The International Monetary Fund issued a report Thursday on a possible replacement for the dollar as the world's reserve currency. The IMF said Special Drawing Rights, or SDRs, could help stabilize the global financial system.

Oh, this must be the same way the Federal Reserve helps stabilize our economy here in the U.S....

SDRs represent potential claims on the currencies of IMF members. They were created by the IMF in 1969 and can be converted into whatever currency a borrower requires at exchange rates based on a weighted basket of international currencies. The IMF typically lends countries funds denominated in SDRs

"Potential claims?"  Is anyone else confused at how this could help anyone?

While they are not a tangible currency, some economists argue that SDRs could be used as a less volatile alternative to the U.S. dollar.

Who are these "economists" anyway?

Dominique Strauss-Kahn, managing director of the IMF, acknowledged there are some "technical hurdles" involved with SDRs, but he believes they could help correct global imbalances and shore up the global financial system.

Central planning by some mega-international-bank will not help anyone anymore than the central banks have helped Greece, Spain, Ireland, Iceland, and the U.S.

"Over time, there may also be a role for the SDR to contribute to a more stable international monetary system," he said.

A more stable monetary system for Goldman Sachs, JPMorgan Chase, and their cronies.  Ultimately the ordinary citizens of the world lose out.

The goal is to have a reserve asset for central banks that better reflects the global economy since the dollar is vulnerable to swings in the domestic economy and changes in U.S. policy.

Of course the dollar is "vulnerable" to swings, its fiat!  Just like this reserve 'asset' would be.

Now, I want to be clear that I'm not saying that the US Dollar should remain the world's reserve currency (I don't think it should remain ANYONE'S currency...it's worthless), I'm simply pointing out that this IMF "alternative" is nothing better (it may even be worse).  It is simply a way to push economic control further and further away from the people of the world.  It's bad enough that today citizens have essentially no control over what their central bank does (and thus their respective economies).  This scheme by the IMF would only lessen the influenc citizens have on their own currencies, countries, and economies.  If the world needs a reserve currency, it should be a real asset like gold or silver, not an "asset" that is "not a tangible currency."

In addition to serving as a reserve currency, the IMF also proposed creating SDR-denominated bonds, which could reduce central banks' dependence on U.S. Treasuries. The Fund also suggested that certain assets, such as oil and gold, which are traded in U.S. dollars, could be priced using SDRs.

Does the world need more bonds (debt)?  Who would the IMF be creating this debt on behalf of?  What kind of control would ordinary citizens have over the IMF? (The answer to that last one is almost none)
Additionally, for those in the U.S., imagine the impact of a reduced dependence on U.S. Treasuries.  If treasury yields rise in the U.S (and they will), the consequences on our budget and deficit will be astronomical.

Fred Bergsten, director of the Peterson Institute for International Economics, said at a conference in Washington that IMF member nations should agree to create $2 trillion worth of SDRs over the next few years.

SDRs, he said, "will further diversify the system."

I think such a scheme would 'diversify thy system' in the same way that Credit Default Swaps and Mortgage Backed Securities helped diversify investors portfolios from 2003-2008.  Try not to think about how they also lead to the largest credit bubble, recession (arguably, depression), and financial disaster in at least a generation...they wouldn't screw up that bad again, would they? (Yes.)

I'll leave you with the best question of all, does the world need the IMF?  (The answer is no.)

• Very good article from Washington's blog about Egypt's "Emergency Powers" vs. US "Emergency Powers" (which are still in place from 2001). Great read, with great research as usual.
• Bernanke, meet Stephanie. Mish writes a great response to "Stephanie" who lives on a fixed income and wants to know what she should do. How great do Bernanke's actions look in this light?
• Maybe a little unrelated, but an interesting read about the USDA's new dietary guidelines. Health is another topic that interests me, and it sometimes finds its way (absurdly) into economics as politicians try to force health ideas and eating habits on us.

What is everyone else reading this week?

The entire article is well worth the read, but I really like his quote from a Bank of Japan study on their enormous multi-decade QE ‘experiment’ (failure):

As a study by the Bank of Japan of its own huge experiment with QE concluded, “While we can enumerate several routes of the monetary base channel which suggest that expansion of the monetary base can have some expansionary effect on the economy, our analyses suggest that the quantitative magnitude of any such effect is highly uncertain and very small.” [The Effect of the Increase in the Monetary Base on Japan's Economy at Zero Interest Rates - An Emprical Analysis, Bank of Japan, 2002].

[Emphasis Mine]

So what have we learned in the U.S. from Japan’s 2 lost decades (with potentially more still coming)?  Apparently Nothing.

Business Week is proving, once again, that economists have learned nothing from Japan in Japan Learns to Live With Deflation:

Ben Bernanke has been lecturing on deflation's perils since he joined the Federal Reserve in 2002 and has often held up Japan as Exhibit A. When the Fed launched QE2, the quantitative easing program to promote credit expansion in the U.S., in November, the central bank chief hoped to avoid the scourge that has devastated Japan's economy. U.S. consumer prices, excluding food and fuel, climbed at their slowest pace since records began in 1959, the Commerce Dept. reported on Dec. 22.

Hmm, so Bernanke has been flaunting Japan as the poster boy for deflation's perils......let's read on:

There's something curious about the way the deflation syndrome has played out in Japan, though. The Japanese don't feel that threatened anymore. "Everyone knew deflation was bad for jobs and bad for the economy, but gradually households and companies just got used to it," says Martin Schulz, a senior economist at Tokyo's Fujitsu Research Institute.

Deflation—the steady drop in prices of goods, wages, and services—has many ill effects. Households are stuck paying off mortgages, car loans, and other debt even as their take-home pay has declined. Also, as housing values fall, consumers have smaller nest eggs for retirement. Companies, meanwhile, are unable to raise prices, which puts pressure on profits.

There are so many flaws with this paragraph.  Households are only stuck paying off mortgages if they took out more debt than they can handle.  The same is true with car loans and "other debt."  Ironically, inflation is what encourages (and in many cases forces) people to take on more debt than they can handle.  Debt is less friendly during deflation, so individuals are less likely to take on debt to begin with.  These problems only really arise when you shift away from an inflationary environment into a deflationary one.  During inflation, people are encouraged to leverage and take on debt.  When teh bubble bursts, deflation will take hold.  For Japan that bubble burst in the 90s, and those holding mortgages were likely in trouble.  Once that bad debt was purged, deflation was no longer a problem.  In fact, as we'll see, it may have been part of the solution.  Let's read on...

Yet the Japanese have discovered the benefits of deflation as well. Monthly pay dropped to an average 315,294 yen ($3,800) in 2009, the lowest level since the government began tracking wage data in 1990. "It's not like I'm promised any pay raises," says Momoko Noguchi. The 24-year-old Tokyo resident gets by on two part-time jobs by shopping for everything from nail polish to dinner plates at her local 100-yen outlet (the Japanese equivalent of an American dollar store), and she pays 400 yen or less for lunch. "I hope prices keep falling." Four out of five Japanese say higher costs would be "unfavorable," according to a central bank survey.

