Decline of the Empire

Gerald Celente And the "Greatest Depression"

Gerald Celente is the founder of the Trends Research Institute. Aside from being a martial artist, Gerald is a professional forecaster with a pretty really good record which includes the "Great Recession"—to begin in 2007, predicted in 2004—and the "Panic of 2008"—the financial meltdown, predicted in 2007. He is often compared to Nostradamus, who seems to have been a piker compared to Celente.

In the December, 2008 Trends Journal, Celente talked about the coming "Greatest Depression"—

Over the course of free-falling 2009, the word from most official sources will be “recession,” and from the few mainstream trophy pessimists, “deep recession.”

For example, the oft-quoted naysayer, Nouriel Roubini, New York University professor of economics, forecasts a two year recession … not Depression. On the sunnier side of Wall Street, the Federal Reserve predicts the US economy will contract only through the middle of 2009 and pledged, “In any event, the Committee agreed to take whatever steps were necessary to support the recovery.’’

What “steps?” The Bernanke Two-Step? Adjust interest rates or print more money? Neither stopped the credit crisis from worsening, the real estate market from tanking or the stock markets from crashing. It was Fed finagling, Washington deregulation and Wall Street’s compulsive gambling that created the crisis. To trust or to seriously consider pronouncements, analyses and predictions made by any of these sources is an exercise in willful self-deception...

Throughout the many years leading up to what we term the “Greatest Depression,” The Trends Research Institute provided copious data and Globalnomic® analysis to support our forecasts of economic upheaval. In the past year alone, we have provided so much hard evidence (housings starts, home sales, foreclosures, bankruptcies, bank failures, unemployment figures, stock indices, leading economic indicators, retail sales, etc.) that further elaboration should be superfluous. (See December 2007 Winter; Spring and Autumn 2008 Trends Journals. Also see “Financial Passover Question: Why is this Depression Different than all other Depressions,” Trends Journal, Autumn 2008.)

2009 was not nearly as bad as Celente believed it would be because he did not anticipate the extraordinary lengths the government and the Fed would go to to prop up this House Of Cards called the U.S. Economy. There's no denying that 2009 was still pretty ugly. Gerald is not deterred by his apparent misfire. He is now predicting that the "Greatest Depression" will start in 2010 (see the video below). Who am I to disagree? Whether we're in a "deep recession" or a "depression" is a matter of semantics.

There is no how-fucked-up-are-we? scale that measures exactly where we stand. The standard measure, Gross Domestic Product (GDP), consistently tells a story at odds with reality as measured by everyday experience. How can anyone still trust official government statistics?

Celente is also a "Decline of the Empire" kind of guy. In 2002, he wrote American Empire Fading Fast. I wasn't able to get the original, but here's an update to the Fading Fast document made in July, 2009.

Empire America Fading Fast

Back in 2002, we forecast that, based on a confluence of emerging-trends, not only was the consumer-based US economy unsustainable, Empire America itself would dissolve.

In 2009, this was no longer a forecast, it was fact. You only had to do the math. Federal obligations were at an astounding and irreconcilable $546,000 per house-hold. Not only was it impossible to pay off the debt given the direction the government was go-ing — printing phantom money, out of thin air, based on nothing and producing practically nothing — the debt was foreordained to increase. 2008 tax revenues had plunged 34 per-cent, and they would plummet further as “The Greatest Depression” set in. Added to the debt load were the unavoidable trillions committed to cover Medicare/Social Security/retirement programs for 78 million aging baby boomers. Those were the inescapable, undeniable numbers. They didn’t lie. But not only were they not being added up, they were invisible: “US hopes of ‘green shoots lift confidence,” read the 26 May 2009 Financial Times headline.

You'll get no argument from me. However, when Celente says the "greatest" depression, the claim is that we should prepare for a shitstorm worse than the worst years of the Great Depression in the early 1930s. Several lines of evidence (e.g. the housing market, unemployment) point to no recovery or gradually worsening conditions. However, it appears that Celente is talking about an actual collapse leading to a breakdown in social order.

