ES -- DX/CL -- isee -- cboe put/call -- specialist/public short ratio -- trinq -- trin -- aaii bull ratio -- abx -- cmbx -- cdx -- vxo p&f -- SPX volatility curve -- VIX:VXO skew -- commodity screen -- cot -- conference board

Tuesday, February 27, 2007


shadow statistics

an excellent read on a very plain problem: our government lies to us about literally everything, and the economy is certainly no exception.

is inflation (as measured by cpi) really tinkering along at a couple percent? while money supply bloats at YoY rates in excess of 10%? or is cpi a statistic so compromised as to represent official cover for an inflationary policy designed to undermine the dollar and so reduce the real value of outstanding public and private debt obligations?

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fear and greed

via big picture, a measure of market sentiment that has gone (before today) off the reservation with optimism.

in conjunction with recent developments in market volatility (historic lows), mutual fund cash (all time low) and margin (all time high), there are a number of contrarian signals out there screaming for a selloff in equities -- not to mention junk bond issuance and other non-equity indicators. today we got one. was it enough? perhaps for now, but in the long run i sincerely doubt it.



chinese shares fall 8.8%

on the back of the bank of japan's interest rate increase last week, the index of chinese a shares collapsed 8.8% overnight, ostensibly in belated response to the government's attempts to slow economic growth and alleviate a raging asset boom gassed by foreign capital and debt.

Market watchers said investors in China were spooked by rumors the government may impose a 20% capital gains tax, while comments by People's Bank of China Governor Zhou Xiaochuan, published in a Chinese-language publication Tuesday, also stirred unease about the prospect for further rate hikes.

"If inflationary pressure increases the central bank should consider monetary policy action, including interest rate policy," the Xinhua Finance news service reported Zhou as saying in the interview, which was published in the Hong Kong Commercial Daily.

Investors were also wary that additional macro-tightening policies could be in the works after the annual session of the China's National People's Congress, which gets underway March 5.

China's central bank lifted the reserve requirement on domestic banks by 50 basis points from Sunday.

"I think the market had gotten a little too expensive and had reached about 26 times forward price earnings, at the top of what we see as a fair value range," Evans said.

but the real fear is the possible disorderly unwinding of the carry trade, which has feuled speculative excess in china's market like few others -- up 174% over the last 14 months.

Markets around the region were pressured by large fund selling, analysts said.

"There may be further squaring of positions in carry-trade portfolios," said Alex To, research director at Tai Fook Securities in Hong Kong. "If Asian markets are on a weakening trend hedge funds are going to liquidate positions and reduce exposure."

this is something i (along with many others) have been nervous about for a couple of years now -- one radical event may rapidly cascade. this is the second shocking downdraft in chinese shares in a month -- emerging markets were lower throughout the region, and all these markets are heavily laden with highly-levered hedge fund capital seeking yield to exploit low interest rates. that capital is hot and volatile, and clearly isn't sticking around through much tumult -- especially as the cost of borrowing in yen has just doubled.

UPDATE: today the yen has rallied, up a shocking 1.7% against the dollar, as hedge funds exposed to asia ex-japan delever, buying yen to pay back loans denominated in that currency. indeed a number of high-yield currencies suffered today -- indicating that some hedgies may be reducing exposure to the carry trade generally.

UPDATE: many of the high-yield markets are being completely crushed today -- brazil down 11.4% -- chile down 6.7% -- mexico down 10.7% -- denmark down 5.2% -- south africa down 5.6% -- greece down 7.5%. all these nations have currencies attractive to the carry trade, and their unified collapse is probably due to the unwinding of global carry trades financed from japan and switzerland. australia, another target, remained unusually unaffected (down 0.74%) but may be forced to catch up tomorrow morning. how asian markets react overnight will be very interesting -- there is certainly room for a rebound rally.

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hersh on the sea change in american foreign policy

like the bourbons, we learn nothing and forget nothing. seymour hersh's insight is singularly devastating.

read the whole thing -- the saudi viewpoints are particularly interesting -- but as far as the americans go -- short version:

the bush administration has decided at the highest level -- bush and cheney -- to abandon (at least for now) its fight against sunni radical groups -- like al-qaeda and the sunni insurgents in iraq -- in an effort to mitigate the rise of iranian/shia power, which is seen as the most terrible (and amazingly unintended) consequence of the invasion of iraq.

it has managed to build a coalition of itself, israel and saudi arabia -- both of which view iran as an existential threat. the three have agreed on four points: 1) the security of israel is primary; 2) the saudis would pressure hamas to make peace with fatah and israel; 3) the americans would work directly with sunni governments against shi'ite power; 4) the saudis would help finance american and israeli actions aimed at regime change in syria, both in lebanon and syria itself.

the saudis are financing a secret war using american and israeli covert forces within both iran and lebanon, using special forces, intelligence services and also -- amazingly -- direct financing and arming of sunni salafist radicals with ties to al-qaeda, operating in both countries. this includes factions of the muslim brotherhood.

moreover, the three have drawn plans to strike at iran militarily, with the capability to execute by early spring.

several intelligence, military and diplomatic sources in the article compare the conditions to the american financing of the sunni radicals of the mujahedeen in afghanistan.

but much more disturbing is the financing aspect, which draws profound comparisons to iran-contra. in what is probably the most depressing part of the whole thing for an american, toward the end hersh outlines how the presidency has become capable of circumventing the congressional power of the purse by using foreign client states (like saudi arabia) to finance clandestine wars -- therefore removing any congressional oversight whatsoever of foreign policy, as well as any need to seek american public approval or even to inform the american public at all. the cia is being intentionally kept out of these military operations because of their legal requirement -- established post-iran-contra -- to disclose to congress.

not only that -- but that the billions in "missing" funds in iraq are not missing -- nor have they necessarily been stolen by iraqis -- they have been used to finance american clandestine operations in the mideast and elsewhere.

the resignation of john negroponte from the nsc last year is specifically tied to his uneasiness over this aspect of cheney's management of foreign policy. negroponte was involved in iran-contra.

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confidence update

the latest conference board consumer numbers are out.

The New York-based Conference Board said that its Consumer Confidence Index rose to 112.5, up from a revised 110.2 in January. Analysts had expected the reading to be 109.

The February index was the highest since August 2001, when the reading was 114, indicating that consumers will continue to fuel the nation's economic growth in the near future.

In a statement, Lynn Franco, director of The Conference Board Consumer Research Center, said that "improving present-day business conditions and an easing in the proportion of consumers claiming jobs are hard to get have combined to lift consumers' spirits."

"All in all, it appears that the pace of economic growth exhibited in the final months of 2006 has carried over into early 2007 and may have even gained a little momentum," she added.

The Present Situation Index, which measures how shoppers feel now about economic conditions, increased to 139.0 from 133.9. The Expectations Index, which measures consumers' outlook in the next six months, edged up slightly to 94.8 from 94.4 last month.

the gauge of future less present expectations, then, dipped to (-44.2) -- a new low for this economic cycle.



junk bond issuance

another point of view on the possibility of recession related by mark hulbert at marketwatch.

The year 2006 saw a record number of junk bonds come to market.

You might think this is good news, especially if you're an investor in junk bonds, which are euphemistically known as "high-yield bonds." But some advisers disagree, arguing that its significance is actually quite bearish.

Consider the arguments currently being made by George Putnam, editor of The Turnaround Letter, a newsletter that focuses on companies that are about to, are in, or which soon will be emerging from, bankruptcy. The service has a good long-term record, according to the Hulbert Financial Digest, ranking in second place for performance over the past 15 years among all monitored newsletters with an annualized gain of 16.5%, vs. 10.9% for the Dow Jones Wilshire 5000 index.

In the most recent issue of his newsletter, Putnam notes that, based on his review of junk bond issuance and bankruptcy filings over the last 20 years, "waves of high yield (junk) bond issuance (are usually) followed by new bankruptcies ... It appears that typically a four-year boom in high yield issuance is followed by a three-year spike in bankruptcies."

If so, recent trends are very bad news indeed, because not only did last year experience a record level of junk bond issuance, it was the fourth year in a row of heavy junk bond issuance. This suggests, according to Putnam, that "more bankruptcies may be heading our way soon."