Faced with consumers such as Noguchi, companies in Japan have actually accelerated deflation. Retailers "have poured a lot of energy into offering products that are cheap but still have high value," says Naozumi Nishimura, an analyst at TIW in Tokyo. "We're seeing some good effects from that."

....

Price cutting by companies has helped Japanese consumers adjust to deflation. The average household owns 1.4 cars and 2.4 color TVs, about a quarter more than in 1990, a Cabinet Office survey shows. Deflation has helped home buyers, too, by forcing prices down from their peaks in 1990: According to calculations based on yearly Land Ministry data, Japan's residential land prices have dropped by an average of 2.9 percent a year over the past two decades.

Golfers pay 26,800 yen ($324) to play on the weekend with a caddy at the Bobby Jones Jr.-designed Oak Hills Country Club, 90 minutes' drive from central Tokyo. Twenty years ago the fee was about 40,000 yen, says Katsutoshi Ohira, acting manager. All told, the proportion of people content with their standard of living was 63.9 percent last year, compared with 63.1 percent in 1989, a government report said.

Deflation is so entrenched in Japan that companies are exporting it. Fast Retailing plans to open 44 Uniqlo stores overseas this fiscal year. Supermarket chain Aeon has earmarked about $2.5 billion over three years to open stores in China and Southeast Asia. Daiso Industries, which dominates the 100-yen retail sector, now has outlets in more than 20 countries.

Amazing, right?  Wages are lower in Japan today than they were in 1990, and yet its ok because prices have declined as well.  In fact, companies are embracing deflation and still managing to profit nicely off of it.  The Japanese are seeing "good effects."  It doesn't sound like Uniqlo is doing so bad in the deflationary environment...

In Japan, where 23 percent of the population is over 65, a sudden rebound in prices would hurt pensioners and retirees especially hard. "It's amazing what you can buy with 100 yen now. We didn't have 100-yen stores before," says Sachiko Enokida, 80, who lives on her bimonthly pension checks from the government. "I would hate for things to get expensive again."

Unfortunately, things are very likely going to get expensive again in Japan.  It's not because of the wrath of deflation, but because of the government's response to deflation over the past 20 years.

Thanks to Keynesian economic clowns screaming for tough action to fight deflation, Japan has built bridges to nowhere, and run record deficits for over 2 decades trying to ward off deflation.  Even amongst their efforts, we see that wages, golf prices, grocery prices, and retail prices are lower than they were 20 years ago....and the people like it that way!

The repercussions of these actions have to come home to roost eventually.  The debt and deficits that have been run up over the past 20 years can't be paid back, and when governments cant pay back their debts they default. When interest rates begin to rise in Japan it will be devastating.  It's not going to be a pretty picture for Japan when that happens.

The irony of Japan's extreme efforts to fight deflation is that deflation is actually the natural course of successful economies.

Deflation is the natural course of successful economies

Not enough people understand this, so I'll say it again: deflation is the natural course of successful economies. You see, in a successful economy, productivity increases, and technology advances.  Both of these things lower prices.  The technology sector is a great example of this.  We often hear how lower prices mean companies can't hire as many people and can't expand, but look at the many technology companies such as Dell, Apple, HP, IBM.  The prices of their technical gadgets and services have declined like rocks for decades even in the midst of inflation. Why?  Because of technological advancements, and massive increases in productivity.  Yet at the same time these companies have grown by leaps and bounds, hiring well-paid employees every step of the way and contributing greatly to economic growth.  I can't stress it enough: deflation is the natural course of successful economies. Deflation should be the norm, not inflation.

Inflation is the course for a theft-based and corrupt economy where governments inflate currency for their benefit and for the benefit of those who they give the money to first at the expense of everyone else.  It causes higher prices, which hurts people who get access to money last (the poor at the bottom of the totem pole).

The Bottom Line

Returning to our article:

The bottom line: Although deflation ultimately poses a serious threat to Japan, ordinary consumers are benefiting from lower prices.

So we see that we have come full circle only to again show that economists are incapable of looking at the facts and learning new things. What will it take to get us to realise that we are following a similar course as Japan?  Japan's central bank explicitly tells us that the effects of quantitative easing are "highly uncertain and very small," and we now see that deflation has not been as horrible for Japan as we have been lead to believe.  The true bottom line is that we find ourselves embarking on the same misguided policies with economists cheering the Fed and the Government on every step of the way, slowly but surely marching our country toward the path of financial ruin.

• Alan Greenspan’s malfeasance — his refusal to perform his regulatory duties because he did not believe in them — allowed the credit bubble to expand, driving housing prices to dangerously unsustainable levels; Greenspan’s advocacy for financial deregulation was a “pivotal failure to stem the flow of toxic mortgages” and “the prime example” of government negligence;
• Ben S. Bernanke failed to foresee the crisis;
• The Bush administration’s “inconsistent response” — saving Bear, but allowing Lehman to crater — “added to the uncertainty and panic in the financial markets.”
• Bush Treasury secretary Henry M. Paulson Jr. wrongly predicted in 2007 that subprime meltdown would be contained.
• The Clinton White House, including then Treasury Secretary Lawrence Summers, made a crucial error in “shielding over-the-counter derivatives from regulation [CFMA]. This was “a key turning point in the march toward the financial crisis.”
• Then NY Fed President, now Treasury secretary Timothy F. Geithner failed to “clamp down on excesses by Citigroup in the lead-up to the crisis;” Further, a month before Lehman’s collapse, Geithner was still in the dark about Lehman’s derivative exposure;
• Low interest rates brought about by the Fed after the 2001 recession “created increased risks” but were not chiefly to blame, according to the FCIC (I place some more weight on Ultra-low rates than they do);
• The financial sector spent $2.7 billion on lobbying from 1999 to 2008, while individuals and committees affiliated with the industry made more than $1 billion in campaign contributions. The impact of which an incestuous relationship between bankers and regulators, Congress and bankers, and classic regulatory capture by the industry.
• The credit-rating agencies “cogs in the wheel of financial destruction.”
• The Securities and Exchange Commission allowed the 5 biggest banks to ramp up their leverage, hold insufficient capital, and engage in risky practices.
• Leverage at the nation’s five largest investment banks was wildly excessive: They kept only $1 in capital to cover losses for about every $40 in assets;
• The Office of the Comptroller of the Currency along with the Office of Thrift Supervision, “federally pre-empted” (blocked) state regulators from reining in lending abuses;
• The report documents “questionable practices by mortgage lenders and careless betting by banks;”
• The report portrays the “bumbling incompetence among corporate chieftains” as to the risk and operations of their own firms:

In FCIC Investigation misses the "Pig Picture" Cause of the Crisis; Next Financial Crisis Brewing Already, Mike Shedlock (Mish) agrees with Ritholtz's points (as do I), but argues:

I cannot dispute any of those points. They are all correct. Yet every one of them happened as a failure "of" regulation, not a failure "to" regulate.

