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Tuesday, December 30, 2008


the governments of china and japan are the only support

brad setser with some very illuminating work.

Both private capital inflows to the US and private capital outflows from the US have fallen sharply. They have gone from a peak of around 15% of US GDP to around zero in a remarkably short period of time

This sharp fall has bearing on the bigger debate over the role global capital, global savings and foreign central banks played in helping to to create the conditions that allowed US households to sustain a large deficit for so long — and whether American and other policy makers should have paid more attention to the risks that came with the surge in foreign demand for US financial assets earlier this decade...

I think we now more or less know that the strong increase in gross capital inflows and outflows after 2004 (gross inflows and outflows basically doubled from late 2004 to mid 2007) was tied to the expansion of the shadow banking system [which has now reversed completely -- gm]. ...

Why didn’t the total collapse in private flows lead financing for the US current account deficit to dry up? That, after all, is what happened in places like Iceland — and Ukraine.

My explanation is pretty straightforward.

Central banks were the main source of financing for the US deficit all along. Setting Japan aside, the big current account surplus countries were all building up their official reserves and sovereign funds — and they were the key vector providing financing to the deficit countries.

in other words, most everything you've ever read or heard about foreign investor demand for "safe" and "liquid" dollar securities as a support of american borrowing habits is just so much horseshit, just nationalist propaganda and american conceit. only the mercantilist trade-protection currency management of the governments of china and japan (as well as petrodollar recycling from oil states) has ever really supported american national profligacy.


If and when China and Japan are no longer able to support the continued growth of US deficit financing, the dollar and the bonds will contract (decrease) in value, and perhaps precipitously, like a house of cards. It is much worse than we had imagined, and more concentrated on these two countries, along with Saudi Arabia, than we had thought.

For now the balance is maintained because of self-interest and fear. But we cannot stress enough the highly artificial nature of the arrangement, and its inherent instability, now that the charade of sustained private investment flow is shown for what it is. There is no economic theory to support this model other than a distorted form of neo-colonial parasitism.

This is why the world has not developed a sound replacement for the dollar hegemony. It is because if they do, they must navigate around the probability, not possibility, of a collapse of their dollar reserves, and a dislocation of their own export driven economies, much worse than we might have imagined. It is not a matter of economic inventiveness; it has become a matter of will.

Who will be the first to flinch? History shows it is rarely a conscious decision, but rather some incident, an accident, some trigger event, even one so small, that it creates astonishment at the size of the avalanche it unleashes.

To make it clear and simple, this is the first evidence we have seen to suggest that hyperinflation is in fact possible in the US. As you know, we have been strongly adverse to the extremes in outcomes, both in terms of a sustained deflation and a significant hyperinflation.

That has now changed. The dollar is a Ponzi scheme, the waters of debt are overflowing the dam of artificial support, and only a few countries, two of them somewhat unstable, are holding back the deluge.

i've suggested here that it is likely that china will maintain the renminbi peg to the dollar in an effort to protect its export sector and engage in what amounts to a competitive currency devaluation, shifting as much of the burden of excess capacity liquidation onto its trading partners as possible. now that it is facing a full-fledged deflationary collapse at home, the dollar-peg-transmitted inflation of the last year is no longer a worry.

this is what keynes would have decried as a maladjustment -- excess capacity is a chinese problem, whereas excess demand (more particularly its residue, excessive debt) is an american one. an appreciation of the renminbi would move china in the direction of ultimate adjustment, that of increased domestic demand and a slimmed-down export sector. but the frictional cost of that transition may well be greater than the chinese political system can tolerate -- and so the adjustment is being resisted, the excesses perpetuated as best as is possible.

but also consider: a continuation of vendor finance will make a market for the colossal wave of american treasury debt issuance that will shortly be hitting the street. to maintain its peg, china will be forced to buy as much as treasury will issue to prevent the fed from monetizing and weakening the dollar vis-a-vis the renminbi.

if china and japan give up the chase and step away from mercantilism, not only will they have to bear the brunt through a rising currency of the contraction of the greatest excess capacity problem in recorded history -- and, in china's case, falling into revolution and chaos as a potential or even probable consequence; they further risk seeing their primary export market implode its currency and fall into a hyperinflationary trap which annihilates its purchasing power, aggravating an already massive retooling of their export-driven economies.

in other words, they probably feel they must try to continue with mercantilism. as martin wolf noted, however, the result is likely to be the united states "spending itself into bankruptcy". some in japan are already offering alternatives to try to prevent a debt-issuance-fueled dollar collapse, but for now the inertial path seems to be a continuation of the global financial balance of terror.

UPDATE: as michael pettis pithily notes -- everybody is working hard to increase global trade imbalances.

The biggest contributors of net demand are the US and non-Germany Europe, and both of these regions are seeing a rapid decline in their net demand contribution (i.e. their trade deficits are expected to shrink). To adjust to this decline the world needs new sources of net demand or else global production must contract sharply via factory closings and rising unemployment. But the largest net supply country, China, is increasing its export of net supply (its trade surplus has been rising) while several trade deficit countries in Asian and elsewhere are switching to trade surplus or otherwise trying to reduce their deficits.

This cannot be sustainable. We cannot expect production to rise while consumption declines except if it comes with a dangerous rise in forced investment (also known as inventory). The crisis cannot even begin to be considered in its final stages until this issue is resolved.

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from perrone: the dollar isn´t a ponzi scheme. in a ponzi scheme, there are no assets underlying purchases. you simply collect money, take some, pay the rest to somebody, and use that payoff as a lure for drawing in more money. it ends when the absence of any asset is exposed, and the line of suckers ends.

there are tremendous assets (in a certain sense unimaginable, really) underlying the dollar, both material and pyschological. we tend not to appreciate the magnitude of these in an epoch of disillusion and despair --and that´s natural and probably even healthy, in the long run. but still.

gm, I´m still a bit confused as to why continued reliance on mercantilist ploys (in a millieu of vanishing external demand) necessarily means less "frictional cost" for China. it won´t work, for one, because the more China tries to shift the burden of over-capacity to the deficit countries the more those economies will rebel and the more the export market will shrivel. and aren´t there political advantages just as ripe and sumptuous for a regime of China´s type to be gained from giving folks at home cheap credit and encouraging them to buy things? you still produce, that´s the point. in fact, it´s the best (only?) way to maintain your production. you just redirect a larger chunk of what you produce to _yourselves_.

finally, in contemplating vendor finance endgame, wouldn´t debt forgiveness and such (hell, Japan´s already talking about it) seem a much more likely and self-interested resolution for everyone than dumping dollars willy-nilly or making some other mutually destructive move that could theoretically open the door to dollar hyperinflation?

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i agree with you perrone -- indeed some time back i referenced research from a hedge fund:

pressure is increasing in china for the appreciation of the yuan to accelerate. this would have the great intermediate-term benefit of moderating chinese inflation and cutting speculative inflows to the country, even though the transition could be disruptive. it is also the long term policy goal of the chinese government as they move to a free floating currency from a dollar peg, which will likely allow the yuan to become the de facto reserve currency of the far east (with all the implied benefits). as demonstrated by private research i've had the pleasure of reading, many highlight the potential cost to china -- particularly forex losses on its massive dollar-debt holdings -- but ignore the manifold benefits. a stronger yuan would reduce the cost of oil for china in local terms, and this benefit alone given the rate of oil consumption in china would all but offset all the forex losses. its export sector would be hampered on the lowest end, but china is already in the process of moving its manufacturing capacity up the scale of finished goods into more complicated products (such as cars and semiconductors) where there are simply no viable competitors in the world on quantity and price. the net cost to china of revaluation is widely overestimated in the united states -- largely out of wishful thinking, i suspect.

again, the hope is that a fall in oil prices thanks to demand destruction and clipped speculation would forestall the pressure to appreciate the yuan, at least out beyond the six months that merrill is speculating above. but for the united states, increasingly rapid yuan revaluation would almost certainly mean the end of the debt supercycle and vendor finance -- and would shift the current credit contraction into a much higher gear, as it would effectively remove from the field the primary creditor of both the american government and the GSEs. the kind of collapse that would come in america following a sudden yuan appreciation would be a life-changing event for all americans. it is going to happen in the not-so-distant future -- but i think we should universally hope that it doesn't this year or next.

but -- in spite of the eventuality of the move and the benefits china would see -- china is in reality neverhteless clearly making the policy choice to weaken the RMB.

i agree further with you that this policy choice only serves to INCREASE the overall damage wrought by the crisis, and in the end the damage to china proper -- it is in effect the chinese smoot-hawley act. it is beggar-thy-neighbor policy.

but within china -- allow me to speculate a moment -- maintaining the peg or even devaluing may be seen as a national response to incipient deflation, just as the united states sees its devaluation. much as the appreciation of the RMB was undertaken with a mind to mitigating the strong inflationary pressure being transmitted by american easy money before deleveraging began in earnest (remember july? lol -- things move fast!), depreciating it is the flip side of the coin. chinese leadership, if it even believes that a current account balance adjustment is necessary, may be gambling that american devotion to free market principles -- after all, we followed that ideology all the way into the trap as others behaved as mercantilists -- and fears of a depressionary global trade collapse will prevent america from sparking a trade war.

anyway, regardless of why, it is what they are doing -- and while i can think it shortsighted and risky and damaging and dangerous, i can also create effective rationalizations for the view that it is a necessary policy response: it has inertia, it is inflationary in a time of deflation, it is a trade relations gamble that could work given american proclivities -- and most of all, it may be the leadership's only real chance of staying in power and avoiding revolt.

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re: debt forgiveness -- p, i'd say coordinated solutions flavored with altruism always look best. in spite of that, they rarely materialize. it's hard to get everyone in the boat together, and many in china and japan will see debt forgiveness as unnecessary and unwanted and against the national interest (again, whether it is or not).

again to cite pettis: Can parochial concerns undermine the global adjustment? It has before.

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rise of the pawnshop

via the journal.

Typically, pawnshop customers have a household income of about $29,000, according to Dave Adelman, president of the 2,400-member National Pawnbrokers Association. But operators around the country say they are seeing a surge in new activity fueled in part by a different clientele: middle- and upper-middle-class customers facing ravaged stock portfolios, tightened bank credit and unexpected layoffs. In areas dogged by high unemployment and foreclosure rates, the pawn business is especially robust.

Rick LaChappelle, owner of four pawnshops in Maine, calculates he has lent about 33% more money this year than last. "The banking industry is not giving out any money right now," he said. "So people are relying on second-tier lending institutions."

... "You can't go to a bank and get small loans to make ends meet, so you come to Rick."



consumer confidence record low

via associated press.

there is a glimmer of hope here. from october:

when future expectations brighten and start to outpoll current conditions, the groundwork is being laid for a recovery.

the differential of future expectations less present situation is +14 with the december report. this could be indicating a nearby low point in consumer psychology.

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house price declines still accelerating, continued

i mentioned it last month as well -- the latest release of case-shiller data is out this morning, via calculated risk.

... [B]oth composite indexes and 14 of the 20 metropolitan areas are reporting new record declines. As of October, the 10-city index is down 25% from its mid-2006 peak and the 20-city is down 23%, Blitzer said.

The indexes showed prices in 10 major metropolitan areas fell 19% in October from a year earlier and 3.6% from September. The drop marks the 10-city index's 13th straight monthly report of a record decline.

In 20 major metropolitan areas, home prices dropped 18% from the prior year, also a record, and 2.2% from September.

there will be no footing beneath the financial system and therefore the global economy until price declines in property, the broadest collateral base underlying global banking, at least begins to mitigate. that they haven't -- that instead, so far from a bottom, declines are actually still picking up momentum -- is frightening testament to what a destructive period still lays before us. the scope of the damage being sustained by financial asset holders is still growing, with no observable floor as yet, and so risks remain as yet to the downside.

UPDATE: 2br/2ba condos in fort myers are listing for less than $25k.

UPDATE: “Frankly, we’re in the midst of a downward spiral and the momentum is building,” [Lennar] Chief Executive Officer Stuart Miller said on a conference call with analysts."

