EconoMonitor

Nouriel Roubini's Global EconoMonitor

The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster

Why did the Fed ease the Fed Funds rate by a whopping 125bps in eight days this past January? It is true that most macro indicators are heading south and suggesting a deep and severe recession that has already started. But the flow of bad macro news in mid-January did not justify, by itself, such a radical inter-meeting emergency Fed action followed by another cut at the formal FOMC meeting.

To understand the Fed actions one has to realize that there is now a rising probability of a “catastrophic” financial and economic outcome, i.e. a vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe. The Fed is seriously worried about this vicious circle and about the risks of a systemic financial meltdown.

That is the reason the Fed had thrown all caution to the wind – after a year in which it was behind the curve and underplaying the economic and financial risks – and has taken a very aggressive approach to risk management; this is a much more aggressive approach than the Greenspan one in spite of the initial views that the Bernanke Fed would be more cautious than Greenspan in reacting to economic and financial vulnerabilities.

To understand the risks that the financial system is facing today I present the “nightmare” or “catastrophic” scenario that the Fed and financial officials around the world are now worried about. Such a scenario – however extreme – has a rising and significant probability of occurring. Thus, it does not describe a very low probability event but rather an outcome that is quite possible.

Start first with the recession that is now enveloping the US economy. Let us assume – as likely – that this recession – that already started in December 2007 – will be worse than the mild ones – that lasted 8 months – that occurred in 1990-91 and 2001. The recession of 2008 will be more severe for several reasons: first, we have the biggest housing bust in US history with home prices likely to eventually fall 20 to 30%; second, because of a credit bubble that went beyond mortgages and because of reckless financial innovation and securitization the ongoing credit bust will lead to a severe credit crunch; third, US households – whose consumption is over 70% of GDP – have spent well beyond their means for years now piling up a massive amount of debt, both mortgage and otherwise; now that home prices are falling and a severe credit crunch is emerging the retrenchment of private consumption will be serious and protracted. So let us suppose that the recession of 2008 will last at least four quarters and, possibly, up to six quarters. What will be the consequences of it?

Here are the twelve steps or stages of a scenario of systemic financial meltdown associated with this severe economic recession…

First, this is the worst housing recession in US history and there is no sign it will bottom out any time soon. At this point it is clear that US home prices will fall between 20% and 30% from their bubbly peak; that would wipe out between $4 trillion and $6 trillion of household wealth. While the subprime meltdown is likely to cause about 2.2 million foreclosures, a 30% fall in home values would imply that over 10 million households would have negative equity in their homes and would have a big incentive to use “jingle mail” (i.e. default, put the home keys in an envelope and send it to their mortgage bank). Moreover, soon enough a few very large home builders will go bankrupt and join the dozens of other small ones that have already gone bankrupt thus leading to another free fall in home builders’ stock prices that have irrationally rallied in the last few weeks in spite of a worsening housing recession.

Second, losses for the financial system from the subprime disaster are now estimated to be as high as $250 to $300 billion. But the financial losses will not be only in subprime mortgages and the related RMBS and CDOs. They are now spreading to near prime and prime mortgages as the same reckless lending practices in subprime (no down-payment, no verification of income, jobs and assets (i.e. NINJA or LIAR loans), interest rate only, negative amortization, teaser rates, etc.) were occurring across the entire spectrum of mortgages; about 60% of all mortgage origination since 2005 through 2007 had these reckless and toxic features. So this is a generalized mortgage crisis and meltdown, not just a subprime one. And losses among all sorts of mortgages will sharply increase as home prices fall sharply and the economy spins into a serious recession. Goldman Sachs now estimates total mortgage credit losses of about $400 billion; but the eventual figures could be much larger if home prices fall more than 20%. Also, the RMBS and CDO markets for securitization of mortgages – already dead for subprime and frozen for other mortgages – remain in a severe credit crunch, thus reducing further the ability of banks to originate mortgages. The mortgage credit crunch will become even more severe.

Also add to the woes and losses of the financial institutions the meltdown of hundreds of billions of off balance SIVs and conduits; this meltdown and the roll-off of the ABCP market has forced banks to bring back on balance sheet these toxic off balance sheet vehicles adding to the capital and liquidity crunch of the financial institutions and adding to their on balance sheet losses. And because of securitization the securitized toxic waste has been spread from banks to capital markets and their investors in the US and abroad, thus increasing – rather than reducing systemic risk – and making the credit crunch global.

Third, the recession will lead – as it is already doing – to a sharp increase in defaults on other forms of unsecured consumer debt: credit cards, auto loans, student loans. There are dozens of millions of subprime credit cards and subprime auto loans in the US. And again defaults in these consumer debt categories will not be limited to subprime borrowers. So add these losses to the financial losses of banks and of other financial institutions (as also these debts were securitized in ABS products), thus leading to a more severe credit crunch. As the Fed loan officers survey suggest the credit crunch is spreading throughout the mortgage market and from mortgages to consumer credit, and from large banks to smaller banks.

Fourth, while there is serious uncertainty about the losses that monolines will undertake on their insurance of RMBS, CDO and other toxic ABS products, it is now clear that such losses are much higher than the $10-15 billion rescue package that regulators are trying to patch up. Some monolines are actually borderline insolvent and none of them deserves at this point a AAA rating regardless of how much realistic recapitalization is provided. Any business that required an AAA rating to stay in business is a business that does not deserve such a rating in the first place. The monolines should be downgraded as no private rescue package – short of an unlikely public bailout – is realistic or feasible given the deep losses of the monolines on their insurance of toxic ABS products.

Next, the downgrade of the monolines will lead to another $150 of writedowns on ABS portfolios for financial institutions that have already massive losses. It will also lead to additional losses on their portfolio of muni bonds. The downgrade of the monolines will also lead to large losses – and potential runs – on the money market funds that invested in some of these toxic products. The money market funds that are backed by banks or that bought liquidity protection from banks against the risk of a fall in the NAV may avoid a run but such a rescue will exacerbate the capital and liquidity problems of their underwriters. The monolines’ downgrade will then also lead to another sharp drop in US equity markets that are already shaken by the risk of a severe
recession and large losses in the financial system.

Fifth, the commercial real estate loan market will soon enter into a meltdown similar to the subprime one. Lending practices in commercial real estate were as reckless as those in residential real estate. The housing crisis will lead – with a short lag – to a bust in non-residential construction as no one will want to build offices, stores, shopping malls/centers in ghost towns. The CMBX index is already pricing a massive increase in credit spreads for non-residential mortgages/loans. And new origination of commercial real estate mortgages is already semi-frozen today; the commercial real estate mortgage market is already seizing up today.

Sixth, it is possible that some large regional or even national bank that is very exposed to mortgages, residential and commercial, will go bankrupt. Thus some big banks may join the 200 plus subprime lenders that have gone bankrupt. This, like in the case of Northern Rock, will lead to depositors’ panic and concerns about deposit insurance. The Fed will have to reaffirm the implicit doctrine that some banks are too big to be allowed to fail. But these bank bankruptcies will lead to severe fiscal losses of bank bailout and effective nationalization of the affected institutions. Already Countrywide – an institution that was more likely insolvent than illiquid – has been bailed out with public money via a $55 billion loan from the FHLB system, a semi-public system of funding of mortgage lenders. Banks’ bankruptcies will add to an already severe credit crunch.

Seventh, the banks losses on their portfolio of leveraged loans are already large and growing. The ability of financial institutions to syndicate and securitize their leveraged loans – a good chunk of which were issued to finance very risky and reckless LBOs – is now at serious risk. And hundreds of billions of dollars of leveraged loans are now stuck on the balance sheet of financial institutions at values well below par (currently about 90 cents on the dollar but soon much lower). Add to this that many reckless LBOs (as senseless LBOs with debt to earnings ratio of seven or eight had become the norm during the go-go days of the credit bubble) have now been postponed, restructured or cancelled. And add to this problem the fact that some actual large LBOs will end up into bankruptcy as some of these corporations taken private are effectively bankrupt in a recession and given the repricing of risk; convenant-lite and PIK toggles may only postpone – not avoid – such bankruptcies and make them uglier when they do eventually occur. The leveraged loans mess is already leading to a freezing up of the CLO market and to growing losses for financial institutions.

Eighth, once a severe recession is underway a massive wave of corporate defaults will take place. In a typical year US corporate default rates are about 3.8% (average for 1971-2007); in 2006 and 2007 this figure was a puny 0.6%. And in a typical US recession such default rates surge above 10%. Also during such distressed periods the RGD – or recovery given default – rates are much lower, thus adding to the total losses from a default. Default rates were very low in the last two years because of a slosh of liquidity, easy credit conditions and very low spreads (with junk bond yields being only 260bps above Treasuries until mid June 2007). But now the repricing of risk has been massive: junk bond spreads close to 700bps, iTraxx and CDX indices pricing massive corporate default rates and the junk bond yield issuance market is now semi-frozen. While on average the US and European corporations are in better shape – in terms of profitability and debt burden – than in 2001 there is a large fat tail of corporations with very low profitability and that have piled up a mass of junk bond debt that will soon come to refinancing at much higher spreads. Corporate default rates will surge during the 2008 recession and peak well above 10% based on recent studies. And once defaults are higher and credit spreads higher massive losses will occur among the credit default swaps (CDS) that provided protection against corporate defaults. Estimates of the losses on a notional value of $50 trillion CDS against a bond base of $5 trillion are varied (from $20 billion to $250 billion with a number closer to the latter figure more likely). Losses on CDS do not represent only a transfer of wealth from those who sold protection to those who bought it. If losses are large some of the counterparties who sold protection – possibly large institutions such as monolines, some hedge funds or a large broker dealer – may go bankrupt leading to even greater systemic risk as those who bought protection may face counterparties who cannot pay.

Ninth, the “shadow banking system” (as defined by the PIMCO folks) or more precisely the “shadow financial system” (as it is composed by non-bank financial institutions) will soon get into serious trouble. This shadow financial system is composed of financial institutions that – like banks – borrow short and in liquid forms and lend or invest long in more illiquid assets. This system includes: SIVs, conduits, money market funds, monolines, investment banks, hedge funds and other non-bank financial institutions. All these institutions are subject to market risk, credit risk (given their risky investments) and especially liquidity/rollover risk as their short term liquid liabilities can be rolled off easily while their assets are more long term and illiquid. Unlike banks these non-bank financial institutions don’t have direct or indirect access to the central bank’s lender of last resort support as they are not depository institutions. Thus, in the case of financial distress and/or illiquidity they may go bankrupt because of both insolvency and/or lack of liquidity and inability to roll over or refinance their short term liabilities. Deepening problems in the economy and in the financial markets and poor risk managements will lead some of these institutions to go belly up: a few large hedge funds, a few money market funds, the entire SIV system and, possibly, one or two large and systemically important broker dealers. Dealing with the distress of this shadow financial system will be very problematic as this system – stressed by credit and liquidity problems – cannot be directly rescued by the central banks in the way that banks can.

Tenth, stock markets in the US and abroad will start pricing a severe US recession – rather than a mild recession – and a sharp global economic slowdown. The fall in stock markets – after the late January 2008 rally fizzles out – will resume as investors will soon realize that the economic downturn is more severe, that the monolines will not be rescued, that financial losses will mount, and that earnings will sharply drop in a recession not just among financial firms but also non financial ones. A few long equity hedge funds will go belly up in 2008 after the massive losses of many hedge funds in August, November and, again, January 2008. Large margin calls will be triggered for long equity investors and another round of massive equity shorting will take place. Long covering and margin calls will lead to a cascading fall in equity markets in the US and a transmission to global equity markets. US and global equity markets will enter into a persistent bear market as in a typical US recession the S&P500 falls by about 28%.

Eleventh, the worsening credit crunch that is affecting most credit markets and credit derivative markets will lead to a dry-up of liquidity in a variety of financial markets, including otherwise very liquid derivatives markets. Another round of credit crunch in interbank markets will ensue triggered by counterparty risk, lack of trust, liquidity premia and credit risk. A variety of interbank rates – TED spreads, BOR-OIS spreads, BOT – Tbill spreads, interbank-policy rate spreads, swap spreads, VIX and other gauges of investors’ risk aversion – will massively widen again. Even th
e easing of the liquidity crunch after massive central banks’ actions in December and January will reverse as credit concerns keep interbank spread wide in spite of further injections of liquidity by central banks.

Twelfth, a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices will ensue leading to a cascading and mounting cycle of losses and further credit contraction. In illiquid market actual market prices are now even lower than the lower fundamental value that they now have given the credit problems in the economy. Market prices include a large illiquidity discount on top of the discount due to the credit and fundamental problems of the underlying assets that are backing the distressed financial assets. Capital losses will lead to margin calls and further reduction of risk taking by a variety of financial institutions that are now forced to mark to market their positions. Such a forced fire sale of assets in illiquid markets will lead to further losses that will further contract credit and trigger further margin calls and disintermediation of credit. The triggering event for the next round of this cascade is the downgrade of the monolines and the ensuing sharp drop in equity markets; both will trigger margin calls and further credit disintermediation.

Based on estimates by Goldman Sachs $200 billion of losses in the financial system lead to a contraction of credit of $2 trillion given that institutions hold about $10 of assets per dollar of capital. The recapitalization of banks sovereign wealth funds – about $80 billion so far – will be unable to stop this credit disintermediation – (the move from off balance sheet to on balance sheet and moves of assets and liabilities from the shadow banking system to the formal banking system) and the ensuing contraction in credit as the mounting losses will dominate by a large margin any bank recapitalization from SWFs. A contagious and cascading spiral of credit disintermediation, credit contraction, sharp fall in asset prices and sharp widening in credit spreads will then be transmitted to most parts of the financial system. This massive credit crunch will make the economic contraction more severe and lead to further financial losses. Total losses in the financial system will add up to more than $1 trillion and the economic recession will become deeper, more protracted and severe.

A near global economic recession will ensue as the financial and credit losses and the credit crunch spread around the world. Panic, fire sales, cascading fall in asset prices will exacerbate the financial and real economic distress as a number of large and systemically important financial institutions go bankrupt. A 1987 style stock market crash could occur leading to further panic and severe financial and economic distress. Monetary and fiscal easing will not be able to prevent a systemic financial meltdown as credit and insolvency problems trump illiquidity problems. The lack of trust in counterparties – driven by the opacity and lack of transparency in financial markets, and uncertainty about the size of the losses and who is holding the toxic waste securities – will add to the impotence of monetary policy and lead to massive hoarding of liquidity that will exacerbates the liquidity and credit crunch.

In this meltdown scenario US and global financial markets will experience their most severe crisis in the last quarter of a century.

Can the Fed and other financial officials avoid this nightmare scenario that keeps them awake at night? The answer to this question – to be detailed in a follow-up article – is twofold: first, it is not easy to manage and control such a contagious financial crisis that is more severe and dangerous than any faced by the US in a quarter of a century; second, the extent and severity of this financial crisis will depend on whether the policy response – monetary, fiscal, regulatory, financial and otherwise – is coherent, timely and credible. I will argue – in my next article – that one should be pessimistic about the ability of policy and financial authorities to manage and contain a crisis of this magnitude; thus, one should be prepared for the worst, i.e. a systemic financial crisis.

 

220 Responses to “The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster”

GuestFebruary 5th, 2008 at 4:24 pm

are they optimistic because the war industries will continue on for years?   By Kim Sengupta Thursday, 31 January 2008    A young man, a student of journalism, is sentenced to death by an Islamic court for downloading a report from the internet. The sentence is then upheld by the country’s rulers. This is Afghanistan – not in Taliban times but six years after “liberation” and under the democratic rule of the West’s ally Hamid Karzai.    The fate of Sayed Pervez Kambaksh has led to domestic and international protests, and deepening concern about erosion of civil liberties in Afghanistan. He was accused of blasphemy after he downloaded a report from a Farsi website which stated that Muslim fundamentalists who claimed the Koran justified the oppression of women had misrepresented the views of the prophet Mohamed.   

MedicFebruary 5th, 2008 at 4:37 pm

Only those in the MSM and financial media with much to lose won’t call this situation what it is. They all have motives – not the least of which is to convince the public not to panic and take their money out of the system.  Smart people are now asking themselves if they should cash out, pay taxes and penalties and lose some of their savings or should they stay in and risk losing it all. I know that 30% in taxes still leaves me with 70% left to start again when this is over. That’s a whole lot better than 20-40% left after loses.  Wake up America. It is past time to protect what you have before it is all gone.

AlessandroFebruary 5th, 2008 at 4:41 pm

Apocalyptic, but frightening plausible.  I thank you again for spelling out what you see in no uncertain terms.

argot -ergot- in the HarvestFebruary 5th, 2008 at 4:50 pm

Wilbur Ross is a shill buying time for the condemned. He will walk-not-run from any portended transactions. The are some tremendously wealthy persons tonight who know that they are ruined.  The extents to which they will tap their political, MSM, Fed, Banker friends for some form of relief will lead to some of the most outrageous activity in the near term.   You can taste the primordial fear now. I am coming to understand the Gold Bugs’ fear of hyperinflation. (Once these gluttons exhaust every other means of preserving their holdings at risk AND fail, their final move will be full public bailout or to inflate themselves out of their predicament).  We are living in a very bleak house indeed.

