Friday, November 30, 2007
some observations on liquidity
Is it just me or are we witnessing the complete drying up of liquidity in the entire financial system? I ask you this because even treasuries are all over the place (this can't be good for Fannie (FNM)). Frankly, I am more scared about what is going to happen in the very near future than I have ever been in my life. Forget being bullish or bearish, I am talking about the financial system (the mechanism) being in huge trouble.
to which was responded:
The financial system, here in the U.S., is not functioning. It is burdened with debt and cannot take on any more. The wheels have stopped. Every ounce of new Fed liquidity (FL) is being sapped up by banks' balance sheets to fund declining asset values. There is no solution except for what we are seeing: massive write-offs by banks (which have just begun) to destroy the debt and required new capital.
This will spread, for there is debt everywhere. Certain governments around the world are flush with fiat foreign currency reserves and are now allocating that to investments in dollars for they have nothing else to do with it. But future appetite and trade dollars will evaporate as deflation kicks in, so this source of funds will dwindle over time.
Look for continued massive appreciation of yen over the dollar, massive bank write-downs, and years of deflation to unwind central banks' decades of inflation.
the real extent of the problem is far worse that appears at first glance because with the miracle of fractional reserve lending, money that was "borrowed into existence" was lent out over and over again.
This was not a problem until now. As long as asset prices are rising banks have plenty of capital to lend. But now that bank balance sheets are impaired there is a mad scramble for cash but there isn't much cash anywhere except of course China, Japan, and the oil states, all sitting on huge US dollar reserves and not knowing what to do with them.
In the end, Citigroup had to be bailed out by Abu Dhabi, an obscure country that no one had heard of until several days ago when petrodollars returned home. Expect to see more cash infusions like that, because there is little cash to be found here.
i've been mentioning petrodollars since reading some fine private research early this year.
i recently read a very interesting paper that addressed the mechanics of low interest rates -- why they are low and have stayed low, why volatility is low -- in an effort to give insight on an eventual rise. it maintained convincingly that oil money -- cash paid by the west for oil -- has been returning to western economies directly (from the mideast and russia) and indirectly (from asian central banks) as asset purchasing power, particularly the purchasing of treasury debt and the aforementioned cdo's. as oil prices have risen -- tripling since 2003 -- the windfall has ever more aggressively been reinvested to keep rates down in spite of heated economic growth and the rising threat of inflation that has seen the federal reserve bank raise interest rates 13 consecutive times (inverting the yield curve). this amounts to literal billions flowing into western capital markets annually since 2003 -- enough to also reflate global capital markets post 2001-2, narrowing credit spreads and risk premia (i.e., boosting stock markets) because oil money tends to be riskier capital. the similarity is to the 1970s, except that whereas oil savings influx abetted wage inflation (the 'real' economy) then it abets asset inflation (the financial economy) now -- a product of our structural development from an industiral to a service economy.
on this view, the rise in global oil prices amounts to a massive wealth transfer from oil importers to oil exporters -- the asset value of oil in the ground has risen by a nominal $50bn. that wealth transfer requires a corresponding markdown on western balance sheets -- one that in the 1970s was facilitated by inflation destroying the value of western assets in real terms even as they held steady in nominal terms. in this incarnation, however, not only has the markdown not yet come -- it has been preceded by a period of interest rates suppressed by recycled petrodollar income which has encouraged a massive debt buildup that will because of the level of debt involved quite possibly require a severe debt-deflation depression to correct. even if it does not -- for, say, western monetary policy reasons -- the resultant avenue of correction will be runaway inflation. either way, a large expansion of risk premia is due -- either way, credit spreads and real interest rates will increase dramatically.
this correction is to be expected once the asset-burgeoning effects of oil revenue investment inflows recede. this can result from either a collapse in oil revenue reinvestments (oil price collapse, greater spending than saving in oil exporting economies) or in a forced delevering of petrodollars removing the amplification of purchasing power (as was engineered in 1981 by fed chairman paul volcker -- this latter may now require a broader view of inflation than the fed now takes, one which includes energy and asset prices). but the telltale indication is likely to arrive in expanding credit spreads, which have remained narrow in spite of yield curve inversion thanks to the abundant liquidity of petrodollar recycling.
of course that petrodollar put has accelerated as oil has teased $100/bbl, but the wealth transfer to third-world economies that have been engaging in 'vendor financing' is now, having decided to no longer fuel the incredible bubble in american mortgage debt market, buying american banks and will probably be buying hard assets of all kinds in coming years. (and, lo, credit spreads have indeed widened dramatically!) said minyan peter, the sort of bid that went into citi is sign of the early stage of the game that we are condemned to play by our own profligacy.
and, as noted, we need the money very badly indeed and should welcome it as the necessary recapitalization of the financial system it represents. hope for more, and quickly! as can be seen through big picture and the new york times, bank capital inadequacy is having massive ramifications already.
Credit flowing to American companies is drying up at a pace not seen in decades, threatening the creation of jobs and the expansion of businesses, while intensifying worries that the economy may be headed for recession.
Not once in the years since the Fed began tracking such numbers in 1973 has this artery of finance constricted so rapidly. Smaller declines preceded three recessions going back to 1975; at other times such declines tended to occur in conjunction with an economic downturn.
the situation is looking bleaker for many businesses. Already, companies in everything from furniture manufacturing to Web site design are tightening their belts, delaying expansion and scrambling for other sources of cash.
“This is a very big deal,” said Andrew Tilton, a senior economist in the United States Economic Research Group at Goldman Sachs. “You’re basically crimping the growth of the more vulnerable companies. If they can’t borrow the money, their options are much more limited. They’d have to have less ambitious hiring plans, buy less machinery and cancel projects.”
In recent years, a lot of commercial lending was inspired by an upward spiral of enrichment: banks made new loans, then swiftly sold them off for profit, using the proceeds to extend still more. But with much of the financial world unnerved by the mortgage meltdown, buyers for commercial loans are scarce.
“Since the resale market went away, major banks have had much less availability to make loans,” said Mark A. Sunshine, president of First Capital, a private commercial lender. “Absolutely, credit is much less available.”
the question is: will foreign entities (such as sovereign wealth funds) offer enough cash, soon enough, to prevent the disorderly collapse of the american economy into a debt-deflation spiral of rampant credit contraction -- one that will likely drive off further bids and recapitalizations? or could they?
i frankly doubt it. from brad setser -- appropriately called "scary graph" -- it's clear from recent TIC data that despite anecdotal instances like abu dhabi's investment, global capital is generally beginning to flee the united states for the first time in more than a decade.
mish again, noting the horrifying pressure building up in the international banking system as exemplified by libor spreads, and passing on this wise quote from fil zucchi of minyanville in december of 2006 with his own comment appended.
As central banks rain liquidity (credit) down on markets, its long range effects eventually cause the very thing central banks are trying to avoid: deflation. The reason people don’t understand this is that it is cumulative; the accumulation of debt is in itself inflationary, but at a certain point it becomes unmanageable. Why is this?
Easy or free money (when central banks drive real interest rates below inflation rates) is irresistible. It wouldn’t be if people managed risk properly but they do not. Easy money causes competition for “projects” to increase; companies with free money take risk with it for less and less return. I am seeing deals getting done in LBO-land and commercial real estate being built using very aggressive assumptions and low cap rates. With all that “money” out there, rates of return drops dramatically. Everyone is starved for income.
At the very time income and returns are dropping, debt is increasing. Less income with more debt means that eventually it gets impossible to service that debt.
Well here we are. It has become impossible to service that debt. Massively rising foreclosures in the residential sector should be proof enough. And the downturn in commercial real estate has just started. Bank capital is severely impacted already and supposedly we are not even in a recession yet. We soon will be and watch what happens to unemployment rates and additional credit impairments when we do.