To be sure, the supply of junk bonds coming to market is not a pinpoint short-term market-timing indicator. Indeed, two years ago, half way through the current four-year wave of heavy junk bond issuance, Putnam issued a warning similar to his current one, arguing that the large number of junk bonds coming to market "strongly suggests that we will begin to see a pickup in bankruptcy activity over the next few years." And, at least so far, this for the most part has not come to pass.

But that doesn't justify ignoring Putnam's argument altogether. Even though junk bond issuance may fail as a short-term market timing indicator, it's still possible that it is quite good at forecasting longer-term trends.

In fact, the evidence suggests that its long-term record might be very good indeed. Consider researched conducted by Owen Lamont, a professor of finance at Yale's School of Management. He has developed a comprehensive theory of the market's cycle based on companies' desire to issue stock, as measured by the percentage of the entire stock market that was newly issued over the preceding three years. This indicator reached its all-time high in 1929, and only slightly behind was the reading in early 2000. In third place was the reading in the early 1970s, just prior to the devastating 1973-74 bear market.

Few market timing indicators have as good a long-term record as that.

Lamont focused his research on the equity market, not on junk bonds, so care should be exercised when applying his conclusions to the current high-yield bond market. But his research provides a powerful foundation to the historical argument that Putnam is making.

What course of action should you take if you agree with Putnam that a bankruptcy wave is imminent? He suggests two: "Lighten up on high-yield exposure, and be ready for some opportunities in distressed bonds."

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Monday, February 26, 2007


a deathly excess

the economist reports:

MARGIN debt in the American stock market has reached a new record of $285bn. In other words, more borrowed money is being used to buy shares than ever before.

As David Rosenberg of Merrill Lynch observes, margin debt has jumped by $40bn in the past three months, a similar rate to early 2000, when the markets were in frenzy. As a proportion of market value, margin debt is now at its highest since the late 1920s, an era that was a by-word for speculation (and resulted in the crash of 1929-32).

There are further signs that sentiment is getting overheated. The proportion of cash held in mutual funds has dropped to 3.9%, equal to its record low (although those lows were recorded only in 2005). Stockmarket analyst Alan Newman says we have gone almost 950 trading days without a 10% correction on Wall Street, the third-longest period in history.

note particularly that margin debt has jumped some $40bn in just the last three months -- a rate of expansion that annualizes to 83%. in the context of the chart included here, this would seem to indicate that we may be very near the top in the markets.



a greenspan torpedo

this page has taken away from its studies of the current state of economics that a recession is looming in the not-too-distant future. postings from the last months pepper the register here. but the equity market, having recovered from a summer slump, has defied that view and headed higher. the reason why remains uncertain as ever, but the word "complacency" has become one of the most often used in financial journals. even as trouble in subprime lending has turned to outright disaster, even as the housing industry -- source of much of the last four years' national economic growth and repository of the national wealth -- has begun to nose over from a spectacular debt-driven run, confidence has remained high.

but today complacency and confidence received a torpedo in the side -- loosed by former fed chairman alan greenspan.

"When you get this far away from a recession invariably forces build up for the next recession, and indeed we are beginning to see that sign," Greenspan said via satellite link to a business conference in Hong Kong. "For example in the U.S., profit margins ... have begun to stabilize, which is an early sign we are in the later stages of a cycle."

"While, yes, it is possible we can get a recession in the latter months of 2007, most forecasters are not making that judgment and indeed are projecting forward into 2008 ... with some slowdown," he said.

Greenspan said that while it would be "very precarious" to try to forecast that far into the future, he could not rule out the possibility of a recession late this year.

Greenspan also warned that the U.S. budget deficit, which for 2006 fell to $247.7 billion, the lowest in four years, remains a concern.

"The American budget deficit is clearly a very significant concern for all of us that are trying to evaluate both the American economy's immediate future and that of the rest of the world," he said via satellite at the VeryGC Global Business Insights 2007 Conference.

Greenspan also said he has seen no economic spillover effects from the slowdown in the U.S. housing market.

"We are now well into the contraction period and so far we have not had any major, significant spillover effects on the American economy from the contraction in housing," he said.

it may not sound much, but it is a word of severe warning. the spillover from housing that not only greenspan but every financial analyst worth his salt fears is probably on the way. as noted by deep bear bill fleckenstein:

In the dark-matter universe (for a quick primer, click here), risky BBB tranches (subgroups) of home-loan-backed securities have been annihilated, and now the A tranches are weakening. Supposedly, the real pain will start when the higher-rated AA and AAA tranches start to weaken. But really, one won't need access to dark-matter market quotes to know that trouble is at hand. It will be obvious when stocks like Washington Mutual and other housing-finance-related stocks start sinking.

that weakness is quite possibly just getting underway in the aa tranches that make up the 2h06 abx basket. washington mutual remains just off its peak.

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Wednesday, February 21, 2007


uncertainty and fear

a fascinating bit relayed by andrew sullivan.


yet more on recession

predicting recession has temporarily gone out of fashion -- becoming even the object of ridicule in plebiscitarian publications -- but difficult data continues to emerge.

What makes it noteworthy is that this Fed index (of industrial production) has been languishing for a while, and is now below its value of six months ago. That, too, can sometimes be benign. We saw a 6-month low in September 2005 after Hurricane Katrina, and in the anemic recovery of 2003. But a 6-month-decline in the index is something that is often associated with the early stages of an economic recession.

from a contrarian viewpoint, seeing published economists recant predictions of recession in an environment of ever-more troubling data is a bad sign.



buying reo

with the popping of the real estate bubble a current fact but prices being sticky as forecast, i've been giving much more consideration to buying an reo property.

tanta at calculated risk outlines the decline of the loss mitigation aspects of mortgage loan servicing among other intersting points about that industry, further including this comment. one of the conclusions is that "nuclear waste" servicers are bidding very little on the dollar to take problem loans off of other people's balance sheets in part because they haven't enough staff to deal with the wave of bankruptcy. some are already adding staff as fast as possible in anticipation of the wave.

as usual, the comments are as informative as the post. here is as succinct an account as can be made of the danger that faces the entire economy over the collapse in housing.

I would add 'negative convexity' is easy.

Bonds go down in price when interest rates go up. The degree to which they do so is measured by 'Convexity' (strictly speaking: the partial derivative of the bond price with respect to the change in interest rates, is normally less than zero).

When interest rates go down, bond prices go up (for the same reason).

Mortgage Backed Securities do not, necessarily, go up when interest rates go down.

This is because when interest rates go down, mortgage holders refinance. And so the MBS holder gets back his or her capital, before he wants/expects it.

Hence negative convexity. An asymmetric response to interest rates.

Analytically, the holder of an MBS has granted the borrower a call option which they can exercise if the MBS starts to rise in value. That is how one normally models these things (can someone confirm this?).

To fight this, investment banks created Collateralized Debt Obligations (CDOs) where the repayment is broken off into 'tranches' of mortgages.

The top tranche is essentially triple A or near enough, typically. The borrowers are very unlikely to default, and to repay-- the tranche is usually protected against early repayment in some way (ie another tranche must be fully repaid, before the top tranche can be repaid).

The bottom tranche (there are normally several, packaged and sold by the investment banks to different investors with different risk-return requirements) is normally called 'the toxic waste'.

In a tough market, the bank has trouble moving that one, the toxic waste. It may have to take it on its own balance sheet. Although it will be 'marked to market' the reality is, if the market is illiquid, there is no market, and it cannot be sold or turned into cash at any price.

In today's wild and crazy markets, hedge funds have been borrowing money from banks to take on CDO tranches-- they are a key part of the market liquidity.

So you have levered holders of CDOs. If something goes wrong, the market could be flooded with low quality MBS/CDO, as the hedge funds (also 'marked to market') will be forced to sell, and effectively the new issue market for MBS will be shut down.

At which point, only banks that keep mortgages on their balance sheet will be lending.

And we will be back to a world of 20% cash down, first mortgages only. The remaining banks will only lend as first mortagors to prime residential real estate, because they will not be able to shift the mortgages off balance sheet and so free up reserves for more lending. This is called a 'credit crunch'.

The housing market will, accordingly, freeze up for some time.