Right now, I don't see what single event, or combination of events, would trigger a collapse in 2010. On the other hand, we now have to worry about Black Swans (as if we didn't have enough to worry about as it is).

I hope catastrophes leading to chaos don't happen this year. A breakdown in social order doesn't sound like any fun at all. Guns make me very uncomfortable. I hope Celente is wrong. Of course, I lost my faith that things would "end well" many, many years ago. Here's the video.

The Hundred Year Flood

There's a nice post over at Anecdotal Economics, where the theme is Making Astrology Look Respectable Since 2005. It's called The Maestro and the Hundred Year Flood. Adjunct professor of finance and banker Keith Hazelton owns the blog. Here we go—

Alan Greenspan’s self-serving “The Crisis,” a 66-page white paper outlining exactly why no part of the extant global financial/ liquidity/credit/solvency/deleveraging crisis was the fault of the Federal Reserve whose board he chaired for 18 years or anyone or any other entity for that matter, contains among the many exculpatory assertions, a fascinating, if not stupefying, revelation that, in setting capital adequacy levels, reserves and leverage limits, policymakers:

“…have chosen capital standards that by any stretch of the imagination cannot protect against all potential adverse loss outcomes. There is implicit in this exercise the admission that, in certain episodes, problems at commercial banks and other financial institutions, when their risk-management systems prove inadequate, will be handled by central banks. At the same time, society on the whole should require that we set this bar very high. Hundred year floods come only once every hundred years. Financial institutions should expect to look to the central bank only in extremely rare situations.” [quote from Greenspan, pages 16-17, all emphasis added].

No sir, Sir Alan. Hundred year floods come on average only once every hundred years, as any undergraduate who has completed Statistics 101 would recognize, presumably based on many centuries of flood observations in a particular locale.

Keith is just warming up. First he must complete the set-up. You need to know a little about statistics.

Now we know if one flips a coin 100 million times, a tabulation of heads/tails results likely will yield a result infinitesimally close to 50/50, so that one may conclude, on average, the actual observation results would prove the statistical probability for each flip that the coin lands heads-up is 50 percent (we conveniently are excluding any possibility of the coin landing, say, balanced vertically on edge.)

We also can be confident in such a large observation, however, that low-probability strings of 10, 20 or 30 consecutive heads-up or tails-up results – while extremely unlikely in 100 flips – would, in fact, be commonplace.

That such occurrences have low probabilities, even extremely low probabilities in smaller observation samples, is immaterial. Regardless of the number of observations, even low probability events are bound to occur, and they are neither randomly nor evenly distributed.

Similarly, nature has no constraints as to the frequency of hundred-year floods, only that on average they should occur once every century, but if it pleases nature to generate 10 hundred-year floods in a century, and none for the next 900 years, albeit a low-probability event, such an observation is completely within the framework of reality.

OK, Keith's ready to let loose now—he lowers the boom!

Neither are there constraints, apparently, on the frequency of meltdowns in the complex, deregulated financial environment we have invented and unleashed upon ourselves, even though, unlike nature, we completely are in control of the frequency and regularity of hundred-year financial disasters.

Which is what is so self-serving about the former Fed chief’s term paper...

I like it. That's my kind of writing. If you're going to tear The Bubblemeister a new asshole, do it with style! And now I invite you to—

imagine if you will, a tranquil Empire, a time that seemed so innocent, perhaps a little too innocent...

...a time when year in and year out, for years on end, everybody hung on Alan Greenspan's every word. Imagine a nation beneath whose seemingly Prosperous Facade dramatic social changes were brewing.

You unlock this door with the key of imagination. Beyond it is another dimension, a dimension of sound, a dimension of sight, a dimension of mind. You're moving into a land of both shadow and substance, of things and ideas. Travel back a mere 5 years—you've just crossed over ... into the Twilight Zone.

We Don't Have The Right Stuff Anymore

You older readers will recall President John F. Kennedy's stirring speech to Congress on May 25, 1961.

