The Bond Market Is Warning of Huge Trouble Ahead

By Anthony Mirhaydari

Fri, Jan 16, 2015, 11:11AM EST

Something odd is happening in the government bond market: Interest rates are pricing in a debt-deflation cataclysm.

How else can you explain the fact that the yield on the U.S. 30-year bond hit a record low of 2.4 percent on Wednesday? Or that Japanese and German 10-year yields are plumbing record lows? Or that five-year yields of bonds issued by Eurozone safe havens Finland, Germany and Switzerland are in outright negative territory?
Something is very wrong here.
For the U.S. 30-year yield, current levels have dropped below the lows set during the 2008 financial panic and 2012 pre-QE3 slowdown. And this is down from the post-recession high of 4.85 percent set in 2010 and a recent high of nearly 4 percent set in late 2013.
With stocks not far from late December's record highs, with job growth surging, investor confidence at extremes, consumer and small business confidence high, GDP growth strong and the Federal Reserve telling everyone it's preparing for its first interest rate hike since 2006, the bond market's message comes off as downright weird.
This is especially true considering the consensus was for interest rates to drift higher this year, something that everyone from the cover of Barron's to the cavalcade of Wall Street analysts have been echoing.

But the bond market’s fear is corroborated by the epic breakdown in industrial commodities, with crude oil down nearly 60 percent from its summertime highs as copper smashes down to mid-2009 levels. It's corroborated by a drop in market-derived inflation expectations, which by my rough measure shown above of the iShares Treasury Inflation-Protected Securities Bond Fund (TIP) vs. the iShares 20+ Year Treasury Bond Fund (TLT), has returned to the panic lows following the collapse of Lehman Brothers.
And it's also now being corroborated by weakness in specifically affected areas of the stock market, such as energy and materials stocks, as well as the companies that service those industries, such as heavy equipment maker Caterpillar (NYSE:CAT). The iShares Energy SPDR (XLE) has lost more than a quarter of its value since June, returning to a trading range it was at in 2011. CAT is down more than 22 percent.
Stock market volatility is drifting higher, and nervousness is rising as people start connecting the dots. There has been a clear increase in share price whipsaws over the last few months. The CBOE Volatility Index (VIX) — known as Wall Street's "fear gauge" — is in the midst of its most persistent period of strength since the chaos surrounding the 2011 downgrade of the U.S. credit rating.
For all the influence of the global central banks in this business cycle, with the Federal Reserve alone taking its monetary base from $800 billion to north of $4 trillion while holding short-term interest rates near zero percent since 2008, the bond market still operates according to the concepts of basic macroeconomics.
And it's warning that we're in trouble. The problem is threefold:
  • The evidence is building that the global economy is slowing, led by weakness in Asia and Europe. The JPMorgan Global Manufacturing PMI, which measures factory activity, last month dropped to its lowest level since August 2013. Activity is declining outright on a month-over-month basis in China, Greece, Austria, Italy and France. 
  • This comes as the developed world governments, reacting to the blowup of private sector debts (mostly real estate), recession and the risk to the financial system in 2008-2009, have piled on public debt. China is in the mix here too, with local government and private credit exploding higher, fueling fixed-asset investment bubbles, overcapacity and now an unresolved bad debt problem that we got a quick taste of in early 2014. In Italy, the government debt-to-GDP ratio has grown from 104 percent in 2008 to 133 percent, with no signs of slowing.
  • All this is occurring at a time of low global inflation, tipping into outright deflation in some areas. Prices at Chinese factory gates have been dropping for months. The Eurozone is expected to have fallen into outright deflation in December. Capital Economics expects consumer price deflation in the United States for January.
Boiling it all down, these market moves are due to Chinese factory overcapacity, Japanese exchange rate mercantilism and Eurozone fiscal austerity. They’ve been accelerated by the collapse in energy prices, which looks set to continue.

The combination of all three trends forms a potent economic poison that has ensnared Japan for decades: A debt-deflation depression.

It's a self-reinforcing cycle whereby economic weakness pushes up budget deficits (as tax revenues drop and spending on things like food stamps rise) and creates deflation amid a lack of demand and an excess of supply. The combination causes public debts to balloon. Efforts to raise taxes and cut spending to contain rising debt levels only tighten the trap.

The debt-deflation spiral raises the real, inflation-adjusted cost of debt as household and businesses try to pay off fixed obligations amid falling wages and revenues. Asset values are pulled lower. And the crisis deepens.

The problem isn't new.

The theory behind the dynamic was developed by economist Irving Fisher in his Debt-Deflation Theory of Great Depressions in 1933, based on data from the Great Depression as well as the depressions of 1837-1841 and 1873-1879. If you're interested, it's worth a read and can be found hosted by the St. Louis Federal Reserve Bank here.

The only way out is to engineer higher inflation and/or wipe the debts away via default. If the problem deepens, as the bond market is warning, I expect more drastic solutions — more so than the stimulus efforts of 2008-2009 and the "quantitative easing" we've seen in recent years — to be discussed.

Greece will probably be the test case following its upcoming election, with the anti-bailout Syriza party leading the polls and demanding Europe grant it debt forgiveness on par with what Germany enjoyed in the 1950s.

Global markets

A tangle of anxieties

As markets slide, investors should worry more about some price drops than others

Jan 17th 2015         

ACCORDING to market lore January is a good month. As bourses open to greet the new year, investors funnel in new cash and share prices rise, creating a “January effect” which the savvy try to surf. But punters seeking a quick buck have been disappointed this year, with the main stockmarket indices in the G7 economies all down (see chart 1, below). Many have had their worst January since 2008. It is not just share prices that are tumbling; oil, gas and metals are falling too. There are many reasons for the rout, but the predominant one in recent days is a fear that the world economy, already feeble, is slowing yet more.

On January 13th the World Bank cut its prediction for global growth in 2015 from 3.4% to 3%. As in 2010, there are worries about a Greek exit from the euro zone. But five years ago Germany’s economy was expanding at close to 4%, and Brazil, Russia, India and China (the BRICs) boasted an average growth rate of 9%. That vigour has gone. In 2014 the German economy grew by just 1.5% and the BRICs have slowed to little over 5%.

Sagging demand and the fear of more weakness to come explains why the decline of many commodity prices has suddenly accelerated. Worries about China loom large, since almost half of the metals used by industrial firms—aluminium, copper, lead, nickel, tin and zinc—are bought by Chinese companies. Forecasts for China’s growth are being pared back (the World Bank now expects growth of 7.1% in 2015). The result has been a market rout: the price of copper has plunged to a five-year low (see chart 1). And with anaemic demand sapping metals prices, mining companies have been hit hard: on January 14th shares of Glencore and Anglo American, FTSE-listed miners, both fell 9%.

