By Ambrose Evans-Pritchard, International Business Editor
Last Updated: 6:27am GMT 03/12/2007
The sterling interbank market has collapsed at the fastest rate in modern history, prompting pleas for immediate rate cuts from a chorus of top British economists.
Office for National Statistics data sourced to the Bank of England shows the volume of market loans in the banking system plunged from £640bn at the onset of the credit crunch in August to £249bn by the end of September, suggesting British lenders have been hit even harder than US banks in relative terms. Total sterling assets dropped from £3,244bn to £2,876bn.
"This is one hell of a shock to the financial system," said Professor Tim Congdon, a leading monetarist at the London School of Economics.
"A market that has taken 30 years to build has completely imploded in a matter of months. Lenders have been squeezed savagely. We've moved into a different era," he said.
Mr Congdon called for a half-point cut to the interest rate to 5.25pc when the Monetary Policy Committee meets this week, warning that the M4 money supply is slowing fast and might contract over the next six months.
Patrick Minford, a professor at Cardiff University, called for a three-quarter point cut, accusing the MPC of "standing idly by" as three-month Libor spreads rocketed by 75 basis points - a severe tightening of credit.
"I regard the Bank's behaviour as highly irresponsible, neglecting a century of monetary teaching from Bagehot on. It is time for some sense to prevail. The Bank look like fools," he said.
The hard-hitting comments were contained in the minutes of the Shadow MPC (SMPC), a group of economists who take the pulse of the economy prior to each MPC vote under the aegis of the Institute of Economic Affairs. SMPC member Peter Warburton, from Economic Perspectives, called for a half-point cut, with further easing in the New Year.
"A profoundly deflationary credit downturn has taken hold," he said. "Recent weeks' dramatic events have infected urgency into the situation."
David Smith, a professor at Derby University and chair of the SMPC, defended the Bank's wait-and-see approach. "The MPC is walking along a narrow and dangerous Alpine ridge in a blinding blizzard. They can't see anything," he said. "People assume that the risk is a credit implosion leading to a second Depression, but there is also a serious risk on the other side of the ridge in terms of inflation.
"The British economy was red hot in the third quarter. RPIX inflation is at 3.1pc. If you look at oil prices, commodities or gold, there are many signs this is like the early 1970s," he said.
"Has the economy suddenly and totally fallen out of bed? We don't know yet, and it would be dangerous at this stage to bet it has. There is a risk rates will have to go up next year, not down," he said.
Most City economists expect the nine-strong MPC to hold rates steady when it meets on Thursday. Sir John Gieve, the Bank's Deputy Governor, and David Blanchflower voted for a quarter-point cut in November, fearing that the property market was starting to buckle.
Credit conditions have tightened abruptly since then, driving Libor back to crisis levels of 6.60pc. The Nationwide house price index dropped 0.8pc in November, the steepest fall in 12 years.
3 December 2007
Blowing Bubbles
by Lewis H Lapham
Harper's Magazine Notebook (November 2007)
Men have an indistinct notion that if they keep up this activity of
joint stocks and spades long enough all will at length ride somewhere,
in next to no time, and for nothing; but though a crowd rushes to the
depot, and the conductor shouts "All aboard!" when the smoke is blown
away and the vapor condensed, it will be perceived that a few are
riding, but the rest are run over, - and it will be called, and will be,
"A melancholy accident". -Henry David Thoreau
Reading the reports from the scene of August's melancholy accident in
the country's credit markets - the bursting of the home-mortgage bubble,
banks sinking into the sand of subprime loans, hedge funds losing 100
percent of their imagined value in a matter of days, the Dow Jones
Industrial Average dropping 250 points in the space of half an hour - I
was struck by the resemblances between the speculation floated on the
guarantee of easy money on Wall Street and the one puffed up on the
promise of certain victory in Iraq. To buyers of highly leveraged debt
the promoters of the "All aboard!" money schemes issued PowerPoints
similar to those concocted in the White House and circulated with former
Secretary of Defense Donald Rumsfeld's proviso that "there are known
unknowns ... But there are also unknown unknowns". A surplus of both
commodities was found in the luggage of the travelers run over in August
on the road to El Dorado. A number of them deserve to be rendered as
military acronyms:
The "NINJA Loan" - Extended to borrowers possessed of no income, no job,
no assets - comparable to the predatory lending of the United States
Army to the freedom-loving sheikhs of Iraq.
The "Neutron Loan" - Designed to remove the occupants but leave the
property intact. Within the next year over a million American home
mortgages are due to foreclose. In August 80,000 people were "displaced
by violence" from their houses and neighborhoods in Iraq; another 2.2
million Iraqis have been obliged to flee the country.
The "Teaser Loan" - An adjustable rate mortgage (ARM) sometimes
requiring no money down or up front but in all variants offered at a low
introductory rate that adjusts only in an upward direction. The American
liberation of Iraq was originally priced at $50 billion over a span of
seven months; the expenses now run to $2 billion a week. Joseph
Stiglitz, the Nobel Prize-winning economist, estimates the eventual cost
of the Iraqi investment at $2 trillion.
The "Liar Loan" - Requiring no documentation attesting to the borrower's
net worth, annual income, or intention to repay - the same terms on
which the CIA accepted the story about Saddam Hussein's weapons of mass
destruction from the Iraqi defector code-named "Curveball".
SIV - "Structured investment vehicle" that "securitizes" subprime loans,
thus creating credit with "access to liabilities". Soon after the
invasion of Iraq the infatuation with a similar method of transforming
loss into gain prompted the Pentagon to welcome terrorists arriving in
Baghdad and Anbar province from everywhere in the Middle East. The
bundling of America's enemies into one target supported the notion that
the war on terror could be won at a single blow. Rush Limbaugh delivered
the good news to his radio audience in the summer of 2003: "We don't
have to go anywhere to find them! They've fielded a jihad all-star team".
"Toxic Waste" - Degraded financial material added as ballast to
higher-quality assets contained in a mortgage-backed bond or security.
AAA - Bond rating affixed by Moody's and Standard & Poor's to SIVs
transporting "toxic waste". The certifications correspond to former CIA
Director George Tenet's assuring President Bush that finding WMDs in
Iraq was a "slam dunk".
Risk Assessment Models - Systems of stock-market trading quantified as
mathematical algorithms and engineered to guarantee the perpetual motion
of profit. They bear comparison to the Pentagon's arsenal of
high-technology weapons - the ones incapable of losing a war.
Model Misbehavior - Inexplicable displays of insubordination on the part
of the algorithms, believed to account for the August loss of $5.5
trillion in the global stock markets. The Bush Administration attributes
its failures in Iraq to model misbehavior on the part of the think-tank
construct (computer-generated, ideologically enhanced) of a
constitutional democracy in Iraq.
CDO - Collateralized debt obligation. A coalition of the willing
assembled with debt instruments of a strength equivalent to the armed
forces sent to Iraq from Albania.
Bubble - Employed as a verb in eighteenth-century London. "To Bubble" -
that is, to cheat, swindle, perpetrate a fraud. In contemporary American
military parlance, a noun - the "surge" of liquidity in the form of
30,000 troops restoring calm to the Baghdad market in civil obedience.
August's misfortunes in the credit markets produced a good deal of
collateral damage elsewhere in the economy-severe losses in the
construction and retail trades, to school and sewer districts, in the
hotel and travel industries, to the 1.7 million families forced to flee
their homes - but the proofs of Wall Street's stupefied greed didn't
rouse the news media or the season's presidential candidates to
exclamations of anger and disgust. Throughout the whole of its history,
the American commonwealth has been subject to the depredations of what
George Washington knew to be "a corrupt squadron of paper-dealers"; a
hundred or even fifty years ago the brokers of the fast shuffle might
have been seen in savage cartoons like those drawn by Thomas Nast
(top-hatred dancing pigs) or pilloried in the language once voiced by
Walt Whitman ("canker'd, crude, superstitious and rotten ...") and E L
Godkin ("a gaudy stream of bespangled, belaced, and beruffled barbarians").
Once upon a time in galaxies far, far away, we recognized the character
of the risk in what was known to the first Dutch settlers in
seventeenth-century New Amsterdam, many of them participants in land or
stock-jobbing ventures, as "The Feast of Fools". It wasn't that the new
arrivals on the American shore didn't believe or delight in the
expectation and promise of fairy gold. Understood as the most demotic of
economic activities, expressive of a yearning for freedom, the game of
speculative finance aligns with the American passion for gambling and
matches the spirit the bet placed by the Declaration of Independence on
the wheel of fortune set up with the slots marked "Life, Liberty and the
Pursuit of Happiness". But we used to know that sometimes the numbers
crap out.
The knowledge began to disappear from the American consciousness and
vocabulary during the dawn of the new "Morning in America" that Ronald
Reagan perceived on the horizon of the 1980s when he set up his
rose-colored telescope on the White House roof. Convinced that "the
difference between an American and any other kind of person is that an
American lives in anticipation of the future because he knows it will be
a great place", Reagan brought with him the preferred attitude that the
dealers in rainbows seek to instill in the minds of the customers
shopping for financial salvation and political romance. Everybody a
winner; the flowers never die.
The attitude has been sustained over the past twenty-five years by the
corporate news media's increasingly messianic testimonies to the wonder
and wisdom of the free market (Alan Greenspan as infallible as the
Pope), by the entertainment industry's loudly applauding the miraculous
transformations of frogs into princes (Donald Trump the hero of our
time), by the government's policy of providing the banks with infusions
of cheap credit on which to float speculative bubble baths (in 1987,
1998, 2001, again in 2007), by a steadily multiplying herd of eager
buyers, their number now estimated at one in every two Americans acting
either as independent agents or as participants in mutual and pension
funds, seeking to acquire, at steadily rising prices, beach front
property on the coast of Utopia.
Together with the promises of an always brighter tomorrow (available on
the Internet, delivered within twenty-four hours) , the widely
distributed faith in the philosophers' stone (that is, the one with
which medieval alchemists supposedly turned lead into gold) accords with
the revelation bestowed on a correspondent for the New York Times in the
autumn of 2004 by a White House sage identified at the time as "a senior
adviser to Bush" but now generally assumed to have been Karl Rove,
President Bush's recently retired man-for-all-seasons. Disdainful of the
meager and obsolete truths that informed the thinking of "the
reality-based community", the sage opened a wider-angle lens on the
vision beheld by Ronald Reagan.
Guys like you, he said, "believe that solutions emerge from your
judicious study of discernible reality. That's not the way the world
really works anymore. We're an empire now, and when we act, we create
our own reality. And while you're studying that reality - judiciously,
as you will - we'll act again, creating other new realities, which you
can study too, and that's how things will sort out. We're history's
actors ... and you, all of you, will be left to just study what we do."
Which didn't mean that the study would be easy to pursue. The Bush
Administration's obsessive hiding of its actions and motives (from
itself as well as from a public audit) rules against the handing-out of
brochures illustrated with the four-color posters of imperial fantasies
decorating the walls at the White House, the Pentagon, the Office of the
Attorney General. On Wall Street the hedge against having to tell the
truth is formed with exemptions from state and federal regulation that
yield the elixir of "opacity". Highly valued by the speculators in the
nineteenth-century stock swindles engineered by Commodore Vanderbilt and
Daniel Drew, opacity allows the private-equity operations to bubble both
the government and their clients, empowering the dealers in SIVs in the
same way that it serves the creators of new realities in Mesopotamia and
assists the poker players in the Las Vegas casinos. Unfortunately, as
with the water in the tale of the sorcerer's apprentice, too much
opacity sloshing around on the trading floors makes it impossible not
only to see what cards the other players hold in their hands but also to
know how much money is on the table. The government in March stopped
publishing the figure that measures the extent of America's money
supply, possibly because by some estimates the financial risk exposure
in the global markets for leveraged derivatives now stands at a sum
somewhere in the vicinity of $60 trillion, four times the size of the
American economy.
When the smoke was blowing away and the vapor being condensed at the
scene of the August wreckage, the fear of ghosts in the Wall Street
attic precluded any movement in the markets for social conscience. The
headlines flowed from the springs of panic, not from the wellheads of
rage, the concern expressed for the concentrations of America's wealth
(its safety, comfort, and good grooming) rather than for the health and
wellbeing of the American citizenry. Together with most everybody else
in the society, the big-ticket print and electronic media are heavily
invested in the virtual realities that not only sustain the opulence of
the country's rentier classes but also shape the course of the country's
politics, sponsor its shows of conspicuous consumption, control the
disposition of its armies. God forbid that the emperors of ice cream
should be seen standing around naked on the reefs of destruction.
The financial press rounded up expert witnesses to cite the canonical
distinction between risk ("present when future events occur with
measurable probability") and uncertainty ("present when the likelihood
of future events is indefinite or incalculable"), to implore the Federal
Reserve for a surge of more money (Jim Cramer shouting into the camera
at CNBC, "We have Armageddon!... This is not the time to be
complacent!"), to say of the SIVs destroyed by the financial equivalents
of improvised roadside bombs, "It is not the corpses at the surface that
are scary, it is the unknown corpses below the surface that may pop up
unexpectedly". "Corpse" in its Wall Street usage refers to a
non-performing financial instrument, not to a dead human being.
In the context of the war in Iraq, the word refers to a non-performing
geopolitical instrument. If over the past four years Wall Street's
deployment of lethal paper has increased the country's mortgage debt to
$9.5 trillion, the Bush Administration's deployment of lethal weapons
has outsourced or exhausted much of the country's military capacity,
meanwhile reducing the credit rating of the All Aboard! American
superpower scheme from an investment-grade security to that of a junk
bond. By the end of August both speculations (the liberalization of
America's capital markets, the liberation of the Islamic Middle East)
were losing "tactical momentum" in the reality-based community. The
Washington politicians faced difficulties similar to those faced by Wall
Street's squadron of paper dealers - how to "securitize" the subprime
loans backing the Iraqi civil war, where to find leverage in the
imaginary numbers attesting to the soundness of the Anbar province ARM,
what degree of protection was left in the hedge of opacity.
The preoccupation with derivatives forecloses debate about the worth of
the underlying investment - the value or non-value of the war as a thing
in itself - and shifts the discussion to the positioning of the
political risk. Process, not product. Not why or to what end do we
continue to kill our own soldiers (the known unknowns) as well as Iraqi
civilians (the unknown unknowns), but which artful dodge stands the best
chance of beguiling the voters in next year's elections while at the
same time preserving the bubble floated on the belief that America's
invincible military power serves as collateral for the $2.5 trillion
debt to foreign central banks that America has neither the means nor the
intention to repay.
Among speculators in the commodity pits trading geopolitical futures,
the rumors speak, as they do among the speculators following the play in
the stock markets, to the coming of "the next big thing". Soon after the
Labor Day weekend the financial press was unanimous in the opinion that
the Federal Reserve was bound to step up the flows of liquidity to the
Wall Street banks in order to sustain the world's faith in the American
dollar. Informed sources in Washington were predicting a preemptive
military strike against Iran. Three Navy battle groups were known to be
present in the Persian Gulf, the president was casting the Iranian
Revolutionary Guard in an increasingly evil light (terrorists, enemies
of civilization), and how better to replenish the credit lost in Iraq
than with a weapons-grade CDO spreading the risk to investors everywhere
within range of a melancholy nuclear accident. With us or against us;
buy American or lose the chance of a lifetime.
_____
Lewis H Lapham is the National Correspondent for Harper's Magazine and
the editor of Lapham's Quarterly.
http://www.billtotten.blogspot.com
http://www.ashisuto.co.jp
Harper's Magazine Notebook (November 2007)
Men have an indistinct notion that if they keep up this activity of
joint stocks and spades long enough all will at length ride somewhere,
in next to no time, and for nothing; but though a crowd rushes to the
depot, and the conductor shouts "All aboard!" when the smoke is blown
away and the vapor condensed, it will be perceived that a few are
riding, but the rest are run over, - and it will be called, and will be,
"A melancholy accident". -Henry David Thoreau
Reading the reports from the scene of August's melancholy accident in
the country's credit markets - the bursting of the home-mortgage bubble,
banks sinking into the sand of subprime loans, hedge funds losing 100
percent of their imagined value in a matter of days, the Dow Jones
Industrial Average dropping 250 points in the space of half an hour - I
was struck by the resemblances between the speculation floated on the
guarantee of easy money on Wall Street and the one puffed up on the
promise of certain victory in Iraq. To buyers of highly leveraged debt
the promoters of the "All aboard!" money schemes issued PowerPoints
similar to those concocted in the White House and circulated with former
Secretary of Defense Donald Rumsfeld's proviso that "there are known
unknowns ... But there are also unknown unknowns". A surplus of both
commodities was found in the luggage of the travelers run over in August
on the road to El Dorado. A number of them deserve to be rendered as
military acronyms:
The "NINJA Loan" - Extended to borrowers possessed of no income, no job,
no assets - comparable to the predatory lending of the United States
Army to the freedom-loving sheikhs of Iraq.
The "Neutron Loan" - Designed to remove the occupants but leave the
property intact. Within the next year over a million American home
mortgages are due to foreclose. In August 80,000 people were "displaced
by violence" from their houses and neighborhoods in Iraq; another 2.2
million Iraqis have been obliged to flee the country.
The "Teaser Loan" - An adjustable rate mortgage (ARM) sometimes
requiring no money down or up front but in all variants offered at a low
introductory rate that adjusts only in an upward direction. The American
liberation of Iraq was originally priced at $50 billion over a span of
seven months; the expenses now run to $2 billion a week. Joseph
Stiglitz, the Nobel Prize-winning economist, estimates the eventual cost
of the Iraqi investment at $2 trillion.
The "Liar Loan" - Requiring no documentation attesting to the borrower's
net worth, annual income, or intention to repay - the same terms on
which the CIA accepted the story about Saddam Hussein's weapons of mass
destruction from the Iraqi defector code-named "Curveball".
SIV - "Structured investment vehicle" that "securitizes" subprime loans,
thus creating credit with "access to liabilities". Soon after the
invasion of Iraq the infatuation with a similar method of transforming
loss into gain prompted the Pentagon to welcome terrorists arriving in
Baghdad and Anbar province from everywhere in the Middle East. The
bundling of America's enemies into one target supported the notion that
the war on terror could be won at a single blow. Rush Limbaugh delivered
the good news to his radio audience in the summer of 2003: "We don't
have to go anywhere to find them! They've fielded a jihad all-star team".
"Toxic Waste" - Degraded financial material added as ballast to
higher-quality assets contained in a mortgage-backed bond or security.
AAA - Bond rating affixed by Moody's and Standard & Poor's to SIVs
transporting "toxic waste". The certifications correspond to former CIA
Director George Tenet's assuring President Bush that finding WMDs in
Iraq was a "slam dunk".
Risk Assessment Models - Systems of stock-market trading quantified as
mathematical algorithms and engineered to guarantee the perpetual motion
of profit. They bear comparison to the Pentagon's arsenal of
high-technology weapons - the ones incapable of losing a war.