I believe that this nation should commit itself to achieving the goal, before this decade is out, of landing a man on the moon and returning him safely to the Earth. No single space project in this period will be more impressive to mankind, or more important for the long-range exploration of space; and none will be so difficult or expensive to accomplish. We propose to accelerate the development of the appropriate lunar space craft. We propose to develop alternate liquid and solid fuel boosters, much larger than any now being developed, until certain which is superior.

By the end of the 1960s, America did land a man on the Moon and return him safely to Earth. When Stanley Kubrick made 2001: A Space Odyssey in 1968, voyages to Jupiter 33 years later did not seem so far fetched. For an Empire at the height of it's power, anything seemed possible. There were many back then who thought we'd have a permanent Moon Base and a spectacular Space Station orbiting the Earth 43 years later in 2010. Perhaps we would be terraforming Mars or mining hydrocarbons on Saturn's moon Titan. Literally, the sky was the limit.

There is no more powerful symbol of our Decline than the disgraceful mess at NASA today. All of our best achievements were in the past. And there they will stay, never to be resurrected again. I woke up yesterday morning to this from my local "newspaper" the Pittsburgh Post-Gazette. 

NASA's $9.4 billion mission to nowhere leaves staff bewildered

Monday, March 29, 2010

By Joel Achenbach, The Washington Post

CAPE CANAVERAL, Fla. — Anyone need a $500 million, 355-foot steel tower for launching rockets into space?

There's one available at NASA's Kennedy Space Center. Never been used.

The mobile launcher has been built for a rocket called the Ares 1 [mock-up left]. The problem is, there is not yet any such thing as an Ares 1 rocket — and if the Obama administration has its way, there never will be.

President Barack Obama's 2011 budget kills that rocket, along with the rest of NASA's Constellation program, the ambitious back-to-the-moon effort initiated under President George W. Bush.

People around the Cape Canaveral were shocked when they heard the news last month. They were already facing the imminent retirement of the aging space shuttle and the likelihood of thousands of layoffs in the contracting corps, but many hoped to find a Constellation job, stay on site and essentially just switch badges.

Now suddenly, they're looking at no shuttle, no Ares 1, no NASA-owned spaceship of any kind in the near future. American astronauts for years to come will hitch rides to space on Russian rockets.

"It's almost like losing manned space flight," said Michele Kosiba, 44, a quality inspector for United Space Alliance.

People are dismayed and bewildered. Mr. Obama has gotten the message and will fly to the Kennedy Space Center on April 15 to hold a space conference and a town hall meeting. He is certain to point out that his budget actually boosts funding for NASA. The new NASA strategy shifts the task of launching astronauts to low Earth orbit from traditional government contracts to commercial contracts. If the private sector can create a taxi to space, NASA can focus on new technologies and longer journeys in the solar system...

Lot's of people are puzzled, or even angry, when I characterize America as an Empire. There is more emotional confusion when I state that it is a Declining Empire. It helps to be older. It definitely helps to know some history. In the 1950s and the 1960s, America had The Right Stuff. 

We don't have The Right Stuff anymore.

Shale Gas Shenanigans

In the years leading up to the crash of the Housing Bubble in 2006 and the subsequent financial meltdown in 2008, there was no shortage of people telling us America's continued prosperity was not in jeopardy. All that talk was nonsense, of course. In 2010, the situation is eerily similar in the natural gas business. We are told that we have 100 years of supply, implying that we will still be producing cheap shale gas long after the oceans are devoid of fish. As in the pre-Housing Bubble days, a few skeptics are crying foul. There are underground rumblings that things are not on the up & up with shale gas.

The first bone of contention is what the actual production costs are. The Financial Times' John Dizard has been questioning the accepted wisdom lately—

A couple of weeks ago, I quoted Ben Dell, an analyst with Bernstein Research in New York, as estimating the shale gas industry really needs a price of $7.50 to $8 [per mcf] to break even on its all-in costs of finding and producing the stuff, which would be a 60 per cent price rise [over about $5 per mcf]. Not easy for many people, or industries, to pay these days...

