Date: Mon, 8 Sep 2008 09:32:03 -0400 (EDT)
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Subject: WEEKLY NEWSLETTER VOL 2 ISSUE 36
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WEEKLY PETROLEUM, SUGAR-BASED ETHANOL and
ECONOMICS NEWSLETTER VOL 2 ISSUE 36.
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Sunday, September 7, 2008. VOL 2 Issue 36.
--OIL FUTURES END BELOW $107 TO POST 8% WEEKLY LOSS.
--OPEC OUTPUT UP FOR 4th STRAIGHT MONTH.
--BRAZIL MINISTER CONFIRMS IRAN INVITATION TO JOIN OPEC.
--BRAZIL PRES LULA: PETROBRAS TO HAVE KEY PRE-SALT OIL ROLE.
--BRAZIL TO DECIDE 10th ROUND OF OIL E & P AUCTION.
--BRAZILIAN ETHANOL PRODUCTION TO TRIPLE BY 2020.
--BRAZIL ETHANOL DEMAND TO INCREASE BY 50%.
--PEMEX TO DISTRIBUTE BIOFUELS.
--SPANISH FIRM TO BUILD NEW REFINERY UNITS IN CHILE.
--COLOMBIA'S ECOPETROL PURCHASED UNOCAL INTERESTS IN GULF COAST.
--PERU TO INVEST $12.5 BILLION IN PETROLEUM AND GAS.
--REPSOL TO SELL 20% OF YPF TO THE PUBLIC.
--YPF TO INVEST $1 BILLION IN ARGENTINA.
--PETROSA TO EXPLORE FOR GAS IN VENEZUELA.
--VENEZUELA TO HOLD PETROLEUM AUCTIONS IN OCTOBER.
--CHAVES WANTS PETROSA TO EXPLORE IN VENEZUELA.
--U.S. OUTLINES FANNIE-FREDDIE TAKEOVER.
--RESET LOANS ADD TO U.S. HOME WOES.
--REGULATORS CLOSE DOWN NEVADA'S SILVER STATE BANK.
--UNEMPLOYMENT RATE SOARS TO 6.1% .
--ANOTHER WEEK, ANOTHER BANK FAILURE, ANOTHER BAILOUT. (My opinion).
OIL FUTURES END BELOW $107 TO POST 8% WEEKLY LOSS
OPEC OUTPUT UP FOR 4th STRAIGHT MONTH
Crude-oil futures closed below $107 per barrel Friday, poised to end the week with a loss of
8% as immediate threats to U.S. energy output faded. A slowdown in global demand was still
a concern, as was uncertainty surrounding a meeting of key oil producers next week.
Crude oil for October delivery fell $1.66 to close at $106.23 a barrel on the New York
Mercantile Exchange after trading as low as $105.60. The contract was at $106.45 in
electronic trading on Globex as of 3 p.m. EDT.
Crude has been on a losing streak since Aug. 27 when it closed at $118.15. For this week, it
lost more than $9 per barrel after finishing last Friday at $115.46.
"Persistent concerns over weakening oil demand" have weighed on oil prices, said Nimit
Khamar, an analyst at Sucden Research, in a note. "The outlook for global economies is
looking far from rosy, and is fuelling concerns over demand destruction and pushing oil
Indeed, "contracting demand has been the compelling rationale of sellers since the July
peak," said Michael Fitzpatrick, an analyst at MF Global. Oil prices have fallen almost 30%
from their record high above $147 in July.
Over the past four weeks, total U.S. products supplied, which is a good indication of demand,
averaged almost 20.3 million barrels per day, down 3.5% from the same time a year ago,
the Energy Department's Energy Information Administration reported Thursday.
Of that, motor gasoline demand averaged 9.4 million barrels, down 1.6% from the same
time a year ago. But the EIA data also showed that motor gasoline supplies fell for a sixth
week in a row.
On Friday, October reformulated gasoline fell 5.4 cents to close at $2.6861 a gallon and
October heating oil dropped 4.1 cents to end at $2.9828 a gallon.
October natural-gas futures rose 12.7 cents to close at $7.449 per million British thermal
units. But they finished more than 6% lower for the week.
The storms in the Atlantic "have been very successful in reducing demand through
evacuations and power outages," said Ben Smith, president of First Enercast Financial, in
emailed comments. It's "an excellent hurricane season if you are a natural gas bear."
Traders have been keeping an eye on storms in the Atlantic as energy production in the Gulf
of Mexico slowly recovers following Hurricane Gustav. It passed the region earlier this week
with apparently little damage to energy infrastructure.
As of Friday, about 90.5% of oil production in the Gulf remained shut-in due to Gustav and
about 79.8% of natural-gas production in the Gulf was down, according to the U.S. Minerals
Hurricane Ike, which was located about 425 miles north of the Leeward Islands as of 11 a.m.
Eastern Friday, packed winds of nearly 120 miles per hour, making it a "major" Category 3
hurricane, according to the National Hurricane Center.
"Watch out for Ike," said James Williams, an economist at WTRG Economics. "It's big and
could end up in the Gulf."
Some forecast models show that Ike may move into the Gulf next week, although most show
a path up the U.S. East Coast, said Fitzpatrick, in a note to clients.
Damage in the Gulf from Hurricane Gustav appears to be minimal and the U.S. Strategic
Petroleum Reserve will probably release some oil to refineries, said Williams.
For now, "there's no question that investors and speculators have lost much of their
enthusiasm for oil," said Tom Kloza, chief oil analyst at the Oil Price Information Service.
"But there is also an historical record that shows that even glancing blows from Gulf Coast
hurricanes -- and the threat of more storms -- casts a legacy that extends 30 or more days
after said events," he said in emailed comments. "The legacy is for products -- gasoline and
diesel, and not for crude."
The average U.S. retail price for a gallon of regular gasoline stood at $3.674 Friday, down
from $3.862 a month ago, but up from $2.807 a year ago, according to AAA's Daily Fuel
"The price difference between gasoline available in the next five days, and gasoline that can
be shipped in the first week of October is about 25 cents per gallon," said Kloza. "That
equates to more than a quarter million dollars per barge or pipeline batch."
Meanwhile, "OPEC is set to meet on Sept. 9, with many market participants expecting them
to reduce production to prevent oversupply," said Sucden's Khamar.
Members of the Organization of the Petroleum Exporting Countries will gather in Vienna over
the next few days and are set to make an announcement Tuesday on production quotas.
OPEC will have to consider several factors, including lower demand projections for 2009 and
higher production from non-OPEC producers, said Kate Dourian, Middle East editor at Platts,
an energy and metals information provider.
But "what must be of grave concern ... is the speed of the oil price decline in recent weeks,"
Iran's representative thinks $100 is "appropriate" and a "minimum," said Fitzpatrick. "The
only question is what form [OPEC] will take, either an official cut or closer scrutiny of current
overproduction," he said.
In a research note Friday, Adam Sieminski, chief energy economist at Deutsche Bank, said
"We expect slower world growth, contango in the crude oil forward curve and declining oil
prices will put OPEC on alert to cut production before the end of the year." Contango means
that futures contracts for oil are priced higher than the near-term delivery contract.
And when OPEC takes action to defend the oil price, Deutsche Bank believes the cartel has a
"70% to 80% chance of enforcing their will on the oil market," said Sieminski.
But "many members do not want to cut production with oil above $100 and so many
international economies in trouble," said Williams.
Oil prices found some support Friday from some weakness in the U.S. dollar. The October
contract climbed as high as $107.93 on Nymex Friday.
The dollar lost ground against major counterparts Friday after the Labor Department
reported an unexpected rise in the August unemployment rate to a five-year high of 6.1%
and a larger-than-expected 84,000 drop in non-farm payrolls.
The dollar index ( DXY78.87, +0.05, +0.1%) , a measure of the greenback against a trade-
weighted basket of currencies, was trading at 78.907, compared with 78.961 in late North
American trading Thursday.
"Since the beginning of the year a total of 605,000 jobs have been cut and we expect at least
another two or three months of negative job growth before the labor market hits a bottom,"
said Kathy Lien, director of currency research at GFT Forex. The jobs data "triggered a sharp
sell-off in the U.S. dollar."
OPEC OUTPUT UP FOR 4TH STRAIGHT MONTH
OPEC oil supply rose for a fourth consecutive month in August, mainly due to higher output
from Iran and smaller increases in Nigeria and Angola, a Reuters survey showed on Monday.
The survey indicates the Organization of the Petroleum Exporting Countries is pumping
almost 800,000 barrels per day more than its target and comes as some members are
voicing concern that the world market is oversupplied.
Extra OPEC oil and declining demand from slowing economies in the West have helped lower
prices to $113 a barrel from a record $147.27 in July. OPEC meets on September 9, and
some analysts expect its next move will be to trim production.
"While the bias has been towards rising output for the last year, that period is drawing to a
close and it's a question of how much actual output is going to be trimmed in coming
months," said Paul Horsnell of Barclays Capital.