Octavio RichettaFebruary 5th, 2008 at 5:22 pm

Written by Guest on 2008-02-05 15:55:23  This is good. The day Kudlow turns bearish cover your shorts…

NewstraderFXFebruary 5th, 2008 at 5:43 pm

The fall in Libor is going to have a positive affect on the mortgage resets. At this point, sub prime ARM borrowers are likely to have a less then 10% per month increase in their monthly mortgage payment. Prime ARM borrowers will have re-sets much lower then that. And if LIBOR keeps falling, some borrowers will actually have the rates re-set down.

AnonymousFebruary 5th, 2008 at 5:48 pm

@NewstraderFX   Too late anyway! They overreached. This general contraction will lead to wage decreases, unemployment, broad-based pullbacks. Those without 6 months savings, and a mortgage payment below 25% net income are still right on the threshold of default. The forecasters are probably underreporting the likely default rates expected a much less severe recession.  Time to sit back and wait it out.

KokopelliFebruary 5th, 2008 at 6:07 pm

Thanks again Professor. That was quite sobering.   What is so depressing about it is that I have gone thru the scenarios just like the Professor and come to similar conclusions but of course, I am an untrained nobody. It is easy for me to tell myself that I am just exaggerating the facts and being overly paranoid. When the Professor goes thru them, well, I guess at least I’m not the only crazy person. I’m in good company.   One issue you missed is the US runs on credit cards. NOT cash. Already Citi is telling some of its best customers that they can not afford to carry them because Citi doesn’t make very much money off cards paid off each month. I guess the 3% they get from the merchants is not adequate any longer. Credit card companies are going to be in big trouble as this unfolds, both from the default issues but I think also from the available liquidity issue. As fictitious capital disappears, debt collapse and all, and little real savings, then liquidity is going to be a problem. That is one of the reasons borrowing rates will go up.   So what happens if/when the credit cards companies no longer have adequate liquidity to fund the transactions? What happens to our consumer driven economic system when you put your card thru the slot and it is rejected? How will commerce work then? Will the government take them over too?   This mess is so big it is beyond comprehension of 99.999999% of the people on in this country. The financial system has gotten so complex that it no longer can function correctly. To many models that were based on some perfect scenario crashing into the wall of reality. Shit happens!  

GloomyFebruary 5th, 2008 at 6:29 pm

Thank you Dr. Roubini. You are the only major economist to tell it like it is. I still have two small issues. First, the BRICs are bubble economies based on unsustainable exports, unrealistic commodity prices, and bubble stock markets and real estate markets of their own. The unwinding of their economies and markets will lead the global economy, not just into a slowdown, but into the abyss. Second, it is time to stop beating around the bush and start summarizing all of your eloquent arguments above in a single word-DEPRESSION?

LiliFebruary 5th, 2008 at 6:32 pm

“that earnings will sharply drop in a recession not just among financial firms but also non financial ones”  Does anybody have some good info about the financial situation of non financial firms ?  People usually say balance sheets of non-financial firms are still quite ok…  Is it true or is it the kind of thing that is being said to not frightening too much (more) the markets ?  Thanks  

GMFebruary 5th, 2008 at 6:38 pm

Hi all,  Been watching this blog for over a year. I am wondering how an economic recession may affect me as a physician. I have learned that healthcare tends to have a recession delayed by 4+/- years from financial/economic recessions. Any input on how healthcare will be affected is greatly appreciated.  Thanks

richinarFebruary 5th, 2008 at 6:57 pm

Ahhh another Fed rate cut or 2 and some checks in the hands of Americans will fix everything. Remember the sound economic fundamentals.

AnonymousFebruary 5th, 2008 at 7:27 pm

Can anyone tell me please, where is the safest place to keep one’s liquid assets? Is it even safe to keep cash in local bank? If not , WHERE?!Any enlightenment will be appreciated. Thank -you for sharing your knowledge so freely Dr. Roubini

GuestFebruary 5th, 2008 at 7:40 pm

Hi all,    Been watching this blog for over a year. I am wondering how an economic recession may affect me as a physician. Written by GM on 2008-02-05 18:38:07  You self-centered jerk!

mad as heckFebruary 5th, 2008 at 7:51 pm

@GM are physicians different then the rest of us? What kind of lame ass question is that? The arrogance. Well, I run a small company, how will it effect me? we will all be screwed, except you will get more heart attack and give me anti anxiety drug business, but the health insurance comapanies hopefully will go insolvent, the greedy bastards and you wont get paid.

JLCFebruary 5th, 2008 at 7:51 pm

“You self-centered jerk!   Written by Guest on 2008-02-05 19:40:38″  Wow, Guest. Lets try to keep it friendly here. Is it not rational for GM to be concerned about his livelihood? I know I’m concerned about mine.

JLCFebruary 5th, 2008 at 8:00 pm

Nice analysis, Professor. I am looking forward to the next installment.  I had a conversation with some business associates today about the economy and the plight of our industry (housing). The senior member of the group stated that he’s seen slowdowns before and its no big deal, it will clean out the industry and top producers like ourselves will come out stronger in the end.   I admire his optimism, but I seriously doubt he has been exposed to anything quite like this. Few of us have. As Kokopelli said, “This mess is so big it is beyond comprehension of 99.999999% of the people on in this country.”  It will be a rude awakening indeed.

fabio arcangeliFebruary 5th, 2008 at 8:01 pm

professor, your analysis is welcome, timely and I share the most of it. I understand the panic argument made by commentator Medic, but I also wonder where we go in a closed system, where almost any economist plays the game of denying that a global recession is ongoing, and the parallel US Electoral process adds Kafkian dimensions to the political-economic cycle. While a complex crisis transmission machinery is at work day and night; both fiscal and monetary weapons are very weak; Fed’s 1.25 overshooting further weakens the latter.  I wait for your chapter 2 and I would like to know your opinion about non-US economic policies as well: 1st in Europe where the recession is already hitting.

charlieFebruary 5th, 2008 at 8:03 pm

Not to mention the numerous lawsuits filed in a last ditch effort to recoup losses. There will be a lot of incompetence that will need to be defenced. As has been mentioned repeatedly, I don’t see how the rating agencies can defend a AAA rating on the monolines whose stock price has dropped over 80% in a few months and has debt yields of 20%. How could a jury buy them saying they didn’t notice anything that was concerning about this?

JLCFebruary 5th, 2008 at 8:13 pm

Professor, I hope to see how the value of the dollar factors in to your follow up analysis.   On the one hand I can see medium term dollar strength as the contagion spreads around the globe and everyone flocks to the perception of safety that the dollar brings as reserve currency.  On the other, the rate cuts, stimulus, and worsening deficit are all big negatives. Various countries with some form of dollar peg are making noise about revaluation to cure increasing domestic inflation. Certain OPEC members want to ditch the dollar.  In Bernanke’s famous deflation speech, he speaks favorably of currency devaluation as a means to stoke inflation, a la Roosevelt during the depression. Will it get that far? I think BB will exhaust all of his other ammunition before reaching that point – or will he? Devaluation looks like the only way the US Gov’t can pay its trillions in unfunded liabilities.  Then again, the loss of reserve currency status for the dollar would probably mean the end of American hegemony. Would certain other nations see the advantage of forcing the issue in a moment of extreme weakness?  Will this crisis be of sufficient quality to threaten the status of the dollar as reserve currency?

GuestFebruary 5th, 2008 at 8:15 pm

 @ Previous post by Gloomy quoting FT: “The government’s (China’s)…dubious new labour law…prevents companies from firing workers with 10 years or more experience… Indeed, the greatest danger to China’s economy is that…the country’s leadership seems to be losing faith in markets and adopting policies…that turn back the clock to old-style communist days… Rather than try to deal with inequality by labour market fiat, the government would do better to improve the social safety net through provision of more and better healthcare and pensions…”    The Financial Times is engaging in Orwelllian “newspeak,”—Up is Down, Freedom is Slavery, Ignorance is Knowledge. Rather than China, it is the FT that is moving down the socialist road.   There is no greater tenet of entrenched socialism than an Iron Curtain “health care/pension” system. Economist F.A. Hayek warned that Socialism was “the fatal conceit,” which promises “equality” but results in equality of servitude to the State.  And that’s what the FT wants isn’t it—a cheap, healthy slave labor pool for the multinational corporations?   In a free economy mankind has a right to negotiate labor contracts, to claim his rightful property from the productivity he generates. Conversely, in the communist state, labor has no voice, a man’s plight is unquestioning servitude at subsistence level – and old muscles must step aside after 10 years to younger, stronger muscles.  The FT, IMO, has taken the low road to serfdom for the people, and unfettered profits for the multinational corps!  Hayek in his famous “Road to Serfdom” said that Socialism (i.e. Communism) paves the way to totalitarianism.  In “The Decline of the West” (1929), Oswald Spengler said, “Ethical Socialism is not a system of compassion, humanity, peace and kindly care, but one of will-to-power.”  The Financial Times’ Orwellian newspeak is “devised to meet the ideological needs of Ingsoc, or English socialism,” and “Big Brother.” In George Orwell’s 1984, Big Brother’s representative chants: “The Party seeks power entirely for its own sake. We are interested solely in power. We are priests of power.”  Ultimately, the Financial Times’ power positions would level the living standards of the United States of America and England to those of the sweatshop labor nations of the world. For, as Charles Peguy said, “Tyranny is always better organized than freedom.” 

Octavio RichettaFebruary 5th, 2008 at 8:19 pm

Written by Guest on 2008-02-05 19:40:38 Written by mad as heck on 2008-02-05 19:51:45  You seem to be the same person. I hope the Professor tracks your user id, IP address, and bans you from here. You seem to equate being a medical doctor with being some kind of a crook.  Perhaps, you are totally ignorant about what the profession is all about (e.g., how manage cared has cornered physicians in just the same many private equity outfits have cornered the employees in the firms they acquire). Not many MDs make million dollar salaries and many of those who do well deserve it.

SophieFebruary 5th, 2008 at 8:26 pm

I have $34,000 in credit card debt. I am unable to find work in Michigan except selling on eBay, which is how I amassed most of my debt. I did well for a couple of years, but loss of sources, increased competition and slow sales over the past 2 years have left me living with my parents and barely able to make my minimum payments. I am not using my credit cards at all, and literally have no money left after bills, food and rent. (I do pay rent, which helps my Mom – it was actually her idea that I move home.) According to the online credit calculators, at my current payments, it will take me 6 years to pay off all my cards, that is if I can find the money. Should I just go ahead and file Chapter 7, since I’m probably stuck at my Mom’s house for the next several years, and will be lucky to find a job at a Target or Walmart? Would a Chapter 7 hurt my chances at finding a crappy minimum wage job?

GuestFebruary 5th, 2008 at 8:45 pm

@octavio I am not the same person. I read the post and found it strange, thats all. I have read the posts here for many months and very few times people mention their positions including myself.

Octavio RichettaFebruary 5th, 2008 at 9:11 pm

Written by Octavio Richetta on 2008-02-05 21:05:09  They will re-open February 13…. It will a Long week for those long the market. US ISM numbers came out at a most inconvinient time.  Perhaps Benny will do whatever he can to assure the celebration is a merry one…

Octavio RichettaFebruary 5th, 2008 at 9:23 pm

‘Anyone for Used Corporate-Debt, Cheap?’ Why Leveraged Loans  That Financed Buyouts  Are Causing Bottleneck By LIZ RAPPAPORT and PETER LATTMAN February 6, 2008  A new problem is rippling through credit markets: Many of the corporate loans used to finance giant buyouts in the past few years are reeling in secondary market trading, making it virtually impossible for banks to unload other commitments they have made.  http://online.wsj.com/article/SB120222620470044309.html?mod=hpp_us_whats_news

G.H.February 5th, 2008 at 9:44 pm

Hang Seng down better than 6%.  My question: will China’s market go belly up before, or after, the Olympics?  G.H. 

GuestFebruary 5th, 2008 at 9:53 pm

   @GM: “I am wondering how an economic recession may affect me as a physician. I have learned that healthcare tends to have a recession delayed by 4+/- years from financial/economic recessions.”  First, apologies.  Secondly, I have no economic knowledge of the healthcare industry. Politically, I think all bets are off on how the country will ride out this recession, as it has never faced conditions such as these before: nor has the public been so informed.  The government recently began indexing Medicare premiums to a retiree’s income, as you know. But, IMO, middle-income classes cannot afford more health costs. So, while Medicaid and assisted Medicare patients probably will see no reduction in care, the middle classes in bad times may have to drop Medicare B and Supplemental insurances. This will reduce healthcare participation on their part.  At the same time, 24 states now are experiencing problems with reduced receipts. If the IRS’s tax receipts fall, IMO, Congress will cut programs for those with least voting clout, i.e. probably the middle to upper classes.  If we go into depression, IMO, government and university employees, who in general have the nation’s best healthcare benefits, probably also will suffer. As for the average working man, a large percentage already have reduced or no health benefits.  All this takes time, of course—so there could be a delay of four years. I’d say if a recession only lasts 12 to 18 months, a medical doctor would encounter minimal economic repercussions. If longer, then, yes. But if the stock market crashes–-with all 401(k)s and pensions on the line—all bets are off.  I will point out that the Economic Benefit Research Institute reports “Americans 75 and older are taking on debt more quickly than those 65 through 74. And bankruptcy filings are increasing fastest among those 65 and older. A frequent culprit: medical debt.” Of course these people also suffer terribly when earnings from their savings are below the inflation rate, particularly on nondiscretionary items such as health/house/car insurance, pharmacy drugs, food, heating, property taxes, car repair, etc. So many already are in terrible “depression.”  My friend’s grandfather began his medical career in private practice in Indianapolis during the 30s. He waited three days for his first patient and many of those who did come paid him in produce or, usually, a roasting hen. He greeted each and every patient like a favorite relative. 

GuestFebruary 5th, 2008 at 10:16 pm

Prof Roubini  There are a variety of scenarios that fall under the general category of “End Of The World” outcome. There’s not just one dramatic endgame. And they vary in severity and consequences.  There are also less severe outcomes, such as a difficult recession followed by a recovery.  At this stage, I think it’s preferable for you to give people constructive guidelines. After all, if the scenario you described really does materialize, then it’s probably time to close down the RGE Monitor, shut down this blog, and move to the countryside with food and a gun. Seriously. :-)   Just a few sessions ago – you were the one calling on the Fed to lower their rates. And … they have done as you proposed.  Better now to help people understand their choices, I think.  PeteCA

kilgoresFebruary 5th, 2008 at 10:16 pm

@GM  >Hi all,    >Been watching this blog for over a year. I am wondering how an economic recession may affect me as a physician. I have learned that healthcare >tends to have a recession delayed by 4+/- years from financial/economic recessions. Any input on how healthcare will be affected is greatly >appreciated.   Doctor, professional service sectors tend to hold up somewhat better than other businesses in a recessionary environment. People will always need health care services; there will always be legal issues; children will still need to be educated; parishes will continue to seek spiritual counseling. Of course, if your patients have no money, you might have to accept payments in kind. I remember once seeing a newsreel from the 1930s in which the family doctor was accepting a fresh chicken, feathers and all, for a house call!  Please don’t take any abrasive reactions to your inquiry personally. There’s a lot of stress going around this board right now. Your question was certainly not out of line.  SWK

GuestFebruary 5th, 2008 at 10:33 pm

 @ Sophie  Any business can fail: it is no disgrace. In fact, according to Dun & Bradstreet, “Businesses with fewer than 20 employees have only a 37% chance of surviving 4 years (of business) and only a 9% chance of surviving 10 years. The University of Tennessee, Ag Extension, says the failure rate for new businesses seems to be around 70% to 80% in the first year and only a half of those who survive the first year will remain in business the next 5 years.  If I were in your circumstances, I would talk with legal assistance in your state regarding your debt. Perhaps it can be reduced. At any rate, I do not believe it would affect your chances of finding a good job. I dealt once with a company that filed bankruptcy three times. (Since then, bankruptcy laws have tightened.) Anyway, below in part is Wikipedia on Chapter 7: check it out. And good luck!  en.wikipedia.org/wiki/Startup_company – 25k  Businesses filing Chapter 7  When a troubled business is badly in debt and unable to service that debt or pay its creditors, it may file (or be forced by its creditors to file) for bankruptcy in a federal court under Chapter 7. A Chapter 7 filing means that the business ceases operations unless continued by the Chapter 7 Trustee. A Chapter 7 Trustee is appointed almost immediately. The Trustee generally sells all the assets and distributes the proceeds to the creditors.  This may or may not mean that all employees will lose their jobs. When a very large company enters Chapter 7 bankruptcy, entire divisions of the company may be sold intact to other companies during the liquidation.  Fully-secured creditors, such as bondholders or mortgage lenders, have a legally-enforceable right to the collateral securing their loans or to the equivalent value, which right cannot be defeated by bankruptcy. A creditor is fully secured if the value of the collateral for its loan to the debtor equals or exceeds the amount of the debt. For this reason, however, fully-secured creditors are not entitled to participate in any distribution of liquidated assets which the bankruptcy trustee might make. In a Chapter 7 case, a corporation or partnership does not receive a bankruptcy discharge. Only an individual can receive a Chapter 7 discharge (see 11 U.S.C. § 727(a)(1)). Once all assets of the corporate or partnership debtor have been fully administered, the case is closed. The debts of the corporation or partnership theoretically continue to exist until applicable statutory periods of limitations expire. 

kilgoresFebruary 5th, 2008 at 10:34 pm

@ Sophie  >Should I just go ahead and file Chapter 7, since I’m probably stuck at my Mom’s house for the next several years, and will be lucky to find a job at ?>a Target or Walmart? Would a Chapter 7 hurt my chances at finding a crappy minimum wage job?   You should probably go talk to a bankruptcy attorney for advice. It sounds as if you might be eligible for Chapter 7 dissolution, although it has become more difficult to qualify since the credit industry lobbied Congress successfully for bankruptcy “reform” that now forces the court to place many debtors in Chapter 13 (you get to repay your debts — no discharge — but you still get the bankruptcy taint). Filing for bankruptcy certainly won’t hurt your chances of getting a typical minimum wage job…though it might hurt your chances of running for public office one day. ;-)   SWK   

GuestFebruary 5th, 2008 at 11:17 pm

 @Anonymous “Can anyone tell me please, where is the safest place to keep one’s liquid assets? Is it even safe to keep cash in local bank? If not , WHERE?! Any enlightenment will be appreciated…”  Keep it in short-term Treasurys, or FDIC or National Credit Union Administration (NCUA) short-term insured accounts. These deposits all are backed by the United States Government. If the government falls it won’t make any difference anyway, and only gold will be safe for a quick exit.   Yes, it’s safe to keep your cash in most banks. If you’re talking about a checking account, check out a bank’s rating. Personally, I would bypass Washington Mutual and Citibank at the moment. Also, some smaller banks without access to the Fed may be in jeopardy and you could lose your uninsured cash in a failure. Just check them out on the Internet, or call them.  

