Frank Shostak
The Federal Reserve is trying a range of new tricks to push new forms of lending as a means of preventing what they fear may otherwise be a major collapse in financial markets. What all these strategies have in common is an unwillingness to come to terms with the reality that the crisis is based on real factors and can't be merely papered over without grave consequence to economic health.
Thus, last Tuesday (March 11), in response to the looming troubles with the Bear Stearns investment bank, the US central bank said that it would offer primary dealers up to $200 billion in Treasury securities for 28 days in exchange for triple A rated mortgage backed securities (MBS) as collateral. As the problems with Bear Stearns intensified and clients started to pull out cash the Fed announced that it was ready to do much more.
Last Sunday, March 16, the Fed announced it would provide direct loans to investment banks through the discount window for the first time since the Great Depression. The Fed has agreed to lend investment banks against a large variety of paper securities including a big chunk of difficult-to-trade securities.
This move by the Fed came in response to Bear Stearns's cash holdings dropping from $17 billion on March 11 to $2 billion on March 14.
The fact that Bear Stearns was rapidly losing cash posed a serious threat to the repo market. In this market, banks and securities firms extend and receive short-term loans that are backed by securities. Fed officials feared that Bear Stearns's dwindled cash situation posed a risk that it would not be able to honor its indebtedness. This in turn could undermine the confidence in the large $4.5 trillion repo market and further damage the credit market.
In the end, Fed officials orchestrated the selling of the Bear Stearns to JP Morgan Chase Co for $2 a share, or $236 million. Note that on December 20, 2007, Bear shares closed at $91.42. The main reason given for this deal was to prevent further uncertainty that was poised to destabilize financial markets.
Most commentators have endlessly praised the innovative methods that Bernanke and his colleagues are introducing to counter the financial crisis. Bernanke, who has written a lot about the causes of the Great Depression, is regarded as the ultimate expert on how to counter the current economic crisis. In short, most commentators are of the view that the man knows what he is doing and he will be able to fix the current financial problems.
Bernanke is of the view that by means of aggressive monetary policy the credit markets can be normalized. Once credit markets are brought back to normalcy, this will play an important role in preventing serious economic crisis. Remember Bernanke's financial accelerator model: a minor shock in the financial sector could result in large damage to the real economy.
In short, Bernanke, by means of his so-called "innovative" policy of fixing the symptoms of the disease, believes he can cure the disease.
What is the source of the disease and why are investment banks so heavily infected by it? The root of the problem is the Fed's very loose interest rate policy and strong monetary pumping from January 2001 to June 2004. The federal funds rate target was lowered from 6.5% to 1%. It is this that has given rise to various malinvestments, which we label here as bubble activities.
We define a bubble as the outcome of activities that have emerged on the back of loose monetary policy of the central bank. In the absence of monetary pumping, these activities would not have emerged. Since bubble activities are not self-funded, their emergence must come at the expense of various self-funded or productive activities. This means that less real saving is left for real wealth-generators, which in turn undermines real wealth formation. (Monetary pumping gives rise to misallocation of resources, which as a rule manifests itself through a relative increase in nonproductive activities against productive activities.)
When new money is created out of thin air, its effect is not felt instantaneously across all the market sectors. The effect moves from one individual to another individual and thus from one market to another market. Monetary pumping then generates bubble activities across all markets as time goes by.
As with any other business, participants in financial markets like investment banks are trying to "make money." It is this that gives rise to the creation of various products like collateralized debt obligations (CDO) and mortgage-backed securities (MBS) in order to secure as big a slice as possible of the pool of newly created money. (Financial entrepreneurs are basically trying to exploit opportunities created by the Fed's loose monetary stance and get as much as possible out of the expanded pool of money.)
As long as the Fed kept pushing money into the system to support the low interest rate target, various activities that sprang up on the back of the loose stance appeared to be for real. When money is plentiful and interest rates are extremely low, investment in various relatively high-yielding assets like CDO's and MBS's that masquerade as top-notch grade investment becomes very attractive. The prompt payment of interest and a very low rate of defaults further reinforce the attractiveness of financially engineered investment products. However, once the central bank tightens its monetary stance — i.e., reduces monetary pumping — this undermines various bubble activities.
The damage from the loose monetary policies of the Fed from January 2001 to June 2004 cannot be undone by trying to fix symptoms. Various activities or financial bubbles that sprang up on the back of loose monetary policies have weakened the bottom line of the economy. This fact cannot be undone by another dosage of policies that attempt to suppress the symptoms. If anything, such policies are likely only to weaken the bottom line further.
Remember that nonproductive activities are not self funded. Their existence is made possible by the diversion of real funding from wealth-generating activities. The diversion of real funding in turn was made possible by loose monetary policy. Hence the tightening in monetary stance from June 2004 to September 2007 is what is currently undermining various false activities.
Monetary policy manifests itself through the prices of various goods and assets. A price of a good is the number of dollars per unit of a good. When the growth momentum of money supply strengthens, this lifts the number of dollars paid per unit of a good generated by a particular activity — i.e., prices go up. Conversely a tighter monetary stance that slows the flow of money puts downward pressure on the prices of assets, or the prices of the goods of various activities.
A tighter monetary stance generates two things. It weakens the supply of real savings to nonproductive activities and weakens the flow of money to these activities. (Remember that real savings are diverted to bubble activities from wealth-generating activities by means of loose monetary policy.)
A diminished flow of real savings starts to undermine the existence of false activities and their solvency becomes questionable. A fall in the flow of money in turn puts downward pressure on the prices of goods of these activities. In fact, prices of goods that emanate from false activities have a tendency to fall sharply during the economic bust. This in turn reduces the flow of investors' money to these activities. As a result the prices of the stocks of bubble activities also tends to fall sharply, which puts more pressure on these activities. (With the value of their assets falling, misdirected investments can now only secure less funding from lenders.)
In contrast, wealth-generating activities that do not need an expansion of money for their existence actually start to gain strength. A fall in the prices of their goods is likely to be less severe than that seen in the prices of the goods of bubble activities. In fact their prices may not fall at all. Remember that wealth generators are engaged in the production of goods and services that are on the highest priority list of consumers. In contrast, bubble investments are engaged in the production of goods and services that are on the low priority list of consumers.
As consumers' real incomes fall because of the damaging effect from loose monetary policy, goods and services produced by various bubble investments may not feature at all on consumers' priority list.
We suspect that at the moment a tighter stance from June 2004 to September 2007 is dominating the current economic scene. So-called economic growth is always assessed in terms of GDP, which is the amount of money spent on final goods and services. The pace of monetary pumping sets the rate of growth of GDP. A stronger money rate of growth tends to be followed by a stronger GDP rate of growth, while a weakening in the money rate of growth is followed by a weakening in the growth momentum of GDP.
The engine of economic growth is not money, however, but real savings. If the pool of real saving is declining or stagnating, then the economy — also in terms of GDP — will follow suit, irrespective of what the Fed is doing.
How a particular sector responds to a tighter monetary stance depends on the extent to which that sector has been infected by bubble investments. The larger the percentage of bubble activities vis-à-vis all activities in a particular sector, the more severe the effect of a tighter stance. $10 $7
If the pool of real savings is still expanding, then it means that bubble investments in general do not dominate the economic scene. (They can still be dominant in a particular sector or sectors.) This means that commercial bank expansion of credit is not going to collapse and the growth momentum of money is likely to hold its ground.
However, if the pool of real savings is falling or stagnating, this could mean that bubble activities are dominating the scene, which in turn raises the likelihood that the commercial banks' expansion of credit will come to a halt. Obviously one can always argue that the Fed could open the money spigots in a big way and flood the economy with money. There is no doubt that the Fed could do it. This does not mean, however, that banks will embark on an expansion of credit if the pool of real savings is falling.
Obviously, then, if the pool of real saving is still healthy, Bernanke's policies might "work." In short, after a time lag, financial markets might start zooming ahead and the real economy will follow suit. We suggest that if this were to happen, the recovery shouldn't be attributed to Bernanke's policies but, rather, understood to have happened despite his policies.
In the alternative scenario, to which we assign a fairly high likelihood, the pool of real savings is actually falling or stagnating. In the framework of the alternative scenario, Bernanke's policies will only do further damage to the stock of savings and sound capital investment, and plunge the economy into a severe and prolonged crisis.
Frank Shostak is an adjunct scholar of the Mises Institute and a frequent contributor to Mises.org. He is chief economist of M.F. Global. Send him mail and see his outstanding Mises.org Daily Articles Archive. Comment on the blog.
21 March 2008
20 March 2008
The Collapse of American Power
By PAUL CRAIG ROBERTS
In his famous book, The Collapse of British Power (1972), Correlli Barnett reports that in the opening days of World War II Great Britain only had enough gold and foreign exchange to finance war expenditures for a few months. The British turned to the Americans to finance their ability to wage war. Barnett writes that this dependency signaled the end of British power.
From their inception, America's 21st century wars against Afghanistan and Iraq have been red ink wars financed by foreigners, principally the Chinese and Japanese, who purchase the US Treasury bonds that the US government issues to finance its red ink budgets.
The Bush administration forecasts a $410 billion federal budget deficit for this year, an indication that, as the US saving rate is approximately zero, the US is not only dependent on foreigners to finance its wars but also dependent on foreigners to finance part of the US government's domestic expenditures. Foreign borrowing is paying US government salaries--perhaps that of the President himself--or funding the expenditures of the various cabinet departments. Financially, the US is not an independent country.
The Bush administration's $410 billion deficit forecast is based on the unrealistic assumption of 2.7% GDP growth in 2008, whereas in actual fact the US economy has fallen into a recession that could be severe. There will be no 2.7% growth, and the actual deficit will be substantially larger than $410 billion.
Just as the government's budget is in disarray, so is the US dollar which continues to decline in value in relation to other currencies. The dollar is under pressure not only from budget deficits, but also from very large trade deficits and from inflation expectations resulting from the Federal Reserve's effort to stabilize the very troubled financial system with large injections of liquidity.
A troubled currency and financial system and large budget and trade deficits do not present an attractive face to creditors. Yet Washington in its hubris seems to believe that the US can forever rely on the Chinese, Japanese and Saudis to finance America's life beyond its means. Imagine the shock when the day arrives that a US Treasury auction of new debt instruments is not fully subscribed.
The US has squandered $500 billion dollars on a war that serves no American purpose. Moreover, the $500 billion is only the out-of-pocket costs. It does not include the replacement cost of the destroyed equipment, the future costs of care for veterans, the cost of the interests on the loans that have financed the war, or the lost US GDP from diverting scarce resources to war. Experts who are not part of the government's spin machine estimate the cost of the Iraq war to be as much as $3 trillion.
The Republican candidate for President said he would be content to continue the war for 100 years. With what resources? When America's creditors consider our behavior they see total fiscal irresponsibility. They see a deluded country that acts as if it is a privilege for foreigners to lend to it, and a deluded country that believes that foreigners will continue to accumulate US debt until the end of time.
The fact of the matter is that the US is bankrupt. David M. Walker, Comptroller General of the US and head of the Government Accountability Office, in his December 17, 2007, report to the US Congress on the financial statements of the US government noted that "the federal government did not maintain effective internal control over financial reporting (including safeguarding assets) and compliance with significant laws and regulations as of September 30, 2007." In everyday language, the US government cannot pass an audit.
Moreover, the GAO report pointed out that the accrued liabilities of the federal government "totaled approximately $53 trillion as of September 30, 2007." No funds have been set aside against this mind boggling liability.
Just so the reader understands, $53 trillion is $53,000 billion.
Frustrated by speaking to deaf ears, Walker recently resigned as head of the Government Accountability Office.
As of March 17, 2008, one Swiss franc is worth more than $1 dollar. In 1970, the exchange rate was 4.2 Swiss francs to the dollar. In 1970, $1 purchased 360 Japanese yen. Today $1 dollar purchases less than 100 yen.
If you were a creditor, would you want to hold debt in a currency that has such a poor record against the currency of a small island country that was nuked and defeated in WW II, or against a small landlocked European country that clings to its independence and is not a member of the EU?
Would you want to hold the debt of a country whose imports exceed its industrial production? According to the latest US statistics as reported in the February 28 issue of Manufacturing and Technology News, in 2007 imports were 14 percent of US GDP and US manufacturing comprised 12% of US GDP. A country whose imports exceed its industrial production cannot close its trade deficit by exporting more.
The dollar has even collapsed in value against the euro, the currency of a make-believe country that does not exist: the European Union. France, Germany, Italy, England and the other members of the EU still exist as sovereign nations. England even retains its own currency. Yet the euro hits new highs daily against the dollar.
Noam Chomsky recently wrote that America thinks that it owns the world. That is definitely the view of the neoconized Bush administration. But the fact of the matter is that the US owes the world. The US "superpower" cannot even finance its own domestic operations, much less its gratuitous wars except via the kindness of foreigners to lend it money that cannot be repaid.
The US will never repay the loans. The American economy has been devastated by offshoring, by foreign competition, and by the importation of foreigners on work visas, while it holds to a free trade ideology that benefits corporate fat cats and shareholders at the expense of American labor. The dollar is failing in its role as reserve currency and will soon be abandoned.
When the dollar ceases to be the reserve currency, the US will no longer be able to pay its bills by borrowing more from foreigners.
I sometimes wonder if the bankrupt "superpower" will be able to scrape together the resources to bring home the troops stationed in its hundreds of bases overseas, or whether they will just be abandoned.
Paul Craig Roberts was Assistant Secretary of the Treasury in the Reagan administration. He was Associate Editor of the Wall Street Journal editorial page and Contributing Editor of National Review. He is coauthor of The Tyranny of Good Intentions.He can be reached at: PaulCraigRoberts@yahoo.com
RE: I might add, for those who missed it
In his famous book, The Collapse of British Power (1972), Correlli Barnett reports that in the opening days of World War II Great Britain only had enough gold and foreign exchange to finance war expenditures for a few months. The British turned to the Americans to finance their ability to wage war. Barnett writes that this dependency signaled the end of British power.
From their inception, America's 21st century wars against Afghanistan and Iraq have been red ink wars financed by foreigners, principally the Chinese and Japanese, who purchase the US Treasury bonds that the US government issues to finance its red ink budgets.
The Bush administration forecasts a $410 billion federal budget deficit for this year, an indication that, as the US saving rate is approximately zero, the US is not only dependent on foreigners to finance its wars but also dependent on foreigners to finance part of the US government's domestic expenditures. Foreign borrowing is paying US government salaries--perhaps that of the President himself--or funding the expenditures of the various cabinet departments. Financially, the US is not an independent country.
The Bush administration's $410 billion deficit forecast is based on the unrealistic assumption of 2.7% GDP growth in 2008, whereas in actual fact the US economy has fallen into a recession that could be severe. There will be no 2.7% growth, and the actual deficit will be substantially larger than $410 billion.
Just as the government's budget is in disarray, so is the US dollar which continues to decline in value in relation to other currencies. The dollar is under pressure not only from budget deficits, but also from very large trade deficits and from inflation expectations resulting from the Federal Reserve's effort to stabilize the very troubled financial system with large injections of liquidity.
A troubled currency and financial system and large budget and trade deficits do not present an attractive face to creditors. Yet Washington in its hubris seems to believe that the US can forever rely on the Chinese, Japanese and Saudis to finance America's life beyond its means. Imagine the shock when the day arrives that a US Treasury auction of new debt instruments is not fully subscribed.
The US has squandered $500 billion dollars on a war that serves no American purpose. Moreover, the $500 billion is only the out-of-pocket costs. It does not include the replacement cost of the destroyed equipment, the future costs of care for veterans, the cost of the interests on the loans that have financed the war, or the lost US GDP from diverting scarce resources to war. Experts who are not part of the government's spin machine estimate the cost of the Iraq war to be as much as $3 trillion.
The Republican candidate for President said he would be content to continue the war for 100 years. With what resources? When America's creditors consider our behavior they see total fiscal irresponsibility. They see a deluded country that acts as if it is a privilege for foreigners to lend to it, and a deluded country that believes that foreigners will continue to accumulate US debt until the end of time.
The fact of the matter is that the US is bankrupt. David M. Walker, Comptroller General of the US and head of the Government Accountability Office, in his December 17, 2007, report to the US Congress on the financial statements of the US government noted that "the federal government did not maintain effective internal control over financial reporting (including safeguarding assets) and compliance with significant laws and regulations as of September 30, 2007." In everyday language, the US government cannot pass an audit.
Moreover, the GAO report pointed out that the accrued liabilities of the federal government "totaled approximately $53 trillion as of September 30, 2007." No funds have been set aside against this mind boggling liability.
Just so the reader understands, $53 trillion is $53,000 billion.
Frustrated by speaking to deaf ears, Walker recently resigned as head of the Government Accountability Office.
As of March 17, 2008, one Swiss franc is worth more than $1 dollar. In 1970, the exchange rate was 4.2 Swiss francs to the dollar. In 1970, $1 purchased 360 Japanese yen. Today $1 dollar purchases less than 100 yen.
If you were a creditor, would you want to hold debt in a currency that has such a poor record against the currency of a small island country that was nuked and defeated in WW II, or against a small landlocked European country that clings to its independence and is not a member of the EU?
Would you want to hold the debt of a country whose imports exceed its industrial production? According to the latest US statistics as reported in the February 28 issue of Manufacturing and Technology News, in 2007 imports were 14 percent of US GDP and US manufacturing comprised 12% of US GDP. A country whose imports exceed its industrial production cannot close its trade deficit by exporting more.
The dollar has even collapsed in value against the euro, the currency of a make-believe country that does not exist: the European Union. France, Germany, Italy, England and the other members of the EU still exist as sovereign nations. England even retains its own currency. Yet the euro hits new highs daily against the dollar.
Noam Chomsky recently wrote that America thinks that it owns the world. That is definitely the view of the neoconized Bush administration. But the fact of the matter is that the US owes the world. The US "superpower" cannot even finance its own domestic operations, much less its gratuitous wars except via the kindness of foreigners to lend it money that cannot be repaid.
The US will never repay the loans. The American economy has been devastated by offshoring, by foreign competition, and by the importation of foreigners on work visas, while it holds to a free trade ideology that benefits corporate fat cats and shareholders at the expense of American labor. The dollar is failing in its role as reserve currency and will soon be abandoned.
When the dollar ceases to be the reserve currency, the US will no longer be able to pay its bills by borrowing more from foreigners.
I sometimes wonder if the bankrupt "superpower" will be able to scrape together the resources to bring home the troops stationed in its hundreds of bases overseas, or whether they will just be abandoned.
Paul Craig Roberts was Assistant Secretary of the Treasury in the Reagan administration. He was Associate Editor of the Wall Street Journal editorial page and Contributing Editor of National Review. He is coauthor of The Tyranny of Good Intentions.He can be reached at: PaulCraigRoberts@yahoo.com
RE: I might add, for those who missed it
17 March 2008
America was conned - who will pay?
