Behind ongoing Israel-Palestine peace plans looms USA-Israel-Iran open conflict
- Decoded news (March 29, 2007) -
In GEAB N°11 (published January 15th), LEAP/E2020 wrote: "Middle East: To conceal its failure in Iraq, the Bush administration is preparing a Shiite-Sunni intra-Muslim war, while Israel gets ready to launch tactical nuclear weapons on Iran's nuclear programme .... The approaching 2008 presidential election will radicalize the two camps starting in spring 2007. Pro-Israeli Democrats on the one hand and a pro-Zionist Bush administration on the other hand will result in placing the Israelo-Iranian crisis on Washington's agenda sometimes in the next three months...".
Today harbingers of war multiply, and paradoxically they take the form of peace talks. The Condoleeza Rice trips to the Middle-East (1), the Riyadh Arab summit to revive Saudi peace plan,… are only meant to conceal the intensity of diplomatic activity in fact designed to prepare and organise the Sunni front (or rather, to avoid it from weakening too much (2)) against Shiite Iran. Far from indicating an appeasement, these moves suggest the imminence of the crisis, where indeed, contrary to the ancient Roman saying "si vis pacem, para bellum", players pretend to prepare peace because they want war. Washington and Tel Aviv strive to prevent withdrawals inside the Sunni camp while Teheran tries to manipulate the United Kingdom (3) in this “phony war”.
The US entry into the « very great depression » generates a stream of domestic crises: political (daily oppositions between Congress and President), economic (entry into recession), financial (bursting of housing-financial bubble) and social (millions of Americans put out on the street). Such a critical domestic situation is pushing Washington to the confrontation with Iran, in order to divert the nation's attention from internal problems.
This conflict will account for a key-factor of the tipping point of the global systemic crisis which LEAP/E2020 anticipated would take place in April 2007. On April 16th, in GEAB N°14 (on subscription), LEAP/E2020 will release its anticipation of the political, economic and strategic consequences of the crisis, including a military anticipation entitled: « Iran-Israel-USA conflict 2007: Towards the first US aircraft carrier sunk since WWII? (4)".
---------
Notes :
(1) Ms Rice's trips to the Middle-East have no chance to reach any concrete result, as explained by this article « Rice and Olmert: disagreement is convenient » published in Haaretz 03/27/2007.
(2) In the past few days, leaders from the Arab Emirates made various declarations intended to disengage their responsibility in the event of a US air strike on Iran: « Emirats Arabes Unis: pas de mise à disposition du territoire en cas d'attaque contre l'Iran », Agence Novosti, 03/27/2007.
(3) As described clearly by the article « British pawns in an Iranian game » published in l'Asia Times 03/29/2007.
(4) The last US aircraft carrier that was sunk in combat was the USS Bismarck Sea, Feb. 21, off the cost of Iwo Jima. Source : « The Lost American Aircraft Carriers ».
In the same category:
GEAB N°13 is available! Global systemic crisis / Housing, financial institutions, stock markets, consumption, currencies: The contagion
30 March 2007
How Blind can they be?
How Blind can they be? _ Euro Capital on the US economy
As our phony economy begins to unravel before our eyes, it is amazing how few people can actually see it. The collective wisdom of stock market pundits, economists, and Federal Reserve officials gives the impression that everything is just fine. Although some acknowledge that housing is slowing down a bit, that there are isolated problems with subprime mortgages, and that inflation is not moderating as quickly as they hoped it would (let’s ignore surging oil prices), few can see any grave threats to continued economic expansion, or the bull market in stocks, bonds or real estate.
Earlier this week a CNBC anchor asked a guest if the "economic baton" might now pass from housing to the consumer, much the same way it previously passed from the stock market to housing. I'm not exactly sure where the anchor believes that consumers will now be getting the money to lead us out of the economic morass. With adjustable rate mortgages now re-setting higher, home equity disappearing, credit card debt mounting, personal savings at record lows, and the cost of basic necessities continuing to rise, the consumer is all tapped out. In fact, consumer spending is not just going to slow down; it is going to fall off the edge of a cliff.
With more traditional mortgage lending standards beginning to return, traditional home prices can not be too far off. And for those who may not have noticed, median home prices are still way above traditional levels as determined by yardsticks such as affordability and rent vs. own analysis. In many markets, normal levels may only be half of their current "appraised" values. However, due to the glut of homes that will ultimately hit the market, and the absence of qualified or willing buyers, home prices, at least in the short term, may fall well below normal levels.
Even when reporting on the subprime mess and the move to raise lending standards, most in the media still get it wrong. They seem to think the emerging “credit crunch” is a problem for home buyers as it makes qualifying for a mortgage that much more difficult. But, by preventing buyers from overpaying for homes, the credit crunch is actually a blessing in disguise. Tighter lending standards will help precipitate a crash in real estate prices. What could be better for potential home buyers than cheap houses? Sure they might have to wait a few more years until they can actually save enough money for a down payment, but since the purchase prices will be so much lower, those down payments will be easier to accumulate. More importantly, since they will be borrowing so much less money, the total cost of buying will be reduced even more substantially. The one caveat of course is that many such individuals might find themselves unemployed for a while, as the housing collapse ushers in a prolonged and severe recession. I guess you can’t have everything!
The real problems will be for existing homeowners, especially those who overpaid, who are unable to sell for their loan amounts, and who lack sufficient home equity or incomes to refinance their adjustable rate mortgages. Also feeling the pinch will be mortgage lenders, who will be unable to recoup their investments when borrowers default. Of course, the ultimate bag holders will be American taxpayers. As the crisis widens, politicians will inevitably seek to bail out everyone in danger of losing money on real estate purchased in the boom years. This will result in huge run-ups of the Federal deficit, which will be financed by inflationary monetary and fiscal policies. As a result, the biggest losses could be reserved for savers, retirees, investors, or anyone left holding dollar-denominated financial assets when the music finally stops playing.
As our phony economy begins to unravel before our eyes, it is amazing how few people can actually see it. The collective wisdom of stock market pundits, economists, and Federal Reserve officials gives the impression that everything is just fine. Although some acknowledge that housing is slowing down a bit, that there are isolated problems with subprime mortgages, and that inflation is not moderating as quickly as they hoped it would (let’s ignore surging oil prices), few can see any grave threats to continued economic expansion, or the bull market in stocks, bonds or real estate.
Earlier this week a CNBC anchor asked a guest if the "economic baton" might now pass from housing to the consumer, much the same way it previously passed from the stock market to housing. I'm not exactly sure where the anchor believes that consumers will now be getting the money to lead us out of the economic morass. With adjustable rate mortgages now re-setting higher, home equity disappearing, credit card debt mounting, personal savings at record lows, and the cost of basic necessities continuing to rise, the consumer is all tapped out. In fact, consumer spending is not just going to slow down; it is going to fall off the edge of a cliff.
With more traditional mortgage lending standards beginning to return, traditional home prices can not be too far off. And for those who may not have noticed, median home prices are still way above traditional levels as determined by yardsticks such as affordability and rent vs. own analysis. In many markets, normal levels may only be half of their current "appraised" values. However, due to the glut of homes that will ultimately hit the market, and the absence of qualified or willing buyers, home prices, at least in the short term, may fall well below normal levels.
Even when reporting on the subprime mess and the move to raise lending standards, most in the media still get it wrong. They seem to think the emerging “credit crunch” is a problem for home buyers as it makes qualifying for a mortgage that much more difficult. But, by preventing buyers from overpaying for homes, the credit crunch is actually a blessing in disguise. Tighter lending standards will help precipitate a crash in real estate prices. What could be better for potential home buyers than cheap houses? Sure they might have to wait a few more years until they can actually save enough money for a down payment, but since the purchase prices will be so much lower, those down payments will be easier to accumulate. More importantly, since they will be borrowing so much less money, the total cost of buying will be reduced even more substantially. The one caveat of course is that many such individuals might find themselves unemployed for a while, as the housing collapse ushers in a prolonged and severe recession. I guess you can’t have everything!
The real problems will be for existing homeowners, especially those who overpaid, who are unable to sell for their loan amounts, and who lack sufficient home equity or incomes to refinance their adjustable rate mortgages. Also feeling the pinch will be mortgage lenders, who will be unable to recoup their investments when borrowers default. Of course, the ultimate bag holders will be American taxpayers. As the crisis widens, politicians will inevitably seek to bail out everyone in danger of losing money on real estate purchased in the boom years. This will result in huge run-ups of the Federal deficit, which will be financed by inflationary monetary and fiscal policies. As a result, the biggest losses could be reserved for savers, retirees, investors, or anyone left holding dollar-denominated financial assets when the music finally stops playing.
Stocks are dead, long live commodities, says Rogers
Investment guru Jim Rogers says the rise of China and the change in the status of the US dollar as a reserve currency is having a profound impact on global demand.
Investment guru Jim Rogers believes that the bull market for stock and bond markets is over and says investors should get into commodities. There is a long-term bull market in commodities which will extend to 2014-2022, he told the Credit Suisse Asian Investment Conference in a keynote speech yesterday.
Rogers started the Quantum Fund with George Soros in 1973 and went on to make a fortune by the age of 37 before giving it up to become a best-selling author, lecturer and commentator, while maintaining his interest in investing.
His research indicated that the shortest commodity bull market lasted for 15 years while the longest was 23 years. advertisement
His own commodity fund index which he set up on August 1, 1998 has increased by 243% since then, whereas the S&P index over the same period has risen 43%. Furthermore he asserted that whenever commodities were in the ascendancy stocks and bonds were in decline, and vice versa.
He reckoned that the big bull market for bonds in the 1980s and 1990s peaked out in 2003 and "has been in the process of making a big top ever since".
"So I would urge all of you to go home and sell all your bonds. I know some of you are bond managers - I would go home and look for another job," he advised the audience.
It was the same for stocks, at least in the West. By all the classic valuations that had stood the test of time - price earnings ratios, dividend yields, price to book ratios – stock markets were overvalued. The current stock market environment is similar to that of the 1970s with big trading ranges, which some people were able to exploit successfully.
"But most people are not very good at this. They need to have a secular bull market when markets are rising all the time to make a lot of money," he warned.
There is widespread ignorance of commodities, according to Rogers, which is reminiscent of attitudes towards stocks and mutual funds some 30 years ago, This is reflected in the 70,000 mutual funds available to the public to invest in stocks and bonds compared with fewer than 50 commodity funds.
The changes in global demand were taking place against a backdrop of the rise of China and the change in the status of the US dollar as the world’s reserve currency.
"It is amazing how many people do not understand the rise of China - China is the next great country in the world," he said. "I know they tell you that they call themselves communists in China - but I tell you they are among the world’s best capitalists right now," he said.
China had come along way since Deng Xiaopings’s open door initiative in 1978, "but this has a long way to go," he said.
"If you see problems in China – get on the phone and buy as much of it as you can," he urged his audience.
Adding "it's something we need to understand because it is going to affect demand for lots of things and change the world as we know it."
The growth in demand for commodities, particularly oil, was due to the demand from mainly China followed by India. "This is just the beginning. The demand by Asia hasn’t even started yet," he said noting that China’s per capita consumption of oil was a fourteenth of that of the US and one tenth that of South Korea and Japan.
With many of the world’s major oilfields in decline, supply was tightening. Faced with the potentially huge increase in demand from China and India prices were destined to rise.
"If the price of oil goes to $150 they’ll be drilling for oil on the White House lawn," he quipped.
The shift in the US from being a creditor nation in 1987 to being the biggest debtor nation in history with debts of $13 trillion would also have major repercussions for global demand.
"What is terrifying to me is that our foreign debt increases at the rate of one trillion every 15 months," Rogers said. The upheaval that would accompany the change in the dollar’s reserve status would be similar to that which accompanied sterling’s change in status some 60 years ago.
Rogers said that as it was US policy to debase the currency there would come a time when Asian countries, which were among the world’s biggest creditors, would start to get out of dollars and put them into real assets that stood to appreciate such as oil, gold and other commodities.
The US dollar was currently being propped up by Asian central banks, which continued their support partly because it was government policy to do so, and partly from bureaucratic inertia.
Investment guru Jim Rogers believes that the bull market for stock and bond markets is over and says investors should get into commodities. There is a long-term bull market in commodities which will extend to 2014-2022, he told the Credit Suisse Asian Investment Conference in a keynote speech yesterday.
Rogers started the Quantum Fund with George Soros in 1973 and went on to make a fortune by the age of 37 before giving it up to become a best-selling author, lecturer and commentator, while maintaining his interest in investing.
His research indicated that the shortest commodity bull market lasted for 15 years while the longest was 23 years. advertisement
His own commodity fund index which he set up on August 1, 1998 has increased by 243% since then, whereas the S&P index over the same period has risen 43%. Furthermore he asserted that whenever commodities were in the ascendancy stocks and bonds were in decline, and vice versa.
He reckoned that the big bull market for bonds in the 1980s and 1990s peaked out in 2003 and "has been in the process of making a big top ever since".
"So I would urge all of you to go home and sell all your bonds. I know some of you are bond managers - I would go home and look for another job," he advised the audience.
It was the same for stocks, at least in the West. By all the classic valuations that had stood the test of time - price earnings ratios, dividend yields, price to book ratios – stock markets were overvalued. The current stock market environment is similar to that of the 1970s with big trading ranges, which some people were able to exploit successfully.
"But most people are not very good at this. They need to have a secular bull market when markets are rising all the time to make a lot of money," he warned.
There is widespread ignorance of commodities, according to Rogers, which is reminiscent of attitudes towards stocks and mutual funds some 30 years ago, This is reflected in the 70,000 mutual funds available to the public to invest in stocks and bonds compared with fewer than 50 commodity funds.
The changes in global demand were taking place against a backdrop of the rise of China and the change in the status of the US dollar as the world’s reserve currency.
"It is amazing how many people do not understand the rise of China - China is the next great country in the world," he said. "I know they tell you that they call themselves communists in China - but I tell you they are among the world’s best capitalists right now," he said.
China had come along way since Deng Xiaopings’s open door initiative in 1978, "but this has a long way to go," he said.
"If you see problems in China – get on the phone and buy as much of it as you can," he urged his audience.
Adding "it's something we need to understand because it is going to affect demand for lots of things and change the world as we know it."
The growth in demand for commodities, particularly oil, was due to the demand from mainly China followed by India. "This is just the beginning. The demand by Asia hasn’t even started yet," he said noting that China’s per capita consumption of oil was a fourteenth of that of the US and one tenth that of South Korea and Japan.
With many of the world’s major oilfields in decline, supply was tightening. Faced with the potentially huge increase in demand from China and India prices were destined to rise.
"If the price of oil goes to $150 they’ll be drilling for oil on the White House lawn," he quipped.
The shift in the US from being a creditor nation in 1987 to being the biggest debtor nation in history with debts of $13 trillion would also have major repercussions for global demand.
"What is terrifying to me is that our foreign debt increases at the rate of one trillion every 15 months," Rogers said. The upheaval that would accompany the change in the dollar’s reserve status would be similar to that which accompanied sterling’s change in status some 60 years ago.
Rogers said that as it was US policy to debase the currency there would come a time when Asian countries, which were among the world’s biggest creditors, would start to get out of dollars and put them into real assets that stood to appreciate such as oil, gold and other commodities.
The US dollar was currently being propped up by Asian central banks, which continued their support partly because it was government policy to do so, and partly from bureaucratic inertia.
29 March 2007
The China Syndrome--Financial Meltdown
charles hugh smith-Weblog and wEssays: "The 1979 film The China Syndrome took its name from the darkly humorous notion that a nuclear reactor meltdown in the U.S. would burn straight through the Earth to China.
(wikipedia entry on The China Syndrome)
Nowadays, the idea that a consumer-spending meltdown in the U.S. could trigger a subsequent slowdown in China's red-hot economy is a given. But perhaps 'The China Syndrome' works both ways, and a meltdown of China's speculative financial bubble will trigger a meltdown in the U.S.'s debt-driven speculative bubbles. "
'No Money Down' Falls Flat
Today's pop quiz involves some potentially exciting new products that mortgage bankers have come up with to make homeownership a reality for cash-strapped first-time buyers.
Here goes: Which of these products do you think makes sense?
(a) The "balloon mortgage," in which the borrower pays only interest for 10 years before a big lump-sum payment is due.
(b) The "liar loan," in which the borrower is asked merely to state his annual income, without presenting any documentation.
(c) The "option ARM" loan, in which the borrower can pay less than the agreed-upon interest and principal payment, simply by adding to the outstanding balance of the loan.
(d) The "piggyback loan," in which a combination of a first and second mortgage eliminates the need for any down payment.
(e) The "teaser loan," which qualifies a borrower for a loan based on an artificially low initial interest rate, even though he or she doesn't have sufficient income to make the monthly payments when the interest rate is reset in two years.
(f) The "stretch loan," in which the borrower has to commit more than 50 percent of gross income to make the monthly payments.
(g) All of the above.
If you answered (g), congratulations! Not only do you qualify for a job as a mortgage banker, but you may also have a future as a Wall Street investment banker and a bank regulator.
No, folks, I'm not making this up. Not only has the industry embraced these "innovations," but it has also begun to combine various features into a single loan and offer it to high-risk borrowers. One cheeky lender went so far as to advertise what it dubbed its "NINJA" loan -- NINJA standing for "No Income, No Job and No Assets."