Juve NalFebruary 5th, 2008 at 11:24 pm

@LB you are as Pastor et Nauta  qui pascet oves in multis tribulationibus: quibus transactis civitas septicollis diruetur, et Iudex tremêndus iudicabit populum suum. Finis  Grateful for your “translation” too…see you on the other side of Al Capone/Bugs Moran’s trading.     

GuestFebruary 6th, 2008 at 12:33 am

@Anonymous “Can anyone tell me please, where is the safest place to keep one’s liquid assets? Is it even safe to keep cash in local bank? If not , WHERE?! Any enlightenment will be appreciated…”   I have spread my liquid assets between several institutions that are FDIC insured and that I consider to be relatively safe. I have some in dollars, and some in various foreign currencies through Everbank (my accounts there are also FDIC insured). I also own gold and silver, both ETF and physical, and have the physical stuff, and some cash, apportioned between several secure storage locations. Do some research and figure out what works best for you.  Whatever you do, don’t put all your eggs in one basket. Spread it out so that if one institution fails you are not totally wiped out. Theres no telling how long it would take the FDIC to reimburse you after a crash.

London BankerFebruary 6th, 2008 at 1:57 am

@ Professor Roubini  An amazingly clear and compelling summary of how the financial imbalances and excesses built up over the past two decades may unwind. There are many things that remain unpredictable, and I worry that there is too little recognition of how the rest of the world will be impacted and will respond.  The reason the Fed and Washington in general fear both inflation and deflation is that these are the only two forces which have ever successfully led to the deposing of entrenched elites. The elites in Washington and on Wall Street remember well how their powers were taken away in the 1930s by Roosevelt and his cadre of young advisors. It wasn’t until the 1950s that they regained control of the levers of power, and only since the 1980s that they have reversed the supervision and regulation which restrained them from excess.  They are even now engineering to retain their power by imposing more secrecy and less accountability in the US system. Note how every “emergency” leads to more secrecy, justified as necessary to “protect” the system or American security? The TAF auction particularly nauseates me as an example of a secret, corrupt, unaccountable process that was introduced without inquiry, consultation or recourse. We can expect a lot more of the same, so that the America which emerges from the next recession may well be unrecognisable as the America that entered it.  In the rest of the world, as well, economic dislocation will lead to political dislocation. Resource rich economies will be suddenly crushed by a collapse in export markets and commodity prices. Bubble real estate and stock markets globally will collapse, leading to huge deflations that impoverish the burgeoning middle classes in emerging markets. The anger will be unleashed on governments, and they will respond with a variety of enlightened and unenlightened measures according to their grip on power and accountability.  I’m glad to be in Europe in these times. Our ups are not as extreme, but our downs are not as extreme either. We have mature and resilient political processes, with a backstop of EU human and civil rights protection. We will all grow poorer together, and that provides a common interest for political reform.  @ Juve Nal  I’m not sure what Saint Malachy has to do with financial collapse, and not sure if I’d give him credence in any event. The end of the world gets prophesied a lot but rarely happens. I’m actually fairly optimistic that we will come out of the coming collapse with more enlightened and mature attitudes which will set the world on a favourable path going forward.  As we are trading quotes, I will offer Gandhi: There have been tyrants and murderers and for a time they seem invincible but in the end, they always fall – think of it, always.  I would like to amend my earlier prediction to be less concrete on the timing. Looking back at MLK weekend, the US markets fell sharply to the close on Friday, leading to the global meltdown on Monday while the US was closed, and setting up the emergency 75bps rate cut on the Tuesday before the US reopened. That set off the rally which lasted through last Friday. We are seeing something of the same thing now, as Asia enters the long holiday weekend for Lunar New Year.  If the same scenario repeats, the markets could continue their fall through until after Presidents Day, with another surprise ill-transparent, unaccountable, massively corrupt bailout or other big surprise on the 19th maybe (monolines?).

GSMFebruary 6th, 2008 at 2:00 am

I note in your piece above Professor that the impact at household levels is not covered. I suspect that is because you see clearly the enormity of the awful trauma and in many cases destitution that is about to befall them.   The policy responses whatever they may be had better start with dealing with the causes of higher food and energy prices and responses to mitigate same. The growing assumption that a deflationary episode lowers these along with all commodities is a dangerous and erroneous path to follow.  Missing also was the fate of the US dollar. Both in terms of value (against gold) and in terms of its position as the worlds reserve currency. I do hope you can comment on these issues in follow up pieces.  My instincts tell me that China, Russia and others are keenly aware of the scenario’s NR is outlining. Trying to war game the mayhem that systemic failure of the US financial system will wrought can only take responses so far. However, nations that can will therefore scramble for safety trying to insulate themselves best they can from the immense fallout. This is one reason now driving China’s actions to secure access to future strategic materials, technology, minerals, energy sources etc.   Professor, you are in fact describing a world in mass chaos. 

Hilary BarnesFebruary 6th, 2008 at 3:22 am

And 13, massive crisis in government finances owing to recession. And 14, collapse of dollar; euro buys 2 (perhaps 3) dollars.

JJFebruary 6th, 2008 at 4:37 am

One could say that there are three avenues to improved economy: production, consumption, and warfare.  During the last few years the current administration has attempted to revive the U.S. economy by promoting consumption with the help of easy credit and non-existent lending standards. In other words, since the poor cannot afford to shop without credit, make credit available to them. They had to do this because of allowing the manufacturing base to erode while promoting the nonsense about “service economy”. In reality an economy can never be based solely on service industries.  Some news articles, when referring to the U.S. national savings rate and consumer spending, give the impression that Americans “choose” to spend all of their money but could actually save if they just wanted. The reality is likely, however, that the amount the national savings rate is as low as it is because of a large part of the population living paycheck-to-paycheck. The small amount that these people could put aside could disappear when unforeseen expenses come up (car breaks down, doctors visit, etc). If the general U.S. population really could save if they wanted to (i.e. had available cash), would the government have to send out money?  Some other articles bring out that European banks should not think they are much better of than their U.S. counterparts, since they have financial losses as well. Many of these fail to bring out, however, that their financial losses are relative to their exposure to the U.S. lending market. The fact is that Europe does have housing bubbles also, but for many reasons they are far less severe than the American one. One of these is that in U.S. the housing bubble is just one of the features of the current crisis; the U.S. crisis has other features that do not exist in Europe.  In any case, as we all know, easy credit led us to the largest real estate bubble in the U.S. history and is now the cause behind the so-called subprime crisis.  Banks have lost billions of dollars and would lose even more if mortgage holders decided to return their house keys en masse. To avoid this prospect the government decided to “help mortgage holders to keep their homes” by lowering interest rates and now sending checks for cash checks to citizens. These are steps that cannot be done every month, however, and will likely not boost the consumption sufficiently. Since manufacturing in the U.S. has largely been outsourced to China, the only other way to boost the economy is by expanding military spending.  This is where McCain comes in, I would say.

London BankerFebruary 6th, 2008 at 5:43 am

@ JJ  It may have been forgotten in America – like so many lessons of the Great Depression and the Great War – but militarism can never add to the wealth of a country in an age of economic co-dependence. This principle was first explained by 1933 Nobel Peace Prize winner Sir Norman Angell, but there has been nothing in the decades of war and loss and struggle since then to prove it other than absolutely accurate.  From the Great Illusion:   He establishes this apparent paradox, in so far as the economic problem is concerned, by showing that wealth in the economically civilized world is founded upon credit and commercial contract (these being the outgrowth of an economic interdependence due to the increasing division of labor and greatly developed communication). If credit and commercial contract are tampered with in an attempt at confiscation, the credit-dependent wealth is undermined, and its collapse involves that of the conqueror; so that if conquest is not to be self-injurious it must respect the enemy’s property, in which case it becomes economically futile. Thus the wealth of conquered territory remains in the hands of the population of such territory. When Germany annexed Alsatia, no individual German secured a single mark’s worth of Alsatian property as the spoils of war. Conquest in the modern world is a process of multiplying by x, and then obtaining the original figure by dividing by x. For a modern nation to add to its territory no more adds to the wealth of the people of such nation than it would add to the wealth of Londoners if the City of London were to annex the county of Hertford. [Norman Angell, The Great Illusion, (New York and London: G. P. Putnam's Sons, 1913), x-xi.]  The only people who make money out of war are the arms dealers, like Bush’s great-grandfather Samuel Bush who profited handsomely from selling to both sides in World War I. Or his grandfather Prescott Bush, who profited handsomely from financing and rearming the Nazis until America entered World War II. Or his father GHW Bush, who founded Carlyle Group to make huge private fortunes from publicly funded wars.  War always has and always will impoverish the people of both an aggressor nation and a conquered nation. Perhaps not in equal degree, but they are impoverished altogether all the same.   

AlessandroFebruary 6th, 2008 at 6:00 am

@JJ and adding to London Banker post  War as an economic stimulus is merely a way to inflate national debt.  Building universities and infrastructures or even paying people to dig holes in the ground would be wiser and more effective.  War is not a way out of a depression. It might be a consequence, thou.

GTSFebruary 6th, 2008 at 6:04 am

Itraxx Europe (financial sector) at 90 !!!. Went up from 70 in 2 days.  Isn’t it an all time high?  What news is on air ?

GaborFebruary 6th, 2008 at 6:49 am

Prof. Roubini,  I agree with you that indeed these are the weakest points in today’s economy (commercial real estates, banks, shadow financials), however I am afraid that these institutions will be saved again. There are many parties who have a vested interested in the global economy to continue this current path. FED, US govt, China, Saud, etc might be willing to come to rescue.  Also it would be interesting to debate the global feedback to the coming recession. Will the fall in export demand undermine the Chinese investment boom? Will it undermine the Chinese trade surplus? If the Chinese investment boom suffers, that means less demand for western capital goods (aircrafts, machinery, telecom equipment etc)-> More severe US, EU recession. If the Chinese govt tries to save domestic investment boom with spending, this may make the Chinese trade surplus suffer -> More inflation, less liquidity ->More severe US, EU financia crisis. 

Octavio RichettaFebruary 6th, 2008 at 7:41 am

Excellent Piece by Hussman an the appropriate use of the “magazine cover” contrarian indicator and what he calls the coming recession: “A Writeoff Recession” which offers an intelligent alternative to the Professor’s views. IMO, things may turn out “in between” the two views.  http://www.hussman.net/wmc/wmc080203.htm

living a nightmareFebruary 6th, 2008 at 7:41 am

 Why am I waking up every morning lately with the dry heaves?  I cant sell my house. Nobody either wants it and the banks are making it harder and harder to get a mortgage. My job is on the line I have very little savings in bank of America (will it be around next year)? College tuition is killing me and the news keeps on getting worse and worse.  CAse Shiller should start a heart attack index due to the economy.   When is this all going to end????  

GirafFebruary 6th, 2008 at 8:47 am

Some very interesting data on bear markets from today’s Gartman Letter:  “THE TEN WORST BEAR MARKETS OF MODERN TIMES IN THE US  10th Worst Stock Market Crash: 1/15/2000 – 10/9/2002 Total Days: 999 Starting DJIA: 11,792.98 Ending DJIA: 7,286.27 Total Loss: -37.8%  9th Worst Stock Market Crash: 11/21/1916 – 12/19/1917 Total Days: 393 Starting DJIA: 110.15 Ending DJIA: 65.95 Total Loss: -40.1%  8th Worst Stock Market Crash: 9/12/1939 – 4/28/1942 Total Days: 959 Starting DJIA: 155.92 Ending DJIA: 92.92 Total Loss: -40.4%  7th Worst Stock Market Crash: 1/11/1973 – 12/06/1974 Total Days: 694 Starting DJIA: 1051.70 Ending DJIA: 577.60 Total Loss: -45.1%  6th Worst Stock Market Crash: 6/17/1901 – 11/9/1903 Total Days: 875 Starting DJIA: 57.33 Ending DJIA: 30.88 Total Loss: -46.1%  The 5th worst stock market crash: 11/3/1919 – 8/24/1921 Total Days: 660 Starting DJIA: 119.62 Ending DJIA: 63.9 Total Loss: -46.6%  4th Worst Stock Market Crash : 9/3/1929 – 11/13/1929 Total Days: 71 Starting DJIA: 381.17 Ending DJIA: 198.69 Total Loss: -47.9% This was, and still remains, the shortest bear market and it was the now infamous “Crash of ’29.” Few realised how short it was however; a mere two and one half months really. It was, however, a truly deadly one for investors saw half their money disappear in those two and one half months.  3rd Worst Stock Market Crash: 1/19/1906 – 11/15/1907 Total Days: 665 Starting DJIA: 75.45 Ending DJIA: 38.83 Total Loss: -48.5% This was the “Panic of 1907″ and it was the market collapse that ushered in The Fed a few years later.  2nd Worst Stock Market Crash: 3/10/1937 – 3/31/1938 Total Days: 386 Starting DJIA: 194.40 Ending DJIA: 98.95 Total Loss: -49.1%  Finally, The Worst Stock Market Crash Ever: 4/17/1930 – 7/8/1932 Total Days: 813 Starting DJIA: 294.07 Ending DJIA: 41.22 Total Loss: -86.0%  This last one is truly the “grand daddy” of all bear markets. We must remember that following “The Crash” of ’29, stock prices rallied quite sharply in what was one of the most violent bull runs of history. Prices rose 48% from their lows made in mid-November of ’29 to their highs in March of ’30. From there, it was a relentless, mauling, devastating new bear market brought on by the idiocy of Smoot-Hawley and the even greatly lunacy of the Federal Reserve Bank’s decision to drain liquidity from the system following Treasury Sec’y Andrew Mellon’s urging that the liquidity created by the selling of stocks the previous autumn be withdrawn from the banking system, fearing inflation! When this most serious bear market had finally run its course, those involved lost 86% of their capital. Put another way, if you had put $1000 in the market at the start of the ’30 bear market it would be down just a bit more than $100 by July 8th, 1932. Remember, the “math” begins to work relentlessly against you after that, for in order to recover the losses incurred the market would have to go up a bit more than 800%. Eventually the market did precisely that, but it took one score and two years to accomplish the task. Being a long term investor is one thing; holding a portfolio for twenty two years, hoping that it will come back, is way beyond that… it is idiocy. Oh, and “Value” existed all along the way down too, we might add! That “Value” was eventually realised, but many investors had passed on to greener pastures by then we are told.”  Dennis is one of the very few contributors to CNBC who tells it like it is. I’m surprised that they ever have him on, given that he also has been talking about recession for several months and continues to point out the vulnerability of stock markets.

