|
Softpanorama |
May the source be with you, but remember the KISS principle ;-)
|
| Jan | Feb | Mar | Apr | May | June | July | Aug | Sep | Oct | Nov | Dec |
| There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present." |
| "No emergency can justify a return to inflation. Inflation can provide
neither the weapons a nation needs to defend its independence nor the
capital goods required for any project. It does not cure unsatisfactory
conditions. It merely helps the rulers whose
policies brought about the catastrophe to exculpate themselves."
-Ludwig von Mises |
| What we are seeing is "headless chicken syndrome". The same people
who bought into low yielding stocks are running away from them in the
same manner. That said there are underlying problems in both the US and UK economies, mostly due to house price inflation not being controlled. Where there is a silly boom there will always be a bust. |
| Superpower America is a ship of fools in denial of their plight.
While offshoring kills American economic prospects, “free market economists”
sing its praises. While war imposes enormous costs on a bankrupt
country, neoconservatives call for more war, and Republicans and Democrats
appropriate war funds which can only be obtained by borrowing abroad. Paul Craig Roberts, Nov 28, 2007 |
Fed Calls Regulatory Overhaul "Timely"
Reuters is reporting Treasury regulatory overhaul plan "timely".Upcoming Treasury Department proposals to make the Federal Reserve the chief regulator of U.S. financial markets and give it sweeping new powers won praise on Saturday from the central bank and the head of the Securities and Exchange Commission.Let's Take a Look at "Timely"
"The Treasury's report presents a timely and thoughtful analysis and is an important first step in the complex task of modernizing our financial and regulatory architecture. We look forward to working with the Congress and others to help develop a policy framework that will enhance financial and economic stability," a Federal Reserve spokeswoman said.
- Housing is imploding.
- There are $500 Trillion in derivatives that no one can possibly understand the financial risks on.
- A huge portion of those derivatives are with JP Morgan (JPM).
- Bear Stearns stock went from $170 to $10 in a year in Shotgun Wedding between Bear Stearns and JP Morgan arranged by the Fed
- Questions Linger Over Lehman's Balance Sheet as Lehman Brothers (LEH) is leveraged 31.7 times.
- Citigroup (C) had to be bailed out by Abu Dhabi Deal Raises Questions About Citigroup's Health
- Merrill Lynch needed $6.6 Billion Bailout From Kuwait, Mizuho.
- Cost of Capital "Ratchets Up" at Citigroup and Merrill
- Morgan Stanley (MS) sold 9.9% of the firm to China after handing out huge bonuses.
- People are walking away from homes
- Businesses Are Advised To Walk Away from agreed upon deals.
- There is an open public debate on Moral Obligations Of Walking Away
- 1 in 10 of the entire state of Ohio is on food stamps.
- Florida, Ohio, and Michigan are in an economic depression.
- There is No market for Asset Backed Commercial Paper (ABCP)
- German Banks Fears Global Meltdown caused by US subprime debt
- There is a $1.1 Trillion HELOC Problem
- Unemployment is poised to soar.
- Commercial real estate is massively overbuilt and poised to plunge.
- Goldman Sachs (GS) is calling for another $460 billion in writedowns.
- The SEC Openly Invites Corporations To Lie.
But I am not persuaded that anyone has done the right analysis. What matters is not so much how big the market cap of the various inflated assets got to be, but how much credit was extended against them. For instance, in Japan, corporations borrowed heavily against the value of urban land (Japanese banks would lend 100% against the nominal value), but unlike the US, homeowners did not have vehicles for extracting their inflated equity, so the residential real estate bubble did not have the same systemic impact that the commercial one did. Some very simple numbers would shed light on the debate. Moreover, we have far more leverage on leverage than Japan did (geared hedge funds and investment banks owning CDOs, which themselves were sometimes leveraged; hedge funds of fund adding another layer of borrowing on top of the borrowing at the hedge fund level). The debt to GDP ratio in the US is 270%, higher than the level before the crash of 1929, when it was 250%. What was the level in Japan in 1989?
Further, I am not certain a US GDP leverage measure tells the full tale. Per the wonders of our originate-and-distribute model, US mortgage and corporate paper is in a lot of foreign hands. Similarly, some levered players in our markets don't necessarily borrow from US concerns (think of all those London-based hedge funds, who probably borrow at least in part from foreign entities). And we also have various derivatives exposures which are not captured in any formal computations of leverage (that's going a bit far, but not by much, since Basel II give the banks considerable latitude in how the compute the equity that needs to be held against derivatives positions).
And to what degree do we offset Japan's very high domestic savings at the time of the crash against its bubble? Consider: even if our credit mess is on paper less bad, we aren't in a position to resolve it internally. Our continued and not-likely-to-reverse-anytime-soon dependence on foreign capital (we had better hope it doesn't change in the near future; the alternative is a dollar crash, which would wreak havoc here and abroad). That is a more complicated problem to parse.
Finally, the article mentions that the US does not face the risk of deflation. We are witnessing liquidity hoarding in the interbank markets. I already have economically literate readers who tell me that they are holding large cash balances at home our of fear of a bank holiday and are trying to find a bank they deem to be safe. A couple of bank failures and we could be well on the way enough withdrawals from banks to generate a money supply contraction, no matter what the Fed does with the monetary base.
That is a long-winded way of saying that the powers that be may be deriving false confidence from looking at incomplete measures of the financial service industry's gearing.
So back to the FT. in "Japan’s ‘lost decade’ offers dire pointers for the Fed," Gillian Tett and Krishna Guha argue that the big lesson from Japan was in the end, the government had to recapitalize the banking system and delay only made matters worse. Yet rescuing banks was highly contentious in Japan, and keep in mind that unlike here, banks were not highly profitable pre-crash and executives were not paid princely sums. In other words, they lacked the controversy of the financial services industry lining its pockets before it went belly up.
I came across this terrific post by Tom Engelhardt via Michael Panzner. Englehardt takes a cold, hard look at the Bush Adminsitration's performance and practices, and argues you don't need to be an economist to predict that whatever limited efforts they make to address the credit crisis are sure to fail. After all, everything they've attempted to accomplish had ended badly.
Comments
- Anonymous said...
- The home mortgage crisis that has Wall Street and consumers worried about an economic meltdown is prompting many in the U.S. Congress to come to the rescue of hard-hit states that just happen to be crucial to their own election-year success.
Florida, Ohio, Michigan and California have some of the highest concentrations of home foreclosures. They also are vote-rich states that congressional and presidential candidates need to win in November's elections.
http://www.reuters.com/article/bondsNews/idUSN2843835220080330
Americans are in for an Argentina moment when the currency collapses as this no pain ever entitlement society tries to spend itself into prosperity. "W" is just a wheel in the machine. The American people are getting what they deserve.
Anonymous said...
A recent USA Today/Gallup poll indicates that a startling 59% of Americans already believe we're heading for a long-term depression, not a recession (and 79% are worried about the possibility).
This is a very profound change in crowd psychology. The media is now bandying about the "D" word in a way that hasn't been seen before. It used to be socially frowned upon for the longest time to even mention the "D" word, and now it it has clearly become socially acceptable. Most people have never observed this prevailing level of fear in their lifetime.
This is no garden-variety recession (with a "V-shaped" recovery) as most economists still assume. The piper is about to be paid.
Mar 29, 2008 | nakedcapitalism.comThe US is acting more and more like a banana republic with every passing day. One of the characteristics of a banana republic is that it puts out flattering-to-the-point-of-being-unreliable data about its economy and important institutions.
Alert reader James Bianco pinged us about a new SEC release today and Floyd Norris of the New York Times' commentary on it, "If Market Prices Are Too Low, Ignore Them," Norris, who is usually pretty understated, disapproved of one of the items in the SEC letter, as do we.
Most readers probably know that accounting rule FAS 157 became effective as of January 1 of this year. It requires companies, subject to certain restrictions, to classify financial assets as Level 1 (easily valued by reference to market prices), Level 2 (doesn't trade actively, but similar enough to actively traded assets that can be valued in relationship) and Level 3 (known in the trade as "mark to model" or "mark to make believe"). Some financial firms opted to comply with FAS 157 early, which led to quite a few investment banks revealing that the value of their Level 3 assets exceeded their net worth.
In the last couple of months, there has been increased worry that mark-to-market accounting leads to the operation of a destructive "financial accelerator." As prevailing values go down, banks have to lower the value of their holdings. This leads to a direct hit to their net worth, which will lead them to contract their balance sheets, either by withholding credit or selling assets. More sales in a weak market lead to further declines in the prices of financial instruments, leading to more writedowns and sales of inventory.
Funny how no one had a problem with mark-to-market when asset prices were rising. The process in reverse leads to mark-to-market gains, higher net worths fueling balance sheet growth and credit expansion, which led to more demand for financial assets. That gives you higher securities prices which least to more mark-to-market gains. Sounds like a bubble, doesn't it?
The SEC's solution for the contractionary version of this dynamic is simple: ignore those market prices if they are too ugly. From the release:
Fair value assumes the exchange of assets or liabilities in orderly transactions. Under SFAS 157, it is appropriate for you to consider actual market prices, or observable inputs, even when the market is less liquid than historical market volumes, unless those prices are the result of a forced liquidation or distress sale (boldface ours).