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Monday, December 29, 2008


cry havoc

A curse shall light upon the limbs of men;
Domestic fury and fierce civil strife
Shall cumber all the parts of Italy;
Blood and destruction shall be so in use
And dreadful objects so familiar
That mothers shall but smile when they behold
Their infants quarter'd with the hands of war;
All pity choked with custom of fell deeds:
And Caesar's spirit, ranging for revenge,
With Ate by his side come hot from hell,
Shall in these confines with a monarch's voice
Cry 'Havoc,' and let slip the dogs of war;
That this foul deed shall smell above the earth
With carrion men, groaning for burial.

as evidence that you can get too negative for my taste, i present not shakespeare's antony but igor panarin.

Prof. Panarin, 50 years old, is not a fringe figure. A former KGB analyst, he is dean of the Russian Foreign Ministry's academy for future diplomats. He is invited to Kremlin receptions, lectures students, publishes books, and appears in the media as an expert on U.S.-Russia relations.

But it's his bleak forecast for the U.S. that is music to the ears of the Kremlin, which in recent years has blamed Washington for everything from instability in the Middle East to the global financial crisis. ...

A polite and cheerful man with a buzz cut, Mr. Panarin insists he does not dislike Americans. But he warns that the outlook for them is dire.

"There's a 55-45% chance right now that disintegration will occur," he says. "One could rejoice in that process," he adds, poker-faced. "But if we're talking reasonably, it's not the best scenario -- for Russia." Though Russia would become more powerful on the global stage, he says, its economy would suffer because it currently depends heavily on the dollar and on trade with the U.S.

Mr. Panarin posits, in brief, that mass immigration, economic decline, and moral degradation will trigger a civil war next fall and the collapse of the dollar. Around the end of June 2010, or early July, he says, the U.S. will break into six pieces -- with Alaska reverting to Russian control. ...

He based the forecast on classified data supplied to him by FAPSI analysts, he says. He predicts that economic, financial and demographic trends will provoke a political and social crisis in the U.S. When the going gets tough, he says, wealthier states will withhold funds from the federal government and effectively secede from the union. Social unrest up to and including a civil war will follow. The U.S. will then split along ethnic lines, and foreign powers will move in. ...

Americans hope President-elect Barack Obama "can work miracles," he wrote. "But when spring comes, it will be clear that there are no miracles."

contra prof. panarin, i think the far more likely outcome of serious civil unrest in the united states -- which is a possibility, so far from dismissing, i see as a significant minority chance if not likely over the coming years -- is not a national breakup but the consolidation of the united states over the course of years into something resembling a thinly-veiled dictatorship under the emergency rule of an imperial executive. such a state would have a much diminished but certainly still important intenational role.

panarin may see himself as another emmanuel todd, but i think todd's own views on la décomposition du système américain are vastly more convincing. nevertheless, the map alone may remain a durable icon of the blackness of this period.

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I'm sorry but while the geopolitical risks are the aspect of this crisis that scare me the most, this prediction seems practically laughable. I know you disagree with it (and I agree that your alternate scenario would be more likely), but you framed this as simply too dire rather than silly and perhaps politically convenient. It's way too specific. Also are there any examples in history of countries splitting up in this way unless there were existing historical fault lines?

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'silly' is about the right tenor, hbl, i'm with you. it's more interesting as a tell of the psychology of the times than anything -- particularly as it appeared in the WSJ.

fwiw, i do think the united states has cultural and geopolitical fault lines, and that we might even see them surface to some extent. but a breakup? i think that's simply an example of russian nationalist projection.

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I see a civil war as a possibility. Also the rise of an American Napoleon. In 1912, Edward Mandell House wrote "Philip Dru, Administrator" about the rise of an American military dictator. A national bankruptcy could bring almost any type of "unpleasantness".

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ia, i think civil unrest is a lock -- whether it rises to the level of civil war complete with the choosing up of armed sides... it is of course possible with the degree of political partisanship we now suffer under in combination with the increasing politicization of the military, but i still think a more remote probability. here's hoping.

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That map won't happen. America is already divided between have's and have nots'. The brick and mortar physical divide will be in ever increasing segregated communities, ghettos versus gated communities. Burger King and Wal-Mart will not abide a divided union. Too much paperwork.
Europe is going to have one hell of a time with demographics which will mirror that of the USA (i.e. a bunch of muts). Immigrants from Asia and Africa outnumber whites in the under 18 generation in western EU nations.

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Saturday, December 27, 2008


a marshall plan for the united states?

yves smith conveys bloomberg:

Japan should write-off its holdings of Treasuries because the U.S. government will struggle to finance increasing debt levels needed to dig the economy out of recession, said Akio Mikuni, president of credit ratings agency Mikuni & Co.

The dollar may lose as much as 40 percent of its value to 50 yen or 60 yen from the current spot rate of 90.40 today in Tokyo unless Japan takes “drastic measures” to help bail out the U.S. economy, Mikuni said. Treasury yields, which are near record lows, may fall further without debt relief, making it difficult for the U.S. to borrow elsewhere, Mikuni said.

“It’s difficult for the U.S. to borrow its way out of this problem,” Mikuni, 69, said in an interview with Bloomberg Television broadcast today. “Japan can help by extending debt cancellations.” ...

Japan should also invest in U.S. roads and bridges to support [american] personal spending and secure demand for its goods as a global recession crimps trade, Mikuni said. ... Combining debt waivers with infrastructure spending would be similar to the Marshall Plan that helped Europe rebuild after the destruction of World War II, Mikuni said.

Japan will also have to accept that a stronger yen is good for the country in order to reduce excessive trade surpluses and deficits, he said. The yen has appreciated 23 percent versus the dollar this year, the most since 1987, as the credit crisis prompted investors to flee riskier assets and repay loans in the Japanese currency.

“Japan’s economic model has been dependent on external demand since the Meiji Period” that began in 1868, Mikuni said. “The model where the U.S. relies on overseas borrowing to fuel its property market is over. A strong yen will spur Japanese domestic spending and reduce import prices, thereby increasing purchasing power.”

mikuni clearly accepts the logic many have found compelling, that trade surpluses are the result of currencies managed to support (with the complicity of both sides) mercantilist trade policies and are both damaging and unsustainable. but i find it curious that japan shouldn't use its war chest to bolster its own domestic demand -- after all, as he notes, the inevitable outcome must be a more powerful japanese consumer and a weaker american one. using japanese savings to grease the transition seems counterproductive -- particularly when japan's own export sector will be in great need of damage control.

as interesting as the main point is the assumption by mikuni that the united states government will not have the capacity to borrow from abroad in order to fund its dalliances. indeed his view is represented as

Treasury yields, which are near record lows, may fall further without debt relief, making it difficult for the U.S. to borrow elsewhere, Mikuni said.

of course mikuni presumes quantitative easing in the form of central bank monetization of treasury issuance to prevent interest rates from rising even as treasury auctions fail. this in turn would drive the collapse of the dollar he envisions, indeed potentially risking a currency crisis amid a massive balance sheet recession and credit deflation.

UPDATE: adding to mikuni's line of thought, this piece via paul kedrosky from the asia news.

In 2007, public debt in the United States was 10.6 trillion dollars, compared to a GDP (gross domestic product) of 13.811 trillion dollars. Public debt in 2007 was therefore 76.75% of GDP. In just one year, direct and indirect public debt have grown to more than 100% of GDP, reaching 176.9% to 184.2%. These percentages exclude the debt guaranteed by policies underwritten by AIG, also nationalized, and liabilities for health spending (Medicaid and Medicare) and pensions (Social Security)[2]. By way of comparison, the Maastricht accords require member states of the European Union (EU) to reduce their public debt to no more than 60% of GDP. Again by way of comparison, in one of the EU countries with the largest public debt, Italy, public debt in 2007 was equal to 104% of GDP.

In 2007, 61.82% [3] of America's public debt was held by foreign investors, most of them Asian. So the U.S. public debt held by nonresident foreigners is equal to about 109.39% (113.86%) of GDP. According to a study by the International Monetary Fund, countries with more than 60% of their public debt held by nonresident foreigners run a high risk of currency crisis and insolvency, or debt default. On the historical level, there are no recent examples of countries with currencies valued at reserve status that have lapsed into public debt insolvency. There are also few or no precedents of such a vast and rapid expansion of public debt.

... In the early months of next year, when the official data are published, the United States will run a serious risk of insolvency. This would involve, in the first place, a valuation crisis for the dollar.

britain, as earlier noted though in terms of external-debt-to-GDP rather than in terms of the proportion of public debt held externally, is even further into this hole than the united states.

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'retail's schumpeterian moment'

via paul kedrosky:

Analysts estimate that from about 10% to 26% of all retailers are in financial distress and in danger of filing for Chapter 11. AlixPartners LLP, a Michigan-based turnaround consulting firm, estimates that 25.8% of 182 large retailers it tracks are at significant risk of filing for bankruptcy or facing financial distress in 2009 or 2010.

and hoteliers may follow.

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GMAC debt-to-equity conversion

part of the shoestring turnaround plan designed to get general motors into survivable condition has involved the conversion of GM's financing arm into a bank holding company, a la GS or MS, to make it eligible for direct fed lending facilities and participation in recapitalization programs. while this may have significant impact on the ability of GMAC to continue to offer easy lending to GM customers, the other option has become outright failure.

the fed predictably approved GMAC's application, but notable to the approval was the condition that GMAC's bondholders participate in the losses in order to recapitalize the company. this is the first corporate 'cramdown' i recall seeing, in spite of the fact that i think such conversions will become widespread of necessity as corporations face dire pressure to restructure, deleverage and get small.

the deadline for the conversion of $38bn of debt to equity with the approval of 75% of GMAC's bondholders passed at midnight friday -- no word on the results has as yet emerged.

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Tuesday, December 23, 2008



ambrose evans-pritchard recently detailed the growing waves of violent protest stirring in far-flung places like russia, china, greece and iceland. while such places seem comfortably distant, the same is not true of kimberly, wisconsin.

“There’s a pent-up anger wherever I travel,” said Leo Gerard, president of the Pittsburgh-based United Steelworkers, which represents 1.2 million members, including the Kimberly mill workers. “People feel very much like they’re being screwed. I really think you’ll see tens of thousands of people if not hundreds of thousands taking to the streets and protesting across the country.”

while the widely-reported unemployment figure in the united states is still under 7%, the more realistic measure is nearing 13% with the prospect of scads of january financial, retail and manufacturing defaults and liquidations on the heels of a sorry christmas sales season. where there aren't outright firings, there are increasingly reductions in hours and wage freezes.

under normal preconditions, this would be an angst-filled time. at a time when american middle-classmen are in an unparalleled state of indebtedness and have watched the assets on which their families' well-being is predicated on decimated by a continuing epic financial market collapse, something more incendiary is altogether possible.

As unemployment grows, displaced workers are starting to protest. In Chicago, employees of Republic Windows & Doors occupied a factory earlier this month after Bank of America Corp. of Charlotte, North Carolina, forced the company out of business by cutting its credit line. Bank of America and New York-based JPMorgan Chase & Co., a part-owner of Republic Windows, agreed Dec. 10 to a $1.75 million loan to cover the severance pay of 240 employees.

“With nothing left to lose, militancy gave them their one hope,” said Harley Shaikin, a labor relations professor at the University of California, Berkeley. “We’ll see more rather than less of this.”

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Good point. I can't think of any significant economic downturn which was not attended by social unrest. This was true in the 1890s, 1930s, and 1970s. It will be true again. In the U.S., it will be manageable, maybe not as deep or violent as the 1930s or 1890s, but what about those new middle classes in Asia who are about to have the rug pulled out from under them? And what about those millions of volatile, young Middle Easterners whose authoritarian regimes won't be able to keep them employed? It's the powerkegs abroad that have me nervous.

