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“There is nothing more deceptive
than an obvious fact.”
|waterfall: “a steep fall or flow of water in a watercourse
from a height, as over a precipice”.
|“A sound banker, alas, is not
one who foresees danger and avoids it, but one who, when he is ruined,
is ruined in a conventional way along with his fellows, so that
no one can really blame him.”
John Maynard Keynes, 1931.
|To paraphrase Henry II, "subprimes, subprimes; will no one rid me of these damned subprimes?"|
Go Ron Paul 2008! Slam the banksters!
A reader comment for
Oct 31, 2007 | Bloomberg.com
Rogers said he increased his year-old short positions in the past six weeks in U.S. investment banks, using exchange-traded funds and bets against individual companies he declined to name. Stocks in the industry, which pays too much in bonuses, may fall as much as 70% in a bear market, he said.
``You see 29-year-olds on Wall Street making $10 million to $20 million a year, and they think it's normal,'' Rogers, 65, said in an interview in London today. ``There have been lots of excesses,'' said Rogers, chairman of Beeland Interests Inc.
The top five U.S. securities firms will probably earn a combined $29.3 billion this year, according to analysts surveyed by Bloomberg, breaking a three-year record streak after Merrill Lynch & Co. reported a $2.2 billion third-quarter loss. Goldman Sachs Group Inc., Morgan Stanley, Merrill, Lehman Brothers Holdings Inc. and Bear Stearns Cos. earned $30.7 billion last year, three times more than their profit in 2002.
Goldman Sachs, Wall Street's most-profitable securities firm, said Sept. 20 that it set aside $16.9 billion to pay salaries, benefits and bonuses in the first nine months of the year, topping the record amount for all of last year.
A month later, Merrill Lynch reported its biggest quarterly loss amid $8.4 billion of writedowns for subprime mortgages, asset-backed bonds and bad loans. The 12-member AMEX Securities Broker/Dealer Index has fallen 13% since the start of June, while the Standard & Poor's 500 Index was little changed.
``Who knows how bad the balance sheets are,'' Rogers said. ``They took on gigantic amounts of bad paper.''
...Rogers said he made the investments using his own money. He declined to say how much he oversees.
The slump in the U.S. housing market ``still has a long way to go'' before recovering, he said. ``Market excesses don't clear themselves out in just four or five months; they take years.''
Sales of previously owned homes in the U.S. dropped 8% in September to 5.04 million, the lowest since record-keeping began in 1999, the National Association of Realtors said Oct. 24. Rogers said he started shorting U.S. home stocks three years ago.
Now another link in the consumer debt chain - credit cards - is starting to show signs of strain. And the fear that the $915 billion in U.S. credit card debt (an uncannily similar figure) may blow up has major financial institutions like Citigroup, American Express, and Bank of America strapping on their Kevlar vests.
... ... ...If there is an international precedent the U.S. should be watching, it's actually that of the U.K. British consumers are just as overstretched as Americans, but since the real estate market there rose faster and fell earlier, they're about 18 months ahead in the credit cycle. Since the last quarter of 2005, credit card delinquencies and charge-off rates in Britain have risen as much as 50%, forcing banks to take huge write-offs.
It's a sign of the times that, according to one survey last month, 6% of British homeowners have been using their credit cards to pay their mortgages. That's suicidal, of course, given that credit card interest rates are more than double even the heftiest mortgage. Keep your fingers crossed that it's not a trend that crosses the Atlantic.
The latest potential problem child in SIV world is Gordian Knot (which, until last Wednesday, had not appeared in the news). Bloomberg reported that Gordian Knot, a London investment house, completed a small financing of about $20 million, which is a rounding error.
I don't know why they even bothered. Gordian Knot has about $58 billion in SIVs outstanding, and Fidelity has about 4% of its money-market funds invested in Gordian-Knot-generated paper. This explains why Fidelity may be willing to be involved in the super-SIV bailout program.
October 28 2007 | FT.com
The falling dollar generates anxiety almost everywhere. Americans and those dependent on American growth worry about the proverbial “hard landing” as inflation and interest rates rise with a weakening dollar, causing asset prices and output to fall. Europeans and others with currencies that float freely against the dollar worry that their currencies will bear a disproportionate share of the dollar’s decline and appreciate too far, leading to competitiveness problems. The falling dollar risks rising inflation, asset bubbles and the loss of macroeconomic control in countries that have tied their currencies to the dollar’s sagging mast.
The dollar’s decline may provoke anxiety but it should not be a surprise to anyone who has followed the global economy in recent years. History suggests that periods when a country’s economy turns down, short-term interest rates are declining and financial strains are increasing are likely to be periods when a nation’s currency depreciates. Moreover the US current account has for years now been financing consumption rather than investment, with the financing coming increasingly from debt rather than equity and shorter rather than longer-term debt.
Banks shut out of the market for short-term loans are finding salvation in a government lending program set up to revive housing during the Great Depression.
Countrywide Financial Corp., Washington Mutual Inc., Hudson City Bancorp Inc. and hundreds of other lenders borrowed a record $163 billion from the 12 Federal Home Loan Banks in August and September as interest rates on asset-backed commercial paper rose as high as 5.6%. The government-sponsored companies were able to make loans at about 4.9%, saving the private banks about $1 billion in annual interest.
To meet the sudden demand, the institutions sold $143 billion of short-term debt in August and September, according to the FHLBs' Office of Finance. The sales pushed outstanding debt up 21% to a record $1.15 trillion, an amount that may become a burden to U.S. taxpayers because almost half comes due before 2009.
The government is ``taking a lot of risks through the Federal Home Loan Banks that are unnecessary,'' according to Peter Wallison, a fellow at the American Enterprise Institute, a Washington-based organization that analyzes public policy, and general counsel at the Treasury Department from 1981 until 1985.
The home loan banks, known as FHLBs, are increasing risks to taxpayers by assuming the role as a lender of last resort, said Wallison. That's the job of the Federal Reserve, he said.
Big US commercial banks have seen $280bn of new debt come on to their balance sheets since the credit squeeze, threatening to undermine economic growth by inhibiting their ability to make new loans.
The banks have been forced to take on to their books large amounts of commercial paper and leveraged loans after investor demand for such assets dried up in the summer.