Over the past 200 years, the stock market's steady upward march occasionally has been disrupted for long stretches, most recently during the Great Depression and the inflation-plagued 1970s. The current market turmoil suggests that we may be in another lost decade. The stock market is trading right where it was nine years ago. Stocks, long touted as the best investment for the long term, have been one of the worst investments over the nine-year period, trounced even by lowly Treasury bonds. The Standard & Poor's 500-stock index, the basis for about half of the $1 trillion invested in U.S. index funds, finished at 1352.99 on Tuesday, below the 1362.80 it hit in April 1999. When dividends and inflation are factored into returns, the S&P 500 has risen an average of just 1.3% a year over the past 10 years, well below the historical norm...
Yale economist Robert Shiller, who predicted the market trouble in his 2000 book "Irrational Exuberance," warns that the market still hasn't shaken off its excesses. He and some other analysts think the latest volatility is a symptom of more trouble to come.
"I have to say that this isn't a great time to be in the stock market," says Prof. Shiller. "The housing crisis that we are going through is going to put a damper on the economy that is longer than a recession. I don't see the stock troubles ending as quickly as many people are imagining"...
Over the past nine years, the S&P 500 is the worst-performing of nine different investment vehicles tracked by Morningstar...
The Dow Jones Industrial Average, which had fewer technology stocks than the S&P 500 and suffered less in the bear market from 2000 to 2002, has held up better, but not a lot better. It has risen less than 1% a year since January 2000...
Comment
Mr. Beach writes:
Mishkin, Bernanke and Greenspan will spend the rest of their lives writing papers in a desperate attempt to salvage some shred of their prior exalted reputation.Our entire financial system is now a monster Ponzi scheme. Of course in this world, any hint of zero inflation or god-forbid, deflation, would lay bare and then flatten the financial world.
Fancy theories and models cannot coverup what is plainly visible: the Fed abandoned their duty to regulate the financial system. Under the Fed's nose, trillions of dollars of debt has been issued that cannot be supported by income today or in the future.
And now the Fed is stuck: it cannot figure out a way to raise home prices, nor can it figure out a way to raise incomes -- so the debt is effectively defaulted and the losses must be taken.
And as it appears, we are headed towards a socialization of the losses -- with the government talking about directly buying mortgage securities.
Under this scenario, we are looking at either
a) enormous consumer price inflation and/or
b) a disorderly fall in the dollar AND
c) a declining standard of living for all Americans.
Mish's Global Economic Trend AnalysisHere is an interesting tale of central bankers working deep into the night last weekend, with Bundesbank President Axel Weber repeatedly in touch by telephone and via videoconferencing with Ben Bernanke in an attempt to orchestrate a bailout of Bear Stearns.
The issues are many: What constitutes too big to fail, who should pay the price for bank failures, what to do about the US dollar, and whether there should be a formal statement on the above.
The issues are still not resolved of course. Nor can they be. Too many banks are insolvent both in the US and abroad.
Let's pick up more of the story in Germans Fear Meltdown of Financial System.
Germany and other industrialized nations are desperately trying to brace themselves against the threat of a collapse of the global financial system. The crisis has now taken its toll on the German economy, where the weak dollar is putting jobs in jeopardy and the credit crunch is paralyzing many businesses.For some time, there has been a tacit agreement among central bankers and the financial ministers of key economies not to allow any bank large enough to jeopardize the system to go under -- no matter what the cost. But, on Sunday, the question arose whether this agreement should be formalized and made public. The central bankers decided against the idea, reasoning that it would practically be an invitation to speculators and large hedge funds to take advantage of this government guarantee.
So, what does apply? Should the state use taxpayer money to help greedy bankers repair the damage caused by their unscrupulous speculation? Should it invest billions to save ailing financial institutions, thereby engendering new risks and side effects? And should the government, to use the words of a Frankfurt investment banker, "treat a drug addict with cocaine"?
How does one explain to honest taxpayers that they should pony up their hard-earned money for a bank like Bear Stearns, whose long-standing CEO forked out $28 million (€18 million) for a 600-square-meter (6,500 square-foot) duplex apartment on New York's Central Park shortly before the collapse of his company? Or that UBS, the crisis-ridden, major Swiss bank, fired three of its senior executives for poor performance only to turn around and pay them roughly 60 million Swiss francs (€38 million/$59.2 million) in golden parachutes?
The central banks and governments of the major industrialized nations are still dodging the answers to these questions.
"I no longer have faith in the ability of the markets to heal themselves," Deutsche Bank CEO Josef Ackermann confessed in a speech delivered last Monday in Frankfurt. Ackermann said that the American example shows that governments and central banks must now play a stronger role.
Even his counterpart at Commerzbank, Klaus-Peter Müller, agreed, saying that the current situation has the potential to develop into "the biggest financial crisis in postwar history" as long as "the markets are allowed to continue operating unchecked." According to Müller, "It would make sense to permit the banks -- retroactively to Jan. 1 -- to account for securities differently by eliminating the daily revaluation requirement." He argues that this would stop the downward spiral on the banks' financial statements.
The German Finance Ministry promptly rejected such calls, saying: "We see no need to become active at the national level." But this assertion is far from the truth. The ministry has become a place of nonstop crisis meetings, the chancellery is kept constantly apprised of the latest developments, and the Federal Financial Supervisory Authority (BaFin) has already set up a task force to address the issue. No one in the government has the slightest doubt that it will intervene the minute another bank begins to falter.
Germany's state-owned banks, which have been especially careless in recent years about investing in American securities backed by subprime loans, are considered greatly at risk. One of them, Bayerische Landesbank, is currently considering writing off €1 billion ($1.54 billion) -- or possibly even more -- in bad debt. In the first two months of 2008 alone, the Bavarian bank's troubled securities portfolio has lost €1 billion in value, and it has fallen even further since. "There could be another billion in losses on top of that," says one banker.
At another state-owned bank, Dusseldorf-based WestLB, €5 billion ($7.7 billions) in government bailout funds are apparently not enough. The bank is already losing its next billion.
If other banks run into trouble, Finance Minister Peer Steinbrück plans to come to their aid with fiscal tools, even if it gets expensive for the government. "Preventing a bank crash," say officials at the finance ministry, "takes precedence over budget consolidation."
US Subprime Market Sinks IKB Bank
Bloomberg is reporting IKB Supervisory Board Denies Fault for Near-Collapse.
Now there's the quote of the month: "Better a miserable ending than misery without end." We need to apply that thinking here in the US instead of attempting to make debt slaves out of homeowners and zombies out of banks.The supervisory board of IKB Deutsche Industriebank AG, the first German casualty of the U.S. subprime market collapse, rebuffed shareholder allegations that it could have averted the near-collapse of the German bank.
"We had no chance to recognize the risks and to avoid the life-threatening crisis," Ulrich Hartmann, head of IKB's supervisory board, said today at the annual general meeting in Dusseldorf.
IKB received an emergency bailout last summer after a finance affiliate that invested in mortgage-backed securities couldn't raise funding amid the credit crunch. The German lender has received financial aid of more than 8 billion euros ($12.6 billion) from Germany's development bank KfW Group, the government and the country's banking associations to stave off insolvency and cover writedowns and losses.
"Apparently, there wasn't a soul in the entire bank who had a grasp of risk management," said Hans-Richard Schmitz of the DSW association, which represents German private investors including IKB shareholders. "Shareholders have been left with a shattered bank and no one wants to take responsibility."
IKB has lost about three-quarters of its market value since July 30, when it cut its full-year forecast and received emergency funding less than two weeks after saying the subprime crisis wouldn't affect it. The bank is currently worth 406 million euros. IKB rose 3 cents, or 0.7 percent, to 4.19 euros in Frankfurt trading after dropping 16 percent yesterday.
Chief Executive Officer Guenther Braeunig today called on shareholders to approve a 1.5 billion-euro stock sale that is "vital to continue running the bank."
"IKB should be shut down," said private investor Hans-Wilhelm Voeller at the congress center in Dusseldorf, where IKB is based and more than 1,000 shareholders were in attendance. "Better a miserable ending than misery without end."
March 27, 2008 | Angry Bear
Peter Morici writes a superb article --"It's time to Cut the Trade Deficit"--in, of all places Forbes, fighting the enemy on its own turf. Among my partially written pieces is one entitled "Credit or Trade," in which I argue that the root of most of our problems is that we have substituted credit for trade. But Morici makes the case superbly:
The entire article follows:
Americans need to knock down some false gods.
Globalization is not an unalloyed good. We don't need 300-horsepower cars. And Wall Street is not a citadel of integrity.
The 1990s were the golden age of free trade. The U.S. sealed the North American Free Trade Agreement, launched the World Trade Organization and escorted China into that temple of global commerce.
The idea was simple: Americans would import more T-shirts and furniture and sell more industrial machinery and software to a world hungry for technology. Americans would move into higher-productivity export industries and earn higher incomes in the trade-off.
In the 2000s, America's CEOs, bankers and management consultants learned how to outsource just about everyone's job but their own. Radiologists who read MRIs, journalists who wrote copy for local papers and computer engineers joined the ranks of workers displaced by imports.
The average American worker's income stagnated, and, for many, inflation-adjusted wages fell. U.S. productivity gains were hogged by executives at Wall Street banks, technology companies and multinationals through big bonuses and peculiar, can't-lose stock options.
The rest of us sunk into debt to fill our gas tanks, feed our children and, admittedly, buy too many cheap imports at Wal-Mart.
