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| (slightly skeptical) Educational society promoting "Back to basics" movement against IT overcomplexity and bastardization of classic Unix | |||||||
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| 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 |
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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 Debt
In 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.
Calculated Risk
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.com
Former 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.
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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.
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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," said Vincent Reinhart, former director of the Division of Monetary Affairs at the Fed and now a scholar at the American Enterprise Institute in Washington. "That's got to tell you the economy is in a pretty precarious state."
"We learned that Bear Stearns's balance sheet on close examination was worth a 10th of its market value," said Reinhart.
... ... ...
Think all that debt on the books of Lehman (LEH), Morgan Stanley (MS), Goldman Sachs (GS), Citigroup (C), Merrill Lynch (MER), Bank of America (BAC), etc., is worth what is claimed? Think again. More revaluations are coming.
Comments:
Mish,
I agree with you at the moment this will be very deflationary. Less money in the hands of consumers will lead to fire sales of inventorie s. Plus the sale of used cars,Harle ys,boats,to ys of all kinds will lead to problems for manufactur es in the near future.
However what happens if the rest of the world takes their bat,ball, and glove and goes home. Without the 2 billion a day we need coming in to stay afloat, won't tresuries fall like a rock causing higher interest rates? Which theoretica lly could lead to true monitizing of the debt. Not disagreein g but curious what your take would be in this scenario.
Yes, it’s an all share deal, which is intriguing. Is this such a steal that, with added patriotic gusto, JPM stock might soar on Monday, throwing a dime or two to impoverished Bear bulls, like Britain’s Joe Lewis? Or is it simply an invitation to the market to confirm that BS really is worthless - worth a billion dollars less than its property assets, no less?
... ... ...
Cynics will no doubt see this as an invitation to target other rumour-prone institutions. BS has gone from $70 to $2 in the space of a week. Others might cite it as the cathartic act that stirs the wider market into a realisation that losses can and will be aportioned, that new (albeit painful) prices for financial assets can be assigned, and the financial world can move on. Cautiously.But DON”T for a moment think that all the guff has now been worked out of the system.
Mish's Global Economic Trend Analysis
I followed leads on the above to Bear Stearns: The Smoking Gun(s) and from the same blog 2007-2009 Bear Market Update. A snip from the former also made reference to the above chart with the following additional commentary.
nightmare, being so large that the failure of any single significant company such as Bear Stearns could precipitate a chain reaction of defaults. As you may recall we pointed out some time ago that after subprime the next area to watch closely as a potential tipping point would be the CDS market.
This article by Jeff Randall in the Telegraph does a nice job of looking at the causes of our credit mess and articulating implications. And he quotes my hero Paul Volcker (do you know that he stayed at the Fed fixing the economy even though his wife was very sick and he was having trouble paying the medical bills on his meager government salary? He had sterling reasons to get out of the pressure cooker and get a more lucrative private sector job, yet he saw his program through).
I found this piece colorful, pointed, and on the money.
From the Telegraph:
When dealers arrive at their desks tomorrow morning, the first question will be: Who's next? Is it just Bear Stearns that has run out of cash, or are other great institutions staring into empty coffers? Investors are already betting that Lehman Brothers, another premier league player, has its financials caught in a mangle.The US locomotive, for so long the engine of global consumption, is not just grinding to a halt, it is falling apart. The New York Times reports this weekend: "Everything seems to be going wrong… People are buying less, but most things are costing more. Mortgage rates are rising, the dollar is falling and prices of key commodities are leaping from one record high to the next."
Where now are the financiers, regulators and politicians who peddled the inanity, "we mustn't talk ourselves into recession"? Of all the vacuous comments made by officialdom, this one, given the rapid spread of financial disruption, grates more than most. Nobody is talking anyone into anything - it's too late for that. Our jeopardy is very real. Recession, if it comes, will be the result not of idle chatter but a conspiracy of silence. It underpinned the fantasy.
For too long, those who warned that the borrowing bubble would burst with terrible consequences were dismissed as congenital gloomsters. Greedy lenders, their irresponsible customers and incompetent ministers formed an unholy alliance to perpetuate a myth: that consumers, companies and governments could keep spending more than they earned and suffer no penalty.
We heard new and intriguing justifications for excess. Banks seemed able to acquire rubbish and recycle it as triple-A securities. It was a sophisticated version of the second-hand shop that advertises: "We buy unwanted junk and sell valuable antiques." Instruments of financial leverage became so complicated that even those trading them did not fully understand how the system worked. All they cared about was the potency of magic that enabled welfare claimants to borrow five or six times the income they were not earning and still make the numbers add up.
So clever were the designers of this wizardry that, though it failed the common sense test, they were able to fool supervisors, credit committees, external auditors, shareholders and regulators - even themselves! Disbelief was suspended by all concerned.
An important pre-condition for a faith in easy money is a complete disregard for the lessons of history. The bulls at Bear Stearns, it seems, were too busy spending their jackpot bonuses to read how and why boom turned to bust at Barings. Picking through the wreckage of his family's bank, two years after it went under, Peter Baring told a Bank of England inquiry that while Nick Leeson was making extraordinary (and wholly illusory) profits, the company's directors concluded that "it was not actually terribly difficult to make money in the securities business".
For securities in the Nineties, read sub-prime in the Noughties. When it looks too good to be true, it usually is. Bear Stearns has suffered crippling losses on mortgage-linked investments. In the same way that Northern Rock lost the confidence of British savers, Bear Stearns eventually exhausted the trust of hedge funds and its other commercial lenders. For a bank that trades by borrowing 30 times its equity base, this was the kiss of death.
Three years ago, Paul Volcker, a former chairman of the Federal Reserve, warned that the US was "an economy on thin ice". In particular he was worried that Americans had become hooked on living imprudently by using their homes as cash machines. He wrote in The Washington Post: "Personal savings in the United States have practically disappeared… we are buying a lot of housing at rising prices, but home ownership has become a vehicle for borrowing as much as a source of financial security."
Does that sound familiar? I'm afraid so. Here in the United Kingdom we have been living a similar dream. Unable to fund all spending ambitions from income, too many Britons have cashed in part of their bricks and mortar for a blast of instant gratification. Worse still, so has the Government. Unwilling to live within its means, even with revenues of about £600 billion a year, Gordon Brown's Circus and its troupe of performing puppets must borrow more than £40 billion next year to make ends meet. Its budgetary indiscipline makes us all more vulnerable to a sharp downturn.
Credit markets have frozen because it is unclear how many more of the big banks, if any, are bluffing. Nobody wants to be caught out trading with a loser. So cash is being hoarded. At the start of last week, the boss of Bear Stearns told the market that his firm was safe. But when lenders called that bluff, the cupboard was bare.
Central banks are trying to calm jitters by pouring billions of dollars into money markets to increase liquidity. Last week another $200 billion was dropped into the system. That was quickly swallowed up amidst screams for yet more emergency injections. Debt junkies, like heroin addicts, demand ever bigger fixes.
And this brings us to the heart of the matter. The rational response to financial pain is risk reduction. But if the pain is removed, or even suppressed, then so is fear. When individuals or institutions believe they will always be bailed out, they lose the incentive to reform. Delinquency is, in effect, encouraged.
In the end, the patient is so full of painkillers that they become part of the problem. The only way forward is for all palliatives to be washed out of the system. Sooner or later borrowers and lenders must address the real cause of discomfort. For many of Wall Street's finest, it will feel like cold turkey.
But consider what other lessons have been learned in this saga;
Investment banks can go under with remarkable speed. The last time we had an investment bank failure was Drexel Burnham Lambert, but everyone on the Street hated Drexel, it was in a niche business that its competitors coveted, so everyone stood aside and the firm was gone in no time flat (I dimly recall that crisis to failure was maybe three business days). But here, even with the Fed and another major bank putting their muscle behind a rescue operation, the outcome will probably be much the same. That isn't just sobering, it's a reality that many haven't witnessed. It will elevate the prevailing level of nervousness.
