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Thursday, June 26, 2008


rumors of credit trouble -- indymac failing?

they're all around, but across the curve sets it up:

There is a repo desk circulating a bid list of structured MBS product and that action has struck fear into the hearts of participants. The concern is that this smacks of a counterparty in trouble and forced liquidation. The concerns rise as June 30 and balance sheet snap shot date approaches.CMBS spreads are wider by 15 to 20 basis points as are the ABX indices. Plain vanilla pass through MBS is about 3 basis points wider to swaps.

whatever they're trying to move, it must be awesome to generate this kind of response -- NDX (-4.06%), SPX (-2.94%), IYF (-4.07%), BKX (-3.86%) @ 60.20 -- that last just atop what many see as a last-ditch line of defense before freefall. all kidding aside, john jansen has been a good read and has previously spotted turns in the credit market really well -- june 13 to button up for some turbulence, march 18 to call a turn for the better.

UPDATE: more, via calculated risk, from longtime bear bill fleckenstein.

I received a phone call from the Lord of the Dark Matter, who began the conversation: "It's about to blow!" He then repeated himself.

He went on to say that behind the scenes, many parts of the credit/mortgage market were "offered only." He said it had nothing to do with month-end or quarter-end. Instead, he believed it had to do with the enormous amount of inventory that would be looking for a home in the next quarter. He believed that the equity market was "miles behind what was occurring in the mortgage-backed/credit markets." Though he noted that he'd said it before, he repeated: "It's never been this bad."

it's just possible that a significant regional bank (outside the fed's lending firewall) is failing and trying to dump the works onto the credit markets, which of course would respond by running into the shadows.

UPDATE: in fact, that bank may be indymac. depositors are running the bank, and chuck schumer is writing letters to the FDIC as IMB calls in its political favors.

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Fluctuations in prices are also driven by supply and demand, which in turn are determined to a large extent on investor psychology. Seeing a stock rise in price may cause investors to jump on the bandwagon and this rush to buy drives the price even faster.
Visit AT:Pipe marking tape

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high court asserts american individual right to gun ownership

i don't know that i've ever commented on gun ownership here.

it's very clear (or should be) that the gun culture of the united states results in some hundreds of otherwise preventable deaths in this country. every comparable developed nation has crime problems; every developed nation has a black market for drugs; none other than the united states has a private gun culture. so when examining the astonishing differences in the per capita figures of violent injury and death between the united states and comparable civilized nations, it should be fairly straightforward that gun ownership is facilitating a counterculture cult of violence here.

that said, i rather have to agree with the decision today by the supreme court, for the first time articulating as constitutional law a right to private gun ownership. more (and better) via scotusblog. indeed, i think that in fact to talk about the right to keep a gun around "for self-defense" misses the point entirely.

the guns are for shooting politicians, soldiers and paramilitary police officers. they are the guarantors not of safety from one's neighbors but of liberty in the face of one's government.

the american power elite know this even if they dare not give it voice, and it does not set well with them. the debate over who should possess weapons and why has slowly, over time, migrated from a conversation about the ultimate check on the authority of a governing body to a question of personal safety. in doing so, it has been caught up in the rampant growth of the broader culture of fear so trenchantly analyzed by british sociologist frank furedi and taken on a far larger place in the american public discourse than perhaps it merits -- having become in some ways the visceral maximalist expression of the unsettled and fearful consideration with which the postmodern american views his neighbors.

statistically, there are something like 30,000 gun deaths in the united states annually. that is very high in comparison to other developed nations -- but also just 1.2% of the 2.4mm american deaths in 2002. much is made of the threat to children from firearms, and yet in 2002 there were just 436 firearm deaths of children 14 and under. for context, there are some 300mm americans of which some 60mm are 14 and under.

another way of saying this is that the chances of a child 14 and under being shot and killed in the united states in any year are about 1 in 137,615. another way of saying that is to say that one could reasonably expect to grow to the age of 15 almost 10,000 times without getting killed by a bullet -- or, you could have about 10,000 kids before you should reasonably expect one of them to get shot and killed before they hit 15.

these are very, very long odds -- indeed, the chances of your kid being killed in a car accident are about six times greater.

longer odds still apply to accidental death by firearms -- the category that eliminates the child homicides that are usually perpetrated by parents -- where just 86 kids in 60mm were killed. if you don't plan on shooting your children, the chances that they will be killed by a gun are nearly zero.

overall, just 776 accidental firearms deaths were reported in 2002 -- 0.8% of all accidental deaths, 0.03% of all deaths. can someone rationally explain the desire for trigger locks given these facts? at such low returns on legislation, why not ban scissors?

some among the obtuse, the paranoid and the unfortunately experienced would disagree -- but these are the concrete truths about gun deaths. vastly more children die each year from accidental drowning, and yet we don't outlaw swimming pools. vastly more children die each year from accidental fire and smoke inhalation, and we don't issue licenses for matches. almost twice as many children accidentally die in snowmobiling and offroad motorbiking/fourwheeling incidents, and there is utterly no outcry here.

but the gun has a special power to give expression to our fears about our society and our neighbors in a period of massive social upheaval and a breakdown of traditional norms regarding social interaction. the gun is the primary symbol of our insecurity about ourselves which we project onto others. this symbolism is why guns play such an outsized role in cinema and literature, and so have become as much a central counterculture iconograph to the nascent 21st century west as the muslim crescent was to the 13th. indeed it stands as the ultimate counterculture icon.

against the irrational fear of guns that permeates our society, we have to set its role in a society as virtually the solitary basis of resistance against government. with all due respect to mahatma gandhi and acknowledging that i do not now and may never own a gun on general principle, nonviolent resistance has severe limits when the government is shameless -- and governments are reliable in experiencing periods of shamelessness. it is this thinking -- and nothing to do with personal safety -- that underwrote the second amendment. the federalist papers offer some eye-opening excerpts on just how far off the original reservation we've already gone.

... [A]mbitious encroachments of the federal government, on the authority of the State governments, would not excite the opposition of a single State, or of a few States only. They would be signals of general alarm. Every government would espouse the common cause. A correspondence would be opened. Plans of resistance would be concerted. One spirit would animate and conduct the whole. The same combinations, in short, would result from an apprehension of the federal, as was produced by the dread of a foreign, yoke; and unless the projected innovations should be voluntarily renounced, the same appeal to a trial of force would be made in the one case as was made in the other. But what degree of madness could ever drive the federal government to such an extremity. In the contest with Great Britain, one part of the empire was employed against the other. The more numerous part invaded the rights of the less numerous part. The attempt was unjust and unwise; but it was not in speculation absolutely chimerical. But what would be the contest in the case we are supposing? Who would be the parties? A few representatives of the people would be opposed to the people themselves; or rather one set of representatives would be contending against thirteen sets of representatives, with the whole body of their common constituents on the side of the latter.

The only refuge left for those who prophesy the downfall of the State governments is the visionary supposition that the federal government may previously accumulate a military force for the projects of ambition. The reasonings contained in these papers must have been employed to little purpose indeed, if it could be necessary now to disprove the reality of this danger. That the people and the States should, for a sufficient period of time, elect an uninterrupted succession of men ready to betray both; that the traitors should, throughout this period, uniformly and systematically pursue some fixed plan for the extension of the military establishment; that the governments and the people of the States should silently and patiently behold the gathering storm, and continue to supply the materials, until it should be prepared to burst on their own heads, must appear to every one more like the incoherent dreams of a delirious jealousy, or the misjudged exaggerations of a counterfeit zeal, than like the sober apprehensions of genuine patriotism. Extravagant as the supposition is, let it however be made. Let a regular army, fully equal to the resources of the country, be formed; and let it be entirely at the devotion of the federal government; still it would not be going too far to say, that the State governments, with the people on their side, would be able to repel the danger. The highest number to which, according to the best computation, a standing army can be carried in any country, does not exceed one hundredth part of the whole number of souls; or one twenty-fifth part of the number able to bear arms. This proportion would not yield, in the United States, an army of more than twenty-five or thirty thousand men. To these would be opposed a militia amounting to near half a million of citizens with arms in their hands, officered by men chosen from among themselves, fighting for their common liberties, and united and conducted by governments possessing their affections and confidence. It may well be doubted, whether a militia thus circumstanced could ever be conquered by such a proportion of regular troops. Those who are best acquainted with the last successful resistance of this country against the British arms, will be most inclined to deny the possibility of it. Besides the advantage of being armed, which the Americans possess over the people of almost every other nation, the existence of subordinate governments, to which the people are attached, and by which the militia officers are appointed, forms a barrier against the enterprises of ambition, more insurmountable than any which a simple government of any form can admit of. Notwithstanding the military establishments in the several kingdoms of Europe, which are carried as far as the public resources will bear, the governments are afraid to trust the people with arms. And it is not certain, that with this aid alone they would not be able to shake off their yokes. But were the people to possess the additional advantages of local governments chosen by themselves, who could collect the national will and direct the national force, and of officers appointed out of the militia, by these governments, and attached both to them and to the militia, it may be affirmed with the greatest assurance, that the throne of every tyranny in Europe would be speedily overturned in spite of the legions which surround it. Let us not insult the free and gallant citizens of America with the suspicion, that they would be less able to defend the rights of which they would be in actual possession, than the debased subjects of arbitrary power would be to rescue theirs from the hands of their oppressors. Let us rather no longer insult them with the supposition that they can ever reduce themselves to the necessity of making the experiment, by a blind and tame submission to the long train of insidious measures which must precede and produce it.