The South Sea Bubble ended in riots as trust was lost. Wall Street also duped the public
Larry Elliott, economics editor
Bear Stearns marks the moment when the global financial crisis went critical. Up until last Friday, it had been possible - just about - to believe that the worst was over and that things were about to get better. That pretence was stripped away when JP Morgan, at the behest of the Federal Reserve, stepped in when the hedge funds pulled the plug on the fifth-biggest US investment bank.
It is now clear that no end is in sight to the turmoil, and the reason for that is that the Fed and the US treasury are no closer to solving the underlying problem than they were eight months ago. The crisis will only end when house prices stop falling and banks stop racking up huge losses on their loans. Doing that, however, will require the US government to intervene directly in the real estate market to end the wave of foreclosures. Ideologically, it is ill-equipped to take that step and, as a result, property prices will fall and the financial meltdown will go on and on.
Ultimately, though, action will be taken because there will be political pressure for it. Indeed, it is somewhat surprising that there is not already rioting in the streets, given the gigantic fraud perpetrated by the financial elite at the expense of ordinary Americans.
The US has just had its weakest period of expansion since the 1950s. Consumption growth has been poor. Investment growth has been modest. Exports have been sluggish. But if you are at the top of the tree, the years since the last recession in 2001 has been a veritable golden age. Salaries for executives have rocketed and profits have soared, because the productivity gains from a growing economy have been disproportionately skewed towards capital.
Patriotic
For ordinary Americans, though, it has been a different story. Real wages have been growing slowly; at just 1.6% a year on average over the latest upswing, well down on the experience of earlier decades. Business, of course, needs consumers to carry on spending in order to make money, so a way had to be found to persuade households to do their patriotic duty. The method chosen was simple. Whip up a colossal housing bubble, convince consumers that it makes sense to borrow money against the rising value of their homes to supplement their meagre real wage growth and watch the profits roll in.
As they did - for a while. Now it's payback time and the mood could get very ugly. Americans, to put it bluntly, have been conned. They have been duped by a bunch of serpent-tongued hucksters who packed up the wagon and made it across the county line before a lynch mob could be formed.
The debate now is not about whether the US is in recession but how deep and long that recession will be. Super-bears have started to say that this is perhaps "The Big One", by which they mean the onset of a new Great Depression. The need to rescue Bear Stearns has done little to still those voices.
As the economics team at HSBC recently pointed out, there has been a "catastrophic breakdown" of trust, and when that has happened in the past - the US in the 1930s, Japan in the 1990s - chucking extra money at the banks in the hope that they will start lending again proves ineffective.
It's not hard to see why trust has become such a rare commodity: Wall Street at the height of the securitisation mania had, in effect, become London at the time of the South Sea Bubble crisis in 1720. Vast quantities of funny paper were changing hands even though those involved in the deals had no idea of their true worth. Nor did they care. Inevitably, now the bubble has burst and the huge Ponzi securitisation scam has been exposed, there has been a reaction. The securitisation market is dead, there is less money sloshing round the system, banks are hoarding their cash.
Having allowed the housing boom to rage out of control for too long and then delaying cuts in interest rates until the housing market was gripped by recessionary forces, the Fed is now trying to make up for lost time with a burst of hyperactivity. It will cut interest rates on Wednesday and keep cutting them: financial markets expect the Fed funds rate to be 1% by the summer, and they are probably right. In most downturns, easier monetary policy does the trick. Lower interest rates make it cheaper to borrow and also change the trade-off between saving and spending. This may not be the usual sort of downturn, however, with consumers going through a period of debt revulsion after the excesses of recent years, even so the consensus is that after two or three quarters of falling output, a slow and sluggish recovery will be under way.
Deflation
These hopes are likely to be dashed, unless there is intervention at home and internationally to tackle the crisis. Domestically, the priority should be to stop homes that have been foreclosed being auctioned on the open market, since by selling them at a 50% discount property prices are driven down. The US does not seem to have learned the lessons from Japan, which encouraged a fire sale of property in the 1990s and was sucked into a classic debt deflation trap as a result. Those who argue, with some force, that it would be counter-productive to intervene in the market because the US needs to work the rottenness out of its system must recognise that the cold turkey option will be very long and painful.
The second form of intervention should be to shore up the dollar, the collapse of which is worrying countries that rely heavily on exports and is the main reason for the surge in commodity prices. Co-ordinated intervention by the major central banks needs to be at the top of the agenda at next month's G7 meeting in Washington, and there could be action even sooner if the dollar continues to tank.
In the longer term, lessons must be learnt from the turmoil. One is that you don't solve the problems of a collapsing bubble by blowing up another, which is what Alan Greenspan did after the dotcom fiasco in 2001 - the most irresponsible behaviour of any central banker in living memory.
The second lesson is that there has to be far stricter regulation not just of the US real estate market but of Wall Street, to prevent the return of irresponsible lending as soon as the recovery is firmly under way. If this is, heaven help us, The Big One, one of the only consolations will be that the repugnance at the orgy of speculation that has sapped the strength of the US economy will put a new New Deal on the political agenda.
But for this to happen there has to be a political response and even though this year's presidential election will be held in the shadow of recession, there appears not to be a potential FDR among the contenders for the White House. Yet if this crisis really does get as bad as some are forecasting, the public will rightly demand more than a slap on the wrist for Wall Street.
Larry Elliott, economics editor
Bear Stearns marks the moment when the global financial crisis went critical. Up until last Friday, it had been possible - just about - to believe that the worst was over and that things were about to get better. That pretence was stripped away when JP Morgan, at the behest of the Federal Reserve, stepped in when the hedge funds pulled the plug on the fifth-biggest US investment bank.
It is now clear that no end is in sight to the turmoil, and the reason for that is that the Fed and the US treasury are no closer to solving the underlying problem than they were eight months ago. The crisis will only end when house prices stop falling and banks stop racking up huge losses on their loans. Doing that, however, will require the US government to intervene directly in the real estate market to end the wave of foreclosures. Ideologically, it is ill-equipped to take that step and, as a result, property prices will fall and the financial meltdown will go on and on.
Ultimately, though, action will be taken because there will be political pressure for it. Indeed, it is somewhat surprising that there is not already rioting in the streets, given the gigantic fraud perpetrated by the financial elite at the expense of ordinary Americans.
The US has just had its weakest period of expansion since the 1950s. Consumption growth has been poor. Investment growth has been modest. Exports have been sluggish. But if you are at the top of the tree, the years since the last recession in 2001 has been a veritable golden age. Salaries for executives have rocketed and profits have soared, because the productivity gains from a growing economy have been disproportionately skewed towards capital.
Patriotic
For ordinary Americans, though, it has been a different story. Real wages have been growing slowly; at just 1.6% a year on average over the latest upswing, well down on the experience of earlier decades. Business, of course, needs consumers to carry on spending in order to make money, so a way had to be found to persuade households to do their patriotic duty. The method chosen was simple. Whip up a colossal housing bubble, convince consumers that it makes sense to borrow money against the rising value of their homes to supplement their meagre real wage growth and watch the profits roll in.
As they did - for a while. Now it's payback time and the mood could get very ugly. Americans, to put it bluntly, have been conned. They have been duped by a bunch of serpent-tongued hucksters who packed up the wagon and made it across the county line before a lynch mob could be formed.
The debate now is not about whether the US is in recession but how deep and long that recession will be. Super-bears have started to say that this is perhaps "The Big One", by which they mean the onset of a new Great Depression. The need to rescue Bear Stearns has done little to still those voices.
As the economics team at HSBC recently pointed out, there has been a "catastrophic breakdown" of trust, and when that has happened in the past - the US in the 1930s, Japan in the 1990s - chucking extra money at the banks in the hope that they will start lending again proves ineffective.
It's not hard to see why trust has become such a rare commodity: Wall Street at the height of the securitisation mania had, in effect, become London at the time of the South Sea Bubble crisis in 1720. Vast quantities of funny paper were changing hands even though those involved in the deals had no idea of their true worth. Nor did they care. Inevitably, now the bubble has burst and the huge Ponzi securitisation scam has been exposed, there has been a reaction. The securitisation market is dead, there is less money sloshing round the system, banks are hoarding their cash.
Having allowed the housing boom to rage out of control for too long and then delaying cuts in interest rates until the housing market was gripped by recessionary forces, the Fed is now trying to make up for lost time with a burst of hyperactivity. It will cut interest rates on Wednesday and keep cutting them: financial markets expect the Fed funds rate to be 1% by the summer, and they are probably right. In most downturns, easier monetary policy does the trick. Lower interest rates make it cheaper to borrow and also change the trade-off between saving and spending. This may not be the usual sort of downturn, however, with consumers going through a period of debt revulsion after the excesses of recent years, even so the consensus is that after two or three quarters of falling output, a slow and sluggish recovery will be under way.
Deflation
These hopes are likely to be dashed, unless there is intervention at home and internationally to tackle the crisis. Domestically, the priority should be to stop homes that have been foreclosed being auctioned on the open market, since by selling them at a 50% discount property prices are driven down. The US does not seem to have learned the lessons from Japan, which encouraged a fire sale of property in the 1990s and was sucked into a classic debt deflation trap as a result. Those who argue, with some force, that it would be counter-productive to intervene in the market because the US needs to work the rottenness out of its system must recognise that the cold turkey option will be very long and painful.
The second form of intervention should be to shore up the dollar, the collapse of which is worrying countries that rely heavily on exports and is the main reason for the surge in commodity prices. Co-ordinated intervention by the major central banks needs to be at the top of the agenda at next month's G7 meeting in Washington, and there could be action even sooner if the dollar continues to tank.
In the longer term, lessons must be learnt from the turmoil. One is that you don't solve the problems of a collapsing bubble by blowing up another, which is what Alan Greenspan did after the dotcom fiasco in 2001 - the most irresponsible behaviour of any central banker in living memory.
The second lesson is that there has to be far stricter regulation not just of the US real estate market but of Wall Street, to prevent the return of irresponsible lending as soon as the recovery is firmly under way. If this is, heaven help us, The Big One, one of the only consolations will be that the repugnance at the orgy of speculation that has sapped the strength of the US economy will put a new New Deal on the political agenda.
But for this to happen there has to be a political response and even though this year's presidential election will be held in the shadow of recession, there appears not to be a potential FDR among the contenders for the White House. Yet if this crisis really does get as bad as some are forecasting, the public will rightly demand more than a slap on the wrist for Wall Street.
Global systemic crisis – End of 2008: Pension funds go off the rails
According to LEAP/E2020, by the end of 2008, a formidable debacle will affect pension funds all over the world, endangering the entire system of capital-based pensions. This financial calamity will bear a particularly dramatic human dimension because it will come at the precise moment when the first wave of baby-boomers phase out of the labour force in the US, EU and Japan: pension fund revenues are collapsing at the very moment when they should be making their first large series of payments to pensioners. In this 23rd edition of the GEAB, our team anticipates the evolution of the upcoming pension fund crisis, details which countries are the most exposed (in particular in Europe) and provides a number of operational and strategic recommendations to face the situation.
Meanwhile, in the present issue (on subscription), LEAP/E2020 anticipates what the global systemic crisis (now obvious to everyone) will bring along in the next few months, as regards in particular to the negative side effects of the US Federal Reserve's bank loans currently contributing to weaken even more the US financial system, and as regards also to bank exposure in the US and in the most exposed European countries. Simultaneously our team analyses the effect of today's US economic and financial crisis on the probability and consequences of an attack on Iran by Israel and the US before the next US presidential election.
In any event, with the announcement of an emergency plan to save the US 5th largest private bank, Bear Stearns (1) (preluding to its being sold or its failing in the coming weeks), it turned out that a large financial institution indeed went bankrupt in the first quarter of 2008, as anticipated by our team in GEAB N°19 (2).
Meanwhile, the US dollar resumed plummeting against Euro, Yen, Yuan; gold soared over 1,000 USD per ounce, oil reached 110 USD per barrel, global stock markets lost 20 percent in three months, and the Fed's most recent attempt to stop the financial crisis through a 200 billion USD bank loan plan has already proved to fail... the bases of the financial and economic order that prevailed in the last decades are collapsing under our eyes, at an increasing pace… all the signs of a systemic crisis are gathered (3).
The whole world is now aware that we are faced to a crisis of unprecedented scope and nature. This level of awareness enables our team to refine some of their anticipations. About currencies for instance, our team undertook to review their estimation of the value of the US dollar against the three other strategic currencies - Euro, Yen and Yuan. LEAP/E2020 now estimates that the EURUSD exchange rate will reach 1.75 at the end of 2008 (instead of the 1.70 estimation made in 2006); the USDYEN rate should fall down to 90 and the USDYUAN down to 6 (4).
US Dollar Index (benchmark currency basket (5)) on 03/14/2008 - Source FxStreet
Faced to the extent of the Very Great US Depression currently unfolding (6), LEAP/E2020 is glad that the US authorities took into consideration the numerous protests (7) and decided to maintain the publication of US economic indicators on the website EconomicIndicators.Gov. In such difficult times, it is important that statistical information on the US economy remains easily available to everyone. The money of a great number of private and public, individual and collective operators depends on this transparency.
In the same sense, the Federal Reserve of Atlanta distributes for free a DVD entitled « Crisis Preparedness: Reconnecting the Financial Lifeline » and designed to help operators of all kinds to anticipate a crisis and get prepared to it (8). In the perspective of a collapse of the real economy in the US (expected to happen in September 2008 according to LEAP/E2020's anticipations (9)), these official advices take a special meaning. For instance, like we have been repeating for months, the DVD keeps saying that in the event of a severe crisis « Cash becomes king », whether the crisis is linked to a natural disaster or a human-made one, as shown by the fact that US insurers have already lost more money because of the subprime crisis than because of the Katrina hurricane, though the worse natural disaster in the history of the US (10).
Non-Borrowed reserves of US depository institutions (1950 – 02/2008) - Source Federal reserve of Saint Louis
To finish with, graphics such as the one above illustrate in a striking manner that the situation is infinitely worse that what the cleverest leader (and they are not many) can imagine. It shows that the US financial system, and that of a large part of the world, is lethally hurt. US banks have no more money; it is as simple and dramatic as that. Contagion will now enter a second phase of development, generating a new series of bank failures by this summer, as anticipated in GEAB N°20, entailing a dislocation of the global financial system in the second semester of 2008.
---------
Notes:
(1) Source: Reuters, 03/14/2008
(2) In GEAB N°19 we said it would take place in February ; it is on March 14th that this first large US bank defaulted. We remind that from now on, according to our November 2007 anticipations, more US, EU and Asian banks will follow.
(3) As a matter of fact, this CNN/Money title is very lucid: « Issue N°1: America's money ». Source: CNN/Money. That is indeed what it is all about: the pure and simple evaporation of thousands of billions of US Dollars illusively accumulated all those years on the accounts of financial institutions, companies, individuals and governments, scattered all over the world. That is exactly the problem detected in the first GEABs at the beginning of 2006.
(4) LEAP/E2020 wishes to stress the fact that in the case of a combined US/Israel attack on Iran this year, our US dollar index estimations for the end of 2008 presented in GEAB N°23 would be even worse. About the rumours suggesting that a concerted action of the central banks will put a stop to the plummeting of the US currency, they do not have any basis: a similar action can no longer be implemented because central banks now have diverging interests due to the decoupling of the world's largest economic regions, as anticipated by LEAP/E2020 many months ago. The collapse of the US Dollar is the result of a US economy in recession and a related devaluation by 50 percent against the other big currencies.
(5) Dollar Index currencies: Euro, Yen, Canadian Dollar, British Pound, Swiss Franc and Swedish Crown. If the Chinese Yuan was added to this list, the US dollar index would fall even more dramatically.
(6) Some websites are even specialised on this subject, such as Depression2.TV whose sub-title is clear: « Surviving the second great depression ».
(7) Excerpt of the announcement posted in the website EconomicIndicators.gov : « ... ESA (Economics and Statistics Administration) initially planned to discontinue the service due to cost concerns but given the feedback ESA received, the decision has been made to continue the site and improve its functionality... ».
(8) Source: Banking Information, Federal Reserve Bank of Atlanta (to order the DVD, here is the direct link)
(9) See GEAB N°22
(9) Source: Bloomberg, 03/14/2008
Meanwhile, in the present issue (on subscription), LEAP/E2020 anticipates what the global systemic crisis (now obvious to everyone) will bring along in the next few months, as regards in particular to the negative side effects of the US Federal Reserve's bank loans currently contributing to weaken even more the US financial system, and as regards also to bank exposure in the US and in the most exposed European countries. Simultaneously our team analyses the effect of today's US economic and financial crisis on the probability and consequences of an attack on Iran by Israel and the US before the next US presidential election.
In any event, with the announcement of an emergency plan to save the US 5th largest private bank, Bear Stearns (1) (preluding to its being sold or its failing in the coming weeks), it turned out that a large financial institution indeed went bankrupt in the first quarter of 2008, as anticipated by our team in GEAB N°19 (2).
Meanwhile, the US dollar resumed plummeting against Euro, Yen, Yuan; gold soared over 1,000 USD per ounce, oil reached 110 USD per barrel, global stock markets lost 20 percent in three months, and the Fed's most recent attempt to stop the financial crisis through a 200 billion USD bank loan plan has already proved to fail... the bases of the financial and economic order that prevailed in the last decades are collapsing under our eyes, at an increasing pace… all the signs of a systemic crisis are gathered (3).
The whole world is now aware that we are faced to a crisis of unprecedented scope and nature. This level of awareness enables our team to refine some of their anticipations. About currencies for instance, our team undertook to review their estimation of the value of the US dollar against the three other strategic currencies - Euro, Yen and Yuan. LEAP/E2020 now estimates that the EURUSD exchange rate will reach 1.75 at the end of 2008 (instead of the 1.70 estimation made in 2006); the USDYEN rate should fall down to 90 and the USDYUAN down to 6 (4).
US Dollar Index (benchmark currency basket (5)) on 03/14/2008 - Source FxStreet
Faced to the extent of the Very Great US Depression currently unfolding (6), LEAP/E2020 is glad that the US authorities took into consideration the numerous protests (7) and decided to maintain the publication of US economic indicators on the website EconomicIndicators.Gov. In such difficult times, it is important that statistical information on the US economy remains easily available to everyone. The money of a great number of private and public, individual and collective operators depends on this transparency.
In the same sense, the Federal Reserve of Atlanta distributes for free a DVD entitled « Crisis Preparedness: Reconnecting the Financial Lifeline » and designed to help operators of all kinds to anticipate a crisis and get prepared to it (8). In the perspective of a collapse of the real economy in the US (expected to happen in September 2008 according to LEAP/E2020's anticipations (9)), these official advices take a special meaning. For instance, like we have been repeating for months, the DVD keeps saying that in the event of a severe crisis « Cash becomes king », whether the crisis is linked to a natural disaster or a human-made one, as shown by the fact that US insurers have already lost more money because of the subprime crisis than because of the Katrina hurricane, though the worse natural disaster in the history of the US (10).