Ominously, even hitherto strong economies are showing signs of weakness. In Britain business investment, previously a contributor to growth, is waning. In America retail sales for December were down 0.9% on the previous month, suggesting American consumers may be pulling in their horns.

One reason for this could be weak wage growth. Average pay is up a mere 1.6% in America and 1.4% in Britain over the past year. Despite a healthy pace of job creation and an unemployment rate down to 5.6%, average American wages fell in December.

But all this gloom must be set against some big reasons for cheer. The dramatic slump in the price of oil has far more to do with plentiful supply than unexpectedly weak demand. A year ago Brent crude, the global benchmark, stood close to $110 per barrel. Today it is below $50 (see chart 2). America’s oil production has grown by more than half, pushing reserves to their highest level for this time of year for the past 80 years, according to America’s government. Naturally, that surge in supply has weighed on the price.

The low-cost petrol, diesel and heating oil that should follow will be a tonic for consumers. If petrol prices drop by two-thirds as oil has done, an American family could save around $2,000 a year, equivalent to a pay rise of around 4.5%. Cheap oil also allowed India’s central bank to cut rates in a surprise move on January 15th. Yet it risks tipping rich countries into deflation (see chart 3).

The tension between reasons for optimism and pessimism is obvious in financial markets. Lower input costs and the fillip that cheaper fuel gives consumers ought to boost the profits both of firms that use energy intensively and those that sell to consumers. At the same time America’s energy firms make up a big chunk of the stockmarket’s capitalisation.

The VIX, a measure of expected volatility dubbed the “fear index”, jumped on January 14th.

Other measures of investor jitters are rising too. Gold prices are creeping up. And the yields on the bonds of countries deemed a safe bet have shrunk: ten-year German bunds pay less than 0.5%, a record low (see chart 4).

There is huge uncertainty about what central banks will do next. Falling inflation calls into question expected rate rises this year in America and Britain in 2015. On January 15th the Swiss National Bank shocked markets by removing its ceiling for the franc, which promptly jumped 14% against the euro. This week a preliminary legal ruling helped clear the way for the European Central Bank to try quantitative easing. Whether sinking markets will win over the hawks on its board remains unclear.

Review & Outlook

Blood on the Forex Floor

The Swiss currency shock leaves losses everywhere.

Jan. 16, 2015 6:47 p.m. ET

Never trust a central banker, not even a Swiss one. The sudden surge in the value of Zurich’s currency resulted in a second day of financial-market carnage on Friday, with banks, currency brokers and their customers suffering hundreds of millions of dollars in foreign-exchange losses—and there may be more bloodletting to come.

The Swiss National Bank lifted the franc’s peg to the euro on Thursday as the eurozone’s devaluation exertions made the policy increasingly costly to maintain, catching global markets by surprise. The largest retail currency broker in the U.S. and Asia, FXCM, reached a deal for a capital infusion of $300 million in cash from Jefferies amid the Swiss franc rally, while traders at Citigroup , Deutsche Bank and Barclays reportedly absorbed major hits in portfolios exposed to the franc.

    Getty Images

Meantime, a New Zealand brokage was ruined overnight and another U.K. house went into insolvency. Financial regulators are canvassing the damage, but the full measure of the shock is likely hidden on company balance sheets for now. First quarter earnings reports could be ugly.

All this is the inevitable consequence of the extraordinary volatility in world currency markets, especially in what economist Robert Mundell once called the most important price in the world—the dollar-euro exchange rate. The devaluation agenda among central banks hoping to grow via exports is shaking the global monetary system, with sometimes nasty surprises.

The lesson of Friday’s forex rout is the familiar one to prepare for the worst. The more disquieting worry is that markets haven’t yet seen the worst.

Gold: $1,200 Production Break Even Level Held In 2014, Only Way Is Up

by: Zoltan Ban             

  • Price of gold has very little downside left due to $1,200 being price level needed to keep current mine production going.
  • Many factors, such as volatility, large piles of printed money, sideways trading stock market all bode well for gold.
  • Some possible headwinds, such as stronger US dollar, but so far, it has not affected price of gold.
After the spectacular collapse in gold prices witnessed in 2012-13, last year was a relatively pleasant change for those who are holding gold in their portfolio. 2014 did see a small drop in the spot price year over year, but the fact that the $1,200 level that I predicted will not be breached for a prolonged period of time due to the need to keep this price level in order to prevent significant production declines held for most of the year, is reason for comfort. Aside from the $1,200 threshold holding, there are a few other reasons to expect gold to start doing well again.

Emerging market central banks net buyers (China & Russia).

It has become clear for the past few years that China, and Russia are increasingly looking to boost their gold reserves. Even though China did not make an official statement in regards to an increase in its gold reserves held by the central bank, in 2013 it did import and produce more gold than was consumed by non-government consumers. It seems as much as 500 tons may have gone into Chinese vaults for storage that year. At least as much might have gone into central bank storage in 2014 as some estimates put Chinese net imports of gold for last year at perhaps 1350 tons (link).

Russia's central bank has been boosting its gold reserves in 2014, even as its overall FX reserves have been declining. In September alone, it increased its reserves by 37 tons (link). it seems many other central banks around the world decided to increase their holdings of gold in 2014, aside from Ukraine, which it seems may have been persuaded to do away with its own gold reserves (link).

What this all means to the gold market is that regardless of whether the 2013 gold crash was masterminded as many people suspect by Western central banks together with a handful of banking institutions such as Goldman Sachs, or perhaps it just happened because people no longer saw gold as a good momentum bet, there is very little growth in the amount of gold available in the Western world, which will make it harder to repeat such a drop in the price of gold again.

Gold's main competitor, stocks no longer look to surge.

As I pointed out in other previous articles, I believe that one of the main factors that led to investors dumping gold was the fact that after it reached $1,900 an ounce, they felt that it had very limited potential upside still left. In the meantime, stocks were on a tear that started at the end of 2009 and at the time when the price of gold started declining from its record high, the stock market was still going strong. Now, we increasingly see more and more sideways momentum in stocks. Furthermore, we are now eight years away from the start of the great financial crisis, which means that we are more or less due for another recession given the average length of economic cycles in the past few decades. In conclusion, the returns on stocks not likely to be as enticing as before, therefore holders of gold will no longer be tempted to sell in order to get into assets with a higher rate of return.

Global fiat currency supply continues to increase.

Since the beginning of the financial crisis the US Federal Reserve's balance sheet has more than quadrupled.

(click to enlarge)
Source. Federal Reserve.

As we can see from the graph, the Federal Reserve has been busy printing money and exchanging it for other assets. But most of this money did not actually make it into circulation. In fact, the money supply in the economy pretty much kept pace with nominal growth more or less.

(click to enlarge)
Source. Federal Reserve St. Louis.