That is the danger.

but more to the point of reo -- that is, homes that have been foreclosed on, passed through auction and are now owned by the bank -- there is much for me to learn here. but this may be an avenue to finding some protection against buying a house in the middle of what may be truly unprecedented price declines.

to and realtytrac -- the first a monitor of local pricing, the second a monitor of foreclsoures -- one might add (via big picture) neighboroo, whose foreclosure may may be of some assistance.

UPDATE: a post at the housing bubble blog relays what is the beginning of some really frightening times in florida as desperate sellers of property overwhelm the potential buying pool.

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Tuesday, February 20, 2007


existential threat

via the washington note, a wonderful analysis of climate change that draws on the philosoophical historical and archaeological tradition of declinism that includes foucault, spengler, toynbee, barzun, paul kennedy, tainter and more recently samuel huntington and jared diamond.

Every political, social and economic system ever created has sooner or later encountered a challenge that its very nature has made it incapable of meeting. The Confucian ruling system of imperial China, which lasted for more than 2,000 years, has some claim still to be the most successful in history, but because it was founded on values of stability and continuity, rather than dynamism and inventiveness, it eventually proved unable to survive in the face of Western imperial capitalism.

For market economies, and the Western model of democracy with which they have been associated, the existential challenge for the foreseeable future will be global warming. Other threats like terrorism may well be damaging, but no other conceivable threat or combination of threats can possibly destroy our entire system. As the recent British official commission chaired by Sir Nicholas Stern correctly stated, climate change "is the greatest and widest-ranging market failure ever seen."

The question now facing us is whether global capitalism and Western democracy can follow the Stern report's recommendations, and make the limited economic adjustments necessary to keep global warming within bounds that will allow us to preserve our system in a recognizable form; or whether our system is so dependent on unlimited consumption that it is by its nature incapable of demanding even small sacrifices from its present elites and populations.

If the latter proves the case, and the world suffers radically destructive climate change, then we must recognize that everything that the West now stands for will be rejected by future generations. The entire democratic capitalist system will be seen to have failed utterly as a model for humanity and as a custodian of essential human interests.

indeed, it seems to me that the west will be remembered with a great deal more nostalgia than that. the scattered seeds of this dying civilization will probably bear fruit, just as the collapse of the hellenic world gave birth to it. but it takes little imagination to envision the infrastrucutre of western civility refusing to adapt thanks to overwhelming complexity, complacency and inertia.

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So do you believe global warming is occurring now, or do you just agree with the philosophical tone of the article?

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the philosophical viewpoint that underlies the article -- that civilizations collapse for an inability to face the challenges that confront it -- is attractive to me, anon, and one with a profound empirical/historical backing.

as to whether global warming is a reality -- in rejecting the certitude of scientism i'm forced to say that i don't know -- but in accepting the premise of a rational, empirical and falsifiable science that the probability grows somewhat higher with advancing years and observations. a great deal of social effort has been put into observing climate and the traces left by past climate in the last few years, and the results of those observations are not promising.

the irreducable complexity of global climate still, i think, poses a formidable (insurmountable, really) barrier -- no one can say with certainty what the future climate will be. most any competent climatologist will admit as much, in my experience. but then, which of us is ever privileged to act on certainty? it's never happened to me in my lifetime.

the fact is that our best empirically-derived estimates of the probabilities of global warming are disturbing and growing moreso -- and have come to warrant action.

i say this last particularly considering a balance of risk and reward.

if we don't act and manmade warming is close to or worse than predictions, where does that leave us? very much where anatol lieven describes, methinks. if we act and it is much less than prediction, where are we? no worse off than our recent climatological history, i suspect. if we don't act and it is less, we have still had some effect -- after all, the world is different for the indisputable existence of amospheric industrial gases -- but we can live with it. if we act and it is what we thought, i expect we have saved western civilization from a collapsed and dark age.

this would itself suggest easily to go forward with mitigation -- but it of course ignores cost. as it turns out, however, the cost is really very minimal -- 1% of global gdp, by the economist's estimate. considering the tail risk, this is a trifle.

so while one can argue the scientific merit of climate change as we now presume to know it, the balance of the risks and a cost-benefit analysis are crushing to the skeptic's case.

the last truly valid refuge, it seems to me, of a skeptic is to argue that the wealth could be better spent on other projects such as alleviating poverty or funding third-world irrigation. but again, i think the tail risk of climate change is so overwhelming in its implications that it simply cannot be ignored. if we do nothing and survive as a civilization whatever climate change does bring, it will have been a considerable spot of luck.

moreover, while there is a valid ethical argument over the actions resulting from the probability of global warming, there is also an ethical argument in favor of accepting responsibility for one's deeds that runs deep in the repositories of accumulated human wisdom. the idea that a rational man can ignore the consequences of his actions -- even if those consequences are possibly but not certainly benign -- is a detrimental one to our civilization. one can argue that even if global warming comes to nothing, it is our moral responsibility to clean up our own mess, as it were.

none of this is to dismiss the quasireligious features of the more extreme brand of climate apocalysm, which are apparent -- nor is it to dismiss the existence of institutional interests in keeping grant money flowing. but neither of these is a remotely adequate means of dismissing climate change. the lunatic fringe exists on either side of the debate and should characterize neither -- and the institutional interests that oppose the dialogue climate change are clearly vastly better organized and better funded than any advocacy. indeed, suppressing climate change as a political concept has become a crusade similar to that which tobacco companies once engaged in to "demonstrate" that cigarettes were completely safe and non-addictive.

fwiw, i've gone back and tagged every mention of global warming here with climate -- peruse if you like.

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Friday, February 16, 2007


giuliani's caveat

from jonathan alter:

I recall going over to Gracie Mansion in this period to interview the mayor. I asked him why he had not even spoken to C. Virginia Fields, the Manhattan borough president, for more than two years. (Fields’s experience was hardly unique among elected officials in New York.) “What’s there to talk about?” Giuliani said petulantly.

This is not a minor thing. It’s not like stiffing Sharpton. It’s like the president of the United States saying, “What’s there to talk about?” with the minority leader of the U.S. House of Representatives. Any good politician knows how to reach out. Giuliani was acting like a prosecutor, which is no big surprise. The question is whether a prosecutorial and authoritarian approach is right for the highest office.

It’s a good bet that Giuliani would be a strong commander in chief. If terrorists attacked again, he would know what to do. But how about the next month? And the month after that? The president is more than a crisis manager. He’s also the defender of the Constitution and the leader of his party. He holds a moral and intensely political position that calls for great skills of conciliation. If FDR had a famously “first-class temperament,” how should we describe Rudy’s? Third-class?

most politicans are insecure, territorial, ambitious, dictatorial, argumentative, petulant and vindictive children on the inside -- it unfortunately happens that these traits are well suited to driving a career in demotic politics.

however, the inability to keep those traits on the inside is a major character flaw that makes giuliani unfit for high office. prosecutors are as a rule by temperament terrible politicians for an ostensibly free society precisely because of their outsized need for total control, regardless of the side of the aisle -- elliot spitzer is no better in any of these senses, for example. and of course the ethical history of any ambitious prosecutor is compromised by the wielding of their power to bring politically useful cases to raise their profile of selected issues. in combination with an immoderate temper, i don't see how americans could conscientiously take the chance of electing a man so disposed.



dinesh d'souza and stanley kurtz

this i wrote to andrew sullivan today.

Mr Sullivan --

Pardon my incomplete first email -- one too many hot keys, apparently.

Regarding your posting Kurtz on D'Souza of February 14:

I would regard D'Souza's argument -- characterized by Kurtz as "arguing that the “deluge of gross depravity and immorality” let loose by the cultural left has not only split our country politically, but has provoked a backlash among the world’s traditional societies — Muslim societies above all" whereupon "If U.S. conservatives could only let pious Muslims see the moral and religious America that disdains the values of the cultural Left, D’Souza promises, Muslim traditionalists would reciprocate by rejecting the violent, anti-American radicals in their midst" -- as seriously flawed as well. But I also think Kurtz's comments little better.

Decadence is not a "liberal" phenomena -- it is a social one, one which affects and indeed creates the parties and views interacting with the society so afflicted.