Imports soared much more rapidly than exports, the annual trade deficit jumped to more than $700 billion and Americans borrowed more than $6 trillion from foreigners to pay for two decades of trade deficits. This math permitted Americans to consume much more than we produced and spend more than we earned.
China is perhaps the biggest renegade in the mugging of the American middle class. The U.S. has slashed tariffs on Chinese products from auto parts to TVs, while China maintains much higher tariffs and notorious regulatory restrictions for U.S. exports in its market.
Topping it all, China subsidizes foreign purchases of its currency, the yuan, to the tune of $460 billion a year, making its products cheap on U.S. store shelves. The U.S. annual trade deficit with China is about $250 billion.
Chinese growth has pushed up global petroleum prices nearly five fold in six years, and the U.S. oil deficit is now $350 billion and rising.
The banks came up with more creative and risky mortgage products that permitted Americans to live beyond their means. We went from 10% down to 5% down to nothing down, with banks lending home buyers closing costs through second trusts.
Some loans that required no payback for five years even let folks dig deeper in their pockets on the premise that home prices would always go up. The banks sold these risky loans, bundled as bonds, to foreign investors like the Chinese government and foreign pension funds, as well as to U.S. insurance companies and corporations with cash to park. The bank executives paid themselves like royalty for the privilege of bilking trusting clients.
When the worst of the bonds--those backed by risking adjustable rate mortgages-- collapsed, the banks got stuck with billions of unsold bonds.
Most recently, Bear Stearns collapsed, and the U.S. Federal Reserve is lending the banks $600 billion against shaky bonds on a 90-day revolving basis. That essentially socializes the banks' losses on bad bonds.
You have to love Ben Bernanke's free trade capitalism. If you are an autoworker put out of work by Korean imports, he, as a good economist, tells you to go to school and find other work. If you are a New York banker caught paying yourself too much and run short of foreign investors to fleece, Ben will make you a loan and keep rolling until the bank finds a new game.
Now foreign investors are getting nervous about all the money they have loaned Americans and the integrity of U.S. banks. They are fleeing dollar investments for euro-denominated securities, gold, oil and just about anything more tangible than the shaky greenback.
Americans are forced to cut back, not just on purchases of cheap Chinese coffee makers, but also on automobiles and other products made in the U.S. Falling demand is casting the U.S. economy into recession, and we won't be able to borrow enough to pull ourselves out.
Getting out of this mess is going to require Americans to live within their means--a.k.a. cut the trade deficit--and throw out the rascals on Wall Street.
Cutting the trade deficit requires burning less gasoline and balancing commerce with China.
Americans must either let the price of gas double to force conservation or accept cars with tougher mileage standards. Fifty miles per gallon by 2020, instead of the 35 required by current law, is achievable, but that means more hybrids and lighter vehicles.
The U.S. government should tax dollar-yuan conversions at a rate equal to China's subsidies on yuan purchases until China stops manipulating currency markets. That would reduce imports from China, move a lot of production back home, raise U.S. productivity and workers incomes, and reduce the federal budget deficit.
Ben Bernanke has given the banks a lot and received little in return--except a lot of bad loans on the Fed's books. It is high time he condition the Fed's largesse on reforms at the big banks, even if that means lower salaries for the Brahmins on Wall Street.
After all, what makes them so special?
October 4, 2005 | The Financial Times
Serious reformist thinking is largely absent -- not only from the political parties but also from the mainstream media and most think-tanks.
The media and think-tanks are also largely disabled by their links to political and economic interests. In the wake of Katrina, the mainstream US media won praise for finally daring to criticise the Bush administration. But there is little sign of their readiness to analyse deep flaws in the US system. The exceptions are race and poverty, issues raised so glaringly by Katrina that only a totalitarian system could avoid mentioning them. Among the fundamental issues absent from public discussion is the political patronage system, in the areas of jobs and financial allocations. Strong criticism has been directed at the Bush administration, quite rightly, for its appointment of unqualified political cronies to senior posts. What no one asks is why the US, alone among developed countries, has such an extensive system of political appointments to vital and highly technical government jobs. Such questions would be considered to reflect lack of patriotism. More importantly, the political parties cannot raise this issue as they are both dependent on patronage to raise funds and gain support. The think-tanks cannot discuss it because too many of their members dream of becoming assistant deputy something or other after the next elections. But at least the media should be able to talk about this.
Similarly, both Congress and the Democratic politicians of Louisiana have been criticised, quite rightly, for senators' colossal diversion of scarce federal funds to pork-barrel projects in their states--something that contributed directly to the disaster in New Orleans. But no one asks why the US system allows opportunities for pork-barrel politics on this scale.
US inability to compare itself to other countries also applies to discussion of global warming and energy conservation. After Katrina, these issues cannot be ignored. But the US public cannot be told how isolated internationally America is on this question. Media discussion too often takes the form of a rigged debate in which scientific evidence for global warming is set against scientific opponents of this thesis--despite the fact there is broad international support for the first position while the second is held essentially by isolated individuals.
If a crisis on the scale of 1929-32 strikes the US now, the country would not find an FDR with a New Deal programme to run against the Republican's Herbert Hoover. It would have a timid, ineffective Hoover for the Democrats running against a Republican Calvin Coolidge, a hidebound defender of the worst aspects of the existing system. If that had been the choice in 1932, the very foundations of the American state would have been in peril
March 4, 2008 | Sudden Debt
I will be on a short trip, so posting will be sporadic for the next few days. Before I go, I want to clear something up, concerning my views on extremism in free markets and their zealot acolytes.
Free markets (in this case financial markets, since they are my area of expertise) without tight regulation to even out the playing field as much as possible, rapidly deteriorate towards crony capitalism, i.e. a particularly virulent form of junglenomics. US financial markets were the envy of the world because a whole array of professional regulators (SEC, NASD, NYSE, FRB, etc) stood ready to send in the feds and bodily carry out manacled perps, in full view of their co-workers and the cameras.
No, it didn't always work out as it should have and many a big fish swam away leaving the minnows to fry in the pan. But mostly it worked, and the markets were the better for it. This is no longer the case and dominant positions now exist (or existed) unchecked in most markets and crony capitalism makes itself evident in many aspects of the US economy (Enron, for example).
Some people sadly still confuse freedom with total lack of regulation, thinking oversight interferes with a "natural" right to do as they please. In that case, their proper place is up in the mountains with the rest of the wild animals (Aristotle had something to say about them, people who do not wish to participate in a cohesive society and be bound by its rules). Others place absolute faith in the invisible hand, thinking it will even out everything all by itself. To my mind, they belong to the Flat Earth Society.
No doubt, they in turn will paint me a "commie", showing a complete lack of understanding about what communism is all about. Well, both communism and absolute laissez-faire don't work - in practice - because they both disregard human nature: man is no saint. He will no more gladly share everything he has with his fellow than he won't fall prey to unfettered greed for individual gain.
Free market capitalism is not antithetical to the common good - quite the contrary; it is just that human nature will always be governed by extremes of fear and greed and behavior must be governed by checks and balances, for everyone's benefit. Likewise for democracy, which can all too easily deteriorate towards mob rule or fascism, a fact understood very well by the writers of the Constitution. It is extremism that I rail against, not freedom.
Bottom line: excellence in market regulation leads to better and freer markets. And please... do not confuse quality with quantity, from either perspective: more is not better, but neither is less. Smarter, more effective, more efficient... that's better.
See you all soon.
March 26, 2008 | Sudden Debt
The size and frequency of the Fed's interventions are increasing with each passing day. I wonder how people can still call this a "free" market with a straight face. Let's call a spade for what it is: privatizing profits and socializing losses is crony capitalism, pure and simple.
Keeping with the spirit of the holidays, it's like the Easter Bunny lets a few chosen children eat all the good eggs, but feeds those tainted with salmonella to the children of a lesser God. Naughty bunny...Naturally, the Fed's hoppity-hops injected shots of optimism to markets teetering on the edge of a nervous breakdown last week. Many speculators are apparently willing to go bottom fishing, projecting an economic rebound in six months. I think they are wrong; their optimism is just one more in a string of bad predictions that got progressively worse: robust growth, moderate growth, Goldilocks, slowdown, no recession, mild recession..
There are two main reasons for my negative prognosis, as far as timing of bottoms goes:
- The labor picture is still nowhere near as bad as it gets in even a typical recession....
- Consumer spending accounts for three quarters of the economy.
March 17, 2008 | Sudden DebtIn Orwell's Animal Farm all animals are equal - except that some are more equal than others. All in the spirit of law, order and the proper functioning of society, of course. Fittingly, the animals that have chosen this role by themselves and for themselves, are the pigs.
Cut to US financial markets today. After years of swinish behavior more reminiscent of Animal House than anything else, the pigs are threatening to destroy the entire farm. As if it wasn't enough that they devoured all the "free market" food available and inundated the world with their excreta, they now wish to be put on the public trough. Truly, some businessmen believe they are more equal than others.
But do not blame the pigs; they are expected to act as swine nature dictates. The fault lies entirely with the farmers, those authorities entrusted by the people to oversee the farm because they supposedly knew better. While the pigs were rampaging and tearing the place apart, they were assuring us all that farms function best when animals are free to do as they please, guided solely by invisible hooves. No regulation, no oversight, no common sense. Oh yes, and pigs fly..