Efforts to reduce risk can have the opposite effect. This was a point made in Richard Bookstaber's A Demon of Our Own Design, that in what he called tightly coupled systems, insurance measures can make things worse (witness: everyone running to buy credit default swaps to contain their risks is making prices skyrocket, which is increasing prices considerably for anyone who want to finance, which hurts the real economy, which increases fundamental risk). And that specifically means that the Fed's moves may well backfire. As we noted yesterday (this obsrevation came from a reader):
The TSLF probably had the perverse effect of killing Carlyle Capital, the exact opposite of what was intended (Robert Peston @ BBC, via Alea). The TSLF gave creditors every incentive to seize Carlyle Capital's collateral in order to present it at the Fed window in exchange for "lovely liquid Treasuries", something which Carlyle Capital itself couldn't do. Bear, on the other hand, is allowed to use the TSLF... but the TSLF doesn't go live until March 27.Specifically, if the yen rallies to 98 or higher on Monday and Tuesday trading in Tokyo, a 100 or even 75 basis point cut by the Fed Tuesday could be disastrous.The Fed is badly out of its depth. Not that this is a surprise, since its actions have looked desperate for a while (was it Barry Ritholtz who said "75 is the new 25"?). This confirmation comes from a hedgie reader:
A last note on the Fed. A friend who’s got very good contacts told me today that they’re completely at sea here, not understanding what’s going on, flying by the seat of their pants, and making policy completely on an ad hoc basis. Not precisely what one would hope for in this situation.Let's all hope next week is not as exciting as I fear it could be.
"Character and Capitalism"
Steve Waldman is on a roll. He has an excellent piece today arguing that despite contemporary notions otherwise, capitalism and character (meaning moral fiber) have not and need not be contradictory.
Although Waldman makes a good case, the barriers to the return of character in commerce are more profound than he lets on.
A colleague of mine, Amar Bhide, a professor at Columbia School, did some field work in the early 1990s on the role of trust in business and was very disheartened with what he found. Power and economic self interest trumped considerations of morality. Business owners were willing to accept being screwed by customers because they felt they needed them. They resented it deeply, they grumbled, but they accepted that they lacked the leverage to demand better treatment (I will need to locate his article, which I think ran in the Harvard Business Review, but the title was something along the lines of "Why Be Honest?" and it concluded, with considerable reluctance, that there wasn't much upside in behaving well).
What makes it possible to have values is enforcement mechanisms, which usually boil down to prevailing standards. In a small town, if a store owner is unpleasant, tries to short change customers, or kicks his dog, word gets out and business suffers. But many of us mange our affairs in a impersonal way (think of Internet purchases). We have limited interactions with people. We might have a relationship with a firm, yet the account manager changes every couple of years. The standards thus reflect what is considered acceptable for the industry as well as the company. Great conduct in the credit card industry (if there even is such a thing) is not the same as great conduct from a hotel. Where is there opportunity for character to enter into either of these interactions? Even if someone goes the extra mile for you, you might never see that person again. Their effort will probably go unrewarded, or worse, might be against policy.
Now I am digressing a bit; Waldman meant character in a narrower Victorian sense, as being a person of one's word. But even then, the drive to efficiency that has become pervasive in American businesses has made it well-nigh impossible for that to be operative. The reliance on FICO scores in place of more nuanced credit decisions is merely the logical result of processes that have been in play for many years.
One of my favorite banking industry factoids is that despite the widespread belief that bigger banks are more efficient, every study of commercial banks ever done has found that they have a slightly increasing cost curve once a certain size threshold has been achieved. Where the increasing costs (per dollar of assets) kicks in varies, but the highest point I saw (this was some years ago) was $5 billion in assets. One study found the break point was $100 million.
Now this flies in the face of most logic. Banking is all about automated, repeatable transactions. Moreover, big banks enjoy tremendous cost advantages in funding (big bond issues and other capital markets sources are much cheaper than relying primarily on deposits). Big banks are also more likely to be in pure fee businesses like M&A and loan servicing which require nothing in the way of assets beyond desks and phones.
My pet theory is that old-fashoned lending, the know-your-borrower types, is much more efficient on an all-in basis than the interpersonal, multi-layered credit scoring processes used in every type of loan product in a large bank. Yes, it costs you a lot more to source the loan. But they probably make it up in lower loan losses (a combination of lower default and more success with loss mitigation, since if you know the borrower, he will probably feel a greater obligation to repay. In addition, if he does experience real duress, your knowledge of him and the community will enable you to make a more informed assessment of his ability to repay, again improving the odds of a successful restructuring.
No academic has ever investigated my pet theory, but as of the last time I read the literature, no one had come up with an explanation. But there is anecdotal evidence. My colleague Doug Smith (no relation) in an article in Slate, pointed out that not-for profit lenders had provided subprime loans, yet experienced losses no worse than on prime loans, precisely because they screened borrowers in the traditional manner, in person, and assessed, among other things, their understanding of the loan and their degree of commitment.
So why, when we have had a resounding failure of impersonal methods of assessment, am I pessimistic about the revival of interest in character? Because it appears our society is unwilling to go back on the false economy of preferring anonymous, rule-based approaches. These methods do broaden the market of possible counterparties, which is seen an entirely beneficial, when there are hidden costs in having only superficial proxies about the people you interact with. If anything, I see ample evidence this attitude is becoming more pervasive.
Some examples: it has become common practice to put vendors to large corporations through a formal approval process. I have found them to be inappropriate and often misguided. For instance, one company required its vendors (which included big ticket law firms and consulting firms) to certify that their employees had gone through drug screening recently (the logic apparently was that if they had a drug habit, they might steal Big Corp's secrets, as if they learned anything that might indeed be that easily traded upon). If you work for a good firm, the idea that you have to get tested to work on XYZ account is a non-starter.
Now a firm like McKinsey can usually escalate matters to a level of management where can get an exemption from this nonsense (a McKinsey partner told me that on a study where it came up, there was absolutely no useful intelligence the firm would be party to, plus, as pointed out, "We pay people well enough for them to afford their own drugs."). But a smaller vendor would be unable to escape this and other cookie cutter demands that are often both intrusive and irrelevant. I've pretty much written off having large corporations as clients (I used to work for them quite frequently). It isn't worth the indignity of going through that process. In fact, it seems destined (ex the firms that can wriggle their way out of it) to assure negative selection: only firms who really need the business will put up with these demands.
Similarly, it's become increasingly common to use credit reports as part of the new hire screening process, even for very low level jobs. Again, I'm not sure what that proves, I can think of plenty of reasons why an otherwise conscientious person might have a bad credit record (say needing to support an ailing parent and becoming overextended). In close calls where there was a particular reason to think it might be helpful, I could see resorting to it, but to use it as a proxy for character is silly.
From Waldman:
Via the indefatigableMark Thoma, our attention is drawn to an odd piece by Robert Skidelsky. I was left mostly bewildered by the article, but I was intrigued by the author's discussion of the virtues that are and are not inculcated by market capitalism:Consider character. It has often been claimed that capitalism rewards the qualities of self-restraint, hard-work, inventiveness, thrift, and prudence. On the other hand, it crowds out virtues that have no economic utility, like heroism, honor, generosity, and pity. (Heroism survives, in part, in the romanticized idea of the “heroic entrepreneur.”)
The problem is not just the moral inadequacy of the economic virtues, but their disappearance. Hard work and inventiveness are still rewarded, but self-restraint, thrift, and prudence surely started to vanish with the first credit card. In the affluent West, everyone borrows to consume as much as possible. America and Britain are drowning in debt.