JMaFebruary 6th, 2008 at 9:09 am

Professor and all, of course i am on board and understand the severity of what is coming down the pipe. However, I find it nearly impossible to convince most people of this reality. I have a personal challenge now to convince my sister who just sold her home to wait at least 6 months and see where prices are before buying the next house. She is, like every woman, primarily focused on the instinctual need for the LONG run to have a roof over her head that she owns and rightfully – not too concerned of price as in 20 years what is the difference what you pay now. Do you or does anyone have any ideas on how to make the point ? Her area is Northwest Indiana 45 minute commute to Chicago and obviously not an Arizona, California or Florida but there will be some effect here as well ultimately ? The plan for now is to find the Shiller type articles and any other places including here which indicate projections for the Midwest. To be quite honest even though this article is likely spot on, the masses would largely scoff at it as it is so far outside the MSM spin.  interesting how marketable such things as repealing the “estate” tax can be sold simply by referring to it as the “death” tax  along the EXACT SAME PRECISE lines (too lazy to search for old article headlines but you get the point) – interesting how marketable such things as “Arab port deals” become simply by referring to them as “sovereign wealth fund” deals – clever, clever literal spinning… China or the United Arab Emirates in the headlines buying the USA a bit of a political quandary – sovereign wealth funds buying the USA ? no worries…  

tbFebruary 6th, 2008 at 9:17 am

has the RSS feed for this blog changed? every time i click on it from Bloglines it just pulls up the RGE homepage…very annoying…

OuterBeltwayFebruary 6th, 2008 at 9:42 am

@LB, Octavio, GSM, Giraf:  LB recently reported that the cash hoards of some major corporations were invested in money market funds. Those money market funds in turn held various debt instruments which were potentially at-risk from the excesses of the debt markets in general (debtor non-performance, ratings fraud, guarantor insolvency, etc.)  That risk applies to individual investors, as well, as we unload equities and go for security, in the form of say, money market funds (for those of us that wish to diversify beyond gold and stable currencies).  I recently reviewed the prospectus for PIMCO’s Institutional money market fund. It has FNMA securities (mortgage backed) and Bear Stearns corporate debt in it. While I suppose that’s “OK” – after all, PIMCO is the U.S.’ premier bond fund operator, it brings up the question:  What are the earmarks (metrics, security types, originators, etc.) of debt which is less likely to be adversely affected by guarantor failure, debtor stress or rating agency excesses that would therefore be desirable securities to see showing up in the prospectus of your favorite money market fund?  The rules of the game have changed radically, and I’m not seeing any recent literature on this vital and timely topic. Comments anyone? 

MedicFebruary 6th, 2008 at 9:50 am

@ GM:  Please excuse some of our friends here who have been so rude. I would like to answer some of your questions, but I am afraid I don’t know enough about what you do and where you practice.  The basics are such:  1. Insurance companies stand to lose significant amounts of money in this crisis – be prepared for even lower reimbursement rates.  2. Government administered programs will also be taking a hit as the US attempts to bail itself out of such a mess. There is hope here, that like in the 1930′s, the Fed may step in and increase spending somewhat (remember in the GD they only spent what amounts today as about 140 billion on such programs as Unemployment, Social Security and others), but it likely will not be lots.  3. If you are a specialist (Surgeon, Anestisia, Neurologist, etc.) be prepared for a leveling of reimbursement as there are still not enough of you in the system. However, like the VA has done in the past 2 decades, regionalization may be the new plan and moving to where your talents are most needed may be an option.  4. If you are a hospital employee (ER, hospitalist) you and your institution may be in trouble. If universal health becomes the way forward (long overdue if I may add) then regional facilities will likely become the goal. Small institutions will be taken over as they will not have enough resources to survive (as is already happening).  5. If you are in private practice – here I have no answers to offer. Reimbursements are already low here (Maine) and getting lower. Our MaineCare (medicaid) system is so underfunded, they owe money from 3 years back and are paying somewhere between 30-40% of billing.   Best of luck. Keep your head down and your eyes open and don’t be afraid to move if necessary.  Medic

K in TXFebruary 6th, 2008 at 9:53 am

Interesting piece in the Dallas paper today. The Dallas Fed Bank President was the only one of the Fed Presidents to vote against the last rate cut. Cheryl Hall interviewed area executives for their take on the recent cuts. Here are a few with link to follow:   David Biegler, chief executive, Estrella Energy LP: “When the crop is at risk of failing, which will cause the hardship of barren ground for an extended period, worrying about a potential future sprouting of weeds is not the proper focus.  ”The necessity and benefits of the cut outweigh the future inflation risk.”    Mark Vamos, William J. O’Neil chair of business journalism at Southern Methodist University: “Every time there’s a financial crisis, an inflection in the business cycle or some other event that has everybody looking to the Fed, you start reading stories asking whether the Fed has lost its mojo.  ”This time it’s – take your pick – the Fed doesn’t have enough room left to cut, the Fed has moved too precipitously, the Fed has lost control over substantial portions of the money supply, there’s going to be stagflation, the Fed can’t cut too aggressively because foreign bondholders will bail out of U.S. debt, and on and on. But the market’s conventional wisdom here is correct: Don’t fight the Fed. Its policy actions on interest rates remain tremendously powerful.  ”And there’s still a lot of room left to for it to maneuver.”    John Boone, chairman of Belmont Global Advisors Inc.: “The Fed cut too fast and perhaps too far. Too many of us have become conditioned to running to the Fed for a reduction in the level of short-term interest rates or [to] the federal government for an economic stimulus package to help bail us out of whatever problems our excessive behavior in the financial area has placed us in.  ”We all need to feel the pain of our excesses so that we’ll hopefully handle our finances in more cautious manner.”   http://www.dallasnews.com/sharedcontent/dws/bus/columnists/chall/stories/DN-hall_06bus.ART.State.Edition1.38aac56.html

London BankerFebruary 6th, 2008 at 9:59 am

@ OuterBeltway  The rules of the game have indeed changed alarmingly. If you are worried enough to be shifting from negotiable securities (equities and bonds) into money market funds, and worried enough there to be scouring the prospectus for possible loss-making holdings, why not go all the way to FDIC insured certificates of deposit? You may lose a few basis points, but if you are more worried about the return OF your capital than the return ON your capital it will be well worth it in peace of mind. You also save management fees and charges, as none will apply to CDs.  Given the flexibility in modern accounting rules, you aren’t going to find all the possible dangers in a portfolio just by examining the holdings. There are likely undisclosed derivative positions, for example.  If the sums involved are too large to manage as a series certificates of deposit with FDIC insured banks, then consider investing directly in Treasuries.  If your objective is to stop worrying – and that’s a good objective right now – then stick to safety and worry about return when the markets are more transparent and credit clarity has returned.

KokopelliFebruary 6th, 2008 at 10:23 am

This mess is all about imbalances. OR as the financial media puts it, mis-priced risk. Caused by lax or non existent regulators and an ignorant Congress and administration who changed the rules to do away with the checks and balances…   I have my own theory of imbalance.   When a wheel on your car is out of balance, if you don’t get it re-balanced, the tire will wear faster. As it wears funny, it can actually cause it to become worse. Funny thing, if you drive faster, the vibration often goes away. Even still, if you keep driving the cord will eventually be exposed enough and you have a blow out which can cause you to lose control and wreck the car.   I say those with the power to control our money supply, for personal selfish reasons, have for 25 years, refused to re-balance the system. They might put a weight here or there (eased up on the access to credit) and it would be OK again. for a while, before the thumping would start again. At a point about 10 years ago we really needed to take the tire off and either replace it or at least re-tread it. We didn’t, we just increased the speed, which seemed OK because the thumping went away but didn’t fix a thing. Then 6 years ago they just put the foot to the floor and went all out, all in. Now the cord of our financial institutions is showing and we need to do a pit stop and replace the tire but we don’t feel we can because if we slow down, the thumping gets much worse and the tire might blow out before we get into the pits.   Here we are driving very fast with tires that are out of balance and the cord is showing and we are afraid to stop. We have reached the top speed and the thumping has started again. Do we just try and pull over hoping we don’t wreck, even though we aren’t even near the pits. Do we try and make it to the pits? Or do we just keep going like there is nothing really wrong and take some more valium and not worry… Oh NO! The pill bottle is empty… What do we do? What do we do?    

AnonymousFebruary 6th, 2008 at 10:26 am

@ Sophie  leave your mother leave Michigan leave the debt keep your chin up (don’t leave your pride)  some place in the world there is a place for you. when you get where you’re going don’t forget what you’ve learned

GirafFebruary 6th, 2008 at 10:41 am

@Outer Beltway  I echo LB’s thoughts. If you are most concerned about return OF capital, rather than return ON capital, you should go straight to Govt securities. While bank deposits are insured to a certain level, I don’t know what the process involves getting your money back, if you are unfortunate to pick the wrong bank and it goes belly up. I suspect (but don’t know for sure) that any yield advantage from bank deps over govt secs, will be eaten up by the time delay getting reimbursed.

GuestFebruary 6th, 2008 at 10:51 am

Written by living a nightmare on 2008-02-06 07:41:53   ”When is this all going to end????”    When we all stop living beyond our means?   

GuestFebruary 6th, 2008 at 10:51 am

@ Sophie and Kilgores   >1.Should I just go ahead and file Chapter 7, since I’m probably stuck at my Mom’s house for the next several years, and will be lucky to find a job at ?>a Target or Walmart? Would a Chapter 7 hurt my chances at finding a crappy minimum wage job?    2. It sounds as if you might be eligible for Chapter 7 dissolution, although it has become more difficult to qualify since the credit industry lobbied Congress successfully for bankruptcy “reform” that now forces the court to place many debtors in Chapter 13 (you get to repay your debts — no discharge — but you still get the bankruptcy taint).  This is meant to correct and clarify. The vast majority of consumer chapter 7 cases do not involve liquidation of anything, and are not properly characterized as dissolution. Furthermore, chapter 13 discharges are routinely granted upon plan completion, except in specifically limited instances. So, with respect, Kilgores, the statement about the taint in chapter 13 without the discharge is simply not factually accurate–though it was obviously well intended.   Chances are, anyone living at home is not making the median income for their geographic region–approximately $40k per year for a single individual, though it varies. For a family of four, in many places of the country, the median is around $70k. Anything below that median on the means test, and there is no presumption of abuse, and therefore, probably a prima facie qualification for chapter 7. But every case is different, and indivdual advice is required, so go see a lawyer.  Good luck.

OuterBeltwayFebruary 6th, 2008 at 12:20 pm

@LB and Giraf:  Thanks for your timely and thoughtful responses. I’ll make good use of them.  Regards, OB

Rich HFebruary 6th, 2008 at 12:21 pm

I love clichés. Their existence is proof of the historical importance of “learning from the past” and “history repeating itself”. …but it’s unfortunate that we sometimes “loose sight of the forest for the trees”. I am guilty of this.  Please read this article in the attached link with a clear mind. I have read similar articles in the past, but never scrutinized or applied them to the real world. My eyes have just been opened to how important this is.  http://www.msnbc.msn.com/id/23005695/  With that said, I move on to another cliché. (Arguably one of the most important and applicable cliché/quotes in the history of mankind) We all know its historical importance!  “Power corrupts. Absolute power corrupts absolutely”. To take this cliché 1 step further… What does “Corrupt Absolute Power” do?  With what you read in the attached story, and your own intuition what do you conclude? I see something far worse then the US credit/debt/secondary market economic crisis. I see at the very least, an equivalent lack of transparency in a COUNTRY that is the current center of worldwide growth. (…and what’s more amazing is our reliance on this country for its current federal funding!?!?!?) We’ve all read about the bubble that exists in China, and we’ve read the recent data showing the size that it’s financials have grown to, but where’s the transparency?   When a government/economy uses FEAR to control information, you lose ALL CREDIBILITY in anything that government/economy says. (“Inciting subversion is a vague charge frequently used to silence whistle-blowers and critics of the ruling Communist Party.”) Which auditor, whistleblower or truth teller will dare contest financial statements from the heads of these financial organizations? They will be labeled “subversive” and be punished. The cyclical deterioration of truth immediately collapses in this structure.  This article has just opened my eyes to the necessary ratings downgrade that will immediately take affect in my own knowledge database. China has officially been downgraded and dubbed:  ChEnron  It’s value is now pennies on the dollar until free speech is not only allowed but defended.  Use your eyes, ears and brain. History repeats. …and to answer my above question: What does “Corrupt Absolute Power” do?   It destroys itself.  Gung hay fat choy Rich H 

GloomyFebruary 6th, 2008 at 12:40 pm

@London Banker Try not to be quite so negative on my country, the US. Yes there is a massive problem that will no doubt lead us into depression. But corruption is universal and I have no doubt it runs at least as deep in the Euro zone as it does here. IMHO what makes a nation or “zone” great is it’s ability to flush out the sewage and start afresh with optimism, enthusiasm, and enterprise. Believe it or not, the pioneering spirit and creativity of our many honest citizens who believe that our constitution and declaration of independence are the blueprints for good government will not fail us. As we have done in the past, we will resume our destiny as one of the great nations of the world. I know that sounds sappy, but that is how I and millions of other Americans feel. There simply is no substitution for optimism as an indomitable national trait.

KJ FoehrFebruary 6th, 2008 at 12:47 pm

Thank you Dr. Roubini for your outstanding analysis of the entire situation.   Although the worst case scenario is very grim, I still believe people need to know the reality of what we may be facing. This is especially valuable in an environment where people are usually given only the rosy scenario that encourages complacency rather than preparation for the possibility of hard times.  Mostly for fun, I have summarized the 12 points and the estimated losses. My summary may be inaccurate due to my lack of expertise / understanding of all the issues. Also, please keep in mind that the loss estimates vary greatly, so I think these numbers should be considered as more of a curiosity or conversation starter rather than an accurate projection of what will happen in our economy.  (Sorry, I coudn’t get the formatting to line everything up as in a table.)   Roubini’s Point # — Description — Estimated loss (mostly midpoint of Roubini’s range)  1. Losses in value of decline in value of residential real estate: $5 trillion  2. Mortgage loan related losses (RMBS, CDSs): $400 billion  3. Credit card losses: no estimate  4. Additional ABS losses from monoline insurers (included in 2 above?): $150 billion  5. Commercial real estate loan losses: no estimate  6. Government losses from bank failures / bailouts: no estimate  7. Bank losses on LBO loans (number is my guesstimate): $50 billion  8. Losses on credit default swaps: $150 billion  9. Losses from failure of some non-bank financial institutions: no estimate  10. Losses due to stock market decline: no estimate  11. Credit crunch will lead to increased lack of liquidity: already covered above (?)  Total of points 2 through 9 (financial losses): $750 billion  12. Vicious circle will propel losses higher and liquidity lower:  (Total of all financial losses — included in 2 – 10 above(?): $1 trillion  Total points 1 – 11 (Total losses from bursting of housing and credit bubbles): $5.75 trillion   Remember, the $5.75 trillion total does not include any estimates for losses related to points 3, 5, 9, and 10, so the final total losses would be significantly greater (maybe $7 or $8 trillion?).  I wonder how this amount of loss compares with previous recessions and/or financial events. Any thoughts?   

London BankerFebruary 6th, 2008 at 12:57 pm

@ Gloomy  I absolutely agree that America can make itself great again if it flushes out the sewage and starts fresh with optimism, enthusiasm and enterprise. I also agree that the Declaration of Independence and the Constitution are a fabulous basis for government. The clean-ups after Watergate and the Iran/Contra scandal are excellent examples of half-hearted but somewhat effective attempts to rein in executive excess and lawlessness.   What has been so worrying the past eight years has been the ease with which the founding documents and principles of America have been abandoned – by its leaders and by its people. Bush got away with torture, extrajudicial arrest and imprisonment, denying due process, imposing “emergency” measures without review or accountability, ignoring laws with “signing statements”, lies, frauds worth billions in defense procurement and homeland security contracts, spying on the citizens without warrant, and much more that we will likely never know about. And he got away with it loyally defended by Congress, the courts, the media and many Americans.  By all means, use the opportunity of the coming crisis to take America back to its roots and its founding principles. Do it with optimism, enthusiasm and enterprise! The rest of the world will be relieved and grateful.

GuestFebruary 6th, 2008 at 1:05 pm

 @Medic “If you are a hospital employee (ER, hospitalist) you and your institution may be in trouble. If universal health becomes the way forward (long overdue if I may add) then regional facilities will likely become the goal. Small institutions will be taken over as they will not have enough resources to survive (as is already happening).   All your points are well received. However, in America’s present quasi-socialist state — where the middle class pays but doesn’t receive – universal health along these lines could be the very straw that breaks the camel’s back.  Already major hospitals have closed along America’s borders because of the load of welfare care. Already, senior citizens, who have paid their way, are cutting pills in half, going to reverse mortgages, to bankruptcy, to zero inheritance for their children, in part because of medical debt. Already, many workers cannot afford health insurance.  My question is, Who’s going to pay? And with what? America has a massive welfare class: her baby boomers are retiring. Lopsided “universal” healthcare may just be the final inbalance on the Kokopelli Wheel that sends this wreck over the clliff.   A Blog exchange on January 7 illuminates America’s problem, IIMO.   Europ@ Weekend Euro – Guest “… daily life in Continental Western Europe is much better and sweeter, precisely thanks to the strong social welfare and worker protection systems…And there are endless benefits from the fact that there is essentially no poverty, everyone has health care, nearly everyone can have a beer at the corner café, and one isn’t worried about one’s neighbours undergoing massive devastation as is the case inside the USA…. Most people accept that there is a trade-off in this kind of managed capitalism, we have less opportunity and economic mobility, but daily life is sweeter and richer in the small ways that count…”    In the United States today, “big money” interests operate our social welfare system and are its primary beneficiaries.   And unlike in Europe, those who pay for the system receive the worst aspects of both socialism and capitalism. Big Lobby and Congress restrict competition to a few monopolies, remove the good aspects of socialism that allow all to share its benefits, pass the exorbitant costs on to the middle class with few benefits, and use welfare perks as political footballs to gain votes by transferring wealth from Peter to Paul. 