Supply from all 13 OPEC countries climbed to 32.82 million bpd in August from 32.59 million
bpd in July, according to the survey of oil firms, OPEC officials and analysts.
Iran accounted for much of the increase. OPEC's second-largest producer supplied less oil
than expected in July due to limited demand for its heavier crude oil grades, which meant
more crude was held in storage.
Output in August rebounded to 4.05 million bpd from 3.7 million bpd in July due to higher
sales, the survey found.
Nigeria and Angola are also pumping more. In Nigeria, where attacks by militants on oil
installations have curbed output, production recovered by 60,000 bpd in August.
Angola also raised output slightly, despite the shutdown on August 16 of BP Plc's 200,000
bpd Plutonio oilfield following an incident at a gas plant at the facility.
OPEC pumps about two in every five barrels of oil.
The survey also found that supply from Saudi Arabia, the world's top oil exporter, has leveled
It pumped 9.65 million bpd in August, slightly less than 9.7 million bpd in July, according to
the survey. Supply estimates fell into a relatively wide range in August from 9.45 million bpd
to 9.8 million bpd.
The kingdom raised output earlier in the year to meet demand and to quell what it saw as
unacceptably high prices.
Kuwaiti supply was revised higher for July after the country's state oil company said last
week the country had joined Saudi Arabia in pumping more oil in a bid to ease prices.
The survey suggests that the 12 members bound by output targets, all except Iraq, pumped
30.46 million bpd in August, 790,000 bpd more than their target of 29.67 million bpd.
OPEC has kept the supply target unchanged this year and meets to review output policy on
September 9 in Vienna. Some OPEC members have suggested output should be cut back.
"In view of the drop in oil prices, there is this possibility that OPEC would approve an output
cut in its upcoming meeting in Vienna," Iran's OPEC governor Mohammad Ali Khatibi was
quoted on Monday as saying.
Among other OPEC members, Iraqi supply declined slightly due to lower shipments from the
country's north and output in Libya was reduced marginally after a crude storage tank caught
BRAZIL MINISTER CONFIRMS IRAN INVITATION TO JOIN OPEC
Brazilian Mines and Energy Minister Edison Lobao confirmed Wednesday that Iran had
extended an invitation for the country to join the Organization of Petroleum Exporting
Countries, the Estado news agency reported Wednesday.
The minister confirmed a report late Tuesday by Folha Online, saying that the offer was
made to join OPEC by an Iranian ambassador.
Lobao told Folha that the offer to join OPEC was evidence that Brazil's new position as an oil
power was recognized internationally.
According to Lobao, OPEC members believe Brazil will beceome one of the world's largest oil
producers. Discussions about Brazil's possible OPEC membership began months ago, after
state-run energy giant Petroleo Brasileiro (PBR), or Petrobras, announced the massive Tupi
find in the pre-salt layer of the Santos Basin.
In November, Petrobras estimated Tupi's recoverable reserves at between 5 billion and 8
billion barrels of oil equivalent.
Brazil took a further step in its development of pre-salt oil deposits Tuesday, with the start of
crude oil production at the first pre-salt well in the Jubarte field off the coast of Espirito Santo
The country's government has so far been cool to OPEC membership, preferring to focus its
efforts on vertical integration of the domestic oil industry. Petrobras has recently announced
a series of refinery investments totaling more than $100 billion that include premium
refineries to produce high-quality diesel and gasoline for export.
Furthermore, President Luiz Inacio Lula da Silva has said that Brazil will not be an exporter of
crude oil but an exporter of high-value petroleum derivatives.
BRAZIL PRES LULA: PETROBRAS TO HAVE KEY PRE-SALT OIL ROLE
Brazilian state-run energy giant Petroleo Brasileiro (PBR) will continue to play a key role in
development of the country's presalt oil reservers, President Luiz Inacio Lula da Silva
President Lula dismissed speculation that creation of a new state-owned company to manage
the country's promising presalt oil deposits would reduce Petrobras to an oil industry has-
"You only have one mother, and Petrobras is the mother of industrialization in this country,"
President Lula said in a speech marking the start of presalt oil production in Espirito Santo
state. The speech was Webcast by Petrobras. Without Petrobras' investments and
exploration, the country wouldn't be in the midst of such an historic moment, he added.
The new state-owned company, preliminarily called Petrosal, is among possible proposals
under study by a government panel evaluating changes to Brazil's oil legislation.
President Lula said that he charged the panel with two objectives: to use money generated
by presalt oil to try to end poverty in Brazil and to improve the country's educational system.
Earlier Tuesday, President Lula kicked off production from Brazil's first producing well from a
presalt well. Well 103 at the Jubarte field, off the coast of Espirito Santo state, is expected to
produce about 18,000 barrels of oil a day.
President Lula called it a "day of independence" for Brazil. When he received a small barrel of
the country's first presalt crude oil, President Lula said that it was difficult to quantify the
"historic dimension, charged with emotion, of receiving a barrel of oil from a depth of more
than 4,000 meters."
BRAZIL TO DECIDE 10th ROUND OF OIL E&P AUCTION
Brazil's National Energy Policy Board will decide on the 10th round of oil exploration and
production concession auctions Wednesday, the president of the country's National
Petroleum Agency said Tuesday.
Quoted by the local Estado news agency, ANP President Haroldo Lima said that if the auction
is approved, details will be published by the government later this week, which would allow
the auction to occur as early as November.
Lima, however, said delays could push the auction to late December. In that case, the ANP
would push for the auction to take place in January.
In addition, the government board will also decide on how to proceed with a smaller
exploration and production auction of mature fields with marginal oil and gas reserves.
According to Lima, the suspended eighth round of E&P concessions will not be discussed by
the government panel until December. The auction includes pre-salt deposits.
"Because the auction includes pre-salt areas, we've opted to wait for the completion of
analysis by the government commission," Lima said.
Brazilian President Luiz Inacio Lula da Silva created the commission to study possible
changes to the country's oil legislation in light of the discovery of the nation's promising pre-
salt oil deposits.
The commission is expected to present proposals to President Lula by the end of September.
"There still is no consensus. We are evaluating the proposals," Lima said.
BRAZILIAN ETHANOL PRODUCTION TO TRIPLE BY 2020
Total Brazilian ethanol production might triple by 2020, according to a representative of the
sugar cane industry association, who also stated that ethanol exports during the first six
months increased by 20% compared to last year.
"Between the first six months of 2007 and 2008, our global ethanol exports increased by
20%. The increase in exports to the U.S. was slightly less," stated last Monday Geraldine
Kutas, international director of the Brazilian Sugar Cane Industry Association (UNICA).
Ethanol sales from Brazil to the U.S. represented about 50% of total exports, explained
Kutas to Reuters in an interview during an energy conference in Slovenia.
Kutas added that the high prices for ethanol in the U.S. allowed Brazil to send half of its
exports directly to the U.S., even with the high import tariffs, while the other half was sent to
the U.S. through the Caribbean without paying the tariffs.
She also stated that Brazil may dispute the high U.S. tariff in the WTO.
"The dialog is our primary instrument (…) however, on the other hand, we are studying the
possibility of a lawsuit in the WTO," stated Kutas.
The U.S. imposed a 54 cent per gallon tariff plus 2.5%, but Brazil got very disgusted last
year when the U.S. slightly reduced the tax credit for domestic ethanol.
Kutas stated that about 54% of this year's sugar cane will be used for ethanol production,
more than the 50% used during 2007, while the remainder will be used for sugar production.
Without doubt, sugar cane production will increase rapidly during the next 12 years since the
country plans to double its sugar cane cultivation area.
"Presently we have 3.4 million hectares planted for ethanol production and a total of 7.3
million hectares for sugar. We see the total sugar cane plantation acreage increasing to 14
million hectares, or doubling by 2020," explained Kutas.
"With this we should be able to triple ethanol production because we are increasing efficiency
(…) and we believe that we have a second generation (of sugar cane) which will be ready by
2015 and this will increase our ethanol productivity by 50%," she added.
BRAZIL ETHANOL DEMAND TO INCREASE 50%
A study by Conab, a Brazilian government agency, also states that ethanol exports will
increase by 72.8% by 2011.
Ethanol demand in Brazil will reach 24.8 billion liters by 2011, which represents an increase
of 50.5% when compared to last year, states a government study by Agencia Nacional de
Abastecimento (Conab) last Thursday.
Ethanol exports are expected to increase by 72.8% to 6.1 billion liters, when compared to
This year, exports of sugar-based ethanol totaled 4.2 billion liters, compared to 3.5 billion
liters last year, said Angelo Bressan, Conab's agroenergy analyst.
PEMEX TO DISTRIBUTE BIOFUELS
Mexican president Felipe Calderon announced that the Mexican state owned petroleum
company Pemex will invest more than $84 million to change the way it distributes gasoline
and diesel to include biofuels such as biodiesel and ethanol.
"The decision has been made," said the president during an inauguration of the Expo Forestal
2008 in Guadalajara, according to a report last Friday by Cambio Sonora.
