Credit Default Swaps

Leveraged trading.. which in many ways is simply gambling.. has been around for quite some time here in the US. . Every day in America, people bet on sports teams without actually owning part of them. "Bucket Shops" as they were called, were essentially gaming establishments.. only instead of the Yankees or the Red Sox, they were betting on a stock.. GE, US Steel, etc.. without actually owning the stock. They were essentially side bets. During the early part of the 1900's, Edwin Lefevre ran one such shop on behalf of the legendary Jesse Livermore. Worse, in these bucket shops, people were buying on margin. For example, if you wanted to bet $1,000 that GE was going up to $65 a share, you would only have to lay down $100. Of course if you were wrong, you owed the bucket shop bookie the other $900. All of this without actually owning any stock.. it was, at it's heart, gambling. These bucket shops became so pervasive that they actually began, through inside information, to affect the actual stock prices.. and this was what in large part led to the "Panic of 1907", where the NYSE lost more than 50% of it's value from the high in 1906. The "Bucket Shop Laws" were enacted by Congress shortly after the Panic.

Fast forward three quarters of a century and we're in the partying 1980's.. the last days of Bill Clinton's presidency to be exact. Alan Greenspan, the Fed Chairman, has become very, very powerful as prosperity grips the nation, with many giving Easy Al the credit. Among those who believed Easy Al was Clinton himself. As his Presidency was coming to a close, Greenspan championed a bill in Congress, HR 5660, called the Commodity Futures Modernization Act, written by a Republican Congressman from Texas on behalf of Goldman Sachs.. He touted it as a necessary further step in the deregulation of Wall Street. It was on the last day of the last lame duck Congress that this bill came up for a vote. In their haste to pass it, the Democrats simply wrapped this bill into an Appropriations Bill, who's passage is a given. The appropriations bill was passed on a "unanimous consent".. ie.. everyone was so anxious to get home for the holidays they did'nt even bother with a formal vote. Clinton signed it into law on New Years Eve. The Commodity Futures Modernization Act allowed for Credit Default Swaps (the new term for bucket shop side bets) to become legal again. Worse, the CFMA expressly forbade any governmental agency, local or federal, to either regulate or halt it. Unknown to Greenspan, Clinton or the bill's authors, they has just unleashed the worst financial crisis in mankind's history, one which has yet to be fully played out.

Instead of betting on the Yankees or even Ford Motor Co, unemployed mathemeticians took this craft to new and unimagineable levels. They were initially sold as insurance policies. Here's an example: JeffBank has $10 million in the vault.. and of this $10 million, a million of it is yours, and it's in the form of a 5 year Certificate of Deposit (CD), therefore you cannot simply go into JeffBank tomorrow morning and get your money out.. you have to wait the five years. Now lets say you were getting nervous about JeffBank.. and thus your million dollars. Therefore you want some form of insurance on it, and so you then turn to "JaneBank" (which also has $10 million in the vault), who agrees to write you an insurance policy on this million dollars.. so long as you pay JaneBank a monthly premium. So far, this is legitimate business. But free from regulation, JaneBank then turns to you and says "If you really think JeffBank is going down, we'll write you a $20 million insurance policy, so long as you make the monthly premiums".. even though they only have $10 million in the bank. These are called "naked" Credit Default Swaps.. and are essentially a side bet. Despite not being able to cover their bets, profits at JaneBank are exploding thanks to the monthly premiums they're collecting.. as are CEO bonuses. Today CDS's are written on everything under the sun.. Greek Government Bonds, City of Detroit Bonds, stocks.. everything. The biggest banks in the US.. CitiBank, JP Morgan, Chase, Bank of America.. are so unimagineably head over heels with CDS's it literally blows the limits of imagination. It makes the problems of JaneBank look like kindergarten. Here's an example of just how bad things are: Bank of America, which has deposits of about $825 billion in deposits, has underwritten CDS's for $48 trillion. Yes Trillion. The entire US economy is only $15 trillion. JP Morgan is the worst.. they guarantee $75 trillion. The entire world economy is $50 trillion. As a whole, US financial institutions have underwritten about $225 Trillion in CDS, guaranteeing everything under the sun.. including each other. So if one big financial institution goes down, they are likely to take a number of others with them. This is exactly what happened on September 18th 2008, when Lehman Bros was allowed to go under.. and instantly made AIG insolvent. The US Government immediately stepped in to save AIG. The street rumor was that if AIG had gone down, it would've taken down Switzerland's largest bank (UBS) and Germany's largest bank (DeutcheBank). It would've been financial armageddon. The biggest CDS these days are written on interest rates. If the US Ten Year Bond goes from it's current 3.65% to 7%, the CDS's this will trigger could crash several very large banks.. which would then crash yet more banks. The Domino Effect on steroids.