David Rosenberg, economist at Merrill Lynch, said that this amount had risen to $280bn since the start of August.
He added that according to data from the Federal Reserve, large bank capital - represented by net assets - had declined by $40bn since the beginning of August. "This has never happened before over such a short timeframe and this is rather serious because such a steep and sudden compression in large-bank capital has the potential to create a negative lending environment," he said.
If left unchecked, this could "significantly inhibit" economic growth, he added.
European banks are facing similar pressures with many observers expressing concern at the ability of some smaller lenders to handle the potential strain on their balance sheets.
... ... ...
According to Moody's, the credit rating agency, assets held by bank-sponsored special investment vehicles fell to $320bn from $395bn in July.
"The large banks have been forced to take commercial paper back on their balance sheets and as a result are choking on assets they did not plan on having - thereby tying up regulatory capital and in turn possibly leading to a reduction in credit extension," said Mr Rosenberg.
He pointed out that 30% of the growth in the debt that US households took on was backed by asset-backed investors.
Americans may soon discover something with which older Brits are all too familiar. A weak currency reaches a certain point when something snaps and it can spiral down, almost out of control. Then interest rates have to be raised, dramatically, to save the currency. Domestic considerations go out of the window.
America has been so almighty for so long, until recently, that it's leaders have little idea what might be coming, although the public, as evidenced by the lady poster from Middle America, has a sixth sense.Americans may soon discover something with which older Brits are all too familiar. A weak currency reaches a certain point when something snaps and it can spiral down, almost out of control. Then interest rates have to be raised, dramatically, to save the currency. Domestic considerations go out of the window.
America has been so almighty for so long, until recently, that it's leaders have little idea what might be coming, although the public, as evidenced by the lady poster from Middle America, has a sixth sense.
Many of the most dubious assets were, indeed, held by hedge funds. But most hedge funds obtain their finance from the banks and 60% of hedge-fund assets are handled by three prime brokers (all of which are big investment banks). In addition, hedge funds own the same assets as banks' trading desks. This means that when the hedge funds are forced to sell, the trading desks are likely to lose money.
Similarly, the SIVs and conduits were not wholly independent of the banking system. Conduits were “off balance-sheet vehicles” that allowed banks to be exposed to complex bonds without requiring them to hold reserves against them. Many SIVs were operated by banks, had banks as investors or had arrangements to call on bank financing when their conventional sources of liquidity failed.
Hedge-fund veteran Rick Bookstaber, the author of A Demon of Our Own Design, spells out a potentially disastrous scenario that could unfold regardless of what the Fed does: Continued foreclosures result in a further drop in housing prices, which results in further foreclosures, which result in a further drop in housing prices. Even for those of us not selling, reduced home values result in a reduced sense of security, which results in reduced consumption, which results in a slowing economy, which … you get the point.
Fundamentally speaking, the ongoing mad dash out of dollars into Euros is misguided.
My rationale is:
1) Europe is printing money faster than the U.S.
2) Credit in Europe is expanding as fast as in the U.S.
3) Interest rates are higher in the U.S. than Europe (at least for now).
A mad dash into Yen would make more sense from a monetary perspective, but that play is avoided because interest rates in Japan are too low.
Eventually, all currencies (except gold) go to zero. The only difference is the speed at which they get there. Warranted or not on relative merits, the U.S. dollar is winning the race among major currency pairs.
...losses from Citigroup's investments backed by mortgages climbed to $1.56 billion for the quarter. That was well above the $1.3 billion loss the company had pre-announced just weeks earlier.
The damage was similar at other big banks:
... ... ...
But the most stunning news -- and the most troubling indicator that credit problems aren't limited to the mortgage market anymore -- came from the credit card companies. Because these lenders have neither direct nor indirect exposure to the mortgage market, the trends here are an indicator of what's happening with consumer credit outside mortgages. And the news in the third quarter wasn't good.
For example,, in its Oct. 22 third-quarter earnings report, put aside an additional $196 million in the third quarter, a 44% jump from the end of the second quarter, for loan losses in its credit card portfolio. The company's total provision for loan losses climbed 25% in the quarter to $982 million. Outstanding loans climbed 23% for the quarter, trailing both the %age increases in credit card and total loan-loss provision.
... ... ..
If consumers who are in good shape decide to cut back on spending in order to reduce their credit card balances, that would take a considerable amount of spending out of the economy. There is some evidence that this has started to happen. Repayment rates are running about 1%age point above their long-term average, according to Bankstocks.com. And credit card utilization rates -- the amount of available credit that consumers actually use -- are near 15-year lows. [ That's misleading: when anybody can have 20 or 30 credit card credit utilization tells you nothing -- NNB]
... ... ..
..banks have been increasing the rates they charge on cards:
- Regular monthly interest rates are going up.
- Penalty interest rates are going up -- to as much as 34% in some states -- for cardholders who make even one late payment.
- More cards are adding a universal penalty clause where missing a payment on one card you hold can trigger a rate increase on all your other cards.
- Late fees have zoomed and so have over-limit fees.
- Grace periods that allow you to pay before interest charges kick in are getting shorter.
- It's harder to get a credit card company to raise a credit limit on an existing card, and new card offers come with lower initial credit limits.
We're witnessing the very early stages of a classic credit crunch in the credit card market.
It's too early to tell if the crunch will get crunchy enough to take a %age point or two out of the 1.9% growth rate projected for the U.S. economy in 2008. But in this part of the debt market -- as in so many others from mortgages to buyout loans -- the trend is clearly toward less available and more expensive credit. That's never a recipe for faster economic growth.
We are presently spending more than we earn and borrowing more than we can ever pay back, which is totally irresponsible and calls for major changes to our economic policies.
If our debt lenders decide to pull the loans that in recent years have been the primary support of our economy, we will have a black day in our markets and economy that will surpass anything previously experienced in America.
Without these loans, our ability to function as a society will grind to a halt and our future standard of living will dramatically decline.
It is time for us as Americans to demand that our leaders adopt a platform of fiscal and common sense policies to reduce our deficits, implement mandatory savings (like Peterson suggested) and reinvigorate American industry.
The U.S. Dollar Index, measuring the dollar's performance against six major peers, has lost 8% in 2007 and set a record low of 76.977 on Oct. 26.