One thing to remember is that there is no such thing as "capitalism". In the real world, there are actual practices and institutions, the details of which bear consequentially on both moral and economic outcomes. There are infinity of possible capitalisms, and at any given moment we are living just one. A stylized graph of supply and demand always hides more than it reveals.
The capitalism we are living right now is rather a nightmare, due to a credit, um, event. So it seems a propos to remember that credit analysis traditionally includes an explicitly moral component. Remember the "5 Cs of Credit"? Character, capacity, capital, collateral, and conditions. Character.
Here's a famous bit of financial history, as recounted by Jean Strouse in the New York Times:
Asked by the lawyer for a congressional investigating committee in 1912 whether bankers issued commercial credit only to people who already had money or property, [J. P. Morgan] said, "No sir; the first thing is character." The skeptical lawyer repeated his question and Morgan, in Victorian terminology, elaborated on his answer — "because a man I do not trust could not get money from me on all the bonds in Christendom."If you think Morgan, the arch plutocrat, was just telling a nice sounding, self-serving lie, think again. Think about a world in which there was no SEC, FDIC, or Federal Reserve; in which there was no technology sufficient to prevent a person from simply disappearing, changing his name, starting over somewhere else. Morgan invested vast sums, and though he was a powerful man, he could always be taken. When parting with a dollar, he could not be so lazy as to presume a courtroom would ensure its repayment. Morgan had to trust.Since Morgan's day, in pursuit of efficiency and safety, we've built up institutions designed to automate and certify the evaluation of character. When we lend money, we don't ask to meet the person who promises to repay us. We look for a nod by a regulator, the AAA brand provided by S&P or Moody's or Fitch, perhaps a FICO score. But those are not markers of character at all. We don't take them to be. We understand that banks engage in regulatory arbitrage, finding ways to stretch their balance sheet as far as possible for yield despite whatever regulatory regime is in place. We know that credit issuers (and bond insurers) do what they need to and no more for their rating, that perfectly dishonorable individuals attend to their FICO scores to maintain access to credit. Actual character is completely washed out of these proxies. The capitalism we have is one that presumes that all actors are sharks, that business is business, and that it is irrational to take any less than you can get away with unless you will "incur costs" from decertification. I'm not sure that J.P. Morgan would be willing to lend to any of us, and it's not because we're worse people. We just live in different times, a different world.
We shouldn't go back to the world as it was at the turn of the century. When character evaluation was a personal exercise, it necessarily depended upon social connections, whether someone you know and trust can vouch for someone you don't yet know, whether you can be sure that disgrace and dishonor would be costly. And we definitely should not adopt a moralistic attitude towards debt nonrepayment right now, just when a throng of irresponsible lenders are demanding "responsibility" from borrowers whose calls they would not even take a year ago. (For the record, I think that "jingle mail" is perfectly acceptable under present circumstances, and that the recent "bankruptcy reform" was a cruel mistake.)
But I do think that it's an interesting technical question, going forward, whether we couldn't set things up so that the criteria by which investors decide where to put their money map more closely to what we would recognize as trustworthiness or character. "Abolish the SEC and the Fed and the ratings agencies!" is not a sufficient proposal. Crises due to misplaced trust long predate those institutions, and are a large part of why they came to be in the first place. Morgan was successful not because he did what everybody did, but because he did what almost nobody did, despite the lack of ratings by S&P to stand-in for due diligence. Investors have always been hopeful and lazy in good times.
T.S. Eliot once wrote, "It is impossible to design a system so perfect that no one needs to be good." Perhaps the art is to come up with a system, however imperfect, under which being good is the best way to succeed.
The current high rate of delinquencies and foreclosures is not confined to the subprime market. In 2007, about 45 percent of foreclosures were on prime, near-prime, or government-backed mortgages.
We are singing the same cautious tune at SitkaPacific and see initial support at 1100 on the S&P 500. That's a long ways off from here, however, and the technical picture could change long before we get there. As of right now, however, my firm agrees with the idea that the technical damage that has occurred that cannot be ignored.
Northern Trust Chief Economist Paul Kasriel writes: Why Did the Fed Raise Rates in October 1931?Kasriel reviews some history, and discusses the implications of the possible end of "Bretton Woods II".
Some commentators have referred to the Chinese and Saudi pegging of their currencies to the U.S. dollar as “Bretton Woods II.” We wonder if the demise of Bretton Woods II is not close at hand. If it is, the greenback could plunge, U.S. consumer inflation could spike, and the Fed would have little choice but to stop cutting its policy interest rate, and, perhaps, even have to raise it, as it did in October 1931.
From the Duke Global CFO Survey: Recession in 2008, no relief until 2009
•54 percent of CFOs say the U.S. is now in recession, and 24 percent of the remaining CFOs say there is a high likelihood of a recession this year. CFOs do not expect the economy to recover until late 2009.CFOs sure are bearish!•Optimism reached its lowest point since the optimism index launched six years ago. Pessimists outnumber optimists by a nine-to-one margin, with 72 percent of CFOs more pessimistic and only 8 percent more optimistic about the U.S. economy than they were last quarter.
•Weak consumer demand and turmoil in the credit and housing markets are the top macro-concerns of CFOs. The high cost of labor ranked as the top internal concern.
•Credit conditions have directly hurt 35 percent of companies, through decreased availability of credit and higher interest rates (up 118 basis points on average). Sixty percent of firms have postponed expansion plans in response to credit market unrest.
•Capital spending is expected to increase only 3.3 percent. Price inflation is expected to rise 3 percent over the next 12 months.
NO ECONOMIC RECOVERY UNTIL 2009
The outlook for the U.S. economy is dismal. Only 13 percent of CFOs think the U.S. economy will turn the corner and begin to rebound in 2008. Another 40 percent say the rebound will occur in the first half of 2009, while 47 percent say recovery will occur more than 15 months from now.
“Our survey started showing evidence of an economic slowdown a year ago,” said John R. Graham, director of the survey and a finance professor at Duke’s Fuqua School of Business. “Today, not only do the CFOs say we are already in recession, they predict a prolonged economic downturn. The news from CFOs is pretty grim.”
And per a comment yesterday by the CEO of Wachovia, we are only in the early innings of the housing crisis. Subprime resets don't peak until August, with a substantial tail after that. Foreclosures take an average of 15 months. We won't see the bottom until at least 2009, perhaps even later. The Fed will be out of tricks well before then.
March 12 2008 | FT.com
The US will avoid a severe and prolonged recession similar to Japan’s in the 1990s because US policymakers will do whatever it takes to avert such an outcome, the Federal Reserve believes.
The central bank’s willingness to embrace unorthodox measures is reflected in its latest supersized liquidity operations, which involve lending financial institutions $436bn in one-month advances of cash and Treasuries.
Fed has also begun to put pressure on lenders to recapitalise and write down the value of home loans, while supporting policy initiatives to ease loan restructuring and support financing of new homes through the Federal Housing Administration.The Fed moves come amid growing concern over the risk of a deep and protracted recession. This fear is driving many mainstream experts to advocate policy interventions once thought radical and extreme.
On Wednesday, John Lipsky, the number two official at the International Monetary Fund, said governments might have to intervene directly with taxpayer money to shore up the financial system. Hank Paulson, US Treasury secretary, is expected to unveil fresh initiatives on Thursday.
Most economists now believe the US is in recession. “The economic debate is shifting to how deep and long it will be,” said Richard Berner, chief US economist at Morgan Stanley.
Until recently, the mainstream view was that any recession would be mild because of the lack of imbalances in the corporate sector, strong global growth, Fed rate cuts and a $168bn fiscal stimulus.
However, a darker view has taken hold as the labour market has started to crack, house price declines have intensified and financial markets deteriorated further. Economists worry that overextended consumers could start pulling back.
