If you want to attend the presentations and discussions over the next four days, you can still do so. But you should contact conference organiser Marcus Matthews today. You can reach him via email at feketeaustralia@gmail.com. And if you're there on Sunday, be sure to say hello.

Yesterday we promised to show you how the funding model for the fiscal welfare state is blowing up. But this is going to have to wait at least another day. Don't worry though. It's not going anywhere.

Today, there is a banking story to cover. You recall that yesterday we were worried about the next banking crisis. But the lingering effects of the last one are still with us. National Australia Bank reported a 43% fall in net profit yesterday. Ouch.

Don't feel too bad for NAB. Net profit fell from $4.54 billion to $2.56 billion. But the bad and doubtful debts charge for the year grew by 53% from $2.49 billion to $3.82 billion. With $654 billion in assets and $616 billion in liabilities, the bank is sitting on $37.8 in equity. A few billion in bad debts and loan losses won't wipe out that amount of equity.

But it's worth noting that NAB's total assets are 17.3x times equity. This isn't as high as some leverage ratios in the U.S. just prior to the banking crisis in 2008. But it's not far off where NAB was at the time. And there are two further risks worth mentioning.

First, as the IMF paper on Aussie banks concluded earlier this year, Aussie banks are probably strong enough to withstand a normal shock to the balance sheet. That is, the IMF stress-tested Aussie banks for losses on their two largest loan portfolios - corporate loans and mortgages. The IMF concluded the banks were adequately capitalised to survive the shocks it tested for, but that, "The above shocks do not constitute a rigorous stress test and the results are only indicative of the health of the banking sector."

If we've learned one thing in the last two years, it's that bankers and analysts have consistently underestimated the frequency and magnitude of systemic shocks. That doesn't mean the IMF conclusions aren't to be trusted. But it means in the event of another more severe shock, the banks could face larger asset writedowns and losses than the IMF has modelled.

This brings us to the second risk worth mentioning. A bank facing bigger loan losses takes fewer risks. It reduces lending. This is how the credit crisis was transmitted from America's housing market to Australia's economy. The Aussie banks had to tighten up to prepare for losses on overseas assets.

Next time around, though, we reckon the losses - when they come - will be on domestic real estate assets. And with so much exposure to domestic real estate (mortgage loans), the assets could face a world of hurt. But even if bank asset quality doesn't crash (housing prices don't crash), an external shock affects Aussie bank liabilities.

The IMF report says that, "On the liabilities side, however, banks had sizable short-term external debt obligations, and access to offshore wholesale markets was disrupted by the Lehman Brothers collapse in September 2008." Of course the government's wholesale funding guarantee eased the pain of this shock, which is one reason why that guarantee may become permanent in all but name.

But the IMF wrote that, "A key remaining vulnerability is the roll-over risk associated with sizable short-term external debt. Banks' wholesale funding (domestic and offshore) accounts for about 50 percent of total funding, of which about 60 percent is offshore. Financial institutions short-term external debt (on a residual maturity basis) is estimated by staff at about $A 400 billion (35 percent of GDP) in March 2009."

Maybe the short-term external debt levels have improved in the last six months. We haven't checked yet. But in simple terms, it means a lot of domestic lending is funding from external funding, borrowing abroad to loan at home. If American banks again blow up on the destruction of their remaining collateral (mortgage loans and U.S. Treasury bonds) we'd predict another ice age in global credit markets.

Needless to say, as a capital importer, this would put Australia in an awfully uncomfortable spot. But hey! No one is worried about that at the moment. The Aussie dollar is being inflated by the U.S. dollar carry trade. It's a shame that the strong Aussie is going to devastate local industry and manufacturing with higher costs, but at least it obscures for now the risk that Aussie banks are reliant on foreign borrowing.

In the bigger picture, this means the investment needs of the economy can't be met by household savings alone. But that's an even bigger problem than we can address today. So we won't!

More cow bell!

And what about our theory that a U.S. dollar rally will trigger a correction in gold, oil, and stock markets and lead to a mini-rally in U.S. Treasury bonds? Bond fund king Bill Gross agrees. Writing on Pimco's website, Gross concedes, "Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets -- while still continuously supported by Fed and Treasury policy makers -- is likely at its pinnacle."

Dr. Doom himself, analyst Nouriel Roubini, called the present market "The mother of all carry trades." "This asset bubble is totally inconsistent with a weaker recovery of economic and financial fundamentals," Roubini said via satellite to a conference in Cape Town, South Africa. "The risk is that we are planting the seeds of the next financial crisis."

With the S&P up nearly 65% since touching 666 in March (seriously), we'd say the seeds are already bearing fruit. But maybe it's poisoned fruit. After all, the rally has been worldwide and extremely impressive by historical standards. But it's fully consistent with previous bear market rallies. If anything, it's happened faster.

What nobody yet knows is if it IS a bear market rally...or a garden variety stock market rally that precedes a recovery in the economy. You know what we think.

There IS one notable difference between 2008 and today, though. Yesterday we mentioned that U.S. banks have loaded up on a whole other kind of super-dodgy collateral; U.S. Treasury notes and bonds. Demand for those securities may go up with a U.S. dollar rally and a reversal of the dollar carry trade. But in the longer-term, we think the banks have invited another toxic house guest on to the balance sheet.

But where did the previous smelly houseguest go? You know, all those mortgage backed securities and subprime loans? Where does that risk now reside? And what happens if it comes home to roost?

According to this report by the San Francisco Federal Reserve, over 95% of all new residential mortgage lending in the U.S. is now being backed directly by the U.S. government. With the banks unable or unwilling to lend, Uncle Sam has become the sugar daddy of the U.S. mortgage market. See the chart below.

The Fed supports this market by purchasing the securitised mortgages issued by Fannie and Freddie. The Congress funds the agencies which make the loans available. But no matter how you slice it, the U.S. government is supporting the housing market. It will continue to do so as a political imperative.

But by taking on this massive liability - not that it doesn't already have its hands full - the Fed is further consigning the dollar to the scrapheap of history. Do you think foreign creditors will not realise that the U.S. is borrowing money to keep house prices elevated? Will they not notice that the U.S. is printing money to do this? And what will happen to the dollar then? And gold?

The truth is that creditors already do know this. Today's Australian Financial Review reports that overseas Chinese investment is "surging." Chinese policy makers are trying to trade dollars for tangible assets or equity in resource shares as quickly as possible. "China reported a 190% jump in overseas investment by its companies for the third quarter."

"Policymakers might be encouraging Chinese firms to invest abroad, in part to help counter pressure for the nation's currency," the article continued. "Investors are betting on the yuan to appreciate as China's growth accelerates from its weakest pace in a year."