Non-Borrowed reserves of US depository institutions (1950 – 02/2008) - Source Federal reserve of Saint Louis
To finish with, graphics such as the one above illustrate in a striking manner that the situation is infinitely worse that what the cleverest leader (and they are not many) can imagine. It shows that the US financial system, and that of a large part of the world, is lethally hurt. US banks have no more money; it is as simple and dramatic as that. Contagion will now enter a second phase of development, generating a new series of bank failures by this summer, as anticipated in GEAB N°20, entailing a dislocation of the global financial system in the second semester of 2008.
---------
Notes:
(1) Source: Reuters, 03/14/2008
(2) In GEAB N°19 we said it would take place in February ; it is on March 14th that this first large US bank defaulted. We remind that from now on, according to our November 2007 anticipations, more US, EU and Asian banks will follow.
(3) As a matter of fact, this CNN/Money title is very lucid: « Issue N°1: America's money ». Source: CNN/Money. That is indeed what it is all about: the pure and simple evaporation of thousands of billions of US Dollars illusively accumulated all those years on the accounts of financial institutions, companies, individuals and governments, scattered all over the world. That is exactly the problem detected in the first GEABs at the beginning of 2006.
(4) LEAP/E2020 wishes to stress the fact that in the case of a combined US/Israel attack on Iran this year, our US dollar index estimations for the end of 2008 presented in GEAB N°23 would be even worse. About the rumours suggesting that a concerted action of the central banks will put a stop to the plummeting of the US currency, they do not have any basis: a similar action can no longer be implemented because central banks now have diverging interests due to the decoupling of the world's largest economic regions, as anticipated by LEAP/E2020 many months ago. The collapse of the US Dollar is the result of a US economy in recession and a related devaluation by 50 percent against the other big currencies.
(5) Dollar Index currencies: Euro, Yen, Canadian Dollar, British Pound, Swiss Franc and Swedish Crown. If the Chinese Yuan was added to this list, the US dollar index would fall even more dramatically.
(6) Some websites are even specialised on this subject, such as Depression2.TV whose sub-title is clear: « Surviving the second great depression ».
(7) Excerpt of the announcement posted in the website EconomicIndicators.gov : « ... ESA (Economics and Statistics Administration) initially planned to discontinue the service due to cost concerns but given the feedback ESA received, the decision has been made to continue the site and improve its functionality... ».
(8) Source: Banking Information, Federal Reserve Bank of Atlanta (to order the DVD, here is the direct link)
(9) See GEAB N°22
(9) Source: Bloomberg, 03/14/2008
Clear and Present Danger
We expect officials to lower the funds rate by a full point to 2% at Tuesday's meeting
The Federal Open Market Committee will convene next week amid continued intense strains in financial markets and signs that economic activity is grinding to a halt. Events bearing on the outlook have worsened substantially since monetary policymakers dropped the funds rate to 3% in late January. The self-feeding downturn now in place shows signs of becoming deeply entrenched, while the ongoing marked deterioration in financial conditions is reinforcing the recessionary dynamic.
Strong consideration ought to be given to an even larger reduction
In this situation, aggressive policy action is warranted and we expect officials to lower the funds rate by a full point to 2% at Tuesday's meeting. Strong consideration ought to be given to an even larger reduction. Such a rate cut coupled with other ongoing policy actions may not be sufficient to stabilize the financial system over even a short horizon. As a result, the accompanying statement likely will higWight policymakers' commitment to pursue a set of policies necessary to secure stability. What is uncertain is whether or not the official communique will detail the various policies under consideration.
Policymakers gradually have signaled their willingness to adopt a more aggressive tack and it is now time to intensify further those efforts. The expansion of T AF, the introduction of the securities lending facility and today' s action to prevent a primary dealer from collapsing are examples of the Fed's more urgent approach to the current crisis.
The financial setting remains on tenterhooks and ongoing instability points to a prolonged adjustment period and uncomfortably elevated probabilities for highly destabilizing outcomes
A functioning financial system is the lifeblood of the U.S. economy and severely challenged market function, clunky intermediation and battered credit market conditions pose a clear and present danger to the economy.
...Bear Steams underscores the current fragility of the system. The Fed has not lent funds in such a capacity for at least several decades and possibly since the Great Depression. The interconnectivity of major financial institutions due to derivatives may have been a contributing factor in the Fed's decision. We cannot be certain, but the spider web of counterparty contracts throughout the financial sector could mean that the failure of one large institution puts the entire system at risk.
Our financial conditions index (FCI) finished February two standard deviations below its norm and has deteriorated considerably further in recent weeks
Our financial conditions index (FCI) provides a framework from which to measure the degree of stress in the broad financial backdrop. The index currently appears to be hovering near minus 2 1/2 sigma, or a level not experienced since the "capital crunch" ofthe early 1990s. Then, as now, the financial sector was saddled with assets that were not performing as anticipated and these problems weighed on the entire economy for an extended period.
While financial conditions as gauged by our index are not yet as restrictive as in that episode, strains in key asset markets are more severe. Dislocations in the mortgage and investment-grade credit markets remain considerable. For instance, the spread between rates on conforming mortgages and the lO-year Treasury still is near its widest level in the past decade, while the cost of buying protection on an index of 125 investment-grade credits has more than doubled so far this year.
Monetary policy cannot be considered to be even remotely close to properly calibrated until strains in the financial system ease
The level of the funds rate -including 0% provides only a partial glimpse of policy's effective stance. Policy is transmitted via the financial system, primarily asset prices, and with actions to date having failed to steady, much less improve, the flnanciallandscape, policy is not positioned to promote moderate growth over time. Until policy is positioned in such a fashion that it first provides a modicum of financial stability and then promotes a more normal set of financial conditions, forecasts of improved economic performance will be just that.
Absent a steadying in the financial backdrop, conditions have the potential to supercharge the increasingly visible self-feeding downturn in the real economy
Consumer spending is slowing quickly. Household demand expanded by a solid 3% plus clip throughout the bulk of expansion but downshifted to 1.9% in the prior quarter and according to this week's retail sales data is inching ahead in Q 1. Core sales were unchanged in February and have increased by a scant 0.2% annualized in the past three months. Real income expectations - spending's primary driver - are fading fast and today's update on this front from the University of Michigan is consistent with an additional deceleration in outlays ahead.
Slowing consumer expenditures will result in a cascade of adverse developments
Weaker spending growth will reduce firms' profit expectations, which in tum will cap businesses' willingness to add to headcount, inventories and the capital stock. The latest canvassing of smaIl firms suggests this process already is under way. Overall optimism has dropped sharply and expansion plans among these firms are probing levels experienced during the past two recessions. At the same time, businesses are not inclined to build inventories, suggesting that the spike in January stockpiles is unlikely to prove durable.
Left unchecked, this toxic background has the potential to fuel a recession unlike any the United States has endured in the past quarter century
The damage already done to the economic outlook is substantial and with the current negative feedback loop putting down deeper and deeper roots by the day, the scope of actions needed to sever this vicious circle is surging.
Continuation of current financial disruptions would usher in a dis inflationary undertow
Ongoing developments also are threat to medium-term price stability. An inflation backdrop that does not distort economic decision making cannot be achieved without financial stability. In this context, while current consumer inflation rates may be higher than many policymakers would prefer, continuation of current financial disruptions would usher in a dis inflationary undertow.
The Federal Open Market Committee will convene next week amid continued intense strains in financial markets and signs that economic activity is grinding to a halt. Events bearing on the outlook have worsened substantially since monetary policymakers dropped the funds rate to 3% in late January. The self-feeding downturn now in place shows signs of becoming deeply entrenched, while the ongoing marked deterioration in financial conditions is reinforcing the recessionary dynamic.
Strong consideration ought to be given to an even larger reduction
In this situation, aggressive policy action is warranted and we expect officials to lower the funds rate by a full point to 2% at Tuesday's meeting. Strong consideration ought to be given to an even larger reduction. Such a rate cut coupled with other ongoing policy actions may not be sufficient to stabilize the financial system over even a short horizon. As a result, the accompanying statement likely will higWight policymakers' commitment to pursue a set of policies necessary to secure stability. What is uncertain is whether or not the official communique will detail the various policies under consideration.
Policymakers gradually have signaled their willingness to adopt a more aggressive tack and it is now time to intensify further those efforts. The expansion of T AF, the introduction of the securities lending facility and today' s action to prevent a primary dealer from collapsing are examples of the Fed's more urgent approach to the current crisis.
The financial setting remains on tenterhooks and ongoing instability points to a prolonged adjustment period and uncomfortably elevated probabilities for highly destabilizing outcomes
A functioning financial system is the lifeblood of the U.S. economy and severely challenged market function, clunky intermediation and battered credit market conditions pose a clear and present danger to the economy.
...Bear Steams underscores the current fragility of the system. The Fed has not lent funds in such a capacity for at least several decades and possibly since the Great Depression. The interconnectivity of major financial institutions due to derivatives may have been a contributing factor in the Fed's decision. We cannot be certain, but the spider web of counterparty contracts throughout the financial sector could mean that the failure of one large institution puts the entire system at risk.
Our financial conditions index (FCI) finished February two standard deviations below its norm and has deteriorated considerably further in recent weeks
Our financial conditions index (FCI) provides a framework from which to measure the degree of stress in the broad financial backdrop. The index currently appears to be hovering near minus 2 1/2 sigma, or a level not experienced since the "capital crunch" ofthe early 1990s. Then, as now, the financial sector was saddled with assets that were not performing as anticipated and these problems weighed on the entire economy for an extended period.
While financial conditions as gauged by our index are not yet as restrictive as in that episode, strains in key asset markets are more severe. Dislocations in the mortgage and investment-grade credit markets remain considerable. For instance, the spread between rates on conforming mortgages and the lO-year Treasury still is near its widest level in the past decade, while the cost of buying protection on an index of 125 investment-grade credits has more than doubled so far this year.
Monetary policy cannot be considered to be even remotely close to properly calibrated until strains in the financial system ease
The level of the funds rate -including 0% provides only a partial glimpse of policy's effective stance. Policy is transmitted via the financial system, primarily asset prices, and with actions to date having failed to steady, much less improve, the flnanciallandscape, policy is not positioned to promote moderate growth over time. Until policy is positioned in such a fashion that it first provides a modicum of financial stability and then promotes a more normal set of financial conditions, forecasts of improved economic performance will be just that.
Absent a steadying in the financial backdrop, conditions have the potential to supercharge the increasingly visible self-feeding downturn in the real economy
Consumer spending is slowing quickly. Household demand expanded by a solid 3% plus clip throughout the bulk of expansion but downshifted to 1.9% in the prior quarter and according to this week's retail sales data is inching ahead in Q 1. Core sales were unchanged in February and have increased by a scant 0.2% annualized in the past three months. Real income expectations - spending's primary driver - are fading fast and today's update on this front from the University of Michigan is consistent with an additional deceleration in outlays ahead.
Slowing consumer expenditures will result in a cascade of adverse developments
Weaker spending growth will reduce firms' profit expectations, which in tum will cap businesses' willingness to add to headcount, inventories and the capital stock. The latest canvassing of smaIl firms suggests this process already is under way. Overall optimism has dropped sharply and expansion plans among these firms are probing levels experienced during the past two recessions. At the same time, businesses are not inclined to build inventories, suggesting that the spike in January stockpiles is unlikely to prove durable.
Left unchecked, this toxic background has the potential to fuel a recession unlike any the United States has endured in the past quarter century
The damage already done to the economic outlook is substantial and with the current negative feedback loop putting down deeper and deeper roots by the day, the scope of actions needed to sever this vicious circle is surging.
Continuation of current financial disruptions would usher in a dis inflationary undertow
Ongoing developments also are threat to medium-term price stability. An inflation backdrop that does not distort economic decision making cannot be achieved without financial stability. In this context, while current consumer inflation rates may be higher than many policymakers would prefer, continuation of current financial disruptions would usher in a dis inflationary undertow.
A world addicted to easy credit must go cold turkey
It's only mid-March, but this is one of Wall Street's sweatiest weekends. Traders' shirts are drenched in the perspiration of unpleasant possibilities. The collapse of once-mighty Bear Stearns is another reminder that the unwinding of the Great Debt Delusion still has a long way to go and many more victims to claim.
Brassneck: Contempt for politicians will benefit the economy
Three Line Whip: What ever happened to Northern Rock?
Read more from Jeff Randall
When, several years from now, economic historians tot up the final casualty list, a trail of destruction will stretch from mobile homes in America's Budweiser belt to the council estates of fish-and-chip Britain. The credit crunch travels with alarming ease.
Alistair Darling's Budget-day boast that Britain is well placed to cope with this turmoil was irrefutable proof of his intellectual bankruptcy. He was either whistling in the dark or wilfully insulting voters' intelligence. Be under no illusion, Friday's dramatic events in New York were neither an aberration nor confined to the surreal world of investment banking. The pain will be lasting and felt by millions who had no idea they were playing with financial fireworks.
When dealers arrive at their desks tomorrow morning, the first question will be: Who's next? Is it just Bear Stearns that has run out of cash, or are other great institutions staring into empty coffers? Investors are already betting that Lehman Brothers, another premier league player, has its financials caught in a mangle.
The US locomotive, for so long the engine of global consumption, is not just grinding to a halt, it is falling apart. The New York Times reports this weekend: "Everything seems to be going wrong… People are buying less, but most things are costing more. Mortgage rates are rising, the dollar is falling and prices of key commodities are leaping from one record high to the next."
Where now are the financiers, regulators and politicians who peddled the inanity, "we mustn't talk ourselves into recession"? Of all the vacuous comments made by officialdom, this one, given the rapid spread of financial disruption, grates more than most. Nobody is talking anyone into anything - it's too late for that. Our jeopardy is very real. Recession, if it comes, will be the result not of idle chatter but a conspiracy of silence. It underpinned the fantasy.
advertisement
For too long, those who warned that the borrowing bubble would burst with terrible consequences were dismissed as congenital gloomsters. Greedy lenders, their irresponsible customers and incompetent ministers formed an unholy alliance to perpetuate a myth: that consumers, companies and governments could keep spending more than they earned and suffer no penalty.
We heard new and intriguing justifications for excess. Banks seemed able to acquire rubbish and recycle it as triple-A securities. It was a sophisticated version of the second-hand shop that advertises: "We buy unwanted junk and sell valuable antiques." Instruments of financial leverage became so complicated that even those trading them did not fully understand how the system worked. All they cared about was the potency of magic that enabled welfare claimants to borrow five or six times the income they were not earning and still make the numbers add up.
So clever were the designers of this wizardry that, though it failed the common sense test, they were able to fool supervisors, credit committees, external auditors, shareholders and regulators - even themselves! Disbelief was suspended by all concerned.
An important pre-condition for a faith in easy money is a complete disregard for the lessons of history. The bulls at Bear Stearns, it seems, were too busy spending their jackpot bonuses to read how and why boom turned to bust at Barings. Picking through the wreckage of his family's bank, two years after it went under, Peter Baring told a Bank of England inquiry that while Nick Leeson was making extraordinary (and wholly illusory) profits, the company's directors concluded that "it was not actually terribly difficult to make money in the securities business".
For securities in the Nineties, read sub-prime in the Noughties. When it looks too good to be true, it usually is. Bear Stearns has suffered crippling losses on mortgage-linked investments. In the same way that Northern Rock lost the confidence of British savers, Bear Stearns eventually exhausted the trust of hedge funds and its other commercial lenders. For a bank that trades by borrowing 30 times its equity base, this was the kiss of death.
Three years ago, Paul Volcker, a former chairman of the Federal Reserve, warned that the US was "an economy on thin ice". In particular he was worried that Americans had become hooked on living imprudently by using their homes as cash machines. He wrote in The Washington Post: "Personal savings in the United States have practically disappeared… we are buying a lot of housing at rising prices, but home ownership has become a vehicle for borrowing as much as a source of financial security."
Does that sound familiar? I'm afraid so. Here in the United Kingdom we have been living a similar dream. Unable to fund all spending ambitions from income, too many Britons have cashed in part of their bricks and mortar for a blast of instant gratification. Worse still, so has the Government. Unwilling to live within its means, even with revenues of about £600 billion a year, Gordon Brown's Circus and its troupe of performing puppets must borrow more than £40 billion next year to make ends meet. Its budgetary indiscipline makes us all more vulnerable to a sharp downturn.
Credit markets have frozen because it is unclear how many more of the big banks, if any, are bluffing. Nobody wants to be caught out trading with a loser. So cash is being hoarded. At the start of last week, the boss of Bear Stearns told the market that his firm was safe. But when lenders called that bluff, the cupboard was bare.
Central banks are trying to calm jitters by pouring billions of dollars into money markets to increase liquidity. Last week another $200 billion was dropped into the system. That was quickly swallowed up amidst screams for yet more emergency injections. Debt junkies, like heroin addicts, demand ever bigger fixes.
And this brings us to the heart of the matter. The rational response to financial pain is risk reduction. But if the pain is removed, or even suppressed, then so is fear. When individuals or institutions believe they will always be bailed out, they lose the incentive to reform. Delinquency is, in effect, encouraged.
In the end, the patient is so full of painkillers that they become part of the problem. The only way forward is for all palliatives to be washed out of the system. Sooner or later borrowers and lenders must address the real cause of discomfort. For many of Wall Street's finest, it will feel like cold turkey.
Brassneck: Contempt for politicians will benefit the economy
Three Line Whip: What ever happened to Northern Rock?
Read more from Jeff Randall
When, several years from now, economic historians tot up the final casualty list, a trail of destruction will stretch from mobile homes in America's Budweiser belt to the council estates of fish-and-chip Britain. The credit crunch travels with alarming ease.
Alistair Darling's Budget-day boast that Britain is well placed to cope with this turmoil was irrefutable proof of his intellectual bankruptcy. He was either whistling in the dark or wilfully insulting voters' intelligence. Be under no illusion, Friday's dramatic events in New York were neither an aberration nor confined to the surreal world of investment banking. The pain will be lasting and felt by millions who had no idea they were playing with financial fireworks.
When dealers arrive at their desks tomorrow morning, the first question will be: Who's next? Is it just Bear Stearns that has run out of cash, or are other great institutions staring into empty coffers? Investors are already betting that Lehman Brothers, another premier league player, has its financials caught in a mangle.
The US locomotive, for so long the engine of global consumption, is not just grinding to a halt, it is falling apart. The New York Times reports this weekend: "Everything seems to be going wrong… People are buying less, but most things are costing more. Mortgage rates are rising, the dollar is falling and prices of key commodities are leaping from one record high to the next."
Where now are the financiers, regulators and politicians who peddled the inanity, "we mustn't talk ourselves into recession"? Of all the vacuous comments made by officialdom, this one, given the rapid spread of financial disruption, grates more than most. Nobody is talking anyone into anything - it's too late for that. Our jeopardy is very real. Recession, if it comes, will be the result not of idle chatter but a conspiracy of silence. It underpinned the fantasy.
advertisement
For too long, those who warned that the borrowing bubble would burst with terrible consequences were dismissed as congenital gloomsters. Greedy lenders, their irresponsible customers and incompetent ministers formed an unholy alliance to perpetuate a myth: that consumers, companies and governments could keep spending more than they earned and suffer no penalty.