Model Misbehavior - Inexplicable displays of insubordination on the part
of the algorithms, believed to account for the August loss of $5.5
trillion in the global stock markets. The Bush Administration attributes
its failures in Iraq to model misbehavior on the part of the think-tank
construct (computer-generated, ideologically enhanced) of a
constitutional democracy in Iraq.
CDO - Collateralized debt obligation. A coalition of the willing
assembled with debt instruments of a strength equivalent to the armed
forces sent to Iraq from Albania.
Bubble - Employed as a verb in eighteenth-century London. "To Bubble" -
that is, to cheat, swindle, perpetrate a fraud. In contemporary American
military parlance, a noun - the "surge" of liquidity in the form of
30,000 troops restoring calm to the Baghdad market in civil obedience.
August's misfortunes in the credit markets produced a good deal of
collateral damage elsewhere in the economy-severe losses in the
construction and retail trades, to school and sewer districts, in the
hotel and travel industries, to the 1.7 million families forced to flee
their homes - but the proofs of Wall Street's stupefied greed didn't
rouse the news media or the season's presidential candidates to
exclamations of anger and disgust. Throughout the whole of its history,
the American commonwealth has been subject to the depredations of what
George Washington knew to be "a corrupt squadron of paper-dealers"; a
hundred or even fifty years ago the brokers of the fast shuffle might
have been seen in savage cartoons like those drawn by Thomas Nast
(top-hatred dancing pigs) or pilloried in the language once voiced by
Walt Whitman ("canker'd, crude, superstitious and rotten ...") and E L
Godkin ("a gaudy stream of bespangled, belaced, and beruffled barbarians").
Once upon a time in galaxies far, far away, we recognized the character
of the risk in what was known to the first Dutch settlers in
seventeenth-century New Amsterdam, many of them participants in land or
stock-jobbing ventures, as "The Feast of Fools". It wasn't that the new
arrivals on the American shore didn't believe or delight in the
expectation and promise of fairy gold. Understood as the most demotic of
economic activities, expressive of a yearning for freedom, the game of
speculative finance aligns with the American passion for gambling and
matches the spirit the bet placed by the Declaration of Independence on
the wheel of fortune set up with the slots marked "Life, Liberty and the
Pursuit of Happiness". But we used to know that sometimes the numbers
crap out.
The knowledge began to disappear from the American consciousness and
vocabulary during the dawn of the new "Morning in America" that Ronald
Reagan perceived on the horizon of the 1980s when he set up his
rose-colored telescope on the White House roof. Convinced that "the
difference between an American and any other kind of person is that an
American lives in anticipation of the future because he knows it will be
a great place", Reagan brought with him the preferred attitude that the
dealers in rainbows seek to instill in the minds of the customers
shopping for financial salvation and political romance. Everybody a
winner; the flowers never die.
The attitude has been sustained over the past twenty-five years by the
corporate news media's increasingly messianic testimonies to the wonder
and wisdom of the free market (Alan Greenspan as infallible as the
Pope), by the entertainment industry's loudly applauding the miraculous
transformations of frogs into princes (Donald Trump the hero of our
time), by the government's policy of providing the banks with infusions
of cheap credit on which to float speculative bubble baths (in 1987,
1998, 2001, again in 2007), by a steadily multiplying herd of eager
buyers, their number now estimated at one in every two Americans acting
either as independent agents or as participants in mutual and pension
funds, seeking to acquire, at steadily rising prices, beach front
property on the coast of Utopia.
Together with the promises of an always brighter tomorrow (available on
the Internet, delivered within twenty-four hours) , the widely
distributed faith in the philosophers' stone (that is, the one with
which medieval alchemists supposedly turned lead into gold) accords with
the revelation bestowed on a correspondent for the New York Times in the
autumn of 2004 by a White House sage identified at the time as "a senior
adviser to Bush" but now generally assumed to have been Karl Rove,
President Bush's recently retired man-for-all-seasons. Disdainful of the
meager and obsolete truths that informed the thinking of "the
reality-based community", the sage opened a wider-angle lens on the
vision beheld by Ronald Reagan.
Guys like you, he said, "believe that solutions emerge from your
judicious study of discernible reality. That's not the way the world
really works anymore. We're an empire now, and when we act, we create
our own reality. And while you're studying that reality - judiciously,
as you will - we'll act again, creating other new realities, which you
can study too, and that's how things will sort out. We're history's
actors ... and you, all of you, will be left to just study what we do."
Which didn't mean that the study would be easy to pursue. The Bush
Administration's obsessive hiding of its actions and motives (from
itself as well as from a public audit) rules against the handing-out of
brochures illustrated with the four-color posters of imperial fantasies
decorating the walls at the White House, the Pentagon, the Office of the
Attorney General. On Wall Street the hedge against having to tell the
truth is formed with exemptions from state and federal regulation that
yield the elixir of "opacity". Highly valued by the speculators in the
nineteenth-century stock swindles engineered by Commodore Vanderbilt and
Daniel Drew, opacity allows the private-equity operations to bubble both
the government and their clients, empowering the dealers in SIVs in the
same way that it serves the creators of new realities in Mesopotamia and
assists the poker players in the Las Vegas casinos. Unfortunately, as
with the water in the tale of the sorcerer's apprentice, too much
opacity sloshing around on the trading floors makes it impossible not
only to see what cards the other players hold in their hands but also to
know how much money is on the table. The government in March stopped
publishing the figure that measures the extent of America's money
supply, possibly because by some estimates the financial risk exposure
in the global markets for leveraged derivatives now stands at a sum
somewhere in the vicinity of $60 trillion, four times the size of the
American economy.
When the smoke was blowing away and the vapor being condensed at the
scene of the August wreckage, the fear of ghosts in the Wall Street
attic precluded any movement in the markets for social conscience. The
headlines flowed from the springs of panic, not from the wellheads of
rage, the concern expressed for the concentrations of America's wealth
(its safety, comfort, and good grooming) rather than for the health and
wellbeing of the American citizenry. Together with most everybody else
in the society, the big-ticket print and electronic media are heavily
invested in the virtual realities that not only sustain the opulence of
the country's rentier classes but also shape the course of the country's
politics, sponsor its shows of conspicuous consumption, control the
disposition of its armies. God forbid that the emperors of ice cream
should be seen standing around naked on the reefs of destruction.
The financial press rounded up expert witnesses to cite the canonical
distinction between risk ("present when future events occur with
measurable probability") and uncertainty ("present when the likelihood
of future events is indefinite or incalculable"), to implore the Federal
Reserve for a surge of more money (Jim Cramer shouting into the camera
at CNBC, "We have Armageddon!... This is not the time to be
complacent!"), to say of the SIVs destroyed by the financial equivalents
of improvised roadside bombs, "It is not the corpses at the surface that
are scary, it is the unknown corpses below the surface that may pop up
unexpectedly". "Corpse" in its Wall Street usage refers to a
non-performing financial instrument, not to a dead human being.
In the context of the war in Iraq, the word refers to a non-performing
geopolitical instrument. If over the past four years Wall Street's
deployment of lethal paper has increased the country's mortgage debt to
$9.5 trillion, the Bush Administration's deployment of lethal weapons
has outsourced or exhausted much of the country's military capacity,
meanwhile reducing the credit rating of the All Aboard! American
superpower scheme from an investment-grade security to that of a junk
bond. By the end of August both speculations (the liberalization of
America's capital markets, the liberation of the Islamic Middle East)
were losing "tactical momentum" in the reality-based community. The
Washington politicians faced difficulties similar to those faced by Wall
Street's squadron of paper dealers - how to "securitize" the subprime
loans backing the Iraqi civil war, where to find leverage in the
imaginary numbers attesting to the soundness of the Anbar province ARM,
what degree of protection was left in the hedge of opacity.
The preoccupation with derivatives forecloses debate about the worth of
the underlying investment - the value or non-value of the war as a thing
in itself - and shifts the discussion to the positioning of the
political risk. Process, not product. Not why or to what end do we
continue to kill our own soldiers (the known unknowns) as well as Iraqi
civilians (the unknown unknowns), but which artful dodge stands the best
chance of beguiling the voters in next year's elections while at the
same time preserving the bubble floated on the belief that America's
invincible military power serves as collateral for the $2.5 trillion
debt to foreign central banks that America has neither the means nor the
intention to repay.
Among speculators in the commodity pits trading geopolitical futures,
the rumors speak, as they do among the speculators following the play in
the stock markets, to the coming of "the next big thing". Soon after the
Labor Day weekend the financial press was unanimous in the opinion that
the Federal Reserve was bound to step up the flows of liquidity to the
Wall Street banks in order to sustain the world's faith in the American
dollar. Informed sources in Washington were predicting a preemptive
military strike against Iran. Three Navy battle groups were known to be
present in the Persian Gulf, the president was casting the Iranian
Revolutionary Guard in an increasingly evil light (terrorists, enemies
of civilization), and how better to replenish the credit lost in Iraq
than with a weapons-grade CDO spreading the risk to investors everywhere
within range of a melancholy nuclear accident. With us or against us;
buy American or lose the chance of a lifetime.
_____
Lewis H Lapham is the National Correspondent for Harper's Magazine and
the editor of Lapham's Quarterly.
http://www.billtotten.blogspot.com
http://www.ashisuto.co.jp
The $41B Bomb Citi Doesn't Want You to Know About
Part of our job here is to call “Shenanigans” when we see them. Earlier this week, Citigroup (C) announced that they had cut a deal with the Abu Dhabi state-sponsored fund, AIDA, to pump $7.5 billion into the company. This has since been widely hailed by the media as the reason that the market has begun to rebound.
Balderdash!
The market rebounded late this week because, a) it was incredibly oversold; and b) we’ve seen the US Dollar rally, and that has taken some of the air out of oil prices.
If you closely examine the Citigroup deal, you will see that it is executive denial at its finest, and is not in the interest of shareholders… well, maybe Abu Dhabi’s shareholders. After all, they managed to secure 5% of an iconic American bank at multi-year lows for the equivalent of about 5 billion Euros. Oh, and did I forget to mention that it’s a convertible preferred that pays 11% and is convertible into common stock between $31.83 to $37.24 a share?
So, why did Citigroup agree to dilute existing shareholder interests by 5%? Why didn’t they just cut the $10 billion in dividends that they pay each year? More importantly, why wasn’t this deal done with an American institution?
I’ll tell you why. Citigroup didn’t go with an American buyer because any American buyer would have demanded a seat on the board and a voice in righting the ship. Heaven forbid that the company get an outspoken voice for change!
Their foreign friends are apparently quite happy to take their 4.9% stake with no board seat. They took 4.9% so they didn’t trigger the filing requirements of a 5% stake. Mmm, I wonder why? What do they have to hide?
Citigroup is making decisions akin to the executive that gets laid off but wants to keep up appearances. Our laid off exec knows he can’t afford that country club membership and his big Mercedes Benz anymore, but he’s determined not to be embarrassed in front of his peers. Too late, buddy, the problems at Citigroup are just too big to indulge in that type of denial. The company holds approximately 41 billion dollars in direct sub-prime exposure via standby loan guarantees, but they hold it “off balance sheet”.
Remember that the Structured Investment Vehicles (SIVs) borrowed billions by issuing short-term commercial paper at low rates, then went out and bought riskier long-term bonds at higher rates with the proceeds. In order to receive an investment grade on the commercial paper that they were selling to fund their operations, the banks guaranteed that if the SIVs got in trouble they would pay back the commercial paper holders.
Well, guess what? The SIVs can’t pay! The non-payment by the SIVs has triggered the standby loan guarantees. In accounting circles, this is called a “reconsideration event”.
That simply means, "Hey, dummy, the risk of this vehicle needs to be reconsidered! Maybe it's time to put this changed risk on your balance sheet!”
Apparently, the triggering of the standby loan guarantees and a shiny brand new $41 billion liability isn’t a big enough event for the geniuses at Citigroup to acknowledge. These so called “professional money men” are indulging in the worst kind of self-deception, usually seen only among rank amateurs and substance abusers.
I understand why Citi’s doing what they are doing. Their internal Tier 1 capital range is in danger of being violated. Their Tier 1 capital ratio (that’s the ratio of bank capital to outstanding loans) currently stands at approximately 7.5%. The regulators will let you get all the way to 6% before they’ll pay you a visit, but Citi doesn’t want to look weak. Their logic is if they can’t even meet their own self-imposed capital ratios of 7.5%, it's just another reminder of how poorly they have managed their risk.
Here's the wake-up call. EVERY PLAYER ON THE PLANET KNOWS YOU SCREWED UP. YOU ARE NOT FOOLING ANYONE. Like a little boy attempting to whistle away his fear as he passes the graveyard, Citi is running scared, and everybody knows it.
They should take a page out of HSBC’s (HBC) book. HSBC came out this week and formally announced that they would shift two Structured Investment Vehicles from “off balance sheet” status to “on balance sheet” status. The two funds represent about $35 billion in total liability. Here we have a management team doing the tough but right thing, no burying the corporate head in the sand here.
In order for the financials to recover a measure of the lost investor confidence currently plaguing the sector, many more banks must follow HSBC’s lead and come clean about every piece of “off balance sheet” exposure they currently face. The sector will not be a buy until they do so.
Disclosure:
Balderdash!
The market rebounded late this week because, a) it was incredibly oversold; and b) we’ve seen the US Dollar rally, and that has taken some of the air out of oil prices.
If you closely examine the Citigroup deal, you will see that it is executive denial at its finest, and is not in the interest of shareholders… well, maybe Abu Dhabi’s shareholders. After all, they managed to secure 5% of an iconic American bank at multi-year lows for the equivalent of about 5 billion Euros. Oh, and did I forget to mention that it’s a convertible preferred that pays 11% and is convertible into common stock between $31.83 to $37.24 a share?
So, why did Citigroup agree to dilute existing shareholder interests by 5%? Why didn’t they just cut the $10 billion in dividends that they pay each year? More importantly, why wasn’t this deal done with an American institution?
I’ll tell you why. Citigroup didn’t go with an American buyer because any American buyer would have demanded a seat on the board and a voice in righting the ship. Heaven forbid that the company get an outspoken voice for change!
Their foreign friends are apparently quite happy to take their 4.9% stake with no board seat. They took 4.9% so they didn’t trigger the filing requirements of a 5% stake. Mmm, I wonder why? What do they have to hide?
Citigroup is making decisions akin to the executive that gets laid off but wants to keep up appearances. Our laid off exec knows he can’t afford that country club membership and his big Mercedes Benz anymore, but he’s determined not to be embarrassed in front of his peers. Too late, buddy, the problems at Citigroup are just too big to indulge in that type of denial. The company holds approximately 41 billion dollars in direct sub-prime exposure via standby loan guarantees, but they hold it “off balance sheet”.
Remember that the Structured Investment Vehicles (SIVs) borrowed billions by issuing short-term commercial paper at low rates, then went out and bought riskier long-term bonds at higher rates with the proceeds. In order to receive an investment grade on the commercial paper that they were selling to fund their operations, the banks guaranteed that if the SIVs got in trouble they would pay back the commercial paper holders.
Well, guess what? The SIVs can’t pay! The non-payment by the SIVs has triggered the standby loan guarantees. In accounting circles, this is called a “reconsideration event”.
That simply means, "Hey, dummy, the risk of this vehicle needs to be reconsidered! Maybe it's time to put this changed risk on your balance sheet!”
Apparently, the triggering of the standby loan guarantees and a shiny brand new $41 billion liability isn’t a big enough event for the geniuses at Citigroup to acknowledge. These so called “professional money men” are indulging in the worst kind of self-deception, usually seen only among rank amateurs and substance abusers.
I understand why Citi’s doing what they are doing. Their internal Tier 1 capital range is in danger of being violated. Their Tier 1 capital ratio (that’s the ratio of bank capital to outstanding loans) currently stands at approximately 7.5%. The regulators will let you get all the way to 6% before they’ll pay you a visit, but Citi doesn’t want to look weak. Their logic is if they can’t even meet their own self-imposed capital ratios of 7.5%, it's just another reminder of how poorly they have managed their risk.
Here's the wake-up call. EVERY PLAYER ON THE PLANET KNOWS YOU SCREWED UP. YOU ARE NOT FOOLING ANYONE. Like a little boy attempting to whistle away his fear as he passes the graveyard, Citi is running scared, and everybody knows it.
They should take a page out of HSBC’s (HBC) book. HSBC came out this week and formally announced that they would shift two Structured Investment Vehicles from “off balance sheet” status to “on balance sheet” status. The two funds represent about $35 billion in total liability. Here we have a management team doing the tough but right thing, no burying the corporate head in the sand here.
In order for the financials to recover a measure of the lost investor confidence currently plaguing the sector, many more banks must follow HSBC’s lead and come clean about every piece of “off balance sheet” exposure they currently face. The sector will not be a buy until they do so.
Disclosure:
29 November 2007
M&S pyjamas' silver lining helps stop MRSA
Pyjamas that have been designed to protect hospital patients from the MRSA superbug have gone on sale in Marks & Spencer.
The £45 garment has silver thread woven into it, which tests show can reduce the spread of infections. The ongoing clinical trial's interim results are positive
M&S is selling the "Sleepsafe" pyjamas, below, at 100 stores as part of a trial.
Silver-laced nightwear has been tested in a handful of hospitals, but M&S has become the first retailer in Britain to stock the pyjamas.
They are only available for men at present and come in three colours - teal, navy and burgundy. A spokesman for M&S said: "They are produced using a fabric which has two per cent silver woven into it. Silver is know for its infection fighting properties and has previously been used by the military.
"The fabric that the pyjamas are made of has been clinically proven to reduce the risk of MRSA by killing bacteria that come into contact with the fabric. Clinical trials are currently ongoing and are three quarters of the way through. The interim results were positive."
advertisement
Katherine Murphy, from the Patients' Association, said: "We welcome the fact these are going on sale, but it shows how desperate the public is."
Dr Mark Enright, a microbiologist at Imperial College London, said that the pyjamas would reduce the risk of a patient getting a skin infection that could infect a wound.
However, Tony Kitchen, of MRSA Support, said: "It sounds like a gimmick - it cannot be a super suit and probably doesn't make a jot of difference.
"The problem lies within the hospitals. They are dirty and it should not be up to the public to safeguard themselves, it's the ethos of the hospital that needs to change.
"We've had troops who manage in the Gulf but end up contracting diseases back in British hospitals. If it's possible to keep that clean in the desert why can't we do it in a hospital?"
Pam Milward, 73, who went into hospital in Redditch, Worcs, three years ago with a rash and ended up unconscious and paralysed for a month after contracting the superbug, said: "If they work then it's a good idea but at £45 they are very expensive for pyjamas."
The £45 garment has silver thread woven into it, which tests show can reduce the spread of infections. The ongoing clinical trial's interim results are positive
M&S is selling the "Sleepsafe" pyjamas, below, at 100 stores as part of a trial.