...A government report on Oct. 31 may show U.S. gross domestic product slowed to an annualized 3.1% growth rate last quarter, from a 3.8% clip in the prior quarter, according to the median estimate in a Bloomberg News survey.
Sales of previously owned homes fell 8% last month, while the median price dropped the most in almost a year, the National Association of Realtors said this week. Countrywide Financial Corp., the biggest U.S. mortgage lender, reported its first quarterly loss in 25 years yesterday as borrowers defaulted.
``We had a string of pretty ugly numbers, both from the real economy side and the financial side,'' said Alan Ruskin, head of international currency strategy in North America at RBS Greenwich Capital Markets Inc. in Greenwich, Connecticut. ``That is weighing on the dollar.''
"I would suggest that....the recovery may be a relatively gradual process and these markets may not look the same when they re-emerge," Kroszner said in a speech to the Institute of International Bankers.
Trading in some derivatives, such as collateralized loan obligations, or CLOs, and collateralized debt obligations, known as CDOs, has ground to a virtual halt since August.
Comments by the readers:
"Put simply, investors suddenly realized that they were much less informed than they originally thought," Kroszner said.
= Had been conned
It's interesting to note that individuals who helped give birth to derivatives, such as Richard Bookstaber and Satyajit Das, are now warning of their dangers. Bookstaber told the Wall Street Journal back on May 18 that because of derivatives, "The odds are pretty high that we'll see other dislocations that match the type of turmoil we saw with the crash in 1987 and with the LTCM crisis." Das is telling whoever will listen that the U.S. is on the verge of a bear market of epic proportions because of credit derivatives.
It used to take a long time before a system became corrupted and dominated by scam artists but not anymore. There are so many people working at careers that bring no value to America that new schemes become corrupted overnight. These CLO and CDO ideas were effectively corrupted out of existence by scam artists, none of which will go to jail. Welcome to the new America, crime isn't just for the inner cities anymore.
"In the months ahead, the Federal Reserve will continue to monitor developments in the financial markets and act as needed to support the effective functioning of these markets and to foster sustainable economic growth and price stability," Kroszner said.
HaaaaaH! I love it! Go Ron Paul 2008! Slam the banksters!
World oil production has already peaked and will fall by half as soon as 2030, according to a report which also warns that extreme shortages of fossil fuels will lead to wars and social breakdown.
The German-based Energy Watch Group will release its study in London today saying that global oil production peaked in 2006 - much earlier than most experts had expected. The report, which predicts that production will now fall by 7% a year, comes after oil prices set new records almost every day last week, on Friday hitting more than $90 (£44) a barrel.
... ... ...
The results are in contrast to projections from the International Energy Agency, which says there is little reason to worry about oil supplies at the moment.
However, the EWG study relies more on actual oil production data which, it says, are more reliable than estimates of reserves still in the ground. The group says official industry estimates put global reserves at about 1.255 gigabarrels - equivalent to 42 years' supply at current consumption rates. But it thinks the figure is only about two thirds of that...
... ... ...
Yesterday, a spokesman for the Department of Business and Enterprise said: "Over the next few years global oil production and refining capacity is expected to increase faster than demand. The world's oil resources are sufficient to sustain economic growth for the foreseeable future. The challenge will be to bring these resources to market in a way that ensures sustainable, timely, reliable and affordable supplies of energy."
Sep 28, 2006 | Asia Times
The United States is a debtor nation, just like the poorest states in Africa, Latin America and Asia. Since the fourth quarter of last year, US citizens and businesses have paid more dividends, interest and the like to foreigners than they have received from abroad.
September retail sales was a gain of 5.0% versus 3.8% in August, before any inflation adjustments", but that inflation is getting so bad that it "could wipe out much of the reported sales gain, after adjustment for pricing increases".
...Four trillion bucks a year in current and deferred federal government spending! A third of GDP! Yikes!
And it gets worse than that, believe it or not, as we learn from Chuck Butler of Everbank, who reports in his famous Daily Pfennig missive that (to paraphrase) the economy is crap, and the budget deficit is going to get worse, in that "Treasury issuance is expected to rise 50% this year! OUCH! It seems the slowdown that no one wants to admit is happening has reduced tax receipts for the first time since 2003."
There seem to be some misconceptions about the monetary consequences of actions that the Federal Reserve has taken to address liquidity needs.
Tomorrow I will attempt to put together what's at risk with SIVs, but that discussion leaves out "Marked to Fantasy". It also leaves out "Marked to Matrix". It also leaves out an impossible to sort out derivatives mess. I talked about derivatives in Genius Fails Again. Here is a short snip.
"Notional amounts of interest rate derivatives outstanding grew almost 14% to $285.7 trillion in the second half of 2006." Look closely at that figure. Yes, that is trillion not billion. And that numbers was from 2006. It is higher today. Is it any wonder the Fed is spooked?Estimates for the current notational amount of derivatives run anywhere from $300 trillion to $500 trillion. Given that accounting rules for banks differ from other corporations and differ still from offshore hedge funds, it is impossible to say what %age of the combined picture is actually market to market, or how big the entire mess really is.
I am confident of one thing: The combined mess is simply too big to bail.
I'm more optimistic than many of my peers, but I admit that there's a significant risk of recession. Before getting into a forecast, let's talk about why I'm not forecasting a recession. The burden of proof relative to a recession forecast lies on the person forecasting a recession. Most of the time we are not in recession. Over the last few decades, they've been arriving about once every 10 years, but even before that, they were only coming once every five years, and lasting less than one year. So the odds are that if you pick a day at random, it will not be a day in a recession. The person forecasting a recession has to tell a story about why we'll be in recession.
Lots of recession stories just don't work, though they are common. We have too much debt. We'll, we've had "too much debt" for years with no sign of collapse. The federal deficit is too large. It was even larger coming out of World War II, with no ill effect. Globalization. But the world economy is booming--how can that be bad for us? Falling dollar: theoretically and historically positive for the economy, not negative.
There are a couple of stories that I find credible--not overwhelmingly persuasive, but credible enough that we should all worry. First, the weak housing market spills over into consumer spending. Note that housing itself is not a big enough sector to cause a recession. However, spillover into consumer spending could trigger a recession. Certainly the growth rate of consumer spending has declined, but total spending is not falling, merely growing at a slower rate.