We heard new and intriguing justifications for excess. Banks seemed able to acquire rubbish and recycle it as triple-A securities. It was a sophisticated version of the second-hand shop that advertises: "We buy unwanted junk and sell valuable antiques." Instruments of financial leverage became so complicated that even those trading them did not fully understand how the system worked. All they cared about was the potency of magic that enabled welfare claimants to borrow five or six times the income they were not earning and still make the numbers add up.
So clever were the designers of this wizardry that, though it failed the common sense test, they were able to fool supervisors, credit committees, external auditors, shareholders and regulators - even themselves! Disbelief was suspended by all concerned.
An important pre-condition for a faith in easy money is a complete disregard for the lessons of history. The bulls at Bear Stearns, it seems, were too busy spending their jackpot bonuses to read how and why boom turned to bust at Barings. Picking through the wreckage of his family's bank, two years after it went under, Peter Baring told a Bank of England inquiry that while Nick Leeson was making extraordinary (and wholly illusory) profits, the company's directors concluded that "it was not actually terribly difficult to make money in the securities business".
For securities in the Nineties, read sub-prime in the Noughties. When it looks too good to be true, it usually is. Bear Stearns has suffered crippling losses on mortgage-linked investments. In the same way that Northern Rock lost the confidence of British savers, Bear Stearns eventually exhausted the trust of hedge funds and its other commercial lenders. For a bank that trades by borrowing 30 times its equity base, this was the kiss of death.
Three years ago, Paul Volcker, a former chairman of the Federal Reserve, warned that the US was "an economy on thin ice". In particular he was worried that Americans had become hooked on living imprudently by using their homes as cash machines. He wrote in The Washington Post: "Personal savings in the United States have practically disappeared… we are buying a lot of housing at rising prices, but home ownership has become a vehicle for borrowing as much as a source of financial security."
Does that sound familiar? I'm afraid so. Here in the United Kingdom we have been living a similar dream. Unable to fund all spending ambitions from income, too many Britons have cashed in part of their bricks and mortar for a blast of instant gratification. Worse still, so has the Government. Unwilling to live within its means, even with revenues of about £600 billion a year, Gordon Brown's Circus and its troupe of performing puppets must borrow more than £40 billion next year to make ends meet. Its budgetary indiscipline makes us all more vulnerable to a sharp downturn.
Credit markets have frozen because it is unclear how many more of the big banks, if any, are bluffing. Nobody wants to be caught out trading with a loser. So cash is being hoarded. At the start of last week, the boss of Bear Stearns told the market that his firm was safe. But when lenders called that bluff, the cupboard was bare.
Central banks are trying to calm jitters by pouring billions of dollars into money markets to increase liquidity. Last week another $200 billion was dropped into the system. That was quickly swallowed up amidst screams for yet more emergency injections. Debt junkies, like heroin addicts, demand ever bigger fixes.
And this brings us to the heart of the matter. The rational response to financial pain is risk reduction. But if the pain is removed, or even suppressed, then so is fear. When individuals or institutions believe they will always be bailed out, they lose the incentive to reform. Delinquency is, in effect, encouraged.
In the end, the patient is so full of painkillers that they become part of the problem. The only way forward is for all palliatives to be washed out of the system. Sooner or later borrowers and lenders must address the real cause of discomfort. For many of Wall Street's finest, it will feel like cold turkey.
15 March 2008
Just The End of Your Way of Life?
Craig Harris
Mar 14, 2008
[Craig, we truly appreciate your taking time to give us your highly-respected and valuable insights to share with our 321gold readers]
I haven't written anything for public consumption in a while, because I've been busy living in what I like to call, "the real world" and making my living by trading my own money. That's what I do these days. I'm a fly on the wall with electronic access to the dens of thieves.
If I come out on top then I transfer those digits for things I need.
Yes I'm still long gold from $290, and crude from $60 but whatever, I've been doing ok. I've been doing ok that is, if the money I have was worth what it used to be, but it isn't. So rather than just slap a label on what it is when words have already arguably lost their meaning, let's discuss it.
I am personally more concerned about quality of life issues than I am about money given the current circumstances.
The last time when I wrote publicly, I was talking about the decline of the empire and the end of the pre eminence of the US dollar...war, that sort of thing.
So that's what's going on now, what I was talking about then.
The US is currently in what I like to call a period of "decay". It is in a period of decay in every possible way. If you live in the real world like I do, it is evident. If you consume a diet of the corporate media cheerleading squad, then you don't live in the real world and it could be difficult for us to communicate during the rest of this essay. We've got people charged with cleaning up the corrupt broken system going out with an $80,000 hooker bill and being replaced by a blind man. The current El Presidente is a wind-up doll for a bunch that should all be in orange jumpsuits. It would be comical if it weren't so sad to watch it all go down. It is a modern day tragedy being played out in real time in the context of a giant government/corporate media theatre production.
It's amazing to me how people who are into politics or religion or whatever will violently oppose some opinions, when people simply report the facts they see around them. Anyway, again... another subject. Politics and religion are both the same thing. They are both simply effective methods to control large masses of people. I just figured that one out not too long ago when I was into my learning the history of the world project. It has always been that way and always will be.
So anyway, that's all I do to make my living. I assimilate the facts I see around me and invest accordingly. I keep a diary of what I think and why, and I even publish it. If I'm right I make money and if I'm wrong I lose money. I like it that way. It keeps me honest.
That's one reason I don't write a lot publicly these days. It is becoming increasingly difficult for people who live in the real world to communicate with those who don't, and there is an increasing number of those who don't just simply because most people believe what they are told and the lies they are being told are now monumental. Astronomical in size. That's one of those universal rules about human beings; the majority will always go along with whatever you tell them. That's just the way it always has been and always will be. All good propagandists know that.
For those who do think for themselves and live in the real world however, everything that is happening today has been entirely predictable and even expected. I mean, the corporate media will say "no one ever saw this" or "they never saw that" and really the case is they just choose not to have those people appear. That's a whole subject in itself however.
I was noting to my subscribers the other evening that if you take a look at a picture of a pump price for gas from ten years ago until now, that's around an 18% increase annualized every year for ten years. All the other prices in the real world have risen at commensurate levels like healthcare and all the big items people like me in the real world need to spend money on.
Furthermore, if you plot energy in the last five years, the numbers are bigger. If you plot the last two the numbers are bigger yet. The last one, bigger yet. So what we have here in the real world are prices accelerating at an ever-increasing double-digit rate. Call that what you want. We have real wages basically constant and good jobs are harder to come by. We have a middle class that is going away. We have the majority of the citizens having their wealth, if they still have any, confiscated due to the ravages of inflation, or with toxic financial contact with the healthcare/pharma, legal or government money machines. So in the "not real world" big brother and his corporate media outlets wants you to believe that there really hasn't been much inflation or any significant changes to the status quoand that lie is so big that you may even believe it.
So if you do, then you don't live in the real world and we cannot communicate effectively because what you think you know is the product of a corporate boardroom. What I know is the product of living.
The other big thing that has happened since I last wrote is that the guys on Wall Street figured out how to loan a bunch of money to people that had no ability or even real desire to repay that money except for the fact that house prices were sure to go ever higher which is the definition of a mania. So working through a little bit of that math, with an estimated 30% of homeowners currently upside down on their mortgages, that works out to around ten trillion dollars of real estate still to be walked away from according to simple math and a few basic assumptions I worked out the other night.
In the "not real world" they have told you from the outset that first there was no real estate bubble, then that there might have been one, then that it would be over quickly and now they aren't sure when it will be over and the PR firms are busy working on what to tell you next.
It's not going to be over any time soon. The big question in my mind is whether the whole thing is about to go kaput or if we are just going to witness a continuous decay as the wealth shifts into a very small percentage of the population... as the middle class flames out. Again, that is a subject in itself. That is the subject of the Straussian nightmare; a change in the form of government that is pitched as the same thing as the old government.
So on top of this Wall Street genius of loaning money to people who could not pay, you have the cure for all this mess being printing more money (creating more debt). So they're going to fix a problem of too much debt by creating more debt. Perfect. They're even monetizing it by taking nearly worthless debt for brand new money created with the push of a button and an organized media campaign to tell you what they did and why it was good and why it was not monetization or covert nationalization of the banking system. It is what it is, call it what you want.
So the idea is that by pushing buttons you can cure these ills, but the reality is that big pile of new money is diluting the old money and sending the US dollar into the toilet. I mean, they're pitching it as all good, and what's left of the free markets are in sharp disagreement with the party line.
Now; the only reason the USA has gotten away with the idea that this balance sheet was compatible with the idea of being the world's reserve currency was that the USA was the global kingpin, the Mac daddy... until the empire did what all empires do and that's get too big for their britches.
Then they always start going off expanding the empire into places that are too expensive to maintain, imposing their will on people who don't want their will imposed on, and then that all gets so expensive and they start making so many enemies they start going bankrupt. That's what always happens. It always does. That's probably another one of those human nature things.
So in the real world right now, we have a situation where the banks are bankrupt, the government is bankrupt, the people are bankrupt, and the cure for this is to lower interest rates and create more money (debt) by pushing a button... diluting the value of the money further and causing everything we have going on now. It all makes sense here in the real world. All the pieces to the puzzle fit and none don't.
So is this stagflation or is this hyperinflation? Well, I'm not carrying a wheelbarrow around with my money in it yet, but I do know the prices and costs of everything I need to live are going up at an ever-increasing rate.
The shape of that curve is a polynomial consistent with ever accelerating inflation which some would call hyperinflation. I know that if I earn a 20% return, then I might be keeping up with the increase in the costs of everything I need to maintain my personal status quo. If you can balance a checkbook and multiply, then you know. If you are one of the ones who believe everything you're told, then you have to not believe your lying eyes or not be able to balance a checkbook.
When the cure for all problems can only be to lower interest rates and dilute the supply of the money by creating more money, then that is a vicious cycle consistent with acceleration or hyperinflation.
I really don't like it when people casually compare what is going on right now to 1929, because in 1929 the cure was basically to spend less and now the cure is basically to spend more. Even worse, being the geniuses we are, we figured out a way to amplify spending, called derivatives. They're based on the real thing but amplifiedlike 100 times. So we've already been doing the "cure" for so long that maybe the patient is no longer responding?
So what we are currently seeing, in both gold and crude oil is a loss of confidence. It's a loss of confidence that this whole thing makes any sense.
It's a loss of confidence in the absurd idea that you can create wealth by pushing a button. Since this whole thing now relies solely on confidence and not any intrinsic value, commodities, especially gold and crude oil, are acting as alternative wealth storage devices to paper currency.
If you have a bushel of corn, then you know what that is. You can eat it, or do a bunch of other stuff with it. With a piece of paper with a picture and official looking numbers on it, well you aren't as sure as you were yesterday what you can do with that. There will be no run on the banks this time around, because the banks can always be refilled with ever more worthless money. Instead of a run on the banks, there will be a run on the dollar. A run on the dollar (or run into commodities) is the modern equivalent to a run on the banks back then, for the reasons I'll get into shortly.
So there is a loss of confidence roughly equal to people's confidence in the government and the banking system. This decreased confidence is fueled by the fact that they are creating too much money. The idea with fiat money is that you only grow the amount of it as the total output of the economy increases otherwise you are diluting it. The thought experiment for that goes like this. You have one giant pile of stuff, and one giant pile of money. Right now there is enough money so that one-dollar gets one pound of stuff. Now, if you double the amount of that money, then it takes two dollars to equal one pound of that stuff. Unless the pound of stuff doubles in size, you have just caused 100% price inflation. So, operations like just zapping a half a trillion or so into existence out of thin air means just a bigger pile of money going after the same amount of stuff. So that's what we have going on now. These are financial engineering acts of desperation to save a system by giving it more of what got it to this point in the first place... debt. So when regular people like me think about that, they think, that doesn't make any sense, and they lose confidence.
That's in the real world. On TV things are still good though. So if you don't like what you're reading here, then go turn on the TV. You'll feel better.
I hate to simplify things too much, but this is the reason Mr. Greenspan called gold the conscience of the central bankers back in the 60's before he lost his mind or whatever happened. Maybe he couldn't resist the power of the ring or something... I don't know. Anyway, it's their conscience because they can't just zap gold into existence with the stroke of a pen.
Guess what? They can zap money into existence now. Poof - you've got money.
Any amount you want. That's why this is fundamentally different from the great depression. This time, they can just increase the giant pile of money. they can just drop it out of helicopters if they have to. They even said so... and it isn't going to buy as much stuff. It doesn't already.
So you still have the same basic problem from a human standpoint. That's the really interesting thing. In other words, whether you have a deflation like in the 30's or an inflation like now, the people suffer similar effects. It's hard to find a job, you can't make ends meet, city and government functions and services are understaffed and underfunded, and you are hungry. They are both a state of decay. Both usually end in war too.
The last one did. This one is different however in a lot of ways... and it's much more serious. It is fundamentally different because it is the end of the world's first experiment in government by the people and it has been replaced by something new.
So if you're into labels, then maybe you can find a label for what to call this. I like to quote Lenin on that:
"Fascism is capitalism in decay." -Vladimir Lenin
So I really don't want to get into all that implies in a short essay, but I will condense it all and say the US is in a state of decay. Political, socioeconomic, leadership, influence, status, any label you can think of.
The US is losing power and influence in the world, and it only has 5% of the world's populationand they're all bankrupt. I like to think of it like a continuum from the US coming out on top after WWII to a banana republic run by El Presidente. That's what I call them now, whoever he or she is, El Presidente because that's what they are. A corporate spokesman who is put there, bought and paid for by Acme corp.
The country has lost its way and is increasingly operating at the whim of the corporate lobbyists and special interests that own the politicians as the stench of it all starts to smell so foul that even the corporate media disinformation campaign can't convince your lying eyes. It is not what it appears to be. It is Rome circa 400's. It has already bankrupted itself policing an unsustainably large global empire. You have to live through the decline.
So that all gets into people living in the real world versus those who are not. Again, it's safe to say that the world is voting with its dollars... and the 5% of the world's population are going down hard on 95% leverage. They aren't going to like it either.
Tune in next time to hear which states secede first.
Mar 14, 2008
[Craig, we truly appreciate your taking time to give us your highly-respected and valuable insights to share with our 321gold readers]
I haven't written anything for public consumption in a while, because I've been busy living in what I like to call, "the real world" and making my living by trading my own money. That's what I do these days. I'm a fly on the wall with electronic access to the dens of thieves.
If I come out on top then I transfer those digits for things I need.
Yes I'm still long gold from $290, and crude from $60 but whatever, I've been doing ok. I've been doing ok that is, if the money I have was worth what it used to be, but it isn't. So rather than just slap a label on what it is when words have already arguably lost their meaning, let's discuss it.
I am personally more concerned about quality of life issues than I am about money given the current circumstances.
The last time when I wrote publicly, I was talking about the decline of the empire and the end of the pre eminence of the US dollar...war, that sort of thing.
So that's what's going on now, what I was talking about then.
The US is currently in what I like to call a period of "decay". It is in a period of decay in every possible way. If you live in the real world like I do, it is evident. If you consume a diet of the corporate media cheerleading squad, then you don't live in the real world and it could be difficult for us to communicate during the rest of this essay. We've got people charged with cleaning up the corrupt broken system going out with an $80,000 hooker bill and being replaced by a blind man. The current El Presidente is a wind-up doll for a bunch that should all be in orange jumpsuits. It would be comical if it weren't so sad to watch it all go down. It is a modern day tragedy being played out in real time in the context of a giant government/corporate media theatre production.
It's amazing to me how people who are into politics or religion or whatever will violently oppose some opinions, when people simply report the facts they see around them. Anyway, again... another subject. Politics and religion are both the same thing. They are both simply effective methods to control large masses of people. I just figured that one out not too long ago when I was into my learning the history of the world project. It has always been that way and always will be.
So anyway, that's all I do to make my living. I assimilate the facts I see around me and invest accordingly. I keep a diary of what I think and why, and I even publish it. If I'm right I make money and if I'm wrong I lose money. I like it that way. It keeps me honest.
That's one reason I don't write a lot publicly these days. It is becoming increasingly difficult for people who live in the real world to communicate with those who don't, and there is an increasing number of those who don't just simply because most people believe what they are told and the lies they are being told are now monumental. Astronomical in size. That's one of those universal rules about human beings; the majority will always go along with whatever you tell them. That's just the way it always has been and always will be. All good propagandists know that.
For those who do think for themselves and live in the real world however, everything that is happening today has been entirely predictable and even expected. I mean, the corporate media will say "no one ever saw this" or "they never saw that" and really the case is they just choose not to have those people appear. That's a whole subject in itself however.
I was noting to my subscribers the other evening that if you take a look at a picture of a pump price for gas from ten years ago until now, that's around an 18% increase annualized every year for ten years. All the other prices in the real world have risen at commensurate levels like healthcare and all the big items people like me in the real world need to spend money on.
Furthermore, if you plot energy in the last five years, the numbers are bigger. If you plot the last two the numbers are bigger yet. The last one, bigger yet. So what we have here in the real world are prices accelerating at an ever-increasing double-digit rate. Call that what you want. We have real wages basically constant and good jobs are harder to come by. We have a middle class that is going away. We have the majority of the citizens having their wealth, if they still have any, confiscated due to the ravages of inflation, or with toxic financial contact with the healthcare/pharma, legal or government money machines. So in the "not real world" big brother and his corporate media outlets wants you to believe that there really hasn't been much inflation or any significant changes to the status quoand that lie is so big that you may even believe it.
So if you do, then you don't live in the real world and we cannot communicate effectively because what you think you know is the product of a corporate boardroom. What I know is the product of living.
The other big thing that has happened since I last wrote is that the guys on Wall Street figured out how to loan a bunch of money to people that had no ability or even real desire to repay that money except for the fact that house prices were sure to go ever higher which is the definition of a mania. So working through a little bit of that math, with an estimated 30% of homeowners currently upside down on their mortgages, that works out to around ten trillion dollars of real estate still to be walked away from according to simple math and a few basic assumptions I worked out the other night.
In the "not real world" they have told you from the outset that first there was no real estate bubble, then that there might have been one, then that it would be over quickly and now they aren't sure when it will be over and the PR firms are busy working on what to tell you next.
It's not going to be over any time soon. The big question in my mind is whether the whole thing is about to go kaput or if we are just going to witness a continuous decay as the wealth shifts into a very small percentage of the population... as the middle class flames out. Again, that is a subject in itself. That is the subject of the Straussian nightmare; a change in the form of government that is pitched as the same thing as the old government.
