Can the Fed and Policy Makers Avoid a Systemic Financial Meltdown? Most Likely Not.
In a recent article I presented a scenario where – in twelve steps – the US and global financial system could experience a systemic financial crisis – or a financial meltdown – coupled with a severe US recession and a global near recession.
The fact that the US is now in a recession is, at this point, without much doubt even if the consensus forecast – always behind the curve – now gives only even odds (49% according to the WSJ panel of forecasters, 50% according to the Bloomberg panel) to a recession outcome. The issue right now is not anymore whether the US will experience a soft landing or a hard landing but rather how hard the hard landing will be. The latest data point to a severe recession ahead lasting at least four quarters rather than mild recession that most forecasters are now predicting: a fall in employment in January; very high and elevated levels of initial and continued unemployment claims; a non-manufacturing ISM that literally plunged; falling – in real term – retail sales in the holiday season; mediocre results and falling sales for most retailers in January; plunging auto sales; very weak and further falling consumer confidence; a credit crunch that is becoming more severe in credit market as measured by a variety of credit spreads; the beginning of a severe recession in commercial real estate; a worsening housing recession; sharply falling home prices; evidence of a serious credit crunch in the banking system based on the Fed survey of loan officers; a correction in all major stock markets and the beginning of a bear market in the NASDAQ; serious evidence of a global economic slowdown, especially in Europe, with outright recession ahead in some European countries. All these indicators points towards a severe recession.
Believing – as the consensus now does – that this will be a mild two-quarter recession and that growth will recover in H2 of 2008 is wishful thinking. The last two recessions – in 1990-91 and 2001 – lasted almost three quarters (precisely 8 months) while the current recession looks fundamentally more severe than the latter two for three reasons: we are experiencing the worst housing recession ever in US history, a shopped-out, saving-less and debt-burdened consumer is now in financial trouble and retrenching; and we have a severe systemic financial crisis. Thus this recession will be longer, deeper and uglier than the previous two.
Since in the previous article I described a 12 steps scenarios towards a financial meltdown and a deep recession the crucial policy question is whether the Fed and other policy officials can prevent such a scenario of a systemic financial crisis.
I will present in this article the eight reasons why I am skeptical that such a systemic risk scenario can be avoided…
Before we get to the many reasons why one should be pessimistic let us consider at least one reason why one could be more optimistic. The main good news in this respect is that, after being behind the curve in its assessment of the economic and financial risks, the Fed now gets it and is worried about a serious systemic financial crisis. For over a year the Fed assessment of the risks to the economy and to the financial markets was flatly wrong. The Fed argued that the housing “slump” would bottom out over a year ago; instead the housing recession got deeper and is nowhere near bottoming out; Bernanke argued repeatedly that the subprime problem would be a niche and contained problem; instead we have observed a severe liquidity and credit crunch that has spread to the entire financial system; the Fed argued that the housing recession would have no significant spillovers to the other sectors of the economy in spite of the importance of housing and in spite of the fact that housing is the main assets of most households; instead we are now observing an economy wide-recession. So to put it simply the Fed – as well as most macro analysts and forecasters – got it totally wrong in its assessment of the risks to the economy and to financial markets.
Today instead the Fed is certainly aware of the risks not just to the real economy but also to financial markets. As senior Fed officials argue in private the risk of a catastrophic event – a small probability of a systemic financial meltdown that would lead to a severe recession – is rising and this scenario, however unlikely, has to be avoided at any cost. This is the main reason why the Fed has thrown caution to the wind and has taken a very aggressive approach to risk management, as signaled by the 125bps Fed Funds easing in eight days in January.
What is the Fed’s and the financial officials’ strategy to avoid the vicious circle of a severe recession and of a systemic catastrophic financial meltdown? Here are the main elements of this strategy and the important limitations and constraints to that strategy.
First, an aggressive monetary easing with the reduction of the Fed Funds rate to reduce the risk of a deeper and more protracted recession. The limits to this monetary policy easing are twofold. First, at some point the Fed needs to worry that an aggressive Fed Funds easing will lead to a disorderly fall of the US dollar, to foreign private investors pulling the plug on the financing of still large US external deficits and to higher imported inflation. Second, monetary policy is relatively ineffective in stimulating the economy as: there is a glut of housing, consumer durables, automobiles and it will take years to clear that glut; i.e. monetary policy becomes less effective as the demand for such capital goods becomes less interest rate sensitive under glut conditions or, in other terms, easing money is like pushing on a string. Second, the problems of the economy are not just problems of illiquidity but rather more deep seated problems of insolvency; and monetary policy cannot resolve serious credit problems in the economy.
Second, a strong provision of liquidity to financial markets to reduce the liquidity crunch in interbank and money markets. Such provision of liquidity failed to reduce such a crunch in the fall of 2007 until the Fed became much more aggressive in December with its new liquidity auctions. Since then interbank spreads have become smaller – especially because markets were pricing very aggressive Fed Funds easing – but such a liquidity crunch has not disappeared – as proxied by the crucial BOR-OIS spread while the credit crunch in credit markets has now become even more severe than in the fall. Also, interbank spreads may significantly widen again for several reasons. First, such spreads include two components, a liquidity premium and a credit premium; while the Fed can affect the former through its provision of liquidity it cannot affect the second and recent evidence suggests that interbank spread are now more driven by credit spreads. Second, with a worsening economy and increasingly large losses in an opaque financial system where lack of trust in counterparties is increasing and where counterparty risk will increase in a deepening recession, credit premia will become larger.
Third, an robust attempt to coordinate a private rescue of the monolines to prevent their rating downgrade and thus avoid another round of writedowns in the financial system. As a senior policy official put it in a private meeting at Davos rescuing the monoline is “a no brainer”. The trouble is that, while a few weeks ago it was thought that a $10 to $15 billion recapitalization of the monolines was thought to be doable and sufficient to prevent such a downgrade it is now becoming increasingly clear that the monoline losses on their insurance of toxic structured finance products are massive and that $10-15 billion will not be enough to avoid a now necessary and unavoidable downgrade
Also, as argued here before, a business model that requires a AAA rating to remain in business is a business model that does not deserve an AAA rating in the first place. As also agreed by Bill Gross of PIMCO bond insurance of structured products was a form of “voodoo finance” that created AAA ratings for toxic instruments that should have never had such ratings in the first place.
And once the unavoidable downgrade of monolines occurs financial institutions will be forced to write down another $150 billion structured finance assets kicking another round of large financial losses. The downgrade of the monolines could 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. Finally, 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. Indeed, in the last few weeks movements of the stock markets have been driven more by news about the fate of the monolines rather than the monetary easing news of the Fed, a signal that markets realize that the economy suffers of credit, rather than just illiquidity, problems.
Fourth, avoiding a more severe credit crunch by an aggressive support of the recapitalization of the financial system through capital injections by sovereign wealth funds (SWF). The risk of a credit crunch following the losses in financial institutions and their reduction in capital is serious. For example, Goldman Sachs estimated that $200 billion of losses in the financial system will lead to a contraction of credit of $2 trillion given that such institutions hold about $10 of assets per dollar of capital.
That is the reason why the Fed, the US Treasury and other financial officials have totally set aside any other concerns about SWFs (their foreign government ownership, their lack of transparency, etc.) and have aggressively supported the recapitalization of the financial system by such SWF. To avoid a more severe recession it is better to restore the balance sheet of the banks via a recap that reduces the need to contract lending and credit than via a contraction of the asset side of such balance sheet. However, this recapitalization of banks by sovereign wealth funds – about $70 billion so far – will be unable to stop the credit crunch and the credit disintermediation (the move from off-balance sheet to on balance sheet of SIVs, conduits and other vehicle; and the 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 in the financial system will dominate by a large margin any bank recapitalization from SWFs.
Based on our analysis such losses in the financial system could add up to more than $1 trillion – not just $200 billion – and a good part of these losses will be among financial institutions such as commercial banks and investment banks. Thus, unless SWF or other financial institutions are willing to throw much more good money after bad money (the Chinese SWF – CIC – lost 30% of its investment into Blackstone in three months alone; while BofA lost most of its $2 billion investment in Countrywide and is not at risk of doubling up its losses by taking over the insolvent Countrywide) it will be impossible to avoid a significant reduction in the capital of the financial system and the severe credit crunch that is now underway. And there is now evidence that even long-investment horizon investors such as SWF are starting to become skeptical about throwing good money after bad money into US and European financial institutions.
Also notice that recent data suggest significant losses and the beginning of a credit crunch among smaller banks and even some medium sized regional and national banks. The chances that banks with serious problems such as Wachovia or WaMu – as opposed to the Citis or Morgans of the world – will get massive support from SWF are very low.
Fifth, attempts to reduce the number of foreclosures among distressed homeowners and provide measure of support of the housing markets. These include the Hope plan to freeze the reset of some ARM mortgages, the lifting of some of the limits to the portfolios of the GSEs, the use of the Federal Home Loan Bank system to provide liquidity to mortgage lenders, use the FHA Secure loan refinance program to reduce the number of foreclosures, etc. But some of these plans are too little too late to make a difference while others are outright inappropriate uses of public money.
To understand the gargantuan challenge that policy makers face in controlling the severity of the housing recession note that it highly likely that US home prices will fall between 20% and 30% from their bubbly peak; that fall would reduce household wealth between $4 trillion and $6 trillion. Also, 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).
Given the size of the meltdown in the housing market and the risks of massive default the measures undertaken so far are either minor band-aid solutions or inappropriate uses of public funds. The Hope plan – while going in the right direction in spirit – is so constrained that it will help only a very small fraction of subprime borrowers in avoiding a reset of their ARMs; studies suggest that – at best – only 5% to 10% of such borrowers will be able to benefits from such a reset. The severity of the housing crisis is such that even a hypothetical plan that allowed all of subprime borrowers to freeze their resets would not be enough. Currently politically unthinkable appropriate solutions – such as an outright across the board reduction of the face value of the mortgages of the order of 10% to 20% to reduce the jingle mail are unconceivable now but may become necessary in the near future to stem a tsunami of defaults and foreclosures.
The time will come – unfortunately too late – when financial institutions will realize that they are better off freezing the resets and, at the same time, write down a part of the face value of the mortgage, to allow strapped homeowners to avoid default as the alternative of foreclosure and selling homes at steeply discounted prices in a very illiquid markets involves larger losses for the creditors than a reduction of the debt burden of illiquid and/or insolvent borrowers. Unfortunately this rational solution to the mortgage credit problems will come too late and only when massive insolvencies will lead banks to appreciate the benefits of this alternative and more radical approach to mortgage distress. In the meanwhile the housing and mortgage carnage will continue at accelerated rates.
Similarly, the FHA Secure program has been so far a total failure and there are now suggestions to vastly expand it to make it more effective. The proposals to allow the GSEs (Fannie and Freddie) to buy or guarantee mortgages above the current conforming limits of $417k (all the way to a new limit of $729k) don’t have much merit. The jumbo loan market may be in distress now but why should the GSE heavily subsidize very large mortgages of upper class Americans. At the $417 limit the GSE are already seriously subsidizing the mortgages by middle and middle upper class households. Now extending this subsidy to the wealthiest households bu
ying McMansions and expensive condos is highly inappropriate public policy. Also, as suggested by OFHEO, such plan may lead the GSE to divert their lending activities from buying and guaranteeing smaller and less expensive mortgages towards bigger jumbo loans.
Finally, the widespread use of the FHLB system to provide liquidity – but more clearly bail out insolvent mortgage lenders – has been outright reckless. Countrywide alone – the poster child of the last decade of reckless and predatory lending practices – received a $51 billion loan from this semi-public system; in the absence of this public bailout Countrywide would have ended up where it should, i.e. into outright bankruptcy. And the largesse of the FHLB system does not stop at Countrywide. A system that usually provides a lending stock of about $150 billion has forked out loans amounting to over $750 billion in the last year with very little oversight of such staggering lending. The risk that this stealth bailout of many insolvent mortgage lenders will end up costing massive amounts of public money is now rising.
Sixth, the Fed and other financial regulators have concentrated on trying to avoid the liquidity and insolvency problems of banks and other depository institutions. Through the provision of massive liquidity – including the new TAF auctions – to these depository institutions, the reduction of the discount rate and the easing of access to the discount window, via actions of forbearance such as the waiver of Regulation W or via the effective bailout of some subprime lenders such as Countrywide via the FHLB system the Fed and other financial regulators have been busy to avoid a “Northern Rock” style of bank collapse and run. Whether such actions are wise as some banking institutions are insolvent and whether such actions will be effective in preventing some bank defaults is open to discussion. There is increasing likelihood that some banks – even some large regional ones or some smaller national ones – may go under during a severe recession, regardless of what the Fed does.
But much more importantly the Fed is not directly able to resolve the liquidity and credit problems of the “shadow banking system” (as defined by the PIMCO folks). A more appropriate definition of this system would be the “shadow financial system” (as it is composed by non-bank financial institutions) and this system is now facing serious problems that cannot be easily addressed by the Fed. 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. The Federal Reserve Act does allow lending by the Fed to non-depository institutions only in extreme emergency conditions and after a very restrictive and cumbersome voting and approval process. And since the Great Depression such emergency authority to lend to non-depository institutions has not been invoked. Thus, while the liquidity injections by the Fed has been helpful in reducing the liquidity crunch among many depository institutions they have been ineffective in dealing with the liquidity and credit problems of such shadow financial system. This is the reason why the SIVs collapsed and their assets and liabilities had to be brought back on-balance sheet. This is why money market funds that experienced massive losses on their holdings of toxic ABS had to be rescued by their holding banks or financial groups. If some large hedge funds were to experience a significant run on their funding – as the risk of redemptions is rising given the large losses by some of them in recent months and in January and the coming deadline for redemptions – no one would be able to bailed them out, thus forcing a potentially dangerous fire sale of their assets in an illiquid market. And at this point one cannot now rule out that one or more large broker dealer may end up into liquidity or credit problems and face bankruptcy. These are all problems that the Fed and other financial regulators cannot resolve, either directly or indirectly.
Seventh, the Fed and financial regulators and supervisors are walking a very fine line between transparency/recognition of losses and forbearance. On one side they recognize the need for financial institutions to be transparent and reveal fully the losses on their balance sheets as the uncertainty about such losses is an importance source of the lack of trust and confidence that has made this crisis severe; they also recognize the need to avoid forms of policy forbearance that would exacerbate such a lack of confidence. At the same time the authorities are trying to avoid – via appropriate forbearance actions – a self destructive asset price deflation and fire sales of assets that would exacerbate the financial meltdown, the credit crunch and the collateral damage to the real economy. The trouble is that finding the right and appropriate “middle way” between transparency and recognition of losses and “appropriate” forbearance is very hard.
The logic of finding a middle way is obvious. Transparency and openness about the losses that financial institutions suffered is necessary to resolve the “Where is Waldo?” problem, i.e. the uncertainty among the investors on who is holding the toxic waste and how much of it; this uncertainty has been the source of the risk aversion, lack of trust in counterparties and liquidity hoarding that has worsened the liquidity and credit crunch. So, greater transparency and recognition of the losses is appropriate to restore confidence in the financial system.
On the other hand there is also recognition that under very distressed and illiquid market conditions too much transparency and too much marking to market may lead to a self-destructive cascade of asset prices falling below medium term fundamental values and the credit crunch getting worse. Specifically, there is now a risk that a vicious circle of financial losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices will take 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 then 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 positi
ons. 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.
As one former senior financial official put in a private Davos session on systemic financial risk if we had today for the auto loans and credit cards an instrument similar to the ABX for pricing the value of subprime loans such form of market transparency would be self-destructive and lead banks to show massive additional losses, even larger than those warranted by the worsening fundamentals in the consumer credit market. In other terms, marking to market in a market where prices are discounted by illiquidity may be self destructive.
The problem is that this principle of avoiding – via appropriate forbearance – a self destructive cascade of asset fire sales in illiquid markets is a sensible idea that it is easier expressed in theory than being applicable in practice. Some of the early attempts to provide such forbearance were actually faulty and destructive of confidence: for example the super-SIV plan was conceptually faulty in the first place and its failure appropriate. If a fire sale of the illiquid assets of the SIV was inappropriate the right solution was not to park such assets in a freakish super-SIV. It was rather to bring back those assets on the balance sheet of banks where they belonged in the first place.
Similarly, the concern about the writedowns that will follow a downgrade of the monolines is well taken. However, desperate attempt to avoid a rating downgrade of monolines that do not deserve such AAA rating are highly inappropriate as the insurance by these monolines of toxic ABS was reckless in the first place. If public concerns about access to financing by state and local governments during a recession period are warranted it is better to split the monoline insured assets between muni bonds and structured finance vehicle, ring fence the muni component and let the rest be downgraded and accept the necessary writedowns on the structured finance assets. If these necessary writedowns will then hurt financial institutions that hold this “insured” toxic waste so be it as these assets should have never been insured in the first place. The ensuing fallout from the necessary writedown – such as the need to avoid fire sales in illiquid markets – should then be addressed with other policy actions.
These examples suggest that while the concerns of authorities on avoiding self destructive fire sales and asset price undershooting (relative to fundamentals) may be warranted providing appropriate – as opposed as inappropriate and self destructive forbearance – is easier said than done. The Fed and other financial authorities are looking for a “middle way” but that middle way may not clearly exist in practice. Thus, there are serious limits to the authorities’ ability to follow sensible policies that avoid a vicious circle of asset price undershooting and excessive credit contraction.
In this regard market perceptions that the Fed is out there to bail out investors and the stock market are also not conducive to greater confidence in the monetary authorities. While the Fed goal may rightly be that of bailing out Main Street rather than Wall Street a recession is now not only unavoidable but also necessary to reduce the imbalances – excessive spending relative to income – that were festered by the asset and credit bubbles that burst last year. While public policy should be concerned about a contraction of demand and economic activity that is in excess of what is necessary to restore economic and financial sustainability public policy should not aggressively prevent the necessary economic adjustment that is now required, i.e. a painful reduction of consumption relative to income and an increase in the saving rate that is necessary to bring the economy on a more sustainable growth path over the medium term.
Thus, the perception by markets that the Fed is trying to avoid the necessary economic correction and the necessary adjustment in asset prices – including a needed sharp reduction in equity price and in home prices and the necessary increase in credit spreads – is a matter of concern. While moral hazard will be contained by the massive losses that lenders and investors will suffer regardless of what the Fed does the perception that the Fed is trying to prevent the necessary adjustment in asset prices is not confidence building. While the Fed may be running out of bubbles to create and while inflation may end up being the last of the problems that the Fed faces ahead market perceptions that the Fed has now altogether ignored concerns about moral hazard and concerns about future inflation are now starting to undermine the credibility of the Fed.
Eighth, and finally, the Anglo-Saxon financial system is in a severe crisis – as argued by Martin Wolf or – as argued here – this is the first crisis of financial globalization and securitization. The reform of the financial system to reduce the risk of future destructive credit and asset bubbles is a massive undertaking that the G7 and the Financial Stability Forum have just started. Formally senior financial official argue that everything is on the table and open to discussion and reform: the flaws and wrong incentives of the securitization (originate and distribute) model, the conflicts of interests of the rating agencies, the poor risk management in financial institutions, the lack of true stress testing, the importance of liquidity risk, the wrong incentives deriving from the system of compensation of bankers and financial sector operators who have an agency problem relative to the firms’ shareholders and an incentive to gamble for redemption, the lack of information and transparency in the financial system, the flaws of Basel 2, the problems of pricing and valuing complex structured finance products, as well as other issues.
Reforming this system is urgent to restore confidence in the financial system and reduce the risks of boom and busts in asset prices and credit that are becoming increasingly self-destructive. It is one thing to have such boom and busts in less developed and complex financial system with lower degrees of financial innovation. It is another one to have these repeated and increasingly unstable cycles in very complex systems that private sector agents and public sector regulators and supervisors don’t fully understand and are unable to control. The risk that a systemic financial meltdown in this most complex “black box” financial system that has run amok will cause a “black swan” event with destructive real economic and financial consequences is rising.
And while policy makers and regulators now claim that everything is on the table in terms of reforming a faulty financial system they stress in private that their preferred approach would be one of “self-regulation” and reforms undertaken by private financial institutions rather than new rules and regulation imposed by authorities. While the right balance between principles and rules in regulation and supervision is open to discussion the recent experience suggests that excessive reliance on principles not backed by appropriate rules, the delusional hope that internal models of risk management will provide the right amount of risk taking, the wishful thinking that “self-regulation” will work, the hope that financial institutions will self reform the system of compensations of bankers are all mistaken views. A more robust set of rules, regulations and supervisions will be necessary as excessive reliance on self-regulation and market discipline has shown its failure. Starting with the interim report that the FSF group headed by Mario Draghi will present to the G7 finance ministers we will see how serious financial official are about reforming the system and reducing the medium terms risks of a systemic financial crisis. For the time being there are good reasons to be skeptical that the r
ight policy actions and reforms will be undertaken.
In conclusion, the risks of a systemic financial meltdown of the sort that I described in my previous article are rising. While the Fed and the financial policy authorities are now fully aware of the risks of this scenario – after a long two years where they misdiagnosed the problems in the economy and the financial system – and they are starting to take some of the appropriate policy actions in the monetary and financial spheres, a realistic assessment of the risks in the real economy and in the financial system suggests that it will be very hard to avoid a severe economic recession and the financial fallout of such a recession. And the risks of a systemic financial crisis that will exacerbate such a US recession and will lead to near recession conditions around the world are now rising.
Bernanke, Mishkin and Geithner now get it in terms of understanding of the economic and financial risks that we are facing. And some of them – like Geithner – were well aware and spoke eloquently of such systemic risks well before the current events and turmoil unfolded. But whether they will be able to manage this crisis and contain its fallout remains to be seen. Unfortunately the early and persistent misdiagnosis by Chairman Bernanke of the problems that the economy and the financial system faced has partly eroded his reputation and credibility among market economists and investors. Managing the treacherous times ahead will not be easy for him as the economy spins into a painful and severe recession while the financial system losses mount and risk causing a systemic financial crisis.
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U.S. Recession Is Now an Even Bet as Spending Slows (Update2) By Shobhana Chandra and Andy Burt Feb. 8 (Bloomberg) — A U.S. recession is now an even bet as job losses and the housing contraction jeopardize the longest-ever expansion in consumer spending, according to a Bloomberg News survey. The world’s largest economy will grow at a 0.5 percent annual rate from January through March, capping the weakest six months since the last economic slump in 2001, according to the median estimate of 62 economists polled from Jan. 30 to Feb. 7. Federal Reserve Chairman Ben S. Bernanke will lower the benchmark interest rate a further half point by June, adding to the fastest easing since at least 1990, the survey showed. The odds of a recession over the next 12 months, pegged at 40 percent in the January survey, jumped to 50 percent as payrolls, auto sales and stocks slumped. “We’re seeing a real squeeze on the consumer,” said Kurt Karl, chief U.S. economist at Swiss Re in New York, the world’s largest reinsurer. “We’re in, or on the brink of, a recession. The Fed will keep cutting rates to help it be a short and shallow one.”
Company Default Risk Soars to Record on CDO Selloff Speculation By Abigail Moses and Neil Unmack Feb. 8 (Bloomberg) — The risk of companies defaulting soared to a record on speculation collateralized debt obligations packaging credit derivatives are being unwound, according to traders of credit-default swaps. Contracts on the benchmark Markit CDX North America Investment Grade Index jumped 5 basis points to 129.5 at 7:45 a.m. in New York, the highest since the index started in 2004, according to Deutsche Bank AG. The Markit iTraxx Europe index rose 6.25 basis points to a record 97.75, according to JPMorgan Chase & Co. “There is speculation structured products are being unwound,” said Jim Reid, head of fundamental credit strategy at Deutsche Bank AG in London. CDOs generate income by packaging credit-default swaps and using their income to pay investors. The value of the securities’ underlying assets plunged in the wake of the credit crisis triggered by the worst U.S. housing slump in 26 years and managers are now having to buy default protection to offset losses, driving benchmark indexes higher. Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates worsening perceptions of credit quality; a decline, the opposite. A constant proportion debt obligation sold by Zurich-based UBS AG collapsed after a drop to 10 percent of net asset value forced the fund to sell its holdings, Moody’s Investors Service said in November. CPDOs are securities that pay investors from income earned by selling credit-default swaps. The Markit iTraxx Crossover Index of 50 companies with mostly high-risk, high-yield credit ratings increased 15 basis points to a record 540 today, JPMorgan prices show. A basis point on a credit-default swap contract protecting 10 million euros ($14.6 million) of debt from default for five years is equivalent to 1,000 euros a year. To contact the reporters on this story: Abigail Moses in London Amoses5@bloomberg.net
The problem with you men, is that they think you can spend $150,000,000,000.00 on a chick, drop your rates, and then Lady Liberty’s gonna just jump right into bed with you! 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? Written by From the heart on 2008-02-08 02:27:03
Written by OuterBeltway on 2008-02-08 08:07:27 (see previous thread) 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.
Dr Roubini, I still have access to your full commentary even as your free trial offer has expired. I just wanted to inform you so that you can take the measures necessary to correct this problem. Thanks, Maundermin
Its not a problem, Maundermin
@ Rich H Guess I was wrong. CME is working parallel to you. This from The Economist: “ The [credit] crisis may help exchanges in another waqy, by highlighting the opacity and illiquidity of some OTC instruments. The CME, for instance, is pushing new clearing services for swaps, currencies and even credit derivatives….” Full article: http://www.economist.com/finance/displaystory.cfm?story_id=10609394 - jd -
Access to my Global Economonitor is now subject to registration. Some postings are available to registered users while others are restricted to paid subscribers of the RGE Monitor (www.rgemonitor.com). So you may not be able to read all of my postings – and you will not have access to the archives – unless you are a subscriber. Best,Nouriel
You can tell when some market manipulation is occurring. (1) Wide swings in futures just prior to market opening–particularly when news or announcements indicate contrary direction (2) Large almost immediate swings in pricing. Watch the bottom bars on many of the daily graphs that indicate volume, while volume buy/sell usually is very moderate indicating regular trading–when certain peril thresholds are reached. BOOM, uniquely huge trades are instantaneously ordered. Any smart money wouldn’t make such immediate purchases, but rather would slowly insert themselves into the market nibbling until they reach their share total. Otherwise they telegraph great demand and drive pricing away from their goal. UNLESS THEIR GOAL IS EITHER TO PUMP OR DILUTE STOCK PRICING. WHICH IS WHAT IS GOING ON WITH GREATER AND GREATER FREQUENCY.