D'Souza does not understand that the American "conservatives" to which he refers to are not of a kind with the Islamic moderates he would hope to court. Indeed, the jingoistic American "conservatism" embodied in and perpetuated by the Bush Administration and Fox News has more in common with salafism than with moderate Muslims (as I intend to argue at some length below). They are products of Western decadence themselves -- in the main, a body politic which is as excessive and baseless as the more plainly decadent progressive movement. That they hide that fact in a reactionary cloak should not deceive.

This ability of decadence to pervert is most easily seen in salafism, the correct evaluation of which is being forwarded by Olivier Roy. This strain of Sunni fundamentalism is a product of the interface of Sunnis with a decadent Western culture -- and as such it is not a strictly Islamic phenomena so much as it is a Western one, which in fact began its intellecutal history in areas of close Muslim-Western interaction and has fed back to traditionally Islamic nations like Saudi Arabia, which have themselves become areas of interface thanks to relentless Western incursions into their social and political affairs. It is notable that salafism is a 20th c phenomena, and that its most prominent figures (such as Abdullah Azzam) were surrounded by and in conflict with Western culture from very early on in their lives.

Mahmood Mamdani wrote of Roy's view in Foreign Affairs:

For Roy, neofundamentalist Islam is "born-again Islam" and strictly a product of the diaspora. Islamic religious debate is no longer monopolized by the learned ulema (teachers); as they have turned to the Internet, the neofundamentalists have also become tulaab (students). As a result, "religion has been secularized, not in the sense that it is under the scrutiny of modern sciences, but to the extent that it is debated outside any specific institutions or corporations." With the traditional ethnic community left behind, "the disappearance of traditional values ... [has laid] the groundwork for re-Islamisation," which has largely become an individual project. "Islamic revivalism goes hand in hand" with a modern trend: the "culture of the self."

The growing individualization of religious practices has prompted believers to create a new community that transcends strict geography. The consequences of these changes have been contradictory. Those who have succeeded in reconciling the self with religion have tended to embrace a "liberal" or "ethical" version of Islam; those who have not have been prone to embrace "neofundamentalist Salafism." Meanwhile, the quest "to build a universal religious identity, de-linked from any specific culture," has come at a price, because such an Islam is "by definition an Islam oblivious to its own history." As a result, "the quest for a pure Islam [has] entail[ed] also an impoverishment of its content," Roy writes, and the ironic consequence of this quest is "secularization, but in the name of fundamentalism."

That is to say, salafism is a manner of Islamic Calvinism -- for what Roy here describes is the identical battle for the conciliation of religion with individualism that became the focus of the Reformation in the essentially archaistic, world-rejecting and frequently violent vein of utter human futility that Calvin spawned. It should not surprise us, then, that many leaders of these movements are Western-educated and even Western-born, and often children of considerable privilege. It is by implanting the Trojan horse of rampant Western individualism in some Muslim minds predisposed to reject it superficially but to adopt it fundamentally that salafism has arisen. Salafis are moving against both the moderate institutional religious body of Islam and the institutional political body of the society that bore them, be that the West or the indigenous governments that they see as having been coopted by the West, all of which they view as despoiled. That is to say, they reject the established order and reserve for themselves an archaistic "pure" version of their religion -- but they also appropriate for themselves the ability to interpret that archaistic vision in any way they see fit. This is the obvious infection of individualism.

This is clearly very similar to the Puritan dynamic, which reacted violently against and fled the decadence of both the religious and political body of a Catholic Europe. American fundamentalist Protestantism bears many of the same marks identified by Roy on the face of fundamentalist Islam -- the quest to build a pure religious identity denuded Calvinism of its Christian history in Catholicism and cast it adrift from any institution, and debased of that grounding history it became the wellspring of all manner of violence and irrationality in the name of Christ -- foregoing the light of a law and reason based in experience (seen now as "oppressive") to embrace the intensely personal release and emotionalism of religious fervor as a salve for the insecurity of unsteady footing.

It seems very clear to me that the hope that moderate Muslims -- deeply faithful in the tradition and lawful order of the ulema whose doctrinal consistency has defined their existence through generations -- are going now to, faced with a Calvinistic movement from within the faith, embrace the ahistorical hyperindividualistic Calvinists of the West who sparked it as their allies is almost totally misplaced.

Unfortunately, Kurtz's utterly simplistic criticisms only exceed in magnitude the errors of D'Souza. To confuse salafism with Islam is to confuse Calvinism with Catholicism, and yet Kurtz does so regularly. Taking for example the point:

Actually, Islam has a long history of producing violent and radical sects (like the Kharijites and the Assassins) in times of crisis.

One must suspend one's disbelief at Kurtz's ignorance to address the "idea". The Hashshashins were a political sect, not a religious one -- he is here akin to confusing Catholicism with the Ku Klux Klan. Further, in supposing the rigorous technological and economic backwardness of the Islamic world, I am forced to wonder if he has ever been anywhere in the Mideast -- or if he can imagine the scope of the changes the Islamic world has adopted in just the last century. No one who has been to Istanbul, to Dubai, to Kuala Lumpur could believe something so devoid of both historical and contemporary context, could they?

I suspect instead Kurtz is hunting up a disposition to barbarism in Islam because he needs it to justify his cultural superiority and therefore the presumptive rightness of his emotional cause -- and with willful ignorance finds it. The evidence lays here:

Here D’Souza is glossing over the unique synthesis of “traditional” family life with egalitarian and individualist values that early Christianity began, and that Tocqueville’s America brought fully into harmony with democracy. Our war on terror has everything to do with the fact that Muslim society has failed to forge such a synthesis.

Indeed -- but Kurtz in his blurry Western ethnocentricity cannot see first that the failure of reconciliation is limited to salafists -- and second, that many in the West, particularly the United States, have in fact failed in that synthesis as profoundly as salafists -- and that they have been slowly pulling Western civilization to pieces for some centuries much as the salafists have just begun to.

It is a very grave conceit and deep historical error to confuse another civilization's manners for barbarism -- one which I like to think the best among us left in the 19th century.

I'm forced to suggest that, as wrong as I find D'Souza's concept and conclusions, he deserves a far better critic than Kurtz.

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the real iran

just to drive home the point of how different iran is from the propagandized, hypersimplistic "mortal enemy" version being spewed like vomit from the mouth of a sick administration -- try this on for size. this is a much more realistic view of iran and iranians. his english-language blog is here.

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hillary clinton and the foreign policy establishment

via washington note, this trenchant analysis of hillary clinton's acquiescence to an interventionist foreign policy.

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Thursday, February 15, 2007


long yields to rise

that's the effective message being sent out by businessweek. perhaps we're already at the end of bill gross' last bond bull?



the gdp picture

a major downward revision in positive q406 data has given a new look to american economic conditions, as noted at big picture.

as batted around here, here and here in the last month, the onset of recession looks to be more and more probable. not only has gdp taken this pessimistic turn, not only is housing finally exhaling, not only has earnings growth sunk below 10%, but industrial production is already in a deepening recession.

but -- as yesterday showed -- these downward revisions are giving room for the fed to move toward the easing that paul mcculley talked about having been priced into market expectations.

The market rallied on Wednesday, when the Fed chief soothed investors nerves, saying that inflation is likely ebbing, reducing chances that the central bank would hike interest rates later this year. However, Bernanke said the Fed would continue to monitor economic data.

interestingly, capital flowed out of the united states in january on a net basis for the first month since june 2005. though it may mean little in a broader view, there was this to say:

The dollar fell against yen and the euro following the report, which, according to Action Economics, "didn't sit too well" with the markets after Tuesday's report on the nation's growing trade gap and a Wall Street Journal report that China is considering shifting some of its $1 trillion in foreign reserves into riskier assets, such as corporate bonds, stocks and even commodities.

no note was made of the recent fall in the price of oil as a check against petrodollar recycling, although this is almost certainly a factor.


Wednesday, February 14, 2007


housing tracker

this site tracks housing valuations in many markets, including chicago.



housing markets and the trade deficit

an excellent simplified analysis of an engine that has driven housing forward which might just as easily drive it back.

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Monday, February 12, 2007


emerging market spreads

a good data source here for spreads of emerging market debt over treasuries, utilizing the jpmorgan embi+ as a proxy for emerging market debt. these spreads have been driven by carry traders working in a high-liquidity, low-volatility environment to all-time lows.