So on top of this Wall Street genius of loaning money to people who could not pay, you have the cure for all this mess being printing more money (creating more debt). So they're going to fix a problem of too much debt by creating more debt. Perfect. They're even monetizing it by taking nearly worthless debt for brand new money created with the push of a button and an organized media campaign to tell you what they did and why it was good and why it was not monetization or covert nationalization of the banking system. It is what it is, call it what you want.
So the idea is that by pushing buttons you can cure these ills, but the reality is that big pile of new money is diluting the old money and sending the US dollar into the toilet. I mean, they're pitching it as all good, and what's left of the free markets are in sharp disagreement with the party line.
Now; the only reason the USA has gotten away with the idea that this balance sheet was compatible with the idea of being the world's reserve currency was that the USA was the global kingpin, the Mac daddy... until the empire did what all empires do and that's get too big for their britches.
Then they always start going off expanding the empire into places that are too expensive to maintain, imposing their will on people who don't want their will imposed on, and then that all gets so expensive and they start making so many enemies they start going bankrupt. That's what always happens. It always does. That's probably another one of those human nature things.
So in the real world right now, we have a situation where the banks are bankrupt, the government is bankrupt, the people are bankrupt, and the cure for this is to lower interest rates and create more money (debt) by pushing a button... diluting the value of the money further and causing everything we have going on now. It all makes sense here in the real world. All the pieces to the puzzle fit and none don't.
So is this stagflation or is this hyperinflation? Well, I'm not carrying a wheelbarrow around with my money in it yet, but I do know the prices and costs of everything I need to live are going up at an ever-increasing rate.
The shape of that curve is a polynomial consistent with ever accelerating inflation which some would call hyperinflation. I know that if I earn a 20% return, then I might be keeping up with the increase in the costs of everything I need to maintain my personal status quo. If you can balance a checkbook and multiply, then you know. If you are one of the ones who believe everything you're told, then you have to not believe your lying eyes or not be able to balance a checkbook.
When the cure for all problems can only be to lower interest rates and dilute the supply of the money by creating more money, then that is a vicious cycle consistent with acceleration or hyperinflation.
I really don't like it when people casually compare what is going on right now to 1929, because in 1929 the cure was basically to spend less and now the cure is basically to spend more. Even worse, being the geniuses we are, we figured out a way to amplify spending, called derivatives. They're based on the real thing but amplifiedlike 100 times. So we've already been doing the "cure" for so long that maybe the patient is no longer responding?
So what we are currently seeing, in both gold and crude oil is a loss of confidence. It's a loss of confidence that this whole thing makes any sense.
It's a loss of confidence in the absurd idea that you can create wealth by pushing a button. Since this whole thing now relies solely on confidence and not any intrinsic value, commodities, especially gold and crude oil, are acting as alternative wealth storage devices to paper currency.
If you have a bushel of corn, then you know what that is. You can eat it, or do a bunch of other stuff with it. With a piece of paper with a picture and official looking numbers on it, well you aren't as sure as you were yesterday what you can do with that. There will be no run on the banks this time around, because the banks can always be refilled with ever more worthless money. Instead of a run on the banks, there will be a run on the dollar. A run on the dollar (or run into commodities) is the modern equivalent to a run on the banks back then, for the reasons I'll get into shortly.
So there is a loss of confidence roughly equal to people's confidence in the government and the banking system. This decreased confidence is fueled by the fact that they are creating too much money. The idea with fiat money is that you only grow the amount of it as the total output of the economy increases otherwise you are diluting it. The thought experiment for that goes like this. You have one giant pile of stuff, and one giant pile of money. Right now there is enough money so that one-dollar gets one pound of stuff. Now, if you double the amount of that money, then it takes two dollars to equal one pound of that stuff. Unless the pound of stuff doubles in size, you have just caused 100% price inflation. So, operations like just zapping a half a trillion or so into existence out of thin air means just a bigger pile of money going after the same amount of stuff. So that's what we have going on now. These are financial engineering acts of desperation to save a system by giving it more of what got it to this point in the first place... debt. So when regular people like me think about that, they think, that doesn't make any sense, and they lose confidence.
That's in the real world. On TV things are still good though. So if you don't like what you're reading here, then go turn on the TV. You'll feel better.
I hate to simplify things too much, but this is the reason Mr. Greenspan called gold the conscience of the central bankers back in the 60's before he lost his mind or whatever happened. Maybe he couldn't resist the power of the ring or something... I don't know. Anyway, it's their conscience because they can't just zap gold into existence with the stroke of a pen.
Guess what? They can zap money into existence now. Poof - you've got money.
Any amount you want. That's why this is fundamentally different from the great depression. This time, they can just increase the giant pile of money. they can just drop it out of helicopters if they have to. They even said so... and it isn't going to buy as much stuff. It doesn't already.
So you still have the same basic problem from a human standpoint. That's the really interesting thing. In other words, whether you have a deflation like in the 30's or an inflation like now, the people suffer similar effects. It's hard to find a job, you can't make ends meet, city and government functions and services are understaffed and underfunded, and you are hungry. They are both a state of decay. Both usually end in war too.
The last one did. This one is different however in a lot of ways... and it's much more serious. It is fundamentally different because it is the end of the world's first experiment in government by the people and it has been replaced by something new.
So if you're into labels, then maybe you can find a label for what to call this. I like to quote Lenin on that:
"Fascism is capitalism in decay." -Vladimir Lenin
So I really don't want to get into all that implies in a short essay, but I will condense it all and say the US is in a state of decay. Political, socioeconomic, leadership, influence, status, any label you can think of.
The US is losing power and influence in the world, and it only has 5% of the world's populationand they're all bankrupt. I like to think of it like a continuum from the US coming out on top after WWII to a banana republic run by El Presidente. That's what I call them now, whoever he or she is, El Presidente because that's what they are. A corporate spokesman who is put there, bought and paid for by Acme corp.
The country has lost its way and is increasingly operating at the whim of the corporate lobbyists and special interests that own the politicians as the stench of it all starts to smell so foul that even the corporate media disinformation campaign can't convince your lying eyes. It is not what it appears to be. It is Rome circa 400's. It has already bankrupted itself policing an unsustainably large global empire. You have to live through the decline.
So that all gets into people living in the real world versus those who are not. Again, it's safe to say that the world is voting with its dollars... and the 5% of the world's population are going down hard on 95% leverage. They aren't going to like it either.
Tune in next time to hear which states secede first.
11 March 2008
the next bomb
ARROYO GRANDE, Calif. (MarketWatch) -- "Charlie and I believe Berkshire should be a fortress of financial strength" wrote Warren Buffett. That was five years before the subprime-credit meltdown.
"We try to be alert to any sort of mega-catastrophe risk, and that posture may make us unduly appreciative about the burgeoning quantities of long-term derivatives contracts and the massive amount of uncollateralized receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."
That warning was in Buffett's 2002 letter to Berkshire shareholders. He saw a future that many others chose to ignore. The Iraq war build-up was at a fever-pitch. The imagery of WMDs and a mushroom cloud fresh in his mind.
Also fresh on Buffett's mind: His acquisition of General Re four years earlier, about the time the Long-Term Capital Management hedge fund almost killed the global monetary system. How? This is crucial: LTCM nearly killed the system with a relatively small $5 billion trading loss. Peanuts compared with the hundreds of billions of dollars of subprime-credit write-offs now making Wall Street's big shots look like amateurs.
Buffett tried to sell off Gen Re's derivatives group. No buyers. Unwinding it was costly, but led to his warning that derivatives are a "financial weapon of mass destruction." That was 2002.
Derivatives bubble explodes five times bigger in five years
Wall Street didn't listen to Buffett. Derivatives grew into a massive bubble, from about $100 trillion to $516 trillion by 2007. The new derivatives bubble was fueled by five key economic and political trends:
Sarbanes-Oxley increased corporate disclosures and government oversight
Federal Reserve's cheap money policies created the subprime-housing boom
War budgets burdened the U.S. Treasury and future entitlements programs
Trade deficits with China and others destroyed the value of the U.S. dollar
Oil and commodity rich nations demanding equity payments rather than debt
In short, despite Buffett's clear warnings, a massive new derivatives bubble is driving the domestic and global economies, a bubble that continues growing today parallel with the subprime-credit meltdown triggering a bear-recession.
Data on the five-fold growth of derivatives to $516 trillion in five years comes from the most recent survey by the Bank of International Settlements, the world's clearinghouse for central banks in Basel, Switzerland. The BIS is like the cashier's window at a racetrack or casino, where you'd place a bet or cash in chips, except on a massive scale: BIS is where the U.S. settles trade imbalances with Saudi Arabia for all that oil we guzzle and gives China IOUs for the tainted drugs and lead-based toys we buy.
To grasp how significant this five-fold bubble increase is, let's put that $516 trillion in the context of some other domestic and international monetary data:
U.S. annual gross domestic product is about $15 trillion
U.S. money supply is also about $15 trillion
Current proposed U.S. federal budget is $3 trillion
U.S. government's maximum legal debt is $9 trillion
U.S. mutual fund companies manage about $12 trillion
World's GDPs for all nations is approximately $50 trillion
Unfunded Social Security and Medicare benefits $50 trillion to $65 trillion
Total value of the world's real estate is estimated at about $75 trillion
Total value of world's stock and bond markets is more than $100 trillion
BIS valuation of world's derivatives back in 2002 was about $100 trillion
BIS 2007 valuation of the world's derivatives is now a whopping $516 trillion
Moreover, the folks at BIS tell me their estimate of $516 trillion only includes "transactions in which a major private dealer (bank) is involved on at least one side of the transaction," but doesn't include private deals between two "non-reporting entities." They did, however, add that their reporting central banks estimate that the coverage of the survey is around 95% on average.
Also, keep in mind that while the $516 trillion "notional" value (maximum in case of a meltdown) of the deals is a good measure of the market's size, the 2007 BIS study notes that the $11 trillion "gross market values provides a more accurate measure of the scale of financial risk transfer taking place in derivatives markets."
Bubbles, domino effects and the 'bad 2%'
However, while that may be true as far as the parties to an individual deal, there are broader risks to the world's economies. Remember back in 1998 when LTCM's little $5 billion loss nearly brought down the world's banking system. That "domino effect" is now repeating many times over, straining the world's monetary, economic and political system as the subprime housing mess metastasizes, taking the U.S. stock market and the world economy down with it.
This cascading "domino effect" was brilliantly described in "The $300 Trillion Time Bomb: If Buffett can't figure out derivatives, can anybody?" published early last year in Portfolio magazine, a couple months before the subprime meltdown. Columnist Jesse Eisinger's $300 trillion figure came from an earlier study of the derivatives market as it was growing from $100 trillion to $516 trillion over five years. Eisinger concluded:
"There's nothing intrinsically scary about derivatives, except when the bad 2% blow up." Unfortunately, that "bad 2%" did blow up a few months afterwards, even as Bernanke and Paulson were assuring America that the subprime mess was "contained."
Bottom line: Little things leverage a heck of a big wallop. It only takes a little spark from a "bad 2% deal" to ignite this $516 trillion weapon of mass destruction. Think of this entire unregulated derivatives market like an unsecured, unpredictable nuclear bomb in a Pakistan stockpile. It's only a matter of time.
World's newest and biggest 'black market'
The fact is, derivatives have become the world's biggest "black market," exceeding the illicit traffic in stuff like arms, drugs, alcohol, gambling, cigarettes, stolen art and pirated movies. Why? Because like all black markets, derivatives are a perfect way of getting rich while avoiding taxes and government regulations. And in today's slowdown, plus a volatile global market, Wall Street knows derivatives remain a lucrative business.
Recently Pimco's bond fund king Bill Gross said "What we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August." In short, not only Warren Buffett, but Bond King Bill Gross, our Fed Chairman Ben Bernanke, the Treasury Secretary Henry Paulson and the rest of America's leaders can't "figure out" the world's $516 trillion derivatives.
Why? Gross says we are creating a new "shadow banking system." Derivatives are now not just risk management tools. As Gross and others see it, the real problem is that derivatives are now a new way of creating money outside the normal central bank liquidity rules. How? Because they're private contracts between two companies or institutions.
BIS is primarily a records-keeper, a toothless tiger that merely collects data giving a legitimacy and false sense of security to this chaotic "shadow banking system" that has become the world's biggest "black market."
That's crucial, folks. Why? Because central banks require reserves like stock brokers require margins, something backing up the transaction. Derivatives don't. They're not "real money." They're paper promises closer to "Monopoly" money than real U.S. dollars.
And it takes place outside normal business channels, out there in the "free market." That's the wonderful world of derivatives, and it's creating a massive bubble that could soon implode.
Comments? Yes, we want to hear your thoughts. Tell us what you think about derivatives: as "financial weapons of mass destruction;" as a "shadow banking system;" as a "black market;" as the next big bubble dangerously exposing us to that unpredictable "bad 2%."
"We try to be alert to any sort of mega-catastrophe risk, and that posture may make us unduly appreciative about the burgeoning quantities of long-term derivatives contracts and the massive amount of uncollateralized receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."
That warning was in Buffett's 2002 letter to Berkshire shareholders. He saw a future that many others chose to ignore. The Iraq war build-up was at a fever-pitch. The imagery of WMDs and a mushroom cloud fresh in his mind.
Also fresh on Buffett's mind: His acquisition of General Re four years earlier, about the time the Long-Term Capital Management hedge fund almost killed the global monetary system. How? This is crucial: LTCM nearly killed the system with a relatively small $5 billion trading loss. Peanuts compared with the hundreds of billions of dollars of subprime-credit write-offs now making Wall Street's big shots look like amateurs.
Buffett tried to sell off Gen Re's derivatives group. No buyers. Unwinding it was costly, but led to his warning that derivatives are a "financial weapon of mass destruction." That was 2002.
Derivatives bubble explodes five times bigger in five years
Wall Street didn't listen to Buffett. Derivatives grew into a massive bubble, from about $100 trillion to $516 trillion by 2007. The new derivatives bubble was fueled by five key economic and political trends:
Sarbanes-Oxley increased corporate disclosures and government oversight
Federal Reserve's cheap money policies created the subprime-housing boom
War budgets burdened the U.S. Treasury and future entitlements programs
Trade deficits with China and others destroyed the value of the U.S. dollar
Oil and commodity rich nations demanding equity payments rather than debt
In short, despite Buffett's clear warnings, a massive new derivatives bubble is driving the domestic and global economies, a bubble that continues growing today parallel with the subprime-credit meltdown triggering a bear-recession.
Data on the five-fold growth of derivatives to $516 trillion in five years comes from the most recent survey by the Bank of International Settlements, the world's clearinghouse for central banks in Basel, Switzerland. The BIS is like the cashier's window at a racetrack or casino, where you'd place a bet or cash in chips, except on a massive scale: BIS is where the U.S. settles trade imbalances with Saudi Arabia for all that oil we guzzle and gives China IOUs for the tainted drugs and lead-based toys we buy.
To grasp how significant this five-fold bubble increase is, let's put that $516 trillion in the context of some other domestic and international monetary data:
U.S. annual gross domestic product is about $15 trillion
U.S. money supply is also about $15 trillion
Current proposed U.S. federal budget is $3 trillion
U.S. government's maximum legal debt is $9 trillion
U.S. mutual fund companies manage about $12 trillion
World's GDPs for all nations is approximately $50 trillion
Unfunded Social Security and Medicare benefits $50 trillion to $65 trillion
Total value of the world's real estate is estimated at about $75 trillion
Total value of world's stock and bond markets is more than $100 trillion
BIS valuation of world's derivatives back in 2002 was about $100 trillion
BIS 2007 valuation of the world's derivatives is now a whopping $516 trillion
Moreover, the folks at BIS tell me their estimate of $516 trillion only includes "transactions in which a major private dealer (bank) is involved on at least one side of the transaction," but doesn't include private deals between two "non-reporting entities." They did, however, add that their reporting central banks estimate that the coverage of the survey is around 95% on average.
Also, keep in mind that while the $516 trillion "notional" value (maximum in case of a meltdown) of the deals is a good measure of the market's size, the 2007 BIS study notes that the $11 trillion "gross market values provides a more accurate measure of the scale of financial risk transfer taking place in derivatives markets."
Bubbles, domino effects and the 'bad 2%'
However, while that may be true as far as the parties to an individual deal, there are broader risks to the world's economies. Remember back in 1998 when LTCM's little $5 billion loss nearly brought down the world's banking system. That "domino effect" is now repeating many times over, straining the world's monetary, economic and political system as the subprime housing mess metastasizes, taking the U.S. stock market and the world economy down with it.
This cascading "domino effect" was brilliantly described in "The $300 Trillion Time Bomb: If Buffett can't figure out derivatives, can anybody?" published early last year in Portfolio magazine, a couple months before the subprime meltdown. Columnist Jesse Eisinger's $300 trillion figure came from an earlier study of the derivatives market as it was growing from $100 trillion to $516 trillion over five years. Eisinger concluded:
"There's nothing intrinsically scary about derivatives, except when the bad 2% blow up." Unfortunately, that "bad 2%" did blow up a few months afterwards, even as Bernanke and Paulson were assuring America that the subprime mess was "contained."
Bottom line: Little things leverage a heck of a big wallop. It only takes a little spark from a "bad 2% deal" to ignite this $516 trillion weapon of mass destruction. Think of this entire unregulated derivatives market like an unsecured, unpredictable nuclear bomb in a Pakistan stockpile. It's only a matter of time.
World's newest and biggest 'black market'
The fact is, derivatives have become the world's biggest "black market," exceeding the illicit traffic in stuff like arms, drugs, alcohol, gambling, cigarettes, stolen art and pirated movies. Why? Because like all black markets, derivatives are a perfect way of getting rich while avoiding taxes and government regulations. And in today's slowdown, plus a volatile global market, Wall Street knows derivatives remain a lucrative business.
Recently Pimco's bond fund king Bill Gross said "What we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August." In short, not only Warren Buffett, but Bond King Bill Gross, our Fed Chairman Ben Bernanke, the Treasury Secretary Henry Paulson and the rest of America's leaders can't "figure out" the world's $516 trillion derivatives.
Why? Gross says we are creating a new "shadow banking system." Derivatives are now not just risk management tools. As Gross and others see it, the real problem is that derivatives are now a new way of creating money outside the normal central bank liquidity rules. How? Because they're private contracts between two companies or institutions.
BIS is primarily a records-keeper, a toothless tiger that merely collects data giving a legitimacy and false sense of security to this chaotic "shadow banking system" that has become the world's biggest "black market."
That's crucial, folks. Why? Because central banks require reserves like stock brokers require margins, something backing up the transaction. Derivatives don't. They're not "real money." They're paper promises closer to "Monopoly" money than real U.S. dollars.
And it takes place outside normal business channels, out there in the "free market." That's the wonderful world of derivatives, and it's creating a massive bubble that could soon implode.
Comments? Yes, we want to hear your thoughts. Tell us what you think about derivatives: as "financial weapons of mass destruction;" as a "shadow banking system;" as a "black market;" as the next big bubble dangerously exposing us to that unpredictable "bad 2%."