The problems are now so huge that it does not matter what the Fed does with interest rates. Asset prices are dropping like a rock even though the stock market has not yet gone down for the count. With the enormous leverage in the system, credit and capital is being destroyed at a very fast clip and it will be destroyed at an even faster clip once the stock market and corporate bond market head south in a major way. Both will.
A key point in this mess is that the Fed cannot provide capital (drop money out of helicopters), all it can do is provide liquidity. However, liquidity is not the problem here, solvency is.
again, i have the distinct impression that what is transpiring here is more than a slowdown, and probably more than a run-of-the-mill, 1990-style recession. it's a good time to get out of debt and hoard your cash, being very particular about the assets you choose to own.
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the paulson mortgage rate freeze
this bit i found to be particularly priceless:
Officials in Washington have been cautious about steps that would be seen as rescuing borrowers, lenders and investors from the consequences of their own bad decisions. That is why few are suggesting direct support for borrowers who can't afford their loans. Mr. Paulson has decided his best option is to prod the markets to sort matters out themselves, as long as companies bear in mind the public interest in keeping people in their homes. "There's not some silver-bullet piece of legislation out there," a senior Treasury official said.
that's how this administration cloaks a wholesale government intervention into the world's largest debt market!
this is a play out of the schwartzenegger playbook, and (as noted by calculated risk) what was said then applies.
it must be said that this amounts to price controls -- and when in the history of mankind have price controls worked to solve any economic problem? the likely result, as pointed out by mish, is to aggravate the problem -- people will be trapped in homes with mortgage notes that are vastly larger than the liquidation value of the house, as prices continue to decline and the payments that are being made on the note cannot significantly mitigate the principal (in fact in many cases actually grow the principal). on the whole, the vast majority of people now in the situation that california is trying to address are catagorically better off walking away from their houses today.
from the lender side, the invaluable tanta contextualizes why paulson and schwartzenegger are getting any traction with these proposals -- the expectation of a tacit government bailout to make this arrangement profitable, or at least more profitable than the extant alternatives.
kevin depew and scott reamer correctly note that it is a game to shift more of the losses at least temporarily onto investors while awaiting the eventual bailout.
Basically, the plan reduces the number of people being screwed. See, there's no free lunch on Wall Street (except for those banks and lenders in bed with the government cartel, the banks in the Fed system), so somebody has to get screwed, it's just a matter of determining which category of victims makes the most expedient category to screw.
Of course, keeping people in their homes sounds like a great idea, but just as there's no free lunch for most investors, there is no free lunch for those who are willing to sacrifice property rights for the greater good. Minyanville Professor Scott Reamer notes, "The idea of property rights for creditors is something no one thinks of, no one. Essentially, creditors are allowed to plunder a little for a long time, thanks to the inflation of credit, then occasionally the government steps in and says, 'Sorry, boys, gotta screw you, but don't worry, you'll make it up on the back end,' which is basically what the Savings & Loan crisis was all about."
not a solution, but a significant step, according to no less a bear than nouriel roubini. i must ruefully admit that it will in the short run and temporarily keep some people in homes that would otherwise go to foreclosure, end up as bank REO on the market and depress prices as aggressively-marked additional supply. to that end, it works against me as a renter who has tried to manage my finances responsibly and wait out the unwind.
but that's american government, indeed american society in a nutshell: do what feels good now, and fuck the responsible ones to do it.
why the monoline defaults are even more serious than they seem
but what i may not have said is why those troubles are coming at the worst possible time for muni bond investors: the financial surity of municipalities and local governments is being overthrown by the collapse in housing.
Treasurer's offices all over the country are bracing for the day when lenders stop paying the taxes on many properties in the worst hit neighborhoods.
Many houses in Cleveland's central city neighborhoods have been so damaged by looting, fires and weather that they are almost total losses. The lenders will eventually walk away from them.
"The lenders will come to us and say, 'We just can't hold the properties any longer. We don't want to pay the demolition costs. Here's the property,' " said Jim Rokakis, Treasurer of Cuyahoga County, which includes Cleveland, one of the cities hardest hit by foreclosures
The trend will not be confined to Midwestern cities like Cleveland, where the local economies have been clobbered by manufacturing job losses.
Many Sun-Belt cities now rank high on the list of foreclosures, especially in California. In a report released this week, the United States Conference of Mayors forecast a reduction in property tax collections in California of nearly $3 billion for 2008.
"Across the country, there has been a boom in property tax volume growth. That's going to stop," said Jim Diffley, the Global Insight economist who put together the analysis for the Mayor's Conference.
it will not only stop; it will reverse hard.
a lot of the borrowings conducted by local government in the recent years of supremely easy credit were predicated on very low intermediate-term interest rates and revenue projections which will now not be met. therefore, the probability of default in these local bond issues has jumped exponentially as terms of credit tighten and houses both fail to sell (and generate transfer tax revenue) and fall into foreclosure (cutting off property tax revenue) at unprecedented rates. at the same time, sales tax revenues are falling sharply -- particularly in states most heavily affected with housing problems, as the credit contraction now starts to compress consumer spending. worse still, many municipalities have or will soon run into the problem now being manifested in florida, where a not-insignificant amount of cash is part of the $900bn locked in frozen asset-backed commercial paper and cannot be redeemed.
as a result, one should expect municipal bonds to become a much more tumultuous field of play in the coming year. and, as previously noted, munis -- alongside the instruments of fannie mae and freddie mac -- underlie a lot of cash-proxy money market funds, pension funds, insurers and commercial bank holdings.
Thursday, November 29, 2007
that's why we're long!
The Standard & Poor's 500 Index added 40.79, or 2.9 percent, to 1,469.02, bringing its two-day gain to 4.4 percent, the most since October 2002. The Dow Jones Industrial Average increased 331.01, or 2.6 percent, to 13,289.45, its best daily advance since April 2003. The Nasdaq Composite gained 82.11 to 2,662.91. More than 13 stocks rose for every one that fell on the New York Stock Exchange.
if history provides context, there's probably significant upside still to come. might not be out of the woods in bottom building, though. possibly a near-term return to at least fill the s&p gap at 1430 created by yesterday's opening gap up. and, as barry ritholtz points out, it might pay to be quick to cash.
Since the decline that began on October 30th, the S&P 500 had gone 19 days without having more than one winning session in a row.
• The longest such streak (since 1999) was the 24-day run that ended on 9/21/01. The second longest streak was 22 days, which ended on 3/21/01. There have been two other streaks of 21 days each, ending on 10/3/00 and 4/29/02, respectively.
• Except for the post 9/11 streak, which marked a climactic V-bottom low in the equity market, other spans seemed to define the first leg of a downdraft that "paused" for anywhere between 4 and 14 days before it resumed.
• Visually speaking, the pattern that developed when those prior one-day-wonder streaks ended was a "flag," which in technical analysis terms, often implies that a move -- in this case, the downtrend -- is about half-way over.
• For what it's worth, the same also holds true for the two shorter streaks of 16 days that ended on 1/28/03 and 4/1/05, respectively.
• Based on past history, then, it seems that once the current streak ends ( i.e., we see two or more winning sessions in a row), the risk is that it won't be long before the market begins another push lower.
with that number of data points, the evidence is merely anecdotal. but the probabilities have to be well considered.
as an adjunct, dr. steenbarger with a brusque post that needs to be brusque in order to cut through the cloud of delusion that is constantly attempting to descend on any human being engaged in the exercize of risk taking. i have managed to utter some variation of all seven at some point or another, and will again. hopefully, and maybe be remembering or rereading this, the next time i do i'll cut it off short.
Tuesday, November 27, 2007
goldman gets bearish
Home prices are also likely to decline substantially. If the economy narrowly escapes a full-blown recession—as we continue to expect in our baseline forecast—a peak-to-trough decline of 15% in house prices is the most likely outcome. This would imply price declines in states such as Florida of up to 30%. If the economy does enter a recession, prices could decline as much as 30% nationwide.
