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

Saturday, November 29, 2008


rally aftermath

i tend to think (along with many others) that some sort of intermediate market low was put in last week. but i'm also extremely wary -- for it seems to me that the proper analogue for what we are now observing is neither 1929 nor 1987 (20th c stock market collapses of comparable volatility) but 1931-1933, the period of prolonged banking sector delevering and liquidation which made the great depression great.

what we've seen from february 2007 through september 2008 (a stretch of some 19 months) is, it seems to me, similar to the suspenseful period between the collapse of the investment trust stock ponzi scheme in september 1929 and the initiation of the bank liquidation spiral in late 1930. as then, most every effort rendered conceivable by the current philosophical paradigm has been made in the interlude to support the failing capital structure of the economy and key financial sector components -- and, as then, those efforts have resulted in what might charitably be termed "ambiguous" results. things might be worse had nothing been done; but they are bad now and getting worse, with the net effect of intervention perhaps being nothing more than a delay in the reckoning.

in any case -- from a trading perspective, the issue of the moment is to try to contextualize the strong price rally which has proceeded from recent lows. i used the dow industrials because the data stretches back to 1915; the DJIA has rallied 18.1% from the intraday low to the close of the fourth day following, which is one of the twenty strongest such rallies in the dataset.

grouping all rallies of 13% or more by date is somewhat instructive. shaded groups are separated by more than 20 days. the table lists the high tick and low tick from today's close over the next 10, 20 and 50 sessions.

what can we say on this data? most likely, there will be a close below where we are today.

however, this second table shows the low tick of the forward 10, 20 or 50 day period from the low-tick initiation of the rally. as you can see, it's quite rare that, over the next 50 days, we would see a new low.

one could surmise, then, that we'll probably see retracement -- but are very unlikely to see a collapse over the next 50 days.

UPDATE: via barry ritholtz, some excellent perspective from doug short.


I'm curious as to your personal assessement of the likelihood of a US stock market stagnation and ongoing decline similar to Japan's over the last 19 years. I know you are aware of the many similarities (and differences) based on links you have commented on such as Koo's balance sheet recession PDF.

I ask in part because the implication I read [perhaps incorrectly] into many of your stock market posts is the assumption of later lows perhaps coming eventually but generally an uptrend ahead of us.

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i think economic stagnation and therefore stock market doldrums (at least in real terms) are just about inevitable, and the stage is certainly set for years of delevering.

but i also think, hbl, from an asset-ownership POV, that it is important to remember that even these sociological debt-repudiation watersheds contain big bull runs within the downtrend. just as secular bulls have cyclical bears entrained, so the opposite is true. such was certainly the case in japan's delevering.

and i further think we might be on the cusp of such an entrained cyclical bull. it may not last long (months?) but it could be very powerful.

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Wednesday, November 26, 2008


more on repo fails

following up on last month -- via paul kedrosky -- this euromoney article discusses the accelerating rate of failures to deliver on treasury repo agreements even in the face of government jawboning to quell the issue.

THE US TREASURY market, the foundation of government bond and corporate bond markets worldwide, is suffering a crisis of confidence at the worst possible moment. ...

There is an even more pressing concern for many participants in this increasingly swollen market: the settlement system has broken down. Following the collapse of Lehman Brothers in September, fails to deliver among the 17 primary dealers in the US treasury market have rocketed to more than $2 trillion over a period of weeks and still lie above $1.3 trillion. Broker/dealers have stopped delivering bonds. Holders of US treasuries are now scared to lend into the repo market in case their bonds are not returned, and potential buyers sit on the sidelines fearful of handing over their money to a counterparty that at best might not deliver a bond on time, and at worst might go under.

... As a result of fails to deliver, the most transparently priced instrument available now has investors scratching their heads. The natural balance of supply and demand has been altered and the true price of treasuries has become obscured. The effects are being seen across other bond markets. “The TIPS (Treasury Inflation Protected Securities) market is also clearly broken,” says Pond. “An obvious trade right now would be to go long TIPS where real yields are high and short the nominal bond in a breakeven inflation trade but hedge funds are fearful that if they go through the repo market the borrow could fail. So we have a situation now in the 10-year TIPS where the market is pricing in zero or negative average inflation for the next 10 years. Inflation has not been that low since the 1930s.” Economists also claim that fails have spread across to other bond markets such as municipals, agencies, mortgage-backed and corporate bonds.

Why the Federal Reserve is not urgently considering regulation is bewildering. As yet, the US Treasury has merely asked for market participants to sort out the situation themselves. That might help reduce fails but it will not eliminate them, and in panic periods they will simply creep back up. The global economy has significantly contracted since the collapse of Lehman Brothers, which spurred the fails to deliver. More market-shocking events are certain to lie ahead. The solution is simple – delivery needs to be enforced, and liquidity returned. If not, confidence in the US treasury markets will be lost. Loans made using treasuries as collateral will be reconsidered, bond markets priced off treasuries will further dry up and, with equity markets so volatile, central banks and investors will not know where to turn.

Fails to deliver in the treasury markets are not a new phenomenon. There is data for fails for treasuries, agencies and mortgage-backed securities as far back as 1990, says Susanne Trimbath, an economist, and former employee of the Depository Trust Co, a subsidiary of Depository Trust and Clearing Corp.

Back then, though, there would be $50 billion of fails in a whole year, she says. That figure has grown enormously. Failures in US treasuries were 8.6% of all treasuries outstanding in the first five months of this year, compared with 1.2% in the first five months of 2007. That has ballooned further over the past three months, hitting more than $2 trillion for almost the entire month of October – more than 20% of the daily treasuries trading volume.

What the treasuries market faces now, at this critical moment, is the consequence of long neglect of some murky aspects of short-term tactical trading in government bonds. ... For years, efforts by the US Treasury itself to formally resolve the growing fails issue have been brushed aside by market participants as unnecessary.

if naked stock shorting is supposed to be an issue, one would think that naked treasury shorting would receive the brunt of government anger. but the treasury itself is such a thoroughly captured institution under the rule of the predators of the bush administration that it seems impossible to imagine a regulatory crackdown when investment banks are likely the preponderant beneficiaries of repo fails. this regulatory issue too, it seems, will roll over to the obama adminstration in wait of an adult hand of discipline.

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consumer contraction continues

via clusterstock, read in on what mastercard is seeing in november e-commerce -- heretofore an only-growth-and-by-leaps-and-bounds division of the economy.

In case you missed it, for the first 23 days of November, eCommerce spending shrank 4% year-over-year. Shrank! This is was a healthy, emerging industry that, six months ago, was growing 15% year over year.

But that's not the half of it. Check out these numbers from MasterCard about ecommerce and overall consumer spending, courtesy of analyst Brian Pitz of Bank of America: ...

eCommerce declines of 7.5% Y/Y reported. For the first time in the industry's history, data indicates eCommerce in the U.S. could post a decline for the quarter. MasterCard Advisory, a division of MasterCard Worldwide, has reported eCommerce spending for the first two weeks of November has declined 7.5% when compared to the same period in 2007. We note the source also showed a decline of 3.9% in October, compared to the comScore estimate for growth of 1.3% Y/Y for that month. We currently estimate 4Q U.S. eCommerce growth of 1.9% Y/Y and are watching for data points as they become available.

Offline retail data shows double-digit declines in several categories. MasterCard Advisors reported that for the first two weeks of November, overall apparel declined 19.0% Y/Y, while electronics declined 22.1% Y/Y and luxury goods declined 21.1% Y/Y. These declines are slightly worse than reported October declines.

These declines aren't just "slightly worse" than October. They're terrifying.

add to that the ongoing durable goods orders collapse, and you have what might well be a nascent depression.


Tuesday, November 25, 2008


montier a bull

via bloomberg:

“With all of these opportunities available I have never been more bullish!” he wrote. “Will I be early? Almost certainly yes, but if I can find assets with attractive returns and I have a long time horizon I would be mad to turn them down.”

this is not a terrible shock as his teammate at socgen, albert edwards, was seeing better days in late october. and they can side with jeremy grantham.

these are some rational big-picture pessimists of the last several years getting constructive, and it would be silly to ignore them. they've all expressed the conviction that they are likely early, and that markets can and probably will trade lower going forward (as is the probability assessed by the lowry report). but i am getting long today on the heels of quantitative easing and the achievement of s&p 750. keeping stops tight, however.