So what is to be done now? Two things:
- (a) Let financial markets sort themselves out, but with rock solid backing for bank depositors, pension funds and public institutions. The public purse should not be used to bail out - directly or indirectly - speculators in hedge funds, private equity funds and the like. Those that live by the leverage sword can defend themselves or perish by credit destruction.
- (b) Revamp public policy towards increasing earned income for working people.
In other words, the focus from now on should be on adding value by means of work and savings (capital formation), instead of inflating assets and borrowing.
Furthermore, we should realize that in a world already inhabited by close to 7 billion people and beset by resource depletion and environmental degradation, defending growth for growth's sake is a losing proposition. The wheels are already wobbling on the Permagrowth model; pumping harder on the accelerator is not going to make it go any faster and will likely result in a fatal crash.
Debt, and finance in general, should be left to re-size downwards to a level that better reflects the carrying capacity of our world. The Fed's current actions are shortsighted and "conservative" in the worst interpretation of the words: they are designed to artificially maintain debt at levels that myopically projects growth as far as the eye can see.
What level of resizing may be necessary? I hope not as much as at Bear Stearns, which got itself bought by Morgan at buzz-saw prices: $2 per share represents a 98% discount from its $84 book value. What scares me, though, is the statement by Morgan's CFO, who said the price reflected the risk the firm was taking, even though he was comfortable with the valuation of assets in Bear's books. It "...gives us the flexibility and margin of error that's appropriate given the speed at which the transaction came together", he said.
If it takes a 98% discount and the explicit guarantee of the Fed for a large portion of assets to buy one of the largest investment banks in the world, where should all other financial firms be trading at? ....Hello? Anyone? Is that a great big silence I hear, or the sound of credit imploding into a vacuum?
Our present predicament is the culmination of many poor policy decisions. Easy money, lax credit standards and the Federal Reserve's interference with the business cycle -- combined with a lack of supervision on the part of the Securities and Exchange Commission and bank regulators -- created an environment that led to excessive risk taking on the part of individuals and financial entities of all stripes.Where were the referees?
Wall Street and all the willing partners in the "securitization process" who sliced and diced or bought and sold mortgage-related paper are thought of as the culprits in this financial tragedy. But they were only spokes in this wheel of trouble. Homeowners, who for a number of years were the beneficiaries of the financial daisy chain, must accept some responsibility.... ... ...
The insidious and dangerous unspoken corollary to all this: Financial pain is now unacceptable. Those in trouble demand to be rescued, and the government seems to agree that the "creative destruction" component of capitalism must not be allowed to do its work. It's a sad irony that as former communist countries embrace capitalism, we seem to be headed in the other direction.
The credit crunch is cutting a broad swath across the economy, and it's hard to know how far it will go. That's because for years, the housing bubble was the heart of the economy.
Several years ago, I sketched out a thesis called "The Next Time Down." Its onset took a bit longer than I had expected (like about three years) due to the lunacy in the credit markets. However, "the next time down" is essentially the situation in which we now find ourselves.
...the pace of massive de-leveraging could accelerate further. That in all likelihood would feed on itself.
... In time, it will be clear that prime mortgages are also vulnerable. You can almost draw (the credit unwind) out in a diagram," said a managing director at the Economic Outlook Group in Princeton, N.J. "With home prices going down, consumers cut back on spending. If consumers cut back on spending, the economy weakens further. If the economy weakens further, fewer people are able to afford mortgages, so home foreclosures increase."
Meanwhile, the problems in the municipal market have been well-chronicled in the media. And, since the plain-vanilla money funds have already flirted with trouble, I wouldn't be shocked to see liquidity or credit issues in that arena, also.
... ... ...
Obfuscation cannot change the big picture. The housing bubble -- which bailed out the equity bubble -- was in essence the economy. Now that we don't have the housing ATM or the jobs it created, the economy will continue to weaken.
...As a rule of thumb, a recession involves at least two consecutive quarters of negative real GDP. According to FXStreet.com, the National Bureau of Economic Research (NBER), the official judge of when recessions begin and end, has broadened its characterization to consider four indicators:
- industrial production,
- payroll employment,
- inflation-adjusted personal income,
- and the volume of sales of the manufacturing and trade sectors.
Unfortunately, these are lagging indicators, taking a full six months to get recognized and announced by the NBER. Since recessions typically last six to 18 months, the recession could potentially be over by time the announcement is made. So how can we at least speculate that we're in a recession while we are in it?
Searching the Internet for the word "recession" can leave your head spinning, as economists deliberate which signs truly reveal that our economy has started slumping. But we've culled all that information down to the best of our Foolish abilities, and we've come up with these four key indicators investors can use to figure out when a recession has arrived.
Slower consumer spending
The collapse of overvalued assets of any form -- such as housing -- can trigger a recession. As consumers watch the values of their inflated assets evaporate, they're less likely (or able) to spend money, because they don't feel wealthy. Thus, watching consumer spending habits can be a great warning sign.These days, investors tend to emphasize the monthly same-store sales performance of big-box retailers such as Wal-Mart (NYSE: WMT) and Target (NYSE: TGT). But keeping a close eye on higher-end consumer-goods companies that typically display strong growth, such as Nordstrom (NYSE: JWN) and Apple (Nasdaq: AAPL), can also be a great indication, should these companies begin to display weakness. Company conference calls in consumer-facing industries will also start attributing weaker performance to lighter customer spending. And with 70% of the U.S. GDP relying on consumer spending, according to Morningstar, any cutback can significantly hurt the economy.
Inverted yield curve
Unlike a normal yield curve, which suggests that interest rates will rise in the future, an inverted curve indicates that investors believe rates will drop in the future, since the yield curve parallels interest rates set by the Fed. Expected declines in interest rates demonstrate investors' confidence that the Fed will continue to lower rates to stimulate a deteriorating economy.Rising unemployment
Watching the weekly unemployment claim reports is quite important. If people lose their jobs, they won't be able to spend money, leading to suffering businesses and a chain of further problems. And when companies release workers, it suggests that business is slowing or expected to slow, and that not as many employees are needed or are affordable.Inflationary pressure
When price hikes for goods such as food, gas, and clothing begin to rise faster than wages, it becomes more difficult for consumers to maintain their spending habits, causing business growth to slow. Plus, these escalating prices increase the cost of inputs, thinning margins and profitability at many food establishments like Panera Bread (Nasdaq: PNRA).Not an exact science
The definition of a recession can vary widely. There are many ways for investors to study the health of the economy; the examples above are simply four of the most prominent ones. Ultimately, a recession occurs when our economy is in a slump, pieces of the economy are flowing in the wrong direction, and people fear for our nation's financial well-being.Luckily, long-term investors aren't too concerned about recessions, since they offer shares of many robust companies at great prices. Still, it's important to understand when our economy faces a challenging atmosphere. Following these signs can give Foolish investors a good idea of our current spot in the economic cycle.
The New York economy is more dependent than ever on high Wall Street incomes, which have jumped by more than half since 2001, to an average of $387,000, according to the city comptroller’s office.
Last year, the finance industry was responsible for nearly a third of all wages earned in the city, the highest in modern times. And each Wall Street job supports three workers in other sectors.
A great many of the 14,000 employees of Bear Stearns are expected to lose their jobs because of the firm’s cash shortage and its pending acquisition by JPMorgan Chase. As the credit crisis unfolds and other firms discover the depths of their losses related to bad loans, few expect the layoffs to stop there.
... ... ...
So far, Economy.com is predicting about 25,000 job losses in the New York area, but that number may be revised as the full impact of Wall Street’s credit troubles becomes clear, said Marisa Di Natale, a senior economist at Economy.com.
After being laid off from her job as an events planner at an upscale resort, Jo Ann Bauer struggled financially. She worked at several lower-paying jobs, relocated to a new city and even declared bankruptcy.
Then in December, she finally accepted her parents' invitation to move into their home — at age 52. "I'm back living in the bedroom that I grew up in," she said.
Taking shelter with parents isn't uncommon for young people in their 20s, especially when the job market is poor. But now the slumping economy and the credit crunch are forcing some children to do so later in life — even in middle age.
Financial planners report receiving many calls from parents seeking advice about taking in their grown children following divorces and layoffs.
Having never experienced anything akin to hyper-inflation in the U.S., save for periods around both the Revolutionary War and Civil War, this is all the more reason to think that hyperinflation is much more possible than many experts currently believe.
This statement came from the head of Japan's top financial regulator. If the powers that be had wanted to soft-pedal the message, they would have used a lower-ranking bureaucrat or a retired official
The Japanese comment is effectively a statement that significant actors in the US financial sector are bankrupt and will need to be recapitalized. Again, that is a shocking diagnosis to make in a public forum. Wantanabe says that the US banking system will need to get new equity from the government. The delay in recapitalizing Japanese banks (it was hard to win over the public) is considered within Japan the biggest reason for the length of their economic crisis
... ... ...
Mr Watanabe warned unless swift and appropriate action was taken by world leaders, the financial market turmoil could lead to a severe dollar crisis.
He said the world’s huge excess liquidity has started flowing out of the US. If that flow were to be extended, it could lead to unprecedented problems.
“One thing is to fix the hole in the bathtub,” he said. “[But] we must recognise that the current crisis is not as straightforward as past dollar crises.”
... ... ...