The argument under the present head may be put into a very concise form, which appears altogether conclusive. Either the mode in which the federal government is to be constructed will render it sufficiently dependent on the people, or it will not. On the first supposition, it will be restrained by that dependence from forming schemes obnoxious to their constituents. On the other supposition, it will not possess the confidence of the people, and its schemes of usurpation will be easily defeated by the State governments, who will be supported by the people.

a variant of the contest here envisioned was later fought between 1861 and 1865, with the northern union states in league with the rump of a deeply divided federal government against the southern confederate states. but the salience of the logic is still copious: the federal government shall be subject to the people, or it shall be defeated by the people. securing the means of that defeat for the preservation of liberty under law is the essence of the second amendment. forgo it, and in time you will have cleared the path of tyranny.

as such, the desire of many among the elite to restrict the private ownership of weaponry is easily explained as a means to challenge their authority in the last resort upon which every previous resort is predicated. they today feel that challenge more deeply than ever, as we all do in the culture of fear, given the clear decline of traditional institutional authority. it seems to me that even the majoritarian revolutionaries that form a minority cabal on the bench of the high court are conflicted in their implementation of the spirit of the amendment -- this decision applies only to federal gun ownership bans such as the one that held in washington, dc, and as such does not rule particularly on the constitutionality state or municipal gun laws.

but the establishment of a firm constitutional penumbra protecting private gun ownership is nevertheless a major interpretation which will echo through gun legislation for a long time to come. so much the better, it seems to me -- for though we pay a price for the enforcement of our liberty, i think it a relatively minor and altogether necessary one.

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"the american power elite know this even if they dare not give it voice, and it does not set well with them."

Indeed. One can only look in wonder at the phenomenal amount of taxpayers money the power elites spend fortifying their offices and presumably valuable filing cabinets from any "assault" instigated by those very same unwashed beknighted taxpayers.

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gm, excellent piece. great analysis. too many morsels to comment on, but, imho, here's a good abstract:

nonviolent resistance has severe limits when the government is shameless -- and governments are reliable in experiencing periods of shamelessness.

again - - brilliant.

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Wednesday, June 25, 2008


montier and edwards on oil, macro

while i do think the oil market is seeing the effects of a speculative period, i do also think that, as i said earlier:

oil is getting scarcer vis-a-vis demand and cost of production is rising and will continue to rise.

peak oil -- whether it be the geological inevitability or simply increasing producer domestic demand reducing the amount available for trade or both -- is a factor as well.

the federal reserve bank, for their part, would be wrong to confuse either with inflation. and that, via barry ritholtz, is the point of a discussion between james montier and albert edwards. included is some terrific discussion about a developing glut of spot oil:

Albert: ... All I’d add is that from thecommodities side what has surprised me, as I have written, was that when I looked at some of the commodities indices, because I was sort of relating the CRB to world growth, it’s only been in the last six months or so that the CRB has totally detached from the cyclical slowdown we’re seeing and gone potty. And when I actually looked at some of the industrial commodity indices that exclude oil, like the Economist’s industrial baskets, which includes agricultural industrial commodities as well as metals, and the IMF industrial commodity index, they’re actually flat year-on-year, which, to be honest, surprised me. So I dug around a bit more and then found out — because I don’t keep my eye on these things all the time — that actually things like lead, zinc and nickel are down about 50% from their peaks. As always, as James says, people reach for growth, so as these sort of cyclical risk dominoes tumble, they funnel into the remaining stories that haven’t yet been disproved. What is interesting is that this is now very much a food and energy bubble. All the speculation seems to have funneled in, even within the commodity complex, to food and energy, just those few commodities. Obviously they are key commodities. But the oil price — before I left London to come out here I read through a stack of newspapers from this week, and saw an interesting article in the Wall Street Journal saying that actually there is a glut of spot oil. Some Gulf states are hiring tankers to basically park their surplus oil in the Gulf, because they can’t find buyers for it.

Right. There’s reportedly an immense amount of inventory afloat in the Gulf.

Albert: And the demand isn’t there for it at the spot end. As James always says, pricing commodities, unlike equities or bonds, is very difficult. You might agree with the structural argument, but where does that mean that the price of oil should be? Should it be at 200? 400? 60? It actually doesn’t tell you where oil should be. Certainly nothing has changed structurally in the last six months. Oil has rocketed up, yet the only cyclical phenomena which has changed is that the IMF forecast for global demand this year has absolutely plummeted. The IEA has cut their forecast for oil demand again and again and again, compared to where they were at the beginning of this year, and yet the price has totally detached itself from those fundamentals. So for me it is clearly a speculative phenomenon. I mean, you had the Goldman oil guy coming out saying “buy,” forecasting $200 on the long-dated contracts. Lo and behold, they jumped $10-$15 because everyone piled in. But I don’t see it. What people forget is that there is always a structural argument. They said in the U.K. that house prices could not fall because there is a shortage of land and we are having all this immigration. Lo and behold, cyclically house prices have just collapsed in the U.K. But the structural argument hasn’t changed. I see the situations in oil and food as similar. I am a structural bull on commodities. But hey, I see the cycle turning, and I think, “No, this has just gone a bit potty.”

It’s silly season. I saw a headline this morning saying that the IEA is about to slash its forecasts of peak production capacities —

Albert: Sure, that’s a methodology change, just like Moody’s has to keep doing. On the way up, methodologies are changed to justify higher prices. When we’re back at $60, and given a global recession, we will be back at $50 or $60 in a year’s time, they’ll be changing the methodology back again.

montier and edwards are forecasting the end of the oil bubble and a steep decline in emerging markets shares in the next six to twelve months. and that of course is not independent from their views of the american economy.

UPDATE: in passing, this morning's ft markets live cited albert edwards' forecast note:

But before he runs off with the story we’ve got, id like to make two observations.
1. The FTSE100 is WAY down. Off 75 points currently.
2. Albert Edwards is predicting the end of the world as we know it.
That’s not news!
Ah, but this is. Look at the severity of this prediction:
A deep recession will result in a profits slump. Coupled with an Ice Age P/E contraction, we see global equity markets falling some 70% from their Oct 07 peak. I expect the S&P to bottom around 500 (verses the 1,575 peak) and FTSE around 3,000 (imagine where consumer confidence will be if equity prices do collapse).

Got that.!?
Tin hat warning or what!?!?!!?
S&P at 500
sure that’s not typo and he means the S&P 500?
Nope –
70% fall forecast
And remember Edwards is the top rated strategist in Europe
he is

looks as though edwards believes his worst-case scenario is in fact unfolding.

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paul krugman and the oil bubble that isn't

at dr. krugman's interesting blog there has been a running analytical polemic on the effect of speculation upon the price of oil. posts in chronological order are here, here, here and here. krugman continues to argue the classical position -- that the net effect of futures speculation among parties which do not take delivery has no effect on the spot price, which is determined by supply and demand of the physical commodity.

to this latest of the series i responded.