GloomyFebruary 6th, 2008 at 1:07 pm

@London Banker Thanks for understanding. Unfortunately, sometimes a disaster is the only way to wake a people up and make them see the error of their ways. 

SkipperFebruary 6th, 2008 at 1:08 pm

The Rules of the Game.  After following Nouriel’s strategic analysis for the last two years, my judgment is that he has been consistently correct in his overall assessment of the scope and magnitude of the macroeconomic problems he has addressed. We are in the midst of a major long-term inflection point which virtually every other economist has missed and which they still do not recognize.   Although the debate over terminology has its value, there really seems to be very little doubt that we headed for an environment somewhere between what has happened in Japan since the early 1990s and what happened worldwide beginning in the 1930s and lasting for a generation. If you understand why Japanese housewives are content to leave their savings in government insured accounts at 0% interest, you begin to see how an asset-appreciation economy can become unhinged. If you can understand why Americans literally hid their gold and paper money in their mattresses during the Great Depression, you begin to see how a credit economy can be broken by the destruction of trust.  The rules of the game are changing. Those who do not escape now will find themselves rounded up and sentenced to a Bataan death march towards impoverishment. 

AlessandroFebruary 6th, 2008 at 1:10 pm

@KJ Foehr  I read that in the Japan financial crisis losses have been estimated to be $1 trilion, I’ll look up the source.

AnonymousFebruary 6th, 2008 at 1:17 pm

@London Banker  I have followed this blog for some time. You seem to have a depth and breadth of understanding of global markets, particularly US markets.  It caught my attention once when you offered a serious solution to assist in the orderly unwinding of debt. Instead of just commenting or forecasting.  I challenge you and others of your caliber to undertake a great endeavor. Like the fine minds and philosophers whose works coalesced in the formulations of the political founders of the USA, you might start to conceive of a system whereby men could engage in the exchange of goods and services that might foster longer, less volatile growth…without the deep downturns. Impossible maybe.   Could you, either in full or niche, help design a better system of allocating credit, regulating the animal spirits, and better managing the whipsaw of free market economics?   Eventually all such intellectual contributions could be strung together to develop an archipelago framework for a much healthier means of sustaining man’s material needs.  Of course, those invested in the present system would be very threatened. They may realize too, though, the need for some revolutionary thought and action.

tutterfrutFebruary 6th, 2008 at 1:24 pm

ECB WATCH: Record ABS Use In Repos As Banks Stay On ECB Drip Dow Jones February 06, 2008: 12:16 PM EST  FRANKFURT -(Dow Jones)- European banks have pledged a record amount of asset- backed securities to the European Central Bank as collateral in return for temporary funds, indicating that banks remain heavily reliant on the ECB for liquidity.  A total of several hundred billion euros worth of ABS – notes backed by repayments on other debt such as mortgages or credit card loans – have been deposited with national central banks in the euro zone to use in the ECB’s liquidity-providing repurchase operations, senior bankers said. ”Everybody is doing it,” a Frankfurt-based banker said, estimating that banks have deposited up to EUR500 billion of ABS with the ECB. http://money.cnn.com/news/newsfeeds/articles/djf500/200802061216DOWJONESDJONLINE000631_FORTUNE5.htm  Queuing with bad paper at the ECB(Exchange Crap Bank)

KJ FoehrFebruary 6th, 2008 at 1:38 pm

This is a good video interview with TJ Marta of RBC Capital on the credit market crisis. He sounds about as worried as Dr. Roubini.   Perhaps his most interesting comment is that if the US government needs to bail out the monoline insurers and probably other financial institutions, as he expects, then the government’s credit rating may be reduced as a result!  http://www.bloomberg.com/avp/avp.htm?clipSRC=mms://media2.bloomberg.com/cache/v6A3ROrCPZNk.asf 

Octavio RichettaFebruary 6th, 2008 at 1:49 pm

Written by tutterfrut on 2008-02-06 13:24:25  From the link:   ”We believe a large portion of ABS issuance (as defined above by Moody’s) – maybe more than 50% – has gone to the ECB for repo since September,” said Benedicte Pfister, a managing director at Moody’s responsible for ABS in Europe, the Middle East and Africa. Total residential mortgage-backed issuance in 2007 was EUR383.6 billion, Moody’s said.  The growing use of ABS as collateral in ECB repos isn’t too alarming, as long as the underlying assets maintain their credit ratings and remain repo-eligible, bankers said. A drop in the credit quality could prompt the ECB to apply a greater valuation haircut, meaning that it would subtract a greater percentage from the asset’s market value to reflect the higher risk associated with the paper. The ECB applies a haircut of up to 12% of the ABS’s market value, depending on the type of the collateral and its maturity date, although in most cases the haircut lies under 5%, bankers said.  It is obvious that the ECB, as well as the FED, are looking the other way when it comes to valuation of the collateral. That is the only way they can keep the banks operational. Otherwise many won’t be meeting reserve requirements/be broke already.   This has been done before. In the 1980s, when banks lost fortunes in third world loans (here is a link but I just read about this in the hard copy of Kuttner’s latest book):  http://www.viewfromsiliconvalley.com/id362.html  When big banks lost many tens of billions on third world loans in the 1980s, the Fed and the Treasury collaborated on workouts, and desisted from requiring that the loans be marked to market, lest several money center banks be declared insolvent. When Citibank was under water in 1990, the president of the Federal Reserve Bank of New York personally undertook a secret mission to Riyadh to persuade a Saudi prince to pump in billions in capital and to agree to be a passive investor

kilgoresFebruary 6th, 2008 at 2:08 pm

@ Guest on 2008-02-06 10:51:21  >This is meant to correct and clarify. The vast majority of consumer chapter 7 cases do not involve liquidation of anything, and are not properly characterized as dissolution. Furthermore, chapter 13 discharges are routinely granted upon plan completion, except in specifically limited instances. So, with respect, Kilgores, the statement about the taint in chapter 13 without the discharge is simply not factually accurate–though it was obviously well intended.  ___  You are absolutely right. Thank you for your clarification. My characterization was entirely too sloppy. When I wrote the word ‘dissolution’ with reference to Chapter 7, I meant to say ‘discharge,’ and when I wrote ‘no discharge’ with respect to Chapter 13, I meant to write ‘no discharge without such repayment.’ My only excuse is that I was exhausted when I drafted that post and could barely keep my eyes open. My main objective at the time was to recommend that Sophie secure the assistance of competent bankrupcty counsel. I’m glad you had the same advice for her.  SWK

London BankerFebruary 6th, 2008 at 2:15 pm

@ Anonymous on 2008-02-06 13:17:54  I have one or two projects in hand which aim to mitigate some of the ill effects of the current crisis.  Good regulation and good financial systems recognise the failings and weaknesses of human nature and build in safeguards to defend institutions and society against excesses. I have in the past worked to strengthen these safeguards, and now that there is an opportunity, I may try again.  I pledge to use my humble powers for good, not evil. ;-)

Octavio RichettaFebruary 6th, 2008 at 2:21 pm

Written by KJ Foehr on 2008-02-06 13:38:40  Great video! IMO, a must see! I am sure this guy reads the blog.

SeanFebruary 6th, 2008 at 2:30 pm

Prof Roubini or London Banker,   Is there any LAW that states Federal Reserve cannot lower the FED Fund Rate to BELOW 0%??    I read that Bernanke committed to Senator Dodd that he will do EVERYTHING in FED power to avoid economy recession. That just spark this wild idea of Below 0% interest rates.    For example, during Deflation, politicians can argue 0% interest rate is tooo high, and may embrace -1% rate commensurate with deflation.    Or maybe -1% rate is effectively the same as Giving Money away for free, and will lead to foreigners abondoning treasury bonds??   For those critics, do not laugh. In Hong Kong back in 1996/1997, I read that the economy was soooo good and liquidity was flowing sooo much that the banks actually charged customers who deposited, and deposit interest rate is 0%!! So essentially you got to pay to deposit into banks, and guess what, where else can you put your “electronics” money in todays electronics world?? Would you endure the hassle and risk to take out say $10K cash/month to put under your mattress/carry along all days/move into bank deposit box (but for how long before its full)???

Rich HFebruary 6th, 2008 at 2:37 pm

@ London Banker on 2008-02-06 14:15:43  Dr. Bankenstien  It’s about time you old windbag! Now get back down to that dungeon and insert that brain in this monster!  Your’s truly, Ricardo CorezonHombre  p.s. “stock are going green”  

London BankerFebruary 6th, 2008 at 2:50 pm

For those of you wondering, Rich H is playing Igor to my Dr Bankenstein.   And yes, I really should be heading back down to the laboratory. I believe I may have left a beaker boiling on the bunsen burner . . .

Octavio RichettaFebruary 6th, 2008 at 2:54 pm

Written by Sean on 2008-02-06 14:30:57  nominal interest rates are the ones you see. Real interest rates are nominal rates minus inflation.  real FF rate is negative already if you use the CPI for 2007 of 3.8% which is a good indicator of short term inflation.  But people may argue that the expected inflation is close to 2% by looking at the yield difference between Straight treasury notes and Inflation protected notes.   http://www.bloomberg.com/markets/rates/index.html  So for example the average inflation rate expected from looking at 5 year notes is 2.65-0.56=2.09%  So if you use this figure FF rate is still +1% real. But I see a problem with this calculation as it subtracts a five year average expected inflation from a short term rate.  On the subject of NOMINAL NEGATIVE rates read this:  http://www.nber.org/~bassetto/research/negrates/negrates.pdf  Negative nominal rates are not possible under equilibrium conditions. Bottom line, it is safe to say you can forget about negative nominal interest rates.  But keep your eye on real rates.   My belief is that in the long term the implicit inflation rate derived from TIPS is right. But short term, inflation will be above 3% and if short term are under 3% one can safely say short term rates are already negative.

AnonymousFebruary 6th, 2008 at 3:42 pm

Warburg Pincus Agress to Buy Up to $750 Million In Stock in Bond Insurer MBIA   The start of the “big” fix

Octavio RichettaFebruary 6th, 2008 at 4:26 pm

Written by Anonymous on 2008-02-06 15:42:44   Tuesday, Feb. 5 2008  Fitch Places MBIA’s ‘AAA’ IFS Rating on Watch Negative (IFS= Insurer Financial Strength)  http://www.foxbusiness.com/markets/industries/finance/article/fitch-places-mbias-aaa-ifs-rating-watch-negative_466479_9.html  MBIA has already raised $1.5 billion of new capital through surplus notes and a direct equity investment from Warburg Pincus, with an additional $500 million equity investment through a rights offering backstopped by Warburg Pincus to close by the end of the first quarter of 2008. Fitch currently believes that these additions to capital may not be sufficient to address the necessary capital needed to maintain MBIA’s ‘AAA’ IFS rating. Fitch will update the Rating Watch Negative status on MBIA and its competitors as its conclusions are reached. 

GirafFebruary 6th, 2008 at 5:09 pm

@OR re T.I.P.S.  Hi OR, I’ve been doing some work on the inflation forecasting skills of the 5 year Treasury minus 5 year TIPS spread. It is quite disappointing. Using daily Fed closing yield data dating back to the end of 2003, the forecast inflation rate has averaged  2.27%. The low was 1.91% in January 2004 (almost matched by the 1.92% last January 23 after the tanking of the Dow, S&P and Nasdaq). The high was 2.94% in March 2005.  CPI has averaged 3.04%, using the average monthly year over year change. Minimum change was an increase of +1.5%, maximum was +4.7%.  I can send you a chart if you like. Send me an e-mail.

GuestFebruary 6th, 2008 at 5:15 pm

Written by Anonymous on 2008-02-06 15:42:44  ”Warburg Pincus Agress to Buy Up to $750 Million In Stock in Bond Insurer MBIA      The start of the “big” fix “    Good money after bad, a la BofA and CFC.

Octavio RichettaFebruary 6th, 2008 at 5:20 pm

Written by Giraf on 2008-02-06 17:09:40  I agree with you. If you buy TIPs, the government is stealing from you. A few years back, Bill Gross wrote a piece about how the government fakes inflation statistics. In addition to things like “rent equivalent” for home prices and more powerful computers having a deflationary effect, I loved this one:  Suppose the price of beef goes up and people start eating more chicken which is cheaper. Then the brains at the BLS lower the weight of beef in the index and increase that of chicken!

Octavio RichettaFebruary 6th, 2008 at 6:04 pm

What credit crunch?:-)  Berkshire’s Buffett Detects No Credit Crunch, Calls Money `Fairly Cheap’ Billionaire Warren Buffett, chairman of Berkshire Hathaway Inc., said a credit crunch isn’t under way and he forecast that the dollar’s value is likely to decline.   Buffett Sees No Credit Crunch, Forecasts Lower Dollar (Update3)   By Sean Pasternak and Doug Alexander  Feb. 6 (Bloomberg) — Billionaire Warren Buffett, chairman of Berkshire Hathaway Inc., said a credit crunch isn’t under way and he forecast that the dollar’s value is likely to decline.    http://www.bloomberg.com/apps/news?pid=20601103&sid=aG3Ye9xx6_tA&refer=news

GirafFebruary 6th, 2008 at 6:39 pm

Octavio Richetta on 2008-02-06 18:04:51  Buffett is right. If you have sound financials, there is no problem getting funding. Who else are the banks going to lend to? The banks have closed the gate after the horse has bolted in tightening lending standards. Probably too little too late. But they are in the business of lending money, the Fed is making it amply available to them and they are looking for top credits to lend it to. If that’s all they ever did, we’d never have the crises.  If you are up to your neck in debt and have no equity, sure the banks are going to turn you away. But money is EASY!

GuestFebruary 6th, 2008 at 6:51 pm

 @JMa: “I have a personal challenge now to convince my sister who just sold her home to wait at least 6 months and see where prices are before buying the next house…”  Perhaps this article would help?  The Housing Recession and the BuildingTrades: Unemployment, Misery, and the Fed by Mark R. Crovelli  http://www.lewrockwell.com/crovelli/crovelli11.htmlby   “This article aims to alert construction workers and business owners to the fact that the bursting of the housing bubble will likely devastate much of the building industry for a very long time to come. The article also offers an explanation as to how we got into this housing mess in the first place, and offers some advice about how construction workers and business owners can at least lessen their exposure to the impending devastation of the building trades.” It is in three parts: The Housing Recession Will Be Devastating, What Caused The Boom In The First Place?, and How to Minimize Your Risk During the Housing Recession.  Crovelli points out that: “A…shift in capital and labor will occur as workers leave cities that have heretofore been the epicenters of the housing boom, (but which are now suffering worst from the bursting of the housing bubble – e.g., San Diego, Las Vegas, and Miami) in search for work elsewhere. We are already seeing signs of this phenomenon in Denver, for example, with framers, roofers and masons from Las Vegas migrating East in the search for work as the housing bubble deflates faster and faster in Las Vegas and southern California.”  Here is Part II: What Caused The Boom In The First Place?  As was noted above, the idea that has been most responsible for the widespread complacency among business owners and construction workers with regard to the housing recession is that the whole housing crisis can be rectified through some action or another by the Fed. This idea is totally mistaken. The root of this mistaken idea lies in the failure of construction workers and business owners to grasp the root causes of the housing bubble in the first place. When the cause of the housing bubble is investigated, however, it becomes clear that the Fed itself was responsible for the creation of the bubble and it is now impotent to forestall a severe housing recession for long.  An example from my own construction experience is perhaps the best way to initially illustrate the Fed’s responsibility in creating the housing bubble. When I was a graduate student at San Diego State University a few years ago, I worked in a number of construction-related capacities in southern California at the peak of the housing boom. One of the most memorable jobs I undertook involved the remodeling of a horse barn for a doctor in the Temecula valley. This doctor had recently acquired a great deal of cash by means of a massive home equity loan, and he was willing to pay me and a good friend $17,000 of this newly acquired money to rebuild a part of his horse barn because he thought it a somewhat unsightly view from his swimming pool. (Interestingly, the good doctor did not, and still does not own horses). At the time, this sort of construction project was being repeated all over southern California, to the point where it would have been more profitable for me to remain a construction worker than it would have been to pursue a job with my graduate degree. Virtually all of the construction projects across southern California (and elsewhere), were financed with either gigantic home loans with ridiculously low interest rates, or, like the good doctor, with home equity loans with ridiculously low interest rates. What few people in southern California seemed to be asking either then or now, however, was where the banks got this massive amount of money to loan out in the first place? How, in other words, did the banks in southern California manage to miraculously come up with billions of dollars to loan out to homeowners who wanted to remodel their horse barns?  The answer is that the Federal Reserve under Greenspan the Magnificent created this money literally out of thin air. The Fed lowered interest rates through various devices (e.g., FOMC purchases of assets with money created out of thin air) to unbelievably low levels, and this action allowed the banks all across America to loan out massive amounts of newly created dollars. This new credit drove up price of real estate to stupendous levels, drove up the wages of construction workers to absurd levels, and dramatically increased the number of people working in the building industries. (It also, incidentally, spurred illegal immigration, as Mexican laborers found it profitable to risk crossing the border to earn artificially high wages from gringo jefes who couldn’t find enough workers to keep pace with the feverish demand for their building services.)  The result of this flood of mortgages and home equity loans was, as we now know, an unsustainable and staggering boom in the building industries. The ultimate responsibility for this unsustainable boom, moreover, was, as was just seen, the Fed and its reckless and unnecessary increase in the money supply which allowed banks to loan out massive amounts of new cash which was subsequently spent on construction. The boom was thus not an expression of increased consumer demand for homes and $40,000 roofs. On the contrary, the boom represented an artificial and destructive bubble that could have been and should have been avoided with sound money (i.e., gold) and 100% reserve banking.   It also should be clear, moreover, that in order to continue this massive boom in construction the Fed would have to continue to artificially increase the money supply in the credit markets. This the Fed could indeed accomplish (and the Fed is in fact moving in this direction with its series of recent interest rate cuts), but the effects of propping up the unsustainable boom would be more damaging than letting the housing recession simply run its course. This is true, in the first place, because if the Fed floods the economy with more and more paper money and credit, this will merely postpone the inevitable recession and massively increase price inflation. Moreover (as I’ve written before), this price inflation will eventually make its way into the credit markets anyway, as banks tack on inflation premiums to their loans to deal with rising inflation. These inflation premiums will reduce the amount of credit available on their own (since businesses and homeowners will have to pay much higher rates of interest), because higher interest rates will, ceteris paribus, reduce demand for credit. In the second place, were the Fed to continue to inflate the housing bubble, this would temporarily induce even more people to move into the building industries, when, as was also seen above, a major part of the problem with the building industries is that there are already too many people working in construction.    