The actual cause of the financial crisis is easy to explain.
1. Loose monetary policies at the Fed
2. Fractional Reserve Lending
3. Congress willing to spend more money that it takes in

Had there not been Fractional Reserve Lending, and had the Fed not cut interest rates to absurd levels while fostering a "too big to fail" attitude at banks, this would not have happened. Perpetual Congressional budget deficits and the Fed's willingness to finance those deficits too cheaply is icing on the "what happened" cake.

To expect smart regulation from those who did not see it coming, the Fed and nearly all of Congress, is preposterous.

Moreover, had there been (by some miracle) regulation to prevent the housing collapse, liquidity would have flowed somewhere else and there would have been a bubble in some other thing.

I completely agree with Mish on these points. In an interesting follow-up to Mish's post, Ritholtz writes:

One of the stranger aspects of human nature — or is it just people with intense affiliations with ideologies? — is the tendency to see the entire world through a distorted lens.

The origins of the financial crisis are no different. It seems that all too many people are willing to use any event to pursue their own agendas, regardless of evidence or proof.

Hence, we have a steady parade of people who seek to blame or exonerate the precise wrong factors which nonetheless fit their preconceived notions.

Examples?

• Mish blames the crisis on 3 factors. While we agree about Ultra Low rates, his other two elements are simply incorrect. “Fractional lending” is his #2 cause. Never mind that this form of credit creation has been around for centuries, he is a vociferous critic of it. Naturally, it was the cause of the crisis. (See: Financial Crisis Brewing Already) Deficits are his #3 cause, which quite bluntly, is beyond my comprehension as a cause of the credit crisis.

I was very surprised by this Response from Ritholtz -- most specifically with regard to fractional reserve lending (FRL). Of all people, I surely thought Ritholtz would see the major influence that FRL has on nearly every bubble, but especially bubbles driven by credit.  Surely Ritholtz must agree that the housing bubble was driven by an over-expansion of credit?

Interestingly enough, Mish responded once more to Ritholtz:

Let' focus on Barry's main rebuttal:

Never mind that this form of credit creation has been around for centuries, he is a vociferous critic of it.

Yep, Fractional Reserve Lending is centuries old. However, what kind of logical rebuttal is that?

The fact is FRL has caused problems for centuries. The best example is the John Law Mississippi Bubble. However, FRL has arguably made every bubble in history worse.

The idea that something cannot be a problem because it has been around for a long time is preposterous. So why do we have it?

FRL has suited the interests of bankers and politicians. That is why it has been around for centuries. Indeed, inflation and credit expansion benefit those with first access to money: banks, the wealthy, and governments (via increased taxes, especially property taxes and sales taxes).

Those at the bottom of the economic totem pole get hammered.

I much enjoyed Mish’s response to Ritholtz’s statement that FRL is a “form of credit creation has been around for centuries.” Murderers and thieves have been around for centuries as well, so they must not be problems either. Even closer to the issue, fraud has been around for centuries, yet I think we all can agree that fraud played a large role in the current economic crisis and housing bubble, can’t we?

While I also agree with Mish’s other points that FRL has "suited the interests of bankers and politicians" and that “credit expansion benefits those with first access to money,” these points don’t do anything to show how FRL helped cause the current crisis. That is what I want to discuss further in this article.

Fractional Reserve Lending

Let’s start with a basic definition. According to wikipedia:

Fractional-reserve banking is the banking practice in which only a fraction of a bank's demand deposits are kept as reserves (cash and other highly liquid assets) available for withdrawal. The bank lends out some or most of the deposited funds, while still allowing all deposits to be withdrawn upon demand. Fractional reserve banking is practiced by all modern commercial banks.

When cash is deposited with one bank a fraction only is retained as a reserve and the remainder can be lent (or spent by the bank to buy securities). Thus, the money lent or spent in this way is subsequently deposited with another bank and increases the cash reserves of that second bank, allowing that second bank to keep a fraction of the new deposit and lend or spend the remainder. Thus the excess cash travels from bank to bank to bank creating new deposits as it goes. Although no individual bank does anything other than lend part of what is deposited with it, the practice of fractional reserve banking in a multi-bank system expands the money supply (cash and demand deposits) to a large multiple of the cash reserves in all banks.

In the U.S. we currently have a 10% reserve requirement for demand deposit (checking) accounts (lets ignore sweeps for now). When someone deposits $1,000 into bank A, bank A will loan out $900 of that money. The receiver of that loan will deposit the $900 into another bank, say bank B, and bank B will carry out the same process of loaning out $810. This process carries on throughout the system, eventually assuring that roughly 10 times the initial deposit is lent out and created out of thin air into the system. Economists have a friendly name for this expansion, and it is called the money multiplier. It doesn’t sound so bad that way, but you could easily call it the “inflator,” or “massive credit expander,” but I guess those don’t sound as nice. Alas, we see that from the initial $1,000 deposit, we will eventually (and usually in very short-order) have $10,000 of deposits created throughout the banking system.

These deposits will be based on money that doesn’t really exist. To really show this, let’s suppose that the government were to introduce a new currency called X, and it prints 1,000X into existence to pay for some construction project. Only 1,000X exist -- that is all that has ever been made. Now let’s assume the banks are told to accept these X notes, and the construction company deposits the 1,000X into a bank. The same process described above will carry on until there are now roughly 10,000X worth of deposits in various banks. But only 1,000X have ever been created! Clearly you can see the problem here. If every depositor tries to withdraw their deposits of currency X, there aren’t enough X’s in existence! This is fraud. Yes Barry, fraud has been around for centuries (likely longer than FRL!), but I still think it is a bad thing.

Above, I posed the question “Surely Ritholtz must agree that the housing bubble was driven by an over-expansion of credit?” Everyone should be able to see that FRL facilitates the extremely easy creation of credit (and essentially ‘money’) out of thin air by the banks. How can this possibly have not contributed (and in large part!) to the current financial crisis?

100% Reserve Banking

Let’s take a moment now to imagine a pre-crisis world without FRL -- or 100% Reserve banking. In such a world, banks would take on deposits, and be required to keep those deposits on hand at all times. Banks would not be allowed to lend out money in demand deposit accounts or sweep them into savings accounts. Depositors would know that their money was always there, and bank runs would not exist, nor would they be a problem if they did exist -- all the money deposited at the bank would always be there, untouched.

So how would the banks loan money?

Well, quite simply, they would have to save money, or borrow money from other savers. Let’s take the classic case of borrowing money from other savers. This is most commonly done through a Certificate of Deposit (CD). When a saver decides to invest in a CD with a bank, the saver is giving his money to the bank for a pre-determined period of time at an agreed upon interest rate. The bank knows that it will have this money for that time period, and can turn around and loan out that money at a higher interest rate for the same time period. The bank would make money on the difference in interest rates.