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fed starts buying mortgage-backed securities

no longer just loans -- this is real quantitative easing. via the ft:

The Federal Reserve announced on Tuesday that it will initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises (GSEs)–Fannie Mae, Freddie Mac, and the Federal Home Loan Banks–and mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae. Spreads of rates on GSE debt and on GSE-guaranteed mortgages have widened appreciably of late. This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally.

And so it begins. Bernanke’s Fed is buying — not just borrowing — mortgage securities. In a huge way too - $500bn in MBS and $100bn in GSE obligations.

The question being: who needed the TARP bailout package, when the Fed could have just done this all along? (Inferred answer: it was a political sop, now that the climate on capital hill has changed, bailouts are de rigueur)

Immediate effect: expect a rally on the ABX.

The Fed is pushing further and further towards a Bank of Japan-like quantitative easing strategy. Purchasing, directly, troubled assets being yet another plank of the BoJ’s plan that Bernanke is replicating.

Financing implications are not yet clear. Either this will result in even more Treasury issuance or, more likely, it will be funded from the Fed’s increased balance sheet without sterilisation, meaning more imbalance in the monetary supply.

clearly the fed has noticed the further acceleration fo housing declines.

the dollar reaction was quick, but we will have to see how the fed competes against the deflationary collapse of credit and therefore monetary velocity. BoJ got a decade of deflation in spite of such policies. they can suck agency MBS out of the system and lower agency rates, but they cannot force anyone to either lend or borrow -- and the psychology of the boom has clearly turned.

as was noted earlier this month as the warmup to quantitative easing became apparent, watching excess reserves on the fed balance sheet will be essential to figuring how (in)effective money printing will be. until now increasing bank liquidity through special repo facilities has resulted, in the face of tightening credit standards and borrower debt aversion, not in significant credit growth but only in massive piles of excess reserves on deposit at the fed -- as of november 20 in the amount of $633bn, as seen on the fed's H.4.1 release, up $624bn on last year at this time.

UPDATE: the result -- a 75 bps one-day dive in mortgage rates.

UPDATE: more and optimism from clusterstock -- at least short-term optimism. with no obvious exit strategy, however, it may be too early to tell.

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It's time to restart the world economy. What a great time to do it. It's sad that a few thousand people control this world of billions.

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house price declines still gathering speed

via ft alphaville, the most recent case-shiller report.

All three aggregate indices and 13 of the 20 metro areas are reporting new record rates of decline. Looking at the returns of the U.S. National Index, prices are back to where they were in early 2004. As of September 2008, the 10-City Composite is down 23.4% from its peak, the 20-City Composite is down 21.8% and the National Composite is down 21.0%.

adds the ft:

The rate of declines measured on a quarterly basis has also accelerated, suggesting earlier optimism about a ‘floor’ for house prices was overblown.

with downside momentum in house prices still growing in force some three years from the peak, i find it very difficult to imagine that we are anywhere near a floor in not only the problems of housing and homebuilders but banking and financial services.

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Perhaps we're falling off the continental shelf and plunging to the deep ocean bed.

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Monday, November 24, 2008


grantham on video

via paul kedrosky -- with conseulo mack

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deflating the CDS bubble

chris whalen of the institutional risk analyst has written -- as previously noted here and here -- on what i find to be compelling insights onto how the credit default swap market is destroying the liquidity environment upon which the global financial system floats.

today whalen critiques the selection of tim geithner to be treasury secretary under barack obama, citing specifically the role that geithner has played as president of the new york fed in either missing the significance of the CDS problem or refusing to attack it in the forms of bear stearns and AIG, which has in nationalization become a seemingly-endless sinkhole of CDS payouts -- and analyzes the foreboding outcomes that lay before us as real commercial defaults begin to rise.

Few observers outside Wall Street understand that the hundreds of billions of dollars pumped into AIG by the Fed of NY and Treasury, funds used to keep the creditors from a default, has been used to fund the payout at face value of credit default swap contracts or "CDS," insurance written by AIG against senior traunches of collateralized debt obligations or "CDOs." The Paulson/Geithner model for dealing with troubled financial institutions such as AIG with net unfunded obligations to pay CDS contracts seems to be to simply provide the needed liquidity and hope for the best. Fed and AIG officials have even been attempting to purchase the CDOs insured by AIG in an attempt to tear up the CDS contracts. But these efforts only focus on a small part of AIG's CDS book.

The Paulson/Geithner bailout model as manifest by the AIG situation is untenable and illustrates why President-elect Obama badly needs a new face at Treasury. A face with real financial credentials, somebody like Fannie Mae CEO Herb Allison. A banker with real world transactional experience, somebody who will know precisely how to deal with the last bubble that needs to be lanced - CDS.

Last Thursday, we gave a presentation to the New York Chapter of the Risk Management Association regarding the US banking sector and the long-term issues facing same. You can read a copy of the slides by clicking here.

As part of the presentation (Page 17-21), IRA co-founder Chris Whalen argued the case made by a reader of The IRA a week before (see "New Hope for Financial Economics: Interview with Bill Janeway,") that until we rid the markets of CDS, there will be no restoring investor confidence in financial institutions. Here is how we presented the situation to about 200 finance and risk professionals in the auditorium of JPM last week. Of note, nobody in the audience argued.

  1. Start with the $50 trillion or so in extant CDS.
  2. Assume that as default rates for all types of collateral rise over next 24-36 months, 40% of the $50 trillion in CDS goes into the money. That is $20 trillion gross notional of CDS which must be funded.
  3. Now assume a 25% recovery rate against that portion of all CDS that goes into the money.
  4. That leaves you with a $15 trillion net amount that must be paid by providers of protection in CDS. And remember, a 40% in the money assumption for CDS is VERY conservative. The rise in loss rates for all type of collateral over the next 24 months could easily make the portion of CDS in the money grow to more like 60-70%. That is $40 plus trillion in notional payments vs. a recovery rate in single digits.

Q: Does anybody really believe that the global central banks and the politicians that stand behind them are going to provide the liquidity to fund $15 trillion or more in CDS payouts? Remember, only a small portion of these positions are actually hedging exposure in the form of the underlying securities. The rest are speculative, in some cases 10, 20 of 30 times the underlying basis. Yet the position taken by Treasury Secretary Paulson and implemented by Tim Geithner (and the Fed Board in Washington, to be fair) is that these leveraged wagers should be paid in full.

Our answer to this cowardly view is that AIG needs to be put into bankruptcy. As we wrote on The Big Picture over the weekend, we'll take our cue from NY State Insurance Commissioner Eric Dinalo and stipulate that we pay true hedge positions at face value, but the specs get pennies on the dollar of the face of CDS. And the specs should take the pennies gratefully and run before the crowd of angry citizens with the torches and pitchforks catch up to them.

President-elect Obama and the American people have a choice: embrace financial sanity and safety and soundness by deflating the last, biggest speculative bubble using the time-tested mechanism of insolvency. Or we can muddle along for the next decade or more, using the Paulson/Geithner model of financial rescue for the AIG CDS Ponzi scheme and embrace the Japanese model of economic stagnation.

... By embracing Geithner, President-elect Barack Obama is endorsing the ill-advised scheme to support AIG directed by Hank Paulson et al at Goldman Sachs and executed by Tim Geithner and Ben Bernanke. News reports have already documented the ties between GS and AIG, and the backroom machinations by Paulson to get the deal done. This scheme to stay AIG's resolution cannot possibly work and when it does collapse, Barak Obama and his administration will wear the blame due through their endorsement of Tim Geithner.

The bailout of AIG represents the last desperate rearguard action by the CDS dealers and the happy squirrels at ISDA, the keepers of the flame of Wall Street financial engineering. Hopefully somebody will pull President-elect Obama aside and give him the facts on this mess before reality bites us all in the collective arse with, say, a bankruptcy filing by GM.

You see, there are trillions of dollars in outstanding CDS contracts for the Big Three automakers, their suppliers and financing vehicles. A filing by GM is not only going to put the real economy into cardiac arrest but will also start a chain reaction meltdown in the CDS markets as other automakers, vendors and finance units like GMAC are also sucked into the quicksand of bankruptcy. You knew when the vendor insurers pulled back from GM a few weeks ago that the jig was up.