GuestFebruary 6th, 2008 at 7:53 pm

The pundits claim that the markets reversed direction and closed lower today because Plosser mentioned inflation worries in his talk. There is something ironic in there, since, if NR is right (and I tend to believe him), inflation will be the least of our worries, and the markets will go down a lot further!  –iww

GuestFebruary 6th, 2008 at 8:02 pm

 @Medic  The article you recommend by Demos (the New York-based public policy research and advocacy organization) in The New England Journal of Medicine eloquently states America’s problems with her health care system. It verifies my grave concerns regarding “the extreme failure of the US to contain medical costs”: i.e. Medicare costs up a record 18.7% in 2006 and health care spending now at 16% of GDP, projected to 20% in 7 years. And care deteriorating.  But until DC’s present one-party political system is cleared out of Washington — and I see no hope with the present Congress and the inferior quality of the Big Lobby contenders for “president” – then I fear implementation of Demos’ conclusion that “It remains to be seen how much exhaustion the health care system will suffer before we turn to national health insurance.”  With the middle class being squeezed by the Democrat mobs on one end and by fascist-style Republican power elitists on the other, the backbone of our country’s strength — the middle class — surely will be broken by a health care system contrived by such political predators.  We agree on the diagnosis. I just fear the political cure.  

Octavio RichettaFebruary 6th, 2008 at 8:19 pm

Written by Giraf on 2008-02-06 18:39:35  I agree. After I posted, the thought crossed my mind that Buffet was just being sarcastic. If the deflation forecast turns out to be wrong, this would be a great opportunity to go into “productive” debt if you have good credit. No wonder Microsoft will issue some debt for the first time ever…

Octavio RichettaFebruary 6th, 2008 at 8:27 pm

This is getting more and more complicated….   http://online.wsj.com/article/SB120225852189145889.html?mod=todays_us_marketplaceq  Speculators May Have Accelerated Housing Downturn Rising Number of Defaults  Also Could Complicate  Effort to Help Homeowners By RUTH SIMON and MICHAEL CORKERY February 6, 2008; Page B8  As lenders pore over their defaulted mortgages, they are learning that the number of people who bought homes as investments is much greater than previously believed.  Such borrowers turn up frequently in analyses of loans that defaulted within months after origination. In many cases, these speculators lied on loan applications, saying they intended to live in the homes in order to obtain more favorable loan terms or failed to provide the requested information.  Roughly 20% of mortgage fraud involved “occupancy fraud,” or borrowers falsely claiming they intended to live in a property, according to an analysis by BasePoint Analytics, a provider of fraud-detection solutions in Carlsbad, Calif. Another study, by Fitch Ratings, looked at 45 subprime loans that defaulted within the first 12 months even though the borrowers had good credit scores. In two-thirds of the cases, borrowers said they intended to live in the property but never moved in. ….  Now, you tell me which model is going to take care of this one…

GuestFebruary 6th, 2008 at 8:44 pm

 It’s in the Charts:  http://suddendebt.blogspot.com/  “The Borrow-Spend-Grow economic model was never in the best of health, to begin with; the charts now officially proclaim it clinically dead. It is time for the attending physicians and the relatives to realize that they won’t revive their patient by increasing the dose of the same medicine. Better to pull the plug and focus on the “maternity ward”, instead. That’s where the new economy will come from.” 

JLCFebruary 7th, 2008 at 1:15 am

@ Written by Octavio Richetta on 2008-02-06 20:27:03  As someone in the housing industry, I can attest that speculators falsely claimed they were going to use the home as a residence quite regularly. It was one of those wink and nod kind of situations, where everybody knows they are lying but nobody cares. Some mortgage brokers even advised, “You intend to live in it when you sign the loan papers, but ‘circumstances’ may ‘change’ after closing” (wink wink smile). Solicitation of fraud.  Yes, the models failed to account for the rampant fraud in the system. Nobody had any skin in the game except some nameless, faceless investors at the distant end of the pipeline. The incentives to abuse the system were too great for most to resist.

AlessandroFebruary 7th, 2008 at 3:28 am

JLC: “Nobody had any skin in the game except some nameless, faceless investors at the distant end of the pipeline.”  The essence of the housing bubble. Nicely worded.

Octavio RichettaFebruary 7th, 2008 at 7:49 am

Equities looking pretty bad in Europe http://finance.yahoo.com/intlindices?e=europe   January retail sales are lousy: http://online.wsj.com/article/SB120238618499550605.html?mod=googlenews_wsj   Futures look terrible: http://money.cnn.com/data/premarket/  Recession worries flare on Wall Street Weak sales from Wal-Mart, cautious outlook from Cisco sends futures lower. http://money.cnn.com/2008/02/07/markets/stockswatch_ny/index.htm  Are you ready Benny? 

London BankerFebruary 7th, 2008 at 9:00 am

The Bank of England dropped 25bps and the ECB held firm.   The Fed looks increasingly incontinent and irresponsible about both inflation and the dollar. I don’t care how scared they are, they aren’t helping when they keep cutting rates. Confidence is lost rather than gained, and credit will be harder to get as foreign creditors flee US risk.

JMaFebruary 7th, 2008 at 9:27 am

“Speculators May Have Accelerated Housing Downturn” May Have ? Really ! No way ! A bubble economy breeds speculators such as these. Who was going to stop the speculation ? the banker paid on commission ? the realtor paid on commission ? The buyer of his 7th or 8th house whose first purchase had unnaturally doubled in price in a few years ? The speculators who rode the house wave like the tech stocks in the 90s AND also got out are heroes in a bubble economy – just like the gold rush in the Wild West. In defense of Toll, he at least gave lip service regarding attempting to be sure the demand was from people actually buying the homes to live in them. However, I am sure the commissioned sales reps really were not exactly concerned whether people lived in a year or not.  Uh oh, the music stopped again and now the bubble economy gets to implode again after another multi-year easy money bender. The Fed is a day trader, an easy money drug dealer and perhaps even a rogue trader at this point.  The kiddees will eat candy until Mommy and Daddy stop them. However, Mommy and Daddy, in other words the Fed likes to give the kiddees more than they can eat over and over again even though the kiddees and in this case the financial system as a whole continue to throw up, vomit and now I suppose you may even say soil themselves over and over again…

GirafFebruary 7th, 2008 at 9:31 am

@LB  Re your recent comment on the US$, how do you account for the strength in the last couple of days? The ECB stood pat and U.S. FF futures are calling for that rate to decline to close to 2%. I read earlier in the week that a couple of “leading FX forecasters” have turned bullish on the $, on the basis, I understood, that the reluctance of the ECB to lower rates will lead to a weaker economy versus what they see as an improving economy in the U.S.   I’d been thinking for some time that the dramatically improving U.S. trade position (apart from occassional negative blips due to oil) would lead to a firmer dollar. However, the recent slashing, and impending further slashing, of ST rates removed some of the underpinnings. Surely a weaker EU economy will lower the potential for U.S. exports, as will a weaker global economy.  Your thoughts?

GuestFebruary 7th, 2008 at 9:45 am

To European Readers  It is worth remembering that a very large amount of money is now sitting on the sidelines in America (in T-bills). That money will eventually need to find a home – it will be re-invested somewhere in the world.   Obviously, the Fed hopes that this money will be re-invested in the domestic US economy. But as Mr Trichet and his counterparts set a firm tone to banking policy, they are also making a strong statement about which banks will be trusted in the future. Therefore, you may well see a migration of wealth from the USA into the European banking system (and equities) over  the long term. It is much too early, in my opinion, to simply say that “decoupling has failed”.   PeteCA

London BankerFebruary 7th, 2008 at 9:53 am

@ Giraf  I always get currencies wrong short term, so don’t pay too much attention to what I say. The dollar has been surprisingly strong, but I’ve attributed this to Wall Street selling off in foreign markets and bringing the money home to prop up US markets. US exports aren’t that exciting, being mostly airplanes and weapons, and probably rigged a bit with friendly allies in the Middle East. US imports have fallen a bit with the collapse of the construction industry as a lot less commodity imports are needed and retail is now collapsing too.   If the dollar does strengthen, it will probably coincide with a sustained fall in the price of oil – which would give a big boost to the US trade balance. This will likely be rigged from the summer, as it was in the last presidential election year. Look at the oil charts for 2004 and you’ll see what I mean. Sharp decline on cue in July and hiked right back up the week after the election.  Foreigners know this election year game and see through it. They aren’t going to invest long term in US investments on the basis of election year window dressing, although they might come to the party over the summer and fall and leave with what they can carry.  Europe is stronger than you suggest. The EU was able to grow its exports to ALL global markets with a strengthening euro for the past 6 years. That’s real strength. It isn’t going to go away any time soon.

GuestFebruary 7th, 2008 at 10:10 am

 Peter Schiff on February 1:  A common definition of insanity is the act of repeating the same activity while expecting a different result. Bernanke is now repeating the same mistakes made by Greenspan, yet he and almost everyone on Wall Street expect a different result. The stock market bubble of the 1990s resulted from interest rates being too low, which sent false signals to businesses, causing them to over-invest in information technology, telecom, and dot coms. When that bubble burst, rather than allowing the corrective recession to run its course, the Fed responded by slashing interest rates. The result was an even larger bubble in real estate; causing consumers too borrow far too much money to buy houses and other goodies.  Now that the housing bubble has burst, the Fed is once again slashing interest rates to postpone the pain. However, in order to correct for years of extravagant borrowing and spending, the country is in desperate need of a period of saving and economizing. But by rewarding debtors and punishing savers, lower interest rates actually encourage the opposite behavior. Given how much harm this strategy has already done in the past why should we assume it will work any better now?…  Ironically of course, by blowing up both the stock market bubble in the 1990s and the real estate bubble that followed, Greenspan actually repeated the same mistakes that previous Fed chairmen Benjamin Strong and William McChensey Martin made in the 1920s and the 1960s respectively. It seems sanity is a major disqualification for central bankers. 

GuestFebruary 7th, 2008 at 10:29 am

   The only function of economic forecasting is to make astrology look respectable.” – John Kenneth Galbraith

GuestFebruary 7th, 2008 at 10:46 am

 Exploding ARMs Roil Bernanke’s Drive to Calm Markets (Update2) By Bob Ivry and Jody Shenn  http://www.bloomberg.com/apps/news?pid=20601109&sid=aFCgFMs3dlSk&refer=home  Feb. 7 (Bloomberg) — Joe Ripplinger took out a $184,000 mortgage in 2006 and makes his payments every month.  Now he owes $192,000.   The 66-year-old Minneapolis house painter has a payment- option adjustable-rate mortgage. It allows him to write a check for $565 a month even though he owes $1,300. The difference is added to the mortgage, and when his total debt reaches $212,000, or after five years have passed, he said his monthly minimum could jump to about $2,800, which he can’t afford.   “We’re barely making it right now,” Ripplinger said.   The estimated 1 million homeowners with $500 billion of option ARMs are beyond the help of interest-rate cuts by Federal Reserve Chairman Ben S. Bernanke. While subprime borrowers face an average increase of 8 percent or less when their adjustable-rate mortgages reset, option ARM homeowners may see their monthly payments double after their adjustments kick in.   “We call them neutron loans because they’re like a neutron bomb,” said Brock Davis, a broker with U.S. Express Mortgage Corp. in Las Vegas. “Three years later the house is still there and the people are gone.”… 

GuestFebruary 7th, 2008 at 10:55 am

 According to 11:00 ET BRIEFING.COM: …U.S. Treasury Secretary Paulson has reiterated that he does not believe the U.S. economy is in recession, according to Reuters.  Isn’t this like the fox coming out of the hen house, closing the door, and telling us the chickens are all okay? 

AnonymousFebruary 7th, 2008 at 11:04 am

@ Guest on 2008-02-07 10:55:21:  No – it is more like the fox coming out of the hen house, closing the door, blood dripping from his jaws – and telling us the chickens are all okay?  (!)  

GuestFebruary 7th, 2008 at 11:23 am

@ Guest on 2008-02-07 10:55:21: and 2008-02-07 11:04:01   No – it is more like the fox coming out of the hen house, closing the door, blood dripping from his jaws – and telling us the chickens are all okay?    (!)   And: if you believe my pretty words, you won’t change your hen house, and me and my friends can keep coming back to have a fine time with your precious chickens. Don’t change anything, my dear friends, things went so good, are going so good, and will be so fine as long as you believe us. Better even, if you leave us in charge, I’ll promise you to spend 150000000000 of your dollars to put more of those delicious chickens in your hen houses.       

GuestFebruary 7th, 2008 at 11:39 am

 A Who from SuddenDebt  I saw this plea for help in Hellasious’ comment section, posted February 7 under “The Fear Factor 2”:  https://www.blogger.com/comment.g?blogID=4102429195693595750&postID=441718148086696540  alexcanuck said… Hello…hello?.. LondonBanker? Giraf? PeteCA? Anyone? Where’d you all go? RGE is inaccessible (to me at least). I miss you. Drop a link or hint. I’m unable to access comments and full entry over on the Professor’s blog. Anyone else with this problem? Site shows me logged in. I don’t post too often, but sure do listen hard. I certainly respect and read Hellasious , but find the comment thread is (rightfully) more on topic. Usually that’s a good thing, but the comments on the Professor’s blog has a life of its own. I think the ongoing discussion there is unique and greatly appreciated! Lot of good info, few trolls, real insights, no paid shills. If not there then where…   Send that boy a brandy barrel, fellows. Signed: St. Bernard  

GuestFebruary 7th, 2008 at 1:16 pm

“Isn’t this like the fox coming out of the hen house, closing the door, and telling us the chickens are all okay?  ”  Maybe Paulsen is a ground hog, coming out of his hole and seeing his shadow. Six more weeks of a robust economy!

tutterfrutFebruary 7th, 2008 at 2:09 pm

Insight: Western banks face SWF backlash  By Gillian Tett  Published: February 7 2008 19:21 | Last updated: February 7 2008 19:21  Earlier this week, I chatted with a jet-lagged senior US financier. Like many of his ilk, he is flitting around the Middle East and Asia trying to extract finance from sovereign wealth funds and other investment groups.  His latest travels have delivered a surprise: some funds are quietly getting cold feet about the idea of putting more capital directly into western banks, he says.  “There is a backlash building,” he muttered into a crackling cell phone.  This is striking stuff. In recent months, many equity investors have taken comfort from the idea that sovereign wealth funds could ride to the rescue of Wall Street, if not the City of London too.   http://www.ft.com/cms/s/7bfc8ee8-d5b1-11dc-8b56-0000779fd2ac.htm

GloomyFebruary 7th, 2008 at 2:32 pm

Only a black swan could prevent catastrophe. How can I possibly resist selling all the rest of my treasuries and buying short positions?

RedCreekFebruary 7th, 2008 at 2:33 pm

@ Tutterfrut re Insight: Western banks face SWF backlash   As was to be expected. SWFs, with all respect, are not the most sophisicated investors which is another reason why Wall street was successful with them (until now). And these SWFs noticed that Prince Al Waleed injected extra capital in Citi so they followed him and injected capital in arrogant&dysfuntional Merrill and others. They forgot to notice that Prince Al Waleed injected preferred equity/PIK/convertible debt, which means that he will control all of Citi if it goes bankrupt… 

tutterfrutFebruary 7th, 2008 at 2:42 pm

@RedCreek  I think Al Waleed indeed made a safe my ass(ets) first injection, rather than a investment…

JMaFebruary 7th, 2008 at 2:50 pm

@Gloomy – you may want to at least consider a balanced position. Look at 2000-2003 charts and all of the bear market rallies in between sell-offs. An equivalent rally to April and May of 2001′s rally would take the DOW to 13,500 or even higher from here before the next absolute pummeling took place. Assign probabilities to each scenario and allocate accordingly. Just a thought from an amateur.