Notice that in this situation, no new money has been created. The saver does not have access to his money during the period he has loaned it to the bank (much unlike when he puts money into a checking account today). Additionally, the saver is actually taking on some known risk when he loans money to the bank. The saver would have an interest in the history of the bank to make good loans that it can repay. If the bank makes a bad loan with his money and can’t repay him, he stands to lose his savings. This is a risk that the saver must consider and be aware of.

So under this system, banks would not be able to create credit for free out of thin air, but would have to either save, or borrow money to loan out. Thus, when bad things happen and loans (mortgages) can’t be repaid, only individuals who have willingly taken on some risk with the bank through CDs (and other time deposits/loans) will be hurt.

Moreover, if a bank were to make many bad loans and bankrupt itself, depositors would still be able to get 100% of their money out of their checking accounts. This is because the bank is not allowed to take the money out of your account while you aren’t looking (as they are today under FRL). So we see that those who loaned their money to banks, and willingly took on some risk in hope of some reward, will be the only ones to lose any money. The depositors at the bank lose nothing.

This brings us to an interesting question.

Why did we bail out banks?

We were often told in 2008 and 2009 that if the government did not bail out the banks, we would have a “systemic collapse.” Everyone seemed to understand that without these bailouts, our banks would go under, and our deposits would be in jeopardy. Nobody wanted to lose their deposits!

As I have shown above, in the absence of a FRL system, there is no systemic collapse. Depositors cannot lose their deposits because deposits are required to be kept on hand, just like items that you keep in a storage unit are kept in the storage unit -- not lent out to others while you aren’t there.  If your mini-storage provider goes bankrupt, do you lose your lawn mower and furniture?!

Surely banks could still go under, but that would be due to bad decisions and bad loans on the banks part (just as it is today). The difference is that, in this world, bad decisions on the part of the banks only hurts the bank itself, and its investors. It cannot hurt its depositors (unless of course the bank is committing fraud, in which case they need to be prosecuted accordingly -- hopefully the link between FRL and fraud is becoming clearer?). This reality will encourage savers to be diligent when deciding which bank to loan their money to, which will, in turn, force banks to be prudent in their lending in order to receive more loans from more savers.

Alas, this is the crux of the matter.  Without FRL, banks have to borrow money from people in an open fashion (i.e. without taking it from their checking accounts while they arent looking). When investors loan out hard-earned money to banks, they will want to make sure they are going to get it back. This imposes restraint on the banks to make good loans to encourage more investors to loan them money.

But banks offer CDs today!

Some of you may mention that banks offer CDs today, so what is the problem? Well, banks do offer CDs today, but the vast majority of their loans comes from their depositors' (demand-deposit) money. In a quick search I couldn’t find any nationwide numbers to show the amount of time deposits (CDs are time deposits) vs. bank loans, but even if I could, the number would be muddled. It would be muddled because savings accounts are also time deposits, but savings accounts have zero reserve requirement, and are generally not locked in for a set period of time like a CD. Because savings accounts are not a loan to the bank like a CD is, I feel like such a number would represent many more savings accounts than CDs, and thus not tell us much. Suffice it to say that much, much, much more credit and "money" is being created from thin air by banks than is being backed by savings loaned to the banks.

Also, while banks do offer CDs today, the ability for banks to repay CDs is much higher than it would be if they could not simply repay the CD with money from its depositors (money that the depositors still think they have “on-demand”). If they were not allowed to touch demand deposits, they would have to find the money elsewhere (most likely by making good loans with the money borrowed, or by charging fees for their services). Because banks can so easily repay CDs without having to necessarily make prudent loans, it lessens the need for investors to be so diligent in picking a bank, which in turn lessens the restrain forced on the bank by its investors to make good loans.

Fractional Reserve Lending Contributed to the Crisis

Hopefully I have made the case that fractional reserve lending was, indeed, a major factor that contributed greatly to the current financial crisis. It is my strong belief that without FRL, banks would have been forced to make better loans (though some still would certainly do otherwise -- and go bankrupt), bailouts would not have been “needed” (I don’t think they were needed anyway), credit would not have expanded at anywhere near the rate it did, no depositors would have lost any money even without an FDIC, house prices would have risen more gradually and with inflation rather than bubbling out of control (due to easy loans facilitated by FRL!), and current government debt and deficits would be much much lower.

With FRL we verge on systemic collapse with every innocent citizen’s money at risk of disappearing overnight due to some remote banker’s bad decisions. Without FRL we may (at worst!) have investors losing money they chose to invest, while leaving uninvolved parties’ money untouched and safe. Even in the worst case, I choose no FRL. After reading this, I hope you do too.

One thing that it seems people never want to talk about is the flip side of that equation.  The government hoped that HAMP would keep millions of people in their houses.  Even ignoring the fact that only 1.4 million have gone through the trial, and less than half of that (550,000) have had their modifications made permanent, we should be asking ourselves if these programs are helping people overall.

What I mean by that is, say the government expected to "help" 5 million people keep their homes with HAMP, that means that 295+ million people are going to be hurt by having to pay for it either through higher taxes, higher inflation, depressed future earnings, or a combination of all three!

Additionally, these higher taxes/costs/burdens on the rest of us, will likely result in fewer job opportunities, more unemployment, and thus more foreclosures in the future.

So does hurting 295+ million people outweigh helping a potential 5 million?

It's also easy to look at specific dollar amounts spent on various programs and argue that they are insignificant and really won't have that big of an impact in the grand scheme of things.  This is bad logic.  The thousands and thousands of government programs like these add up and amount to something very large and very real.  The burden placed on each of us (businesses, too) by these programs is a very real and present drag on the economy.

If we looked at all government programs and evaluated them in this way, we'd be much more likely to have a small and limited government -- not to mention more rights, freedoms, and security.

Whenever someone mentions how many people the government "helped," subtract that number from 300 million to see just how many people are paying for it.  Is it worth the cost?

I especially agree with his sentiment that Iceland can attribute its quick and strong recovery to the fact that it's government did not bail out the country's banks. Also, the economist from Ireland gets it right when he says "nobody really knows how bankrupt the system is," also mentioning that "Spain and Italy might be the straws that break the camel's back." Definitely a video worth watching.

Other interesting reads from the week below:

• I always love it when a simple accounting change can get rid of losses. Now the Federal Reserve can take advantage of accounting mirages as well!
• In a very welcome surprise, the FCIC (Financial Crisis Inquiry Commission) found that failures of government regulation, Greenspan, Bernanke, Fed low interest rates, and more were causes of the financial crisis.
• Rand Paul Unveils $500 Billion in Cuts
• Are We Accidentally Medicating Ourselves Into a Mind-Numbing, Body-Weakening Stupor?

Also, some interesting photos and videos of the riots in Egypt can be found here (photo), here (youtube), and here (youtube).

As a study by the Bank of Japan of its own huge experiment with QE concluded, "While we can enumerate several routes of the monetary base channel which suggest that expansion of the monetary base can have some expansionary effect on the economy, our analyses suggest that the quantitative magnitude of any such effect is highly uncertain and very small." [The Effect of the Increase in the Monetary Base on Japan's Economy at Zero Interest Rates - An Emprical Analysis, Bank of Japan, 2002].