The basic problem is that house price declines create large amounts of negative equity. Homeowners with negative equity lose their ability to respond to adverse financial events such as job loss or mortgage reset by refinancing or selling their home, and they therefore become much more likely to default. The importance of this problem is illustrated in Exhibit 16, which shows the distribution of home equity among US mortgage holders at the end of 2006 according to an analysis by First American CoreLogic, Inc. About 7% of US mortgage holders had negative equity at that point, and another 14% had equity of less than 15%. Thus, 21% of all mortgage holders—holding about $3 trillion in aggregate mortgage debt given the average mortgage debt held by the vulnerable borrowers—would be put into a negative-equity position if home prices fell by 15%.
note that december 2006 data has already been altered by nationwide price declines in the area of 5%. something more than 1 in 10 american homeowners today are already upside down in their mortgages -- and most of them, i'll wager, are staring monster rate resets dead in the eye.
they avoid the r-word, but recession is implied all over the report.
giuliani's pet pedophile
Since 2002, Msgr. Alan Placa has worked for Rudy Giuliani as a consultant at Giuliani Partners. In 2003 a grand jury report of Suffolk County, NY, accused Placa of sexually abusing multiple victims.
A spokeswoman for Giuliani Partners told Salon Magazine that the former New York City mayor believes Placa was "unjustly accused." The grand jury report contains accusations from three alleged victims, including two children (Placa is named as "Priest F" in the report.) According to testimony before the grand jury, "Everyone in the school knew to stay away from Priest F."
Placa has been suspended from his priestly duties for the past five years...
One simple question: why has the press not pursued this story more aggressively? Nothing quite highlights Giuliani's blindness toward friends and cronies like this story. That Giuliani is still paying the guy a salary long after these serious accusations became public boggles the mind. It speaks to an arrogance, flawed judgment and personal contempt for the law that should disqualify Giuliani from any serious aspiration to the presidency.
consider as well, beyond the sheer narcissism and unbridled megalomania that is the central feature of giuliani's public persona, the fact that he has retained norm podhoretz as his foreign policy advisor.
would it come to pass -- though it appears unlikely at this moment -- giuliani's election would be a signal event in the history of the united states, much as the elevation of nero following tiberius and caligula indicates convincingly the depth of the social sickness in ancient rome at that time which would later become so much worse. (which is certainly not to say electing hillary clinton absolves the united states of such political and social health issues!) as it is, his likely nomination to the republican candidacy -- he leads the iowa electronic market handily -- shines like a beacon of depravity for that political party. it may well in fact mark the historical moral low point for the GOP since its foundation in 1854.
Monday, November 26, 2007
citi raises $7.5bn at punitive terms
Citigroup Inc., the U.S. bank searching for a new chief executive as it faces at least $8 billion of writedowns, agreed to sell as much as 4.9 percent of the company to the government of Abu Dhabi for $7.5 billion.
Citigroup will sell equity units to the Abu Dhabi Investment Authority that convert into common shares, the New York-based lender said today in a press release.
``This investment, from one of the world's leading and most sophisticated equity investors, provides further capital to allow Citi to pursue attractive opportunities to grow its business,'' Win Bischoff, Citigroup's acting CEO, said in the statement. It helps ``strengthen our capital base,'' he said.
ADIA, the sovereign wealth fund of the government of Abu Dhabi, is buying equity units that convert into Citigroup shares at prices ranging from $31.83 to $37.24 per share, on dates ranging from March 15, 2010, to Sept. 15, 2011, the U.S. bank said. The units will pay 11 percent annual interest.
ELEVEN PERCENT! that, folks, is the price of total desperation. citi certainly knows it is facing insolvency if it agrees to take on a deal like this.
the difficult part ot imagine is that this is probably the first of many bank recapitalizations, and has the virtue of being among the first. later infusions may come at even more punitive rates.
the initial reaction -- shares jump, treasuries slide. this is an oversold market looking for a catalyst, and it may have just found one.
UPDATE: meredith whitney of cibc commented interestingly on citi this morning on bloomberg television, noting among other things that 1) this is less than a quarter of the capital she believes citi must raise; 2) eliminating the dividend -- a certainty in her view -- brings in just $4bn a year; 3) citi is therefore still faced with the probability of asset sales; 4) most importantly, while citi cannot sell CDOs or RMBS in much quantity into these markets, it cannot improve its risk-weighted tier one capital ratio by selling treasuries and agency debt. this last is because of the risk weighting of the calculation -- divesting itself of the safest securities in its portfolio makes the remaining portfolio riskier, thereby requiring greater capital reserves to be held against it. such is citi's situation that the equity raised by selling treasuries wouldn't be sufficient to cover the increased reserve requirements! citi is thus still looking at having to sell well over $100 billion in assets including other, somewhat risker but still desirable assets -- such as credit card receivables -- in order to repair its tier one capital ratio even after ADIA's stake purchase.
UPDATE: wise words from minyan peter.
reeking of desperation
how hard is it to stay long this disaster? when you've my natural disposition, VERY. but the exercize is proving fruitful insofaras i am compelled to make and remake the bullish case against my nature, and nothing represents a greater triumph of self-control than to be able to do so competently.
i've already taken arguments about new lows and isee sentiment in my favor. now i'm going to lay claim to the ten-year treasury rate of change.
most equity investors know anything at all about treasury bonds only insofaras they represent the "flight to safety" -- when stocks dive, treasuries rally. is that true now?
in the last twelve sessions, the ten-year yield has collapsed 11.24% -- a tremendous move that relates more to the panic surrounding credit markets and the economic outlook than to any equity market event. but the only other occasions of this size of downdraft (going back to 1962) are notable:
- may 20-23, 2003 -- emerging from the 2002-3 triple bottom, from may 20 to june 17 the s&p 500 jumped 10% with no appreciable downdraft.
- october 1-5, 1998 -- the bottom of the 1998 ltcm collapse -- from october 5 to november 27, the s&p climbed 20.6% after a three-day downdraft of less than 3%.
- october 30 - november 4, 1987 -- the crash of 1987 -- by october 30, the s&p had bounced 16% from the october 19 low, and the index fell 13% to retest that low going into december and then advance another 16% to new highs in january 1988.
- october 12-14, 1982 -- the 1982 low was seen in august, and this point followed a very sharp rally off that low. the market went on to advance another 6.4% by november 9 with no downdraft.
- november 9-18, 1981 -- a rally in the 1980-1982 bear -- the s&p advanced 5.0% from november 18 to december 4. no downdraft.
- april 16-22, 1980 -- following a deep downturn in 1q1980, the s&p rallied straight up over 13% from mid-april to mid-june, and kept headed higher after that.
- november 23, 1970 -- the rally marking the end of the 1968-70 bear had begun in may -- the subsequent rally in the s&p ran to february 16 and totaled 17.1%.
other points which might be considered close-but-no-cigar, most of which were also really good equity buy points:
- september 24 - october 3, 2003
- september 23-30, 2002
- october 2, 2001
- december 26, 2000
- june 6, 1995
- june 26, 1986
- march 3-13, 1986
- june 5, 1985
- january 5, 1981
- march 23, 1971
- october 23, 1969
- december 20, 1966
3q profit growth officially negative
David stresses that profits drive the business cycle -- capital spending and employment feed off them. And he sighs: "It has always been thus." Hence, he's ineluctably forced to the conclusion that a recession in the economy "is either here or no more than two quarters away." And he goes on to note the last two times corporate earnings skidded to a comparable extent into negative terrain were in the fourth quarters of 1989 and 2000 (both instances, we might add, proved the beginnings or a prelude to something ugly in the stock market as well as the overall economy).
