Heed the Warnings of the Three Bears

Here are economic warnings from three big bears.

These folks have been telling us for years that our economic policy would lead the Fed to "bail out" the system with massive doses of liquidity and lower interest rates.

Now, the Fed is trying to walk a tightrope, making policy choices to try to keep the economy on the right course. Policymakers are trying to avoid deflationary collapse on the one hand, and hyperinflation on the other.

The three bears are not optimistic.

Bert Dohmen -- Prelude to Meltdown

Bert Dohmen has written the Wellington Letter for more than 30 years. He has always been just slightly ahead of the curve, much to the benefit of his subscribers. Dohmen's new book is Prelude to Meltdown.

When the Dow Jones Industrial Average made its first close ever above 14,000, in the midst of euphoria last summer, Dohmen sent out a warning that it was a market top -- and it was.

Today his economic forecast is gloomy: "The world has seen the greatest credit bubble ever seen by man... The enormity of this problem is beyond anything we have ever seen in financial history."

"The size of the leverage and the financial instruments that are outstanding, and now defaulting, are beyond the ability of any central bank, or all of the central banks combined, to bail out. We've never had a situation where the central banks were not big enough to bail out a situation -- but we have it now."

He warns about further problems in the banking industry:

"My forecast is that the next big crisis will be the credit default swaps -- a $45 trillion dollar, highly leveraged market. These are basically insurance policies that buyers of mortgage securities (CDOs) bought against a mortgage default. Banks and hedge funds 'wrote' this insurance, a highly leveraged speculation. Now that the mortgages are defaulting, the sellers are saying they don't have the capital to make good on the insurance.

"The key word over the next year is counterparty risk, because these were unregulated side deals, created outside of the banking system. This is a shadow unregulated banking system much larger than the regulated banking system. The regulators were totally asleep. They let it happen."

Dohmen's not worried that all the liquidity and lower interest rates being created by the Fed will cause inflation. Instead he sees a deflationary collapse, and recommends the relative safety of U.S Treasury securities.

A. Gary Shilling -- Deflation

Economist Gary Shilling has been predicting an oncoming deflation for years -- even as stock and housing prices continued to rise. His January 2004 newsletter warned: "Sub-prime loans are probably the greatest financial problem facing the nation in the years ahead."

Yes, he was ahead of his time.

What's Shilling saying now? "We are in a very serious global recession, the length and breadth of which will be determined by three factors. First is the depth of the collapse in housing: "We're looking for a 25% price decline from top to bottom."