There is also a growing awareness that monetary policy alone might not be able to contain the risk of a severe recession, because of wide risk spreads and constraints imposed by inflation.
The difficulties now facing policymakers “seem as great today, if not greater, than at any other time in the post-war period”, said William White, chief economist at the Bank for International Settlements.
Some analysts now expect a double-dip recession, with growth fading after a short-lived boost from the fiscal stimulus.
This bleak view is reflected in financial markets, where the return on five-year Treasury inflation-protected securities is slightly negative – suggesting that real interest rates will average less than zero for five years.
There is concern that banks are pulling back on capital at risk, drawing liquidity from the markets and triggering forced sales by hedge funds.
“You have three vicious cycles going on simultaneously,” says Lawrence Summers, a former US Treasury secretary.
- “A liquidity vicious cycle – in which asset prices fall, people sell and therefore prices fall more;
- a Keynesian vicious cycle – where people’s incomes go down, so they spend less, so other people’s income falls and they spend less;
- and a credit accelerator, where economic losses cause financial problems that cause more real economy problems.”
Mr Summers says the situation is “qualitatively” though not “quantitatively” similar to that faced by Japan in the 1990s.
Fed officials insist the US will not end up like Japan, not because economics could not deliver such an outcome, but because the US system will not allow problems to fester.
Housing has been worse than expected every month for years. And it is interesting to note that economists still expect GDP to be positive through June. So you can book GDP as one of the things guaranteed to be worse than expected. Jobs are going to continue to be miserable, so count on jobs to be worse than expected.
Just what does it take to get economists tuned into reality? Are economists always such an optimistic lot? Or do they get paid by their firms to purposely present overly optimistic scenarios that do not have a snowball's chance in hell of happening?
In the meantime, expect everything to be worse than expected and you will do far better at predicting what's going to happen than 85% of the economists surveyed. If you expect things to be far worse than expected you will likely do better than almost all of them.
naked capitalism
This is not a two year problem. The last housing recession (started ~ 1988) lasted 15 quarters, and that was with a Resolution Trust Corporation to force market clearing.
With failure on the individual mortgage level, no easy way to either resturcure or liquidate mortgages due to the way they have been securitized (and the lack of workout skills at lenders; they outsource to credit counsellors), this will take at least as long to resolve.
And having the Fed socialize losses reduces the incentive to have market clearing. We are instead going the Japan route of having zombie financial institutions and prolonged low growth. But Japan at least had a very high savings rate, so they could manage this internally. I'm not sure our friendly creditors will cut us suficient slack.
naked capitalism
But witness a Bloomberg story Monday, the big prime brokers (Morgan Stanley, Goldman, Deutsche, and Bear control over 80% of the market) have increased their margin requirements.. This is going to push firms that might have OK under the old standards into margin call territory. That will lead to forced sales. That in turn will lead to lower asset prices.
naked capitalism
Reader comments
Lune said...
Just as I suspected. With a hundred billion here, a hundred billion there, pretty soon you're talking about real money (at least until the dollar tanks again :-). But quite frankly, what is the public getting in return for this $400 bil (and counting) federal guarantee?
Right now, while the bankers are crying uncle is the best time to force some much needed regulations and restrictions onto the industry. The only way to do that is to get Congress to explicitly provide the guarantee that the Fed is currently doing, and include in that legislation reforms of the industry.
Right now, the Fed has extracted nothing from the industry in exchange for this largesse. And once the industry is back on its feet, the cries of "Govt get off our backs" will inevitably start again.
I realize that creating a new regulatory scheme out of whole cloth will take some time. But the upside to waiting is that the banks' positions are likely to get weaker still, which means their bargaining power vis-a-vis Congress will be even worse. As for the markets themselves, I don't think a rise in risk premiums for agency debt is a catastrophic scenario for the typical Main St. borrower who's already locked in his mortgage terms. If it leads to the implosion of a bunch of hedge funds, why, that's just a bonus in my books :-)
Now we have clarity, says the FT’s John Authers in Tuesday’s Short View column. Last week’s awful employment data from the US ended all arguments about whether the US is heading for a recession: it is already in one. Now we need only argue about its severity and its duration.
Meanwhile, the equity market has given up its attempt to deny the credit crisis and has lapsed into a bear market, defined as a 20 per cent fall from peak to trough. Europe, Japan and China are already bear markets. The S&P 500 is down only 17 per cent, but this is an illusion of the weak dollar: in euro terms it is down 27 per cent.
Optimists draw parallels with two shallow bear markets: 1990 (which lasted a year, with a fall of 19.9 per cent) and 1998 (a four-month decline of 19.3 per cent). But the 1998 comparison is specious. The US was not in recession. The crisis was concentrated in the LTCM hedge fund. All the interested parties could be gathered into one room. Hope springs eternal, as market rallies in recent months attest, but there is no chance that this crisis can be solved so easily.
The 1990 parallel is more beguiling. Then as now the US was heading into a recession, and the problem centred on irresponsible home lending.
But that bear market included Iraq’s invasion of Kuwait. Most importantly, the financial system has changed, and now relies on credit and money markets that barely existed in 1990. It is ever more apparent that they are not functioning.
On Monday, Wall Street threw in the towel. The morning’s worst fallers are a list of the groups that dominated the world of secuks most deeply involved in mortgage finance. As with the economy, we have clarity: the credit market model is broken and must be fixed.
Oooh, the week has barely started and we've already had an overdose of adrenaline-generating news. Thornburg Mortgage and Carlyle Capital, both twisting in the wind, battered by margin calls, look unlikely to escape bankruptcy (Thornburg has already defaulted on financing agreements; Carlyle is seeking a standstill). Freddie and Fannie took a further beating thanks to a Barron's article that took a harsh look at Fannie's finances. Bear Stearns and Lehman were the focus of worries about solvency. WaMu is reported to be seeking cash from private equity investors and sovereign wealth funds.
Now at first this looks like a financial market meltdown, but there is some interdependence in these developments. On the one hand, the latest market downturn has been triggered by the increase of the conforming loan limits for Fannie and Freddie, which has led to a rise in their credit spreads since late January. Since then, there has been more discussion in DC about various ways to ameliorate the ever-worsening housing mess, and too many solutions involve Freddie and Fannie sopping up dubious debt for anyone's taste, particularly in the absence of an explicit Federal guarantee of their obligations. The sudden rise in spreads is effectively a protest against this line of action.
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But witness a Bloomberg story Monday, the big prime brokers (Morgan Stanley, Goldman, Deutsche, and Bear control over 80% of the market) have increased their margin requirements.. This is going to push firms that might have OK under the old standards into margin call territory. That will lead to forced sales. That in turn will lead to lower asset prices.
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We have other sightings of banks shooting themselves in the foot in misguided attempts to save their hides.
naked capitalism
As with the monoline insurer fiasco, the rating agencies give critics more evidence that their grades are a sham, dictated by political considerations instead of economic reality. Some sources for the story expect ratings to be lowered in six weeks. I wouldn't hold my breath.
From Bloomberg:
Even after downgrading almost 10,000 subprime-mortgage bonds, Standard & Poor's and Moody's Investors Service haven't cut the ones that matter most: AAA securities that are the mainstays of bank and insurance company investments.None of the 80 AAA securities in ABX indexes that track subprime bonds meet the criteria S&P had even before it toughened ratings standards in February, according to data compiled by Bloomberg. A bond sold by Deutsche Bank AG in May 2006 is AAA at both companies even though 43 percent of the underlying mortgages are delinquent.
Sticking to the rules would strip at least $120 billion in bonds of their AAA status, extending the pain of a mortgage crisis that's triggered $188 billion in writedowns for the world's largest financial firms. AAA debt fell as low as 61 cents on the dollar after record home foreclosures and a decline to AA may push the value of the debt to 26 cents, according to Credit Suisse Group.