February 6 - Financial Times (Richard McGregor): "Risk premiums on emerging market bonds yesterday were close to record lows as hopes of a credit rating upgrade for Brazil spurred another round of buying. As bond prices rose, the risk premium on emerging market bonds, as measured by JPMorgan's EMBI+ index, a market barometer, touched an intraday low of just 164 basis points over US Treasuries during trading. The lowest close for the index - 165bp over US Treasuries - was reached on Friday."



housing damage widening

patches of evidence for the onset of slower american economic growth are starting to amass, though they remain scattered. stock markets took a tumble friday -- though this from a technically overbought position, many made the correlation with word from cleveland's fed governor that the carnage taking place in housing is not the responsibility of the fed to fight -- that not only will rates not be cut for housing, but may even be raised.

"The national inflation picture has been clouded in the past few years by large swings in energy, commodity, and housing prices. As these markets normalize, and as we gain a clearer picture of the underlying inflation trend, we may see that some inflation risks remain. In that case, some additional policy firming may be needed - depending, of course, on the outlook for both inflation and economic growth."

hopes for a nascent recovery in housing cannot have been encouraged here -- and indeed tranches of commodified housing mortgages (known as CDOs and tracked by bond index ABX) are tanking. this graph shows the ABX relating to high-risk (BBB) mortgages originated in the second half of 2006, which are now selling at 89 cents on the dollar on default fears. but in some ways more disturbing is the deterioration in CDOs reflecting better credits -- such as AA bonds (100 cents) and A bonds (96 cents) in the same timeframe, both of which have taken a sharp turn down.

could this indicate the beginning of a capital flight from mortgage debt? certainly the press is reporting that wall street is nervous.

The once booming market for home loans to people with weak credit -- known as sub-prime mortgages and made largely to minorities, the poor and first-time buyers stretching to afford a home -- is coming under greater pressure. The evidence can be seen in rising default rates, increasingly strained finances at mortgage lenders and growing doubts among investors.

Now, Wall Street firms, which had helped fuel the growth in the market by bankrolling and investing in sub-prime mortgage lenders, have begun to pinch off the money spigot.

Several mortgage lenders have recently collapsed. While the failures so far are small in number, some industry officials are concerned that they could be the first in a wave. The sub-prime sector, which produced loans worth more than $500 billion in the first nine months of last year, could shrink significantly.

Wall Street firms were attracted to such lenders because they helped feed a pipeline of securities backed by the mortgages, a market bigger than the one for U.S. Treasury bonds and notes. Merrill Lynch, for example, backed $67.8 billion in residential mortgages in the first nine months of 2006, up 58.4 percent from the period a year earlier.

But an increasing number of borrowers are defaulting on sub-prime loans earlier now than they did a year ago, often within six months of having taken the loan out, shaking Wall Street's confidence in its sub-prime partners.

Nearly 1 million homeowners nationwide either lost their homes or missed monthly payments from July to September, according to the Mortgage Bankers Association.

In a December report, the Center for Responsible Lending estimated that nearly 20 percent of those who took out risky mortgages will lose their homes nationwide. In California, more than 21 percent are likely to default, with a foreclosure rate as high as 25 percent in some areas.

In one indication that investors are losing their taste for mortgages, hedge funds that specialize in mortgage-backed securities had an outflow of $1.8 billion in 2006, down from an inflow of $1.8 billion in 2005, according to Hedge Fund Research. It was the only category of hedge funds to have a negative flow for the year.

``We have been and continue to be cautious about the sub-prime market -- its lending standards, decline in home price appreciation, other deteriorating credit fundamentals,'' said Jim Higgins, chief executive of Sorin Capital Management.

Mortgage lenders as small as Ownit and as big as Wells Fargo sit in the middle of housing's food chain that starts with individual home buyers and can end with investors in exotic credit derivatives on the other side of the world. Smaller lenders like Ownit use money provided by banks like JPMorgan and Merrill Lynch to make loans that it receives from mortgage brokers who interact with and help fill in the paperwork for people buying homes or refinancing existing loans.

Once completed, the mortgages are sold to Wall Street banks that package hundreds of loans at a time into bonds that are sold to investors and traded in financial markets.

The bonds are sliced into different layers of risk and many investors typically accept lower returns in exchange for guarantees that they will be paid ahead of people in the lower-quality portions of the securities if borrowers default on mortgages. Investors also shield themselves by requiring mortgage companies like Ownit to buy back mortgages that incur ``early payment defaults,'' an industry term for loans that have turned bad quickly.

In recent months, banks have sought the safety of these protective measures and grown pickier about the kinds of loans they will buy after noticing that a growing number of borrowers who took out loans in 2006 were falling behind on payments just a few months after they had been issued.

and that confirms rumors from elsewhere in the mortgage broker chain that merrill lynch is making margin calls to "mortgage warehouse borrowers" to whom it has lent working capital.

In some quarters it's being called a liquidity crisis, the likes that haven't been seen in the subprime sector since 1998. On Friday, National Mortgage News Online reported that Merrill Lynch was making margin calls on certain warehouse customers, asking these non-depositories for more capital. Meanwhile, we're told that higher-ups at Merrill are questioning why it bought First Franklin -- and why it paid so much money for it. Will heads roll at Merrill? A spokesman there told us that yes, margin calls are occurring, but the company is more than happy with First Franklin. We're also told that some Wall Street firms are getting ready to trim back their warehouse lending operations. Which Wall Street firm will be the first to run screaming from the industry, shouting, "What have I done? What have I done?" Stay tuned…

with the ABX indeces of even moderate risk levels turning down -- and the higher risk end falling apart -- a rout may be on. some few economists are starting to predict recession, noting that the recent bounce in housing was ephemeral and weather-related -- but a rapid unwinding of mortgage exposure would probably bring on a credit crunch that would quickly seal this fate as inevitable.

it is important to note that high-yielding american mortgage debt is on one end of a large number of carry trades -- it may pay to keep an eye on yen-dollar trading. as carry trades unwind, all those who sold yen (the most important carry trade currency) to buy higher-yielding dollar assets will be coming back to buy yen and pay down loans. recent weakness in the yen indicates that this is not yet happening.

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Friday, February 09, 2007


jeffrey hart, again

as profiled:

“Like the Whig gentry who were the Founders, I loathe populism,” Hart explains. “Most especially in the form of populist religion, i.e., the current pestiferous bible-banging evangelicals, whom I regard as organized ignorance, a menace to public health, to science, to medicine, to serious Western religion, to intellect and indeed to sanity. Evangelicalism, driven by emotion, and not creedal, is thoroughly erratic and by its nature cannot be conservative. My conservatism is aristocratic in spirit, anti-populist and rooted in the Northeast. It is Burke brought up to date. A ‘social conservative’ in my view is not a moral authoritarian Evangelical who wants to push people around, but an American gentleman, conservative in a social sense. He has gone to a good school, maybe shops at J. Press, maybe plays tennis or golf, and drinks either Bombay or Beefeater martinis, or maybe Dewar's on the rocks, or both."

i think one can legitimately argue the last sentence in detail and in concept, but the contrast to the slovenly wild-eyed ridiculousness of populism is the point.

from "the conservative mind":

Drawing on Pascal’s statement that “man is neither angel nor brute, and the misfortune is that he who would act the angel acts the brute,” Hart wrote: “The Conservative Mind, most of the time, has shown a healthy resistance to utopianism and its various informed ideologies. Ideology is always wrong because it edits reality and paralyzes thought.”

from "the evangelical effect"

One thing everyone can agree upon about Bush is that as president he has brought religion into politics in a way unknown to recent memory. And he has owed both of his electoral victories to his Evangelical Christian base. This indispensable base has profoundly affected his policies, foreign and domestic.

The Bush presidency often is called conservative. That is a mistake. It is populist and radical, and its principal energies have roots in American history, and these roots are not conservative.

... Traditional Christianity sees the Resurrection as linking our familiar world of empirical fact with the realm of the beyond-time: Jesus inhabits both. Therefore Jesus is the crux (not to make a pun) of Christianity. To quote Paul again, "Unless Christ is risen, our preaching is groundless."