There's a tendency, David notes, especially prevalent among the considerable number of die-hard optimists, "to strip financial-related earnings out of the pie" because financials now account for 30% of corporate profits and crow about how good everything else is. Well, everything else isn't so hot and, as David observes, "stripping out financials is like stripping out California, Florida, New York and Texas from GDP."
i've mentioned the trend in profit growth before, indeed as early as february. and i noted the breadth of listlessness in consumer stock sectors here.
i'm certainly long for a trade, but in the larger frame it's time to batten down the hatches for the recession (or is it more?) of 2008. (though many disagree.)
i tend to think that we're in the early stages of something bigger. consider: the united states fell into a period of panics, depression and valuation compression from 1929 to 1949, then again from 1968 to 1982. these were not the first such periods -- consider the 1770s and 1780s, 1819-1848 and 1869-1896 -- but they are the ones most easily researched. each of these depressed periods began with a massive speculative credit bubble that was subsequently unwound, with credit destruction breeding a pessimism eventually so dominating in capital markets that broad-based stock indexes could be bought for something like 12x-to-15x dividends (not earnings) or less. the current s&p 500 is valued at something like 50x dividends, near the most expensive levels in history.
the point is less to forecast such a period than to understand that such periods do occur and will in every probability occur again. moreover, the catalyst for such a period is in place.
Wednesday, November 21, 2007
the case for holding on
but there's Real Fear out there right now. to wit:
And what's interesting is that looking forward 90 days, traders are as fearful now as they have been at any time all year. All of the last five years in fact. Converting to SPX options, this particular measure has not been this high since 2002.
I hit up volatility charts for 30 Day, 60 Day and 180 day readings going back 10 years, and no matter which one you look at, the story is similar. We are very near five year highs. The 30 and 60 day numbers were a bit higher in August, but other than that, we have not seen these levels since 2002.
something else to note about volatility -- VXO is making lower highs as the market makes lower prices, and that is a good sign. other examples include march 2007, october 2005, october 2004, august 2004 (indeed, from a larger perspective, the entire 2004 decline from february to october), february/march 2003 (and indeed the whole triple-bottom set from october 2002 to march 2003), february 2003, march 2001, december 2000, may 2000... anyway.
and the isee:
The ISEE’s close of 68 on Friday was the seventh lowest end of day reading in the index during the five years for which data is available.
or, in more detail:
Data from the International Securities Exchange, or ISE, also began to show signs that complacency may be breaking down. As I noted last week, the all- securities call/put ratio at the ISE hit 67.85 on Friday (November 16). Readings as low as this are pretty uncommon – counting this latest one, there have been 22 going back to the beginning of 2006. And many of these readings have occurred in clusters.
My colleagues, Bob Becks and Joseph W. Sunderman, took a look at the implications of a low ISEE call/put ratio (below 90). In their quantitative study, they eliminated signals that occurred within 20 days of the first signal, due to the tendency of these extremely low call/put ratios to occur in clusters. That leaves a total of seven unique signals. Ten trading days after these signals, the SPY has been positive 86% of the time with an average gain of 1.1%. Thirty days out, the SPY was positive 100% of the time, with the average return being 3.2%. The 90-days period following such a signal is really impressive. The SPY was in the black 100% of the time with an average return of 9.1%. Unless we're transitioning to a bear market, which I highly doubt, this study suggests that it's a good time to be long the market, no matter how gut-wrenching it may be on a day-to-day basis.
and of course there is the 20-day new lows, which have continued to make lower highs in the s&p 500 even as the index price has ticked lower and as 65-day new lows have grown. dr. brett steenbarger has been following along:
Going back to September, 2002, which is when I first began collecting the data on 65-day new highs and lows, we've had only 22 occasions in which those new lows [across all exchanges] have exceeded 1500. Forty days later, the S&P 500 Index (SPY) was up every single time, by an average of 5.33%. That is much stronger than the average 40-day gain of 1.83% (845 up, 398 down) for the remainder of the sample. The bear case is that this time is different, owing to dynamics of housing, credit, etc. If that's the case, we should see new lows expand from here and beyond the levels registered in August of this year. The bull case rests on a drying up of new lows and then an expansion of new highs going forward. I'll be tracking that measure closely.
there's a battle on today -- the day before thanksgiving, the most bullish day of the year historically -- to again defend s&p 1425, a price level critical to the august bottom. below that is the 1410 level, and the last-ditch defense of 1378.
some new ideas for me to research -- herding sentiment and buy/sell climaxes.
UPDATE: a new low in this leg down to s&p 1416 today with vicious closing action -- but we finally get a nonconfirm from 65-day new lows to pair with our now-weeks-old tapering of 20-day new lows and nh-nl.
it may not turn up right now, and there could be more downside, but chances are that the vast bulk of the losses are behind. i was early to the long side, but i think it would be very dangerous to short here.
another notable bit of action -- just 5 of the nasdaq 100 closed over their 30-day moving average. the last time that was true: august 6, 2004. before that: september 17-26, 2001 -- the september 11 reaction low. before that: august 28-september 2, 1998 -- the long-term capital management crisis low. before that: july 11-17, 1996.
these were spectacular buying points. from 8/12/4, the ndx climbed trough-to-peak over 20% in the following four months. following the 9/26/1 low, the ndx climbed 45% in less than three months. from the 8/31/98 low, the ndx jumped 20% in just 16 trading sessions. from the hammer low of 7/16/96, the ndx jumped 17% is less than a month (and jumped 45% over seven months). so there might be a few more days of pain ahead -- but on the other side is likely a sharp rally.
scope of the housing disaster finally begins to dawn on government officials
In an interview, [Treasury Secretary] Mr. Paulson said the number of potential home-loan defaults "will be significantly bigger" in 2008 than in 2007. He said he is "aggressively encouraging" the mortgage-service industry -- which collects loan payments from borrowers -- to develop criteria that would enable large groups of borrowers who might default on their payments to qualify for loans with better terms.
"We're never going to be able to process the number of workouts and modifications that are going to be necessary doing it just sort of one-off," Mr. Paulson said. "I've talked to enough people now to know there's no way that's going to work."
the california state government is taking the lead:
Gov. Arnold Schwarzenegger announced a deal Tuesday with four mortgage lenders to freeze adjustable interest rates for some of the state's highest-risk borrowers.
but it must be said that this amounts to price controls -- and when in the history of mankind have price controls worked to solve any economic problem? the likely result, as pointed out by mish, is to aggravate the problem -- people will be trapped in homes with mortgage notes that are vastly larger than the liquidation value of the house, as prices continue to decline and the payments that are being made on the note cannot significantly mitigate the principal (in fact in many cases actually grow the principal). on the whole, the vast majority of people now in the situation that california is trying to address are catagorically better off walking away from their houses today.
from the lender side, the invaluable tanta contextualizes why paulson and schwartzenegger are getting any traction with these proposals -- the expectation of a tacit government bailout to make this arrangement profitable, or at least more profitable than the extant alternatives.
[W]hy have mortgage lenders worked out troubled loans ever since the dawn of mortgage lending? Because lenders do what lenders do: seek maximum profits. If a loan was supposed to earn you a dollar, but isn't earning you anything because the borrower is not paying, and you have the choice of restructuring, and getting, say, 90 cents, or foreclosing, and getting, say, 70 cents, you restructure.
... That requires people with skills. Enough people with skills to look at a lot of delinquent or about-to-be deliquent loans fast enough to not miss your window of opportunity on that 90 cents. ...
The industry is telling you right now that they just don't have enough people with the right skills to be able to wade through all the problem (or potential problem) loans fast enough to make the workout/foreclose decision. ...