In fact, these innovative products are now so commonplace, they have been the driving force in the boom in the housing industry at least since 2005. They are a big reason why homeownership has increased from 65 percent of households to a record 69 percent. They help explain why outstanding mortgage debt has increased by $9.5 trillion in the past four years. And they are, unquestionably, a big factor behind the incredible run-up in home prices.
Now they are also a major reason the subprime mortgage market is melting down, why 1.5 million Americans may lose their homes to foreclosure and why hundreds of thousands of homes could be dumped on an already glutted market. They also represent a huge cloud hanging over Wall Street investment houses, which packaged and sold these mortgages to investors around the world.
How did we get to this point?
It began years ago when Lewis Ranieri, an investment banker at the old Salomon Brothers, dreamed up the idea of buying mortgages from bank lenders, bundling them and issuing bonds with the bundles as collateral. The monthly payments from homeowners were used to pay interest on the bonds, and principal was repaid once all the mortgages had been paid down or refinanced.
Thanks to Ranieri and his successors, almost anyone can originate a mortgage loan -- not just banks and big mortgage lenders, but any mortgage broker with a Web site and a phone. Some banks still keep the mortgages they write. But most other originators sell them to investment banks that package and "securitize" them. And because the originators make their money from fees and from selling the loans, they don't have much at risk if borrowers can't keep up with their payments.
And therein lies the problem: an incentive structure that encourages originators to write risky loans, collect the big fees and let someone else suffer the consequences.
This "moral hazard," as economists call it, has been magnified by another innovation in the capital markets. Instead of packaging entire mortgages, Wall Street came up with the idea of dividing them into "tranches." The safest tranche, which offers investors a relatively low interest rate, will be the first to be paid off if too many borrowers default and their houses are sold at foreclosure auction. The owners of the riskiest tranche, in contrast, will be the last to be paid, and thus have the biggest risk if too many houses are auctioned for less than the value of their loans. In return for this risk, their bonds offer the highest yield.
It was this ability to chop packages of mortgages into different risk tranches that really enabled the mortgage industry to rush headlong into all those new products and new markets -- in particular, the subprime market for borrowers with sketchy credit histories. Selling the safe tranches was easy, while the riskiest tranches appealed to the booming hedge-fund industry and other investors like pension funds desperate for anything offering a higher yield. So eager were global investors for these securities that when the housing market began to slow, they practically invited the mortgage bankers to keep generating new loans even if it meant they were riskier. The mortgage bankers were only too happy to oblige.
By the spring of 2005, the deterioration of lending standards was pretty clear. They were the subject of numerous eye-popping articles in The Post by my colleague Kirstin Downey. Regulators began to warn publicly of the problem, among them Fed Chairman Alan Greenspan. Several members of Congress called for a clampdown. Mortgage insurers and numerous independent analysts warned of a gathering crisis.
But it wasn't until December 2005 that the four bank regulatory agencies were able to hash out their differences and offer for public comment some "guidance" for what they politely called "nontraditional mortgages." Months ensued as the mortgage bankers fought the proposed rules with all the usual bogus arguments, accusing the agencies of "regulatory overreach," "stifling innovation" and substituting the judgment of bureaucrats for the collective wisdom of thousands of experienced lenders and millions of sophisticated investors. And they warned that any tightening of standards would trigger a credit crunch and burst the housing bubble that their loosey-goosey lending had helped spawn.
The industry campaign didn't sway the regulators, but it did delay final implementation of the guidance until September 2006, both by federal and many state regulators. And even now, with the market for subprime mortgages collapsing around them, the mortgage bankers and their highly paid enablers on Wall Street continue to deny there is a serious problem, or that they have any responsibility for it. In substance and tone, they sound almost exactly like the accounting firms and investment banks back when Enron and WorldCom were crashing around them.
What we have here is a failure of common sense. With occasional exceptions, bankers shouldn't make -- or be allowed to make -- mortgage loans that require no money down and no documentation of income to people who won't be able to afford the monthly payments if interest rates rise, house prices fall or the roof springs a leak. It's not a whole lot more complicated than that.
Here goes: Which of these products do you think makes sense?
(a) The "balloon mortgage," in which the borrower pays only interest for 10 years before a big lump-sum payment is due.
(b) The "liar loan," in which the borrower is asked merely to state his annual income, without presenting any documentation.
(c) The "option ARM" loan, in which the borrower can pay less than the agreed-upon interest and principal payment, simply by adding to the outstanding balance of the loan.
(d) The "piggyback loan," in which a combination of a first and second mortgage eliminates the need for any down payment.
(e) The "teaser loan," which qualifies a borrower for a loan based on an artificially low initial interest rate, even though he or she doesn't have sufficient income to make the monthly payments when the interest rate is reset in two years.
(f) The "stretch loan," in which the borrower has to commit more than 50 percent of gross income to make the monthly payments.
(g) All of the above.
If you answered (g), congratulations! Not only do you qualify for a job as a mortgage banker, but you may also have a future as a Wall Street investment banker and a bank regulator.
No, folks, I'm not making this up. Not only has the industry embraced these "innovations," but it has also begun to combine various features into a single loan and offer it to high-risk borrowers. One cheeky lender went so far as to advertise what it dubbed its "NINJA" loan -- NINJA standing for "No Income, No Job and No Assets."
In fact, these innovative products are now so commonplace, they have been the driving force in the boom in the housing industry at least since 2005. They are a big reason why homeownership has increased from 65 percent of households to a record 69 percent. They help explain why outstanding mortgage debt has increased by $9.5 trillion in the past four years. And they are, unquestionably, a big factor behind the incredible run-up in home prices.
Now they are also a major reason the subprime mortgage market is melting down, why 1.5 million Americans may lose their homes to foreclosure and why hundreds of thousands of homes could be dumped on an already glutted market. They also represent a huge cloud hanging over Wall Street investment houses, which packaged and sold these mortgages to investors around the world.
How did we get to this point?
It began years ago when Lewis Ranieri, an investment banker at the old Salomon Brothers, dreamed up the idea of buying mortgages from bank lenders, bundling them and issuing bonds with the bundles as collateral. The monthly payments from homeowners were used to pay interest on the bonds, and principal was repaid once all the mortgages had been paid down or refinanced.
Thanks to Ranieri and his successors, almost anyone can originate a mortgage loan -- not just banks and big mortgage lenders, but any mortgage broker with a Web site and a phone. Some banks still keep the mortgages they write. But most other originators sell them to investment banks that package and "securitize" them. And because the originators make their money from fees and from selling the loans, they don't have much at risk if borrowers can't keep up with their payments.
And therein lies the problem: an incentive structure that encourages originators to write risky loans, collect the big fees and let someone else suffer the consequences.
This "moral hazard," as economists call it, has been magnified by another innovation in the capital markets. Instead of packaging entire mortgages, Wall Street came up with the idea of dividing them into "tranches." The safest tranche, which offers investors a relatively low interest rate, will be the first to be paid off if too many borrowers default and their houses are sold at foreclosure auction. The owners of the riskiest tranche, in contrast, will be the last to be paid, and thus have the biggest risk if too many houses are auctioned for less than the value of their loans. In return for this risk, their bonds offer the highest yield.
It was this ability to chop packages of mortgages into different risk tranches that really enabled the mortgage industry to rush headlong into all those new products and new markets -- in particular, the subprime market for borrowers with sketchy credit histories. Selling the safe tranches was easy, while the riskiest tranches appealed to the booming hedge-fund industry and other investors like pension funds desperate for anything offering a higher yield. So eager were global investors for these securities that when the housing market began to slow, they practically invited the mortgage bankers to keep generating new loans even if it meant they were riskier. The mortgage bankers were only too happy to oblige.
By the spring of 2005, the deterioration of lending standards was pretty clear. They were the subject of numerous eye-popping articles in The Post by my colleague Kirstin Downey. Regulators began to warn publicly of the problem, among them Fed Chairman Alan Greenspan. Several members of Congress called for a clampdown. Mortgage insurers and numerous independent analysts warned of a gathering crisis.
But it wasn't until December 2005 that the four bank regulatory agencies were able to hash out their differences and offer for public comment some "guidance" for what they politely called "nontraditional mortgages." Months ensued as the mortgage bankers fought the proposed rules with all the usual bogus arguments, accusing the agencies of "regulatory overreach," "stifling innovation" and substituting the judgment of bureaucrats for the collective wisdom of thousands of experienced lenders and millions of sophisticated investors. And they warned that any tightening of standards would trigger a credit crunch and burst the housing bubble that their loosey-goosey lending had helped spawn.
The industry campaign didn't sway the regulators, but it did delay final implementation of the guidance until September 2006, both by federal and many state regulators. And even now, with the market for subprime mortgages collapsing around them, the mortgage bankers and their highly paid enablers on Wall Street continue to deny there is a serious problem, or that they have any responsibility for it. In substance and tone, they sound almost exactly like the accounting firms and investment banks back when Enron and WorldCom were crashing around them.
What we have here is a failure of common sense. With occasional exceptions, bankers shouldn't make -- or be allowed to make -- mortgage loans that require no money down and no documentation of income to people who won't be able to afford the monthly payments if interest rates rise, house prices fall or the roof springs a leak. It's not a whole lot more complicated than that.
28 March 2007
Flurry of activity by US near Iran Reported
MOSCOW, March 27 (RIA Novosti) - Russian military intelligence services are reporting a flurry of activity by U.S. Armed Forces near Iran's borders, a high-ranking security source said Tuesday.
"The latest military intelligence data point to heightened U.S. military preparations for both an air and ground operation against Iran," the official said, adding that the Pentagon has probably not yet made a final decision as to when an attack will be launched.
He said the Pentagon is looking for a way to deliver a strike against Iran "that would enable the Americans to bring the country to its knees at minimal cost."
He also said the U.S. Naval presence in the Persian Gulf has for the first time in the past four years reached the level that existed shortly before the invasion of Iraq in March 2003.
Col.-Gen. Leonid Ivashov, vice president of the Academy of Geopolitical Sciences, said last week that the Pentagon is planning to deliver a massive air strike on Iran's military infrastructure in the near future.
A new U.S. carrier battle group has been dispatched to the Gulf.
The USS John C. Stennis, with a crew of 3,200 and around 80 fixed-wing aircraft, including F/A-18 Hornet and Superhornet fighter-bombers, eight support ships and four nuclear submarines are heading for the Gulf, where a similar group led by the USS Dwight D. Eisenhower has been deployed since December 2006.
The U.S. is also sending Patriot anti-missile systems to the region.
"The latest military intelligence data point to heightened U.S. military preparations for both an air and ground operation against Iran," the official said, adding that the Pentagon has probably not yet made a final decision as to when an attack will be launched.
He said the Pentagon is looking for a way to deliver a strike against Iran "that would enable the Americans to bring the country to its knees at minimal cost."
He also said the U.S. Naval presence in the Persian Gulf has for the first time in the past four years reached the level that existed shortly before the invasion of Iraq in March 2003.
Col.-Gen. Leonid Ivashov, vice president of the Academy of Geopolitical Sciences, said last week that the Pentagon is planning to deliver a massive air strike on Iran's military infrastructure in the near future.
A new U.S. carrier battle group has been dispatched to the Gulf.
The USS John C. Stennis, with a crew of 3,200 and around 80 fixed-wing aircraft, including F/A-18 Hornet and Superhornet fighter-bombers, eight support ships and four nuclear submarines are heading for the Gulf, where a similar group led by the USS Dwight D. Eisenhower has been deployed since December 2006.
The U.S. is also sending Patriot anti-missile systems to the region.
27 March 2007
The lesson's of the subprime meltdown
We see subprime as risk and valuable lesson. This market is in for a rough run. There are sweet dreams of containment; they defy reality. There is no such thing as a subprime neighborhood. Subprime is concentrated more heavily in some areas than others; it is everywhere. Thus broader housing-weakness questions are when and how bad, not if. Hundreds of billions of dollars in loans were made to people who clearly could not repay, absent significant annual house-price appreciation and cash-out refinancing. This means that we made housing loans to create housing-price appreciation on which loan repayment was predicated. Sometimes we are tempted to think that this credit boom has gotten a bit out of control. There is no long-run safe substitute for earnings, savings and income growth when increasing credit. This is not to say there cannot be a lot of money made, valuable financial innovation and long periods of great returns.
The other vital lesson involves our brave world of fully managed risk and nearly perfectly hedged positions. Have other markets and asset classes become dependent on credit growth to drive up asset prices to allow further credit growth? A huge Maginot Line of default defense has been erected to keep loss exposure out. Many valuable and potent new risk-management techniques and products have been developed. Riskier borrowers remain risky to all the various parties that extend credit to them. This showed up fast and furious as the cost of credit-default protection shot up and interest-rate premiums snapped into correlated action with every increase in subprime stress.
The greatest risk may be in thinking that risk has been conquered. It cannot be. It has not been. Risk has simply been redistributed and repriced, downward. As perceived risk fell and sharing grew, new monies were freed up for riskier lending and new, riskier projects. Loans went through and new projects were launched. Default risk continued/continues to grow as credit grows and allocations hunt for return. There is no innovating around this basic reality of financial gravity.
We are looking for periods of contagious fear in credit-risk-reduction markets feeding back and forth with particularly risky asset markets. The real danger slumbers - we hope - so long as massive quantities of cheap credit allow the roll-over financing of future rounds of debt. If this slows sharply, or runs in reverse, US subprime housing turmoil is the tip of the iceberg. There has been a lot of subprime allocation of capital and risk across the past few years. Subprime will either become a heeded warning shot across the bow, or a prelude to violent repricings to come.
The other vital lesson involves our brave world of fully managed risk and nearly perfectly hedged positions. Have other markets and asset classes become dependent on credit growth to drive up asset prices to allow further credit growth? A huge Maginot Line of default defense has been erected to keep loss exposure out. Many valuable and potent new risk-management techniques and products have been developed. Riskier borrowers remain risky to all the various parties that extend credit to them. This showed up fast and furious as the cost of credit-default protection shot up and interest-rate premiums snapped into correlated action with every increase in subprime stress.
The greatest risk may be in thinking that risk has been conquered. It cannot be. It has not been. Risk has simply been redistributed and repriced, downward. As perceived risk fell and sharing grew, new monies were freed up for riskier lending and new, riskier projects. Loans went through and new projects were launched. Default risk continued/continues to grow as credit grows and allocations hunt for return. There is no innovating around this basic reality of financial gravity.
We are looking for periods of contagious fear in credit-risk-reduction markets feeding back and forth with particularly risky asset markets. The real danger slumbers - we hope - so long as massive quantities of cheap credit allow the roll-over financing of future rounds of debt. If this slows sharply, or runs in reverse, US subprime housing turmoil is the tip of the iceberg. There has been a lot of subprime allocation of capital and risk across the past few years. Subprime will either become a heeded warning shot across the bow, or a prelude to violent repricings to come.
A US colleague contemplates the US dollar - A ponzi scheme?
As part of my work associated with the bankruptcy that I am working on, I have been preparing a report for the Bankruptcy Court highlighting how this entity was a Ponzi scheme. And, I am stunned by the similarities with fiat currency.
The AICPA describes a Ponzi scheme as follows (AICPA Consulting Services Practice Aid 97-1, Fraud Investigations In Litigation And Dispute Resolution Services, page 75/100-31)[R1]
“A Ponzi or pyramid scheme is usually any venture wherein earlier investors are repaid principal plus interest with funds provided by later investors. There may or may not be a legitimate business purpose for the venture, but the need for capital creates and continues the scheme. Often, unusually high investment returns or other inducements are offered by the promoters to attract investors.”
Think about fiat currency. Since the beginning of the credit cycle circa 1933, anyone with access to credit has been rewarded – taken out by later investors. And, the US government has been paying earlier taxpayers with later taxpayers while implemented an unsustainable program – social security.
The AICPA identifies three common characteristics of a Ponzi scheme (AICPA Consulting Services Practice Aid 97-1, Fraud Investigations In Litigation And Dispute Resolution Services, page 75/100-31[R1]):
i. The business activity depends on outside investor money;
ii. The investor money is not used according to the stated purpose. Some of the investor money is used to pay the returns promised to earlier investors; and,
iii. The business enterprise lacks profits sufficient to provide the promised returns and, therefore, depends on an ever increasing supply of investor money.
Again, think about fiat currency. The entire period that I have data (1960), there has not been a single 12 month period where M2 has declined and only 1 period (4 consecutive months in 1994) when M3 declined (when they still reported it). With fiat, to maintain the growth of debt, the fed encourages miss and mal investment – anything to maintain the growth rate of debt. So, investor money (use of proceeds from debt issuance) does not go to the growth of productive assets (industry). Thus, the business enterprise lacks profits from productive activity, lacks the profits from productive activity and therefore depends on an ever increasing supply of fiduciary media.
In addition, Floyd v. Dunson, 209 B.R. 424[R5, pg 7] and Lake States Commodities, Inc. v. Sellas, 272 B.R. 233[R6, pg 8] identify elements of a Ponzi scheme which are consistent with the AICPA guidance as follows:
i. Deposits were made from investors;
ii. The Ponzi operator conducted no legitimate business as represented to investors;
iii. The purported business of the Ponzi operator produces no profits or earnings, rather the source of funds is the new investments by investors; and,
iv. Payments to investors are made from other investor's invested funds.