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Spot the American; "powerkegs abroad" makes him nervous. People in those places have been rioting for years and the regimes haven't been able to keep them employed..ever..That's why you'll find millions of ME and NA nationals in Europe and US. Besides the economies of those countries are still based on farming and/or basic resources, lower on the scale of economic development but less volatile. I've been caught in riots in 4-5 different countries. Only been afraid once, in a developed western country where the police reacted in an unpredictable way, increasing the danger for everyone involved no doubt due to their lack of experience in handling these things. How will the US authorities react? Send in the National guard perhaps, and what happens once they start shooting? Deaths in riots are common all over the world, not so in the US and Western Europe....

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synthetic CDOs in WSJ

here's the link.

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Monday, December 22, 2008


merrill: downside yet to come

via ft alphaville -- merrill's banks analyst stuart graham:

Mr Graham believes that the current consensus view of recovery in the second half of next year is misplaced. Yes, action by the authorities could provide a surprise on the upside, but in this analyst’s view a credit bubble has to be followed by a credit contraction. Period.

And that contraction clearly has some way to go. Merrill Lynch reckons large banks have so far shed €800bn of the €5.5 trillion necessary.

So far the declines in Europe are zero. Although not our base case, we see the risk of negative loan growth in the UK, Spain and Ireland possibly for the next four years.

Just to reinforce the sense of gloom, Mr Graham has a “hypothetical downside scenario” where European banks could require a further €123bn of capital, meaning that anyone trying to spot value by looking at current book values is probably wasting their time.

Here come the bad debts. Lead indicators point to a severe deterioration in asset quality. We see commercial real estate, shipping and CEE as particular hot spots. We forecast provisions of 115bps in 2009, rising to 123bps in 2010, with our stress test based off 159bps (a re-run of 1992’s 152bps).

Funding pressures remain a concern for CEOs. Maturity profiles have shortened and it is not clear to us how banks can be weaned off government guarantees and central bank repo lines. All banks are targeting retail funding but this is becoming more expensive in a very low interest rate environment.

Political risks are very high. The sector faces unprecedented political and regulatory scrutiny. Pressure on deposit spreads would normally lead to wider asset margins but can the banks put through such price increases? The threat of nationalisation hangs over some institutions.

even though that €800bn is perhaps less than 15% of the final estimated need for writedowns, one must remember that in a full-regulatory-velocity fractional reserve lending system (which is certainly what we had and more in early 2007) it probably underpinned some €8tn in potential loans. is it any wonder there is a credit crunch? and is it any wonder that the efficacy of contrived and inappropriate government efforts seems worthy of derision?

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GM-- I have to agree with this. The financial market collapse has been witnessed (though we will hit deeper lows in 2009, for sure), but the full economic collapse is only beginning. All those layoffs have yet to fully impact consumer spending, for example; there is a difference between fearful retrenchment of consumer spending and consumers literally having no money, or a few hundred bucks a week in unemployment checks.

That said, a slightly off-topic question for you: don't you think oil at this price is a no-brainer? The downside is perhaps 50%. The upside is a four bagger. Right?

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depends on your holding period, m, is my guess. i wouldn't be surprised to see oil reach further down than most expect -- is $25 out of reach? i don't think so.

the age of oil scarcity is coming, and if you can hold for the land-export model to come into effect i think you'd make some scratch. problem is, i'm not sure how global depression delays the demand development of oil exporters -- except to say that it will, probably significantly.

i've been mulling the explorers and developers, actually -- it's death for them right now, and probably for the next couple years as projects get delays and canceled. but after the storm they will be needed, and there will be a time in here when one will be able to buy them for nothing. they are essentially a levered play on WTIC, and headed through peak oil you'd think there's going to be value among the survivors of this vicious reversal and rout.

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Sunday, December 21, 2008


it's official: paulson and bernanke are at sea in the storm of the century

lots of folks have noted the lack of a plan in the government response to the financial crisis. paulson did little in confirming the reality of the assumption.

but far worse than a lack of a plan is the general drift of the planless response -- which has been to attempt to support ridiculously high asset prices distorted by the massive credit bubble that has now irrevocably popped.

this crisis could have been attacked by nationalizing insolvent institutions, hiving off bad assets under government-recapitalized "bad banks", and returning delevered and scoured banks into the wild to lend responsibly with clean balance sheets. that would, however, have killed returns on investment for assetholders, shareholders and some bondholders as well -- and the overarching lesson that i would draw from the government response is that the government is the bitch of assetholders whose gilt capital lies at the corner of wall and broad, as a sensible and proven workout plan has been avoided in every instance. instead, we've repeatedly seen the only responses that might minimize short-run pain for asset holders -- transfering incredible credit risk to the government, recklessly daring foreign creditors to destroy the currency.

that this plan has failed to stem the rout of asset prices is testament to its futility -- after all, the destruction of credit is far easier and simpler than its construction, and the size of the collapsing bubble remains an order of magnitude larger than the government itself. the futility becomes inevitable particularly when government, cowed by assetholders, refuses to disintermediate them by nationalizing their holding companies, preferring instead to let large damaged banks hoard hundreds of billions in excess reserves.

but failure, rather than being admitted to be a necessary product of incorrect aims and philosophy, is spun as a matter of insufficient effort. and so the effort is taken to ever-more-ridiculous extremes. yves smith relays the latest and as yet most stupid effort -- the attempt to float hedge funds on the government balance sheet so long as they buy securitized consumer loans.

Hedge funds will be allowed to borrow from the Federal Reserve for the first time under a landmark $200bn programme intended to support consumer credit.

The Fed said on Friday it would offer low-cost three-year funding to any US company investing in securitised consumer loans under the Term Asset-backed Securities Loan Facility (TALF). This includes hedge funds, which have never been able to borrow from the US central bank before, although the Fed may not permit hedge funds to use offshore vehicles to conduct the transactions. ...

A senior official in the outgoing Bush administration told the Financial Times it could also be broadened to include new commercial and residential mortgage-backed securities.

The Fed thinks risk premiums or “spreads” for consumer loans are much higher than would be justified by likely default rates, even assuming a nasty recession.

It attributes this to a lack of buying interest in the secondary market where the loans are sold on to investors. By making loans to these investors on attractive terms it aims to increase market liquidity.

Making the scheme open to all US companies is a radical departure for the Fed, which normally supports financial market liquidity indirectly by ensuring banks have adequate liquidity to make loans to other investors.

However, the liquidity the Fed is providing to banks is not flowing through to financial markets, because banks are balance-sheet constrained and risk-averse. So it is channelling funds directly to investors.

The scheme is not designed specifically for hedge funds and a wide range of financial institutions are likely to participate.

Nonetheless, Fed officials hope that hedge funds will be among those investors that take advantage of the low-cost finance to drive down spreads.

The loans will be secured only against the securities and not the borrower. However, the Fed will lend slightly less than the value of the securities pledged as collateral. The Treasury has committed $20bn to cover potential losses.

Since the credit crisis erupted, hedge funds have complained that they cannot get the leverage they need to arbitrage away excessive spreads and meet high hurdle rates of return.

“Demand is there for leverage but not supply,” said Sylvan Chackman, head of global equity financing at Merrill Lynch.

In effect, the Fed will now take on the role of prime broker – the lead bank that lends to a hedge fund – for specific assets.

this is utter madness, with the fed now to act exactly as bear stearns and lehman brothers once did. the dollar now well and truly deserves, whether it happens or not, to die a disorderly and horrible death under the malfeasant mismanagement of paulson and bernanke. most unfortunately, such a collapse would destroy the savings of every hardworking and risk-averse american by rendering the purchasing power of his currency null.

UPDATE: ambrose evans-pritchard makes his best case for madness-as-sanity while recognizing the risk:

"The bond markets could go into free fall," said Marc Ostwald from Monument Securities.

"The Fed went into this all guns blazing just as the Neo-cons went into Iraq thinking it was a great idea to get rid of Saddam, without planning an exit strategy. As soon as we get the first uptick in inflation, the markets are going to turn and say this is what we feared would happen all along. Then what?" he said.

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"this is utter madness, with the fed now to act exactly as bear stearns and lehman brothers once did. the dollar now well and truly deserves, whether it happens or not, to die a disorderly and horrible death under the malfeasant mismanagement of paulson and bernanke."

OK, but now tell us what you really think!

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sorry, br -- rather losing my cool! -- but this is ridiculous. i work in the hedge fund world, and i can see no good reason any part of this business should be receiving government assistance. attempting to reinflate the dead and decomposing shadow banking system is as thoughtless and reactionary a "solution" to the problems this country faces as is imaginable. turning the fed into an investment bank, with $200bn today surely to be followed by much more after it has become the securitization market, is lunacy!

i am not one who necessarily believes that the morality of what has happened is cleanly delineated -- if pain can be spared the many by begrudgingly rewarding some who deserve otherwise, so be it. but this is insanity. what would success look like?

i'm left with two potential conclusions. one is that the fed really thinks the credit markets went awry not in 1996 or 2002 but in 2008, and that if we could get back to 2007 conditions all would be well. they have, after all, treated this more as a liquidity crisis than what it is from th estart. that would be testament to their delusional stupidity, something i do not wish to believe true of them.

the other is that they know otherwise, but are so craven in their fealty to assetholders that they are willing to risk the destruction of the government itself in an effort to preserve their privileges, even if the odds of success are not good or even significant. that, unfortunately, seems at least as likely.

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from perrone: gm, you know I love you, way back from the days of 1060 west, when it became clear you could think better than most. so it's as a pal that I hint to you -- cause I can listen to you from the outside while you, like all of us, can only listen to yourself from the inside -- that your fears about the currency have more to do with your primal terrors and passions than with your reasoned judgment. it's right here, when you write "most unfortunately, such a collapse would destroy the savings of every hardworking and risk-averse american by rendering the purchasing power of his currency null." I know you feel hard for justice, for equity, for decency, for fairness. so this is deeply pissing you off and scaring you, and that's understandable, and you're mostly dead-on as far as fingering the administration for bending over and contorting into every imaginable position for its pimps.

but I insist -- and many folks are having real trouble seeing this simply because it's so clear, so basic -- that the kind of currency collapse you evoke can only occur at the margins or outside the margins of an economic system, not at the center. that "horrible death" can befall the Hungarian or Zimbabwean coin, or even Germany's when it had just lost a world war and was pinned to the dirt under a mountain of war reparations. but it simply doesn't apply to the world's largest economy (especially in the absence of anything resembling a healthy competitor), it loses it's meaning. it becomes something else.

this DOES NOT mean that we won't end up monetarizing debt, that always happens, and does imply some real devaluation of the currency. but it kind of crawls along, people adjust as it goes, and the benefits it brings usually well outweigh its hardships.

is Bush's gang totally reprehensible, totally cynical, totally baldly in service of the cocksuckers who have brought the world economy to its knees and made a shitload of money doing so? god yes. are they totally fucked? oh hell yeah. is this going to mean a hellish amount of pain for at least half of all Americans and very probably more? yes. but it will soon become clear to everyone that years and years will pass before we even remember what inflation was.

again, I hug you, amigo.

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i don't doubt, perrone, that it is made more difficult by centrality. and i take a probability of a serious devaluation of the dollar as far more likely than burning deutschemarks in the woodstove -- particularly in the next few years, while the credit bubble unwind overwhelms. i agree with you that deflation is likely near-term.

but consider:

one way to view what is happening is an imbalance of production and consumption. this is most obvious between china and the united states, but operates on other levels as well. taking that example:

china produces more than it consumes. we consume more than we produce. the resolution of the current account imbalance is what this crisis is really about; it can be accomplished by i) china reducing production and increasing consumption; or ii) america reducing consumption and increasing production. the vehicle for inducing that change is currency exchange rate.

an economically normal adjustment would involve the renminbi rising vis-a-vis the dollar; this would make american exports more profitable, chinese exports less profitable. china would be forced to increase domestic consumption, including of some american goods, to absorb their excess capacity. america would be forced to reduce consumption as purchasing power declines, but with plenty of room made for domestic production to increase in the absence of effective foreign competition. facilitating this transition should be the job of government.

but it won't be frictionless. it means reduced standards of living on both sides in the transition as both economies reorient.

and this is why, so far, china is refusing to allow its currency to appreciate -- is in fact now talking about depreciating it vis-a-vis the dollar. this is an attempt to maintain a large current account surplus and protect its exporters and stave off civil unrest; it shifts the contraction of excess capacity onto america.

this is likely to produce countermeasures -- including a greater measure of quantitative easing than would otherwise have been needed. this dynamic, feeding on itself, could quickly devolve into a game of global competitive devaluations -- feeding something very much like a hyperinflation in a game of hot potato involving global excess manufacturing capacity.

it will also likely begin an explicit trade war, with the attendant decline in international trade -- so i do agree that deflation remains a difficult reality. but i wouldn't dismiss the prospect of a serious monetary inflation whose signs would become much more apparent following the waning of the credit deflation some time from now.