... As Bloomberg News reported in August: "A default by one of the automakers would trigger writedowns and losses in the $1.2 trillion market for collateralized debt obligations that pool derivatives linked to corporate debt… Credit-default swaps on GM and Ford were included in more than 80 percent of CDOs created before they lost their investment-grade debt rankings in 2005, according to data compiled by Standard & Poor's."

At some point, Washington is going to be forced to accept that bankruptcy and liquidation, the harsh medicine used with other financial insolvencies, are the best ways to deal with the last, greatest bubble, namely the CDS market. When the end comes, it will effect some of the largest financial institutions in the world, chief among them Citigroup (NYSE:C), JPMorganChase (NYSE:JPM), GS and MS, as well as some large Euroland banks.

The impending blowback from a CDS unwind at less than face amount is one of the reasons that the financial markets have been pummeling the equity values of the larger banks last week. Any bank with a large derivatives trading book is likely to be mortally wounded as the CDS markets finally collapse. We don't see problems with interest rate or currency contracts, by the way, only the great CDS Ponzi scheme is at issue - hopefully, if authorities around the world act with purpose on rendering extinct CDS contracts as they exist today. Call it a Christmas present to the entire world.

Indeed, as this issue of The IRA goes to press, news reports indicate that C is in talks with the Treasury for further financial support under the TARP, including a "bad bank" option to offload assets. [no bad bank, but C has been bailed -- gm.] A bad bank approach may be a good model for applying the principle of receivership to the too-big-too fail mega institutions, but the cost is government control of these banks.

Q: Does a "bad bank" bailout for C by Treasury and FDIC qualify as a default under the ISDA protocols!?

We've been predicting that Treasury will eventually be in charge of C. On the day the government formally takes control, we say that Treasury should and hire FDIC to start selling branches and assets. Thus does the liquidation continue and we get closer to the bottom of the great unwind. Stay tuned.

it rather begs the question of what will happen if speculative CDS are not torn up and geithner leads the next administration on a quest to provide liquidity enough to settle everything at face. peter schiff might have that exactly right -- in time, when the deleveraging slows, the dollar could be in for a savage collapse. further, yves smith cites the ft's wolfgang munchau on quantitative easing and the probability of "successful" central bank resolutions to deflationary economic conditions leading directly to a dollar currency crisis for a country highly dependent on foreign credit.

The US policy establishment regards this crisis principally as carrying a “one-tailed”, or one-sided, risk of a deflationary depression, to be avoided at all costs. But there are also grave risks associated with making a type-two error. A subsequent rise in US inflation could trigger a mass flight out of dollar assets and a large rise in US market interest rates, followed by a huge recession. The main difference is that the policy options would be a lot more constrained under such a scenario. In fact, a type-two error could also give rise to a depression – only later. I still think it is best to treat the crisis as an event with a “two-tailed” risk.

says smith:

... [T]he Fed seems worried solely about deflation, and not about a possible US currency crisis. This is a shocking oversight. The Fed (and many others) keep drawing analogies between the US in the Great Depression and its situation now. That is flawed and dangerous.

The US was a massive creditor before the Depression and ran a very large trade surplus, to the point where the gold accumulation by the US was destabilzing to the world financial system. Sound familiar? That is the role China plays now, not the US.

What happened to the nations that were in the US's shoes at the onset of the Great Depression, the overconsuming, indebted European customers of the US? They devalued their currencies, defaulted (or partially defaulted and forced a renegotiation) on foreign debts, and suffered milder downturns than the US did.

But the authorities are not even considering the possibility of debt default or a dollar crisis in their plans.

reading garet garrett while substituting the appropriate parties makes for some morose reading.

should the fed see its way clear to following on whalen's advice -- admitting that supporting the entire CDS construct could result in a highly counterproductive typ-two error, and thereby finally employing bankruptcy as an aid in unwinding the bubble -- this probability would diminish radically.

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citi bailed for now

a smallish package for a bank with immense problems. citi stock is priced as an option and is predictably much higher, but for how long?

as david merkel notes, the problems are not going away and as the other TBTF banks come calling it will present a stress test of the credit of the american government. but in the shorter term -- citi is carrying about $3.3tn in assets on and off their balance sheet. what is $20bn in preferred to that? indeed, what is loss mitigation on $300bn of assets to that? this looks to me a bandage built to buy time for a bank circling the drain, not the surgery and recovery needed to heal the patient.

that opens a line of speculation. if citi won't be allowed to fail, why isn't the deal enough to put its safety beyond doubt? there are several possible reasons, but i'd sadly suspect first that it is because the government is in a bit of denial, still does not comprehend the seriousness of what is happening and just how many multiples of its capital citi has frittered away. and it is probably getting plenty of help in that delusion from citi itself, whose executives have unfortunately demonstrated either their lack of comprehension or the depth of their malevolent predatory drive from the start.

UPDATE: i see i'm not alone in that assessment.

UPDATE: in john hempton's note on a citi prepack bankruptcy -- which is centered on a painful but ultimately necessary debt-to-equity conversion -- he included a liquidity provision that looks much like what the government has done here. citi will be able to repo the guaranteed assets with the fed, increasing its ability to stay afloat. but this again is testament to the view of this crisis as one of liquidity and not solvency -- in other words, it adds weight to the idea that the government doesn't get it, or is at least merely kicking the can down the road.

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Friday, November 21, 2008


a bubble that broke the world

via -- garet garrett's tome on the debt mania of the 1920s.

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the death of citi

citi has been spiralling for days, and it looks like it could be taken over this weekend in spite of gary crittenden's happy talk.

the big question is "how?" clusterstock forwards john hempton's critique of what an FDIC takeover might look like.

It is open to Sheila Bair (and her fellow regulators) to seize Citigroup (deeming it unsound) and to leave at the holding company – and worth near zero – all the equity, preferred shares and holding company debt obligations. Indeed this is precisely what she did at Washington Mutual. What she did once she might do again.

This will in fact result in a full successful resolution of the Citigroup problem at no cost to the government from Citigroup. There is a darn strong case for doing it.

There are 17.5 billion in short term parent company debt and 117.5 billion in parent company debt with more than a year’s maturity. There are a further 27.4 billion in perpetual preferred securities and 28.5 billion in subordinated debentures.

If Sheila Bair confiscates Citigroup and leaves all those liabilities at the holding company then it is economically the equivalent of a 184 billion dollar equity injection into the remaining group. A cancelled liability of course is the equivalent of new (non cash) capital.

The new Citigroup should be adequately capitalised – albeit government owned. The FDIC could IPO the new Citigroup once this market mess had died down (and remit most the proceeds to former bond holders). A shrinking Citigroup with an additional 184 billion in capital shouldn’t cost the government anything. ...


And you knew there would be a but…

If Sheila Bair was to confiscate a really big bank and cancel all the parent company liabilities then no other bank in America would be able to raise parent company debt. Indeed I think that has been the case ever since Sheila Bair did the reckless and irresponsible takeover of Washington Mutual… but it would certainly be the case if the parent company liabilities of Citigroup were cancelled.

And that would be a huge decision indeed because then every bank with parent company liabilities (meaning almost every bank in North America) would fail.

Many – but not all – could be taken over in the same fashion at little cost to the government. But almost all of them would wind up property of the US Government.

Full nationalisation, Swedish or Norwegian style, is an effective end to a financial crisis – and Sheila Bair has the power and has proved that she is willing to use it. But it is a decision way above her pay grade. (Where is President Obama’s new Treasury Secretary?)

... Postscript 2: Actually I think the die was cast for Citigroup when Sheila Bair confiscated WaMu. The lesson was learnt that bank debt could be treated very unfairly by regulators and hence banks were never going to be able to get finance again. The worst decision of this cycle was to let Lehman fail so badly - creditors got very scared. The second worst was the reckless way in which creditors of WaMu were treated - it made them even more scared.

don't look now, but shares of jpmorgan chase are falling precipitously as well as it bank of america. JPM is my TBTF home, and BAC is banker to half of american households.

UPDATE: hugh hendry of eclectica:

"All financials will be owned by the U.S. government in a year," Hendry said. "I bet you."

at least citi will have company.