So I worked people in the energy service industry, and gas producers to try and refute Ben Dell’s numbers. I couldn’t. My industry sources’ numbers all converged close to $8 per mcf. They do not believe the producers are covering their all-in costs. 

For example, as a Texan gas man described the now-hot Marcellus gas fields in Pennsylvania: “One company was saying they can develop reserves there for a little over $1.15 per mcf. If you ask them, they say it costs them $3m to drill and complete wells that average 3bn cu ft of reserves, produced over 40 years. Those reserves are calculated on the basis of high initial production [IP] rates that decline rapidly. There is insufficient data to have an accurate estimate for the assumed life of the wells [for the EUR]. You can’t check any of this, because unlike elsewhere in the US, the state doesn’t release official monthly production numbers for three years”.

“There is a ton of sleight of hand going on here,” he alleges. “The ‘costs’ don’t include the cost of the land, the seismic survey, the operating costs, and other expenses.” Remember, though, that no one with a competent securities lawyer ever needs to tell a lie.

[My note: mcf stands for thousand cubic feet, the standard industry unit of production.]

There are two different magic tricks going on here. First, some costs, like those for the land, are simply left out of the accounting equation. Moreover, shale gas operators like Chesapeake quote very high IP rates on their best wells and estimate a very large ultimately recoverable (EUR) from these wells, despite the fact that decline rates on shale gas wells are typically very steep after the first few months of production. The larger your assumed recoverable per well is, the more profitable your well appears to be. Dizard refers to all this as a sleight of hand, and that's exactly what it appears to be.

Operator production cost estimates look like a form of fraud, but it's the financial and reserves accounting part of things where the stench gets really bad. Here I turn to Allen Brooks' Gas shales: Energy market solution or problem?

Energy investors have embraced the gas shale phenomenon. In fact, if producers don’t have gas shale acreage to highlight in investor presentations — suggesting reserve and production growth — they are ignored in the marketplace. By overstating producing gas shale reserves, companies are able to show extremely favorable finding and development (F&D) economics. Low F&D costs are critical for producers to tap Wall Street for the funds necessary to sustain their aggressive gas shale drilling efforts.

The cost of leases and their relatively short lives have placed a premium on accelerated exploitation. As a result, the industry has been outrunning its ability and desire to complete wells given low natural gas prices. Producers with significant gas volumes previously could hedge at higher prices. This price disparity augmented cash flows. Additionally, large gas shale producers tapped Wall Street for additional capital, entered into joint ventures with larger companies lacking a presence in these plays, and sold assets. But the surge in gas shale production, coupled with the recession and a lackluster demand for natural gas, has pressured gas prices. Producers are now struggling to show both production growth and profitability.

Producers can not demonstrate production growth and profitability in the current low price environment. At the same time, by overstating reserves (EURs) in their shale gas acreage, they can "tap Wall Street" to keep the party going. But wait, it gets worse. Kurt Cobb interviewed B. J. Doyle, vice president of operations for a small Houston-based oil and natural gas exploration company. Here's the clincher—

[Shale gas operators] will drill prospects that they believe have no reasonable chance of doing anything other than breaking even. Why will they do this? To boost stated reserves, a number by which Wall Street judges the value of oil and gas companies.They won't, however, make any true profit on these wells. But they will become what Wall Street calls an "asset play." They will be valued on their assets, in this case stated reserves, rather than on their profitability.

These shale gas producers are an asset play. And this outcome obviously benefits the Wall Street banks who lend them money. Indeed, this is their exit strategy from the unprofitable drilling treadmill they are currently on. If shale gas production can be said to be in a bubble, this is where that bubble lies. And the strategy is working! Rigzone reports on the acquisition frenzy—

BP PLC is expected to announce Tuesday an expansion of its U.S. shale-gas operations through a joint-venture deal in Texas with privately held Lewis Energy Group worth at least $160 million...