While accompanied by the environment secretary, Rafael Elvira Quezada, Calderon assured
that this decision would be followed by pressure from the government to support the
establishment of plantations of native plants in over 100 thousand hectares for biofuel
According to Pemex, it is anticipated that in the case of ethanol, supply could come from
sugar cane production centers such as the states of Tamaulipas and Veracruz.
Calderon also stated that the National Center of Genetic Studies will be built in Guadalajara,
to study the properties of various native grains and plants, for their ability to produce
biofuels, with an investment of $33 million.
SPANISH FIRM TO BUILD NEW REFINERY UNITS IN CHILE
The Spanish contracting firm Technicas Reunidas (TR), signed a contract to build a new unit
for Enap's Aconcagua refinery in Chile, for $150 million, announced the company on
The contract includes the design and construction of an olefin saturation plant, a butane
isomerization plant and a sulfuric acid regeneration plant. Construction should be completed
in the third quarter of 2010, as stated by the firm to the Comision Nacional del Mercado de
Valores (CNMV), as reported this past Thursday by El Mostrador.
TR, one of the largest Spanish contracting firms, specializes in energy, petroleum, gas and
electric generation projects.
Last year the company, controlled by the Llado family, increased its work backlog with
projects in Saudi Arabia, Greece, Hungary and Holland.
In Spain the company is building two hydrogen plants in Repsol's petrochemical complex in
COLOMBIA'S ECOPETROL PURCHASED UNOCAL INTERESTS IN GULF COAST
The Colombian state owned petroleum company Ecopetrol, announced this past Tuesday the
purchase for $510 million of interests in crude production blocks in the Gulf of Mexico from
UNOCAL, the first transaction by the Colombian company in the U.S.
The purchase still needs approval from Colombian and U.S. authorities, said Ecopetrol in a
Ecopetrol is implementing its $58 billion investment plan (until 2015), especially in activities
such as exploration and acquisition of reserves outside of the country.
"Ecopetrol America, Inc., an American subsidiary of Ecopetrol S.A., has celebrated the
signing of an acquisition contract with Union Oil Company of California for 100% of its
participation in certain petroleum blocks," stated the Colombian firm.
Presently Ecopetrol has foreign exploration operations in Brazil and Peru.
PERU TO INVEST $12.5 BILLION IN PETROLEUM AND GAS
Peruvian investments in exploration and production of petroleum and natural gas until 2015
will increase to $12.5 billion, of which $4.3 billion will go to activities in the Selva zone,
according to Petroperu's general manager, Ronaldo Egusquiza.
The executive said that of this total amount of investments, $2.7 billion will be used for
exploration activities and $9.8 billion for development and production activities for petroleum
and natural gas.
"This investment does not include the new auction of 22 blocks, to be delivered next week,
and which will represent an additional investment of $1.2 billion just for the exploration
phase," explained Egusquiza, according to a report this past Thursday by Radio Programas
He also added that of the $12.5 billion – between 2006 and 2007 – a total of $345 million
has already been spent in the exploration phase and $1.3 billion in the development phase.
The investments correspond to the 80 contracts presently in force with Petroperu.
Finally, the executive indicated that with the next auction he expects that the total number of
contracts will exceed 100 contracts in force.
REPSOL TO SELL 20% OF YPF TO THE PUBLIC
The Spanish petroleum company Repsol YPF has hired the French bank BNP Paribas as the
coordinator in the placement of shares.
In this public offering other banks will also participate, such as UBS, Goldman Sachs, Credit
Suisse and Raymond James as placers of the international portion, while Santander and Itau
will place the local shares, according to a press release by the firm, and as reported on
Tuesday by La Republica.
Repsol intends to place in the stock market 20% of its Argentinian subsidiary before the end
of the year, and thus conclude the sale of 45% of YPF, which was initiated at the end of
2007, with the purchase by Enrique Eskenazi of a 25% interest in the company.
This past March, YPF requested an authorization from the SEC to issue shares equivalent to a
20% interest at a maximum price of $39.46 each.
In total, YPF registered 78.6 million shares to be placed in the stock exchange, with a
proposed value reaching $3.104 billion, and which places a total value of the firm at $15.52
YPF TO INVEST $1 BILLION IN ARGENTINA
YPF, a partially owned subsidiary of the Spanish petroleum company Repsol, the largest
petroleum company in Argentina, announced this past Wednesday that it had formed a global
program of negotiable obligations (NOs) for $1 billion, to finance investments in exploration
and production of petroleum and gas, according to information the company provided to
Boletin Oficial de la Comision Nacional de Valores (CNV), the Argentinian equivalent to our
The company also said that part of the funds will be used to install infrastructure for the
industrialization of products derived from hydrocarbons, such as Nafta and other
petrochemical products, according to a report this past Thursday in El Cronista.
The decision to go to the market for funds was made by both partners when the Petersen
Group, owned by the Eskenazi family, joined the company with a purchase of 14.9% of its
capital in February.
The funds being obtained in this manner can only be utilized for projects in Argentina. The
company is in the process of investing $2 billion in the country this year, with the majority
being used to raise its levels of reserves and production, which had been declining.
In addition, the company announced large projects, such as project Aurora, which will spend
$100 million for drilling four offshore wells, to better assess the petroleum and gas potential
of an offshore field.
In total, the company has an ongoing investment program of $11.7 billion until 2012.
The issuance of YPF NOs will end after this issue because of the credit crisis in the U.S. and
also because of an argument between the Argentinian government and Argentinian investors.
For both reasons, placement of NOs ended after the placement of $1.3 billion by several
firms, which already had previous approval for the NOs from the CNV.
PETROSA TO EXPLORE FOR GAS IN VENEZUELA
The state owned South African petroleum company PetroSA was qualified to be an operator
to explore for gas offshore Venezuela.
The company, which last Tuesday signed petroleum exploration and production of heavy
crude agreements with the Venezuelan state owned company PDVSA, said that it also agreed
to participate in reserves in an area of the Orinoco Belt in the South American country.
"PetroSA signed an agreement for a study of quantification and certification of reserves in the
Boyaca 4 block, with an area of 700 square kilometers, on the Orinoco Belt," announced the
firm in a report published on Thursday by Cadena Global.
According to the agreements signed on Tuesday, PetroSA stated that it had invited PDVSA to
participate in the construction in South Africa of the Coega refinery, which will produce
400,000 bpd, a project with an estimated investment of $11 billion.
PDVSA was also invited "to use crude storage facilities in Saldanha, South Africa, which has a
capacity of 45 million barrels, for possible trans-shipment to Asia and the Far East."
VENEZUELA TO HOLD PETROLEUM AUCTIONS IN OCTOBER
Venezuela may auction three areas in a block of the Orinoco Belt this October, a vast reserve
of heavy petroleum that it seeks to explore together with private firms, stated the minister of
energy, Rafael Ramirez, in declarations published last Monday by the local press.
The government of Hugo Chavez announced last year that it would look for partners to
increase his production and that the first areas to be auctioned off would be the Carabobo
"Soon we will announce the rules for the process in the Belt, where we will offer three blocks
in Carabobo, which is the most advanced (the reserve estimate is complete). Probably in
October we will invite companies to participate," said Ramirez, as quoted in the local
newspaper El Universal.
The minister added that the production capacity of these areas will be about 200,000 bd. He
added that "all" companies are invited to participate, except the U.S. based ExonMobil, which
continues a court action against Venezuela, regarding its exit because of the nationalization
of its production facilities in the Belt.
Ramirez added that ConocoPhillips –also in an arbitration process—could participate if it
reaches an agreement prior to the auction.
After the nationalization several companies remained as minority owners in the Belt, such as
Chevron, Statoil, TOTAL, while Conoco and Exxon abandoned the projects.
The crude from this area has to go through an improvement process before it can be
processed by conventional refineries. PDVSA stated last June that it would hold a round of
open auctions to private companies for three blocks: Carabobo I, Carabobo II, and Carabobo
In the Carabobo I block, PDVSA and Petrobras of Brazil certified reserves of 10 billion barrels
of heavy crude. Venezuela is one of the largest suppliers of crude to the U.S.
CHAVEZ WANTS PETROSA TO EXPLORE IN VENEZUELA
The president of Venezuela, Hugo Chavez, advised this past Tuesday the South African state
owned petroleum company PetroSA to explore for petroleum reserves in the South American
PetroSA has been holding high level negotiations with its Venezuelan counterpart PDVSA,
about exploration and production projects of heavy crude in the Orinoco Belt of Venezuela.
"PetroSA go immediately to Venezuela to begin work together with us in the Orinoco Belt, the
largest petroleum belt in the world," said Chavez in a press conference during an official visit
to South Africa.