Most currencies that are not the U.S. dollar could appreciate in the coming years. Australia's currency has already done so. Brazil is considering a tax on capital flows into the country in order to prevent investors from speculating on a further rise in its currency by buying Brazilian assets. And of course speculators have tried for years to find a way to position themselves for an appreciation in China's currency. China's capital markets are not friendly in this regard, although Hong Kong stocks remain a popular option.

The fact that countries like Australia, China, and Brazil are trying to limit currency appreciation versus the greenback shows you how unbalanced the world economy still is, how unprepared it is for the reality that America's deleveraging will take place for years. Households and businesses must save and repair balance sheets. Some other country is going to have to consume what the world produces.

In the interim, the U.S. government will increase deficit spending to make up the difference. It is the stupidity of Keynesianism to support aggregate demand when what everyone needs is a correction and a recovery. But all the Feds will succeed in doing is blowing up the balance sheet of the U.S. government in spectacular fashion. Go gold.

Mind you we still think the short-term move is a dollar rally and some profit-taking on the dollar carry trade. We asked Slipstream Trader Murray Dawes what he sees when looking at the U.S. dollar index. Murray spends most of his time finding trading opportunities in Aussie stocks. But he also knows that Aussie markets (and capital flows) are still massively affected by what's going on in America.

Murray wrote that, "If we look at this chart of the US Dollar index going back to 1985, you can see quite clearly that the 10 week moving average crossing over the 35 week moving average has been a very good indicator of the trend. There are only a few instances over that whole time period where this indicator gave a false signal."

Click to enlarge

"Therefore," Murray continues, "we should be keeping an eye on this indicator going forward to tell us whether the US Dollar index has turned back up and is ready for a counter trend rally. The short US Dollar trade is getting pretty full, as I have mentioned in the past. And there is a high correlation between the direction of the dollar and the direction of gold, oil and stocks.

"The US Dollar has taken over the Yens role of funding the carry trade and this will be the situation for as long as the Fed remains too scared to raise rates, which seems to be for the foreseeable future. So we can probably expect the dollar to weaken further over the long term, but a counter trend rally (short squeeze) may be closer than people think and this would lead to weakness in commodities and stocks.

"When should we trade this move? Well have a look at the chart again. Notice the false breaks that keep occurring when the all time lows get breached (denoted by the numbers 1,2,3). With the trend still strongly down we can expect to see either a false break of the lows around 71 reached last year or if that doesn't occur then a crossover of the 10 week/35 week moving average to confirm that the trend has changed. Trading the move before either of these are confirmed would be jumping the gun."

Murray is tracking which Aussie stocks will move if and when we see the dollar index break out. We'll keep you posted.

Dan Denning
for The Daily Reckoning Australia

• Rally in Stocks and Rise in Aussie Dollar is a Result of the Carry Trade
• IMF Report Concludes Aussie Banks are “Very Sound”…
• A National Mortgage Bubble
• Australian Banks Must Increase Fees or Expand Loans to Remain Profitable
• How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?

The Simpleton's Analysis:

Consumers cut back. The economy sank.

Now, government must take action. It must help people out and take up the slack.

The downturn took $12 trillion off Americans' net worth. The feds have pledged about $12 trillion to fix the problem.

But wait, where does government get any money?

Hey, they borrow it, just like consumers did. And besides, it's ultimately the same money - taxpayers' money. So what's the big diff?

The big diff is the subject of today's Daily Reckoning.

The first big diff is that the feds don't spend your money the way you would. Private citizens spend money they don't have on things they want but don't need. The feds spend money that doesn't belong to them on things that the rightful owners don't even want.

Wait a minute. Markets were closed yesterday. With no figures to report, we should talk about something important. What's important about macroeconomics? Nothing. It's 95% claptrap. The other 5% is pure fraud.

At least as practiced by the leading macroeconomists of our time - such as Ben Bernanke, Tim Geithner and Larry Summers. It's just a show-off sport...the idea is to impress the world with some fancy data-heavy formula...win the Nobel Prize and save the world. That way, you get what all men crave...money and power. Why do men (and women) want money and power? Aww, c'mon...we explained it already. Because it improves their chances of survival and procreation. In a DNA study, for example, they found that Genghis Khan, today, has something like 6 million male descendants. Is that success or what?

The great Khans of today are no longer the steppe warriors on horseback. They're basketball players, rock 'n' roll stars, actors, and hedge fund managers...and, oh yes, occasionally - economists.

The link between economic theory and procreation is probably very weak; but that doesn't stop economists from wanting to strut around and show off. And the way for an economist to show off is to get himself appointed to the President's Council of Economic Advisors...or to the central bank...or get a professorial post at Princeton...etc. etc. This you do by producing tomes, formulae and hypotheses. And, don't forget to write a piece for The Wall Street Journal from time to time.

Another important hint: your work has to suggest that you can manipulate the business cycle, control the credit cycle, or generally make things turn out the way people want.

If you are a Daily Reckoning-type economist, you can forget fame and fortune completely. Who wants to hear from a macroeconomist who tells people to leave well enough alone...and to let the forces of natural economics sort out their own problems? No one...at least no one who is running for public office. Instead, they want someone who will promise to "Save the World."

Save the world from what? Why...from the damage done by other economists!

Two generations of American economists thought the way to bring prosperity was to encourage consumption. On the face of it, the idea is absurd. Classical economists...and Daily Reckoning commentators...laugh at the idea. You don't really get rich by consuming; you get rich by saving and investing.

But they had their charts and graphs...their theories and their jobs teaching economics at prestigious universities. Naturally, they had the feds' ears too - since every politician wants to promise more consumption. The feds favored home ownership, for example...even by people who were bad credit risks. They set up Fannie and Freddie to make it easy for people to buy houses. They even passed a law requiring banks to lend to people who weren't likely to pay them back; that was the origin of the sub-prime mortgage market! They kept interest rates low, too, so people could borrow at affordable rates. And they inflated the currency, so consumers would want to spend their money rather than save it. They also opened the world to free trade, so Americans could buy more, cheaper stuff made by foreigners. For 50 years, they cultivated consumption and let production go to seed.

And now...wouldn't you know it...Americans have over-consumed. Personal expenditures per capital rose 25% between 2003-2005. Personal debt soared to over $13 trillion...about $124,000 per household. Total debt/GDP tripled since 1980.

And now, it's payback time. The private sector has cut back. Consumers need to under-consume to make up for the over-consumption of the bubble years. Savings rates are rising. Spending is falling (see below)...

And so what do the simpletons do? Private citizens are unwilling to consume...so they push the government to consume their money for them!