Its not a problem, Maundermin Written by Guest on 2008-02-08 09:14:55 What do you mean guest?
@Sickened on 2008-02-08 07:33:21 With respect, you should have attributed your post to Dennis Gartman. It was taken directly from today’s Gartman Letter.
Great detailed, “value added” post! It takes skill and HARD WORK to stay as [IMO] the top economics blog in the world. You devote several paragraphs to the FED, its “middle way” dilemma, and the problems associated with it. Perhaps this is obvious but why not say “straight up” that: The FED is “looking the other way” at the TAF, i.e., taking junk collateral and pricing it WAY ABOVE even the most “optimistic” market prices. This sounds to me as “do as I say but not as I do”.
Lately the discussion has been of the “moral obligation of walking away” The erosion of American conscience and ethical base is because of the failure in leadership to make it a moral imperative. When a FED deliberately falsifies data sets in order that they may sidestep inflation to “goose” the economy with overly low interest rates, they steal value from the dollar on every transaction. Consumer comes to understand that their basic exchange rights are violated with price instability. When economic stimulus is applied to artificially alter the supply/demand curve in housing and it becomes a roulette table of easy credit/speculation/ATM, people lose sight of prudence. Now after the banks and Fed have used the consumer as the end-all-be-all, they balk when John Q. doesn’t feel morally obliged to pay for a depreciating asset unfairly marked to myth for the next 30 years. A moral supply side where reneging is an accepted condition.
I’ve tried to move all non-retirement funds to FDIC insured CD’s, but am confused about what to do with retirement accounts. Your comments would be most helpful. I’ve got a rollover IRA in Vanguard’s Prime Money Market Fund. I moved my 401(k) funds at work in to the Nationwide Money Market Fund (formerly Gartmore Money Market Fund). Should I be concerned about these money market funds?
For Gloomy Maybe you could join this bet… Bear Stearns Makes $1 Billion Bet on Subprime Market Decline By Bradley Keoun Feb. 8 (Bloomberg) — Bear Stearns Cos., the U.S. securities firm that posted its first-ever loss last quarter on mortgage writedowns, is betting more than $1 billion that subprime home loans and bonds will continue to decline. The wager, a “short” position on subprime mortgage securities, was increased from $600 million at the end of November, Chief Financial Officer Sam Molinaro said today at an investor conference in Naples, Florida. The company also reduced its holdings of so-called collateralized debt obligations and underlying bonds, Molinaro said. http://www.bloomberg.com/apps/news?pid=20601087&sid=ap5RXayJzChk&refer=home
Guest: “Has anyone really taken a good look at this $150,000,000,000 proposal?” I’m not sure that your theory will work as explained. It’s difficult to see how a bailout to the average citizen would wind up back in the hands of Wall St banks. However … a bailout timed for March would be perfect timing to allow a lot of American families to pay their taxes in April. It could be that Uncle Sam is worried that many of its citizens may default on their IRS payments. After all, a lot of state budgets are already showing major shortfalls due to low tax income. So, either the IRS benefits, or companies like AmEx and Capital One will benefit (citizens make extra payments on their credit card debt). I doubt the $150 billion will do a lot to stimulate consumer spending.
From Dr. Roubini’s excellent blog today it appears he still believes the monolines will be downgraded. It is my gut feeling that Wall Street and the government will never allow this to happen without some kind of plan put in place to protect municipal bonds and money markets. Downgrading MBIA and ABK without such a plan, I think, would indeed cause the kind of systemic financial meltdown that the Prof. has described. And the impact of this to the economy is too great to be permitted. I still believe the powers that be will pull out all the stops in order to prevent this from happening. To allow a downgrade without a protection plan, I think, would be seen by historians as a crucial error comparable with the Smoot-Hawley Tariff of 1930 and the Fed raising interest rates in 1931. IMO, a downgrade of the monolines, without a plan to protect the financial system from the ramifications, could be the seminal event that drives us into a New Depression.
PRofessor Ropubini A very thoughtful analysis – think you are correct. At the risk of over-simplification, I think the underlying issue is that of asset price deflation and the financial system. It has been a while since I read Bernanke’s papers but my impression is that he thought that action by the Fed could prevent a financial crisis or meltdown and spiral downwards in asset prices. I am not convinced and believe strongly that the causality flows from falling asset prices leading to risk of a financial crisis (at times I have the impression Bernanke held the opposite view). So far the view that falling asset prices lead to a financial crisis is being born out – falling house prices and the declines in financial assets built on the housing market are pushing the financial system towards a deepening crisis. The key question is how far asset prices, notably housing fall will. You are quite correct in detailing the feedbacks from the financial system crisis to the economy and asset prices. A key point why the whole process may be an inevitable downward spiral is the shift in expectations accompanying falling asset prices. Once there is a profound shift frome expectations of asset price appreciation to expectations of depreciation, a major prop supporting asset markets is lost (witness the housing market) and it will not return soon. In this light research by Shiller and others has highlighted the role of expectations of future price appreciation in fuelling the housing boom/bubble.
I believe the monoline solution will involve: (1) Partial forbearance or hiding compromised debt AKA Japan ’90′s (2) TAF-like below-market lending from FED to nonbank entities (maybe leaping over redtape fenceoffs)Activist FED moving beyond legal constraints like FED executive orders (3) Partial bailout with FDIC like FSLIC funds in 80′s, even if benefitted entities are outside traditional insured base (4) congressional intervention to orchestrate public bailout with taxdollars (5) If liquidation becomes necessary, orderly and drawn-out sequentially timed auctions of securities to avoid dumping into price depression (6) Devil-may-care inflationary policy to meet shortcomings with price instability exchanged for reduced systemic risk. Already at hand. Put these together in context with our current account deficit, budget deficit, war expeditures, and babyboomer social programs, how can the US government not have their credit rating reduced. And if not overtly reduced, foreign buyers of debt will take market signals to the same effect.
Am missing the regular posters. This blog is not the same without them. Can anyone provide the acheson (sp?) blog address, where it was suggested some might move to avoid the registration process on RGE? Might Dr. Roubini consider revolking the registration requirement to attract regular bloggers back to this site? Thanks.
@Octavio: First, thanks for your excellent reply. I did appreciate Mr. Fisher’s allusions to Johnson-Martin, but he watered it down by spending a few paragraphs congratulating himself and the Fed Board for its current degree of “independence”. It appears to me that the Fed’s right on-board with Admin policy, and has been for quite some time – certainly throughout Greenspan’s tenure, and I haven’t heard anything terribly insightful or “off-message” from Bernanke to date. If the Fed truly is “independent”, why haven’t we heard any independent testimony in front of Congress? The only ideas forthcoming from the Fed seem more directed at reducing economic losses to banks instead of increasing the economic viability of the country at large. And while it’s laudable that Mr. Fisher voted against reduction in the FF rate, he was quite silent about viable alternatives – although I certainly grant your point that if he had new ideas, it probably wouldn’t do to vet them aloud for the first time in a foreign country. I still can’t find the “beef”.
As I finished the final sentence of this piece, I glanced down at my computer clock. It read “19:29″.
Written by OuterBeltway on 2008-02-08 12:59:25 And even less “beef” in these: Fed’s Yellen Says U.S. Will Probably Avoid Recession (Update1) By Vivien Lou Chen http://www.bloomberg.com/apps/news?pid=20601103&sid=arGUDMqRo99Y&refer=us Atlanta Fed’s Lockhart says inflation ‘above my personal comfort zone’ 02.08.08, 12:46 PM ET http://www.forbes.com/markets/feeds/afx/2008/02/08/afx4633499.html
@Octavio ”Fed’s Lockhart says inflation ‘above my personal comfort zone’” Can’t he ask for a pay raise, in his position?
@Guest 12:19:51 acheson.wordpress.com
@London Banker previous thread: “Herbert Walker sold billions of dollars of bonds… Many…became worthless during the depression… no one…held accountable… Prescott Bush…president of Fritz Thyssen’s US bank and the Holland Amerika Line… seized at the start of WWII as enemy property…never prosecuted… Instead, Prescott Bush became a…senator… his protege Richard Nixon… president. His son… 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… for some.” If the Republicans and Bush are so bad, why don’t the House Democrats as a majority do something? If the country has its worst administration in history, what are our precious Democrats doing about it? Nothing! The word “impeachment” is not even mentionable. Yes, America has its worst president in a while. And it also has its worst Democrat majority in a while. When Paulson goes to the House and huddles down with the Democrat and Republican leadership, he gets a bill in a minute. Why? They are the same people. The point is that the country can no longer sustain a One Party oligarchy. It disenfranchises too many people. Thomas Jefferson rightfully considered party politics the opposite of freedom. I am tired of one-party politics.
Professor, I would like to see a post titled along the lines “Ten things that can be done to mitigate or reduce the impact of the coming systemic financial crisis”. You have done an excellent job of predicting the various tipping points and their causes with regards to the economy. I would hope that you have some ideas on how to stem the problems. If you were able to come up with a plan of action that caught fire you would go down as the most important economic mind of our times. Simply forcasting disaster is easy… avoiding it may be much more difficult. Here are a couple of my ideas. First, Abolish the tax code and implement a flat tax. Second, Sell some of the ghost towns you often refer to to foreign governments. Third, Abolish the FED. Fourth, Stop all foreign aid until our government is no longer operating in deficit. Fifth, Stop all domestic non emergency government spending until our government is no longer operating in deficit. Sixth, Reconcile our national debt Seventh, Reduce our dependency on foreign oil by taxing it to pay down our national debt. Eighth, End the unnessesary spending on the war in Iraq. How much more good can we do for them anyways???? Ninth, Work with world governments to establish a worldwide currency. Tenth, Ensure all parties responsibile for the current crisis are held accountable… unlike their books.
@ richinar You want to abolish the FED, but have on world currency. I’m confused on your thinking with this. I agree the FED needs to go, but I don’t agree on a world currency.
Off-topic — politics Guest wrote on 2008-02-08 13:55:55 “Yes, America has its worst president in a while. And it also has its worst Democrat majority in a while.” I truly believe this will change for the better on January 20, 2009 when Barack Obama is inaugurated President. Guest also wrote on 2008-02-08 13:55:55 “The point is that the country can no longer sustain a One Party oligarchy. It disenfranchises too many people. Thomas Jefferson rightfully considered party politics the opposite of freedom. I am tired of one-party politics.” I think there are very real and significant differences between the parties in their political and economic philosophies. The problem is a lack of backbone, leadership, and vision among our political “leaders”. This will also change when Obama is President. To paraphrase Gerald Ford: On January 20, 2009, our long national nightmare will be over. This statement is much more true now than it was when Nixon resigned in 1974.
If there is an economic comparability to an electrical engineer, it is Nouriel Roubini. One of the finest examples of his overall economic insight is today’s explanation of where we are, how we got here, and where we’re headed. Rarely do I encounter an economist who, IMO, can envision the economic system in its entirety, front to end, and apply it. Most economists, it seems to me, prefer to concentrate on specific trees and miss the forest. Just a way of saying thanks, I guess, for today’s update on the economy’s repositioning. It has been extremely helpful to me.
“Tape painting” just started. Let’s see how high they can get it up in 25 min. Short covering?
Written by richinar on 2008-02-08 13:56:35 First, Abolish the tax code and implement a flat tax. - A straight flat tax is regressive – we already have enough of a gap between the haves and have nots – better a simplified tiered percentage system with breaks only for things that invest in the future (i.e. education, raising a child, creating jobs). Second, Sell some of the ghost towns you often refer to to foreign governments. - How much do you think this would raise? Wouldn’t these governments demand some kind of sovereignty over said property? Third, Abolish the FED. - Sure, sounds like a plan. Better to have a government equivalent. Now how do we avoid corruption and incompetence? Fourth, Stop all foreign aid until our government is no longer operating in deficit. - Okay with that except for humanitarian aid/disaster relief – no need to be the stingy bastards of the planet. Fifth, Stop all domestic non emergency government spending until our government is no longer operating in deficit. - Short sighted I’m afraid. Cut “pork”? Sure. But it’s tough to do without also cutting investment (i.e. research and development). And if you cut social spending you will have an emergency before too long. Sixth, Reconcile our national debt. - A very good idea in theory. Seventh, Reduce our dependency on foreign oil by taxing it to pay down our national debt. - Prefer a debit card style gas rationing system whereby an “energy hog” tax is added to every gallon over a given ration. Less damaging to the poor, working or otherwise and a market could be created for re-sale of unused rations. Eighth, End the unnessesary spending on the war in Iraq. How much more good can we do for them anyways???? - Good with me. Unfortunately it wouldn’t be responsible to cut said spending to $0 as it seems that since we broke it we bear some responsibility for fixing it. Ninth, Work with world governments to establish a worldwide currency. - Other than ending exchange speculation how would this be advantageous? I’m thinking that an alternative monetary base could be energy which everyone uses, but how to do it? Tenth, Ensure all parties responsibile for the current crisis are held accountable… unlike their books. - Lock ‘em up!
@KJFoehr: “Off-topic — politics” I believe what you mean to day is that “personal” politics is off-topic. You brought your candidate into it. I didn’t. Politics, per se, is very much a part of economic policy – witness who moves the chess pieces on the economic chessboard. Even the Fed was introduced into the economy via politics – under Woodrow Wilson. I respect your views: but I cannot agree that politics is not deeply involved in the American economy.
All of the neocons at the CPAC convention this morning were chanting “four more years” when Bush came on stage. Will they still be singing the same tune next fall when we are in a deep recession? http://jtaplin.wordpress.com/2008/02/08/george-w-bust/
“chanting “four more years” when Bush came on stage. “ it’s a cult.
Guest wrote on 2008-02-08 14:55:09 “I respect your views: but I cannot agree that politics is not deeply involved in the American economy.” Actually, I also believe politics is deeply intertwined with the economy. I was merely warning those who may be irritated by reading a post that strays too far away from the “thread” topic, and to those who don’t want to read any gratuitous political comments / advocacy. I also respect your views, and I feel strongly that more respect for the differing views of others is sorely needed in our country now.
@ Octavio Richetta on 2008-02-08 08:54:02 ”(I liked the Single-Malt/Tequila analogy very much). You may argue we already knew what the guy was thinking; now we know.” Do you happen to have a link to this? I missed it and now I am deeply intrigued. Also very interested in the full metaphor!
Moving on Up to a Free Lunch It turns out — as President Bush claims — the top 40 percent of US taxpayers did pay a greater share of taxes in 2005 than in 2000. It was just the tip-top tenth of 1 percent, those 300,000 men and women and children who made at least $1.7 million in 2005, who got the big tax relief. That’s the way investigative reporter David Cay Johnston tells it in his new book, “Free Lunch.” Johnston recalls Bush’s famous remarks to a white-tie crowd at the Waldorf-Astoria during his 2000 campaign. Referring to his audience as the “haves and have mores,” he said, “Some people call you the elite. I call you my base.” Syndicated columnist Froma Harrop, delving Tuesday into “Free Lunch,” said the 300,000 “have mores” made nearly as much money as all150 million Americans in the lower half in 20005. http://www.creators.com/opinion/froma-harrop/-i-call-you-my-base.html “So the high earners below this super-elite accounted for the entire heavier burden of the top 40 percent. These are the members of the upper middle class — the doctors, lawyers and businesspeople who have to work for their money,” she writes. “For the connected, government gives away public land at deep discounts. It jiggers the tax code to make moving factories to China more profitable. It undoes safety regulations that subtract from the bottom line. It weakens consumer protections, letting financial institutions prey on the unsophisticated and the not-very-bright. In fine-print legislation, it shifts risk from the corporate managers onto investors and makes the taxpayer cover their mistakes. There’s a reason why the number of registered lobbyists in Washington has more than doubled to 35,000 since Bush took office.” Money Tip by Guest: The top 5% who earn about $550,000 up pay about 40% of US taxes. But those just beneath are taxed a close rate with little paycheck left at the end of the day. This means a $102,000 professional single living in San Jose in a median five-room $700,000 house with a 30-year mortgage at 6% is out about $70,000 — for mortgage payments ($31,000), for property taxes ($9,000), Social Security ($6,324)*, Medicare ($1,479), 401k ($15,500) and car payments ($6,720) — leaving a robust $32,000 for federal incomes taxes, state taxes, house insurance, utilities, gasoline, car insurance, food, state disability insurance, car repair… Not much is left for lunch, even at McDonald’s, so I suggest a Smart Money tip: boost your salary by $1,598,000 and qualify for a “free lunch.” *represents a 4.6% increase over last year’s maximum
DUMBED DOWN AMERICAN CRISIS MANAGEMENT Dr. Roubini is my favorite economist, he’s terrifying at times, but pragmatic. His predictions come true too. I’d add to his article today that yes, we need more math and science in our schools…..but especially in our elite management of this fragile economy. I read on AP news yesterday, which Dr. Roubini referenced too, that unemployment “new” files were 356K for last week! That’s horrifying. Do the math, extrapolating this worse case last week to a whole year: 356,000 x 52= 18,000,000 new unemployment filings per year…. What is that? An approximate 10-20% American 2008 unemployment rate if it doesn’t improve from last week? Sounds more like a stagdeflation great depression, than a severe recession if that happens.
@KJFoehr I get it: makes sense. Thanks for the clarification!
http://www.markit.com/information/products/abx.html the bad… http://www.markit.com/information/products/lcdx.html the worse… http://www.markit.com/information/products/cmbx.html the worst… doh ! it is difficult to see a bounce through this – in my twisted often incorrect mind i still assign a chance and begrudgingly resources to a significant rally from here coupled with many out of the money puts in case we go into the abyss soon… does anyone know how i can get my user name to work at home – i can only access the blog from work where i guess my e-mail is authenticated – but obviously it would be great to be able to access from home as well ? i can citrix in to work but no internet published on the session…
Dr. Roubini, Thanks for shining a light a letting us have access to your clear insight. God bless you, sit!
JMa, You can always use RGE registration username and password to read my blog from home or anywhere else you are. Best, Nouriel
Dr. Roubini First, thank you for this blog. I’m becoming very concerned about FHLB. I’m new to this field, and finding it hard to figure out exactly what’s actually going on, but it seems to me that FHLB is taking on massive amounts of (probably bad) mortgage debt at face value. What happens when FHLB becomes insolvent? A public bail-out? Is there any structure in place to limit the ability of private banks to sell their bad mortgages to the FHLB system? It looks to me like this is an under-appreciated problem that could become huge. But you’re much better connected to this information than I am, so I’d appreciate being told I’m wrong, and why. thanks, lilnev
Prof. It may be true that using public money is “inappropriate” to bailing out mad mortgages and propping up home prices, but given that there is zero political interest in letting those prices fall, the only alternative is to inflate the prices of everything else and let home prices remain where they are nominally, but fall in real terms. As we have seen, the House just passed a massive increase in the GSEs, and OFHEO. There is no chance that this will be ratchetted down. The bailout/inflation plan is well underway.
Professor, which trick is more DIRTY? 1) Freezing the resets for those mortgage borrowers at 1% teaser rate? 2) Lending Countrywide et al with $750 Billion? I would say option 1 is more Dirty! Why? Since it involves changing CONTRACT at will to obviously bailing out the Speculators. At least lending Countrywide et al come with a discount to collateral, and all borrowings are conducted according to decades of laws and rules. Of course one could argue the value of collateral, but again, it does not break any existing laws and rules. With these teaser rates, these housing speculators won in 2003, 2004, 2005 and 2006, and they get to keep the profit. Now that they loss due to these teaser rate, they got bailed out by your proposal of freezing teaser rate at 1%. Because of this proposal, all future RESPONSIBLE home buyer like me would have to shell out higher mortgage rate because the lender now demands “contract risk protection” . Seems like Professor love Dirty Trick eh.
Miss America- Oh yes baby!!! I love it when you talk dirty like that!!!
JMa wrote on 2008-02-08 15:49:24 “http://www.markit.com/information/products/abx.html the bad… http://www.markit.com/information/products/lcdx.html the worse… http://www.markit.com/information/products/cmbx.html the worst… doh ! it is difficult to see a bounce through this – in my twisted often incorrect mind i still assign a chance and begrudgingly resources to a significant rally from here coupled with many out of the money puts in case we go into the abyss soon…” What is going on with the CMBXs? The spreads are through the roof! Does anyone know what was the catalyst for this movement today? And CDXs don’t look much better! http://www.markit.com/information/products/cdx.html The way these credit markets look, “they” had better come up with a VERY good plan for the monolines next week; otherwise financials, and maybe the whole stock market, are going to break!
@ JMa Try logging out from RGE Monitor before leaving the office. I too have trouble from my laptop if I haven’t logged out of an active session on my desktop.
Dr Roubini Thanks for your excellent articles Can you please explain where the notional value of OTC derivitives fits into this scenario. The Bank of International Settlements states that the total amount is $516 Trillion (June 2007) yet this has a face value of $15 Trillion. I don’t work in the financial world, just morbidly facinated by this crisis. Mike Peters
I wish I could see the pitchbooks and/or other presentation materials used by “top” senior bankers on their quests for SWF capital.
Look at this fellows: (http://www.federalreserve.gov/Releases/H3/Current/ ). Table 1 under “non-borrowed” column. This shows that banks money in Nov. 2007 was positive $42.2B and in January 2008 it became negative $8.7B. In only two month such a huge loss of money. It looks very ominous, does not it? May be some of you with more expertise can elaborate more on this one.
“What is going on with the CMBXs? The spreads are through the roof! Does anyone know what was the catalyst for this movement today? And CDXs don’t look much better! “ According to Gary Dorsch, SirChartsAlot.com, “In a shocking development, OPEC signaled it might abandon the US dollar for pricing oil and adopt the Euro Ifthe Arab oil kingdoms sense a US Democratic victory in November, Petro-dollars will begin to flow to gold, and the US dollar peg with the Saudi riyal and other Persian Gulf currencies could crack overnight. Iran appears to have know-how to produce enough material for a single nuclear warhead in a year. The neo-cons in Washington have a smoking gun, for a military strike on Iran.” There’s more, posted on his website.
thanks for log in from home tips !
Written by BK on 2008-02-08 15:41:04 http://www.dallasfed.org/news/speeches/fisher/2008/fs080207.cfm
Written by JMa on 2008-02-08 17:49:38 And one more “stupid” tip: Go to “Manage my Account” and change the random initial password to something you can remember, and type from anywhere!
“I’m becoming very concerned about FHLB. I’m new to this field, and finding it hard to figure out exactly what’s actually going on, but it seems to me that FHLB is taking on massive amounts of (probably bad) mortgage debt at face value. What happens when FHLB becomes insolvent? A public bail-out? Is there any structure in place to limit the ability of private banks to sell their bad mortgages to the FHLB system? It looks to me like this is an under-appreciated problem that could become huge. But you’re much better connected to this information than I am, so I’d appreciate being told I’m wrong, and why. thanks, lilnev According to the 2008 PNB Paribas report, government backed finance implicitly financed the bulk of the financial sector’s credit market activities in Q3 and so kept the financial system afloat. The FHLB was, in feffect, operating as the financial system’s lender of last resort as the credit crunch intensified. Total borrowing for government sponsored enterprises soared to a “truly mind boggling 15.2% of GDP in Q3. Now here’s the good part. ” When an FHLB member bank fails, the FHLB is first in line for repayment before even the FDIC” See the Jan 14, 2008 BNP Paribas US Market Outlook, pages 14, 15.
Mortgage defaults are GREATLY exceeding the estimates derived from “rocket science” garbage in-garbage out models. The Rise of the Mortgage ‘Walkers’ By NICOLE GELINAS February 8, 2008; Page A17 http://online.wsj.com/article/SB120243369715152501.html?mod=rss_opinion_main Fitch Ratings, while telling investors last Friday to expect additional “widespread and significant downgrades” on $139 billion worth of subprime loans, has cited a new factor in their “worsening performance.” ”The apparent willingness of borrowers to ‘walk away’ from mortgage debt,” the analysts noted, “has contributed to extraordinary high levels of early default” on loans issued during the 18 months before the mortgage bubble burst. It expects losses to reach 21% of initial loan balances for subprime mortgages issued in 2006 and 26% for those issued in early 2007. Such behavior, where not precipitated by willful fraud, shows that American homebuyers supposedly duped by their lenders aren’t so dumb. They’re perfectly capable of acting rationally without political interference. … Essentially, mortgage-bond investors, seemingly unwittingly, sold homebuyers a put option, without properly pricing it, and now homeowners are exercising that option. Moreover, prime borrowers in many markets face the same incentives. Yes, this behavior is new — but only when it comes to houses. Americans have long been able to cut their losses from bad investments and start over. It stands to reason that when the market made houses into yet another speculative investment, Americans would do the same
WAWAWA wrote on 2008-02-08 17:36:13 “Look at this fellows: (http://www.federalreserve.gov/Releases/H3/Current/ ). Table 1 under “non-borrowed” column. This shows that banks money in Nov. 2007 was positive $42.2B and in January 2008 it became negative $8.7B. In only two month such a huge loss of money. It looks very ominous, does not it? May be some of you with more expertise can elaborate more on this one.” I’m not sure about this, and I would love to hear an explanation from an expert on it too. But my assumption is that the number in the first column is the amount of reserves on hand, and the second column is the amount of those reserves that are not borrowed from the Fed. So in this report (Table 1) it means the reserves held by member banks for Jan 30 were $41.635 Billion, and the amount borrowed from the Federal Reserve was $50.390 Billion. (The difference between columns one and two. Therefore, it appears the amount of borrowed funds held by “depository institutions” is greater than their reserves (by $7.775 Billion). I suppose this is the result of the two big auctions the Fed had in January to push money out to the banks that needed funds. It is obviously an unsustainable situation, but I don’t know how long the member banks have to pay back to money to the Fed. And I suppose if the crisis continues, the Fed will just roll-over the loans indefinitely until the crisis is over, if possible… Yet, it does indicate some banks are apparently in serious trouble, but then we already knew that. We just don’t know, for sure, who and how much trouble they are in. Can any experts comment on this?