10 March 2008
The dude on inflation
Paper money eventually returns to its intrinsic value ---- zero. Voltaire
A friend recently asked me when is a day or so longer than a few weeks? When the Dude says he'll write again within that time.
Another friend of mine, and all around bright fellow, has, through a few days of debate on the causes of rising prices, inspired me to finally start posting again.
I find it fascinating how different minds think about the same issue. The "bones of contention" in any debate, assuming (and this is a big IF) the issue has been properly defined, reveal the differing underlying beliefs.
After going back and forth on the issue of the necessary causes of rising prices, I saw his underlying assumption: some force, such as might occur if a market was "cornered," a la the Hunt's silver play of a few decades past, must come into play in order for prices to rise. Thus he kept, quite reasonably, under that view, asking for the mechanism that drove prices higher.
Throughout the exchange I found myself at something of a loss for words. It seemed obvious to me that prices should be rising, yet I couldn't explain the basis of my view to an inquiring mind. Finally, having spent a few days pondering why I thought higher prices were so obvious but he didn't, the answer came to me- he was assuming that the unit of account and medium of exchange was of stable value, while I had accepted Voltaire's view, above, as true- paper money, such as the US$, was returning to its intrinsic value, zero.
In my next response to him, I inverted the arrow of causality: The better question to ask is how the price (which is simply the relation of a good/service to a unit of account of minute intrinsic, but some implied value) of any good stays the same over time instead of rising. That seems to me a more difficult question to answer.
That is, in a fiat money system, price stability is a low entropy configuration requiring some enforcement to maintain, inflation, i.e. a shift in a currency's perceived value towards its intrinsic value, is a shift to a configuration of greater entropy.
For those unfamiliar with the concept, entropy can be thought to rise as potential dissipates. A state of higher entropy is, in a sense, more disordered than a state of lower entropy. The second law of thermodynamics states that the world acts spontaneously to minimize potentials- tends to a state of higher entropy. For instance, an ice cube placed on a table at room temperature will melt without being heated or a concentration of gas, perhaps enclosed in a chamber under the same pressure as the surrounding room, will diffuse through the room over time after the chamber is opened.
Voltaire's view, which I share, implies that some ordering force must be applied to maintain the value of paper money. Remove the ordering force and paper money will begin losing value just as the ice cube on the table in your room (assuming you can afford heating oil these days) will begin to melt if heat is not constantly drawn from it.
This line of thought reminded me of my recent read of Greenspan's The Age of Turbulence- particularly his oft expressed sense that a well functioning, efficient economy (however one might define such terms) was a "natural" occurrence, at least in the west, due, as he notes in relating his observations of Russia's shift to Capitalism, to our long standing traditions of valuing private property, etc. An inefficient economy in the US, according to Greenspan, is a result of restrictions or rules which impede the transition to its natural state. Free the markets, and, he avers, things will sort themselves out.
This runs counter to the second law of thermodynamics. Of course, we are not bits of ice or molecules of gas, thus this law should only be assumed to operate on our physical beings (for instance the entropic process by which every ordered biological entity is always tending to death and disintegration, mitigated only temporarily by regular additions of energy (food), water and air).
Yet, it seems to me one can imagine this law operating on cultures as well. As the fall of myriad cultures over history seems to attest, humans, barring organizing forces, (which might be internal, such as simple faith that "the system" is working, or external, such as the imposition of sanctions on certain behaviors, what we call the justice system) are always tending towards the "noble savage." Our current state of, despite the occasional war, and other atrocities, high level cooperation is the "un-natural" or low entropy state, always pregnant with a return to barbarism.
Returning to the topic at hand (I need to force myself to stop digressing, or expressing my natural mental entropy) it seems to me that Central Banking in America at least, has forgotten its primary function by assuming that zero inflation under a fiat money system was a "natural" result. The Fed or Treasury would need to "do something wrong" to ignite inflation.
Au contraire, say I, the natural value of these colored, variously numbered pieces of paper in my pocket is almost nil. The Fed needs to "do something right," i.e. enforce the view that paper money has value, in order to stop inflation from occurring. Acting as if external imbalances never need to be resolved, blocking the mortgage market from clearing, and cutting interest rates ever closer to zero (etc.) don't seem to me to be policies that will stall the now accelerating entropic process of the US$ finding its intrinsic value.
p.s. I'm not arguing that restrictions are necessarily a good thing, the fewer the better, so long as the really important ones, like maintaining a stable unit of account, are enforced.
A friend recently asked me when is a day or so longer than a few weeks? When the Dude says he'll write again within that time.
Another friend of mine, and all around bright fellow, has, through a few days of debate on the causes of rising prices, inspired me to finally start posting again.
I find it fascinating how different minds think about the same issue. The "bones of contention" in any debate, assuming (and this is a big IF) the issue has been properly defined, reveal the differing underlying beliefs.
After going back and forth on the issue of the necessary causes of rising prices, I saw his underlying assumption: some force, such as might occur if a market was "cornered," a la the Hunt's silver play of a few decades past, must come into play in order for prices to rise. Thus he kept, quite reasonably, under that view, asking for the mechanism that drove prices higher.
Throughout the exchange I found myself at something of a loss for words. It seemed obvious to me that prices should be rising, yet I couldn't explain the basis of my view to an inquiring mind. Finally, having spent a few days pondering why I thought higher prices were so obvious but he didn't, the answer came to me- he was assuming that the unit of account and medium of exchange was of stable value, while I had accepted Voltaire's view, above, as true- paper money, such as the US$, was returning to its intrinsic value, zero.
In my next response to him, I inverted the arrow of causality: The better question to ask is how the price (which is simply the relation of a good/service to a unit of account of minute intrinsic, but some implied value) of any good stays the same over time instead of rising. That seems to me a more difficult question to answer.
That is, in a fiat money system, price stability is a low entropy configuration requiring some enforcement to maintain, inflation, i.e. a shift in a currency's perceived value towards its intrinsic value, is a shift to a configuration of greater entropy.
For those unfamiliar with the concept, entropy can be thought to rise as potential dissipates. A state of higher entropy is, in a sense, more disordered than a state of lower entropy. The second law of thermodynamics states that the world acts spontaneously to minimize potentials- tends to a state of higher entropy. For instance, an ice cube placed on a table at room temperature will melt without being heated or a concentration of gas, perhaps enclosed in a chamber under the same pressure as the surrounding room, will diffuse through the room over time after the chamber is opened.
Voltaire's view, which I share, implies that some ordering force must be applied to maintain the value of paper money. Remove the ordering force and paper money will begin losing value just as the ice cube on the table in your room (assuming you can afford heating oil these days) will begin to melt if heat is not constantly drawn from it.
This line of thought reminded me of my recent read of Greenspan's The Age of Turbulence- particularly his oft expressed sense that a well functioning, efficient economy (however one might define such terms) was a "natural" occurrence, at least in the west, due, as he notes in relating his observations of Russia's shift to Capitalism, to our long standing traditions of valuing private property, etc. An inefficient economy in the US, according to Greenspan, is a result of restrictions or rules which impede the transition to its natural state. Free the markets, and, he avers, things will sort themselves out.
This runs counter to the second law of thermodynamics. Of course, we are not bits of ice or molecules of gas, thus this law should only be assumed to operate on our physical beings (for instance the entropic process by which every ordered biological entity is always tending to death and disintegration, mitigated only temporarily by regular additions of energy (food), water and air).
Yet, it seems to me one can imagine this law operating on cultures as well. As the fall of myriad cultures over history seems to attest, humans, barring organizing forces, (which might be internal, such as simple faith that "the system" is working, or external, such as the imposition of sanctions on certain behaviors, what we call the justice system) are always tending towards the "noble savage." Our current state of, despite the occasional war, and other atrocities, high level cooperation is the "un-natural" or low entropy state, always pregnant with a return to barbarism.
Returning to the topic at hand (I need to force myself to stop digressing, or expressing my natural mental entropy) it seems to me that Central Banking in America at least, has forgotten its primary function by assuming that zero inflation under a fiat money system was a "natural" result. The Fed or Treasury would need to "do something wrong" to ignite inflation.
Au contraire, say I, the natural value of these colored, variously numbered pieces of paper in my pocket is almost nil. The Fed needs to "do something right," i.e. enforce the view that paper money has value, in order to stop inflation from occurring. Acting as if external imbalances never need to be resolved, blocking the mortgage market from clearing, and cutting interest rates ever closer to zero (etc.) don't seem to me to be policies that will stall the now accelerating entropic process of the US$ finding its intrinsic value.
p.s. I'm not arguing that restrictions are necessarily a good thing, the fewer the better, so long as the really important ones, like maintaining a stable unit of account, are enforced.
The Face-Slap Theory
By PAUL KRUGMAN
Friday's employment report — which was so weak that it had many economists declaring that we're already in a recession — was bad news. But it was actually less disturbing than what's going on in the financial markets.
The scariest thing I've read recently is a speech given last week by Tim Geithner, the president of the Federal Reserve Bank of New York. Mr. Geithner came as close as a Fed official can to saying that we're in the midst of a financial meltdown.
To understand the gravity of the situation, you have to know what the Fed did last summer, and again last fall.
As late as August the favorite buzzword of financial officials was “contained”: problems in subprime mortgages, we were assured, wouldn't spread to other financial markets or to the economy as a whole.
Soon afterward, however, a full-fledged financial panic began. Investors pulled hundreds of billions of dollars out of asset-backed commercial paper, a little-known but important market that has taken over a lot of the work banks used to do. This de facto bank run sent shock waves through the financial system.
The Fed responded by rushing money to banks, and markets partially calmed down, for a little while. But by December the panic was back.
Again, the Fed responded by rushing money to banks, this time via a new arrangement called the Term Auction Facility. Again the markets calmed down, for a while.
But again, the respite was only temporary. Last month another market you've never heard of, the $300 billion market for auction-rate securities (don't ask), suffered the equivalent of a bank run. Last week two big financial companies announced that they had been unable to raise the cash demanded by their lenders. Even Fannie Mae and Freddie Mac, the giant government-sponsored mortgage agencies long regarded as safe places to put your money, are now having trouble attracting funds.
One consequence of the crisis is that while the Fed has been cutting the interest rate it controls — the so-called Fed funds rate — the rates that matter most directly to the economy, including rates on mortgages and corporate bonds, have been rising. And that's sure to worsen the economic downturn.
What's going on? Mr. Geithner described a vicious circle in which banks and other market players who took on too much risk are all trying to get out of unsafe investments at the same time, causing “significant collateral damage to market functioning.”
A report released last Friday by JPMorgan Chase was even blunter. It described what's happening as a “systemic margin call,” in which the whole financial system is facing demands to come up with cash it doesn't have. (A financial joke making the rounds, via the blog Calculated Risk: “Who is this guy Margin that keeps calling me?”)
The Fed's latest plan to break this vicious circle is — as the financial Web site interfluidity.com cruelly but accurately describes it — to turn itself into Wall Street's pawnbroker. Banks that might have raised cash by selling assets will be encouraged, instead, to borrow money from the Fed, using the assets as collateral. In a worst-case scenario, the Federal Reserve would find itself owning around $200 billion worth of mortgage-backed securities.
Some observers worry that the Fed is taking over the banks' financial risk. But what worries me more is that the move seems trivial compared with the size of the problem: $200 billion may sound like a lot of money, but when you compare it with the size of the markets that are melting down — there are $11 trillion in U.S. mortgages outstanding — it's a drop in the bucket.
The only way the Fed's action could work is through the slap-in-the-face effect: by creating a pause in the selling frenzy, the Fed could give hysterical markets a chance to regain their sense of perspective. And to be fair, that has worked in the past.
But slap-in-the-face only works if the market's problems are mainly a matter of psychology. And given that the Fed has already slapped the market in the face twice, only to see the financial crisis come roaring back, that's hard to believe.
The third time could be the charm. But I doubt it. Soon, we'll probably have to do something real about reducing the risks investors face.
A plan to restore the credibility of municipal bond insurance would be a start (how crazy is it that New York State, rather than the federal government, is taking the lead here?). I also suspect that the feds will have to get explicit about guaranteeing the debt of Fannie and Freddie, which really are too big to fail.
Nobody wants to put taxpayers on the hook for the financial industry's follies; we can all hope that, in the end, a bailout won't be necessary. But hope is not a plan.
Friday's employment report — which was so weak that it had many economists declaring that we're already in a recession — was bad news. But it was actually less disturbing than what's going on in the financial markets.
The scariest thing I've read recently is a speech given last week by Tim Geithner, the president of the Federal Reserve Bank of New York. Mr. Geithner came as close as a Fed official can to saying that we're in the midst of a financial meltdown.
To understand the gravity of the situation, you have to know what the Fed did last summer, and again last fall.
As late as August the favorite buzzword of financial officials was “contained”: problems in subprime mortgages, we were assured, wouldn't spread to other financial markets or to the economy as a whole.
Soon afterward, however, a full-fledged financial panic began. Investors pulled hundreds of billions of dollars out of asset-backed commercial paper, a little-known but important market that has taken over a lot of the work banks used to do. This de facto bank run sent shock waves through the financial system.
The Fed responded by rushing money to banks, and markets partially calmed down, for a little while. But by December the panic was back.
Again, the Fed responded by rushing money to banks, this time via a new arrangement called the Term Auction Facility. Again the markets calmed down, for a while.
But again, the respite was only temporary. Last month another market you've never heard of, the $300 billion market for auction-rate securities (don't ask), suffered the equivalent of a bank run. Last week two big financial companies announced that they had been unable to raise the cash demanded by their lenders. Even Fannie Mae and Freddie Mac, the giant government-sponsored mortgage agencies long regarded as safe places to put your money, are now having trouble attracting funds.
One consequence of the crisis is that while the Fed has been cutting the interest rate it controls — the so-called Fed funds rate — the rates that matter most directly to the economy, including rates on mortgages and corporate bonds, have been rising. And that's sure to worsen the economic downturn.
What's going on? Mr. Geithner described a vicious circle in which banks and other market players who took on too much risk are all trying to get out of unsafe investments at the same time, causing “significant collateral damage to market functioning.”
A report released last Friday by JPMorgan Chase was even blunter. It described what's happening as a “systemic margin call,” in which the whole financial system is facing demands to come up with cash it doesn't have. (A financial joke making the rounds, via the blog Calculated Risk: “Who is this guy Margin that keeps calling me?”)
The Fed's latest plan to break this vicious circle is — as the financial Web site interfluidity.com cruelly but accurately describes it — to turn itself into Wall Street's pawnbroker. Banks that might have raised cash by selling assets will be encouraged, instead, to borrow money from the Fed, using the assets as collateral. In a worst-case scenario, the Federal Reserve would find itself owning around $200 billion worth of mortgage-backed securities.
Some observers worry that the Fed is taking over the banks' financial risk. But what worries me more is that the move seems trivial compared with the size of the problem: $200 billion may sound like a lot of money, but when you compare it with the size of the markets that are melting down — there are $11 trillion in U.S. mortgages outstanding — it's a drop in the bucket.
The only way the Fed's action could work is through the slap-in-the-face effect: by creating a pause in the selling frenzy, the Fed could give hysterical markets a chance to regain their sense of perspective. And to be fair, that has worked in the past.
But slap-in-the-face only works if the market's problems are mainly a matter of psychology. And given that the Fed has already slapped the market in the face twice, only to see the financial crisis come roaring back, that's hard to believe.
The third time could be the charm. But I doubt it. Soon, we'll probably have to do something real about reducing the risks investors face.
A plan to restore the credibility of municipal bond insurance would be a start (how crazy is it that New York State, rather than the federal government, is taking the lead here?). I also suspect that the feds will have to get explicit about guaranteeing the debt of Fannie and Freddie, which really are too big to fail.
Nobody wants to put taxpayers on the hook for the financial industry's follies; we can all hope that, in the end, a bailout won't be necessary. But hope is not a plan.
9 March 2008
Aussie doze into disaster
Im even having problems with my own family trying to reign in a 15 year term family trust investment adviser (and family friend) with a stellar track history, while trying to convince my siblings that this is different and that funds that name themselves "conservative" are in fact prone to up to 50% losses in the next 12 months, the sentiment is Australia is still very adamant that this is just a correction and we will be back to growth in a few months
Its like running an election campaign :), but when you dissect the various funds make up, the reality I am finding is horrendously risky . There are funds actually called "conservative funds" lol, when you look below the covers you find that that some of the gearing approaches 50%, there are many folks in Australia that are going to lose a large portion of the superannuation (401k in US terms) and they charge fees between 2-4% annually even if they do lose most your money. Some of the strictly conservative funds hold stock like Macquarie Bank (one of the most highly leveraged investment banks in the world). Because its been such a performer over the last 15 years they perceive this as conservative !
All the research is teaching me how exposed most Australians are to the kind of "shock and awe" event that we have been discussing for the last few years. it almost impossible to get the investment profiles of these funds, so I have been doing it via forensically tracing the share registrars and sub notices etc folks like Colonial who say market a fund as so called "conservative" in order to chase returns have warped are basically overweight financial s, their investors are consoling are still consoling themselves by the so called "conservative" tags are showing 3 months losses of 13-25% and if our "good time" investment adviser is anything to go by they haven't gone much below the branding themselves.
Even the Aussie golds producers are exposed to massive leverage from these funds , we both know the history and volatility of the gold market, so many folk are leveraging themselves into gold stocks like Lihir and Newcrest and track gold via USD gold not realizing that AUD gold is showing half the USD return on gold than AUD over 10, 5 , 2, 1, 3mth periods . Folks are reading Sinclair, Puplava etc and not realisng that AUD currency strength is discounting returns by 50% and $1500 gold could be matched by 1.50 AUD by 2011.
The invest in the metal not the stock or at least diversify is totally lost on them.
Its going to be allot uglier than even I think we realized most Aussie investor have no idea how much they are about to lose.
Its like running an election campaign :), but when you dissect the various funds make up, the reality I am finding is horrendously risky . There are funds actually called "conservative funds" lol, when you look below the covers you find that that some of the gearing approaches 50%, there are many folks in Australia that are going to lose a large portion of the superannuation (401k in US terms) and they charge fees between 2-4% annually even if they do lose most your money. Some of the strictly conservative funds hold stock like Macquarie Bank (one of the most highly leveraged investment banks in the world). Because its been such a performer over the last 15 years they perceive this as conservative !
All the research is teaching me how exposed most Australians are to the kind of "shock and awe" event that we have been discussing for the last few years. it almost impossible to get the investment profiles of these funds, so I have been doing it via forensically tracing the share registrars and sub notices etc folks like Colonial who say market a fund as so called "conservative" in order to chase returns have warped are basically overweight financial s, their investors are consoling are still consoling themselves by the so called "conservative" tags are showing 3 months losses of 13-25% and if our "good time" investment adviser is anything to go by they haven't gone much below the branding themselves.