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on that nascent trade war -- the telegraph. the united states may be about to attack the global depression with an analogue of "imperial preference" -- but will it be as effective in a world where surplus nations are not bound to the gold standard the way america stubbornly was until 1933?

in those days, the deficit pound bloc was allowed to shunt off the lion's share of the adjustment onto the surplus countries, deeply aggravating the american collapse in production as the hoover administration stuck to gold convertibility.

i doubt china will make that mistake, though certainly it will suffer for its excess capacity.

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from perrone: ah, but China is making EXACTLY that mistake, by failing (refusing) to let it's currency appreciate. I would argue that in a global depression -- and we're in one, brother -- the kind of structure that produces a huge current account surplus is, somewhat ironically, a significantly more onerous burden than that which produced the gaping current account deficit. why? because the inevitable adjustment is far more traumatic for the surplus country(ies), really, particularly is the context of the competitive devaluations/beggars trade war you astutely convey. the best way for China to mitigate its dislocation and trauma would be to allow it's currency to appreciate, thus spurring natural and salutary rebalancing.

reduced standards of living, that's one thing. yeah, that's implied, and will happen. "serious monetary inflation" may happen, eventually. if/when it does my guess is it will be welcomed and celebrated -- with basically good reason.

the horrible death of the dollar in a blazing hyperinflation bonfire, on the other hand, I just can't find any plausible way to work it into the story. I'm open to narratives I've missed, and would be fascinated to hear them.

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GM, I work in the hedge fund business as well. For the record, I agree with you.

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the best way for China to mitigate its dislocation and trauma would be to allow its currency to appreciate, thus spurring natural and salutary rebalancing.

i agree with this, perrone, because i am an american -- but will china?

the big "mistake" the united states made, by which it unwittingly accepted a disproportionate share of the contraction in excess capacity until 1934, was to stick to the gold standard as others depreciated in 1931. using, the dollar appreciated versus the pound and the swedish kronor by nearly 40% in 1932, by 60% vs the yen, and these countries emerged from the depression relatively unscathed [ie delGDP > (-8%)]. france, on the other hand, did not devalue until 1937 and each saw something like a (-15%) contraction in GDP. germany never devalued (following the great inflation of 1924) -- indeed the reichsmark was the strongest currency of the era -- and suffered nearly as much as the united states (and much more, of course, if you count the 1933 election results).

so what we're asking china to do is pursue a path by which it attacks the economic sector it has built its national rise upon heretofore -- exports -- which is already going to be weakened in an effort to amplify its immediate economic pain. in effect, we're asking them to play the role of the united states in the great depression up until 1934, allowing their creditors to lessen their adjustment obligations while they decimate their core competency.

it strikes me that china is unlikely to do any such thing unless it is compelled to. china has been a command economy, particularly as regards the RMB. that won't go quietly.

i suspect instead it is going to have to be demonstrated to china exactly why they don't have a choice -- that continuing to peg to the dollar or even depreciate will bring only tariffs and competitive devaluation in a trade war is cannot win.

and the reason why they will have to be shown is that the united states, unlike britain in the depression, is a massive net debtor vis-a-vis china and others. it was never within the capacity of the united states in the 1930s to force a true currency crisis on sweden, japan or (far more importantly) britain's "imperial preference" sphere. but it IS well within china's ability to at least attempt such a currency attack.

if china is going to be told to take the brunt of the disaster, why would it not counter by threatening to destroy the united states altogether? its forex reserve pile is almost certainly viewed by some important people in china as its "nuclear option" insurance policy. it may perceive itself as having little to lose in exercizing the policy if it's being told to price itself out of american export markets anyway and take a (-30%) GDP hit -- one which the government would probably not survive and is acutely aware that it would not survive.

it looks to me like china has the ultimate beggar-thy-neighbor trump card in this hand -- dumping hundreds of billions of treasuries onto the market and sparking a run on the dollar (which is currently more overowned than ever before) may very well end both the 'treasury bubble' and the greenback.

can you fellas disassemble that argument and show me wrong? please do! i don't much like the implications....

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or, as a piece of private research i'm reading said:

"Weimar Germany suffered through its inflationary and deflationary crises ... because as a defeated debtor country it was not in command of its own financial destiny. ... The United States is not Weimar Germany, but ... [it] is, financially speaking, a vassal state. ... The various sovereign creditors are now in a contest of strength to determine who is senior in the capital structure, and what the real value of their claims shall be. ... So long as the creditors remain in partial control of the process, deflation wins out over inflation....

... but if the debtor becomes unruly, something worse than a debt-deflation is possible.

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There won't be a run on any part of the term structure, the Fed can just buy up everything China dumps. They're already doing it with agencies. Once they dump all those newly created dollars, that could very well constitute a run on the dollar. Bernanke probably wants a controlled, steady, dollar devaluation as he believes that the 40% devaluation during the Great Depression was instrumental in leading us out of it.

Since you're in the hedge fund business, you should read Clarium's latest quarterly thought piece, if you have access to it. It's all FX and China focused, makes some interesting points.

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thanks for the discussion, folks.

Once they dump all those newly created dollars, that could very well constitute a run on the dollar.

right, br -- monetizing on that scale risks a monster inflation once delevering slows (or reverses, lol). this is certainly one view of potential currency mismanagement. once such an inflation begins, is the fed really going to extricate itself immediately from its lending facilities, contract its balance sheet and risk plunging the still-weak economy back into deflationary depression? still, perrone is right -- this sort of inflation would probably be welcomed here in some measure, provided it isn't allowed to run away.

the more serious if remote inflationary view, though, has to be of competitive devaluations. it seems to me that the risk being run by bernanke is that the dollar might be made to break in a very disorderly way -- while the reward is supposed to be an orderly relative devaluation. staying on the reward side can only happen with china's complicity, it seems to me, and i'm not sure what the quid pro quo is. telling them that they have to suffer the brunt of a great depression and potentially a complete social collapse in order to eat excess demand and move off the export-growth model -- isn't that the end of the stick they get either way?

that weimar bit actually is in clarium's conclusion. :) have to admit i'm still digesting their argument, though, which is more sophisticated than mine. they don't seem to see competitive devaluations as a big near-term risk, though.

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i want to re-emphasize, though -- we are going to get some serious and long deflationary impulse before any of this currency-related stuff shows up as rising prices, if it ever does. i have some sympathy for lee adler's view -- we're obviously seeing wage deflation and a huge spike in unemployment quick on the heels a massive debt delevering in the shadow banking system. this is so far from inflation that it's hard to think about anything having to do with the fed's exit strategy.

but there will come a time when that matters -- and expansions of loans to beleaguered speculators to gin up some securitization will aggravate those problems.

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from perrone: gm, I want to get back to you on this, with some clarification that might offer _some_ comfort -- but right now I´m away from home and it´s not as easy to find the time and place to sit down and write. stay tuned, I´ll find a chance soon, I think. happy holidays.

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from perrone: OK, I think there´s some confusion here about what the US´ big mistake really was back in the early 30s. my argument is that sticking to the gold standard wasn´t what did the damage -- the dollar was going to appreciate no matter what, because the US was the huge surplus country (and btw, gm, Britain and the rest _were_ big net debtors -- BIG net debtors), and while sticking to the gold standard sped that appreciation and increased the short-term shock who´s to say that was necessarily the worst alternative (you prefer 15 years of slow quicksand like 90s and 00s Japan?)?

no, the real mistake -- for the surplus-burdened US -- was sticking for too long to a futile, dead-end strategy of (trying to) propping up exports instead of drawing down reserves and redirecting them to full-throttle domestic fiscal stimulus. and THAT´S the same mistake China seems to be on the verge of making.

look, the export market´s enfeebled. it´s mostly gone, just like in the 30s, whether you (the US in the 30s, China now) like it or not, and whether you see it or not. your currency HAS to appreciate, because that´s the only way for a semblance of world balance to return, and without that semblance of balance the world economy won´t heal and start growing again. you HAVE to consume more now -- that´s the only way for you to get better. if you stick to an export subsidy/cheap currency tack you can only incite trade wars and hurt yourself more.

so maybe it´s clearer now why I contend a surplus is worse than a deficit when depression comes. a deficit country will be forced to increase production, which is definitely palatable, although you consume less. but the surplus country, well, there were two ways for the US to adjust in the 30s -- consume much more or drastically cut production. cutting production is more traumatic, and that´s what the US was forced to do, because its export strategy necessarily failed. once it turned to bolstering consumption, things improved. my prescription for China isn´t borne of an American-centric perspective, but of an historical one. I think.

how´s that?

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perrone, i totally agree. indeed, china's recent deliberate weakening of the renminbi is little more than mercantilist trade policy for the benefit of its oversized export sector. that's the opposite of the necessary currency adjustment, as you note.

but that the adjustment is necessary or even optimal from the global perspective does not mean china will acquiesce to it. i think instead it will continue to attempt to bolster its exports through competitive devaluation -- maintaining their dollar link or even weakening against the dollar -- for as long as possible, as the alternative may really be violent revolution in china.

the harder they try to boost their export sector by weakening their currency, the more of the contraction of excess capacity will be transferred to its deficit trading partners, ie the united states and europe. indeed, in the overall view, the degree of damage is likely increased by so doing.

this was spared europe in the 1930s by the american refusal (thanks ot the stubborn ideology of sound money) to devalue until 1933, pushing the collapse of excess capacity onto the US and making the great depression great here while much less so in britain and other early debasers.

i see what you're saying about the need of china to allow appreciation or a clearly undervalued currency -- and that perhaps that adjustment isn't really the hard way out after all but merely the necessity. i simply don't think china, unburdened by a hard currency, will be willing to go along with what is necessary -- particularly early on in the process. rather, it will try to manage its currency to its perceived national advantage, perhaps political existence.

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Friday, December 19, 2008


cars get money

the shoe-dodger-in-chief tells hank paulson to kick the automakers $14bn out of the TARP to hold them over into the obama administration. they will not file bankruptcy, and that's just as well given the ramifications. they've been given to march 31 either to come up with a viable restructuring plan, to organize a chapter 11 financing, or procure a much better bailout from the new administration and congress following january 20.

bush explicitly included bondholders to share in the pain via a debt-to-equity conversion. good luck with that one.

the only lamentable point is that i didn't get to say, "this is a goodbye kiss, you dog!" to ford in this post. i've owned three, and the first two had the transmission fail before 75,000 miles. third one (not my decision!) is in the garage at 73,000 and behaving oddly lately. gulp.

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Ford's suck gm. The U.S. car folks won't like this, but I haven't bought or regularly drove an American car since 1990. Guess what gm, car's have never been a headache in my life.

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I don't know if it counts, but I'm still driving a 96 Mazda B2300 (basically a Ford Ranger with a different grill and color scheme) after 156,000 miles with no problems. I love that truck, and looking at replacing it with a newer used Ranger. Ford does trucks really well. Cars? I've had good and bad.

But I would never buy a GM or Chrysler vehicle of any type.