The minister said that while the US credit turmoil was structurally similar to Japan’s at the time of its bad debt crisis, there was an important difference in that risk in Japan was contained in the banking sector. In the US, it had been dispersed widely into other areas of the financial industry. So “it is not clear how big the hole [in the US] is because the fire has spread to products other than securitised products
Comments
Jojo said...Yes, this is extraordinary for Japan. So the question is why and why now?
It sounds like Japan is very fearful that the crisis in the USA will hurt Japan's slow recovery, perhaps even sending the country back into recession. The weakened dollar and a USA recession are certain to affect Japan's exports negatively.
I'm also reminded of all the times I have pointed out over the last few years that what happened to Japan could well happen to the USA (80% drop in RE prices, years of no to little growth, etc.). The standard pat reply was almost always that Japan was different. Yes, they are. They at least had personal savings. The USA is a debtor nation with little personal savings. This will make our turn at the wheel that much worse.
Yves Smith said...
t worst.While Japan's bubble on paper was bigger on paper, residential real estate did not trade anywhere near as often as in the US (Japanese are not as mobile and seldom go from starter homes to bigger homes) and in 1990, they didn't have our home equity extraction techniques. But corporate real estate was leveraged to the gills at crazy, fictitious levels (land almost never was sold in central Tokyo partly due to confiscatory taxes, partly due to the fact that for a company to sell land was an admission it was going bankrupt. Selling land was like selling your children. Imagine what a Manhattan or London office building would go for if only one sold a year). And equity prices were nutty and margined.
But while our nominal asset inflation isn't as bad, we have all sorts of leverage on leverage the Japanese did not have: leverage in some CDO structures, hedge funds, hedge fund of fund that sometimes add more gearing, plus all kinds of derivatives that enable investors to take what amount to levered bets....so the amount of debt and synthetics relative to the sustainable value of the underlying assets may be more similar to Japan at the peak than anyone here wants to admit.
We may never know for sure whether the Federal Reserve's rescue of Bear Stearns averted a seizure of the $516 trillion derivatives system, the ultimate Chernobyl for global finance.
"If the Fed had not stepped in, we would have had pandemonium," said James Melcher, president of the New York hedge fund Balestra Capital.
"There was the risk of a total meltdown at the beginning of last week. I don't think most people have any idea how bad this chain could have been, and I am still not sure the Fed can maintain the solvency of the US banking system."
All through early March the frontline players had watched in horror as Bear Stearns came under assault and then shrivelled into nothing as its $17bn reserve cushion vanished.
Melcher was already prepared - true to form for a man who made a fabulous return last year betting on the collapse of US mortgage securities. He is now turning his sights on Eastern Europe, the next shoe to drop.
"We've been worried for a long time there would be nobody to pay on the other side of our contracts, so we took profits early and got out of everything. The Greenspan policies that led to this have been the most irresponsible episode the world has ever seen," he said.
Fed chairman Ben Bernanke has moved with breathtaking speed to contain the crisis. Last Sunday night, he resorted to the "nuclear option", invoking a Depression-era clause - Article 13 (3) of the Federal Reserve Act - to be used in "unusual and exigent circumstances".
The emergency vote by five governors allows the Fed to shoulder $30bn of direct credit risk from the Bear Stearns carcass. By taking this course, the Fed has crossed the Rubicon of central banking.
... ... ...The Bank for International Settlements uses a concept of "gross market value" to weight the real exposure. This is roughly 2 per cent of the notional level. For Bear Stearns this would be $270bn, or so.
"There is no real way to gauge the market risk," said an official
"We don't know how much is backed by collateral. We don't know what would happen in a crisis, and if we don't know, nobody does," he said.
Under the rescue deal, JP Morgan Chase will take over Bear Stearns' $13.4 trillion contracts - lock, stock, and barrel.
But JP Morgan is already up to its neck in this soup, with $77 trillion of contracts. It will now have $90 trillion on its books, a sixth of the global market.
Risk is being concentrated further. There are echoes of the old reinsurance chains at Lloyd's, but on a vaster scale.
The most neuralgic niche is the $45 trillion market for credit default swaps (CDS). These CDS swaps are a way of betting on the credit quality of companies without having to buy the underlying bonds, which are less liquid. They have long been the bête noire of New York Fed chief Timothy Geithner, alarmed that 10 banks make up 89 per cent of the contracts.
"The same names show up in multiple types of positions. These create the potential for squeezes in cash markets, magnifying the risk of adverse dynamics," he said.
"They could increase systemic risk, by amplifying rather than dampening the movement in asset prices," he said.
This is what happened as the banking crisis gathered pace. The CDS spreads measuring default risk on Bear Stearns debt rocketed from 246 to 792 in a single day on March 13 amid - untrue - rumours that the broker was preparing to invoke bankruptcy protection.
Was it the spike in spreads that set off the panic run on Bear Stearns by New York insiders? Or are the CDS spreads merely serving as a barometer?
In the old days it was hard for speculators to take "short" bets on bonds. Credit derivatives open up a whole new game.
"It is now much easier to short credit, " said James Batterman, a derivatives expert at Fitch Ratings in New York. "CDS swaps can be used for speculation, and that can cause skittish markets to overshoot," he said.
For now the meltdown panic has subsided. Yet the hottest document flying around the City last week was a paper by Barclays Capital probing what might happen in a counterparty default.
It is not for bedtime reading. Direct losses from a CDS breakdown alone could be $80bn, but the potential risks are much greater.
In theory, the contracts are matching. One sides loses, the other gains, operating through a neutral counterparty (ie Bear Stearns). But if the system seizes up, the mechanism is not neutral at all. It becomes viciously one-sided.
"Upon the default of the counterparty, [traded] derivatives would be immediately repriced, with spreads widening dramatically," said the Barclays report.
This is "gap risk", the stuff of trading nightmares. Fortunes can vanish in a moment.
One side would suddenly be trapped with staggering losses on their books. Yet the winners would be unable to collect their prize from the insolvent bank in the middle. It would take years to unravel all the claims in court. By then the financial landscape would be a scene of carnage.
Warren Buffett famously described derivatives as "weapons of mass financial destruction". The analogy is suspect, of course. Allied troops never found the alleged weapons in Iraq. This time, Washington's pre-emptive shock and awe may have been well-advised.
But could oil prices fall sharply?
Setting aside peak oil arguments for now, it's important to realize that both the supply and demand curves for oil are, in general, very steep. If there is little unused capacity, it takes time for more oil production to become available since this involves huge capital intensive projects. And, in the short term, demand is fairly inelastic over a wide range of prices; people stay with their routines and keep their same vehicle. With two steep curves (supply and demand), a small increase in quantity demanded will lead to a large increase in prices.
And, of course, the opposite is also true. A relatively small decrease in demand (or increase in supply) would cause a significant drop in price.
As the U.S. economy weakens, there is waning demand for oil in the U.S.:
According to the US Energy Information Administration's weekly inventory report, the overall consumption of oil and crude products dropped 3.2 percent in the last four weeks compared to the same period last year.Perhaps the growth in demand in China and India (and elsewhere) will more than offset the small decline in U.S. demand. But there may be another important factor - the behavior of the GCC countries.What if the supply-demand curve for oil has multiple equilibrium points? And what if the GCC countries have been limiting production because of the lack of other investment opportunities? The following is from a paper by Professor Krugman several years ago: The Energy Crisis Revisited
The fact that oil is an exhaustible resource means that not extracting it is a form of investment. And it is an investment that might look attractive to a national government when oil prices are high. If a country does not want to spend all of the massive flow of cash generated by a sudden price increase on consumption, it must do one of three things: engage in real investment at home, which is subject to diminishing returns; invest abroad; or "invest" by cutting oil extraction, and hence reducing supply.
"Stage III of a financial crisis is when a central bank runs out of ammunition--when pushing interest rates too the floor and swapping out all of its assets does not restore the good equilibrium. Then you face a threefold choice: depression, inflation, or public intervention. Depression is to be avoided. Inflation--resolving the financial crisis by printing enough money to boost the price level far enough that all of a sudden everyone's incomes and real asset values are high enough to pay off their nominal debts--is generally best avoided too. As John Maynard Keynes wrote more than eighty years ago: "The Individualistic Capitalism of today, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring-rod of value, and cannot be efficient--perhaps cannot survive--without one."
Can debt induced slow down be countered by increased military spending ? "...personal debt in the United States is $13.8 trillion, including mortgage debt, slightly less than the country’s $14 trillion G.D.P."
Reuters is reporting Recession fears mount on jobless, factory data.Signs of recession are now unmistakable. Lets take a look.
The Financial Times is reporting World trade decelerates almost to standstill.
"This is a substantial deceleration," the institute said. "World trade volume growth is on a downward trend." The last time annual growth in trade went negative was in 2001, when the shallow US recession that followed the bursting of the technology bubble and the shock of the September 11 attacks caused global commerce to contract.The institute said that imports into both the US and European Union fell in the three months to January.
Factory activity in the U.S. Mid-Atlantic region shrank for the fourth consecutive month in March, according to the Philadelphia Federal Reserve Bank's business activity index, which came in at minus 17.4 this month.A Key Change In Auto Lending Psychology suggests the American auto industry may be heading for its worst year in a decade."The key message from this survey is that things are quite bad, but that sentiment has, so far, weakened further than hard activity," Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, New York, said about the Philly Fed report.