Can any experts comment on this? Written by KJ Foehr on 2008-02-08 20:10:24 See: http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_baum&sid=a7EAJelhvLh0 –iww
@Anonymous: “I moved my 401(k) funds at work in to the Nationwide Money Market Fund (formerly Gartmore Money Market Fund). Should I be concerned about these money market funds?” If they aren’t insured you should be concerned. You can lose all your money. I’ve always believed that the majority of companies intentionally limit 401(k investment choices to the stock market or to very low-rate uninsured Money Market funds as a way for Wall Street to insure itself a constant supply of money flow. If you are referring to Nationwide Bank’s Money Market fund, it is FDIC insured up to $100,000 per deposit And your rate probably is “competitive.”
@ KJ Foehr & WAWAWA: I am not an expert, but I do find this facinating. I believe the take home message from these figures is this: The banks are borrowing even their mandated reserves from the FED. This has never happened before as I understand it. Why? How much trouble are they in? If you go back and read NR’s last 2 posts, you will know how much. This is a disaster on an unbelievable scale. I have doubts not only about banks and financial institutions, but about the government being able to borrow to keep this country afloat. Hard times indeed are on their way – nothing like anyone has seen in their lifetime.
off topic @KJ Foehr ”I feel strongly that more respect for the differing views of others is sorely needed in our country now.” I would like to cheer this sentiment wholeheartedly. It is our best chance for survival.
Hard times indeed are on their way – nothing like anyone has seen in their lifetime. Written by Medic on 2008-02-08 20:54:56 Oh, please! Let’s control our hysteria. And let’s go read that Bloomberg article above. –iww
@ iww: If I am hysterical, then I am in good company. If I am overreacting and being a fool, then so be it. If you don’t believe that the US is in severe trouble, I feel badly for you. As I have said here before, with an economy based on consumerism (70%), this was destined to fail. Fixing our system will be difficult and take some time. The hardest step will be the first – honesty. ”Given a choice between changing and proving that it is not necessary, most people get busy with the proof” – John Kenneth Galbraith
@Octavio: “The apparent willingness of borrowers to ‘walk away’ from mortgage debt…shows that American homebuyers supposedly duped by their lenders aren’t so dumb… mortgage-bond investors, seemingly unwittingly, sold homebuyers a put option, without properly pricing it, and now homeowners are exercising that option… It stands to reason that when the market made houses into yet another speculative investment, Americans would do the same.” I hope no one misses this story. Walking away from a 20% down mortgage may be unthinkable, but it’s tempting to walk from a 5% down when all your neighbors’ houses are tanking. I thought Gelinas’ point that a high number of “walkers” cutting losses, particularly in prime, may mean bad credit scores will be less critical in the future. After all, lenders will need these buyers again to buy houses. With a big down payment, a horrible credit score may not look so bad. Too bad the public caught on to the maestro’s magic… Incidentally, I thought today’s entire WSJ, front to back, a portent of hard landing in process.
@ KJFoehr: “…it appears the amount of borrowed funds held by ‘depository institutions’ is greater than their reserves (by $7.775 Billion)… It is obviously an unsustainable situation… I suppose if the crisis continues, the Fed will just roll-over the loans indefinitely until the crisis is over, if possible… If a country could build an economy out of printing money, then Zimbabwe and Argentina would lead the world. I think the SWF’s are figuring this out. @“Can any experts comment on this?“ — Where is Slumlord when you need him?
While the rest of you are predicting the end of the world as we know it let me just state -as some one involved in construction and real estate -that things are starting to move . Repossessed homes are selling for 40% less then what they sold for in 06 , my employees ( in construction ) are willing to accept at least a $1-$4 an hr cut in wages in exchange for job security , all of our resubmitted bids ( reflecting the lower wage costs and conditional on the work starting this month ) have been accepted . All of our employees currently on unemployment will be rehired by March . They dont ring a bell at the top of a market -neither at the bottom At a certain price the market moves -there is money waiting on the sidelines
Some thoughts by Dr. Nikolai Bezroukov on Softpanorama. http://www.softpanorama.org/Skeptics/Financial_skeptic/Protecting_your_401K/index.shtml Now the rich person having $60M/year in fresh investment money can invest that money very efficiently and can afford to have very competent investment advisers. They might very well make an after-inflation return of 3% off of conservative investments. Our poor but thrifty person either puts the money in the bank (getting perhaps -3% after inflation) or follows the advice on the TV networks and loses even more money buying overpriced stock and getting caught in pyramid schemes. Dean Baker in his Year of the fat cats made a very similar observation: “…If we go back 10 years, we find that the … average real return on [the S&P 500] … has been 3.2%, a bit lower than the yield that was available on inflation-indexed government bonds 10 years ago. “This is rather striking. It is unlikely that many people invested in stock for the sort of return that is typically associated with government bonds, which are much less risky. At least for the last decade, stockholders have not been rewarded for taking this risk. [ It was Wall Street that was rewarded for all the risk 401K investors had taken --NNB] “This brings us to the topic of CEO pay. We saw an explosion in CEO pay that began in the 1980s and has continued into the current decade. … “This explosion of pay at the top was justified by many economists based on the returns that they produced for shareholders. The argument was that even these incredibly high salaries still were just a small fraction of the value that the CEOs generated, so their pay was money well spent. These exorbitant salaries gave the CEOs the necessary incentive to produce extraordinary returns.” But the real shift in public sentiment happened in 2008. On Feb 8, 2008 naked capitalism reported: “In the last month or so, I have noticed a marked increase in hostility towards the financial services industry, both in the number of cynical, critical comments on this blog and the intensity of their venom. These are a few from the last week: “’The wealth creation over the past decade plus has been on the back of a system that has grown more corrupt by the year. It is a parasitic system that is rotten to the core and feeding off the real economy, empowered by the bankrupt foreign economic policy that has essentially given away our competitive advantages and gutted out industrial base. Who said American’s aren’t generous? ……’ ”’Global collusion and financial engineering gurus fused together packages of localized loan pools into globalized loan pools in hopes that the default rates would be insignificant and thus any impairment or dilution would be diluted to zero risk.’ ”’The result of what these gurus engineered is a global systemic financial failure resulting in denial on their part, no accountability on their part and defaults on a global scale never before seen. These gurus will return to Davos with new derivatives and be held in high regard, versus being placed into global prison cells! …..’ ”’Wall Street has become a conduit unto itself and a zero sum wealth ‘creator’ for the financial economy at the expense of the real economy. We are heading for a complete disaster and the more you read this moronic commentary [from a Wall Street strategist] the more you realize that never has there been a better time to sell. Rotten to the core.’”
@Anonymous: “Repossessed homes are selling for 40% less then what they sold for in 06…” I am interested in real estate — in certain locations. But not falling real estate in new developments outside of reasonable driving distance near prime employment markets. Would it be fair of me to ask where these repossessed homes you mention are, and in what general area you are located where new construction is reviving? Thanks for any input you can give me.
My comments about real estate concern Northern California -primarliy Marin to Sonoma counties . These are early signs . Construction workers willing to work for less in exchange for job security. Bank repo’s selling for 40% below 06 prices . Patient investors with good credit and a time horizon beyond a year ( these are not flippers ) are staring to move . These are investors who have been through several real estate cycles and have owned property in various states for over 30 yrs.
baum sounds wrong to me on bank reserves…there was a fundamental qualitative shift…with the TAF the fed is taking cdos and cmos as collateral, which is not the case with the repos…the fed is now stuck with illiquid and overvalued collateral…slumlord will hopefully have more to say on this…i find it suspicious that the st. louis fed just changed the way they calculate net free reserves so that the previous five decades look more volatile than before and the current situation doesn’t look as bad…what is it now based on the h.3?…minus $48.9 billion?…and that’s an understatement because h.3 gives the two-week daily average…whereas we know from the h.4 that the TAF is not $50 billion outstanding but $60 billion…she says the fed doesn’t care…no…the fed cares…the question of reserves may be so sensitive that baum could only write one side of the story…
–iww wrote as Guest on 2008-02-08 21:12:32 “Oh, please! Let’s control our hysteria. And let’s go read that Bloomberg article above.” http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_baum&sid=a7EAJelhvLh0 I know this is something I know very little about, so maybe it’s just me, but this article is about as clear as mud! Early in the article the author says, “Volcker knew interest rates had to rise significantly to slay the inflation dragon; he didn’t know by how much. So he changed the Fed’s operating procedure from targeting a price (the overnight interbank lending rate) to a quantity (the monetary aggregates — specifically non-borrowed reserves).” This indicates that non-borrowed reserves are important – so important that Volcker used it as his tool to raise interest rates and break inflation. So it must be a powerful tool, right? But then in the very next sentence the author cites a quote from some expert who says, “There is no relationship between non-borrowed reserves and anything the Fed cares about, be it inflation, employment or real GDP”. Huh? If there is no relationship, then why did Volcker target it? And how could he have used non-borrowed reserves to raise interest rates and break inflation in the late ‘70s? That’s a mystery to me. Then, a little later, there is more obfuscation: “Reserves can be borrowed (from the Fed’s discount window) or non-borrowed (supplied via the Fed’s daily open market operations). It matters not one whit to the Fed where the banks acquire the reserves they require. If they borrow directly from the Fed, they don’t need to tap the interbank, or fed funds, market.” OK, let’s see… the banks can either borrow the funds from the Fed or from other banks. So all the funds are actually borrowed in either case? That can’t be true, can it? Still later the author writes this, “… the Fed is “a monopoly provider of reserves,” said Jim Glassman, senior U.S. economist at JPMorgan Chase & Co. “This is a non-starter. There is no such thing as a banking system short of reserves. The Fed has absolute control over the supply.” There may be times, such as late last year, when banks are reluctant to lend to one another for a period longer than overnight. “And any one bank can have a problem” funding itself, Glassman said. But in a world where “the Fed can print money, there is no shortage,” he said. “The banks get the reserves they want.”” What’s that add up to? Sounds to me like it means reserves are meaningless! Reserves, schmeserves! Why bother having them at all if there can never be a shortage? Bottom line? No problem! Reserves don’t matter. Borrowings don’t matter. Don’t worry; be happy! The banks can never run out of money, I guess. No matter how much they lose, there is a never ending supply! What a system! What a country! Booyah! Buy! Buy! Buy! I think this author knows less about this subject than she thinks. I don’t know much, but I gotta believe at some point reserves and borrowings do matter! If not how could a bank ever fail? And banks can and do fail! Please correct me where I am wrong; I would really like to get to the reality of this situation. Is it important or not?
From previous thread; @LB, Octavio, GSM, Giraf: “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? “ Written by OuterBeltway on 2008-02-06 09:42:42 My belief is that any MM fund exposed to debt or derivative instruments in mortgage ,Commercial RE or Corp Bonds spheres is potentially tainted. What is known is that LOT’S is not known on the integrity of this paper. This means all surprises will be to the downside. What then remains is the extent of the exposure within the fund to this dodgy paper ie measure the risk. For me if it is anything beyond the value return on treasuries, why accept that risk? In other words, my concerns for now on return OF capital outweigh my desires for return on capital. As a cash type alternative there are some decent hard currency funds around- Merck Hard Currency Fund is not bad.
From Dr. Roubini’s excellent blog today it appears he still believes the monolines will be downgraded. It is my gut feeling that Wall Street and the government will never allow this to happen without some kind of plan put in place to protect municipal bonds and money markets. IMO, a downgrade of the monolines, without a plan to protect the financial system from the ramifications, could be the seminal event that drives us into a New Depression. Written by KJ Foehr on 2008-02-08 11:35:53 @KJ, Please read Ben’s now infamous 2002 speech. It is clear that the Fed , in its plethora of responses to “deflation”, has plans for supporting muni and state bonds etc. This however ignores the plight of the dollar and the damaging Inflation a debased dollar is ushering forth. Chainsawing rates only stokes the inflation now evident in food and energy prices while gutting the savings of the fiscally prudent. Yes, it is wise to prepare for a New Depression- IMHO.
@ Mike Peters There is a huge difference between nominal value of derivatives outstanding and the book or net value of derivatives because of netting. If I buy 100 long contracts and later buy 80 short contracts on a derivatives exchange like the CME, my net position with the clearinghouse as central counterparty is 20 long. In the over the counter (OTC) market, there is no central counterparty or clearinghouse which will centrally net the positions. All positions which haven’t reached maturity (and derivatives can be up to 5 years or longer) remain on the books as open nominal positions. Most banks acting as dealers will have fairly balanced positions over time, with their proprietary trading desks taking some positions they think will be profitable. The result is huge nominal value of derivatives outstanding, but much smaller value at risk on trading books. The big threat to this state of affairs would arise if one or several active OTC derivatives traders went into default, whether banks or hedge funds. This would throw off all the netted positions of their counterparties and cause a lot of stress in the market. @ Non-Borrowed Reserves Commenters There is something very fishy happening in the arcana of monetary and reserve aggregates. The TAF auction always struck me as a corrupt mechanism, relying on secrecy to hide both the price of Fed money and the recipients. Add to that the degradation of collateral as the Fed accepts toxic waste at 85 percent of face value, and you know that the picture you see in the statistics no longer correlates to the reality on the ground. With all respect to Caroline Baum, How Non-Borrowed Reserves Became a Sexy Subject, this is not the 1970s and Bernanke is not Volker. There was good reason to trust that Volker was giving the US economy the medicine it needed to cure the ills amassed under Johnson, Nixon and Ford (unfunded war spending, dollar devaluation, bloated government deficits, etc.). There is no reason to trust that Bernanke is giving the economy the medicine it needs rather than stripping the economy to add to the spoils of Bush administration cronies.
Written by London Banker on 2008-02-09 03:42:48 ”There is no reason to trust that Bernanke is giving the economy the medicine it needs rather than stripping the economy to add to the spoils of Bush administration cronies.” In addition, don’t forget Benny is a registered republican (NYT magazine article on Benny I posted in early January) and we are in an election year…
Latest forecast on US economy from NT: Recession Now – Putting Our Forecast Where Our Mouth Has Been http://web-xp2a-pws.ntrs.com/popups/popup.html?http://web-xp2a-pws.ntrs.com/content//media/attachment/data/econ_research/0802/document/us0208.pdf
As I said – good company.
Umm, isn’t there a moral hazard problem with the idea that lenders should consider writing off 10-20% of a person’s mortgage?? This, like lowering interest rates in the face of this mess are two suggestions by Roubini that just don’t make sense! These ideas are the same poison that got us into this mess. Unfortunately, the only cure is default, pain, and time to recover a savings. All other ideas are just economist and politician machismo.
Abelson this week: Things look pretty bad at Freddie and Fannie: http://online.barrons.com/article/SB120251609108955361.html?mod=9_0031_b_this_weeks_magazine_columns&page=sp …. IN LIKE VEIN, THE DIE-HARD CHEERLEADERS still doing business at the same old treat-and-treacle shop can’t contain their delight that Uncle Sam, freshly empowered by the economic-stimulus plan, will ride to the rescue of the fast-vanishing housing industry by getting Fannie Mae and Freddie Mac to loosen up their lending and guarantee gosh-knows-how-many billions of dollars of mortgages that currently don’t qualify for Fannie and Freddie’s imprimatur. ISI Group’s perspicacious pair, Tom Gallagher and Andy Laperriere, dryly point out one little drawback to this possibility: Fannie and Freddie simply don’t have the scratch for that sort of undertaking (and we use that word advisedly). They cite in the way of support for that melancholy conclusion a recent study by Credit Suisse. Naturally, we lost no time asking our trusty researcher, Teresa Vozzo, to scare up a copy of the Credit Suisse report and, after careful perusal, we can attest it’s strictly a first-rate piece of analysis. Among other eye-openers, it reckons that Freddie could be forced to recognize a write-down for the fourth quarter of last year of $8 billion to $11 billion, which works out to a cool $8 to $11 a share. Those unrealized losses, according to Credit Suisse, would take a king-sized 30%-to-40% bite out of Freddie’s Sept. 30 book value of $27.63 a share. And that would be atop the $3.80-per-share loss estimated for ’07′s final quarter. By the reckoning of analysts Moshe Orenbuch and Kerry Hueston, who authored the report, Fannie faces a smaller hit, but by no means an insignificant one — $2.25 billion to $5 billion, or 5% to 10% of its book value of $31.74 a share. And that doesn’t count the $2.45-a-share loss they expect Fannie to show for last year’s closing quarter, which it should report before this month ends. Fannie’s and Freddie’s woes have not gone unnoticed, except perhaps by the sagacious solons who cobbled together, with more haste than deliberation, the stimulus package. The stocks have taken a terrible shellacking in rather a few months. From above 65, Fannie’s shares have been more than cut in half. Meanwhile, shares of Freddie — which still has large exposure to the credit crunch — have nosedived from the low 60s to under 30. Credit Suisse, in case you wondered, remains negative on both. To state the obvious — one of the skills every journalist quickly acquires and never loses — neither Fannie nor Freddie seems in very good shape to give housing a lift. It’s like asking an exhausted swimmer desperately trying to keep his head above water if perchance he can spare a few life preservers. WE CAN’T THINK OF THE LAST TIME we said anything nice about a government or quasi-governmental institution, except maybe Alcatraz, and darned if they didn’t go and mothball the place. However, we want to commend a very fine primer that’ll tell you everything you need to know and a lot more about mortgages and the mortgage market. It’s in the current Federal Reserve Bank of St. Louis Review, and the authors are Daniel J. McDonald and Daniel L. Thornton. To the two Dans, for a bang-up job in explaining that often-mystifying market clearly and in the mother tongue, we offer a hearty Bravo! http://research.stlouisfed.org/publications/review/08/01/JanFeb08Review.pdf
From a guy who’s been around… “It was late ’06 when [Fed Chairman Benjamin] Bernanke said he thought the high prices of homes in the U.S. merely reflected a strong U.S. economy. Was he not looking at the data?” — Jeremy Grantham This Credit Crisis Has a Long Way to Run Interview with Jeremy Grantham, Chief Investment Strategist, GMO By SANDRA WARD http://online.barrons.com/article/SB120251582071855267.html?mod=9_0031_b_this_weeks_magazine_main ONE OF THE GRANDEST OF THINKERS AND MOST ELOQUENT of oracles, Jeremy Grantham has long been the voice of reason in an industry prone to excesses and embellishment. By taking the long view, blending quantitative strategies and technical analysis with sound and experienced judgment, Grantham, chairman of Boston-based GMO, consistently uncovers with his team the best values among a wide range of global asset classes. The payoff is outstanding performance and risk management. In return, clients have entrusted the firm with about $150 billion. As the man who warned early of a worldwide bubble forming, we turned to him as that bubble has started bursting. Barron’s: You, along with George Soros, have called this the worst financial crisis we’ve had in the post-war era. Grantham: This is much more global than, say, the savings-and-loan crisis was. The world is obviously much more globalized than at any time since the late 19th century and much more interrelated in almost every way, certainly financially. To have the leading economy and the reserve currency having a major-league credit crisis would by itself make it more important than earlier ones. Secondly, this occurred at a time of what I believe is the first global bubble in pretty well all asset prices, so there is a much greater degree of broad-based vulnerability. Then it is a question of degree, and how carried away the sloppy lending was: It was very carried away. Not just in the design of needlessly complicated instruments, but in the enthusiasm — recklessness one might say — with which they were sold. Can these bubbles burst if the Fed is easing the way they are? Well, this is an amazing little tidbit. People think the Federal Reserve can stop a bear market because they can throw money at it and lower interest rates. It is even more certain we can collectively stop a bear market if some fiscal stimulus is thrown in. To which I say, ‘Oh, you mean like 2000 and 2002?’ — when they threw what I call the greatest stimulus in American history, an unparalleled series of interest-rate cuts, cumulating in two, almost three, years of negative real returns, real interest rates coupled with a really substantial tax cut, which would never have happened without 9/11. The combination would have gotten the dead to walk, and it stopped the bear market eventually. But the Standard & Poor’s 500 was down 50% and the Nasdaq — which was all anyone talked about back then — went down 78%. And a puny five to six years later, people are saying there is not going to be a bear market because the Fed is going to lower rates and because the government is going to have a stimulus package. But we have just been there, done that, and we had a nice bear market. … ($)
A bit more from the link above (stuff you have been reading here all along): … Incidentally, it was late in ’06 when [Fed Chairman Benjamin] Bernanke said he thought the high prices of homes in the U.S. merely reflected a strong U.S. economy. Was he not looking at the data? Did he not measure long-term house prices? Had he not seen how they ebbed and flowed as a multiple of family income, which they do here and in the U.K. and everywhere else? And with it being so obviously a bubble, how could he have said that? He was taking his cue from Alan Greenspan, who said we should all be taking out adjustable-rate mortgages. Greenspan and Bernanke have taken a hands-off approach for two consecutive great bubbles, first in TMT — telecommunications, media and technology — and second, in housing. A hands-off approach is a polite way of saying they facilitated this. And what is the point of a 125-basis-point rate reduction, other than to provide reinforcement for the people who borrow short and lend long? From bankers who have committed every crime you could possibly accuse a banker of, to hedge funds who borrow short, leverage, and invest long in the stock market — that’s who really benefits from the interest-rate reduction. The economy, broadly defined, does not. I have an exhibit that shows the 30 years prior to 1982 when the debt-to-gross domestic product ratio was completely flat at 1.2 times. Total debt is defined as government debt, personal debt, corporate debt and financial debt. Then in the 25 years after 1982, the flat line goes up at a 45 degrees angle from 1.2 times to 3.1 times GDP. Massive. In the first 30 years, when debt is flat, annual GDP growth is its usual battleship, growing at 3.5% and hardly twitching. After the massive increase in debt, GDP, far from accelerating, grew at 3%. So debt in the aggregate does not drive the economy. The economy is driven by education, man-hours worked, capital investment and technology. It is not driven by what I owe you and you owe me. So the Fed’s actions won’t stave off a slowdown? Since when did the thought of an economic slowdown induce such hysteria? That was a response to the decline in global markets. It was aimed at the stock market. It was aimed at banking disorder and banking profits. It doesn’t have that much of a powerful effect on the economy. If it had any more profound effect, there would be a positive relationship between debt increasing and GDP growth, and there is none. But it is driving down the dollar. It drives down the dollar, which is inflationary, and, eventually, it could be seriously inflationary. …
KJ Foehr on 2008-02-09 00:21:59 The Bloomberg article is quite correct. The Fed controls the level of reserves to manage the funds rate around its target level. The high level of borrowed reserves is simply a result of the TAF process, which enables some banks to source required reserves when they are having trouble borrowing them normally from the interbank market. This is irrelevant to the Fed’s ability to manage total system reserves at a level that allows funds to trade close to the target interest rate. The TAF is just an extension of the discount window. Both are a form of borrowed reserves. Volcker targeted money supply, but he targeted interest rates (i.e. the funds rate) in order to do it. Today’s Fed targets the funds rate in response to many economic and financial conditions, of which money supply is very low on the list. The Fed always targets interest rates (the funds rate). It’s a false comparison (often made) to say that Volcker targeted money supply instead of interest rates. That’s simply not the case – he did both.