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Bank of America and Mr. Higgins missing $millions, It can happen to you, my fellow Americans

More info:

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Thursday, December 18, 2008


"orderly" bankruptcy for automakers

this is apparently what the white house is thinking. meanwhile, chrysler is shutting down for a month, in what must be a crippling blow to suffering parts suppliers and others in the automotive chain -- indeed i'll be quite surprised if they ever reopen.

yves smith, in addressing the ominous reopening ot GM-chrysler merger talks, discusses how the flow of sentiment -- much as the lead-in to the lehman brothers bankruptcy -- has moved toward bankruptcy as the necessary reorganization tool in spite of the many difficulties it may present to the viability of the business.

With Lehman, the big unknown that should have been investigated was the true state of its balance sheet. With the Big Three, the wild card is how consumers would react. No matter how great theoretical advantages of Chapter 11 are, if a large proportion of customers abandon the company due to worries about its future, there is nothing to save. The Chapter 11 will morph into a liquidation as expected cashflows during the Chapter 11 process fall vastly short of anticipated levels. Assessing likely consumer reaction is far easier and less fraught than subjecting Lehman to serious examination would have been (there was a real risk that it could have fed concerns about the firm and accelerated its demise).

But as with Lehman, the public is developing bailout fatigue, and the carmaker's failings seem more obvious than those of the financial industry, and therefore less deserving of forbearance.

i would submit that an 'orderly' bankruptcy for the automakers is quite unlikely for so long as the credit default swap market exists in its current form. if credit events at GM and chrysler trigger collateral calls on the multiparty CDS that underlie huge piles of synthetic CDOs, bankruptcy here could well spark another wave of the illiquidity and forced asset sales such as was seen in the aftermath of lehman -- except this time, with trillions in synthetic CDOs on bank balance sheets being revalued from 95 cents to pennies or less, such a wave might be accompanied by massive bank nationalizations.

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Bank of America and Mr. Higgins missing $millions, It can happen to you, my fellow Americans

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Wednesday, December 17, 2008


josh rosner and doug dachille on bloomberg

i just caught their devastating reaction to the fed's recent purchases of agencies and analysis of consequences on 'taking stock' -- this is a reminder to self to look for transcript/video.

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Bank of America and Mr. Higgins missing $millions, It can happen to you, my fellow Americans

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Tuesday, December 16, 2008



zero-interest-rate policy is here.

UPDATE: yves smith on consequences here and here.

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It's not looking good for the USD, eh?

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from perrone: on the ultimate danger to the USD (again), of course that's an animal that must be watched and managed. but is it a marauding beast or a dog, ready to be our best friend? the extremely prescient discussion of Keynes' insights this blog has promoted (great, great work GM) must lead us to believe the US is doing just what it ought to do, right? as the largest current account deficit country, it ought to see it's currency sink relative to those of the current account surplus countries and it's production (at the cost of its consumption) ramped up. zirp pushes you in that direction. the view that it's misguided domestic "stimulus" has it exactly backwards, it seems to me.

the question I tremble at is what happens to world trade if the US follows the plan but the surplus countries refuse to -- if they refuse to let their currencies get stronger and/or refuse to stimulate internal demand? a race to the bottom, I guess. but even then, the USD will be just as strong (weak) as any other fiat currency.


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perrone, i think that has it exactly right -- beggar thy neighbor. given what is transpiring now in emerging markets, a ghastly race to the bottom looks like the order of the day.

mathew is right -- no good news for the buck here, at least relative to goods. but i think those looking for a currency crisis (including me) should look to GBP first; they are on a high wire relative to every other developed economy.

the dollar crosses with surplus nation currencies, however, i suspect will be stubborn. the dollar has sold off hard recently on quantitative easing, but others will quickly follow down to ZIRP and QE. and let us not forget that this is still a crisis of dollar-, CHF- and yen-based deleveraging -- a lot of dollars are being consumed as dollar debt is paid down. it's going to be easier in some respects for QE to get results in other economies.

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a good monitor of the renminbi-dollar cross is CNY -- no appreciable devaluation here yet in spite of the dollar crushing in december.

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i follow this blog even though I usually have no idea what you are talking about GM. It's either been luck or fortune but so far I haven't seen any kind of slow down in my industry (wind energy). I figured that people would put buying a turbine on the back burner as soon as the credit market dried up.

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there's a lot of speculation, dj, that your field will be one of the beneficiaries of fiscal stimulus in the form of government infrastructure spending, which is set to gear up as a sort of new-new-deal. with energy demand falling off a cliff, i'd be interested to see how capex reductions affect your line of work in between now and any eventual government outlays. please keep me up to speed -- and good luck! looks like a good place to ride this out.

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Basically what I did was shift our market from companies looking to offset energy costs at their plants to buyers with a steady source of federal money. We inked a deal with a Native American tribe, a community college and a High School within the last 2 months. The school market is going to get tougher because almost all states are bringing fresh budget cuts. But I agree that wind is a hot topic right now and with a little more federal incentives it could really grow fast.

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Bank of America and Mr. Higgins missing $millions, It can happen to you, my fellow Americans

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Sunday, December 14, 2008


negative chinese GDP change

per calculated risk, this is the first such forecast i have seen but this is certainly a confirmation of vitaliy katsenelson.

UPDATE: yves smith on new data from chinese electrical production -- down (-9.6%) in november YoY. the clear implication is that even dubious and inflated official chinese statistics soon won't be able to hide the depth of china's economic collapse.

UPDATE: michael pettis:

I can’t prove it, of course, but I think Chinese inflation is a money-based phenomenon and I am guessing that if China is experiencing deflation it is also experiencing rapid contraction in outstanding credit – much more rapid than we think. In China like in most developing countries, as I have written many times before, the structure of balance sheets tends to reinforce trends, which increases underlying volatility. We may have suddenly swung from ferocious credit expansion to ferocious credit contraction. The fear of deflation next year, in that case, is well founded.

terrible news for those hoping that surplus nation demand might be stimulated to absorb capacity that had once gone to the west.

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Saturday, December 13, 2008


obama goes mum on blagojevich

bad sign.

Obama's staff has declined to respond to even basic questions, like who is conducting the probe, how long it will take, what issues are being explored and whether they are working with federal investigators. Obama has promised transparency throughout his service and to divulge contacts his staff has had with Blagojevich's office in the coming days. But his staff has locked down on inquiries in the meantime.

The Obama transition team's refusal to talk has contributed to a maelstrom around Obama's incoming White House chief of staff, Rahm Emanuel, a Chicago congressman likely to have been in contact with the governor, who was arrested this week in a corruption scandal. But Emanuel is not a target of the probe, according to people who have been briefed on the investigation. ...

Asked if any conversations between Emanuel and Blagojevich were captured on government wiretaps, Obama spokesman Robert Gibbs said, "I honestly don't know." Other transition officials refused to respond to inquiries.

"honestly don't know"... right.

as an illinoisan, a chicagoan, and one who actually voted for obama, let me tell you all that anyone who thinks he's clean is drinking the koolaid. the president-elect is an illinois pol in bed with rahm, emil jones and jimmy deleo, backed by rezko, alexi giannoulias and others even less likeable. he is as dirty as any of them, and if you imagine otherwise i have some waterfront real estate i'd like to sell you. it's the chicago way. if he succeeded here, he's dirty; he'd have been railroaded long ago if he weren't playing ball.

please note that obama, in issuing a catagorical denial of contact between his camp and blagojevich over the senate seat, has already told a lie to the press on this one -- and an easily outed one, as fitzgerald apparently has rahm on tape with blago. why are they dissembling? my money says that either rahm is on tape discussing at unseemly length a quid pro quo with blago OR he could be and they don't know if the feds have it on tape. the trib notes:

Though now working full-time on Obama's transition, Emanuel has yet to resign his congressional seat. Illinois law has a different process for filling vacant House seats than Senate seats. When Emanuel resigns, a special election will be held for his replacement.

One alleged scheme outlined in the charges against Blagojevich involves the special election for Emanuel's seat. The government affidavit said Blagojevich and others were recorded talking about an unnamed "president-elect adviser" concerned about the election for Emanuel's congressional seat who might help the governor land a new job at a non-profit organization.

that could be why rahm apparently went to the feds and told them how to get blago -- i'd wager rahm tried to get fitzgerald to firewall the investigation from the obama camp on good-for-the-country grounds, and maybe even with more information, in an effort to save their political skins. fitzgerald is also talking to his future boss -- the fact that he went public with blago now may be because he think he'll be shut down come january 20 because he might know too much about members of the obama camp.

if this sounds speculative, it is -- but i submit you haven't been watching illinois politics long enough if you don't assume the very worst. history shows that chances are i'm underestimating the depth of the filth on all sides. this country's politics would get a lot cleaner if every illinois pol past and present were crowded into soldier field, the doors locked and the joint set on fire.

moreover, lisa madigan has decided to hold the state hostage, as noted by equity private at dealbreaker, holding up payments and attempting a coup d'etat by circumventing the impeachment process with a declaration of incapacity meant for medical emergencies. quality.


Only in Illinois could Michael Madigan's daugter posture as a reformer. I'll admit she's easier on the eyes than, say, Emil Jones, but as a lefter than left lefty I'll be voting for Mark Ryan in any prospective primary and a straight Republican ticket on the next ballot on general "throw the bums out" principle.

I agree on Obama, by the way—not sure it's relevant to the job he'll do in office, but anyone who thinks he's not soiled by this filth is delusional.

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my jaw dropped when he selected Emmanuel. There was no reason, except the fact that we all know he's corrupt as hell. I really thought Obama would have been smart enough to distance himself from Cook County Dems.

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i can't disagree with tossing the bums out, anon, but high-level republicans are as deeply invested in the combine as the democrats. everyone is in the same boat, scratching each others' back.

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ccd -- the question is, who could he go to? and if he tried, wouldn't they take their revenge?

for better or worse, obama's political family is inescapably in chicago.

more from kass today -- he'll be essential in reading this situation as it unfolds.

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meanwhile -- it appears the chicago tribune, desperate to sell copy even in bankruptcy, fucked up fitzgerald's investigation and a chance to nail jesse junior to a wall.

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making this whole thing even stranger. after all of the shit with Emmanuel and Blago, guess who Obama tapes to be his secretary of education? CPS CEO Arnie Duncan. LMAO.

CPS is one of the WORST Public School Systems in this country. These people haven't a fucking clue. Promoting this guy from that position is a 'get out of jail' card for Duncan.


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lol -- 'change we need' clearly doesn't mean abandoning the chicago school of political patronage, ccd.

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however -- and this is an important point -- what is happening here is a big fat nothing in the context of what's gone down in the white house since 9/11/2001. the senate armed services committee released a report last week linking the white house and the president to war crimes in iraq.

obama is a machine pol rewarding some cronies. bush just got done impersonating a less-competent mussolini for two terms in what was unquestionably the most damaging presidency in the history of the nation. so some perspective is called for.

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I heard that story on Friday afternoon gm, nothing after that. Amazing none of the right wing wackos picked it up this week.

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Sadly, Blago, Daley, Rahm and Obama have nothing on Bush and his thugs.

That article at is a must read for Americans. The fact that the president of the US decided the Geneva Convention did not apply is fucking sick. This goes against everything we are told this country stands for. Remember Bush told us we were the 'good guys'. Huh?

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ccd, i did see some rumblings over the weekend that the obama administration might actually move in a preliminary direction of an american war crimes prosecution.

i can only imagine the histrionics among the limbaugh/hannity/unthinking right -- how dare any "american" question Our Unquestionable National Greatness, lol -- but i think such a prosecution could be, properly handled, a tremendous salve for the united states. it has to be demonstrated that the institutions which were installed to protect the people from malicious leadership are still there. and that's far from a settled question -- does anyone, for example, expect an effective prosecution on the causes of the national malfeasance which we are now seeing the consequences of?

the real question is whether or not the united states has a lawful government capable of corrective action -- or if instead it has a massive civil service directed by mere cronyism and convenience.

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gm, that would be something if they actually tried to go after Bush and his cronies for the crimes they have committed.

As for Rush, Hannity and all the rest of the right wing wackos. The fact that not one of them has stood up and said that these things were wrong; the fact that not one of them has called out Bush and his cronies for the last 8 years just proves that all they are is mouthpieces supplied with talking points from the RNC.