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profound new depths of delevering

the ongoing disaster in the equity market is the lesser part of the devastation -- like the proverbial iceberg, it's the highly-visible but minor part of the whole thing. the credit markets are now enduring some of the most amazing liquidation symptoms ever seen.

for example, massive liquidation of agency debt held by overseas investors has driven agency spreads to treasuries to all-time and previously inconceivable highs. asian central banks have clearly decided to vacate the GSEs, and that will have further severe ramifications for a housing sector that even with GSE support is dying (though to be sure the treasury may force-feed the mortgage market through the conservatorship). the financial times offers this stunning commentary regarding china:

Dresdner, in a note out today, observes that it won’t be long before all the world’s big central banks are operating a Zirp: that is, a zero interest rates policy.

There’s one economy, though, for which a Japan-style recession is of particular significance to the world. And no, we’re not talking about the US.

Writes Dresdner’s Peter Tasker (HT he also, for the headline):

China’s jumbo fiscal package is eerily similar to Japan’s 1990s stimulus plans, which totalled Yen 100 trillion, 20% of GDP. Japan’s attempt to bolster already excessive levels of fixed asset investment failed. China must take radical measures to raise the consumption share of GDP or face a long and painful adjustment.
Japan was, like today’s China, an economy with a structural surplus of savings. As with China, super-easy monetary policy generated an investment-led boom and an explosion in financial asset prices. As the bubble inflated, investment rose to an unsustainably high proportion of GNP and consumption fell to historically low levels. The opposite phenomenon took place in the economies of key trading partners, which were undersaving and over-consuming.

When the inevitable happened and Japan’s financial bubble burst, the authorities understood that a rapid deflation of the fixed asset investment bubble would risk a depression. Hence the strategy of replacing corporate capex with government-led big projects. …

Is China following the same path? It certainly looks that way.

What significance this? Well, only the fact that the world economy has grown pretty dependent on China’s fixed-asset habit. ...

As FT Alphaville observed yesterday, the stability of the US - and its ability to whether a crippling depression - is dependent on dollar inflows. Foreign buyers have already turned away from anything but Treasuries.

China - as of only last week - is now the world’s largest holder of Treasury bills. If Dresdner is right, and China will be forced to reevaluate that hard-won position, then who knows what will happen.

further -- and perhaps even as ominously -- observe what is happening in swap spreads, where what was only recently thought to be a mathematical impossibility -- that the market would offer long-term fixed rates at a significant discount to floating rates -- is an ever-deepening reality. david merkel noted:

... long duration managers (pension plans, life insurers) have for some reason felt forced to buy fixed-rate promises through the swap market, rather than buying zero coupon bonds, the longest of which yield more than 3.5%, considerably more than swap rates. Anyone holding a position to receive 30-yr fixed, pay floating saw it appreciate by 9-10%, which is pretty amazing.

the invaluable john jansen offers an explanation for what is happening here.

I just spoke with an options trader about this historic move. He said that there structured product trades buried in trading books all over the world which are melting. There is a massive short in the 30 year sector (in Treasury paper and in the swap market) which resulted from sales of cheap volatility. Some of these positions have been on the books of various entities for years and it is only recently that the chickens have come home to roost. Each time the spread turns more negative, that movement forces some one to receive in swaps to hedge there position. There are short the long end trades in every permutation and combination along the curve. The receiving creates a self fulfilling prophecy which compels someone else to receive. He had no opinion on when this would end.

in essence, if i understand the dynamic (which is questionable), underfunded pension funds are being compelled to buy fixed long-term treasury yields because they are being hurt killed slaughtered on the titanic piles of shorter-duration structured finance they have bought over the last five years in an effort to grow their way into an ability to meet the obligations of retired workers. CMBS have this week followed RMBS and CDOs and LBOs and corporates down the toilet -- all of the above being now severely illiquid. they are in the swap market most likely because they no longer have the balance sheet to, as merkel noted, buy bonds directly, and cannot make room by sales because there is no sizable bid.

if institutional money is in this kind of pain and being pushed to the wall, there may be yet more frightening deleveraging to come in short order.

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Thursday, November 20, 2008



save us godwhat kind of comment is one supposed to offer in response to this?

courtesy of calculated risk with an ad hoc update to reflect today's further (-6.7%) decline.

the crash hit 747.78 in the s&p -- forcing an 11-year closing low at 752.44. this was my price target from october 3 based on jeff cooper's fractal comparison. the worst should be over, but even with the s&p now down (-50.9%) (-51.9%) from its high of 1523.57 and kevin depew on board it's hard to want to step in.

it is, as noted by cr, now the most severe market crash since the great depression.

UPDATE: traders narrative links to a presentation by the lowry report (my "newsletter", which has paid for itself many times over) regarding the onging bear, including a chart-laden .pdf illustrating their supply and demand measures. the prognosis: put bluntly, no end yet in sight, indeed an intensification of deleveraging.

  • during highly volatile days Oct 15, 16, 21, 22 and Nov 5, 6, selling pressure continued to rise
  • buyers not using trading range or volatility to step up and accumulate shares while sellers remain active
  • Nov 19th 2008 took buying power -10 to 127 and selling pressure +12 to 906, an all time high
  • very rare to see market bottom when selling pressure is at all time high

hopefully, with prices now at new lows, demand will materialize -- from where i'm not sure, but hopefully. if not, we will go lower.

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The scary thing is, I don't think we've seen true capitulation yet.

I had a sense there would not be a bounce today because everyone was waiting for the rally.

If it fails to come tomorrow, we may see a huge sell off the next two days (Friday and Monday).

And does anyone really want to hold over a holiday weekend next week?

My biggest regret is selling SRS at $158 last Thursday. Oh well.

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yah, to think i actually cleared off my shorts last week and went long for, oh, about 20 minutes before hitting my stops. but at least there were stops.

now, however, the market is again so oversold that it could scream higher on the least provocation -- clearly not an ideal short entry position, so i sit in cash. which is not bad.

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make it stop gm, make it stop

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richard russell

via prieur de plessis at minyanville -- this as a sort of waymarker. russell is 84 and has been editing the dow theory letters since 1958. he was five years old in 1929.

Here's what Richard Russell (Dow Theory Letters) -- one of the few market commentators with first-hand experience of the Great Depression -- has to say:

The market is warning of a coming depression. Next year there’ll be a huge problem of unemployment, job openings will have disappeared, and every business will be going over its personal thinking in terms of who the business can do without.

The sentiment in the country will be dark grey to jet black. Fortunes will have been wiped out. Thousands of savings plans and 401Ks will have been shattered. Americans who have never experienced true hard times will be living hard times. Confusion and fear will be rampant. How do I know all this? I’ve been here before, I know the signs.

i'm not sure what to make of this kind of pessimism, though i surely agree with him. just today i commented at david merkel's blog:

i would suggest that — while the financial crisis shares features with many financial crises, including 1907 — the economic features have unfortunately little in common with such sanguine views. the financial crisis was a trigger, a detonator, for something else.

mr merkel’s emphasis on total debt-to-GDP is essential in my view — that is the lodestone by which we’ll find our way out of this. and it is further essential to understand the consumer aspect of this crisis — economic historian david livingston recently wrote a must-read essay on the convergence of thirty years of declining real wages (and its converse, record profits) with unprecedented consumer debt loading via a scheme of securitization that amounted to a credit market version of the investment trust of the late 1920s.

that scheme has collapsed completely, and much as with the collapse of blue ridge and shenandoah in 1929 there is simply no going back — debt will now have to normalize now vis-a-vis incomes at tighter-than-normal underwriting standards as grossly inflated balance sheets are reduced, and that promises a very dark march ahead.

nothing of the kind was afoot in 1907 or 1987 or 1998. it is now. that must be understood to understand the economic fallout.

i still think it’s an open question as to whether government can find a way to transfer (through TARP and what will surely be its successors) enough private debt onto its own balance sheet to mitigate the most apocalyptic visions of liquidation — but early returns are obviously terrible, and there very probably isn’t enough balance sheet capacity to take on the entire pile which must be resolved. hopefully they don’t annihiliate the currency in so doing.

nevertheless, the breadth and extent of the current pessimism makes me shiver. it's uncomfortable.

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government financing of automaker DIP?

luigi zingales promotes a government-financed chapter 11 reorganization for the automakers, who will otherwise likely be headed for liquidation.

The restructuring cost at GM will of course be high, both in human and financial terms. But the alternative is worse: to spend $25 billion on aggravating and postponing the problem. It would be better to give away that money directly to the workers rather than let GM decide how to dissipate it. At over $200,000 for each of GM’s 123,000 North American employees it would a very nice gift. The taxpayers’ cost would be the same, but at least the money would help secure a future to hard-hit households.