Mike Peters Americans should be concerned about the explosion in derivatives trading at our largest banks. Warren Buffet has already summarized this situation quite neatly: “Derivatives are weapons of financial mass destruction”. The explosion of derivatives poses serious risks in the world of both large banks and hedge funds. As LB noted, one risk is the possibility of counterparty default. Derivatives really only work if there are winners and losers. For every trade, there must be a winner and a loser. If someone cannot pay (default), then losses can ripple through the system. For this reason I think that it was very foolish for the Fed (in the Greenspan years) to allow the enormous growth in OTC derivatives trading (OTC deals are negotiated privately). In reality, a big part of the exploding derviatives trad is based on mutually cancelling deals. Imagine you run a trading desk at a large bank. You make a derivatives trade that says a certain interest rate will go up. Then you make a second deal (with another party) that the same intertest rate will go down. These two trades are mutually offsetting. What you gain on one trade, you lose on the other. So why do this? Because by carefully managing the terms of the deal, and the length of the contracts, you can make a slight price gain on the pair of contracts. And then, when you run an enormous number of deals, you make good money. So that’s one way that they are operating (but not always – straight derivatives deals still exist too). However, Wall St is being too smart for its own good. The swcheme I have described can also fall apart, and generate very big losses. All it takes is for the market to move in ways that are unexpected (outside the parameters of trading models). Then they are sunk. So it’s still a risky game. PeteCA
Lilnev: “I’m becoming very concerned about FHLB. I’m new to this field, and finding it hard to figure out exactly what’s actually going on …” Lilnev, what’s going on is that we are nationalizing these bad mortgage debts. Huge numbers of lousy mortgage deals are being funneled into the FHLB. The losses will eventually be passed to the American taxpayer – either through higher inflation rates (Fed expanding the money supply), or if the system collapses in the future and the US Gov’t is forced to default on its own debt. In addition to the explosion of bad debts being pushed onto the Federal Home Loan Bank (FHLB) – these mortgages now adding up to hundreds of bilions of dollars – there is also the problem of the latest Gov’t budget. The proposed budget by the US administration includes a deficit exceeding $400 billion for this year. Add that into the existing federal budget deficit, now bigger than $9200 billion dollars. Uncle Sam is hading for a downgrade on its credit rating. And when that happens, it might not simply be from AAA down to AA. More like AAA down to BB. When the ratings companies do FINALLY catch up and revise their credit ratings, the change can be a big shock! As an American, you have a right to be emotional about this. We are ruining this country for our kids. Seriously. PeteCA
Mike Shedlock’s latest article on bank reserves is well worth reading, especially the following quoted figures: ”Over a third of the nation’s community banks have commercial real estate concentrations exceeding 300 percent of their capital, and almost 30 percent have construction and development loans exceeding 100 percent of capital.” With values of commercial real estate now starting to sink in many parts of the USA, this is a real concern. This is a good time for Americans to check the status of their own bank, esp. if it’s a small bank (assets less than $2 billion). And above all, make sure your deposits do not exceed the FDIC limit of $100,000. PeteCA
Now I’m starting to get scared-and I’m short the market! I think the game will be up soon. May God have mercy on all of us! The powers that be are starting to admit their impotence. G-7 Says Global Growth May Weaken, Market Turmoil to Persist By John Fraher and Theophilos Argitis Feb. 10 (Bloomberg) — Group of Seven policy makers said the U.S. economy may slow further, eroding global growth, and officials forecast more financial-market turmoil. “Downside risks still persist, which include further deterioration of the U.S. residential housing markets” and tighter credit conditions, G-7 finance ministers and central bankers said in a statement in Tokyo yesterday. U.S. Treasury Secretary Henry Paulson said “we should expect continued volatility” in markets as risk is repriced. The G-7 is trying to limit the damage from a housing slump that has pushed the U.S. to the brink of a recession and may consign the world economy to its worst year since 2003. While the statement didn’t propose specific measures, European Central Bank President Jean-Claude Trichet said officials will do what’s necessary to counter a “significant market correction.” “The problems are going right through all parts of the financial markets and there’s not much the G-7 can do about this,” said Gilles Moec, an economist at Bank of America Corp. in London. “There’s a danger that the downturn will become a self-fulfilling prophecy.” Some officials signaled they were willing to take steps to promote growth. Bank of Canada Governor Mark Carney, whose term began two week ago, signaled he will lower interest rates. Luxembourg Prime Minister Jean-Claude Juncker, who represents finance ministers from the 15-nation euro region, said some European countries may have room to cut taxes. Stock Market Slump More than $6.7 trillion has been wiped from world stock markets since the beginning of the year amid concern that the U.S. slowdown would spread and financial institutions would report more losses. The rout, which started in August when credit markets seized up, forced central banks in December to move in concert to inject cash into financial markets in the biggest act of international cooperation since the Sept. 11 terrorist attacks. Risks remain “that further shocks may lead to a prolonged recurrence of the acute liquidity pressures experienced last year,” Bank of Italy Governor Mario Draghi said. “It is likely we face a prolonged adjustment, which could be difficult.” The Federal Reserve, the Bank of England and the Bank of Canada have cut rates this year and the European Central Bank signaled it may lower them. “Going forward, we will continue to watch developments closely and will continue to take appropriate actions, individually and collectively, in order to secure stability and growth,” the G-7 statement said. Risks to Growth Risks to growth include tighter credit conditions and heightened inflation expectations, the statement said. Some economists say the ability of G-7 policy makers to end the crisis is limited. The group consists of the U.S., the U.K., Canada, Italy, France, Germany and Japan. “This is a credit market problem in the West which has to play itself out,” said Peter Spencer, adviser to the Ernst & Young Item Club and a former U.K. Treasury official. Aside from rate cuts and tax reductions, “I don’t think there’s a lot more that can be done.” Germany and Japan signaled they have no plans to follow the example of the U.S. government, which approved a package including tax rebates worth $168 billion. “Each nation should overcome obstacles by taking steps that are the most suitable to them,” Japanese Finance Minister Fukushiro Nukaga said. Faster Yuan Gains The G-7 agreed that China should do more to defuse global trade tensions by allowing the yuan to climb against the dollar and other currencies. “We encourage accelerated appreciation of its effective exchange rate,” the statement said. While the yuan has climbed 4.5 percent against the dollar since the October statement, it’s risen just 3 percent against the euro in the same period. “I’m a bit surprised by the pressure they’re adding on China,” said Tim Condon, head of Asian research at ING Groep NV in Singapore. “I thought China would be under the radar at this meeting given the rapid pace of yuan appreciation that China has been observing this year.” French Finance Minister Christine Lagarde said the stronger euro “continues to pose difficulties for European exporters.” Trichet said “we are particularly attentive to what happens in the bilateral relationship between the euro and the yuan.” The statement made no mention of the weakness of the dollar. Credit Crisis The G-7 also pledged to act on the recommendations of the Financial Stability Forum of regulators, which yesterday proposed measures to prevent a repeat of the credit crisis. Deutsche Bank AG Chief Executive Officer Josef Ackermann said Feb. 7 rating downgrades for bond insurers hurt by the subprime slump “could be a tsunami-like event.” Italy’s Draghi, who drafted the report, said banks should publish more information about their losses and improve risk management. The report also said authorities must address “potential conflicts of interest” at credit-rating companies and improve understanding of banks’ off-balance sheet positions, according to the statement. The G-7 asked the International Monetary Fund and the Basel, Switzerland-based Financial Stability Forum to report at the next meeting in April “on their respective roles in identifying potential vulnerabilities and enhancing early warning capabilities,” the statement said. To contact the reporter on this story: Rainer Buergin in Tokyo at email@example.com John Fraher in Tokyo at firstname.lastname@example.org Last Updated: February 9, 2008 11:06 EST
Another look at non-borrowed reserves and TAF… http://www.nakedcapitalism.com/2008/02/ubs-raises-concern-about-negative-non.html
Professor- Here are some ideas for some alternative thinking about how to get ourselves out of the coming severe recession. I would love feedback from you and your readers. http://jtaplin.wordpress.com/2008/02/09/wheres-the-big-idea/
@Octavio — Question to Jeremy Grantham, chairman of Boston-based GMO: “So the Fed’s actions won’t stave off a slowdown?” Grantham’s answer: ”Since when did the thought of an economic slowdown induce such hysteria? That was a response to the decline in global markets. It was aimed at the stock market. It was aimed at banking disorder and banking profits…” And there you have it. Bernanke works for the people who hired him – the private banking cartel shareholders of the Fed. And now, IMO, even the stock market will be sacrificed if necessary to save the Banking Brotherhood. Since its inception, the Fed cartel has lived by Collis P. Huntington’s words: “Whatever is not nailed down is mine. Whatever I can pry loose is not nailed down.” Its classic cartel structure of shared monopoly to reduce free-enterprise competition and increase profits has quietly enabled it to use the American economy as its private garner.
From the Economist: ”It is tempting to believe the economic and credit problems are a short-term blip and that Wall Street will be rescued by the Fed as it has been so often before. But every time that view seems about to take hold, something happens to make investors fear a more sinister possibility: that years of debt-financed growth are finally unravelling and that the Anglo-Saxon economies face as bleak a decade as Japan did in the 1990s. The market may not hit bottom until that fear recedes.” http://www.economist.com/finance/PrinterFriendly.cfm?story_id=10656844
@PeteCA: Thanks for the explanations. Nice.
Guest: “Since its inception, the Fed cartel has lived by Collis P. Huntington’s words: “Whatever is not nailed down is mine. Whatever I can pry loose is not nailed down.” Like a growing number of folks, I do have some issues with decisions the Fed made in the Greenspan era. And yes, their panic reaction (lately) appeared to be tied more to the behavior of the stock market. The Fed is aware (and so are the politicians) that people tend to judge wealth by how the Dow Jones is doing. It’s a perception thing. But keep in mind that the Fed’s principal task is to safeguard the US banking system. That’s what they do – it’s their charter. So if all else fails, they will try to concentrate on that one single goal. I don’t believe that they can save all the banks this year, esp. not some of the smaller ones. And I’m not even sure they plan to save every bank. You can think of the Term Auction Facility (TAF) as the measure-of-last-resort for banks that are having serious problems. The idea is that if a bank is desperate, and running low on reserves, then they can go to the TAF and get loans based on handing over really bad collateral (e.g. bad loans on commercial real estate). But the bank in question still has to take that liquidity (loan) and make it WORK. They have to generate new profits from their banking business, and hopefully in the process restore their reserves to a good level. Although the public is not seeing what’s going on at the TAF, you can bet that regulators are watching it pretty carefully. It’s still a “bad sign” if a bank has to go repeatedly to the TAF – there’s probably a pretty good chance it will be shut down (i.e. go bankrupt and deposits will be refunded to customers through the FDIC). Bottom line is … we are over-housed, over-shopped, and over-banked in this country. Our asset values have to come into line with our real productivity – that’s what this recession is really all about. PeteCA
@ Prof. Jon Taplin on 2008-02-09 12:52:02 Professor- Here are some ideas for some alternative thinking about how to get ourselves out of the coming severe recession. Dear Prof. Taplin, I once made an experience with waiting/writing for the coming of a big idea: after the fall of the Berlin wall, when we Germans (the high-brainers at least) thought about some big ideas to find a better way to political and economical unification than the hasty takeover chancellor Kohl organized. Of course Germany could have done better in a lot of issues, but there is no way how even the biggest idea could solve the problems of undercapitalization of East German enterprises, lack of infrastructure, markets and productivity. Someone would have to pay a trillion of todays Dollars for that – the difference between good and bad ideas is the difference between two hundred billions more or less. Of course, two hundred billions is a lot of money, and it was worth thinking about how you can save them – but nonetheless you had to prepared to pay eight hundred billions. Would the German people vote for a politician who offered them a perspective of paying 800 and saving 200? Helmut Kohl did not take that risk: He promised in 1990 we could have unification without paying for it. It was no big idea, just a simple lie, and it worked for him. In your situation, even the biggest idea can’t make the public and private debt disappear. You will need a lot of money, earned money, to do that, and big ideas can only reduce that amount by a small fraction. Will your people vote for a politician who offers them a perspective of paying 800 and saving 200? Surely not. Not yet.
From Mish: Borrowed Reserves And Tin-Foil Hats Many people have been asking me about Caroline Baum’s recent article How Non-Borrowed Reserves Became a Sexy Subject. Let’s take a look at the highlights. …. What’s caused the hullabaloo recently is the dive in non-borrowed reserves from $44 billion in early December to minus $8.8 billion at the end of January. It isn’t a mystery what happened. The Fed announced the creation of a Term Auction Facility on Dec. 12, enabling banks to borrow for 28 days versus a wide range of collateral. The minimum bid the Fed accepts is the expected funds rate one month out, which in the current environment means cheaper funding costs than the fed funds market. So what would you do if you were a bank? Lower Cost Loans made through the TAF are categorized as borrowed reserves. The Fed had $50 billion of loans in place at the end of January, which “caused the borrowed reserves figure to balloon and the non-borrowed figure to decline by a corresponding amount,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey, in a Feb. 6 commentary. All of a sudden, people who never glanced at the Fed’s H.3 statistical release are now experts on “Aggregate Reserves of Depository Institutions and the Monetary Base.” Their e-mails have the same sense of foreboding as the missives put out by the Black Helicopter/Tin-Foil Hat crowd. …. [The Tin-Foil Hat crowd] is overlooking the fact that the Fed is “a monopoly provider of reserves,” said Jim Glassman, senior U.S. economist at JPMorgan Chase & Co. ”There is no such thing as a banking system short of reserves. The Fed has absolute control over the supply.” There may be times, such as late last year, when banks are reluctant to lend to one another for a period longer than overnight. “And any one bank can have a problem” funding itself, Glassman said. But in a world where “the Fed can print money, there is no shortage,” he said. “The banks get the reserves they want.” …. Glassman is flat out wrong. There is indeed such a thing as a banking system being short of reserves. In addition, the Fed does not have absolute control over supply of reserves. Let’s start with a discussion of how the TAF works and work our way to the correct conclusions. Banks participating in the Term Auction Facility (TAF) have to put up collateral for the amounts they borrow. Term Auction Facility Under the term auction facility (TAF), the Federal Reserve will auction term funds to depository institutions. All depository institutions that are eligible to borrow under the primary credit program will be eligible to participate in TAF auctions. All advances must be fully collateralized. Discount Window Collateral The Federal Reserve Banks accept a broad range of assets as discount window collateral. Discount window loans must be collateralized to the satisfaction of the local Reserve Bank. [Click here for more about Pledging Collateral.] The Reserve Banks will consider accepting as discount window collateral any assets that meet regulatory standards for sound asset quality. A listing of the most commonly pledged asset types can be found by clicking on the Collateral Margins Table on this site. Depository institutions should direct questions regarding specific assets to local Reserve Bank staff. Clearly, the Fed does not hand out reserves willy-nilly. It lends them, but only if banks have sufficient collateral. Furthermore lending is not “printing”. Thus Glassman, the senior U.S. economist at JPMorgan Chase & Co. really needs an education here. Still more education is required. The Fed does not have “control” over supply of reserves because it does not have control over assets held and loans made by member banks. If Glassman’s thinking is representative of bank thinking in general, it’s no wonder banks balance sheets are so $#@%’d up. A shortage of reserves comes into play when banks no longer have sufficient collateral to exchange for temporary reserves. Banks that do not have sufficient collateral, do not get loans from the discount window or the TAF. Period. End of Story. The Fed does NOT simply “print money” and hand it out to capital impaired banks. Bankruptcies result. Reserves At Citigroup If Citigroup could have borrowed reserves from the Fed at 3-4% wouldn’t it had done so instead of raising $7.5 billion from Abu Dhabi at an interest rates of 11%? See Petrodollars Return Home and Abu Dhabi Deal Raises Questions About Citigroup’s Health for more on Abu Dhabi. Citigroup went back to the well a second time under even more onerous terms as discussed in Cost of Capital “Ratchets Up” at Citigroup and Merrill. Dozens Of Banks Will Fail Reuters is reporting Dozens of U.S. banks will fail by 2010. Dozens of U.S. banks will fail in the next two years as losses from soured loans mount and regulators crack down on lenders that take too much risk, especially in real estate and construction, an analyst said. The surge would follow a placid 3-1/2 year period in which just four banks collapsed, all in the last year, RBC Capital Markets analyst Gerard Cassidy said in a Friday interview. Between 50 and 150 U.S. banks — as many as one in 57 — could fail by early 2010, mostly those with no more than a couple of billion dollars of assets, Cassidy said. That rate of failure would be the highest in at least 15 years, or since the winding down of the savings-and-loan debacle. ”The initial round of failures will come from smaller banks with limited access to capital and overexposure to commercial real estate,” Cassidy said. Analyst Tanya Azarchs expects the pain to spread to regional banks, and especially “some of the smaller players that have yet to feel the full extent” of the credit crunch. Cassidy said: “The regulatory focus is now acutely on commercial real estate. The problems are centered around construction loans in residential housing. Home prices and sales are declining. This leaves builders unable to carry the debt they took on because they can’t sell their homes.” A top U.S. bank regulator, Comptroller of the Currency John Dugan, said on Thursday that his office was prepared to intervene if banks with large real estate exposure maintained unreasonably low reserves for bad loans. Remarks By Dugan Remarks by John C. Dugan Comptroller of the Currency January 31, 2008 Over a third of the nation’s community banks have commercial real estate concentrations exceeding 300 percent of their capital, and almost 30 percent have construction and development loans exceeding 100 percent of capital. Here in Florida, as in other states where housing is so important to local economic growth, the concentration levels are more pronounced. Over 60 percent of Florida banks have CRE loans exceeding 300 percent of capital, and more than half have C&D loans exceeding 100 percent of capital. We’re now entering a stage of the CRE credit cycle where problems have started to surface and losses have started to increase – which is the second inescapable fact I mentioned at the outset. In terms of asset quality, our horizontal reviews have indeed confirmed a significant increase in the number of problem residential construction and development loans in community banks across the country.
Given these circumstances, what do we see as the consequences in the coming months? Not surprisingly, there will be more frequent interaction between supervisors and banks with concentrations in CRE loans that are declining in quality. There will be more criticized assets; increases to loan loss reserves; and more problem banks. And yes, there will be an increase in bank failures. I want to emphasize today, as we see the clear signs of CRE credit quality declining, that we will expect banks with CRE concentrations to make realistic assessments of their portfolio based on current, changed market conditions. That may require you to obtain new appraisals. For those of you in stressed markets, it will almost certainly require you to downgrade more of your assets, increase loan loss provisions, and reassess the adequacy of bank capital. I firmly believe that in this environment, increases in loan loss reserves for many banks are both warranted and prudent. I would be extremely surprised if your auditors disagreed with this position – but if they do with respect to a national bank, I urge you to contact your examiner-in-charge or Assistant Deputy Comptroller. If we have to intervene in this situation, we will not hesitate to do so. Read this again and again until it sinks in: Over a third of the nation’s community banks have commercial real estate concentrations exceeding 300 percent of their capital, and almost 30 percent have construction and development loans exceeding 100 percent of capital. There will be more criticized assets; increases to loan loss reserves; and more problem banks. And yes, there will be an increase in bank failures. Why Will Banks Fail? Banks will fail because they do not have sufficient reserves. Banks cannot borrow those reserves because they do not have sufficient collateral. The Fed’s collateral requirements do not permit printing money and handing that money over to failing banks. The Fed will not change those requirements and start printing money because of the “checkmate” scenario discussed below. Does the Fed care about borrowed reserves? Here’s a statement that caught my eye from Baum’s article made by one of my favorite economists, Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago. ”There is no relationship between non-borrowed reserves and anything the Fed cares about, be it inflation, employment or real GDP.” On this point, I believe Kasriel is correct. However, the Fed has not been concerned about many things that history proves they should have been concerned about: housing, lending standards, derivatives, ARMs, and asset bubbles for starters. Here’s the deal. Bank reserves are net borrowed. This comes at a time when commercial real estate is about to plunge and bank balance sheets are loaded to the gills with them. This also comes at a time when social attitudes towards debt are going to impair Bernanke’s ability to inflate. For more on social attitudes, please see 60 Minutes Legitimizes Walking Away, Changing Social Attitudes About Debt, and a Crash Course For Bernanke. Finally, banks will not be going deeper to the “TAF well” as long as the rules state “All advances must be fully collateralized.” Once collateral runs out, it’s the end of the line. If the Fed is not concerned about this situation, they soon will be. Of course there are those who believe the Fed will break the rules and eliminate all collateral requirements. So far anyway, they have not done so. Let’s assume however, when push comes to shove, the Fed acting under duress does just what Glassman says, and provides permanent capital for free. The Checkmate Scenario Stop and think what massive printing would do to the US dollar and long term interest rates. It’s called Checkmate. And that is why the Fed would not do what Glassman suggests, even if they could. The market won’t allow it! Let’s review Weak U.S. Dollar May Be ‘Checkmate’ for the Fed: Caroline Baum. ”It’s check for the economy now; it’s facing checkmate,” says Paul Kasriel, director of economic research at the Northern Trust Corp. in Chicago. ”Checkmate is the dollar. Bernanke’s problem is that if he cuts, the dollar will go down even more. He may not be able to provide as much support for the economy as his predecessor.” ….. Credit events are deflationary by nature. Simply put, when lenders sustain large losses, they can’t extend credit. Caroline, you had it correct the first time! “Simply put, when lenders sustain large losses, they can’t extend credit.” And by substituting the word “print” for “cut”, Kasriel has it correct as well. Cutting interest rates is one thing, physical printing of dollars is another. An Interview With Kasriel For more on the checkmate scenario, please consider an Interview with Paul Kasriel. Kasriel: U.S. banks currently hold record amounts of mortgage-related assets on their books. If the housing market were to go into a deep recession resulting in massive mortgage defaults, the U.S. banking system could sustain huge losses similar to what the Japanese banks experienced in the 1990s. If this were to occur, the Fed could cut interest rates to zero but it would have little positive effect on economic activity or inflation. Short of the Fed depositing newly-created money directly into private sector accounts, I suspect that a deflation would occur under these circumstances. Again, crippled banking systems tend to bring on deflations. And crippled banking systems seem to result from the bursting of asset bubbles because of the sharp decline in the value of the collateral backing bank loans. Mish: So when does it all end? Kasriel: That is extremely difficult to project. If the current housing recession were to turn into a housing depression, leading to massive mortgage defaults, it could end. Alternatively, if there were a run on the dollar in the foreign exchange market, price inflation could spike up and the Fed would have no choice but to raise interest rates aggressively. Given the record leverage in the U.S. economy, the rise in interest rates would prompt large scale bankruptcies. These are the two “checkmate” scenarios that come to mind. Who’s Wearing The Tin-Foil Hats? Few have been better at correctly calling out the Tin-Foil hats over the years as Caroline Baum. I am a Baum fan. I recommend her book “Just What I said”. You can find it on my recommended reading list on the left. I did a review in Bookmobile: Master Traders & Just what I said. In this case however, it is Jim Glassman, senior U.S. economist at JPMorgan (and anyone else who believes reserves will be printed into existence) who are wearing the Tin-Foil hats. Things That “Can’t” Happen will happen. And those with misguided faith in the Fed’s ability and willingness to print reserves are in for a rude awakening. Mike “Mish” Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post Listd up. http://globaleconomicanalysis.blogspot.com/
Regarding unemployment in the USA, see John Mauldin’s most recent article at: http://www.safehaven.com/article-9429.htm His essential point is that over 500,000 jobs may have been lost in the USA over the last 6 months, because these people were self-employed and did not show up in the statistics. That would go a long way to explaining the trouble affecting the budgets of a lot of American families. PeteCA
Connecting the dots: 1.Guest on 2008-02-09 11:05:26 Fromyour NC link: What if the Fed’s rate cuts aren’t motivated by the desire to stave off recession, rather they’re to prevent a major banking crisis. Not one of escalating subprime losses or monoline downgrades, but actually a sheer lack of cash. The Fed’s not telling anyone what it’s up to because it doesn’t want to cause panic, but the evidence is actually there in its own data… Ok, so things might not be quite as bad as that, but the situation isn’t far off. That’s because of the TAF. ….a savvy bank can put down lesser quality paper that it can’t generally do very much with (and certainly no one else really wants it), raise funds through the TAF, then use those funds to put down as reserves, and then conveniently gets paid a modest rate of interest against those reserves (which acts as a partial offset against the TAF). While there’s a small net cost to the banks, the real loser here is the Fed, what it gets stuck with is an ever growing pile of collateral. Now consider this – that collateral is actually what’s backing the entire US banking system by way of its conversion to dollars and then the flow of those same dollars back to the Fed…. All this changes the complex of the US banking system somewhat. From the gold standard to the subprime standard perhaps? … Individual banks are accordingly unwilling to use the discount window because it says loud and clear they are in trouble. That was one of the reasons for creating the TAF, so that banks could get discount-window type funding, but longer-term (the discount window is overnight, while the TAF is 28 or 35 days, depending on the auction) on a non-disclosed basis. However, as we said at the outset, the Fed has made TAF funding so attractive that banks should be trying to access it whether they need it or not. Thus we cannot tell whether the TAF borrowing is a substitute for going to the discount window, which is a sign of trouble, or merely opportunistic. And the TAF usage is the cause of the negative non-borrowed reserves. But perhaps the point to make is that the fundamental question is the continued existence of the TAF (the non-borrowed reserves issue is a red herring). It was implemented to address extreme risk aversion in the interbank markets, which was made worse by the customary fall in liquidity at year end (banks wind down their activities in December to make accounting cleaner). The TAF was initially supposed to be a temporary facility, but (as far as I can tell) there is no plan to wean banks off it. To reiterate: the negative non-borrowed reserves are not the real issue; the question is whether banks have become reliant on the TAF. In this bad credit market, when the Fed is on a program to ease aggressively, the Fed is not going to tinker with the TAF whether or not there is still a real need for it. Thus we mere mortals outside the regulatory regime will remain largely in the dark as to whether it is a prop or a mere expedient. 2. Guest on 2008-02-09 12:58:31 your own words: And there you have it. Bernanke works for the people who hired him – the private banking cartel shareholders of the Fed. And now, IMO, even the stock market will be sacrificed if necessary to save the Banking Brotherhood. Since its inception, the Fed cartel has lived by Collis P. Huntington’s words: “Whatever is not nailed down is mine. Whatever I can pry loose is not nailed down.” Its classic cartel structure of shared monopoly to reduce free-enterprise competition and increase profits has quietly enabled it to use the American economy as its private garner. As the Profesdor has said it is not just a liquidity crisis, it is an insolvency crisis [stupid]. The US banking cartel with the FED as its leader will make sure they “survive” insolvency while a huge chunk of the “shadow banking system”, i.e., their competition, disappears. So what is going on is actually a “dream world” for the banks. The FED via rates heading towards 1% and the TAF facility, which works on worthtless paper, will allow them to avoid insolvency while those that are not part of the cartel get wipped out. Financial alchemy appears to be alive and well; but remember: to this day, no-one has found a cheap way of converting lead into gold. What is going on is that 1% rates combined with TAF puts the HUGE FED printing press at the service of GS, Citi, etc. so that they can not only continue their speculative bubble games but also have a monopoly at it! So what is the downside? Printing presses backfire. Too much paper money slushing around = weaker USD and higher inflation. So you and I get poorer while GS partners continue to get richer.
Anonymous wrote on 2008-02-09 09:24:41 “The Bloomberg article is quite correct. The Fed controls the level of reserves to manage the funds rate around its target level. The high level of borrowed reserves is simply a result of the TAF process, which enables some banks to source required reserves when they are having trouble borrowing them normally from the interbank market. This is irrelevant to the Fed’s ability to manage total system reserves at a level that allows funds to trade close to the target interest rate.” Thank you for your comments. I think I understand that Volcker wanted to raise rates and shrink the money supply to fight inflation. And, conversely, Bernanke wants to lower rates and increase the money supply to spur growth and I believe, reduce the possibility of deflation. I also can see why the non-borrowed reserve number is irrelevant to the Fed now. But I am not concerned about the Fed. I am not short the Fed; I am short financial stocks. So I want to know what this negative number tells us about the financial condition of the member banks. Guest wrote on 2008-02-09 11:05:26 “Another look at non-borrowed reserves and TAF… http://www.nakedcapitalism.com/2008/02/ubs-raises-concern-about-negative-non.html “ I think this article comes closest to explaining the situation that we are concerned about. And the bottom line appears to be that we cannot know, because of the lack of transparency (like that for which we criticize other nations), whether the negative number means some bank or banks are in SERIOUS trouble, or whether they are merely taking advantage of the opportunity to unload devalued and unsalable CDOs on the Fed. Logically we must assume both is happening concurrently, some are having serious cash shortage problems, and others are gaming the system. As usual, we will probably not know the truth until a bank surprises us with a bankruptcy filing. Bottom line: The negative non-borrowed reserve number IS relevant to the financial health of the member banks, but in this situation we cannot know HOW relevant it is. Good luck to all. This coming week may be pivotal in the current financial crisis, at least in the near-term. A good monoline bailout plan and the signing into law of the stimulus package would rally equities and stave off a financial meltdown in the short-term. Longer term, however, the fate of the financial system is still very unclear, IMO.
italics on italics now off?