This means that the industry cannot do what it needs to do to defend itself. It will continue to take 70 cents instead of 90 cents, because it does not have the resources to commit to this problem, or because if it did commit those resources, the extra cost of staffing up and training and recruiting and so on would make the 90 cents scenario no longer achievable. Eventually the recoveries either converge--it's just as expensive to work out as it is to foreclose--or they don't, but only because the RE market is diving faster than salaries for workout specialists are improving, so that you end up with the choice of 70 cents or 50 cents, then the choice of 50 cents or 30 cents, down to wherever this has to go to sort itself out. Equilibrium in the housing market or servicer bankruptcy, whichever comes first.
Concrete bennies have to be put on the table. Regulatory relief. Fun with reserve and capital calculations. Approval of mergers and acquisitions. You know the drill. This is about maximizing profit. You are going to have to do something that makes this profitable, if you're going to expect lenders to do it on a large scale. Your job, of course, will be to write the PR that says that all this "regulatory relief" to for-profit banks and mortgage companies is all about Helping the Poor and being Heroes to Homeowners. I suspect you're up to that task. There is no shortage of PR-writers in this administration.
... [I]t does seem like you might want to be kind of cautious about how many goodies you put on the regulatory table in order to get the lenders to play ball. I for one am not sure you can afford to cover all the checks your mouth is writing any more than the lenders can. It sounds to me like you probably need to hire a bunch of regulatory relief workout specialists who can put some dollars and cents on your options here.
this paper further outlines the certain costs and uncertain benefits of loan modifications.
Tuesday, November 20, 2007
ACA capital on the ropes
ACA has long been a convenient dumping ground in which major subprime securitizers like Bear Stearns (BSC), Citigroup (C), Merrill Lynch (MER) and some 25 other prominent dealers could pitch billions of dollars of risky obligations for modest premiums. That let them gussy up their balance sheets and shift any potential mark-to-market hits to ACA.
If ACA Capital were to founder, more than $69 billion worth of CDOs, including the $25 billion in subprime paper, would come rumbling back to the Wall Street banks, and likely with heavy attendant losses.
That's why Wall Street has continued to do a brisk business with the beleaguered firm. In the third quarter, ACA insured some $7 billion of subprime collateralized-debt obligations. Even if the company survives for only another couple of quarters, that would stave off the recognition of billions of dollars of losses.
more on the knock-on effects...
freddie mac -- what a cockup the financials are in!
it's also becoming clear that the problems in the banking and financial system as a result of the housing situation are incredibly serious. the two government-sponsored agencies charged with providing liquidity to the mortgage markets -- fannie mae and freddie mac -- have seen their stock destroyed in the last six weeks. they are both making new lows today in tandem on the backs of news that freddie lost $2bn in 3q; took an $8bn hit to its equity between the loss, credit writedowns and additional loss reserving; is seeking to raise capital; and will likely cut its dividend as it seeks a way to repair its bloated balance sheet.
freddie and fannie are bumping into reserve rule limits, meaning that they will have to devote income not to purchasing more mortgages or to paying dividends but to repairing their own balance sheet. the GSEs have been the buyer of last resort in the mortgage market, and with their pace of acquisition now set to slow we can expect to see higher interest rates for mortgages across the board, even tighter lending standards, and therefore even slower year-over-year home sales.
and it is all presaging the troubles yet to be admitted by wall street banks. per a commenter at calculated risk:
I listened to the conference call - Freddie's auditors require them to call the street and get quotes on their loans and securities for pricing purposes. Under this approach, Freddie took horrific credit losses in the third quarter. Freddie is close to Lehman and Goldman which is why they have been retained to raise capital. So, the question was asked if the street (persumably Lehman and Goldman) are using the same marks to value their own positions. Remember that Lehman and Goldman gave Freddie the disasterous levels but their portfolios show no such losses. The question got a nervous laugh followed by a "we are not going there" response.
jim rogers says the decline in fannie and freddie is still in its early stages, particularly fannie. mish thinks the same way i do:
"We have begun raising prices, tightened our credit standards and enhanced our risk management practices," Piszel said. "We also continue to improve our internal controls."
My Comment: Raising prices huh? We finally have explicit confirmation of what I have been saying for a long time: Mortgage rates are going to disconnect from 10-year treasuries over default concerns. We can now add capital impairment as a reason for further disconnect.
the most direct potential consequence of a slowdown in GSE purchasing, though, is the threat to countrywide financial. cfc's business model used to consist of using borrowed money to make questionable loans and sell them on to private investors; the credit crunch reduced it to using borrowed money to make prime conforming loans and selling them on to the GSEs. if that dries up materially, countrywide is done. its credit default swaps skyrocketed on the news.
Monday, November 19, 2007
An ambulance rushing a heart attack victim to Detroit from a Windsor hospital ill-equipped to perform life-saving surgery was stopped for secondary inspection Monday by U.S. Customs, despite the fact it carried a man fighting for his life.
Rick Laporte, 49 -- who twice had been brought back to life with defibrillators -- was being rushed across the border when a U.S. border guard ignored protocol at the Detroit portion of the tunnel and forced the ambulance -- with siren and lights flashing -- to pull over.
U.S. Customs officers at the secondary inspection site told the ambulance driver to go inside the office to produce identification, said a frustrated Larry Amlin, of Windsor Essex EMS.
Other guards told the paramedic crew to open the back doors of the ambulance, then asked Laporte to verbally confirm his identify, said Lauzon.
further note that the ambulance had a canadian police escort! someone working customs has clearly been watching too much television.
but what is particularly revolting is that this state of abject, quasi-psychotic paranoia is becoming in many eyes the identifying trait of the united states as a place, as an institution, perhaps even as a people -- and (insane anecdotal incidents aside) not without reason.
[B]etween 2000 and 2006, the number of Britons visiting America declined by 11 percent. In that same period British travel to India went up 102 percent, to New Zealand 106 percent, to Turkey 82 percent and to the Caribbean 31 percent. If you're wondering why, read the polls or any travelogue on a British Web site. They are filled with horror stories about the inconvenience and indignity of traveling to America.
and here we're talking about the british -- not only our closest cultural kin but no strangers to the haze of statehouse bullshit themselves. imagine what it must be like to contemplate a trip to the united states if you are a self-respecting and decent pakistani.
the united states has been degenerating in social terms for decades already along with much of the western world. after september 11, 2001, however, the pace of the collapse took on a new earnestness and became deeply tainted by a fear borne of heartwrenching ignorance. i have sincerely waited on the oft-praised decency and sensibility of my fellow americans to belatedly reverse the excesses of the black spiral of fear, hostility and self-defeat since that day -- and have yet to be rewarded. one wonders if it hasn't already begun to feed on itself irretrievably, exploiting the cultural naivite and insecurity that has long been seen to be both a strength and a weakness of america.
the fed in denial
Looking back at the evolution of monetary and financial affairs over the past century shows that policy frameworks have had to be adjusted when they failed to cope with the emergence of a significant problem. The new framework then is pushed to its limits, resulting in a new economic problem. The lightly regulated framework of the first two decades of the 20th century was discredited by the Depression and was replaced by a heavily regulated one accompanied by discretionary fiscal and monetary policy. This in turn was discredited by the great inflation of the 1970s and was replaced by a lightly regulated one with greater emphasis on medium-term anti-inflationary monetary policy. This has acquitted itself well over the past 15 years and is still working effectively, but over the next decade or two will probably face the type of challenges I have outlined.
No one is very good at picking the next major epoch, and we mainly react after the damage has been done. I am influenced by the fact that as the great inflation of the 1970s was building from the mid-1960s, no one, including the central bank, had a mandate to prevent it. As we struggled to come to grips with it, governments made decisions that effectively gave the central bank a mandate, and central banks worked out a framework that to date has been effective in dealing with it. No one has a clear mandate at the moment to deal with the threat of major financial instability, but I cannot help but feel that the threat from that source is greater than the threat from inflation, deflation, the balance of payments and the other familiar economic variables we have confronted in the past.