Home price appreciation, which seems to be the most likely issue related to consumer spending, peaked in 2004 (quarter over quarter calculation) or 2005 (year over year calculation). If we were going to see a recession, I think it would be here by now.
The other good reason for worrying about recession is spillover from the financial problems associated with the housing weakness, especially sub-prime loans. What I hear, however, is that standard-quality borrowers can still get credit. That applies to consumers looking for credit cards, car loans, or mortgages, as well as businesses. Even homebuilders, I'm told, are subject to the same credit standards as six months ago (though fewer of them meet the credit standards these days).
So I don't see spillover from housing problems being large enough to trigger a recession. There's enough spillover that my forecast is for sub-par growth, in the two to three % range, for the next four quarters. And I'm continuing to recommend contingency planning for recession, but I ALWAYS recommend that. However, businesses should be planning on increased sales and the need for increased capacity. Companies that hunker down at this time are more likely to lose market share than improve their positions.
Technorati Tags: contingency planning, economic forecast, housing, recession, subprime credit
The ... bankers hatched the idea of setting up a fund that would issue short-term commercial paper and medium-term notes to investors, then use the money to buy higher-yielding assets, typically longer-term ones. The bank would profit by collecting fees for operating the fund. The fund's assets would belong to its investors, so they would stay off the bank's balance sheet. SIVs had an advantage over conduits, a similar structure that was already gaining popularity: They didn't require banks to cover fully the fund's debts if the commercial-paper market dried up.
Wachovia Corp.'s third-quarter net income dropped 10% as loan-loss provisions quadrupled and the company recorded $1.3 billion in losses and write-downs. Wachovia also signaled increasing credit troubles ahead.
My comment: This is indeed how banks ducked the ownership rule. And now that Citigroup has bent every rule under the sun to avoid Post-Enron Rules, it now is seeking a bailout that will allow it to do exactly what Enron was doing: hide a horrendous balance sheet and in effect keep two sets of books. Paulson calls this a "market based solution". It is anything but a market based solution. The true definition would be called Enron Accounting at Citigroup Sponsored by the Treasury.
How Big is the Problem at Citigroup?
With a hat tip to Polecolaw for the idea, let's compare net tangible assets at Citigroup to the amount at risk at SIVs and conduits. Let's use $160 billion figure for the combined SIV and conduit numbers and see what comparisons we can find.
Citigroup Net tangible assets as of June 30 2007 are $65.5 billion. That's kind of interesting isn't it? Citigroup has $65.5 billion in net tangible assets but $160 billion invested in off balance sheet SIVs and conduits.
If a fire sale of those SIVs and conduits resulted in a 25% loss, Citigroup would have net tangible assets of $25.5 billion. If a fire sale of SIVs and conduits resulted in a 41% loss in those SIVs and conduits, Citigroup would have zero net tangible assets.
Does Paulson, the Fed, or Citigroup want to find out what those assets are worth? Of course not. That is the reason for a Don't Ask - Don't Sell policy and approval of Enron Style Accounting by Paulson.
Mike Shedlock / Mish
In three of the past four rate-cut cycles, stocks actually fell in the six months following the first drop in rates. Sam Stovall, chief investment strategist for Standard & Poor's, points out that following the first Fed rate cut in 1990, stocks sank nearly 14%. "So you never know," he says.
More turbulence, in other words, is a distinct possibility. And, collectively, investors are heading into this uncertain period with highly aggressive portfolios. Employees in 401(k) plans recently held nearly 70% of their accounts in stocks, marking their biggest bet on equities since July 2001, according to Hewitt Associates. What's more, many of those portfolios have gravitated toward some of the riskiest types of stocks.
...After several years of big gains in riskier types of equities, "the average investor is probably overweight emerging markets and small-cap stocks," says Richard Bernstein, chief investment strategist at Merrill Lynch.
...Another option is simply to seek out funds that have a long-term track record of bumping up and down less than their peers. We've done that for you. Within the Money 70, Dodge & Cox Income, Neuberger Berman Fasciano, Selected American, Vanguard Emerging Markets Stock Index and Vanguard International Growth are examples of funds with relatively smooth, consistent track records.
...by going from an aggressive 80% stock-20% bond portfolio to a 60-40 mix - and using Money 70 low-risk funds - your worst short-term losses would have been cut in half over the past 10 years.
... a 60-40 strategy utilizing the Money 70 funds cost you about 0.3 %age points a year for the past decade
Diana Olick chronicles some aspects of the truly ugly housing and general recession occurring in Michigan. Detroit home prices down 32%, one foreclosure for every 29 homes, local subprime implosion and an auction where homes are being sold for the price of a new sofa! Could this be a harbinger of things to come?
Originally aired on: 10/9/2007 on CNBC.
Federal Reserve Bank of St. Louis President William Poole spoke Tuesday before the Industrial Asset Management Council. In the Q&A session, a member of the audience posed the follow question:
“Dr. Poole, on M3 - I believe it is a number the government doesn’t now publish - what effect do you think the amount of money we’re printing and putting into the economy – what effect does it have as far as devaluing the dollar in the world markets.”
Dr. Poole’s response:
“The Federal Reserve stopped publication of M3 a year or so ago… It was after extensive exploration of whether anybody actually used the measure. We didn’t use it internally and we decided that very few people actually used it… Now that is not in anyway directly related to the other question you asked about the depreciation of the dollar.
The depreciation of the dollar is something that is not explicable. And the way I like to phrase this – I like to put my academic hat back on. If you look at academic studies of forecasts of the exchange rates across the major currencies, you find that the forecasts are simply not worth a damn. Your best forecast of where the dollar is going to be a year from now is where it is now. There is no model that will beat that simple model. And people have dug into this over and over again. Obviously, you can make a ton of money if you were able to have accurate forecasts. No one has been able to come up with a forecasting methodology that will make you a lot of money. And you can’t make money under the forecast that the dollar is the same as it is right now a year from now. I can go a step beyond that though – and this is what I think is really interesting. The academic literature is also full of papers trying to explain exchange rate fluctuations after the fact – after you have all the data that you can put your hands on – data that you can’t accurately forecast, but data that after you get your hands on it might logically explain the fluctuations of currency values. And those models aren’t worth a damn either. We cannot explain the fluctuations of currencies after they have occurred even with all the data that we can dig out. And therefore, to me, it’s completely unsupported idle speculation not only to make the forecast but to talk about why the dollar has behaved as it has. I know the financial pages and the traders love to talk about that, but I would challenge any of them to construct a model that would stand up to a peer review journal in economics or finance. The models just aren’t that good.”