With Obama and his group of merrymen taking power, I really think the right needs a voice more than ever in this country. If it's one of these boobs, count me out. Find someone who is thoughtful and articulate and not just rehashing the same old rhetoric again and again and again.

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Bank of America and Mr. Higgins missing $millions, It can happen to you, my fellow Americans

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Friday, December 12, 2008


retail sales collapse

per calculated risk. the chart here is provided by the bank credit analyst, which i prefer as it dates back to the 1981-82 period. but CR well notes:

Although the Census Bureau reported that nominal retail sales decreased 8.4% year-over-year (retail and food services decreased 7.4%), real retail sales declined by 10.1% (on a YoY basis). This is the largest YoY decline since the Census Bureau started keeping data.

the rate of inflation in 1982 as measured by CPI had already subsided to 4% under paul volcker's tenure at the fed -- so this retail collapse really is quite a lot worse than that seen in 1981-82. the rate of employment growth, it seems to me, will also soon breach those precedents.

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Great, informative blog. How are you positioning yourself in this haywire market? It's tempting to go heavy on the short side via SRS, FAZ and SKF and such. The problem is that it seems like the PPT is doing their part to make sure the market doesn't crumble before Christmas. Are you standing aside or accumulating a position? Thanks in advance.

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z, i've been trying from both sides since january 2008, with the result of being about flat to a bit up. so i'm not killing it or anything. just fyi.

imo, there's been a monster drawdown that should spark a rally. i had considered going in that s&p 750 would mark the crash low. maybe it still will. but the fact is that the market still looks like a series of lower highs to me, and i've seen no real evidence of strong accumulation. that it hasn't behaved better says something.

so i'm mostly in cash, with some longs. with the market short-term overbought now, i'm thinking about taking those longs off monday am. this doesn't so far much look like the kind of powerful rally i would expect off a final low. given how damaged the banking sector is -- normally the investment banks, following their november 30 end-of-fiscal-year, would boost liquidity in stocks and create a santa claus rally -- but that clearly won't be operative this season -- i'm inclined to be cautious.

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Bank of America and Mr. Higgins missing $millions, It can happen to you, my fellow Americans

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why britain could be iceland

the spectator with a stunning chart. note at least that this is gross external debt -- britain also has large claims on foreign assets.

i've commented on iceland a bit and the potential for currency crises to strike where a nation is reliant on foreign financing.

the united states has a problem with foreign finance because the finance required to close its yawning current account deficit is large in relation to the global capacity to provide such finance.

britain has a much more straightforward problem -- they've borrowed far too much from outside the pound currency regime in relation to their income. it's no wonder the pound is collapsing.

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blagojevich, deleo, rahm and obama

john kass in the tribune sketches the close chicago connection between indicted illinois governor rod blagojevich, jimmy deleo and white-house-chief-of-staff-to-be and obama confidante rahm emanuel.

emanuel, it has been said, is the man who told the feds how exactly to nail blagojevich. and he could have done so to protect himself as well as the president-elect, building a firewall between the investigation and the obama camp in return for aiding the feds.

whether or not they helped nominate the wrong candidate, this may be a good test for the national media, as to whether the obama 'mania' that held them for the duration of the campaign still has legs. if the washington papers were ever to put aside their fears of being forcibly disembarked from the white house ship of media relations, they would get a very interesting look at the origins of a chicago machine politician who is to be our next president.

UPDATE: emanuel was certainly talking to blagojevich, it seems. pretty hard to imagine that the subject of how much the senate seat was going to cost didn't come up.


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treasury will finance automakers

per bloomberg. put aside for a moment whether or not treasury should be funding that which congress explicitly won't -- although the continuing transfer of the power of the purse form the legislative to the executive is being laid bare before the world by the crisis.

rather, consider the synthetic CDO disaster that may (or may not) have just been narrowly averted. more from option armageddon, expanding on the insights of the institutional risk analyst and chris whalen.

[N]ews about AIG reveals that the current problem with CDS has very little to do with the nature of the market and negative economic incentives, but with how the contracts work. As Martin Mayer says, it’s the plumbing, not the principals, that matters most. AIG does not seem to have lost all that much money, or I should say does not seem to have handed it over to counterparties. Rather, as the nature of the bad bets AIG made became clear the insurance giant has been forced to post larger and larger amounts of cash in collateral accounts to prove that it can pay its CDS obligations if in fact the underlying companies do default.

The money is not gone, it’s just stuck waiting for things to get better or get worse. Sure eventual payouts might be needed and that would be bad for those who have to pay, but then at least the money could be put back to work by those on the receiving end. Right now CDS seems to be working as a big liquidity sponge, sucking up cash into collateral accounts and keeping it from greasing the economy. This is likely happening to everyone, though on a scale smaller than AIG.

What’s interesting about all this is that the collateral positing requirements of a CDS contract are basically self-imposed capital adequacy requirements between parties to a CDS trade (great book on regulating capital here). Capital adequacy requirements have long been considered the brakes on the global economic locomotive. They keep banks from betting too big when times are good. And, if managed properly, they are reduced during bad times so banks can pull the cork out and lend, lend, lend. One of the big fears with CDS is that there really were no capital adequacy requirements. To a certain extent this is true, because nobody checks to make sure a counterparty can post the collateral when it’s due. The collateral requirements of CDS contracts, however, act like capital adequacy requirements. As it becomes likely that a CDS contract will have to be paid out, collateral requirements, er, require that protection sellers have more cash on hand.

If collateral posting is forcing cash into collateral accounts that otherwise could be used to make loans, we have a problem. And that problem is likely to get worse as more debtors become unable to pay their bills, CDS spreads rise, and more cash needs to be posted as collateral. The CDS market seems basically to be a liquidity easting machine and if that’s true then all the lowering of rates and injection of dollars into banks won’t do much unless something is done to either a) reduce collateral requirements on CDS trades (what would that do to the CDS market?) b) improve the credit of all debtors, which would reduce CDS spreads and let money out of collateral accounts.

The CDS market seems to be set up to make things worse when they look bad by sucking cash out of a cash starved system. Not smart.

now we have since discovered that it isn't happening to everyone all the time -- CDS dealer banks don't post collateral between one another, which means their potential liquidity issues are still ahead of them. but beyond single-name CDS it is critical to realize that, as kimball noted, "DTCC completely ignores CDO-related CDS, perhaps 40% of the market." and the automakers are named in a huge proportion of them.

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."

should they trigger, the losses in synthetic CDOs will be massive.

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madoff 'ponzi scheme'; deeper GSE fraud

via michael panzner -- another massive blow to trust in the securities industry, this one striking at big money.

The SEC's complaint, filed in federal court in Manhattan, alleges that Madoff yesterday informed two senior employees that his investment advisory business was a fraud. Madoff told these employees that he was "finished," that he had "absolutely nothing," that "it's all just one big lie," and that it was "basically, a giant Ponzi scheme." The senior employees understood him to be saying that he had for years been paying returns to certain investors out of the principal received from other, different investors. Madoff admitted in this conversation that the firm was insolvent and had been for years, and that he estimated the losses from this fraud were at least $50 billion.

but it might not have been the biggest financial fraud revealed this week, as the testimony of former fannie mae chief credit officer edward pinto directed attention to the massive role the GSEs played in financing the very alt-a and subprime mortgages they claimed to be uninvolved in and inoculated to. option armaggeddon calls paul krugman to task for his earlier defense of the now-nationalized GSEs.

This whitewashing of Fannie’s/Freddie’s role in the housing mess was proven absolutely false today when Krugman’s own paper reported on one insider’s account of the VERY LARGE extent to which Fan & Fred gorged on toxic mortgages:

Fannie Mae and Freddie Mac engaged in “an orgy of junk mortgage development” that turned the two mortgage-finance giants into vast repositories of subprime and similarly risky loans, a former Fannie executive testified on Tuesday…

The former executive, Edward J. Pinto, who was chief credit officer at Fannie Mae, [said] that the mortgage giants now guarantee or hold 10.5 million nonprime loans worth $1.6 trillion — one in three of all subprime loans, and nearly two in three of all so-called Alt-A loans, often called “liar loans.”…

Such loans now make up 34 percent of the total single-family mortgage portfolios at Fannie Mae and Freddie Mac, a level that will link them to eight million foreclosures, or one in six, in coming years.

The [new york times] article notes how Fan/Fred “adopted accounting practices that masked their subprime and Alt-A lending…[even while they] insisted that their involvement with subprime and other nonprime loans ha[d] been minimal.” Indeed despite the concerns of its own risk managers, Fannie “further increased its purchases of subprime loans, according to a January 2007 internal presentation.”

it's become very clear that fannie and freddie were killed by their massive and irresponsible leverage applied to loans of obviously terrible quality, bought with virtually no internal quality control or competence. plans for the government to use these two behemoths to bolster the housing market seem inoperable for so long as they are to be economic units unto themselves -- they must be insolvent to the tune of several hundreds of billions.


Thursday, December 11, 2008


auto bailout stalls

per yves smith. paulson may have to use TARP -- the same TARP republicans tried to murder in the womb a few months ago -- to save GM and chrysler.

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beggar thy neighbor

paul krugman on a newsweek interview with german finance minister peer steinbrueck.

The world economy is in a terrifying nosedive, visible everywhere. Yet Mr. Steinbrueck is standing firm against any extraordinary fiscal measures, and denounces Gordon Brown for his “crass Keynesianism.”

You might ask why we should care. Germany’s economy is the biggest in Europe, but even so it only accounts for about a fifth of EU GDP, and it’s only about a quarter the size of the US economy. So how much does German intransigence matter?

The answer is that the nature of the crisis, combined with the high degree of European economic integration, gives Germany a special strategic role right now — and Mr. Steinbrueck is therefore doing a remarkable amount of damage.

the stand of mr steinbrueck and indeed the government of angela merkel appears measured and principled.

For a while the position in Brussels and a few other places has been "We're now very much for setting up large-scale spending programs, but we're not really going to ask what the exact effects of those might be. And since the amounts are so high, well, let's get the Germans to pay because they can." Ms. Merkel and I are trying to calm them down a bit just now, and understandably that's getting us criticized.

The speed at which proposals are put together under pressure that don't even pass an economic test is breathtaking and depressing. Our British friends are now cutting their value-added tax. We have no idea how much of that stores will pass on to customers. Are you really going to buy a DVD player because it now costs £39.10 instead of £39.90? All this will do is raise Britain's debt to a level that will take a whole generation to work off. The same people who would never touch deficit spending are now tossing around billions. The switch from decades of supply-side politics all the way to a crass Keynesianism is breathtaking. When I ask about the origins of the crisis, economists I respect tell me it is the credit-financed growth of recent years and decades. Isn't this the same mistake everyone is suddenly making again, under all the public pressure?

It's the yearning for the Great Rescue Plan. It doesn't exist. It doesn't exist!

i can only with great difficulty envision any federal department head in america, a country which has grown far more demotic than many european states, actually telling people to take their medicine. right or wrong, kudos to steinbrueck for having the courage of his convictions -- though i suspect he does so in the belief that germans aren't facing the brunt of the disease and is telling others in the eurozone to swallow hard.

but -- while i agree with steinbrueck that the assertion of keynesian acolytes regarding the absolute need for speed is likely a manifestation of the inability to accept the inherent inefficacy of stimulative policy in the face of a large systemic delevering in its early and most momentous phases -- there is also i think little doubt that his nation, along with other large creditor states such as china, japan and the petrodollar states are the key component of any successful plan to invigorate the global economy. and they aren't living up to their responsibilities.

keynes argued rightly for a global rebalancing -- something which can only be accomplished by closing large current account gaps. the ways in which this can be done are currency adjustments -- which surplus nations accepting stronger currencies, and vice versa for deficit nations -- and demand management -- which means relative increases in domestic demand in surplus nations and increased relative savings in deficit nations.

this was in cataclysmic manner accomplished in the 1920s and 1930s -- which in time saw, for example, the german mark weakened considerably against the american dollar, a resulting relative increase in european export competitiveness vis-a-vis the united states, a closure of the massive interwar american trade surplus with europe, and a relative reduction in the standard of living for european consumers (in spite of a tremendous demand collapse in the united states in the early 1930s). in a very important article, michael pettis addressed these issues recently.

it certainly seems that the imbalances that led up to the current crisis were in many ways similar to the imbalances of the 1920s – with a few countries, dominated by one very large one, running massive current account surpluses and accumulating, in the process, rapidly growing central bank reserves. ...