Overall, however, we believe that paying off workers and liquidating the company is equivalent to putting the patient out of his misery before attempting to administer the best economic medicine. Some may argue that GM has been receiving medicine from taxpayers for quite some time, but clearly it has been receiving the wrong medicine. A Chapter 11 bankruptcy gives a firm that needs to restructure the chance to recover. If Chapter 11 cannot save GM, then nothing can.

the question is whether the white house or congressional republicans -- many of whom seem uninterested in doing much to help -- would support even debtor-in-possession (DIP) financing where a bailout has gotten short shrift.

UPDATE: bloomberg is reporting a senate compromise bill, though the more zealous house republicans may not be on board.

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yen-denominated treasuries?

it's a concession to reality that the united states will end up having to accede to as its borrowing has become too large a slice of global savings. naked capitalism cites the trial balloon floated by large japanese banks, probably in concert with the japanese government.

UPDATE: on reading today's ft, i bumped this post forward. they rightly note the wholesale transfer of debt to the government balance sheet now underway as the necessary step in maintaining debt-to-GDP and avoiding a debt deflation more serious than that experienced in the 1930s. and they further correctly note the need of continuing and even expanded foreign financing to avoid a dollar collapse, with this financing now directed into treasuries only (and neither agencies nor corporates). which leads to:

Certainly, neither a sharp devaluation of the dollar or the increased cost of protecting against a US default is attractive to the dollar-surplus nations. The question is what other choice do they have?

One theory is the redirection of dollars on a mass scale into the financing of emerging market economies. Both EM corporate and sovereign dollar-denominated debt issuance will increasingly be able to compete with the issuance of the US and UK treasures. While it might not absorb all the surpluses, it would certainly be enough to knock the balance.

In that scenario, what could the US do? One theory doing the rounds in Japan is US foreign-currency denominated debt issuance of its own. According to the Asia Times this would incentivise flows by protecting against possible dollar devaluation. Plus, the practice is not new. It was done before by the Carter administration in the 1970s. Known as “Carter bonds”, the debt was denominated in German marks and Swiss francs to attract foreign investors.

Faced with the unprecedented growth of the US budget deficit and the prospect of an increasingly weaker dollar compared with the yen reducing the value of Treasury debt held by Japan, economists in Tokyo are calling for the administration of president-elect Barack Obama to issue US Treasuries denominated in yen and other currencies. The issuance of foreign currency-denominated US Treasures would reduce the perceived risk of holding the debt.

Behold the dawn of the ‘Obama bond’.

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Wednesday, November 19, 2008


what's wrong with berkshire hathaway?

it's a financialized insurance company with extraordinary exposure to equities, after all. it's shares are crashing and CDS are suddenly running very wide. felix salmon is questioning its triple-a rating.

All insurance companies have a certain amount of event risk. But for Berkshire Hathaway the event the company is most worried about isn't a hurricane or an earthquake -- it's a credit downgrade. Roger Ehrenberg asks the question on everybody's mind: "If the market continues to push against Berkshire's credit will a downgrade become a self-fulfilling prophecy?"

A downgrade could be very, very bad for Berkshire, depending on how its collateral agreements are worded. At some point, Berkshire's counterparties are going to be able to ask it to put up a lot of collateral against the derivatives contracts it has written -- not only the CDS contracts, mind, but quite possibly also the long-dated put options it's written on broad stock-market indices. Such collateral calls could be extremely harmful to Berkshire's business model -- and that's before taking into account the loss of business at its new monoline subsidiary.

when monoline insurers were revealed to be a house of cards built on little more than an impeccable rating, few hesitated to say that any such company didn't deserve such a rating. berkie (not alone among insurers) is exactly that.

despite the protestations of the acolytes of warren buffett, this relentless liquidation spiral can very definitely kill berkshire hathaway along with many other insurers.

UPDATE: felix salmon with more on berkshire.

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wow. what a vapid analysis. zero balance sheet information brought to light yet you make conjecture about a company going bk? don't quit night school.

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part of the point, anon, is that BRK/A is becoming an example of the truth that, in a liquidation spiral, no very sophisticated balance sheet analysis is really required if confidence gives out. berkshire is involved in a series of large derivative contracts where its minimal collateral posting is predicated on its rating -- and that might be enough. ehrenberg:

Fears are centered around the long-dated equity index put options it wrote beginning in 2005, on a notional amount of around $40 billion. In Warren's eyes he has secured almost $5 billion in option premium that he can use for acquisitions, stock buybacks, etc. In the market's eyes some believe Berkshire is going to have to come up with collateral for the decline in the short option position. Reality is, the only way Berkshire has to post is if its credit rating falls below a pre-determined level. As unlikely as this may seem, those in the credit derivatives markets are looking at Berkshire credit risk with a wary eye. Sentiment in this market is as volatile as the VIX: if the market continues to push against Berkshire's credit will a downgrade become a self-fulfilling prophecy?

not only is BRK/A collateral posting vulnerable to a ratings change -- so would its underwriting business, including its new monoline. and the fact that it is vulnerable to a ratings downgrade has already obviously jaundiced credit markets w/r/t BRK-A -- and if the ratings agencies follow the market, $30bn+ in cash might be very little defense given credit illiquidity and the financing requirements of any insurer.

one of the things that is a lot different about a liquidation spiral is that even good companies are killed because of what was previously thought to be responsible and manageable exposure to leverage. its symptomatic of all such periods in market history, and the failure of BRK/A would join a long list of previously unimaginable failures immanentized by a systemic delevering.

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stopped out

tried that long to no avail. the aggressiveness of selling pressure continues to amaze, as the newsletter tracked it to new correction lows on monday and tuesday both. now prices seem to be following in spite of positive divergences.

what a nightmare market.



synthetic CDO unwind continued

i bloggd this a few weeks ago, but it remains the 800 pound gorilla that is about the wreck what remains of the economic room.

alan kohler of aussie business spectator has some interesting views following an simple explanation of how synthetic CDOs work.

As the world slips into recession, it is also on the brink of a synthetic CDO cataclysm that could actually save the global banking system.

It is a truly great irony that the world’s banks could end up being saved not by governments, but by the synthetic CDO time bomb that they set ticking with their own questionable practices during the credit boom.

Alternatively, the triggering of default on the trillions of dollars worth of synthetic CDOs that were sold before 2007 could be a disaster that tips the world from recession into depression. Nobody knows, but it won’t be a small event.

the upshot is that synthetic CDOs -- soon to trigger as a byproduct of defaults among the reference list -- will result in a massive one-time transfer of trillions in capital to the originating banks from the investors to whom the synthetic CDOs were sold. while kohler notes this could bolster the banking system -- indeed perhaps save the money center banks who sold them -- the loss is likely to devastate the investors, which include insurers, pension funds, money market funds, municipalities, individuals, corporations, and of course other banks.

it may be important to note that most synthetic CDOs are partially-funded -- that is, the notes sold to investors raise an amount of cash (held in the special-purpose structure) insufficient to pay out the entire CDS should it trigger. this means that the originating banks will not receive the entire notional value of the protection but merely the amount held in the structure -- unless, of course, they have contracted a monoline to pay the difference (LOL).

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CPI deflation

the CPI falls (-1.0%) in october, yet another series record in a metric dating back to 1947, per bloomberg.

``We are seeing the fallout of global recession on inflation,'' said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts. ``In commodity prices, it's leading to deflation.''

A Labor report yesterday showed wholesale prices fell 2.8 percent last month, the most on record. Last week, the government also said the cost of imported goods declined by the most ever.

Food prices, which account for about a fifth of the CPI, increased 0.3 percent after a 0.6 percent increase in September.

The drop in core prices reflected declines in the cost of clothing, automobiles, air fares and hotel rates. New-vehicle prices fell 0.5 percent and clothing costs dropped 1 percent. The price of airfares plunged 4.8 percent, the most since June 1999.

The cost of all services, excluding fuel, was unchanged, the first time it hadn't increased since 1982.

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commercial MBS crushed

across the curve:

CMBX AAAs widened by 130 basis points. AJ tranches widened 250 basis points to 350 basis points. ( I am lacking expertise in this area but believe an AJ is sort of a junior AAA piece.) And tranches below AAA widened 150 basis points to 350 basis points.