A post-event question from a Bloomberg reporter: “I was hoping you could elaborate a little bit on the implications of the weakness in the dollar right now… whether implications on inflation or just the economy in general.”
Dr. Poole: “I don’t see any implications for inflation, at least with the magnitude of the depreciation that we’ve seen so far. The evidence is that – there’s a literature that looks at what’s called “pass through” – pass through of changes in domestic prices. And the evidence is that the pass through coefficient has gotten small and smaller.”
Dr. Poole and the Federal Reserve more generally are at this point succumbing to Not So Benign Neglect of our nation’s currency. For a top U.S. central banker to claim today that the dollar’s ongoing five-year devaluation is “inexplicable” is simply hard to swallow. And to seemingly dismiss analyses of the predictably deleterious currency effects stemming from unprecedented Credit excess and resulting Current Account Deficits (as “completely unsupported idle speculation”) is barren central banking. I would also suggest to Dr. Poole that there surely won’t be a single hedge fund manager or Wall Street proprietary trader interested in submitting an academic paper on the issue of forecasting the dollar: they have been and remain far too busy making enormous and easy speculative profits from dollar debasement.
The nature of Dr. Poole’s dismissal of currency-induced inflationary ramifications is further indicative of what are increasingly evident deficiencies in our “academic” Fed. September’s 4.4% y-o-y increase in the Producer Price Index follows yesterday’s report of a 5.2% y-o-y jump in the Import Price Index (monthly imports running almost $200bn!). And with crude trading today above $84 for the first time – and commodities indices recently breaking out to new record highs – this is not the time for inflation complacency. Surging energy costs have already spread to the food complex and beyond. The nature of Inflation Dynamics will now ensure more pronounced “knock-on” effects throughout. It is also worth noting that the Baltic Dry Freight cost index this week increased y-t-d gains to 140% (up “fivefold since 2003”). Especially with China, India and greater Asia’s heightened inflationary backdrop, to not expect a meaningfully higher “pass through” from foreign manufactures is wishful thinking, suspect analysis, and regrettably poor central banking.
While on the subject of less-than-exemplary central banking, this week’s improved Trade Deficit is deserving of a brief comment. It has been the Greenspan/Bernanke doctrine to view the weakening dollar as an integral facet of an expected long-term gradual adjustment in global imbalances - including our Current Account position. As such, August’s better-than-expected $57.6bn trade shortfall (vs. year ago $67.6bn) – with Goods Exports up 13.2% y-o-y compared to a 2.4% gain in Goods Imports – might be viewed as confirming the merits of the gradualist approach.
Not surprisingly, the dollar barely budged from multi-decade lows despite the positive trade news. At this point, any marginal beneficial improvement in trade-related financial flows is inconsequential when compared to the massive scope of speculative finance these days seeking to profit from further dollar depreciation. The fact of the matter is that the “gradualist” approach completely failed to anticipate that multi-year dollar debasement would stoke powerful Inflationary Biases throughout "Un-dollar" asset classes (certainly including currencies, commodities, international real estate, global equity and debt securities, and art/collectables). And once Bubbles take hold…
The fateful flaw in U.S. central banking has been to focus on a depreciating dollar as the key mechanism for rectifying excesses and imbalances, while completely disregarding Credit and financial excesses. It was an easy – seemingly painless – expedient that had no chance of success. The pressing need to commence the process of financial and economic adjustment (“pressing” in respect to the nature of escalating distortions and structural impairment) required policies that would directly alter financial developments and restrain excess.
Instead, a declining dollar within the backdrop of Federal Reserve accommodation worked only to further bolster distortions and imbalances both at home and abroad. It can be viewed as the worst of all policy courses – virtually condoning a system of escalating Credit and speculative abuses, while ensuring a major additional element (our weak currency) supportive of global excesses. To be sure, Destabilizing Monetary Processes and Monetary Disorder sprang from the confluence of booming Wall Street finance, the burgeoning leveraged speculator community, and rapidly escalating Inflationary Biases and Bubble Dynamics throughout global Credit and economic systems. Weak dollar policies could not have been more Bubble friendly.
Confronted abruptly this summer with Acute Financial Fragility, the Fed in both words and deeds again aggressively accommodated Bubble perpetuation. It is important to compare and contrast the current “reliquefication”/“reflation” with the previous episode. First, and foremost, when the Fed began aggressive post-tech Bubble “mopping-up” accommodation in early 2001, the dollar index traded near 120 (today 78.22). Approaching $6.0 TN, international reserves assets have inflated about three-fold since 2001. Chinese reserves have ballooned from about $170bn to $1.434 TN. The price of oil is up almost three-fold; gold almost the same. The price of copper has inflated from about $80 to $350, lagging some of the other industrial metals. The price of wheat is up more than three-fold. The Goldman Sachs Commodities index rallied from 250 to 550. Brazil’s Bovespa equities index has inflated from about 15,000 to 62,500; the Mexican Bolsa 5,000 to 32,500; Russia’s RTS 130 to 2,100; the Shanghai Composite from about 2,000 to 6,000; and India’s Sensex 4,000 to 18,000.
The median price of a home in California began 2001 at about $244,000, before topping out this April at $597,640. Contrarily, after spiking to 4,816 in March of 2000, the NASDAQ100 did not trade back above 2000 for more than seven years. Post-tech Bubble liquidity (characteristically) avoided the technology sector like the plague. After all, a much more enticing Inflationary Bias was gaining momentum with fledgling Mortgage Finance and Housing Bubbles (“Liquidity Loves Inflation”). The Fed may have believed it was conducting appropriate “mopping up” policies, but commanding Financial Structures ensured that it was more a case of Bubble accommodation.
The serious issues associated with the current “reflation” are many. For one, the dollar is structurally quite fragile while the most robust Inflationary Biases are in non-Dollar Asset Classes. Previously, Fed reflationary policies provided a competitive advantage for U.S. risk assets that worked to incite sufficient financial flows to support or even boost the greenback. This proved a huge ongoing advantage for our expansionary Credit system. Today, the negative ramifications associated with dollar weakness more than offset the Fed’s capacity to inflate U.S. securities prices. The Fed’s recent rate cut proved a bonanza for most foreign markets (currencies, commodities, equities, bonds, etc.), especially relative to dollar-denominated mortgage securities (the previous Bubble asset class of choice).