Bill Bonner
for The Daily Reckoning Australia

• Where Do the Feds Get Any Money?
• Baby Boomers Face Early Retirement With No Money Saved
• Feds’ Plan is to Reflate the Economy
• Why Weren’t Economists On Top of This Thing?
• 2009 Federal Deficit Could Go As High As $2 Trillion

The Bernanke Fed announced a "stunning" plan to save the world from depression on Wednesday.

The numbers were hard to follow, but they were big:

$300 billion, was the number Bloomberg reported

$1 trillion, said the New York Times.

$1.2 trillion, countered the Washington Post.

It turned out that all these numbers were correct. The Fed was going to buy $300 billion of U.S. Treasury bonds...and more of other securities - notably bonds from Fannie and Freddie.

"Quantitative easing," the papers called it.

"What's that?" investors wanted to know.

So, it took them a while to put two and two together. But when they'd done the math they began to see what we've been warning about.

"This is a very powerful and aggressive move," said the chief economist at Bank of New York Mellon Corp., speaking with Bloomberg Television. "One of the reasons I've been arguing we won't have a depression is we've got a Fed chairman who understands the problem and is going to come with the right diagnosis and the right medicine."

Bloomberg continues: "With the purchases of Treasuries and housing debt, Bernanke is effectively using the Fed's powers to print money and aim it where he and other officials believe it will have the greatest impact in lowering borrowing costs."

What do we know? Maybe Ben Bernanke will be able to do what no central banker has ever done before: put in just the right amount of inflation...not too much, not too little. In the past, they tended to overdo it. There are not many examples. France, England and America in the 18th century. Practically no examples we know of in the 19th century (they'd learned their lesson!). And in the 20th century - only marginal countries...or countries with nothing left to lose...engaged in 'quantitative easing.' Germany did it in the 1920s, because her war reparations burden was greater than she could sustain. Argentina did it in the 1980s, because it owed too much money to too many foreigners. And Zimbabwe did it in 2003-2009, for reasons of its own.

There are not many examples because the consequences of over-doing it are so horrible, central bankers have generally not done it at all. Quantitative easing was always a possibility...but it was always a last resort...like blowing up the powder and spiking the guns; it was something you did when you knew you'd lost the battle already.

But here is the world's biggest economy and its oldest (arguably) and most successful government...doing something that used to be done only by desperadoes...

What does it mean? Where does it lead?

We don't know. But we don't think we want to go there.

Investors didn't seem to want to go there either. They sold off stocks and bought gold.

Gold shot up on Wednesday, after the Fed announcement. Then, it just kept going...adding another $70 yesterday. We wondered why the price hadn't already hit $1,000. It looks like it soon will...this morning it is back over $960 an ounce.

Meanwhile, oil rose above $50, the dollar took a big drop and the Dow finished down 85 points. The greenback slipped to $1.36 per euro.

As to the stock market, whether this is a pause in the rally...or a reversal, caused by the Fed announcement...we don't know. Our guess is that it's just a pause. The rebound is still unfinished business. Besides, investors aren't running scared like they were a few weeks ago. Sentiment seems more relaxed. "We'll muddle through this somehow," investors tell themselves.

And the news appears more positive...at least, if you stand on your head and look up it.

Jobless benefits, for example. They're getting paid out to a record number of recipients. But not as many as economists had expected.

The leading indicators are down 0.4% in February - but not as much as expected.

And consumers are spending less money - but not as much less as expected.

And, of course, there's the money flowing from Washington. The auto suppliers just got $5 billion. Obama's budget will probably reach $2 trillion in deficit this year. And this extra $1.2 trillion from the Fed is not exactly small change. And that's in addition to the $11.7 trillion the feds have already ponied up in their fight against a free market. Investors are going to look at this flood of cash from the Fed and figure that it has to go somewhere. Some of it is bound to go into the stock market.

Now, we turn to our friends in Baltimore to see what the have in store for us...

"The larger [monetary] story," opines Rob Parenteau, lending a The 5 Min. Forecast a hand today, "can be found in the deleveraging effort of households, which accelerated in the fourth quarter of 2008.

"We have never seen such a sustained buildup of credit flows to the U.S. household sector like the one that began in the late '90s. Nor has the U.S. economy experienced such a reversal of household credit flows since the Great Depression.

"Policymakers, investors and entrepreneurs need to grasp this essential piece of the puzzle:

"There are good reasons why the household sector is are paying down debt in an environment of declining asset prices and personal income. Falling asset prices reduce wealth faster than households can pay down debt.

"We believe this has a number of very important implications, not the least of which is for the restructuring of global growth away from a growing dependence on consumer debt binges in Anglo-American developed nations. Not to mention the policy objective of renewing lending to the private sector... it's misguided."

And yet, it's the very core of the justification for the TARP bailout and the broader Congressional stimulus plan. Rob unpacks this phenomenon in the latest issue of the Richebächer Letter entitled "Deleveraging Demystified".

The 5 Min Forecast is an executive series e-letter that provides a quick and dirty analysis of daily economic and financial developments - in five minutes or less.

And back to Bill with more thoughts...

"Fed's decision to put more money into the financial system reflects its worry that the U.S. economy is plagued by excess capacity," says the Wall Street Journal.

As we keep saying, the economically correct thing to do would be to let the excess capacity sort itself out. People lose their jobs - and get new ones. Factories close down...and open up again, producing something else. Companies go broke...and new companies spring up to take their places. That's what needs to happen. Then, after this restructuring, the economy can begin rebuilding on a more solid foundation.

But the Fed doesn't listen to us. Ben Bernanke is determined to stop a Japan-style depression from happening in the United States - at all costs. And the only way he can possibly stop it - by his logic - is by increasing demand. Putting more money into circulation gives people more money to spend. It also raises prices - giving them a reason to spend it now.

"Will it work?" was the question put to our little band of analysts this morning.

"It depends on what you mean by 'work'," was the answer.

Bernanke has set the blaze...broken the glass...and pulled the alarm. Now, the sirens whine and the crowds form. He has no choice but to follow through. What that means is that he must continue fanning the flames...inflating the money supply (monetizing the debt)... until consumer prices rise (reflecting an increase in demand).

We don't know how long that will take. But in that sense...it will work...sooner or later. Prices will rise...people will spend.

But what else? Do prices suddenly go wild? Or, do they gently rise...giving the feds time to get out the fire extinguishers before the whole economy burns down?

We don't know. But here is a guess: between the time the flames shoot up out of the roof...and the time the feds have the conflagration under control...you'll see gold over $2,000 an ounce.