Cash CMBS underperformed the index and some AAA bonds with 30 percent protection widened 200 basis points. These are AAA bonds (allegedly) trading swaps plus 1050 basis points. That is alot of yield and alot of fear.

Quoth the Buffalo Springfield circa 1966,” Something’s happening here and what it is aint exactly clear”. It feels as though the bond markets are setting up for another patch of very rough weather.

a long time coming -- calculated risk has been calling the CRE crash for months -- but it is now undeniably here with some unexpected large defaults serving as catalyst. banks, particularly regionals heavily exposed to commercial real estate, are going to be facing a massive wave of losses.

UPDATE: it continues today.

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Tuesday, November 18, 2008


CDS funding disaster revisited

i linked to the institutional risk analyst's recent missive regarding the collateral posting requirements of credit default swaps and the role CDS have played in sucking the liquidity out of the global financial system.

chris whalen revisits this theme in interviewing bill janeway.

the credit default swap has become what i would consider the hidden epicenter of the global crisis to correspond to the more visible warzone in CDOs, together comprising the coup de grace of what janeway calls "the greatest mountain of leverage that the world has ever seen."

[L]ast week Bloomberg News published a very important article talking about Brooksley Born, the former chairwoman of the CFTC and now a retired partner at Arnold & Porter law firm. The behavior of Summers and Greenspan over a decade ago in personally attacking and smearing Born when she dared to suggest that OTC derivatives might pose a systemic threat to the global economy enabled the explosive growth of the OTC derivatives markets.

Today there are over $50 trillion in outstanding credit default derivatives contracts, for example, contracts which must be funded by the global financial system as default rates rise and credit recovery rates fall. As we have written previously funding these CDS contracts as they move into the money may become an oppressive drain of liquidity from financial institutions and the global economy.

Meanwhile, last week Treasury Secretary Hank Paulson, finally admitted that his asset purchase idea was DOA. Although Paulson had sold the Congress on the bailout proposal based on purchases of assets, he has finally come around to the view we and others have been espousing for months, namely that capital injections into solvent banks is the first, best use for the bailout funds. But it may not be the only use for the bailout funds provided by the Congress.

As we shall be discussing in our comments at the Risk Management Association this Thursday in New York, we may actually need an asset purchase program after all, but not as originally envisioned by the Congress or the Bush Administration. Instead of a vague, voluntary program to allow banks to tender assets to the Treasury, we believe that the Congress must eventually legislate a mandatory exchange program to remove all of the extant CDS and complex structured assets from the global financial system. So serious and enduring are the negative effects of financial cancers such as CDS and complex structured assets, in our view, that the only way to save the patient - that is, the global economy and financial system - is mandatory surgery.

UPDATE: fil zucchi at minyanville notes that a similar line of thought has emerged in the senate.

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the foundation of american exceptionalism

for some time i have believed that the ridiculous caricature of america that was embodied in the doctrine of american exceptionalism which became a foundational component of the conceit of neoconservatism was a monstrous manner of hubris which would, in the end, lead to a spectacular fall proportional in size and time-honored in both literature and nature.

for some time, it appeared to many that the fall might be limited to a foreign policy comeuppance and the obviation of the unipolar worldview. but we should now see that the hubris of what might be seen in retrospect as the reaganite period ran far deeper than a cartoonish foreign policy. the most powerful vehicle of american empire is, as with any empire, not its armed forces but its currency. empires are primarily political and economic constructs, and when the integrity of economic policy particularly is compromised there is no army which can subsequently maintain the integrity of empire.

nouriel roubini has already addressed this point. but today there are others -- via barry ritholtz an anonymous author here, and further at vox eu carmen and vincent reinhart.

i have recently highlighted the plight of iceland, and further passed on the ruminations of willem buiter as he considers -- here and here -- whether the UK isn't already in a very similar triple crisis of banking, sovereign debt and currency. the reinharts further reiterate what it is exactly that differentiates the united states -- which is nearly as well positioned for such a disaster as the united kingdom -- and what could erode that difference which has made the dollar a surprising safehaven.

If this had happened to any other government in the world whose national financial institutions were in as deep disarray as those of the US, investors would have run for the hills – cutting off the offending nation from global capital markets. But for the US, just the opposite has happened.

Rather than facing prohibitive costs of raising funds, US Treasury Bills have seen yields fall in absolute terms and markedly in relative terms to the yields on private instruments. This has been called a “flight to safety”.3 But why do global investors rush into a burning building at the first sign of smoke?

The answer lies in part with the exchange market practices of key emerging market economies.

but resentment is now clearly building in the provinces.

it is becoming clearer to all that what hubristic fools of the last three decades once took as a military, philosophical or even spiritual foundation for american exceptionalism was all along really an economic foundation -- one whose basic manifestation was and remains the dollar and the treasury debt denominated by it. as these pillars erode, so does the american empire wane. reinhart's warning is that what remains of those pillars must now be treated with great care, lest the bulwark that has kept the united states from meeting an awful fate be breached and the prognostications of the anonymous author come to pass.

UPDATE: brad setser on the flight from dollar risk:

Normally, this kind of fall-off in foreign demand would be associated not just with a credit crisis but also with a currency crisis. A country cannot finance a trade and current account deficit without financing, and two big sources of financing for the US deficit — foreign purchases of Agencies and US corporate bonds — has disappeared. The US, though, isn’t a normal country. The fall in demand for risky US assets was offset by a rise in demand for Treasuries and the sale of foreign assets by Americans. ...

The notion that sovereign investors are always and at all times a stabilizing force in the market should be put to rest. China has clearly kept the RMB dollar stable — and been a big source of demand for Treasuries. But it has been a seller of other assets in a time of stress. ...

Of course, Treasuries aren’t entirely risk free. I don’t believe that there is a real risk the Treasury would default. Buying credit-default swap protection on the US is something by colleague Paul Swartz calls an end-of-the-world trade. But foreign investors holding long-term Treasuries are clearly taking a lot of currency risk — especially if they are buying in now, after the dollar has rallied …

The US is taking a risk too. The rising stock of short-term bills held abroad does potentially leave the US more exposed to a rollover crisis.

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Monday, November 17, 2008


nothing new

via paul kedrosky -- tacitus describes an ancient credit crunch from the reign of the emperor tiberius.

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david frum

when the republican party began its recriminations phase in the onset of presidential defeat, i should not have been as surprised as i was to hear david frum diagnosing the problems of the GOP correctly. frum is a neojacobin, neoconservative in the parlance, and as such is at least not opposed to an intellectual tradition for the sake of anti-intellectualism. it has been for him i'm sure as much as myself disgusting to watch the conservative party given a framework by william buckley disassembled and destroyed by a bunch of savages whose heroes look like sarah palin and mike huckabee.

nor should i be surprised, i suppose, to see that giving voice to a self-critical reality within the confines of this new, inbred rump of the post-intellectual republican party means a sort of ostracism -- particularly having seen what became of william buckley and then his son.

but that frum has fled the now-degenerate national review is nonetheless a poignant statement regarding the completeness of the self-immolation of the republican party and its core institutions.

Mr. Frum said deciding to leave was amicable, but distancing himself from the magazine founded by his idol, Mr. Buckley, was not a hard decision. He said the controversy over Governor Palin’s nomination for vice president was “symbolic of a lot of differences” between his views and those of National Review’s.

“I am really and truly frightened by the collapse of support for the Republican Party by the young and the educated,” he said.

Mr. Frum witnessed the upbraiding his fellow conservative, the columnist Kathleen Parker, received when she wrote in her syndicated column on the National Review’s Web site arguing that Governor Palin was unfit to be vice president. Ms. Parker received nearly 11,000 e-mail messages, one of which lamented that her mother did not abort her.

“Who says public discourse hasn’t deteriorated?” she wrote in a followup column that ran on the Web site. (National Review, as Mr. [Rich] Lowry [the managing editor] pointed out, can hardly be held responsible for a reader’s nasty e-mail messages.)

true, but it certainly can be held responsible for cultivating a subscriber base of virulent jackbooted reactionaries.



imagining a 21st c depression

an intriguing thought experiment from the boston globe.

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roubini calls (-10%) GDP

yves discusses the latest missive of nouriel roubini, which articulates his thoughts on the capitulation of the consumer.

