Thursday, August 09, 2007
is the credit crunch finally here?
Sooner or later the market will realize that this is a credit crunch. We have not seen a real credit crunch since 1973. Go back to your history books to witness what a credit crunch does to asset prices. Pure and simple, when the borrowing dries up, there is no "money" to buy assets.
This is a process that is likely to take years to correct. It will not be a pretty process as debt gets destroyed (foreclosures) until enough of these excesses get wiped away to start anew. It was all caused by too-easy credit for too long by a Central bank not willing to let the market itself handle the allocation of capital. It insisted on providing credit cheaply when the market didn't deserve it.
So U.S. consumers have lived beyond their means for too long. They have wasted away their savings and are now in too much debt. Pure and simple.
so does nouriel roubini.
Insolvent and bankrupt households, mortgage lenders, home builders, leveraged hedge funds and asset managers, and non-financial corporations. This is not just a liquidity crisis like in the 1998 LTCM episode. This is rather a liquidity crisis that signals a more fundamental debt, credit and insolvency crisis among many economic agents in the US and global economy. Liquidity runs can be resolved by the liquidity injections of a lender of last resort: in the cases of the liquidity crises of Mexico, Korea, Turkey, Brazil that international lender of last resort was the IMF; but in the insolvency crises of Russia, Argentina, and Ecudaor the provision of the liquidity by the lender of last resort – the IMF – only postponed the inevitable default and made the crisis deeper and uglier. And provision of liquidity during an insolvency crisis causes moral hazard as it creates expectations of investors’ bailout. Thus, while the Fed and the ECB had not option today but to provide massive liquidity in the presence of a most severe liquidity crunch and run, they should not delude themselves that this liquidity injections can resolve the deep insolvency problems of many overstretched borrowers: households, financial institutions, corporates. Insolvency/credit crises lead to financial and economic distress – hard landing of economies – and cannot be resolved with liquidity injections by a lender of last resort. And now the vicious circle of a weakening US economy – with a housing recession getting worse and a fatigued consumer being at the tipping point - and a generalized credit crunch sharply increased the probability that the US economy will experience a hard landing. We are indeed at a "Minsky Moment" and this recent financial turmoil is the beginning of a much more serious and protracted US and global credit crunch. The risks of a systemic crisis are rising: liquidity injections and lender of last resort bail out of insolvent borrowers - however necessary and unavoidable during a liquidity panic- will not work; it will only pospone and exacerbate the eventual and unavoidable insolvencies.
this could be a terrible shock.
bnp paribas shuttered three funds with large holdings of united states mortgage-backed securities exposure because it hasn't been able to get a price on those assets since monday. that is a serious liquidity event in major credit markets, which have apparently gone into something like panic. the investment banking world is really on the precipice now, and i doubt the odds of a true cascading crash -- however remote -- have been higher since 1998, perhaps since 1987. that probably won't happen, of course. but with some very important credit market underpinnings having broken down, it now easily could. hard to say when liquidity will return, but the speculation has been in weeks.
central banks worldwide injected liquidity today in the hopes of alleviating disaster, but as roubini and minyanville note this is a crash protection measure, not a solution. it had previously been noted by lee adler
The Fed has again brought the SOMA to the bottom of the long term 5% growth channel as it leans against the speculative fever that has gripped the credit markets for the past several years. The growth rate has been zero since last Thanksgiving and only 3.25 % over the past year. The Fed’s actions over the past three months are shocking. Why, in the midst of a credit crunch, is the Fed still pushing at the bottom of the channel and threatening to break it? This is the question of the hour.
You have to wonder if the Fed is asleep at the switch or if it really wants to foment a crash. The answer is “no,” of course, but if their aim was to prick the bubble, then it’s likely that they have succeeded. It is not likely that they can now manage the consequences. The act of keeping monetary base growth at zero as the financial system spiraled into the black hole of a deflating credit bubble could go down as one of the Fed’s great blunders ever. Not that pumping would solve the long term problems of the economy, but we are talking here about a possible liquidity crisis with the potential to turn into a crash.
I’ve been saying that only if the gods have gone crazy would the Fed tighten the monetary base here, but historically, we know that they’ve made mistakes before. So, we’ll see. They’ve clearly been leaning against the tide of credit market speculative mania, and after 8 months that lean has finally begun to have an effect. So the question is whether Ben has seen enough and is unnerved enough to start giving the guys some gas again. In that respect, Monday’s rally was counterproductive for those desperately wanting a rate cut. Bernanke may really believe the phony economic data coming out of Washington, or the Wall Street Journal editorial last week that touted “the best economy in the history of the world”. If they really do believe that garbage, then they are not about to loosen the monetary
base to any significant degree.
the indexes are difficult reads now -- these are not measuring very liquid securities and the makeup of each cdo in the index varies -- but the pictures are amazing. subprime has been a problem for months now but...
... this is triple-a asset backed. this was not considered possible a couple months ago by many people.
high-yield corporate credit default swaps.
spreads on investment grade, high yield and emerging markets.
central bank liquidity injections appear to be (at least temporarily) relieving pressure on these measures. but for how long? adler:
After this week, the giant sucking sound from the Treasury will resume until the end of September according to the Treasury Borrowing Advisory Committee (TBAC) report. One ominous sign was that the TBAC had estimated in May that the Treasury would need only $2 billion in new money in the 4 week bill. Instead they are raising $17 billion. Things are not going as well as planned whether in revenue collections, or increased expenditures. I haven’t checked the Treasury statements, but I suspect that the revenue projections are falling short, if the reports from the California and Florida Departments of Revenue are any indication.
The Fed has given itself plenty of room to offset the pressure from the Treasury but so far it hasn’t. If the FCBs don’t step up and the Fed doesn’t pump, after this week’s Treasury paydown the market should begin to feel enormous pressure again.
In another shocker, foreign central banks were net sellers last week, according to the Fed's data on custodial holdings. It put the short term FCB indicator back on the sell side, and left the intermediate indicator in a holding pattern rather than turning up, as expected. At this week’s auctions indirect bidders including FCBs added only $1.6 billion to their holdings. That could be signaling a bare cupboard ahead, but while we are aware of what they do at the Treasury auctions, not all indirect buyers are FCBs, and what the FCB indicator does also depends on what they do in the secondary market, particularly for GSEs. We get that data from the Fed every Thursday evening for settlements through Wednesday.