"Whatever you say about the futures market, it can only drive up the spot price by causing physical hoarding of physical goods."

this is the doctrine i question, dr. krugman. why should price setting in reality be as reductive as a supply/demand curve in a world so plainly complex? that is the model and it is easy -- too easy -- to understand. but it is not the reality.

i think it more honest to say that the supply/demand curve demonstrates the pressure applied to the extant price to rise or fall because of the realities of supply and demand -- but does it determine the price? no. the price is determined by one thing only -- the sum of the expectations of market participants.

if me and my supplier friends are bringing commodity x to market to sell to buyers, we settle on a price to exchange the commodity. that price is not determined by supply and demand -- there's no equation that says "if you bring five this is worth $30". the price is the reflection of the sum of our expectations.

for any commodity that has a perceived range of cost of production, the price is normally above that cost or supply will fall incrementally until the price rises. and for any commodity that has a perceived range of benefit of ownership, the price is normally below that benefit or demand will fall incrementally until the price lowers.

but if the spread between the perceived cost of production and the perceived benefit derived is wide -- and for oil, it clearly is -- where exactly the price falls between the two limits is driven as much or more by the psychology of the participants as the realities of cost. and where mania takes hold, price movement temporarily outside the boundaries of cost/benefit are not uncommon.

i don't dismiss the supply/demand reality -- oil is getting scarcer vis-a-vis demand and cost of production is rising and will continue to rise. but neither do i think one can dismiss the speculative fervor that has taken hold in the oil market and say it has no effect simply because every long in the futures has its short. the price of oil between the margins of cost and benefit is defined largely by the expectations of the participants in the futures market -- for the spot market as well as the derivatives.

this behavioral component of trading has little or no place in the conventional view of efficient-market economics, but is nevertheless an obvious reality. i think the role of market participant expectations is being underestimated vis-a-vis the supply/demand argument.

yves smith relays thomas palley and others, entering the fray against krugman and efficient-market notions. one of smith's commenters notes a conundrum that can only be the product of a temporary dislocation in the price of oil:

That is, the total refined products have been selling for less than the price of raw oil...that's why refiners are at sub-90% capacity (and bottomed in the low 80%'s...aka Katrina/Rita levels).

Put another way, there is more demand for oil than there is for the actual distillates...or, one more way - the distillate paper market isnt responding like the crude paper market is (aka one of them might be broken).

as notes smith:

This is not definitive, but the fact that refiners are getting squeezed is not consistent with the notion that crude prices are driven by end market demand.

furthermore, says palley -- echoing some of my own thoughts as commented on krugman's blog:

Reflecting their faith in markets, most economists dismiss the idea that speculation is responsible for the price rise. If speculation were really the cause, they argue, there should be an increase in oil inventories, because higher prices would reduce consumption, forcing speculators to accumulate oil. The fact that inventories have not risen supposedly exonerates oil speculators.

But the picture is far more complicated, because oil demand is extremely price insensitive.

certainly supply and demand play a big role. i myself think that slackening demand is likely to curb real prices. and i've looked for hoarding too. but expectations of seeing the hoarding in a bubble should be modest:

the truth is that commodities DO boom and bust -- they always have. it may be important to argue about the mechanism, as waldman here does and cogently, but not as important as simply realizing that -- because it has happened -- there IS a mechanism. and that one is in a speculative bubble is NEVER simply as obvious as looking for invenory buildups, for if it were so easy there would never be a speculative boom in the first place.

some have pointed out that supply may in fact be held off the market and kept in the ground -- a good hiding spot, as national production figures are not entirely reliable. others have noted that iranian sour crude is sitting in tankers, and that strategic stockpiling around the OECD is going on. so perhaps the hoarding that dr. krugman needs to see to be convinced is in fact before him. more from palley, in a bit saliently contextualized by the testimony of phillip verleger exerpted by yves smith:

Unfortunately, proving that speculation is responsible for rising prices is difficult, because speculation tends to occur during booms, so that price increases easily masquerade as a reflection of economic fundamentals. But, contrary to economists’ claims, oil inventories do reveal a footprint of speculation. Inventories are actually at historically normal levels and 10% higher than five years ago. Furthermore, with oil prices up so much, inventories should have fallen, owing to strong incentives to reduce holdings. Meanwhile, The Wall Street Journal has reported that financial firms are increasingly involved in leasing oil storage capacity.

The root problem is that financial markets can now mobilize tens of billions of dollars for speculative purposes. This has enabled traders collectively to hit upon a strategy of buying oil and quickly re-selling it when end users accommodate higher prices – a situation that has been aggravated by the Bush administration, which has persistently added oil supplies to the US strategic reserve, further inflating demand and providing additional storage capacity.

as an aside, an increasingly mentioned and somewhat compelling complementary argument notes that, because of refinery mismatches to output type, sour crude is having a hard time finding a market while light sweet is in much higher demand. as the economist notes:

Saudi Arabia's motives for wanting to lower prices are clear. The trouble is that it cannot manipulate markets as before. The kingdom has a fifth of known reserves. It supplies an eighth of the world's oil and remains, crucially, the only producer with at least some spare capacity. A huge investment plan under way should raise its capacity from 11.3m barrels a day in 2007 to 12.5m by next year. Noting pleas from George Bush and Ban Ki-moon, the UN's secretary-general, the Saudis have upped actual production twice in the past month, raising it by 500,000 barrels a day to its present level of 9.5m.

But much of that new output, and most of the reserve capacity, is in the form of heavier oils that are costlier to refine and for which there is less thirst. The Saudis are unlikely to bring new, lighter crude, or bigger refining capacity for their heavier oils, onto world markets until next year. Even then the incremental rise may not offset demand. So energy watchers hope the Jeddah conference will reveal something bolder than promises of more oil.

in any case, i went short the oil sector through the proshares' DUG this morning (too late). we'll see how it pans out -- playing in a bubble is always dangerous.

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Tuesday, June 24, 2008


bank credit contraction and monetary aggregate growth

we interviewed a potential investment this morning who has constructed a long-only international asset-allocation model using ETFs and futures. the jist of the program is to identify national markets where overall allocation has shifted to defensive measures and sentiment is poor but which is also seeing increased liquidity, then overweight there -- and vice versa. the principle is that liquidity will lead equities.

i was surprised as the current model portfolio composition -- heavily overweight the united states. there's a compelling case made that the BRIC economies are in liquidity challenged environments and will see difficulty (this i don't disagree with) but the opposite case is made for the US. sentiment is poor, liquidity is improving.

sentiment is poor -- right, i agree. but liquidity is a catalyst?

this led to some discussion, and i can summarize the opinion of the investment as follows: federal reserve action has resulted in pronounced m3 growth, which has fostered a steepened yield curve. these are taken as signs of successful liquidity creation. such conditions have -- citing 1982, 1990 and 2003 -- been excellent long entries.

while i broadly agree with the general scenario and think the ideas fertile, unfortunately this doesn't ring true to me. i posited an alternative:

in the previous examples, sentiment wanes, capital migrated from risk to cash in anticipation of disaster as a sort of systemic loan-loss reserve, but disaster did not materialize -- therefore, capital was redeployed and risk taking was rewarded.

what of the case where disaster does materialize -- where the hoarding of sideline cash in a systemic loan-loss reserve is never redeployed because it ends up covering losses?

there was no answer for this.

i unfortunately got to mish's offering today after that meeting, and with it paul kasriel's latest commentary. i earlier noted the stalling of monetary aggregates in britain and the united states. as kasriel says:

... [L]et's take a look at what commercial banks have been doing with their loans and investments. Chart 2 shows that in the 13 weeks ended June 4, loans and investments at all commercial banks were contracting at an annual rate of 2.25%. It is true that bank credit growth ballooned in 2007 as banks were forced to take on credit that had originally been financed in the commercial paper market. But we seem to be over that "hump."

that is, the migration of off-balance sheet vehicles back onto bank balance sheet (a la citibank) has caused outstanding bank balance sheet assets to rise dramatically in 2008. that has been offset on the liability side by desperate searches for deposit funding -- one which the flight to safety has helped to satisfy as funds brought out of collapsing asset-backed commerical paper markets largely found their way into bank time deposits, money markets and short-term treasuries -- in order to avoid capital ratio impairment.

this is exactly what it sounds like -- an increase in the balance sheet leverage employed by banks. these are forced loans, not the kind that support healthy economic growth and not really credit or monetary aggregate growth at all. it is instead simply a reaccounting of previously granted credit as it forcibly migrated fron the shadow banking system onto bank balance sheets (what has been called "reintermediation"). indeed i think, even as m3 skyrocketed, actual bank credit had been slowing, probably stagnant at best -- and now that formerly hidden bank exposure has been largely made visible and included in m3, the bank credit and monetary aggregate measures kept by the fed will now show contraction, as kasriel and mish say.

since the flight to safety has abated, however, we've instead more recently seen banks selling equity stakes in an effort to raise actual capital even as their newly-returned-to-balance sheet assets were written down to continue to support balance sheet growth.

now, it seems that financing window is closing on the banks -- and the first true asset sales are underway. these will be forced into highly nervous and illiquid markets, result in highly deleterious marks for remaining assets, but are becoming completely necessary as those nefarious assets seem to find a way to confound and disappoint even the pessimists quarter after quarter -- as the housing bust continues to accelerate, as the commerical real estate bust accelerates, as a consumer-led recession characterized by the worst figures in the history of the conference board's future expectations index sets in. though the banks have done their best to push these assets onto the balance sheet of the federal reserve and the european central bank, they still own them -- and no one at the fed has said anything about destroying the central bank's balance sheet and monetizing their gone-to-hell SIV leftovers. to the contrary, the hawks are playing hardball and traders expect rate hikes in what i see as an echo of 1931.

with the prospect of burgeoning bank failures and FDIC receiverships now on the near horizon, it seems to me increasingly that -- while monetary aggregates have grown and institutional money market funds have grown rapidly out of fear -- this does not in fact present a liquidity boom. rather, these are better thought of as systemic loan-loss reserves which will be used as systemic deleveraging progresses. i may of course be very wrong, but i fear there's very little market fuel to be had here.