RedCreekFebruary 7th, 2008 at 2:53 pm

@ Tutterfrut  I believe that quite a few “save my ass(ets)” investments have been made recently (Warburg Pincus, BofA,…). Unfortunately for them, they apparently were not reading the blog of our Hero Nouriel Roubini… 

RedCreekFebruary 7th, 2008 at 2:56 pm

By the way, Nouri, I am an NYU Stern MBA grad but unfortunately graduated before you arrived there.  U da man, maaaan!

GloomyFebruary 7th, 2008 at 2:57 pm

Will no one try to stop me. Otherwise I’ll cash in my treasuries, take a second mortgage on my home (if I can find a bank still willing to lend, a challenge I admit), cash in my pension, borrow from parents and in laws. I will put it all in XLF puts. PLEASE someone tell me how this stinking, fetid, rotten mess can possibly not go to hell in a handbasket in the next few months!  Desperately,  Gloomy

GloomyFebruary 7th, 2008 at 3:04 pm

@JMa So what could cause a rally before a crash? We had massive rate cuts and government handout plans all with no effect. I know black swans are possible, but other than a one in a million shot what could cause a significant powerful rally?

RedCreekFebruary 7th, 2008 at 3:06 pm

@ Gloomy  Agraid you will smarter people than me advising you, but if this is of any help to you – I am looking for ways to short the US economy too. I am currently working in NY in private equity banking and even living literally ON Wall Street (cheaper than you think by the way) but looking for a job in London or Hong Kong.

RedCreekFebruary 7th, 2008 at 3:09 pm

[sincere apologies; correcting spelling mistakes - i need fresh air]  @ Gloomy    Afraid you will need smarter people than me advising you, but if this is of any help to you – I am looking for ways to short the US economy too. I am currently working in NY in private equity banking and even living literally ON Wall Street (cheaper than you think by the way) but looking for a job in London or Hong Kong.

AlessandroFebruary 7th, 2008 at 3:14 pm

@Gloomy  think counterparty risk.  In the worst case scenario suggested in the NR post the put seller may not be able to fulfill its obligation. This is already happening with MBI and ABK, so it is not such an extreme event as it seems.

JMaFebruary 7th, 2008 at 3:17 pm

@Gloomy, i hear you loud and clear it seems the 52nd, 53rd and 54th cards have been played from the Fed / Treasury deck at this point and i personally can not imagine yet another rate cut right now. having said that, whatever it may be who knows what, there were so many remarkable rallies from 2000-2003 almost all the way back to the highs prior to selling off to the new lows. my very amateur position now is about 30% cash, 30% long at the money calls and 40% long out of the money puts. in other words, a higher probability IMHO view of a rally from here, but if we do crash or even sell-off there is a higher put count. personally, i would prefer a rally to 13,500, the vix much cheaper, MSM singing a new song and a pending rate cut to take us even higher before i would assign a much higher weighting to shorting or buying puts – that is my humble take at the moment which is updated all day long every darn day in this casino of a market.

JMaFebruary 7th, 2008 at 3:28 pm

“30-Year Treasuries Fall Most Since 2004 After $9 Billion Sale” i have only been wondering and waiting for this for over one and a half years… i mean the dollar index declines from 120 to 75 or almost 40% since 2001 ish and people are interested in US dollar denominated debt the whole time, but now all of a sudden someone has finally said gee wait a minute. i don’t understand nor do i understand the loyalty to us equities during the 40% dollar pummeling over the past 6 or 7 years.   i think someone just spotted workers installing padding on Ben Bernanke’s office walls to soften the blows when he starts running himself into the walls of his office everyday for taking the job…  separately – SWSF = Sovereign Wealth Sucker Funds  

GloomyFebruary 7th, 2008 at 3:44 pm

Thanks for your thoughts. Part of my plea was based in reality (I am buying more puts), but partly this is an intellectual excercise to try to see if anyone thinks there is anything even remotely on the horizon which could derail a collapse of finacial institutions SOON. The monoline rescue looks more and more unlikely every day and is on the short horizon. Can Bernanke really keep increasing funding through his backdoor operation? It seems to me that once he starts doing more than 100 billion at a pop with no real collateral(soon), lots of eyebrows are going to start being raised in Congress and elsewhere. Given everything outlined by Dr. R above, little of which has been accounted for yet, the implosion point seems near to me. Do others also have the feeling that we are talking weeks now until armageddon?

AlessandroFebruary 7th, 2008 at 3:46 pm

@Gloomy  and JMa is correct. This market is a shiny casino full of professional cheaters, including the croupier. Even hedge funds are getting slaughtered like fat pigs.

MedicFebruary 7th, 2008 at 3:51 pm

@ Gloomy:  My fellow medical friend – what is it you are seeking? Are you trying to make money on this rigged disaster that will continue to be unpredictable until it finally crashes, or are you trying to preserve wealth?  As a medical professional, my advice is that you are not in good shape trying to make money here – think about it like this: right now investing for gains is like having elective surgery when you are obese, smoke 3 packs a day and are diabetic. Why do it if you don’t have to?  If, however, wealth preservation is the goal, then spread what you have around in various assests such as CD’s (in FDIC insured banks), some gold / silver and even some European bonds. Think lower risk until the patient loses weight, gets their diabetes under control and stops smoking.  

JMaFebruary 7th, 2008 at 4:28 pm

it looks like they passed the Stimulus Package, I mean the Destabilizing Package or the Trade Imbalance Package that will add to the budget deficit and trade deficits with one stroke of the pen. here you go debt strapped consumer junkies, take one more hit off of the government’s debt-driven-consumption crack pipe and enjoy one of your last highs on us while buying shit at Walmart from the Chinese that YOU DO NOT NEED ! if you are going to shoot from the hip like this, could they not at least send each taxpayer a form with 5 options for which a payment could be made automatically: you know credit card payment or mortgage payment or gift cards ? NONE of these options would have been for WALMART ! BTW – so far the futures do not really care about this news… 

Hood then CrusoeFebruary 7th, 2008 at 4:43 pm

Yes, we are going to have a big breakout imminently.   I worry however that upon a truly drastic break, market suspensions, complete closures, and perhaps nationalization of all the trading assets may be likely.  Remember we are at the tipping point of a whole new set of rules here.  Foreign markets are great until they decide GAME OVER. In the event of a cataclysmic collapse–this may be the unthinkable, black swan, event.  Trying to collect gains from shorts, retrieve whatever left in equity longs after a PLUNGE may be impossible. Remember markets don’t have FDIC, they play nice only as long as such a nationalization isn’t in their greater interest. Maybe John Bogle was right, take all your money off the table, and put it where it is accessible.   Eventually gunpowder not stored near your person is the same as NO gunpowder. Remember the bank failures of the 30′s? Doors shut, sorry sucker, you just lost all your money.  Foreign croupiers may just do the same–don’t fail to consider worst case scenario.

RedCreekFebruary 7th, 2008 at 4:43 pm

The grapevine just told me that GS is positioning itself for a short squeeze in april-may. any thoughts?

GuestFebruary 7th, 2008 at 5:05 pm

 @Gloomy  Abelson’s take is not as delightful and medically apropos as Medic’s, but putting words into Abelson’s mouth I think he considers the market in for a long coast downward, not a slam dunk crash. NR already is braced for a hard economic landing with a systemic financial meltdown and may be on lookout for a black swan.   Abelson wrote in his Feb4 column (Barron’s):  “Indeed, as the estimable David Rosenberg of Merrill Lynch, who consistently comes up with some great stuff, points out, in the 2000-2002 bear market, there were no fewer than 16 rallies of at least 5% in the S&P, each lasting on average about a month, and no fewer than 35 bounces of 5% or more in the Nasdaq (which still managed to wind up losing nearly 80% of its value).  “The investment byword remains don’t buy the rally (rather, sell it). And stay defensive. This bear market is nowhere near over.”   Remember when Greenspan said in 2001 that he was going to try something no one had ever tried before? Well, as a popped try, the 2008 Economy Equation probably would read: 2007 Economy minus 6-Year $5T Housing Bubble equals 51% S&P 500 correction of 2000-2002 minus the fallout/disaster X factor.  

GloomyFebruary 7th, 2008 at 5:12 pm

“Half the time I am hyperconservative in the conduct of my own affairs; the other half I am hyperagressive. This may not seem exceptional except that my conservatism applies to what others may call risk taking , and my aggressiveness to areas where others recommend caution” -The Black Swan Read Roubini’s post above again and ask whether to be short the market over the next 6 months is risk taking or conservative behavior. Why is it considered OK to be agressive in the allocation of ones portfolio to stocks when they are undervalued and economic conditions are right, yet “too agressive” when one is short an overvalued market when economic conditions are catastrophic?

JPFebruary 7th, 2008 at 5:17 pm

@ Guest on 2008-02-07 10:10:52  Maybe I am crazy, but I think these rate cuts will help the economy. I agree that the spenders (spending >= earnings) will use it to take on more debt – if the lenders are willing to make the loans – which I don’t think is the case.   The savers (spending < earnings) are refinancing their first mortgages to free up some cash flow by lowering debt service. Some of that cash *should* make it into the economy.   Case in point: assuming another 50bp cut that sticks, my business will see a reduction of interest expense of over $16,000 in 2008. Not much, but more than the couple hundred bucks that the government is sending us. 

AnonymousFebruary 7th, 2008 at 5:47 pm

Another sign of an economy in trouble; and the ultimate ethics of US Businessmen  When times are good, and in order to sidestep burdensome US regulations, businesses stoop to hiring illegals with fraudulent paperwork. They pay below market rate wages, avoid steep insurance and workers comp, can ask employees to work longer, harder hours, and have less worry about collective bargaining or specific legal redress.   Also, when hard times hit, they simply call INS or ICE to run a raid on the business to clean out the illegals. These workers get a free trip home, the company parlays the hardship of layoffs into a governmentally oppressive action (no severance or unemployment), the government looks good to the anti- illegal immigration crowd, and NO labor stats reporting reductions in labor force.  Win, win for everyone in the downturn. Except for the workers who lost their jobs and had wages diluted by illegal employment, taxpayers who bear costs for repatriation & enforcement, and illegal families who have roots torn up and moved.  What a wonderful world.

MedicFebruary 7th, 2008 at 6:12 pm

@ Gloomy:  The issue is not that your theory of shorting over the next 6 months is not valid – it is. The question that arrises though is: How much do you think the markets are manipulated by those in power?  If you believe the markets can and are being manipulated (even to a small degree), then you must ask if you are able to predict where the inevitable peaks and troughs will be. Can you reasonably argue against the government, investment banks and the incredibly wealthy trying to bring this thing down at as slow a pace as possible (at least until next January)? The reality will not be what we see. We know better….but the timing of the official crash will be delayed as long as possible.  Again, my friend, if you don’t need to do it…..why risk it?

4822February 7th, 2008 at 6:23 pm

Chrysler to halve product lines:   http://online.wsj.com/article/SB120242637224352011.html?mod=googlenews_wsj  In December, Chief Executive Robert Nardelli told employees Chrysler was on track to lose about $1.6 billion last year, people familiar with the matter said.  In meetings with dealers last week and this week, Chrysler executives said they have accepted the “reality” that Chrysler can’t expect to increase its sales volume dramatically.  ”We are a 2.7 million vehicle a year company, not a four million a year company,” Vice Chairman Jim Press said, according to people who attended the meetings. 

YankeeFebruary 7th, 2008 at 6:28 pm

My last post was just eaten..  Gloomy, et al. All I can tell you is that I am uber conservative right now. Not the time to be playing in the mkts unless it is money you can afford to lose.   I cashed out my Citi/State St 401(K) in December. Who in their right mind would keep it THERE? Paid off my mortgage and have no debt. Have CASH, (not to be confused with money mkt or CDs) in a place where I can get to it even if my bank closes. I am not stupid. I too, have an MBA – in Finance – from a good school and I do not recognize the current market. I don’t WANT to know what synthetic CDOs are – they are a load of crap – THAT IS WHAT THEY ARE! Foisted on the unsuspecting, naive and lazy by white collar criminals who will skate when this implodes.  I recommend some CASH – like greenbacks. I will get back in the market when it is transparent and not a second before. I am 45 and hopefully have 20 years of working (I hope) and will make sure that I have accumulated what I need to be OK.  Get out of debt. Pay off your mortgage if you can (i.e. get out of the whole RE debacle and implosion – stay above it for the sake of your sanity. Make sure you have $ to live on or access to such because i posted before: try to take a sum of cash from an electronic blip to dollar bills. You are treated like a suspicious money-laundering leper. You should have a few thou on hand, imho.   Please don’t try to outsmart what is going on now. You can’t. The market is irrational and then also manipulated.  

GloomyFebruary 7th, 2008 at 6:35 pm

@Medic Yes, the market can be manipulated for a few days. But not for long periods of time (months), and not when the mountain of economic weight is so great (see Roubini above). The manipulators are just not strong enough. If you believe they are, then your should never buy another stock when conditions are favorable. Under your theory the market is always rigged against you. Do you ever buy stocks, my friend? Why bother? The truth is that we have all been brainwashed by talking heads against going short. There is some basis for this, as markets generally go up and shorting as a whole is sailing against the wind. But look, the wind has changed. Why not re-rig your sails? Do not fear that an occasional ill gust will blow against you from some lesser gods when Zeus himself could not have sent better weather for sailing south, my friend.

YankeeFebruary 7th, 2008 at 7:01 pm

Gloomy – it is not that stocks are high or low, going short, going long – it is that there is crap lurking in potentially every portfolio. For me, the issue is transparency.

GloomyFebruary 7th, 2008 at 7:04 pm

@Yankee Take a good, long look at Roubini’s comments above. That’s all the transparency you need.

YankeeFebruary 7th, 2008 at 7:07 pm

@ RH I agree w/you re: ChEnron. I trust them less than our gov’t. At least we can post on blogs without being arrested. That is why I still own $$$. I look at it this way: the U.S. is my ship. If I am potentially going to sink, it will be on my ship, not some Chinese ship. I’ll let Jim Rodgers sink on that one.  Yankee

YankeeFebruary 7th, 2008 at 7:12 pm

True, the worst case scenario above is truly horrific. But you can take my dance ticket. I am sitting this one out!

GirafFebruary 7th, 2008 at 7:23 pm

@Gloomy  I know you and I have had this debate before and that you want an event example to prove to you that the stock market will move higher from here. I cannot provide it but like everybody else, will be able to tell you after the fact why its happened. What I do know is that markets OFTEN move for no apparent reason. THEN we figure out why. I said two weeks ago that I thought the S&P 500 and DJI had put in bottoms, at least temporarily. The trading patterns since then would seem to confirm it. We could easily see a rally on the S&P 500 to the 1425-1450 area, just on short covering and the upside momentum pulling in money that is sitting on the sidelines. I tend to agree with JMa’s read that we can have this rally, which will peter out, leading to another sharp downleg.   Bulls, bears and pigs. I recall you saying that you bought 1425 puts in December, which at that time would have been way out of the money. Now they are in the money to the tune of about 100 bucks. Why not lock in some of that profit now and re-establish at higher levels?  As to this Armegeddon stuff, I just don’t know. I have heard “The end of the world is nigh” story many times in the last 40 years and have believed it once or twice. But we always seem to muddle by. Maybe “this one” will get me because my guard is down.  Good luck.

SophieFebruary 7th, 2008 at 7:59 pm

Thank you to those who responded to my question about bankruptcy, especially “Anonymous” – very good, even clairvoyant advice. I will talk to a lawyer before making a decision.

GloomyFebruary 7th, 2008 at 8:05 pm

Thanks to everyone for your comments and letting me air my views. I much appreciate your valuable perspectives and will keep them in mind.   Yours,  Gloomy

MedicFebruary 7th, 2008 at 8:17 pm

@ Gloomy:  As no doubt, you can tell from my posts, I am out of the market. Moved everything out of US stocks about 10 months ago. I have only what I advised for you above and will convert all to cash before (I hope) most financials are toast. I am happy to sit this one out, but I wish you the best of luck. Again, your theory makes complete sense – I just can’t get over the feeling that this is going to be a bit longer fall, but much more damaging than anyone thinks. No empire lasts forever. The irony is, this one is likely to be one of the shortest.  PS – after watching my government lie with absolute abandon to wage the Iraq war (and watching the population go along for the ride for some time), I know there is nothing beyond Bush & Co. They will control this until not only the evidence is known, but the sheeple wake up. That will definately take some time.

Leo70February 7th, 2008 at 8:58 pm

@Giraf on 2008-02-06 17:09:40  Re: TIIS, check out the Nov/Dec 2000 issue of the St. Louis Fed Review. 

GirafFebruary 7th, 2008 at 9:19 pm

@Leo70  Thanks for that. I’ve just downloaded the pdf but it’s too late and one glass of red wine too many, to absorb it this evening. Will read it tomorrow.

GirafFebruary 7th, 2008 at 9:22 pm

@Leo70  Thanks for that. I’ve just downloaded the pdf but it’s much too late and one glass of red wine too many, to absorb the document tonight. I’ll give it a shot tomorrow.