The fact that most of this money did not make it into the real economy is what thwarted the theories of currency debasement and hyperinflation coming due to all the money printing. We have to realize however that the money that has been printed is still around, mainly parked in banks and for the Federal Reserve to start shrinking that balance sheet, if it needs to in order to fight back a flare-up in inflation, it would have to start selling assets from its balance sheets that may not necessarily be very desirable in the market. That was the main reason those assets were parked there in the first place.

I think the money that has been printed and used to shore up the banks may at any point start chasing certain assets such as commodities for instance, causing inflation to pick up in the economy. If such an event will come to pass, it is hard to see how the Federal Reserve would go about controlling inflation given that all the money printed in recent years will chase the assets with the best potential return. The assets currently on the Fed balance sheet will most likely fail to compete with a surging price of oil for instance.

Similar problems can be encountered with other major central banks, such as that of Japan which nearly doubled the size of its balance sheet in the past year or so (link). The ECB is increasingly expected to start an aggressive expansion of its own balance sheet in order to deal with the Euro zone's problems.

Strong US dollar and falling oil prices did not take gold down in past months.

Ordinarily a strong US dollar tends to discourage gold buying, because strength in the world's most important fiat currency suggests that there is overall confidence in paper assets. A weak oil price also tends to drag gold prices down with it, because there is a historical correlation between the two that rarely breaks down. In the past few months however, the two seem to have decoupled. If this relationship will continue to stay decoupled, it could signal the beginning of a bull market in gold in my opinion because traders will no longer link its momentum to that of oil. This is very important because as I often stated, oil prices above $100 a barrel are not economically sustainable, therefore upward momentum is limited and as long as the two traded together, there was a limit to the price of gold as well.

Low bond yields.

An important factor that should make gold a long-term investment attraction is the low yield on debt. Investors have been chasing interest returns for a few years now, causing them to increasingly accept relatively high risk for relatively low rewards. One such example is the high yield debt in the shale oil & gas sector, which is now all the sudden looking shaky (link). Even Italian ten year bonds, which in my view is a relatively high risk asset only yields 1.7% and for investors outside the Euro zone, it also presents a currency risk (link).

Some headwinds in 2015.

Even though it has not been the case so far, there is reason to expect that the strength of the US dollar will dampen demand for gold as an investment. Demand for gold may also be dampened by a worsening of economic conditions in places such as Russia. Given that Russia is burning through its FX reserves, it may not make much sense to continue stockpiling gold just now, because there may come a time to have to sell again before the price of oil recovers significantly enough to help stop the shrinking of its reserve pile.

Even so, I expect 2015 will be a decent year for gold. Given that it closed below $1,200 in 2014, it stands a good chance of closing above that level for 2015. A decent gain in price should reignite the interest of traders. There is also a good chance of the safety trade reigniting as there are many sources of volatility, ranging from default risks, such as Ukraine, and some oil companies, to perhaps some holders of oil hedges or debt. The continued difficulty in the EU economy is also a reason to worry in my opinion as it continues to give rise to increased support to fringe political elements. Aside from that, we are now headed closer and closer to the window of expectations for another recession given the expected average length of economic cycles. I personally expect that it will be triggered by a spike in oil prices from current low levels, to somewhere far above the $100/barrel plateau level we became accustomed to in past few years.

Even if I am wrong and gold will not have a stellar year, I don't see much downside to owning it either. After all, it has to stay at a level that keeps mining production going.

Francs, Fear and Folly

Paul Krugman

JAN. 15, 2015

Ah, Switzerland, famed for cuckoo clocks and sound money. Other nations may experiment with radical economic policies, but with the Swiss you don’t get surprises.
Until you do. On Thursday the Swiss National Bank, the equivalent of the Federal Reserve, shocked the financial world with a double whammy, simultaneously abandoning its policy of pegging the Swiss franc to the euro and cutting the interest rate it pays on bank reserves to minus, that’s right, minus 0.75 percent. Market turmoil ensued.
And you should feel a shiver of fear, even if you don’t have any direct financial stake in the value of the franc. For Switzerland’s monetary travails illustrate in miniature just how hard it is to fight the deflationary vortex now dragging down much of the world economy.
What you need to understand is that all the usual rules of economic policy changed when financial crisis struck in 2008; we entered a looking-glass world, and we still haven’t emerged.

In many cases, economic virtues became vices: Willingness to save became a drag on investment, fiscal probity a route to stagnation. And in the case of the Swiss, having a reputation for safe banks and sound money became a major liability.
Here’s how it worked: When Greece entered its debt crisis at the end of 2009, and other European nations found themselves under severe stress, money seeking a safe haven began pouring into Switzerland. This in turn sent the Swiss franc soaring, with devastating effects on the competitiveness of Swiss manufacturing, and threatened to push Switzerland — which already had very low inflation and very low interest rates — into Japanese-style deflation.

So Swiss monetary officials went all out in an effort to weaken their currency. You might think that making your currency worth less is easy — can’t you just print more bills? — but in the post-crisis world it’s not easy at all. Just printing money and stuffing it into the banks does nothing; it just sits there. The Swiss tried a more direct approach, selling francs and buying euros on the foreign exchange market, in the process acquiring a huge hoard of euros. But even that wasn’t doing the trick.

Then, in 2011, the Swiss National Bank tried a psychological tactic. “The current massive overvaluation of the Swiss franc,” it declared, “poses an acute threat to the Swiss economy and carries the risk of a deflationary development.” And it therefore announced that it would set a minimum value for the euro — 1.2 Swiss francs — and that to enforce this minimum it was “prepared to buy foreign currency in unlimited quantities.” What the bank clearly hoped was that by drawing this line in the sand it would limit the number of euros it actually had to buy.

And for three years it worked. But on Thursday the Swiss suddenly gave up. We don’t know exactly why; nobody I know believes the official explanation, that it’s a response to a weakening euro. But it seems likely that a fresh wave of safe-haven money was making the effort to keep the franc down too expensive.
If you ask me, the Swiss just made a big mistake. But frankly — francly? — the fate of Switzerland isn’t the important issue. What’s important, instead, is the demonstration of just how hard it is to fight the deflationary forces that are now afflicting much of the world — not just Europe and Japan, but quite possibly China too. And while America has had a pretty good run the past few quarters, it would be foolish to assume that we’re immune.
What this says is that you really, really shouldn’t let yourself get too close to deflation — you might fall in, and then it’s extremely hard to get out. This is one reason that slashing government spending in a depressed economy is such a bad idea: It’s not just the immediate cost in lost jobs, but the increased risk of getting caught in a deflationary trap. 