Again, the similarities of Ponzi to fiat (the overall impact of fiat) are simply overwhelming. Ponzi operators conduct no legitimate business as represented to investors – in terms of growth of productive assets. Notice how GM, Ford and GE are now finance companies with manufacturing divisions – and the US as a whole is consuming capital at an alarming rate. The highest and best use of funds is share buybacks? The source of funds is the new investments by investors – think of the private equity mania.
Finally, the Association of Certified Fraud Examiners (“ACFE”) also provides relevant guidance for an analysis of Ponzi Schemes. According to the 2006 ACFE Fraud Examiners Manual, one category of Ponzi schemes is a “product front.” Within product fronts, “speculations” are a common occurrence and are discussed as follows (Association of Certified Fraud Examiners, 2006 Fraud Examiners Manual, pages 1.733 – 1.738[R2]):
“Speculation frauds don't always start out as cons, but when their rollercoaster dips, many speculators find it too tempting to hang on and ride – they figure they can phony their way through the crisis, and pick up again later. Again, it's math that usually dooms these players. They simply can't make money fast enough to feed the deficits. They need a payoff so big nothing short of a miracle – or more fraud – will suffice.”
Think about this one – with David Stockman trying to phony his way through a crises - or Enron, or Worldcom. How many more companies are in crises, but are barely able to keep the façade intact – for now. Businesses that started out as legitimate concerns only to evolved into frauds. I am guessing that all the doubling down in derivative activity will provide a virtual cornucopia of this type of activity.
Now another interesting phenomena of Ponzi schemes is that the moment that the rate of growth of investor money does not continue to increase, the entity is invariably in trouble (which was certainly the case with this company). In the same manner, think about how the fed is doing anything and everything to maintain debt growth. Here's what happens to the Ponzi entity is that the cash balance stays low, but the payout to others invariably catches up with new investors. Sound familiar? With the US having a negative savings rate, and debt growth has continued to grow.
And the Litigation Services Handbook, Second Edition (1995), Weil, Wagner and Frank, page 23-8[A52];
“…investors are encouraged to leave their principal and earned interest income in the hands of the program promoters, to be rolled-over into new programs.”
Principal and interest are then “rolled- over” which “conserves cash and delays the inevitable collapse of the scheme.”
Again, doesn't this sound exactly like the fed – enabling and encouraging every method possible to conserve cash by, suspending settlement of securities, allowing for GSE insolvency, and encouraging every possible avenue of bailout. Or in the context of keeping everyone ‘on board' with fiat, with high levels of debt, ‘investments in the desired asset bubbles of real estate, stocks and bonds – all the while trying to discourage speculation in commodities – especially gold. Round and round fiat goes, where it stops, only the Goldman Sachs & the fed know.
The AICPA describes a Ponzi scheme as follows (AICPA Consulting Services Practice Aid 97-1, Fraud Investigations In Litigation And Dispute Resolution Services, page 75/100-31)[R1]
“A Ponzi or pyramid scheme is usually any venture wherein earlier investors are repaid principal plus interest with funds provided by later investors. There may or may not be a legitimate business purpose for the venture, but the need for capital creates and continues the scheme. Often, unusually high investment returns or other inducements are offered by the promoters to attract investors.”
Think about fiat currency. Since the beginning of the credit cycle circa 1933, anyone with access to credit has been rewarded – taken out by later investors. And, the US government has been paying earlier taxpayers with later taxpayers while implemented an unsustainable program – social security.
The AICPA identifies three common characteristics of a Ponzi scheme (AICPA Consulting Services Practice Aid 97-1, Fraud Investigations In Litigation And Dispute Resolution Services, page 75/100-31[R1]):
i. The business activity depends on outside investor money;
ii. The investor money is not used according to the stated purpose. Some of the investor money is used to pay the returns promised to earlier investors; and,
iii. The business enterprise lacks profits sufficient to provide the promised returns and, therefore, depends on an ever increasing supply of investor money.
Again, think about fiat currency. The entire period that I have data (1960), there has not been a single 12 month period where M2 has declined and only 1 period (4 consecutive months in 1994) when M3 declined (when they still reported it). With fiat, to maintain the growth of debt, the fed encourages miss and mal investment – anything to maintain the growth rate of debt. So, investor money (use of proceeds from debt issuance) does not go to the growth of productive assets (industry). Thus, the business enterprise lacks profits from productive activity, lacks the profits from productive activity and therefore depends on an ever increasing supply of fiduciary media.
In addition, Floyd v. Dunson, 209 B.R. 424[R5, pg 7] and Lake States Commodities, Inc. v. Sellas, 272 B.R. 233[R6, pg 8] identify elements of a Ponzi scheme which are consistent with the AICPA guidance as follows:
i. Deposits were made from investors;
ii. The Ponzi operator conducted no legitimate business as represented to investors;
iii. The purported business of the Ponzi operator produces no profits or earnings, rather the source of funds is the new investments by investors; and,
iv. Payments to investors are made from other investor's invested funds.
Again, the similarities of Ponzi to fiat (the overall impact of fiat) are simply overwhelming. Ponzi operators conduct no legitimate business as represented to investors – in terms of growth of productive assets. Notice how GM, Ford and GE are now finance companies with manufacturing divisions – and the US as a whole is consuming capital at an alarming rate. The highest and best use of funds is share buybacks? The source of funds is the new investments by investors – think of the private equity mania.
Finally, the Association of Certified Fraud Examiners (“ACFE”) also provides relevant guidance for an analysis of Ponzi Schemes. According to the 2006 ACFE Fraud Examiners Manual, one category of Ponzi schemes is a “product front.” Within product fronts, “speculations” are a common occurrence and are discussed as follows (Association of Certified Fraud Examiners, 2006 Fraud Examiners Manual, pages 1.733 – 1.738[R2]):
“Speculation frauds don't always start out as cons, but when their rollercoaster dips, many speculators find it too tempting to hang on and ride – they figure they can phony their way through the crisis, and pick up again later. Again, it's math that usually dooms these players. They simply can't make money fast enough to feed the deficits. They need a payoff so big nothing short of a miracle – or more fraud – will suffice.”
Think about this one – with David Stockman trying to phony his way through a crises - or Enron, or Worldcom. How many more companies are in crises, but are barely able to keep the façade intact – for now. Businesses that started out as legitimate concerns only to evolved into frauds. I am guessing that all the doubling down in derivative activity will provide a virtual cornucopia of this type of activity.
Now another interesting phenomena of Ponzi schemes is that the moment that the rate of growth of investor money does not continue to increase, the entity is invariably in trouble (which was certainly the case with this company). In the same manner, think about how the fed is doing anything and everything to maintain debt growth. Here's what happens to the Ponzi entity is that the cash balance stays low, but the payout to others invariably catches up with new investors. Sound familiar? With the US having a negative savings rate, and debt growth has continued to grow.
And the Litigation Services Handbook, Second Edition (1995), Weil, Wagner and Frank, page 23-8[A52];
“…investors are encouraged to leave their principal and earned interest income in the hands of the program promoters, to be rolled-over into new programs.”
Principal and interest are then “rolled- over” which “conserves cash and delays the inevitable collapse of the scheme.”
Again, doesn't this sound exactly like the fed – enabling and encouraging every method possible to conserve cash by, suspending settlement of securities, allowing for GSE insolvency, and encouraging every possible avenue of bailout. Or in the context of keeping everyone ‘on board' with fiat, with high levels of debt, ‘investments in the desired asset bubbles of real estate, stocks and bonds – all the while trying to discourage speculation in commodities – especially gold. Round and round fiat goes, where it stops, only the Goldman Sachs & the fed know.
U.S. launches show of force
DUBAI, United Arab Emirates - The U.S. Navy on Tuesday began its largest demonstration of force in the Persian Gulf since the 2003 invasion of Iraq, led by a pair of aircraft carriers and backed by warplanes flying simulated attack maneuvers off the coast of Iran.
The maneuvers bring together two strike groups of U.S. warships and more than 100 U.S. warplanes to conduct simulated air warfare in the crowded Gulf shipping lanes.
The U.S. exercises come just four days after Iran’s capture of 15 British sailors and marines who Iran said had strayed into Iranian waters near the Gulf. Britain and the U.S. Navy have insisted the British sailors were operating in Iraqi waters.
Story continues below ↓advertisement
U.S. Navy Cmdr. Kevin Aandahl said the U.S. maneuvers were not organized in response to the capture of the British sailors — nor were they meant to threaten the Islamic Republic, whose navy operates in the same waters.
He declined to specify when the Navy planned the exercises.
Aandahl said the U.S. warships would stay out of Iranian territorial waters, which extend 12 miles off the Iranian coast.
Simultaneous French operations
A French naval strike group, led by the aircraft carrier Charles de Gaulle, was operating simultaneously just outside the Gulf. But the French ships were supporting the NATO forces in Afghanistan and not taking part in the U.S. maneuvers, officials said.
Overall, the exercises involve more than 10,000 U.S. personnel on warships and aircraft making simulated attacks on enemy shipping with aircraft and ships, hunting enemy submarines and finding mines.
“What it should be seen as by Iran or anyone else is that it’s for regional stability and security,” Aandahl said. “These ships are just another demonstration of that. If there’s a destabilizing effect, it’s Iran’s behavior.”
The maneuvers bring together two strike groups of U.S. warships and more than 100 U.S. warplanes to conduct simulated air warfare in the crowded Gulf shipping lanes.
The U.S. exercises come just four days after Iran’s capture of 15 British sailors and marines who Iran said had strayed into Iranian waters near the Gulf. Britain and the U.S. Navy have insisted the British sailors were operating in Iraqi waters.
Story continues below ↓advertisement
U.S. Navy Cmdr. Kevin Aandahl said the U.S. maneuvers were not organized in response to the capture of the British sailors — nor were they meant to threaten the Islamic Republic, whose navy operates in the same waters.
He declined to specify when the Navy planned the exercises.
Aandahl said the U.S. warships would stay out of Iranian territorial waters, which extend 12 miles off the Iranian coast.
Simultaneous French operations
A French naval strike group, led by the aircraft carrier Charles de Gaulle, was operating simultaneously just outside the Gulf. But the French ships were supporting the NATO forces in Afghanistan and not taking part in the U.S. maneuvers, officials said.
Overall, the exercises involve more than 10,000 U.S. personnel on warships and aircraft making simulated attacks on enemy shipping with aircraft and ships, hunting enemy submarines and finding mines.
“What it should be seen as by Iran or anyone else is that it’s for regional stability and security,” Aandahl said. “These ships are just another demonstration of that. If there’s a destabilizing effect, it’s Iran’s behavior.”
26 March 2007
Bond insurers and rating agencies in bed
Short-Seller Fires Torpedo at Biggest Bond Insurer: Joe Mysak
By Joe Mysak
March 23 (Bloomberg) -- If you want to piece together the sad recent history of MBIA Inc., the biggest municipal bond insurer, you could go through articles, sift through disclosure documents, attempt to gain access to transcripts of board meetings.
Or you could read through a 32-page letter written by William Ackman of Pershing Square Capital Management in New York.
The letter, a copy of which was obtained this week by Bloomberg News, is dated March 2 and was sent to John Siffert of Lankler Siffert & Wohl.
Siffert is a lawyer who was hired by MBIA Inc. at the behest of regulators after the firm settled a federal fraud investigation in January. He is looking into how the company does business.
The letter doesn't make for cheery reading, if you are an MBIA shareholder or if you own bonds insured by the firm. In fact, it reads a lot like an indictment, with prescriptive remedies including axing management, making them give back their bonuses and installing an independent board of directors.
Ackman has been a bear on MBIA stock for years, and in the letter says he expects ``having a net short position'' in MBIA Holdings, which is the insurer's parent, ``for the foreseeable future.'' That is, he's betting that MBIA stock goes down.
Happy Days
If you have been following the story at all, and you probably have if you either own the company's shares or some of the almost $1 trillion in bonds it has insured, you probably thought that all of its troubles were behind it.
That was certainly the opinion of investors and analysts contacted after the firm paid $75 million in January to conclude the federal inquiry into the securities and accounting fraud regulators said MBIA engaged in to conceal some stiff losses, the result of a hospital bond default. MBIA neither admitted nor denied wrongdoing.
Not so, says Ackman. ``We believe that there are a substantial number of additional troubled exposures at MBIA Insurance that are not properly accounted for, thereby giving the NYSID and members of the investment and analyst community a false sense of MBIA Insurance's capital adequacy,'' he writes.
NYSID is the New York State Insurance Department.
Ackman wants the Armonk, New York-based MBIA Insurance to hire an independent consultant to look at what the company has insured as well as its reserves and capital.
Conflicts of Interest
And then there's this little bombshell.
``While MBIA might claim that the ratings agencies effectively serve this function, we believe that the rating agencies have actual and perceived conflicts of interest in that MBIA Insurance is effectively one of the largest customers (if not the single largest customer) of Moody's, Standard & Poor's and Fitch as one of the largest public finance guarantors and structured finance issuers in the world.''
The rating companies regularly are paid by MBIA to evaluate the bonds it insures. They are the ones that determine the firm's so-called claims-paying ability. If you want to be a big-time municipal bond insurer, you want this to be AAA.
But wait a minute, as they say on late-night television: That's not all!
``Over the coming weeks and months we anticipate providing you with additional analysis of Holdings' other business practices that fall within the broader scope of your investigation,'' Ackman writes.
So, yes, it seems there's more.
Sleep Insurance
The Ackman letter was featured in a story on Bloomberg News on Wednesday. Predictably enough, nobody wanted to talk about it. But it doesn't look like Ackman is going away.
What a mess. Bond insurance didn't start this way. The insurers were supposed to underwrite business to a famous ``zero- loss standard,'' as they called it. That is, they never really expected to pay a claim. Can you imagine? The stuff they insured -- state and local bonds -- hardly ever defaulted.
There was a lot of resistance to using this new product when it was introduced back in the 1970s. Bond insurance? Who needed such a thing? Who would want it?
Well, a lot of people, it eventually turned out. Issuers liked it because it put a triple-A rating on their bonds, which meant they wouldn't have to pay as much to borrow. Investors liked it because even if the unimaginable happened and an issuer failed to make its debt service payment, they would still receive timely repayment of principal and interest. More than half of the municipal bonds that are sold every year are now insured.
The model works, until the insurers start looking for profits in other businesses and riskier credits. And now comes a great unraveling.
Bond insurance used to be known as investor's sleep insurance. How quaint.
(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)
By Joe Mysak
March 23 (Bloomberg) -- If you want to piece together the sad recent history of MBIA Inc., the biggest municipal bond insurer, you could go through articles, sift through disclosure documents, attempt to gain access to transcripts of board meetings.
Or you could read through a 32-page letter written by William Ackman of Pershing Square Capital Management in New York.
The letter, a copy of which was obtained this week by Bloomberg News, is dated March 2 and was sent to John Siffert of Lankler Siffert & Wohl.
Siffert is a lawyer who was hired by MBIA Inc. at the behest of regulators after the firm settled a federal fraud investigation in January. He is looking into how the company does business.
The letter doesn't make for cheery reading, if you are an MBIA shareholder or if you own bonds insured by the firm. In fact, it reads a lot like an indictment, with prescriptive remedies including axing management, making them give back their bonuses and installing an independent board of directors.
Ackman has been a bear on MBIA stock for years, and in the letter says he expects ``having a net short position'' in MBIA Holdings, which is the insurer's parent, ``for the foreseeable future.'' That is, he's betting that MBIA stock goes down.
Happy Days
If you have been following the story at all, and you probably have if you either own the company's shares or some of the almost $1 trillion in bonds it has insured, you probably thought that all of its troubles were behind it.
That was certainly the opinion of investors and analysts contacted after the firm paid $75 million in January to conclude the federal inquiry into the securities and accounting fraud regulators said MBIA engaged in to conceal some stiff losses, the result of a hospital bond default. MBIA neither admitted nor denied wrongdoing.
Not so, says Ackman. ``We believe that there are a substantial number of additional troubled exposures at MBIA Insurance that are not properly accounted for, thereby giving the NYSID and members of the investment and analyst community a false sense of MBIA Insurance's capital adequacy,'' he writes.
NYSID is the New York State Insurance Department.
Ackman wants the Armonk, New York-based MBIA Insurance to hire an independent consultant to look at what the company has insured as well as its reserves and capital.
Conflicts of Interest
And then there's this little bombshell.
``While MBIA might claim that the ratings agencies effectively serve this function, we believe that the rating agencies have actual and perceived conflicts of interest in that MBIA Insurance is effectively one of the largest customers (if not the single largest customer) of Moody's, Standard & Poor's and Fitch as one of the largest public finance guarantors and structured finance issuers in the world.''
The rating companies regularly are paid by MBIA to evaluate the bonds it insures. They are the ones that determine the firm's so-called claims-paying ability. If you want to be a big-time municipal bond insurer, you want this to be AAA.
But wait a minute, as they say on late-night television: That's not all!
``Over the coming weeks and months we anticipate providing you with additional analysis of Holdings' other business practices that fall within the broader scope of your investigation,'' Ackman writes.
So, yes, it seems there's more.
Sleep Insurance
The Ackman letter was featured in a story on Bloomberg News on Wednesday. Predictably enough, nobody wanted to talk about it. But it doesn't look like Ackman is going away.