On that point, supported by other evidence in the four narratives, the entire structure of Christian theology rests, and its representation of such theology in language, such as the Apostles' Creed, in ritual, in art, in music. The linguistic formulations in the creed took about 1,000 years to reach finished form, but their origins can be traced back to the generation of the apostles themselves. No individual can push ahead alone in such an effort of thought and representation as this exhibits. Populism falls on its face, trusting in emotion. Nor is Scripture enough, unless you know how to read these ancient texts.

Because Evangelicalism is sustained by no structure of ideas, and, beyond that, has no institutional support in a continuing church, it flares up in repeated "Awakenings," and then subsides as the emotion dissipates. Because it is populist and homemade, its assertions tend often to be ridiculous, the easy targets for the latest version of H.L. Mencken.

If we recall Leo Strauss's formulation that "Athens and Jerusalem" -- science and spiritual aspiration -- are the core of Western civilization, American Evangelicalism is a threat to both, through ignorance of both.

Except for that major qualification, Evangelicalism would not matter much if it were a private superstition, a sort of hobby, except that the Evangelicalism of the Bush variety has real and often dangerous effects on the world in which the rest of us, and even they, live.

i previously noted one of hart's many books -- but clearly need to read the man. this is a titanic conservative, unlike so many, the vast majority who pass themselves off duplicitously under that rubric because they were too ridiculous to either find a loud voice in the democratic party or to build a trotskyite party of any consequence.

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I was just wondering if you had any thoughts on some of the recent blog debates on the definition of conservatism. Ross Douthat's effort has received a fair amount of criticism, but I found Austin Bramwell's discussion far more interesting. Bramwell is not a typical vulgar Republican yet I wondered if you found his attempt to link conservatism to Weberian legitimacy to be too akin to the majoritarianism that you have often criticized.

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more on impending recession

via yahoo -- the latest rbc report on consumer confidence shows that, while overall confidence has swelled to a new cycle high and current conditions are at 114, future expectations continue to diminish.

Another index tracking peoples' feelings about economic conditions and their own financial prospects over the next six months dropped to 69.2 in February, suggesting consumers are somewhat apprehensive about what the future may hold. This expectations index had surged to 83.8 in January after a long period of weakness.

the differential of future and present is thus (-44.8). this report is not the conference board report which i generally follow, which has been indicating growing odds of a severe consumer recession for some time.

i also sat in on a presentation yesterday of an event-driven/distressed manager who runs a $600mm fund and is raising capital. the difficulty she has found in finding effective hedges for her style has led her to an economically-sensitive position -- the experience of 2001-2 is still fresh in her mind, and she further exhibited a reactionary nervousness in 2005 by going to a 40% cash position (though that intuition clearly did not pan out, despite very convincing signs that it would -- quite possibly in retrospect the petrodollar put can be the explanation of the markets refusal to yield, as it was from a december 2004 low of ~$40/bbl that oil shot up to $60 by july 2005 and the high 70s in july 2006).

her pessimism was more understated than my own, but she too explicitly understands all too well that yield curves do not remain inverted forever, and the process of unwinding them is not pretty. beyond noting that spreads are so narrow that they cannot really get narrower in a pragmatic world, she is also seeing increasing nervousness among financiers in the distressed, m&a and private equity fields -- for example, refi deals that were getting done last year to keep companies out of bankruptcy by extending their debt obligations out over several years are simply not finding bankers now -- and interprets this to mean the onset of a general credit contraction.

yesterday was also another red-letter day in the subprime market.

HSBC Holdings PLC, Europe's biggest bank and a major player in the U.S. subprime mortgage, disclosed it would need to set aside almost $10.6 billion to cover loans the bank expects won't be repaid.

Separately, New Century Financial Inc., a subprime lender based in Irvine, Calif., said it lost track of how severely the loans in its portfolio were losing their value.

Investors who buy the company's mortgage loans in the secondary market have been selling the loans back when borrowers default, New Century said. The company said because of accounting errors it underestimated how many loans would be resold and how much value those loans would lose before ending up back in New Century's portfolio.

New Century's stock closed down more than 35 percent Thursday, dragging the entire industry with it. Insurers like PMI Group Inc., Radian Group Inc. and MGIC Investment Corp., which write policies covering mortgage debt, also fell.

in conjunction with the havoc being visited on the subprime mortgage market, these are important signs of an economic rollover.

the stock market is so far showing few signs of slowing, with participation remaining relatively broad. but bond yields may have made an important top in june of 2006, which pimco's bill gross subsequently identified as a bond bull opportunity. in his latest missive, he remains quite wary while noting that economic fundamentals aren't driving bond prices anymore -- leverage and financial flows are, while the stock market is getting further support from buybacks.

In effect, despite the chicken and egg aspect of why the trade deficit exists – because foreign investors want to invest in the U.S. or because U.S. consumers want to buy things – there is likely near unanimity that it is now responsible for pumping nearly $800 billion of cash flow into our bond and equity markets annually. Without it, both bond and stock prices would be much lower, the $800 billion for instance representing 3 - 4x our current federal budget deficit. Almost perversely, then, an increasing current account deficit supports and elevates U.S. asset prices as the liquidity from it is used to buy stocks and bonds.

Notice that in 2001 a monthly trend reversal of $10 billion ($120 billion annually) neatly coincided with a 20% decline in stock prices and a flat bond market despite a developing recession. While the real economy was certainly influencing stocks and corporate profits, the effect of financial flows was also becoming apparent, certainly in the bond market and suspiciously so in stocks as well. The draining of $120 billion from the foreign cash flow pump appeared to have magnifying, “it’s different this time,” effects on both. The trade deficit resumed its downward trek in 2002 and as it did, stocks recovered and a strange phenomena began to be observed in the bond market – what Ben Bernanke was to call a global savings glut – which because it was recycled primarily into U.S. financial markets via an accelerating trade deficit – resulted in artificially high bond prices and low interest rates. Bernanke’s “glut” effect appears to have continued up until the present day as unusual and persistent negative yield curves in the U.S. have had little of their normal cyclical dampening effect on asset prices and the real economy.

Combined, the total rise in corporate share buybacks and the financing for bond and stock markets via the increasing trade deficit have injected an average of perhaps $1 trillion annually of purchasing power into our asset markets since the end of the 2001 recession. Because hedge funds and levered players of all types have been aware of this trade deficit/share buyback “put” and have acted upon it, the incalculable but conservatively estimatable pump from these two sources alone have poured in several trillions of purchasing power per year. Take that money and use it to invest in further high powered and levered financial instruments such as CDOs, CPDOs, and 0% down funny money mortgages of all varieties and you can understand why asset markets have done so well in recent years, and why, as my initial Outlook sentence suggested, it is so hard to analyze “value” in asset markets these days. Prices are increasingly being determined by value insensitive flows and speculative leverage as opposed to fundamentals.

gross is indicating that the music will stop when the contributors to the current account deficit -- petrodollar and asian import recycling -- falter. and this is an end which gross too, like our friendly distressed manager, now sees signs of.

there’s an ill wind blowin’ this time around, or to put it another way perhaps, many of our proverbial 100 bottles of beer on the wall may have been taken down, drained, and have totally inebriated the asset markets to the point of preventing further significant price advances. Drunks do, after all, at some point stagger home, roll into bed, and at least sleep it off for a good number of hours. The suggestion of no more bottles of beer on the wall comes from several sources, the first of which appears in Chart 1 as a recent reversal in the trade deficit. While some of this improvement is due to the standard dollar weakness of the past 12 months and its dampening impact on imports, much of it is due to the decline of oil since August/September of 2006. ... [T]he recent $20 reversal in per barrel oil prices results in a reduction of $100 billion or so in the annual trade deficit, and a like amount of liquidity extraction from bond and stock markets, much more if associated leverage is unwound. Granted, some would claim that there will still be $700 billion or so of purchasing power coming into our markets, but higher asset prices in a levered economy are dependent on greater and greater injections of liquidity, not less. Should oil hold in the $55 range, this extraction of high powered 100+ proof alcohol from the markets will be noticeable.

that is, a stanching of the petrodollar put can break the markets.