Today’s news about October retail sales (-2.8% relative to the previous month and now down in real terms for five months in a row) confirm what this forum has been arguing for a while, i.e. that the U.S. has entered its most severe consumer-led recession in decades. At this rate of free fall in consumption real GDP growth could be a whopping 5% negative or even worse in Q4 of 2008. And this is not a temporary phenomenon as almost all of the fundamentals driving consumption are heading south on a persistent and structural basis. ...

To bring back the household savings rate to the level of a decade ago (about 6% of GDP) consumption will have to fall – relative to current GDP levels – by almost a trillion dollar. If all of this adjustment were to occur in 12 months GDP would contract directly by 7% and indirectly (including the further collapse of residential and corporate capex spending in a severe recession) by 10%, an exemplification of the Keynesian “paradox of thrift”. If such an adjustment were to occur over 24 months rather than 12 months you would still have negative GDP growth of 5% for two years in a row with a cumulative fall in GDP from its peak of 10% (note that in the worst US recession since WWII such cumulative fall in GDP was only 3.7% in 1957-58). One can thus only hope that this adjustment of consumption and savings rates occurs only slowly over time – four years rather than two. Even in that scenario the cumulative fall of GDP could be of the order of 4-5%, i.e. the worst US recession since WWII. Note that the cumulative fall in GDP in the 2001 recession was only 0.4% and in the 1990-9 recession was only 1.3%. So, the current recession may end up being three times as long and at least three times as deep (in terms of output contraction) than the last two and worse than any other post WWII recession.

for context, a commenter at naked capitalism provided the worst annual GDP contractions of the 20th c:

1932: -13.0%
1930: -8.6%
1931: -6.4%
1938: -3.4%

and of course roubini is not making anything like the worst case scenario in caculating a return to a savings rate well below the long-term average and factoring only increased savings and corresponding diminished consumption. with other factors at work, reality could indeed be worse.

this year has indeed seen the return of hardship -- and it will get harder in 2009.

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to be a contrarian

note who was preponderantly broadcasting the non-analysis that actually presumed to mock peter schiff, who was of course exactly right on every single point.

it's broadly true of network television news of course -- but if you consume fox news in particular for anything except the current barometric reading of american stupidity, you have been duped. the agenda is not information; it is assuaging the american national insecurity complex, which is of course quite profitable.

the deeper lesson, of course, is on the difficulty of being a contrarian -- even when you have the problem and its resolution nailed. standing against the tide is not easy even when, perhaps particularly when it is a tide of belligerent idiocy.

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"barometric reading of american stupidity" lol

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Saturday, November 15, 2008


more on the trade finance shutdown

in the few weeks since my last reminder of the collapse of shipping backed by letters of credit, problems have become significantly worse. baltic dry rates have continued to crater, and shipping is being idled in quantity. london banker offers this overview and update.

When central bankers back in the old days argued that banks were “special” – and therefore demanded higher capital, strict limits on leverage, tight constraints on business activity, and superior integrity of management – it was because they appreciated the harm that a bank failure would have in undermining the supply chain for business in the real economy for real people causing real joblessness and real hunger if any bank along the chain should be unable to perform.

As the “specialness” of banks eroded with the decline of the real economy (and the migration globally of many of those real jobs making real goods and providing real added-value services to real people), the nature of systemic risk was adjusted to become self-referencing to the financial elite. Central bankers of the current generation only understand systemic risk as referring to contagion of illiquidity among financial institutions.

They and we all are about to learn the lessons of the past anew.

the collapse of global trade is one of the key elements which levered the financial collapse of 1929 into the great economic depresison of the 1930s. and we are witnessing the early stages of just such a collapse in global trade. brad setser noted last week the downturn in both exports and imports. calculated risk sees it in the port traffic data. the WTO doesn't seem to see relief on the horizon even as global stocks run down. the UK independent:

[T]he real trouble is less obvious, largely unprecedented, and potentially devastating.

... "We have the hugely worrying and unprecedented development where there are perfectly creditworthy shippers and receivers unable to open perfectly standardletters of credit," Mr Kerr-Dineen said.

Cargos are sitting on docksidesbecause the finance is not available to ship them, with the gravest implications for the future. "This is a nuclear bomb in the freight market, and in world trade," Mr Kerr-Dineen said. "Liquidity has to return because if there isinsufficient money to provide standard finance, world trade will be sharply cut back and economic growth willimplode."

Against such a background, more recent concerns over the economic slowdown in both the East and the West have pushed users of commodities to run down their existing stocks, rather than buy in new supplies at what are still relatively inflated prices.

These are all to some extentpredictable economic adjustments, but a more sinister effect has been that de-stocking is masking the shortages caused by the dearth of credit. Mr Kerr-Dineen says there are around three months left before stocks run out.

"If the problem is not resolved, there will be no way in which even the sharply revised economic growth forecasts for 2009 will be met, because without normal trade economies cannot function. Ultimately, flour mills will run out of wheat and power stations will run out of coal," he said.

George Cambanis, head of global shipping at Deloitte, said: "Everybody can still hold their breath for the time being, but it is anybody's guess how long it will take for money to startcirculating again."

He added: "Trading has virtually come to a standstill, because there is no cargo for the ships. There has also been no trading of vessels in the last few weeks, so there is no market value out there for companies' capital investment in their ships."

the revolution of the last ten years which yielded "just-in-time" shipping and razor thin inventory management seemed not long ago to be one of the cost saving benefits of the information age. in this light, however, it looks more like an expedient transmission for the conversion of severe financing difficulties into a global economic collapse as rapidly as possible.

Of the $13.6 trillion of goods traded worldwide, 90 percent rely on letters of credit or related forms of financing and guarantees such as trade credit insurance.

think about that for a moment.

UPDATE james surowiecki on the perils of the food supply chain. the financial times on the perils of integrated suppliers generally.

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bund auction failure

yves smith of naked capitalism pens a comprehensive missive regarding the failures of western government responses to triage and delever their financial sectors -- in an attempt to avert growth contraction -- preferring instead to attempt to transfer balance sheet risk without contraction onto government balance sheets.

the result has been rising creditworthiness concerns regarding western governments. willem buiter:

To be solvent, the face value of the government’s net financial obligations has to be no larger than the present discounted value of current and future primary government surpluses (government surpluses excluding net interest and other investment income)....

With the true net public debt to GDP ratio probably already well above 100 percent of GDP and rising, and with massive public sector deficits, partly cyclical and partly structural, about to materialise, the markets will question the fiscal-financial sustainability of the government’s programme with increasing vehemence. The CDS spreads on UK public debt will start rising. The notion that, except for currency, there may not be a safe sterling-denominated asset may come as a shock. But the same is true in the US. In 2009, the US government will have to sell (gross) at least $ 2 trillion worth of government debt (the sum of the Federal deficit plus asset purchases plus refinancing of maturing debt). The largest such figure ever in the past was $550 billion. In the US too, the markets will have to learn to do without a US dollar financial instrument that is free of default risk.

what's more, this is not an issue for the distant future. via yves, the financial times.

A German 10-year bond auction failed – something more or less unheard of until this year – as cash-strapped banks and investors snubbed the government offering.

It is a clear sign of straitened times when a benchmark bond in one of the most liquid markets in the world cannot attract enough bids to reach its target amount.

Crucially, it raises serious doubts about whether governments can raise the vast amounts of debt needed to fund fiscal stimulus packages and bank recapitalisations in the current tough market conditions.

Any sign of waning demand may force up bond yields – putting further pressure on public finances when they are already under strain.

... Germany – in spite of its fourth 10-year Bund failure this year – and the US are likely to be more successful in attracting investors and depressing yields, should the difficult conditions persist, than other countries as they have the most liquid markets and are seen as safe havens...

Another problem for the governments is the competition from banks and financial institutions, which have sovereign guarantees yet offer much higher yields.

For example, this week the UK’s Nationwide priced a three-year deal at close to 100 basis points over gilts.

“The simplistic question is, why buy government paper when you can buy government-backed paper such as this for a much greater return?,” says Sean Shepley, fixed income strategist at Credit Suisse.

the implications for the united states?

Nowhere is the issue more pressing than in the US.