What a mess. Bond insurance didn't start this way. The insurers were supposed to underwrite business to a famous ``zero- loss standard,'' as they called it. That is, they never really expected to pay a claim. Can you imagine? The stuff they insured -- state and local bonds -- hardly ever defaulted.
There was a lot of resistance to using this new product when it was introduced back in the 1970s. Bond insurance? Who needed such a thing? Who would want it?
Well, a lot of people, it eventually turned out. Issuers liked it because it put a triple-A rating on their bonds, which meant they wouldn't have to pay as much to borrow. Investors liked it because even if the unimaginable happened and an issuer failed to make its debt service payment, they would still receive timely repayment of principal and interest. More than half of the municipal bonds that are sold every year are now insured.
The model works, until the insurers start looking for profits in other businesses and riskier credits. And now comes a great unraveling.
Bond insurance used to be known as investor's sleep insurance. How quaint.
(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)
24 March 2007
Why Investors Lose Money:
Investors have a number of weaknesses which often result in investment failure. Identifying these weaknesses is the first step to reducing them. Our Investment Scoring and Timing System is designed to help minimize these weaknesses in order to give us a potential advantage over the market. The following are some key reasons why we believe investors lose money.
1) Emotions
Money is important to our survival, social status and way of life and therefore dealing with finances is an emotional subject. As a result emotions tend to have exceptionally negative consequences on our investment decision making. When our investments are doing well, we tend to add to our positions or hold on to our investments too long. Alternatively, when our investments are doing poorly we tend to sell our positions in fear of losing money. This response is not conducive to making a successful investment. Emotional investment decisions tend to cause the investor to "buy high" and "sell low". Obviously this is not the best strategy.
As a group, people tend to make terrible investors. People often have a desire to be accepted among their peers and frequently seek comfort and approval from others. They like to share common thoughts and theories at social events. For instance, people find it agreeable to discuss popular topics such as a "hot" real-estate market. In the peak of a bull market it is fun and easy for everyone to get along and agree on the current "hot" market. However, few investors buy when a market is unpopular and not doing well, but history suggests these are usually the ones who succeed with their investment strategies. These are the investors who see value in unpopular investments and buy when they are "on sale". Often these individuals are dismissed as being "uninformed" because they disregard the latest perceived, "can't lose," "hot" investment. In reality we can not all make money. Someone must lose if others are to gain. History repeatedly demonstrates that it is the popular group belief that generally takes the loss.
2) Discipline
Some investors may realize the pitfalls of emotional investment decisions but because they lack an investment strategy they still fall victim to the same problems. It is hard to resist the temptation to hold onto a winning investment. People gamble and want to hold onto that investment a little longer than advisable. Contrarily, if an investor has experienced previous losses, it is hard to resist selling an investment to lock in the profits. However when they do, people are often disappointed with the trivial gain when that same investment continues to increase in value many times over. Discipline is an exceptionally difficult trait to master. Methodically approaching your investment strategy with a predetermined plan and system makes disciplined investing easier.
3) Ignorance
People are taught throughout their lives the importance of studying hard in order to get a good job so that they will earn a good pay. Unfortunately they are not taught what to do with the money after it has been earned. It is our opinion that a small percentage of the population benefits from this ignorance. As shown in the past, a massive transfer of wealth from the general population to a select few regularly occurs. Also, people tend to naively believe they will outperform the market with little to no strategy. Even worse, investors commonly implement widely accepted yet faulty strategies that greatly reduce their probability of success. Understanding basic rules and having a predetermined system helps investors remain focused and be on the right side of the trade.
4) Misinformation
Networks and various media often discuss current financial trends. In our opinion the "hype" of the media calling this move or that move is merely speculative "noise" and generally irrelevant. These short term explanations make us question our investments, sell out early, buy late and generally create an unwanted emotional response. This "noise" and potential misinformation causes us to lose focus of the "big picture" and major trend. We believe it is this "noise" that stands between success and failure as an investor. We use Our Charts to help illustrate the market trend and bypass this emotional noise.
1) Emotions
Money is important to our survival, social status and way of life and therefore dealing with finances is an emotional subject. As a result emotions tend to have exceptionally negative consequences on our investment decision making. When our investments are doing well, we tend to add to our positions or hold on to our investments too long. Alternatively, when our investments are doing poorly we tend to sell our positions in fear of losing money. This response is not conducive to making a successful investment. Emotional investment decisions tend to cause the investor to "buy high" and "sell low". Obviously this is not the best strategy.
As a group, people tend to make terrible investors. People often have a desire to be accepted among their peers and frequently seek comfort and approval from others. They like to share common thoughts and theories at social events. For instance, people find it agreeable to discuss popular topics such as a "hot" real-estate market. In the peak of a bull market it is fun and easy for everyone to get along and agree on the current "hot" market. However, few investors buy when a market is unpopular and not doing well, but history suggests these are usually the ones who succeed with their investment strategies. These are the investors who see value in unpopular investments and buy when they are "on sale". Often these individuals are dismissed as being "uninformed" because they disregard the latest perceived, "can't lose," "hot" investment. In reality we can not all make money. Someone must lose if others are to gain. History repeatedly demonstrates that it is the popular group belief that generally takes the loss.
2) Discipline
Some investors may realize the pitfalls of emotional investment decisions but because they lack an investment strategy they still fall victim to the same problems. It is hard to resist the temptation to hold onto a winning investment. People gamble and want to hold onto that investment a little longer than advisable. Contrarily, if an investor has experienced previous losses, it is hard to resist selling an investment to lock in the profits. However when they do, people are often disappointed with the trivial gain when that same investment continues to increase in value many times over. Discipline is an exceptionally difficult trait to master. Methodically approaching your investment strategy with a predetermined plan and system makes disciplined investing easier.
3) Ignorance
People are taught throughout their lives the importance of studying hard in order to get a good job so that they will earn a good pay. Unfortunately they are not taught what to do with the money after it has been earned. It is our opinion that a small percentage of the population benefits from this ignorance. As shown in the past, a massive transfer of wealth from the general population to a select few regularly occurs. Also, people tend to naively believe they will outperform the market with little to no strategy. Even worse, investors commonly implement widely accepted yet faulty strategies that greatly reduce their probability of success. Understanding basic rules and having a predetermined system helps investors remain focused and be on the right side of the trade.
4) Misinformation
Networks and various media often discuss current financial trends. In our opinion the "hype" of the media calling this move or that move is merely speculative "noise" and generally irrelevant. These short term explanations make us question our investments, sell out early, buy late and generally create an unwanted emotional response. This "noise" and potential misinformation causes us to lose focus of the "big picture" and major trend. We believe it is this "noise" that stands between success and failure as an investor. We use Our Charts to help illustrate the market trend and bypass this emotional noise.
23 March 2007
Leading Economic Indicators point down
Today the Conference Board reported that its index of Leading Economic Indicators (LEI) for February declined by 0.5% on the heel’s of January’s downwardly revised 0.3% drop. The January-February LEI average is down 0.49% from its Q1:2006 average. If the January and February levels of the LEI are not changed after revisions, then in order for the first quarter’s LEI average to equal that of Q1:2006, the March LEI would have to increase 1.7%. The last time the month-to-month increase in the LEI even approached this magnitude was back in March 2004, when it increased 1.4%. So, as of right now, the odds favor the first quarterly average year-over-year contraction in the LEI of this current economic expansion.
If, in fact, we are about to witness a year-over-year decline in the quarterly average of the LEI, would that be a big deal, cyclically speaking. History shouts, “YES!” Chart 1 shows that a year-over-year contraction in the quarterly average LEI has heralded every recession (vertically shaded areas) since that of 1960, yielding only one false signal. That false signal occurred in late 1966 through early 1967. Back then, this period of economic turbulence was called the “mini-recession of 1967.” An official recession was never named for this period but the pace of economic activity did slow. Real GDP just did not contract – perhaps because of series Fed rate cuts commencing early in 1967. Notice also in Chart 1 that after the first quarter the year-over-year change in the LEI is negative, successive quarters also are negative. In other words, the LEI has not given any “head-fakes” after it first signals a recession.
The LEI might be termed the ultimate Rodney Dangerfield of economic statistics – it can’t get no respect. The LEI often is referred to derisively by mainstream Wall Street economists as the index of Misleading Indicators. I suppose that if there were an indicator that gave consistently better advance warnings of the onset of recessions and recoveries than one’s my “proprietary” GDP forecasting model, I would not look kindly on this indicator either for fear of having my forecasting job replaced by a Conference Board press release. And although I might publicly deride the LEI, I would privately incorporate it into my forecasts. Judging from how poorly consensus economic forecasts consistently fail to anticipate cyclical turning points, it looks as though many macroeconomic forecasters are either ignorant of how well the LEI outperforms them or are just plain stupid. What is most amazing, though, is that evidently the chief economic forecaster for the Conference Board, the very organization that calculates and publishes the LEI, seems to be currently ignoring the very strong cyclical message being sent by the recent behavior of the LEI. To wit, the Conference Board’s 2007 real GDP growth forecast submitted for the March Blue Chip Survey was 2.9% -- considerably above the average forecast of the 50 survey respondents of 2.5% and the second highest of the forecasts, with 3.0% taking “top honors.” But it looks as though one forecaster may be paying more attention to the LEI than he used to. FOMC transcripts show that then Fed Chairman Alan Greenspan failed in August 1990 to realize that a recession already was underway and in October 2000 that a recession was imminent even though the behavior of the LEI clearly was signaling as much. But perhaps Greenspan’s recent 30% probability forecast of a 2007 recession is based on a new appreciation of the LEI.
To corroborate the recession-warning signal being sent by the LEI, I have developed another recession-warning indicator. I have found that every recession starting with the 1970 recession has been immediately preceded by the following combination - a negative spread between the yield on the Treasury 10-year security and the federal funds rate (hereafter referred to as “the spread) on a four-quarter moving average basis and a year-over-year contraction in the quarterly average of the CPI-adjusted monetary base. The monetary base is the sum of bank reserves and coin/currency, both of which have been created out of thin air, as it were, by the Fed. Chart 2 shows the historical behavior of the “Kasriel Recession-Warning Indicator” (KRWI). For the theoretical underpinnings of the KRWI, see “The Inverted Yield Curve – Is It Really Different This Time?” The Econtrarian, March 16, 2007.
The KRWI has given no false signals in that when it has warned of a recession, there has been one. Unlike the LEI, which signaled a recession for 1967, the KRWI did not. However the 1960 recession was not signaled by the KRWI because the spread remained positive, although it did narrow. As of the fourth quarter of last year, the spread moved into negative territory, but the year-over-year change in the real monetary base remained positive. So, like the LEI, as of the fourth quarter of last year, the KRWI had not signaled that a recession was imminent.
But how is the KRWI shaping up in the current quarter? About the same as the LEI. The KRWI in terms of monthly data is shown in Chart 3. Barring some miraculous change between now and the end of this month, the spread component of the KRWI will be deeper into negative territory. In February, the year-over-year change in the real monetary base turned negative by about 50 basis points. The January-February average of the real monetary base is barely above its quarterly average of Q1:2006. Again barring revisions to January/February data, the March 2007 real monetary base would have to increase by about 0.2% over that of its March 2006 level in order for the year-over-year change in the real monetary base to remain in positive territory in the first quarter of this year and thus not trigger an imminent recession warning by the KRWI. If the year-over-year increase in the March CPI were to stay at its February reading of 2.4%, this would require a year-over-year increase in the March nominal monetary base of 2.6% in order to get a positive year-over-year change in the real monetary base. In the first two weeks of March, the year-over-year increase in the nominal monetary base is just 1.9%.
In sum, barring upward revisions in the LEI and KRWI and sharp increases in the immediate months ahead, both of these indicators will be sending a signal that a recession is on the horizon. Perhaps this will be the first time in over 45 years that the KRWI will emit a false signal and only the second time that the LEI emits a false signal. Perhaps.
If, in fact, we are about to witness a year-over-year decline in the quarterly average of the LEI, would that be a big deal, cyclically speaking. History shouts, “YES!” Chart 1 shows that a year-over-year contraction in the quarterly average LEI has heralded every recession (vertically shaded areas) since that of 1960, yielding only one false signal. That false signal occurred in late 1966 through early 1967. Back then, this period of economic turbulence was called the “mini-recession of 1967.” An official recession was never named for this period but the pace of economic activity did slow. Real GDP just did not contract – perhaps because of series Fed rate cuts commencing early in 1967. Notice also in Chart 1 that after the first quarter the year-over-year change in the LEI is negative, successive quarters also are negative. In other words, the LEI has not given any “head-fakes” after it first signals a recession.
The LEI might be termed the ultimate Rodney Dangerfield of economic statistics – it can’t get no respect. The LEI often is referred to derisively by mainstream Wall Street economists as the index of Misleading Indicators. I suppose that if there were an indicator that gave consistently better advance warnings of the onset of recessions and recoveries than one’s my “proprietary” GDP forecasting model, I would not look kindly on this indicator either for fear of having my forecasting job replaced by a Conference Board press release. And although I might publicly deride the LEI, I would privately incorporate it into my forecasts. Judging from how poorly consensus economic forecasts consistently fail to anticipate cyclical turning points, it looks as though many macroeconomic forecasters are either ignorant of how well the LEI outperforms them or are just plain stupid. What is most amazing, though, is that evidently the chief economic forecaster for the Conference Board, the very organization that calculates and publishes the LEI, seems to be currently ignoring the very strong cyclical message being sent by the recent behavior of the LEI. To wit, the Conference Board’s 2007 real GDP growth forecast submitted for the March Blue Chip Survey was 2.9% -- considerably above the average forecast of the 50 survey respondents of 2.5% and the second highest of the forecasts, with 3.0% taking “top honors.” But it looks as though one forecaster may be paying more attention to the LEI than he used to. FOMC transcripts show that then Fed Chairman Alan Greenspan failed in August 1990 to realize that a recession already was underway and in October 2000 that a recession was imminent even though the behavior of the LEI clearly was signaling as much. But perhaps Greenspan’s recent 30% probability forecast of a 2007 recession is based on a new appreciation of the LEI.
To corroborate the recession-warning signal being sent by the LEI, I have developed another recession-warning indicator. I have found that every recession starting with the 1970 recession has been immediately preceded by the following combination - a negative spread between the yield on the Treasury 10-year security and the federal funds rate (hereafter referred to as “the spread) on a four-quarter moving average basis and a year-over-year contraction in the quarterly average of the CPI-adjusted monetary base. The monetary base is the sum of bank reserves and coin/currency, both of which have been created out of thin air, as it were, by the Fed. Chart 2 shows the historical behavior of the “Kasriel Recession-Warning Indicator” (KRWI). For the theoretical underpinnings of the KRWI, see “The Inverted Yield Curve – Is It Really Different This Time?” The Econtrarian, March 16, 2007.
The KRWI has given no false signals in that when it has warned of a recession, there has been one. Unlike the LEI, which signaled a recession for 1967, the KRWI did not. However the 1960 recession was not signaled by the KRWI because the spread remained positive, although it did narrow. As of the fourth quarter of last year, the spread moved into negative territory, but the year-over-year change in the real monetary base remained positive. So, like the LEI, as of the fourth quarter of last year, the KRWI had not signaled that a recession was imminent.
But how is the KRWI shaping up in the current quarter? About the same as the LEI. The KRWI in terms of monthly data is shown in Chart 3. Barring some miraculous change between now and the end of this month, the spread component of the KRWI will be deeper into negative territory. In February, the year-over-year change in the real monetary base turned negative by about 50 basis points. The January-February average of the real monetary base is barely above its quarterly average of Q1:2006. Again barring revisions to January/February data, the March 2007 real monetary base would have to increase by about 0.2% over that of its March 2006 level in order for the year-over-year change in the real monetary base to remain in positive territory in the first quarter of this year and thus not trigger an imminent recession warning by the KRWI. If the year-over-year increase in the March CPI were to stay at its February reading of 2.4%, this would require a year-over-year increase in the March nominal monetary base of 2.6% in order to get a positive year-over-year change in the real monetary base. In the first two weeks of March, the year-over-year increase in the nominal monetary base is just 1.9%.
In sum, barring upward revisions in the LEI and KRWI and sharp increases in the immediate months ahead, both of these indicators will be sending a signal that a recession is on the horizon. Perhaps this will be the first time in over 45 years that the KRWI will emit a false signal and only the second time that the LEI emits a false signal. Perhaps.
18 March 2007
Subprime Contagion Effects:
Doug Nolan:
The Mortgage Finance Bubble should have burst last year, taking the lead from housing market dynamics. But the extraordinary dynamism associated with global Credit, speculative and liquidity excesses proved overpowering. The global leveraged speculating community was in aggressive expansion mode; Bubble excesses were going to reckless extremes throughout "Credit arbitrage;" the M&A and corporate debt Bubbles were in full bloom; and securities leveraging was taking the entire world by storm.
The resulting global liquidity cataclysm ensured insatiable demand for higher-yielding instruments, in large part satisfied by Wall Street's unprecedented CDO (collateralized debt obligations) issuance boom. Despite the turn in U.S. housing, the unprecedented deluge in speculative finance created rapacious demand for riskier loans, certainly including subprime mortgages - vulnerable housing markets notwithstanding. Readily available mortgage finance empowered subprime originators to accommodate throngs of simply terrible Credits (many borrowers content to submit fraudulent loan applications) desperate to refinance problematic mortgages with payments about to reset significantly higher. When Wall Street pool operators recognized the unfolding disaster - and began rigorously scouring portfolios for problem loans and imperfect applications to return to the originators ("early payment defaults") - the subprime Bubble was brought to a screeching halt.