The bottom portion of my post above (i.e., my input is not supposed to be italics; sorry) As the Professor has said: “it is not just a liquidity crisis, it is an insolvency crisis” [stupid]. The US banking cartel with the FED as its leader will make sure they “survive” insolvency while a huge chunk of the “shadow banking system”, i.e., their competition, disappears. So what is going on is actually a “dream world” for the banks. The FED via rates heading towards 1% and the TAF facility, which works on worthtless paper, will allow them to avoid insolvency while those that are not part of the cartel get wipped out. Financial alchemy appears to be alive and well; but remember: to this day, no-one has found a cheap way of converting lead into gold. What is going on is that 1% rates combined with TAF puts the HUGE FED printing press at the service of GS, Citi, etc. so that they can not only continue their speculative bubble games but also have a monopoly at it! So what is the downside? Printing presses backfire. Too much paper money slushing around = weaker USD and higher inflation. So you and I get poorer while GS partners continue to get richer.
@Gloomy: the Economist: “It is tempting to believe the economic and credit problems are a short-term blip and that Wall Street will be rescued by the Fed as it has been so often before. But every time that view seems about to take hold, something happens…” Once there is proof that the government is temporarily in the hands of the bankers who are running it for themselves, then all the Fed’s words — “rough patch,” “fractional reserves,” “stimulus package,” “mild recession,” “deflation fears,” “2% inflation,” “short-term blip,” “Fed rescue,” “irrational exuberance,” “ investor greed,” “improved economy…” –- are just cover up for their own interests. It’s so simple. It’s part of one single lie, i.e. that the public somehow has something to say about its monetary system. Ah, the showmanship of Jim Cramer, the excitement of Rate Cut Week, Gentle Ben’s kindly visage, Greenspan’s magic wand, color charts that go up and down… But as for influencing a central banker, or a US “Representative,” it can’t be done. It’s a cut off. IMO, the monetary manipulators believe themselves in huge trouble. They are feeding the public the story in increments—like the SocGen fraud. It just gets progressively worse. If Friday’s Wall Street Journal could be read back in October, people would find it incredulous.
Hellasious today: http://suddendebt.blogspot.com/ The latest Market Moonshot required more debt fuel and went less distance, even when compared to the historic dotcom bubble. If I were the flight ops director I would be concerned. In the words of David Bowie’s classic song: Though I’m past one hundred thousand miles I’m feeling very still And I think my spaceship knows which way to go… Ground control to Major Tom Your circuits dead, there’s something wrong Can you hear me, Major Tom?
Logically we must assume both is happening concurrently, some are having serious cash shortage problems, and others are gaming the system. As usual, we will probably not know the truth until a bank surprises us with a bankruptcy filing. Bottom line: The negative non-borrowed reserve number IS relevant to the financial health of the member banks, but in this situation we cannot know HOW relevant it is. Written by KJ Foehr on 2008-02-09 14:43:53 I think I agree with you here, KJ Foehr. The lack of transparency built into TAF is a problem. But then it may be part of the solution, if it’s going to help the system solve its problems without causing any more hysteria than exists already, especially on the blogosphere. –iiww
HELP ! Many on this blog feel that CD’s and Treasuries are the safer way to invest at this point. Does anyone have any thoughts about the safety of investing in Swiss Francs (FXF) ?
CD’s & T’s pay such a poor % right now (HSBC Emails us just about daily that our interest rate is being lowered on our online account) that FXF makes sense…..Safety and capital preservation get tougher by the hour here in 2008……I like to keep things simple…..Who has been more prudent with their currency? Switzerland or the USA? Good Luck to all…..
Written by KJ Foehr on 2008-02-09 14:43:53 I am short financial stocks. So I want to know what this negative number tells us about the financial condition of the member banks. Read my post above and…. Does anyone here remember Michael Price? (Mutual Fund Manager, activist, value investor that sold out to Franklin Templeton Investments. http://en.wikipedia.org/wiki/Michael_Price – not much in wiki) I just remembered him because I read about 10-12 years ago an book interview (will have to pull it out of storage – I am still unpacking my move to Argentina) in which he describes his investment in Chase Manhattan which led to the merger with Chemical Bank: http://www.hedricksmith.com/site_bottomline/html/e1_trans.html My recollection is that he mentions he started accumulating Chase stock too early. So, IMO, it is still too early to buy the big banks a lot more pain and low earnings are coming despite the FED’s help. But eventually they will be a great buy. However, people know about this and with so much greed sloshing around it may be that the banks never fall as low as they should. But remember investors are impatient, they will buy the banks but as earnings disappoint they will sell them again. So one would have to wait until everyone is sick and tired of the banks (e.g., wait for a BW cover on this) before an investment with a Graham style margin of safety can be made. As for shorting the banks, I am short them via some SKF ( http://www.proshares.com/funds/skf.html?Index ) but honest to god, I have no idea for how long this trade will work. Don’t forget one is facing the full power of the FED and the steepest yield curve in a while. Bottom line, shorting the banks now implies you are placing a bet on the Professor’s near insolvency, continued big losses at big banks horse which may render the steep yield curve powerless.
Politics off topic for the macroeconomy? Is the cost of the war and what voters think about it off topic? Anyone here read Juan Cole, the most authoritative voice on the Iraq war, today? ”Over two-thirds of Americans think that getting out of Iraq will help the US economy a great deal (48%) or at least somewhat (20%). Myself, I think that is the death knell of the Iraq War and spells very bad news for John McCain. McCain’s argument is that if Iraq can be pacified, such that troops are not being killed, then there is no intrinsic objection to the US keeping bases there. But first of all, his premise is not evident, and the news of the troop deaths this week argues against complacency on that score. Besides, the public is noting an objection even in the case of no troop deaths, which is the extra expense. If the war really is going to cost $2 trillion, they can think of other ways they’d like to spend that money, including on unemployment checks for themselves since they are afraid they are about to be fired because of the recession. Hearteningly, even after decades of Republican propaganda about the miraculous properties of “tax cuts” (mainly on their own rich selves), more Americans still think a good way to get out of the recession is for the government to spend more money on health care, education and housing than think it can all be fixed with a tax cut. Only 28 percent think that anything Bush does is going to help them avoid economic bad times. Since McCain is trying out for the role of Son of Bush, that is also bad news for him.” Quote from Juan Cole’s blog. Original AP article on the poll: http://ap.google.com/article/ALeqM5iu6xjCz8Ykakz5T6AjT3olMgRXTwD8UMCQAO1
@Gloomy, thanks for the great posts (Economist and Mish) Written by ABC on 2008-02-09 16:10:47 CAn you imagine where we would be today if what we have poured down the drain in Iraq would have been spent in locally R&D and public projects and improving the US image WW? http://www.nationalpriorities.org/costofwar_home http://www.nytimes.com/2007/01/17/business/17leonhardt.html?_r=1&oref=slogin Economix What $1.2 Trillion Can Buy By DAVID LEONHARDT Published: January 17, 2007 The human mind isn’t very well equipped to make sense of a figure like $1.2 trillion. We don’t deal with a trillion of anything in our daily lives, and so when we come across such a big number, it is hard to distinguish it from any other big number. Millions, billions, a trillion — they all start to sound the same. The way to come to grips with $1.2 trillion is to forget about the number itself and think instead about what you could buy with the money. When you do that, a trillion stops sounding anything like millions or billions. For starters, $1.2 trillion would pay for an unprecedented public health campaign — a doubling of cancer research funding, treatment for every American whose diabetes or heart disease is now going unmanaged and a global immunization campaign to save millions of children’s lives. Combined, the cost of running those programs for a decade wouldn’t use up even half our money pot. So we could then turn to poverty and education, starting with universal preschool for every 3- and 4-year-old child across the country. The city of New Orleans could also receive a huge increase in reconstruction funds. The final big chunk of the money could go to national security. The recommendations of the 9/11 Commission that have not been put in place — better baggage and cargo screening, stronger measures against nuclear proliferation — could be enacted. Financing for the war in Afghanistan could be increased to beat back the Taliban’s recent gains, and a peacekeeping force could put a stop to the genocide in Darfur. All that would be one way to spend $1.2 trillion. Here would be another: The war in Iraq. In the days before the war almost five years ago, the Pentagon estimated that it would cost about $50 billion. Democratic staff members in Congress largely agreed. Lawrence Lindsey, a White House economic adviser, was a bit more realistic, predicting that the cost could go as high as $200 billion, but President Bush fired him in part for saying so. These estimates probably would have turned out to be too optimistic even if the war had gone well. Throughout history, people have typically underestimated the cost of war, as William Nordhaus, a Yale economist, has pointed out. But the deteriorating situation in Iraq has caused the initial predictions to be off the mark by a scale that is difficult to fathom. The operation itself — the helicopters, the tanks, the fuel needed to run them, the combat pay for enlisted troops, the salaries of reservists and contractors, the rebuilding of Iraq — is costing more than $300 million a day, estimates Scott Wallsten, an economist in Washington. That translates into a couple of billion dollars a week and, over the full course of the war, an eventual total of $700 billion in direct spending. The two best-known analyses of the war’s costs agree on this figure, but they diverge from there. Linda Bilmes, at the Kennedy School of Government at Harvard, and Joseph Stiglitz, a Nobel laureate and former Clinton administration adviser, put a total price tag of more than $2 trillion on the war. They include a number of indirect costs, like the economic stimulus that the war funds would have provided if they had been spent in this country. Mr. Wallsten, who worked with Katrina Kosec, another economist, argues for a figure closer to $1 trillion in today’s dollars. My own estimate falls on the conservative side, largely because it focuses on the actual money that Americans would have been able to spend in the absence of a war. I didn’t even attempt to put a monetary value on the more than 3,000 American deaths in the war. Besides the direct military spending, I’m including the gas tax that the war has effectively imposed on American families (to the benefit of oil-producing countries like Iran, Russia and Saudi Arabia). At the start of 2003, a barrel of oil was selling for $30. Since then, the average price has been about $50. Attributing even $5 of this difference to the conflict adds another $150 billion to the war’s price tag, Ms. Bilmes and Mr. Stiglitz say. The war has also guaranteed some big future expenses. Replacing the hardware used in Iraq and otherwise getting the United States military back into its prewar fighting shape could cost $100 billion. And if this war’s veterans receive disability payments and medical care at the same rate as veterans of the first gulf war, their health costs will add up to $250 billion. If the disability rate matches Vietnam’s, the number climbs higher. Either way, Ms. Bilmes says, “It’s like a miniature Medicare.” In economic terms, you can think of these medical costs as the difference between how productive the soldiers would have been as, say, computer programmers or firefighters and how productive they will be as wounded veterans. In human terms, you can think of soldiers like Jason Poole, a young corporal profiled in The New York Times last year. Before the war, he had planned to be a teacher. After being hit by a roadside bomb in 2004, he spent hundreds of hours learning to walk and talk again, and he now splits his time between a community college and a hospital in Northern California. Whatever number you use for the war’s total cost, it will tower over costs that normally seem prohibitive. Right now, including everything, the war is costing about $200 billion a year. Treating heart disease and diabetes, by contrast, would probably cost about $50 billion a year. The remaining 9/11 Commission recommendations — held up in Congress partly because of their cost — might cost somewhat less. Universal preschool would be $35 billion. In Afghanistan, $10 billion could make a real difference. At the National Cancer Institute, annual budget is about $6 billion. “This war has skewed our thinking about resources,” said Mr. Wallsten, a senior fellow at the Progress and Freedom Foundation, a conservative-leaning research group. “In the context of the war, $20 billion is nothing.” As it happens, $20 billion is not a bad ballpark estimate for the added cost of Mr. Bush’s planned surge in troops. By itself, of course, that price tag doesn’t mean the surge is a bad idea. If it offers the best chance to stabilize Iraq, then it may well be the right option. But the standard shouldn’t simply be whether a surge is better than the most popular alternative — a far-less-expensive political strategy that includes getting tough with the Iraqi government. The standard should be whether the surge would be better than the political strategy plus whatever else might be accomplished with the $20 billion. This time, it would be nice to have that discussion before the troops reach Iraq.
@ Octavio Richetta “As for shorting the banks, I am short them via some SKF ( http://www.proshares.com/funds/skf.html?Index ) but honest to god, I have no idea for how long this trade will work. Don’t forget one is facing the full power of the FED and the steepest yield curve in a while. Bottom line, shorting the banks now implies you are placing a bet on the Professor’s near insolvency, continued big losses at big banks horse which may render the steep yield curve powerless.” I’m not short the big banks. I’m in SKF with shorts in ABK, PMI, RDN, XL, NCC, CCRT, MCO. I’ve already covered CFC, and some other financials. I own SRS, plus shorts in homebuilders, SPG, CBG, along with other misc. shorts and short ETFs. I think the financials will bottom first, so I will probably sell SKF and cover the other financial shorts first, maybe within 2 months, depending on what happens, and hold the others longer. And yes, I do believe the Prof is mostly correct about insolvency and continued big losses at banks. The steep yield curve will help, eventually, but not enough this year, IMO. Good luck.
Hazleton: If you invest in Swiss francs, you are making a currency bet. Therefore … understand your currency risks (and rewards) before going ahead. You can open your own Swiss account (beware many online “agents” offering to open these accounts for a steep fee). You must sign regulations and agreements that reveal what you are doing to US authorities. It is not possible to do the banking transaction and hide tax gains. If you do a transaction in this country, as through Everbank (“foreign CD’s”), then understand that your money is not sitting in Switzerland. It is actually in a bank account in the USA. You are getting “effective” currency gains/losses, and Everbank achieves this by using trades in the currency futures market. You can also look at one of the “hard currency” funds. You must decide, though, how long you want your money in the fund and whether you believe the US dollar will decline or rise (esp. against the euro) in this timeframe. A currency investment would be a good way to go if the US dollar crashes, but that is speculative. PeteCA
I couldn’t find my first post so I will will try again. @Guest 2008-02-08 22:24:34 and Lenny The Fed giveth and the Fed taketh away. I’ve been quiet for the past few weeks since I’ve not had anything really intelligent to say. (too much babble on the internet anyway) But while I am thinking of something interesting to say about non borrowed reserves her is an interesting paper by Paul Kavriel. web-xp2a-pws.ntrs.com/content//media/attachment/data/econ_research/0712/document/dd121207.pdf
Written by KJ Foehr on 2008-02-09 16:40:36 I am under 5% short via a number of short ETFs, I do it just for fun/try getting a bit of alpha. In a past life, I used to “venture” quite a bit more but I can no longer handle the pressure of being short. I just finished reading “Hedge Hunters” – features interviews with a couple dozen or so hedge fund managers – including short only Chanos (I admire the guy) http://en.wikipedia.org/wiki/James_Chanos On reading the book, one thing comes across rather well: Hedge fund managers that survive the game don’t use much leverage and have a heavy focus on risk management. For instance, I my recollection is that Chanos juggles about 50 names at the time with positions of about 2% eacg, never letting them run above 4%. Written by Guest on 2008-02-09 16:42:54 Good point. I have said it many times, you may read repeatedly here that the USD is going to crash, etc. But if you live in the US/countries under US influence your main currency has to be the USD (It is for Buffet!). The USD is not going to be wiped out (in fact many intelligent people think it is close to bottom). So it is OK to go into some Yen, Swiss Frank, Gold, Soft commodities, etc. But if you take extreme positions you will not be able to handle the volatility and you will invariably end up selling at a loss. As for USD fixed income investing(IMO, equities are out of the question for now), it is a bit late to come into the game; treasuries, including TIPs, have made most of their runs (even though Shilling believes the 30 yr is going to under 3%. I have a bit of money behind that bet via stripped treasuries but it is a roller coaster ride and I still don’t know if the bet is going to payoff). It is a mine field out there but the FED will continue to cut rates – some believe all the way down to 1% – so there is capital appreciation money to be made. But the game is not easy: you have to avoid most corporates (GSE mortgage bonds many say are fine but even there US government guarantee is not as direct for treasuries) and more. I honestly do not know how to ride the FF rates down cycle while at the same time staying away from the mines. I do not trust most bond fund managers, even conservative TIAACREF bond account, they all have at least some toxic mortgage stuff waiting to be downgraded and written down. The guy I let do the driving for me is Bill Gross. He knows what he is doing he is not going to walk into a mine field. There may be cheaper guys who can do the job (PTTDX has a 0.75% which is high compared to bond ETFs) but, IMHO, Bill Gross will let you sleep well at night even if you are the paranoid type. Why am I saying all this? I usually skip/ignore posts about investing/investment advice but I see so many of them, so many people who don’t have a hint about what they are doing that it breaks my heart. Just the other day I read about this guy who liquidated his 401k (I assume that with a 10% penalty and having to pay taxes on it!) to pay his mortgage down! If you have a stable job, a fixed rate mortgage that allows you to shelter some income why would anyone do something as crazy as that? Given the uncertainty on inflation, owing money in a fixed rate mortgage is actually a good thing. if you have a 6% fixed in a 35% tax bracket your after tax real interest rate with 3% inflation (we all know it is higher) is only (6-3)*.75= 2.25%
yep india’s booming! bad when shame of not paying your bills leads one to swallow pesticides http://www.pbs.org/wnet/wideangle/shows/vidarbha/index.html#videoplayer WAKE UP PEOPLE TIME FOR CHANGE The Film At a moment when India is enjoying record economic growth, THE DYING FIELDS turns to Vidarbha’s four million cotton farmers who have been left behind, struggling to survive on less than two dollars a day. WIDE ANGLE cameras follow Kishor Tiwari, former businessman turned farmer advocate, whose tiny office in the heart of this cotton-growing region functions as the archive and watchdog for the suicide epidemic; traveling salesmen hawking genetically modified – and costly – cotton seeds that require irrigation that few Vidarbha farmers have; the last rites of a farmer who couldn’t pay his debts; a tour of the poison ward at the local hospital, where beds are always filled; and a visit by then-president of India, A.J.P. Abdul Kalam, whom the farming widows beseech for help in convincing the government to forgive their debts.
@ Octavio Richetta on 2008-02-09 14:52:24 ”So what is the downside? Printing presses backfire. Too much paper money slushing around = weaker USD and higher inflation. So you and I get poorer while GS partners continue to get richer.” That’s a ‘given! It is called “Moral Hazard” the underlying, a priori, essence of the structural integrity (lack thereof)of the global financial system. For well over 20 years now this system has sucked at the blood of the real economies for its survival and expansion with the able assistance of Mr Greenspan; it is now finished, for the moment. It is now “reform” (of the financial system) that is on the lips of the Ministers of the G7, somewhat far too late and nobody is listening. It is time for survival where the ‘customers’ of yesterday are to become the ‘victims’ of today. You are about to experience the greatest betrayal in our World’s written history, a betrayal which will reach for 2 generations and more into our future (of the grassroots) so that those of ‘leadership’(Hah!)can remain comfortable, er today. PeterJB Keyword: survival
I enjoy this blog and comments. I have been bearish on housing since 2004 and didn’t understand what fueled the housing bubble until I started reading blogs like this one. Can you financial gurus tell me if anyone has successfully and comfortably retired on their 401K assets alone? My 401K is all I have for the future and I watch and manage it religiously because I think the buy and hold bull market may be over for a long time. I would think the initial wave of boomers are covered by traditional pension plans in addition to 401k plans. Maybe later some will retire solely on their own assets like 401k’s and IRAs. I think what will most likely happen is that the majority of baby boomers will never afford to comfortably retire on 401Ks and will continue to work in some capacity even part-time. BTW I am at the beginning of Gen-X.
Warning: Politically Tainted Comments @ Octatvio “What $1.2 Trillion Can Buy” Thanks for all the great input. Just one extra thought on the article above written by David Leonhardt. Yes, $1.2 Trillion can buy a lot of war and/or a lot of health care but the final cost to America may be priceless — her sovereignty and freedom. The Piper has a way of getting paid for taking innocent life. A Republican all my life, and a state delegate to the California Republican Party, the party and I departed in 2003 when it and the neo-cons left me for good. I have been an Independent ever since, except when I re-registered to vote for Ron Paul, a great statesman. I will never vote for a John McCain, or a Hilliary Clinton. If either one is America’s choice, Americans will get the government they deserve. Unfortunately, as Lord Boyd-Orr said, “If people have to choose between freedom and sandwiches they will take sandwiches.” The article above quotes Mr. Wallsten, a senior fellow at the Progress and Freedom Foundation, a conservative-leaning research group, as saying, “This war has skewed our thinking about resources.” Yes, it has, particularly human life.
KJ Foehr on 2008-02-09 14:43:53 I think the point is that the non-borrowed reserve number really isn’t telling you anything more than what the TAF process itself is telling you – which is that there has obviously been considerable stress in the financial system. Naked Capitalism updated its post to this effect after I posted a comment to that effect on its links post. Roubini’s analysis of the overall situation is far more cogent than anything to be derived from looking at TAF or non-borrowed reserve numbers. There is a LOT more to worry about beyond what’s in the TAF/non-borrowed data. The monolines are THE critical piece of the puzzle now.
As the financial media drags out the old ruse of “fractional reserve” banking again, here’s a take by The Mogambo Guru with his ultimate conclusion: “In short, the banks loaned every additional dime of the trillions of dollars that they took in! And then more on top of that! No additional reserves at all! Not an additional dime of reserves has been added in a decade or more!” by The Mogambo Guru http://www.dailyreckoning.com/Writers/Mogambo/DREssays/MG121907.html I look around the Hopefully Impregnable Mogambo Fortress Of Fear (HIMFOF) and wonder why I am so scared. Things don’t “feel” right. I am nervous. I am edgy. I am, obviously, armed to the teeth, trigger-happy and “an accident waiting to happen… … prices of assets are being discovered to be as flimsy and whimsical as a Mogambo promise… I notice that people get angrier about losing money – especially lots of money… So I look at Total Fed Credit, the magical fount from whence springs credit in the banks, and I note with some alarm that it is actually down by $3.181 billion last week (written 12-12-07). I gulp in horror! Down! This means that people are losing money and no new money is being created by the Fed to replace it! Yikes! This is Bad, Bad News Of The Monetary Kind (BBNOTMK)… we are doomed! I know that you don’t believe me, because I was at the street corner all morning long, yelling this same news to all the people who were driving through the intersection, and none of them believed me, either! (Weird!)!”… So instead of fruitlessly arguing with you, too, about the implications of this drop in the creation of excess money and credit, I will merely raise my Bony Mogambo Index Finger (BMIF) and point you to Ludwig von Mises himself, who noted, “The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market.” And in case you are of the weird and thoroughly-modern neo-Keynesian persuasion which says that all that is ever needed is more and cheaper money provided by the banking system at lower and lower interest rates, which means that you actually believe that there can never be too much debt and that debt can grow exponentially forever, then I will not come over there and slap your ignorant face, but merely again point to Mises, who says, “But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system.” It is times like now that I realize the value of education, and wish that I had paid more attention in school instead of acting like some juvenile delinquent moron and thus having to endure my parents endlessly arguing with the principal about whether I am the spawn of Satan or not. I now rue my ignorance because I cannot calculate how much a #@**/! money comes from $3.181 billion of new credit when multiplied times the fractional-reserve multiplier in the banks. I mean, if the banks must keep in reserves 10% of deposits, like in the classic textbook example, then the first bank in the chain can lend out 90% of this new deposit of Fed credit, or 0.90($3.181 billion) = $2.863 billion, and when that loaned money is ultimately deposited by the recipients into other banks, those banks can then loan out another 0.90($2.863) = $2.577 billion, and then when that money is loaned and ultimately deposited in other banks, those banks can lend out another 0.90($2.577 billion) =$2.319 billion, on and on and on until the last dollar is borrowed from the next-to-the last bank in the chain and deposited into the last bank in the chain. To find the total amount of new money created, you have you add it all up, hour after hour of struggling with a stupid calculator, making mistake after mistake and having to start over again and over again until you are so frustrated and angry that you hit the little buttons so hard with your finger that you hurt yourself, and there is blood all over the calculator, and your finger is hurting like hell and you are raving, screaming, insanely mad. Then, demonstrating Heroic Mogambo Determinism (HMD), you finally, at long last, your finger throbbing, find that the sum total of new money created is actually equal to the inverse of the fractional reserve multiplier times the amount of money deposited! This means I could have merely multiplied the stupid $3.181 billion times 10 to get the answer, instead of laboriously adding them all up, one by one! This is a HUGE a #@**/! time-saver, about which I learned only AFTER the nightmare described above, and that is why I remember it so well, with scars and a ruined calculator to remind me of the ordeal. The point is that the “required reserves” in the banks is still about the same stinking $42 billion that it has been for the last eight years! No change! In short, the banks loaned every additional dime of the trillions of dollars that they took in! And then more on top of that! No additional reserves at all! Not a #@**/! additional dime of reserves has been added in a decade or more!
Written by Guest on 2008-02-09 18:38:02 ”Americans will get the government they deserve.” What happens is that the system abuses the little guy so much (I hope Bush son goes down in history as the worst US president of all times) that people end up making the wrong choices such as populist Chavez in Venezuela. I believe he won with over 80% of the vote. People were sick and tired of all the corruption but with him now it is 100X worse! IMO, there is no way People in the US will elect McCain which means whatever candidate ends up winning the democratic nomination should win. Things are no so bad in the US that people are ready to vote for someone as RP at this juncture. I don’t follow politics much so I am not even sure his economic ideas is what this country needs. Someone like Roosevelt would be better. On the trillion dollar spending, the situation is an hypothetical one: Given that you are going to pour a trillion USD down the war drain, you could instead, for example, give $4000/person to 250 million Americans! 1 trillion USD is a lot of DOUGH!
@Octavio “IMO, there is no way People in the US will elect McCain which means whatever candidate ends up winning the democratic nomination should win…” Maybe. But in my opinion, a new wind is blowing. The Republicans and the Democrats went every step of the way with this war. Remember Kerry? Remember Hilliary? Remember Pelosi? The Democrats were not just blind followers. Obama gets his loudest applause when he opposes the war. “War” has become a code word for the “establishment.” It’s the reason key Democrats have turned against Hilliary—she’s part of the “establishment.” We are in recession here. Many of the people on this blog are caught in a buzz saw between a Republican administration transferring their wealth to the elites and a Democrat administration that pushes the definition of “middleclass” down to its constituents –the non-producers. The reason government can’t take more money from wage-earning producers is the system won’t stand it: the producers don’t have it. They’re taxed out. Maxed out. They’ll walk. Or revolt. Or form a third party. It is no longer a matter of if, but when.