"The fact that they've kept those ratings where they are is laughable,'' said Kyle Bass, chief executive officer of Hayman Capital Partners, a Dallas-based hedge fund that made $500 million last year betting lower-rated subprime-mortgage bonds would decline in value. "Downgrades of AAA and AA bonds are imminent, and they're going to be significant.''
Bass estimates most of AAA subprime bonds in the ABX indexes will be cut by an average of six or seven levels within six weeks.
Near the end he acknowledges that it is quite possible that Fed is powerless to save the financial system.
What he thinks is possible is to save the current system by pumping more credit into it, since it is already impossible to pay interest on all the credit out there without borrowing more. And who would lend more to people who cannot repay?What it means is that we are at the point where fractional reserve banking breaks down. Only way out is to blow up the debt - by deflation or inflation, someone will suffer.
Anyhow, he made no mention of the dollar collapse or underreported raging inflation. Those events can't be ignored. Did he ignore them?
March 11 | Bloomberg
Bear Stearns denied rumors that it was insolvent and Morgan Stanley cut its earnings estimates on U.S. banks.
Citigroup Inc. and other U.S. banks had their combined earnings estimate cut by $8.8 billion at Morgan Stanley, which cited slower equity capital markets and a "severe'' deterioration in credit conditions this year.
March 10 | Bloomberg
Bond investors have never been so sure that the Federal Reserve will lose control of inflation. They're so convinced that they're giving up yields just to buy debt securities that protect against rising consumer prices.
The yield on the five-year Treasury Inflation-Protected Security due in 2012 has been negative since Feb. 29, and traded today at minus 0.17 percent. The notes, which were first sold in 1997, have never before traded below zero. Even so, firms from Deutsche Asset Management to Vanguard Group Inc., the second- biggest U.S. mutual fund company, say TIPS are a bargain.
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"It's crazy,'' said Richard Schlanger, a portfolio manager at Boston-based Pioneer Asset Management, which oversees $44 billion in fixed income. "You're paying the government to buy five-year TIPS. People are hiding in Treasuries for liquidity's sake because of a lack of liquidity in other markets. Eventually this will pass.''Record-low TIPS yields also reflect bets on surging commodities. Crude oil futures rose to $106.54 last week and are up 70 percent in the past year.
Growth in countries such as China and India mean that rising prices for goods including wheat, gold, and oil "may be a permanent thing,'' said Paul Samuelson, the second recipient of the Nobel Prize in economics who helped popularize the term "stagflation.'' "This time it's primarily not made-in-America inflation.''
March 10 | Bloomberg
The hedge-fund industry is reeling from its worst crisis in a decade as banks are now demanding more money pledged to support outstanding loans even when the investment is backed by the full faith and credit of the United States.
Since Feb. 15, at least six hedge funds, totaling more than $5.4 billion, have been forced to liquidate or sell holdings because their lenders -- staggered by almost $190 billion of asset writedowns and credit losses caused by the collapse of the subprime-mortgage market -- raised borrowing rates by as much as 10-fold with new claims for extra collateral.
While lenders are most unsettled by credit consisting of real estate and consumer debt, bankers are now attempting to raise the rates they charge on Treasuries, considered the world's safest securities, because of the price fluctuations in the bond market.
"If you have leverage, you're stuffed,'' said Alex Allen, chief investment officer of London-based Eddington Capital Management Ltd., which has $195 million invested in hedge funds for clients. He likens the crisis to a bank panic turned upside down with bankers, not depositors, concerned they won't get their money back.
The lending crackdown is the worst to hit the $1.9 trillion hedge-fund industry since Russia's debt default in 1998 roiled global credit markets and required the U.S. Federal Reserve to pressure the securities industry to arrange a $3.6 billion bailout of Greenwich, Connecticut-based Long-Term Capital Management LP. Today, hedge funds are being forced to sell assets to meet banks' margin calls, resulting in the dissolution of the funds.
"There has to be more in the next weeks,'' Allen said. "There are people who have been hanging on by their fingernails who can't hold on much, much longer.''
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"It's not a question of prime brokers deciding which firms live and which don't,'' said Odi Lahav, head of the European Alternate Investment Group at Moody's Investors Service in London. "They're trying to manage their own risk. There's a Darwinian aspect to survivorship in this industry.''
I was at the Mealey's Subprime-Backed Securities Litigation Conference in New York today and I heard an interesting take on why so many Americans have, contrary to expectations, continued to pile up debts in the face of what looks to be a fairly dramatic slowdown.According to Joseph Mason, an Associate Professor of Finance at Drexel University and a speaker at the event, one reason for the disconnect may be the fact that few adults under the age of 55 have had first-hand experience dealing with the kind of gut-wrenching recession we last saw during the 1970s.
Some managers set themselves up for a stumble by taking on too much leverage and not anticipating that terms could change, said Christopher Cruden, CEO of Lugano, Switzerland-based Insch Capital Management, which oversees $150 million for clients."If you're going to dance with the devil, there comes a time when your toes are going to be stepped on,'' Cruden said. "Prime brokers are there to do business, not be your friend.''
March 07, 2008
There's an old saying: assume the worst, hope for the best and be prepared for whatever happens. Amid mounting evidence that the U.S. is headed into recession, that is advice worth taking, especially in regards to earning a living. In "With Recession Looming, Be Prepared for a Layoff" MSNBC's Laura T. Coffey details a 10-step plan for coping with what is likely to be a fast-growing threat.
You may feel secure now, but you never know when the pink slip is coming
The dreaded “R” word – recession – has been dominating business headlines for months now. More and more economists are predicting bleak economic conditions and weak job growth in the coming months.
On Friday, it was reported that employers slashed 63,000 jobs in February, the most in five years. Do you need any more signs that we are teetering on the verge of recession?
Even if you feel secure in your job at this moment in time, here’s a sobering thought: Because of forces beyond your control, you could be hit with an unexpected layoff at almost any moment.
For this reason, it’s always a good idea to plan ahead for potential financial emergencies before they strike. The following tips can help.
1. Establish an emergency fund. Set aside enough money to cover your basic living expenses for three to six months. This should give you the ability to pay your rent or mortgage, buy food and repay debts. Consider socking this money away in an online-only, high-yield money market account or a short-term certificate of deposit. For more details about how to choose such an account and earn more interest on your dough, read this past “10 Tips” column on the subject.
2. Live within your means. Try hard not to spend excessively on items and services you don’t truly need. This will make it even easier to build up that emergency fund once and for all. For additional ideas about how to establish an emergency fund, this past “10 Tips” column about how many middle-class families are being squeezed financially could be of help to you.
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6. Network, network, network. Always make a point of getting to know as many people as you can in your line of work. By having plenty of friends and contacts in your industry, you’ll stand a better chance of finding work quickly if you lose your job.
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9. Pursue higher education while you can. Do you work for a large company that offers a “Corporate U,” or for an employer that helps cover education costs at schools in your area? Tap into that resource so you can improve your skills and bolster your resume. Hundreds of corporate university classes have been accredited, meaning you could get college credit for them if you ever enroll in a degree program.
10. Investigate your health insurance policy. Be clear on what your health plan covers, and figure out how much it would cost to extend your employer’s group insurance coverage through the federal program COBRA.
Be aware that you would have to pay both the employer and employee shares of the premiums – ouch – but at least you’d get to keep the same coverage.
Having infected the municipal bond market, the subprime disaster may soon spread into the student loan program. (Hat tip: Acheson). The Pennsylvania Higher Education Assistance Agency
convened an emergency Student Loan Funding Summit today, bringing together a diverse group of state and federal government, higher education and financial leaders to address a potentially devastating shortage of student loan funding for students and families.
This student loan funding crisis began with the recent subprime mortgage meltdown and subsequent turmoil in the capital markets. These far-reaching economic problems have now given rise to a new bond market crisis, which is further compounding the funding problem for many lenders.