The Flow of Finance will now pose extraordinary challenges and risks. The unfolding mortgage crisis (especially in “private-label” and jumbo) will prove stubbornly immune to “reliquefication” benefits. This dynamic places home prices, the consumer balance sheet, and the general U.S. economy in harm’s way. At the same time, there are the stock market Bubble and an acutely vulnerable dollar. I will presuppose that the Fed is hopeful to ignore equities and currencies, while operating monetary policy with a focus on the Credit market and real economy. Such a policy course, however, implies at this point much greater currency, market instability, and inflationary risks than our central bankers seem to appreciate.
I would furthermore contend that the nature of current Risk Intermediation is seductively problematic. On a short-term basis, enormous bank and money-fund led financial sector expansion has been sufficient to over-inflate non-mortgage Credit. It’s been too easy - and Credit to sustain the boom too risky. Meantime, post-Bubble risk aversion festers in mortgage-related finance that will creep ever-closer to spilling over into an economic downturn and a reemergence of financial turbulence. We can expect foreign demand for our risk assets to remain tepid at best.
Despite current market euphoria, these processes are significantly elevating the systemic risks associated with today’s ballooning financial sector balance sheet. A stock market Bubble beset by destabilizing speculative dynamics only compounds systemic vulnerabilities. Such a backdrop seems to beckon for a currency crisis, a risk that leaves our Federal Reserve policymakers with much less flexibility than they or the markets today appreciate. There are major costs associated with Not So Benign Neglect. The Fed had better at least start sounding like they’ve thought through some of the issues.
On Friday, several pieces of key bank data were reported by the Federal Reserve:
First, for August, non-mortgage consumer debt rose at an annual rate of 5.9%, up from 4.7% in July. The bulk of the increase came from revolving debt, principally credit cards, which rose at 8.1% versus 7.5% in July.
To frame the revolving credit figure, here is some historical data:
That credit card debt growth is accelerating at a time when retail sales growth is slowing suggests that more consumers are turning to their cards to finance their basic monthly cash flow. As I have said previously, it appears that the credit card banks have become the consumer lender of last resort. How long this can continue, particularly with the slowdown in personal income growth, (from 0.9% monthly income growth in January to 0.3% in August) remains to be seen.
Year Annual Growth Rate 2003 2.3% 2004 3.8% 2005 3.1% 2006 6.3% June 2007 7.1% July 2007 7.5% August 2007 8.1%
The outlook is uncertain for metals - for the first time since the bull market started in 2001, analysts agree that the days when metal prices rose in harmony are now over. The threat of a US economic slowdown is casting a long shadow and it’s not clear whether the continuing boom in China will be able to sustain current prices.
Cast your mind back – if you can – to the fevered days of the early 1980s, writes the FT’s Tony Jackson in his Monday column. Then, the Aden sisters were everyone’s favourite oracle - for a while - on gold prices.Their prescience seemed uncanny. They said gold would go to $850 and it did. They said it would fall to $300 and it did. Then they made the tactical error of saying it would go to $4,000 and it did not. So they relapsed into obscurity.
How different things are today, notes Jackson. Most commodities, gold among them, have been racing away again. But in judging such things, we no longer rely on a couple of weird sisters in Costa Rica. We go by logic and fundamentals. Well, sort of. There are several possible reasons for a rising gold price, such as a reluctance by rich individuals to entrust cash to today’s banking system. But the most popular reason – fear of inflation – seems less than logical.
We would expect fear of inflation to show up elsewhere, most obviously in the yield gap between inflation-linked Treasury bonds (TIPS) and conventional Treasuries. For if we take the yield on TIPS to be real, the gap represents inflationary expectations.
- Since the start of this year, the gold price has risen 15 per cent, while the TIPS spread has not risen at all.
- Since the start of last year gold is up some 40 per cent, and the TIPS spread has actually fallen.
- In any case, who said gold was an inflation hedge? The price today is about $730 per ounce. When the Aden sisters were on the case it hit $875. Adjusted for US inflation, the price has fallen 60 per cent.
To Jackson, this seems symptomatic:
At a Commodities Week conference in London last week, I heard various fund managers talking up commodities as an asset class. Most of their logic seemed pretty flaky as well.
Much was made of the lack of correlation between commodities and other assets. It was worth accepting a lower return on commodities than on fixed interest, we were told, because they behaved differently from bonds and equities.
That was why pension funds started moving into them five years ago.
But the single biggest headache for pension funds five years ago, recalls Jackson, was that bonds and equities were behaving differently from each other. As they parted company, so liabilities rose and assets fell.
Diversification, in other words, “means different things at different times,” he notes.
That apart, the conference was a handy reminder of how far the commodities bull story relies on guesswork. In particular, “we were told that even if the US economy succumbs to its housing crisis, the rest of the world – for which, read China – will be unaffected”.
There is simply no means of knowing that, since we are in new economic territory.
Nor do we know whether the recent strength in commodity prices is structural or cyclical. But a word of warning came from David Humphreys, who as chief economist first with Rio Tinto and now with the nickel giant Norilsk has seen more cycles than most.
The base metals industry is crucially exposed to time-lags, he noted. Both supply and demand are inelastic and lead times are long. In the last cycle, the copper price peaked in 1995. But capital expenditure kept rising until 1997 and production did not peak until 2003.
This time, the cycle could prove more acute. In the 1990s, the psychology of the big mining companies was dominated by low growth expectations. When the present cycle kicked off in 2003, they were slow to grasp how things had changed.
When they did, they ran into the usual supply constraints caused by rising prices, only worse.
But there are now enormous projects under way. For the next three or four years at least, big increases in the supply of base metals are inevitable.
Meanwhile China forges ahead on the basis of cheap labour, free capital and – until lately – free use of the environment. It also consumes about three times as much base metals per unit of GDP as an advanced economy – for the meantime, anyway.
Could that all go wrong? “Search me,” says Jackson. But, he adds, “while it is easy to poke fun at the Aden sisters, it is slightly harder to spot the difference between them and their modern-day successors.”