Japan is falling into the pit: http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/02/10/ccjapan110.xml Last time I looked Japan and the US made up over 35% of world GDP. It is getting very hard to see how with these 2 giants in recession the rest of the world will not follow……..
@ Dan on 2008-02-09 18:31:08 “I enjoy this blog and comments. I have been bearish on housing since 2004 and didn’t understand what fueled the housing bubble until I started reading blogs like this one. Can you financial gurus tell me if anyone has successfully and comfortably retired on their 401K assets alone? My 401K is all I have for the future and I watch and manage it religiously because I think the buy and hold bull market may be over for a long time. I would think the initial wave of boomers are covered by traditional pension plans in addition to 401k plans. Maybe later some will retire solely on their own assets like 401k’s and IRAs. I think what will most likely happen is that the majority of baby boomers will never afford to comfortably retire on 401Ks and will continue to work in some capacity even part-time. BTW I am at the beginning of Gen-X.” Of course some people have more than enough in their tax deferred retirement accounts to retire. IMO, anything involving people happens with a bell curve frequency distribution. Thus, we can confidently assume that many on the right side of the frequency distribution will have sufficient savings to retire comfortably, and likewise, that many on the left side will not and will need help. And, further, we can see that the majority in the middle will struggle, will less comfortably, or will continue to work in retirement in order to supplement their retirement income. This reminds me of something a finance professor once said in class, “There is a continual migration of dollars from ninnies to non-ninnies.” I.e., generally speaking, smarter people will end up with more money in their retirement accounts (and be further to the right of the bell curve.) But what does it matter what others do? It matters most what you do. And you should be able to easily save enough in your tax deferred retirement accounts. My rule of thumb is you need 20 times the annual amount you think you will need during retirement. So, if you think you will need $50K to retire well, then you need $1 million when you retire. That number will undoubtedly increase in future decades due to inflation, and you will need to adjust the number accordingly. But we cannot know what the inflation rate will be over the next 40 years, so the best we can do is to speak now in current year dollars. Here are some links you may find useful. http://www.cbo.gov/ftpdoc.cfm?index=5195 http://www.gao.gov/new.items/d06718.pdf http://www.crystalbull.com/Critical_Mass_Retirement_Calculator.php This is just my opinion; others will have different ideas, I am sure. Good luck.
@hazelton, You might want to look at this currency fund, http://www.merkfund.com/
@ KJ Foehr on 2008-02-09 22:15:22 ”This reminds me of something a finance professor once said in class, “There is a continual migration of dollars from ninnies to non-ninnies.” I.e., generally speaking, smarter people will end up with more money in their retirement accounts (and be further to the right of the bell curve.)” There is an old saying: Get a job you like and you will never work. Or, words to that effect. ”smarter people..” Not everybody focuses their life’s achievements and goals on making money and their retirement accounts, a priori. Some like to create, others like to adventure, while others, pioneer, explore, enquire, teach, etc., etc. So to state that smarter people will end up with more money is invalid and suggests that “smarter people” are only those that focus on monetary matters. Maybe you could say that the more cunning people end up with more money? Obviously the idea of “smarter people” is false, misleading and without foundation and is perhaps part of the problem as to where we find ourselves today. Making money and securing one’s future is fine but it don’t make you smarter (or better in any such way or manner) than someone helping people who need help, for example, as a life’s ambition and undertaking. A thief is not necessarily “smarter people” nor are Bankers. Personally, I have always found the pursuit of money for the sake of “wealth” and such interests boring, trivial and a waste of a life. peterjb
peterjb wrote on 2008-02-09 23:58:38 “Not everybody focuses their life’s achievements and goals on making money and their retirement accounts, a priori. Some like to create, others like to adventure, while others, pioneer, explore, enquire, teach, etc., etc. So to state that smarter people will end up with more money is invalid and suggests that “smarter people” are only those that focus on monetary matters. Maybe you could say that the more cunning people end up with more money? Obviously the idea of “smarter people” is false, misleading and without foundation and is perhaps part of the problem as to where we find ourselves today. Making money and securing one’s future is fine but it don’t make you smarter (or better in any such way or manner) than someone helping people who need help, for example, as a life’s ambition and undertaking. A thief is not necessarily “smarter people” nor are Bankers. Personally, I have always found the pursuit of money for the sake of “wealth” and such interests boring, trivial and a waste of a life.” I believe the following, especially the last sentence, “A human being is part of the whole called by us universe, a part limited in time and space. We experience ourselves, our thoughts and feelings as something separate from the rest. A kind of optical delusion of consciousness. This delusion is a kind of prison for us, restricting us to our personal desires and to affection for a few persons nearest to us. Our task must be to free ourselves from the prison by widening our circle of compassion to embrace all living creatures and the whole of nature in its beauty. The true value of a human being is determined by the measure and the sense in which they have obtained liberation from the self. …” Albert Einstein, 1954 The above view of life has nothing to do with money. And I was talking about saving for a comfortable retirement, not becoming wealthy, nor did I say the pursuit of money should be anyone’s life goal or focus of their life’s achievement. Further, I purposely used the phrase “generally speaking”, meaning “on average”, and that means there is not a perfect 100% positive correlation between “smartness” and retirement account size. I also believe there are many different kinds of intelligence, and not all intelligent people are concerned with the accumulation of money. However, regardless of our talents, we all will need money for retirement, and I stand by my statement as a general rule. You also wrote, “Making money and securing one’s future is fine but it don’t make you smarter…” I didn’t say it made you smarter; I said, in general, smarter people will end up with more money in their retirement accounts than less smart people; i.e., the “smarter” a person is, the better investment decisions he or she will make over the course of their working careers. You also implied that people who help others are “better” than those who make money: “(or better in any such way or manner) than someone helping people who need help, for example, as a life’s ambition and undertaking.” Well I don’t believe the two are mutually exclusive. Who is the “better” person? Someone who works as a volunteer in an AIDS hospice for 30 years, or Bill Gates who has provided millions of dollars to build AIDS hospices and pay for the care of patients? You wrote, “Personally, I have always found the pursuit of money for the sake of “wealth” and such interests boring, trivial and a waste of a life.” Considering the charitable donations of Bill Gates and Warren Buffett and other wealthy philanthropists, do you consider their pursuit of money to be “a waste of a life”? Bottom line: IMO, money / wealth is neither good nor bad, it is the use of it that makes it so.
More bad news for the textbook deflationists. While debate about inventive ways on how to spur growth continues (code for how do we shove more debt down household’s debt burdened throats), the cost of living for families is soaring- even if it ISN’T getting official respect. Some examples; NEW DELHI: After a gap of about six months, the inflation rate once again crossed the four-per cent mark due to rising prices of cereals, salt and bakery products. SAN FRANCISCO (MarketWatch) — A benchmark for a range of commodities hit a record high on Friday, a reminder to the Federal Reserve that inflation risks loom even as it concentrates on reviving U.S. economic growth by slashing interest rates. Wheat, platinum lead roaring commodities rallyReuters Friday February 8 2008 By Barani Krishnan NEW YORK, Feb 8 (Reuters) – Commodities from energy to metals and agriculture surged on Friday, with wheat and platinum hitting record highs for a straight week running on supply concerns. Funds also plowed into markets like sugar, coffee and cocoa, making analysts believe that commodities could trump stocks and bonds in the event of a U.S. or even a global recession. SYDNEY, Feb 08, 2008 (Thomson Financial via COMTEX)The Reserve Bank of Australia raised interest rates by a cumulative 50 basis points in August and November to rein in inflation.
@ KJ Foehr on 2008-02-10 01:18:06 ”… do you consider their pursuit of money to be “a waste of a life”? “ Only if “their” referred to me – I er stated “Personally”.. in my statement. ”Who is the “better” person?” The context of my comment was “smarter”. ”Bottom line: IMO, money / wealth is neither good nor bad, it is the use of it that makes it so. “ I don’t believe that a person or persons who have spent their lives taking monies from the unsuspecting and gullible through Ponzi pyramid schemes and conveniently find in the later years a need to throw a few of their pennies onto brainless charities – usually for tax avoidance purposes or through the leverages of personal fortunes that cost them nothing – to cast a few coins of silver that have been neatly extracted from the efforts, sweat and trust of the real economy, anything more than a self defeating and tasteless pang of misplaced guilt! But then, that’s life. And, again, “personally” I feel that the pursuit of money for the sake of money itself, is just a waste of a life. PeterJB
@Andy Hamilton Great post. Another huge headwind for the economies of the world. ”We tend to forget that Japan remains the world’s top creditor nation by far, the shy master of fate. The country’s net foreign assets of $3,000bn roughly match the net debts of the US. The yen “carry trade” – borrowing cheap in Tokyo to chase yields from New Zealand, to Brazil, Iceland, and above all Britain – has juiced the global asset boom this decade by $1,000bn. It is perhaps the biggest liquidity pump of them all, yet it stopped pumping in August. Indeed, it is sucking the money back out again.” http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/02/10/ccjapan110.xml
KJ Foehr on 2008-02-09 22:15:22 Thanks for the links. I agree about the bell curve distribution of assets. Lets hope the middle of that curve is sufficient. I’m not chasing wealth, just trying to stay out of poverty when I stop working. I guess my biggest concern is that I doubt the US stock market will be the retirement funding panacea that has been sold to all of us. We will know soon enough as the boomers retire and see how many are successful retiring on their own assets.
Sayin’ and doin’ are two different things. So much for the masters of the universe saving the world! WE SAY: Feb. 11 (Bloomberg) — Group of Seven officials, warning of further financial-market turmoil, indicated they’ll be forced into more interest-rate cuts and tax reductions to shore up the global economy. Finance ministers and central bankers ended a weekend meeting in Tokyo with a statement that “downside risks persist,” including the U.S. housing slump and tighter credit conditions. Without proposing specific remedies, the group pledged “appropriate actions, individually and collectively.” WE DO: The G7 and fiscal intervention Published: February 8 2008 14:30 | Last updated: February 8 2008 19:09 One of the supposed benefits of regular meetings between the world’s finance ministers and central bankers is policy co-ordination. Global responses to problems, the theory goes, are more effective than countries acting independently. Irrespective of whether that is actually true, this weekend’s Group of Seven finance meeting looks anything but harmonious. Members are at odds over how to deal with slowing economic growth as well as over other repercussions of the credit crunch. There is even disagreement about the scope of the problem, in particular whether it is predominantly a US mess. But a country’s stance is not determined in a talking shop. Much of what a government or central bank can actually do is influenced by the structural limits to action at home. EDITOR’S CHOICE United G7 line on credit crisis sought – Feb-08Editorial comment: Unite and prepare – Feb-07G7 likely to reject idea of concerted stimulus – Feb-05Berlin may go it alone on bank regulations – Feb-05It is counterintuitive, therefore, that some of the countries that can least afford to spend themselves out of trouble are the ones calling for stimulus packages. The US has already waded in with a $150bn fiscal package, equivalent to 1 per cent of gross domestic product. Sure, the likelihood of a US recession is probably the highest among the G7. But its 2008 budget deficit was already forecast to be 3.4 per cent of GDP. The UK’s chancellor has also mumbled about government support for the economy in spite of a weak and deteriorating fiscal position. Rubbing it in at the other end of the scale, countries with the healthiest balances, such as Germany and Canada, have shown no appetite for a concerted effort to support the global economy through fiscal spending. Germany’s deputy finance minister has said the blame, and thus the responsibility, lies squarely with the US. What both camps might share, however, is poor timing. The US should have provided a fiscal boost before its economy rolled over, and when it had the money. Minted countries should perhaps start spending now, before it’s too late. http://www.ft.com/cms/s/1/5f197830-d652-11dc-b9f4-0000779fd2ac.html
Gloomy @ 10:05:17 The “poor timing” you refer to would be seen as poor timing anytime after ’02? ’03? when the fiscal imbalances really began to expand exponentially and like the Professor began to be ridiculed for saying the piper might want to be paid.
Gloomy @ 10:05:17 Should be “and FOLKS like the Professor….
@KJ Foehr on 2008-02-10 01:18:06 ”Who is the “better” person? Someone who works as a volunteer in an AIDS hospice for 30 years, or Bill Gates who has provided millions of dollars to build AIDS hospices and pay for the care of patients? … ”Considering the charitable donations of Bill Gates and Warren Buffett and other wealthy philanthropists, do you consider their pursuit of money to be “a waste of a life”?” — There is balance in the universe don’t you know… For all the positive aspects of the Bill & Melinda Gates Foundation there is also the negative: http://www.alternet.org/stories/47713/?comments=view&cID=530246&pID=519584 If you gave a friend five dollars, and at the same time picked his pocket of five dollars, neither one of you would be much worse off — but you wouldn’t be much better off either. The largest foundation in the world, the Bill and Melinda Gates Foundation, is doing just that, only on a multi-billion-dollar scale, and at the expense of millions of people living in the poorest parts of the world. The Los Angeles Times recently published a carefully researched article about the conflicts that exist within the Gates Foundation between the companies that the foundation invests in and the grants that it makes, particularly in Africa. For instance, the article explains that Gates is investing in an Italian oil company, Eni, that spews pollution, and “250 toxic chemicals in [its] fumes and soot have long been linked to respiratory disease and cancer.” This is the same part of the world where the Gates Foundation grants millions of dollars on vaccinations to immunize children against deadly diseases like polio and measles. – Mark (the original? one)
Written by Gloomy on 2008-02-10 09:15:00 Hi Gloomy, Thanks for the great link. Asia: next shoe to drop and it looks like it will drop rather fast. We may start seeing the Chinese New Year’s hangover next Tuesday/Wednesday when bourses open.
Maybe someone should tell the 50% of economists who don’t think there is a recession to get out of their offices once in a while: ”Empty homes and for-sale signs clutter neighborhoods. You’ve lost your job or know someone who has. Your paycheck and nest egg are taking a hit. Could the country be in recession? Sixty-one percent of the public believes the economy is now suffering through its first recession since 2001, according to an Associated Press-Ipsos poll.” http://news.yahoo.com/s/ap/20080210/ap_on_bi_ge/recession_vibes&printer=1;_ylt=AkEthwnfoiYCru6Hz9mCHxNv24cA
@Octavio I can’t help but think that we will see a world wide collapse in the next few weeks. What do you think?
@ Dan on 2008-02-09 18:31:08 Early Gen-X person worries about 401K being enough for retirement. Early-Gen X implies you are 40+ years old. Let’s assume you are 45 and have saved 0 money towards retirement. The biggest problem with 401k’s is ignorance and lack of discipline. 1. Given your age you must contribute the most you can. Let’s assume your company matches you 50% and that so that you can save $20K/year (includes your co’s contribution). Assuming you can achieve an avg. rate of return of 8% nominal (5% real at 3% inflation) in 20 years you would have (use this calculator: http://www.investopedia.com/calculator/AnnuityFV.aspx ) at 65: using 8% return: $915,239.29 To see it in today’s dollars use 5% and you get: $661,319.08* which assuming you will also get SS should be enough for a spartan lifestyle if you are single. If you are married and your wife works and saves about the same you will be better off due to economies of scale (live under the same roof, stay in the same room at a hotel, ride in the same car, etc.) The trick is achieving your 5% real annual return (Right now with almost negative real rates it does not look easy but things will get better) 1. I assume you know zero about investing so go to a low cost investment house such as Vanguard that won’t rip you off, do as they say. Dollar cost averaging will take care of you. There in a wealth of information in their website including learning materials (As of now, I have $0 invested with Vanguard, not even their etfs but that is another story) 2. Make sure you stay the course. Ignore whatever gloom and doom you read here and elsewhere, do not try to time the market. Use the asset split recommended for your age and stick to low cost investments. Most Mutual Fund houses rip you off taking in between 10-20% of what you earn (more in bad years). 3. When you get to retirement age, if you are not worth more than a couple million USD in today’s dollars, buy a lifetime annuity leaving the funds invested in a portfolio that continues to give you some exposure to equities. (Fidelity has gotten bery competitive in this area. I assume Vanguard is competitive too. I have not invested any money in annuities. TIAACREF is another good place but only for academic/nonprofit employees) So if at 65 you have about $700K assume you will live to be 85 and that you can continue to make your 5% real/year: (use this calculator http://www.planningtips.com/cgi-bin/simple.pl) $700000 initial investment at 5%: You can take out 4619.69 a month/month (before taxes) for 20 years . For 30 years you ca take out $3,757. There are three catches here: 1. staying the course, 2. achieving 5% real return/year. 3. The fact that the return rates varies, some years if can be a lot higher, some years it can be a lot lower (I do not want to get into things like calculating the probability of a substantial loss at some point in time which you will only have to worry about if you first do things right for a number of years)
Gloomy – you might be interested in Fleckenstein’s new post. He says, “The bulls have come back out to suggest we’ve seen the worst of the credit crisis. But the real problem — too many bad mortgages — won’t be easily solved.” http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/HousingMessTooBigForAQuickFix.aspx He points out mortgages have been so sliced and diced that “Hardly a mortgage is left in the place it was originated. Conceivably, any given mortgage could be held by 50 or 100 financial institutions rather than just one. And every community has unique problems to deal with. “As for those folks who think still-lower interest rates would reinvigorate demand, Bob Campbell of the San Diego Real Estate Timing newsletter counters with this undeniable fact: ‘When an asset like real estate becomes overvalued, even if you drop interest rates to zero, you can’t force consumers to borrow more, because they’ve already borrowed too much. Nor can you force lenders to lend, because they’re already puking on ‘bad paper.’ It’s called a liquidity trap.’ “I don’t believe there’s any way to get the genie back into the bottle or to solve not just the size but the complexity of the fundamental mortgage problem: Too many people are involved with too many different agendas to make these credit problems go away quickly and easily.” But then he says: “Even so, many Wall Street participants envision a quick ending to the unwind of the credit/housing mess. It’s their belief the economy will skirt a recession or experience one that’s minor and painless. “For instance, Richard Russell recently wrote in his Dow Theory Letters: ‘As for the recession, the stock market’s not worried about one, so why should you??’” “(Of course, the market didn’t worry about the tech bubble, credit bubble or real-estate bubble, either.) ”’I have to think that the Dow Jones Transportation Average ($DJT) is telling the story,’ Russell wrote. ‘From the Transport low of 4140.29 recorded on January 17, the Transports rallied to (a recent) closing high of 4807. . . . It follows that if the Transports have recorded their lows, then no matter what the Dow does, the correction or decline or bear market — or whatever you want to call it — has ended.’” NOTE: Isn’t this rather an about face for Richard Russell (although I haven’t followed him for two years)? I mean, what does he mean by “the stock market’s not worried…?” Fleckenstein also has a link to a Jim Jubak video “The Market Has More to Fall” – “The Dow industrials’ big rebound Jan. 23 appears to have been set off by computer trades: After stocks fell, large funds wound up with too much money in bonds and had to re-balance. So the swing was probably not a sign of a bottom.”
Written by Gloomy on 2008-02-10 13:16:31 That is a tough one. I also thought the roof was going to cave in fall of 98 (LTCM collapse), that GS and his cronies wouldn’t be able to save the day but they did! The .com collapse was delayed almost three years. This time it is much worse but you never know… I think the world economy is going to slow down a lot more than the average guy thinks and that inflation, as well as real rates, will come down (The financial crisis/credit crunch will be a big part of it but I don’t think a total melt-down of the world financial system is likely, even though I am prepared for it. If that would happen, IMO, US treasuries and a little gold will be the place to be) I am prepared to profit some from a world slowdown within a highly diversified framework (Excessive greed backfires). In the mean time, i.e., while the FED keeps lowering rates and most people don’t have a clue about what the hell is going on (inflation? deflation? stag-deflation?, etc. and the lord knows what) I continue to especulate in soft commodities and gold (again, wihout excessive greed) Bottom line: for me the key is capital preservation (like most, I have only learnt this the hard way). I more or less follow these two rules rule #1. do not loose money rule #2 do not forget rule number 1. (of course, taking into consideration that if you are taking risks you must be prepared to stomach some volatility – mine is under 0.5%/day even when all turns out against me) Going back to your question, my BIASED most likely scenario view, is that the next few weeks will bring “hell” to Asia (Japan already saw some last week), Australia, and many emerging markets, and that things will unfold at a far greater pace that the subprime crisis unfolded in the US.
@Octavio “Ignore whatever gloom and doom you read here and elsewhere, do not try to time the market…” Question. Say you were going to invest retirement funds in a self-employed SEP plan (waiting until March and April because of uncertain ’07 income) at the maximum contribution cap of $42,000. Say you wanted it in stocks, maybe an S&P Index. Would you not time the market somewhat (by rolling distributions from a Money Market) under present conditions? If so, over what time span? If not, aren’t you assuming a lot of risk?
@Octavio Thanks. It just seems that while unrealistic attitudes persist, the market does keep declining to the steady drumbeat of bad news, with no good news on the horizon. I’m not saying that there couldn’t be suprise good news or market manipulators who might alter the course of things. It just seems to me that the bad news keeps geeting worse and worse (for example the Asian problem we were talking about)and keeps hammering like a pile driver. So I just have a feeling it must cause a serious fracture soon. How much more can investors psyches take?Do you not FEEL it? Is it just me?
AP Many Believe US Is Already in Recession Sunday February 10, 2:29 pm ET By Jeannine Aversa, AP Economics Writer Nearly 2 Out of 3 People in AP-Ipsos Poll Believe Country Is Already in Grips of Recession http://biz.yahoo.com/ap/080210/recession_vibes.html http://biz.yahoo.com/ap/080210/recession_vibes.html
@Octavio Sorry, I think our posts are crossing. Thanks for your answer.
… instead of all this seller/buyer beware /wear a gun = protection society a return to–> do not harm preventative society?
Written by Guest on 2008-02-10 14:41:35 I was just trying to give you some general advice that assumed you knew nothing about investing (which may be better than knowing some). You are right that in a way, I am telling you “do as I say instead of do as I do”. Yes, you are right, I would not jump into equities right now, waiting a bit sounds like a better strategy. When rates are coming down (they still are) bonds do well, except for the fact that now there is chaos in fixed income markets so you have to be very careful. As I have said before check out PTTDX* (not Vanguard that is PIMCO) but do not wait until FF rates are under 2% check it out. In years the FED was cutting rates it returned 8-9%. YTD it has already returned over 3% so I don’t know how much juice is left 124 bps later… also look at PSSDX also managed by Gross, it shorts the S&P 500 in an intelligent way so you get some income plus even if the index return is positive for the year Bill may soften some of that. But don’t be greedy, don’t put 100% into it. Also notice, most mutual funds have a 6mo lockout period (you loose money if you sell early) this is not the case with etfs of which there is plenty. From vanguard check out this one: VFITX lower cost: check this out: 12b-1 Fee None! even safer than PTTDX lower expected return but remember PTTDX eats up 0.75% of the return! https://personal.vanguard.com/us/funds/snapshot?FundId=0035&FundIntExt=INT https://personal.vanguard.com/us/funds/holdings?FundId=0035&FundIntExt=INT
AP Yahoo Board to Spurn $44B Microsoft Bid Sunday February 10, 7:45 am ET By Michael Liedtke, AP Business Writer Yahoo Board Intends to Turn Down Microsoft’s Unsolicited $44.6 Billion Takeover Bid http://biz.yahoo.com/ap/080210/microsoft_yahoo.html IMO, an aggressive takeover of yahoo will not work and Microsoft knows it. Aside from the yahoo franchise, the key asset here is people, not RE, not mineral resources. If people at Yahoo hate Microsoft (I don’t know this for a fact) the merger will be a failure. Very few people outside Microsoft were hot about this merger. The additional wrinkle makes the prospects even worse. Google’s stratospheric stock may recover some next week.
Really super advice and commentary today. If anyone interested,I saved this advice written in November: ”If you are asking for investment advice for your life savings…I suggest you get qualified professional help from a Fee-Only Advisor. The National Association of Personal Financial Advisors(NAPFA), is the national professional association. It has a list of qualified advisors at http://www.napfa.org.” It was written by Ryan Darwish, author of “The Emperor’s Clothes: Megatrends Affecting Your Financial and Investment Decisions.” www.investmentmegatrends.com
Paulson Says Global Economy Faces `Serious, Persisting’ Risk From Markets U.S. Treasury Secretary Henry Paulson said the global economy faces “downside risks” from the rout of capital markets that is “serious and persisting.” http://www.bloomberg.com/apps/news?pid=20601103&sid=aA7A9yXU7UMw&refer=news He is scared but he will be fine, even make money out of the mess he helped create:-)
Retail Sales Probably Fell in January: U.S. Economy Preview By Shobhana Chandra http://www.bloomberg.com/apps/news?pid=20601103&sid=adHYaVoilwIg&refer=news Even the most pessimistic forecasters (e.g., Shilling who sees 2008 GDP falling over 3% in 08) pencil in a drop in consumer spending of about 1.5% vs 07. What would happen if we get double that?, i.e., a 3% decline in real consumer spending. The probability of that is very low but let’s run the numbers: Consumer spending is 70% of GDP so a 1.5% decline means a 1.5*.7=1.05% hit to GDP. A 3% decline means 2.1% hit to GDP; Just on consumer spending. Please note that exports/lower imports won’t save the day.
A nice collection of Bearish news that, despite the bias, reflects very well the situation we are in: http://www.prudentbear.com/
A great one from the current issue of BW. Credit Crunch at its best. The Fed is lowering rates but the Banks are cutting credit card credit limits and hiking rates! Over the Limit Americans accustomed to cheap and easy money—and an economy geared to their free-spending ways—face a harsh new reality as banks raise rates and lower ceilings on credit cards http://www.businessweek.com/magazine/content/08_07/b4071034382063.htm?chan=magazine+channel_top+stories
insolvency crisis This is what i noticed you can’t get blood from a stone. if you look at canadian bankruptcy numbers on stats can. you will notice that yes over the past five years the trend was down however, the personal outstanding balances are larger than in past trends… so following this thinking if the numbers of personal insovlencies increase (which they seem to be doing) this would mean even greater losses outstanding.