Even the Aussie golds producers are exposed to massive leverage from these funds , we both know the history and volatility of the gold market, so many folk are leveraging themselves into gold stocks like Lihir and Newcrest and track gold via USD gold not realizing that AUD gold is showing half the USD return on gold than AUD over 10, 5 , 2, 1, 3mth periods . Folks are reading Sinclair, Puplava etc and not realisng that AUD currency strength is discounting returns by 50% and $1500 gold could be matched by 1.50 AUD by 2011.
The invest in the metal not the stock or at least diversify is totally lost on them.
Its going to be allot uglier than even I think we realized most Aussie investor have no idea how much they are about to lose.
8 March 2008
Blowed up real good
March 07, 2008
"Stability is destabilizing" - Hyman Minsky
Before I became a wheeler-dealer online stock trader (eight years paycheck free!), I made my living building and running large computer models of oceans and atmospheres. The bigger and more complex the model, the greater the chance of "something going wrong" (i.e. the model becoming numerically unstable). This means some or many of the model values would go to infinity, whereupon the programs would halt.
It was a numerical, not a physics, problem. Though journal editors didn't like me describing how some particular model had "blowed up real good", they had started generating values (of say velocity) which went exponentially larger in an explosive way.
Typically, just before the models would go berserk, they would start exhibiting unusual behaviour. This meant they would develop swings in value, both in time and in "neighbouring" grid points. The swings would amplify and then something else would go unstable. Things that shouldn't correlate (move together) often started to quite strongly.
All manner of models are susceptible, and making them larger often didn't help. Global fluid models can go unstable just as easily as closed ones.
So, I would then look over the models, and then try to enhance, damp, smooth, decorrelate, or whatever, to try and get the models to work. It wasn't easy, and certain aspects of fluid modelling are considered insoluble. You just have to try and minimize the damage and get the things working.
When I left the field after cashing in on (or more correctly out of) the Tech Boom of the late nineties, I thought I was done with numerical instability. Which brings us to the main point; timeseries of financial instruments are starting to look a lot like those fluid models about to go unstable.
Bonds drop a point in one day, recover the next, silver drops 30 cents as funds exit en masse, and so on. The financial model analogy is not so far fetched. There are hundreds, if not thousands, of computers doing dynamic risk hedging every day of the week, all interacting and buying and selling protection of one sort or another.
There are hedge funds trading hundreds of billions of dollars in a heartbeat waiting to jump on the next trend. Governments of all size are trying to "do something" to manipulate their currencies and respective economies. It's a potent combination, and getting bigger every day. And previously "uncorrelated" financial instruments of many kinds suddenly are. Quite strongly.
One of the recent advances made in fluid numerical modelling was stability analysis. You'd look at the equations and the way they were implemented and look for unstable "modes". This was often done after a particular mode had made it's presence known in a more painful way. And, as the models got more complex, so did the stability analysis to the point where it really wasn't of much help.
The models I ran could therefore go unstable purely by their own internal structure. Run along fine for a while, and then,"pffft", off they'd go. No external shock was needed to get the ball rolling. Equivalently, the 10 sigma event which may create financial havoc may lie within.
In ocean modelling, it is possible to smooth out bottom topography, limit changes in model variables to small increments, and force conditions back to "long term averages". The price paid for such levels of adjustment is that you are effectively introducing fictitious forces, and the models then often bear little resemblance to reality.
Financial markets, unfortunately, also look a lot like these kinds of models at times. The heavy hand of stability has been all too evident in the financial markets (e.g. volatility indices) the past few years, to the point where the "real" economy is probably totally skewed.
As an another example, in the book "Competion" by James Case, there is a reproduction of Senator Moynihan's argument against the balanced budget proposal of the 1980's. It shows 100 years of US GDP growth smoothed out after WW II with the introduction of Keynesian stimulus. This has been trumpeted as a good thing. I wonder. When I did similar things in the models, it oftentimes meant that the imbalances responsible for the natural variability built up over time. Then they became a bigger problem.
The ultimate cause of the problems in fluid models is limitations of computer size and speed . You have to represent the aggregate of all the fluid processes in a particular (often spatially large) grid box to a few numbers. The real world "sorts itself out" on smaller scales not resolved by the computer models.
The equivalent financial problem today is too much wealth and power in too few hands. The system accomodates the accumulation of great wealth, and legislation designed to prevent financial excesses has all but been eliminated.
There are now few "independent" economies or other anchors (like gold used to be) which could counterbalance a disruption in another area. And this hugely macro economy has been stabilized all too well to the point where the building imbalances may ensure that "something's gotta give".
And how, pray tell, does this help us make better investment decisions? Well first, you can probably count on a whole lot more volatility ahead. It isn't a time to be sticking your financial neck out to the point where a sudden wild swing can wipe you out. One strike and you're out in this league. Margin bad, liquidity good.
Dave Ramsden
Second, the financial "mode" which ultimately "goes exponential" may never be fully identified. There's no point trying to understand potential causation. "Safe" financial strategies may backfire as easily as "risky" ones. Stay flexible.
Third, big models are the sum of a lot of smaller, separate processes. After a period of huge frustration, we'd often break the models down into simpler, localized versions and try to understand and cure the problems there. Often, that was all we could do. Some bigger models never did work.
Led by cheap energy and technological advances, a long period of economic integration is now under stress. I see a potential process of dis-integration ahead. Lots of "paper promises" by large institutions are breaking down. There've been recent recent bank runs and halts on fund redemptions. The underlying economic model shows signs of breaking down (or breaking up).
Big institutions are under pressure to prevent a global meltdown. Personally, I see the unfolding crisis as beyond anyone's understanding or control. That's certainly what the timeseries data says to my eye. How bad the crisis will get, what form it will take, or how long to unfold are anybody's guesses, but I wouldn't count on government to supply your basic needs in ten years or so.
So, be prepared for a return of the 70's catch phrase "small is beautiful", only in this case, it might be more akin to "small is all we got". Who knows how local economies will need to get to reach sustainable equilibria.
And, if things get really bad, prepare yourself to participate in a very local economy, so have resources close to hand. Your financial institution may not answer the phone one day, so have some of your assets in real, physical form.
The adjustment to a new economic world will take a while. Problem solvers, like investors, are going to have to come to their senses one at a time. Big economies are ultimately built out of small, resilient ones, and a lot of competitive smaller players would really help the process.
Maybe by then there'll be a new macro paradigm to replace the discredited ones, with even some Minsky baked into official economic models. Ones that won't blow up real good.
"Stability is destabilizing" - Hyman Minsky
Before I became a wheeler-dealer online stock trader (eight years paycheck free!), I made my living building and running large computer models of oceans and atmospheres. The bigger and more complex the model, the greater the chance of "something going wrong" (i.e. the model becoming numerically unstable). This means some or many of the model values would go to infinity, whereupon the programs would halt.
It was a numerical, not a physics, problem. Though journal editors didn't like me describing how some particular model had "blowed up real good", they had started generating values (of say velocity) which went exponentially larger in an explosive way.
Typically, just before the models would go berserk, they would start exhibiting unusual behaviour. This meant they would develop swings in value, both in time and in "neighbouring" grid points. The swings would amplify and then something else would go unstable. Things that shouldn't correlate (move together) often started to quite strongly.
All manner of models are susceptible, and making them larger often didn't help. Global fluid models can go unstable just as easily as closed ones.
So, I would then look over the models, and then try to enhance, damp, smooth, decorrelate, or whatever, to try and get the models to work. It wasn't easy, and certain aspects of fluid modelling are considered insoluble. You just have to try and minimize the damage and get the things working.
When I left the field after cashing in on (or more correctly out of) the Tech Boom of the late nineties, I thought I was done with numerical instability. Which brings us to the main point; timeseries of financial instruments are starting to look a lot like those fluid models about to go unstable.
Bonds drop a point in one day, recover the next, silver drops 30 cents as funds exit en masse, and so on. The financial model analogy is not so far fetched. There are hundreds, if not thousands, of computers doing dynamic risk hedging every day of the week, all interacting and buying and selling protection of one sort or another.
There are hedge funds trading hundreds of billions of dollars in a heartbeat waiting to jump on the next trend. Governments of all size are trying to "do something" to manipulate their currencies and respective economies. It's a potent combination, and getting bigger every day. And previously "uncorrelated" financial instruments of many kinds suddenly are. Quite strongly.
One of the recent advances made in fluid numerical modelling was stability analysis. You'd look at the equations and the way they were implemented and look for unstable "modes". This was often done after a particular mode had made it's presence known in a more painful way. And, as the models got more complex, so did the stability analysis to the point where it really wasn't of much help.
The models I ran could therefore go unstable purely by their own internal structure. Run along fine for a while, and then,"pffft", off they'd go. No external shock was needed to get the ball rolling. Equivalently, the 10 sigma event which may create financial havoc may lie within.
In ocean modelling, it is possible to smooth out bottom topography, limit changes in model variables to small increments, and force conditions back to "long term averages". The price paid for such levels of adjustment is that you are effectively introducing fictitious forces, and the models then often bear little resemblance to reality.
Financial markets, unfortunately, also look a lot like these kinds of models at times. The heavy hand of stability has been all too evident in the financial markets (e.g. volatility indices) the past few years, to the point where the "real" economy is probably totally skewed.
As an another example, in the book "Competion" by James Case, there is a reproduction of Senator Moynihan's argument against the balanced budget proposal of the 1980's. It shows 100 years of US GDP growth smoothed out after WW II with the introduction of Keynesian stimulus. This has been trumpeted as a good thing. I wonder. When I did similar things in the models, it oftentimes meant that the imbalances responsible for the natural variability built up over time. Then they became a bigger problem.
The ultimate cause of the problems in fluid models is limitations of computer size and speed . You have to represent the aggregate of all the fluid processes in a particular (often spatially large) grid box to a few numbers. The real world "sorts itself out" on smaller scales not resolved by the computer models.
The equivalent financial problem today is too much wealth and power in too few hands. The system accomodates the accumulation of great wealth, and legislation designed to prevent financial excesses has all but been eliminated.
There are now few "independent" economies or other anchors (like gold used to be) which could counterbalance a disruption in another area. And this hugely macro economy has been stabilized all too well to the point where the building imbalances may ensure that "something's gotta give".
And how, pray tell, does this help us make better investment decisions? Well first, you can probably count on a whole lot more volatility ahead. It isn't a time to be sticking your financial neck out to the point where a sudden wild swing can wipe you out. One strike and you're out in this league. Margin bad, liquidity good.
Dave Ramsden
Second, the financial "mode" which ultimately "goes exponential" may never be fully identified. There's no point trying to understand potential causation. "Safe" financial strategies may backfire as easily as "risky" ones. Stay flexible.
Third, big models are the sum of a lot of smaller, separate processes. After a period of huge frustration, we'd often break the models down into simpler, localized versions and try to understand and cure the problems there. Often, that was all we could do. Some bigger models never did work.
Led by cheap energy and technological advances, a long period of economic integration is now under stress. I see a potential process of dis-integration ahead. Lots of "paper promises" by large institutions are breaking down. There've been recent recent bank runs and halts on fund redemptions. The underlying economic model shows signs of breaking down (or breaking up).
Big institutions are under pressure to prevent a global meltdown. Personally, I see the unfolding crisis as beyond anyone's understanding or control. That's certainly what the timeseries data says to my eye. How bad the crisis will get, what form it will take, or how long to unfold are anybody's guesses, but I wouldn't count on government to supply your basic needs in ten years or so.
So, be prepared for a return of the 70's catch phrase "small is beautiful", only in this case, it might be more akin to "small is all we got". Who knows how local economies will need to get to reach sustainable equilibria.
And, if things get really bad, prepare yourself to participate in a very local economy, so have resources close to hand. Your financial institution may not answer the phone one day, so have some of your assets in real, physical form.
The adjustment to a new economic world will take a while. Problem solvers, like investors, are going to have to come to their senses one at a time. Big economies are ultimately built out of small, resilient ones, and a lot of competitive smaller players would really help the process.
Maybe by then there'll be a new macro paradigm to replace the discredited ones, with even some Minsky baked into official economic models. Ones that won't blow up real good.
7 March 2008
Jim Willie nails it..
- Posted Friday, 7 March 2008 | Digg This Article | Source: GoldSeek.com
The title should really be “Psychology of 1000-20-100” to give respect to the major signpost price targets. The $1000 gold target is within reach. The $20 silver target has been breached. The $100 crude oil price has been breached. Before long, all three price levels will serve as support. When a gold target of $1000 was proposed three to four years ago, most people dominated (or bound) by conventional thinking dismissed such talk as silly, irresponsible, even ludicrous. Not any more! The same goes for silver and crude oil with their respective distant price targets, each attained. Profound market psychology is in the process of changing. Many new wrong analyses will come to the table, like so many casseroles containing rancid meat and rotten vegetables as ingredients. They will maintain that now these three goals have been met, the great selloff can begin. They will be dead wrong. The great commodity bull market is entering into its second crucial phase, marked by a failing US financial system, a USDollar in freefall, an insolvent US banking system, a perfect storm in US housing, the beginning of an endless USEconomic recession, inept banking leadership, and equally bankrupt economic stewardship. As the futility of policy measures becomes recognized, as rescue packages have almost no effect, as various markets refuse to stabilize, the gold price will rise further. In time the steps will be massive, like $100 in a single day. My guess is the year 2009 will see such days. Already, in the last two weeks we have been treated to two different days with at least a $1 range in the silver price. Volatility is here, to the upside, crushing shorts, lifting spirits for bulls.
PERFECT STORM DEVELOPS
Numerous vicious cycles have begun to strike at the core of the US system, both the economy and the banking system. They are each powerful. They will not relent. They will inflict horrendous damage. They will rip apart the ramparts of the USEconomy, then the fabric of American life. My colleague Roger Wiegand has been vocal in his dire warnings, one of few who see the upcoming carnage, disruption, and chaos. When people ask whether the USDollar has hit bottom, a simple question goes out as my reply. HAS ANYTHING BEEN FIXED? HAVE ALL DESPERATE MEASURES BEEN INVOKED? The answer to the first question is NO WAY! and to the second question NOT EVEN CLOSE! So the declines will continue, as US economic, banking, and political leaders squirm in reaction to utter futility in their policies to date, and continued futility in their upcoming policies. Their errors are many, in prescribing solutions which are more of the same inflationary wallpaper, which demonstrate no conceivable depth of understanding for the corner they have painted the United States into. YOU CANNOT FIX INFLATION PROBLEMS WITH MORE INFLATION, any more than you can treat an alcoholic with a morning whisky chaser! This 2008 year the system breaks, and it is breaking on almost all fronts. Feedback loops are kicking into gear, and they are incredibly powerful, vicious, and difficult to interrupt.
During my 20 years in Boston, on at least four or five occasions, residents were treated to Nor’Easters, nasty storms off the Atlantic Coast that resembles an egg beater. Storms would lift moisture from the ocean, circulate air in the upper lofts, as warm air current would come north from New York, cold air would come south from Montreal, and heavy water-filled air would come east from the ocean itself. Storms would sometimes last for days on end, dumping wave after wave of snow. The most beautiful aspect of the storms in my view was the bluish hue of the snow itself, having taken and deposited blue algae from the ocean water. In certain sunlight afterward, the awesome display of nature was something to behold. The Nor’Easter storm was a vicious circle. People would ask if the storm would ever end. Eventually, one of the three directions of wind strength would prevail, usually the south along the eastern seaboard. My imagination marvels at the power of nature embedded in rare weather systems. In the last few years, other vicious cycles have captured my attention. The Halloween Nor’Easter off the east coast in November 1991 was devastating (shown below). Its story was told in a movie called The Perfect Storm in 2000. This killer storm was an unusual Nor’easter that escaped the tropical zone, absorbed one hurricane, and ultimately evolved into a small hurricane late in its life cycle. Damage totaled $208 million while the death toll climbed to 12 people. The hurricane was the second costliest storm of the season, behind only Hurricane Bob.
VICIOUS CYCLES ENGAGE
The HOUSING vicious cycle will ensure steady decline in home prices. Numerous factors are at work to keep the damaging process caught in cycle after cycle. Questions continue on whether the worst is over for housing. The answer is NO.
The BANK vicious cycle will ensure steady losses in bonds and portfolios. Numerous factors are at work to keep the damaging process caught in cycle after cycle. Questions continue on whether the worst is over for banking. The answer is NO.
The RECESSION vicious cycle will ensure steady decline in USDollar value, since it is the stock of the Untied States. Numerous factors are at work to keep the damaging process caught in cycle after cycle. Questions continue on whether the worst is over for the USEconomy. The answer is NO.
DEVASTATING EFFECT
The end result of these vicious cycles is round after round of harmful blows to the USDollar. A perfect storm has fully developed. After forming, it is gathering power. The psychology behind the storm becomes intense when the feedback loops become clear. Remarkably, parallel vicious cycles work to render horrible damage on both the tangible economy, with the housing market as foundation, and the financial sector, with the banking industry as foundation. Reaction by the financial markets to the US housing market decline, the US bank system meltdown, and the USEconomic recession, whose collective report card will increasingly be perceived through the USDollar lens, might resemble what is seen in the movie by actors heart-throb George Clooney and bad boy Mark Wahlberg. Giant waves overtake their tiny fishing vessel, much like similar images of FOREX waves of US$ exchange rate declines overwhelming the USEconomy. Never does prosperity come amidst a powerful currency decline. Instead of slower economic growth bringing down prices, the opposite will occur. The falling USDollar will force commodity and energy prices higher, the ugly consequence of decades of import dependence. Most economic policy directed by US banking and political leaders has fostered that dependence. Case in point is rising gasoline prices, amidst falling volume demand!!! Bernanke has it wrong. Next comes picking the rancid fruit from the withered industrial vines.
The final arbiter will be the gold price, along with its sibling the silver price. Great difficulty comes in fighting US giant corporations. The big US banks freely sell fraudulent bonds on a global scale with impunity, protected by the USGovt and US Congress. The big US corporations enjoy advantages with capitalization from a brisk bond and stock market, from size, and from the ability to subsidize losses. Mostly honest firms, they are hard to compete against. However, Microsoft does stand out, with a recent $1.35 billion fine imposed by the European Commission for chronic foul play of some monopoly shade. Microsoft treats the string of similar rulings with contempt, regarding such levies as mere cost of doing business. The big US Military cannot be opposed on its terms, but can suffer from being bogged down in guerrilla wars, not to mention the devastating ignored effects of sand damage. That leaves the USDollar as the remaining vulnerable to wave after wave of selling, from foreign disgust, utter shock over the seemingly unstoppable deterioration, and basic good judgment to sell the stock in “USA Inc” which is the USDollar itself. The reality is that the Untied States are gradually morphing into a Third World nation, complete with a puppet leadership.
A bearish triangle was much more prominent within what mistakenly was identified as a double bottom reversal pattern. The primary trend exerted itself in strong terms. The breakdown was sudden. The 20-week moving average proved formidable as resistance. USFed Chairman Bernanke and the minion knights of his Knothead Table gave a full green light for continued interest rate cuts, acknowledging the USEconomic distress, fully aware of the bank insolvency. They recklessly opened the door to heavy volume USDollar sales. The world noticed, did not blink, and hit the SELL button. Buttressed by continued monetary ease, unleashed waves of monetary inflation, complete with attendant rabid price inflation, factors behind the gold bull are increasing in number. Gold will surpass the $1000 mark within weeks. Continue to watch silver, whose ratio with gold will surely improve. In other words, silver gains will outpace those of gold. The desperate central banks have no silver to dump on the market.