Friday, November 16, 2007
goldman's economic call -- the great depression?
The slump in global credit markets may force banks, brokerages and hedge funds to cut lending by $2 trillion and trigger a ``substantial recession'' in the U.S., according to Goldman Sachs Group Inc.
Losses related to record home foreclosures using a ``back- of-the-envelope'' calculation may be as high as $400 billion for financial companies, Jan Hatzius, chief U.S. economist at Goldman in New York wrote in a report dated yesterday. The effects may be amplified tenfold as companies that borrowed to finance their investments scale back lending, the report said.
``The likely mortgage credit losses pose a significantly bigger macroeconomic risk than generally recognized,'' Hatzius wrote. ``It is easy to see how such a shock could produce a substantial recession'' or ``a long period of very sluggish growth,'' he wrote.
Goldman's forecast reduction in lending is equivalent to 7 percent of total U.S. household, corporate and government debt, hurting an economy already beset by the slowing housing market. Wells Fargo & Co. Chief Executive Officer John Stumpf said yesterday that the property market is the worst since the Great Depression.
Hatzius said his report is based on a ``conservative estimate'' of financial companies cutting lending by 10 times the loss to their capital. Investors realizing half of the potential losses, at $200 billion, would have to scale back lending by $2 trillion, he said.
``The response to those kinds of risks is to lower interest rates, and we think the Fed will lower interest rates,'' Hatzius said in an interview today. Goldman predicts a quarter-point cut when the Fed meets on Dec. 11.
If Goldman's forecast reduction in lending occurs over a single year, the U.S. economy could fall into recession, Hatzius wrote. The drop in lending over two to four years would probably result in ``very sluggish growth,'' he said.
Deutsche Bank AG, Germany's biggest bank, also said in a report this week that credit losses may be $400 billion. That's equivalent to ``one bad day in the stock market,'' or 2.5 percent of the value of U.S. equities, Hatzius wrote.
``No serious analyst would argue that a 2.5 percent equity market decline will make an important difference to the economic outlook,'' Hatzius wrote. ``So what's different about the mortgage credit losses? In a word, leverage.''
a lot of people have missed the point entirely on the housing problem by looking at the potential loan losses, comparing them to the size of the economy and concluding that there is no problem. what makes the housing decline so disastrous is the borrowing that is predicated on the loans -- the leverage in the system that is anchored to housing is the proverbial onion, with layer upon layer all facing an unexpected unwind.
hatzius is being generous at $2tn -- i would expect considerably more credit contraction than that, in the area of $5tn or more IF the system remains stable and no major banks or GSEs fail outright.
that would be something on the order of 10% of the american credit/money supply pie.
for context, in the great depression, monetary measures like m2 collapsed in excess of 30%. there is a question here of how bad this could be. this overview of the great depression expounds on the credit theory of the depression, which is that explored by irving fisher in his seminal 1933 "debt-deflation theory of great depressions" and furthered by ben bernanke in 1983.
Bernanke (1983) argues that the monetary hypothesis: (i) is not a complete explanation of the link between the financial sector and aggregate output in the 1930s; (ii) does not explain how it was that decreases in the money supply caused output to keep falling over many years, especially since it is widely believed that changes in the money supply only change prices and other nominal economic values in the long run, not real economic values like output ; and (iii) is quantitatively insufficient to explain the depth of the decline in output. Bernanke (1983) not only resurrected and sharpened Fisher’s (1933) debt deflation hypothesis, but also made further contributions to what has come to be known as the nonmonetary/financial hypothesis.
Bernanke (1983), building on the monetary hypothesis of Friedman and Schwartz (1963), presents an alternative interpretation of the way in which the financial crises may have affected output. The argument involves both the effects of debt deflation and the impact that bank panics had on the ability of financial markets to efficiently allocate funds from lenders to borrowers. These nonmonetary/financial theories hold that events in financial markets other than shocks to the money supply can help to account for the paths of output and prices during the Great Depression.
Fisher (1933) asserted that the dominant forces that account for “great” depressions are (nominal) over-indebtedness and deflation. Specifically, he argued that real debt burdens were substantially increased when there were dramatic declines in the price level and nominal incomes. The combination of deflation, falling nominal income and increasing real debt burdens led to debtor insolvency, lowered aggregate demand, and thereby contributed to a continuing decline in the price level and thus further increases in the real burden of debt.
Bernanke (1983), in what is now called the “credit view,” provided additional details to help explain Fisher’s debt deflation hypothesis. He argued that in normal circumstances, an initial decline in prices merely reallocates wealth from debtors to creditors, such as banks. Usually, such wealth redistributions are minor in magnitude and have no first-order impact on the economy. However, in the face of large shocks, deflation in the prices of assets forfeited to banks by debtor bankruptcies leads to a decline in the nominal value of assets on bank balance sheets. For a given value of bank liabilities, also denominated in nominal terms, this deterioration in bank assets threatens insolvency. As banks reallocate away from loans to safer government securities, some borrowers, particularly small ones, are unable to obtain funds, often at any price. Further, if this reallocation is long-lived, the shortage of credit for these borrowers helps to explain the persistence of the downturn. As the disappearance of bank financing forces lower expenditure plans, aggregate demand declines, which again contributes to the downward deflationary spiral. For debt deflation to be operative, it is necessary to demonstrate that there was a substantial build-up of debt prior to the onset of the Depression and that the deflation of the 1930s was at least partially unanticipated at medium- and long-term horizons at the time that the debt was being incurred. Both of these conditions appear to have been in place (Fackler and Parker, 2001; Hamilton, 1992; Evans and Wachtel, 1993).
In addition, the financial panics which occurred hindered the credit allocation mechanism. Bernanke (1983) explains that the process of credit intermediation requires substantial information gathering and non-trivial market-making activities. The financial disruptions of 1930–33 are correctly viewed as substantial impediments to the performance of these services and thus impaired the efficient allocation of credit between lenders and borrowers. That is, financial panics and debtor and business bankruptcies resulted in a increase in the real cost of credit intermediation. As the cost of credit intermediation increased, sources of credit for many borrowers (especially households, farmers and small firms) became expensive or even unobtainable at any price. This tightening of credit put downward pressure on aggregate demand and helped turn the recession of 1929–30 into the Great Depression. The empirical support for the validity of the nonmonetary/financial hypothesis during the Depression is substantial (Bernanke, 1983; Fackler and Parker, 1994, 2001; Hamilton, 1987, 1992), although support for the “credit view” for the transmission mechanism of monetary policy in post-World War II economic activity is substantially weaker. In combination, considering the preponderance of empirical results and historical simulations contained in the economic literature, the monetary hypothesis and the nonmonetary/financial hypothesis go a substantial distance toward accounting for the economic experiences of the United States during the Great Depression.
from the start of the great depression, net private debt (fig 15) fell about 18% in nominal terms -- and it is important to realize that this means a contraction in money supply in the broadest sense, as debt is credit and credit is akin to money. in the first few years, that broad money supply contraction actually outpaced the actual nominal debt payoff -- such that (fig 16) REAL net private debt increased even as NOMINAL net private debt decreased. this is because the first people to pay down private debt were the banks, and the money multiplying effect of fractional reserve banking ran in reverse. as credit became impossible to get, gross domestic product collapsed, meaning that real debt as a percentage of gdp (fig 17) jumped some 60% between 1929 and 1933.
this is a very similar situation to what we face today. as hatzius noted, banks are looking at monstrous writeoffs and will be forced to contract credit -- that is, the broadest measure of money supply. that credit/money contraction, coming at a time of such high levels of general indebtedness across the economy, will force the level of real net private debt higher very quickly and compel a sharp fall in economic activity -- particularly if, that is, the federal reserve bank does not fairly radically expand narrow money supply and recapitalize banks either by steepening the yield curve sharply or simply giving balance sheet relief to the major banks.
what separates recession from depression in my opinion is this: broad money supply contraction actually outpaced the actual nominal debt payoff -- such that REAL net private debt increased even as NOMINAL net private debt decreased. one tries to raise capital ratio by selling assets, but prices mark down so quickly under even modest selling pressure that the losses incurred on remaining assets outsize the capital raised by the sale. in the event, trying to repair the aggregate national balance sheet actually and paradoxically destroys the balance sheet. this can only occur when there are huge numbers of sellers and almost no buyers, beginning from a level of very high indebtedness. and that's exactly what the banks are facing in the market for residential mortgage-backed securities and CDOs, to the extent that they are liquid at all.