That Bear Stole My Picnic Basket http://images.businessweek.com/ss/08/01/0131_ceo_losers/index_01.htm
The Professor’s current and previous post combo is starting to look right on target…
Gloomy: “I can’t help but think that we will see a world wide collapse in the next few weeks. What do you think?” Not sure what collapse you are referring to. If you mean a further deterioration in global stock markets, then yes. Probably not a plunge, because central banks will take action. More likely, a much greater tightening of consumer spending in the USA, a surge in foreclosures and deliquencies, and a rise in corporate defaults and bankruptcies. In other words, if you thought that retail spending by consumers took a nosedive in Jan, just wait till you see what happens in Feb-April. Not pretty. It’s possible we may see one (or more) of the major hedge funds go under … in which case we will see a mad scramble to cover default risks. Wall St is very worried about counterparty defaults – esp. affecting the CDS market. I couldn’t tell you what will happen with the monoline insurers. Personally, I think they are toast. If there was an easy rescue – it would have already been done. The big Wall St banks still face huge losses ahead, and they need to safeguard themselves. There’s not a lot of room for generosity right now (even when things are serious). Anybody who says this credit crisis is behind us … does not understand the scope of the problem. I wouldn’t say the global financial system is going to collapse in a few weeks, though. You should be more worried about the US dollar in the future. There’s not much reason for foreign buyers to keep purchasing US bonds right now. Chinese citizens can earn more yield on their own bonds at this stage. Everybody’s on a tear about “the US dollar going up”, but it’s prospects in the months ahead don’t look good to me. PeteCA
Professor Still more kudos to you – your predictions that the banks had owned up to the merest fraction of the subprime disaster is verified post-G7; the figure is now put at $400 billion (and climbing) http://www.ft.com/cms/s/0/8727f20c-d80a-11dc-98f7-0000779fd2ac.html So far they have come clean on less than $120B ie somewhat less than a third. Note that the article also states that government bail outs for more banks becomes more and more likely (presumably as the Sovereign Funds realise they were mugs to put cash in when bank shares were no-where near the bottom (and refuse to buy any more)) leaving governments as the buyers of last resort. With information like this out in the open how an earth can economists be talking of a market bottom or even a short lived slow down. Even if there were ‘only’ another $280billion of right downs out there this amount is enough to cripple banks and the financial markets for at least the next 6-12 months!
@Andy Hamilton: “… government bail outs for more banks becomes more and more likely (presumably as the Sovereign Funds realise they were mugs…” As “government” means “the people,” I guess that makes you and me the “mugs of last resort.”
The tax break China gets but you don’t By Raymond Richman, Howard Richman and Jesse Richman http://www.worldnetdaily.com/index.php?fa=PAGE.view&pageId=55899 “The United States tax system has a tax break that encourages… foreign governments to take over U.S. corporations… It exempts foreign governments from paying any U.S. taxes on dividends, interest or any other income earned from their U.S. investments. Other governments have the same policy. It’s a sort of gentleman’s agreement among governments: We won’t tax you if you won’t tax us. “The problem with this “gentleman’s agreement” is that it is one-sided. The U.S. government has virtually no investments abroad, while other governments are putting together huge bankrolls to invest in the United States. Morgan Stanley estimates that Sovereign Wealth Funds, the funds set up by foreign governments to invest in foreign equities, currently have $2.5 trillion in assets and will have $12 trillion by 2015. As a result of the giant U.S. trade deficits ($713 billion in 2007), foreign governments have huge surpluses of dollars with which to buy American businesses – and they’re doing so….”
By accident watching a piece of “American Gladiator on TV”. Super-muscled “gladiators”, cheering crowds, dramatic music, blazing fires, and even the commentator seems to be on a steroid overdose. And the first price seems to be a huge American SUV! And of course you see the American colors everywhere. How did ancient Rome go through its final days again…?
And as if on perfect cue the downgrades of Chinese growth start arriving: http://www.telegraph.co.uk/money/main.jhtml?view=DETAILS&grid=&xml=/money/2008/02/11/cnchina111.xml De-coupling? Don’t make me larrrffff……..
Another Asia related item (Japan afraid to lose face and admit sub-prime losses?) http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/02/10/ccjapan110.xml
THis is what Asia/India/Australia/NZ are up to (note that HK and SK are open, China Taiwan and Japan are closed today): http://www.bloomberg.com/markets/stocks/wei_region3.html HK holding up rather well. It was closed TH and FR. Asian 2008 holidays all in one place: http://money.aol.ca/article/diary-asian-holidays-to-december-2008/79818/
Following free email available by subscription only at: http://www.dailyreckoning.com.au:80/ Bargaining with the Bear London, England – Melbourne, Australia Monday, 11 February 2008 In This Issue: Bargaining with the Bear… Liquidation underway… Commodities hit a new all-time high… ———————————- From Dan Denning at the Old Hat Factory: –Relentless. That’s what this bear market in credit is. It won’t quit. –First it was subprime loans. Then Alt-A. It will probably include securitized credit card receivables before it’s over. Now, we have trouble in the European junk bond market and rumblings in the corporate bond market. And at long last, liquidation in the CDO market. –”The European high-yield bond market remains frozen, as spreads at the widest levels in nearly five years fail to draw investors worried that prices may fall further due to the global credit turmoil,” reports Natalie Harrison for Reuters. The great unwinding of leverage may be about to hit another gear. –”Unwinding of synthetic CDOs – which reference CDS contracts – is thought to be behind some of the rapid spread-widening on credit indices on Friday,” reports Sam Jones at the Financial Times. –It gets tricky here. But the basic explanation for Friday’s action is that to shut down a CDO you have to buy protection in the credit default swap market. Like any market, higher demand usually leads to higher prices. The unwinding of CDOs will mean higher prices for credit default risk, and big losses on CDOs. –DABDA. Denial, anger, bargaining, acceptance, depression, acceptance. –Those are the stages of grief according to Elizabeth Kubler-Ross in her book, “On Death and Dying.” This bull market in financial engineering and credit is either dead or dying. But you can see that various market participants are at different stages in the grieving process. –Ben Bernanke is somewhere between denial and bargaining. He knows there’s a problem, but he would like to bargain with the Bear. “Let me cut rates to help home owners. You can have your pound of flesh from savers if you’d like. But please Bear, be reasonable.” –The Bear is not reasonable, but he is thoughtful. He wants you to believe he can be reasoned with. That way he can swipe you one paw at a time at his own leisurely pace. If you run, it makes his job harder. He wants you to sit and be still. It’s easier to eat a stationary target. –Jean Claude Trichet is also bargaining. Until recently, the European Central Bank has been a rock in the fight against inflation. It has not cut rates to “stimulate” or promote growth. But the credit Bear even has Trichet spooked. He has sat down to offer the Bear some easy-money honey. –”Uncertainty about the prospects for economic growth is unusually high,” Trichet told reporters last week. “We have had a reappraisal of risk in financial markets which triggered unusually high uncertainty, so the risks are on the downside from that standpoint.” –Trichet used the word “growth” and not “inflation” suggesting every so subtly that the bias at his bank is to cut European interest rates to ignite “growth.” This prompted a bout of U.S. dollar strength last week which could continue. –How very strange. Just last week, the U.S. Treasury had trouble auctioning $9 billion in thirty-year bonds. The market seemed to tell Uncle Sam, we do not want to lend you money for 30-years at a mediocre interest rate of 4.45%. Yet relatively speaking, the dollar could rally. Why? –We have no idea. In a world of relative currency movements, it’s a constant battle between growth and yield over which determines the market value of a currency. Sometimes investors value higher yields on government debt, believing that makes a government’s money strong. Other times, high growth economies are valued. –Our prediction is that gold and silver will to better than paper money for the next few years, both relatively and absolutely. As Bill says, all paper money eventually finds its intrinsic value. –For more on silver, see today’s essay. Psychologically, precious metals accept the Bear in credit. Indeed, they hug him as safely as one can hug an angry, furry, be-clawed 300-kilo animal. The more he mauls financial assets, the better it ought to be for real assets. –And be prepared for more mauling of financial assets this week. “There were reports that several large German banks will need capital infusions to complete some upcoming mergers,” reports Leslie Wines at the Associated Press. As you can see from the figures below compiled by BNP Paribas, the losses in the global banking sector have already been substantial. …. Source: BNP Paribas –Expect more liquidation and loss-taking. “In addition, there was speculation that European firms have been selling some of the bad subprime debt held in the complex asset pools known as collateralized debt obligations, the economics firm said. The liquidation of low-quality assets often intensifies demand for safe assets.” –Here, finally, we have some good news. Demand for “safe assets” is precious metals bullish. But the larger issue is cleaning out the rot in the badly corrupted global financial system. –For the economy and the stock market to get back on solid economic footing, the past excesses and mis-allocated capital of the previous credit boom have to be liquidated. Banks must take losses. Fictitious assets must be marked down to their real value instead of held on a balance sheet. –”This is a credit market problem in the West which has to play itself out,” said Peter Spencer, a former British Treasury official in today’s Age. It could begin playing itself out this week as more CDOs are forced to close up shop by creditors anxious to take their losses and get on with their financial lives. If creditors accept losses, it means we’re one day closer to liquidation, and starting from a cleaner economic slate. –What precisely is happening in CDO-land? At Christmas,” The FT continues, “Thirty-three 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 senior creditors are now pushing for CDOs to be liquidated – indicating the beginnings, perhaps, of a much-speculated-upon 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.” –All this means you should expect more volatility and selling in equity markets. Doing nothing is the first act of a cautious investor. With fewer buyers, prices should fall. And in the meantime, Australian investors are trying to sort out what’s going on between BHP and RIO. –Some reader mail. ”In reading all the articles about the BHP bid for Rio Tinto, I keep wondering why no one cites Kloppers’ disastrous strategy? ”While he was attempting to clever and ‘coy,’ and underbidding on Rio Tinto, he allowed time for the Chinese to come in and frustrate the effort. He was playing ches
s while he should have gone for a decisive smash play – much like Albanese did for Alcan. In fact, I think the Rio Tinto CEO has played a far smarter game so far and if the merger goes through, I would select him as the surviving executive though I doubt that would happen. –It’s a full mail bag today. Daily Reckoning, You suggest investors are at property auctions in today’s newsletter. Why would you bid at a property auction when good value customer and profit growth shares are to be had? I keep an eye on residential property, and the yields are the lowest I have ever seen. Renters don’t look as though they will be able to pay more in the next few years to me. Property is a strange beast. I wonder what the trend in average time between listing and sale has been for the last couple of years in the investment segment of the market. Now for some simple questions. Can you please explain how RIO will benefit RIO’s shareholders by continuing to drive the price of both BHP and the lockstepped RIO shares down? Can you speculate on what BHP/RIO shares would be worth now if RIO had accepted the first scrip for scrip offer, when the scrip price ratio pre offer was actually as good as or better than the latest offer? Please explain how the RIO directors’ strategy to date benefited RIO’s general shareholders? Some of RIO’s major investors took the money, and ran. They did OK, but some observers perceive that the new player has the ability to block a fully beneficial clean merger, and has a natural interest in keeping prices from (both) BHP AND RIO low as well. Since the Chinese have got their blocking stake, and potentially a seat or two on RIO’s board, what will RIO shares be worth the morning after the night before if BHP withdraws its offer? Doesn’t the likelihood of an FIRB barrier make BHP the only takeover game in town? And here is a complicated question. What will Twiggy in the middle Fortescue be worth when (and if) BHP and RIO are combined. Are we having fun yet? Regards, Brian And now over to Bill Bonner in London, England: First, the basic facts: The Dow rose a bit yesterday. The dollar went up too. Commodities hit a new all-time high , with the CRB at 509 and wheat over $10 a bushel. U.S. stocks of spring wheat are expected to go down 25% compared to last year. Gold rose $10 – to $910, and then went up another three bucks after the market closed. From an inflationary point of view, these are all positive signs. The feds are desperately afraid prices will fall. They’re doing all they can to keep the party going. It’s either “inflation…or the peace of the cemeteries,” an Argentine official once remarked. Inflation or death! Boom…or bust! Well…er…yes. Still, the revelers seem to be putting on their coats, one by one, and heading for the door. A Wall Street Journal poll of economists gives dead even odds of a recession in 2008. If the peace of the cemeteries is really creeping up on us, we should see consumers cutting back. And the giant retailers ought to confirm it. Sure enough, China’s American outlet store – Wal-Mart – tells us that sales are not as good as it has expected. Wal-Mart “leads the parade of sales misses” says a report on CNNMoney . ”I think its results show that its core of low-income shoppers and now the middle class households who shop there are cutting back,” remarked an analyst. ”Retailers struggle as Americans pull back,” is how the International Herald Tribune sees it. “You’re seeing the continuing unfolding of the consumer spending slowdown,” said another expert on retails sales. It’s the next big thing, dear reader – downsizing, cutting back, making do. Barely on the radar screen now, thrift is coming into focus more clearly day by day. So far, people are a bit embarrassed about it…a bit ashamed that they have had to cut back. But soon, it will be popular…fashionable…and finally, almost obligatory. Capitalism is a moral system, not an economic system. It rewards virtue and punishes error…and after punishment…atonement…and then, a new appreciation for virtue. ”Virtue is what used to pay,” said an economist with a shrewd eye and a forgettable name. And if the economist whose name we can’t remember didn’t say that, we’ll say it. Saving money, self-discipline, forbearance – they’re all virtues because they paid off in the past. Not every year…not in every trend…but, generally, over the long run they pay off. They will be virtues again because they will pay off again. Wasting money…spending recklessly…and going into debt will soon be seen as social gaffes…as errors…and as bad taste. Of course, the feds are doing all they can to prevent saving. Lower interest rates and rising consumer prices discourage saving. But the struggle between Mr. Market and the market manipulators is as old as the struggle between vice and virtue. Sometimes one side wins. Sometimes the other. But in the end, what must happen sooner or later does happen. When consumers must cut back, they do cut back. People do what pays. But what pays now? What pays is saving money. But not in dollars…and not in any other paper currency . The market manipulators are in charge of them all…and they’re all determined to see them go down. ”ECB stands pat, but signals a new line of thinking,” is the headline in today’s International Herald Tribune . Recently, the dollar has been rising against the euro. Speculators thought the ECB wouldn’t follow through on its threat to raise rates to fight inflation. They were right. Instead, the ECB stood still – acknowledging that a slowdown in the United States may reduce demand and thereby slacken inflationary pressure in Europe. The Bank of England, on the other hand, cut its key rate by a quarter point. And the ECB said it might do the same. Both the pound and the euro fell against the dollar. *** Prices are rising in Europe as in America. Bread is up 12% in Germany over the last 12 months. Butter has gone up 45%. Milk 25%. By the time the average European has finished his breakfast, he is feeling a little queasy. And by the time he has driven to work, after filling his gas tank with fuel that costs about four times as much as it does in the United States, he is sick. The Europeans have been caught by the dollar too. As America emitted more pieces of green paper, foreign banks had to emit their own colored paper to keep up with it. Otherwise, their currencies would have gone up against the dollar…making their economies less competitive on the world market. It was a cycle that appeared virtuous for quite a while. More and more money in circulation had the effect of boosting up share prices…and house prices. People thought they were better off. But now, assets are falling in price…consumer products are going up. Now people are getting the kind of inflation that they don’t like…and now they want someone to do something about it. Opinion polls show that purchasing power is one of the main complaints of voters. Politicians are talking about solutions. And central bankers are under pressure to raise rates, not lower them. At the same time, the pressures from deflation are mounting too. A spokesman for Price Waterhouse Coopers says the subprime debt problem has still not fully expressed itself. And “the credit crunch gets worse,”
writes Floyd Norris in the New York Times. Bankruptcy filings by companies with leveraged loans outstanding are running more than four times last year’s rate. *** “McCain can never win,” came the considered judgment of Henry, who will be able to vote for the first time in the November election. “He’s too ugly.” ”Oh Henry, don’t be silly,” said his mother. “You don’t vote for people based on what they look like. Besides, whoever is elected is bound to be better than our current president.” What set off the remark was today’s news. Mr. George W. Bush, president of the Land of the Free, 2000 years after the birth of Christ, and more than 200 years after the U.S. Constitution banned the use of ‘cruel and unusual punishment,’ said he saw no problem with waterboarding – even when used against people who had never been convicted of a crime. ”It is disgraceful,” said Elizabeth. “Pretty soon the IRS will be using it in tax audits.” It may be disgraceful, but it is not illogical. President Bush believes torturing prisoners by holding them underwater has provided useful intelligence ‘and saved American lives.’ ”Well, nailing Christ to the cross might have provided useful information,” came the response, “but it was still wrong.” Capitalism is a moral system, we pointed out yesterday. In the long run, it pays to save your money…make your investments carefully…work hard and avoid unnecessary spending. Capitalism will reward you. It is a ‘system’ that rewards virtue…and punishes lapses of judgment. But there are times when it seems like lapses of judgment pay off. When prices run up – as they did in the housing bubble of ’97-’07 – you begin to seem like a bit of a fool if you stay out of it. It is as if a wild party was going on down the block…you feel left out if you don’t go. And the people who are having the best time are the people who have let themselves go. They’re drinking hard…and dancing on the tables. They buy houses they can’t afford…and make money when prices rise. They buy subprime debt…and earn higher yields than more solid credits. They speculate on Chinese stocks…and they seem like geniuses. ”C’mon…get with the program,” they say. “Get in the swing of things…buy a new house; just claim that you earn more than you really do…and don’t worry, the appraiser will go along…and you’ll be able to borrow as much as you want. Then, you can ‘take out equity’ just like everyone else.” The guy who sticks to his principles feels like a hopeless fuddy duddy…a loser and a chump. He saves…and his savings lose value to inflation. He looks for value in the stock market – and can’t find a thing. He drives his old car…and holds on to his old house, while his neighbors splash out. But then, comes the correction…and he doesn’t look like such a dope after all. Always and everywhere, you can do what seems convenient…or you can do what is right. Sometimes it is hard to tell which is which; often it is not. When the Japanese invaded China in World War II they used waterboarding against their prisoners – holding them under dirty, soapy water until they were obliged to breathe the water into their lungs. Then, they hauled them out, punched the water out of them…and laughed at their prisoners gasping on the floor. What useful information they got from their victims, we don’t know…but we have no doubt that they justified their tortures with the familiar excuse: it was useful. In that same inglorious epoch, the Germans and the Soviets both invaded Poland. The poor Poles were doomed. The Bolsheviks rounded up the Polish officers and systematically murdered them…and then tried to pin it on the Nazis. It wasn’t a very nice thing to do, but it would have been damned inconvenient to allow those officers to live…and possibly pose a danger to Soviet control later on. Likewise, the Germans went to work on the Poles on their side of the frontier…and later in all of Poland. They rounded up the communists…the trade unionists…the religious leaders…the Jews…and the troublemakers. They did not hold back from torture either – not if it might save the lives of German soldiers! Then, they moved on – to murdering millions. Once you allow yourself to do what is convenient…instead of doing what is right…you are on the road to Hell.
Monday morning could be brutal at the market open. http://jtaplin.wordpress.com/2008/02/10/monday-could-be-brutal/
Very interesting article by Munchau in Monday’s FT. If I understand correctly, we will either get strong inflation (if no deep recession) or deflation (if recession is deep). Assuming that NR is correct, then we should be heading straight for a severe inflation of the US debt (national and privately held) and an inevitable collapse of the USD???? http://www.ft.com/cms/s/0/73bc130a-d7f2-11dc-98f7-0000779fd2ac.html A repeat of the Great Depression is unlikely By Wolfgang Munchau Published: February 10 2008 19:05 | Last updated: February 10 2008 19:05 How big is the risk of global deflation? Five years ago, central banks led by the US Federal Reserve fretted and cut short-term interest rates aggressively. This time the Fed is largely alone in seeking insurance against the possibility of a deflationary depression. Both the European Central Bank and the Bank of England may ease further. But neither is inclined to follow the Fed into “whatever it takes” territory. Deflation is the ultimate economic calamity – because of the human and financial misery it brings and the constraints it puts on policy. We fear deflation because of its self-reinforcing effects. If people expect prices to fall tomorrow, they hold back on consumption today. If investors expect falling returns, they hoard cash. This is also known as the liquidity trap. In his debt-deflation theory, the US economist Irving Fisher explained a truly toxic mechanism that has some potential implications for our own post-subprime world. If a debt crisis coincides with severe deflation, the value of outstanding debt rises even as debt gets repaid. While all this is happening, central banks are constrained in their ability to stimulate the economy by the zero nominal interest rate bind. But it is important to remember that these destructive mechanisms do not kick in the minute the officially recorded rate of inflation falls a fraction below zero. The deflation we fear is a large slump in the price level and a permanent shift in price expectations. During the Great Depression, the US wholesale price index fell by 33 per cent. Such a price fall is not likely in our globalised economy. So even if a repeat of the Great Depression is unlikely, how about a Small Depression, similar to Japan’s in the 1990s? Popular folklore has it that the bursting of an asset price bubble and a restrictive monetary policy caused that country’s 1990s stagnation. While Japan undoubtedly suffered a fall in consumer prices in the second half of the 1990s, its deflation was relatively mild, with annual prices falling by less than1 per cent. More important, these price falls did not produce nearly as many of those toxic self-reinforcing effects that were in evidence during the early 1930s. A far more plausible explanation of Japan’s lost decade is that by Professors Fumio Hayashi and Edward Prescott* who explain it in terms of weak factor productivity growth. When productivity falls, so does an economy’s long-run real interest rate. And when that happens, the effect of monetary policy stimulus is accordingly reduced. An examination of credit conditions and flow of funds data led them to conclude that a credit crunch might have contributed to Japan’s economic misery only briefly from late 1997 to early 1998, but cannot explain a whole decade of low growth. Is there a risk that the US will suffer a Japanese-style lost decade? Of course, but for different reasons. US growth will slow as the savings rate needs to rise. For a country with an unsustainable current account deficit, this is necessary and inevitable adjustment, not a catastrophic event against which one should seek insurance. In terms of its structural characteristics, the US economy is not comparable to Japan in the 1990s and even less comparable to the US in the 1930s. US productivity growth is much higher than Japan’s and much of Europe’s. That said, there is one scenario that could produce a 1930s-style deflationary depression in the US: a large-scale financial meltdown. By that I mean a situation in which the financial sector would cease to fulfil one of its basic functions: to provide liquidity to the real economy. But surely, lower central bank interest rates today could neither prevent such a scenario from happening, nor provide any comfort to an economy when it has no physical access to credit. In the eurozone, deflation is not likely either. There is no comparable indebtedness problem, except perhaps in Spain; no property crash, except in Spain and Ireland; and a relatively robust financial sector. Of course, the eurozone is not decoupled from the global economy. The UK is perhaps more vulnerable, because of the relatively large size of the financial sector in the economy, an over-reliance on a property market that is about to deflate, and chronically low productivity growth in non-financial sectors. There is now clearly the possibility of a severe and prolonged recession, followed by a long period of low growth. So the risk of a global deflationary depression is small. But might it still not be worth insuring against? The trouble is that such “insurance” does not come in the form of a “price” but in the form of additional risk – of future inflation and financial instability. Last week, 10-year US Treasuries bonds yielded a mere 3.7 per cent, a rate below the actual rate of US consumer price inflation. In the event that the US recession turns out to be unexpectedly shallow and short (not very probable in my view, but vastly more probable than a deflationary depression), yields may well shoot up to 6 or 7 per cent. So the “price” for avoiding deflation may be a bond market meltdown, your quintessential financial crisis. The rise in interest rates implicit in such a scenario would then give us a valid reason to fret about the future. *The 1990s in Japan: A Lost Decade, Review of Economic Dynamics, 2002 Send your comments to email@example.com
How did ancient Rome go through its final days again…? Written by Guest on 2008-02-10 19:53:47 Ancient Rome in its last days was blindsided by an obscure tribe called the Vandals. These Vandals had roamed parts of Western and Eastern Europe for decades before departing for Carthage across the straits of Gibraltar from Spain. In taking Carthage, the Vandals hit Rome’s lifeline to its breadbasket at a time when Roman armies were dealing with another tribe of nasties to the northeast- the Hun. Once the Vandals secured Carthage and its wealth they just squeezed. One fine day, the Vandals sailed back across the Med and walked into Rome unopposed as the populace was on holiday, enjoying the wonders of the coliseum and slaughtering its citizens in public etc. For several weeks the Vandals looted, stole and pillaged- NOT burned , destroyed or raped- Rome and its suburbs. Then, they left. Rome ,of course, ceased to be “Rome. But, that event gave rise to rather more nasty power- one who we still see effective until today- The Catholic church and the Vatican. The great empire of Rome was terminally weakened for decades earlier from within by greed and perversion of their elitist politics. As well as an arrogance toward all neighbours. In the end though it was something so subtle as Rome’s basic need- food- that brought her empire undone. Thereafter, the Roman empire dwindled and decayed as her people simply “got over it” .
“Assuming that NR is correct, then we should be heading straight for a severe inflation of the US debt (national and privately held) and an inevitable collapse of the USD???? “ Written by RedCreek on 2008-02-11 01:06:57 Heading??? Have you looked at the CRB index recently? On Friday it hit all time record highs. I would say that inflation, in certain very important things (like food and energy) is alive, well and prospering. Like Rodney Dangerfield, it ” caint get no respect” ! And with the Euro sitting at just below all time highs, not to mention gold already at near all time highs, I think it a tad premature to breath easy about avoiding an outright dollar collapse here. All the guests are here but this party has not even started yet.
@GSM: I am only an amateur economist but i was thinking as follows: (1) NR Correct = financial system collapse = very severe recession = strong asset deflation = strong US public and private debt inflation = USD collapse (below 2 Euros?) (2) NR not correct = no financial system collapse (OR financial system officially nationalized) = asset inflation = debt deflation = supports USD
@ GSM looks to me like we are in scenario 2 at this moment: CPI inflation, asset and commodities inflation, and no continued material deterioration of the USD. But this is a state of unstable disequilibrium and as you say, the party has not yet started. I am afraid that we might move towards scenario 1 in a matter of weeks or months at most (fin sys meltdown, inflation turning into deflation, usd collapse). End of Rome.
