2009-03-11

U.S. Banks Overrun by Dirty, Rotten Scoundrels

Dirty, Rotten Scoundrels. The world is full of them.

Our theme today comes from a movie, in which Michael Caine teaches Steve Martin how to be a gigolo. The idea is to identify rich, vulnerable women...seduce them...and then take their money.

In today's world, becoming a real gigolo is social climbing. The average man - even one from a good school and a good family - is an oaf. Next to him, the gigolo, with his suave manners and dandyish airs, is like a Venetian palace next to a double wide.

Besides, the gigolo gives value for money. A woman gets little thrill or merit from landing a Wall Street hustler; no matter how rich, he is almost always boorish and preoccupied. But the gigolo brings refinement and taste to a woman; he makes her feel exceptional because he is exceptional. To a woman of a certain age, his attentions are a welcome as bad lighting.

We only bring it up because it is the front-page story at the Financial Times this morning. Whether life imitates art, or the other way around, we don't know; but yesterday a poor gigolo was sentenced to six years in a German hoosegow for taking advantage of Susanne Klatten. The two met at a health spa - where the hunter scouted his prey. Then, after he had made his advances...without too much resistance, it appears... he made up some cock-and-bull story about having an accident in which a child was hurt. According to him, the mafia was after him. And if he didn't come up with $7 million to pay them off, he was going to have his fine bones broken - or worse.

Naturally, his rich mistress produced the money. But then he got greedy and wanted more. He threatened to show some embarrassing photos to her husband. And then she called the cops.

All of this might have gone unnoticed had the woman involved not been the richest woman in Germany, heiress to the BMW fortune.

Ms. Klatten, no doubt, regrets the affair. Her spirit might have been willing to put up a fight, but her flesh was weak...as it with us all. But she is hardly the only woman - or man - to be robbed by dirty, rotten scoundrels.

"Help needed as investing frauds rise," says a piece in the International Herald Tribune. The IHT focuses on another swindler - Arthur Nadel, accused of bilking investors out of as much as $300 million. But the point of the article is that while jobs are scarce - even bank robbers can't find a bank worth robbing - 'receivers,' court appointed liquidators, can name their price: It's a "job that has become increasingly in demand in such huge investment fraud cases as the Bernard Madoff scandal and the one against the Texas tycoon, Allen Stanford."

But first, let's turn to the headlines...then we'll come back to the dirty, rotten scoundrels.

Yesterday, the Dow lost another 80 points. Oil continued its rise - to $47. And gold reversed downward, losing $24. Maybe the correction in gold isn't over...we'll see.

The Wall Street Journal is now wondering out loud if the Dow could fall to 5,000. And so is Barron's. It's a 'bearish possibility,' says the WSJ. But Barron's voices what we think is still the dominant emotion of this market. "Will the Dow fall to 5,000?" it asks. "We don't think so," it replies.

Not only are the papers discussing our Dow target, they're also beginning to catch on to what is really happening.

The economy is in the grip of a "depression dynamic," says Bloomberg. For the first time sine WWII, the global economy is shrinking...it continues...led by the United States of America.

"Job losses hint at vast remaking of U.S. economy," adds the New York Times.

David Rosenberg of Merrill Lynch looks that the numbers: There are now 12.5 million people out of work in the United States - a 25-year high. This is a lot more joblessness than the typical recession produces, he notes. "In just five months we have lost 50% more than we usually do in a classic 10-month recession."

Oh, for an old-fashioned 10-month recession! This is not a recession at all - it's a depression, in which the economy will be restructured, not merely re-inflated.

*** In a speech yesterday, Helicopter Ben stated that a recovery would "remain out of reach" if the major financial institutions were allowed to fail.

If the banking sector is stabilized, said he, a recovery later this year is not out of the question.

Once the banks find their footing, the Fed chairman says, "then I think there is a good chance the recession will end later this year and 2010 will be a period of growth.

At the risk of sounding redundant: this is a depression. Not a recession. But nothing like a nice, healthy dose of deluded optimism from the head of the Federal Reserve to get you through a Tuesday.

*** Depressions seem to bring out the dirty, rotten scoundrels. Richard Fuld - formerly head of Lehman Bros. - was in Paris this week. A friend reports seeing him at a wedding reception held at the exclusive Automobile Club on the Place de la Concorde. We didn't ask questions. But we're happy to see Mr. Fuld still has the joie de vivre to go out...socialize...and have a good time.

Some guys would have been laid low by his experience; they would cower in a bolthole somewhere...unable to show their faces in public...embarrassed and ashamed. After all, Fuld sank one of the world's great financial institutions...and brought billions worth of losses to millions of people. If he were Japanese, for example, he would have at stepped in front of a bullet train or removed his own intestines. But dirty rotten scoundrels just go to fancy weddings.