So now that we know the problem, has the Obama Administration done anything meaningful to halt this insane cancer ? The Frank-Dodd Reform Act calls for CDS's to be regulated.. but not eliminated. It's yet to happen.. the lawyers are still working on the specifics. Why were'nt they simply eliminated ? This is a question best directed towards your Congressman.. and very likely they will have absolutely no idea what a CDS actually is. By reading this article, you now know more than 3/4's of the US House of Representatives. The banksters who are making bazillions on the profits from these highly dangerous devices.. and who are giving Congressmen millions in "consulting fees" and "campaign contributions".. are banking on Congressional ignorance and silence.. and they're getting it. Thus do civilizations collapse.

Egypt & Rice

The events in Egypt have went from bad to very much worse. Mubarak's regime yesterday resorted to violence to quell the protesters. Thousands of "Mubarak supporters".. most of them, as it turned out, were secret policemen.. rode in on horses and camels dressed as Bedouins, swords gleaming in the sun, and attacked the protesters. The Army withdrew it's troops as this was happening, which was a clear change of tactics.. most of the protesters welcomed the Army as protectors of their right to protest. Last night, these same "supporters" opened fire on the protesters. The last figure I found was 300 dead and 2,000 wounded. Shortly after this, the Army arrived and separated the protesters from the "Mubarak supporters" by force of arms. These very bloody events are, in my view, the last desperate gasp of a dying regime. Foreigners.. especially journalists.. have been attacked, including CNN's Anderson Cooper.. twice. Make no mistake.. Egypt is descending into a very ugly end game. Here are a few facts.. apparently the police have been pulled from their everyday duties enforcing the law to deal with the protesters.. and the thugs have taken full advantage as crime, looting and all manner of lawlessness has taken place. Reports of thugs setting up "check points" and exacting taxes for passage is a very dangerous precedent; this is how civil societies begin to melt down.

Egypt's economy relies heavily on tourism, mostly from Europeans looking to leave winter behind and see the Pyramids. Tourism contributes $14 billion to Egypt's economy.. and this has completely dried up. The country's stock market closed yesterday after a few days of clifftop declines. Today the government limited withdrawls from Egyptian banks to $10,000/day as apparently there has been a run on the banks. Within a few days, this number will come down to less than a thousand. The nation's gold reserves are undoubtedly being plundered. The Egyptian Pound has also taken a severe beating.. and these, along with soaring grain prices that caused this misery in the first place, have put very poor Egyptians in a desperate situation. These economic calamities will be hard to reverse in the short term even if Mubarak leaves.

The US today finally came out in support of the protesters and asked Mubarak to step down. Last week I believed that Mubarak would'nt last past the weekend.. apparently the old bugger is pretty stubborn.. indeed he came out and said that he's going to die on Egyptian soil. He also said that neither he or his son will be running in the elections scheduled for September. This was not nearly enough for the protesters, nor should it be. I still believe that Mubarak is finished, and I think the military will in the end escort the old Pharaoh into exile beside his son in a posh London suburb.

During the 2009 financial crisis, the term contagion was bandied about with abandon, and it indeed proved to be true. This crisis.. which I still believe is a financial one at it's heart.. also has begun it's contagion. Protests in Algeria continue, as do relatively small ones in Jordan.. which caused King Abdallah to dismiss the PM and  appoint a new one. In Yemen, President Saleh.. another corrupt dictator.. awoke to 20,000 people in the streets marching and demand his ouster, which I think will probably happen. Of these disturbances, Jordan's appears to be the least dangerous.. there is a measure of democracy there, and the King has asked the new PM to draw up some constitutional changes which give elections more power and the King less. Yemen is a country that unnerves me.. desperately poor, having one of the world's highest birth rates, and with declining water and oil resources (and the aforementioned rise in grain prices), this nations' fortunes are going downhill fast, and the fallout will undoubtedly affect Saudi Arabia much like Mexico's problems affect the US. Yemen might become the third nation in recent history (Somalia & Haiti preceded them) to descend into a kind of chaos with no central government or national currency.

About two weeks ago, investor Jim Rogers announced that he was going heavily long rice.. and quite apparently he was not alone. Rice has gone from under $10 per hundredweight of rough rice at the beginning of 2010 to $16.60 today.. and nearly 11% in the last 4 days.It was about $13.40 at the beginning of this year. Wheat and especially cotton have also skyrocketed this year, with wheat hitting $8.63/bushel.. double what it was just last June. The panic buying and hoarding I described could be beginning on a national level: Algeria bought 800,000 tonnes of wheat this last week, bringing their purchases in January to 1.8mm tonnes.. quadruple their usual purchase tonnage. Part of rice's move in the last couple of days has to do with very heavy purchases by both Indonesia and Bangladesh; Indonesia's purchase was also quadruple their historic norm. Having been a commodities trader, I can tell you that these are pretty serious price moves. Some of it is indeed speculation, but most drastic moves in commodities have an underlying truth in them, and this one is no different. Many traders use "technicals", a mathematic program based on charts, to predict the direction of prices. These technicals are all pointing towards rice reaching $20 in the near future, possibly next week. This would be a very serious event in Africa and Asia, especially very poor Asian nations such as Bangladesh, Nigeria and Pakistan. Remember that in very poor nations, people use a very large portion of their incomes on food, and such price rises are very dangerous as more and more people go hungry. There are rumblings that this could be the beginning of a hyperinflationary storm or a new food crisis.. but for me, these dire predictions are a tad premature. Still, the poor nations of the world will indeed see hunger this year, with Africa and parts of Asia hit hard. Egypt's misery might indeed be the just the beginning.