It’s also a reason to be very cautious about raising interest rates when you have low inflation, even if you don’t think deflation is imminent. Right now serious people — the same serious people who decided, wrongly, that 2010 was the year we should pivot from jobs to deficits — seem to be arriving at a consensus that the Fed should start hiking very soon. But why? There’s no sign of accelerating inflation in the actual data, and market indicators of expected inflation are plunging, suggesting that investors see deflationary risk even if the Fed doesn’t.
And I share that market concern. If the U.S. recovery weakens, either through contagion from troubles abroad or because our own fundamentals aren’t as strong as we think, tightening monetary policy could all too easily prove to be an act of utter folly.
So let’s learn from the Swiss. They’ve been careful; they’ve maintained sound money for generations. And now they’re paying the price.

01/16/2015 11:43 AM

Gorbachev Interview

'I Am Truly and Deeply Concerned'

Interview Conducted by Matthias Schepp and Britta Sandberg

In a SPIEGEL interview, former Soviet leader Mikhail Gorbachev discusses the dangers of poor relations between Russia and the West in the Ukraine crisis, saying there is a danger that things could get worse. Germany, he says, has a significant role to play.

Thick snowflakes fall in front of the window of the office on Leningradsky Avenue in northwestern Moscow. Mikhail Gorbachev's foundation has been located here for the past 23 years -- a place for political research projects, charity initiatives, conferences and book publishing.

Photos from bygone eras hang on the walls. There's one showing the former Soviet leader with George Bush Sr., in another he is with François Mitterrand. Still others depict Gorbachev with Helmut Kohl and Shimon Peres. There are also numerous images of his wife Raisa Gorbachev, who died in 1999 after a battle with leukemia. One in oil hangs over his desk while the large-format photograph across the room is the last photo taken of the former first lady. Gorbachev's voice falters when he speaks of her.

The 83-year-old has undergone three serious operations recently -- one on his spine, prostate surgery and another on his carotid artery. Now he's facing a fourth. The medication he takes has changed his face and he no longer likes to be photographed. "I always look like a bulldog in photos now," he says. "Mr. Gorbachev, you don't look like a bulldog," we respond. "Of course I do -- now stop it."

He then dispatches a press officer to grab a photo of him published by a Russian newspaper. If one was so inclined, slight similarities with a bulldog could perhaps be found. Even more so after the two-and-a-half hour interview he gave SPIEGEL. He has seldom been so combative.

SPIEGEL: Michael Sergeyevich, few contributed more to ending the Cold War than you. Now it is returning as a result of the Ukraine crisis. How painful is that?

Gorbachev: It gives one a feeling of déjà-vu. Perhaps that would even make a good headline for this interview: Everything appears to be repeating itself. There was a time for building a Wall and a time for tearing it down. I'm not the only person to thank for the fact that this wall no longer exists. (Former Chancellor) Willy Brandt's Ostpolitik was important, as were the protests in Eastern Europe. Now, new walls are being built and the situation is threatening to escalate. I do, in fact, see all the signs of a new Cold War. Things could blow up at any time if we don't act. The loss of trust is disastrous. Moscow no longer believes the West and the West doesn't believe Moscow. That's terrible.

SPIEGEL: Do you think it is possible there could be another major war in Europe?
Gorbachev: Such a scenario shouldn't even be considered. Such a war today would inevitably lead to a nuclear war. But the statements from both sides and the propaganda lead me to fear the worst. If one side loses its nerves in this inflamed atmosphere, then we won't survive the coming years.

SPIEGEL: Aren't you overstating things a bit?

Gorbachev: I don't say such things lightly. I am a man with a conscience. But that's the way things are. I am truly and deeply concerned.

SPIEGEL: The new Russian military doctrine labels NATO's eastern expansion and the "reinforcement of NATO's offensive capabilities" as one of the primary threats facing Russia. Do you agree?

Gorbachev: NATO's eastward expansion has destroyed the European security architecture as it was defined in the Helsinki Final Act in 1975. The eastern expansion was a 180-degree reversal, a departure from the decision of the Paris Charter in 1990 taken together by all the European states to put the Cold War behind us for good. Russian proposals, like the one by former President Dmitri Medvedev that we should sit down together to work on a new security architecture, were arrogantly ignored by the West. We are now seeing the results.

SPIEGEL: The Ukraine conflict is a personal one for you -- and not just for political reasons.

Gorbachev: That is correct, and anything else would be strange. I am, after all, half Ukrainian.
My mother was Ukrainian and my wife Raisa was too. I spoke my very first words in Ukrainian, and the first songs I heard were Ukrainian. The southern Russian region of Stavropol, where I come from and where I once served as party chief, had a partnership during Soviet times with Ukraine's Donetsk region, where this terrible war is raging today. Back then we offered each other mutual help. We were friends and we lived in one state. Still, even today I have friends and relatives in Ukraine -- as do most Russians.

SPIEGEL: As general secretary of the Communist Party, you fought for glasnost (openness) and perestroika (restructuring) in your country. Has everything that you pushed for during your political life fallen into ruin under Putin?

Gorbachev: I take an entirely different view. Glasnost isn't dead and neither is democracy. A new generation has grown up in Russia under entirely different conditions -- and it is much freer than in the Soviet Union. The clock can no longer be turned back. Nothing has fallen into ruin.

SPIEGEL: Yet Russian leadership is more authoritarian than it has been in a long time.
Gorbachev: What do you mean by "a long time"?

SPIEGEL: Since pre-Gorbachev times in the Soviet Union. There are once again limits on the freedom of opinion and the press, and elections aren't free.

Gorbachev: Then we have the same view of things. Since then, I have become an old man and I have a long journey behind me. When I became a member of the Communist Party, I wrote an essay called: "Stalin, our war glory, Stalin inspires us, the youth." Today I support those who fight against venerating Stalin.

SPIEGEL: Putin is limiting democracy, but a majority still appears to be satisfied with his leadership. Why?

Gorbachev: When Putin moved into the Kremlin, he inherited a difficult legacy. There was chaos everywhere. The economy was crippled, entire regions wanted to secede. There was a threat of Russia disintegrating. Putin stopped this process and that will remain the greatest achievement of his time in office. Even if Putin hadn't managed to achieve anything else, he will always be credited with that. Yes, he does sometimes resort to authoritarian methods. I have often spoken out against this. That's also why I opposed him taking office for a third term.

SPIEGEL: Does Russia need a new top-down perestroika, as recently called for by former finance minister Alexei Kudrin, a Putin confidant who is also highly respected in the West?

Gorbachev: You are welcome to tell Alexei Kudrin that I agree with him. Russia is only halfway along the path to democracy -- the rest still lies ahead of us. Unfortunately, the Kremlin is currently focused on a conservative agenda. I think that's a mistake.

SPIEGEL: What drives Putin? Years ago, you wrote that he was only interested in staying in power.

Gorbachev: I can't look inside of Putin, so I don't know. But we will not progress without democracy and popular participation. We need free elections and people's involvement in the political process. Things cannot continue as they have until now, with a law being discussed for the first time in the morning and then already getting passed that night.