Of course, we have no particular reason to single out poor Dick Fuld. The scoundrels are so thick on the ground, you can scarcely jump out of a window on Wall Street these days without falling on one of them.

Forbes says the entire U.S. financial industry is "effectively insolvent," thanks to their errors and omissions. But now that everyone is pointing his finger at capitalists...we take their part. We're suckers for lost causes and underdogs. Yes, they are dirty rotten scoundrels...but the people who now pretend to save us from them are even dirtier and rottener.

At least Dick Fuld got rich honestly - by misleading investors. Even Bernie Madoff made his money, too, the old-fashioned way - like a gigolo - by defrauding investors, one at a time.

But now the whole thing has been turned over to the big boys. Now we're getting theft and fraud on a much bigger scale. Trillions of dollars are being given out by politicians and functionaries. AIG, for example, has been described as 'where taxpayers' money goes to die.' But it doesn't die in AIG - it goes to pay off debts to the biggest boys left in the room - Merrill and Goldman Sachs. 'In the room, in the deal,' they say on Wall Street. Goldman was actually in the room with Tim Geithner and the feds - the only investment bank present - when the decision was made to 'rescue' AIG. Goldman may not have mentioned it at the time, but AIG owed Goldman billions of dollars. Now, the taxpayers bailout AIG so that Goldman can get its money.

*** "Our world is broken," writes Gillian Tett in the Financial Times this morning.

The FT is doing a series on the "Future of Capitalism." A lot of ponderous blah blah, as near as we can tell.

Yesterday, Martin Wolf - whom finance ministers and leading economists read in order to find out what to think - had a nice turn of phrase. Derivatives, he said, did not - as advertised - transfer the risk to those people most able to manage it. "They transferred the risk to those least able to understand it."

But when Wall Street's vaults were open, what did they find? They hadn't transferred it at all! So much risk was left in the hands of the people who created it that - when it blew up - it flattened the entire investment banking industry.

The blah blahers misunderstand their subject. Invariably, they see capitalism as a machine-like 'system' that has lost a gear or gotten a flat tire. They spend their ink wondering how to fix it. Invariably, the solutions come at someone else's expense.

Nationalize the banks. Tighten regulation. More bailout money. The usual claptrap.

Why do we say 'claptrap?' Because all these worthy fixes only make the problem worse...while, of course, giving more power and money to the scoundrels.

Already trillions of dollars have been spent supposedly fixing the machine. The latest estimate we saw was $11.7 trillion; we were so flummoxed by the number we forgot to find out where it came from. No matter. The important thing is this: they've spent trillions so far...and the machine is broker than ever. They can spend trillions more, it won't 'fix' the machine. Because it's not a machine...

"It is like saying to someone that the emperor has no clothes on...and then you find he had no underpants either," says Warren Buffet.

Buffett, too, has been surprised by how broke the machine is. He told investors last October that he was buying stocks...and they should too. Since then, the stock market has lost about 25% more of its value. The Sage of the Plains says he doesn't regret his letter from last autumn, he just wishes he had written it a few months later. He also says he sees an "economic Pearl Harbor" coming...

Economic 'Pearl Harbor?' C'mon Warren...that's a negative and silly way to look at it. The Japanese attack on Pearl Harbor was vicious, unprovoked and underhanded. Here in the building in London with the gold balls - no kidding, our office building has gold balls on the roof - we always look on the bright side. But you don't have to crane your neck to see the bright side of the worldwide financial meltdown...and it has nothing in common with Pearl Harbor. What's going on is that capitalism is going through a phase...a very healthy phase of 'positive collapse.'

We know we've given our version of the events leading up to this crisis. We will give it again.

The feds encouraged people to borrow...lend...and spend. People did it. And then they over-did it. And when they finished overdoing it they discovered that they had built way too many houses...and that the houses were priced far beyond what people could afford to pay for them. What followed was a crash in the housing market. It was not too much later that the financial industry realized that its collateral was being undermined. That's when all Hell broke loose. Suddenly, practically every asset in the world was called into question. How much did it owe? To whom? What if it couldn't pay?

The credit crunch was misinterpreted by the authorities. They thought it was a liquidity problem. So, they put out trillions of dollars to 'solve' the problem.

The problem was caused by too much spending...and they still think that if we spend a few trillions more...the problem will disappear.

Of course, it won't happen, because the real problem is debt. And there are only three ways to solve that problem: You can default. You can inflate. Or, you can work your way out (maybe).

The feds favor inflation. But $50 trillion has disappeared from the world's asset markets. So far, the feds haven't been able to keep up.

Give them time.

Buffett has faith. "Five years from now," he says, "I can guarantee you that the machine will be running fine. We have the greatest economic machine that man has ever created."