The second source of vulnerability comes from the corporate buyback stash, a trend itself as Chart 3 points out that is beginning to level off and reverse. Peter Bernstein, in a recent January missive, suggests that corporate profits as a % of GDP cannot continue to grow at the same pace. “Everybody else” he writes “is going to want a piece of that juicy action. Employees will demand higher wages, customers will demand lower prices, and the government will levy higher taxes.” ... Corporate profits are significantly influenced by the growth rate of real and (importantly) nominal GDP. As Chart 5 hints, should nominal GDP decline into the 4-5% range over the next several years as discussed in last month’s Investment Outlook, corporate profits and ultimately the juice for share buybacks will be affected as well. Chart 5, points to the possibility of reducing profits as a % of GDP by as much as 2% over the next several years if 5% nominal is where we are headed. If so, then share buybacks could be cut back by a good $100+ billion in the near term future.

that is, recent disappointments in q406 profitability are just the beginning of a gdp growth decline that will gradually end the stimulus of share buybacks.

UPDATE: big picture cites the slowdown in earnings growth.

timing is everything, of course, but one can look at the predictions of gdp growth and the dependency of ever-larger current account deficits on $80 oil and know that there isn't much more room for this cycle to run up. paul mcculley notes that the markets have priced fed easing into this year -- thus doing the work of easing preemptively -- without much assurance that the fed will actually ease in 2007. the easy money condition already in place requires fed justification soon to avoid being withdrawn.

Thus, we have a paradox: the Fed doesn’t want to signal ease, because the data are looking better, but the data are looking better because the market is explicitly betting on Fed easing. In fact, I believe that it is not just the yield curve that is making that bet, but “risk assets” more generally, notably ebullient stocks with low volatility and tight corporate credit spreads (which are linked, of course, by the Merton thesis1).

This paradox will not long endure, in my view: either the Fed will “validate” the markets’ pricing of easing, or the markets will un-price that easing, tightening financial conditions. In the former scenario we will all live happily ever after, or something like that, sometimes labeled a Goldilocks soft landing.

In the latter scenario, we will all live happily ever after, too, but only after an unnecessary interlude of melancholy, where the markets undo the easing “work” they have done for the Fed, re-opening downside risks to economic growth that provide justification for the Fed to do its own easing work.

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the justification of stovepiping

this is how accountability for the fabrication of evidence that led to a ghastly war in which hundreds of thousands have been killed is denied in washington -- via kevin drum:

Intelligence provided by former undersecretary of defense Douglas J. Feith to buttress the White House case for invading Iraq included "reporting of dubious quality or reliability" that supported the political views of senior administration officials rather than the conclusions of the intelligence community, according to a report by the Pentagon's inspector general.

Feith's office "was predisposed to finding a significant relationship between Iraq and al Qaeda," according to portions of the report, released yesterday by Sen. Carl M. Levin (D-Mich.). The inspector general described Feith's activities as "an alternative intelligence assessment process."

In a telephone interview yesterday, Feith emphasized the inspector general's conclusion that his actions, described in the report as "inappropriate," were not unlawful. "This was not 'alternative intelligence assessment,' " he said. "It was from the start a criticism of the consensus of the intelligence community, and in presenting it I was not endorsing its substance."

Feith, who was defense policy chief before leaving the government in 2005, was one of the key contributors to the administration's rationale for war. His intelligence activities, authorized by then-Defense Secretary Donald H. Rumsfeld and his deputy, Paul D. Wolfowitz, and coordinated with Vice President Cheney's office, stemmed from an administration belief that the CIA was underplaying evidence of then-Iraqi leader Saddam Hussein's ties with al-Qaeda.

In interviews with Pentagon investigators, the summary document said, Feith insisted that his activities did not constitute intelligence and that "even if they were, [they] would be appropriate given that they were responding to direction from the Deputy Secretary of Defense."

got that? allow me to paraphrase: "i didn't know or care if any of that stuff was actually true -- i was only concocting it because i was told to."

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Monday, February 05, 2007


the chinese stock bubble

some mainstream information from bloomberg, which has risen spectacularly since the opening of the liquidity tap by the federal reserve in 2002.

China's equity exchanges have long had more in common with casinos than markets. Investors were reminded of that on Jan. 31 when China's stocks tumbled the most in at least 21 months after a lawmaker said shares were overvalued. The comments by Cheng Siwei, vice chairman of the National People's Congress, fueled speculation the government will act to limit investment.

Speaking in Dubai, Cheng said only 30 percent of companies listed on the Shanghai Stock Exchange ``are good to invest in by Western standards,'' and investors in the remaining 70 percent will probably lose money. His words sent the Shanghai and Shenzhen 300 Index, which tracks yuan-denominated A shares listed on China's two exchanges, down 6.5 percent, the biggest one-day drop since the measure was introduced in April 2005.

A couple of things are worth considering here. One, when you think about what Cheng said, the biggest surprise is that Chinese stocks didn't fall more. You have to wonder if his 30/70 comment is too optimistic given China's lack of corporate transparency and government efforts to slow the economy.

Two, even after the Jan. 31 plunge, this year's gain is still 17 percent. No, that's not a typographical error. If stocks had ended unchanged on that day, they would be up almost 25 percent in little more than four weeks. How is that not a bubble?

``Every investor thinks they can win, but many will end up losing,'' Cheng was quoted as saying in the Financial Times.

Cheng's comments seem reminiscent of ones by Microsoft Corp. Chief Executive Officer Steve Ballmer in September 1999. After Ballmer, who was company president at the time, quipped that ``there's such an overvaluation of tech stocks that it's absurd,'' markets plunged.

To say ``irrational exuberance'' has crept into China would make Alan Greenspan's catchphrase seem like an understatement. Just as many investors wished they had heeded Ballmer's warning, bettors may regret not reacting more to Cheng's.

The popping of China's bubble probably won't hurt global markets the way the Nasdaq Composite Index's implosion did in 2000. That episode probably has former Federal Reserve Chairman Greenspan wishing he had done more than just raise questions about bubbles in the mid-to-late 1990s. Why the Fed didn't try to temper that exuberance will long mar Greenspan's legacy.

You can bet China's central bank governor, Zhou Xiaochuan, is thinking about what he can do to return some sobriety to markets. Whatever China ends up doing, the bubble speaks volumes about the cracks in Asia's No. 2 economy -- and misperceptions about its medium-term outlook.

One can argue that after a long period of lackluster performance, China's share markets are playing catch-up. Yet the idea that a multiyear rally in Chinese shares is afoot lacks support from the underlying economy.

Untold numbers of bad loans in banks? No problem, we have growth pushing 11 percent, Chinese officials seem to be saying. Raising hundreds of millions out of poverty? We have rapid growth. Stock exchanges that look more like Ponzi schemes than markets? Again, we'll grow our way to health.

Chinese stocks may one day be a stellar investment. At the moment, they seem more like the casinos that Chinese law forbids.

and this charming anecdote:

Last month, I sat next to a U.K. hedge-fund manager on a flight from Tokyo to Bangkok. The day before, while in Shanghai, he was buying DVDs from a salesman who said with a wink: ``If you don't own Tsingtao Brewery Co. stock, you should get in now.'' The hedge-fund manager, who refused to be quoted by name, called it his ``Joe Kennedy moment.''

in short, when the united states turned on the liquidity in 2002, flooding the markets with inflationary money supply in response to fears of a deflationary debt liquidation, it made no (indeed cannot make) condition on where that liquidity was to go. the money the fed either printed outright or encouraged others to borrow sparked the subsequent "reflation", which has found its way into every market around the globe. several real estate markets worldwide have boomed; risk premia in emerging markets debt have compressed; commodities prices have skyrocketed; and small third-world stockmarkets have flourished.

the net result has been a multifarious global asset boom funded largely by leverage -- most notoriously, by the yen carry trade. and the chinese stock market has been one of the greatest global beneficiaries.

will it be unwound? the answer is yes, in time; the more important question is how. it could be disastrous as it was in 1998, if some yen-positive news emerges to force pain onto those carry traders who (all being short yen) are not hedged against the currency effects that would drive the yen much higher in an unwinding -- it is important to note that the basis points being garnered by the traders evaporate if the borrowing currency appreciates. to the extent they are hedged, some counterparty has taken their currency risk and, if somewhere concentrated, such risk could be singularly devastating in a rapid move.

such is the risk of leverage -- sudden moves can devastate levered players, as is apparently happening with red kite and as happened with amaranth in commodities.

note that sudden upward moves in borrowing currencies -- japan yen, swiss franc -- are likely to be accompanied by interest rate cuts in those currencies. investing in franc- and yen-denominated bonds seems a potentially excellent carry-trade-unwinding play. one possible eventual vehicle is prudent global income. merk hard currency is another; permanent portfolio may be another. swiss franc annuities may be another. some major banks offer foreign-currency-denominated cds.