Chavez later said that the governments of both countries signed petroleum and gas
cooperation and exploration agreements in Venezuela. There were no immediate details
PetroSA operates one of the largest gas to liquids refineries, located in Mossel Bay, in the
coast of South Africa, and also exploring for petroleum in Equatorial Guinea, Gabon and
Everton September, vice president of PetroSA, stated last month that Venezuelan petroleum
may go to the firm's new project, the $7 billion Coega refinery, which will process about
The refinery, which will begin operations in 2015, will permit PetroSA to export products to
the southern part of the African continent.
U.S. OUTLINES FANNIE-FREDDIE TAKEOVER
The U.S. government, increasingly alarmed by a housing slump that threatens to pull down
the whole economy, is taking over the business of ensuring that funding is available for home
The U.S. Treasury announced a plan Sunday that provides as much as $200 billion of new
capital plus new credit lines for the country's main suppliers of funds for home loans, Fannie
Mae and Freddie Mac, and puts the two companies under management control of their
regulator, the Federal Housing Finance Agency, or FHFA. Treasury Secretary Henry Paulson
said the moves will increase the availability of credit for home buyers.
The Treasury also plans to buy an unspecified amount of mortgage-backed securities issued
by Fannie and Freddie in an effort to bring down borrowing costs for home buyers. Despite
steep interest-rate cuts by the Federal Reserve, the cost of a typical 30-year fixed-rate
mortgage has remained well over 6% for most of the past year.
The moves are likely to nudge down interest rates for consumers and help prevent a
worsening of what is already the worst housing bust since the 1930s. At least in the short
run, the actions also further entrench the government in a mortgage industry, leaving
taxpayers exposed to default-related losses that could run into the scores of billions. In the
longer run, Mr. Paulson aims to drastically shrink the amount of mortgages and related
securities held by the companies, but he noted it will be up to Congress and future
administrations to decide what shape Fannie and Freddie ultimately take.
Mr. Paulson said the government had no choice other than to prop up Fannie and Freddie,
companies created by Congress to support the housing market but owned by private
shareholders. The more than $5 trillion of debt and mortgage-backed securities issued by the
companies is owned by central banks and other investors world-wide. "A failure of either of
them would cause great turmoil in our financial markets here at home and around the
globe," Mr. Paulson said.
James Lockhart, director of the FHFA, said the regulator seized management control of the
companies because their ability to cope with heavy losses was "in doubt," given their small
cushions of capital and inability to raise further money from private sources. The
conservatorship will last indefinitely as the regulator tries to nurse the companies back to
Mr. Lockhart appointed a new chief executive officer for each company but said he hopes to
keep most other employees in place. At Fannie, Herb Allison, who has served for the past
eight years as chairman of the investment company TIAA-CREF, succeeds Daniel Mudd.
Freddie's chief executive, Richard Syron, was replaced by David Moffett, who has been vice
chairman and chief financial officer of US Bancorp.
All lobbying by the companies, which were long renowned for their ability to influence
Congress, "will be halted immediately," Mr. Lockhart said.
The regulator will eliminate common and preferred stock dividends, saving a total of $2
billion a year for the companies.
To ensure that the companies don't run out of capital, the Treasury agreed to acquire $1
billion of senior preferred stock from each company immediately. The preferred stock comes
with an annual dividend yield of 10% and warrants giving the Treasury the right to acquire
79.9% of the companies' common stock "at a nominal price." In addition, the Treasury will
stand ready to acquire as much as $100 billion of preferred stock in each company, though it
said it doesn't expect them to need that much capital.
The Treasury also announced an arrangement under which it will stand ready to make short-
term loans to Fannie, Freddie and the 12 regional Federal Home Loan Banks, privately owned
cooperates that were created by Congress to help banks fund housing. The borrowings would
be backed by mortgage securities or other approved collateral and bear interest at 0.50
percentage point above the London interbank offered rate, or Libor, a measure of the fees
banks charge one another for short-term loans. Under normal conditions, Fannie and Freddie
typically can borrow money for less than Libor, but these Treasury loans would be a
Mr. Paulson signals that he wants to remake the U.S. housing-finance system in the longer
term, ditching the "flawed business model" of government-sponsored enterprises like Fannie
and Freddie. This model has produced conflicts between the companies' desire to earn
maximum profits for their shareholders and the public mission of supporting housing that has
persuaded investors that the government would have to rescue them in a crisis.
The plan limits the size of each companies' mortgage portfolios to a maximum of $850 billion
as of the end of 2009. After that, the Treasury intends for the mortgage holdings to shrink
about 10% a year until they reach about $250 billion at each company. But that is subject to
decisions that may be made by Congress and future administrations.
The government had to wade deeper into the mortgage market because for now "private
markets are just not willing to put up the capital" for home mortgages at prices U.S.
consumers could afford, said Susan Wachter, a professor of real estate and finance at the
University of Pennsylvania's Wharton School. Without government support for the mortgage
market, home prices would fall much farther, exposing the country as a whole to greater
economic strain, Ms. Wachter says.
House Financial Services Committee Chairman Barney Frank (D., Mass.) said in an interview
that the near-term effects of the conservatorship will be to "strengthen the public mission of
what they do" to prop up the housing market. Mr. Frank said the companies' ultimate size,
scope, and mission will be something that won't be addressed for at least six or 12 months,
when the next Congress and the next White House are in control. He said policy makers will
look closely at the future of the companies and their conflicting public/private mission next
year as part of a huge overhaul of financial regulation.
Fannie and Freddie got into trouble largely because they embraced riskier types of loans just
as the housing market was starting to crumble in 2006 and 2007 in an effort to regain from
Wall Street rivals a bigger share of the mortgage market. As those loans started to go bad,
the companies began recording big losses in the second half of last year. They then failed to
raise enough capital late last year, when investors were still fairly bullish on their prospects,
to see them through the current storm. The companies have recorded combined losses
totaling about $14 billion over the past four quarters, eating deeply into their meager capital
holdings, and most analysts expect them to report sizable losses for at least another couple
of years as the costs of foreclosures mount.
The move means the federal government will stand directly behind the vast majority of home
loans made in the U.S. Fannie and Freddie already own or guarantee about $5.3 trillion of
home loans, or nearly half those outstanding. In recent months, they have backed more than
70% of new home mortgages, while the Federal Housing Administration, a government
agency, has insured most of the rest, according to Inside Mortgage Finance, a trade
The bulk of U.S. home loans are packaged into securities and sold to investors. Fannie,
Freddie and the FHA have dominated the market since mid-2007, when investors lost faith in
mortgage securities other than those backed by those government-linked entities. "When the
panic is on, everybody wants a government guarantee," says Alex Pollock, a resident fellow
at the American Enterprise Institute, a Washington think tank.
Fannie and Freddie's credit problems are largely a reflection of the overall weakness in the
housing market. Some 9.2% of mortgages on one-to-four family homes were at least a
month overdue or in the foreclosure process in the second quarter, according to the latest
survey of the Mortgage Bankers Association. That is the highest percentage in the 39 years
that the trade group has been doing the surveys.
"Make no mistake, anybody in the mortgage business is going to see much higher losses
than they thought they would a year ago because we've had the worst housing market and
the largest home price declines that anybody has seen," said Thomas Lawler, a housing
economist in Leesburg, Va., who formerly worked for Fannie.
But both companies made things worse by loosening their standards and accepting riskier
types of loans. Fannie and Freddie's credit losses are being driven primarily by loans made in
2006 and 2007, when lending standards were loosest; by mortgages made to borrowers who
fell outside their traditional lending standards, and by heavy exposure to loans in such areas
as California and Florida where home prices have fallen most sharply. Loans made in 2006
and 2007 account for 65% of second-quarter credit losses at Freddie Mac and nearly 60% of
those losses at Fannie Me, according to company estimates.
"Business they thought were prime is turning out not to be prime because of limited
documentation of income and declining home prices," said Guy Cecala, publisher of Inside
Both companies promised to stay away from toxic loans. As early as 2005, Fannie executives
publicly expressed concerns about growing risks in the mortgage market. In May of that
year, Thomas Lund, a Fannie Mae executive vice president, said that lenders should be
concerned if borrowers straining to afford homes were given loans allowing for low payments
in the early years but storing up much higher ones for later. "In many cases the consumers
may not understand all the risks," he said.
In a report presented to a group of home builders that same month, Fannie said that the
probability of housing busts has "risen sharply in certain parts of the country," partly because
of looser lending standards. Among other thing, the report cited increases in the number of
riskier loans, including ones that allow borrowers to delay repaying principal or aren't backed
by full documentation of borrowers' income or assets.
Yet both companies expanded their exposure to riskier loans, both through their traditional
guarantee business and through the purchase of mortgage-backed securities. At both Fannie
and Freddie, so-called Alt-A loans, a category between prime and subprime, accounted for
roughly 50% of credit losses in the second quarter, even though such loans accounted for
only about 10% of the companies' business. Alt-A mortgages include loans made with less
than full documentation of borrowers' income or assets.
Mortgages made to borrowers in California, Florida, Arizona and Nevada accounted for 47%
of Fannie Mae's credit losses in the second quarter and 65% of credit losses at Freddie Mac.