SPIEGEL: Are the Russians ready for more democracy?

Gorbachev: That's a question you will have to ask our opposition, which isn't very powerful.

SPIEGEL: But we're asking you.

Gorbachev: It's simply not okay when those who think differently are oppressed or when someone like anti-corruption blogger and politician Alexei Navalny is placed under house arrest just because he opened his mouth. It's not good when government offices or key posts in state-owned businesses are assigned on the basis of friendships, as happens here.

SPIEGEL: With the economy struggling and the ruble collapsing, do you think there's any chance Putin will change course?

Gorbachev: He really doesn't need to be afraid because he is still very popular. If Putin has the feeling that he no longer has any other choice, then I think he will act accordingly.

SPIEGEL: In November, during the presentation of your new book, you said that Putin suffers from an affliction that was no stranger to you during your time in the Kremlin: an excess of self-confidence. Putin, you said, sees himself as being second only to God.

Gorbachev: Perhaps he considers himself to be equal to God (laughs). Of course Putin isn't God. But those who carry responsibility also need to be determined and capable of taking decisions -- in other words, a healthy portion of self-confidence.

SPIEGEL: You, yourself, were often accused of being irresolute.

Gorbachev: Then how did this allegedly indecisive Gorbachev manage to push through perestroika against immense resistance? How did he declare glasnost, which allowed the freedom of word and religion? Why did he provide the freedom of travel, when, previously, every Soviet citizen who wanted to go abroad had to go through a lengthy procedure? And why did this allegedly irresolute person suddenly decide to end the nuclear arms race by completely eliminating medium-range missiles and reducing long-range missiles by half? If all of that wasn't courageous and decisive, then what is?

SPIEGEL: Still, does it bother you that many in your country see you as the man who destroyed the Soviet Union?

Gorbachev: Many today know that isn't true. Unfortunately, I even hear that kind of innuendo from President Putin, not to mention the so-called patriots. They would love nothing better than to drag me and the Communist Party to court on charges of high treason.

SPIEGEL: Would it have been better if the Soviet Union had remained intact?

Gorbachev: Surely. The rapidly induced collapse of the Soviet Union is also part of the deeper reason for the current Ukraine conflict.

SPIEGEL: You're speaking of 1991, when the Soviet Union broke up as a result of its conflicts between different nationalities and because of economic and supply crises.

Gorbachev: The opponents of perestroika had already lost the public political battle, so they instead focused on escalation and instigated a putsch. They wanted power, but they destroyed the Soviet Union. My successor Boris Yeltsin prescribed a shock therapy under which Russia still suffers today. I had a reform program. Although union was a part of the Soviet Union's name, it wasn't really a union. The republics had only very limited sovereignty and competencies. That's why I presented a reformed union treaty that was to be signed on August 20, 1991. But the nomenklatura feared the new era.

SPIEGEL: In a farewell speech before you left the Kremlin at the end of 1991, you emphasized the successes of your policies and said that no one living in neighboring countries needed to fear Russian troops any longer. Now, that fear is back.

Gorbachev: Unfortunately, we forget the things that history teaches us.

SPIEGEL: Whose fault is that?

Gorbachev: You're asking me the eternal question of who is responsible: the wife or the mother-in-law (laughs). Seriously though: Russia and the West both bear responsibility, if to a different degree. No one has displayed an understanding for the seriousness of the situation.

SPIEGEL: Who carries the greater responsibility for the Ukraine conflict?

Gorbachev: Casting blame isn't helpful in this highly dangerous crisis. But I do want to be clear about a few things. In November 1990, at the Conference for Security and Cooperation in Paris, the talk was of a new peaceful world order. George Bush, Sr. and I were especially active in promoting this. But nothing came of it -- a demilitarization of politics didn't happen. Instead, a dangerous winner's mentality became widespread in America. I criticize this attitude every time I visit the United States. I remind people of how John F. Kennedy took a stand against the demonization of people in the Soviet Union and said that a true peace could not be a Pax americana, that peace could not be dictated by America. There is either peace for all or there is no peace.

SPIEGEL: Did America not emerge as the victor of the Cold War?

Gorbachev: Would America have been able to achieve these massive changes without Moscow, without us? No! We showed at the time what is possible if we work together: We solved regional conflicts, we achieved German reunification, the withdrawal of Soviet troops from Eastern Europe, nuclear disarmament. Unfortunately, America then started building a global empire, a mega empire.

SPIEGEL: When did America begin down that path?

Gorbachev: You know yourselves. When the Soviet Union fell, those who didn't wish us well shed crocodile tears as they rubbed their hands together beneath the table. The Americans began by surrounding Russia with so-called rings of defense -- NATO's eastward expansion. NATO intervened militarily in the Yugoslavian civil war without the consent of the United Nations. That was a precedent-setting case. All that triggered a backlash in Russia. No Kremlin leader can ignore something like that.
'Sanctions Are not an Instrument that Should Be Used'

SPIEGEL: It's interesting that an older generation of politicians -- (former US Secretary of State) Henry Kissinger, (former German Chancellor) Helmut Schmidt and former German Foreign Minister Hans-Dietrich Genscher, for example -- are urging level-headedness in the Ukraine crisis. You yourself have addressed presidents Putin and Obama.

Gorbachev: Yes, and that was already one year ago, on January 23. I called on both to negotiate with each other because the Ukraine conflict is a threat to the entire world and not just to Ukraine and its neighbors. My letters were a cry from the depths of my soul.

SPIEGEL: Did you get an answer?

Gorbachev: I fell on deaf ears.

SPIEGEL: You had a similar experience in Berlin in November. The warnings you gave on the occasion of the Berlin Wall anniversary were dismissed as those of an aging politician. The Germans criticize you because of your pro-Putin stance. Does that bother you?

Gorbachev: The Germans love Angela Merkel. That's why people criticize me and not Merkel. But a smart country like Germany should not resort to the kind of level of conversation you might expect to find in a pub.

SPIEGEL: You met with Angela Merkel in the Chancellery. How did the talk go?

Gorbachev: Friendly. We spoke with each other for about an hour. But the balance of power was unequal. A female advisor to the chancellor was there, so I had two women against me. I could very clearly sense that the chancellor is under pressure -- both domestically and in terms of foreign policy. I explained to her that people needed to sit down for as long as it takes to find a solution. You won't achieve anything by tripping all over each other with rash statements. Angela Merkel agreed with me, even if she acts differently.

SPIEGEL: Did you criticize the West's sanctions against Russia in your talk with the chancellor?

Gorbachev: Ask Angela Merkel. I might pull your leg.

SPIEGEL: But we would like to get an answer from you.