As a result, lenders throughout the nation are exiting the $50 billion Federal Family Education Loan Program (FFELP) while others are being forced to curtail their activity, seriously jeopardizing the funding plans of millions of American students. In recent weeks:
- College Loan Corp, the nation’s eighth largest student lender, ended its participation in the FFELP program.
- Iowa Student Loan Liquidity Corp announced that it is unable to properly fund loans for the 2008-09 school year.
- Michigan suspended one of its college loan programs.
- Montana's student loan agency tried unsuccessfully to sell $583 million in bonds during the last ten days, which means it will be more difficult for the agency to make student loans.
PHEAA, itself, experienced "failed auctions" in the troubled bond market for the first time in its history, substantially increasing its cost of borrowing and putting its ability to fund additional student loans at risk.
"As many Americans face foreclosure on their homes, millions of college students may now face foreclosure on their plans for a higher education," said State Representative William F. Adolph, Chairman of the PHEAA Board of Directors. "We must act quickly and we must act now - before our students are caught in a painful student aid funding crunch that could put their college plans financially out of reach."
Given that Sen. Obama has garnered the support of Paul Volcker, the highly-respected former chairman of the Federal Reserve under Presidents Carter and Reagan, U.S. voters are apt to get a meaningful and well-considered reply. "I think we are skating on increasingly thin ice," Mr. Volcker noted in the Washington Post in April 2005. He warned that the stagflation of the 1970s was characterized by "a volatile and depressed dollar, inflationary pressures, a sudden increase in interest rates and a couple of big recessions." Mr. Volcker's solution? Act now to comply with "the oldest lesson of economic policy: a strong sense of monetary and fiscal discipline."
The bank now sees prices falling 30 percent, from its prior 25 percent forecast. Those prices have declined 14 percent since mid-2006, JPMorgan said.
Those who dismantled New Deal safeguards should be help responsible, not a regular corporate pigs who cannot control their appetite...
On a global scale, U.S. CEOs earn considerably more money on average than their peers abroad, and about 600 times more than the average U.S. worker, up from just 40 times in 1980, according to academic studies of executive pay.
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Nell Minow, editor of The Corporate Library and an investor rights advocate, at the hearing said, "There is an obvious disconnect between the performance of these CEOs and the compensation they received. They led the companies in a risky strategic direction that resulted in significant losses."The executives, along with members of their companies' boards who also testified, defended their pay packages as being aligned with shareholder interests, competitive in the market for management talent, and overseen properly by directors.
But Minow criticized "all-upside, no downside pay plans." She said a key American corporate governance weakness, even in the post-Enron era, remains investors' inability to do much about excessive CEO pay approved by subservient boards.
She urged the Senate to adopt legislation already passed in the House to give shareholders a non-binding "say on pay."
"We would characterize this situation as a systemic margin call."
Mar 8, 2008
NEW YORK (Reuters) - Wall Street banks are facing a "systemic margin call" that may deplete banks of $325 billion of capital due to deteriorating subprime U.S. mortgages, JPMorgan Chase & Co (JPM.N: Quote, Profile, Research), said in a report late on Friday.
JPMorgan, which sent a default notice to Thornburg Mortgage Inc. (TMA.N: Quote, Profile, Research) after the lender missed a $28 million margin call, said more default notices and margin calls were likely. The Carlyle Group's mortgage fund also failed to meet $37 million in margin calls this week.
"A systemic credit crunch is underway, driven primarily by bank writedowns for subprime mortgages," according to the report co-authored by analyst Christopher Flanagan. "We would characterize this situation as a systemic margin call."
The credit crisis that began about a year ago will likely intensify after Friday's weak February U.S. employment report "that most definitely signals recession," JPMorgan said.
Indeed, corporate bond spreads widened to a new record on Friday, surpassing levels seen in October 2002 during a boom in bankruptcies following the dot-com crash. U.S. employers cut payrolls in February for a second consecutive month, slashing 63,000 jobs, the biggest monthly job decline in nearly five years, the U.S. Labor Department reported on Friday.
"The weak February employment report points to an economy in recession," JPMorgan said.
The JPMorgan report included a revised bleaker forecast for subprime-related home prices. The bank now sees prices falling 30 percent, from its prior 25 percent forecast. Those prices have declined 14 percent since mid-2006, JPMorgan said.
The U.S. jobs results also came after the Federal Reserve expanded the amount of its short-term auctions to $100 billion in total in the central bank's latest effort to ease credit concerns. Ongoing concerns about bond insurers, known as monolines, and their effort to save their top ratings also are weighing on market sentiment.
(Editing by Eric Beech)
Zombification of Banks
Bernanke clearly has some new innovations, but the name of the game itself has not changed much: Banks are so capital impaired they cannot lend. They refuse to write down assets to reasonable levels because to do so would bankrupt them.
Thus with each passing day, the more asset values plunge, the more zombified our banking system becomes. Zombification of banks is exactly what happened in Japan. Bernanke could cut interest rates to zero tomorrow and it would not change matters much if at all.
Academia is meeting a real world test, and Bernanke has met his match.
naked capitalism On Krugman's Worries and the Breakdown of the Securitization Model
Anonymous said...
Yves, Great blog. On this issue, here is a recent academic paper that is fairly easy to read:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1083184Anonymous said...
Anonymous said...
Yes, there is a breakdown in trust in the credit markets as Krugman has stated. One step in restoring faith in the system would be to jail the heads of the investment banks and the ratings agencies for colluding to commit fraud. Put a face on a crime and start by jailing Paulson.It seems to me that a major cause was the mispricing of the credit due to the alleged "insurance" provided. Basically, you had a below market premium paid to the monolines to bring the securitized debt to AAA. Consequently, much more debt was issued at too low of an interest rate. If this debt was properly priced, or if premiums were accurately priced, I believe this problem would have been much smaller. In addition, the governments sanctioning of only 3 rating agencies, instead of allowing the market to dictate the number and business model of the rating agencies, exacerbated the problem and caused further dislocations. On top of it, the rating agencies were being paid by the issuers of the securities. All of these factors caused the tsunami we see today, and it will take some time to clear out the problem.
... ... ...
Anonymous said...
Anonymous said...As for the decrease in costs of financial transactions, these must be weighed against the hy spend to bail out the players, not to mention the trillions of dollars that the investors stand to lose when all if this is said and done.
So in the end, securitization has led to a model of smooth sailing for a number of years followed by a fall off the cliff. I don't know if that's really the best way to structure the financial world.
yves, do I understand correctly that you're saying the problem with going back to the 80's is simply there is no real way to get there from here? In other words if there was a path back, then it might be reasonable. Second, how much of the lower cost of securitized lending comes from lack of attention to detail (that was present back when the banks were lending their own money). From my own very limited knowledge of the mortgage industry, it seems that most or all the efficiency resulted from lack of attention to detail (verifying borrowers income, mortgage servicers keeping accurate records, hiring competent lawyers to handle foreclosures, etc.)
So the Fed is throwing another wave of money in, via the TAF and also additional loans to banks. All this lending is backed by collateral: the banks are setting aside various stuff, but probably mainly mortgage-backed securities....
OK, this is just like the way you analyze sterilized intervention in currencies. And the usual problem with such intervention applies: the financial markets are so huge that even big interventions tend to look like a drop in the bucket. If foreign exchange intervention works, it’s usually because of the “slap in the face” effect: the markets are getting hysterical, and intervention gives them a chance to come to their senses.
And the problem now becomes obvious. This is now the third time Ben & co. have tried slapping the market in the face — and panic keeps coming back. So maybe the markets aren’t hysterical — maybe they’re just facing reality. And in that case the markets don’t need a slap in the face, they need more fundamental treatment — and maybe triage.
