit. “People used to put their belongings in boxes,” Mr. Reger said. “But Hefties are a lot cheaper. These people came in under stress, which explains why they defaulted a few months later.”

A “residential unit” is one where the renter tries to illegally live in the unit. “We used to see one or two residential units a month,” Mr. Reger said. “Now I’m seeing 6 or 8 or 10. At one facility in D.C. the other day, we had three residentials.”

Not every area is seeing an increase in auctions. Neal Grossman, who runs auctions at storage facilities in Ohio, said a higher percentage of storage customers are rescuing their possessions at the last minute.

When renters default on their monthly payments, facilities replace the lock with one of their own. That way, the renter cannot come around at the last minute and empty out his unit.

Mr. Grossman cut locks on 87 units in March but, as many people paid at the last minute, ended up auctioning only 21 of them in April. Both numbers were down from a year ago, he said, suggesting “the worst is behind us.”

In Chicago, on the other hand, the ranks of the dispossessed seem to be swelling. Storage facilities in Illinois that intend to auction off units in default must publish a legal notice alerting the owners. The suburban Daily Herald ran notices for 62 auctions in the Chicago metro area on a recent Monday, some of them involving more than 10 units.

Brook Snyder runs the Chicago operation for Blair Auction. A good-humored 34-year-old with a penchant for bright shirts and three-day stubble, Mr. Snyder has made a career of delivering bad news: He has been an assistant to court officers doing evictions as well as a process server delivering legal papers to people being sued.

“I try to treat everyone with respect,” Mr. Snyder said. “Anyone can have hard times.”

On auction days he drives from site to site, trailing a caravan of hopeful bidders. When everyone is assembled in front of a defaulted unit, he takes off the lock. Forbidden to enter or touch, bidders make offers based on a glimpse and well-honed instinct. The entire process is over in a moment.

In three brisk days, Mr. Snyder held auctions at 23 U-Store-It facilities. At the first site, in Gurnee north of the city, he raised the door on an indoor unit, revealing what was essentially a one-room apartment: bed raised high, recumbent bicycle in the corner, file cabinet, vacuum cleaner and, for power, many extension cords. The contents sold for $675.

The next warehouse, in Waukegan, brought a unit full of — depending on how you look at it — cherished household possessions or somebody’s trash. Most of the bidders took the latter view, disdaining an offer. Tonya Boyd bought the bulging plastic bags for all of $6. “It looks like someone had some troubles,” said Ms. Boyd, an employment specialist. There were piles of clothes, brand-new women’s shoes, old chairs, a dirty fan, kitchenware.

For some units, $6 is too much. “A dollar bill, first dollar bill takes it,” Mr. Snyder implored in front of one unit. “Come on, this is everything they own!” To no avail.

This is the eternal mystery of self-storage. If the material was worth money, it was foolish to let it go to default. If it was not worth much, why spend at least $50 a month to store it?

Mr. Jernigan, the U-Store-It executive, says budgets are stretched tight. “People pay their cellphone, rent, credit card before they get down to their storage unit,” he said.

Self-storage site managers describe an irrational tendency in some clients. One said she had seen customers who lost their possessions at auction come back and rent another unit. Mr. Snyder said he had removed a lock from the same delinquent unit six times in one year. Five times the renter had paid up at the last minute; the sixth time, a few weeks ago, it was auctioned.

“His luck ran out,” Mr. Snyder said.

The Smart Money?

The bulls says the worst is over and that it is time to be invested in financial shares. Let's see if that jibes with reality. Here are just a few brief news items from this past week:

• Warren Buffet says "there's going to be more pain" and that the Bear Stearns bailout "doesn't mean the losses are over by a long shot."
• After taking $45 billion in write-downs and losses over the past nine months, Citigroup announces plans to sell $400 billion in assets in an attempt to keep itself afloat.
• American International Group announced another round of record quarterly losses, detailed plans to raise $12.5 billion in capital, and said that there can be "no assurance" that the losses are over.
• The Financial Times reported that "Bankruptcies and Defaults Gather Pace":

The number of companies defaulting on their junk-rated debt and filing for bankruptcy in North America is running at its fastest pace in five years amid the slowing economy and contraction in credit markets.

So far this year, 28 “entities” have defaulted, according to Standard & Poor’s. The defaulted debt of the one Canadian and 27 US companies totals $18.4bn and exceeds the 17 defaults in the US for all of last year.

S&P said the pace of US defaults in the first five months of the year is the fastest since 2003.

The US is leading the global default rate for companies, said Ken Emery, senior vice-president at Moody's.

The global default rate for speculative-grade companies rose to 1.7 per cent in April, up from 1.5 per cent in March and a multi-decade low of less than 1 per cent last year, said Moody's.

Meanwhile, in the US the default rate rose from 1.8 per cent in March to 2.1 per cent in April. Moody's expects the global default rate to reach 4.98 per cent by the end of the year, with defaults in the US reaching 5.7 per cent. In Europe the default rate is currently 0.7 per cent.