Fannie Mae said recently it was opening on-site offices in Florida and California to help it
better handle rising defaults and manage the swelling inventory of foreclosed properties in
those two states. At Freddie Mac, 17% of Alt-A borrowers now owe more than their homes
are worth, according to company estimates. Both Fannie Mae and Freddie Mac require
mortgage insurance when a borrower takes out a mortgage for more than 80% of a home's
value. But prices have dropped so much in some parts of the country that the companies are
seeing losses even where they financed 80% or less of a home's value.
Both companies are also heavily exposed to some of the mortgage industry's most troubled
players. Countrywide Financial Corp., now part of Bank of America Corp., was the largest
provider of loans purchased by Fannie Mae, accounting for 29.1% of its business in 2007,
according to Inside Mortgage Finance, and was the second largest source of loans for Freddie
Mac, with a 16.2% share. Both Countrywide and IndyMac Financial Corp., which was taken
over by the Federal Deposit Insurance Corp. this summer, boosted their sales to Fannie and
Freddie as other investors pulled back. IndyMac, which previously had focused its business
on Alt-A loans that didn't meet Fannie and Freddie guidelines, switched to a policy of making
loans that could meet their standards in 2007.
Both Fannie and Freddie say they are aggressively scrutinizing defaulted loans to see if those
mortgages didn't meet the representations and warranties made by lenders at the time of
origination. "We are looking at every loan to look for things like misrepresentation," Fannie
Mae's Mr. Lund said during a recent conference call with investors. One example, he said,
would be loans made to investors who claimed they planned to live in the property.
The companies have also been hurt by purchases of mortgage-backed securities that were
backed by subprime and Alt-A loans packaged by Wall Street. The two companies bought a
total of roughly $227 billion of securities backed by such loans in 2006 and 2007, according
to the Office of Federal Housing Enterprise Oversight. "They bought higher-rated paper," but
the value of such securities has fallen as rising credit losses have produced led to large
numbers of rating agency downgrades, said Josh Rosner, managing director of Graham
Fisher & Co. Mr. Rosner estimates that the two companies purchased 30% to 50% of
mortgage-securities issued by Wall Street.
Both companies have resorted to questionable accounting changes that delay the need to
recognize losses on some delinquent loans. The two companies guarantee payments on loans
that back mortgage securities held by others. If borrowers default on those loans, Fannie and
Freddie have to compensate the investors. Until December, Freddie's policy generally was to
buy problem loans from the investors shortly after they become 120 days overdue. Now, it
can wait until payments are as much as 24 months overdue. Fannie made similar changes
late last year. When Fannie and Freddie buy delinquent loans from investors, the companies
must mark the loans down to estimates of their current market value.
In another step aimed at slowing the flood of foreclosures, Fannie earlier this year began
offering to finance unsecured loans of as much as $15,000 to people who have fallen behind
on their mortgage payments. These loans are designed to allow the borrowers to pay the
past-due amounts on their mortgages. These 15-year loans are aimed at people who fell
behind on their payments because of a temporary financial squeeze — caused, for instance,
by a divorce, death in the family or medical problem — but who can afford to meet future
monthly payments, Fannie officials have said. Some critics say the loans may be just a
stopgap that saddles people with additional debt they can't afford.
Fannie and Freddie grew at a dizzying pace for most of the past two decades, raising their
combined holdings of mortgages to $1.58 trillion in 2003 from $136 billion in 1990 and
enriching shareholders and executives. They dominated their industry. In 2003, Fannie and
Freddie provided funding or guarantees for about 57% of U.S. home mortgages originated.
But then the companies' efforts to disguise the normal fluctuations in their earnings led to
regulatory findings that they had violated accounting rules. The scandals flushed out top
executives at both firms. In late 2003, Freddie drafted in as its chairman and CEO Mr. Syron,
a former president of the Federal Reserve Bank of Boston and chief executive of the
American Stock Exchange. A year later, Fannie gave a battlefield promotion to its chief
operating officer, Daniel Mudd, giving its CEO job to the decorated ex-Marine, a son of TV
newsman Roger Mudd.
As Messrs. Syron and Mudd cleaned up the accounting mess, their companies lost market
share. That was partly because of their accounting distractions and the tighter regulatory
clamps imposed as a result. But it was also because Wall Street firms aggressively created
their own mortgage securities out of riskier types of loans that didn't meet the traditional
standards of Fannie and Freddie: subprime loans for people with bad records for paying bills
and so-called Alt-A loans, a category below prime that generally involves borrowers who
don't fully document their income or assets.
The Fannie and Freddie share of the market dropped to a low of about 38% in 2005 and
2006. By 2006, Fannie and Freddie, eager to regain market share, were buying more Alt-A
loans as well as other types of supposedly prime loans that allow borrowers to start out with
very low payments and face the music later. Those are the loans going bad now.
In late 2006 and early 2007, defaults on subprime, Alt-A and other riskier types of loans
began surging, and hundreds of small to midsized lenders crashed into oblivion. Wall Street
suddenly could no longer sell securities backed by what were now seen as toxic mortgages,
and that led to mammoth write-downs at investment banks.
Fannie and Freddie initially appeared to be in good shape to reclaim their dominance of the
market. They had avoided some of the worst lending practices, and their Wall Street rivals
were on the ropes. The companies' market share shot up to 68% in this year's first quarter
from 45% a year earlier.
Late last year, Fannie and Freddie scrambled to shore up their capital by selling a combined
$13 billion of preferred shares. Selling those shares meant that a big chunk of future profits
would go to the preferred holders rather than the owners of common shares.
At an investor conference in December, Mr. Syron apologized to the common shareholders:
"We wanted to dilute common shareholders like we wanted to shoot ourselves in the head
with a gun," he said. In retrospect, however, the companies should have raised much more
capital while markets were still receptive to them.
At a conference for investors March 12 at the Hudson Theatre in Manhattan's Time Square,
Mr. Syron promised to take care of his shareholders as well as the "mission" of supporting
the housing market. "We expect to thrive to the benefit of our shareholders, and also for the
benefit of the country," he said.
Ken Posner, then an analyst at Morgan Stanley, reminded him of his "fiduciary duty" to
existing shareholders. "You would not raise capital unless you thought it would benefit
existing shareholders," Mr. Posner said. "I just want to make sure I have got that right."
Mr. Syron replied: "You got it right."
Then, in an apparent allusion to pressure on him from regulators and lawmakers, he added:
"This company will bow to no one .... on our responsibility to shareholders."
Mr. Syron got angry calls from Capitol Hill over that remark. He later said he should have
said Freddie would be "second to none" in meeting its fiduciary duties to shareholders.
Like most other companies in the housing and mortgage industries, Fannie and Freddie
underestimated how much home prices would fall.
Robert Shiller, a Yale University economist, in a newly published book recalls speaking in a
panel discussion in October 2006 with Frank Nothaft, Freddie's chief economist. Mr. Shiller
writes that he asked Mr. Nothaft whether Freddie had "stress-tested" in its computer
modeling for the likely impact of falling home prices. Mr. Nothhaft replied that Freddie had
looked at the possibility of prices falling as much as 13.4% on a national basis. "What about
the possibility of a drop that is bigger than that?" Prof. Shiller asked. He says Mr. Nothaft
replied that such a drop had never occurred, at least since the depression of the 1930s.
In August, Freddie estimated that home prices will decline 18% to 20% from their 2006
peaks before reaching bottom. (Freddie uses its own home-price index designed to match the
types of mortgages the company funds.)
Mr. Nothaft couldn't be reached for comment.
Mr. Syron may walk away with an exit package that could total as much as $15 million, says
David Schmidt, a senior consultant at James F. Reda & Associates LLC, a compensation
consulting concern in New York. That includes a pension and deferred compensation, about
$3.7 million in severance pay, and a possible payment of $8.8 million to compensate for
forfeiting certain equity grants.
Mr. Mudd's exit package, including stock he already owns, could total $14 million, Mr.
Schmidt estimates. That includes $5 million in pension and deferred compensation, $4.2
million in severance pay and $3.4 million of restricted stock, based on Friday's closing price.
That value of that stock could fall sharply, however.
RESET LOANS ADD TO U.S. HOME WOES
The stricken US mortgage market is set to suffer further setbacks in the next two years as
$96bn of risky home loans sold with initial flexible payment options switch to more stringent
These will raise borrowers' monthly payments by about 60 per cent.
The changing terms could more than double the number of borrowers falling behind on so-
called "option adjustable rate mortgages" issued between 2004 and 2007.
This is according to research published Tuesday by Fitch Ratings.
Option ARMs allow borrowers to choose a low minimum monthly payment that often falls
short of the interest due on the loan, typically for five years.
The difference between the minimum and the full payment is added to the mortgage balance.
This ability to borrow more before having to start repayment is known as "negative
At the five-year mark, the loan terms are "recast" and the monthly payment is increased to
ensure the full repayment of the loan by maturity.