I’ve been reading Tim Geithner’s talk on the financial situation, via Mark Thoma. Lay readers may not know this, but Geithner, as the president of the New York Fed, is at the center of the hurricane: when markets go blooey, it’s generally the New York Fed — which is where the markets are — rather than officials in DC that’s trying to manage the chaos.
Geithner talks in central bankerese, so you have to do some translation, but it’s really quite frightening:
The current episode has a basic dynamic in common with all past crises. As market participants have moved to reduce exposure to further losses, to step on the brake, the brake became the accelerator, amplifying the shock. Measured risk has increased more quickly than many institutions have been able reduce it, and attempts to reduce it have added to volatility and downward pressure on prices, further increasing measured exposure to risk … The rational actions taken by even the strongest financial institutions to reduce exposure to future losses have caused significant collateral damage to market functioning. This, in turn, has intensified the liquidity problems for a wide range of bank and nonbank financial institutions.
That’s pretty close to saying that the financial markets are melting down.
Geithner then goes on to describe the policy measures being taken. And here’s the thing: I don’t think it’s just me, the actions sound trivial compared with the problem. He more or less admits that credit markets are worsening faster than the Fed can cut rates, so that money is effectively getting more expensive, not cheaper; the other measures he describes sound minor. Rearranging deck chairs — that may be too strong, but it’s pretty unreassuring.
So what should be done? I’m not sure (and I’m thinking about it, hard.) For now, I’d just say that this is really, really scary.
Fed Officials Downplay TIPS Inflation Signal,
More noteworthy is that senior Fed officials have tended in the last month to look at every inflation warning as a glass half full. Surveys of consumers and professional forecasters both show an increase in expected inflation; but senior Fed officials focus on the small magnitude of the increases rather than the fact of them, and note that these measures remain within the range of recent years. The rise in core inflation (which excludes food and energy) is attributed primarily to pass-through of energy prices and unsustained drops in certain categories earlier last year, with the implication that both effects are temporary. The rise in commodity prices is seen either as a reflection of global growth or speculation rather than an endogenous response to expected inflation. Similarly, the fall in the dollar is attributed to differential growth rates and interest rates between the U.S. and its trading partners. Core inflation measured by the price index of personal consumption expenditures has been above the 1.5% to 2% range of Federal Open Market Committee definitions of price stability for three months now. Mr. Bernanke noted both data points in his testimony to Congress last week but did not connect them. Blogger Tim Duy says, “What is clear is that the Fed remains eager to dismiss any inconvenient information.”
To be sure, the Fed has good, fundamental reasons to be optimistic on inflation, perhaps most important the fact that a recession, if it happens, will do a lot to contain wage and price gains. Credit market conditions are worse than ever. “It is increasingly obvious that the Fed is in a no-win situation,” writes Mr. Duy. “The best case scenario for the Fed is that nominal wage growth is kept in check by a deteriorating labor market. This will help contain inflation expectations and prevent a more serious 1970’s type of environment.”
iTulip.com Forums
Elizabeth Kübler-Ross defined the five stages of coming to terms with grief and tragedy as denial, anger, bargaining, depression, and acceptance, and applied it quite successfully to various forms of catastrophic personal loss, such as death of a loved one, sudden end to one's career, and so forth. Several thinkers, notably James Howard Kunstler and, more recently John Michael Greer, have pointed out that the Kübler-Ross model is also quite terrifyingly accurate in reflecting the process by which society as a whole (or at least the informed and thinking parts of it) is reconciling itself to the inevitability of a discontinuous future, with our institutions and life support systems undermined by a combination of resource depletion, catastrophic climate change, and political impotence. But so far, little has been said specifically about the finer structure of these discontinuities. Instead, there is to be found a continuum of subjective judgments, ranging from "a severe and prolonged recession" (the prediction we most often read in the financial press), to Kunstler's evocative but unscientific-sounding "clusterfuck," to the ever-popular "Collapse of Western Civilization," painted with an ever-wider brush-stroke.
For those of us who have already gone through all of the emotional stages of reconciling ourselves to the prospect of social and economic upheaval, it might be helpful to have a more precise terminology that goes beyond such emotionally charged phrases. Defining a taxonomy of collapses might prove to be more than just an intellectual exercise: based on our abilities and circumstances, some of us may be able to specifically plan for a certain stage of collapse as a temporary, or even permanent, stopping point. Even if society at the current stage of socioeconomic complexity will no longer be possible, and even if, as Tainter points in his "Collapse of Complex Societies," there are circumstances in which collapse happens to be the correct adaptive response, it need not automatically cause a population crash, with the survivors disbanding into solitary, feral humans dispersed in the wilderness and subsisting miserably. Collapse can be conceived of as an orderly, organized retreat rather than a rout.
Stages of Collapse
Stage 1: Financial collapse. Faith in "business as usual" is lost. The future is no longer assumed resemble the past in any way that allows risk to be assessed and financial assets to be guaranteed. Financial institutions become insolvent; savings are wiped out, and access to capital is lost.
Stage 2: Commercial collapse. Faith that "the market shall provide" is lost. Money is devalued and/or becomes scarce, commodities are hoarded, import and retail chains break down, and widespread shortages of survival necessities become the norm.
Stage 3: Political collapse. Faith that "the government will take care of you" is lost. As official attempts to mitigate widespread loss of access to commercial sources of survival necessities fail to make a difference, the political establishment loses legitimacy and relevance.
Stage 4: Social collapse. Faith that "your people will take care of you" is lost, as local social institutions, be they charities or other groups that rush in to fill the power vacuum run out of resources or fail through internal conflict.
Stage 5: Cultural collapse. Faith in the goodness of humanity is lost. People lose their capacity for "kindness, generosity, consideration, affection, honesty, hospitality, compassion, charity" (Turnbull, The Mountain People). Families disband and compete as individuals for scarce resources. The new motto becomes "May you die today so that I die tomorrow" (Solzhenitsyn, The Gulag Archipelago). There may even be some cannibalism.
Although many people imagine collapse to be a sort of elevator that goes to the sub-basement (our Stage 5) no matter which button you push, no such automatic mechanism can be discerned. Rather, driving us all to Stage 5 will require that a concerted effort be made at each of the intervening stages. That all the players seem poised to make just such an effort may give this collapse the form a classical tragedy - a conscious but inexorable march to perdition - rather than a farce ("Oops! Ah, here we are, Stage 5." - "So, whom do we eat first?" - "Me! I am delicious!") Let us sketch out this process.
BREMERTON, Wash. -- Bremerton police said four banks were vandalized early Thursday, with each incident involving windows broken with pieces of concrete that had notes taped to them, reported KIRO 7 Eyewitness News.
The banks involved were a US Bank at 2020 Sixth St., a Key Bank at 3750 Wheaton Way, a Bank of America at 1000 Sixth St. and a Kitsap Bank at 3425 Wheaton Way.
According to police, the vandals did not go in any of the banks.“No entry was gained and nothing was taken, so it appears this was the delivery of some kind of message by the perpetrators,” Andy Oakley with Bremerton police said.
Police said the content of the notes were all the same and read as follows:
“Directions: Attach to brick and throw through window”
“Here is your brick back." "Recognize it? You should.”
“It is part of the wall that you, as one of the elite upper class, have helped to build between the minority ruling class, and the majority working class throughout history. By flaunting your decadence, you have made yourself a target.”
“Get used to it!”
“Social youth chaos-f___ s___ up!”
Months of turmoil in the municipal-bond market, long a placid haven for individual investors, reached a boiling point Friday -- as hedge funds were forced to unwind complicated bets and in the process dump billions of dollars of the securities.As a result of that surprising forced selling, yields on debt from municipalities and other tax-exempt issuers jumped to their highest levels in history, when compared with safe debt issued by the U.S. government. The average AAA-rated, 30-year municipal bond yielded 5.14% Friday afternoon, compared with 4.42% on a U.S. Treasury 30-year bond.