*** Poor Tim. The U.S. Treasury Secretary is "out of the loop," says one source. He's "on thin ice," says a member of Congress.

He appeared on TV and said he couldn't stop the AIG bonuses. Then, the next day, his boss goes on the air: "Yes we can!" says he.

"US moves to take back bonuses," says today's Wall Street Journal headline.

Geithner has only been on the job a couple of months. And he's had to deal with bailouts, meltdowns, regulatory restructuring. It's a "crushing workload," says the New York Times.

But it's the bonus sideshow that gets people's attention. And poor Tim is on the wrong side of the story.

Bill Bonner
for The Daily Reckoning Australia

• Feds’ Plan is to Reflate the Economy
• Geitner Plan Falls Short
• Gold Calls Bernanke’s Bluff
• Daily Reckoning Plan to Save the World
• Obama Admits: America is Out of Money

The feds let it be known that they stood behind the two back in 1968 - when they were set up in their present form. They were no longer on the government's financial books, but every lender knew they wouldn't be allowed to go broke. So far, Treasury Secretary Hank Paulson has counted on that implicit guarantee - along with a long line of credit - to keep the two going. But now that investors are selling off the stock, he may have to come up with some real cash to put on the equity side too.

As reported here - we still have trouble believing it - Fannie and Freddie are each in the red by about $50 billion. They're about $100 billion short, in other words. And judging by yesterday's trading, private investors are in no mood to ante up. Which leaves good ol' Uncle Sam. He's not very bright; but at least he has very deep pockets...and a printing press in the basement.

But that still leaves an open question: the feds may be forced to take back Fannie and Freddie (they were publicly owned prior to '68), but at what price? At $10 a share? Or $2 a share?

Apart from Fannie and Freddie, stocks generally rallied Wednesday. The Dow rose 69 points.

Oil rose to $116. Gold rose too - to $822.

Gold is down nearly 3% for the year. But our Trade of the Decade is still, technically, up - since stocks are off 14%.

Gold is the "the epitome of human stupidity," said an opinion in the Telegraph newspaper. "A metal that is dug out of the ground at great cost to be reinterred in bank vaults as a protection against the same stupidity as caused it to be dug up in the first place."

The writer is right. Gold is useful because humans are stupid. That's why it is always useful; because humans are reliably numbskulls. And it is particularly useful when humans are particularly stupid. Remember, a correction is equal and opposite to the deception that preceded it. When people have deceived themselves in an especially monumental way, the following correction is a doozy. And that's when you want to have some kruggerands in your pockets and a little bolt-hole in South America.

We never know what will happen, but we'll stick with our Trade of the Decade a while longer - just to see how it turns out.

Bill Bonner
for The Daily Reckoning Australia

• Fannie and Freddie in a Free Market Economy
• Fannie and Freddie Say Goodbye to Veto
• Fannie and Freddie are Finito
• Freddie and Fannie Hit Hard as Stock Falls to its Lowest Since 1995
• Fannie Mae and Freddie Mac Investors Have Already Lost 80% of Their Money

The big news this morning is that President Bush has dropped his threat of a veto for the housing bill that will bail both Fannie Mae and Freddie Mac out, and also offer relief to homeowners that have gotten in over their heads and now run the risk of foreclosure. CNNMoney.com reports that the legislation would allow the Federal Housing Agency to insure up to "$300 billion in new 30-year fixed rate mortgages for at-risk borrowers in owner-occupied homes if their lenders agree to write-down their loan balances to 90% of the current appraised value of their homes...The cost of the FHA program - which would begin on October 1 and be in place for just a few years - would be funded by fees from Fannie and Freddie."

And of course, since Fannie and Freddie are seriously ill-equipped to offer up those kinds of funds at the present moment, the bill would allow the Treasury broad powers that would provide the mortgage giants with liquidity and a "capital background" - basically an unlimited line of credit. It is generally understood that this will leave U.S. taxpayers with a gigantic bill to pay - in fact, yesterday the CBO estimated the cost of the "rescue" at $25 billion, and said there is a chance that it could end up costing the U.S. government $100 billion in the long term. Does the term "hemorrhaging money" mean anything to you, dear reader?

Kate Incontrera
for The Daily Reckoning Australia

• What’s Going to Happen to the Mortgage Twins – Fannie and Freddie
• Fannie and Freddie are Finito
• How Much it Really Cost to Bailout Fannie Mae and Freddie Mac
• Freddie and Fannie Hit Hard as Stock Falls to its Lowest Since 1995
• The Two Pillars of the U.S. Mortgage Market, Fannie Mae and Freddie Mac, Wobbled Again Yesterday

"The prospect for every GSE bond clearly states that it is not backed by the United States government," says Matt Kibbe, president of FreedomWorks. "That's why investors holding agency bonds already receive a significant risk premium over Treasuries."

The Russians ignored the warnings and grabbed the risk premium. Today, fully 21% of Russia's monetary reserves are invested in the obligations of Fannie, Freddie and the Home Loan Banks. And the largest holder of Fannie and Freddie debt is another friendly foreigner, China. The middle kingdom, according to the FreedomWorks organization, owns $376 billion worth of U.S. agency bonds. Altogether, foreigners hold $1.3 trillion of them.

Maybe the foreigners didn't understand what they were getting into. Or maybe they did.

Franklin Delano Roosevelt, whose family had made a fortune in the opium trade, promised the nation a "New Deal" during the Great Depression of the ‘30s. But what he gave it was more like the old false shuffle. The president pulled cards from the bottom of the deck, pretending that government bureaucrats could do a better job of allocating capital than private investors. In 1938, he set up the Federal National Mortgage Association, b.k.a. Fannie Mae. Then, as now, the national housing market was in crisis. House prices had been declining for almost a decade. Who wanted to lend money against falling collateral values? Only a fool...or a government.

For the next 32 years, the firm resembled a nationwide savings and loan institution -- borrowing from large institutions and lending to smaller ones, keeping a piece of the spread for its trouble. But Fannie Mae was an imposter from the get-go. Lenders knew that it had something no free market business ever had – the full faith and credit of the US government behind it. Fannie was able to borrow at below-market rates; lenders knew they had no risk of losing their money in a default or bankruptcy. Fannie, with the aces dealt her by the Roosevelt administration, dominated the business for the next 30 years.

Then, another crisis came along, followed by another bamboozle, this one perpetrated by Lyndon Johnson. Specifically, the feds were spending too much on wars – the War on Poverty at home...and one against the Viet Cong across the ocean. Victory eluded Lyndon Johnson on both fronts, but his handling of Fannie Mae should have brought him at least a bronze star. Attempting to balance the government's ledgers (this was in the days when Americans still believed in balanced budgets), he moved the mortgage business off of the Federal government's books, privatizing it as a ‘government sponsored agency.' For good measure, he created a competing organization – the Federal Home Mortgage Association, b.k.a. Freddie Mac.