Silver-laced nightwear has been tested in a handful of hospitals, but M&S has become the first retailer in Britain to stock the pyjamas.
They are only available for men at present and come in three colours - teal, navy and burgundy. A spokesman for M&S said: "They are produced using a fabric which has two per cent silver woven into it. Silver is know for its infection fighting properties and has previously been used by the military.
"The fabric that the pyjamas are made of has been clinically proven to reduce the risk of MRSA by killing bacteria that come into contact with the fabric. Clinical trials are currently ongoing and are three quarters of the way through. The interim results were positive."
advertisement
Katherine Murphy, from the Patients' Association, said: "We welcome the fact these are going on sale, but it shows how desperate the public is."
Dr Mark Enright, a microbiologist at Imperial College London, said that the pyjamas would reduce the risk of a patient getting a skin infection that could infect a wound.
However, Tony Kitchen, of MRSA Support, said: "It sounds like a gimmick - it cannot be a super suit and probably doesn't make a jot of difference.
"The problem lies within the hospitals. They are dirty and it should not be up to the public to safeguard themselves, it's the ethos of the hospital that needs to change.
"We've had troops who manage in the Gulf but end up contracting diseases back in British hospitals. If it's possible to keep that clean in the desert why can't we do it in a hospital?"
Pam Milward, 73, who went into hospital in Redditch, Worcs, three years ago with a rash and ended up unconscious and paralysed for a month after contracting the superbug, said: "If they work then it's a good idea but at £45 they are very expensive for pyjamas."
spirals of death
Close observers of the US housing finance disaster in recent months will have noted a curious phenomenon. Companies such as Countrywide that were in late August regarded as rock solid have recently passed clearly into the danger zone while those like Fannie Mae and Freddie Mac that were regarded as potential market saviors have come under a cloud. In Britain Northern Rock, whose September bailout was said to be modest, involving little risk to the taxpayer has now turned into an immense 25 billion pound ($51 billion) potential black hole – real money even in the US economy let alone in the much smaller British one. This illustrates a deeply troubling quality of the largest downturns: the tendency for the free market to turn into a death spiral, in which even sound well-run institutions are engulfed.
Death spirals are fairly rare in financial history. The Wall Street Crash of 1929 was perhaps the most virulent example. After the first downturn, the market recovered for several months. Then the collapse of the Bank of the United States in December 1930, together with the further economic damage from the Smoot-Hawley Tariff caused a further collapse in confidence and activity that was concentrated in the banking sector, as relatively solid institutions followed the Bank of the United States into bankruptcy. The Federal Reserve failed to correct for the money supply contraction caused by the bank bankruptcies, leading the US economy further into the pit. The additional shove given by President Herbert Hoover’s 1932 tax increase was almost unnecessary; only the confidence brought by a new president (albeit with equally counterproductive economic policies) brought recovery from 1933. By the time the spiral was over, more than one fourth of the banks in the United States had gone bankrupt and the stock market had bottomed out at one tenth of its peak.
A second death spiral, with somewhat less dire economic consequences, occurred in Britain in 1973-74. Edward Heath’s government had removed the quantitative controls on bank lending in 1971, which resulted in an orgy of high risk lending against real estate, very similar to the recent episode in the US except that most of the loans were made against commercial real estate rather than housing. When the first major real estate lender, London and County Bank, collapsed in November 1973 another more conservative house, First National Finance (FNFC), was used as the epicenter of the “lifeboat” rescue organized by the Bank of England. However, the decline in confidence and real estate values quickly sucked FNFC into the maelstrom.
The lifeboat rescue fund grew larger and larger for more than a year as the stock market declined to record low levels, 70% below its 1972 high. Homebuilders such as Northern Developments, in no way involved in the original crash but dependent on bank lending, were dragged down. So were the two most important entrepreneurial finance houses, both internationally diversified and neither significantly involved in commercial real estate lending – Jessel Securities, founded by Oliver Jessel and Slater Walker, founded by Jim Slater.
Neither Jessel nor Slater had been aggressively run – indeed Jim Slater had begun de-leveraging a year before the crash, as he saw trouble coming – and no wrongdoing was proved against the head of either organization, yet by the end of 1975 both very substantial companies had gone bankrupt and neither founder played a significant further role in the British financial sector. This was a great pity: in losing Jessel and Slater Britain had lost not only their very able founders but the most aggressive entrepreneurial teams in the City of London, who might have been best able to compete against the foreign invasion when Britain deregulated the financial services sector in 1986.
The British experience of 1973-74 seems more like the current position in the United States. National policy is currently reasonably neutral, so far avoiding the twin dangers of protectionism and tax increases which caused the medium sized downturn of 1929-30 to turn into the Great Depression. The problem is concentrated in the property sector. However there are already worrying signs that the magic alchemy of modern finance, though such mechanisms as securitization vehicles whose funding falls apart and complex derivative securities that prove to be unsalable in a crisis, is causing the problem to metastasize. In the consumer sector, GMAC has reported problems with its automobile loan portfolio, while it appears that credit card debt quality is rapidly deteriorating. In the corporate loan sector, loans to aggressive leveraged buyouts have got in trouble, and loans to hedge funds and private equity funds have been sharply cut back. (The latter effect can be seen in the movement of the yen/dollar exchange rate from 120 to 108, as the hedge funds’ ”carry trade” positions have been de-leveraged.)
The “death spiral” characteristics of the current market are pretty clear. If Fed Chairman Ben Bernanke’s original estimate of subprime loan losses of $50-100 billion had been anywhere close to accurate, there would have been no problem. The market deals with difficulties of that size all the time, without significant effect on surrounding sectors. A few fringe operators go bankrupt, a few large houses show unexpected losses, and the overall market continues without a tremor. The collapse of the Amaranth hedge fund in September 2006 or that of Refco a year earlier were substantial events, causing losses to a number of those institutions’ business partners, but there was no question of any general market disturbance.
When the subprime problem first emerged in February, it appeared that it would also be limited. A number of subprime lenders, relatively insignificant institutions, were forced to shut down. However the general market appeared unaffected; its view appeared to be that the problem was localized and should have no effect on the real economy, nor even any great effect on the broader housing finance market.
August’s widening in Libor spreads, at which banks lend money to each other, should have told us that this problem would be different, and altogether more important. If leading banks were unable to assess each other’s credit quality for short term transactions then something much more serious was wrong than the collapse of a modest fringe sector of the housing finance market. The Fed’s chosen solution, dropping interest rates and pumping more money into the system, did not address the real problem and was thus useless, as it has since proved. It has only postponed the denouement for a few months and stored up further trouble with inflation.
Two factors are at play here. The first is sheer size. If as now appears likely the eventual losses in the home mortgage market do not total only $100 billion, but a figure much closer to $1 trillion, then the subprime debacle becomes something much more than a localized meltdown. $1 trillion of losses is 7% of US Gross Domestic Product. The market cannot absorb losses of that size without some major institutional bankruptcies or a lengthy recession. The closest equivalent problem is the savings and loan collapse of 1989-92; that caused a major housing downturn but only a minor recession. However its cost (mostly borne by the US taxpayer) of $176 billion was about 3% of 1990 US GDP, only half the size of the likely current losses on mortgage loans.
The second is lack of transparency, and the blow to confidence that comes from the dawning suspicion that a large portion of the derivatives and securitization mechanisms designed in the last quarter century are faulty. The unluckily timed implementation for years beginning after November 15 of FAS Rule 157, requiring banks to divide their assets into three levels according to their degree of marketability, has thrown an unwelcome spotlight on the problem. If Level 3 assets can be valued only by reference to an internal valuation model, and have been allowed to accrue value in banks’ financial statements for a decade or more (enabling hefty bonuses to their progenitors) then how do we know they are really worth anything close to what the model says, and how do we go about realizing them, in a market where confidence has vanished?
To ask those questions is to answer them. Since every incentive led bank mathematicians to devise models that maximized the reported value of the bank’s holdings, and since little or no market existed by which those values could be checked, it is likely that today those assets’ book values are highly overstated. Moreover, even in banks where the mathematicians and their bosses were scrupulously, even impossibly disinterested and intelligent, there still remains the problem that those assets are worth far less in a downturn, because their illiquidity makes them intrinsically unattractive in a market where liquidity has become once more important. Anyone who has attempted to sell venture capital positions in a bear market can attest to how rapidly and completely the value of such assets can disappear. It is thus perfectly possible that the true realizable value of “Level 3” holdings in a bear market is no more than 10% of their book value.
This immediately demonstrates the problem. Goldman Sachs, generally regarded as insulated from the subprime mortgage problem, has $72 billion of Level 3 assets; its capital is only $36 billion. If anything like 90% of the Level 3 assets’ value has to be written off, Goldman Sachs is insolvent. They do not have the option of acting like Nomura Securities did recently, selling everything possible and writing the remainder down to zero, because they would be without capital. Instead they are likely to be dragged kicking and screaming, quarter by quarter, to a gradual writedown and sale of their Level 3 assets, with their true position remaining undisclosed and obfuscated by meaninglessly optimistic statements by top management. Only the bonuses will survive, paid in cash and draining liquidity from the struggling company.
That’s what a death spiral looks like. The US survived the Great Depression, eventually, and Britain survived the 1973-74 debacle. However the market recovered only after it had plumbed depths previously thought impossible, at which even the soundest investments were trading far below their true value. After normality returned, the financial services landscape was very different, with many large and apparently solid houses having disappeared, a generation of participants reduced to driving taxis or selling apples and a generation of investors scarred by their losses and unwilling to return to the market. Emergency infusions of money, from the Fed or the taxpayers, generally do no good, only postponing the denouement and delaying the arrival of truly bargain price levels.
Such spirals of death represent the final definitive triumph of the bears.
Death spirals are fairly rare in financial history. The Wall Street Crash of 1929 was perhaps the most virulent example. After the first downturn, the market recovered for several months. Then the collapse of the Bank of the United States in December 1930, together with the further economic damage from the Smoot-Hawley Tariff caused a further collapse in confidence and activity that was concentrated in the banking sector, as relatively solid institutions followed the Bank of the United States into bankruptcy. The Federal Reserve failed to correct for the money supply contraction caused by the bank bankruptcies, leading the US economy further into the pit. The additional shove given by President Herbert Hoover’s 1932 tax increase was almost unnecessary; only the confidence brought by a new president (albeit with equally counterproductive economic policies) brought recovery from 1933. By the time the spiral was over, more than one fourth of the banks in the United States had gone bankrupt and the stock market had bottomed out at one tenth of its peak.
A second death spiral, with somewhat less dire economic consequences, occurred in Britain in 1973-74. Edward Heath’s government had removed the quantitative controls on bank lending in 1971, which resulted in an orgy of high risk lending against real estate, very similar to the recent episode in the US except that most of the loans were made against commercial real estate rather than housing. When the first major real estate lender, London and County Bank, collapsed in November 1973 another more conservative house, First National Finance (FNFC), was used as the epicenter of the “lifeboat” rescue organized by the Bank of England. However, the decline in confidence and real estate values quickly sucked FNFC into the maelstrom.
The lifeboat rescue fund grew larger and larger for more than a year as the stock market declined to record low levels, 70% below its 1972 high. Homebuilders such as Northern Developments, in no way involved in the original crash but dependent on bank lending, were dragged down. So were the two most important entrepreneurial finance houses, both internationally diversified and neither significantly involved in commercial real estate lending – Jessel Securities, founded by Oliver Jessel and Slater Walker, founded by Jim Slater.
Neither Jessel nor Slater had been aggressively run – indeed Jim Slater had begun de-leveraging a year before the crash, as he saw trouble coming – and no wrongdoing was proved against the head of either organization, yet by the end of 1975 both very substantial companies had gone bankrupt and neither founder played a significant further role in the British financial sector. This was a great pity: in losing Jessel and Slater Britain had lost not only their very able founders but the most aggressive entrepreneurial teams in the City of London, who might have been best able to compete against the foreign invasion when Britain deregulated the financial services sector in 1986.
The British experience of 1973-74 seems more like the current position in the United States. National policy is currently reasonably neutral, so far avoiding the twin dangers of protectionism and tax increases which caused the medium sized downturn of 1929-30 to turn into the Great Depression. The problem is concentrated in the property sector. However there are already worrying signs that the magic alchemy of modern finance, though such mechanisms as securitization vehicles whose funding falls apart and complex derivative securities that prove to be unsalable in a crisis, is causing the problem to metastasize. In the consumer sector, GMAC has reported problems with its automobile loan portfolio, while it appears that credit card debt quality is rapidly deteriorating. In the corporate loan sector, loans to aggressive leveraged buyouts have got in trouble, and loans to hedge funds and private equity funds have been sharply cut back. (The latter effect can be seen in the movement of the yen/dollar exchange rate from 120 to 108, as the hedge funds’ ”carry trade” positions have been de-leveraged.)
The “death spiral” characteristics of the current market are pretty clear. If Fed Chairman Ben Bernanke’s original estimate of subprime loan losses of $50-100 billion had been anywhere close to accurate, there would have been no problem. The market deals with difficulties of that size all the time, without significant effect on surrounding sectors. A few fringe operators go bankrupt, a few large houses show unexpected losses, and the overall market continues without a tremor. The collapse of the Amaranth hedge fund in September 2006 or that of Refco a year earlier were substantial events, causing losses to a number of those institutions’ business partners, but there was no question of any general market disturbance.
When the subprime problem first emerged in February, it appeared that it would also be limited. A number of subprime lenders, relatively insignificant institutions, were forced to shut down. However the general market appeared unaffected; its view appeared to be that the problem was localized and should have no effect on the real economy, nor even any great effect on the broader housing finance market.
August’s widening in Libor spreads, at which banks lend money to each other, should have told us that this problem would be different, and altogether more important. If leading banks were unable to assess each other’s credit quality for short term transactions then something much more serious was wrong than the collapse of a modest fringe sector of the housing finance market. The Fed’s chosen solution, dropping interest rates and pumping more money into the system, did not address the real problem and was thus useless, as it has since proved. It has only postponed the denouement for a few months and stored up further trouble with inflation.
Two factors are at play here. The first is sheer size. If as now appears likely the eventual losses in the home mortgage market do not total only $100 billion, but a figure much closer to $1 trillion, then the subprime debacle becomes something much more than a localized meltdown. $1 trillion of losses is 7% of US Gross Domestic Product. The market cannot absorb losses of that size without some major institutional bankruptcies or a lengthy recession. The closest equivalent problem is the savings and loan collapse of 1989-92; that caused a major housing downturn but only a minor recession. However its cost (mostly borne by the US taxpayer) of $176 billion was about 3% of 1990 US GDP, only half the size of the likely current losses on mortgage loans.
The second is lack of transparency, and the blow to confidence that comes from the dawning suspicion that a large portion of the derivatives and securitization mechanisms designed in the last quarter century are faulty. The unluckily timed implementation for years beginning after November 15 of FAS Rule 157, requiring banks to divide their assets into three levels according to their degree of marketability, has thrown an unwelcome spotlight on the problem. If Level 3 assets can be valued only by reference to an internal valuation model, and have been allowed to accrue value in banks’ financial statements for a decade or more (enabling hefty bonuses to their progenitors) then how do we know they are really worth anything close to what the model says, and how do we go about realizing them, in a market where confidence has vanished?
To ask those questions is to answer them. Since every incentive led bank mathematicians to devise models that maximized the reported value of the bank’s holdings, and since little or no market existed by which those values could be checked, it is likely that today those assets’ book values are highly overstated. Moreover, even in banks where the mathematicians and their bosses were scrupulously, even impossibly disinterested and intelligent, there still remains the problem that those assets are worth far less in a downturn, because their illiquidity makes them intrinsically unattractive in a market where liquidity has become once more important. Anyone who has attempted to sell venture capital positions in a bear market can attest to how rapidly and completely the value of such assets can disappear. It is thus perfectly possible that the true realizable value of “Level 3” holdings in a bear market is no more than 10% of their book value.
This immediately demonstrates the problem. Goldman Sachs, generally regarded as insulated from the subprime mortgage problem, has $72 billion of Level 3 assets; its capital is only $36 billion. If anything like 90% of the Level 3 assets’ value has to be written off, Goldman Sachs is insolvent. They do not have the option of acting like Nomura Securities did recently, selling everything possible and writing the remainder down to zero, because they would be without capital. Instead they are likely to be dragged kicking and screaming, quarter by quarter, to a gradual writedown and sale of their Level 3 assets, with their true position remaining undisclosed and obfuscated by meaninglessly optimistic statements by top management. Only the bonuses will survive, paid in cash and draining liquidity from the struggling company.
That’s what a death spiral looks like. The US survived the Great Depression, eventually, and Britain survived the 1973-74 debacle. However the market recovered only after it had plumbed depths previously thought impossible, at which even the soundest investments were trading far below their true value. After normality returned, the financial services landscape was very different, with many large and apparently solid houses having disappeared, a generation of participants reduced to driving taxis or selling apples and a generation of investors scarred by their losses and unwilling to return to the market. Emergency infusions of money, from the Fed or the taxpayers, generally do no good, only postponing the denouement and delaying the arrival of truly bargain price levels.
Such spirals of death represent the final definitive triumph of the bears.
Regulatory Debauchery
Dazzling World of Derivatives (2006, FT-Prentice Hall).
Earlier versions of some parts of this article have appeared in Business Standard (India), www.businessspectator.com and www.minyanville.com
Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. Debauching the regulatory apparatus is a step along the same road.
Current problems in credit markets are attributable, in part, to failures on the part of central banks and regulators. The response to the credit crisis also contains fundamental deficiencies.
The “Greenspan” Put
Central bankers fueled the liquidity bubble through excessive monetary growth and low interest rates. The “Greenspan Put” repeatedly bailed out banks and investors from poor decisions or irrational exuberance underwriting excessive risk taking. Asset price bubbles rolled merrily along; waves of risk mis-pricing moving through different markets. The current credit crisis has its origins in the Federal Reserve’s interest rate cuts of the early 2000s that helped engineer the housing bubble. This enabled the markets and economy to recover from the Internet bubble.
Bank regulators have presided over substantive changes in financial institution balance sheets and risks. The balance sheet of large banks and investment banks now hold high levels of risky and illiquid assets, such as private-equity investments, bridge loans, hedge funds investments, distressed debt and exotic derivatives. Derivative transactions with and loans to hedge funds through their prime broking operations are substantial. Assets and exposures in “arbitrage” conduit vehicles, structured investment vehicles (“SIVs”) and hedge funds outside regulated bank balance sheets have increased. A recent OECD analysis[i] shows that while major banks have increased capital and reduced reliance on short-term funding the risks have increased faster.
Regulators have been uncritically accepting of financial innovation. The benefit of dispersion of risk through the final system has become the accepted orthodoxy. The risks of a diffuse, opaque, globally inter-linked, highly leveraged financial system have largely been ignored. Belatedly, in its 2007 annual report, the Bank of International Settlements (“BIS”) admitted that “our understanding of economic processes may be even less today than it was in the past”.