[Emphasis Mine]

So what have we learned in the U.S. from Japan's 2 lost decades (with potentially more still coming)?  Apparently Nothing.  Maybe it'll take us 2+ decades of failed policies to finally realise the same thing (one decade is already behind us).  Hopefully we can wake up before then.  As I said before, the entire article is really worth a read.

I believe that the issue is very simple, and I think the consequences of both actions are clear.  If we raise the debt ceiling, we simply prolong the day of reckoning while also making that day far worse when it does arrive (and it will).  If we don't raise the debt ceiling, we can begin to face the consequences of our reckless past sooner rather than later, and those consequences will inevitably be less than if we prolong them to a future date.

Raising the debt ceiling is akin to applying for another credit card to pay off your current credit card that you cant currently afford to pay off.  Anyone that has ever paid off a debt should understand that this practice is completely unsustainable, and will only worsen the consequences down the road.  At some point, we have to decide to face up to our unsustainable course, and begin to tackle the problem.

What happens if we don't raise the debt ceiling?

This morning Pat Toomey, a newly elected Republican Senator for Pennsylvania, penned an article on just this topic: How to Freeze the Debt Ceiling Without Risking Default.  The article reads:

For months, some political leaders and commentators have argued that failure to raise the debt ceiling would necessarily cause the U.S. to default on its debt. President Obama's Council of Economic Advisors chairman, Austan Goolsbee, recently warned, "If we get to the point where you've damaged the full faith and credit of the United States, that would be the first default in history caused purely by insanity. I don't see why anybody's talking about playing chicken with the debt ceiling."

In fact, if Congress refuses to raise the debt ceiling, the federal government will still have far more than enough money to fully service our debt. Next year, for instance, about 6.5% of all projected federal government expenditures will go to interest on our debt, and tax revenue is projected to cover about 67% of all government expenditures. With roughly 10 times more income than needed to honor our debt obligations, why would we ever default?

To make absolutely sure, I intend to introduce legislation that would require the Treasury to make interest payments on our debt its first priority in the event that the debt ceiling is not raised. This would not only ensure the continued confidence of investors at home and abroad, but would enable us to have an honest debate about the consequences of our eventual decision about the debt ceiling.

I have grabbed some charts from http://www.usgovernmentspending.com to show some of the debt/revenue/interest data in an easy-to-understand visual format.

For fiscal year 2011, the U.S. is expecting to spend $3.83 Trillion, while it plans to have revenues of $2.56 Trillion.  This leaves a deficit of $1.27 Trillion dollars.

Currently, the debt ceiling is set at $14.29 Trillion, and the current debt outstanding is roughly just over $14 Trillion (as of the time of this writing).  That leaves the treasury with just under $300 billion in borrowing capacity before the current debt ceiling is reached.

Interest on our debt outstanding for 2011 will cost roughly $250 billion.  In order for the treasury to continue paying the interest in full for 2011, without incurring any more new debt, it will have to spend $250 billion of its $2.56 Trillion in revenues, which will leave it with roughly $2.31 Trillion dollars left over to pay for the remaining $3.58 Trillion in expenses.

The ultimate reality here is that 3.58 - 2.31 = $1.27 Trillion dollars in cuts that will have to be made elsewhere in the budget in order for the treasury to sell no new debt while still continuing to pay the interest in full.

When we look at the raw numbers, it sounds a lot more difficult than the simple way Senator Toomey describes the situation, but still, I agree with Mr. Toomey.  The only sane option is to face up to this reality now, rather than later when the numbers will be far worse.

At some point we have to put our fut down and admit that we have a debt problem, and begin to face it head on instead of repeatedly kicking the can down the road.

Cutting $1.27 Trillion

While I think the debt ceiling will likely end up being raised anyway, I would like to take a look at some of the things that could be cut were the debt ceiling to stay where it currently is. Let's take a high-level look at where the spending goes (source: http://www.usgovernmentspending.com/year2011_US.html)

Right off the bat I think nearly 100% of the Education spending can be gotten rid of.  Note that I am looking at the Federal column (first column, in black) only.  States would still be spending money on their school systems, but cutting the money at the federal level would get rid of the Department of Education (ED) bureaucracy that is wasting money, and harming the education of our citizens.  Let's say that takes off $130 Billion, just in case we can't get rid of it all.

Next up would be Defense.  We can easily slash defense spending by a minimum of 50% by bringing troops home from places like Italy, Japan, Vietnam, not to mention Iraq.  Not only would this save us boat loads of money ($500 billion!), but it would strengthen our defense.  We are currently spreading our army thin by having a presence in too many places that we don't even need to be.  Let's close up shop, stop making other countries mad at us, save money, and become safer and more defense (rather than offense) driven.  Let's count that as $500 billion off.

Welfare and Pension cuts would need to come next.  Nobody is going to like cutting these, but it has to be done because these programs are unsustainable.  We need to make employees contribute more to their pensions, and even convert them completely to 401k/IRA's where possible (essentially everywhere).  Welfare and Pensions combined are nearly $1.3 Trillion dollars.  We need to face the reality that these programs eventually need to be cut by 100%, but in the interim let's assume 40% cuts.  This gets us another $500 billion.

Finally, the healthcare category needs to be taken care of.  We spend almost $900 billion a year on healthcare spending, which includes things like medicare, medicaid, and provisions from the new healthcare legislation, amongst other things.  The said truth is that medicare is already bankrupt, and more and more doctors are refusing to take medicare because it pays so little.  The cost of these programs is too great, and the benefits are too small for them to continue.  The model is broken.  If we just assume 40% cuts here, that gets us $359 Billion, which brings our total cuts to just over $1.35 Trillion.  Not bad, maybe we can to throw in some tax cuts ;)

These cuts are really just the tip of the ice berg.  We need to abolish the Department of Energy, abolish the DEA, get rid of the Department of Homeland Security (we have barely even had it for an entire decade...how necessary can it be?), which has become essentially the  biggest and most wasteful bureaucracy that we have (with the exception of maybe the DOD).   While we're at it, how about getting rid of the IRS completely in favor of a flat tax (which we work down to a 0% rate).   The TSA surely needs to go as well.  The list could go on and on....

It's actually pretty easy to come up with the necessary cuts, the only hard part is for congress to get the political will to carry them out.  The other side of the coin is educating the American people so that they truly understand the situation we are in.

One sure fire way to create the political will to make these and other cuts happen is to urge your congressmen and congresswomen not to raise the debt ceiling.  If we can prevent the debt ceiling from being raised, we might see what it looks like for Geithner to do something useful.

The cuts sound harsh, but they are coming

The cuts that I have outlined above certainly may sound rather harsh and drastic to some of you, but I want to inform you of the harsh reality of the situation we currently find ourselves in:  These cuts, and probably many more, are coming one way or another.  The only choice we have is if they come by in an orderly and controlled fashion, or if they come chaotically as a result of currency and confidence crisis in the U.S.