The Labor Department's report suggested a further deterioration in the job market, although it said increases in first-time claims last week and the week before reflected, at least in part, a strike by autoworkers.
It said 378,000 initial claims for jobless benefits were filed in the week ended March 15, up from 356,000 in the prior week. Economists had expected a rise to just 360,000.
Comments:
March 21 – Washington Post: “To Understand Wednesday’
s decision by federal regulators to let Fannie Mae and Freddie Mac set aside less cash to protect against losses, imagine a family that keeps its precious antique silver in a strongbox on a high shelf, beyond easy reach. The regulators have essentiall y authorized Fannie and Freddie to pawn some of their family silver. Currently, the two firms, known as government -sponsored enterprise s, or GSEs, have combined reserves of $82 billion. This includes an extra amount that the regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), required them to hold while they got their books in order after accounting scandals. Now it is reducing that extra cushion by $5.8 billion. The newly freed-up money will leverage the purchase and securitiza
tion of up to $200 billion in home loans.
March 20, 2008 | financialsense.comFormer Fed Chairman Alan Greenspan, one of the major architects of the current crisis finally “fessed up” the other day when he referred to the current crisis as the “most wrenching since the end of the Second World War.” But the end of the Second World War marked the start of the boom times in America (at least for those who lived to tell the tale) so he must really be referring to the crisis since the beginning of the Second World War, which would be the late 1930s. And this decade is basically where we’re now at.
The modern 1930s are the logical consequence of the “New Economy” of the past decade, just as the original was a logical consequence of the “Roaring Twenties.” In each case, technology and leverage combined to create a potent but ultimately poisonous brew of wildly inflated asset prices. In essence, greedy CEOs (and investment managers) said, “we brought you the new economy, please cash us out now.” And a gullible American public affirmed this by bidding up prices to insane levels, expecting to share, rather than subsidize, the wealth of the selling shareholders. First the tech companies, then the financial intermediaries were then caught in traps of their own making, and escaped as sorely crippled entities, if they survived at all. But by this time, the more privileged players had “taken their money and run.”
Probably without meaning to, the Los Angeles Times aptly summed things up with an article headlined “A New Great Depression? It’s Different This Time.” The aptness is if you interpret the headline as “The Depression is Different This Time” as opposed to “Things Are Different This Time.” The details will naturally differ from those of the 1930s, but the substance will remain the same. But the paper dismisses the popping of asset bubbles in housing and stocks as merely “disturbing parallels.” Working together, the Fed (and the modern J.P. Morgan) “saved” Bear Stearns, the modern Bank of the United States, thereby preventing a collapse of the banking system. International trade remains robust, at least for now. So things don’t seem to bad, at least to the Times.
But are things really that different almost 80 years later? For instance, the popping of major asset bubbles almost defines a recession by itself. And one can argue that the 1930s collapse of the banking system is the consequence, or reflection of the real economy, rather than its cause. So saving one insolvent institution isn’t going to prevent the unraveling of the rest of the system early in the new century. And yes, the international situation is okay, but that’s just because America is the cause, rather than the recipient, of global economic problems this time around; falling stock prices abroad are saying that foreign GDP growth will soon collapse as a result of America’s troubles.
In deciding whether or not we are headed toward depression, one needs to look at the substance of economic events, as opposed to the form. Some examples of the substance: 1) A post-war record level of home foreclosures headed to 1930s levels fueled by a similarly record collapse of home prices. 2) Several major “runs on banks” as investors begin to wake up to the fact that a lot of what passes for collateral is in fact worth very little. 3) A panicked Fed trying to head off a financial panic by simultaneously lowering interest rates and injecting money into the system.
And what’s worse, we are only in the early stages of the crisis. Last year, 2007, was the year that the mortgage market unwound. This year, 2008, will feature the collapse of major financial institutions, starting, but not ending, with Bear Stearns. Next year, 2009, will be the year when the problems make their way to the rest of the U.S. economy, including the still-buoyant industrial sector. By 2010, the recession (or worse) will be global.
Some take comfort in the fact that we haven’t yet seen soup lines, or 25% unemployment. But soup lines are merely an unnecessary (and hopefully unrepeated) appendage of the above. And anecdotal evidence suggests that many welfare agencies are now stretched to the absolute limit, meaning that new soup lines will appear if the system is tested just a bit more. And unemployment hasn’t risen because companies have so far chosen to cut health care and pension contributions rather than lay off workers. One can easily get to the 1930s 25% unemployment with a 0% headline unemployment rate—by assuming that half the work force will be “temps” working half time without fringe benefits.
But perhaps one of the better definitions of the modern 1930s was given in a previous article on this site—a two decade pullback in the American standard of living to the 1980s (the original took American consumption back to the 1910s). Such a pullback seems inevitable from the deleveraging and loss of wealth that is now taking place. Moreover, such a retreat would last for an extended period of time.
March 19, 2008 | Econbrowser
But suppose you believe that oil over $100 a barrel is a destabilizing influence-- and I do-- and that the Fed's recent decisions on the fed funds rate are the primary reason that oil is over $100-- and I do-- and that further reductions in the Tbill rate have limited capacity to stimulate demand-- and I do. Suppose you also saw a risk that the inflation, financial uncertainty, and slide of the dollar could precipitate a run from the dollar, introducing an international currency crisis dimension to our current headaches.
Well, if you did, then even if you were very, very worried about our current financial problems-- and I am-- you would still want to draw the line somewhere, and acknowledge that there is some point beyond which lowering the fed funds rate further will do more harm than good. When we've got that rate to 2.25%, and people are telling surveyors they are expecting 4.5% inflation, we need to be open to the possibility that we've already reached such a point.
I think the Fed missed an opportunity here. A 25 or a 50 basis point cut would have sent commodity prices crashing. Even the mildly hawkish surprise of "only" a 75 basis point cut may have some effects in that direction. If the Fed did convince the commodity speculators that their path leads only to ruin-- and I believe the Fed could easily have done just that-- that would leave Bernanke with a lot more maneuvering room to cope with what comes next. If the commodity demon were under control, maybe we'd have the breathing room later to bring the fed funds rate all the way down to 1%. While the speculation remains rampant, however, I expect to get nothing but trouble for the effort.
The Fed is firing its gun into the air. We may soon really wish we had some more ammunition.
Comments
Posted by: oops at March 19, 2008 09:54 AM
One of the "signature" Obama stump speech lines refers to "the same people repeating the same actions expecting a different result."Here we have supposedly intelligent, educated "folks" expecting that another iteration of a "1% solution" will do anything other than engender another crisis, inevitably even worse than the current one.
The absolute unwillingness to actually solve a problem rather than just attempt illusory and bogus fixes constitutes a cultuaral character disorder in the United States, probably a fatal one.
Perhaps it is inevitable that a greatest generation be followed by, well, this lot.
===
Posted by: Retirement Investment at March 19, 2008 03:41 PM
"a real estate bubble to replace the tech bubble, now a commodity bubble to replace the real estate bubble."That may not be a bad strategy given the circumstances.
Instead of have a 10-year depression from 2001 to 2011, divide it up into three 3-year downturns, with 5-year respite's between them. The correction is gentler and more easily digested. Also, the brunt of pain of the final bubble popping (2015 or so) will be felt on China and the Middle East, rather than the US.
So not a bad strategy, perhaps.
===
Posted by: Michael Roberts at March 19, 2008 05:17 PM
It will be interesting to see if monetary base growth has picked up since january. Last years interest rate cuts did nothing to buck the downward trend in monetary base growth.
At the risk of being accused of being an unreconstructed monetarist, I think the slow growth in monetary base is alarming.
For starters, basic monetary theory (shared by monetarists, Tobinesque old guard Keynesians and New Keyensians alike) suggests that the first stage in the monetary transmission process for monetary stimulus should involve an increase in the monetary base. Additionally, the asset market crisis should ential a 'flight to quality', which would stimulate monetary base growth under interest rate targeting.
Monetary base has a much better track record for forecasting inflation and nominal GDP growth than M1 or M2; it is easier to adjust the base for the institutional changes cause the poor performance of these aggregates. Maybe we should be looking at St Luois adjusted monetary base, and not just the negative short term interest rates, in assesing US monetary conditions.
David Roche, who heads Independent Strategy, a London-based investment consultancy, argues today in the Financial Times that the bull run in commodities is soon to come to an end.
A big factor in the outlook for commodities is whether you believe our credit crisis will lead to inflation or deflation. Bernanke's aggressive rate cuts and the dollar's swift fall made commodities look like a great haven. But with the failure of the Fed's moves to revive lending, the high odds of a deep recession that pulls down emerging economies, and worries about the financial system leading to liquidity hoarding, the prospects for commodities are far from compelling.
Indeed, Monday Paul Krugman worried that we are getting close to a liquidity trap. Michael Shedlock, in "Now Presenting: Deflation!" gives us this chart as evidence...
When we've said the greenback could lose its reserve currency status to the euro, the idea has often been met with derision. Yet we see evidence that international commercial transactions are moving away from dollar-based invoicing, a sign that the tectonic plates are shifting.
In a post at VoxEU, Jeff Frankel, a Serious Economist (and an American at that) discusses why the euro is a plausible replacement for the dollar as the main coin of international commerce. And Frankel cites a cause not often mentioned: loss of respect for the US as dominant military power.