As recent events show the risk transfer is largely cosmetic. In excess of $300 billion of risk in the form of Asset backed Commercial paper (“ABS CP”) - short term IOUs secured against high grade (AAA/AA rated) securities including CDOs (“Collateralised Debt Obligations”) – has returned to bank balance sheets as ABS CP investors have gone on a buyer’s strike.
Financial institutions have already incurred losses of over US$ 50 billion. A substantial volume of assets is likely to return onto bank balance sheets as off-balance sheet structures and hedge funds are forced to sell. For examples, HSBC has announced that it will bring around US$ 45 billion of assets from two SIVs de facto back on balance sheet. The total amount that will be re-intermediated by banks may be in the range of US$ 1 to 2 trillion. Weaker banks have been forced to forage down the back of the sofa for any loose change to add to their dwindling liquidity to meet these commitments. This has led to sharp rises in inter-bank lending and borrowing rates as well as general shortage of funds, especially for riskier borrowers.
Mean reversion
Central banks have reverted to type in dealing with the crisis. There is no difference between a run on a bank and shutdown of access to funding from the capital markets. US mortgage lenders have faced old-fashioned runs. Northern Rock found itself requiring central bank support (in excess of £20 billion (US$ 40 billion)) as it was unable to raise required funding in money markets. The Chancellor of the UK Exchequer was forced to effectively guarantee the UK system of bank deposits to restore confidence Central banks, including the Fed and European Central Bank (“ECB”), have pumped money into the system in an effort to ease the liquidity crunch.
In further regulatory debauchery, the Fed recently allowed banks to pledge ABS CP as well as highly rated asset-backed securities, corporate bonds and mortgage-backed instruments as collateral for funding at the discount window. Funding has been extended from overnight to 30 days. Other central banks have followed suit.
Traditionally, only government securities are eligible for discounting. A fundamental principal of the discount window is that it is designed to provide short-term liquidity against instruments of unimpeachable credit quality. The regulatory spin is that this is “temporary” “in the light of market conditions” and “recognises innovation in the market”.
There are profound practical and policy issues in this development. What price will the central banks attribute to these riskier securities? What is the level of the advance that the central bank will offer and how will this be adjusted as market values of the underlying collateral changes? There are unconfirmed suggestions that the central banks are placing a value of 85% on AAA CDO securities. Given that there is significant uncertainty about the value of the security and even how they should be valued, the entry into this debate by central banks is curious.
There is also the question what happens if the bank cannot redeem the borrowing at the end of the 30 days and the value of the securities is below the level of the amount advance. This is precisely the problem confronting lenders who have lent against these securities. Central banks appear to have entered the field of prime broking, perhaps tempted by the profitability. In widening the eligible assets, central banks are effectively underwriting the credit risk and the liquidity of the financial system with public money.
The moves have also done little to ease liquidity or credit market concerns. Following the cut in the discount rate, four major US banks used the discount window: “to encourage its use by other financial institutions”. They did not need cash. It was a sign of strength. In the words of financial historian, Charles Geisst, it was : “like someone from the Upper East Side being seen in .. Wal-Mart”.
In other cases of “déjà vu all over again”, there have been suggestions that Fannie Mae and Ginnie Mae step in to buy mortgages to support liquidity as they have done in past crisis. The two institutions have assets and guarantees of almost US$4.0 trillion supported by stockholders’ equity of around US$60 billion. Both entities have also reported recent losses and have been forced to raise capital. The scope for liquidity creation by this route is likely to be difficult.
Socialism for Wall Street
In good times, financial markets embrace Capitalism. In bad times, financial markets re-discover Socialism. Currently, the US Federal Reserve is engaged in a dangerous strategy to look after its Wall Street friends.
The Fed has cut the fed funds and discount rates. The markets cheered the Fed decision to cut rates in September and then again in October. “This is manna. I am blown away. These guys get it I could hug these guys. This is what we wanted.” Jim Cramer, CNBC's markets pundit, was at the forefront of the cheerleading. Since the Fed's interest rate cuts, equity markets have reached records levels and the junk debt has recovered modestly.
Relief has been short lived. In recent weeks, the differential between inter-bank rates and the central bank targeted rates has widened to levels not seen since August. This points to further potential cuts in both rates by the end of the year. Lower cuts are inconsistent with above target inflation levels resulting from high oil prices, higher food prices, increasing cost pressures in emerging economies such as China and the potential inflationary effect of a weaker US dollar.
The US central bank’s strategy is clear. The current credit problems require a substantial reduction in the level of borrowings and leverage in the global financial system. Asset prices ramped up by excessive debt need to adjust. The adjustment can take place via a “crash”. This would be de-stabilizing and would wreak further havoc on already weakened banks. Alternatively, the de-leveraging and price adjustment can be achieved by creating inflation through loose monetary policy. If asset prices remain at current levels, higher inflation allows values to fall in real terms. Higher inflation also reduces the value of the borrowings that must be paid back allowing the required reduction in leverage.
Between January 1960 and December 1974, the Dow Jones Industrial Average was substantially unchanged. This is despite significant periodic rallies during the “go-go years”. If inflation averaged 5% pa, then the value of the market (ignoring dividends) lost around half (50%) of its value in real (inflation adjusted) terms.
The Fed strategy also assists affected banks. The large writedowns in risky assets and the expected re-intermediation of assets means that some banks need large infusions of capital. Given recent performance and subdued profit outlook, it would be difficult for them to raise this capital at acceptable prices.
Lower short-term interest rates allow banks to borrow cheaply. The money can be used to purchase government bonds that provide higher returns than the cost of borrowing. This generates profits for the bank without the banks having to hold capital against their assets (banks generally are not required to hold capital against government securities). The profits help re-capitalize the bank. An added benefit is that the US government can fund its deficit by selling its debt to the banks. This would be handy if foreign demand for US Treasuries decreases in response to the weaker dollar.
In the 1980s, US manufacturers looked to Japan as the source of ideas to improve efficiency. Remember “Just-in-Time” manufacturing, “zero defect” etc. Now, it seems US regulators are borrowing ideas from their Japanese colleagues. The Bank of Japan used the same strategy to re-capitalize the loss making Japanese banks after the collapse of the “bubble economy” in 1989.
Higher inflation expectations are already evident in higher gold prices, the steeper US yield curve (long term rates are higher than short-term rates) and the weaker US dollar. Foreign investors, especially large sovereign investment funds, are switching from financial assets (bonds) to “real” assets (companies with real businesses) reflecting higher inflationary expectations.
The strategy is dangerous. Inflation can lead to a significant transfer of wealth from investors to borrowers. Inflation once embedded in the economy distorts economic activity such as investment and savings. The experience of the late 1970s and early 1980s highlights the difficulties in recapturing the inflation beast once uncaged. Paul Volcker, then Chairman of the Federal Reserve, bravely increased interest rates to stratospheric levels to squeeze inflation out of the financial system.
The strategy may also not work. The cuts in rates do not appear to have had the desired effect in improving market liquidity conditions. Default risk concerns continue to inhibit lending and other routine financial transactions. Lower rates may set off further bubbles – for example, in equities and emerging markets. Asset prices may fall sharply anyway. In fairness to Dr. Bernanke, he has limited policy alternatives available.
Central bankers have stated that “errant” banks and investors will not be “bailed out”. Actual actions suggest otherwise. Banks have played their “nuclear” option well. The specter of “systemic risk” – whether real or not - is one a central banker cannot ignore. The banks continue to privatize gains and socialize losses.
These moves have attracted remarkably little scrutiny or comment. Central banks are effectively underwriting the credit risk and the liquidity of the financial system with public money but without any transparent political debate. Socialism for Wall Street prevails, once again.
Central banks and regulators bear a serious responsibility for safeguarding the functioning and integrity of financial systems. At the moment they are being exposed like the Wizard of Oz – old desperate men (they are mainly men) behind the curtain running from one lever to another in a desperate attempt to maintain illusions.
© 2007 Satyajit Das All Rights reserved.
[1] See Adrian Blundell-Wignall (2007) An Overview of Hedge Funds and Structured Products: Issues in Leverage and Risk; OECD
Earlier versions of some parts of this article have appeared in Business Standard (India), www.businessspectator.com and www.minyanville.com
Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. Debauching the regulatory apparatus is a step along the same road.
Current problems in credit markets are attributable, in part, to failures on the part of central banks and regulators. The response to the credit crisis also contains fundamental deficiencies.
The “Greenspan” Put
Central bankers fueled the liquidity bubble through excessive monetary growth and low interest rates. The “Greenspan Put” repeatedly bailed out banks and investors from poor decisions or irrational exuberance underwriting excessive risk taking. Asset price bubbles rolled merrily along; waves of risk mis-pricing moving through different markets. The current credit crisis has its origins in the Federal Reserve’s interest rate cuts of the early 2000s that helped engineer the housing bubble. This enabled the markets and economy to recover from the Internet bubble.
Bank regulators have presided over substantive changes in financial institution balance sheets and risks. The balance sheet of large banks and investment banks now hold high levels of risky and illiquid assets, such as private-equity investments, bridge loans, hedge funds investments, distressed debt and exotic derivatives. Derivative transactions with and loans to hedge funds through their prime broking operations are substantial. Assets and exposures in “arbitrage” conduit vehicles, structured investment vehicles (“SIVs”) and hedge funds outside regulated bank balance sheets have increased. A recent OECD analysis[i] shows that while major banks have increased capital and reduced reliance on short-term funding the risks have increased faster.
Regulators have been uncritically accepting of financial innovation. The benefit of dispersion of risk through the final system has become the accepted orthodoxy. The risks of a diffuse, opaque, globally inter-linked, highly leveraged financial system have largely been ignored. Belatedly, in its 2007 annual report, the Bank of International Settlements (“BIS”) admitted that “our understanding of economic processes may be even less today than it was in the past”.
As recent events show the risk transfer is largely cosmetic. In excess of $300 billion of risk in the form of Asset backed Commercial paper (“ABS CP”) - short term IOUs secured against high grade (AAA/AA rated) securities including CDOs (“Collateralised Debt Obligations”) – has returned to bank balance sheets as ABS CP investors have gone on a buyer’s strike.
Financial institutions have already incurred losses of over US$ 50 billion. A substantial volume of assets is likely to return onto bank balance sheets as off-balance sheet structures and hedge funds are forced to sell. For examples, HSBC has announced that it will bring around US$ 45 billion of assets from two SIVs de facto back on balance sheet. The total amount that will be re-intermediated by banks may be in the range of US$ 1 to 2 trillion. Weaker banks have been forced to forage down the back of the sofa for any loose change to add to their dwindling liquidity to meet these commitments. This has led to sharp rises in inter-bank lending and borrowing rates as well as general shortage of funds, especially for riskier borrowers.
Mean reversion
Central banks have reverted to type in dealing with the crisis. There is no difference between a run on a bank and shutdown of access to funding from the capital markets. US mortgage lenders have faced old-fashioned runs. Northern Rock found itself requiring central bank support (in excess of £20 billion (US$ 40 billion)) as it was unable to raise required funding in money markets. The Chancellor of the UK Exchequer was forced to effectively guarantee the UK system of bank deposits to restore confidence Central banks, including the Fed and European Central Bank (“ECB”), have pumped money into the system in an effort to ease the liquidity crunch.
In further regulatory debauchery, the Fed recently allowed banks to pledge ABS CP as well as highly rated asset-backed securities, corporate bonds and mortgage-backed instruments as collateral for funding at the discount window. Funding has been extended from overnight to 30 days. Other central banks have followed suit.
Traditionally, only government securities are eligible for discounting. A fundamental principal of the discount window is that it is designed to provide short-term liquidity against instruments of unimpeachable credit quality. The regulatory spin is that this is “temporary” “in the light of market conditions” and “recognises innovation in the market”.
There are profound practical and policy issues in this development. What price will the central banks attribute to these riskier securities? What is the level of the advance that the central bank will offer and how will this be adjusted as market values of the underlying collateral changes? There are unconfirmed suggestions that the central banks are placing a value of 85% on AAA CDO securities. Given that there is significant uncertainty about the value of the security and even how they should be valued, the entry into this debate by central banks is curious.
There is also the question what happens if the bank cannot redeem the borrowing at the end of the 30 days and the value of the securities is below the level of the amount advance. This is precisely the problem confronting lenders who have lent against these securities. Central banks appear to have entered the field of prime broking, perhaps tempted by the profitability. In widening the eligible assets, central banks are effectively underwriting the credit risk and the liquidity of the financial system with public money.
The moves have also done little to ease liquidity or credit market concerns. Following the cut in the discount rate, four major US banks used the discount window: “to encourage its use by other financial institutions”. They did not need cash. It was a sign of strength. In the words of financial historian, Charles Geisst, it was : “like someone from the Upper East Side being seen in .. Wal-Mart”.
In other cases of “déjà vu all over again”, there have been suggestions that Fannie Mae and Ginnie Mae step in to buy mortgages to support liquidity as they have done in past crisis. The two institutions have assets and guarantees of almost US$4.0 trillion supported by stockholders’ equity of around US$60 billion. Both entities have also reported recent losses and have been forced to raise capital. The scope for liquidity creation by this route is likely to be difficult.
Socialism for Wall Street
In good times, financial markets embrace Capitalism. In bad times, financial markets re-discover Socialism. Currently, the US Federal Reserve is engaged in a dangerous strategy to look after its Wall Street friends.
The Fed has cut the fed funds and discount rates. The markets cheered the Fed decision to cut rates in September and then again in October. “This is manna. I am blown away. These guys get it I could hug these guys. This is what we wanted.” Jim Cramer, CNBC's markets pundit, was at the forefront of the cheerleading. Since the Fed's interest rate cuts, equity markets have reached records levels and the junk debt has recovered modestly.
Relief has been short lived. In recent weeks, the differential between inter-bank rates and the central bank targeted rates has widened to levels not seen since August. This points to further potential cuts in both rates by the end of the year. Lower cuts are inconsistent with above target inflation levels resulting from high oil prices, higher food prices, increasing cost pressures in emerging economies such as China and the potential inflationary effect of a weaker US dollar.
The US central bank’s strategy is clear. The current credit problems require a substantial reduction in the level of borrowings and leverage in the global financial system. Asset prices ramped up by excessive debt need to adjust. The adjustment can take place via a “crash”. This would be de-stabilizing and would wreak further havoc on already weakened banks. Alternatively, the de-leveraging and price adjustment can be achieved by creating inflation through loose monetary policy. If asset prices remain at current levels, higher inflation allows values to fall in real terms. Higher inflation also reduces the value of the borrowings that must be paid back allowing the required reduction in leverage.
Between January 1960 and December 1974, the Dow Jones Industrial Average was substantially unchanged. This is despite significant periodic rallies during the “go-go years”. If inflation averaged 5% pa, then the value of the market (ignoring dividends) lost around half (50%) of its value in real (inflation adjusted) terms.
The Fed strategy also assists affected banks. The large writedowns in risky assets and the expected re-intermediation of assets means that some banks need large infusions of capital. Given recent performance and subdued profit outlook, it would be difficult for them to raise this capital at acceptable prices.
Lower short-term interest rates allow banks to borrow cheaply. The money can be used to purchase government bonds that provide higher returns than the cost of borrowing. This generates profits for the bank without the banks having to hold capital against their assets (banks generally are not required to hold capital against government securities). The profits help re-capitalize the bank. An added benefit is that the US government can fund its deficit by selling its debt to the banks. This would be handy if foreign demand for US Treasuries decreases in response to the weaker dollar.
In the 1980s, US manufacturers looked to Japan as the source of ideas to improve efficiency. Remember “Just-in-Time” manufacturing, “zero defect” etc. Now, it seems US regulators are borrowing ideas from their Japanese colleagues. The Bank of Japan used the same strategy to re-capitalize the loss making Japanese banks after the collapse of the “bubble economy” in 1989.
Higher inflation expectations are already evident in higher gold prices, the steeper US yield curve (long term rates are higher than short-term rates) and the weaker US dollar. Foreign investors, especially large sovereign investment funds, are switching from financial assets (bonds) to “real” assets (companies with real businesses) reflecting higher inflationary expectations.
The strategy is dangerous. Inflation can lead to a significant transfer of wealth from investors to borrowers. Inflation once embedded in the economy distorts economic activity such as investment and savings. The experience of the late 1970s and early 1980s highlights the difficulties in recapturing the inflation beast once uncaged. Paul Volcker, then Chairman of the Federal Reserve, bravely increased interest rates to stratospheric levels to squeeze inflation out of the financial system.
The strategy may also not work. The cuts in rates do not appear to have had the desired effect in improving market liquidity conditions. Default risk concerns continue to inhibit lending and other routine financial transactions. Lower rates may set off further bubbles – for example, in equities and emerging markets. Asset prices may fall sharply anyway. In fairness to Dr. Bernanke, he has limited policy alternatives available.
Central bankers have stated that “errant” banks and investors will not be “bailed out”. Actual actions suggest otherwise. Banks have played their “nuclear” option well. The specter of “systemic risk” – whether real or not - is one a central banker cannot ignore. The banks continue to privatize gains and socialize losses.
These moves have attracted remarkably little scrutiny or comment. Central banks are effectively underwriting the credit risk and the liquidity of the financial system with public money but without any transparent political debate. Socialism for Wall Street prevails, once again.
Central banks and regulators bear a serious responsibility for safeguarding the functioning and integrity of financial systems. At the moment they are being exposed like the Wizard of Oz – old desperate men (they are mainly men) behind the curtain running from one lever to another in a desperate attempt to maintain illusions.
© 2007 Satyajit Das All Rights reserved.
[1] See Adrian Blundell-Wignall (2007) An Overview of Hedge Funds and Structured Products: Issues in Leverage and Risk; OECD
28 November 2007
Google Plans to Develop Cheaper Solar, Wind Power
By Ari Levy
Nov. 27 (Bloomberg) -- Google Inc., whose corporate motto is ``don't be evil,'' created a research group to develop cheaper renewable energy sources, focusing on solar, wind and other alternative forms of power.
Google, the owner of the most-used Internet search engine, said today that it's hiring engineers and energy experts to lead a process that may cost hundreds of millions of dollars.
The project, called Renewable Energy Cheaper Than Coal, is meant first to help Google cut its energy costs and then to offer customers cheaper power. It follows initiatives this year to maximize the efficiency of its data centers, which account for most of the energy Google consumes.
``We're a large consumer of energy due to our data centers, so we're a natural customer,'' Larry Page, Google's co-founder, said in an interview. ``We see opportunities to make significant investments that generate positive returns.''
Investors might worry about the company's ``long-term focus'' and questioned whether the project was a good fit for the company, said Jordan Rohan, an analyst at RBC Capital Markets in New York. Mountain View, California-based Google makes 99 percent of its revenue selling advertising.
`What the Heck?'
``What the heck are they doing? It boggles the mind,'' said Rohan, who advises buying Google shares. ``The company is blessed with the best business model on the Internet. This makes me worry about Google's priorities.''