GuestFebruary 8th, 2008 at 12:28 am

Gloomy  What, you’re selling Treasuries? That’s disappointing. I was hoping that as many people as possible would pile into T-Bills – forcing the rate down as low as possible.  It’s nothing to do with you. I just want to see how far Ben Bernanke is willing to crank down the Fed rate, so he can get under the short end of the yield curve.   It’s kinda’ like watching Shaquille O’Neal squirm his way under a limbo stick. :-)   PeteCA

From the heartFebruary 8th, 2008 at 2:27 am

The problem with you men, is that they think they can spend $150,000,000,000.00 on a chick, drop their rates, and then Lady Liberty’s gonna just jump right into bed with them! Well not this time! Especially not with the various strands of mortgaged backed herpies this country has! Every few weeks, the sores come and go, but the Financially Transmitted Disease will not go away. And even if you lie to miss Liberty, and tell her you’ve brought monoline protection, she’s smart enough to know better.  Tonight’s topic… Bush.   Now, now gentlemen keep your minds out of the gutter. I bring him up because it’s that time of the month.   Tax time. (what time of the month did you think I meant?)   Has anyone really taken a good look at this $150,000,000,000 proposal? I hear so many detractors on this blog, and so many political cheerleaders on TV that I don’t know what to think. From up on my high heals, I can’t help but think everyone has missed the whole purpose.   Why roll out $150,000,000,000?   I hear you guys wave around your big ideas and complaints, but no one has seemed to identify the big question???  WHY?  To send $600 to a guy in Spokane Wash? To send $1200 to a married couple in Sayville NY? So that my grandmother can buy a big screen that’s made in China? So that I can buy a Prada bag?  NO! You’ve all missed it.   There is a far deeper darker reason.  This money is being rolled out to circumvent the standard bailout of cash flow to Wall St’s high end, in particular its banks. (it’s not going to China)  A check for $150,000,000,000.00 is being written to infuse immediate cash to the folks on Wall St. through trickle down economics.   It’s $75,000 wage limit, ($150,000 joint) are geared to send money to the bottom 80% of America, that will in turn pay off credit cards, loans, etc…  That infusion of cash in turn goes directly to Wall St, and then gives banks and other majors, cash to purchase distressed debt from the Hedge Fund/Private equity community. (that Hedge Fund/ PE community are the Top 1%. They don’t receive or need that $600 check)  Don’t get me wrong… Not all Hedge/PE’s are created equal. The CEO’s and families of your majors are in the right HF/PE’s. The well funded ones. (so even if/when they’re fired, their golden parachutes open quite nicely)  Its those hedge funds and PE’s that have the new rich folks in them that will suffer. Your top 19-2% of America that made millions during the Dot coms. The new loose money that didn’t pay its dues and belong in the game. They take the hit.  This $150,000,000,000.00 is part of the game that many seemed to miss.  …but this Miss, didn’t miss it.   xoxoxoxo Miss America  p.s. Does anyone know how many soda cans the Gov’t will have to return, in order to collect $150,000,000,000 from the deposits? 

tutterfrutFebruary 8th, 2008 at 3:06 am

Bond market fears as UK debt soars  By Ambrose Evans-Pritchard Last Updated: 2:40am GMT 08/02/2008  The sharp rise in unfunded state spending drew a yellow card warning from the fiscal police in Brussels last month. More worrying, it has begun to set off rumblings of discontent among the much-feared bond vigilantes.  Andrew Guy, head of ADG Capital Management, said the Treasury could no longer take it for granted that foreign buyers would turn up at the bond auctions.  ”We are nearing the point where Asian and Middle East investors are going to charge a much higher premium for holding British sovereign debt,” he said. “Once a government loses credibility, these investment shifts can happen with alarming speed.” http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/02/08/cnukecon108.xml  

GuestFebruary 8th, 2008 at 4:05 am

woke up this morning read some articles and the had the fry heaves.  This is getting worse every day. When will the public turn into angry mobs? its going to happen.

oy veyFebruary 8th, 2008 at 4:21 am

@guest woke up this morning read some articles and the had the fry heaves  dry heaves is what you meant.  I too have been having them for weeks.  WILL ANYONE BE HELD ACCOUNTABLE? This is uncharterd territory and wall street needs to sink into hell for this.

tutterfrutFebruary 8th, 2008 at 4:31 am

The first cut is the deepest…  Super Friday for monolines? Moody’s cuts rating on XLCA Feb 08 10:04 by Sam Jones Comment  SCA’s bond insurance business, XL Capital Assurance, lost its crucial AAA rating on Thursday evening. But Moody’s didn’t just cut XLCA, the fourth largest bond insurer, from AAA to AA. It downgraded it by six notches. More…  SCA’s bond insurance business, XL Capital Assurance, lost its crucial AAA rating on Thursday evening. But Moody’s didn’t just cut XLCA, the fourth largest bond insurer, from AAA to AA. It downgraded it by six notches.  The implications for other bond-insurers are troubling. Monoline downgrades have previously only been imagined as cuts of one or two notches, with the expectation being that a recovery might well be probable in the future.  Although XLCA’s situation is particularly dire relative to its size (it, like ACA, was heavily involved in CDO insurance) it does nonetheless bode ill for the two biggest players: Ambac and MBIA. Were they to be downgraded it would be bad enough, were they to be downgraded further than AA, it would be absolutely disastrous.  http://ftalphaville.ft.com/blog/2008/02/08/10807/super-friday-for-monolines-moodys-cuts-rating-on-xlca/

RedCreekFebruary 8th, 2008 at 4:32 am

“XCLA has contracts on around $154.2bn of debt, which will be cut by at least the same number of notches – to A3, according to Moody’s. In fact, you can view the massive lists of securities downgraded here (40,151 munis), here (103 structured) and here (137 corporate).  An instant impact then, irregardless of what bond prices do, will be that banks holding those insured bonds will have to stump up a great deal of extra regulatory capital. AAA rated bonds require very little. But under Basel II, the extra capital needed for riskier tranches is considerable. Yves Smith at Naked Capitalism has a good take here.” 

London BankerFebruary 8th, 2008 at 5:02 am

@ RedCreek and tutterfrut  The irony, of course, is that the US authorities refused to implement Basle II for any but the largest 20 banks in the USA, while Europe implemented Basle II accross the board for all banks, regardless of size or business model. As a result, the pro-cylical ratcheting of ever tighter capital will constrain European banks much more harshly than their American cousins.  As usual, the US outsources its pain for others to feel.  @ oy vey  There will be no accountability. And this is not uncharted territory, but familiar territory to those in power.  Herbert Walker sold billions of dollars of bonds to Americans to rebuild Germany in the 1920s and 1930s. Many of the bonds became worthless during the depression years, but no one was ever held accountable.   His son-in-law Prescott Bush was president of Fritz Thyssen’s US bank and the Holland Amerika Line, both of which were seized at the start of WWII as enemy property. He was never prosecuted for trading with the enemy.  Instead, Prescott Bush became a hugely powerful senator after WWII, and his protege Richard Nixon became vice president and then president. His son became the head of CIA black ops from the front company Zapata Oil and then director of the CIA, vice president and president. His grandson became president.  America has and always will be the land of opportunity, that forgives mistakes and provides new vistas of prosperity – for some. 

London BankerFebruary 8th, 2008 at 5:10 am

Before Rich H and others beat me up for being anti-American, I will agree wholeheartedly with his “ChEnron” analysis and say that America is still a great place to live and a great place to do business. The faults that is has are often because Americans prefer to believe the best about themselves rather than be objective about their leaders’ conduct and their own history. They are too kind, turning a blind eye to those who take advantage of them.  Here in Europe we have a certain amount of corruption, but we also have a healthy distrust of authority. The two balance out pretty well, keeping the authorities from taking corruption too far – and making them share a bit more of the wealth with the masses.

Octavio RichettaFebruary 8th, 2008 at 5:39 am

More on the 30 year “disaster” auction yesterday   (30-Year Treasuries Fall Most Since 2004 After $9 Billion Sale  http://www.bloomberg.com/apps/news?pid=20602007&sid=a2mQtJAaw6lw&refer=rates )  From Brad Setser blog. A picture is worth a thousand words. Scroll down to the second picture. Look at the solid black line (net chinese purchase of US assets). The chinese are buying less US Treasuries. They are now into WW equities such as Rio Tinto. So they sell the USD we give them when we buy chinese junk and then buy non-USD denominated investments with it. So they still sterilize the RMB but are holding more assets denominated in non-USD currencies. This is no good for the USD/US treasuries: Dollar down, inflation up , long rates up. Not a pretty picture….   Understanding the world through pictures: China, Japan, Europe and US current account adjustment  http://www.rgemonitor.com/blog/setser/238837 (second picture) It also shows that recorded capital flows from China are falling relative to China’s surplus – a development that likely reflects Chinese purchases through London and Hong Kong more than a major shift away from US assets. Note the gap between Chinese reserve growth and recorded inflows to the US that starts to develop after q2 2006. It isn’t a coincidence that the q2 data is the last survey. Chinese purchases will be revised up when the US data is revised this spring.   

GuestFebruary 8th, 2008 at 6:16 am

CDO update: talk of firesale, liquidations begin  At Christmas, 33 CDOs had triggered “events of default”. Mid January and that number had risen to 58. According to Standard & Poor’s that figure has now spiked to 80 – worth around $97bn.  The number of defaulting CDOs has in fact increased by $13bn in the past week alone.  But more worrying is the fact that of those transactions, senior creditors now seem to be pushing for liquidation – indicating the beginnings of a long speculated-about fire sale of CDO assets. A total of 18 CDOs, worth an estimated $18bn, have opted for liquidation as at Thursday. One is understood to have completed the process.  Unwinding of synthetic CDOs – which reference CDS contracts – is thought to be behind some of the rapid spread-widening on credit indices on Friday.  More painful liquidations are also to be expected. Further downgrades of RMBS – particularly 2006-2007 vintages, and the downgrading of bond insurer XLCA on Thursday, which played big in the CDO world – will push a great deal more CDOs towards default. 

Octavio RichettaFebruary 8th, 2008 at 7:09 am

AP Stocks Head for Lower Open Friday February 8, 7:35 am ET  By Joe Bel Bruno, AP Business Writer  Wall Street Heads for Lower Open Amid Recession Fears, Earnings   http://biz.yahoo.com/ap/080208/wall_street.html  Investors are also waiting for more economic data. U.S. wholesale trade inventories due at 10 a.m. EST might show distributors in December limited their stockpiles amid weak retail sales.  This is a key figure to watch a “larger than expected” correction would indicate an accelerated decline in inventories (i.e., negative second derivative) which is typical during recessions and “naive” linear extrapolation doesn’t pick up.  

samFebruary 8th, 2008 at 7:25 am

THIS STORY MAKES ME INCREDIBLY MAD    Creators of Credit Crunch Revel in Las Vegas  http://www.cnbc.com/id/23065301  We had the bastards all in one room. The FBI should have arrested each and everyone of them. But then agian, the FBI probably works for them on thier off hours. I predict if this gets even worse, there will be chaos and people will look for scapegoats. I hope its the right scapegoats.   

hazletonFebruary 8th, 2008 at 7:25 am

@London Banker  Your information is fascinating – I have never seen it mentioned anywhere. The “Sins of the Father” are being played out in front of our eyes.

hazletonFebruary 8th, 2008 at 7:30 am

@London Banker  That is fascinating information about the Bush Family. I have never seen it mentioned anywhere. ”The Sins of the Father” are being played out in front of our eyes.

sickenedFebruary 8th, 2008 at 7:33 am

Sobering  committee meeting President Jean-Claude Trichet said three words that changed the entire demeanour of the market and sent shudders throughthe hearts, minds and pocket books of investorseverywhere: “unusually highuncertainty.” Mr. Trichet said this regarding the Banks view of the European economy looking forward, nothing that there is an “unusually high uncertainty” regarding the economic future there, suggesting rather strongly that at least he, amongst the European monetary authorities, is prepared to stop pushing rates higher and is prepared, sooner rather than later, to being allowing rates to fall. prior to his statement,the EUR was trading at ornear 1.4625, and moments after his comment, it was trading 1.4450, moving through three “big figures” in a matter of a few breathless moments. The EUR has found some support at the 1.4450 level, and perhaps it may hold, but we have our doubts given the enormity of the positions taken against the US dollar and taken for the EUR over the course of the past several months. As we have saidtime and time and time again, the “boat is listing to one side,” and when the boat carrying the world’s speculative positions is so heavily laden in one direction, many eventually drown. Many have in the past twenty four hours; many more shall in the coming days and weeks, for it may take at least that long to unwind the huge positions accumulated

OuterBeltwayFebruary 8th, 2008 at 8:07 am

@Octavio:  Re: Mr. Fisher’s speech in Mexico City…what did you find so fascinating? I read that as standard pablum from the Fed – we are doing the balancing act, take away the punchbowl, put the punchbowl back, timing is everything, etc.   Not much about the fundamentals: consumption over-reach, comparative advantage favors BRIC for the next decade or two till living standards reach equilibrium, Wall Street fraud bilks Main Street USA, Taxpayers will provide yet another massive wealth transfer to the rich.  If his vote to restrain downward motion of the FF rate was influenced by the fundamentals, it was sure hard to pick that out of his speech.  I give the speech a grade of DDP, for Dumbed Down Pablum.  I hope you saw something better in it, and if so, please point it out.

Octavio RichettaFebruary 8th, 2008 at 8:53 am

Written by OuterBeltway on 2008-02-08 08:07:27  It seems you rather not have read Fisher’s speech/found in it no marginal contribution to your mental model of how the world operates.   I never expected to come across some “radical finding” in a speech from a fed official, specially if delivered “south of the border” as this is typically the type of speech that makes you fall asleep. So in light of my diminished expectations, there were three things I liked [and that is at least a couple more than I find in the hundreds of pieces I read every day], all referring back to the state the US economy is now in:  1. The reference to Venezuela’s Economy which is in the shambles, despite $100 oil and Venezuela been a top ten oil producer/exporter, due in no small part to a lax monetary policy which will be aggravated now that the CB’s independence has been taken away.  2. The role of the Fed in generating run-away inflation in the 70s under circumstances that are very similar to what we have today: i) a republican president, ii) a stupid, expensive war going on iii) a high budget deficit iv) evidence of growing inflationary pressures. (Given the closeness of the historical events to the current situation in the US, conspiracy theory types will also ask themselves why the allusion to the Johnson-Martin alleged deal-making was necessary in the speech)   3. A confirmation from the man himself on why he voted against the latest cut: The lagged effect of monetary policy; he thought enough was enough and that the extra juice will increase inflation (I liked the Single-Malt/Tequila analogy very much). You may argue we already knew what the guy was thinking; now we know.

Redd GreenMarch 4th, 2008 at 2:07 pm

Re: ”…Remember, the $5.75 trillion total does not include any estimates for losses related to points 3, 5, 9, and 10, so the final total losses would be significantly greater (maybe $7 or $8 trillion?).  I wonder how this amount of loss compares with previous recessions and/or financial events. Any thoughts?  Written by KJ Foehr on 2008-02-06 12:47:03…”  Mr Foehr:  The statements, and thoughts, even in the article, are not quite accurate. $5.75 trillion did not, and probably won’t, ‘disappear’. It changed hands. The only thing that truly causes money to disappear is a contraction of the money supply, which has not happened. The cause of the great depression was the intentional, conscious act of reeling in the money supply from 1929 until about 1932 by the Federal Reserve. Which is why, in 70+ years we have not had a depression, as nasty as some of the recessions were.   We need to be much more critical about these issues. Money has changed hands, a great deal of money, and we have a long way to go before the ‘transfer’ is over. But, in the US, the Federal Reserve has increased the money supply %423 in just under 25 years (Fed’s own numbers). That averages out to %17 monetary inflation, and it certainly didn’t happen linearly. And the Fed’s decision to stop publishing M3 numbers in 2006 was clearly not because “its too expensive to collect the data” as they said. They clearly already have the data, its the publishing that someone wanted to stop.   A very smart person I speak to from time to time had suggested that hiding the M3 numbers is a red flag that those with the most power and financial wealth are moving their wealth, quietly, before something happens.   Here’s the point: Stock market goes up, real estate prices go up. The most wealthy people get out at the top, quietly. Stock market goes down, real estate prices go down. Wealth is transferred. It’s happened more or less that way since the world’s central banks have been a cartel, around 1913.   A separate alarm is going off now, that of the absurd increase in the money supply. Perhaps Professor Roubini would like to comment on the combined effect of the mortgage problems, commercial paper problems, insurance, banking, and the absurd increase in the money supply, that is apparently now being hidden from us? Best Regards Michael London       

CathyMarch 16th, 2008 at 1:45 pm

I have what may be a stupid question (as I am not an analyst of any kind). If I have a $1000 debt, could I pay this off cheaper in the event the dollar collapses if I have invested in another currency (a stronger one, like maybe the Euro)? Since My Euro’s (this is theoretical) will remain intact, while the dollar is basically worthless, would not that mean I could pay this debt off quickly with the Euro’s and basically pennies on the dollars I owe? Isn’t that the “reasoning” of some of these Fed and Govt people, that by debasing the currency they will actually lessen the debt?

'mr noiseSeptember 3rd, 2012 at 8:19 pm

by the way in macro perspective Roubini , his views and offcourse this masterpiece "The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster" are outstanding

only to translate it to market behaviour has been for the most people very very difficult and not profitable.
without may be, the losses would have been much bigger.

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