Tony Crescenzi, strategist at Miller Tabak, says: “In a world with finite capital and where sovereign nations everywhere are in need of capital to finance their financial and economic stabilisation efforts, the substantial increase in Treasury supply could become manifested in higher long-term interest rates.”

yesterday john jansen monitored the 30-year auction. as he later noted, "the Treasury held a 30 year bond auction and nobody showed up for the party."

with the potential for rising "risk-free" yields at the first sign of equity market stabilization, we could be entering what will perhaps be the most damaging phase of the crisis of western economies.

it's long been held as orthodoxy that the the primary "policy error" of the great depression was the unwillingness of governments to assume sufficient responsibility in shouldering the burdens of private overindebtedness.

and yet, some would characterize the actions of the governments of the early 1930s as building a firewall between government and the private sector -- assuring that there would in the aftermath that there would be a government to pick up the pieces and start again.

the current cast of characters -- faced with a level of systemic indebtedness which dwarfs all precedent -- have thusfar chosen specifically to risk what their forebears did not see fit to. and what a wager it is, with the health and welfare of the leading national governments and currencies that represent the west in the balance -- and the example of failure looming in the shadows.

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Friday, November 14, 2008


on history and its purpose

The aspects to which I would have every reader apply himself most attentively are the levels of life and morality and the character of men and policies, in peace and in war, by which our realm was acquired and expanded. Then let him observe how when discipline wavered morality first tottered and then began the head long plunge, until it has reached the present level when we can tolerate neither our vices nor their remedies.

It is this in particular that makes the study of history salutary and profitable: patterns of every sort of action are set out on a luminous monument for your inspection, and you may choose models for yourself and your state to imitate, and faults, base in their issue as in their inception, to avoid. If partiality for my own enterprise does not deceive me, there has never been any commonwealth grander or purer or richer in good examples, none into which greed and luxury were naturalized so late, none where lowly means and frugality were so long and so highly esteemed. In the degree that possessions were scant so was avarice also: it is only lately that riches have introduced greed and pleasures overflowing have imported a passion for individual and general ruin.

-- livy

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long into the pullback

on yesterday's more constructive view -- index funds -- but with stops. this has to be the first time i've ever bought into a market that's (-5%) on the day with nearly 90% of volume running negative. i feel slightly nauseated. the stops are there and i'd be relieved to have them hit and be out. market would have to get to approximately down (-7.3%) today to hit the trigger. audentes fortuna iuvat!



liquidating the automakers

it was more than three years ago that the debt of ford and general motors were downgraded to junk. the process of slow deterioration seems now to be coming to a head.

the two are suffering massively under the weight of economic contraction -- see today's retail sales disaster report -- and further look where things are going -- in historical context -- and are burning through cash at a rate that may make them insolvent before year end. while the bailout-mad treasury dishes cash to seemingly every applicant in any line of business, in fact there are limits to what the feds will do. and republicans in this lame-duck congress are not inclined to take big steps to save the automakers and the bush adminstration will not dip into the TARP for aid.

``I don't know of a single Republican who is willing to support'' the auto bailout, Democrat Christopher Dodd, chairman of the Senate Banking Committee, said yesterday, adding that he would be careful about bringing up any measure that might fail.

It is ``highly uncertain'' Congress will pass a bailout package this year, Goldman Sachs Group Inc. analyst Patrick Archambault wrote in a research note yesterday.

GOP lawmakers are pushing for reform as a condition of the bill, and it's hard to fault them. but there also has to be a realization that the automakers will likely not be able to reorganize.

``If we were in a different overall economic environment, one of them going down wouldn't necessarily kill'' the industry, he said. A weakened economy and frozen debt markets make an automaker bankruptcy impossible, with a Chapter 11 filing for reorganization resulting in liquidation instead, Ross said.

Failures by automakers and related businesses would lead to a drain on government spending for unemployment benefits, health care and pension recoveries, said Ross, whose WL Ross & Co. is based in New York. GM has said bankruptcy isn't an option.

i mentioned to a friend yesterday that financing for chapter 11 reorganization simply isn't available, which as howard davidowitz makes plain on bloomberg has meant the chapter 7 liquidation of several retail chains already.

and today comes word that the automakers' cash needs will intensify as european credit insurers are stepping away from the american majors.

The withdrawal of credit insurance – which covered suppliers against the risk of the automakers failing – has previously hastened the demise of a string of European companies. Euler Hermes, Atradius or Coface, which control more than 80% of the world’s credit insurance market, are refusing to write policies for suppliers trading with GM or Ford on credit. GM and Ford are two of the biggest groups ever to be blacklisted. The cut-off of cover will primarily affect the companies’ large operations in Europe, where the insurers do the bulk of their business. US suppliers largely operate without insurance. The move leaves three possible scenarios: GM and Ford can start paying upfront for goods; they can hope their suppliers will trade uninsured; or they could be unable to buy the parts they need for car production.

as a result of the confluence of economic depression, financing crisis and political obstruction, the big three carmakers look increasingly likely to fold up shop in the next few months -- along with many of their supply chain dependents.

more than 200,000 people work for the big three directly; there are over 3 million employed in the supply chain.

the response to the onset of depression in this country has been a combination of demand stimulation, limitless liquidity provision and (so far) limited capital injections into banks and bank-like financing structures. as many have noted, liquidity provision, while perhaps desirable and even necessary, is not a solution to what is a solvency disaster. capital injection has, thusfar, been a failure -- not least because the beneficiary institutions have not yet delevered or even marked their assets properly, and are therefore inclined to hold capital as a loan-loss reserve.

should the automakers go to liquidation, for all the happy talk in washington one can declare demand management a failure too. the bankruptcy will be difficult enough, particularly if chris whalen is correct about the liquidity sink effect of credit default swaps awaiting delivery, of which there would be trillions outstanding referencing the big three. but the blow to aggregate consumer income as millions in the automotive industry see their paychecks stopped would place severe pressure on already-collapsing consumer demand.

if the carmakers are allowed to BK, congress must at least assure financing for reorganization if it is even to make a show of avoiding the "policy errors" that "caused" the great depression.

UPDATE: mish relays how demand management in chicago is about to get a whole lot more difficult.

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from perrone: did you see this at the curious capitalist --

"GMerdammerung." god, I needed a good laugh. I almost peed myself.

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LMAO! enjoy, perrone!

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Thursday, November 13, 2008


torturing democracy

watch. and further reconsider the role of vice president cheney in undermining the constitutional system of checks and balances.

i say again, that more than 40% of this country's citizens voted to return a republican to the white house in the aftermath of what has gone on in the last eight years stands as nothing less than an indictment of our postmodern democracy as a fool's form of government. america was never intended to be so lowly, and is too good a concept to be left in the hands of its dimwitted citizens and their illusory heroes.

and yet that is no endorsement of barack obama, who is guising a continuation of this fatal disease under the rubric of "centrism". the way has been cleared by the bush administration of any remaining obstacle for the ascendancy of the unitary executive, an office as easy to abuse for a democrat as a republican. the man is not yet in office, and already he is disappointing -- soon enough, i suspect, to be yet another illusory hero revealed.

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Just as you can see the fate of the US car industry prewritten in the fate of the British industry a generation ago, I fear that you can perhaps see Obama foreshadowed in Tony Blair. I'll grant you that there are differences - Obama is probably more intelligent than Blair, and is probably not such a consummate actor - but it's the similarities that are more striking.

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so far so good

my short position stop-losses were all triggered in today's huge rebound rally. it ended up being a positive resolution in spite of being caught short two weeks ago, especially as i doubled down my (not very large) short position at almost exactly the top tick of the intervening rally on november 4.

was that a successful test? not really, but it might be close enough. one of the possible avenues for making a trading low is for the market to be driven down beneath important technical levels -- where plenty of stop-loss sell orders live -- forcing longs to cover with smart money taking the other side of the trade. that clears the way then for a rally benefitting smart money.

kevin depew may be irritated by the closing levels in the futures, as a daily demark countdown buy signal was foiled by too powerful a close. a spot of consolidation over the next few days would, however, clear that up.

the newsletter after the close further noted that today was very nearly/could be revised to a 90% upside day -- my data actually showed that it was one -- following a cluster of three (in the s&p) or four (in the NDX) 90% down days in six sessions. that's often seen at solid lows.

moreover, s&p 20-day new lows maintained their positive divergence, as did the mcclellan oscillator, as did volatility envelopes. in short -- there's a number of signals here pointing to a tradeable low in place.

yesterday's fresh lows in cumulative issues and volume are of concern looking further out -- this is still a very sick market, as attested by today's monster 11.8% range in the NDX -- but need not prevent a rally here.

much will depend on the character of the follow-through now. but so far, so good. some retracement of an auspicious kind would be a good long entry.

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