Google rose $7.57 to $673.57 at 4 p.m. New York time in Nasdaq Stock Market trading. The shares have gained 46 percent this year.
Through internal development and investments in other companies, Google expects to generate revenue in the alternative- energy market. Its philanthropic arm, Google.org, will make grants to companies, laboratories and universities working on related projects, the company said in a statement.
The goal is to create a gigawatt of renewable energy, enough to power a city the size of San Francisco for less than it would cost using coal, in ``years, not in decades,'' Page said. Coal accounts for more than 50 percent of all U.S. power and is one of the biggest sources of carbon emissions.
A typical data center consumes 300 megawatts to 400 megawatts of energy, according to Sandeep Aggarwal, an analyst at Oppenheimer & Co. in San Francisco. Google probably has 10 to 15 data centers, he said. One gigawatt equals 1,000 megawatts.
Large Consumer
``If Google is consuming between 3,000 to 5,000 megawatts of energy, they might be one of the largest consumers of energy,'' said Agarwal, who recommends buying the shares, which he doesn't own. ``If they can figure out how to save money in their energy consumption, this sounds like a positive to me.''
Google is already working with Pasadena, California-based ESolar Inc., a solar-power company, and Alameda, California-based Makani Power Inc., a developer of wind energy.
``Climate change is a very important reason for this announcement but it's not the only reason,'' Google co-founder Sergey Brin said today on a conference call. ``There's a lot of demand'' for cheaper energy, he said.
The company plans to hire 20 to 30 people over the next year for the project, Bill Weihl, the head of Google's environmental programs, said on the call. In June, Google and five partners including Microsoft Corp. started the Climate Savers Computing Initiative, a plan to save electricity in personal computers.
To contact the reporter on this story: Ari Levy in San Francisco at levy5@bloomberg.net .
Nov. 27 (Bloomberg) -- Google Inc., whose corporate motto is ``don't be evil,'' created a research group to develop cheaper renewable energy sources, focusing on solar, wind and other alternative forms of power.
Google, the owner of the most-used Internet search engine, said today that it's hiring engineers and energy experts to lead a process that may cost hundreds of millions of dollars.
The project, called Renewable Energy Cheaper Than Coal, is meant first to help Google cut its energy costs and then to offer customers cheaper power. It follows initiatives this year to maximize the efficiency of its data centers, which account for most of the energy Google consumes.
``We're a large consumer of energy due to our data centers, so we're a natural customer,'' Larry Page, Google's co-founder, said in an interview. ``We see opportunities to make significant investments that generate positive returns.''
Investors might worry about the company's ``long-term focus'' and questioned whether the project was a good fit for the company, said Jordan Rohan, an analyst at RBC Capital Markets in New York. Mountain View, California-based Google makes 99 percent of its revenue selling advertising.
`What the Heck?'
``What the heck are they doing? It boggles the mind,'' said Rohan, who advises buying Google shares. ``The company is blessed with the best business model on the Internet. This makes me worry about Google's priorities.''
Google rose $7.57 to $673.57 at 4 p.m. New York time in Nasdaq Stock Market trading. The shares have gained 46 percent this year.
Through internal development and investments in other companies, Google expects to generate revenue in the alternative- energy market. Its philanthropic arm, Google.org, will make grants to companies, laboratories and universities working on related projects, the company said in a statement.
The goal is to create a gigawatt of renewable energy, enough to power a city the size of San Francisco for less than it would cost using coal, in ``years, not in decades,'' Page said. Coal accounts for more than 50 percent of all U.S. power and is one of the biggest sources of carbon emissions.
A typical data center consumes 300 megawatts to 400 megawatts of energy, according to Sandeep Aggarwal, an analyst at Oppenheimer & Co. in San Francisco. Google probably has 10 to 15 data centers, he said. One gigawatt equals 1,000 megawatts.
Large Consumer
``If Google is consuming between 3,000 to 5,000 megawatts of energy, they might be one of the largest consumers of energy,'' said Agarwal, who recommends buying the shares, which he doesn't own. ``If they can figure out how to save money in their energy consumption, this sounds like a positive to me.''
Google is already working with Pasadena, California-based ESolar Inc., a solar-power company, and Alameda, California-based Makani Power Inc., a developer of wind energy.
``Climate change is a very important reason for this announcement but it's not the only reason,'' Google co-founder Sergey Brin said today on a conference call. ``There's a lot of demand'' for cheaper energy, he said.
The company plans to hire 20 to 30 people over the next year for the project, Bill Weihl, the head of Google's environmental programs, said on the call. In June, Google and five partners including Microsoft Corp. started the Climate Savers Computing Initiative, a plan to save electricity in personal computers.
To contact the reporter on this story: Ari Levy in San Francisco at levy5@bloomberg.net .
25 November 2007
Panic of 2008
RHINEBECK, N.Y., Nov. 19 (UPI) -- A financial crisis will likely send the U.S. dollar into a free fall of as much as 90 percent and gold soaring to $2,000 an ounce, a trends researcher said.
"We are going to see economic times the likes of which no living person has seen," Trends Research Institute Director Gerald Celente said, forecasting a "Panic of 2008."
"The bigger they are, the harder they'll fall," he said in an interview with New York's Hudson Valley Business Journal.
Celente -- who forecast the subprime mortgage financial crisis and the dollar's decline a year ago and gold's current rise in May -- told the newspaper the subprime mortgage meltdown was just the first "small, high-risk segment of the market" to collapse.
Derivative dealers, hedge funds, buyout firms and other market players will also unravel, he said.
Massive corporate losses, such as those recently posted by Citigroup Inc. and General Motors Corp., will also be fairly common "for some time to come," he said.
He said he would not "be surprised if giants tumble to their deaths," Celente said.
The Panic of 2008 will lead to a lower U.S. standard of living, he said.
A result will be a drop in holiday spending a year from now, followed by a permanent end of the "retail holiday frenzy" that has driven the U.S. economy since the 1940s, he said.
"We are going to see economic times the likes of which no living person has seen," Trends Research Institute Director Gerald Celente said, forecasting a "Panic of 2008."
"The bigger they are, the harder they'll fall," he said in an interview with New York's Hudson Valley Business Journal.
Celente -- who forecast the subprime mortgage financial crisis and the dollar's decline a year ago and gold's current rise in May -- told the newspaper the subprime mortgage meltdown was just the first "small, high-risk segment of the market" to collapse.
Derivative dealers, hedge funds, buyout firms and other market players will also unravel, he said.
Massive corporate losses, such as those recently posted by Citigroup Inc. and General Motors Corp., will also be fairly common "for some time to come," he said.
He said he would not "be surprised if giants tumble to their deaths," Celente said.
The Panic of 2008 will lead to a lower U.S. standard of living, he said.
A result will be a drop in holiday spending a year from now, followed by a permanent end of the "retail holiday frenzy" that has driven the U.S. economy since the 1940s, he said.
24 November 2007
Bankers Gone Wild
By PAUL KRUGMAN
“What were they smoking?” asks the cover of the current issue of Fortune magazine. Underneath the headline are photos of recently deposed Wall Street titans, captioned with the staggering sums they managed to lose.
The answer, of course, is that they were high on the usual drug greed. And they were encouraged to make socially destructive decisions by a system of executive compensation that should have been reformed after the Enron and WorldCom scandals, but wasn't.
In a direct sense, the carnage on Wall Street is all about the great housing slump.
This slump was both predictable and predicted. “These days,” I wrote in August 2005, “Americans make a living selling each other houses, paid for with money borrowed from the Chinese. Somehow, that doesn't seem like a sustainable lifestyle.” It wasn't.
But even as the danger signs multiplied, Wall Street piled into bonds backed by dubious home mortgages. Most of the bad investments now shaking the financial world seem to have been made in the final frenzy of the housing bubble, or even after the bubble began to deflate.
In fact, according to Fortune, Merrill Lynch made its biggest purchases of bad debt in the first half of this year after the subprime crisis had already become public knowledge.
Now the bill is coming due, and almost everyone that is, almost everyone except the people responsible is having to pay.
The losses suffered by shareholders in Merrill, Citigroup, Bear Stearns and so on are the least of it. Far more important in human terms are the hundreds of thousands if not millions of American families lured into mortgage deals they didn't understand, who now face sharp increases in their payments and, in many cases, the loss of their houses as their interest rates reset.
And then there's the collateral damage to the economy.
You still hear occasional claims that the subprime fiasco is no big deal. Even though the numbers keep getting bigger some observers are now talking about $400 billion in losses these losses are small compared with the total value of financial assets.
But bad housing investments are crippling financial institutions that play a crucial role in providing credit, by wiping out much of their capital. In a recent report, Goldman Sachs suggested that housing-related losses could force banks and other players to cut lending by as much as $2 trillion enough to trigger a nasty recession, if it happens quickly.
Beyond that, there's a pervasive loss of trust, which is like sand thrown in the gears of the financial system. The crisis of confidence is plainly visible in the market data: there's an almost unprecedented spread between the very low interest rates investors are willing to accept on U.S. government debt which is still considered safe and the much higher interest rates at which banks are willing to lend to each other.
How did things go so wrong?
Part of the answer is that people who should have been alert to the dangers, and taken precautionary measures, instead blithely assured Americans that everything was fine, and even encouraged them to take out risky mortgages. Yes, Alan Greenspan, that means you.
But another part of the answer lies in what hasn't happened to the men on that Fortune cover namely, they haven't been forced to give back any of the huge paychecks they received before the folly of their decisions became apparent.
Around 25 years ago, American business and the American political system bought into the idea that greed is good. Executives are lavishly rewarded if the companies they run seem successful: last year the chief executives of Merrill and Citigroup were paid $48 million and $25.6 million, respectively.
But if the success turns out to have been an illusion well, they still get to keep the money. Heads they win, tails we lose.
Not only is this grossly unfair, it encourages bad risk-taking, and sometimes fraud. If an executive can create the appearance of success, even for a couple of years, he will walk away immensely wealthy. Meanwhile, the subsequent revelation that appearances were deceiving is someone else's problem.
If all this sounds familiar, it should. The huge rewards executives receive if they can fake success are what led to the great corporate scandals of a few years back. There's no indication that any laws were broken this time but the public's trust was nonetheless betrayed, once again.
The point is that the subprime crisis and the credit crunch are, in an important sense, the result of our failure to effectively reform corporate governance after the last set of scandals.
John Edwards recently came out with a corporate reform plan, but it didn't receive a lot of attention. Corporate governance still isn't regarded as a major political issue. But it should be.
“What were they smoking?” asks the cover of the current issue of Fortune magazine. Underneath the headline are photos of recently deposed Wall Street titans, captioned with the staggering sums they managed to lose.
The answer, of course, is that they were high on the usual drug greed. And they were encouraged to make socially destructive decisions by a system of executive compensation that should have been reformed after the Enron and WorldCom scandals, but wasn't.
In a direct sense, the carnage on Wall Street is all about the great housing slump.
This slump was both predictable and predicted. “These days,” I wrote in August 2005, “Americans make a living selling each other houses, paid for with money borrowed from the Chinese. Somehow, that doesn't seem like a sustainable lifestyle.” It wasn't.
But even as the danger signs multiplied, Wall Street piled into bonds backed by dubious home mortgages. Most of the bad investments now shaking the financial world seem to have been made in the final frenzy of the housing bubble, or even after the bubble began to deflate.
In fact, according to Fortune, Merrill Lynch made its biggest purchases of bad debt in the first half of this year after the subprime crisis had already become public knowledge.
Now the bill is coming due, and almost everyone that is, almost everyone except the people responsible is having to pay.
The losses suffered by shareholders in Merrill, Citigroup, Bear Stearns and so on are the least of it. Far more important in human terms are the hundreds of thousands if not millions of American families lured into mortgage deals they didn't understand, who now face sharp increases in their payments and, in many cases, the loss of their houses as their interest rates reset.
And then there's the collateral damage to the economy.
You still hear occasional claims that the subprime fiasco is no big deal. Even though the numbers keep getting bigger some observers are now talking about $400 billion in losses these losses are small compared with the total value of financial assets.
But bad housing investments are crippling financial institutions that play a crucial role in providing credit, by wiping out much of their capital. In a recent report, Goldman Sachs suggested that housing-related losses could force banks and other players to cut lending by as much as $2 trillion enough to trigger a nasty recession, if it happens quickly.
Beyond that, there's a pervasive loss of trust, which is like sand thrown in the gears of the financial system. The crisis of confidence is plainly visible in the market data: there's an almost unprecedented spread between the very low interest rates investors are willing to accept on U.S. government debt which is still considered safe and the much higher interest rates at which banks are willing to lend to each other.
How did things go so wrong?
Part of the answer is that people who should have been alert to the dangers, and taken precautionary measures, instead blithely assured Americans that everything was fine, and even encouraged them to take out risky mortgages. Yes, Alan Greenspan, that means you.
But another part of the answer lies in what hasn't happened to the men on that Fortune cover namely, they haven't been forced to give back any of the huge paychecks they received before the folly of their decisions became apparent.
Around 25 years ago, American business and the American political system bought into the idea that greed is good. Executives are lavishly rewarded if the companies they run seem successful: last year the chief executives of Merrill and Citigroup were paid $48 million and $25.6 million, respectively.
But if the success turns out to have been an illusion well, they still get to keep the money. Heads they win, tails we lose.
Not only is this grossly unfair, it encourages bad risk-taking, and sometimes fraud. If an executive can create the appearance of success, even for a couple of years, he will walk away immensely wealthy. Meanwhile, the subsequent revelation that appearances were deceiving is someone else's problem.
If all this sounds familiar, it should. The huge rewards executives receive if they can fake success are what led to the great corporate scandals of a few years back. There's no indication that any laws were broken this time but the public's trust was nonetheless betrayed, once again.
The point is that the subprime crisis and the credit crunch are, in an important sense, the result of our failure to effectively reform corporate governance after the last set of scandals.
John Edwards recently came out with a corporate reform plan, but it didn't receive a lot of attention. Corporate governance still isn't regarded as a major political issue. But it should be.
22 November 2007
Dark Horse of the Year: Ron Paul
http://men.style.com/gq/blogs/gqeditors/2007/11/gqs-dark-horse.html
GQ Men of the Year 2007
We've chosen presidential candidate Ron Paul as our Dark Horse of the Year—in GQ's December Men of the Year issue, on stands nationwide on November 27th. Here's why.
Washington sure seems like a town full of bullies sometimes. Along comes a 72-year-old physician from south Texas who weighs maybe 140 pounds with rocks in his pockets, whom most people, at the beginning of the year, couldn't have picked out of a two-person lineup, who took in barely enough first-quarter money to buy a fancy Italian car, who comes armed with ideas both misbegotten (Abolish the Fed!) and very much not (End this war! Stop indefinitely detaining human beings!), and what do the folks who run the Republican Party do?
They try to silence him. The head of the Michigan Republicans calls for his removal from the debates. Rudy Giuliani attacks him for—what else?—insufficient patriotism. To witness this is to understand the fear Ron Paul has instilled in the GOP.
He has tapped into his party's silent minority, one that won't abide torture, reckless spending, or endless war. And his supporters (and admittedly, there are some real conspiracy-minded moonbats among them) have rewarded Paul for his courageousness, to the tune of more than $5 million in campaign contributions in the third quarter—about the same as John McCain has raised.
It isn't a revolution, but Ron Paul's candidacy serves as a reminder that electoral politics needn't be a joyless march to a clothespin vote. It can be daring and kind of kooky, too. —Greg Veis
GQ Men of the Year 2007
We've chosen presidential candidate Ron Paul as our Dark Horse of the Year—in GQ's December Men of the Year issue, on stands nationwide on November 27th. Here's why.
Washington sure seems like a town full of bullies sometimes. Along comes a 72-year-old physician from south Texas who weighs maybe 140 pounds with rocks in his pockets, whom most people, at the beginning of the year, couldn't have picked out of a two-person lineup, who took in barely enough first-quarter money to buy a fancy Italian car, who comes armed with ideas both misbegotten (Abolish the Fed!) and very much not (End this war! Stop indefinitely detaining human beings!), and what do the folks who run the Republican Party do?
They try to silence him. The head of the Michigan Republicans calls for his removal from the debates. Rudy Giuliani attacks him for—what else?—insufficient patriotism. To witness this is to understand the fear Ron Paul has instilled in the GOP.
He has tapped into his party's silent minority, one that won't abide torture, reckless spending, or endless war. And his supporters (and admittedly, there are some real conspiracy-minded moonbats among them) have rewarded Paul for his courageousness, to the tune of more than $5 million in campaign contributions in the third quarter—about the same as John McCain has raised.
It isn't a revolution, but Ron Paul's candidacy serves as a reminder that electoral politics needn't be a joyless march to a clothespin vote. It can be daring and kind of kooky, too. —Greg Veis
Citibank SIVs Hit Norway Townships
by Mike Shedlock
Several Norway townships are caught up in the international credit crisis.
Several small townships in northern Norway went along with a securities firm's advice and invested as much as NOK 4 billion in complicated American commercial paper sold by Citibank. They now risk losing it all.
The township politicians are both embarrassed and angry at the financial advisers who they now claim led them astray. "They think we're a bunch of small-town fools," one local mayor told newspaper Dagens Næringsliv.
Officials in four northern Norwegian townships (Narvik, Rana, Hemnes and Hattfjelldal) went along with an alleged recommendation by Terra Securities to invest a total of NOK 451 million in what they're now calling "high-risk structured products" offered by Citibank and sold for Citibank by Terra.
To boost returns, the Norwegian townships also borrowed NOK 3.5 billion to invest in Citibank's products, which later lost as much as 50 percent of their value because of the US credit crunch.
By now it should be clear that Asset Backed Commercial Paper ABCP problems are likely to turn up anywhere and everywhere.
Here is a small sampling:
Two Bear Stearns (BSC) Hedge Funds went to Zero
Two Hedge Funds in Australia liquidated
Money has been frozen in Canada including the Yukon
US and Canadian pension plans are affected
Two banks in Germany were bailed out by the ECB
Norway Townships borrowed money to invest in this mess
Citigroup (C) and Merrill Lynch (MER) both lost their CEOs over this mess
Hundreds of $billions in potential losses are still circulating
The latest news in the US is that SIV debts are hiding in scores of public school funds and close to a $billion in defaults losses had not even been disclosed as late as a week ago even though this mess has been brewing for six months. See SIV Debts A Disaster For Public School Funds for more on this story.
Very Expensive Lessons
Don't chase yield
Don't buy something you do not understand
There is no free lunch
Rating agencies opinions are essentially worthless because they are never timely enough and because their business model creates enormous credibility as well as conflict of interest issues
Don't trust Citigroup, Bear Stearns, Merrill Lynch or anyone else hawking debt
That last point is critical. Lack of trust will impact Citigroup, Bear Stearns, and Merrill Lynch's credibility, as well as their ability to raise capital for years to come. Trust once lost, is not easily restored.