BP's move is the latest in a string of deals that have brought major oil companies into U.S. shale gas--a substantial resource that has boosted U.S. gas reserves significantly and is transforming the energy industry... BP, Norway's Statoil SA (STO) and other big oil companies also aim to apply expertise gained in North America to their efforts overseas to extract gas from deep, hard, shale-rock formations.

Several companies have been jostling for acquisitions in the sector, which was pioneered by smaller, independent U.S. producers such as Chesapeake Energy Corp. (CHK) and XTO Energy Inc. (XTO). France's Total SA (TOT) agreed in January to acquire a quarter of Chesapeake's Barnett Shale operations in Texas for $2.25 billion. This came the month after Exxon Mobil Corp. (XOM) gave shale-gas development a definitive stamp of approval by agreeing to acquire XTO in an all-share deal valued at around $31 billion.

What is the upshot of these Shale Gas Shenanigans? As the major oil & gas companies get more involved, the shale gas boom will likely go bust in 2010 and thereafter until prices rise above costs to make production profitable. As Brooks put it, Exxon Mobil "has the financial strength to withstand a low gas price environment and marginal returns from gas shale activity until technology helps to lower development costs." Dizard was simply sarcastic:

The majors, which can’t seem to explore their way out of a grocery bag these days, at least in the onshore US, needed those elastic “reserves” to replace politically risky hydrocarbons in geologically better locations. They, and the remaining independent producers, will be bailed out by gas at $10 an mcf – double today’s level – or higher. Then the service industry will be able to raise prices to cover its full costs.

Don’t tell the political people. Not that they’d listen.

The shale gas boom has been the sole bright spot in America's energy picture, and maybe the only bright spot in the economy as a whole. And what does that bright spot turn out to be? An asset play whereby shale gas producers, conniving with bankers, inflate their own value, hoping to get out while the getting is good.

What else would you expect in 21st century America?

Also see Part I — Betting The House On Shale Gas

Betting The House On Shale Gas

This is the first of a two stories on shale gas. Today I will put the Shale Gas Boom in proper context. Tomorrow I will explain why I think there is a bubble in shale gas production.

Penn State professor Frank Clemente, testifying before a Senate hearing on natural gas in October, 2009, had this to say—

Natural gas price in the next decade is one of the most important U.S. energy questions. Steadily increasing U.S. dependence on gas poses risk to higher energy prices and electric reliability and national energy security, especially because the Energy Information Administration (EIA) projects natural gas supply to decline 4 percent through 2020...

Where Will We Get the Gas?

Despite our starkly negative experiences with higher natural gas prices and the debilitating volatility of those prices, optimism for the fuel appears to be a contagion.

Several groups have suggested that natural gas can be substituted for coal as the primary fuel for generating electricity. Others have proposed that natural gas can provide fuel for vehicles, and yet even others have argued that we can continue to build wind turbines at a frenetic rate because natural gas will be there to back up this highly intermittent supply.

When one objectively examines the data, however, these questions are moot. The real question is: Can natural gas production even meet existing demand, let alone incremental demand? As Figure 3 shows [below], the EIA has projected that by 2020 conventional onshore natural gas production in the U.S. will decrease more than 34 percent, and supplies from Canada will drop 60 percent.

These declines will be only partially offset by two highly questionable new sources: shale gas and liquefied natural gas (LNG) imports. It is important to consider the limitations and unknowns of each in turn.

And you thought I was a pessimist! However, here Frank relies on an EIA forecast, and such forecasts are notorious for containing mountains of bullshit. The EIA's preliminary 2010 Annual Energy Outlook (AEO) is a case in point. Nonetheless, I will quote it below. Clemente's Figure 3 shows that we will get a little over 3 trillion cubic feet (Tcf) of gas from shales in 2020, but another excellent report puts the number at 4.5 Tcf. Both numbers come from the EIA! No doubt the two analysts are using EIA outlooks from different years.