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Monday, June 23, 2008


the return of smoot-hawley

via mish -- stunning, but it demonstrates clearly that the myopia of politics trumps even the most desperate need of policy.

"This marks a fundamental shift in U.S.-China trade relations," said Gilbert Kaplan, a lawyer for U.S. pipe makers. "It's the first time we've confronted their subsidies by putting duties on imports."

Two types of tariffs will apply to the Chinese pipe: countervailing duties, used to counter subsidies, will average 37.2 percent; and anti-dumping duties, to compensate for goods sold overseas at prices below those at home, will be 69.2 percent on 31 of the largest producers. Other companies face higher duties.

the sincere stupidity of this move comes over on may levels. in the face of finished goods price deflation against raw input price inflation -- the age old mechanism of recession in which business margins are squeezed and firms are sent to bankruptcy -- the government of the united states proposes to, in essence, further raise the prices of inputs and unfinsihed goods by taxing the low-cost provider of choice (ie, china).

it means even greater pressure on profit margins for those who use an unfinished good like steel pipe, which will push more finished goods manufacturers to bankruptcy than would have been the case otherwise. it means higher unemployment, as the manufacture and sale of finished goods has become a larger part of our economy than it ever was in the 19th or early 20th century.

but steel pipe in itself is not nearly so important as the follow-on consequences -- two of which jump out at me.

first is the prospect of retaliation. china is already revaluing the yuan lower, which is steadily drying up its need to finance the american economy. in curtailing chinese imports, that impetus will be reinforced by compounding the currency adjustment with a reduction in trade volume.

the full impact of the yuan's slow but accelerating revaluation hasn't hit yet, as brad setser points out that foreign central bank reserve growth is still massive and flowing into american agency and treasury debt. a trade war, however, might put the entire balance of terror on new terms.

second is the misguided diminishment of one of the anglophone empire's primary institutional tools, along with the united nations and the world bank: the WTO. if free reciprocal trade is moved further down the list of american priorities, will the importance of the WTO -- which as much as any other institution is responsible for the global dominance of american multinationals and finance -- be diminished? such a progression would be to the detriment of the united states, dependent as it is on foreign trade and capital flow for just about everything.

UPDATE: michael pettis sees a change in the nature of chinese reserve accumulation.

It now seems that China’s rate of reserve accumulation, seemingly unsustainable even two years ago, has reached even higher levels, but what is powering it now is not the (relatively) stable trade surplus and FDI accounts but rather highly unstable speculative inflows.... If I am right, it seems to me that there has not just been a quantitative change in China’s and the world’s balance of payments accounts in recent months (i.e. even more rapid growth in an already unsustainable rate of Chinese foreign currency reserve growth), but also a qualitative change – the cause of China’s reserve growth has shifted significantly. The old mechanism, large trade deficits in some countries balanced by rapid reserve accumulation in others, has been converted into something much more complex and maybe even pro-cyclical (hence volatility enhancing): large trade deficits in some countries plus massive speculative inflows in others are being balanced by even more massive reserve accumulation in the latter countries.

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bank capital raising petering out

i mentioned it a bit last week, but here's yves smith with a broader rundown.

at the end of the day, it means exaclty what financial times' writers john dizard and gillian tett say it means -- there must be a massive recapitalization financed by government where private capital is too smart to step in. it is already underway -- the united states has seen the effective nationalization of its mortgage market already.

if it isn't attempted in its fullest -- and even if it is but is unsuccessful at stemming the tide of liquidation -- i've little doubt that depression is next.

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gm - pretty scary, eh? more and more widespread chatter of the "c" and "d" words - crash and depression. i am preparing for one or both, though i expect to be offset by the unprepared. but - fail to plan, plan to fail, for sure.

best, darkcloud

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you know, dc, i'm actually a bit relieved to see stockmarket crash calls emerging -- no true crash is so well telegraphed as to have major brokerage houses calling it in advance.

but, while that may portend a more grinding and frustrating zig-zag decline with sharp rallies amid, i don't see how the reality -- consumer pain, pinched banks, much too much leverage and concentration -- allows for optimism. how else can this end but a sizable contraction?

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trust me, gm. there is all but no optimism in yours truly here - my wife nicknamed me "darkcloud " because she knows me better than anyone. on another note, i have to say, i find no disagreement with your comment here nor your blog discussions. i confess though - i am well behind Mish, Yves and you on the knowledge and being informed scales. thank God you folks are out there for the rest of us. have a good one. go cubs.

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Friday, June 20, 2008


deflation awareness rising

kevin depew of minyanville:

Yesterday's Philadelphia Fed Survey slipped by the majority of media outlets without a single commentary on the most important part of the report: pass through of higher input costs. Just about everyone noted the prices-paid index surged to 69.3 in June, "the highest since 1980." But there wasn't enough attention paid to the ability of firms to pass through those costs.

I mean, look, we already know firms have been facing dramatically higher input costs. What is important, however, is how much of those higher input costs get passed through to consumers. Incredibly, the index for prices received actually fell in June, from 31.6 to 29.7.

The special questions in the report are worth noting. "What impact are these recent cost increases having, or expected to have, on the prices of your finished products over the next three months?" A little more than 65% expect price increases, with the average expected price change is 5.4%. Meanwhile, since the beginning of the year, the average reported price increase is just 3.8%.

And for those wondering about price increases related to delivery of raw materials, more than 70% reported experiencing any shortages or delayed delivery of raw materials or intermediate products.

Finally, from the Producer Price Indexes released earlier this week we can build this chart showing the spread between crude goods prices and finished goods prices. This chart goes back to 1987 and we can see how stretched this spread has become.

This is precisely how inflation sows the seeds for deflation. Margins will continue to be squeezed, and every day that goes by with food and energy prices elevated adds what is essentially a layer of leverage to the eventual unwind.

good analysts are trying to make a distinction between a terms-of-trade shock (such as we're seeing in oil) and an inflationary wage-price spiral. pimco's paul mcculley is one:

Most importantly, wage inflation is now only loosely connected to price inflation, in the wake of a more globally competitive, less unionized labor force. As Vice Chairman Kohn hinted, the combination of somewhat higher inflation and higher unemployment is a prescription for diminished pricing power by labor, leading to lower real wages (than would be dictated by labor’s productivity growth). Thus, unlike the 1970s, there is little wage fuel to generate over-heating aggregate demand and, thus, a sustained price-wage-price inflationary spiral.

... Deflating asset prices in a highly levered economy are a much more nefarious outcome than temporary increases in inflation in goods and services. This is particularly the case from a starting point of low inflation in goods and services (excluding those involved in the negative terms of trade shock). How so? Simple: a negative terms of trade shock and asset price deflation are a prescription for not just a recession, but a nasty one. More to the point, from a starting point of low goods and services inflation, the Fed is never far from the zero lower limit on nominal short-term interest rates, commonly known as a liquidity trap.

To be sure, the Fed must be aware of the dreaded second and third round effects, constantly checking to make sure that real wages and real profits are being eroded by the aberrantly high headline inflation. But, assuming the evidence supports that thesis, as the following graph displays, it would be an absolute folly for the Fed – or any central bank in similar circumstances – to hike interest rates in an attempt to make the negative terms of trade shock go away. By definition, it can’t. And if it tries, it will create an even bigger mess. In this case, the motto of a central bank should be the same as that of a physician: first, do no harm.