Egypt's Hunger

The nation of Egypt is the Arab world's largest nation population wise, with 83 million souls. In 1980, it's population was only 45 million.. and herein lies a good part of Egypt's problem.. population growth colliding with the limits of agriculture. Food prices are rising fast in Egypt, where the vast majority of the population has to spend a large (and sharply increasing) percentage of their incomes on basic food. As I explained last week, declining food production this year in combination with Big Ben's printing presses and increased demand from newly wealthy China and India have put the world's food situation in a precarious position, especially for poor nations like Egypt.

Like Tunisia, part to the problem is the corruption and nepotism of President Hosni Mubarak's government, which used heavy handed security forces to intimidate anyone brave enough to speak out. Hundreds of activists have "disappeared" over the last couple of decades. Corruption is at every level of government. Egypt also spends lavishly on it's military, supposedly as a defense against Israel. Mubarak's government has recieves about $3 billion in US aid each year, about half of which is military aid.. mostly paid as a ransom to keep the peace with Israel. To our credit, the US has helped the Egyptian people as well through US and UN aid agencies and trade treaties. The lifestyles of most Egyptians is acceptable; those with the right connections have it much better. Most Egyptians want what we all want.. a better life, education and peace. Mubarak's sham elections, corruption, heavy handed police and the setting up of his son, Gamal Mubarak, as heir apparent nauseated most, but life was still OK for most Egyptians. Full bellies and hope for a better future make for happy people. There was some semblance of economic growth, hope and justice for most.

As food prices began to rise last year however, those full bellies began growling for those at the bottom of Egypt's economic food chain. Riots and protests in several nations emboldened those who were hungry to begin their own protests last month. Mubarak's tough police units moved in swiftly and little was ever heard of the matter here in the outside world or on Egypt's media outlets. But when food price protests turned into violent mobs in Tunisia and forced out that nation's corrupt leadership, the Egyptian leadership began to get scared.

Sure enough, ever more bold and violent protests have taken hold in Egypt, culminating in today's bloody mayhem, when police opened fire on protesters, killing two protestors and a policeman. Earlier this week, ZeroHedge reported that large shipments of gold were leaving the nation. Today we saw tens of thousands violently protesting, throwing rocks and bottles at police in an event organized by protesters via Twitter and other social network sites. Today the Egyptian government blocked Twitter in Egypt. The police, obviously feeling threatened by flying debris, opened fire on protesters in Suez, killing one. Tonite we have confirmation that the heir apparent Gamal Mubarak and his family have fled to London with 97 suitcases. This is huge news.. it will show the Egyptian people that their corrupt government is crumbling. Members of Mubarak's political party were burning their membership cards. It looks like the rats are fleeing the rotten ship of state. I look for Gamal's departure to embolden the protesters tomorrow and unless something drastic is done I think Mubarak himself will join Tunisia's Ben Ali in exile before the weekend is out.

Tunisia was a small, insignificant nation not noticed in the grand scheme of the Great Powers. Egypt is a very different animal.. it has a very large military establishment and is a stone's throw from both Israel and Saudi Arabia. For US interests in the region, this could be a huge blow depending on what follows Mubarak. The peace treaty with Israel hangs in the balance. Egypt's army is infinitely stronger than Saudi Arabia's. The nightmare scenario for the US is that an Islamist government takes over in Egypt if Mubarak does fall. My guess here is something different.. I think Mubarak will go, but the Army will keep order and arrange new.. and free.. elections. This might actually work out well for the people of Egypt.. but I do think that any new government will be far less friendly to the US. The Army will not allow sweeping cuts to it's budget, and so while they'll have a new government, little of importance will change.

As with Tunisia, overthrowing corrupt, despotic regimes is the easy part. Delivering on things like food prices and stability is a whole other matter; the protests continue around the clock in Tunis days after the President fled the nation. Indeed when instability rears it's ugly head, the common people do the exact thing they should'nt.. hoard food, thus exacerbating the problems. The instability will deeply affect Egyptian financial institutions; bank runs are one likely event, as is a stock market massacre. Those who do empty their bank accounts will begin hoarding food, petrol and other basics. Solving the people's hunger for democracy will be the easy part. With a rapidly growing population and declining global harvests, solving their hunger will prove a mighty task indeed, especially if the ending here gets quite ugly.