This entry was posted by Gwen Robinson on Monday, October 8th, 2007 at 7:00 and is filed under Capital markets. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
Three Ways the Debt Slave Act of 2005 Will Fail
When the Fed, Congress, the FDIC, Countrywide Financial (CFC), consumer advocacy groups, and banks like Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC) are all acting to prevent "something" from happening, the logical conclusion is because it is in the best interest of the lenders for that "something" not to happen. The "something" in this case is foreclosure.
- Unemployment has bottomed. It has nowhere to go but up. Anyone losing a job will flunk the means test. Therefore lenders willing to make loans to poor risks will regret it sooner or later.
- Anyone with a job, looking at the fundamentals of debt enslavement, just might manage to lose that job on purpose.
- Many who do survive the system will strive to never run up a credit card balance again.
Sooner or later, those on the edge are going to realize that what everyone the above collective group wants (debt slavery), just might not be in their best interest. As more and more legislation is enacted (and silly ideas proposed) to prevent foreclosures, the greater the likelihood that people find a way around the measures.
Mike Shedlock / Mish
Want to get rid of your leveraged loans quickly? Don’t sweat. All you have to do is leverage up the leverage by creating a new vehicle. Let’s call them UFOs (or Unidentified Financing Objects).
These have a standard CLO structure, but they remain private, are controlled by the banks and are designed to help shift the catalogue of leveraged loans stuck on their balance sheets from financing deals.
Here’s how they work.
The bank holding the loans teams up with a hedge fund, or a buy-out group. Together, they create a UFO to buy selective loans at the current market discount, say 96 cents in the dollar, from themselves.
The bank, which owns the loans at par value, takes the write-off, but gets to hold on to the better quality debt tranches, which it can carry at a much lower cost of capital.
The hedge fund/buyout group takes the highly-leveraged “first loss” or an equity slice of the UFO, in the hope that it can make profit on the underlying loans when they return to par value at maturity or when the debt is refinanced.
The banks say these UFOs are a pure creative genius, that they do the market a favour by creating liquidity where there is none, and help lift the secondary prices of the loans by demonstrating demand.
Meanwhile, they can get a substantial return on the senior slices of debt - at least relative to their cost of funding and the risk capital they are required to hold.
But the credit squeeze means there are hardly any new CLOs to absorb the current loans on offer, so it’s only the bank-sponsored UFOs that can snap up these loans.
It’s like selling your house and giving the buyer the financing. Have you really offloaded it, and is the price a real market price?
These UFOs are not a reflection of real demand driving improving leveraged loan prices.
These new vehicles being created in a stagnant market are merely a stealthy way of financially-engineering the burden of costly risk away from the bank.
It all looks a bit like a close encounter with the wrong kind. Another leveraged solution to an already leveraged problem isn’t a way out of the credit crunch.
December 14, 2004 | Economic Policy Institute
The United States is currently borrowing $665 billion annually from foreign lenders to finance the gap between payments to and receipts from the rest of the world, an amount equivalent to $5,500 per American household. This borrowing entails serious costs for the U.S. economy. However, these costs have been hidden for the past few years, predominantly by the historically low interest rates, which resulted from the Federal Reserve’s attempts to spur economic recovery after the 2001 recession and from a downturn in domestic investment. This happy scenario will not persist indefinitely, and when interest rates rise, the costs of U.S. borrowing will have serious economic consequences:
• With no improvement in the current account deficit, the external debt of the United States will rise from 24% of total U.S. gross domestic product (GDP) at the end of 2003 to 64% by 2014.
• The cost of servicing just the additional debt incurred from 2004 to 2014 will rise to 1.7% of GDP by 2014, the equivalent of $250 billion in 2004 dollars.
Recent declines in the value of the dollar, while a welcome development, must be more broadly based among a larger cross-section of trading partners to bring the international accounts of the United States back into rough balance. Specifically, nations that actively manage the value of their currencies must allow the value of these currencies to rise vis-à-vis the dollar.
Will a subprime borrower be helped by the cut in interest rates? Will his or her adjustable-rate mortgage that is about to reset to a much higher rate suddenly become affordable? Will mortgage derivatives suddenly become tradable? Or will these illiquid derivatives be accepted as collateral once again for speculators to borrow money? We believe the answer is a clear no because the problems are prices, not access to money
Incidentally, in a recent speech in Germany, Bernanke pointed out that longer-term interest rates are likely to move higher. He thinks that we may see higher long-term interest rates within the next decade. In our opinion, we might be faced with higher long-term borrowing costs much sooner.
... ... ...
The Fed's policies are thus aimed at restoring profitability at US banks [ as backbone of the USA economy -- NNB]
Can someone please tell me what we need more of?
- Home Depots/Lowes?
- Pizza Huts/Restaurants of any kind?
- Strip Malls?
- Furniture Stores?
- Nail Salons?
- Office Supply Stores?
- Grocery Stores?
- Appliance/Electronics Stores?
- Auto Dealers?
In the latest issue of his (lengthy) subscriber monthly commentary on gloomboomdoom.com, Faber says that while he was never a particularly dedicated economics student, “one of the first economic laws I learned was that countries which have a relatively high inflation rate have weakening currencies”.
Considering the dollar’s sharp loss of value over the last few years, it would seem that US “inflation” is far higher than the “clowns at the Bureau of Labor Statistics would have us believe”, he notes.
In fixed income markets, many investors focus exclusively on estimates of expected payoffs, such as credit ratings, without considering the state of the economy in which default is likely to occur… We show that many structured finance instruments can be characterized as economic catastrophe bonds, but offer far less compensation that alternatives with comparative payoff profiles.
...The prioritization rule allows senior tranches to have low default probabilities and garner high credit ratings. However, it also confines senior tranche losses to systemically bad economic states, effectively creating economic catastrophe bonds… Securities that fail to deliver their promised payments in the “worst” economic states will have low values, because these are precisely the states where a dollar is most valuable.
... ... ...
Citigroup warned that third-quarter earnings will probably drop by 60%, as the nation's biggest financial institution takes more than $3 billion in writedowns for securities backed by bad mortgages and troubled loans for corporate buyouts. Swiss bank UBS also said Monday it will post a loss of up to $690 million in the third quarter, partly due to losses linked to U.S. subprime mortgages
... ... ...