I can’t help thinking that there is an important lesson in here for us. In the 1930s it was noteworthy that the current account surplus countries like the US and the net exporters in Latin America suffered more deeply from the crisis than did current account deficit countries, especially, it seems, once barriers to trade were imposed. The extreme case of the latter was Germany. As I understand it Germany imposed trade restrictions early, in which German imports were largely paid for in export credits, so that Germany more or less ran a balanced trade account after many years of large deficits. It was the first country to emerge from the Great Depression – in fact I don’t really think there was a depression in Germany to speak of – in part, I think, because its low savings and high trade barriers permitted the investment multiplier to work very effectively.

The US, on the other hand suffered a deep crisis in the 1930s, and its imposition of trade tariffs made things worse, not just because impediments to trade are costly to the global economy, but rather because it eliminated the ability of the US to absorb expanding demand from other countries and to force other countries to absorb excess US production. Once international trade is eliminated, in other words, US excess production over consumption had to be resolved wholly within the US, and that meant that either the US engineered a substantial increase in domestic demand by fiscal means, as Keynes demanded, or that it adjust via a collapse in production. It did the latter.

I am worried about some of the conclusions I might be drawing. The first conclusion, I think, is pretty clear and I have already discussed it. Demand has to expand and it isn’t like to be households or businesses that do the job. The burden must fall on governments to expand fiscally.

On that point I think most people agree with me generally, but are less convinced than I am that the main role in resolving the global demand problem must fall on the current-account-surplus countries, whose high savings rate must decline. They have produced more than the world is currently able to consume, and if they do not boost demand significantly, they will be forced to cut supply significantly.

that is now where germany, china and japan are -- facing surprisingly steep domestic recessions that they anticipated least, supposing their conservative financial system positioning would keep them above the fray. it hasn't. with private sector demand fading sharply in all three nations, governments are hesitating to move in to aggressively manage domestic demand -- indeed are instead broadly trying to bolster exports where they are addressing anything at all.

this begs for a trade war.

[This analysis] suggests that although a collapse in world trade might be bad for the global economy overall, the pain will not be evenly distributed, and some countries might even benefit, and in that case they may actually move to restrict global trade. Current account deficit countries will suffer much less from anti-trade policies, in other words, and may even benefit because it gives their domestic fiscal policies greater traction. This may encourage them to attack trade if the global economy gets much worse.

As things currently stand, for example, fiscal expansion in the US has a much lower multiplier because in an open economy it is not US savings that matter but rather global savings, and global savings rates are much higher than domestic savings rates. In addition, a boost in US demand is exported through the current account deficit to other countries. Will the US continue to accept these limitations off trade if the US is forced to bear the brunt of the effort to increase global demand, or will at some point protectionist legislation become irresistible?

I think this is sort of what happened in the 1930s. The US refused to bear the brunt of the adjustment which, as the leading creator of global overcapacity it should have. Countries like Germany that opted out of the system seemed to bear little of the pain. When the US government enacted Smoot-Hawley, as a way of forcing even more of the US adjustment onto the rest of the world, it made it very easy for the rest of the world to opt out of the trading system, thereby forcing the full adjustment onto the US. In fact the US ended up bearing more than its full share of the adjustment because the decline in international trade actually made things worse for everybody.

The collapse in global trade forced most of the economic adjustment onto countries, like the US, whose excess savings and rapidly rising capacity created the global overcapacity problem in the first place. The Great Depression was brutal for the US and for some Latin American countries, but not nearly as bad for continental Europe and I think barely noticed in corporatist Germany and Italy. What if current account deficit countries conclude today, like they seem to have done in the 1930s, that by restricting trade they can force most of the global adjustment onto the current account surplus countries? That would be devastating for Asian exporters and especially China.

dani rodrik is also talking about this, as pettis notes, whereupon he says:

I have had a number of conversations with US and European officials in the past two weeks, and I get the impression that there is going to be a substantial hardening, especially in Europe, of positions on international trade, and I suspect that European officials are nowhere near as committed to keeping the market for global trade open as American officials are, but even American officials will turn against trade if popular discontent rises enough.

The reason that I am very uncomfortable with the whole line of reasoning Dani Rodrik, I and others have been following is that I do firmly believe that active international trade is in the long-term interests of the world, and especially in the long-term interest of very poor countries like China. In the short term, however, I think it would be dishonest to say that reducing trade cannot create any benefits – it can help many trade-deficit countries struggling with insufficient domestic demand by diverting domestic demand that used to go abroad.

and it is with that context that pettis stands horrified by the trade numbers released by china yesterday -- less for its shocking decline in YoY exports than an ominous collapse in imports of (-18%), suggesting a staggering collapse in domestic demand, and a record $40bn monthly trade surplus, suggesting that china is shifting the entire load of demand management onto deficit nations. this policy, pettis suggests, can only incite a trade war in 2009 which will decimate china.

In October China’s trade surplus was $35.2 billion, the highest every reached by any country at any time in history. In November that record was smashed. In the last three months China’s trade surplus has been $96 billion, nearly equal to the $100 billion from the first six months of 2008.

The headlines in China and around the world have been dominated by the contraction in Chinese exports, and this certainly is a bad number, but it cannot be a surprise and it is not the number on which we really should be focusing. The trade surplus is much more worrying, and soon enough that is what all the headlines will be reporting. Remember that the trade surplus is the measure of Chinese overcapacity that is being exported onto the world economy, but the world economy is looking for ways to increase net consumption, not net production. While demand in the rest of the world is shrinking, China is providing even more overcapacity, which means effectively that not only is China not absorbing its share of the demand/supply adjustment, it is exacerbating the imbalance. Other countries are going to have to withstand a faster decline in production than otherwise.

I know that China is facing a real problem of economic slowdown, one that seriously worries policy-makers. The other guest on the CCTV show last night was the chief economist of a large local securities firm, and he accomplished the not-inconsiderable feat of making me sound like an optimist. But still, it is wholly unrealistic to assume that the rest of the world will accept that they must bear more than 100% of the adjustment in order to pull China out of its trouble.

much the same dynamic as is playing out between china and the united states is also playing out between germany and its eurozone compatriots, less currency manipulation.

so i think the comments of steinbrueck might be reconsidered in another light rather than principled. the courage of his convictions may end up being as suicidal for germany as for china. germany does not have the option within the eurozone to devalue its currency as a form of trade barrier as china has begun to, so euro nations will be protected on that front. but all euro parties may have to accept that absorbing german overcapacity is necessarily a eurozone project in need of german participation. refusing to expand spending in germany could easily lead to a devastatingly rapid adjustment as export demand collapses in deficit nations. and from brussels looking out, the EU as an aggregate net importer and deficit entity might even see this as reason to fire the first shots in a global trade war -- amplifying the harm to germany.

as such, with the world quickly now moving away from open trade and toward beggar-thy-neighbor, the economic assault that is following on the heels of the financial barrage may fall particularly hard on germany and china.

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Wednesday, December 10, 2008


will the auto bailout trigger CDS?

financial times relays BoA's ruminations on a "car czar", which come down a "maybe".

[A]n auto czar would have authority over car companies’ expenditure above $25m. According to the 2003 credit derivatives definitions of the International Swaps and Derivatives Association, the trade body that tries to organise these things, a criteria for a credit event is when the reference entity:

“seeks or becomes subject to the appointment of an administrator, provisional liquidator, conservator, receiver, trustee, custodian or other similar official for it or for all or substantially all its assets”

So the key question here is whether the President’s designee would count as an administrator, trustee, custodian, etc (i.e. what’s the legal definition of a czar?). BoA for one, “absent specific language in a bailout plan to the contrary,” is thinking yes.

such concerns might be motive for the decided lack of enthusiasm in credit markets on the bailout compromise that is apparently emerging between the bush white house and congressional democrats.

no worries, though. the same congressional republicans who tried to kill the TARP are threatening this one too.

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the tobin's q bottom


A global stock slump may have further to go, according to Tobin’s Q ratio, which compares the market value of companies to the cost of their constituent parts, CLSA Ltd. strategist Russell Napier said.

The ratio, developed in 1969 by Nobel Prize-winning economist James Tobin, shows the Standard & Poor’s 500 Index is still too expensive relative to the cost of replacing assets, said Napier. While the 39 percent drop in the index this year pushed equity prices below replacement cost, history suggests the ratio must sink further as deflation sets in, he said. The S&P may plunge another 55 percent to 400 by 2014, Napier said.

“The Q has come down to its average, however it’s not always stopped at the average,” said Napier, Institutional Investor’s top-ranked Asia strategist from 1997-1999. “It has tended to go significantly below that in long bear markets.”

Napier, who teaches at Edinburgh Business School and advised clients to buy oil in 2002 before it tripled, based his S&P 500 forecast on the Q ratio for U.S. equities as well as the 10-year cyclically adjusted price-to-earnings ratio, another measure of long-term value.

Before the trough in 2014, investors are likely to see a so- called bear market rally for the next two years as central bank actions delay the onset of deflation, Napier said.

“In the long run, stocks will become even cheaper,” said Brian Shepardson, who helps manage $1.9 billion at Xenia, Ohio- based James Investment Research. The firm’s James Balanced Golden Rainbow Fund beat 98 percent of similar funds this year. “There’s a likelihood of some type of rally and further pullback surpassing the lows we’ve already set.”

The Q ratio on U.S. equities has dropped to 0.7 from a peak of 2.9 in 1999, and reaching 0.3 has always signaled the end of a bear market, said Napier, 44, the author of “Anatomy of the Bear,” a study of how business cycles change course. The Q ratio for U.S. equities has fluctuated between 0.3 and 3 in the past 130 years.

At the end of the four largest U.S. bear markets in 1921, 1932, 1949 and 1982, the Q ratio fell to 0.3 or lower, and history is likely to repeat, said Napier. From the 1982 trough, the S&P 500 grew more than 14-fold to the middle of 2000, when Napier says the last bull market ended.

“For those who are worried about losing much of their investment almost overnight, very clearly you’d want to wait for those signals to give a much stronger case,” he said. The bear market will have “a painful resolution, it’s just a question of how painful, over what period of time and for what parties.”

Federal Reserve Chairman Ben S. Bernanke’s indication that he will use “quantitative easing” to prevent deflation points to a stock market rally that may last for the next two years, Napier said. With quantitative easing, a tool pioneered by the Bank of Japan, central banks can stimulate inflation by printing money and flooding the market with cash in order to encourage consumers to spend.

The government’s efforts will eventually fail as ballooning government debt devalues the dollar, causes investors to flee U.S. assets and takes the S&P 500 to its eventual bottom in 2014, Napier said.

“Bear markets always end for exactly the same reason, and that is the market begins to price in deflation,” he said. “Equities will be incredibly cheap.”

yves smith picks it up as well. not exactly new news, but that's the bear case.

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I hear Lowry issued a buy ..

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they did, rb, and although it is a signal that often triggers in bear rallies the picture is improving as we go.

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Tuesday, December 09, 2008


another voice for CDS moratorium

via yves smith -- the financial times' john dizard advocates the CDS moratorium earlier proposed by chris whalen and others.

For several years, I have been among those calling for thoughtful, prudent, moderate steps for the reform of the credit default swaps market. They should be put on exchanges, put through central clearing houses, settlement backlogs reduced and then eliminated . . . etc.

I was wrong. The global credit default swaps market should just be liquidated, the contracts allowed to expire and the booby traps defused. Where they can't be defused, they will explode, and we will have to deal with the loss of capital and litigation.

still, the fallout from the synthetic CDO would make this a titanic step.