Here's the EIA's 2010 gas outlook—

You can clearly see that natural gas production is lower than it's historical peak (black line) in 2020. That's not good. And you can also see that the shale gas share must get bigger & bigger for us to achieve this unhappy outcome. Let's get back to Frank—

Shale gas production. This is the only bright spot in the domestic supply picture, and substantial reserves exist. There are questions, however, along four key lines:

• Deliverability at scale. Although the shale gas resource is extensive, even the relatively optimistic EIA projections indicate increases in shale gas will offset only about half of supply declines in other key sources (e.g., Canada). Decline rates in shale gas wells can approach 70 percent the first year, creating a constant treadmill to find additional resources and drill new wells.
• Environmental and water impact. The impact of the fracturing process is a matter of growing concern, particularly in New York and Pennsylvania regarding the Marcellus shale play. The Congressional Research Service, for example, recently reported, “The hydraulic fracturing treatments used to stimulate gas production from shale have stirred environmental concerns over excessive water consumption, drinking water well contamination, and surface water contamination from both drilling activities and fracturing fluid disposal.” In the Marcellus shale region, for example, the Delaware River Basin Commission, responsible for a watershed that serves more than 10 million people, has identified three major areas of concern: reduction of stream flow, pollution of ground and surface water and proper disposal of “frac water.”
• New regulations. These regulations emerging from environmental concerns could significantly impact production and price. IHS Global Insight estimates that simply subjecting hydraulic fracturing to the federal underground injections control requirements in the Safe Drinking Water Act would result in a 20 percent reduction in the number of new wells drilled and a 10 percent loss of natural gas production.
• Cost and sustainability. The eventual cost and sustainability of shale gas production are open to question. Geologist Arthur Berman has argued that the high decline rates will make shale gas wells far more costly than projected, and the current rush to shale gas is a “speculative bubble.” Dow Chemical Co. echoed these concerns in 2009 testimony before the U.S. Senate on the role of natural gas. “Although increased supply from shale gas appears to have changed the production profile, we have seen similar scenarios occur,” Dow testified. “In each case, the initial hopes were too high and production increases were not as large as initially expected.”

America has Bet the House on a big shale gas boom over the next decade (and to a limited extent, LNG imports—see Clemente's testimony). Tomorrow I will focus on the cost and sustainability issues that lie at the heart of the current debate on shale gas production.

Also see Part II — Shale Gas Shenanigans

Terra Incognita

Barry Ritholtz, owner of The Big Picture, author of Bailout Nation and frequent guest of the financial press, commented on the ethics of mortgage modification at National Public Radio (NPR). The story was called Financial Blogger on Ethics of Mortgage Modification. Responding to this characterization, Barry said—

(Financial blogger? Really — after all this time, that’s how I am described?)

I could not resist commenting, so I had to register at The Big Picture. Here's the comment—

Oh, Barry. Financial Blogger.

Over at NPR they know they are important and they know you are not.

You reside in that vast Terra Incognita that lies Outside The Beltway.

It is only on rare occasions that they report Events occurring in that Vast Wasteland.

They do not venture out there themselves. They rely on “local” (means “foreign”) correspondents to see how the Natives are faring.

'Nuf said.

Remedy du Jour -- March 27, 2010

Although there's no shortage of outrageous things to report on, it's Saturday, which means it's time for our Remedy du Jour. First up, Bonnie Raitt plays a medley of tunes by the great Mississippi bluesman Fred McDowell. I had the pleasure of seeing Fred in 1972 at the folk & blues festival at the University of Chicago, where I was getting an undergraduate degree—not in economics! Bonnie studied with Fred before he passed on, so you guitar players will notice that she plays with the slide on the second finger of the left hand, not the pinkie (like me and most others).

Second we have jazz pianist Robert Glasper doing his fine tune F.T.B. Today's film clip is from Robert Redford's The Legend of Bagger Vance. It's finally time to choose for Matt Damon.

Invisible Hand Goes Missing

Unfettered markets always lead to efficient outcomes. Alan Greenspan and many, many others believed this nonsense. As economist Joseph Stiglitz reminds us, that's why the Bubblemeister would opine that there's no such thing as a bubble, there's just a little froth in the economy. His intellectual heir, Ben Bernanke, learned this Great Truth at the feet of the master.