Late payments and defaults on such mortgages are already running as high as 24 per cent in
some areas, said Fitch.
It added that the potential average payment increase on recasting loans was 63 per cent.
In cash terms this amounted to an average of $1,053 extra due each month.
"The combined impact of payment shock ... declining home prices and restricted availability
of mortgage credit may leave many option ARM borrowers unwilling to continue paying their
mortgage," said Huxley Somerville, analyst at Fitch Ratings.
"The current severe environment has left borrowers with few alternatives to foreclosure," he
Mr. Somerville said the ARM market had the highest proportion of borrowers with limited
proof of income at more than 80 per cent of loans. This increased the likelihood of default.
"Borrowers who used the [minimum payment] option to extend themselves into larger
houses could easily be overwhelmed by the higher mortgage costs," he said.
The bulk of the $200bn of outstanding option ARMs will not hit their five-year anniversaries
until after 2010.
Many option ARMs, however, have a limit on negative amortization – typically between 110
per cent and 125 per cent of the original loan amount.
If a borrower hits this limit, the loan can recast much earlier.
Fitch expects roughly $29bn of option ARMs to recast to higher monthly payments by the end
of 2009 and an additional $67bn to recast in 2010.
Fitch anticipates that more than half of these will be as a result of stressed borrowers hitting
their negative amortization ceilings.
About three-quarters of option ARM borrowers chose to make just the minimum payment on
their loan over the last two years, according to LoanPerformance, a mortgage research
With many borrowers approaching their negative amortization limits, accelerating loan
recasts could exacerbate the housing slump in some of the most stressed markets, said
Fitch. More than half of existing option ARM loans are in California, according to data from
"Because of their use as an affordability product, option ARM defaults will likely spread into
higher priced neighborhoods, as many borrowers leveraged the very low minimum monthly
payment to buy more expensive homes," said Mr. Somerville at Fitch.
REGULATORS CLOSE DOWN NEVADA'S SILVER STATE BANK
State and federal regulators shut down Nevada's Silver State Bank late Friday. It was the
11th bank to fail in the U.S. so far this year.
The bank, which was overexposed to risky real-estate loans, had almost $2 billion in assets
and 17 branches in Nevada and Arizona.
Until six weeks ago, Andrew McCain, the son of Republican presidential nominee Sen. John
McCain of Arizona, was a member of Silver State's board and also its three-member audit
committee. Andrew McCain left the Henderson, Nev., bank July 26 after five months on the
board, citing "personal reasons." He is Sen. McCain's adopted son from his first marriage.
There is no evidence that Andrew McCain, 46, committed any wrongdoing, nor is there any
indication that Sen. McCain had any knowledge of or involvement in Silver State's problems.
UNEMPLOYMENT RATE SOARS TO 6.1%
The unemployment rate soared to 6.1% in August, the highest rate in almost five years, as
the economy took a turn for the worse. The rate has steadily climbed this year from a cycle
low of 4.4%.
U.S. stock futures dropped sharply after the data were released Friday morning.
Nonfarm payrolls decreased by 84,000, the Labor Department reported Friday, more than
the 75,000 drop expected by economists surveyed by MarketWatch.
"It looks pretty dismal. The theme [is] of a U.S. economy sliding ever so surely into
recession," said Michael Gregory, a senior economist at BMO Capital Markets in Toronto. In
the months ahead, job losses of more than 100,000 will be much more commonplace, he
The factory sector, especially the auto industry, shed jobs in August. Employment services,
considered a bellwether of future labor-market trends, also had sharp losses.
The weak labor market is sure to rekindle fears of an incipient recession among traders.
Economists have been warning that the economy appeared to be stalling, but Wall Street
was dazzled late last month by the strong 3.3% GDP growth reported in the April-June
Other aspects of the report pointed toward a weakening labor market.
Payroll losses in the previous two months were larger than previously estimated.
The jobless rate rose for a clear-cut reason: People lost jobs. According to a separate survey
of households, employment fell by 342,000 to 145.6 million. Unemployment rose by 592,000
to 9.4 million. The labor force fell by 8,000 in August.
Average hourly earnings increased a larger-than-expected 7 cents, or 0.4%, bringing the
year-over-year gain to 3.6%. Higher wages could fuel inflation, Fed officials fear, but so far
wages have remained tame.
The weak report should postpone any rate hike from the Federal Reserve. Although some Fed
officials have been agitating for a tightening sooner rather than later, most analysts believe it
will be difficult for the Fed to justify raising rates in face of labor market weakness.
"We may start hearing that the Fed may have to ease," Gregory said.
Job losses across the private sector
There were job losses across the private sector, only government and education and health
care added workers.
Factory payroll losses accelerated, dropping by 61,000, their eighth straight monthly decline.
Construction jobs fell by 8,000 in August.
Both of these sectors haven't experienced job gains in more than a year.
According to the payroll survey of business establishments, private-sector payrolls fell by
67,000, twice the 33,000 estimated by the ADP national employment report Wednesday.
Service-producing industries lost 27,000 jobs, with losses seen in retail, transportation and
financial services. Temporary-help jobs fell by 37,000.
ANOTHER WEEK, ANOTHER BANK FAILURE, ANOTHER BAILOUT. (My opinion)
As I write this, word comes that the U.S. treasury is taking over Fannie and Freddie. Of
course, another bank failed last week, this time in Nevada. I have not had the time to look
into the terms of the Fannie and Freddie takeover. Of course, this is not news for my
readers, for earlier this year when the Feds lowered the capital requirements for Fannie and
Freddie and asked them to make Jumbo loans, the writing was obviously on the wall. I stated
in this newsletter that Fannie and Freddie would soon be in big trouble. Now, I am saying for
the record that the U.S. itself will soon be in big trouble.
Some things are for sure even without looking at the details yet. The news is not good for all
Americans and it bodes badly for the budget deficit. The red ink is going to get bigger and
harder to control. Why? Because we are nowhere near the end of our problems. The treasury
has no idea what it is taking on and what the repercussions will be. As if this news is not
enough, last week brought word that the reason the U.S. dollar began to rise was due to
coordinated interference by the world's central banks. This is also not good, and will backfire
in the long run. This is a perfect example of bad long term economic policy for the sake of
short term unsustainable relief. However, to drive home this point, consider this excerpt from
an essay by French economist Frederic Bastiat:
"In the economic sphere an act, an institution, a law produces not only one effect, but a
series of effects. Of these effects, the first alone is immediate; it appears simultaneously with
its cause; it is seen. The other effects emerge on subsequently; they are not seen; we are
fortunate if we foresee them.
There is only one difference between a bad economist and a good one: the bad economist
confines himself to the visible effect; the good economist takes into account both the effect
that can be seen and those effects that must be foreseen.
Yet this difference is tremendous; for it almost always happens that when immediate
consequence is favorable, the later consequences are disastrous, and vice versa. Whence it
follows that the bad economist pursues a small present good that will be followed by a great
evil to come, while the good economist pursues a great good to come, at the risk of a small
A recent study from the Congressional Budget Office (CBO) has zero credibility. It pegged
likely taxpayer losses in the Fannie Mae and Freddie Mac bailouts at $25 billion. For those
with a sense of history, it is worth remembering that the S&L bailout had a $160 billion price
tag. The numbers diverge so far from reality as to be laugh-out-loud funny. Funny, that is,
except that the CBO estimate demonstrates a willful disconnect with the actual consequences
of federal government actions.
As demonstrated below, the real cost of the bailouts will easily exceed $1.3 trillion. In fact,
the real cost is likely to range between $1.3 trillion to $1.6 trillion, and is not unlikely to
reach $2.5 trillion.
Between 2001 and 2007, Fannie and Freddie purchased or guaranteed $700 billion of Alt-A
and subprime loans. Given the default rates on these loans – and the fact that the price of
the housing that is the ultimate security of the loans will, for reasons demonstrated below,
fall by at least thirty percent – this alone implies a loss for Fannie and Freddie on the order of
Fannie and Freddie acknowledge already-impaired loans on the balance sheet of $19 billion,
which they have used creative accounting to avoid deleting from the shareholder equity
account. This means that Fannie and Freddie have a maximum of $64 billion in capital
Given the inevitable losses on the Alt-A/subprime portion of their portfolio, it must be the
case that if the federal government, as it is doing, guarantees Fannie and Freddie's solvency,
the difference between the loss and the capital to be made up by the government (i.e., the
taxpayers) must equal, not $25 billion but $147 billion.
That alone would mean that the CBO is blowing smoke with their estimated cost figures, and
if you think back to the S&L cost of $160 billion, this is not a surprising result. The real
picture is so much worse that it is pretty obvious the CBO is flat out inventing figures just to
get the politicians through November.
The real story is simple. We have witnessed the largest asset-price bubble in US history,
making the tech-stock bubble seem like an overdone weekly rally.
When you look at the graph of the Case-Shiller residential real-estate index, an index dating
from 1890 to the present and an index which measures the cost of housing in comparison to
other goods, the first thing you see is that the 2001 to 2006 bubble stands out like a fifty
foot saguaro cactus in a patch of daisies. There simply has never been anything like it.