... Which means, my friends, that low, even negative real short-term interest rates are here to stay for a considerable period.

i have to agree -- and must hope, along with mcculley, that central bankers like plosser and poole are jawboning the economy out onto a plank with absolutely no intention of actually shoving it off into a sea of falling monetary aggregates. against the expectation of markets, and hopefully with the forbearance of the chinese, the lesson of 1931 must be enforced -- if it can be.

i read yesterday an excellent bit of private research regarding the end of the yuan-dollar peg and will have to write about it. suffice to say for now that the analyst's view was that the depegging of the yuan has already begun and is accelerating under the duress of rampant inflation in china as loose american monetary policy and hot money flows translate through the currency peg into their economy. the end of the debt supercycle, as the bank credit analyst called it, he put at being three to four years away, quite possibly sooner if chinese inflation continues to be problematic.

this is all another way of suggesting that the federal reserve bank may not have the freedom it would like to hold rates low and liquidity high, as it would force the kind of foreign capital flight the BCA sees as the final reckoning of debt-fuelled american aspirations.

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from bad to worse

late last year i blurbed on chrysler's unsaleable pier loans. the interest in the company's LBO debt was clearly low. but few foresaw what is becoming of the american auto industry in general as this credit contraction manifests as an all-out consumer-led recession -- or worse.

When Chrysler announced plans to cut 12,000 jobs in November -- on top of 13,000 over three years -- executives were assuming Americans would buy fewer vehicles in 2008 than in any year in a decade, only about 15.5 million. Nardelli said that "conservative estimate" was pretty close for the first three months of the year.

But sales were 7% to 8% below that rate in April and May. And so far in June, he said, J.D. Power and Associates and Citigroup are seeing a sales pace that is almost 20% lower -- only 12.5 million vehicles per year.

"This is the lowest sales level in 16 years and indicates a significant and continued softening of the U.S. automotive market," Nardelli wrote.

... U.S. car and truck sales are down 8.4% so far this year; sales of Chrysler's three brands are down 19.3%.

... Cole added that an annual rate of 12.5 million in June is a major decline. "That's really falling off the cliff. That's going to mean some more cuts," Cole said.

"That is going to hit cash very hard through the industry," he added. "Production cuts, employee cuts -- I think it's going to depend upon the company. That's tough stuff."

... If J.D. Power's forecast for June -- an annualized rate of 12.5 million sales -- continues for long, Erich Merkle of IRN Inc. said, it would be "Armageddon. Doomsday."

"I don't think there is anyone out there prepared for 12.5" million annual U.S. sales, he said. "I know it is only one month, but still that would show some signs that there is some real deterioration in the market, that would mean the economy is really slowing down significantly."

today, per calculated risk, ford is warning on sales as well. the already-overleveraged american consumer is faced with plummeting home values and troubled banks killing off mortgage equity withdrawal, limiting car sales overall -- not to mention the sharp rise in unemployment indicating that job losses are mounting. for american carmakers, profitability is concentrated in fuel-inefficient trucks and SUVs. sales of these particularly have been poisoned by $4/gallon gas.

"Armageddon. Doomsday. I don't think there is anyone out there prepared for 12.5"

the economy could be headed for some honest-to-god fireworks in the second half, and it's an open question as to whether any of the big three american carmakers will see the other side.

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Wednesday, June 18, 2008


deflation now increasingly likely in the united states

i earlier passed on the analysis of the bank of england through the telegraph, noting that the collapse of monetary aggregates in the UK were demonstrating accelerating deflationary credit destruction.

"The money supply is plummeting. This is potentially serious," he said.

... The Bank of England says the overall M4 figure - growing at 11.1pc - is distorted by strains in the interbank markets. Once this effect is stripped out, the M4 growth rate is down 16pc a year ago to 4.5pc in the first quarter.

put that side by side with the reportage of marketwatch's irwin kellner:

From a compound annual rate of more than 16% between the middle of January and the middle of March, M2's growth rate in the past two months has slowed to a little over 1%, according to the Federal Reserve Bank of St. Louis.

The growth rate of highly liquid funds, which the St. Louis Fed calls MZM (money of zero maturity) has skidded even more, from an annual rate of 34% to only 6.5% at last count.

Further up the line, growth of the monetary base, reflecting the Fed's own balance sheet, has slowed from 7.4% to only 1.1%. Meanwhile, the St. Louis Fed's measure of bank reserves is actually lower today than it was in June 2007.

this stuff gets reported here. m2 has been conspicuously flat since february. bank credit (page 17) peaked in march as well at $9.55tn and has fallen through may 28 to $9.38tn. notably, commercial and industrial loans -- an oncoming source of tremendous concern for regional and community banks -- is still growing.

both credit demand and credit supply are fading fast, with banks facing the gradual closing of capital markets to further capital raises.

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credit crisis loss estimates still growing, part 2

best estimate used to be $1tn.

john paulson tops that -- $1.3tn, per yves smith.

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again, bank failures are coming

i've been saying for many months now that bank failures are very certainly coming. indeed some already have, including countrywide and bear stearns.

i previously cited institutional risk analytics in its comments on jpmorgan chase. jpm subsequently has raised capital, though its future remains widely undoubted.

now IRA discusses the buildup of the FDIC following a factfinding mission to washington.

The IRA was trolling the financial services channel in Washington last week, meeting with regulators and members of Congress to discuss the various topics arising from the widening subprime debacle. Probably the most significant discovery during our trip is news that the FDIC is making feverish operational preparations for an unprecedented wave of bank failures, large and small. This data point tracks with the rising number of calls we have been receiving at IRA HQ in Los Angeles from retail customers about the financial condition of specific banking institutions.

Just as abnormally low loan loss rates at US banks during the past five years suggested an eventual and equally abnormal upsurge in default rates, the fact of virtually no bank failures during that same period now means we shall see an above-normal number of failures in coming months and years. Our colleagues at the FDIC, at least among Washington regulators, seem to understand the systemic significance of this fact.

The largest failed bank resolutions by the FDIC to date involved institutions with tens or hundreds of thousands of depositors, but we hear in the channel that plans are being implemented to staff call centers to deal with inquiries from millions of depositors from multiple failed banks. The model for this effort, of note, is NetBank, the $2.5 billion asset Internet bank which failed last year at a cost of over $100 million to the deposit insurance fund. We described same in our comment (Death of a Business Model: NetBank, October 1, 2007).

We hear that the FDIC resolution of the virtual Netbank generated more than 3x the normal volume of inbound calls from depositors compared to a conventional, brick and mortal bank of similar asset size. We also hear that the FDIC is preparing a rule-making process to require banks to uniformly tag deposit accounts within their internal systems so that a resolution of a larger institution is possible.

FDIC Chairman Sheila Bair reportedly has made the completion of the deposit identification project the agency's top priority for 2008. At present, when FDIC personnel go into a failed institution, they often must manually reconstruct deposit ownership records using external software tools. The new rule is intended to address this potentially huge operational deficiency, but it may be too late - years too late -- to affect the outcome of the anticipated number and magnitude of bank failures.

the beginning of those failures may be in the near term. minyanville's bennet sedacca commnets on today's report regarding fifth third bank and its need to raise capital with punitively-priced preferred convertibles.

They're based in the Rust belt, where manufacturing jobs are losing ground by the day. To come to market with a preferred offering, if I had to take a guess, it would need to be 10+%. FITB announced that it's slashing the dividend and will attempt to sell $2 billion in convertible preferred shares with a yield in the 8.5% along with some nasty dilution for current equity owners. This is a disastrous turn of events, but one that was inevitable. Welcome to desperation station.

Who are the usual buyers of all the preferred deals we've been seeing over the past year? Mom and Pop retail—they won’t buy anymore, as Wall Street has jammed them full of securities that are severely underwater. Insurance companies--hmmm, let’s see--they won’t buy as they're so deep in Level 3 Assets that they're issuing themselves! What about the PIMCO’s of the world? It's most likely full up as well. So the capital raising window, in the sense we're used to is in the process of closing.

This means that corporations will now do whatever they must in order to stay solvent? They'll slash jobs and dividends and attempt to raise capital by issuing common equity. The problem is that they're too late; they should have done this already. Instead they were stubborn and ‘hoped’ they would be OK and the economy would recover. But as they say ‘hope is a poor roadmap to success'.

and more, via mish:

Minyan Peter, former treasurer for a major US bank offered these comments on Fifth Third:

While the announcement out of Fifth Third this morning is simple, I can't understate its importance.

Fifth Third to Sell certain noncore businesses.

By all accounts the market for hybrid securities - straight preferred and convertible preferreds - for financial institutions has or is in the process of closing. This now leaves institutions with the Sophie's Choice of either wickedly diluting shareholders (some again) through the issuance of common stock or selling off "non core" assets to cover losses.

Like the last minutes of "Around the World in 80 Days", banks will now burn the side of the ship with hopes of making it to shore.