This week the latest Federal Reserve Senior Loan Officer survey highlighted tougher lending conditions from banks to lower-rated corporate borrowers. In spite of the recent rally in credit markets, the number of junk-rated companies trading at highly elevated levels remains well above normal.

"This increases the risks to the weakest links, entities rated B minus or lower," said S&P. Weak links, which are three times more likely to default than the rest of the speculative grade market, rose to 101 entities in April. This was compared with 78 at the end of 2007 and a 10-year low of 64 in July.

"If the recession is deeper and longer than expected and lending constraints worsen more markedly, the default rate could be significantly more pronounced and severe, possibly reaching 8.5 per cent," said S&P. Such a rate would reflect 136 defaults.

Yep, I guess those smart money guys are right. No sign of trouble here.

Another Costly and Complicated Headache

The tentacles of this emerging crisis just keep spreading. However, the focus is gradually moving away from losses that are directly related to the bursting credit and housing bubbles to those that stem from second and third-order effects. In "Empty Homes Spur Cities' Suits," The National Law Journal's Julie Kay details yet another costly and complicated headache for cities, taxpayers and financial institutions alike.

Homeowners aren't the only ones claiming they were victimized by the subprime foreclosure debacle sweeping the nation.

Cities now dealing with scores of abandoned, foreclosed homes have started suing banks and mortgage companies to recoup their costs, while other cities are hauling lenders before code enforcement boards and county courts to force them to maintain abandoned properties.

The innovative legal tactics are designed to recoup the city's lost property taxes as well as the cost of fire departments, police, code enforcement or even demolition -- any city services needed to clean up or deal with the foreclosed properties.

Cleveland; Baltimore; Buffalo, N.Y.; and Minneapolis, Minn., have all filed lawsuits against lenders or developers based on the devastating effects foreclosures have wreaked on their communities. The lawsuits were filed in recent months under different theories, in state and federal court.

Cleveland and Buffalo filed suits under public nuisance laws. Minneapolis' suit was brought on consumer fraud grounds, while Baltimore took the unusual approach of filing suit in federal court under alleged Fair Housing Act violations.

In addition to filing a lawsuit in February, Buffalo city prosecutors routinely haul banking officials before the local housing court to force them to fix up foreclosed and abandoned properties.

MORE TO COME

John Relman, a Washington attorney, was hired by the city of Baltimore to file suit against Wells Fargo. He has received inquiries from other cities and expects more foreclosure suits to be filed in the future.

"You can look at almost any of the major cities and see significant foreclosure trends, stretching across the country," said Relman of Relman & Dane. "Any city that has racially segregated housing patterns and high levels of foreclosure could wind up suing -- cities across the Midwest, cities in California. It's almost everywhere."

The notion that cities are also victims of the subprime foreclosure crisis started to catch on at the beginning of the year. While the details of the suits differ, they all allege that cities are losing tax revenue from foreclosed and neighboring homes whose values are reduced, and from having to keep the abandoned houses free from rats, vagrants and disrepair -- and from potentially turning into crack houses.

Cleveland and Baltimore filed their suits in early January. Cleveland's suit was filed in state court against 21 investment banks and lenders, essentially pitting middle America against Wall Street. It appears to be the first to be filed on the foreclosure issue using public nuisance laws. City of Cleveland v. Deutsche Bank, No. CV08646970 (Cuyahoga Co., Ohio, Ct. C.P.).

Public nuisance is one of the oldest common law torts and grants people the right to "quiet enjoyment." Such suits are brought on behalf of the public, alleging that the defendant caused an unreasonable interference with the health, safety and peace of comfort of the general public.

Cleveland alleges that, after suffering more than 7,500 foreclosures last year -- an average of 20 a day -- the city now has "entire streets, blocks and neighborhoods" of abandoned homes that have become "eyesores ... fire hazards ... and targets for looters and criminals."

The city hired a team of lawyers with Cohen Rosenthal & Kramer of Cleveland, headed up by Joshua Cohen, to assist. The firm is working on a contingency basis.

Cleveland is seeking to hold lenders accountable for predatory lending practices. "The purveyors of subprime loans could have or should have ... foreseen a foreclosure crisis as inescapable consequence of their conduct," the lawsuit states.

The lenders -- which have labeled the Cleveland suit without merit in countersuits -- include the biggest financial institutions in the United States, including Bear Stearns, Bank of America, Citigroup, Merrill Lynch, Lehman Brothers and Wells Fargo.

Merrill Lynch declined comment on the suit. JP Morgan Chase and Morgan Stanley did not return calls for comment by deadline. The American Bankers Association also declined comment.

Several of the banks countersued in federal court, alleging that federal banking laws render them immune from any state lawsuits.

"It's a blatant attempt by them to establish federal jurisdiction in case the main action is thrown out," Cohen said.

STRATEGIZING IN BUFFALO

Buffalo's suit against 39 lenders, including Citibank, Chase Manhattan and Bank of New York, also cited city and state nuisance laws as well as New York state's property maintenance code.

Kevin Heine, spokesman for Bank of New York, pointed out that, while some banks named in the suit did originate the mortgage loans, the Bank of New York did