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Friday, February 02, 2007



chalmers johnson's new book is foretasted at with an essay by the author.

It is possible that, at some future moment, the US military could actually take over the government and declare a dictatorship (though its commanders would undoubtedly find a gentler, more user-friendly name for it). That is, after all, how the Roman republic ended – by being turned over to a populist general, Julius Caesar, who had just been declared dictator for life. After his assassination and a short interregnum, it was his grandnephew Octavian who succeeded him and became the first Roman emperor, Augustus Caesar. The American military is unlikely to go that route. But one cannot ignore the fact that professional military officers seem to have played a considerable role in getting rid of their civilian overlord, Secretary of Defense Donald Rumsfeld. The new directors of the CIA, its main internal branches, the National Security Agency, and many other key organs of the "defense establishment" are now military (or ex-military) officers, strongly suggesting that the military does not need to take over the government in order to control it. Meanwhile, the all-volunteer army has emerged as an ever more separate institution in our society, its profile less and less like that of the general populace.

Nonetheless, military coups, however decorous, are not part of the American tradition, nor that of the officer corps, which might well worry about how the citizenry would react to a move toward open military dictatorship. Moreover, prosecutions of low-level military torturers from Abu Ghraib prison and killers of civilians in Iraq have demonstrated to enlisted troops that obedience to illegal orders can result in dire punishment in a situation where those of higher rank go free. No one knows whether ordinary soldiers, even from what is no longer in any normal sense a citizen army, would obey clearly illegal orders to oust an elected government or whether the officer corps would ever have sufficient confidence to issue such orders. In addition, the present system already offers the military high command so much – in funds, prestige, and future employment via the famed "revolving door" of the military-industrial complex – that a perilous transition to anything like direct military rule would make little sense under reasonably normal conditions.

Whatever future developments may prove to be, my best guess is that the US will continue to maintain a façade of Constitutional government and drift along until financial bankruptcy overtakes it.

this is certainly the fate of most empires, but johnson's analysis of rumsfeld's removal is exactly what i would have said.

this has always been the most insistent danger to the republic presented by the rise of such incompetent ideologues and advocates of an unfettered spartanism and nascent dictatorship. the goals of such power-mad nietzscheans cannot be met without the allegiance of the armed forces, who are always the final repository of power in any amoral state, and yet the nature of such men as rumsfeld is not to collaborate but to dominate. as has been shown in parable by the travails of captain ian fishback, many thoughtful military men must be considering that their oath to the constitution and their loyalty to the elected political administration of the country are no longer one and the same.

such a realization of divorce, if it comes to wide realization, spells the end of democracy in the united states or any democracy. the american military is just as capable as any other army of history of becoming its own kingmaker, and the inability of popular democracy to enforce a reasonable measure of culpability and restraint on american political leadership in the face of organized efforts to the contrary end is becoming a glaring systemic flaw. how long the military remains aloof of that fact and its consequences largely determines the remaining lifespan of our system of government.

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recession forecasting

in an otherwise positive q4 employment report, the effect of the declining level of residential investment showed up in a contracting housing sector.

Residential construction employment decreased by 11,400 jobs in January and is down 112.2 thousand, or about 3.2%, from the peak in February. This is just the beginning of the loss of several hundred thousand residential construction jobs over the next year or so.

the spillover hasn't yet hit retail consumption, but some potential signs are developing -- see fig.4.

(Interestingly, non-oil imports tend to decline multiple quarters before recessions, so don't wish for too many quarters of real ex.-oil import decline...).

real import growth (ex-oil) peaked in 4q2003 and again in 1q2006 -- and elsewhere, retail employment may have peaked for this cycle in 1q2006. this timeframe -- first quarter 2006 -- perhaps notably follows the first fracture of the residential real estate bubble, which peaked in 3q2005.

is this the beginning of a more pervasive economic downturn? possibly. the treasury yield curve inverted in q42005 -- some 14 months ago -- and, as this tool can illustrate, the steepness of the inversion has since aggravated somewhat. a proper comparison can be made by running the tool from january 2000 to october 2000 -- the point of greatest inversion -- by which time recession had struck (though, typically, the fact was not recognized until later). the speed with which that inversion translated into recession, however, is not typical -- the event can precede the slowdown by years. the american stock markets (normally good leading economic indicators) have not yet faltered, and though the 10-year bond yield may have peaked in july 2006 the spread over corporates and emerging market debt instruments of like duration -- which are historically very narrow, indicating complacency -- have not widened appreciably. the conference board's leading economic indicator stands at 138.0, which is essentially flat from august 2005 -- but the consumer confidence differential (future less present) that i assign considerable weight to as an indicator of oncoming consumer-driven recession has deteriorated from zero in 2004 to (-20) in march 2005 to (-39.4) today.

most disquieting may be the aspect of a quite positive q4 gdp report which showed personal consumption expenditure declining for the first time in 45 years.

on balance, the curve inversion and consumer expectations continue to indicate that recession will not long be forestalled, though its imminence can be questioned. the housing deterioration, however, may be the leading edge. to be noted is the carnage now taking place among subprime lenders, the most exposed of all financial sectors, as default rates on low-quality loans start to spike and investors (who have been purchasing mortgage-backed securities from subprime lenders in search of yield) start exercizing their right to force the originator to repurchase bad loans on "warrants and representations" -- essentially, exposed lies concocted by the originator to make the loan to people who should never have been given them. as these subprime lenders have little capital on their balance sheet, forced repurchases of defaulting loans can quickly force them to bankruptcy -- which is now happening at the remarkable rate of several a day.

In any case, one is generally made to repurchase a loan at par (you might have to give back any actual premium paid if it’s an EPD [that is, 90 days late within the first year], depends on the contract). So passing it off to a junk dealer, in turn, at a bid in the 80s is a painful thing. Hanging on to it, if you’re as thinly capitalized as your average subprime mortgage banker, is out of the question. Hence the “bloodbath.”

If it hits an outfit like Fremont—which is an FDIC-insured thrift and can therefore hang onto this stuff a lot longer than a mortgage banker can—we’ll be out of “thinning the herd” and into “decimation.” One reason it’s so hard to tell at the moment how bad this might get is that it’s hard to tell how many more “pending” repurchases we have out there. The EPD garbage is just the first wave.

watching fremont general may be interesting -- they showed up on a list of particularly dangerous housing-related stocks i perused a couple years ago. this bit in the orange country register documents their plight.

Lenders made two mistakes, according to UBS and other analysts.

They didn't scrutinize borrowers' incomes, and they allowed subprime borrowers, who by definition have had past problems with their credit, to take on lots of risk.

Borrowers took advantage of "stated income" loan programs, where they simply tell lenders what they earn, said David Liu, director of UBS' mortgage strategy group.

And many first-time homebuyers made a small down payment or none at all. Often they took out simultaneous second mortgages to avoid paying mortgage insurance.

Borrowers gambled on rising home prices to bail them out of trouble, analysts said. Consumers thought home prices would keep climbing, which would enable them to sell or refinance if they got into a jam, analysts said.

But stalling or falling home prices last year changed all that, UBS' Liu said. Borrowers quickly began to miss payments.

"They lost the motivation or incentive to send in the checks," Liu said.

Because of the way loans are ultimately funded, it's very costly for lenders when a borrower misses one of the first payments on a loan.

Lenders package loans in big pools and sell them as bonds to investors. If a borrower misses the first payment, an investment bank putting the whole deal together can compel the lender to buy back the loan.

Lenders typically lose a lot of money when they must buy back delinquent loans. They lose transaction costs and may sell the loan again at a loss. Often when a borrower has defaulted, there is little or no equity in the home, so a foreclosure sale will not cover costs.

if damage in the banking sector starts to spread to fdic-insured outfits like fremont, one wonders if even the macro efficacy of the petrodollar put in holding down interest rates will be enough to stave off or just soften what must be seen as an overdue credit contraction and recession. this writer for one has been paranoid to the possibility since 2005, but it now seems real damage is underway.

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