Please take note: The game has changed.

as capital raising becomes virtually impossible, with credit markets still largely frozen and deleveraging by security sales actually impossible -- see lehman brothers' duplicitous efforts at closely-held spinoffs disguised as deleveraging -- what is already a manifestly deflationary credit contraction will likely accelerate rapidly as banks are broken up in forced sales or fail outright. i have felt increasingly confident -- here and here most recently -- that debt deflation is the probable resolution of the popped credit bubble we face. i wonder if in fact the next few quarters will not, at some distant date, be seen as one of the most difficult economic periods in the history of the united states.

UPDATE: from a may 19 commentary by institutional risk analytics:

With Q1 earnings releases from most US banks completed, it's time to assess the progression of loan loss rates from 2007 through the first three months of 2008 and what it implies for the rest of the year. ...

... A number of our colleagues have commented recently that credit cards do not seem to be experiencing unusually high default rates, but the results of COF's credit card unit seem to contradict that view. Overall, in 2008 we look for loss rates among all US banks to at least double from the 80bp of defaults reported to the FDIC for 2007.

... We continue to worry about the rate of change in bank default rates going in to Q2 2008 and the rest of the year. We worry that the rate of change in bank default rates may not slow until 2009, a scenario that is pretty close to a worst case scenario for the US economy that sees many US banks at 2x early 1990s levels of loan defaults. If the rate of increase in bank loan defaults accelerates in Q2 2008 for most banks, then all of the proverbial bets are off.

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senator dodd exposed

connecticut democratic senator chris dodd has been at the forefront of crafting housing relief legislation as chairman of the senate committee on banking, housing and urban affairs. just in case you imagined any such bill would be more than a sop to banks, dodd has had his pants taken down in public as the sweetheart deal countrywide cut him has made the new york times, following north dakota democratic senator and budget committee chair kent conrad last week.

At a tense news conference, he flatly denied seeking or receiving any discount from the lender.

But his concession that he never inquired or even wondered whether his special status with Countrywide might be related to his position as a senator prompted a barrage of new questions about the terms of his mortgages and about exactly what he knew and when he knew it.

“Somebody told you you were in a V.I.P. program,” a reporter said, “And you didn’t think you were getting ... ”

Mr. Dodd cut off the reporter and finished the question himself. “A special deal on a loan?” the senator asked. “No.”

... Mr. Dodd said that he was a longtime customer of Countrywide and refinanced the mortgages on his homes in 2003 after shopping for the best deal. Ultimately, he obtained a five-year adjustable rate loan at 4.25 percent for his house in Washington and a 10-year adjustable rate loan at 4.5 percent for his house in East Haddam, Conn.

via housing wire:

There are a ton of old jokes that abound on Capitol Hill around what’s known as the “ostrich defense,” and this is teeing up one for the record books. Senator gets a great mortgage, and is told he’s in a VIP program — but doesn’t think for a minute that being a VIP got him special treatment.

Dodd would apparently have us believe, using that sort of logic, that any Las Vegas high-roller making a casino’s VIP list has no idea they’re getting extra perks, relative to the average Joes that aren’t tossing away $50,000 per visit. Or that a frequent flier with platinum status — read: VIP — has no idea that their access to exclusive travel clubs and seat upgrades isn’t something that’s offered to everyone else. In short, we’d have to be dumb enough to believe that being a VIP doesn’t really mean being a VIP.

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al-sadr still restrained before elections

per juan cole:

The Sadr Movement says it will not oppose the planned military operation in Amara as long as the Iraqi government does not take advantage of it to make arbitrary arrests of its members.

... The USG Open Source Center translates an interview in the Kuwaiti al-Watan newspaper with Dr. Asma al-Musawi of the Sadr Movement, in which she comments on negotiations between the US and Iraqi governments on a Status of Forces Agreement. She confirms that the Sadrists insist that any SOFA be submitted for a national referendum and says that if such a referendum passed the agreement, the Sadrists would accept it. She also confirms that the government of PM Nuri al-Maliki has decided to exclude the Sadrists from the fall provincial elections on the grounds that the Sadr Movement maintains an armed militia, the Mahdi Army. (But the Islamic Supreme Council of Iraq, al-Maliki's current power base, also maintains a militia, the Badr Corps, but it is not being sanctioned for it. Muqtada al-Sadr's recent decisions to turn the bulk of the Mahdi Army into a social service organization and to field candidates only under other party lists appear to be calculated to get around al-Maliki's decision.

so it seems that the reassertion of the mahdi army thankfully never came off, with moktada al-sadr, with the fighting of late march having been curtailed. the economist this week made a cover story of the improvements in iraq, but in the end concedes that, whatever the multifactor analysis of the betterment, all rests on al-sadr.

Another reason for the drop in violence is that the mass movement loyal to a fierce Shia cleric, Muqtada al-Sadr, has also either decided to back off, perhaps just for the time being, or has been beaten back by a mixture of American and Iraqi government forces. Earlier this year, Sadrist violence had risen, culminating in March in a big battle for the southern port city of Basra. At first, the Sadrists seemed to have fended off attempts by the Iraqi army to squash them. The Sadrists' Mahdi Army militias elsewhere in southern and central Iraq and in the eastern slums of Baghdad known as Sadr City rose up in solidarity with their brothers in Basra. From their base in Sadr City, on the opposite side of the Tigris, they subjected Baghdad's Green Zone to a hail of mortar and rocket fire.

But in mid-May they accepted a truce. Since then, the Iraqi army has been able to patrol Sadr City more or less unmolested, uncovering weapons caches and sniffing out leaders of so-called “special groups” of renegade Sadrists who appear to be beyond the control of Mr Sadr himself. The government will get a big boost if it can at last bring basic services into the wretched slums of Sadr City, such as electricity, sanitation and medicine. In Basra too, after an astonishing turn-round, the Iraqi army seems to have bested the Sadrists.

Yet the Sadrists still have a wide base of support, especially among the poor. Mr Sadr himself may be planning to turn his movement into a mainstream political-cum-religious party. The prime minister, Nuri al-Maliki, aiming his wrath at the Sadrists, has said that no party may take part in the provincial elections unless it first disbands its militias. No one expects the Mahdi Army to disband fully—and no one is sure how much control Mr Sadr has over his movement's fractious components. He may manage to persuade most of his militiamen to stand down. But if Mr Maliki seeks to disbar the movement from competing in the elections, the Sadrists may still run as independents—and could yet sweep the board in the south.

so what remains true about iraq is that the dimunition of violence is a product of its internal dynamics -- particularly the decisions of moktada al-sadr and the mahdi army -- and not of external military impositions from the united states. but this is nonetheless the best news, however tentative, to emerge from iraq in some time. if al-sadr sees his avenue to power as a political one and not a military one, iraq has a chance of stability. if not, it doesn't.

as such, provincial elections are approaching and june 30 potentially represents a watershed, as the point whereby iraqi electoral coalitions will be registered. prime minister nuri al-maliki has sought to prevent al-sadr from registering on the pretense of the mahdi army being an illegal militia, even though al-maliki is himself affiliated with his own party militia, the badr brigade. if he and his american supporters succeed in marginalizing the sadrists, there may be a return to violence.

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deflation now in evidence in the UK

there have been a rash of disaster calls among analysts -- what i would take normally as a contrarian setup. on top of both the BIS and AIG's analyst, bob janjuah royal bank of scotland calls s&p 1050 within three months.

but there is something more afoot it seems. as expectations of rate increases get built into the market following manifest central bank inflationary concerns, reiterated by yet another fed governor (this time william poole) yesterday, bond yields have risen and the curve has flattened dramatically -- there is de facto tightening of liquidity in the bond market already.

and it is coming in spite of the first verifiable and overt signal of deflation in the UK. it's picked up by the telegraph, via ft alphaville:

The M4 monetary supply in particular, is plummeting. The headline number - a growth rate of 11.1 per cent - masks a precipitous decline when crisis-driven interbank market factors are stripped out. The M4 growth rate is down year-on-year 16 per cent according to the BoE. That contraction in lending could have a huge impact on the economy - and makes inflationary-killing rate hikes less of a sure path to take for the Old Lady.

i've not seen anyone run a similar stripped-down series of monetary aggregates for the united states, but i would expect exactly the same phenomena is underway here as well (though perhaps not so pronounced, thanks to the policy rate cuts of the federal reserve earlier this year). the upward bent of both the dollar (in a now nascent rally against the euro) and sterling would seem to tentatively corroborate as much. per the telegraph itself:

The M4 money data - which includes a wide range of bank accounts as well as cash - often gives advance warning of major shifts in the economy.