Many are the ham-fisted dictators and sticky-fingered kleptocrats who have nationalized industries. Even without a credit crunch for camouflage, Francois Mitterand nationalized 36 leading French banks in 1982. Robert Mugabe grabbed farmland in the Zimbabwe. Evo Morales took the gas industry. And Hugo Chavez seized the Orinoco oil fields in 2007. But Lyndon Johnson rarely gets credit for his great advance in the history of public larceny: he privatized the profits while nationalizing the losses. This formula has been a honey pot for clever dirigistes ever since, providing countless opportunities for defeated politicians, hacks and hustlers – speaking fees, consulting contracts, board memberships, bonuses, stock options (notably, the $170 million spent on lobbyists over the past 10 years...mentioned above) – things that wouldn't be possible for a "public" company. In effect, Fannie Mae could pick the taxpayer's pocket twice – once by sticking him with a mortgage he couldn't rea lly afford and a second time by raiding the taxpayers' vault for a bailout.

In the case at hand, by the year 2007, the CEOs of Fannie and Freddie were earning salaries that would have been respectable, even on Wall Street. Fannie's main man, Daniel Mudd took home $13.4 million in 2007, a year in which the firm lost $2.1 billion. While the Freddie Kruger of mortgage finance, Dick Syron, pocketed $18.3 for helping Freddie Mac to a $3 billion loss and a 33% trim for the shareholders.

As recently as May of this year, Mr. Mudd told the New York Times that he was "seeing the best opportunities since I've been in this business." Two months later, both Fannie and Freddie are "insolvent," says former Fed governor William Poole.

In a better world, Mudd and Syron would be hanged...and the bondholders would be wiped out along with the shareholders. But last Sunday, U.S. Treasury Secretary Henry Paulson announced a bailout. And on Monday, an auction of Freddie Mac debt was oversubscribed. The Russians were right; the deck was stacked from the very beginning.

Bill Bonner
for The Daily Reckoning Australia

• Fannie and Freddie Say Goodbye to Veto
• Freddie Mac’s Main Man is in the News
• What’s Going to Happen to the Mortgage Twins – Fannie and Freddie
• Fannie and Freddie are Finito
• Fannie and Freddie in a Free Market Economy

Last night, we attended a birthday party for our old friend, Lord Rees-Mogg. Tout London was there – Maggie Thatcher and David Cameron, for example.

We had heard that Mrs. Thatcher had been unwell; but she looked spry...even sturdy. It was not the occasion to ask a serious question...but we wondered how she must feel. She, along with Ronald Reagan, did so much to set capitalism free. But now, it is being put back in a cage...

All the world’s major markets are in major declines. The worst hit so far are those in the Far East – which are falling again this morning. Among the Asian markets, only Vietnam seems to be on the mend. European markets are down 20%-25%. But Shanghai has lost 40%...and Vietnam has been trimmed more than 50%.

Not much action in the U.S. stock market yesterday. Fannie and Freddie kept treading water, with their heads barely above the waves. Oil stayed at $145.

“U.S. action on lenders calms tense markets,” says a headline on the International Herald Tribune. “Rescue of Fannie Mae and Freddie Mac has ripples around the globe.”

The Financial Times saw the situation differently: “US banks suffer as bail-out fails to calm nerves,” begins the cover story.

And that interpretation would be closest to the truth...at the open of the U.S. markets today, the Dow is down triple-digits.

“The Fed stepped in and tried to bail out Fannie Mae and Freddie Mac, but talk continued to circulate that there would be nothing left. Add the FDIC takeover of IndyMac and the focus of the market shifted to who would be the next to fold,” said Marc Pado, U.S. market strategist at Cantor Fitzgerald.

Despite the rescue of Fannie and Freddie, U.S. banks, such as Washington Mutual and Cleveland’s National City, are in full retreat following the collapse of IndyMac. WaMu went down 35%...National City plunged 27%.

And where’s that strong dollar that Bernanke and Paulson were talking about? It was supposed to go up...after U.S. officials announced a change of policy. Henceforth, the feds were going to fight inflation, remember? Henry Paulson said a strong dollar was in America’s interest...and that there would be no more hanky panky going on with the greenback. Honest. Cross my heart and hope to die.

Today, the dollar continues to slide. The euro briefly hit a record against the U.S. dollar before falling back below $1.60. And yesterday, gold rose another 13 bucks, bringing it back to $973.

“God, guns and gold,” we explained to our French friends over the weekend, “are the three core values to a real American.”

Of course, we went on to explain that there weren’t many real Americans left. Most of them died with Eisenhower...or before. But that’s a long story.

We will try to stay “on message” this morning. But how can we? Everywhere we look, there are so many delicious distractions...so many exquisite ironies...so many feet in so many mouths. How can we help but laugh?

So we’re laughing at Henry Paulson today. As soon as the man is under a little pressure, he buckles to the forces of modern mobocratic government. It was all very well for the nation’s two biggest mortgage finance companies to be part of the ‘free enterprise’ sector – when the wind was at their backs. Fannie and Freddie were just important parts of the financial sector. They helped “allocate credit” to people who needed it. Mongering credit was good work since the ’80s. Since 2002, it was especially good work – up until about a year ago. So who could begrudge Daniel Mudd’s $13.4 million 2007 pay package as CEO of Fannie Mae? Or, who would be sour enough to complain about Dick Syron’s $18.3 million wage from Freddie Mac? These guys were just getting rewarded for good performance, right?

Well, not exactly. Syron’s pay went up 25% last year – even as the company went from a $2.3 billion profit in 2006 to a $3 billion loss in ’07. And Mr. Mudd got a 7% increase, while the company posted a $2.1 billion loss and shareholders took a 33% haircut.

Okay...so maybe shareholders overpaid them a little. But that’s how compensation works in the free market; you get what you can get away with. So, bravo to them! Besides, they were helping the whole great machinery of capitalism make Americans rich. That’s why they gave out all those rich consulting contracts to former members of Congress. And that’s why they spent millions on lobbyists...angling the politicians to protect the mortgage market at all costs.

But what’s this? The wind has whipped around, and now blows a gale into the twin lenders’ faces. Now, we discover that these were “government sponsored enterprises” all along. They were part of America’s social welfare system, it turns out, not part of the free market. They were just performing a public service – helping make sure the poor plebes had roofs over their heads. And now that the two GSEs are having trouble, naturally, the full faith and credit of the United States of America has to be lined up to support them.