No one can say with certainty when the U.S. will face a loss of confidence, but we can say with certainty that unless we change course drastically, it is the path that we are on.  The current path is unsustainable and can only end in disaster without drastic change.  The sooner the changes, the better.

So, to start of the first post in this series, here are my interesting links for the week:

• An interesting read about wikileaks over at the Atlantic: The Hazards of Nerd Supremacy: The Case of WikiLeaks
• Doug short has a good read (as usual) that takes readers Inside the Consumer Price Index.
• A good video from CSPAN BookTV with Steven Greenhut, Author of Plunder: How Public Employee Unions are Raiding Treasuries, Controlling Our Lives and Bankrupting the Nation.
• A gold standard is being supported by Alan Greenspan (I'm aso surprised of the talk about Ayn Rand in the video)

What are you all reading this week?

The Irish Government collapsed yesterday, with multiple ministerial resignations propelling Prime Minister Brian Cowen into setting 11 March as the date for a general election. His Fianna Fail party, which dominates the government, is widely expected to be largely wiped out in the contest, since under the Cowen leadership it has slumped to unprecedented depths in opinion polls.

....

Many Fianna Fail members of the Dail, the Irish parliament, have announced they are not standing again, because they are unlikely to be re-elected or because they realise they will face years in opposition.

....

This has led to predictions that Fianna Fail could drop from more than 70 seats to fewer than 20, a result which would represent a seismic change in Ireland's political patterns.

The bold above is mine.  Reuters provides a good timeline of events leading up to the current state of affairs that interested readers may wish to take a look at.

The Wall Street Journal reports in Ireland to hold general election on March 11:

Both Fine Gael and Labour have also expressed their desire to alter the terms of the European Union and International Monetary Fund's EUR67.5 billion rescue package, particularly the 5.8% average interest rate. Ireland will contribute an additional EUR17.5 billion to the package.

But the government has said the interest rate is set and can't be renegotiated unilaterally by Ireland. Cowen insists the bailout was essential to stabilize the economy in the wake of the financial crisis that has ravaged the country since the collapse in the construction sector.

Come March, I believe we will see quite clearly that the interest rate is not set and can be renegotiated.  In fact, hot on the heels of these news stories, is this gem about the IMF says interest rate on Irish loan to fall:

The interest rate that Ireland is paying on its International Monetary Fund loan is set to fall as part of changes being made to member countries' voting shares, the IMF said on Thursday.

IMF spokesman David Hawley told a regular news briefing that Ireland's IMF quota, which determines among other things how much a country contributes and can borrow from the IMF, was set to increase following governance reforms approved in 2008.

"Ireland is one of those countries whose quota stands to increase under this agreement," Hawley said. "As a consequence, the amount of its loan relative to its quota will fall, and that will have a bearing on the interest rate paid on its borrowing from the IMF."

Hawley said the rate currently stands at 3.1 percent.

He said the IMF was in the process of calculating the adjustments for each member country, but could not offer exact figures. The quota changes would probably affect several other borrowers, he said, but could not elaborate.

Looks like the rates may already be dropping.  Is the IMF just trying to make the people of Ireland feel a little bit more comfortable with a lower interest rate?  Is the IMF possibly scared about what the next government may decide to do about their debt burden, and thus, are already trying to ease some of the discontent in Ireland?

I believe that Ireland should tell the EU and IMF to shove it, and default on its loans from the EU and IMF as well as its loans from UK, German, French, US.  This is surely Ireland's quickest way back to a healthy economy.

European Comission Chief, Jose Manuel Barroso, feels that Ireland has only itself to blame for the costly bailout:

"The problems of Ireland were created by irresponsible financial behaviour of financial institutions and a lack of supervision in the Irish market," Mr Barroso hit back in an angry exchange. "Europe is now part of the solution. It was not Europe that created this fiscally irresponsible situation and this financially irresponsible behaviour."

Ireland is certainly partly responsible for their own problems, but surely the banks that loaned Ireland money that can't possibly be paid back must take responsibility for their own actions as well!

If I loan someone $10,000 to start a business and they go bankrupt and can't pay me back, we are both at fault.  That is a risk that I take when I loan out my money, and it is my responsibility to do my due diligence when selecting who to loan my money to.

Similarly, banks should do their due diligence, and should be prepared for the writedowns and losses that come when loans cannot be repaid.  If a bank cannot handle the risk that it has willingly put into its own portfolio, then it will likely face bankruptcy like any other business that can't pay the bills.

In a heated debate at the European Parliament's second home in the French city of Strasbourg, Mr Higgins complained that the €85bn bailout package was "nothing more than another tool to cushion major European banks from the consequences of their reckless speculation on financial markets.

"Far from being a bailout, your IMF and EU mechanism makes vassals of Irish taxpayers to European banks and enslaves the working people of Europe to the markets, who lead you around by the nose," Mr Higgins said.

"It is a vicious weapon dictated by markets masquerading as benign."

Bingo.  Joe Higgins, Member of the European Parliament for Dublin, Ireland, seems to understand what is going on here.  I think the people of Ireland have figured it out as well, and the upcoming election will hopefully bring good news for Ireland, and likely bad news for foolish banks that lent to the over-indebted country.

It will certainly be interesting to watch what develops in the Eurozone after March...if the lid can stay on that long.

This episode has 2 Act's, the first discusses Brazil's transition to the current Brazilian Real by using the non-monetary reference "currency," the URV.  The second act discusses the Federal Reserve, how it "works" and what they have been involved with during the current crisis.

It is just under an hour but well worth the listen.

Addendum: Came across this NPR piece from October 2010 on the Brazilian URV. Those that liked the clip above may also be interested in How Fake Money Saved Brazil

The Government can't protect us from everything.

No matter how many regulations and restrictions government puts in place, and no matter how many liberties they take away from us, you will never be fully protected by them.

Thus, the question becomes:

Where do we draw the line?

Benjamin Franklin famously wrote:

They who can give up essential liberty to obtain a little temporary safety, deserve neither liberty nor safety.

I don't think it could be any truer today.  We should not give up our liberties in support of "protection."  If guns are illegal to possess, then only the criminals will have them.  If someone pulls a gun on you in public, you no longer have the ability to protect yourself.  You are at the mercy of police response times.  Thus, by giving up your right to bear arms, you have lost a very important right, and you have also become less able to defend and protect yourself.

We must stop giving up our rights in the name of security.

We must realize that a large part of our protection relies on ourselves.

Additionally, I think it is important to remember one of the main reasons that the founders thought the right to bear arms was so important:

“A free people ought not only to be armed and disciplined, but they should have sufficient arms and ammunition to maintain a status of independence from any who might attempt to abuse them, which would include their own government.” ~George Washington

We don't have the right to bear arms simply to protect ourselves from one another, but also in order that we may stand up to our own government if it becomes too tyrannical.