Leading monetarists such as Professor Tim Congdon from the London School of Economics warned three years ago that surging M4 growth would lead to a property bubble and inflation.

This is exactly what occurred, although a surge in global food and oil prices have been a crucial factor.

Mr Congdon say the risk has now inverted as the credit crisis eats into bank lending.

"The money supply is plummeting. This is potentially serious," he said.

... The Bank of England says the overall M4 figure - growing at 11.1pc - is distorted by strains in the interbank markets. Once this effect is stripped out, the M4 growth rate is down 16pc a year ago to 4.5pc in the first quarter.

The money markets have already begun to price in two to three rate rises this year, so some degree of tightening is already happening.

"A rate rise is out of the question. The Bank may soon need to start cutting," said Mr Ward.

The Bank's Governor, Mervyn King, pays close attention to M4 data. This might explain why he has played down the surge in inflation to 3.3pc in May, the highest since the Labour era began.

official optimism at junctures like these is essentially meaningless without rigorous evidenciary support -- i pay little mind to the proclamations of monetary and banking authorities now, given that duress has palpably stressed these folks, however well intentioned they may be, and what james montier calls a "conspiracy of optimism" must be their charted course.

in reality, evidence indicates that -- for all the debt-deleveraging and credit constriction we've already seen -- more is coming, for big banks and smaller banks alike. the effect of monoline downgrades is still in front of us, and liquidity problems are apparently returning to credit markets. the effect on the historically overleveraged consumer is predictable, but the intensity is surprising virtually everyone:

[I]n November ... executives were assuming Americans would buy ... only about 15.5 million [vehicles in 2008]. ... [S]o far in June ... J.D. Power and Associates and Citigroup are seeing a sales pace that is almost 20% lower -- only 12.5 million vehicles per year.

"This is the lowest sales level in 16 years and indicates a significant and continued softening of the U.S. automotive market," Nardelli wrote.
If J.D. Power's forecast for June -- an annualized rate of 12.5 million sales -- continues for long, Erich Merkle of IRN Inc. said, it would be "Armageddon. Doomsday."

under such circumstances, it is exceedingly difficult to commit to a position directly contrary to the most recent institutional converts to market doomsaying.

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Tuesday, June 17, 2008


road to revulsion

how would a deflationary asset-price collapse play out? with the unfettered optimism of banking authorities all the way down -- via john mauldin, societe generale's james montier.

We have seen the heads of virtually all financial institutions stand up over the last few months and claim the worst is behind us. Why would anyone listen to these people? They didn't see the disaster coming, and yet somehow they are qualified to tell us it is all alright! Perhaps I am just unduly sceptical, but this reeks of a conspiracy of optimism. The recession has barely started, let alone reached its nadir. The market moves of late have all the hallmarks of a classic sucker's rally. This isn't discounting the recovery, this is denial! Far from being behind us, the worst may well still be ahead!

unfortunately, i suspect montier is dead right -- we have sailed past the breaking point of the financial institutions that support the market. their engines of profitability such as dominated the last several years (particularly securitization) have largely been dismantled. they ae left in the aftermath heavily overleveraged into securities which are defaulting at unexpected, record and increasing rates. thusfar, they have managed to delay the inevitable by expanding balance sheet with the help of central banks to prevent cascading liquidations and insistently refusing to mark portfolios down to what could really be got for them.

that period of evasion will, however, pass in due time. and what will be left is the continuation, indeed the brunt of a systemic deleveraging which has only just begun in the last year and will take several more quarters to play out. per montier:

... [S]anguinity is likely to be misplaced. The slowdown in the US is barely starting. The charts below show that both the demand and supply for .credit. are evaporating. This effective shutdown of both sides of the market should be a serious concern for monetary policy makers, as it is one of the hallmarks of a liquidity trap situation.

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associated press going the way of the record company

via big picture, tech crunch and calculated risk -- the hubbub regarding the associated press' efforts to intimidate some profitability out of a dying business model.

good luck. in the meantime, i'll join others in trying to direct my links to sources and people who actually want circulation and the profitability that comes with it.



central bank policies pressing limits, increasing friction

i've long wondered about the efficacy of the eurpeam monetary union which produced the euro. for the better part of two millennia, europeans have been periodically attempting to reconstruct the commercial unity of roman empire. none have succeeded, and it's hard to know why the euro should succeed where others have failed.

now that it is faced with real duress -- really its first stress test -- it is interesting to note the sensitivity of geographic, economic and cultural fault lines within the eurozone.

Ordinary Germans have begun to reject euro bank notes with serial numbers from Italy, Spain, Greece and Portugal, raising concerns that public support for monetary union may be waning in the eurozone's anchor country.

Germany's Handelsblatt newspaper says bankers have detected a curious pattern where customers are withdrawing cash directly from branches, screening the notes to determine the origin of issue. They ask for paper from the southern states to be exchanged for German notes.

... People clearly suspect that southern notes may lose value in a crisis, or if the eurozone breaks apart. This is what happened in the US in the Jackson era of the 1840s when dollar notes from different regions traded at different values.

... Inflation touches a very sensitive nerve in Germany. Holger Schmeiding, from Bank of America, said the country had suffered two traumatic sets of inflation in living memory, first in Weimar in 1923 and then in 1948.

"People suffered a 90pc haircut on financial assets in the currency reform of 1948. The inflationary effects of two world wars were catastrophic," he said.

A group of leading German professors warned at the outset of EMU that the euro would tend to be weaker than old Deutsche Mark, and that it would fuel inflation over time. German citizens were never given a vote on the abolition of the D-Mark, which had become a symbol of Germany's rebirth after the war.

Many have kept a stash of D-Marks hidden in mattresses to this day. A recent IPOS poll showed that 59pc of Germany now had serious doubts about the euro.

any monetary union is a compromise between disparate economies. the united states remains under the dollar even though monetary policies do not uniformly address the varying conditions of california, illinois, florida and new york. the difference may simply be one of nationalism -- but that is a very big difference.

however, the dollar zone can reasonably be said to include a wide variety of dollar-pegged economies -- not the least of which is china. and the dollar zone unity too is breaking apart at the seams.

Senior Chinese officials are publicly and loudly rebuking the Americans on their handling of the economy and defending their own more assertive style of regulation.

Chinese officials seem to be galled by the apparent hypocrisy of Americans telling them what to do while the American economy is at best stagnant. China, on the other hand, has maintained its feverish growth.

Some officials are promoting a Chinese style of economic management that they suggest serves developing countries better than the American model, in much the same way they argue that they are in no hurry to copy American-style multiparty democracy.

In the last six weeks alone, a senior banking regulator blamed Washington’s “warped conception” of market regulation for the subprime mortgage crisis that is rattling the world economy; the Chinese envoy to the World Trade Organization called on the United States to halt the dollar’s unchecked depreciation before the slide further worsens soaring oil and food prices; and Chinese agencies denounced a federal committee charged with vetting foreign investments in the United States, saying the Americans were showing “hostility” and a “discriminatory attitude,” not least toward the Chinese.

Chinese officials are expressing their disdain in forums around the world. Last month, Liu Mingkang, the chairman of the China Banking Regulatory Commission, delivered a lecture at the British Museum in London in which he blamed the American government for the subprime mortgage crisis that came close to freezing Western debt markets and required extensive intervention by the Federal Reserve. The turmoil, he said, was “counteracting the course of global civilization.”

“Does moneymaking or doing business justify the regulators in ignoring their duty for prudential supervision and their job of preventing misbehavior?” he said.

One of Mr. Liu’s colleagues, Liao Min, told the newspaper The Financial Times in late May that the “Western consensus on the relation between the market and the government should be reviewed.”

“In practice, they tend to overestimate the power of the market and overlook the regulatory role of the government, and this warped conception is at the root of the subprime crisis,” said Mr. Liao, director general of the commission.

but the heavy ammunition is buried on page two.

... [T]he Americans allowed the dollar to plunge in value. That angered the Chinese, which keeps most of its $1.76 trillion in foreign reserves in dollars. Chinese officials have accused the Americans of mismanaging the dollar at a time when Washington is still pressing China to appreciate the renminbi to narrow the trade deficit.

This month, the Chinese envoy to the World Trade Organization said in Geneva that the United States had failed to safeguard the value of its currency, worsening the pain for people around the world who pay high oil and food prices in dollars.

The envoy, Sun Zhenyu, also said the United States was engaging in protectionism by imposing unfair duties on Chinese goods and subsidizing American products.

Also this month, several Chinese institutions submitted sharp critiques to the Treasury Department of proposed new regulations relating to foreign investment in the United States. Some of the remarks were scathing.