Gorbachev: I have forgotten again everything that was said about that (laughs). You'll have to ask the chancellor. Incidentally, I didn't tell Putin anything about the conversation either. I'm even less inclined to tell SPIEGEL. If you want, you can ask me a third time now, but there's no point in trying to lead my down the slippery slope.

SPIEGEL: Why do you consider sanctions to be wrong?

Gorbachev: They damage the economies of both countries. It was wrong to exclude Russia from the G-8. That's vendetta-like and there is nothing to be gained from it. Sanctions are not an instrument that should be used if we want to maintain our exemplary relations.

SPIEGEL: It looks as though such relations are a thing of the past.

Gorbachev: A great deal of progress was made in the relationship between Germany and Russia after the fall of the Wall. We built up singularly good relations. We can't allow that to be destroyed now. At the moment, the West is largely shutting Russia out of efforts to solve global problems on issues ranging from the battle against terrorism and the Islamic State to climate change. What's the good in that? We need to "de-ice" our relations again and we urgently need a new thaw. We Russians will do everything to try to make that happen. I think Russia is orienting its policies in that direction. In Germany, though, it looks as though there is a competition to see who can be the most unyielding when it comes to Russia.

SPIEGEL: But there are also many who see things differently. Former SPD leader Matthias Platzeck has proposed that a new referendum be held over Crimea under the aegis of the Organization for Security and Cooperation in Europe in order to provide legitimacy to the annexation under international law. What do you think of that idea?

Gorbachev: The new Germany wants to interfere everywhere. What legitimacy is needed for Crimea? Even if the referendum had deficiencies, there can be no doubt that the people there clearly and unambiguously said they wanted to be a part of Russia.

SPIEGEL: Your position on the referendum is astoundingly mild. Even Putin's own human rights commission detected voter fraud. Are you disappointed in the Germans?

Gorbachev: Many in Germany seem to want to participate in the new division of Europe. It's probably better if I stop here. Don't provoke me any longer. I am a Russian and I shouldn't say too much about Germany's domestic affairs.

SPIEGEL: Germany's internal affairs affect all of Europe.

Gorbachev: The way things stand between Germany and Russia has repercussions for the global political climate. We can never forget that, also in the Ukraine crisis.

SPIEGEL: What do you think a solution to the crisis might look like?

Gorbachev: An immediate cease-fire, followed by an international effort to rebuild the destroyed areas. If necessary, we need to invite Otto von Bismarck again. He said that Germany should never wage war with Russia. Germany already tried once during World War II to expand its sphere of influence into the east. What lessons does it still need? It hasn't been forgotten in my country: the massive destruction, the women who waited for husbands who never returned home. It is good that our people have reconciled with each other.

SPIEGEL: And Merkel nevertheless says today that Putin lives in another world. Do you understand where she is coming from?

Gorbachev: No, not entirely. And I'm not the only one who doesn't understand. Please recall President Putin's speech at the Munich Security Conference in 2007. Putin clearly stated at the time where Russia's red lines are and that Russia does not agree to NATO's advance on its borders. For us Russians, by the way, Putin wasn't saying anything new. So why was it that our partners were so astounded? I get the impression that the German people understood Putin very well at the time -- in any case better than the political elite in Germany. It is a mistake to try to get rid of Putin.

SPIEGEL: Why would it be a mistake?

Gorbachev: It's hopelessly stupid and highly dangerous. Putin should leave office at the end of his term. Unfortunately, the German idea is very different. It envisions the further tightening of sanctions until the Russians take to the streets and topple Putin.

SPIEGEL: You don't appear to think much of Angela Merkel.

Gorbachev: On the contrary -- I like her as a person and a politician. But that doesn't mean I don't have the right to criticize her, just as she has the right to criticize me. The same applies in my relations to Putin. He is an experienced president who has done and continues to do much for Russia. At the same time, some things have to be said openly to him.

SPIEGEL: Are you a happy person today?

Gorbachev: I wrote a few years back that there aren't really any happy reformers. I wasn't in the best of spirits at the time and I allowed myself to get carried away with this sentence. Yes, when I look back, I am a happy person. Tackling major projects and leading an important state was, of course, great.

SPIEGEL: What does a typical day look like for you now? How do you spend your free time?

Gorbachev: My wife Raisa and I had a shared passion. We went on long walks every day, five to six kilometers. That helped me deal with stress. My legs, unfortunately, no longer play along, but I'm not the only one with that problem. I recently visited Helmut Schmidt. He was standing up when he greeted me, but he told me that he often has to use a wheelchair. Helmut Kohl and George Bush Sr. also have also begun relying on technical aids. I fear the time is coming when I will also have to motorize myself.

SPIEGEL: Is it difficult for you to accept that your strength is waning?

Gorbachev: In terms of my health, I felt very good until I turned 75. I continued to jet around the world. The death of my wife Raisa in 1999 was a difficult blow. The last year and a half hasn't been very good; I had to undergo three serious operations. Incidentally, all three took place in Germany. The whole world is fighting against aging, but there's nothing you can do about it. In some ways I feel old, but in others I still feel young. That's how I am.

SPIEGEL: What matters most to you in the years that you still have left?

Gorbachev: To live life and not just survive or vegetate and wait for death. I want to travel to America again in February to give lectures. Next to my books, they're my only source of revenue. I still have goals and that keeps me going.

SPIEGEL: What goals are they?

Gorbachev: I want to continue to be part of the discussion about Russia's future, about global peace and environmental protection. I want to write books, give lectures, attend conferences and give interviews.

SPIEGEL: To try once more to change the world and make it a better place?

Gorbachev: That's no longer necessary. Glasnost and Perestroika live on and they can no longer be stopped.

SPIEGEL: Do you have a fear of death?

Gorbachev: Not at all. I don't know why, but I have none.

SPIEGEL: Mikhail Sergeyevich, we thank you for this interview.

Read This, Spike That

Cheap Oil’s Dark Shadow

Many market watchers see oil prices falling further, imperiling the fracking industry and stocks of companies that serve it.