One of the least publicized, relevant facts is that over half the subprime loans weren't for purchases; more than half were cash-out refinances.
... ... ...
Half the subprimes were cash out refis. This isn't implausible. Freddie Mac reported that cash-out (meaning the new mortgage was at least 5% larger than the one it replaced) refis for its borrowers were 35% in the second quarter of 2007, and noted that refinancings as a proportion of total mortgages were declining, which is typical in a rising interest rate environment.
Now why is this so significant? It gives a completely different picture of the nature of the problem. It suggests that many of the people who took out subprimes weren't people who bought more housing than they could afford. It says they were already overstressed and overstretched financially. Using their home as a source of cash was a gamble to keep themselves out of bankruptcy, but in many cases, that bet didn't work out.
WSJ: Borrowers Abandon Mortgages as Prices Drop.
Some financial advisers are even encouraging homeowners who are upside down to consider foreclosure, which they see as a purely financial decision with limited negative consequences. YouWalkAway.com, a Web site started in January that offers foreclosure counseling to homeowners, advises that borrowers who default on one mortgage can typically get another mortgage between two and four years after a foreclosure. "before you know it, you will have this behind you and a fresh start!" the site says.NYT: Facing Default, Some Walk Out on New Homes.“There’s a whole lot of people who would’ve been stuck as renters without these exotic loan products,” Professor Sinai said. “Now it’s like they can do their renting from the bank, and if house values go up, they become the owner. If they go down, you have the choice to give the house back to the bank. You aren’t any worse off than renting, and you got a chance to do extremely well. If it’s heads I win, tails the bank loses, it’s worth the gamble.”
Nov 28, 2007 | informationclearinghouse.info
Hubris and arrogance are too ensconced in Washington for policymakers to be aware of the economic policy trap in which they have placed the US economy. If the subprime mortgage meltdown is half as bad as predicted, low US interest rates will be required in order to contain the crisis. But if the dollar’s plight is half as bad as predicted, high US interest rates will be required if foreigners are to continue to hold dollars and to finance US budget and trade deficits.
Which will Washington sacrifice, the domestic financial system and over-extended homeowners or its ability to finance deficits?
The answer seems obvious. Everything will be sacrificed in order to protect Washington’s ability to borrow abroad. Without the ability to borrow abroad, Washington cannot conduct its wars of aggression, and Americans cannot continue to consume $800 billion dollars more each year than the economy produces.
A few years ago the euro was worth 85 cents. Today it is worth $1.48. This is an enormous decline in the exchange value of the US dollar. Foreigners who finance the US budget and trade deficits have experienced a huge drop in the value of their dollar holdings. The interest rate on US Treasury bonds does not come close to compensating foreigners for the decline in the value of the dollar against other traded currencies. Investment returns from real estate and equities do not offset the losses from the decline in the dollar’s value.
China holds over one trillion dollars, and Japan almost one trillion, in dollar-denominated assets. Other countries have lesser but still substantial amounts. As the US dollar is the reserve currency, the entire world’s investment portfolio is over-weighted in dollars.
No country wants to hold a depreciating asset, and no country wants to acquire more depreciating assets. In order to reassure itself, Wall Street claims that foreign countries are locked into accumulating dollars in order to protect the value of their existing dollar holdings. But this is utter nonsense. The US dollar has lost 60% of its value during the current administration. Obviously, countries are not locked into accumulating dollars.
The reason the dollar has not completely collapsed is that there is no clear alternative as reserve currency. The euro is a currency without a country. It is the monetary unit of the European Union, but the countries of Europe have not surrendered their sovereignty to the EU. Moreover, the UK, a member of the EU, retains the British pound. The fact that a currency as politically exposed as the euro can rise in value so rapidly against the US dollar is powerful evidence of the weakness of the US dollar.
Japan and China have willingly accumulated dollars as the counterpart of their penetration and capture of US domestic markets. Japan and China have viewed the productive capacity and wealth created in their domestic economies by the success of their exports as compensation for the decline in the value of their dollar holdings. However, both countries have seen the writing on the wall, ignored by Washington and American economists: By offshoring production for US markets, the US has no prospect of closing its trade deficit. The offshored production of US firms counts as imports when it returns to the US to be marketed. The more US production moves abroad, the less there is to export and the higher imports rise.
Japan and China, indeed, the entire world, realize that they cannot continue forever to give Americans real goods and services in exchange for depreciating paper dollars. China is endeavoring to turn its development inward and to rely on its potentially huge domestic market. Japan is pinning hopes on participating in Asia’s economic development.
The dollar’s decline has resulted from foreigners accumulating new dollars at a lower rate. They still accumulate dollars, but fewer. As new dollars are still being produced at high rates, their value has dropped.
If foreigners were to stop accumulating new dollars, the dollar’s value would plummet. If foreigners were to reduce their existing holdings of dollars, superpower America would instantly disappear. [Will they ? To whom they will sell the produced goods? For Chinese this is lose-lose proposition]
Foreigners have continued to accumulate dollars in the expectation that sooner or later Washington would address its trade and budget deficits. However, now these deficits seem to have passed the point of no return.
The sharp decline in the dollar has not closed the trade deficit by increasing exports and decreasing imports. Offshoring prevents the possibility of exports reducing the trade deficit, and Americans are now dependent on imports (including offshored production) for which there are no longer any domestically produced alternatives. The US trade deficit will close when foreigners cease to finance it.
The budget deficit cannot be closed by taxation without driving up unemployment and poverty. American median family incomes have experienced no real increase during the 21st century. Moreover, if the huge bonuses paid to CEOs for offshoring their corporations’ production and to Wall Street for marketing subprime derivatives are removed from the income figures, Americans have experienced a decline in real income. Some studies, such as the Economic Mobility Project, find long-term declines in the real median incomes of some US population groups and a decline in upward mobility.
The situation may be even more dire. Recent work by Susan Houseman concludes that US statistical data systems, which were set in place prior to the development of offshoring, are counting some foreign production as part of US productivity and GDP growth, thus overstating the actual performance of the US economy.
The falling dollar has pushed oil to $100 a barrel, which in turn will drive up other prices. The falling dollar means that the imports and offshored production on which Americans are dependent will rise in price. This is not a formula to produce a rise in US real incomes.
In the 21st century, the US economy has been driven by consumers going deeper in debt. Consumption fueled by increases in indebtedness received its greatest boost from Fed chairman Alan Greenspan’s low interest rate policy. Greenspan covered up the adverse effects of offshoring on the US economy by engineering a housing boom. The boom created employment in construction and financial firms and pushed up home prices, thus creating equity for consumers to spend to keep consumer demand growing.
This source of US economic growth is exhausted and imploding. The full consequences of the housing bust remain to be realized. American consumers lack discretionary income and can pay higher taxes only by reducing their consumption. The service industries, which have provided the only source of new jobs in the 21st century, are already experiencing falling demand. A tax increase would cause widespread distress.
As John Maynard Keynes and his followers made clear, a tax increase on a recessionary economy is a recipe for falling tax revenues as well as economic hardship.
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.
By focusing America on war in the Middle East, the purpose of which is to guarantee Israel’s territorial expansion, the executive and legislative branches, along with the media, have let slip the last opportunities the US had to put its financial house in order. We have arrived at the point where it is no longer bold to say that nothing now can be done. Unless the rest of the world decides to underwrite our economic rescue, the chips will fall where they may.
Dr. Roberts was Assistant Secretary of the US Treasury for Economic Policy in the Reagan administration. He is credited with curing stagflation and eliminating “Phillips curve” trade-offs between employment and inflation, an achievement now on the verge of being lost by the worst economic mismanagement in US history.
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