That the Mortgage Finance Bubble did not succumb last year only ensured the peril associated with a protracted period of terminal blow-off excesses. Excesses included unprecedented speculation in Credit derivatives (including a Trillion or two of new CDOs), equities Bubbles spanning the globe, and only greater Bubble distortions and imbalances in U.S. and global economies. The exponential growth in risky lending, in the leveraged speculating community, in the derivatives markets, and in speculative flows to global asset markets were accommodated another year. Wall Street finance became an only more imposing source of global "money," Credit and marketplace liquidity, operating with the type of power and control central banks could only dream of.
Reading through this week's Wall Street earnings releases and listening to their conference calls left me with the sense that these firms and their clients are especially poorly positioned for an abrupt change in the market environment. Everyone is quick to state that their subprime exposure is small and that they have successfully "hedged." We are also told that market tumult has been isolated in the subprime marketplace, and that marketplace liquidity remains extraordinarily abundant. All of this may be true for now, but it does not alter the reality that the subprime collapse may very well mark a key (historic?) inflection point for the U.S. Mortgage Finance Bubble and intertwined global risk markets generally.
Clearly, the subprime collapse has quickly imposed dramatically tighter Credit standards and Availability for risky borrowers. I would expect this to speed housing price declines in some areas, with mounting Credit losses ushering in the ugly downside of Credit cycle. To be sure, this has provided a belated wakeup call regarding the latent Acute Financial Fragility of Ponzi Finance Units. Importantly, the flow (deluge) of speculative finance played a critical role in the subprime boom, and its abrupt reversal has instigated almost immediate collapse.
The bulls argue that subprime amounts to only a small portion of mortgage debt - and thus will have only minimal economic impact. More discerning analysis would instead focus on the Financial Sphere Ramifications Associated with the Hasty Reversal of Speculative Flows from Risky Mortgage Instruments. Is the flight out of subprime mortgages, securitizations and other derivatives a harbinger of things to come for the entire mortgage marketplace? Does the move toward Risk Aversion (position liquidation and/or hedging operations) in this sector mark a momentous marketplace shift from Risk Embracement to Risk Aversion?
In analyzing potential Subprime Contagion Effects, we must begin with a critical question: Is the general backdrop characterized by soundness and stability or is it more a case of excess, weak debt structures, and general fragility. Again, subprime collapsed so abruptly because of the acute fragility associated with Ponzi Finance. Unfortunately, analysis of general mortgage market vulnerability leaves me quite uneasy.
The entire Mortgage Finance Bubble is today especially susceptible to Subprime Contagion Effects. For starters, lending standards should be expected to tightened significantly throughout the "Alt-A," "jumbo," and prime "exotic" mortgage marketplace. This will likely pose a greater dilemma than subprime restraint for vulnerable high-priced housing across the country, with all eyes on California. For years now, the "Golden State" has been at the epicenter of mortgage lending excesses. I suspect the state has also been the leader in mortgage fraud. Going forward, I fully expect California to lead the nation in Credit losses and mortgage/housing angst.
Throughout the boom, the securitization of mortgage Credit provided endless finance for homebuyers and speculators, as well as endless profits for the holders of these instruments. As long as home prices were inflating, there was little concern whether the underlying collateral was a reasonably valued home in, say, Texas or a highly inflated property in the San Francisco Bay Area. Now, with Credit conditions beginning to tighten, I expect holders of MBS, ABS, CDOs, etc. to take a more keen interest in the type and location of underlying collateral. This Contagion Effect will mark a significant reversal in speculative flows from the mortgage arena.
For some time it has been my belief that a California housing bust would bring an end to the GSEs as we presently know them. Never in my wildest imagination did I contemplate the median price for the entire state inflating to $560,000. A bust would now likely take down the GSEs, the mortgage insurers, scores of banks, and wreak bloody havoc throughout the entire securitization and derivatives marketplaces. While few will today subscribe to such a scenario, I certainly expect the marketplace to begin contemplating and gravitating away from such risks. And I don't think it would take that much for the marketplace to start nervously totaling up the capital and reserves available for future Credit losses from the thinly capitalized guarantors of the so far pristine "AAA" agency securities marketplace. Again, there are now reasons to ponder various Contagion Effects that together could foster a major and self-reinforcing reversal of speculative flows.
Ominously, renewed dollar weakness has been an early Subprime Contagion Effect. Sure, the market now perceives the Fed will in the not too distant future cut rates and narrow rate differentials. But I also believe more may be at work. The transformation of risky Credits into perceived "money-like" instruments - that foreigners have been happy to accumulate - has lent great support to the dollar over these past few years of massive Current Account Deficits. A bursting Mortgage Finance Bubble and what it could mean for the securitization markets and risk intermediaries create the potential for Subprime Contagion Effects to precipitate a real problem for the dollar.
The Mortgage Finance Bubble should have burst last year, taking the lead from housing market dynamics. But the extraordinary dynamism associated with global Credit, speculative and liquidity excesses proved overpowering. The global leveraged speculating community was in aggressive expansion mode; Bubble excesses were going to reckless extremes throughout "Credit arbitrage;" the M&A and corporate debt Bubbles were in full bloom; and securities leveraging was taking the entire world by storm.
The resulting global liquidity cataclysm ensured insatiable demand for higher-yielding instruments, in large part satisfied by Wall Street's unprecedented CDO (collateralized debt obligations) issuance boom. Despite the turn in U.S. housing, the unprecedented deluge in speculative finance created rapacious demand for riskier loans, certainly including subprime mortgages - vulnerable housing markets notwithstanding. Readily available mortgage finance empowered subprime originators to accommodate throngs of simply terrible Credits (many borrowers content to submit fraudulent loan applications) desperate to refinance problematic mortgages with payments about to reset significantly higher. When Wall Street pool operators recognized the unfolding disaster - and began rigorously scouring portfolios for problem loans and imperfect applications to return to the originators ("early payment defaults") - the subprime Bubble was brought to a screeching halt.
That the Mortgage Finance Bubble did not succumb last year only ensured the peril associated with a protracted period of terminal blow-off excesses. Excesses included unprecedented speculation in Credit derivatives (including a Trillion or two of new CDOs), equities Bubbles spanning the globe, and only greater Bubble distortions and imbalances in U.S. and global economies. The exponential growth in risky lending, in the leveraged speculating community, in the derivatives markets, and in speculative flows to global asset markets were accommodated another year. Wall Street finance became an only more imposing source of global "money," Credit and marketplace liquidity, operating with the type of power and control central banks could only dream of.
Reading through this week's Wall Street earnings releases and listening to their conference calls left me with the sense that these firms and their clients are especially poorly positioned for an abrupt change in the market environment. Everyone is quick to state that their subprime exposure is small and that they have successfully "hedged." We are also told that market tumult has been isolated in the subprime marketplace, and that marketplace liquidity remains extraordinarily abundant. All of this may be true for now, but it does not alter the reality that the subprime collapse may very well mark a key (historic?) inflection point for the U.S. Mortgage Finance Bubble and intertwined global risk markets generally.
Clearly, the subprime collapse has quickly imposed dramatically tighter Credit standards and Availability for risky borrowers. I would expect this to speed housing price declines in some areas, with mounting Credit losses ushering in the ugly downside of Credit cycle. To be sure, this has provided a belated wakeup call regarding the latent Acute Financial Fragility of Ponzi Finance Units. Importantly, the flow (deluge) of speculative finance played a critical role in the subprime boom, and its abrupt reversal has instigated almost immediate collapse.
The bulls argue that subprime amounts to only a small portion of mortgage debt - and thus will have only minimal economic impact. More discerning analysis would instead focus on the Financial Sphere Ramifications Associated with the Hasty Reversal of Speculative Flows from Risky Mortgage Instruments. Is the flight out of subprime mortgages, securitizations and other derivatives a harbinger of things to come for the entire mortgage marketplace? Does the move toward Risk Aversion (position liquidation and/or hedging operations) in this sector mark a momentous marketplace shift from Risk Embracement to Risk Aversion?
In analyzing potential Subprime Contagion Effects, we must begin with a critical question: Is the general backdrop characterized by soundness and stability or is it more a case of excess, weak debt structures, and general fragility. Again, subprime collapsed so abruptly because of the acute fragility associated with Ponzi Finance. Unfortunately, analysis of general mortgage market vulnerability leaves me quite uneasy.
The entire Mortgage Finance Bubble is today especially susceptible to Subprime Contagion Effects. For starters, lending standards should be expected to tightened significantly throughout the "Alt-A," "jumbo," and prime "exotic" mortgage marketplace. This will likely pose a greater dilemma than subprime restraint for vulnerable high-priced housing across the country, with all eyes on California. For years now, the "Golden State" has been at the epicenter of mortgage lending excesses. I suspect the state has also been the leader in mortgage fraud. Going forward, I fully expect California to lead the nation in Credit losses and mortgage/housing angst.
Throughout the boom, the securitization of mortgage Credit provided endless finance for homebuyers and speculators, as well as endless profits for the holders of these instruments. As long as home prices were inflating, there was little concern whether the underlying collateral was a reasonably valued home in, say, Texas or a highly inflated property in the San Francisco Bay Area. Now, with Credit conditions beginning to tighten, I expect holders of MBS, ABS, CDOs, etc. to take a more keen interest in the type and location of underlying collateral. This Contagion Effect will mark a significant reversal in speculative flows from the mortgage arena.
For some time it has been my belief that a California housing bust would bring an end to the GSEs as we presently know them. Never in my wildest imagination did I contemplate the median price for the entire state inflating to $560,000. A bust would now likely take down the GSEs, the mortgage insurers, scores of banks, and wreak bloody havoc throughout the entire securitization and derivatives marketplaces. While few will today subscribe to such a scenario, I certainly expect the marketplace to begin contemplating and gravitating away from such risks. And I don't think it would take that much for the marketplace to start nervously totaling up the capital and reserves available for future Credit losses from the thinly capitalized guarantors of the so far pristine "AAA" agency securities marketplace. Again, there are now reasons to ponder various Contagion Effects that together could foster a major and self-reinforcing reversal of speculative flows.
Ominously, renewed dollar weakness has been an early Subprime Contagion Effect. Sure, the market now perceives the Fed will in the not too distant future cut rates and narrow rate differentials. But I also believe more may be at work. The transformation of risky Credits into perceived "money-like" instruments - that foreigners have been happy to accumulate - has lent great support to the dollar over these past few years of massive Current Account Deficits. A bursting Mortgage Finance Bubble and what it could mean for the securitization markets and risk intermediaries create the potential for Subprime Contagion Effects to precipitate a real problem for the dollar.
Digital gold and a flawed global order
By Benn Steil
It is remarkable how the world's short history of floating exchange rates has affected popular thinking about what is eternally normal and proper in the economic system. Recently, China-bashing US Senators Charles Schumer and Lindsey Graham wrote matter-of-factly that: "One of the fundamental tenets of free trade is that currencies should float."
Such a "tenet" would have been considered monstrous by most of the economics profession up until the last three decades of the 20th century, prior to which money accepted across borders had generally been gold, or claims on gold, for about 2,500 years. Even John Maynard Keynes, the arch-slayer of the last remnants of commodity money, was an adamant supporter of fixed exchange rates.
Floating exchange rates have proved a source of tremendous periodic instability, yielding repeated currency crises in countries whose currencies are not acceptable for international transactions, but which build up imbalances in their national balance sheets through their imports of dollar capital. The fundamental difference between capital flows under indelibly fixed and flexible exchange rates was well known generations ago, decades before the modern era of globalisation. As Friedrich Hayek noted in a 1937 lecture, under fixed rates "the effect of short-term capital movements will be on the whole to reduce the amplitude of the actual fluctuations . . . If exchanges, however, are variable, the capital movements will tend to work in the same direction as the original cause and thereby to intensify it." This logic was mirrored precisely by the radical change in capital flow behaviour that accompanied the crumbling of a credible international monetary anchor, gold, between the first and second world wars.
Monetary nationalists, who believe it natural that every country should have its own paper currency and not waste resources hoarding gold or hard currency reserves, must eventually demand capital controls - as the most noted economist critic of globalisation, Joseph Stiglitz, has done - in order to stop the people from disturbing the government's control of national credit conditions. But the government cannot stop there, Hayek reasoned, as "exchange control designed to prevent effectively the outflow of capital would really have to involve a complete control of foreign trade, since of course any variation in the terms of credit on exports or imports means an international capital movement".
Indeed, this is precisely the path the Argentine government has been following since abandoning its dollar currency board in 2002. Since writing off $80bn worth, or 75 per cent in nominal terms, of its debts, the government has been resorting to ever-more intrusive means in order to counteract the ability of its citizens to protect what remains of their savings and to buy from or sell to foreigners.
In 2003, the Argentine government introduced capital and domestic price controls, the aim being to keep the exchange rate down while simultaneously containing the inflation that policy was giving rise to. In 2004, energy sector controls were extended to include export taxes and partial export bans on oil and gas. In 2005, rules were imposed forcing companies to convert most foreign proceeds into pesos and limiting the amount of foreign currency that individuals could acquire to invest abroad. In 2006, in an effort to stop the rise of inflation beyond 1 per cent per month, President Nestor Kirchner demanded "voluntary" price freezes on about 300 products, targeting component products of the official consumer price index, and extended export bans to beef and other products.
Argentina could not be a more fitting fulfilment of Hayek's fears, that the spread of monetary nationalism could only lead to ever greater international economic and political conflict. Since the 2002 devaluation, the Argentine government has been in continuous conflict with its European counterparts over the expropriations imposed on the latter's bondholders and corporate direct investors; and the population has turned viscerally anti-American, anti-International Monetary Fund and anti-globalisation.
It was well understood before the Bretton Woods era that monetary nationalism would fundamentally change the way capital flows naturally operate, making of a benign economic force one that would necessarily wreak havoc with flexible exchange rates. The global monetary order that has emerged since the 1970s is now globalisation's greatest source of vulnerability.
What is to be done? Realistically, sauve qui peut must be the message for nations whose currencies are not wanted by foreigners. Dollarisation - abandonment of parochial currencies in favour of the dollar, euro or other internationally accepted money - is, in a world of fiat currencies, unsupported by gold or silver, the only way to globalise safely.
Of course, the status of internationally accepted money is not heaven-bestowed and there is no way effectively to insure against the unwinding of "global imbalances" should China, with nearly $1,000bn (£509bn) of reserves, and other reserve-rich central banks come to fear the unbearable lightness of their fiat holdings. Digitised commodity money may then be in store for us. Gold banks already exist that allow clients to make and receive digital gold payments - a form of electronic money, backed by gold in storage - around the globe. The business has grown significantly in recent years, in tandem with the dollar's decline.
As radical and implausible as it may sound, digitising the earth's 2,500-year experiment with commodity money may ultimately prove far more sustainable than our recent 35-year experiment with monetary sovereignty.
The writer is director of international economics at the Council on Foreign Relations and co-author of Financial Statecraft
It is remarkable how the world's short history of floating exchange rates has affected popular thinking about what is eternally normal and proper in the economic system. Recently, China-bashing US Senators Charles Schumer and Lindsey Graham wrote matter-of-factly that: "One of the fundamental tenets of free trade is that currencies should float."
Such a "tenet" would have been considered monstrous by most of the economics profession up until the last three decades of the 20th century, prior to which money accepted across borders had generally been gold, or claims on gold, for about 2,500 years. Even John Maynard Keynes, the arch-slayer of the last remnants of commodity money, was an adamant supporter of fixed exchange rates.
Floating exchange rates have proved a source of tremendous periodic instability, yielding repeated currency crises in countries whose currencies are not acceptable for international transactions, but which build up imbalances in their national balance sheets through their imports of dollar capital. The fundamental difference between capital flows under indelibly fixed and flexible exchange rates was well known generations ago, decades before the modern era of globalisation. As Friedrich Hayek noted in a 1937 lecture, under fixed rates "the effect of short-term capital movements will be on the whole to reduce the amplitude of the actual fluctuations . . . If exchanges, however, are variable, the capital movements will tend to work in the same direction as the original cause and thereby to intensify it." This logic was mirrored precisely by the radical change in capital flow behaviour that accompanied the crumbling of a credible international monetary anchor, gold, between the first and second world wars.
Monetary nationalists, who believe it natural that every country should have its own paper currency and not waste resources hoarding gold or hard currency reserves, must eventually demand capital controls - as the most noted economist critic of globalisation, Joseph Stiglitz, has done - in order to stop the people from disturbing the government's control of national credit conditions. But the government cannot stop there, Hayek reasoned, as "exchange control designed to prevent effectively the outflow of capital would really have to involve a complete control of foreign trade, since of course any variation in the terms of credit on exports or imports means an international capital movement".
Indeed, this is precisely the path the Argentine government has been following since abandoning its dollar currency board in 2002. Since writing off $80bn worth, or 75 per cent in nominal terms, of its debts, the government has been resorting to ever-more intrusive means in order to counteract the ability of its citizens to protect what remains of their savings and to buy from or sell to foreigners.