@ Redcreek, Same here,a very amateur economist with an engineering background. I try hard not to game scenario’s too far ahead and ALWAYS keep it simple based on concrete supportive diversity of facts. ALL information is in the price, and until it becomes clear that food and energy prices are abating, it makes no sense for me to sideline the resulting severe inflationary effects. I believe NR has it spot on with the financial scenario as it pertains to the US and the de-coupling argument. It looks and will likely be a horrific financial calamaty that is unfolding, particularly in the US. However, believeing the dollar can somehow escape demolotion defies my belief for now. Therefore, in simple terms; Collapsed Dollar= MUCH higher energy prices=MUCH higher food prices= MUCH higher inflation. Beyond that my scenario blurs. The CRB index is confirming- for now. Ordinarily the bond market would reflect price inflation- it doesnt. Why not? I think 2 reasons 1) Safety haven- enough big players are scared and this is their last hideout before dumping dollars and fleeing. 2) The bond market is being heavily manipulated by TPTB to provide the image of financial stability.(I wont go into bogus official US economic data). So, what is real and what is smoke and mirrors? What to believe and what scenario will prevail? I’ll stay with the CRB. What people pay worldwide for real stuff speaks louder to me that what they pay in the US for paper/promises/IOU’s etc in a very dodgy currency. At some point this game(the bond markets/dollar etc) will be up- the dam will burst.One way or another, it WILL become clear. Until then I just don’t want to get hurt and be positioned for profits.
I think also considerable weight needs to be given to how big an impact the credit crush is and will have in stopping new commodity production coming on stream .In effect, the credit crush will significantly aid destruction of future potential competition for holders of todays known mineral and commodity resources. You might want to think about that if you are an India or China, or BHP and RIO, Texaco , Chevron, Gazprom, Saudi Aramco etc.If you hold the resources NOW, even should demand decline, all that future competition is effectively being restrained- even cancelled. Makes your holdings/reserves that much more valuable I would say.
The Croesus Chronicles A Chrysler-Scale Bailout Of Those Monolines Robert Lenzner, 02.11.08 http://www.forbes.com/2008/02/08/croesus-chronicles-monolines-oped-cz_rl_0211croesus.html?partner=yahootix If there is a solution, it’s to get the Fed and the banks to agree that the equity in Ambac Financial Group (nyse: ABK – news – people ), MBIA (nyse: MBE – news – people ) and others must be wiped out and that the complex portfolios of derivative contracts and municipal bonds must be put in a separate facility to work out the values over the next five to 10 years. This is crucial since no one–not central banks, not the Treasury, not the cream of investment banking, certainly not the fools running the commercial banks or even the vultures at private equity firms–can determine their liabilities going forward. New York University professor Noriel Roubini (see “Look Out Below”) believes a credit downgrading will mean more massive write-offs by banks, as well as less credit available for an economy diving into a deep recession. You want to know fear itself? The monolines apparently have guaranteed $1.5 trillion worth of variable-rate munis that might have to be liquidated should credit ratings be lowered. It’s like Waiting for Godot, a frightening play whose tone is anxiety-provoking, to say the least. Ackman calls any downgrading of $1.5 trillion in muni bonds the potential linchpin of a systemic risk. The rot is overwhelming. Who can deal with it? The Fed and Treasury should see this is no time to let the free market deal with a crisis. Yes, there’s need for a cleanup of the mess. But first the bailout. Are you listening, Mr. Bernanke and Mr. Paulson? Get going.
OutFront Look Out Below Robert Lenzner 02.25.08 http://www.forbes.com/business/forbes/2008/0225/036a.html If you get depressed easily, don’t read this story. Here’s one sage’s prediction of a long, deep recession. It may be time to christen a new Dr. Doom. The candidate: Nouriel Roubini, an economist at New York University’s business school. He makes the old Dr. Doom, bond pessimist Henry Kaufman, look like Dr. Phil. No mincer of words, Roubini thinks a full-blown panic will scorch the global economy. He recently laid out his scenario for central bankers in Davos and had them chewing it for hours. He thinks the immediate spark will be the collapse of bond insurers (MBIA, Ambac, FGIC and others). These insurers have guaranteed $72 billion worth of collateralized debt obligations, now crumbling in value as housing prices fall. Cheerier sages see an economy lifting off in the second half, fueled by the Fed’s rate cuts, and a rebound in the shares of bond insurers. Roubini says lower rates won’t help. There are significant risks of insolvency. Here’s his prediction of how it’ll play out: Bond Insurers Lose the Triple-A At press time New York State was trying to arrange a capital infusion for the bond insurers. Roubini doesn’t think it’ll work, and there’s no Plan B–yet. Lacking that, insurers will lose their gilt-edged rating. Then the banks (Merrill, Citi and others) that paid them for protection against default of their collateralized debt obligations will face more writedowns–well beyond the $100 billion that’s been written down already. Financial losses in subprime mortgages could be $400 billion and in the whole financial system more than $1 trillion. A big bank might go under. Contagion Spreads Writedowns will begin percolating up from subprime mortgages to near-prime and prime mortgages, commercial real estate, auto loans, credit cards, corporate buyout loans, corporate bonds and derivatives. If leveraged banks, brokers and hedge funds should suffer $200 billion in domestic credit losses, they would have to pull back on $2 trillion in lending, according to a Goldman Sachs (nyse: GS – news – people ) analysis. Roubini says the rest of the world will “recouple” rather than decouple, as financial losses spread to other world capital markets, especially Europe. Sovereign wealth funds will not be large enough to play savior. Credit spreads will keep widening. Equities, housing, commodities, emerging market assets and the dollar will get hurt. “Cash is king in 2008,” says Roubini. A Protracted Recession Ensues Roubini says the U.S. went into recession in December and will stay there for at least a year. We’ve got excess inventories of unsold goods (consumer durables, autos), a shopped-out consumer and a growing weakness in labor markets with no new jobs (net of losses) and no rise in real wages. Home prices, down 8% currently, could fall by 20% to 30% total before bottoming. The Shadow Banking System Dies Banks got hooked on off-balance-sheet entities like structured investment vehicles, which Roubini calls the “shadow banking system.” But the shadow system has no access to the “lender of last resort” support of central banks. When the banks tire of bailing out their sivs, holders of siv paper will have losses.
Goldilocks, what a truly stubborn bunch! IMO, they will be run over by a BIG freight train. Economy Rebounds Before Election, Treasuries Show (Update2) By Daniel Kruger Feb. 11 (Bloomberg) — Before you can say “Barack Obama is president of the United States,” the economy will be growing faster again. That forecast is based on the rise in the five-year Treasury yield from its lowest level relative to two- and 10- year notes since 2001. The last two times that happened was during the recessions of 1990 and 2001, and the economy began to expand within nine months. “We’re actually starting to see tell-tale signs by the market that it expects the economy to be in recovery in six to nine months,” said James Caron, head of U.S. interest-rate strategy in New York at Morgan Stanley. The five-year note “tends to be the most forward-looking point on the curve,” said Caron, whose firm is one of the 20 primary dealers of U.S. government securities that trade with the Federal Reserve. http://www.bloomberg.com/apps/news?pid=20602007&sid=aFKw2_PcRylg&refer=rates
@ London Banker, and all the other traders trying to figure out the next market move, this could be an additional food for thought… This comes from a free blog of Sy Harding “As long-time subscribers know from my occasional rants about it, I suspect the pattern comes from the big program-trading firms driving the market down with the power of their sell programs in the week before the expirations, so they can buy about to expire options at pennies on the dollar, and then driving the market up the week of the options expirations with their buy programs, to reap huge profits on those options. Program-trading does dominate the markets, accounting for 27% of total NYSE trading volume this week. Only 1.06% of program trades were for index arbitrage, so presumably the rest was on directional trading. And who are the program-trading firms? The major brokerage firms and investment banks trading primarily for their own accounts. The top ten for volume this week were Lehman Bros., Goldman Sachs, Morgan Stanley, Merrill Lynch, Credit Suisse, Deutsche Bank, UBS Securities (Switzerland based), Bear Stearns, RBC Capital (Royal Bank of Canada), and BNP Paribas (large French bank). They are very successful trading for their own accounts as was seen in how, while announcing huge losses on write-downs of mortgage-backed securities and loans, many of them reported huge offsetting profits from their trading departments.” Considering your banking/trading experience, would you subscribe under this scenario? Thank you in advance,
LB, Octavio, GSM: Lately, we’ve heard a lot about debt excesses. I assert that the debt is not a problem; the problem is what the debt was spent upon (e.g. flat-screen TV .vs. course in advanced thermal design for homes). The point here is not that money was borrowed and spent, but to what effect? Hellasious, among others, reports a diminishing incremental effect of increased debt on GDP. This trend has been apparent for decades. This fact, in my opinion, is worthy of intense scrutiny. Suppose that a dollar represents a “share” in Enterprise U.S.A, and that the core function of the Fed is to “maintain the value of the dollar”. Doesn’t it astonish you that the main “solution” to our economic woes advocated by the Fed is to simply adjust the supply/demand of dollars? It’s amazing the amount of ambivalence that exists about the Fed’s role. Think of the commentary we often hear about the Fed: “One-hammer fits all”, “it’s all in what the market thinks they can do, not what they actually do”, “they just trapeze from one bubble to the next”. Think of all the cross-currents of expectation, and how little people really understand the function of the Fed. Now contrast that muddled view with what must happen, e.g. with the leadership that must be exercised in order to fix our economy. Leadership that really should be independent, per Dallas Fed Chief Fisher’s remarks the other day (thanks, Octavio). So here’s the thought-experiment gauntlet I’m throwing down: a) Please define the current mission of the Fed, in one sentence b) If you were to re-define their mission as “maintaining a viable economy that maximally benefits the maximum number of U.S. citizens”, what are the three (no more) top objectives that institution should have, and how would they execute that role. Again, three one-liners. I invite all observers to weigh in. Remember, brevity is the signal trait of brilliance.
@Kaaskop “The top ten for volume this week were Lehman Bros., Goldman Sachs, Morgan Stanley, Merrill Lynch, Credit Suisse, Deutsche Bank, UBS Securities (Switzerland based), Bear Stearns, RBC Capital (Royal Bank of Canada), and BNP Paribas (large French bank). They are very successful trading for their own accounts as was seen in how, while announcing huge losses on write-downs of mortgage-backed securities and loans, many of them reported huge offsetting profits from their trading departments.” The name of the game is bailout The rules are written by owners of the larger banks. The game is to shift losses to the taxpayers when their loans go sour – which they inevitably do. The game begins when the Fed allows the commercial banks to create checkbook money out of nothing… QUOTE: “The real menance of our Republic is the invisible government which like a giant octopus sprawls its slimy legs over our cities, states and nation. At the head is a small group of banking houses… This little coterie…run our government for their own selfish ends. It operates under cover of a self-created screen…seizes…our executive officers…legislative bodies…schools…courts…newspapers and every agency created for the public protection.” N.Y. Mayor, John Hylan
@OuterBeltway: “Please define the current mission of the Fed, in one sentence …” Federal Reserve shareholders, entrusted with the power to control the nation’s money supply and manage its economy, eventually will use that power to confiscate the wealth of their neighbors — which is where we are now.
The Fed isn’t fooling anyone…by Jim Jubak http://articles.moneycentral.msn.com/Investing/JubaksJournal/TheFedIsntFoolingAnyone.aspx ”The central bank’s interest-rate cuts may be a quick fix for 2008, but they’ll create a massive inflationary push in 2009, leading us right back into another boom-bust cycle.”
Had to pass on this comment to “Pondering the Bailout” from The Wall Street Examiner.” http://wallstreetexaminer.com/blogs/cutting/?p=153 Winston Munn wrote: Mr. Milstein made two points that are correct: 1) growth in the world economic system is dependent upon credit expansion, and 2) the problem is one of capital impairments. His solution is truly disgusting, for what it calls for is to use the U.S. taxpayer as a monoline insurance company to write credit default swap contracts on subprime mortgages. The problem with housing was and still is that houses are overpriced compared to wages. The reversion to the mean in housing prices will not be stopped simply by freezing teaser rates when there is a 10-month supply of houses on the market. But Mr. Milstein wants the U.S. government (i.e., taxpayers), to assume the dual risks of further collateral depreciation and loan defaults, while the banks get to hold onto mark-to-make believe asset values to support their capitalization. All this Milstein plan accomplishes is an underlying bid for the credit bubble – it is nothing more than an attempt to support decaying asset values with public funding. It is not a plan – it is an outrage
@ OuterBeltway So here’s the thought-experiment gauntlet I’m throwing down: a) Please define the current mission of the Fed, in one sentence b) If you were to re-define their mission as “maintaining a viable economy that maximally benefits the maximum number of U.S. citizens”, what are the three (no more) top objectives that institution should have, and how would they execute that role. Again, three one-liners. (a) The current mission of the Fed is to privatise profits and socialise losses to the maximum benefit of the entitled elites, hypothecating the maximum wealth from all other classes of Americans. (b) If the Fed were to have a mission of serving the interests of a maximum of US citizens, its top three objectives would be: (1) Preserve the credibility and purchasing power of the dollar to attract and retain foreign credit and investment flows and provide a predictable basis for domestic investment decisions; (2) Apply prudential supervision and regulation to reinforce traditional banking constructs such as tying finance to the productive use of that finance to promote repayment of the debt and the general economic welfare; enforcing lending parameters which reward prudence, caution and productive use of credit; and limiting the scope for conflicts of interest and contagion arising from intermingling of commercial banking with investment banking and other speculative enterprise; and (3) Promote fiscal discpline by using the levers of monetary policy to offset imprudence and poor judgement of the Executive and Legislative branches by hiking interest rates when deficit spending exceeds small, temporary imbalances to restore fiscal discipline.
The following post copied from wallstreet examiner claims, that ECB under Trichet is taking far more worthless collateral when lending money than the FED thus “trshing the EURO”. Could anyone comment on this please. Thank you BMH ECB A Dumping Ground for Financial Toxic Waste by Lee Adler ECB President Jean-Claude Trichet said Thursday that European Banks have “pledged more private paper, such as asset-backed securities, to the European Central Bank to use as collateral in its liquidity-providing repurchase operations, but that does not mean that the ECB is bailing out private banks.” Trichet said that “It is clear that all of us on both sides of the Atlantic have noted an increase of the collateral [that is] in the form of private paper. Treasuries were less utilized by banks as collateral and we have observed that on both sides of the Atlantic.” That’s the kicker. There’s just one problem. Trichet’s statement is disingenuous and grossly misleading. There is little similarity between the actions of the ECB to those of the Fed, both in kind, and in magnitude. An excellent piece by Dow Jones gives a rundown on the gory details. The article reports that senior European bankers estimate that up to 500 billion Euros in ABS of questionable value has been pledged to the ECB in return for short term financing. While the ECB’s Trashit says, “Hey! Everybody’s doing it, not just us”, it’s important to distinguish a couple of things. First, the Fed does not take ABS collateral in its open market operations, although they do accept it along with all other kinds of conventional collateral at the discount window and via the new Term Auction Facility (TAF) which the Fed started in December. The amounts taken at the discount window are inconsequential, and the TAF, at a rolling $60 billion, which it appears the Fed may make permanent, is insignificant compared with what the ECB is reportedly doing. The Fed also takes a relatively small amount of Mortgage Backed collateral for its repo operations. The amount of MBS backed repos at any time is usually no more than $10 billion, and often not more than a few billion. The Fed is pretty tough about collateral. Their collateral rules for the TAF require 50% overcollateralization. While the Fed may have $60 billion in TAF credit outstanding, there’s no way to know how much of it is backed by ABS collateral. It’s probably safe to assume that not all of the collateral accepted is ABS. On the other hand, it would appear that the ECB is possibly financing up to a half trillion of ABS according to the Dow Jones report, quoting people supposedly in the know. The fact that the ECB’s Trashit felt it necessary to defend the ECBs actions lends validity to the estimates. Much of this ABS collateral is likely to be fictitious capital, that is paper that is backed by assets which are worth less (Did Buffet really say “worth less” or “worthless” in his recent comments about the direction of the dollar?) in many cases much less, than the notional value of the securities. Under the circumstances the ECB is turning the Euro into trash compared to the US Dollar. The USD is sound money by comparison. At least the paper issued by the Fed is more than 90% backed by Treasury debt. That could be one reason why the US Dollar Index charts are evidencing the possibility of a major bottom. Compared to the Euro, you could say that the dollar is as good as gold. Yeah. Right. Many market followers may be making the erroneous assumption that the US Fed is the most reckless actor in the grand scheme of desperately propping up the collapsing credit bubble. The ECB (and the BOE, another bad actor) have actually been far more reckless in aggressively bailing out failed institutions, financing worthless paper, and debasing their currencies. The Bernanke Fed has actually been a model of restraint in comparison. Of course, everything is relative. It’s a question of who’s “less bad,” and in the end, none of it makes much difference anyway. We are all going to have to pay for it. Stay up to date with the daily machina
Fantastic article by Antal Fekete: http://www.safehaven.com/article-9433.htm
@BMH on 2008-02-11 13:48:22 ECB A Dumping Ground for Financial Toxic Waste The story of Lee Adler concerning toxic waste collateral accepted by ECB is almost correct. Correct is: The ECB has accepted ABS and RMBS in an amount never seen before as collateral for lendings to private banks. Maybe half a trillion, maybe more, maybe less – they accept collaterals at almost face value what no-one else in the market is doing. Incorrect: It’s not toxic waste, it’s AAA. All collateral the ECB accepts has to be rated AAA. I’m sure a lot of these AAA ratings are garbage, and I’m sure the banks concerned and Moody’s know that – but I’m not so sure, if the ECB knows. Just one example: About 50 billion Euros of Spanish RMBS have got a AAA rating simply for one reason – to be used as collateral for the ECB. Given the half-insolvent state of the Spanish economy these ratings can’t be sustainable. Don’t panic, the ECB tells us: The RMBS are usually used as collateral for repo’s with a duration of seven days, and if the papers lose their AAA rating, they can no more be used as collateral. But what happens, if a Spanish bank collapses within seven days without warning signs? Then “the Eurozone” has to pay the price. Not the ECB, not the Spanish central bank – the Eurozone. Very cute. I’m sure the ECB will put an end to that kind of business. But I think not before election day in Spain, the 9th of March.
London Banker: “The current mission of the Fed is to privatise profits and socialise losses to the maximum benefit of the entitled elites, hypothecating the maximum wealth from all other classes of Americans.” You say ‘the current mission of the FED’ and certainly looks like it is since quite some time now. From you vibrant defenses of Paul Volker and Mervyn King it is evident that you think the central banking (and possibly fiat currencies) can have and must have a higher mission. But what is this higher mission? Isn’t it obvious that central banks as the monopolist banking charter will always end up abusing their immense power for the benefit of their cronies? The proposal of the Austrian school is ‘stick to the gold standard and be done with fiat currency and central banks altogether’. With all the problem that the gold standard can have, isn’t it a neat way to clean up a huge source of corruption? Your opinon and/or links on the subject are greatly appreciated.
Hey - There are many studies about the situation of households and (bank or non bank) financial institutions ; but does somebody now a report/study/paper/etc. on the financial situation of us firms ? - I’m a bit lost right now with all the contradictory stuff out there about firms : debt level high or low, default still low or high and increasing… ? What I understand is that in 90-91, the bubble was more fueled by household debt (and real estate prices) than corporate debt ; then untill 2001 it was more fueled by corporate debt (and equities prices) ; right now it’s again like in 90… Is it correct ? Thank you for your answers ! lili
@ OuterBeltway: Current mission of Fed – Screw ‘em. It’s our money! Three goals – 1. Save the Banks (see mission) 2. Use all our power to preserve our way of life (see mission) 3. It can’t fail while we’re alive (see mission again) Those are my thoughts. I welcome yours.
from cnbc.com ”Six Major Banks to Unveil Plan to Halt Foreclosures Six of the largest U.S. mortgage lenders will announce on Tuesday a program to identify seriously delinquent borrowers and halt any foreclosure process while they try to work out a new payment scheme, sources familiar with the plan said.” once again, the question is how do you price the mortgage backed securities built of mortgages with changing and uncertain terms ? it is impossible.
Written by BMH on 2008-02-11 13:48:22 The ECB maneuvers make the FED’s TAF look like a joke! This goes to show that the coming out of the closet is barely starting. 100 Billion written down so far, about 900 billion to go…. Goldilocks want to believe 50% of the looses have come out. Look at IAG’s case. They wanted to get away with murder but the auditors stopped them: Feb. 11 (Bloomberg) — American International Group Inc., the world’s largest insurer by assets, fell the most in 20 years in New York trading after its auditor found faulty accounting may have understated losses on some holdings.
“LB, Octavio, GSM: Lately, we’ve heard a lot about debt excesses. I assert that the debt is not a problem; the problem is what the debt was spent upon (e.g. flat-screen TV .vs. course in advanced thermal design for homes). The point here is not that money was borrowed and spent, but to what effect?” In addition the government’s waste of money in the Iraq war which has increased the nation’s debt by about 500 billion(? please correct me), in terms of UNPRODUCTIVE debt the best two examples from the private sector are private equity leveraged buyouts and share buybacks funded with debt. These maneuvers do nothing to increase the wealth of the country. Love for country seems to be inversely proportional to net worth:-) An interesting exercise would be to calculate a frequency distribution for the net worth of the US soldiers and civilians that have died in this war so far.
Article in the UK Telegraph from Ambrose Evans-Pritchard speculates a huge exposure to subprime within Japanese Banks and quotes Hans Redeker, currency chief at BNP Paribas that Japan could be the place where the next big problem is going to pop up! I cannot judge the veracity of such an article, since it seems like speculative conjecture based on suspicious empirical evidence! Does anybody care to comment?
Now that we know the mission of the Fed, what is the mission of America’s “two-party” political system? Let us speak in parables. A mother gave her son two apples – a big one and a little one. She said to her son, “Give your little sister a choice of which apple she wants.” Later she saw her daughter eating the little apple. “Son,” she said, “I thought I told you to give your sister a choice.” “I did,” he said. “I gave her a choice of the little one or none at all.”
Krugman gloomier than CR! http://krugman.blogs.nytimes.com/2008/02/10/postmodern-recessions/ And while they haven’t been as deep as the older type of recession, they’ve proved hard to end (not officially, but in terms of employment), precisely because housing — which is the main thing that responds to monetary policy — has to rise above normal levels rather than recover from an interest-imposed slump. That’s why I think our current problems will last a long time. CR says 2009; I say 2010.
OTTAWA – It’s a perfect financial storm of flat earnings, increased spending and plummeting savings. A new report by the Vanier Institute of the Family says Canadians are buried in record debt averaging $80,000 per household. Author Roger Sauve says total debt is now 131 per cent of household income after income tax and benefits – up from 91 per cent in 1990. Many Canadians have borrowed cash at lower interest rates to buy more expensive homes. But credit-card debt has almost doubled since 1990 to $22,500 from $12,000. Bankruptcies and proposals that allow partial debt repayment soared to more than 100,000 last year from 43,000 in 1990. Sauve says another recession would be disastrous for many Canadians teetering on the financial edge http://www.cbc.ca/cp/business/080211/b021192A.html
First, thanks to all responders re: the Federal Reserve thought experiment. Some observations: a) There was a great deal of diversity of opinion about the actual mission of the Fed. The only thing the answers had in common was the degree of cynicism, and the agreement that maximizing the general welfare was not the Fed’s purpose in life. Rather it was to enhance the welfare of the owners of the Fed (e.g. major banks). b) Everyone seems to agree that our economic problems stem from mis-allocation of resources (use debt for consumption, wars, etc. – anything but wealth-building purposes) c) LB mentioned some things that I’d hoped would get more play. In addition to the more mundane function of defending the value of the dollar, he suggested that the Fed prevent banks from taking on too much risk (return to Glass-Steagall constraints), and he went so far as to advocate that the Fed use monetary policy to force Congress to live within its means. I suggest we springboard off LB’s ideas, and take the fight directly to the problem, which I see as: 1) Resources are being mis-allocated in a colossal way 2) There is no official advocate for the economy – I’m using “economy” in this context as a proxy for the collective economic welfare of the U.S. citizenry. I propose that the Fed’s role should be changed to this: a) Educate the public to thoroughly understand what productive behavior is, and its impact on the general economic welfare of the nation. People need to understand the distinction between consumption and production, and to be able to spot and invest in productive activities, whether at the individual, local, state, or national levels b) Speak out loudly and clearly when the nation’s fiscal, foreign, energy, and environmental policies take us in directions that are economically unsustainable. The Fed should act more like the Supreme Court than the weenies at the FTC. The Fed has the world’s best bully pulpit, but they never use it! The annual State of the Union address should be immediately followed by Fed Chairman commentary about the net economic effect of the President’s proposed policies. c) Perform the classical monetary functions to maintain a stable value for the currency, etc., etc. Note the emphasis on public education and policy advocacy. This is what I see as being the most “broken”. Thanks to all for your thoughtful and timely feedback. For those that haven’t commented yet, feel free to jump in. Kind of a slow news day, so there should be some spare CPU cycles available
Every should read the letter of Pershing Square Capital Management L.P. dated Jan 30 and released publicly on Bond Insurer Transparency. A real mess for MBIA and Ambac surely much more worse than I expected. Solution for that will be diificult, US taxpayers should be very worry. US plan to bail out them will cost them maybe much more than the failure of those company. I have puts I will buy more and keep them.
Ayn Rand predicted much of this in Atlas Shrugged over 50 years ago. Those that produce, and who are responsible for their own affairs, will quit the effort. Colorado, or is it now Panama, here we come.
It is obvious that we are entering a period when there is insufficient income to pay the debt that is in our system (gov’t, private and corporate). It is highly unlikely that income will increase with global wage arbitrage, therefore I expect to see a collapse in the debt instruments and a surrender of the overpriced capital securing the debt. This will continue to erode the value of asset prices and simultaneously destroy the money supply, eventually leading to long term deflation.