Frankel argues that the savings-rich countries who have benefitted from our armed presence, like Japan and the Gulf States, have seen buying our Treasuries as a fair deal in return to enjoying our protection.
But the Bush Administration's unilateralism and recklessness (which have also been accompanied by unprecedented current account deficits, which increase the need for foreign capital greatly) have tried the patience of our creditors.
"I tend to agree with the fellow who says, `Hey, this is the greatest financial crisis since World War II,''' said Jean- Marie Eveillard, 68, who runs the $21.3 billion First Eagle Global Fund in New York.The fund, which has returned an average 15.2 percent each year this decade compared with a less than 0.1 percent annualized gain for the S&P 500, has about 25 percent in cash and gold, more than its holdings in U.S. stocks.
"Investors who take the attitude that the economy will be slow in the first half and then it will turn around, they're probably dreaming ... ... ...
Different Kind of Bear"This is a different kind of bear market,'' Byron Wien, chief investment strategist at Pequot Capital Management Inc., a Westport, Connecticut-based hedge fund with $7 billion in assets. "This is serious and it isn't over yet. There's more to come because people are still too complacent.'' The 75-year-old strategist, who expects U.S. stocks may fall 10 percent more, said the fund has a so-called net short position, or more wagers against stocks than bets that they will advance.
"We'll see further de-levering before we see a floor in equity values,'' said Bob Parker, vice chairman of Credit Suisse Asset Management in London, which manages more than $600 billion.
Glass-Steagall Act
Losses at financial firms from the mortgage collapse may eventually triple to $600 billion as defaults on home loans grow, says Zurich-based UBS AG. One reason banks are losing money is the repeal nine years ago of the 1933 Glass-Steagall Act, which separated commercial and investment banking after excessive risk- taking contributed to the Great Depression, Eveillard said.
The repeal enabled commercial lenders such as Citigroup, the largest U.S. bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities.
Citigroup, which has fallen 36 percent since reporting in January the biggest quarterly loss in its 196-year history, may have writedowns of $15 billion this quarter, according to New York-based Merrill Lynch & Co. That would add to the $22 billion that Citigroup already lost because of the housing slump.
"Glass-Steagall protected bankers against themselves,'' Eveillard said. "Bankers are sheep. They don't mind going over the cliff if everyone else goes over the cliff.''
`Stagflation' Risk
The fastest interest-rate cuts in two decades and record oil prices are fueling expectations inflation may accelerate even as the economy slows, a phenomenon known as "stagflation'' that plagued the U.S. in the 1970s. Consumer prices were unchanged in February after jumping 4.3 percent in January from a year earlier, almost double the pace six months before.
Yields on securities that protect against rising consumer prices turned negative for the first time ever at the end of last month, evidence investors are so sure the Fed will lose control of inflation as it tries to reignite growth that they are willing to give up interest payments to protect their principal.
"It would be a mistake for investors to rule out an unusually bad outcome,'' said Dennis Stattman, who runs the $46 billion BlackRock Global Allocation Fund from Plainsboro, New Jersey. "This is not just a set of emotions taking over, with pessimism trumping abundant signs of spring.''
`Is it Cheap?'
The fund, which can invest in stocks, bonds, currencies and derivatives globally, holds put options on the S&P 500 and structured notes that increase in value when the measure falls. The fund is also the most "underweight'' U.S. equities of any asset class outside the dollar, he said.
Investors are skeptical of valuations because of the prospect of a stagnating economy, said Roland Lescure, chief investment officer at Groupama Asset Management in Paris. S&P 500 members are trading at 13.28 times forecast profit, data compiled by Bloomberg show. The last time the historic price-earnings ratio traded at that level was in 1989.
Versus 10-year Treasury notes, U.S. stocks yielded 1.62 percentage points more in earnings in January, the widest advantage since at least 1986, according to Bloomberg data.
"The market is cheaper, but is it cheap?'' said Lescure, 41, who oversees $140 billion. "I am not so sure. There is more bad news to come.''
... ... ...
Nobody expects an investment bank to be a charitable institution, but Bear has a particularly nasty reputation. As Gretchen Morgenson ... reminds us, Bear “has often operated in the gray areas of Wall Street and with an aggressive, brass-knuckles approach.”
Bear was a major promoter of the most questionable subprime lenders.
... ... ...
As Bear goes, so will go the rest of the financial system. And if history is any guide, the coming taxpayer-financed bailout will end up costing a lot of money.
The U.S. savings and loan crisis of the 1980s ended up costing taxpayers 3.2 percent of G.D.P., the equivalent of $450 billion today. Some estimates put the fiscal cost of Japan’s post-bubble cleanup at more than 20 percent of G.D.P. — the equivalent of $3 trillion for the United States.
If these numbers shock you, they should. But the big bailout is coming. The only question is how well it will be managed.
Comments
Bail Out says...
The danger with Bear was counter party risk in the synthetic securities market. Loss of confidence that Bear would honor its derivatives contracts may very well have ended credit in the derivatives market. JP Morgan has a solid reputation, and the Fed has backed them up.
Bear itself was not bailed out, as shareholders lost virtually everything. Only the synthetic credit market was bailed out.
bullbust says...
As I said, the important thing is to bail out the system, not the people who got us into this mess. That means cleaning out the shareholders in failed institutions, making bondholders take a haircut, and canceling the stock options of executives who got rich playing heads I win, tails you lose.
Admirable, even if it's late. Let's see how many of his fellow economists join him in this call.
That’s an O.K. resolution for this case — but not a model for the much bigger bailout to come.
The integrity of this call depends on how forcefully this idea is voiced and publicized. I hope this does not end here - that this is not an empty gesture for some future citation of "I mad the call for B and TRC like cleanup."
An examination and correction, of the blind herd behavior by economists, is well worth it. Why is your discipline so corrupt?
LesserFlea says...A month ago Morgensen did a NYT story on credit default swaps.
She stated that J.P Morgan-Chase was on one side or the other of $7.8 trillion of these swaps.
One would think that the counter-party for a bunch of them would have been their client, Bear-Stearns. No doubt JPM hedged by insuring somewhere else; keeping some fee differential based on the fact that they are a big time bank and the unknown counter-parties on the other side were less formidable ---and now, we suppose, unable
to pay up.So my question is:
How do we know that this whole deal isn't just to hold off the reckoning for JPM, rather than being this move reluctantly taken by JPM as a favor to the whole world?
a says...
"...take the real economy down with it..."
I think this point needs to be disputed. Americans are over-consuming and need to consume less. That means an indisputable hit to the real economy, as Americans need to become poorer if not much poorer. Pretending this is just a crisis in financial institutions is wishful thinking. There's also a crisis in the real economy, which is being masked by the crisis on Wall Street.
ddt says...Who ya gonna call?
Paul Krugman
http://krugman.blogs.nytimes.com/2008/03/17/who-ya-gonna-call/Nouriel* is right: this is the worst financial crisis since the Great Depression, and the Fed, with the best will in the world, probably lacks the tools to deal with it. Broader action is necessary.
But then comes the question: who ya gonna call?
The Gang That Couldn’t think Straight still holds the White House; no good ideas will come from that quarter. Worse, Incurious George would probably veto any sensible plan from Congress, even if said plan could get past a filibuster.
Hey, here’s an idea! Let’s create a nonpartisan expert commission, headed by Alan Gr …. oh, wait. He’s part of the problem. In fact, is there any way we can repossess his book royalties?Seriously, it’s very hard to see who can take charge.
Things fall apart, and the center doesn’t exist.
*http://www.rgemonitor.com/blog/roubini/249924
Bruce Wilder says...anne:
"Americans are over-consuming and need to consume less. That means an indisputable hit to the real economy, as Americans need to become poorer if not much poorer."
Always crazed viciousness, all the time.
The observation of "viciousness" has become a bad habit; without discretion, it is no longer a useful insight, it is just empty slander and a waste of bytes.
Robinia says...The comment by off-floor trader James was very interesting:
But what is going on today is just ... stealing. Its robbing every decent person who works for a living. Its getting to be just ridiculous, and we who know better ought to be ashamed if we are not speaking out.While I agree with Robert Feinman that some Bear Stearns employees must be retained to accomplish the transitions, there are some financial sector jobs in sub-prime loan pushing, complex financial product structuring, etc., etc. that are basically what James sees them as: professional theives. That type of job must be rooted out of the system, along with the persons who posess those skills. They must find honest work in another sector, and we must use better judgement in whom we admire and give accolades to in the business press.
Bruce Wilder says...ScentofViolets: "I come away from Krugman's column with this thought: certain segments of the economy should take a sound beating - and deservedly so. The question is, will they get it?"
I find myself thinking much the same thing.
This kind of cleaning out of the rot at the top cannot proceed without affecting every last one of us, though.
The impulse to "fix" the problem as "expediently" as possible, however, is identical with preserving the rot. Worrying "later" about "the details" whether those details are details of implementation or later reform is simply a cop-out. We are here because of the reforms pressed by the Right. We are here because Clinton presided over the repeal of Glass-Steagall and allowed Arthur Leavitt to be euthanized. We are here because the reforms that followed WorldCom and Enron were way too little, too late.