Several Norway townships are caught up in the international credit crisis.
Several small townships in northern Norway went along with a securities firm's advice and invested as much as NOK 4 billion in complicated American commercial paper sold by Citibank. They now risk losing it all.
The township politicians are both embarrassed and angry at the financial advisers who they now claim led them astray. "They think we're a bunch of small-town fools," one local mayor told newspaper Dagens Næringsliv.
Officials in four northern Norwegian townships (Narvik, Rana, Hemnes and Hattfjelldal) went along with an alleged recommendation by Terra Securities to invest a total of NOK 451 million in what they're now calling "high-risk structured products" offered by Citibank and sold for Citibank by Terra.
To boost returns, the Norwegian townships also borrowed NOK 3.5 billion to invest in Citibank's products, which later lost as much as 50 percent of their value because of the US credit crunch.
By now it should be clear that Asset Backed Commercial Paper ABCP problems are likely to turn up anywhere and everywhere.
Here is a small sampling:
Two Bear Stearns (BSC) Hedge Funds went to Zero
Two Hedge Funds in Australia liquidated
Money has been frozen in Canada including the Yukon
US and Canadian pension plans are affected
Two banks in Germany were bailed out by the ECB
Norway Townships borrowed money to invest in this mess
Citigroup (C) and Merrill Lynch (MER) both lost their CEOs over this mess
Hundreds of $billions in potential losses are still circulating
The latest news in the US is that SIV debts are hiding in scores of public school funds and close to a $billion in defaults losses had not even been disclosed as late as a week ago even though this mess has been brewing for six months. See SIV Debts A Disaster For Public School Funds for more on this story.
Very Expensive Lessons
Don't chase yield
Don't buy something you do not understand
There is no free lunch
Rating agencies opinions are essentially worthless because they are never timely enough and because their business model creates enormous credibility as well as conflict of interest issues
Don't trust Citigroup, Bear Stearns, Merrill Lynch or anyone else hawking debt
That last point is critical. Lack of trust will impact Citigroup, Bear Stearns, and Merrill Lynch's credibility, as well as their ability to raise capital for years to come. Trust once lost, is not easily restored.
Gold & Deflation/Inflation by Marc Faber
I am asked constantly how gold would perform in a deflationary collapse. With the propensity of the Fed and the ECB to flood the system with liquidity and to take "extraordinary measures" whenever problems arise, deflation is a remote possibility for the foreseeable future. So, before worrying about deflation, I would worry inflation accelerating strongly in the years to come - especially if the US economy stagnates. But let us assume that at some point in the future deflation follows. What then? In my opinion, deflation could only be triggered by one event: a total collapse of the existing global credit bubble. And the only event that I can think of that would trigger such a debt collapse would be a third world war. The failure of a large bank - say, Citigroup - wouldn't do the trick, because the Fed would immediately bail it out (unless Ron Paul is US President).
Now in a debt collapse, where would you rather have your money? In bank deposits, in CDs, in dubious commercial paper, in bonds, in money market funds - all of which would experience soaring default rates - or in physical gold, ideally in a safe deposit box? I think that, particularly in a debt collapse, physical gold would shine, as people the world over would become extremely concerned about, not the return on their money (interest), but the return of their money. This would be particularly true of Asian central banks, which now have less than 2% of their reserves in gold but hold massive quantities of all kind of debt securities.
Consequently, while I find the gold price to be currently somewhat overbought, I still think that gold will be one of the best investments over the next couple of years. In particular, I would expect demand for gold from individuals around the world to increase meaningfully - especially in Asia - at a time when production is unlikely to increase. I wish to add that I am not a "gold bug". I would much prefer to live in a world in which central banks' top priority was to safeguard paper money's purchasing power and its function as a "store of value". I would also much rather live in a world in which the US dollar was a strong currency, and where America was as free as it was in the 1960s, and the economic and financial imbalances weren't as extreme as they are today. As Steven Roach recently remarked, "no nation has ever devalued its way into prosperity". But the fact is, the time has come when we can no longer trust central banks. Therefore, each individual must be his own central bank and maintain adequate reserves for himself in the form of physical gold. The supply of paper money is potentially endless, whereas the supply of gold is very limited. (In fact, gold production from mines is declining.)
Marc Faber
excerpted from
The Gloom, Boom & Doom Report - Nov 2007
Now in a debt collapse, where would you rather have your money? In bank deposits, in CDs, in dubious commercial paper, in bonds, in money market funds - all of which would experience soaring default rates - or in physical gold, ideally in a safe deposit box? I think that, particularly in a debt collapse, physical gold would shine, as people the world over would become extremely concerned about, not the return on their money (interest), but the return of their money. This would be particularly true of Asian central banks, which now have less than 2% of their reserves in gold but hold massive quantities of all kind of debt securities.
Consequently, while I find the gold price to be currently somewhat overbought, I still think that gold will be one of the best investments over the next couple of years. In particular, I would expect demand for gold from individuals around the world to increase meaningfully - especially in Asia - at a time when production is unlikely to increase. I wish to add that I am not a "gold bug". I would much prefer to live in a world in which central banks' top priority was to safeguard paper money's purchasing power and its function as a "store of value". I would also much rather live in a world in which the US dollar was a strong currency, and where America was as free as it was in the 1960s, and the economic and financial imbalances weren't as extreme as they are today. As Steven Roach recently remarked, "no nation has ever devalued its way into prosperity". But the fact is, the time has come when we can no longer trust central banks. Therefore, each individual must be his own central bank and maintain adequate reserves for himself in the form of physical gold. The supply of paper money is potentially endless, whereas the supply of gold is very limited. (In fact, gold production from mines is declining.)
Marc Faber
excerpted from
The Gloom, Boom & Doom Report - Nov 2007
Central bankers grapple with dollar conundrum
Central bankers grapple with dollar conundrum
By Peter Garnham in London
Published: November 21 2007 02:00 | Last updated: November 21 2007 02:00
The sliding dollar has presented custodians of the world's massive foreign exchange reserves with a conundrum.
Countries such as China and those in the Gulf, which peg their currencies to the dollar, risk inflationary pressure that has the potential to trigger serious economic and social problems.
But any move to cut their links to the dollar could spark a run on the currency that would undermine the value of their reserves.
Global currency reserves have soared from $2,000bn in the second quarter of 2002 to $5,700bn (€3,885bn, £2,780bn) in the corresponding period this year, according to the International Monetary Fund.
Furthermore, two-thirds of the world's reserves are in the hands of six countries: China, Japan, Taiwan, South Korea, Russia and Singapore.
But China tops the league, with the latest official figures showing the value of its reserves at $1,443.6bn in July.
Many of China's trading partners argue that this stockpile - which grew at $40bn-$50bn a month in the first half of the year - has been caused by what they believe to be an undervalued renminbi.
Most analysts say that
the country's reserves have accumulated rapidly since July and that this explains the growing concern about the dollar expressed by Chinese officials.
Yesterday the dollar plunged to a record low of $1.4813 against the euro.
Beijing does not reveal the currency composition of its reserves. However, informed observers say the weightings of its various currencies roughly follow the latest figures from the IMF.
Central banks which have revealed the make-up of their reserves hold on average 64.7 per cent in dollars, 25.5 per cent in euros and the remainder in currencies such as sterling, yen and the Australian dollar.
China's concerns have been highlighted by Wen Jiabao, the premier, who said the country had never experienced such pressure over its reserves and that he was worried about how to preserve their value.
Hans Redeker, at BNP Paribas, says these comments are a clear indication that China wants to slow down the pace of increase of its reserves.
Primarily driven by food prices, China's rising rate of inflation currently stands at 6.5 per cent. Mr Redeker suggests that a rising renminbi is now favourable for the country as it will reduce import price pressure for food products.
"The undervalued renminbi supplied the globe with excess liquidity while the investment boom created demand for raw materials," he says. "This overvaluation [of raw materials] is now going to correct as China leads its currency closer to its fair value and tighter domestic conditions slow investment spending."
While an appreciation of the renminbi would slow China's accumulation of foreign exchange reserves, it would not address the problems caused by the weak dollar undermining their value.
Simon Derrick, at Bank of New York Mellon, says it is ironic that a large part of the reason for the dollar's fall can be attributed to central bank reserve managers.
IMF data reveal that, in the second quarter of 2002, the dollar represented 71 per cent of central bank holdings, while only 19.7 per cent was held in euros.
"All the available evidence indicates that the phenomenal growth in foreign exchange reserves over the past five years has been accompanied by a notable push to diversify away from the dollar and into the euro," he says. "This explains the rise of the euro."
Other analysts were less sure of the role played by central bank reserve diversification in the dollar's fall.
They say cyclical factors are the main driver behind the dollar's 40 per cent drop against the euro since 2002, arguing that the shift in reserve currency allocations needed to drive the dollar so far would be much greater than the shifts reported by the IMF.
Marc Chandler, at Brown Brothers Harriman, says central banks may well be diversifying new reserve accumulation away from the dollar, but China's recent comments do not mean they are diversifying existing holdings. "What incentive do they have to tip their hand, even if that is what they intend to do?" he asks.
In any case, Mr Chandler believes it is unlikely that the Peoples' Bank of China has turned from the traditional role of a central bank to become a currency speculator.
By Peter Garnham in London
Published: November 21 2007 02:00 | Last updated: November 21 2007 02:00
The sliding dollar has presented custodians of the world's massive foreign exchange reserves with a conundrum.
Countries such as China and those in the Gulf, which peg their currencies to the dollar, risk inflationary pressure that has the potential to trigger serious economic and social problems.
But any move to cut their links to the dollar could spark a run on the currency that would undermine the value of their reserves.
Global currency reserves have soared from $2,000bn in the second quarter of 2002 to $5,700bn (€3,885bn, £2,780bn) in the corresponding period this year, according to the International Monetary Fund.
Furthermore, two-thirds of the world's reserves are in the hands of six countries: China, Japan, Taiwan, South Korea, Russia and Singapore.
But China tops the league, with the latest official figures showing the value of its reserves at $1,443.6bn in July.
Many of China's trading partners argue that this stockpile - which grew at $40bn-$50bn a month in the first half of the year - has been caused by what they believe to be an undervalued renminbi.
Most analysts say that
the country's reserves have accumulated rapidly since July and that this explains the growing concern about the dollar expressed by Chinese officials.
Yesterday the dollar plunged to a record low of $1.4813 against the euro.
Beijing does not reveal the currency composition of its reserves. However, informed observers say the weightings of its various currencies roughly follow the latest figures from the IMF.
Central banks which have revealed the make-up of their reserves hold on average 64.7 per cent in dollars, 25.5 per cent in euros and the remainder in currencies such as sterling, yen and the Australian dollar.
China's concerns have been highlighted by Wen Jiabao, the premier, who said the country had never experienced such pressure over its reserves and that he was worried about how to preserve their value.
Hans Redeker, at BNP Paribas, says these comments are a clear indication that China wants to slow down the pace of increase of its reserves.
Primarily driven by food prices, China's rising rate of inflation currently stands at 6.5 per cent. Mr Redeker suggests that a rising renminbi is now favourable for the country as it will reduce import price pressure for food products.
"The undervalued renminbi supplied the globe with excess liquidity while the investment boom created demand for raw materials," he says. "This overvaluation [of raw materials] is now going to correct as China leads its currency closer to its fair value and tighter domestic conditions slow investment spending."
While an appreciation of the renminbi would slow China's accumulation of foreign exchange reserves, it would not address the problems caused by the weak dollar undermining their value.
Simon Derrick, at Bank of New York Mellon, says it is ironic that a large part of the reason for the dollar's fall can be attributed to central bank reserve managers.
IMF data reveal that, in the second quarter of 2002, the dollar represented 71 per cent of central bank holdings, while only 19.7 per cent was held in euros.
"All the available evidence indicates that the phenomenal growth in foreign exchange reserves over the past five years has been accompanied by a notable push to diversify away from the dollar and into the euro," he says. "This explains the rise of the euro."
Other analysts were less sure of the role played by central bank reserve diversification in the dollar's fall.
They say cyclical factors are the main driver behind the dollar's 40 per cent drop against the euro since 2002, arguing that the shift in reserve currency allocations needed to drive the dollar so far would be much greater than the shifts reported by the IMF.
Marc Chandler, at Brown Brothers Harriman, says central banks may well be diversifying new reserve accumulation away from the dollar, but China's recent comments do not mean they are diversifying existing holdings. "What incentive do they have to tip their hand, even if that is what they intend to do?" he asks.
In any case, Mr Chandler believes it is unlikely that the Peoples' Bank of China has turned from the traditional role of a central bank to become a currency speculator.
Global crash imminent, warns expert
Global crash imminent, warns expert
by Joel Bowman on Sunday, 18 November 2007
A sharp downward correction is due in the global markets as real estate, stocks and energy soar to record highs, warned a leading expert on the opening day at this year's Dubai International Financial Centre (DIFC) Week.
Even as emerging markets like China, India and Brazil careen ahead at voracious growth rates, the speculative "bubbles" arising in the markets could cause a major global recession, cautioned Robert Shiller, the Stanley B. Resor Professor of Economics at Yale University, at yesterday's event.
"Perhaps we have gotten a little too confident in the global economic growth," said Shiller. "The problem is high oil, stock and real estate prices. I believe that a substantial part is speculative bubble thinking. We have gotten too confident of the prices in these markets," he said.
Story continues below ↓
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Oil prices, driven partly by demand from the rampant economic expansion of emerging markets, are flirting with all time record prices, even when adjusted for the devaluing of the U.S. dollar, in which oil is almost universally priced.
Housing too has been boosted to obscene highs on the back of the liquidity glut caused by low interest rates around the turn of the century and by speculative buying. Shiller pointed to the increase in long term home prices in the Netherlands, Norway and the U.S. to illustrate the precarious position the markets have been elevated to.
Now that the global credit crunch has all but dried up the lending and borrowing frenzy that fueled these price run-ups, the markets could face troubled times ahead.
"The unwinding of these markets is the most serious risk facing these markets today," Shiller said.
The confidence of consumers and investors has steadily eroded as they buckle under the pressure of these record high prices, according to measures taken by the Yale School of Management Stock Market Crash Confidence Index and its Market Valuation Confidence Index.
Shiller also pointed to the futures market, such as that of the CME in Chicago, which now predicts a major, ongoing decline over the coming four years.
DIFC Week runs until November 23 and features presentations from a host of economic leaders including Dr. Nasser Saidi, Larry Summers, Jeffery Sachs and Freakonomics author, Steven Levitt. View exclusive coverage at ArabianBusiness.com's Special Report .
by Joel Bowman on Sunday, 18 November 2007
A sharp downward correction is due in the global markets as real estate, stocks and energy soar to record highs, warned a leading expert on the opening day at this year's Dubai International Financial Centre (DIFC) Week.
Even as emerging markets like China, India and Brazil careen ahead at voracious growth rates, the speculative "bubbles" arising in the markets could cause a major global recession, cautioned Robert Shiller, the Stanley B. Resor Professor of Economics at Yale University, at yesterday's event.
"Perhaps we have gotten a little too confident in the global economic growth," said Shiller. "The problem is high oil, stock and real estate prices. I believe that a substantial part is speculative bubble thinking. We have gotten too confident of the prices in these markets," he said.
Story continues below ↓
advertisement
Oil prices, driven partly by demand from the rampant economic expansion of emerging markets, are flirting with all time record prices, even when adjusted for the devaluing of the U.S. dollar, in which oil is almost universally priced.
Housing too has been boosted to obscene highs on the back of the liquidity glut caused by low interest rates around the turn of the century and by speculative buying. Shiller pointed to the increase in long term home prices in the Netherlands, Norway and the U.S. to illustrate the precarious position the markets have been elevated to.
Now that the global credit crunch has all but dried up the lending and borrowing frenzy that fueled these price run-ups, the markets could face troubled times ahead.
"The unwinding of these markets is the most serious risk facing these markets today," Shiller said.
The confidence of consumers and investors has steadily eroded as they buckle under the pressure of these record high prices, according to measures taken by the Yale School of Management Stock Market Crash Confidence Index and its Market Valuation Confidence Index.
Shiller also pointed to the futures market, such as that of the CME in Chicago, which now predicts a major, ongoing decline over the coming four years.
DIFC Week runs until November 23 and features presentations from a host of economic leaders including Dr. Nasser Saidi, Larry Summers, Jeffery Sachs and Freakonomics author, Steven Levitt. View exclusive coverage at ArabianBusiness.com's Special Report .
21 November 2007
The Coming Crash
Message from John L. Petersen on the Coming Crash
November 19, 2007
It appears that the world in general and the United States in particular are on the edge of a major disruption in the global financial system. Here's the summary as we see it.
At a recent Board meeting of The Arlington Institute, Dr. David Martin, CEO of M*CAM and one of the members of the Board was asked for his assessment of the global financial situation in the coming months.
Here are my notes from his response:
I stand by my commentary in July of '06.
The next shoe to fall is consumer credit
Currently as reports came in on the 3rd quarter, foreclosures were up 470% this quarter alone. They will be up over 500% this coming quarter (4th). A foreclosure in our terms is when the bank has officially declared an account insolvent and tries to regain the asset (if it exists). The person who is foreclosed upon can no longer secure any traditional consumer credit. This in turn goes straight to the banks as no one will be able to get the store issued charge cards.
A minority of people pay off their consumer debt every month. When one considers the combination of consumer credit card debt and the compounded debt of “home equity” financing, we estimate that less than 20% of people actually carry no consumer credit from one month to the next. Many of the ones who don't pay off their carried consumer debt have at least one credit card at its limit and therefore lack credit capacity. Most have their paycheck directly covering bills and servicing the minimum balance due.
Therefore people who are foreclosed upon will not be able to obtain credit and since their paychecks will be maxed out, there will not be extra cash left over from the paycheck to service a new debt.
Next, everybody buys things at Christmas. As much as 40% of retail sales are done in the 4th quarter of the year – i.e. the retail miracle. The purchase decline in retail goods this fourth quarter will occur because many credit-only consumers will lack the credit capacity mentioned above. Frequently, people overcharge their limit and the banks (albeit a profit center for subprime credit users) levy a penalty by increasing interest rates and charging additional fees. In the 4th quarter of 2007, the amount of people overcharging their limits will be too many for the banks to handle. We do not have a system in place to deal with overcharge on that scale. A substantial number of this December's purchases will go into an overdraft on credit limits.
CDO – Collateral Debt Obligation – Consumer Credit
Consumer credit pooled debt investment instruments (a form of CDO) are originated and rated based on underlying historical credit behavior and a complex series of predictive models for repayment dynamics. CDOs have “strips” which are a combination of similar profile tranches within a larger investment product. Based on the market's appetite for risk, investment performance guarantees (or credit enhancements) are packaged with the credits. These credit guarantees are issued by insurance companies, reinsurance companies, and other specialty finance companies – many operating with extra-territorial jurisdiction rendering fiscal oversight more complicated.