“Paulson Puts Treasury’s Weight Behind Fannie, Freddie,” says Bloomberg.

Everywhere we look, we see more evidence that post-Reagan Republicans and post-Thatcher Tories have given up on free enterprise. They have decided that the problems in the economy are too important to be left to business and Wall Street. Congress needs to intervene, say the meddlers, in order to guarantee the nation a smoothly-functioning financial system.

Everyone seems to feel the same way...the free marketers have had their chance. Now, it’s time for a little “adult supervision.” But adult supervision in this context – putting politicians in charge of the economy – is like adult entertainment; it is a salacious fantasy.

And so, it is all happening as we expected...and as we predicted in these pages. What can we do now, but buckle our seat belts...and prepare to enjoy the show? Well, you could try to make a little money...while everyone else is being swept away in the flood of failing financials.

As if the pretensions and conceits of the financial industry weren’t comic enough...we’re now going to see a hilarious farce. The same people who set up a government sponsored enterprise to jack up the mortgage market...and created the biggest housing bubble the world has ever seen...now come to the rescue when the bubble pops.

How, exactly, are they going to rescue America’s mortgage industry? Henry Paulson says they’re going to lend more money to Fannie and Freddie. And he wants the feds to buy their stock too. That should do it. Fannie and Freddie, in their heyday, put their hands on 80% of all the new mortgages in the entire country. Now, they have a book of business that includes more than $5 trillion in liabilities – an amount equal to about half the outstanding mortgages in the country...and a third of the nation’s total GDP.

In other words, Fannie and Freddie are probably the two most important businesses in the consumer economy. Now, nearly three decades after the Reagan Revolution, they will be nationalized. Is that progress...or what?

*** CNN reports that U.S. pension plans have lost about $280 billion.

“Since the credit crunch hit last fall, pension plans funded by S&P 1500 companies have lost about $280 billion in assets, according to an actuary at Mercer, a human resources consulting firm.

“On paper, the losses from last October tally $160 billion. However, according to Mercer actuary Adrian Hartshorn, the asset losses are closer to $280 billion when pension plan assets and liabilities are considered together. The assets, which totaled roughly $1.7 trillion at the end of October 2007, fell by 17%, leaving about $1.4 trillion in assets at the end of June.

“Companies should be concerned, he said, because – assuming no change in the market – a typical U.S. company can expect their pension expenses to increase between 20% and 30% in 2009. That's due to the higher cost of servicing the pension plan's debt and the smaller return from the plan's assets.”

*** “The only things worth owning right now are the financials...and gold,” said a fund manager last night. “I think gold is only about half way to where it is going. And the financials – some of them – are so cheap that you can’t go too far wrong. We’re looking at major banks paying a dividend over 10%. These kind of opportunities don’t come along very often.

“Of course, you have to be prepared for a lot of bad news. We’re going to see more bankruptcies. We’re going to see more markdowns...and more panics...

“But if you’re a value investor...or, I guess I should say, if you’re a young value investor with plenty of time ahead of you...the banks look like good buys.”

Bill Bonner
The Daily Reckoning Australia

• Fannie and Freddie in a Free Market Economy
• Fannie and Freddie Say Goodbye to Veto
• Fannie and Freddie are Finito
• What’s Going to Happen to the Mortgage Twins – Fannie and Freddie
• Fannie and Freddie: Playing With a Stacked Deck

Now getting hot is the war between inflation and deflation. Both sides launched major attacks at the end of last week.

Fannie, Freddie – Finito

Yes, the dark twins of mortgage finance dominated the news over the weekend. Every financial page covered the story. One story reported that the government was mounting a rescue operation. Another said the Fed had opened its discount window to them. Another had the U.S. Treasury Secretary denying that they needed any extraordinary assistance. Still another explained how they got into such a mess.

Of course, here at The Daily Reckoning we know how they got themselves into such a jamb. They lent money to people who couldn’t pay it back. And they weren’t the only ones.

“Crisis Deepens as Big Bank Fails,” adds the Wall Street Journal. The big bank is IndyMac. It is the largest bank failure since Continental Illinois bit the dust in ’84. Much of the depositors’ money is protected by FDIC insurance. But there’s still $1 billion uninsured. And, of course, FDIC can’t bail out everyone; it only has so much money.

“Analysts say more banks could fail,” reports the International Herald Tribune.

FDIC can bail out a few of these banks...but not all of them. And there is no way it can bail out Fannie and Freddie. Together, the twins have more than $5 trillion in liabilities. That’s more than a third of US GDP. And former Fed governor William Poole says they’re broke already.

Investors are still holding on – barely. Fannie’s shares fell to $10.25 on Friday. Freddie was down to $7.75 – for a total loss of 87% from the peak. (We previously reported that the share had traded as high as $60. Actually, the high was closer to $100. Sometimes we get the facts wrong, here at The Daily Reckoning. But it’s the interpretation of the erroneous facts that matters; of course, we get that wrong too, sometimes.)

Fannie and Freddie are “too big to fail,” no doubt about it. But who has the money to stop them from failing? Where are those Sovereign Wealth Funds when you really need them? We doubt whether they are stupid enough to do it, but what a coup it would be! We mean, if the Sovereign Wealth Funds recapitalized America’s largest mortgage lenders. So far, they’ve contented themselves with a few minor purchases of America’s iconic buildings, infrastructure and industries. But if they bought control of Fannie and Freddie, they would hold the mortgage on America’s housing too. And they could get rid of trillions of their unwanted dollars. (Foreign central banks already hold large pieces of Fannie and Freddie’s debt.)

But for the moment, the bailout looks like it will come from homegrown sources. Ben Bernanke called on Freddie’s CEO over the weekend. It is believed that the Fed chairman let it be known that its discount window would be opened a bit wider today – wide enough to lend directly to Fannie and Freddie. This will give them access to money at a preferential rate – about half the rate of consumer price inflation. You’d think you could make a fortune – if you could borrow so cheaply. In “normal” times, it would be a cinch. But in wartime, it’s hard to make money – even when lenders give you credit at no cost. No matter where you put the cash, it’s always in danger of getting blown up.

Bill Bonner
for The Daily Reckoning Australia

• Fannie and Freddie Say Goodbye to Veto
• Fannie and Freddie in a Free Market Economy
• What’s Going to Happen to the Mortgage Twins – Fannie and Freddie
• How Much it Really Cost to Bailout Fannie Mae and Freddie Mac
• Freddie and Fannie Hit Hard as Stock Falls to its Lowest Since 1995

Poor Mr. John Devaney. He had to sell his Renoir. His Gulfstream. One of his mansions. And his yacht. Ouch. He says he’s personally lost $150 million trying to keep his funds alive. Alas, in vain!