How convenient. For most of the last 3 decades, many influential economists embraced a theory that justified wholesale theft by the Finance industry because the magical powers of Adam Smith's Invisible Hand would always result in greater "efficiency" in the economy. It's as if Homo sapiens had suddenly stumbled upon a miraculous potion— this was framed as the efficient market hypothesis. Drinking this cleansing kool-aid would enable us to see clearly that Gordon Gekko was right, unfettered greed is good. Hundreds of years of economic history, and thousands of years of human history, could simply be tossed out the window. Move on, nothing to learn there.

As the condition of the Empire deteriorated over these past 30 years, it was essential that there be effective rationalizations those Running The Show could cite to justify why theft was not only condoned, but actively promoted through further calls for deregulation. There will always be clueless intellectuals willing to provide these rationalizations. Economists are the High Priests of American Culture, and Gross Domestic Product is the False Idol they worship, so most of the required intellectuals were practitioners of The Dismal Science.

Where is that Invisible Hand? It's gone missing...

The reason that the invisible hand often seemed invisible was that it wasn't there

Bad Money

In his recent testimony before Congress Treasury Secretary Tim Geithner admitted that Obama & Company have no clue about what to do with Fannie Mae and Freddie Mac. This sinkhole has now cost taxpayers over $125 billion but that's nowhere close to the final tab, especially if the housing market tanks again.

The Congressional panel tasked with overseeing the nation's financial system and the Treasury Secretary both agree that there's a problem with the nation's system of housing finance. Fixing it, though, may be the biggest problem of all -- and neither one seems to have a clear answer...

But the administration doesn't have any concrete plans, Geithner said. Rather, he outlined broad principles and the administration continues to punt the issue into next year. In short, the current model of private shareholders supported by an implicit or explicit taxpayer guarantee is unsustainable and likely to be changed, Geithner said. The question is when and how much.

Meanwhile, taxpayers have pumped more than $125 billion into the failed firms -- and on the hook for many more after the administration promised an unlimited source of funds just before Christmas to backstop their growing losses.

"We will do everything necessary to ensure these institutions have the capital they need to meet their commitments," Geithner said in response to tough questions from Rep. Scott Garrett, a New Jersey Republican.

Underscoring the need for change, Geithner acknowledged that taxpayers are likely to face "very substantial" losses on the government's takeover of Fannie and Freddie...

How did we get into this mess? No doubt that is a very complex question which we don't have time to deal with here, but the Huffington Post Investigative Fund provides an interesting perspective in Why Fannie and Freddie Continue to Cost Taxpayers Billions—

Fannie and Freddie's losses largely stem from internal decisions made in 2006 and 2007 that sent the companies on a shopping spree for dubious mortgages, according to regulatory filings, congressional testimony and interviews with economists and former Fannie Mae employees. Fannie and Freddie uncharacteristically collected more than $1 trillion in subprime and other risky mortgages---many of which were branded “alternative,” or alt-a, because they did not meet the rules set by Fannie and Freddie...

OK, Fannie & Freddie got into the subprime mortgage market, which was not part of their charter. Why?

For 40 years, they functioned as publicly traded companies controlled by shareholders who demand profits. But they also operate under a congressional charter, as government-sponsored enterprises (GSEs), to keep credit flowing in minority and low-income communities. The charter also carried an implicit guarantee that if the companies got into trouble, the taxpayer would bail them out.

To follow their mandates, the companies developed two key lines of business. One is to buy mortgages from lenders, which can then use the money to offer new loans to consumers. Fannie and Freddie bundle the loans, guarantee them against default and sell them as securities to investors such as pension funds. The second line of business is management of their own investment portfolios.

Although both sides of the business helped bring the companies down, last year’s losses stemmed largely from the loans they bought and guaranteed in 2006 and 2007. Before 2006, the companies dominated the residential mortgage market, owning or guaranteeing more than half of new mortgages. But after initially resisting the subprime boom, they began losing their control to Wall Street banks. Fannie and Freddie’s market share plummeted to 37 percent in 2006.