By John Kimelman           

January 9, 2015

Oil is now trading at slightly below $50 a barrel, less than half of what it was worth last June. And some believe that conditions of oversupply coupled with weakening demand from Europe and Asia could send prices down further.
Such a move could imperil the nascent fracking boom in the United States and further pressure a host of U.S. energy stocks.
On Thursday, investor Carl Icahn said on CNBC that he thinks that “oil actually will probably go lower,” at least in the short term. And earlier this week, Bank of America put out a research note saying that oil prices both in the U.S. and overseas could fall to between $35 to $40 a barrel in the coming months.
In a piece for the Fiscal Times, veteran financial writer Anthony Mirhaydari makes the supply-demand case for why a further drop in oil is highly plausible.
“It’s clear that a quick reversal isn’t coming,” he argues, referring to oil’s price decline. “ OPEC is showing steely resolve in its effort to recapture market share from U.S. shale oil producers. Most oil exporting nations are trapped in a prisoners’ dilemma: They all want higher prices as their national budgets feel the pinch. But none of them want to make the production cuts needed to align supply with the depressed demand that has resulted from economic weakness across much of Europe and Asia.
As for the demand side of the equation, Mirhaydari adds that “demand is unlikely to soak up the excess supply anytime soon, with Europe stalled, Japan picking up the pieces from its recent sales tax hike and China still trying to control its runaway housing and fixed-asset investment bubbles without pricking its bad debt problem.”
Of course, not everyone is so pessimistic about oil. None other than T. Boone Pickens, a legendary U.S. oil explorer, argues that oil could return to $100 a barrel in the next 12 to 18 months because low prices will invariably lead to more demand combined with tightened supplies.
But writing on the Forbes site, energy analyst Michal Lynch points out that such forecasts are often weighed down by the personal biases of the handicapper.
“People almost always start from their particular beliefs and preferences before analyzing the facts,” writes Lynch. “Few in the industry, or governments that rely on oil revenues, considered the possibility that prices could drop below the $100/barrel level for any length of time.”
Lynch adds: “When I suggested, at a 2012 OPEC conference, that long-term prices were likely to be in the $50-60/barrel range, not only was it suggested (from the audience) that I was joking, or (from a panel member) that I was possibly an idiot, but no one seemed to think such a decline even worthy of consideration.”
Assuming that oil is incapable of recovering in the coming year or two, what will it mean for America’s oil and gas boom, built both on technologies such as hydraulic fracturing (or fracking) along with a better price for the end product.
Writing for Fortune, veteran writer Shawn Tully argues that the shale oil revolution is in serious trouble.
“The recent drop in oil prices poses a major challenge to the frackers. But oil producers, Wall Street analysts, and most industry experts claim the setback will be brief and minor,” writes Tully. “Don’t believe them.”
Tully argues that “at best,” today’s producers may be able to hold production close to current levels.
“What’s gravely endangered is the advertised bonanza that virtually everyone deemed inevitable just a few short months ago.”
He writes that on average, the “all-in,” breakeven cost for U.S. hydraulic shale is $65 per barrel, according to a study by Rystad Energy and Morgan Stanley Commodity Research. “So, with the current price at $48, the industry is under siege,” he writes.
“Right now, all signs are pointing to retreat. The count of rotary rigs in use—a proxy for new drilling—has fallen from 1,930 to 1,881 since October, after soaring during most of 2014. Continental Resources, a major force in shale, has announced that it will lower its drilling budget by 40% in 2015.

Because of the constant need to drill, frackers are always raising more and more money by selling equity, securing bank loans, and selling junk bonds. Many are already heavily indebted. It’s unclear if banks and investors will keep the capital flowing at these prices.”
Of course, this reversal of fortunes for fracking, along with conventional oil and gas exploration, is not good news for many services stocks that are the handmaidens to enterprises extracting fossil fuels from the land and sea.
A piece on the CNNMoney site warns that investors should shun a variety of oilfield services companies, including Haliburton and Schlumberger, which have already fallen hard in recent months.
“Despite the recent retreat, the pain may not be over for shareholders of oilfield service companies,” writes CNNMoney.

Industrial Production Drops By Most In 11 Months (After Biggest Surge Since 2010)

by Tyler Durden

01/16/2015 09:21 -0500

Industrial Production dropped 0.1% in December (slightly worse than expected) after November's 1.3% surge - the biggest sicne may 2010. Not since Jan 2014's Polar Vortex has Industrial Production dropped more than this. The 5.5% surge in vehicle production - as suspected - was entirely unsustainable and dropped 0.9% in December and Utilities collapsed 7.3% on the month - the worst dropo since Jan 2006.

Industrial Production dropped most since Jan 2014...

led by Motor Vehicles...

and Utilities...

Charts: Bloomberg

End of CB Power – SNB Folds

Bruce Krasting

Thursday, January 15, 2015

I wrote about the Swiss National Bank being forced to abandon its currency peg to the Euro on 12/3/14, 12/8/14 and 1/11/15. That said, I’m blown away that this has happened today.
Thomas Jordan, the head of the SNB has repeated said that the Franc peg would last forever, and that he would be willing to intervene in “Unlimited Amounts” in support of the peg.

Jordan has folded on his promise like a cheap suit in the rain. When push came to shove, Jordan failed to deliver.

The Swiss economy will rapidly fall into recession as a result of the SNB move. The Swiss stock market has been blasted, the currency is now nearly 20% higher than it was a day before.

Someone will have to fall on the sword, the arrows are pointing at Jordan.

The dust has not settled on this development as of this morning. I will stick my neck out and say that the failure to hold the minimum rate will result in a one time loss for the SNB of close to $100B.

That’s a huge amount of money. It comes to 20% of the Swiss GDP! If this type of loss were incurred by the US Fed it would result in a loss in excess of $2 Trillion!

In the coming days and weeks there will be more fallout from the SNB disaster. There will be reports of big losses and gains from today’s events. But that is a side show to the real story. We have just witnesses the collapse of a promise by a major central bank.

The Fed, Bank of Japan, ECB, SNB and other Central Banks have repeatedly made the same promises over the past half decade:

Don’t worry! We are here. We will do anything it takes to achieve the stability we desire.
We are stronger than the markets. We can overwhelm all forces. We will never let go – just trust us!
I never believed in these promises, but the vast majority of those who are active in financial markets did. The entire world has signed onto the notion that Central Banks are all powerful.

We now have evidence that they are not.

Anyone who continues to believes in the All Powerful CB after today is a fool. Those who believed in Jordan’s promises now have red ink on their hands – lots of it! 

The next central bank that will come into the market’s cross hairs is the ECB. Mario Draghi has made promises that he would “Do anything – in any amount”.  Like I said, you would be a fool to continue to believe in that promise as of this morning.

We’ve just taken a huge leap into chaos. The linchpin of the capital markets has been the trust in the CBs. The market’s anchors have now been tossed overboard.


The Next Subprime Crisis Has Already Started

By Shah Gilani, Capital Wave Strategist, Money Morning

January 16, 2015

Reading about what's going on in the subprime auto lending space is a lot like reading about drive-by shootings.

Unless you're a subprime borrower, or live in a neighborhood where drive-bys are happening, you probably don't know much about either or think they affect you.

But if you listen closely there's muffled financial "gunfire" already in your neighborhood.

And it's much closer to your doorstep than you think.

Here's what you need to know…

Yield Chasers Have Found a New Target

Subprime auto borrowers are getting killed by dealerships, their financing agents, and banks putting them on the financial frontline for default.

Even if not everyone is a subprime auto borrower the trend is rippling out into the U.S. economy.