These strips come in several categories:
* Investment grade
* Almost investment grade
* Junk and
* Why did we give them a credit card?
All of these grades are priced on historical default rates. The credit insurance companies (AIG, MBIA, Ambac, Financial Security Assurance, Channel Re, XL, Zurich Re and other reinsurers) have, from time to time, issued credit guarantees to the securities. Banks sell debt in the form of a Collateralized Debt Obligation (CDO).
Minor shifts in default actuarial activity (+/- 25 basis points) from normative behavior is absorbed within pricing of these financial guaranty contracts. However fundamental shifts (hundreds or thousands of basis points in one quarter) are not built into the model and result in credit enhancement insolvency on a major scale. When the insurer cannot pay based on its own liquidity impairment, the bank is left with catastrophic (an insurance term for excessive loss outside of expected) exposure.
If in a single quarter we have an increased foreclosure rate of 400% (or 4000 basis points) the insurance contracts simply cannot handle that kind of drastic shift as evidenced by the write offs in the third quarter. When we will follow the drastic third quarter with a loss of 500% in the fourth quarter, the trajectory becomes clear.
Neither the banking nor the insurance industry has a historical experience in dealing with this type of challenge and neither has the liquidity linked to these contracts to support system wide collapse.
Where was the announcement of this? There was no announcement.
However Hank Greenberg is resurfacing in AIG leadership even during an SEC investigation because without him, no one else can remember where the counterparty risks are. In order to save the insurance industry, shareholders have looked past alleged SEC violations as there is no one with Mr. Greenberg's awareness of the market and counterparty agreements who can hope to navigate the coming challenges. In the 4th quarter, the US will have another record foreclosure announcement. Once you're over 25% (25 basis point) foreclosure, all models are broken.
Under a consumer credit melt-down, Capital One and/or Wachovia are likely going to put a massive foreclosure liability to an insurance company and the insurance company will not have liquidity to cover the exposure.
This is the problem we got into when we issued credit card debt on top of secondary mortgages – (inflated the value of the home) and gave out credit based on faux equity that no one really had.
The reason why this problem is the second shoe to fall (subprime mortgage collapse was the first shoe) is because consumer credit has a different foreclosure frequency than traditional mortgage credit.
December is when the maturity of the giant buyout of the economy moves.
By December, you'll have a second round of charge offs based on consumer credit. The real big problem – when you foreclose on consumer credit, people stop buying things. When people stop buying things, we don't have a tertiary way to pump liquidity into the market. People won't have extra cash from their paychecks and won't have capacity on their cards.
Try this case study:
Go to the mall and stand in front of counter at Victoria Secret. Watch what happens when someone wants to pay with cash. The clerk won't know how to ring up cash. They will need a manager to come over to give change and unlock drawers. When you don't have capacity on those cards, you don't buy things. VISA credit cards actually denigrate using cash in their run-up-to-Christmas add campaign.
Next, go to any savings bank data set. If you were going to spend $1000 in cash this Christmas, can you do it? For the most part, the answer would be “no” because we have had a net negative spending for the last 5 years.
Therefore there will be depressed consumer spending this Christmas but what is spent, people will overcharge. This will take what used to be good investments in CDOs and will change the dynamic. If you used to be a person who paid their bills on time, you will now only pay half. If the credit companies are counting on the top two tranches to pay their card off in full and they don't, they won't have liquidity to cover the rest. The banks cannot afford the top tranch paying half.
The estimates are out. There will be at least $400B in the first round of charge offs in the CDO market.
We're not going to be done with the subprime mortgage when the CDOs fall. Therefore we will have an insolvency problem with the banks that are mentioned above.
This is the kiss of death of a privately held Federal Reserve. For the Federal Reserve to function, its stakeholder banks (like JP Morgan Chase) must remain viable and liquid. When one of them, or any major bank in the U.S. (like Bank of America, Citibank, Wells Fargo, Bank of New York, Washington Mutual, etc.) is impaired or ceases to exist, the architecture of the Fed's capacity to respond to systemic challenges is unsustainable.
If the banks have no money, they can't pump liquidity into the market. Taking half of a trillion dollars out of market in a single distressed write down becomes problematic. The US banking system does not have the liquidity to take the hit.
The actual solvency of the Federal Deposit Insurance Corporation is relatively indecipherable due to the fact that their treasury management processes (and the risks of their own investment strategies) are not uniformly disclosed with sufficient transparency. The FDIC was set up for isolated problems with a few bad banks but is NOT prepared to “insure” the system in an industry-wide crisis. The actual liquidity reserve of the “insurance” that Americans view as their safety net is 1/100th the actual exposure of outstanding deposits. The actual coverage ratio for the Bank Insurance Fund (BIF) fell below 1.25% in 2002, the same year that less stable credit practices were adopted by America's leading banks.
The funny part is that the Federal Government will be on holiday when all of this happens. There will be no one to put freeze actions and moratoria on actions. The only way you stop the cataclysm is to put together civil actions on deposit withdrawals.
As I discussed previously, the Chinese currency wild-card may become relevant far sooner than expected. An effort by China to convert its $1.4 trillion U.S. Treasury holdings into euros is not viable for many reasons – not the least of which is the European Central Bank's inability to absorb such an event. As China continues its rush away from supporting U.S. Treasuries and as Middle Eastern investors are buying them up in more diversified holdings, a new “currency exchange” is unfolding. Realizing that they cannot liquidate their holdings, it appears that the Chinese are currently using their U.S. Treasury holdings as collateral for euro denominated purchases and long term infrastructure transactions. In other words, they may be “liquidating” their holdings as collateral and, in so doing, effectively migrating to non-dollar value without ever having to officially dump their current Treasury holdings.
Therefore, collateralize the credit in dollars – especially if you're long in dollars. The lender/financier won't call the note because you have it structured in such a way to both allow it to perform and hold illiquid collateral that no one wants. This essentially inflates euros. Although you can't sell dollars, the whole purpose of collateral is that it is a second source of payment – collateral is there to down rate the risk of the loan. Secondary becomes irrelevant.
When February comes, the Chinese are going to do something as they will have to decide what the exposure is going to be with the treasury. As I see it they have to just dump the treasury. They only keep it because they can use it – they have 43% direct/indirect of US treasuries so they'll dump them on the market.
The US Congressional pressures to decouple the RMB will work, but not in the way we want. Our plan includes helping them hold on to the treasuries, it does not involve them not holding the dollar anymore. The US wanted the tether to be part of the float. This will cause disenfranchisement of the US electorate (during primary season). February is also when public (media) will realize we won't pull out of this.
Side note: Mayor Bloomberg could enter the race at this point, being the savior candidate (at least economically), but has $1B dollars in non-liquid money so he may not be able to enter.
March is when we realize that the dollar doesn't come back.
OPEC price with the whole fluctuation of oil futures presages the event. They are going to run the price of oil as high as they can get it on the dollar, while buying US treasuries from China with the money. When the dollar does collapse, they'll flip denominations. The wild card is long about March when the OPEC cuts spot oil off the dollar to the euro. One can look at the current oil price at close to $100/barrel and fail to see that, as this premium price is currently turning around and investing in a weakening dollar, the effective price (less the dollar investment hedge) is probably closer to $50/barrel than the spot price reflects.
Currency problems will change the game – they are financially structuring themselves to take the hit.
When we can't afford to buy oil commodities on a spot market – it compounds the problem however the consumer that Saudi Arabia ships to is liquid (China). In the US it is a big problem. There is still a market for oil; it just changes. When you come out of Straits of Hormuz, turn left.
RE: Key Paragraph Jacking Oil To Keep Up Dollar Demand... GrislyBear
NEW 11/20/2007 7:07:38 PM
OPEC price with the whole fluctuation of oil futures presages the event. They are going to run the price of oil as high as they can get it on the dollar, while buying US treasuries from China with the money. When the dollar does collapse, they'll flip denominations. The wild card is long about March when the OPEC cuts spot oil off the dollar to the euro. One can look at the current oil price at close to $100/barrel and fail to see that, as this premium price is currently turning around and investing in a weakening dollar, the effective price (less the dollar investment hedge) is probably closer to $50/barrel than the spot price reflects.
Several other analysts have made this point.
But since the USA consumes 25% of world oil, and less than 5% of world's population, the game can't go on much longer.
Specifically, at some point whether that be $150 or $200 oil, demand will crash and ironically, so will the USD price.
Weird.
RE: Thanks, notsure smokey
NEW 11/20/2007 8:20:09 PM
"This is the kiss of death of a privately held Federal Reserve. For the Federal Reserve to function, its stakeholder banks (like JP Morgan Chase) must remain viable and liquid. When one of them, or any major bank in the U.S. (like Bank of America, Citibank, Wells Fargo, Bank of New York, Washington Mutual, etc.) is impaired or ceases to exist, the architecture of the Fed's capacity to respond to systemic challenges is unsustainable.
If the banks have no money, they can't pump liquidity into the market. Taking half of a trillion dollars out of market in a single distressed write down becomes problematic. The US banking system does not have the liquidity to take the hit. "
***
The Federal Reserve Banking system is based on collateralized debt. Before banks or other financial institutions can borrow from the system, they must offer something of equal value as collateral plus any added interest for the duration of the loan.
Ben Bernanke, in his "printing press" speech of 2002, either knowingly or unknowingly misspoke when he described the Fed's unlimited ability to provide liquidity to the markets.
The Fed injects liquidity into the financial system by buying certain assets like US treasuries. This process does not add any value to the system. It is the financial system which must use the injection of liquidity to add value through providing credit to entities which can then invest or speculate in appreciating assets.
As long as the financial/economic system is growing, banks and other financial entities will be able to use the credit issued by the Fed to grow their asset base by issuing their own credit to the expanding economy. They can then not only repay their loans from the Fed, but also buy US treasuries and other financial assets which can be used as collateral for future loans.
This mechanism works as long as appreciating assets in the system continue to expand the capacity for more debt. Financial bubbles of the recent past have been able to expand debt beyond its normal limits by hyperinflating the values of assets involved in the bubbles.
As long as these hyperinflating assets remained in the virtual reality of the financial markets like stocks, bonds and the derivatives thereof, they seemingly had infinite potential to appreciate.
But when the expansion of credit spread into the real economy through rising real estate prices, the asset appreciation began to be limited by the incomes of the real estate investors and speculators. This limitation of income then brought the expansion of credit to a dead-end through debt saturation.
The REAL economy brought the virtual expansion of financial assets to a screeching halt.
Without new assets with which to offer as collateral, the banks and large financial entities can no longer purchase the collateral necessary to expand their asset base through selling more credit. Therefore as the asset bubbles pop and defaults increase, the banks and their depositors are left holding the bag.
The Fed can lower interest rates down to zero, but without an expansion of the basis for collateral, the demand for credit will remain flat while the increasing defaults continue to destroy any possibility of credit expansion.
All talk of Weimar hyperinflation at this point is simply talk. The Federal Reserve banking system based on collateralized debt would have to be replaced with a nationalized banking system in order for a Weimar or Zimbabwe type hyperinflation of the monetary base to occur.
Of course, anything is possible.
Maybe Congress will forgo their upcoming paid holidays to abolish the Fed.
Ya think?
November 19, 2007
It appears that the world in general and the United States in particular are on the edge of a major disruption in the global financial system. Here's the summary as we see it.
At a recent Board meeting of The Arlington Institute, Dr. David Martin, CEO of M*CAM and one of the members of the Board was asked for his assessment of the global financial situation in the coming months.
Here are my notes from his response:
I stand by my commentary in July of '06.
The next shoe to fall is consumer credit
Currently as reports came in on the 3rd quarter, foreclosures were up 470% this quarter alone. They will be up over 500% this coming quarter (4th). A foreclosure in our terms is when the bank has officially declared an account insolvent and tries to regain the asset (if it exists). The person who is foreclosed upon can no longer secure any traditional consumer credit. This in turn goes straight to the banks as no one will be able to get the store issued charge cards.
A minority of people pay off their consumer debt every month. When one considers the combination of consumer credit card debt and the compounded debt of “home equity” financing, we estimate that less than 20% of people actually carry no consumer credit from one month to the next. Many of the ones who don't pay off their carried consumer debt have at least one credit card at its limit and therefore lack credit capacity. Most have their paycheck directly covering bills and servicing the minimum balance due.
Therefore people who are foreclosed upon will not be able to obtain credit and since their paychecks will be maxed out, there will not be extra cash left over from the paycheck to service a new debt.
Next, everybody buys things at Christmas. As much as 40% of retail sales are done in the 4th quarter of the year – i.e. the retail miracle. The purchase decline in retail goods this fourth quarter will occur because many credit-only consumers will lack the credit capacity mentioned above. Frequently, people overcharge their limit and the banks (albeit a profit center for subprime credit users) levy a penalty by increasing interest rates and charging additional fees. In the 4th quarter of 2007, the amount of people overcharging their limits will be too many for the banks to handle. We do not have a system in place to deal with overcharge on that scale. A substantial number of this December's purchases will go into an overdraft on credit limits.
CDO – Collateral Debt Obligation – Consumer Credit
Consumer credit pooled debt investment instruments (a form of CDO) are originated and rated based on underlying historical credit behavior and a complex series of predictive models for repayment dynamics. CDOs have “strips” which are a combination of similar profile tranches within a larger investment product. Based on the market's appetite for risk, investment performance guarantees (or credit enhancements) are packaged with the credits. These credit guarantees are issued by insurance companies, reinsurance companies, and other specialty finance companies – many operating with extra-territorial jurisdiction rendering fiscal oversight more complicated.
These strips come in several categories:
* Investment grade
* Almost investment grade
* Junk and
* Why did we give them a credit card?
All of these grades are priced on historical default rates. The credit insurance companies (AIG, MBIA, Ambac, Financial Security Assurance, Channel Re, XL, Zurich Re and other reinsurers) have, from time to time, issued credit guarantees to the securities. Banks sell debt in the form of a Collateralized Debt Obligation (CDO).
Minor shifts in default actuarial activity (+/- 25 basis points) from normative behavior is absorbed within pricing of these financial guaranty contracts. However fundamental shifts (hundreds or thousands of basis points in one quarter) are not built into the model and result in credit enhancement insolvency on a major scale. When the insurer cannot pay based on its own liquidity impairment, the bank is left with catastrophic (an insurance term for excessive loss outside of expected) exposure.
If in a single quarter we have an increased foreclosure rate of 400% (or 4000 basis points) the insurance contracts simply cannot handle that kind of drastic shift as evidenced by the write offs in the third quarter. When we will follow the drastic third quarter with a loss of 500% in the fourth quarter, the trajectory becomes clear.
Neither the banking nor the insurance industry has a historical experience in dealing with this type of challenge and neither has the liquidity linked to these contracts to support system wide collapse.
Where was the announcement of this? There was no announcement.
However Hank Greenberg is resurfacing in AIG leadership even during an SEC investigation because without him, no one else can remember where the counterparty risks are. In order to save the insurance industry, shareholders have looked past alleged SEC violations as there is no one with Mr. Greenberg's awareness of the market and counterparty agreements who can hope to navigate the coming challenges. In the 4th quarter, the US will have another record foreclosure announcement. Once you're over 25% (25 basis point) foreclosure, all models are broken.
Under a consumer credit melt-down, Capital One and/or Wachovia are likely going to put a massive foreclosure liability to an insurance company and the insurance company will not have liquidity to cover the exposure.
This is the problem we got into when we issued credit card debt on top of secondary mortgages – (inflated the value of the home) and gave out credit based on faux equity that no one really had.
The reason why this problem is the second shoe to fall (subprime mortgage collapse was the first shoe) is because consumer credit has a different foreclosure frequency than traditional mortgage credit.
December is when the maturity of the giant buyout of the economy moves.
By December, you'll have a second round of charge offs based on consumer credit. The real big problem – when you foreclose on consumer credit, people stop buying things. When people stop buying things, we don't have a tertiary way to pump liquidity into the market. People won't have extra cash from their paychecks and won't have capacity on their cards.
Try this case study:
Go to the mall and stand in front of counter at Victoria Secret. Watch what happens when someone wants to pay with cash. The clerk won't know how to ring up cash. They will need a manager to come over to give change and unlock drawers. When you don't have capacity on those cards, you don't buy things. VISA credit cards actually denigrate using cash in their run-up-to-Christmas add campaign.
Next, go to any savings bank data set. If you were going to spend $1000 in cash this Christmas, can you do it? For the most part, the answer would be “no” because we have had a net negative spending for the last 5 years.
Therefore there will be depressed consumer spending this Christmas but what is spent, people will overcharge. This will take what used to be good investments in CDOs and will change the dynamic. If you used to be a person who paid their bills on time, you will now only pay half. If the credit companies are counting on the top two tranches to pay their card off in full and they don't, they won't have liquidity to cover the rest. The banks cannot afford the top tranch paying half.
The estimates are out. There will be at least $400B in the first round of charge offs in the CDO market.
We're not going to be done with the subprime mortgage when the CDOs fall. Therefore we will have an insolvency problem with the banks that are mentioned above.
This is the kiss of death of a privately held Federal Reserve. For the Federal Reserve to function, its stakeholder banks (like JP Morgan Chase) must remain viable and liquid. When one of them, or any major bank in the U.S. (like Bank of America, Citibank, Wells Fargo, Bank of New York, Washington Mutual, etc.) is impaired or ceases to exist, the architecture of the Fed's capacity to respond to systemic challenges is unsustainable.
If the banks have no money, they can't pump liquidity into the market. Taking half of a trillion dollars out of market in a single distressed write down becomes problematic. The US banking system does not have the liquidity to take the hit.
The actual solvency of the Federal Deposit Insurance Corporation is relatively indecipherable due to the fact that their treasury management processes (and the risks of their own investment strategies) are not uniformly disclosed with sufficient transparency. The FDIC was set up for isolated problems with a few bad banks but is NOT prepared to “insure” the system in an industry-wide crisis. The actual liquidity reserve of the “insurance” that Americans view as their safety net is 1/100th the actual exposure of outstanding deposits. The actual coverage ratio for the Bank Insurance Fund (BIF) fell below 1.25% in 2002, the same year that less stable credit practices were adopted by America's leading banks.
The funny part is that the Federal Government will be on holiday when all of this happens. There will be no one to put freeze actions and moratoria on actions. The only way you stop the cataclysm is to put together civil actions on deposit withdrawals.
As I discussed previously, the Chinese currency wild-card may become relevant far sooner than expected. An effort by China to convert its $1.4 trillion U.S. Treasury holdings into euros is not viable for many reasons – not the least of which is the European Central Bank's inability to absorb such an event. As China continues its rush away from supporting U.S. Treasuries and as Middle Eastern investors are buying them up in more diversified holdings, a new “currency exchange” is unfolding. Realizing that they cannot liquidate their holdings, it appears that the Chinese are currently using their U.S. Treasury holdings as collateral for euro denominated purchases and long term infrastructure transactions. In other words, they may be “liquidating” their holdings as collateral and, in so doing, effectively migrating to non-dollar value without ever having to officially dump their current Treasury holdings.