They decided to rev up their buying and guaranteeing of risky mortgages. This decision restored their market share but also helped destroy the companies...

These so-called Government Sponsored Enterprises (GSEs) were losing share in the housing market. The GSEs were not competing "successfully" with unrestrained garbage lending by Wall Street banks. So they got into the NINJA (no job, no income, no assets) loan business. And now taxpayers are on the hook for untold billions in losses.

The phrase "bad money" sometimes refers to Gresham's Law, which had a very specific meaning when it was articulated by Thomas Gresham (1519-1579). Literally, it applied to two different currencies, one of which had proper backing whereas the other did not. Now the phrase has been generalized, as Kevin Phillips explained to Bill Moyers in September, 2008.

Moyers— Give me a quick definition of "bad money."

Phillips— Well, "bad money" has a triple connotation. The first is "bad money" in the sense of bad capitalism drives out good capitalism.

Moyers— That's sort of a historical...

Phillips— That's right. We've had...

Moyers— I don't understand why it is. But...

Phillips— Well, because you have to compete with sleaze.Get a little more sleaze in your own operations. And you look at all these lies, these deceptions, these frauds that have been going on. But, I mean, there aren't too many people that would say back two or three years ago that the way to prosper more was to do less of the cheating. You had to do what the others were doing. And that's the way these things — it was true in the Twenties. It's been true in plenty of other bubbles. You have to do it. So just the question of what's been bubbling here and the hugeness of the problem hasn't been revealed to people.

Moyers— You say it's the greatest story never told.

Phillips— Well, the greatest story never told in several senses. The first sense and when I [say] bad money, it's bad capitalism and bad money in the sense of the dollar and bad money in the sense of bad dog, bad Wall Street. But what's here that doesn't get the attention is the United States in the last 20 years undertook an enormous transformation of itself with no attention paid. And what it means is and what makes all this so frightening is the country is at risk because of the size of the financial sector that has never been graded on its competence and behavior in any serious way. They are the economy at this point. And we are now seeing what happens when a 20 to 21 percent of GDP financial sector starts to come unglued.

Etc. Fannie & Freddie collapsed because they felt the need to compete with sleaze. They needed to get more sleaze into their operation. Thus we get the phrase "bad money drives out good money." Although the Moyers interview is 18 months old now, it is still worth watching. I regard it as a classic introduction to why we are screwed now and for the foreseeable future.

I have included only the first of three videos, the one in which Phillips describes "Bad Money." To watch the entire interview, look at part II and part III over at youtube.

CNBC Doubts The Empire's Decline

DOTE reader Compound F points out that David Murrin, co-founder and CIO of the hedge fund Emergent Asset Management, was on CNBC's Squawk Box Europe arguing for a rapid Decline of the American Empire.

The passage of the health care law shows that the US empire is declining because it illustrates the fact that people expect the state to take care of them, David Murrin, the co-founder of Emergent Asset Management hedge fund manager, told CNBC...

In their expansionary phase, empires force people to go out, seek risks and fend for themselves, Murrin said, reminding of the dismantling of the British empire after the war, when the National Health Service, which ensures universal health coverage in Britain, was created.

"This [imperial decline] is actually a dead-set course that societies get into and it will happen very quickly I'm afraid," he told "Squawk Box Europe."

"As you start to build a system it becomes cohesive because of its success… the fractures in the American system I think are more apparent than ever," Murrin added.

China's rise will be much faster than most people anticipate as the country's military prowess increases, he said.

I'm not sure I buy Murrin's assessment of the significance of universal medical coverage. Germany and other countries do just fine despite their "socialistic" tendencies. Health care reform in the U.S. comes 20 years too late regardless of your view of the situation. In any case, cheerleaders on CNBC weren't buying most of Murrin's story—what a surprise!

Here you go. FYI, my including a video interview does not imply my endorsement of everything the interviewee says.