When you know what you are looking at – the biggest bubble in history – it is scary.
To be precise, the Case-Shiller Index in its entire 110-year history had never crossed 140
until the recent bubble. In 2006, it reached 210. Every single real-estate bubble in the past
has at best been followed by a fall back to at least the 110 level in the postwar era, although
the bubble preceding the Great Depression witnessed a fall to 60.
What this means is that in the best-case scenario, real-estate prices have to fall in the
medium to long run by almost half.
Now consider Fannie and Freddie. Just looking at their portfolios on the balance sheet
without the guarantees, let us accept (for no particular reason other than a desire that the
reader sleep better at night) that real-estate prices only fall by thirty percent.
Well, since Uncle Sam is now committed to "doing whatever it takes," that is a loss right
there of $1 trillion. This commitment to keep financial markets open as usual is made in spite
of the overwhelming evidence that what we have been taught is usual is in fact delusional,
given that Fannie and Freddie own $3 trillion and change of mortgages.
The CBO is not fence-post stupid, so obviously just as in the S&L fiasco in 1988, they are
outright inventing figures so that the politicians can slither into November and then
announce, Whoops! Our numbers were a little low.
The more realistic scenario is actually worse. Fannie and Freddie own and guarantee a total
of more than $5 trillion in mortgages.
Given the long-run historically plausible equilibrium values of residential real estate as
embodied in the Case-Shiller Index, that means that the taxpayer loss definitely reaches
$1.3 trillion, easily ranging up to $1.6 trillion.
Unfortunately, that is the good news. The bad news is that if real-estate prices were to
replicate the Great Depression (as would surely occur in the case that hedging instruments of
Fannie and Freddie were to catastrophically fail due to counterparty failure – and given the
absurdly low risk premiums on credit-default swaps at the height of the bubble, such an
event cannot be considered unlikely) the Case-Shiller Index tells us that the loss to the
taxpayers could exceed $2.5 trillion dollars.
I don't know what those people in Washington are taking to sleep at night after all their
electorally driven accounting and finance exercises, but I can tell you what they will be doing
to keep the government open for business: printing a whole lot of money.
Chairman Bernanke has the discount window open to any collateralization not worth the
paper it is written on, so in effect he has the helicopters ready to drop hundred-dollar bills
over Wall Street – as he once famously described the ultimate policy instrument of a fiat-
Of course, if he does that, we will have to change his nickname from Helicopter Ben to
Hyperinflation Ben, which answers the question of who picks up the tab of bailing out Fannie
and Freddie: anyone owning dollars.
Produce a lot of something, and it becomes worth less. And given the losses at Fannie and
Freddie, the taxpayer guarantee, and the ongoing initiation of Boomer retirement, only the
inflation tax will work to pay for keeping Fannie and Freddie afloat.
Like it or not, we are about to enter interesting times, and it is too bad our supposed
professional civil servants at the Congressional Budget Office have failed to tell the emperor
the truth: that he is buck-naked bankrupt and getting ready to take a lot of people with him.
Our only hope is to (1) accept up front a twenty-percent fall in American living standards for
a people living beyond their means for the past twenty-five years on the delusions made
possible by fiat money, and (2) simultaneously discipline the creature from Jekyll Island,
a.k.a. the Federal Reserve System, not to create new money just to prop up asset-price
Another serious problem is that with the FED policies notwithstanding, the banks have no
DESIRE to lend. They are scared of everything, everyone, and each other.
A net of roughly two-thirds of the banks surveyed by the FED said they were tightening
standards on prime mortgages; 84.4% said they were cracking down on nontraditional
financing; and 85.7% said they were tightening up on subprime loans. These figures are off
the charts — by far the highest the Fed has ever found in the 18 years it has conducted its
Banks that want to lend don't have the CAPACITY to do so.
Banks are required to maintain a minimum cushion of capital. Think of it as the last line of
defense against bad loans and other problems. It also serves as a base upon which banks
can build a book of loans and other assets.
When capital levels are healthy, banks have a huge capacity to lend. But when capital is
being eroded — say, by the charging off of a huge pile of bad debts — banks have to react
by cutting back on new lending.
Don't just take my word for it. Get a load of the comments out this week from the president
of the Federal Reserve Bank of Boston, Eric Rosengren. I've highlighted a few key passages:
Eric Rosengren, Federal Reserve Bank of Boston
"We see that mounting losses at financial institutions, and an increasing reluctance among
investors to invest new capital while the economic outlook is unclear, are forcing financial
institutions to 'shrink their balance sheets.'
"Allow me to explain that notion for the non-bankers here today. Recall that a loan is
counted as an asset on a bank's balance sheet. Banks hold capital in part as a reserve
against the possibility that a loan will default. Thus banks attempt to maintain a reasonable
ratio of capital to assets. If a bank experiences a reduction in the value of its capital or an
increase in its assets (for example as credit lines that were extended in better times are
tapped), the bank must take steps to shrink the asset side of its balance sheet in order to
restore its desired capital-to-asset ratio.
"In other words, the bank becomes more restrictive in its lending. This shrinkage in lending
entails tighter underwriting standards, wider interest rate margins, and reduced credit
In normal times, banks can replenish capital by generating and retaining earnings over time.
That's the slow way. Or they can go out and sell common shares, preferred shares, or so-
called hybrid securities that have characteristics of both equity and debt. That's the fast way.
But if investors don't want that kind of paper, lenders have to pay through the nose to raise
money. Some institutions can be shut out of the market entirely. That's exactly what is
happening now. The welcoming arms that banks and brokers found in 2007 and early 2008
have been replaced with cold shoulders.
Why? Potential investors can see the writing on the wall. They know that profits across the
banking industry plunged 86.5% to just $5 billion in the second quarter, according to the
FDIC. They know that we're going to see a big wave of bank failures in the next 12-24
months. And they don't want to get swept up in it.
More importantly, the sovereign wealth funds in Dubai, Singapore, and elsewhere ... and
other private investors ... have seen their prior investments in U.S. banks sink dramatically
in value. So they're increasingly reluctant to throw good money after bad.
Or as the Fed's Rosengren said:
"An alternative is to raise more capital, but this can be quite difficult in times like these,
when investors are wary of putting more money into some seemingly fragile financial
institutions. Witness the reliance, particularly by some large, well-known institutions, on
foreign sources of capital like the sovereign wealth funds in recent months."
The tightening trend has spilled over into commercial real estate, where almost 81% of those
polled said they were tightening standards. That's another record!
Two-thirds of respondents were tightening standards on credit card borrowers, more than
double the level of just three months earlier, and the highest ever. Auto loans? Personal
loans? Same story there — record-high tightening readings.
Here's a credit crisis update:
Legendary PIMCO manager William H. "Bill" Gross is pleading for unprecedented intervention
to avoid a catastrophic "financial tsunami." This represents a change in his tenor and may be
self-motivated - at least in part - by the billions of dollars in junk debt his funds are holding,
but it's a change nonetheless. And that makes it worth noting.
The dollar LIBOR has reached a four-month high, according to the British Bankers Association
and the interbank costs of borrowing both short-term Euros and dollars continue to edge
higher. This suggests banks still don't trust each other and continue to foresee higher, rather
than lower, risks ahead. Remember that higher interest rates reflect higher risks.
Primary dealers hit the U.S. Treasury with $45 billion worth of bids for only $25 billion worth
of Treasuries - or nearly twice as much as the U.S. Federal Reserve was prepared to sell.
This suggests that banks are still cash-strapped and that they have nowhere else to turn.
U.S. regulators, including the Federal Deposit Insurance Corp. (FDIC), are increasingly
worried enough about their own finances that they are hatching plans to raid the Treasury's
coffers at a time when the list of trouble institutions is rising at the fastest rate since the U.S.
Savings & Loan Crisis.
Banks are now borrowing primary credit to the tune of a record $18.98 billion per day from
the Fed - up from $18.47 billion per day only a week ago.
Still not convinced that the strong second quarter growth was nothing more than a mirage?
Here's something that may change your mind: A report released by the Mortgage Bankers
Association today shows that a record 1.249 million homes were in foreclosure during the
In addition, from the end of March to June 30, 2.9 million homeowners were delinquent on
their mortgage payments – up 25% from the same time period last year.
Our friends at Strategic Investment warn that there is an even bigger property bust on the
horizon – in commercial property.
The bust could be worse for banks, stocks and the U.S. economy as a whole than the current
residential debacle...an almost unbelievable notion. Bloomberg says that the United States
could see the worst drop in commercial property since the 2001 recession and Morgan
Stanley is calling for a 15% drop over the next 2 years.