In 2003, the Argentine government introduced capital and domestic price controls, the aim being to keep the exchange rate down while simultaneously containing the inflation that policy was giving rise to. In 2004, energy sector controls were extended to include export taxes and partial export bans on oil and gas. In 2005, rules were imposed forcing companies to convert most foreign proceeds into pesos and limiting the amount of foreign currency that individuals could acquire to invest abroad. In 2006, in an effort to stop the rise of inflation beyond 1 per cent per month, President Nestor Kirchner demanded "voluntary" price freezes on about 300 products, targeting component products of the official consumer price index, and extended export bans to beef and other products.
Argentina could not be a more fitting fulfilment of Hayek's fears, that the spread of monetary nationalism could only lead to ever greater international economic and political conflict. Since the 2002 devaluation, the Argentine government has been in continuous conflict with its European counterparts over the expropriations imposed on the latter's bondholders and corporate direct investors; and the population has turned viscerally anti-American, anti-International Monetary Fund and anti-globalisation.
It was well understood before the Bretton Woods era that monetary nationalism would fundamentally change the way capital flows naturally operate, making of a benign economic force one that would necessarily wreak havoc with flexible exchange rates. The global monetary order that has emerged since the 1970s is now globalisation's greatest source of vulnerability.
What is to be done? Realistically, sauve qui peut must be the message for nations whose currencies are not wanted by foreigners. Dollarisation - abandonment of parochial currencies in favour of the dollar, euro or other internationally accepted money - is, in a world of fiat currencies, unsupported by gold or silver, the only way to globalise safely.
Of course, the status of internationally accepted money is not heaven-bestowed and there is no way effectively to insure against the unwinding of "global imbalances" should China, with nearly $1,000bn (£509bn) of reserves, and other reserve-rich central banks come to fear the unbearable lightness of their fiat holdings. Digitised commodity money may then be in store for us. Gold banks already exist that allow clients to make and receive digital gold payments - a form of electronic money, backed by gold in storage - around the globe. The business has grown significantly in recent years, in tandem with the dollar's decline.
As radical and implausible as it may sound, digitising the earth's 2,500-year experiment with commodity money may ultimately prove far more sustainable than our recent 35-year experiment with monetary sovereignty.
The writer is director of international economics at the Council on Foreign Relations and co-author of Financial Statecraft
17 March 2007
Why the subprime bust will spread
By Henry C K Liu
Years ago when the US debt bubble spread over to the housing sector, warnings from many quarters about the systemic danger of subprime mortgages were categorically dismissed by Wall Street cheerleaders as Chicken Little "sky is falling" hysteria. Even weeks before bad news on the housing finance sector was shaping up as a clear and present danger, adamant denial was still loud enough to drown out reason.
Both Federal Reserve chairman Ben Bernanke and Treasury Secretary Henry Paulson, two top officials in charge of US monetary policy, continue to provide obligatory assurance to the nervous public that the United States' economic fundamentals are sound in the face of a jittery market. Days before being delisted from the New York Stock Exchange, shares of the collapsed New Century, a distressed subprime mortgage lender, were recommended by a major Wall Street brokerage firm as a "buy". That firm is now under criminal and regulatory investigation.
On the pages of Asia Times Online over the past two years, I have tried to put forth the rationale for the inevitability of a US housing bubble burst, pointing out reasons that the resultant financial meltdown will be much more widespread and severe than has been generally acknowledged.
On September 14, 2005, I wrote in Greenspan, the Wizard of Bubbleland:
History has shown that the Fed, more often than not, has made wrong decisions based on faulty projection. Greenspan has been rightly criticized for letting a housing price "bubble" develop, equating it to the one that swept technology stocks to stratospheric levels before bursting in 2000. Greenspan argues the Fed's role is to mop up after bubbles burst, since bubbles are hard to spot and deflate safely. But accidents are also difficult to predict, and that difficulty is not a good argument against buying insurance. There is no doubt that there is a price to be paid for every policy action. But the price of prematurely slowing down a debt bubble is infinitely lower than letting the bubble build until it bursts uncontrollably. In finance as in medicine, prevention is preferable to even the best cure. All market participants know pigs lose money. And a monetary pig loses control of the economy.
Alan Greenspan, then Fed chairman, notwithstanding his denial of responsibility in helping through the 1990s to unleash the equity bubble, had this to say in 2004 in hindsight after the bubble burst in 2000: "Instead of trying to contain a putative bubble by drastic actions with largely unpredictable consequences, we chose, as we noted in our mid-1999 congressional testimony, to focus on policies to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion."
By "the next expansion", Greenspan meant the next bubble, which manifested itself in housing. The mitigating policy was a massive injection of liquidity into the US banking system.
There is a structural reason that the housing bubble replaced the high-tech bubble. Houses cannot be imported like manufactured goods, although much of the content in houses, such as furniture, hardware, windows, kitchen equipment and bath fixtures, is manufactured overseas. Construction jobs cannot be outsourced overseas to take advantage of wage arbitrage. Instead, some non-skilled jobs are filled by low-wage illegal immigrants.
Total outstanding home mortgages in the US in 1999 were US$4.45 trillion, and by 2004 this amount had grown to $7.56 trillion, most of which was absorbed by refinancing of higher home prices at lower interest rates. When Greenspan took over at the Fed in 1987, total outstanding US home mortgages stood only at $1.82 trillion. On his watch, outstanding home mortgages quadrupled. Much of this money has been printed by the Fed, exported through the trade deficit and reimported as debt.
The most popular of all derivative products is the interest-rate swap, which in essence allows participants to make bets on the direction interest rates will take. According to the US Office of the Comptroller of the Currency (OCC), interest-rate swaps accounted for three out of four derivative contracts held by US commercial banks at the end of 1999. The notional value of these swaps totaled almost $25 trillion; 2-3% of that ($500 billion to $750 billion) reflected the banks' true credit risk in these products. Monetary economists have no idea whether notional values are part of the money supply and with what discount ratio. As we now know from experience, creative accounting has legally and illegally transformed debt proceeds as revenue.
The 2005 OCC report "Condition and Performance of Commercial Banks" shows that loan demand in the US grew at 11% in the first quarter of 2005 while core deposits grew at 7%, producing a 4-percentage-point gap. That meant that US banks' loan growth was not fully funded by deposits. The report identified possible risks as: cooling off in housing markets accompanying slower loan growth; past regional housing-price declines lingering; and credit-quality problems in housing spilling over to other loan types. Not a comforting picture.
Derivatives of all kinds weigh heavily on banks' capital structures. But interest-rate swaps can be especially toxic when interest rates rise. And since only a few business economists predicted a jump in rates for the first half of the year when 1999 began while yields in fact rose 25%, these institutions found themselves on the wrong side of an interest-rate gamble by 2000. Moreover, as interest rates rose, US banks' income diminished from interest-rate-related businesses such as mortgage lending. Interest-sensitive sources of income were the revenue disappointment in 2000, as trading was in 1999. The banks' response was to lower credit requirement for loans to increase interest-rate spread.
On Greenspan's 18-year watch, assets of US government-sponsored enterprises (GSEs) ballooned 830%, from $346 billion to $2.872 trillion. GSEs are financing entities created by the US Congress to fund subsidized loans to certain groups of borrowers such as middle- and low-income homeowners, farmers and students. Agency mortgage-backed securities (MBSs) surged 670% to $3.55 trillion. Outstanding asset-backed securities (ABSs) exploded from $75 billion to more than $2.7 trillion.
Greenspan presided over the greatest expansion of speculative finance in history, including a trillion-dollar hedge-fund industry, bloated Wall Street-firm balance sheets approaching $2 trillion, a $3.3 trillion repo (repurchase agreement) market, and a global derivatives market with notional values surpassing an unfathomable $220 trillion. Granted, notional values are not true risk exposures. But a swing of 1% in interest rate on a notional value of $220 trillion is $2.2 trillion, about 20% of US gross domestic product.
This practice of borrowing short-term at low interest rates to lend long-term at higher interest rates, known as "carry trade" in bank parlance, when globalized by deregulated cross-border flow of funds eventually led to the Asian financial crisis of 1997, when interest-rate and exchange-rate volatility became the new paradigm. Today, there are undeniable signs that the same interest-rate risks have infested the US housing bubble in recent years. And the Fed's traditional gradualism, now revived as "measured pace" in raising the Fed Funds Rate targets in response to rapid asset-price inflation, has had little effect in curbing bank lending to fund rampant speculation.
In 2005, Greenspan repeatedly denied the existence of a national housing bubble by drawing on the conventional wisdom that the US housing market was highly disaggregated by location, which was true enough. Disaggregated markets are normally not exposed to contagion, a term given to the process of distressed deals dragging down healthy deals in the same market as speculator throw good money after bad to try to stem the tide of losses. But the bubble in the housing market was caused by creative housing finance made possible by the emergence of a deregulated global credit market through finance liberalization. The low cost of mortgages lifted all US house prices beyond levels sustainable by household income in otherwise disaggregated markets.
Under cross-border finance liberalization, negative wealth effects from asset-value correction are highly contagious. For example, the Dallas Fed Beige Book released on July 27, 2005, states: "Contacts say real-estate investment is extremely high in part because the district's competitively priced markets are attracting investment capital from more expensive coastal markets." The nationwide proliferation of no-income-verification, interest-only, zero-equity and cash-out loans, while making financial sense in a rising market, is fatally toxic in a falling market, which will hit a speculative boom as surely as the sun will set. Since the money financing this housing bubble is sourced globally, a bursting of the US housing bubble will have dire consequences globally.
Through mortgage-backed securitization, banks now are mere loan intermediaries that assume no long-term risk on the risky loans they make, which are sold as securitized debt of unbundled levels of risk to institutional investors with varying risk appetite commensurate with their varying need for higher returns. But who are institutional investors? They are mostly pension funds that manage the money the US working public depends on for retirement. In other words, the aggregate retirement assets of the working public are exposed to the risk of the same working public defaulting on their house mortgages.
When a homeowner loses his or her home through default of its mortgage, the homeowner will also lose his or her retirement nest egg invested in the securitized mortgage pool, while the banks stay technically solvent. That is the hidden network of linked financial landmines in a housing bubble financed by mortgage-backed securitization to which no one until recently has been paying attention. The bursting of the housing bubble will act as a detonator for a massive pension crisis.
On September 29, 2005, I wrote in The repo time bomb:
Commercial banks profit from using low-interest-rate repo proceeds to finance high-interest-rate "subprime" lending - credit cards, home equity loans, automobile loans etc - to borrowers of high credit risks at double-digit interest rates compounded monthly. To reduce their capital requirement, banks then remove their loans from their balance sheets by selling the CMOs (collateralized mortgage obligations) with unbundled risks to a wide range of investors seeking higher returns commensurate with higher risk. In another era, such high-risk/high-interest loan activities were known as loan-sharking. Yet Greenspan is on record as having said that systemic risk is a good tradeoff for unprecedented economic expansion.
Repos are now one of the largest and most active sectors in the US money market. More specifically, banks appear to be actively managing their inventories, to respond to changes in customer demand and the opportunity costs of holding cash, using innovative ways to bypass reserve requirements. Rising customer demand for new loans is fueled by and in turn drives further down falling credit standards and widens interest-rate spread in a vicious cycle of unrestrained credit expansion.
Again, on October 27, 2005, I wrote in How the US money market really works:
When asset prices rise, it reflects a change in the money supply/asset relationship, meaning more money chasing the same number of assets. Thus when asset prices rise, it is not necessarily a healthy sign for the economy. It reflects a troublesome condition in which additional money is not creating correspondingly more assets. It is a fundamental self-deception for economists to view asset-price appreciation as economic growth. A housing bubble is an example of this ...
Money now, especially virtual money, is created quite independently of Fed action, and money creation has become much less sensitive to interest-rate fluctuations. This explains why the measured pace at which the Fed has been raising the Fed funds rate target has little direct or immediate effect on the housing bubble.
On January 11, 2006, I wrote in Of debt, deflation and rotten apples:
In the US, where loan securitization is widespread, banks are tempted to push risky loans by passing on the long-term risk to non-bank investors through debt securitization. Credit-default swaps, a relatively novel form of derivative contract, allow investors to hedge against securitized mortgage pools. This type of contract, known as asset-back securities, has been limited to the corporate bond market, conventional home mortgages, and auto and credit-card loans. Last June [2005], a new standard contract began trading by hedge funds that bets on home-equity securities backed by adjustable-rate loans to subprime borrowers, not as a hedge strategy but as a profit center. When bearish trades are profitable, their bets can easily become self-fulfilling prophesies by kick-starting a downward vicious cycle.
Total outstanding home mortgages in the US in 1999 were $4.45 trillion, and by the end of 2004 this amount grew to $8.13 trillion, most of which was absorbed by refinancing of higher home prices at lower interest rates. When Greenspan took over at the Fed in 1987, total outstanding home mortgages in the US stood only at $1.82 trillion. On his 18-year watch, outstanding home mortgages quadrupled to $8.821 trillion by the end of third-quarter 2005. Much of this money has been printed by the Fed, exported through the trade deficit and re-imported as debt [in the capital account surplus]. Given that new housing units have been about 5% of the US housing stock per year, at the rate of about 2 million units per year, the housing stock increased by 100% over a period of 18 years while outstanding mortgages increased by more than 400%.
The Bank of Japan's zero-interest policy, combined with general asset deflation in the yen economy, has caught the Japanese insurance companies in a financial vise. Both new loan rates and asset values are insufficient to carry previous long-term yields promised to customers. Japan does not have a debtor-friendly bankruptcy law, as the US has. At any rate, insurance companies, like banks, cannot file for bankruptcy in the US. As a regulated sector, insurance companies are governed by an insurance commission in each state, which normally has a reinsurance fund to take care of unit insolvency. The funds are nowhere near sufficient to handle systemic collapse. The same happened to the US Federal Deposit Insurance Corp in the 1980s.
The insurance sector in the US will face serious problems as the Federal Reserve again lowers the Fed Funds Rate targets and keeps them near zero for extended periods. Several segments of the insurance sector, such as health insurance and casualty insurance, are already in distress for other reasons. Government-insured pension schemes are under pressure as troubled industrial giants such as General Motors default on their pension obligation, along with the airlines.
In the era of industrial capitalism, a low interest rate was a stimulant. But in this era of finance capitalism flirting fearlessly with debt, lowering rates creates complex problems, especially when most big borrowers routinely hedge their interest-rate exposures. For them, even when short-term rates drop or rise abruptly, the cost remains the same for the duration of the loan term, the only difference being that they pay a different party. While debtors remain solvent, investors in securitized loans go under. Credit derivatives have been the hot source of profit for most finance companies and will be the weapon of massive destruction for the financial system, as Warren Buffet warned.
Again on February 16, 2006, I wrote in The global money and currency markets:
In the United States, when house prices have generally tripled in less than a decade, it is evidence that the value of the dollar has declined by a factor of three in the same time period. Consumer prices have not risen by the same amount because of outsourcing of manufacturing to low-wage economies overseas which also acts as a depressant on domestic wages. Imbalance in the economy appears if wages and earnings have not risen proportional to prices.
A homeowner whose house has increased 300% in market price while his income has risen only 30% has not become richer. He has become a victim of uneven inflation. He may enjoy a one-time joyride with cash-out financing with a new mortgage, but his income cannot sustain the new mortgage payments if interest rates rise, and he will lose his home. And interest rates will rise if his income increases, because that is how the Fed defines inflation. Thus when his income rises, the market price of his home will fall, giving him an incentive to walk away from a big mortgage in which he has little equity tie-up. This can become a systemic problem for the mortgage-backed security sector.
That, dear readers, is why the US subprime mortgage bust will spread and cause severe damage to the global finance system.
---------------------------------------------------
Henry C K Liu is chairman of a New York-based private investment group. His website is at www.henryckliu.com.
Years ago when the US debt bubble spread over to the housing sector, warnings from many quarters about the systemic danger of subprime mortgages were categorically dismissed by Wall Street cheerleaders as Chicken Little "sky is falling" hysteria. Even weeks before bad news on the housing finance sector was shaping up as a clear and present danger, adamant denial was still loud enough to drown out reason.
Both Federal Reserve chairman Ben Bernanke and Treasury Secretary Henry Paulson, two top officials in charge of US monetary policy, continue to provide obligatory assurance to the nervous public that the United States' economic fundamentals are sound in the face of a jittery market. Days before being delisted from the New York Stock Exchange, shares of the collapsed New Century, a distressed subprime mortgage lender, were recommended by a major Wall Street brokerage firm as a "buy". That firm is now under criminal and regulatory investigation.
On the pages of Asia Times Online over the past two years, I have tried to put forth the rationale for the inevitability of a US housing bubble burst, pointing out reasons that the resultant financial meltdown will be much more widespread and severe than has been generally acknowledged.
On September 14, 2005, I wrote in Greenspan, the Wizard of Bubbleland:
History has shown that the Fed, more often than not, has made wrong decisions based on faulty projection. Greenspan has been rightly criticized for letting a housing price "bubble" develop, equating it to the one that swept technology stocks to stratospheric levels before bursting in 2000. Greenspan argues the Fed's role is to mop up after bubbles burst, since bubbles are hard to spot and deflate safely. But accidents are also difficult to predict, and that difficulty is not a good argument against buying insurance. There is no doubt that there is a price to be paid for every policy action. But the price of prematurely slowing down a debt bubble is infinitely lower than letting the bubble build until it bursts uncontrollably. In finance as in medicine, prevention is preferable to even the best cure. All market participants know pigs lose money. And a monetary pig loses control of the economy.