“Devaney funds wiped out,” Bloomberg reports.

Now, the sad victim of the credit crunch is reduced to living in his remaining mansion in Aspen...and flying first class in commercial aircraft.

But is Mr. Devaney beaten? Not at all. “Do I retire?” (Even in his straightened circumstances, he allows himself a rhetorical flourish...) “No,” he replies, as if there were any doubt about it.

And why should he? He may have wiped out a handful of unlucky investors, but there are still plenty more.

Yes, dear reader...the battle between inflation and deflation...between truth and malarkey...between comeuppance and postponement continues.

Elizabeth’s stockbroker kindly wrote her a letter, explaining why her account had lost money:

“On the one hand, fixed income markets were signaling a weak economy and even deflationary conditions as interest rates were below the rate of inflation. On the other hand, commodity markets were signaling a strengthening economy and even highly inflationary conditions as the prices of almost all raw materials rose sharply...housing problems were getting worse, not stabilizing...[leading to] fears that the banks might be in worse shape than had been thought...this prompted analysts to predict continuing losses at financial institutions in what seemed like a competition to see who could generate the most frightening numbers...”

(We would say Bridgewater Associates won the competition with last week’s prediction that $1.6 trillion would be lost directly...and $12 trillion of credit would be withdrawn from the economy...)

“To top off the anxiety,” the broker continued, “oil prices spiked dramatically to more than double the level they had reached only months earlier, stoking inflation worries.”

Sound familiar? Inflation and deflation...both hitting hard.

What’s he doing about this situation? He’s “taking profits” and holding cash.

What happened yesterday on Wall Street? The Dow rose 81 points. The euro rose slightly.

Most of the headlines this week told of deflation’s hearty counter-offensive, which began only about a week ago. Foreclosures rose 53% in June, from a year ago. Bank seizures have almost tripled, according to Bloomberg.

And poor Freddie and Fannie.

He that did ride so high doth lie so low, as Marc Antony said of Caesar, after the latter was stabbed to death. Freddie and Fannie were the darlings of Wall Street...the leaders of the house price bubble...with nearly half the nation’s $12 trillion worth of mortgages. A couple of years ago, they could do no wrong.

Now, they can do no right.

The government-chartered mortgage lenders are “in turmoil,” says the Financial Times.

They should be in Chapter 11, says former St. Louis Fed chief, William Poole. Fannie has $5.2 billion more in liabilities than in assets, he says. Both lenders are insolvent, he maintains. Like a racehorse in the Kentucky Derby, they should be given the coup de grace as quickly as possible, he believes.

That is not likely to happen. The feds are counting on Fannie and Freddie to end the nation’s housing misery, not make it worse. They’re not going to let the twins go under. Instead, they’re going to give them more rope...and show them the steps to the scaffold.

Yes, dear reader...this is what it has come to. It’s not just a war between inflation and deflation. It’s also a fight between the forces of delusion...and the forces of reality. The delusion is that you can make the problems caused by too much credit go away – by giving more credit! A related delusion: that you can make people richer by printing up more money for them. Yet another: that you can spend your way out of a slump caused by too much spending. And here’s another: the federal bureaucrats can manage the economy better than it can manage itself. And how’s this: that hedge fund hustlers such as Mr. Devaney can make you rich by making huge gambles with your money. Or this: that if you just allow capitalism to work, we’ll all get rich.

The reality is that you can’t get something for nothing. Asians are gaining wealth because they work for peanuts and save their money. Americans are losing wealth because they spend too much and don’t save at all. And when a bubble is ready to pop, it will pop...no matter what you do. Sometimes you can delay it...or push the damage onto to someone who doesn’t deserve it – such as the taxpayer. But all interventions just make the situation worse...causing more, and bigger problems elsewhere.

Fannie’s shares fell 13% yesterday. The whole financial sector went down too...and now is at a loss of about 46% for the year.

Bill Bonner
The Daily Reckoning Australia

• Fannie and Freddie in a Free Market Economy
• What’s Going to Happen to the Mortgage Twins – Fannie and Freddie
• Fannie and Freddie Say Goodbye to Veto
• Freddie and Fannie Hit Hard as Stock Falls to its Lowest Since 1995
• Fannie and Freddie are Finito

Actually, it began years ago when people began to think that house prices always go up in double digits. But anyway, it will be interesting to see how things develop in Australia. In the U.S. and the U.K. the mortgage lenders fells first, then the builders, then the banks, and finally the consumers.

The two big pillars of the U.S. mortgage system—Fannie and Freddie—are surely doomed now. First, U.S. Fed Chairman Ben Bernanke told Congress both are well capitalized. Haven’t we heard this one before?

Isn’t this what Bear Stearns said before it collapsed? Didn’t Citigroup say it was well capitalised, and then ask for more money? Why would anyone believe these investment bankers anymore when they tell the public they are well capitalised? It’s almost like the moment a CEO of a company says it’s “well capitalised” you should be prepared for a nasty shock.

We don’t mean to alarmist about the GSEs. But as we explained to a colleague over the weekend, our job here at the Old Hat Factory is not to tell you what you may already know, or can read in the papers. Our job is to tell you about the low-probability but high magnitude investment events that could affect your money. And just to be clear, the collapse of Bear Stearns and the whole credit crisis would look like mere child’s play should a genuine crisis unfold in the quality of the debt owned and guaranteed by Fannie Mae and Freddie Mac.

It would be the equivalent of that absurd scenario in that global warming movie a few years ago, where the Gulf Stream stops flowing and the entire Northern hemisphere enters a new ice age...in a matter of days. The insolvency of the GSEs is as close as you’re ever going to want to get to Financial Doomsday and live to tell about it.

Yet just yesterday Former Fed Governor William Poole told the world what many have been saying for awhile now: if you use conventional accounting methods, Fannie and Freddie are already technically insolvent.  Poole said, “Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer”.

In simple terms, Poole points out that Freddie Mac owes US$5.2 billion more than its assets are currently worth. Shareholders took note.  Fannie shares fell 14% in New York trading while sister Freddie fell 22%.

What’s really bad news for these companies is that two U.S. Senators stood up to tell the world that these two companies are “too big to fail.” Republican Presidential nominee John McCain told reporters, “They must not fail,” and that they “are vital to Americans' ability to own their own homes.”

Later, the distinguished windbag Senator from the state of New York, Charles Schumer said, “Markets should be assured that the federal government will stand by Fannie Mae and Freddie Mac.” He said the firms are “are too important to go under,” and Congress “will act quickly”.