New and used auto dealerships and their finance arms, manufactured lending partnerships, banks, private equity companies, insurance companies, mutual funds (and the usual cadre of lap-dog lobbyists and paid-for legislators) are doing to subprime auto borrowers what coddled mortgage lenders did to subprime housing borrowers.

They are teeing them up for a long drive down a dead-end road.

The game at both ends and in the middle is just the same. So are a lot of the players.

On the output end are the investors. Fixed income investors from mutual funds and insurance companies to mom and pop investors are once again desperate for yield.

When the Federal Reserve kept interest rates low through the 2000s, fixed income investors reached for yield further and further out on the risk spectrum. On the very end of the yield tree's flimsiest limbs, subprime mortgages and mortgage-backed securities blossomed. And investors picked them off like the low hanging fruit they appeared to be.

We know what happened next.

Ever since 2008's credit crisis and the Great Recession, the Fed's zero interest rate policies made it even harder for savers and bond investors to earn any interest.

So, with the mortgage tree cut down, the usual-suspect financial intermediaries cultivated the next best species of fruit-bearing trees: auto loans.

As financial intermediaries, banks make a lot of auto loans, but not as many as financing arms of auto manufacturers. And because auto loans are so profitable, lending partnerships and private equity companies and other "investors" eagerly provide abundant pools of money to borrowers in need of financing new and used cars.

It's really these "intermediaries" that keep the wheels of the auto industry turning.

How fast are those wheels turning? Because of abundant financing and low interest rates, new light-vehicles sales in 2014 totaled over 16.5 million units. That's up 5.6% from 2013 and the highest new vehicle sales level since 2006.

According to, loans to prime borrowers on new vehicles average 2.75% on six-year term loans.

But it's not just auto manufacturers' financing arms and banks providing money to new car purchasers that's making auto sales pop. The same banks and manufacturers' financing units, along with aggressive financing partnerships, are providing huge pools of money to dealers of used cars across the country.

According to the Federal Reserve, outstanding auto loans for new and used cars reached $934 billion at the end of September 2014. That's up from a total of $809 billion outstanding just two years ago. By the end of the first quarter of 2015 the total outstanding volume of auto loans is expected to exceed $1 trillion.

While prime borrowers financing new and used cars aren't worrisome – just as prime mortgage borrowers weren't a problem in the heyday of the housing boom – it's subprime borrowers who are eclipsing prime borrowers in the auto sales arena, just as they did in the late stages of the housing boom, that's becoming a worrisome trend.

And just like in the mortgage-money free-for-all, it's the intermediaries pushing loans on subprime borrowers. They can then charge them exorbitant interest rates. That's what's fueling the rapid increase in subprime auto lending, especially on used cars.

Of course, in the modern era, very few intermediaries keep the loans they make "on their books." Instead, they rely on other banking intermediaries or their own in-house securitization assembly lines to package thousands of auto loans into "asset-backed securities" to sell to eager investors seeking above market interest rate investments.

The difference in the new subprime rip-off game is in the input function of the financing equation.

Used car buyers in the latest push-them, plunder-them, package-their-promises, and sell them to salivating yield-hungry investors are far less credit worthy than the crap-shooting, credit-impaired homebuyers sucked into the mortgage mania game.

Sadly, it's the lowest rung of borrowers, many of them desperate for transportation to look for work, get to work, to take sick family members to and from doctors and hospitals, or to run their small transportation businesses, that get saddled with the worst high interest rate loans.

Of all outstanding auto loans made up to the end of Q3 in 2014, 23% were subprime loans to borrowers with less than a 640 credit score. That's up from 21% in 2009. Still, not as high as the 28% share subprime borrowers accounted for in pre-recession 2007.

Because of the way used car dealers are incentivized to make the biggest loans possible to subprime borrowers, they regularly roll in "extras" to the whole loan they offer unsuspecting or desperate buyers: title, taxes, dealer-prep fees, extended warranties, undercoating and rustproofing charges, sometimes collateral insurance, and the cost of buying out an existing loan on a trade-in.

As a result, on approximately 23% of subprime loans, the outstanding principal owed exceeds the resale value of the purchased vehicle by 200%.

Experian Automobile, a unit of credit rating company Experian, recently reported that as of September 2014 the average loan-to-value on all financed autos was close to 115%.

Of all auto loans made last year, 31% went to subprime purchasers. That's up 17% in two years.

With interest rates often starting at 22% annually, it's not hard to see why delinquencies are on the rise…

Of all auto loans made from January 2014 through November 2014, 2.6% were delinquent by 30 days or more. But, according to Equifax, of all subprime auto loans made in just the first quarter of 2014, by November, 8.4% had missed at least one payment. For comparison purposes, in 2008 the delinquency rate was 9%.

Mark Zandi of Moody's Analytics recently said of subprime auto loans, they're "eroding now, and pretty quickly."

Regulators Have Taken Notice

While the FTC generally oversees auto sales practices and is looking into several dealers and financing operations, the Consumer Financial Protection Bureau (CFPB) has been especially aggressive in attacking dealer "mark-ups" (the profit dealers earn for putting buyers into expensive financing schemes).

Asserting their responsibility to enforce "fair lending" laws the CFPB extracted a $98 million settlement from Ally Financial (formerly General Motors' financing arm) in 2013 for unfair mark-ups. The CFPB has threatened American Honda Finance, Toyota Motor Credit, and others. They are believed to be cooperating with the Bureau's ongoing inquiries.

In addition, the Justice Department has subpoenaed GM Financial, Santander Consumer USA Holdings, and others over their lending practices and dealer mark-ups.

Not to be left out of the action, the Securities and Exchange Commission (SEC) is believed to be investigating Ally Financial and others, and has hinted of possible forthcoming settlements.

The strange thing is not a lot of people are overly worried about excessive subprime auto lending blowing up and undermining markets or the economy.

Institutional investors seem happy with the extra yield they're taking in on the packaged loans they're buying and comfortable believing borrowers will continue to pay up.

Securitizers and raters are confident, for the most part, that auto buyers, many of whom have already declared bankruptcy, aren't able to do so again for another seven years, so they can't easily discharge their new obligations.

And many investors and financiers point to the fact that autos aren't homes. They can be easily repossessed. An increasing number of sold autos are being fitted with automatic cutoff switches that allow dealers to turn off cars remotely if a payment is even a few days late.

All that may be well and good. Still, with the proliferation of subprime auto loans to an increasingly stressed and increasingly delinquent army of struggling borrowers, sooner or later dealers may run out of discredited buyers to sell their repossessed vehicles to.

While I'm not worried about stray bullets in drive-by shootings wreaking havoc in my neighborhood, I am worried that subprime auto drivers might shoot themselves in the foot.

That foot's on the accelerator, and the market and the economy are heading into another ditch.