Therefore, collateralize the credit in dollars – especially if you're long in dollars. The lender/financier won't call the note because you have it structured in such a way to both allow it to perform and hold illiquid collateral that no one wants. This essentially inflates euros. Although you can't sell dollars, the whole purpose of collateral is that it is a second source of payment – collateral is there to down rate the risk of the loan. Secondary becomes irrelevant.
When February comes, the Chinese are going to do something as they will have to decide what the exposure is going to be with the treasury. As I see it they have to just dump the treasury. They only keep it because they can use it – they have 43% direct/indirect of US treasuries so they'll dump them on the market.
The US Congressional pressures to decouple the RMB will work, but not in the way we want. Our plan includes helping them hold on to the treasuries, it does not involve them not holding the dollar anymore. The US wanted the tether to be part of the float. This will cause disenfranchisement of the US electorate (during primary season). February is also when public (media) will realize we won't pull out of this.
Side note: Mayor Bloomberg could enter the race at this point, being the savior candidate (at least economically), but has $1B dollars in non-liquid money so he may not be able to enter.
March is when we realize that the dollar doesn't come back.
OPEC price with the whole fluctuation of oil futures presages the event. They are going to run the price of oil as high as they can get it on the dollar, while buying US treasuries from China with the money. When the dollar does collapse, they'll flip denominations. The wild card is long about March when the OPEC cuts spot oil off the dollar to the euro. One can look at the current oil price at close to $100/barrel and fail to see that, as this premium price is currently turning around and investing in a weakening dollar, the effective price (less the dollar investment hedge) is probably closer to $50/barrel than the spot price reflects.
Currency problems will change the game – they are financially structuring themselves to take the hit.
When we can't afford to buy oil commodities on a spot market – it compounds the problem however the consumer that Saudi Arabia ships to is liquid (China). In the US it is a big problem. There is still a market for oil; it just changes. When you come out of Straits of Hormuz, turn left.
RE: Key Paragraph Jacking Oil To Keep Up Dollar Demand... GrislyBear
NEW 11/20/2007 7:07:38 PM
OPEC price with the whole fluctuation of oil futures presages the event. They are going to run the price of oil as high as they can get it on the dollar, while buying US treasuries from China with the money. When the dollar does collapse, they'll flip denominations. The wild card is long about March when the OPEC cuts spot oil off the dollar to the euro. One can look at the current oil price at close to $100/barrel and fail to see that, as this premium price is currently turning around and investing in a weakening dollar, the effective price (less the dollar investment hedge) is probably closer to $50/barrel than the spot price reflects.
Several other analysts have made this point.
But since the USA consumes 25% of world oil, and less than 5% of world's population, the game can't go on much longer.
Specifically, at some point whether that be $150 or $200 oil, demand will crash and ironically, so will the USD price.
Weird.
RE: Thanks, notsure smokey
NEW 11/20/2007 8:20:09 PM
"This is the kiss of death of a privately held Federal Reserve. For the Federal Reserve to function, its stakeholder banks (like JP Morgan Chase) must remain viable and liquid. When one of them, or any major bank in the U.S. (like Bank of America, Citibank, Wells Fargo, Bank of New York, Washington Mutual, etc.) is impaired or ceases to exist, the architecture of the Fed's capacity to respond to systemic challenges is unsustainable.
If the banks have no money, they can't pump liquidity into the market. Taking half of a trillion dollars out of market in a single distressed write down becomes problematic. The US banking system does not have the liquidity to take the hit. "
***
The Federal Reserve Banking system is based on collateralized debt. Before banks or other financial institutions can borrow from the system, they must offer something of equal value as collateral plus any added interest for the duration of the loan.
Ben Bernanke, in his "printing press" speech of 2002, either knowingly or unknowingly misspoke when he described the Fed's unlimited ability to provide liquidity to the markets.
The Fed injects liquidity into the financial system by buying certain assets like US treasuries. This process does not add any value to the system. It is the financial system which must use the injection of liquidity to add value through providing credit to entities which can then invest or speculate in appreciating assets.
As long as the financial/economic system is growing, banks and other financial entities will be able to use the credit issued by the Fed to grow their asset base by issuing their own credit to the expanding economy. They can then not only repay their loans from the Fed, but also buy US treasuries and other financial assets which can be used as collateral for future loans.
This mechanism works as long as appreciating assets in the system continue to expand the capacity for more debt. Financial bubbles of the recent past have been able to expand debt beyond its normal limits by hyperinflating the values of assets involved in the bubbles.
As long as these hyperinflating assets remained in the virtual reality of the financial markets like stocks, bonds and the derivatives thereof, they seemingly had infinite potential to appreciate.
But when the expansion of credit spread into the real economy through rising real estate prices, the asset appreciation began to be limited by the incomes of the real estate investors and speculators. This limitation of income then brought the expansion of credit to a dead-end through debt saturation.
The REAL economy brought the virtual expansion of financial assets to a screeching halt.
Without new assets with which to offer as collateral, the banks and large financial entities can no longer purchase the collateral necessary to expand their asset base through selling more credit. Therefore as the asset bubbles pop and defaults increase, the banks and their depositors are left holding the bag.
The Fed can lower interest rates down to zero, but without an expansion of the basis for collateral, the demand for credit will remain flat while the increasing defaults continue to destroy any possibility of credit expansion.
All talk of Weimar hyperinflation at this point is simply talk. The Federal Reserve banking system based on collateralized debt would have to be replaced with a nationalized banking system in order for a Weimar or Zimbabwe type hyperinflation of the monetary base to occur.
Of course, anything is possible.
Maybe Congress will forgo their upcoming paid holidays to abolish the Fed.
Ya think?
19 November 2007
LEAP/E2020
LEAP/E2020 now estimates that at least one large US financial institution (bank, insurance, investment fund) will file for bankruptcy before February 2008, sparking off bankruptcies among a series of other financial institutions and banks in Europe (in the UK especially), in Asia and in various emerging countries. According to an expression by Blackstone president Tony James's (1), a financial « black hole » was formed after the US subprime crisis.
The triggering factors for a major financial institution to go bankrupt are now so powerful and warning clues so numerous that, according to our researchers, the probability that it happens within three month now reaches 100%. Probabilities are as high that the US authorities will try to introduce a reimbursement protection-net in order to avoid panic from spreading throughout the entire US financial system (2); but the size of the bankruptcy will immediately hit the most exposed financial institutions operating in the US and in the rest of the world. Countries whose financial operators are the most linked to US financial operators will be on the frontline: United Kingdom, Japan, China in particular (3).
There are four main triggering factors, according to our team:
1. Drastic drop in revenues for banks operating in the US
2. Slumping value of assets owned by these banks resulting from new US banking regulation (FASB regulation 157)
3. Increasing weakness of bond insurers
4. Economic recession in the US
These factors must of course be placed in the general context described by LEAP/E2020 since the beginning of 2006, i.e. a global systemic crisis, which only today is beginning to be grasped by the world's political, financial and economic leaders (4). The fact that over the past two years, the largest financial operators and central banks, the US Fed and the Bank of England in particular, were systematically late on the course of events, entails to believe that they will only become fully aware of the existence of a banking crisis once some major event has happened, once it is too late to efficiently prevent the system's contamination.
University of Michigan « Consumer Sentiment » (November 2007 included) – Source: Federal Reserve Bank of Saint Louis / LEAP/E2020
In the present public announcement of the GEAB N°19, LEAP/E2020 chose to present its anticipation of drastic drops in the revenues of banks operating in the US (Factor N°1).
Factor N° 1 - Drastic drop in revenues for banks operating in the US
As detailed in GEAB N°19, the coming into effect of the FASB 157 standard on November 15, 2007, will directly involve the financial statements of financial institutions operating in the US and expose them to the consequences of a loss in value of a large proportion of their assets, knowing that this part is increasing. Indeed the subprime crisis was nothing but a catalyst for a wider-ranging financial crisis today affecting all US financial assets (5). The CDOs altogether are now dragged into a general confidence crisis, and they represent a large part of bank assets since, in the past few years, large banks from lenders became investors and speculators, like hedge funds.
By the way, the latter represented for nearly a decade a growing source of revenue for large international banks. Everyone still has in the mind the huge fees that these hedge funds and investments funds paid to the banks in the framework of their various operations such as LBOs (Leverage Buy-Out), M&As (Merger and Acquisition) and other IPOs (Initial Public Offering). These not-so-remote-times (they ended last summer) now belong to the past.
Today, hedge funds are striving to avoid bankruptcy. Investment funds deepen their losses as they try to avoid being sucked into the “financial black hole” mentioned by Blackwater's CEO (cf Factor N°2, GEAB N°19).
Merger and Acquisition projects are at a standstill. For instance, in the technology sector (a privileged target of M&As), Wall Street saw the amount of transactions decrease from USD 99 billion in the third quarter of 2006 down to USD 52 billion in the third quarter of 2007 (i.e. a 50 percent drop), knowing that the credit crisis was only beginning in the third quarter of 2007. Yet the weakness of the US dollar provoked a frenzy of European LBOs in the US; indeed for the first time the Europeans bought as much as their North-American counterparts (6).
LBO freeze – Source Dealogic
Despite the fact that IPOs on Wall Street resisted quite well the Summer crisis, they are now postponed to unknown dates, when times are less gloomy. For instance, the number of IPOs for more than USD 1 billion fell from 8 per quarter (in the third quarter of 2006) to 2 (in this year's third quarter), knowing that this trends is strengthening as recently illustrated by RWE, this German energy supplier who decided to postpone its American Water division's public listing because of the credit crisis in the US (7); another example is provided by Rusal, the Russian aluminium giant who postponed to an unknown date its planned IPO, though it promised to count as this year's most important one and despite the fact that operating banks have already been designated (i.e. Morgan Stanley, JP. Morgan and Deutsche Bank) (8).
With regard to LBOs (these remarkable financial packages which make it possible to buy a company with the riches it potentially contains (9)), the market is practically closed. Moreover all transactions that were not frozen or cancelled end up in court, as illustrated by the emblematic case of SallieMae, the student loan company, and JC. Flowers (a very active investment fund with no website!) (10). In October, LBOs only represented 5 percent of all M&As, versus 31 percent in June 2007.
US banks' level of exposure to financial derivative risks – Source Contraryinvestor
All these tendencies point in the same direction: the loss of a significant source of revenues for banks operating in the US, that will soon combine with the consequences of the implementation of the FASB 157 standard on the one hand and with the CDO crisis on the other, meaning the loss in value of an important part of the same banks' assets.
Indeed in 2006, revenues drawn from their advisory and intermediary services in LBOs, M&As, etc… represented 27 percent of their total revenue, after experiencing the strongest progression recorded in the past seven years (seven years before, in 1999, i.e. on the even of the Internet bubble burst!). Moreover in 2006 already, these revenues had to compensate for losses induced by the first effects of the subprime crisis. In 2007, losses related to the mortgage market literally exploded compared to 2006, and everyone can see that all large financial transactions' advisory and intermediary services have now dried up (11).
No need to be visionary to conclude that these banks will experience between the end of this year and the beginning of next year a severe crisis capable of entailing losses that some of them will not be able to cope with. According to LEAP/E2020, all these clues are harbingers of a major banking crisis whose causes and consequences for investors and savers are retailed in the GEAB N°19.
---------
Notes:
(1)Tony James used this expression to describe the financial environment that led his capital investment company, one of Wall Street's wonders until a few weeks ago, to announce a USD-113 million loss (source Forbes, 11/12/2007). Blackstone's shares were listed on the stock market last year, simultaneously with a number of other mega-investment funds such as KKR or Fortress, for instance. By the way, last spring, our team warned that these Initial Public Offerings (IPOs) in fact aimed at pooling future losses rather than past profits. This is now confirmed.
(2)It is already the case with “Paulson's super-conduit” (cf. GEAB N°18).
(3)For more details on the level of exposure to US financial risks, see GEAB N°16, 17 and 18 in particular.
(4) This means that they are only beginning to understand the « systemic » nature of this crisis. Until now, they first refused to admit that there was a crisis, and then they treated it as one more episode of the usual economic and financial cycles.
(5) Source: Bloomberg, 11/13/2007
(6) Source: The451Group, 10/01/2007
(7) Source: YahooNews/Reuters, 11/14/2007
(8) Source: Financial Information Service, 09/21/2007
(9) As long as they manage to convince a sufficiently large amount of financial operators to lend them the corresponding sum.
The triggering factors for a major financial institution to go bankrupt are now so powerful and warning clues so numerous that, according to our researchers, the probability that it happens within three month now reaches 100%. Probabilities are as high that the US authorities will try to introduce a reimbursement protection-net in order to avoid panic from spreading throughout the entire US financial system (2); but the size of the bankruptcy will immediately hit the most exposed financial institutions operating in the US and in the rest of the world. Countries whose financial operators are the most linked to US financial operators will be on the frontline: United Kingdom, Japan, China in particular (3).
There are four main triggering factors, according to our team:
1. Drastic drop in revenues for banks operating in the US
2. Slumping value of assets owned by these banks resulting from new US banking regulation (FASB regulation 157)
3. Increasing weakness of bond insurers
4. Economic recession in the US
These factors must of course be placed in the general context described by LEAP/E2020 since the beginning of 2006, i.e. a global systemic crisis, which only today is beginning to be grasped by the world's political, financial and economic leaders (4). The fact that over the past two years, the largest financial operators and central banks, the US Fed and the Bank of England in particular, were systematically late on the course of events, entails to believe that they will only become fully aware of the existence of a banking crisis once some major event has happened, once it is too late to efficiently prevent the system's contamination.
University of Michigan « Consumer Sentiment » (November 2007 included) – Source: Federal Reserve Bank of Saint Louis / LEAP/E2020
In the present public announcement of the GEAB N°19, LEAP/E2020 chose to present its anticipation of drastic drops in the revenues of banks operating in the US (Factor N°1).
Factor N° 1 - Drastic drop in revenues for banks operating in the US
As detailed in GEAB N°19, the coming into effect of the FASB 157 standard on November 15, 2007, will directly involve the financial statements of financial institutions operating in the US and expose them to the consequences of a loss in value of a large proportion of their assets, knowing that this part is increasing. Indeed the subprime crisis was nothing but a catalyst for a wider-ranging financial crisis today affecting all US financial assets (5). The CDOs altogether are now dragged into a general confidence crisis, and they represent a large part of bank assets since, in the past few years, large banks from lenders became investors and speculators, like hedge funds.
By the way, the latter represented for nearly a decade a growing source of revenue for large international banks. Everyone still has in the mind the huge fees that these hedge funds and investments funds paid to the banks in the framework of their various operations such as LBOs (Leverage Buy-Out), M&As (Merger and Acquisition) and other IPOs (Initial Public Offering). These not-so-remote-times (they ended last summer) now belong to the past.
Today, hedge funds are striving to avoid bankruptcy. Investment funds deepen their losses as they try to avoid being sucked into the “financial black hole” mentioned by Blackwater's CEO (cf Factor N°2, GEAB N°19).
Merger and Acquisition projects are at a standstill. For instance, in the technology sector (a privileged target of M&As), Wall Street saw the amount of transactions decrease from USD 99 billion in the third quarter of 2006 down to USD 52 billion in the third quarter of 2007 (i.e. a 50 percent drop), knowing that the credit crisis was only beginning in the third quarter of 2007. Yet the weakness of the US dollar provoked a frenzy of European LBOs in the US; indeed for the first time the Europeans bought as much as their North-American counterparts (6).
LBO freeze – Source Dealogic
Despite the fact that IPOs on Wall Street resisted quite well the Summer crisis, they are now postponed to unknown dates, when times are less gloomy. For instance, the number of IPOs for more than USD 1 billion fell from 8 per quarter (in the third quarter of 2006) to 2 (in this year's third quarter), knowing that this trends is strengthening as recently illustrated by RWE, this German energy supplier who decided to postpone its American Water division's public listing because of the credit crisis in the US (7); another example is provided by Rusal, the Russian aluminium giant who postponed to an unknown date its planned IPO, though it promised to count as this year's most important one and despite the fact that operating banks have already been designated (i.e. Morgan Stanley, JP. Morgan and Deutsche Bank) (8).
With regard to LBOs (these remarkable financial packages which make it possible to buy a company with the riches it potentially contains (9)), the market is practically closed. Moreover all transactions that were not frozen or cancelled end up in court, as illustrated by the emblematic case of SallieMae, the student loan company, and JC. Flowers (a very active investment fund with no website!) (10). In October, LBOs only represented 5 percent of all M&As, versus 31 percent in June 2007.
US banks' level of exposure to financial derivative risks – Source Contraryinvestor
All these tendencies point in the same direction: the loss of a significant source of revenues for banks operating in the US, that will soon combine with the consequences of the implementation of the FASB 157 standard on the one hand and with the CDO crisis on the other, meaning the loss in value of an important part of the same banks' assets.
Indeed in 2006, revenues drawn from their advisory and intermediary services in LBOs, M&As, etc… represented 27 percent of their total revenue, after experiencing the strongest progression recorded in the past seven years (seven years before, in 1999, i.e. on the even of the Internet bubble burst!). Moreover in 2006 already, these revenues had to compensate for losses induced by the first effects of the subprime crisis. In 2007, losses related to the mortgage market literally exploded compared to 2006, and everyone can see that all large financial transactions' advisory and intermediary services have now dried up (11).
No need to be visionary to conclude that these banks will experience between the end of this year and the beginning of next year a severe crisis capable of entailing losses that some of them will not be able to cope with. According to LEAP/E2020, all these clues are harbingers of a major banking crisis whose causes and consequences for investors and savers are retailed in the GEAB N°19.
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Notes:
(1)Tony James used this expression to describe the financial environment that led his capital investment company, one of Wall Street's wonders until a few weeks ago, to announce a USD-113 million loss (source Forbes, 11/12/2007). Blackstone's shares were listed on the stock market last year, simultaneously with a number of other mega-investment funds such as KKR or Fortress, for instance. By the way, last spring, our team warned that these Initial Public Offerings (IPOs) in fact aimed at pooling future losses rather than past profits. This is now confirmed.
(2)It is already the case with “Paulson's super-conduit” (cf. GEAB N°18).
(3)For more details on the level of exposure to US financial risks, see GEAB N°16, 17 and 18 in particular.
(4) This means that they are only beginning to understand the « systemic » nature of this crisis. Until now, they first refused to admit that there was a crisis, and then they treated it as one more episode of the usual economic and financial cycles.
(5) Source: Bloomberg, 11/13/2007
(6) Source: The451Group, 10/01/2007
(7) Source: YahooNews/Reuters, 11/14/2007
(8) Source: Financial Information Service, 09/21/2007
(9) As long as they manage to convince a sufficiently large amount of financial operators to lend them the corresponding sum.
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