“The regulations still include some sections and procedures which reflect the enshrouded protectionism, an obvious contradiction to the spirit of free competition the U.S. has championed since long time ago,” wrote the China Securities Regulatory Commission.

The commission said the proposed regulations reflected a “self-evident hostility” and “discriminatory attitude” to certain types of foreign investments and “will ultimately hurt enthusiasm of foreign investment in the U.S.

in other words, if you wish to see us continue to finance your current account deficit, you must not threaten us with the soft default of currency devaluation and step in to defend the dollar. or else.

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israel, hamas declare truce in gaza

great news if it holds:

A ceasefire would aim to end rocket and mortar bomb attacks on Israel from the Gaza Strip and Israeli raids in the territory. Israel has said it would continue preparing for possible large-scale military action should a truce fall apart.

Shortly before the Palestinian official said a six-month ceasefire had been reached, Israel launched air strikes that killed six militants in the Gaza Strip.

Israel stopped short of confirming the timing of what it said would be an informal arrangement to halt fighting. An Israeli official said Israeli intelligence chiefs were skeptical a truce could last.

this hopefully is the end of a year-long nightmare in gaza. normalizing relations is a process of many steps, but this is the first one. israel's steps toward a lasting peace with syria, which are ongoing, are certainly enhanced by finding a compromise in palestine -- but of course no outcome can be ruled out in the mideast.

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I am sure that Hamas can be trusted...yeah right.

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nor can israel be trusted -- but trustworthiness is hardly the point. i think both sides long ago showed that ethics has no place in the palestinian question.

what's more important is that neither side can definitively win, while both sides can continue to lose simultaneously.

the only way toward success for both is cooperative -- a point some would say has been obvious for a generation, and yet which the power elite on either side has been recalcitrant to admit.

i'd like to hope that the dynamics within both kadima/israel and hamas/palestine have opened a window for a real reconciliation in spite of the radical destructive elements that both must contend with. the odds of it, of course, are long. but there's no question, i think, that this is the first necessary step for both sides -- if successful, maybe they can take some more together.

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Monday, June 16, 2008


tent cities

sometimes it's quite hard for people to imagine, regardless of the warnings from within the financial community, the possibility of a deep, prolonged, deflationary recession. part of that disbelief is a lack of material signs. abstract monetary indicators are one thing; burgeoning crowd of homeless and dispossessed are another.

so witness, via mish, a disconcerting echo of john steinbeck's okies.

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the PIK-toggle 'debt-bomb'

from the wsj's deal journal:

The buyout boom removed hundreds of stocks from the coverage lists of Wall Street equity research shops. But while private-equity firms have lessened the burden of stock jockeys, their debt-laden purchases have created more work for bond analysts. And a year after the credit crunch ground the LBO craze to a halt, these debt researchers are beginning to digest all this new debt that surrounds them.

And they don’t like what they see.

Standard & Poor’s analyst Diane Vazza issued today the niftily titled report “PIK-tok, PIK-tok, Delaying the Inevitable.” The piece looks at PIK-toggles, the risky debt structure created during the easy-money LBO boom. “Payment-in-kind toggles” allow a company to shut off cash payments and pay interest by issuing more debt instead. While the flexible financing terms allow companies to conserve cash during stress periods, Vazza writes that “for firms with poor financial prospects, the issuance of PIK-toggle notes might only be delaying the inevitable and could likely deteriorate the recovery prospects for non-PIK debt holders.”

Vazza singles out Welsh Carson’s buyout of U.S. Oncology as a poster child for the problematic situation where companies exercise the toggle feature when earnings are declining. The health-care outfit flipped the toggle switch on during the first quarter, at a time when its pretax earnings declined 37.5% from the year-earlier period.

The S&P report follows one issued Thursday by the debt analysts over at Fitch, who also are none too keen on the crop of LBO deals done from 2004 to 2007. They looked at about 200 “golden age”-era LBOs and concluded that the credit quality of these companies has “visibly eroded” since last summer.

“The risk of default is rising,” they write, sounding a warning bell for the roughly $450 billion of LBO-linked leveraged loans that came to market in those halcyon days of yore. About half of the companies they analyzed had a negative outlook or were on review to be downgraded (with only 3% having a positive outlook).

The report leads off by mentioning the high-profile bust of Apollo’s Linens ‘n Things, and suggests that Linens could be the tip of the default iceberg in retail/consumer land. Consumer cyclical LBOs, which account for about a quarter of the companies Fitch examined, are “particularly sensitive to the type of macroeconomic weakness and consumer retrenchment the US economy is currently experiencing.”

just another, less publicized aspect of the potentially catastrophic debt bubble-and-unwind we are now facing. commenter darkcloud offered this note from financial sense, which cites through the banking times the june 2008 quarterly review published by the bank of international settlements. the BIS has (to its credit) been sounding the alarm on an underestimated potential for disaster for more than a year. the view is gaining adherents, it seems -- yves smith passes on the comments of stricken insurer AIG's analyst bernard connolly, who discourses on a "crisis of capitalism" and warns against raising policy rates. says smith:

While I am not certain I agree fully with Connolly's analysis, I do think the Fed has cut too deeply, too fast. As much as it would be better for rates to be higher, I'm not certain if we can get from A to B right now. The financial system is a mess. For instance, banks for some time have been well behind on foreclosures; it appears this is by design, so as not to alarm the public and shareholders. Similarly, the Bank of England says banks are hoarding cash, another sign of fragility. The Fed somehow hoped that banks would recapitalize in this window of improved market conditions, but they haven't to even remotely the degree necessary, and the losses in the pipeline are probably worse than the Fed has been willing to admit to itself.

As much as I don't like coddling banks, my sense is things are far more precarious than they appear. I'd rather see the Fed sit tight for three or four months and see if demand destruction due to high oil prices and a cut in subsidies in developing countries (particularly China, which has said it will lower supports and may take action after the Olympics) puts some downward pressure on oil prices.

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Friday, June 13, 2008


batten down the hatches

well observed by the lowry letter, which i never wish to quote at any length, particularly as regards proprietary data -- go subscribe. it's the best market timing newsletter.

One factor that makes this bear market somewhat different than most, is that it includes a recently ended two month rally. A review of only those bear markets during the past 80 years that included a rally lasting two months or more (1929-’32, 1946-’49, 1969-’70, 1973-’74, 1981-’82, 2000-’03) reveals that those bear markets have commonly contained a number of multi-month rallies (false starts) before reaching their final bottoms. These bear markets also tended to last longer and produced deeper losses than the average of all bear markets. We recognize that, as Mark Twain said, “history does not repeat, but it often rhymes.” Even if the present case simply rhymes with the past 80 years, investors may have to get accustomed to a strategy of narrowly structured equity portfolios in an atmosphere of intermediate rallies followed by new lows.

this rally is fit for fading, it seems to me. it's further interesting to note that bond market problems have returned, via across the curve.

Conversations with Treasury traders tell me that a degree of illiquidity has crept back into the treasury market as well as other markets. One factor worth noting is that we are approaching June 30 quarter end and traders will be enjoined to keep the balance sheet sleek and spare. The practical consequence is that traders can not and will not hold positions. Bid to offer spreads have elongated and when a trader gets hit or lifted, he quickly resolves the trade in the brokers market. I have heard similar comments from a salesman who actively hawks derivatives and this morning a mortgage portfolio manager at a state fund noted that the improvement in liquidity post Bear Stearns had evaporated. It is not quite as bad as it was in March but the significant improvement in trading capabilities has faded.

stir evenly, apply medium heat and then add a `Big Nose Dive' in Consumer Spending, as forecast by gary shilling via bloomberg and barry ritholtz. "we're looking for the biggest decline in consumer spending of any recession since the 1930s." serves all of us, i fear.

particularly enlightening is shilling's equation (in the last 30 seconds) of china today with japan 1989, where once everyone in the western world was frightened mindless of japanese world domination. sign me up -- i think china remains an excellent short even following a massive decline.

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nice posts - - thanks.

here's some scary truth back at ya:

(excerpt) Central bank body warns of Great Depression -

The Bank for International Settlements (BIS), the organisation that fosters cooperation between central banks, has warned that the credit crisis could lead world economies into a crash on a scale not seen since the 1930s. In its latest quarterly report, the body points out that the Great Depression of the 1930s was not foreseen and that commentators on the financial turmoil, instigated by the US sub-prime mortgage crisis, may not have grasped the level of exposure that lies at its heart.

from: Run for the Trees-BIS and the Black Swans by John Needham, The Daniel Code Report | June 13, 2008



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