And, we're still doing it. We are still lying, as a matter of policy. Everyone complains about how uselessly corrupt the ratings agencies have become. But, now -- right now -- the ratings agencies are refraining from writing down the ratings on AAA bonds that aren't AAA bonds, in the name of expediency. The SEC is allowing the banks to not report honestly on the SIVs that have collapsed back to the mother ship. And, the other day, in Congress, the credit card companies, who have been screwing people senseless, managed to squash testimony on their predatory behavior.
Whether particular criminal executives should be "punished" is just one aspect of a system that has failed because of dishonesty and fraud and predation. If you keep alive that system, now, there will be no reform, later. That's a friggin' lie. There will be no reform until those who oppose reform are ruined and destroyed. That's the way it works. Keep alive this system and the fraud and predation will just go on. The American middle class will disappear underneath credit card debt and home equity losses, and the plutocracy will continue to advance.
The only "rescue", the only "bailout" plans that make any sense are the ones that explicitly call for the ruin of this rotten system. Nationalize and pursue civil forfeiture on a mass scale. Worry about the details of an honest banking system later.
Granville, born in 1923, remembers his banker father's bad moods following the stock-market crash of 1929. The younger Granville began his career at defunct brokerage E.F. Hutton in 1957, quit in 1963 to begin publishing a weekly newsletter and wrote nine books on investing."We're in a crash,'' Granville, 84, said in a telephone interview from Kansas City, Missouri, where he lives and works. "This is the worst I've seen, and I've studied every bit of history all my life.''....
Stovall, 82, started out as a junior security analyst at E.F. Hutton in 1953 and ascended to head of research. He also held the posts of research director at Nuveen Corp. and director of investment policy at Dean Witter Reynolds Inc. before founding and running his own firm for 15 years and selling it to Prudential Financial Inc. in 2000. He currently chairs the investment strategy committee at Sarasota, Florida-based Wood Asset Management, which oversees $1.6 billion.
Granville correctly forecast the bear market of 1977-78. Later, he failed to foresee the rally that started in 1982 and lasted for five years. He also called for losses in 1995 before the so-called Internet bubble began.
On March 11, 2000, a day after the Nasdaq Composite Index peaked at 5,048.62, he wrote that investors in technology stocks "will soon be burned.'' The index, which now gets 42 percent of its value from computer-related shares, sank 78 percent through Oct. 9, 2002....
"With confidence at a low ebb, you wonder if this contagion will spread,'' Stovall said in a telephone interview from his office. "We have to be concerned about the stability of the whole financial system.''
Perhaps I'm a cynic, but I think the timing of uberbull Abby Joseph Cohen's change in duties is no coincidence: Abby Joseph Cohen, among the most bullish investment strategist on Wall Street this year, will stop making Standard & Poor's 500 Index forecasts for Goldman Sachs Group Inc.She was succeeded in the role by David Kostin, Goldman's U.S. investment strategist, spokesman Ed Canaday said in a telephone interview. Kostin today predicted the S&P 500 may fall 10 percent to 1,160 before rebounding to 1,380 by year's end.
The 56-year-old Cohen now has the title "senior investment strategist'' and conhan others. All in the spirit of law, order and the proper functioning of society, of course.
As feared, foreign bond holders have begun to exercise a collective vote of no confidence in the devaluation policies of the US government. The Federal Reserve faces a potential veto of its Asian, Mid East and European investors stood aside at last week's auction of 10-year US Treasury notes. "It was a disaster," said Ray Attrill from 4castweb. "We may be close to the point where the uglier consequences of benign neglect towards the currency are revealed."
The share of foreign buyers ("indirect bidders") plummeted to 5.8%, from an average 25% over the last eight weeks. On the Richter Scale of unfolding dramas, this matches the death of Bear Stearns.
Rightly or wrongly, a view has taken hold that Washington is cynically debasing the coinage, hoping to export its day of reckoning through beggar-thy-neighbour policies.
It is not my view. I believe the forces of debt deflation now engulfing America - and soon half the world - are so powerful that nobody will be worrying about inflation a year hence.
Yes, the Fed caused this mess by setting the price of credit too low for too long, feeding the cancer of debt dependency. But we are in the eye of the storm now. This is not a time for priggery.
The Fed's emergency actions are imperative. Last week's collapse of confidence in the creditworthiness of Fannie Mae and Freddie Mac was life-threatening. These agencies underpin 60% of the $11,000bn market for US home loans.
With the "financial accelerator" kicking into top gear - downwards - we may need everything that Ben Bernanke can offer.
Bear Stearns may be worse than LTCM collapse Jeff Randall: A world addicted to easy credit must go cold turkey How Bear Stearns ran out of the necessities "The situation is getting worse, and the risks are that it could get very bad," said Martin Feldstein, head of the National Bureau of Economic Research. "There's no doubt that this year and next year are going to be very difficult."
Even monetary policy à l'outrance may not be enough to halt the spiral. Former US Treasury secretary Lawrence Summers says the Fed's shower of liquidity cannot cure a bankruptcy crisis caused by a tidal wave of property defaults.
"It is like fighting a virus with antibiotics," he said.
We can no longer exclude a partial nationalisation of the American banking system, modelled on the Nordic rescue in the early 1990s.
But even if you think the Fed has no choice other than to take dramatic action, the critics are also right in warning that this comes at a serious cost and it may backfire.
The imminent risk is that global flight from US Treasury and agency debt drives up long-term rates, the key funding instrument for mortgages and corporations. The effect could outweigh Fed easing.
Overall credit conditions could tighten into a slump (like 1930). It's the stuff of bad dreams. Is this the moment when America finally discovers the meaning of the Faustian pact it signed so blithely with Asian creditors?
As the Wall Street Journal wrote this weekend, the entire country is facing a "margin call". The US has come to depend on $800bn inflows of cheap foreign capital each year to cover shopping bills. They may have to pay a much stiffer rent.
As of June 2007, foreigners owned $6,007bn of long-term US debt. (Equal to 66% of the entire US federal debt). The biggest holdings by country are, in billions: Japan (901), China (870), UK (475), Luxembourg (424), Cayman Islands (422), Belgium (369), Ireland (176), Germany (155), Switzerland (140), Bermuda (133), Netherlands (123), Korea (118), Russia (109), Taiwan (107), Canada (106), Brazil (103). Who is jumping ship?
The Chinese have quickened the pace of yuan appreciation to choke off 8.7% inflation, slowing US bond purchases. Petrodollar funds, working through UK off-shore accounts, are clearly dumping dollars amid rumours that Gulf states - overheating wildly - are about to break their dollar pegs. But mostly likely, the twin crash in the dollar and US agency debt reflects a broad exodus by global wealth managers, afraid that America is spinning out of control. Sauve qui peut.
The bond debacle last week tallies with the crash in the dollar index to an all-time low of 71.58, down 14.6% in a year. The greenback is nearing parity with the Swiss franc - shocking for those who remember when it was 4.375 francs in 1970. Against the euro it has hit $1.57, from $0.82 in 2000. Against the yen it has smashed through Y100. Spare a thought for Toyota. It loses $350m in revenues for every one yen move. That is an $8.75bn hit since June. Tokyo's Nikkei index is crumbling. Less understood, it is also causing a self-reinforcing spiral of credit shrinkage throughout the global system.
Japanese investors and foreign funds are having to close their yen "carry trade" positions. A chunk of the $1,400bn trade built up over six years has been viciously unwound in weeks. The harder the dollar falls, the further this must go.
It is unsettling to watch the world's reserve currency disintegrate. Commodities from gold to oil and wheat are taking on the role of safe-haven "currencies". The monetary order is becoming unhinged.
I doubt the dollar can fall much further. What is it to fall against? The spreading credit contagion will cause large parts of the globe to downgrade in hot pursuit - starting with Europe.
Few noticed last week that the Italian treasury auction was also a flop. The bids collapsed. For the first time since the launch of EMU, Italy failed to sell a full batch of state bonds.
The euro blasted higher anyway, driven by hot money flows. The funds are beguiled by Germany's "Exportwunder", for now. It cannot last. The demented level of $1.57 will not be tolerated by French, Italian and Spanish politicians. The Latin property bubbles are deflating fast.
The race to the bottom must soon begin. Half the world will be slashing rates this year to stave off credit contraction. The dollar will have a lot of company. Small comfort.
With trading floors awash with worries about who could be next, the CDS spreads of financial institutions were moving wider. The correlation market began to fall too, implying that the market is shifting from predicting general, systemic risk to “single-name” risk — the idea that some institutions are more vulnerable than others.With many credit investors sitting on the sidelines, the only catalyst for performance in credit markets is likely to be intervention from the Fed or US government, said Jim Reid at Deutsche Bank, in a note to clients.
“The Fed has now stepped up a gear and ultimately we probably need the US Government to do so too. Even though we believe in free markets and believe that pain should be felt after such an unruly credit binge, we also think we are close to a financial system meltdown. At this stage moral hazard arguments need to be put in a wider perspective.”
But Mehernosh Engineer, credit strategist at BNP Paribas, said that intervention efforts would not be effective until the Fed recognised the nature of the crisis.
The core problem is that the Fed is still not acknowledging that triple A rated CDOs are not triple A. Until it does, the market is just seeing through all of its interventions. The Fed is trying to portray this as a liquidity problem but it’s an insolvency problem based on deteriorating assets.
Mish's Global Economic Trend Analysis
"It is a serious extension of putting the Federal Reserve's balance sheet in harm's way,"