Alan Greenspan, then Fed chairman, notwithstanding his denial of responsibility in helping through the 1990s to unleash the equity bubble, had this to say in 2004 in hindsight after the bubble burst in 2000: "Instead of trying to contain a putative bubble by drastic actions with largely unpredictable consequences, we chose, as we noted in our mid-1999 congressional testimony, to focus on policies to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion."
By "the next expansion", Greenspan meant the next bubble, which manifested itself in housing. The mitigating policy was a massive injection of liquidity into the US banking system.
There is a structural reason that the housing bubble replaced the high-tech bubble. Houses cannot be imported like manufactured goods, although much of the content in houses, such as furniture, hardware, windows, kitchen equipment and bath fixtures, is manufactured overseas. Construction jobs cannot be outsourced overseas to take advantage of wage arbitrage. Instead, some non-skilled jobs are filled by low-wage illegal immigrants.
Total outstanding home mortgages in the US in 1999 were US$4.45 trillion, and by 2004 this amount had grown to $7.56 trillion, most of which was absorbed by refinancing of higher home prices at lower interest rates. When Greenspan took over at the Fed in 1987, total outstanding US home mortgages stood only at $1.82 trillion. On his watch, outstanding home mortgages quadrupled. Much of this money has been printed by the Fed, exported through the trade deficit and reimported as debt.
The most popular of all derivative products is the interest-rate swap, which in essence allows participants to make bets on the direction interest rates will take. According to the US Office of the Comptroller of the Currency (OCC), interest-rate swaps accounted for three out of four derivative contracts held by US commercial banks at the end of 1999. The notional value of these swaps totaled almost $25 trillion; 2-3% of that ($500 billion to $750 billion) reflected the banks' true credit risk in these products. Monetary economists have no idea whether notional values are part of the money supply and with what discount ratio. As we now know from experience, creative accounting has legally and illegally transformed debt proceeds as revenue.
The 2005 OCC report "Condition and Performance of Commercial Banks" shows that loan demand in the US grew at 11% in the first quarter of 2005 while core deposits grew at 7%, producing a 4-percentage-point gap. That meant that US banks' loan growth was not fully funded by deposits. The report identified possible risks as: cooling off in housing markets accompanying slower loan growth; past regional housing-price declines lingering; and credit-quality problems in housing spilling over to other loan types. Not a comforting picture.
Derivatives of all kinds weigh heavily on banks' capital structures. But interest-rate swaps can be especially toxic when interest rates rise. And since only a few business economists predicted a jump in rates for the first half of the year when 1999 began while yields in fact rose 25%, these institutions found themselves on the wrong side of an interest-rate gamble by 2000. Moreover, as interest rates rose, US banks' income diminished from interest-rate-related businesses such as mortgage lending. Interest-sensitive sources of income were the revenue disappointment in 2000, as trading was in 1999. The banks' response was to lower credit requirement for loans to increase interest-rate spread.
On Greenspan's 18-year watch, assets of US government-sponsored enterprises (GSEs) ballooned 830%, from $346 billion to $2.872 trillion. GSEs are financing entities created by the US Congress to fund subsidized loans to certain groups of borrowers such as middle- and low-income homeowners, farmers and students. Agency mortgage-backed securities (MBSs) surged 670% to $3.55 trillion. Outstanding asset-backed securities (ABSs) exploded from $75 billion to more than $2.7 trillion.
Greenspan presided over the greatest expansion of speculative finance in history, including a trillion-dollar hedge-fund industry, bloated Wall Street-firm balance sheets approaching $2 trillion, a $3.3 trillion repo (repurchase agreement) market, and a global derivatives market with notional values surpassing an unfathomable $220 trillion. Granted, notional values are not true risk exposures. But a swing of 1% in interest rate on a notional value of $220 trillion is $2.2 trillion, about 20% of US gross domestic product.
This practice of borrowing short-term at low interest rates to lend long-term at higher interest rates, known as "carry trade" in bank parlance, when globalized by deregulated cross-border flow of funds eventually led to the Asian financial crisis of 1997, when interest-rate and exchange-rate volatility became the new paradigm. Today, there are undeniable signs that the same interest-rate risks have infested the US housing bubble in recent years. And the Fed's traditional gradualism, now revived as "measured pace" in raising the Fed Funds Rate targets in response to rapid asset-price inflation, has had little effect in curbing bank lending to fund rampant speculation.
In 2005, Greenspan repeatedly denied the existence of a national housing bubble by drawing on the conventional wisdom that the US housing market was highly disaggregated by location, which was true enough. Disaggregated markets are normally not exposed to contagion, a term given to the process of distressed deals dragging down healthy deals in the same market as speculator throw good money after bad to try to stem the tide of losses. But the bubble in the housing market was caused by creative housing finance made possible by the emergence of a deregulated global credit market through finance liberalization. The low cost of mortgages lifted all US house prices beyond levels sustainable by household income in otherwise disaggregated markets.
Under cross-border finance liberalization, negative wealth effects from asset-value correction are highly contagious. For example, the Dallas Fed Beige Book released on July 27, 2005, states: "Contacts say real-estate investment is extremely high in part because the district's competitively priced markets are attracting investment capital from more expensive coastal markets." The nationwide proliferation of no-income-verification, interest-only, zero-equity and cash-out loans, while making financial sense in a rising market, is fatally toxic in a falling market, which will hit a speculative boom as surely as the sun will set. Since the money financing this housing bubble is sourced globally, a bursting of the US housing bubble will have dire consequences globally.
Through mortgage-backed securitization, banks now are mere loan intermediaries that assume no long-term risk on the risky loans they make, which are sold as securitized debt of unbundled levels of risk to institutional investors with varying risk appetite commensurate with their varying need for higher returns. But who are institutional investors? They are mostly pension funds that manage the money the US working public depends on for retirement. In other words, the aggregate retirement assets of the working public are exposed to the risk of the same working public defaulting on their house mortgages.
When a homeowner loses his or her home through default of its mortgage, the homeowner will also lose his or her retirement nest egg invested in the securitized mortgage pool, while the banks stay technically solvent. That is the hidden network of linked financial landmines in a housing bubble financed by mortgage-backed securitization to which no one until recently has been paying attention. The bursting of the housing bubble will act as a detonator for a massive pension crisis.
On September 29, 2005, I wrote in The repo time bomb:
Commercial banks profit from using low-interest-rate repo proceeds to finance high-interest-rate "subprime" lending - credit cards, home equity loans, automobile loans etc - to borrowers of high credit risks at double-digit interest rates compounded monthly. To reduce their capital requirement, banks then remove their loans from their balance sheets by selling the CMOs (collateralized mortgage obligations) with unbundled risks to a wide range of investors seeking higher returns commensurate with higher risk. In another era, such high-risk/high-interest loan activities were known as loan-sharking. Yet Greenspan is on record as having said that systemic risk is a good tradeoff for unprecedented economic expansion.
Repos are now one of the largest and most active sectors in the US money market. More specifically, banks appear to be actively managing their inventories, to respond to changes in customer demand and the opportunity costs of holding cash, using innovative ways to bypass reserve requirements. Rising customer demand for new loans is fueled by and in turn drives further down falling credit standards and widens interest-rate spread in a vicious cycle of unrestrained credit expansion.
Again, on October 27, 2005, I wrote in How the US money market really works:
When asset prices rise, it reflects a change in the money supply/asset relationship, meaning more money chasing the same number of assets. Thus when asset prices rise, it is not necessarily a healthy sign for the economy. It reflects a troublesome condition in which additional money is not creating correspondingly more assets. It is a fundamental self-deception for economists to view asset-price appreciation as economic growth. A housing bubble is an example of this ...
Money now, especially virtual money, is created quite independently of Fed action, and money creation has become much less sensitive to interest-rate fluctuations. This explains why the measured pace at which the Fed has been raising the Fed funds rate target has little direct or immediate effect on the housing bubble.
On January 11, 2006, I wrote in Of debt, deflation and rotten apples:
In the US, where loan securitization is widespread, banks are tempted to push risky loans by passing on the long-term risk to non-bank investors through debt securitization. Credit-default swaps, a relatively novel form of derivative contract, allow investors to hedge against securitized mortgage pools. This type of contract, known as asset-back securities, has been limited to the corporate bond market, conventional home mortgages, and auto and credit-card loans. Last June [2005], a new standard contract began trading by hedge funds that bets on home-equity securities backed by adjustable-rate loans to subprime borrowers, not as a hedge strategy but as a profit center. When bearish trades are profitable, their bets can easily become self-fulfilling prophesies by kick-starting a downward vicious cycle.
Total outstanding home mortgages in the US in 1999 were $4.45 trillion, and by the end of 2004 this amount grew to $8.13 trillion, most of which was absorbed by refinancing of higher home prices at lower interest rates. When Greenspan took over at the Fed in 1987, total outstanding home mortgages in the US stood only at $1.82 trillion. On his 18-year watch, outstanding home mortgages quadrupled to $8.821 trillion by the end of third-quarter 2005. Much of this money has been printed by the Fed, exported through the trade deficit and re-imported as debt [in the capital account surplus]. Given that new housing units have been about 5% of the US housing stock per year, at the rate of about 2 million units per year, the housing stock increased by 100% over a period of 18 years while outstanding mortgages increased by more than 400%.
The Bank of Japan's zero-interest policy, combined with general asset deflation in the yen economy, has caught the Japanese insurance companies in a financial vise. Both new loan rates and asset values are insufficient to carry previous long-term yields promised to customers. Japan does not have a debtor-friendly bankruptcy law, as the US has. At any rate, insurance companies, like banks, cannot file for bankruptcy in the US. As a regulated sector, insurance companies are governed by an insurance commission in each state, which normally has a reinsurance fund to take care of unit insolvency. The funds are nowhere near sufficient to handle systemic collapse. The same happened to the US Federal Deposit Insurance Corp in the 1980s.
The insurance sector in the US will face serious problems as the Federal Reserve again lowers the Fed Funds Rate targets and keeps them near zero for extended periods. Several segments of the insurance sector, such as health insurance and casualty insurance, are already in distress for other reasons. Government-insured pension schemes are under pressure as troubled industrial giants such as General Motors default on their pension obligation, along with the airlines.
In the era of industrial capitalism, a low interest rate was a stimulant. But in this era of finance capitalism flirting fearlessly with debt, lowering rates creates complex problems, especially when most big borrowers routinely hedge their interest-rate exposures. For them, even when short-term rates drop or rise abruptly, the cost remains the same for the duration of the loan term, the only difference being that they pay a different party. While debtors remain solvent, investors in securitized loans go under. Credit derivatives have been the hot source of profit for most finance companies and will be the weapon of massive destruction for the financial system, as Warren Buffet warned.
Again on February 16, 2006, I wrote in The global money and currency markets:
In the United States, when house prices have generally tripled in less than a decade, it is evidence that the value of the dollar has declined by a factor of three in the same time period. Consumer prices have not risen by the same amount because of outsourcing of manufacturing to low-wage economies overseas which also acts as a depressant on domestic wages. Imbalance in the economy appears if wages and earnings have not risen proportional to prices.
A homeowner whose house has increased 300% in market price while his income has risen only 30% has not become richer. He has become a victim of uneven inflation. He may enjoy a one-time joyride with cash-out financing with a new mortgage, but his income cannot sustain the new mortgage payments if interest rates rise, and he will lose his home. And interest rates will rise if his income increases, because that is how the Fed defines inflation. Thus when his income rises, the market price of his home will fall, giving him an incentive to walk away from a big mortgage in which he has little equity tie-up. This can become a systemic problem for the mortgage-backed security sector.
That, dear readers, is why the US subprime mortgage bust will spread and cause severe damage to the global finance system.
---------------------------------------------------
Henry C K Liu is chairman of a New York-based private investment group. His website is at www.henryckliu.com.
16 March 2007
A sea-change in risk perception
RISKY BUSINESS
A sea-change in risk perception
By Jephraim P Gundzik
Overly loose monetary policy in the US and Japan has masked rising global investment risk. This tidal wave of cheap dollars and yen encouraged investors to ignore age-old risks associated with soaring credit growth.
Plunging stock markets around the world and dollar depreciation indicate that risk perceptions are changing dramatically. This change in risk perception will produce a prolonged and sharp correction in all of the world's stock markets. Growing risk aversion will push US Treasury yields lower, triggering dollar devaluation and soaring precious-metals prices in the months ahead.
Blame the Fed and the BOJ
In an attempt to deflect imported deflation from Japan, the US Federal Reserve under Alan Greenspan began to loosen monetary policy in early 2001. After the terrorist attacks on New York City and the Pentagon in September 2001, the Greenspan Fed pushed interest rates aggressively lower to support the US economy and financial system. Though the economy began to recover in 2002, the Fed maintained its aggressive easing through 2004, pushing US interest rates to a 50-year low.
The Fed reversed course in late 2004, but the very slow pace of monetary-policy tightening did little to weaken thriving mortgage-credit growth, which continued to bound higher in 2005. The combination of super-loose monetary policy and very gradual monetary-policy tightening encouraged mortgage lenders in the US greatly to loosen credit standards, triggering unprecedented growth in US real-estate values and home construction.
The booming housing market accelerated US economic growth, further obscuring investment risk associated with very rapid credit growth and sharply deteriorating credit standards.
The Bank of Japan (BOJ) followed the Fed's example throughout the early 2000s, leaving nominal interest rates at 0%. Monetary policy in Japan was further loosened after the BOJ implemented its quantitative easing policy, which flooded the financial system with cash in the hope of reviving domestic credit growth and private demand. Rapidly changing demographics in Japan muted the impact of the BOJ's free-money policy. This forced the BOJ to prolong this policy, which remains largely in place.
Though the BOJ had trouble boosting private demand at home, its free-money policy began to flow through the financial system, which became an intermediary for external yen borrowing. This external borrowing, more commonly known as the yen carry trade, lavished trillions of yen on foreign banks, brokers, insurance companies and investors who subsequently invested in much higher-yielding assets, especially in emerging-market countries.
The limitless supply of ultra-cheap yen from the BOJ greatly obscured investment risk not only in Japan but wherever the yen carry trade was used by investors to boost returns. Because the yen carry trade was employed in stock, bond and real-estate markets around the world, the BOJ in effect muted global investment risk, pushing asset values to massively overvalued levels relative to risk.
Risk exists after all
Though monetary policy in the US and Japan remains extremely loose, the sudden downdraft in global equity markets and dollar depreciation, which began early this month, indicate that risk perceptions have changed dramatically. This sudden shift was driven by unexpected weakness in the US economy - the product of the collapsing housing market, soaring real-estate foreclosures, and their very negative impact on the US financial system.
Investors around the world ignored excruciatingly obvious indications, which first appeared in early 2006, that the US housing market was rapidly weakening. Investors also failed to understand the negative implications this weakness held for global economic growth and asset values. While the Fed and the BOJ are to blame for obscuring investment risk, the perpetuation of this masquerade has been greatly abetted by the world's largest investment banks and brokerages.
These institutions, with their exceedingly optimistic global economic outlooks, also encouraged investors to ignore investment risk associated with super-fast credit growth. The time has come to pay the piper. Banks, brokerages and investors will pay a huge price over the next several months for ignoring rising investment risk over the past several years. Unlike the mid-2006 mild correction in global asset values and the dollar, the current correction promises to be exceedingly brutal.
The 2006 mini-correction was driven by fear that monetary policy in the US and Japan would tighten significantly. The Fed and the BOJ quickly allayed these fears by keeping monetary policy overly loose. This led to a rebound in asset values and dollar appreciation against the yen as investors redoubled their yen-carry-trade positions.
In contrast, the current correction is being driven by the closing gap between US economic reality and perceptions spun by banks and brokers promising a "Goldilocks" recovery. As the reality of rapidly slowing US economic growth and spreading problems in the financial system overtakes investors, the overvalued US equity market will continue its downward trek, falling another 20% at least. To be sure, the gathering US economic recession will force the Fed to loosen monetary policy further. However, this will do little to arrest the decline of the economy or the stock market.
Though interest rates will fall in the US, this will not immediately stimulate a resurgence in the housing market. Mortgage lenders and banks saddled with growing non-performing loan portfolios will continue to tighten credit standards, leaving many potential borrowers in the cold. At the same time, surging foreclosures will add to the housing supply, forcing home prices much lower. This loss of home equity combined with a credit drought will undercut private demand in the US, prompting a rise in unemployment and further weakness in private demand.
A 20% correction in US stocks will push stock markets around the world lower. However, emerging-market equity and bond prices are likely to plunge much more deeply. The yen carry trade has pushed hundreds of billions of dollars into emerging-market assets over the past two years, though investment risk in many countries has increased exponentially. Economic recession and falling interest rates in the US could prove to be the dollar's death knell, forcing sustained unwinding of the yen carry trade.
Dollar weakness will greatly benefit precious metals, especially gold, in 2007. Falling US interest rates will also benefit precious metals, particularly if rising commodity prices continue to push global inflation higher. The pendulum has begun to swing away from risk predilection toward risk aversion. Fasten your seatbelts, because this swing is gaining momentum.