By the way, the announcement of Intl Monetary Fund gold sales is huge bullish. The Swiss announcement of heavy gold sales last summer was also bullish. These are desperate signals, as they are running out of gold bullion to dump. IN BASIC TERMS, THEY ARE DESPERATE. The Euro Central Bank will be the last to cut official interest rates. The gold bull will return to European shores sooner than Trichet might expect. That event will usher in the gold price vaulting past the millennium mark.
The title should really be “Psychology of 1000-20-100” to give respect to the major signpost price targets. The $1000 gold target is within reach. The $20 silver target has been breached. The $100 crude oil price has been breached. Before long, all three price levels will serve as support. When a gold target of $1000 was proposed three to four years ago, most people dominated (or bound) by conventional thinking dismissed such talk as silly, irresponsible, even ludicrous. Not any more! The same goes for silver and crude oil with their respective distant price targets, each attained. Profound market psychology is in the process of changing. Many new wrong analyses will come to the table, like so many casseroles containing rancid meat and rotten vegetables as ingredients. They will maintain that now these three goals have been met, the great selloff can begin. They will be dead wrong. The great commodity bull market is entering into its second crucial phase, marked by a failing US financial system, a USDollar in freefall, an insolvent US banking system, a perfect storm in US housing, the beginning of an endless USEconomic recession, inept banking leadership, and equally bankrupt economic stewardship. As the futility of policy measures becomes recognized, as rescue packages have almost no effect, as various markets refuse to stabilize, the gold price will rise further. In time the steps will be massive, like $100 in a single day. My guess is the year 2009 will see such days. Already, in the last two weeks we have been treated to two different days with at least a $1 range in the silver price. Volatility is here, to the upside, crushing shorts, lifting spirits for bulls.
PERFECT STORM DEVELOPS
Numerous vicious cycles have begun to strike at the core of the US system, both the economy and the banking system. They are each powerful. They will not relent. They will inflict horrendous damage. They will rip apart the ramparts of the USEconomy, then the fabric of American life. My colleague Roger Wiegand has been vocal in his dire warnings, one of few who see the upcoming carnage, disruption, and chaos. When people ask whether the USDollar has hit bottom, a simple question goes out as my reply. HAS ANYTHING BEEN FIXED? HAVE ALL DESPERATE MEASURES BEEN INVOKED? The answer to the first question is NO WAY! and to the second question NOT EVEN CLOSE! So the declines will continue, as US economic, banking, and political leaders squirm in reaction to utter futility in their policies to date, and continued futility in their upcoming policies. Their errors are many, in prescribing solutions which are more of the same inflationary wallpaper, which demonstrate no conceivable depth of understanding for the corner they have painted the United States into. YOU CANNOT FIX INFLATION PROBLEMS WITH MORE INFLATION, any more than you can treat an alcoholic with a morning whisky chaser! This 2008 year the system breaks, and it is breaking on almost all fronts. Feedback loops are kicking into gear, and they are incredibly powerful, vicious, and difficult to interrupt.
During my 20 years in Boston, on at least four or five occasions, residents were treated to Nor’Easters, nasty storms off the Atlantic Coast that resembles an egg beater. Storms would lift moisture from the ocean, circulate air in the upper lofts, as warm air current would come north from New York, cold air would come south from Montreal, and heavy water-filled air would come east from the ocean itself. Storms would sometimes last for days on end, dumping wave after wave of snow. The most beautiful aspect of the storms in my view was the bluish hue of the snow itself, having taken and deposited blue algae from the ocean water. In certain sunlight afterward, the awesome display of nature was something to behold. The Nor’Easter storm was a vicious circle. People would ask if the storm would ever end. Eventually, one of the three directions of wind strength would prevail, usually the south along the eastern seaboard. My imagination marvels at the power of nature embedded in rare weather systems. In the last few years, other vicious cycles have captured my attention. The Halloween Nor’Easter off the east coast in November 1991 was devastating (shown below). Its story was told in a movie called The Perfect Storm in 2000. This killer storm was an unusual Nor’easter that escaped the tropical zone, absorbed one hurricane, and ultimately evolved into a small hurricane late in its life cycle. Damage totaled $208 million while the death toll climbed to 12 people. The hurricane was the second costliest storm of the season, behind only Hurricane Bob.
VICIOUS CYCLES ENGAGE
The HOUSING vicious cycle will ensure steady decline in home prices. Numerous factors are at work to keep the damaging process caught in cycle after cycle. Questions continue on whether the worst is over for housing. The answer is NO.
The BANK vicious cycle will ensure steady losses in bonds and portfolios. Numerous factors are at work to keep the damaging process caught in cycle after cycle. Questions continue on whether the worst is over for banking. The answer is NO.
The RECESSION vicious cycle will ensure steady decline in USDollar value, since it is the stock of the Untied States. Numerous factors are at work to keep the damaging process caught in cycle after cycle. Questions continue on whether the worst is over for the USEconomy. The answer is NO.
DEVASTATING EFFECT
The end result of these vicious cycles is round after round of harmful blows to the USDollar. A perfect storm has fully developed. After forming, it is gathering power. The psychology behind the storm becomes intense when the feedback loops become clear. Remarkably, parallel vicious cycles work to render horrible damage on both the tangible economy, with the housing market as foundation, and the financial sector, with the banking industry as foundation. Reaction by the financial markets to the US housing market decline, the US bank system meltdown, and the USEconomic recession, whose collective report card will increasingly be perceived through the USDollar lens, might resemble what is seen in the movie by actors heart-throb George Clooney and bad boy Mark Wahlberg. Giant waves overtake their tiny fishing vessel, much like similar images of FOREX waves of US$ exchange rate declines overwhelming the USEconomy. Never does prosperity come amidst a powerful currency decline. Instead of slower economic growth bringing down prices, the opposite will occur. The falling USDollar will force commodity and energy prices higher, the ugly consequence of decades of import dependence. Most economic policy directed by US banking and political leaders has fostered that dependence. Case in point is rising gasoline prices, amidst falling volume demand!!! Bernanke has it wrong. Next comes picking the rancid fruit from the withered industrial vines.
The final arbiter will be the gold price, along with its sibling the silver price. Great difficulty comes in fighting US giant corporations. The big US banks freely sell fraudulent bonds on a global scale with impunity, protected by the USGovt and US Congress. The big US corporations enjoy advantages with capitalization from a brisk bond and stock market, from size, and from the ability to subsidize losses. Mostly honest firms, they are hard to compete against. However, Microsoft does stand out, with a recent $1.35 billion fine imposed by the European Commission for chronic foul play of some monopoly shade. Microsoft treats the string of similar rulings with contempt, regarding such levies as mere cost of doing business. The big US Military cannot be opposed on its terms, but can suffer from being bogged down in guerrilla wars, not to mention the devastating ignored effects of sand damage. That leaves the USDollar as the remaining vulnerable to wave after wave of selling, from foreign disgust, utter shock over the seemingly unstoppable deterioration, and basic good judgment to sell the stock in “USA Inc” which is the USDollar itself. The reality is that the Untied States are gradually morphing into a Third World nation, complete with a puppet leadership.
A bearish triangle was much more prominent within what mistakenly was identified as a double bottom reversal pattern. The primary trend exerted itself in strong terms. The breakdown was sudden. The 20-week moving average proved formidable as resistance. USFed Chairman Bernanke and the minion knights of his Knothead Table gave a full green light for continued interest rate cuts, acknowledging the USEconomic distress, fully aware of the bank insolvency. They recklessly opened the door to heavy volume USDollar sales. The world noticed, did not blink, and hit the SELL button. Buttressed by continued monetary ease, unleashed waves of monetary inflation, complete with attendant rabid price inflation, factors behind the gold bull are increasing in number. Gold will surpass the $1000 mark within weeks. Continue to watch silver, whose ratio with gold will surely improve. In other words, silver gains will outpace those of gold. The desperate central banks have no silver to dump on the market.
By the way, the announcement of Intl Monetary Fund gold sales is huge bullish. The Swiss announcement of heavy gold sales last summer was also bullish. These are desperate signals, as they are running out of gold bullion to dump. IN BASIC TERMS, THEY ARE DESPERATE. The Euro Central Bank will be the last to cut official interest rates. The gold bull will return to European shores sooner than Trichet might expect. That event will usher in the gold price vaulting past the millennium mark.
4 March 2008
Ebola of the Financial kind
March 3 (Bloomberg) -- The extra yields investors demand on bonds backed by assets from commercial mortgages to credit cards rose to records last week, as the debt-market slump prompted banks, hedge funds and other investors to shun the securities.
The extra yields, or spreads, over benchmarks have surged since mid-2007 as a weakening U.S. economy erodes confidence in the bonds' credit quality and as losses on debt investments lead to forced sales and reduced demand. The spread widening may herald more losses for the world's largest banks, which have reported more than $180 billion in mortgage-related losses.
``People are calling it financial Ebola,'' Ed Steffelin, a senior managing director at GSC Group in New York, said in a telephone interview last week, referring to the deadly, contagious virus named after the Ebola River Valley in the Democratic Republic of the Congo.
Yields on three-year, AAA rated credit-card bonds with floating rates rose to 75 basis points over the London interbank offered rate, up from 40 basis points at the start of the year, according to Deutsche Bank AG data. Spreads over three-year swap rates for three-year, AAA rated fixed-rate auto-loan securities rose to 140 basis points, up from 75 basis points. The average spread over U.S. Treasuries on AAA rated commercial-mortgage securities climbed to 364 basis points, from 167 basis points on Dec. 31, according to Lehman Brothers Holdings Inc. index data.
A basis point is 0.01 percentage point.
Subprime Bonds
Deerfield Capital Corp., a Chicago-based investor in mortgage- and asset-backed bonds, last week said it's sold ``substantially all,'' or $1.3 billion, of its residential bonds that lack guarantees from government-linked entities such as Washington-based Fannie Mae this year through Feb. 15.
The company needed to ``increase our liquidity position'' at a faster pace than originally planned as prices fell for the securities, which Deerfield used as collateral for loans, Chief Executive Officer Jonathan Trutter said in a Feb. 29 statement. Deerfield reported a $110 million fourth-quarter loss and sold the securities this quarter at a loss of about $152 million.
Spreads for three-year AAA bonds backed by U.S. subprime or home-equity loans rose to 380 basis points, up from 250 basis points, according to Deutsche Bank, Germany's biggest bank. Default rates on subprime mortgages, sold to borrowers with poor credit or high debt, have surged to records.
Commercial Mortgages
Such securities lost 5.9 percent last month, when price drops and interest payments are considered, according to Lehman Brothers data. They have cost investors 9.3 percent so far this year and 18.1 percent over the past 12 months.
It's become difficult, if not impossible, for investors to determine how much holdings of mortgage- or asset-backed bonds are worth because new issuance and trading has nearly ceased, according to bond buyers such as Sanjeev Handa, head of global public markets at TIAA-CREF, and Thornburg Mortgage Inc., the Santa Fe, New Mexico-based mortgage investor.
AAA rated commercial-mortgage securities slumped 3.5 percent last month and have dropped 4.7 percent so far this year, according to a Lehman Brothers index. AA securities fell 10.3 percent in February and have lost 15.6 percent this year, according to an index from the New York-based company.
Top-rated credit-card and auto securities last month returned 0.04 percent and 0.06 percent, respectively, according to Lehman. They've returned 1.9 percent and 0.79 percent this year. Swap rates are the fixed yields paid in return for floating-rate payments based on short-term interest rates.
Underscoring how credit-concerns are only one issue for securitized debt, spreads over the 3-month Libor on AAA rated, two-year bonds backed by government-guaranteed student loans entered this month at 60 basis points, up from 40 basis points at the end of 2007, according to Deutsche Bank data.
European Spreads
Spreads on European securities also jumped again last month, according to a Merrill Lynch & Co. report today. Reaching new highs were: AAA bonds comprised of U.K. prime mortgages, credit cards, and commercial mortgages; Dutch home mortgages; and ``eurozone'' auto loans. Some spreads were in or near ``improbable three-digit territory,'' compared with less than 25 basis points a year earlier, the report said.
The widening has been ``in almost complete disregard for credit fundamentals in Europe,'' analysts including Altynay Davletova, Caspar Cook and Alexander Batchvarov wrote.
Peloton Partners LLP, the London-based hedge-fund manager, said last week that tumbling prices for U.S. home-loan securities and ``severely tightening terms'' on bond-secured lending from banks is forcing it to liquidate a $1.8 billion asset-backed fund.
Margin Calls
The fund owned about $17 billion of securities backed by Alt-A, subprime and other U.S. mortgage debt, along with bets against about $6 billion of subprime-loan bonds, according to people who have seen the firm's positions. Alt-A mortgages fall between prime and subprime loans in terms of expected defaults.
Deerfield said last week that some banks have stopped lending against mortgage securities -- even the bonds backed by non-subprime loans that the company owned -- while other lenders have ``significantly'' increased collateral demands.
Thornburg, which today said it's failed to meet $270 million of margin calls, said last week that AAA rated Alt-A mortgage securities tumbled 10 percent to 15 percent in the first 27 days of February. Mortgage-bond prices fell further in the last two days of the month, the company said today.
Goldman Sachs Group Inc., Morgan Stanley, Lehman Brothers, Bear Stearns Cos. and Merrill Lynch today had their profit estimates for 2008 and 2009 cut by Sanford C. Bernstein & Co.'s Brad Hintz, who cited more writedowns for the world's largest securities firms and a market recovery that may take three years. In the last two weeks, at least seven analysts have cut their first-quarter profit estimates for the brokers.
The extra yields, or spreads, over benchmarks have surged since mid-2007 as a weakening U.S. economy erodes confidence in the bonds' credit quality and as losses on debt investments lead to forced sales and reduced demand. The spread widening may herald more losses for the world's largest banks, which have reported more than $180 billion in mortgage-related losses.
``People are calling it financial Ebola,'' Ed Steffelin, a senior managing director at GSC Group in New York, said in a telephone interview last week, referring to the deadly, contagious virus named after the Ebola River Valley in the Democratic Republic of the Congo.
Yields on three-year, AAA rated credit-card bonds with floating rates rose to 75 basis points over the London interbank offered rate, up from 40 basis points at the start of the year, according to Deutsche Bank AG data. Spreads over three-year swap rates for three-year, AAA rated fixed-rate auto-loan securities rose to 140 basis points, up from 75 basis points. The average spread over U.S. Treasuries on AAA rated commercial-mortgage securities climbed to 364 basis points, from 167 basis points on Dec. 31, according to Lehman Brothers Holdings Inc. index data.
A basis point is 0.01 percentage point.
Subprime Bonds
Deerfield Capital Corp., a Chicago-based investor in mortgage- and asset-backed bonds, last week said it's sold ``substantially all,'' or $1.3 billion, of its residential bonds that lack guarantees from government-linked entities such as Washington-based Fannie Mae this year through Feb. 15.
The company needed to ``increase our liquidity position'' at a faster pace than originally planned as prices fell for the securities, which Deerfield used as collateral for loans, Chief Executive Officer Jonathan Trutter said in a Feb. 29 statement. Deerfield reported a $110 million fourth-quarter loss and sold the securities this quarter at a loss of about $152 million.
Spreads for three-year AAA bonds backed by U.S. subprime or home-equity loans rose to 380 basis points, up from 250 basis points, according to Deutsche Bank, Germany's biggest bank. Default rates on subprime mortgages, sold to borrowers with poor credit or high debt, have surged to records.
Commercial Mortgages
Such securities lost 5.9 percent last month, when price drops and interest payments are considered, according to Lehman Brothers data. They have cost investors 9.3 percent so far this year and 18.1 percent over the past 12 months.
It's become difficult, if not impossible, for investors to determine how much holdings of mortgage- or asset-backed bonds are worth because new issuance and trading has nearly ceased, according to bond buyers such as Sanjeev Handa, head of global public markets at TIAA-CREF, and Thornburg Mortgage Inc., the Santa Fe, New Mexico-based mortgage investor.
AAA rated commercial-mortgage securities slumped 3.5 percent last month and have dropped 4.7 percent so far this year, according to a Lehman Brothers index. AA securities fell 10.3 percent in February and have lost 15.6 percent this year, according to an index from the New York-based company.
Top-rated credit-card and auto securities last month returned 0.04 percent and 0.06 percent, respectively, according to Lehman. They've returned 1.9 percent and 0.79 percent this year. Swap rates are the fixed yields paid in return for floating-rate payments based on short-term interest rates.
Underscoring how credit-concerns are only one issue for securitized debt, spreads over the 3-month Libor on AAA rated, two-year bonds backed by government-guaranteed student loans entered this month at 60 basis points, up from 40 basis points at the end of 2007, according to Deutsche Bank data.
European Spreads
Spreads on European securities also jumped again last month, according to a Merrill Lynch & Co. report today. Reaching new highs were: AAA bonds comprised of U.K. prime mortgages, credit cards, and commercial mortgages; Dutch home mortgages; and ``eurozone'' auto loans. Some spreads were in or near ``improbable three-digit territory,'' compared with less than 25 basis points a year earlier, the report said.
The widening has been ``in almost complete disregard for credit fundamentals in Europe,'' analysts including Altynay Davletova, Caspar Cook and Alexander Batchvarov wrote.
Peloton Partners LLP, the London-based hedge-fund manager, said last week that tumbling prices for U.S. home-loan securities and ``severely tightening terms'' on bond-secured lending from banks is forcing it to liquidate a $1.8 billion asset-backed fund.
Margin Calls
The fund owned about $17 billion of securities backed by Alt-A, subprime and other U.S. mortgage debt, along with bets against about $6 billion of subprime-loan bonds, according to people who have seen the firm's positions. Alt-A mortgages fall between prime and subprime loans in terms of expected defaults.
Deerfield said last week that some banks have stopped lending against mortgage securities -- even the bonds backed by non-subprime loans that the company owned -- while other lenders have ``significantly'' increased collateral demands.
Thornburg, which today said it's failed to meet $270 million of margin calls, said last week that AAA rated Alt-A mortgage securities tumbled 10 percent to 15 percent in the first 27 days of February. Mortgage-bond prices fell further in the last two days of the month, the company said today.
Goldman Sachs Group Inc., Morgan Stanley, Lehman Brothers, Bear Stearns Cos. and Merrill Lynch today had their profit estimates for 2008 and 2009 cut by Sanford C. Bernstein & Co.'s Brad Hintz, who cited more writedowns for the world's largest securities firms and a market recovery that may take three years. In the last two weeks, at least seven analysts have cut their first-quarter profit estimates for the brokers.
Subscribe to:
Posts (Atom)