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the pessimist's case

something disturbingly like universal agreement on the probability of a rally in both credit and equity has emerged in recent weeks. even i am more optimistic in the near term. dissenting view is suspiciously hard to find, in fact, though nassim taleb does well -- and suki mann at socgen is also suspicious of the call for a credit rally.

[W]e don’t see a marginal bidder come in to help spreads go sustainably tighter. Still, the tremendous carry and breakevens means the many investors are content to add risk at these levels (and for spreads to remain wide) as long as default fears remain low.

risk premia remaining so large for the forseeable future is terrifying news for corporate borrowers. as graham turner of GFC consulting explains, skyrocketing corporate debt costs will mean phenomenal growth in joblessness is all but baked into the cake -- that it is now likely too late to prevent a deflationary depression.

The US unemployment rate could surpass the 1982 high of 10.8 percent by the end of next year. And it will carry on climbing, possibly reaching 15 percent or more by 2010.

The resulting social upheaval will pose a grave challenge for Barack Obama’s incoming administration. But the paucity of his economic strategy should concern us too.

Obama’s plan is heavily influenced by Lawrence Summers, the former US treasury secretary. It amounts to little more than a rehash of the post-war “Keynesian” consensus that failed to resuscitate Japan’s economy in the 1990s.

Increases in public spending or tax giveaways will not solve the core problem, which is how to stop borrowers from defaulting.

In 1932 the Federal Reserve drove interest rates down aggressively, which helped turn the tide. Corporate borrowing costs fell. It was still not enough – but it was more proactive than the botched policies of today.

By the time the Obama camp realises the error of its ways, even the more radical policies of the 1930s may well be insufficient. Interest rate controls, unparalleled intervention and a state of emergency may be the belated response to stem the slide into depression.

and that is indeed the jist of the correlation shown in this BoA chart courtesy of the ft.

Either: the market is broken; or we’re looking at a coming default rate spike more severe than that seen during the Great Depression.

and this is at a time when an ever-greater slice of american non-financial companies are joining the ranks of the junk issuers.

as noted by michael panzner, the economist also picked up on this theme.

It is not panic stations yet. Most firms can survive for a while with the credit tap turned off. Analysis by Moody’s, a rating agency, shows that the vast majority of highly rated companies in America and Europe have enough headroom, in the form of cash and undrawn bank facilities, to be able to survive for 12 months without needing new financing.

For now, an uneasy truce exists between most companies and their lenders. ... But hard choices are looming.

As the economic news worsens and profits dive, more firms will be at risk of breaching covenants ... Furthermore, a good deal of debt will fall due in the next few years: Reuters Loan Pricing Corporation, a data provider, estimates that more than $1 trillion of loans will need to be refinanced globally in each of the next three years, mainly in America and Europe.

Competition for capital is bound to increase in that time, given the coming torrent of government-debt issuance. ... With little obvious benefit in waiting, many expect to see a concerted effort by companies to renegotiate funding facilities early in 2009, once the year-end squeeze is over (see article).

In the face of more requests for waivers and refinancings, banks will react selectively. ... The lucky ones will still pay a hefty price for access to credit. Not only will the costs of borrowing zoom, but terms will become much tighter. ... For those firms that find doors starting to shut on them, the prospects are grim.

the outline of an obama "economic rescue" plan has cheered optimists, but i have to concur with turner. as ed harrison also noted last week, every government effort thusfar has met with futility as banks are simply not in a position to lend out reserves as they struggle with insolvency. the result has been spiking reserves on deposit at the fed and a collapsing money multiplier -- a liquidity trap. keynesian economic stimulus will certainly benefit some firms greatly and more broadly help maintain some level of aggregate wages and spending in the face of mounting bankruptcies and layoffs. but it will neither return the banks to health nor restore the credit markets to function, and this continuing dysfunction will ensure continued delevering, defaults and capital destruction. stimulus is a salve, not a cure. on the evidence gathered so far the cure, such as it may be, is quite probably simply further deleveraging and a weeding-out of the overindebted.

moreover, a return to a sustainable path will look on an international capital-flows level very much like the elimination of vendor finance. china, japan and petrodollar states have been complicit with the united states over the last twenty years in maintaining huge current account surpluses through the recycling of overvalued dollars. this long-noted misallocation must be corrected for international finance to rebalance in a sustainable condition. that will mean more foreign home-market demand and more savings within the united states, britain and other debtor nations -- either at current aggregate levels of production and consumption per capita or something rather less.

so far -- while petrostates have seen revenues crash and their participation in vendor finance decline dramatically -- the inertia of government on both sides is resisting this reversion. germany, japan and china have all taken steps to devalue their currency (in china's case) or cautiously approach stimulating domestic demand for fear of deficit spending. dani rodrik muses on the need of such spending to avoid a bout of protectionism. the economist also addressed these issues recently by noting that surplus nations have become overly dependent on exports.

Countries that have lived beyond their means may feel a justifiable remorse as their booms turn to bust. Surplus countries are simply stupefied by their plight. They should not be. A persistent current-account surplus is a symptom of unbalanced growth, just as a big deficit is. Countries that save too little to cover their capital spending are at the mercy of foreign investors; countries that save too much are at the mercy of foreign demand. China gets barracked for its current-account surplus, which was $372 billion last year, according to the IMF. Yet the combined surpluses of Germany and Japan amounted to a vast $463 billion.

If the world economy is to adjust to higher saving in shopaholic deficit countries, such as America, it will require surplus nations to stimulate their domestic spending. Germany, unlike Japan, can at least benefit from lower interest rates: on December 4th the European Central Bank cut them by 0.75 percentage points to 2.5%. It can also afford a much bigger fiscal stimulus than it has announced so far. Japan is far more constrained by its huge public-sector debt. But both countries can start by shaking off the mindset that demand has to come from somewhere else.

good as that sounds, change isn't forthcoming -- and as the economist notes, tendencies to save are reflexively strengthened by a downturn which has destroyed savings. given still cloudy but emergent reports of an ongoing deflationary collapse in china, the idea of increasing demand emerging from surplus nations seems very remote.

moreover, the governments of the united states and britain are firing every cannon and shell at their citizens in an effort to get them to borrow yet more and their banks in an effort to get them to lend yet more. but it won't happen -- mortgage securitization is dead, the banks are awash and downsizing, and social mood has moved from extravagance to thrift.

indeed one wonders if the likely outcome isn't simply a series of competitive devaluations ping-ponging between surplus and debtor economies -- one which germany would surely lose out on, failing a collapse of the euro. one should note that such manipulations of currency function as, among other things, little less than a series of import tariffs. indeed china's longstanding dollar-peg (followed by its dirty float) has fostered its reliance on exports while providing a shield against affordable imports, a mercantilist policy which has helped suppress consumer spending in china. those who worry about the return of smoot-hawley and regimes of protectionism would do well to monitor currency interventions. dani rodrik comments on competitive mercantilism.

so the adjustments necessary as a curative are being fought in each country even as palliatives to the status quo ante are being doled out by the barrel. if this generates cheer, it can only be as temporary as an aspirin.

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Linking to The Socialist Worker?? I'll let it slide, but only because you consistently direct me to great op-eds and blog posts I haven't seen.

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from perrone: hey, between the wall street journal and the socialist worker, who do you think's made the better calls? and who's world view is less like that turkey Taleb talked about, the one absolutely convinced of abundance and benevolence even as the farmer takes the axe from the shed and amples out to the coop . . .

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Point well taken. I think that has less to do with the people at the Socialist Worker being smart and more to do with them being able to think critically about the big picture without being bound by efficient market ideology. They do, however, adhere to a far more dangerous ideology.

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lol -- br, you don't know how i smiled and shook my head to link to that rag. if it weren't for the pedigree of graham turner in calling this mess, i certainly would not have. his book, "the credit crunch", is an detailed if unorthodox read. when the economist can praise it even though turner questions the validity of the accepted wisdom of free trade, you know it's worthwhile.

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and if this is not a time for unorthodox thinkng and a healthy skepticism of accepted wisdon, when would be? :)

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Friday, December 05, 2008


november jobs

it is no longer ridiculous to talk about a depression. we're in one.

it is true that a loss of 530,000 jobs is, in the grand scheme, not the end. bespoke contextualized this report well.

but -- compounded with large downward revisions for september and october as well -- the employment picture is going from gray to black with a speed reminiscent only of a full-fledged depression.

henry blodget makes a couple of points overlooked by reflexive optimists. first, the headline unemployment rate is misleading at 6.7% because of the statistical whitewashing the u-3 number gets. a more sensible definition of unemployment -- and one much closer to the method used in the last depression -- is u-6, which is inclusive of those who are falling off the dole because they've become despondent of finding work at all, as well as those who've taken part-time work while looking for a real job (the "marginally attached", in the parlance). that rate has skyrocketed to a seasonally-adjusted 12.5% from 11.8% in october, and will go much higher in coming months.

secondly, blodget rightly notes that unemployment in the great depression didn't start at 25%. indeed, we are at 12.5% likely suffering from an unemployment problem significantly worse than was the united states of late 1930, when the rate was less than 10%. what is comparable, however, is the rate of increase. from 1929 to 1930, unemployment ran from 4% to 9%; from november 2007 to november 2008, u-6 has run from 8.4% to 12.5%.

with joblessness set to further accelerate in coming months as companies get more aggressive about downsizing, we should not be surprised if even the mainstream u-3 rate gets well into the teens, with u-6 perhaps approaching 20%. and that will surely put aside any reflexive reticence to compare situations that in truth are frighteningly similar.



more reading

jim grant in the financial times on the anomalous pricing in corporate and convertible bonds amid a treasury frenzy.

jonathan ruffer in the spectator on the forgotten lessons of currency collapses and the prospects of a reminder.

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taleb: worse than anyone thinks and it will happen fast

again via paul kedrosky, nassim taleb on charlie rose.

this follows on an earlier interview which included benoit mandelbrot.

key takeaways: the precedent of 1929-1933 may be deceiving because of the speed of information and the tightness of coupling in a globalized, datalinked world -- what needs to happen is more, as debt levels incurred under the delusion of efficient-market-hypothesis-derived value-at-risk modeling are much larger than they ever were in the 1920s or indeed any previous event, but it may happen much faster.

taleb is talking about an accelerated deflationary depression -- systemic collpase, really -- of unimaginable ferocity.

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Thursday, December 04, 2008


deflation in china

the call from morgan stanley.

Despite still relatively high CPI and PPI inflation at the current juncture, we believe that a perfect storm for deflation is gathering strength under the surface and is expected to bring about a deflationary impulse in 1H09, which may morph into persistent deflation in 2H09 and beyond, barring an aggressive policy response up front.

Deflation is not always a bad thing. However, it is very difficult to make a distinction between ‘good’ and ‘bad’ deflation in practice, given the entwining supply and demand shocks. Our best judgment is that the potential deflation that we envisage to emerge in 1H09 will be a mixture of ‘good’ and ‘bad’ deflation, with the former likely dominating the latter. ...

The initial deflationary impulse due to positive supply shocks should bring about cost savings, especially to the energy- and raw materials-intensive sectors. However, with sticky nominal wages, we believe that persistent deflation will cause real wages to rise, profit margins to fall and employment to be cut back, which may set off a deflationary cycle with far more serious consequences. A deflationary environment generally favors bond holders (or creditors) over equity investors (or debtors).

The key is to prevent deflationary expectations from getting entrenched. We expect further aggressive policy responses in the coming months.

this just in -- things are not going well in china. looks like michael pettis and vitaliy katsenelson are gaining adherents.

with a property market collapse now accelerating and multiplying china's woes, the chinese government has begun to devalue the renminbi. this of course is exactly the opposite of the needed adjustment. governments on both sides of the pacific are attempting to prevent the united states from closing its current account deficit -- the united states by attempting to force further lending and consuming, china by weakening its currency to protect its exporters -- and to continue the unsustainable and dying system of vendor finance. god help us if it works -- the result would merely enlarge the ultimate problems of both countries while postponing them for a little while, as did government measures in 2002-2004 under alan greenspan and the bush administration.

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