Who do these men think they are, Moses parting the Red Sea. We’ve never seen public servant or elected politician perform a miracle. Acts of God that defy the laws of nature are generally reserved to...you know...God.  Saying something “must not fail” doesn’t mean you can prevent it.

But it’s Friday. So how about a hand for the unbridled idiocy of American policy makers! How about a standing ovation for the dizzying heights of audacity reached by people so far out of touch with reality that they believe they can defy the laws of economics? Hip hip! Hooray!

What exactly do you think the U.S. Congress can do to save the GSEs? By our reckoning, it can provide the GSEs with cash to continue to meet operating expenses. There are only two other options. And let’s be clear about this: if the U.S. Government chooses either of the remaining options, it will be a virtual death blow for the U.S. dollar the rest of this year and pop the largest remaining sub-bubble in the credit market.

What can Congress do? First, it can ask the Fed to extend its securities lending program to the GSEs. Fannie and Freddie would be able to exchange impaired mortgage-backed bonds for liquid U.S. Treasuries. Granted, the Fed is running low on Treasuries already, having lent billions to its buddies on Wall Street. But that is a great thing about being a central bank with a monopoly on money. The Fed can simply print more money to buy more Treasuries (although the U.S. Treasury Department would have to create new debt to sell to the Fed).

The other option for U.S. policy makers is to clearly state that Fannie and Freddie bonds are backed by the full faith and credit of the United States government. You can take that for what it’s worth. We wonder how the bond market would take it. How much faith and credit does the world currently have in the financial position of the United States?

Fannie and Freddie have guaranteed more than US$5.2 trillion in mortgage-backed bonds and securitised mortgages. Who owns them? As we said the other day...everyone! Central banks...pension funds...insurance companies. The big and terrifying fact for the world’s financial system is that GSE debt makes up some portion of the assets of many financial institutions and investment funds.

The U.S. government can move to stabilise that market by guaranteeing the debt. But we believe that if it does so, it will lead directly to the popping of the other big remaining bubble in the credit markets: the U.S. Treasury market (bonds and notes).

In the sixty three years since the end of World War Two, there hasn’t been a much safer investment on the planet than U.S. Treasury bonds, at least according to conventional wisdom. But the credit rating agencies, for what they’re worth, would have to take a serious look at downgrading the credit quality of sovereign American debt if the U.S. government changed its implied backing of GSE debt to an explicit backing.

The consequences of a (much deserved) lower credit rating for the U.S. government are too long to go into here. Suffice it to say the bond market won’t wait. The trouble is, what do you do with your money if government bonds aren’t safe? Cash is one answer. Owning some form of your wealth in precious metals is another. Gold should regain ground against oil in the second half if the GSE story continues to unfold in nightmare fashion.

In any event, it hasn’t quite come to that. Congress, Obama, and McCain must all be hoping that the GSE problem just goes away, at least until after the election. But the market will not wait. It could be a brutal summer.

As the GSE story unfolds, we may have to revise our oil forecast. All things being equal, there are plenty of signs that high oil prices are hammering economic activity. That should lead to lower oil prices. But the GSE problem is going to weaken the dollar one way or the other. A weaker dollar means higher oil prices, regardless of what happens in the global economy...or Iran. And on that score, the oil price moved up US$5 as the Iranians lobbed a couple of missiles into the sky.

Speaking of oil, CSIRO released a new report today wondering where Australia would get its future liquid fuels in a world of higher energy prices. CSIRO’s  Dr John Wright says, that,  “Australia’s fuel mix will shift in the near term to include the expanded use of diesel, gaseous fuels such as LPG and hybrid electric vehicles, with even greater diversity beyond 2020 that might include hydrogen, synthetic fuels from coal or gas and advanced biofuels that will not impact food production.”

The report also went out of its way to define Peak Oil. “Peak oil,” it tells us, “is the point in time when oil production reaches its maximum annual rate, after which the annual production declines each year. While the term is currently used to describe a peak in total world oil production, in practice, a succession of peaks have already occurred in different oil-producing regions throughout the world.”

But wait, there’s more. “Eventually the rate of production decline at mature oil fields exceeds the rate of expansion at new oil fields and total world production will have peaked.”

Pretty simply put, and hard to argue with. The report then predicts that in a worst case scenario, petrol could cost you...$8/litre. Hey, we didn’t make it up. The chart is below.

Petrol to reach $8/litre?

Source:  Fuel for Thought, the Future of Transport Fuels, Challenges and Opportunities, CSIRO, June 2008

That $8/litre figure comes from a scenario in which oil production declines faster than expected and alternative fuels don’t develop more quickly. As we’ve highlighted here and in our small cap letter, the race to find substitutes for petroleum is well and truly on. There will be many losers and a few winners.

According to CSIRO speculation, ethanol will play a much bigger role in Australia’s fuel mix, along with fuel cells, coal-to-liquids, and plug-in-hybrids. We’ve got exposure to each of these potentially vast markets with our share tip recommendations in the small cap letter. It’s going to take a portfolio of energy experiments to get the world over the Peak Oil hump—and that’s if we get over the hump.

CSIRO’s Future Fuels Portfolio

One small housekeeping note. A few readers of Diggers and Drillers have written in wondering why they have to subscribe to a whole new newsletter to get the share tips from the small cap market. A fair question, with what we hope is a useful answer: they are written by different editors with different investment ideas.

Diggers and Drillers is a resource newsletter written by Al Robinson, an Australian with a background in finance and a specialist at analysing resource stocks. Al has his own ideas, his own world-view, and his own research on Aussie resource stocks.

The small cap letter may pick resource stocks from time-to-time (if we think that have a huge resource that’s trading at below market value and something will change that in the near future). But most of our small-cap tips are in energy, technology, biopharma, and other industries that have nothing to do with resource economics. These companies have new businesses in new industries, and often, for the firm to work, the industry has to develop commercially.

It’s exciting stuff. But it’s vastly different from the resource industry. So they are different letters written by different men with different investment approaches. Ultimately, they are both judged by how well the tips perform. Ultimately, both are directly related to the global boom in urbanisation and soaring energy prices, but invest in it from different direction. And yes, if you’re interested in both, we’re going to make it possible for you to get them both for one price. Stay tuned.

• The Two Pillars of the U.S. Mortgage Market, Fannie Mae and Freddie Mac, Wobbled Again Yesterday
• GSEs Fannie Mae & Freddie Mac on Death Watch
• Fannie and Freddie are Finito
• Fannie and Freddie Say Goodbye to Veto
• Fannie and Freddie in a Free Market Economy