UPDATE: having dug up my copy of fisher's 1933 article and charts, chart v shows the decline in national wealth from 1929 to 1933 as $362bn to $150bn nominal ($270bn in 1929 dollars) -- that's a 25% decline in real wealth.
this earlier post references the potential of an $8tn decline (with the weight of dean baker's opinion) on a $45tn tangible asset base -- a 17% decline, and this of course before taking into account other aspects of the weakening american credit picture, such as commercial real estate. i hesitate to add this as this is not strictly apples to apples -- national wealth in this case should encompass not only consumer durables and real estate but net financial equity as well. but it does provide some sense of the scale of the problems the united states is now facing. it seems to me that it's a potentially embarrassing understatement to say that these are larger problems than were seen in 1990.
UPDATE: via calculated risk, some discussion about the scale of equity losses among homeowners -- particularly how it hasn't started showing up yet because ofheo house price indexes are still in the process of nosing over.
Thursday, November 15, 2007
it barely seems possible to me that a significant rally could emerge from this financial carnage. but i have to trade the charts. to be certain, i'll be quick with the trigger to back out of these rallies (if they are rallies) on signs of faltering strength.
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a nation of sheep
given what arthur silber points out about the american public's prejudice to impeach president bush and especially vice president cheney, one can question whether or not there truly is a complete inability of americans in the main to conprehend what is happening to their society, or if that inability is merely partial and hopelessly muddled. but what is certain is that the will to act -- to get off fat and lazy asses and move to protect one's own civil liberties -- has not risen even to a point where corrective political means are engaged. indeed, americans stupidly re-elected this administration in 2004, well after the lawlessness of its will to power was exposed. indeed, it seems to me that, like any mob, it hailed what it then perceived as a victor in war above all things, to the mindless exclusion of all things.
here i think we see the cultural degeneracy of imperial america coming home to roost. in this desensitized, voyeuristic entertainment society, so dedicated to the pursuit of visceral fantasy as a means of abandoning an inconvenient reality, our own natural rights and their assassination at the hands of barely-veiled fascists has taken on the feel of a "reality" television show. politics has become an unseen writer's script; washington, new york, california, iraq, iran and afghanistan have become like stage settings; the politicians, often literally, are actors. there is a profound unreality -- more accurately, perhaps, surreality -- about american political life in the entertainment age, particularly as news media become ever more alike to gossip magazines and the intellectual gatekeepers of american public life are increasingly ignored or even ridiculed at "elitist". and we, the people, are ever more of a kind with the chorus of greek drama -- unable to affect the action, merely reacting in joy or horror to accentuate the drama of what we observe from a disengaged vantage point.
i am no fan of democracy, to be sure -- contrary to so many unconsidered views of this day and place, it is the form of government which assures the swiftest destruction of law and liberty. and i suppose i expect no more from americans than for them to sign away their rights with a cheer and a champagne toast. but it fills me with a profound sadness anyway, particularly as i look on my young daughter. this is not the society i want her to grow up a part of.
A free market liberal democracy does not appear to be the default state of societies. Inevitably they descend into some sort of degenerate, totalitarian, autocracy. Our illustrious political class has sliced and diced and divided the population to the point where they no longer care about the rights of their neighbors so long as their own state of well being is not diminished. I don't think the nazis power was derived from ultra-nationalistic pride so much as it was from a society that thought: "who gives a fuck, they aren't coming after me"
Until they did that is...
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Wednesday, November 14, 2007
peak energy consequences
a two-part assessment from the oil drum -- part 1 and part 2 -- speculates that the global peak in oil and natural gas production will, by 2050, mean a ~30% contraction in available energy supplies on the back of an 80% collapse in the energy production of those two resources.
the decline in overall energy is predicated, however, on suppression of the use of coal for climatological reasons, and assumes no technological redress such as carbon sequestration. as such, it's more than fair to wonder if the western world would not find ways to attack the problem in the face of a 30% energy output decline and corresponding gdp collapse.
but the discussion has interesting consequences anyway. first is the concept of the net oil export problem -- which is to say that, as net exporters of oil grow their domestic economies and become greater consumers, while also reaching production peaks and falling into production decline, they have significantly less oil to export to nations (like the united states) which rely heavily on oil imports. as the linked presentation-sans-narrative demonstrates, the point at which the major oil exporters become net oil importers is as soon as 2025.
but that of course would be the point at which net oil exporters start to see their energy supply crowded. net importers will feel the pinch much sooner.
regarding just the import needs of the united states, the supply of oil available for importation on the international market may well fall to a level beneath projected american oil demand by 2011 -- and beneath even current levels of american oil consumption by 2015. that is, the net oil export problem is not decades away but a handful of years -- if indeed it isn't already touching us in the form of much higher oil prices and the apparent inability of swing producers to increase production in the face of it.
when cast on this timeframe, it becomes yet clearer why the united states invaded iraq -- and why we will not leave. it simply isn't sufficient to have access to international oil markets, as they are likely to be insufficient in the near future to underpin even economic stagnation in the united states. one must have political control, and the will to extract oil from a place like iraq while ensuring that it does not consume the oil it produces. the united states acts in this way as a kind of vampire, retarding the development of iraq to facilitate its own ends.
and of course there is no guarantee of success in iraq -- either in establishing working conditions that would allow direct oil production transfers to the united states in any quantity, or of making the further finds in unexplored iraq that will be so necessary to pushing peak oil out on the timescale meaningfully.
however, one also has to make room for the countervailing view. one element of it is perspective:
Daniel Yergin, chairman of CERA, noted that this is the fifth time the world is said to be running out of oil. "Each time—whether it was the 'gasoline famine' at the end of World War I or the 'permanent shortage' of the 1970s—technology and the opening of new frontier areas has banished the specter of decline," asserted Yergin. "There's no reason to think technology is finished this time."
second, there is the argument that prices are high because of inelastic supply, caused by underinvestment in production capacity in recent years (when the price of oil was much lower), as well as the growth of demand from china and india. ronald bailey, as befits an inveterate anarchist and probably correctly, blames national oil companies for this underinvestment -- but the salient point is that the reserves exist even though they are not being tapped.
please note that this second argument is undermined by the first. yergin is tacitly admitting that exploiting known reserves may not be enough under current technology, and implying that innovation is needed. it may well be forthcoming, but it's also important to note that there has not been a major oilfield discovery in 40 years. moreover, 60% of the world's oil production comes from 1% of its oil fields. when those huge fields go into decline, oil production will probably slow. and that is exactly what is being assessed for fields like mexico's cantarell and saudi arabia's ghawar.
the primary disagreement is not on methodology, in the end, but on the assessment of known reserves. those who believe the government of saudi arabia is exaggerating much as kuwait admitted to doing think peak oil is now; those who do not thing peak oil is some decades off.
UPDATE: more from john mauldin.