Buffett is a genius; everybody knows it. But like the FT's capitalism improvers, he misunderstands how capitalism works. Machine? It is nothing of the sort. Capitalism is not a collection of nuts and bolts, gears and switches. Instead, it is a moral 'system.' 'Do unto others as you would have them do unto you,' is all you need to know about it.

And like any moral 'system,' it rarely gives the capitalists what they hope for...or what they want. It gives them what they deserve. And right now, it's giving it to them good and hard.

Laissez-faire! Let the bad times roll!

Incidentally, the Oracle of Omaha made an appearance in our award- winning documentary, I.O.U.S.A., along with former Treasury Secretaries Paul O'Neill and Robert Rubin, former Fed Chairman Paul Volcker and more economic luminaries. If you missed the film the first time around, now is your chance to see what these economic heavy-hitters have to say about the state of the U.S. and global economy - and learn how to save your retirement. It's all in our Emergency 'Personal Bailout' Bundle, which includes the I.O.U.S.A. DVD, companion book and a special report that details how you can bailout your own finances - and accrue enough wealth to retire early.

Get it here: Emergency 'Personal Bailout' Bundle.

*** And this from our old friend John Mauldin:

"Join us in San Diego, April 4th, for the Richard Russell Tribute Dinner.

"We are going to be hosting a special tribute dinner to honor Richard Russell for his outstanding contribution of over 50 years. He is one of my personal heroes as well as a good friend. At 84, his writing today is better than ever, and now he writes every day, not just once a month! Richard is an institution in the investment writing world.

"Richard has some of the most loyal readers anywhere. I have personally talked to readers who have been reading Dow Theory Letters almost since the beginning (1956), and their enthusiasm for all things Richard has not waned.

"The dinner will be Saturday evening, April 4, 2009 in San Diego. You can get tickets here, which are a bargain at $195. Any extra money will be donated to Richard's favorite charity."
HOW MUCH COAL IS THERE?
by Byron W. King

I've been following the U.S. and world energy predicament for over 35 years. If there's one common thread in the discussion over the course of nearly four decades, it's that someone is sure to say something like, "The U.S. has a lot of coal." Depending on who is doing the talking, maybe the comment will be even more specific, along the lines of "Heck, the U.S. is the Saudi Arabia of coal." Or if the speaker really wants to impress you with precision, it will be, "The U.S. has a 250-year supply of coal."

In other words, relax. It's OK. Don't panic. No matter how bad the energy situation gets out there in the rest of the world, here in the good old U.S. of A., we can always just dig some more coal. That'll let us stay warm, run our industries and keep the lights on. Right? Well, let's take a peek under the rocks and examine the state of U.S. coal reserves. In fact, here's a map from the U.S. Energy Information Agency. And based on the map, it sure looks like there's a lot of coal out there. But is there?

First, I've been hearing that "250-year supply" - thing since about 1973. But the U.S. has been mining, burning and exporting coal in immense quantities for all that time. So don't you think that the reserve estimate might have shrunk down to something like 215 years by now? Nope. That 250-year number seems never to change, kind of like those Saudi oil reserve estimates that stay the same year after year. Despite decades of coal mining, a lot of people still want to believe (and probably want you to believe) that the U.S. has a bottomless pit of coal resources.

Second, the map shows only in a very general way where coal was originally located. The map does not illustrate historical mining trends or demonstrate how people have dug out the coal during the past 150 years of industrial activity in the U.S. Sure, the map shows the coal-rich areas in a broad, arm-waving kind of way. But many of those areas, especially in the eastern and Appalachian region, are mined out near the surface. You need to understand that much of the shallow and easily obtained reserves are gone. The only way to get to the remaining coal is through complex stripping operations or deep and expensive shaft mines.

You also need to understand that a large-scale map does not explain whether or not it is commercially or environmentally possible to dig the coal from the ground. Look at the map of Alaska, for example. Alaska appears to hold large coal resources, and by some estimates, 30% of U.S. coal resources are in Alaska. One characteristic of most U.S. maps is that they typically show Alaska drawn to a different scale than the lower 48 states. In other words, if Alaska were mapped to the same scale as the lower 48 states, Alaska would dwarf every other state. (The main landmass of Alaska is more than twice the size of Texas.)

That's good, right? If the map of Alaska is small in comparison with the lower 48, then the Alaska coal resources must in reality be even larger. (As big as Nebraska, maybe?) Then again, those large Alaska coal resources are almost entirely north of the Arctic Circle, in the exceedingly rugged Brooks Range. The fact is that there is only one coal dragline in all of Alaska (at the Usibelli Mine, south of Fairbanks). There is only one single-track railroad in Alaska that runs from the Pacific Coast to Fairbanks, far from the coal measures in the northwest part of the state and adjacent to the Arctic Ocean. So in northern Alaska, where the large coal resources are located, there are no coal mines. Furthermore, in Alaska's far north, there are no coal miners, no coal mining equipment, no mining support businesses, no coal-transport facilities and no coal-loading piers. There are no power plants even remotely capable of supplying power to an Arctic coal mine. And the environmental challenges of digging and shipping coal from north of the Arctic Circle are simply mind-boggling.