Congressman Walter Jones is asking for an investigation into whether the Federal Reserve's money printing is driving up prices for commodities, including crude oil and gasoline.

The Farmville Republican has sent a letter to U.S. Rep. Ron Paul of Texas, the incoming chairman of the House Domestic Monetary Policy Subcommittee, asking him to look at the connection between the printing of money and rising prices.

This is hopefully only a first glimpse of what is to come from Ron Paul at his new position as the Monetary Policy Subcommittee chairman.  We certainly need more information on what the fed is doing, and a more in-depth look at the real causes behind rising prices can't hurt.

As you can see i've redone the theme and pared down the colors.  I'm a fan of keeping things simple.  For now I'm just going to put the most recent post on the home page, with

I'll probably be posting less frequently than I had in the past, and my posts will likely be geared towards more philosophical arguments with respect to economics,  and logic, and freedom.

I hope you'll enjoy what's to come.  Thanks.

“For Greece, the problem is completely over,” said Prodi, who was also Italian prime minister, in an interview in Shanghai today. “I don’t see any other case now in Europe. I don’t think there is any reason to think the euro system will collapse or will suffer greatly because of Greece.”

In previous articles I have mentioned that one thing we can be sure of is lots of hand waving and talk, but not necessarily a lot of action. This seems to be hand waving and an attempt to boost confidence. Unfortunately for Greece, it's problems persist no matter how much confidence people have that they don't. Years of too much spending combined with pension guarantees and citizens taxed to the hilt cannot be remedied by confidence alone. Greece is going to face tough times, and it's hard to imagine that the worst is behind Greece.

Intervention by European nations to date “was enough” and countries such as Spain and Portugal have “plenty of time” to get their finances in order, said Prodi.

What intervention by European nations? Talk? Has any real help other than "moral support" and talk of potential aid really been extended? Germany's Chancellor, Angele Merkel, has repeatedly refused any financial aid to Greece, and with good reason! German's don't need to bail out the Greeks, and if they do, you can bet Spain, Italy, and others will try to jump on board.

Prodi says these countries have "plenty of time," and time is definitely one thing that Greece and other countries do have, I think its just a matter of how good that time will be. Time is what it is going to take to resolve these issuesn the meantime it probably won't be a pretty picture for the economies of these countries, nor of the Eurozone.

The financial crisis that began in 2008 changed everything. Government policies to deal with the crisis have significantly altered the OMB estimates, as the two Obama budgets (2010 and 2011) dramatically illustrate. The 2010 budget (presented February 26, 2009, 11 days before the market low) included a forecast for the fiscal-year-end debt that proved to be 8.3% higher than the 2009 final number, a fact that illustrates the magnitude of uncertainty introduced by the financial crisis. The 2011 six-year forecast has scaled back the numbers for 2010 and 2011, but it closely tracks the later trend of the previous budget.

These federal debt forecasts confirm we what already know — 2008 was a major economic turning point, a metaphoric fork in the road. However, the chart helps us quantify the magnitude of the new direction. The current 2015 forecast of a 19.68 Trillion debt is about 46% higher than the equivalent point (about 13.5 Trillion) on the road not taken.

If you didn't already know, we are on an unsustainable course. This will hurt the poor and middle class the most, as it already is.

Gross domestic product will rise 2.7 percent in the 12 months through June 2010, 3 percent in fiscal 2011 and 3.8 percent the following two years, the Sydney-based forecaster said today.

A surge in house construction and government investment in infrastructure such as schools and roads will help stoke economic growth, BIS Shrapnel predicts. Inflationary pressures, leading to higher interest rates, will increase in three to four years as a mining expansion intensifies.

I am no expert on Australia, but I am a regular reader of Steve Keen's blog, and happen to agree with his theory that Australia is in the middle of a massive credit bubble. Though Mr. Keen recently lost a bet with respect to Australia's housing market, I still believe he has the right idea longer term. Interested readers will want to check out his new site on the topic. From this site:

The first graph above shows the continuing housing bubble that I believe exists in Australia. While BIS Shrapnel suggests "A surge in house construction...will stoke economic growth," I happen to believe that Australia may run into the same problem plaguing the U.S with housing and construction right now -- Australia's bubble may even be bigger! The third graph shows Australias rising private debt to GDP, and the second graph shows where the debt is rising the quickest --mortgages.

Central Bank Signaling Weakness?

I have no idea when the housing bubble will actually burst, but all of these graphs provide strong evidence that there may be a bubble. These are not the only signs we have, however. On February 2nd, the Australian Central Bank failed to raise interest rates as was the overwhelming general consensus among economists.

“The rapid adjustment process is over and the rate hikes, when they do come, will be further apart,” said Matthew Johnson, an interest-rate strategist at UBS AG in Sydney. “The overarching message from the Reserve Bank is that while things are better than we thought, we’re not out of the woods just yet.”

It appears that Australia's Central bank may be beginning to fear the future, and the bursting of this bubble.  It may not be long before the Australian Central bank finds itself racing towards 0% interest rates as the US and other parts of the world were doing in 2008.  Also, with regards to  not being "out of the woods" yet, I would say this is probably very understated. Not only is Australia "not out of the woods just yet," but the worst is probably ahead of them rather than behind them. The article continues:

“Three consecutive hikes late last year coupled with out- of-cycle increases by commercial banks appeared to have stung,” said Prasad Patkar, who helps manage about $1.5 billion at Platypus Asset Management in Sydney. Today’s decision “reduces the serious risk of a policy blunder. A pause is welcome.”

Sorry Prasad, but a serious policy blunder has already been made. Interest rates were kept too low for too long, and a credit bubble has already been blown. It has to be unwound eventually, It's just a matter of how bad Australia's politicians are willing to make the problem before it blows up.

Politicians Haven't Helped

Australian Politicians have been extending, increasing, and extending its First time home buyer "grant" for nearly a decade. To think this hasnt been a huge factor in the housing bubble is simply ignorant.

On 1 October 2009 to the 31 December 2009, $7000 will be provided only to home owners buying new homes or building a new home on top of the regular $7000 once off payment. $3500 will be given to home owners buying established homes.

On January 2010, the scheme will default to $7000 for all first home owners.

Type	Scheme	Eligible Dates	Benefit
Established Homes	First Home Owner Grant	1 July 2000 - present	$7000
New Homes / Construction	First Home Owner Grant	1 July 2000 - present	$7000
Established Homes	First Home Owner Boost	13 Oct 2008 - 30 Sept 2009	$7000
New Homes / Construction	First Home Owner Boost	13 Oct 2008 - 30 Sept 2009	$14000
Established Homes	First Home Owner Boost	1 Oct 2009 - 31 Dec 2010	$3500
New Homes / Construction	First Home Owner Boost	1 Oct 2009 - 31 Dec 2010	$7000

We can see the politicians have been at it for a while, offering up to $14,000 dollars as recently as September 2009!

Boom or Bust?