The sharp increase in mortgage defaults, and the resulting damage to their loan portfolios and mortgage-backed bond holdings, provides banks with a strong cover to get as much bad news out of the way as possible. According to that view, while more loan problems may lie ahead, they won’t be as bad as those now being reported for three-month period just ended.
... ... ...
But not everyone is convinced the financial storm that all but shut down global credit markets in early August — and lopped nearly 10% off stock prices this summer — has passed.
“There will be more write-offs of this nature; this is a systemic crisis,” said Richard Bove, a veteran banking analysts now with Punk, Ziegel. “People simply don't believe that there is a crisis of this nature out there. They believe that basically the Federal Reserve can solve any problem whatsoever."
... ... ..
A weak dollar helps make U.S. products look cheap in foreign markets. And profits made in stronger foreign currencies look bigger when brought back home and converted into dollars. Roughly half the companies in the S&P 500 index earn a significant portion of their profits from overseas operations
“Economic growth is likely to continue in the near term, although at a slower pace,” said Ken Goldstein, labor economist for the Conference Board.
For growth to continue, however, Goldstein said there will be two potential hurdles to overcome — business confidence and the “wealth effect,” which has been hit by falling home prices.
“This loss of household assets, if combined with weak employment growth, could have a negative impact on consumer spending going forward,” Goldstein said.
Sep. 25, 2007 | Washington Post
... ... ...
Government central banks have two crucial responsibilities. The first is to control inflation, which can be hugely destabilizing. The rise of U.S. inflation from 1% in 1960 to 13% in 1979 caused four recessions of increasing severity. The other job is to prevent financial panics. These can devastate confidence and credit flows. Bank runs in the 1930s worsened the Great Depression, when unemployment peaked at 25%.
Unfortunately, these tasks can collide. The standard antidote for a bank run (people demanding their money back) is for the Fed to lend liberally to besieged banks so they can repay terrified depositors and quell the fear. But if the Fed is too lax with money and credit, it may feed inflation — resulting in the proverbial “too much money chasing too few goods.” Last week the Fed shifted its emphasis from fighting inflation to preventing panic. Was that the right call?
... ... ...
Sounds sensible, but it could be shortsighted. “The unemployment rate is 4.6%. Is that a crisis? Suppose it goes to 5%. It’s still not a crisis,” says economist Allan Meltzer of Carnegie Mellon University. “It sure looks like they’re responding to pressures from the markets, from Congress.”
Implicit in this view is that the economy and financial markets must periodically suffer setbacks. These remind investors to be prudent; they also check price and wage increases. A falling dollar last week (against the euro and the yen) suggests that inflation anxieties are not entirely abstract.
October 2 2007 | FT
International investor confidence in US markets will be damaged unless regulators rethink plans to give shareholders only limited powers to change the make-up of US company boards, a group of leading investors has warned.
The investors, who include the Australian Council of Super-Investors and the UK’s National Association of Pension Funds and manage $2,100bn in assets, have criticised the proposals from the Securities and Exchange Commission on board nominations by investors.
“The harsh reality is that US corporate governance practices are on a relative decline,” the group said in a letter to the SEC. “Political winds in the US have recently swung toward rolling back investor protections. This does not give us confidence about future rights of shareholders in the US.”
Corn futures gained 9.7% last month, and soybean futures climbed 14% in September, up 79% in the past year, after US farmers cut acreage 15% to a 12-year low. Wheat futures were up 21% for September towards $10 /bushel, the sixth straight monthly gain. Milk futures are up 70% from a year ago.
Crude oil prices rose 16% last quarter, the biggest quarterly %age gain since the first quarter of 2005. In US dollars, West Texas Intermediate is up 30% in the past year. Oil is up 16% in euros, 19% in British pounds and 26% in yen.
Oct 3, 2007 | naked capitalism/WSJ
What is remarkable about the present crisis is how traditional it is, despite the modern paraphernalia of securitised lending. We are seeing old-fashioned bad lending and old-fashioned mispricing of risk. What is remarkable, in addition, is the severity of the consequences. The US market in asset-backed paper contracted by 21 per cent between August 8 and October 1. The flight from risk also brought about big divergences between interest rates on commercial paper and US Treasury bills and between central bank interest rates and those in interbank three-month markets. This disruption, moreover, has taken place at the core of the world economy: the US housing market and debt markets of advanced countries.
... Shilling suggests that there may be significant revisions to employment and retail sales data leading to a more pessimistic picture and that the Federal Reserve is probably already planning to do two more rate cuts before the end of the year.
Originally aired on: 9/26/2007 on Bloomberg
But home construction, even with lower rates, is not going to turn around fast. At the peak of the market, we were building 2,000,000 new homes a year in the US. As the following chart from the Conference Board shows (thanks to Dennis Gartman), it is not unusual for housing starts to drop below 1,000,000, and this typically precedes a recession.
"As shown in the graph below, each time the year-over-year increase in Total Household Debt has dropped more than 40% below its recent peak, a recession (or in the case of 1967, a mini-recession) has occurred. The mid-1980's slowdown touched this level, but did not exceed it.
The current -38.9% level is approaching this boundary and, based on recent credit tightening by financial institutions, is likely to drop significantly below the -40% level....
The latest ISM report indicated that 11 industries reported growth in September: petroleum and coal products; apparel and leather products; electrical equipment, appliances and components; food, beverage and tobacco products; paper products; nonmetallic mineral products; chemical products; plastics and rubber products; computer and electronic products; transportation equipment and miscellaneous manufacturing.
The index of new orders dropped to 53.4 in September from 55.3 the previous month, and the index of new export orders also declined to 54.5 in September from 57.0 in August. The production index, meanwhile, fell to 54.6 from 56.1.
Still, the employment reading edged up to 51.7 last month from 51.3 in August.
The inventory index dropped sharply, registering 41.6 in September, the lowest since January, after a reading of 45.4 in August. The institute’s Ore said this suggested “the sector is apparently in excellent shape with regard to inventories.”
Nine thousand is too much for this country. That meant that there will be consolidation.
Unemployment in the U.S. probably rose to a one-year high in September and manufacturing slowed for a third month as the housing recession reverberated through the economy, economists said before reports this week.
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