Aside from the modest amounts of coal currently being mined near Fairbanks, it is likely that virtually none of the coal of Alaska will ever see the light of day. Most of the coal resources of Alaska are simply unavailable to the U.S. economy in anything but the most far-out and far-fetched scenarios of long-term planning.

Back in the lower 48, you can see from the map that there are coal resources in many states. The main concentrations of coal resources are in Appalachia, the Illinois Basin area and out west in Wyoming and Montana. But coal mining is a highly concentrated extractive industry. Only 53 large U.S. coal mines account for about 60% of total U.S. coal output.

Three states alone - Pennsylvania, Kentucky and West Virginia - produce 52% of the high-quality thermal and metallurgical coal in the U.S. Coal output in all three of these states has been flat or in decline for many years. This is because the U.S. Northeast was the part of the nation first settled, and was the heart of the nation's industrial expansion in the 19th and 20th centuries. It's no surprise that the coal of this region was exploited first. Now the digging is much more difficult.

Today, Pennsylvania's anthracite coal (high carbon, clean burning) is almost gone. Small mining companies in the "hard coal" country (mom and pop operations, mostly) exploit coal seams as thin as just a few inches. In western Pennsylvania, long-wall mining for bituminous coal has become a controversial practice due to its damage to surface structures and water tables. Further south, in West Virginia (the second largest coal-producing state, after Wyoming), much coal is mined in a ruinous environmental practice called mountaintop removal. (It's exactly what it sounds like.) Even with mountaintop removal - moving 20 tons or more of mountain to obtain 1 ton of coal - West Virginia is nearing its maximum production rate for coal. According to a recent report from the U.S. Geological Survey, production will decline in West Virginia within the next few years.

Despite how it appears on the map, the interior region of the U.S. (Illinois, Arkansas, Indiana, Kansas, western Kentucky, Louisiana, Mississippi, Missouri, Oklahoma and Texas) produces the least amount of coal of all the nation's producing regions. The Illinois Basin boasts large reserves of bituminous coal, but production has dropped there since the mid-1990s. Coal from that region generally has high sulfur content (3-7%), so according to the U.S. Clean Air Act it cannot be burned, absent expensive pretreatment and combustion cleansing.

In Wyoming, the Gillette coal field, in the Powder River Basin, is the most prolific coal field in the U.S. This region has been nicknamed the "Fort Knox of coal." In 2006, output from the Gillette region totaled over 431 million short tons of coal, or over 37% of U.S. total yearly production. Wyoming coal has relatively lower energy content than Eastern coal, but it also has extremely low sulfur content. Thus, many of the 600 coal-fired power plants in the U.S. buy Wyoming coal to blend with other coal with higher sulfur content to meet Clean Air standards.

Previous coal studies of the Powder River Basin indicated that its coal measures would last many decades, if not a century or more. One early estimate of total coal resource in the Gillette field was just over 200 billion short tons. More recently, the development of coalbed methane (CBM) gas exploitation in the Gillette coal measures has added an entirely new set of hard data points to previous estimates. The interpretation of these new data provides a shocking downward revision of the coal resources and reserves in the Gillette coal fields.

According to a recent USGS study (Assessment of Coal Geology, Resources and Reserves in the Gillette Coalfield, Powder River Basin, Wyoming, USGS open-file report 2008-1202), the coal reserve estimate for the Gillette coal field is 10.1 billion short tons, which is a mere 5% of the original 200 billion ton resource total. In other words, the USGS has just revised the Gillette resource base down by 95%.

This dramatic downward revision is just the beginning of many more disappointing announcements. Other researchers are performing analyses in all U.S. coal mining regions, using more of the updated data that are coming in from the field. This is long overdue. It's one thing to feel good about your own press releases. But for setting energy policy, the U.S. needs to have a detailed, mine-by-mine analysis of resources and reserves based on current data using all of the available geological and mathematical tools for modeling. In the end, we should not be surprised to learn that only a small fraction of previously estimated coal reserves will ever be economically recoverable.

The U.S. almost certainly does not have a 250-year supply of coal. The nation will be fortunate if its coal supplies can stretch for another century. And even if the U.S. continues to use coal at current levels of output - which is unlikely in the face of the looming political controls on carbon - the supply issue will almost surely come to a head in as few as 10-20 years. In the world of long-range energy planning for the U.S. economy, the issue is ripe to address now.

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