Australia is in a bubble, and judging from what the housing bubble brought to America, it is likely to bring a period of economic hardship to Australia, and very likely a prolonged recession combined with a period of deflation. Credit is beginning to tighten in Australia, and people are burdened with too much debt that cannot be paid off.

BIS Shrapnel thinks that Australia is poised for a "boom," I think they are primed for a "bust."

The current "shadow inventory" (including all delinquent loans, not only those that are real estate owned [REO]) of troubled mortgages will likely take about 33 months?or nearly three years?to clear at the current rate of liquidations. Moreover, we believe this estimate is conservative, as we do not assume any loans that have yet to show any serious signs of distress to date will default in the future and further increase the overhang of homes. Nonetheless, we believe that in reality additional loans will default in the near future due to the weak economic environment, distressed residential home values, and the resulting contraction in the supply of mortgage finance.

We believe that the recent reversal in housing prices is the result of a temporary constriction in the supply of foreclosed homes on the market. This temporary constriction ensued because servicers have completed fewer foreclosures due to court delays, servicing backlogs, and political pressure to keep borrowers in their homes. However, there is a rapidly growing shadow inventory of properties where borrowers are delinquent but foreclosure has not been completed. Overall, it is our opinion that recent positive housing reports should not be construed as a sign that the distress in the residential housing market is abating, but rather should be attributed to the temporarily limited supply of homes on the market.

I don't think housing is turning around anytime soon, and S&P seems to agree. The article is chock-full of interesting charts and graphs, interested readers should definitely check out the entire thing.

S&P Concludes:

We believe that the recent constriction in the supply of foreclosed homes on the market is a temporary one. Loan modifications and the observed extension of time distressed loans remained as such may simply have delayed the inevitable, creating the demonstrated shadow inventory of troubled loans. Ultimately, the majority of the properties these distressed loans represent will likely have to be liquidated.

Our estimate of $473.4 billion in loans that will eventually need to be liquidated corresponds to approximately 1.75 million individual properties. This number represents almost 50% of the existing homes available for sale as of December 2009, and moreover, only accounts for expected defaults for mortgages outstanding in the private securitization market which makes up less than a third of the total securitization market and less than 5% of the total mortgage market. While we do not expect all of these distressed properties to liquidate at the same time, the significant percentage of the current supply that these distressed loans represent does reveal the potential future increase in housing supply. An influx of liquidated properties is likely to prompt a decline in prices if unaccompanied by a comparable increase in demand (see chart 15).

I couldn't agree more that loan modifications and other measures have only "delayed the inevitable." The current inventory level of homes will take quite some time to clear, and even once it does clear, lack of demand (as well as availability!) for credit will likely lessen the demand for housing further.

Additionally, once mortgage rates do start to rise, this will slowly lessen the prices that new buyers will be able to afford, thus keeping downward pressure on house prices for some time after that. The Fed is set to exit its mortgage buying program soon, and if they exit and stay out (still not guaranteed) it will definitely cause mortgage rates to rise, probably by around 0.3-0.5% in my estimation.

Mortgage Delinquency Rates at All Time High
Transunion also has a report stating that mortgage loan delinquencies are reaching all time highs.

TransUnion's quarterly analysis of trends in the mortgage industry found that mortgage loan delinquency (the ratio of borrowers 60 or more days past due) increased for the 12th straight quarter, hitting an all-time national average high of 6.89 percent for the fourth quarter of 2009. This quarter marks the first time the mortgage delinquency rate increase did not decelerate after doing so for three consecutive periods.

This statistic, which is traditionally seen as a precursor to foreclosure, increased 10.24 percent from the previous quarter's 6.25 percent average. Year-over-year, mortgage borrower delinquency is up approximately 50 percent (from 4.58 percent).

To recap, we have a massive shadow housing inventory that won't be cleared for likely 3 years or more, we have a lessening supply of credit as well as a lowered demand for credit, we have the Fed exiting its mortgage buying program, and we have mortgage delinquencies hitting all time highs. All this data translates to an extremely prolonged rut in housing. I think the best case scenario for housing over the next 3 years or so is probably flat, with decent risk to the downside.

Everyone ready to invest in home builders?

As much as I tried to find some verifiable evidence that the EU was going to provide aid to Greece, it was not to be found. The best we got was a promise of “determined and coordinated action.” That doesn't say much to me.

Today I came across this little gem from reuters with Eurogroup Chairman Jean-Claude Juncker. Juncker says:

"I cannot today name an exact instrument... We have many instruments ready and will use them if necessary," he said.

I can't help but think this sounds very suspicous. It sounds very much like "We don't have any instruments or know what we can do, but we want you to think we do!"

"The basis of the Maastricht Treaty is that a state bankruptcy does not come into question. If we had thought a euro zone member could go bankrupt, we would have devised instruments to deal with that. This is not envisaged," Juncker said.

Sounds like he's telling us that they had not foreseen a bankruptcy as possible in the Eurozone, and this would lead me to conclude that they probably had no "instruments" set up in the event of a bankruptcy.

While the markets seemed to be very optimistic about the news of EU aid on Thursday and Friday, I remain very skeptical. Until we see this "deal" in full, It doesn't look to me like there is much to hope for. The EU thought bankruptcy of a member state was impossible and thus had nothing in place in case it happens. Now they claim to have many instruments, but yet cannot name any. They pledge moral support, and "determined" action, but I don't think either of those have much of an affect on Greece's real problems.

Greece doesn't really have a good way out, and aid from the rest of the EU will be very difficult as citizens of other EU states will not be happy about such actions. Europeans are known for violent protests and extreme civil unrest when they get angry, so I think any bailout or aid will be difficult to comey by.

We don't know for sure what will happen in the Eurozone with Greece, Spain, Portugal, or Italy, but one thing seems quite clear to me. We can definitely expect to see lots of smoke, mirrors, hand-waving, and potentially even coverup once things blow up (and I think they will). The best thing for the citizens of Greece (and the rest of the eurozone, by not having to bail them out) may indeed be a default that allows them to start over, and potentially no longer be part of the EU or its currency schemes.

Addendum

Forgot to mention the ultimate sell signal that Blackrock gave us this week regarding Greek bonds.

The company has a so-called overweight position on Greek debt, holding more securities than allocated in its benchmark, even after Standard & Poor’s, Fitch Ratings and Moody’s Investors Service cut the country’s credit grades in December. The fund may continue with this strategy for “some time,” said Michael Krautzberger, co-head of European fixed-income in London, after EU leaders pledged yesterday to help Greece regain control of its finances.

“They won’t allow a Lehman-type crisis,” said Krautzberger, who helps oversee BlackRock’s $3.35 trillion of assets. “The market has worried too much about an imminent government default in Europe that will not happen because of the solidarity.”

"Solidarity" doesn't seem to be stopping local cities in the U.S. from declaring bankruptcy. Such confidence in a group that didn't even think bankruptcy was a possibility when it was formed. In addition to the fact that the seemingly have no real instruments to use and seem to have their hands tied, all I can say is thanks Blackrock for the tip to stay away from Greek bonds.