Everyone ought to take a look at the Fed's books. Hardly more than 12 months ago, the
American central bank's vaults were so full of U.S. Treasury debt that anything else in there
wasn't worth talking about. But at the end of last year, the bank began buying up the
flotsam and jetsam from sinking Wall Street ships. Now, the Fed's assets look like a poor
man's attic – including $106 billion of junk in a category known as "other." What exactly is in
these credits, we don't know. But we know they weren't there a year ago and they are only
there now because other financial institutions were desperate to get rid of them. The Fed,
serving as chump of last resort, was the only player dumb enough, or rich enough, to take
Jobs and Recession: Barry Ritholtz worries about what happens when year-over-year
employment numbers turn negative. He quotes Merrill Lynch's David Rosenberg, "Once the
YoY trend in payrolls goes negative, it does not bounce back – it is the hallmark for a new
trend that lasts more than a year; and at the trough reaches -1.5% to -2%. So, we have
already seen 463,000 jobs cut so far this year, and the historical record would tell you that
there is probably between another 1.5-2.0 million to go before the job market backdrop
stabilizes." Barry adds, "when employment data goes negative on a year over year basis, we
get a recession 100% of the time."
99% of Mutual Funds are in the Red!
The other day, Morningstar published a shocking statistic - just 17 out of nearly 2,100 public
mutual funds made investors money over the past year.
How's that for an "elite" performance?
While the folks who manage these funds kick back and enjoy another lavish vacation -
possibly on your dime - you can fight back. Just write me and ask me how!
The U.S. Federal Reserve released its Beige Book report last week (Wednesday), which looks
at the economic conditions in the 12 Fed regions. "The pace of economic activity has been
slow in most districts," the report said, Bloomberg News reported. "Wage pressures were
characterized as moderate by most districts amid a general pullback in hiring."
August was another weak month for auto sales as most major carmakers reported declines.
Ford Motor Co. (F) reported 26.6% decline, while General Motors Corp. (GM) sales fell
20.4%. Toyota Motor Corp. (ADR: TM) fared better with a 9.4% decline, but Japanese rival
Nissan Motor Co. Ltd. (ADR: NSANY) had a surprising 13.6% increase, Reuters reported.
GMAC Financial Services (GMA) announced that it would close all 200 GMAC Mortgage retail
offices and reduce and its Residential Capital LLC unit in an effort to cut costs and streamline
operations, The Wall Street Journal reported. Approximately 5,000 employees, 60% of
Residential Capital staff, will be let go.
ECB Clamps Down on Collateral Standards
Amid concern that banks have been using the European Central Bank as a storehouse to
dump risky mortgage-backed-securities, the ECB Thursday announced the first major change
in its operational framework since market turmoil began last summer.
The bulk of the changes are aimed at discouraging banks from dumping hard-to-sell asset-
backed-securities at the ECB. After February next year, for example, the central bank will cut
12% from the value of asset-backed securities that it takes as collateral in exchange for
short-term loans, up from as little as 2% before.
ECB policymakers have been particularly concerned that banks are increasingly bundling
risky mortgages together in products designed for the sole purpose of getting central-bank
funds. To curtail banks' impulses to create and submit such products, the central bank will
impose an additional premium of 5% on asset-backed securities that — because they have
never traded — are hard to value.
In a move that surprised markets, the ECB also said it will impose an extra 5% penalty on
unsecured bank bonds. "Under the former system, bonds issued by banks and nonfinancial
corporations were treated equally in terms of haircut," wrote Bank of America economist
Gilles Moec in a note to clients. Thursday's change "means that the ECB now considers that,
on average, banks are more at risk than non-financial corporations."
While these and other changes fell short of the most drastic steps the ECB could have taken
— which would have included banning asset-backed securities altogether — Mr. Moec says
"the changes should still be painful for a number of banks in the euro zone. The average
refinancing cost for banks in the euro zone will probably increase … Furthermore, they will
probably postpone further any fundamental recovery on the ABS market."
The ECB did cut the banking sector some slack, delaying the changes until February 1, 2009,
to avoid exacerbating tensions that typically arise in the inter-bank lending market around
the turn of the year, when banks are squaring their books. ECB President Jean-Claude
Trichet said the changes would only affect a "small fraction" of the more than one trillion
Euros of assets banks submit as collateral each year. Asset-backed securities amounted to
16% of the collateral in 2007.
In a nod to the fact that markets remain off kilter and banks reluctant to lend to one another
for longer periods of time, Mr. Trichet also said the central bank is renewing a batch of extra
longer-term loans it extended to banks earlier this year. Two three-month loans of 50 billion
Euros each and one six-month loan of 25 billion Euros now mature early next year, instead of
later this year.
Worse Inflation: Daniel Gross of Slate warns that despite the drop in energy prices, inflation
might be getting worse. "We know the Federal Reserve and the stock market are more
concerned about the next three months than the last three months. And the recent fall in
commodity prices should, in theory, translate into lower prices for all participants in the
economy. Or maybe not. First, there's always a lag between the action in the commodity
markets and the prices of finished goods—especially at a time when companies desperately
need to pad their margins. Second, despite the action in the commodity pits in recent weeks,
the indicators of inflation at the producer level have picked up pace through this year,
accelerating through the second quarter and into July. Third, many companies have reached
their limit in absorbing higher costs."
Slow Income Growth?: On his blog, Lane Kenworthy compares median income to GDP per
capita and sees a major disparity. "Various excuses and rationalizations have been offered:
It's okay because Americans now get more in employer benefits instead of in their paycheck.
Family size has shrunk, so slow income growth isn't a big deal. A lot of those in the bottom
half are immigrants, and even with slow income growth they're better off than they would
have been in their native country. None of these is compelling. The disconnect between
economic growth and middle-class income growth is due largely to rising inequality. In the
past several decades much of the economy's growth has gone to those at the top of the
income distribution. Faster income growth wouldn't render other middle-class strains
irrelevant. But it would help."
Making Globalization Work: Richard Baldwin writes for the voxeu blog about how
governments need to respond to make globalization work. "The first unbundling radically
transformed society. Governments reacted or failed. But promoting more appropriate skills
was just one element. It is deeply misguided to think of skills separately from the full
governmental package. In the first wave, governments realized that farm and factory require
different skill sets. The first unbundling saw primary education brought into the public sector
and radically transformed. But this was one piece of the puzzle. As farmers moved to
factories, new vagaries faced them — redundancies, inflation, and more. Part of the reaction
was to establish welfare states, but equally important was the establishment of labor
organizations. Likewise, the new unbundling will require a revamp of education policies,
welfare states, and labor organizations."
Let's go back to mid-July... The euro has hit $1.60 again and there's just not a lot of love
going around for the dollar. What the markets are feeling (in July) is the weight of the world
on their shoulders, because of the rot on the vine with financial institutions...
"Then, almost miraculously the dollar got up from its death bed... And the weight was lifted,
but by whom, and why? We found out just last week that it was a coordinated intervention
by the central banks of the U.S., Japan, and Eurozone to prop up the dollar. And once the
dollar buying got up some momentum, the Big Boy Brokerages were all touting the return of
the greenback! But why did the U.S. feel it needed to intervene? Even the Brazilian
government has been holding weekly auctions to purchase dollars. Yes, dear reader. This is
not a very good sign. Think about it for a moment.
If US inflationary expectations were to go up to 4 or 5 per cent, we might see an exodus of
global investors from the US, forcing an abrupt and destructive adjustment of the US current
We have heard time and again that global investors collude as they have an interest to
prevent such an outcome, but this is a silly conspiracy theory. Some recent research* by the
economists Harald Hau and Hélène Rey suggests that global investors might be inclined to
switch out of dollars much faster than some people believe.
The result would be a toxic feedback loop of a falling US dollar, rising US inflation and real
financial disturbance of a kind we have not yet seen. It would lead to a huge increase in
dollar market interest rates, bank failures and a recession – of the type where nobody would
argue whether it fulfills the technical criteria or not. This scenario would constitute a huge
crisis for Europeans as well, who would be cracking up under the weight of an overshooting
Maybe I am seeing ghosts. Maybe not. However, do you think it is prudent to take chances
with these kinds of possible outcomes? This is no time for business as usual.
"I find the great thing in this world is not so much where we stand, as in what direction we
are moving. To reach the port of heaven, we must sail sometimes with the wind and
sometimes against it. But we must sail, and not drift, or lie at anchor."
Oliver Wendell Holmes, Sr.
"Chaos is the score upon which reality is written."
Yes dear reader, another week has passed, another bank failure occurred and another bailout
is being orchestrated by the government. Right now all is being done to ensure relatively
smooth elections. However, the truth will come out. It always does in the end. Write me if
the urge strikes you. For smooth sailing is not what awaits us ahead.
My best wishes for all of you,
Nothing in this e-mail should be considered personalized investment advice. Although our
employees may answer your general customer service questions, they are not licensed under
securities laws to address your particular investment situation. No communication by our
employees to you should be deemed as personalized investment advice.
The information in this newsletter has been gathered from a number of sources including the
mainstream media such as The Wall Street Journal, the Associated Press, the Financial
Times, as well as CCC's own insights, industry relationships, and analysis of this and other
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