----------------------------------------------
Jephraim P Gundzik is president of Condor Advisers. Condor Advisers provides investment risk analysis to individuals and institutions worldwide. Visit www.condoradvisers.com for more information.
A sea-change in risk perception
By Jephraim P Gundzik
Overly loose monetary policy in the US and Japan has masked rising global investment risk. This tidal wave of cheap dollars and yen encouraged investors to ignore age-old risks associated with soaring credit growth.
Plunging stock markets around the world and dollar depreciation indicate that risk perceptions are changing dramatically. This change in risk perception will produce a prolonged and sharp correction in all of the world's stock markets. Growing risk aversion will push US Treasury yields lower, triggering dollar devaluation and soaring precious-metals prices in the months ahead.
Blame the Fed and the BOJ
In an attempt to deflect imported deflation from Japan, the US Federal Reserve under Alan Greenspan began to loosen monetary policy in early 2001. After the terrorist attacks on New York City and the Pentagon in September 2001, the Greenspan Fed pushed interest rates aggressively lower to support the US economy and financial system. Though the economy began to recover in 2002, the Fed maintained its aggressive easing through 2004, pushing US interest rates to a 50-year low.
The Fed reversed course in late 2004, but the very slow pace of monetary-policy tightening did little to weaken thriving mortgage-credit growth, which continued to bound higher in 2005. The combination of super-loose monetary policy and very gradual monetary-policy tightening encouraged mortgage lenders in the US greatly to loosen credit standards, triggering unprecedented growth in US real-estate values and home construction.
The booming housing market accelerated US economic growth, further obscuring investment risk associated with very rapid credit growth and sharply deteriorating credit standards.
The Bank of Japan (BOJ) followed the Fed's example throughout the early 2000s, leaving nominal interest rates at 0%. Monetary policy in Japan was further loosened after the BOJ implemented its quantitative easing policy, which flooded the financial system with cash in the hope of reviving domestic credit growth and private demand. Rapidly changing demographics in Japan muted the impact of the BOJ's free-money policy. This forced the BOJ to prolong this policy, which remains largely in place.
Though the BOJ had trouble boosting private demand at home, its free-money policy began to flow through the financial system, which became an intermediary for external yen borrowing. This external borrowing, more commonly known as the yen carry trade, lavished trillions of yen on foreign banks, brokers, insurance companies and investors who subsequently invested in much higher-yielding assets, especially in emerging-market countries.
The limitless supply of ultra-cheap yen from the BOJ greatly obscured investment risk not only in Japan but wherever the yen carry trade was used by investors to boost returns. Because the yen carry trade was employed in stock, bond and real-estate markets around the world, the BOJ in effect muted global investment risk, pushing asset values to massively overvalued levels relative to risk.
Risk exists after all
Though monetary policy in the US and Japan remains extremely loose, the sudden downdraft in global equity markets and dollar depreciation, which began early this month, indicate that risk perceptions have changed dramatically. This sudden shift was driven by unexpected weakness in the US economy - the product of the collapsing housing market, soaring real-estate foreclosures, and their very negative impact on the US financial system.
Investors around the world ignored excruciatingly obvious indications, which first appeared in early 2006, that the US housing market was rapidly weakening. Investors also failed to understand the negative implications this weakness held for global economic growth and asset values. While the Fed and the BOJ are to blame for obscuring investment risk, the perpetuation of this masquerade has been greatly abetted by the world's largest investment banks and brokerages.
These institutions, with their exceedingly optimistic global economic outlooks, also encouraged investors to ignore investment risk associated with super-fast credit growth. The time has come to pay the piper. Banks, brokerages and investors will pay a huge price over the next several months for ignoring rising investment risk over the past several years. Unlike the mid-2006 mild correction in global asset values and the dollar, the current correction promises to be exceedingly brutal.
The 2006 mini-correction was driven by fear that monetary policy in the US and Japan would tighten significantly. The Fed and the BOJ quickly allayed these fears by keeping monetary policy overly loose. This led to a rebound in asset values and dollar appreciation against the yen as investors redoubled their yen-carry-trade positions.
In contrast, the current correction is being driven by the closing gap between US economic reality and perceptions spun by banks and brokers promising a "Goldilocks" recovery. As the reality of rapidly slowing US economic growth and spreading problems in the financial system overtakes investors, the overvalued US equity market will continue its downward trek, falling another 20% at least. To be sure, the gathering US economic recession will force the Fed to loosen monetary policy further. However, this will do little to arrest the decline of the economy or the stock market.
Though interest rates will fall in the US, this will not immediately stimulate a resurgence in the housing market. Mortgage lenders and banks saddled with growing non-performing loan portfolios will continue to tighten credit standards, leaving many potential borrowers in the cold. At the same time, surging foreclosures will add to the housing supply, forcing home prices much lower. This loss of home equity combined with a credit drought will undercut private demand in the US, prompting a rise in unemployment and further weakness in private demand.
A 20% correction in US stocks will push stock markets around the world lower. However, emerging-market equity and bond prices are likely to plunge much more deeply. The yen carry trade has pushed hundreds of billions of dollars into emerging-market assets over the past two years, though investment risk in many countries has increased exponentially. Economic recession and falling interest rates in the US could prove to be the dollar's death knell, forcing sustained unwinding of the yen carry trade.
Dollar weakness will greatly benefit precious metals, especially gold, in 2007. Falling US interest rates will also benefit precious metals, particularly if rising commodity prices continue to push global inflation higher. The pendulum has begun to swing away from risk predilection toward risk aversion. Fasten your seatbelts, because this swing is gaining momentum.
----------------------------------------------
Jephraim P Gundzik is president of Condor Advisers. Condor Advisers provides investment risk analysis to individuals and institutions worldwide. Visit www.condoradvisers.com for more information.
15 March 2007
Top investor sees U.S. property crash
MOSCOW (Reuters) - Commodities investment guru Jim Rogers stepped into the U.S. subprime fray on Wednesday, predicting a real estate crash that would trigger defaults and spread contagion to emerging markets.
"You can't believe how bad it's going to get before it gets any better," the prominent U.S. fund manager told Reuters by telephone from New York.
"It's going to be a disaster for many people who don't have a clue about what happens when a real estate bubble pops.
"It is going to be a huge mess," said Rogers, who has put his $15 million belle epoque mansion on Manhattan's Upper West Side on the market and is planning to move to Asia.
Worries about losses in the U.S. mortgage market have sent stock prices falling in Asia and Europe, with shares in financial services companies falling the most.
Some investors fear the problems of lenders who make subprime loans to people with weak credit histories are spreading to mainstream financial firms and will worsen the U.S. housing slowdown.
"Real estate prices will go down 40-50 percent in bubble areas. There will be massive defaults. This time it'll be worse because we haven't had this kind of speculative buying in U.S. history," Rogers said.
"When markets turn from bubble to reality, a lot of people get burned."
The fund manager, who co-founded the Quantum Fund with billionaire investor George Soros in the 1970s and has focused on commodities since 1998, said the crisis would spread to emerging markets which he said now faced a prolonged bear run.
"When you have a financial crisis, it reverberates in other financial markets, especially in those with speculative excess," he said.
"Right now, there is huge speculative excess in emerging markets around the world. There will be a lot of money coming out of emerging markets.
"I've sold out of emerging markets except for China," said Rogers, long a prominent China bull.
Even in China, the world's fastest expanding economy, Rogers said stocks were overvalued and could go down 30-40 percent.
But he added: "China is one of the few countries in the world where I'm willing to sit out a 30-40 percent decline."
The last stock market bubble to burst was the dot-com craze which sparked a crash from March 2000 to October 2002.
When the last bubble burst in Japan, said Rogers, stock prices went down 85 percent despite the country's high savings rate and huge balance of payment surplus.
"This is the end of the liquidity party," said Rogers. "Some emerging markets will go down 80 percent, some will go down 50 percent. Some will most probably collapse."
"You can't believe how bad it's going to get before it gets any better," the prominent U.S. fund manager told Reuters by telephone from New York.
"It's going to be a disaster for many people who don't have a clue about what happens when a real estate bubble pops.
"It is going to be a huge mess," said Rogers, who has put his $15 million belle epoque mansion on Manhattan's Upper West Side on the market and is planning to move to Asia.
Worries about losses in the U.S. mortgage market have sent stock prices falling in Asia and Europe, with shares in financial services companies falling the most.
Some investors fear the problems of lenders who make subprime loans to people with weak credit histories are spreading to mainstream financial firms and will worsen the U.S. housing slowdown.
"Real estate prices will go down 40-50 percent in bubble areas. There will be massive defaults. This time it'll be worse because we haven't had this kind of speculative buying in U.S. history," Rogers said.
"When markets turn from bubble to reality, a lot of people get burned."
The fund manager, who co-founded the Quantum Fund with billionaire investor George Soros in the 1970s and has focused on commodities since 1998, said the crisis would spread to emerging markets which he said now faced a prolonged bear run.
"When you have a financial crisis, it reverberates in other financial markets, especially in those with speculative excess," he said.
"Right now, there is huge speculative excess in emerging markets around the world. There will be a lot of money coming out of emerging markets.
"I've sold out of emerging markets except for China," said Rogers, long a prominent China bull.
Even in China, the world's fastest expanding economy, Rogers said stocks were overvalued and could go down 30-40 percent.
But he added: "China is one of the few countries in the world where I'm willing to sit out a 30-40 percent decline."
The last stock market bubble to burst was the dot-com craze which sparked a crash from March 2000 to October 2002.
When the last bubble burst in Japan, said Rogers, stock prices went down 85 percent despite the country's high savings rate and huge balance of payment surplus.
"This is the end of the liquidity party," said Rogers. "Some emerging markets will go down 80 percent, some will go down 50 percent. Some will most probably collapse."
14 March 2007
Leaving Iraq: The Grim Truth
Rolling Stone : Leaving Iraq: The Grim Truth: "The war in Iraq isn't over yet, but -- surge or no surge -- the United States has already lost. That's the grim consensus of a panel of experts assembled by Rolling Stone to assess the future of Iraq. 'Even if we had a million men to go in, it's too late now,' says retired four-star Gen. Tony McPeak, who served on the Joint Chiefs of Staff during the Gulf War. 'Humpty Dumpty can't be put back together again.'
Those on the panel -- including diplomats, counterterror analysts and a former top military commander -- agree that President Bush's attempt to secure Baghdad will only succeed in dragging out the conflict, creating something far beyond any Vietnam-style 'quagmire.' The surge won't bring an end to the sectarian cleansing that has ravaged Iraq, as the newly empowered Shiite majority seeks to settle scores built up during centuries of oppressive rule by the Sunni minority. It will do nothing to defuse the powder keg that an independence-minded Kurdistan, in Iraq's northern provinces, poses to the governments of Turkey, Syria and Iran, which have long brutalized their own Kurdish separatists. And it will only worsen the global war on terror."
Those on the panel -- including diplomats, counterterror analysts and a former top military commander -- agree that President Bush's attempt to secure Baghdad will only succeed in dragging out the conflict, creating something far beyond any Vietnam-style 'quagmire.' The surge won't bring an end to the sectarian cleansing that has ravaged Iraq, as the newly empowered Shiite majority seeks to settle scores built up during centuries of oppressive rule by the Sunni minority. It will do nothing to defuse the powder keg that an independence-minded Kurdistan, in Iraq's northern provinces, poses to the governments of Turkey, Syria and Iran, which have long brutalized their own Kurdish separatists. And it will only worsen the global war on terror."
The Minsky Moment: They Can Run, But They Can’t Hide
The collapse of New Century this week illustrates in spades the end game of Ponzi finance. All the incentives for Ponzi business models are front loaded, that being collecting fees and commissions for silly season and often fraudulent transactions. Once the string has been run, the loots from these transactions are stuffed into the criminal rat lines, and the game of musical chairs begins.
It is at this twisting in the wind “break point” that the hyperreality crowd gets the “surprise”, that makes their denial no longer an illusionary asset, but a liability. There is then a mad scramble to determine who becomes the final bagholders of the Ponzi scam. That’s when a term that will without doubt become increasingly familiar enters the lexicon, the “margin call”. Margin calls pull the plug on Ponzi finance “liquidity”.
New Century said in a securities filing yesterday that all its lenders had frozen their credit lines and were demanding that it buy back $8.4 billion in loans that it issued using the money it borrowed from the banks — money New Century says it does not have.
Of course all the players will pretend and proclaim that it will be somebody else who will end up holding these Old Maid Cards, or guarantee their loss claims. They will also pretend that this drama will be drawn out, and that they can head for the exits in an orderly fashion. In reality though historic Minsky moments of this magnitude unfold quite rapidly. In fact, last night we were greeted with yet another budding implosion, this time an outfit with the hyperreal motherhood and apple pie name Accredited Home Lenders.
What continues to be remarkable about these turkey shoot setups is how the shares stay levitated right up to the very end. Incredibly, even on the eve of their collapses these firms are fully supported by Wall Street dead fish with “buy recommendations”. Despite the overwhelming evidence that Toto has pulled the curtain on the magnificent Wizard of Oz, these firms still are treated as credible institutions? A thinking person has to wonder at what point the marks tire of “surprises” and the commentary from shills, thus accelerating the Minsky moment.
link
It is at this twisting in the wind “break point” that the hyperreality crowd gets the “surprise”, that makes their denial no longer an illusionary asset, but a liability. There is then a mad scramble to determine who becomes the final bagholders of the Ponzi scam. That’s when a term that will without doubt become increasingly familiar enters the lexicon, the “margin call”. Margin calls pull the plug on Ponzi finance “liquidity”.
New Century said in a securities filing yesterday that all its lenders had frozen their credit lines and were demanding that it buy back $8.4 billion in loans that it issued using the money it borrowed from the banks — money New Century says it does not have.
Of course all the players will pretend and proclaim that it will be somebody else who will end up holding these Old Maid Cards, or guarantee their loss claims. They will also pretend that this drama will be drawn out, and that they can head for the exits in an orderly fashion. In reality though historic Minsky moments of this magnitude unfold quite rapidly. In fact, last night we were greeted with yet another budding implosion, this time an outfit with the hyperreal motherhood and apple pie name Accredited Home Lenders.
What continues to be remarkable about these turkey shoot setups is how the shares stay levitated right up to the very end. Incredibly, even on the eve of their collapses these firms are fully supported by Wall Street dead fish with “buy recommendations”. Despite the overwhelming evidence that Toto has pulled the curtain on the magnificent Wizard of Oz, these firms still are treated as credible institutions? A thinking person has to wonder at what point the marks tire of “surprises” and the commentary from shills, thus accelerating the Minsky moment.
link
12 March 2007
Peak Gold
St. LOUIS (ResourceInvestor.com) -- Yesterday, South Africa’s Chamber of Mines reported that gold output fell last year to 275 tonnes, down 8% from 2005. Some sources say South Africa’s decline in gold production is now becoming a global affair, as seen in leading gold producing countries.
According to stats from GoldSheets.com, U.S. gold output for last year declined from 262 tonnes to 260 tonnes. Australian production fell to 251 tonnes from 263 tonnes. Gold produced in Peru declined to 203 tonnes from 207 tonnes. Russian gold output dropped 4 tonnes in 2006 to152 tonnes, while Canada fell from 118 tonnes to 104 tonnes.
“Production in Australia, South Africa, Canada and Peru is expected to continue slumping in the next few years, probably stabilizing in 2010, but never reaching their peak levels from years past,” said Neal R. Ryan, Vice President and Director of Economic Research for Blanchard and Company, Inc. Peak Oil
According to stats from GoldSheets.com, U.S. gold output for last year declined from 262 tonnes to 260 tonnes. Australian production fell to 251 tonnes from 263 tonnes. Gold produced in Peru declined to 203 tonnes from 207 tonnes. Russian gold output dropped 4 tonnes in 2006 to152 tonnes, while Canada fell from 118 tonnes to 104 tonnes.
“Production in Australia, South Africa, Canada and Peru is expected to continue slumping in the next few years, probably stabilizing in 2010, but never reaching their peak levels from years past,” said Neal R. Ryan, Vice President and Director of Economic Research for Blanchard and Company, Inc. Peak Oil
6 March 2007
Profound Prediction from Priceton
May correction and early top in 2007 predicted in 1997. The 6.8 year international confidence cycle.
1 March 2007
(OT) Chaney in Afghanistan -- amusing and insightfull
The Swamp - Chicago Tribune - Blogs.: "One of the most peculiar artifices of the White House is the 'senior administration official.''
This is the official who provides all sorts of background information and insight into the White House's thinking on policies and practices for reporters, but refuses to permit his or her name to be cited.
Such as this 'senior administration official,'' who spoke with reporters about Vice President Dick Cheney's intentions with his visits to Pakistan and Afghanistan this week as the vice president was flying out of Kabul on a military transport jet, according to an official White House transcript released:"
This is the official who provides all sorts of background information and insight into the White House's thinking on policies and practices for reporters, but refuses to permit his or her name to be cited.
Such as this 'senior administration official,'' who spoke with reporters about Vice President Dick Cheney's intentions with his visits to Pakistan and Afghanistan this week as the vice president was flying out of Kabul on a military transport jet, according to an official White House transcript released:"
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