Tuesday, November 13, 2007
oil industry executives, economists concede oil "peak"
ConocoPhillips (COP) Chief Executive James Mulva had earlier told a New York financial conference that he doubted that world oil producers would be able to meet forecast long-term energy demand growth. The International Energy Agency, the energy watchdog for western economies, has projected 2030 world oil demand of 116 million barrels a day. But Mulva said he doesn't believe oil supply will ever exceed 100 million barrels a day. He didn't offer a price forecast.
"Demand will be going up, but it will be constrained by supply," Mulva said. " I don't think we are going to see the supply going over 100 million barrels a day and the reason is: Where is all that going to come from?"
"Where is the oil going to come from?" This is the CEO of the third biggest oil major in the USA, admitting that we no longer know where we can get access to oil.
"peak oil" -- the concept of a global maxima in oil production rates which we have either reached or are about to reach -- has been forecast for decades and for just as long openly despised and ridiculed by many as a "doomsday" fantasy.
but now it is apparently here, the admission of oil company leadership themselves and very probably already driving national policy. indeed, we are never leaving iraq because iraq represents in many respects the last, best hope of major oilfield discovery and development.
and success in that endeavor, which underlies everything the united states has done in iraq, is beyond important precisely because oil shortfalls are already upon us and will worsen markedly, even if global recession slackens demand growth.
On the energy security, oil prices part, the numbers, one doesn’t need to be a big energy expert or anything: it’s just mathematics. I can tell you that we, in the next seven to eight years, need to bring about 37.5 million barrels per day of oil into the markets, for two reasons. One, the increase in the demand, about one third of it, and two thirds, there is a decline in the existing fields [and there is a need] to compensate for the decline. (...) [what] we expect [to be put in production] is 25 million barrels per day, and this is in the case of no slippages, no delays in the projects, and everything goes on time, which is very rare. So, there is a gap of 13.5 [sic] million barrels per day. (...) Within the next seven years.
What needs to be underlined here is that we already know, to a large extent, what oil fields will be put in production over the next 5-7 years. It takes several years to put a field online, and thus most of that medium term future capacity is already in the planning stage or in the construction phase, and is known to the industry and to institutions like the IEA which can have access to confidential company or national data.
And they are telling us we have this HUGE gap - just to give you an idea, it's almost equal to US imports... unless OPEC suddenly decides to invest more.
"unless opec suddenly decides to invest more" is a key phrase, as the industry view is that, while non-opec nations are experiencing peak oil as a group, reserves are plentiful in opec nations and that merely more drilling capacity is required to make up shortfalls. however, this supposition is tenuous at best, and in many ways contradicted by what outsiders are implying from saudi drilling activity.
regardless, the oil industry is finally admitting that production will not keep up with demand in the intermediate term -- not nearly. as it comes to pass, this will obviously have major international economic ramifications.
Monday, November 12, 2007
armistice day 2007
It is customary to maintain that American wars are all fought on behalf of freedom, but few notice that for the sake of freedom millions of young men are enslaved for years, Shanghaied by conscription into a life whose every dimension is at odds with the idea of freedom. Flag, uniforms, bugle calls, band music, and all the trappings of military glory hardly suffice to persuade the hapless conscript that he is involved in the defense of freedom, especially when his weekend pass has just been canceled at the last minute in retribution for a heartfelt satiric remark which his sergeant has just overheard. To invoke a rude term which I hope will offend no one here, the culture of war is hardly separable from the culture of chicken shit.
Earlier in our history, invasion or physical pressure against American territory were provocations leading to war. During the Nixon era, the U.S. became "Kissingerized." No longer requiring threats to American territory, threats to American "national interest" became a sufficient reason for sending the troops into bloody action. National interest is an interesting term because it is legally meaningless and constitutionally undefinable, hence popular. The term "national interest" is the best gift ever awarded to those Americans who are neurotically bellicose, but who, like Henry Kissinger, always seem to avoid being on the frontline, preferring to serve their country by getting others to drop bombs on people. Of course, the people they drop bombs on, and this is notable, are always more primitive and unfortunate than themselves. They are always smaller in stature. They usually have darker skins. That is what the current culture of war seems to amount to. Clearly, we should abhor it.
contrast these thoughts -- which were earned by fussell in front-line duty in the second world war -- with these.
Bush, who is spending the weekend at his Crawford, Texas ranch, visited an American Legion post in nearby Waco to attend the ceremony where two Army soldiers and two Marines were honored with anthems and tributes to their heroism.
At the emotional service where some family members were crying, Bush praised the valor of the soldiers and expressed empathy for the "aching hearts" of those they left behind.
"In their sorrow, these families need to know, and families all across our nation of the fallen, need to know that your loved ones served a cause that is good and just and noble," Bush said. "And as their commander-in-chief, I'm making this promise: their sacrifice will not be vain."
the words of one of "those Americans who are neurotically bellicose, but who ... always seem to avoid being on the frontline, preferring to serve their country by getting others to drop bombs on people."
e*trade heading to bankruptcy
if you have a savings account at wamu, NOW is the time to go down to the branch and withdraw all your money. the question remains open as to whether countrywide and other such originators will be similarly destroyed, but if it happens to wamu the chances are good.
one should now also include e*trade with wamu and countrywide. if you have assets in a bank account there, do yourself a favor and go close the account today. you're probably insured by the fdic up to $100,000 -- but do you really want to risk government competence on getting your cash out when you need it?
things haven't got this far yet elsewhere, but other public banks to watch include wachovia and (yes) citigroup. it seems unlikely to me that such large institutions would be allowed to fail -- more likely that they would receive direct capital injections from government -- but one can never quite say.
the yen rears its ugly head
that last bit -- "for so long as currency exchange rates remain stable" -- is the key caveat, as sudden currency moves can wipe out years of returns and force unwinds that perpetuate the disastrous currency move. many are watching for signs of strength in the japanese yen as a proxy for increased risk aversion on the part of carry traders and the potential beginning of a massive global deleveraging.
greg weldon at minyanville visits the topic:
Evidence the pair of charts on display below plotting the Eurocurrency versus the Japanese Yen. These charts reveal key technical pivot points, and the eye-opening ‘tightness’ in the positive correlation between this FX cross, and the US equity market, as it relates to the top-down macro-monetary ‘reflation-deflation-balance.’
EUR-JPY violated the 100-Day EXP-MA, on the back of a negative MACD pattern and double-top pattern. A push below the most recent downside pivot point at 160.50 yen per euro constitutes a significant break, and would put the summer lows ‘into play’, just below 150.00.
A move to 150 by the yen against the euro would bode ill for ‘reflated asset prices’, since an appreciation in the Japanese currency would imply more ‘tightening’ in global credit conditions, amid capital repatriation.
Indeed, the US equity market might be particularly ‘exposed’, with the August lows coming into view for the bears. Naturally, a violation of those lows, in the context of an intensified rally in the JPY would imply a significant worsening in the current ‘credit crunch’.
this is the link to the euro:yen at stockcharts.com.
similar patterns are present against other popular carry trade object currencies, such as the australian dollar and new zealand dollar.
today the yen broke key resistance against the us dollar at 112 yen, and has traded as strongly as 109 yen to the dollar. since june, the yen has strengthened by 22% against the buck.
UPDATE: how big a deal is it? how large is the carry trade? note this from ken fisher via ft: the yen is acutely correlated to stock index prices worldwide.
On days when the euro rises against the yen, stocks rise. On days when the yen rises to the euro, stocks fall. This year’s daily yen/euro changes perfectly track this summer’s stock market correction and subsequent resurrection. Make a chart of stocks, then the yen/euro spread; slip one on top of the other, and they are virtually indistinguishable.
the conclusion is that yen borrowing and little else is driving the bull market in equities, and has been since 2006.
With the correlation this high, do not fear a weak dollar; fear a strong yen. Any material sign of BoJ tightening would be very bearish.
there is a truly massive deleveraging in the wings, if it ever begins to accumulate momentum.