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Saturday, February 28, 2009


berkshire letter

write it and weep.

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gross outlook

via peter cohan at AOL's daily finance.

... [I]n Gross's view, growth prospects are so dim that there is no point in owning stocks since common stock investors will not benefit when there's no economic growth. Moreover, they'll be last in line for any dividends that might be available.

i'd be hard pressed to argue. bill gross, being who he is, has his name attached to his every comment. that enforces a public responsibility to something the elder galbraith, in his "the great crash", defined as 'incantation'. so comments as bleak as this from a decidedly institutional man say a lot.

given cover of anonymity, wired investors will go a lot further. paul kedrosky links to a new york magazine with a distressed investor:

NYM: How are you doing?

V: Since I saw you last, things have deteriorated more than even I could have imagined. We're invested in virtually all sectors, primarily through debt, so we have pretty good access to management. The color coming from them is mind-bogglingly awful. We need to flush all the banks and start again. I told my wife I'm putting gold bars and shotguns under our bed.

NYM: Can we take refuge with you, if it comes to that?

V: You're more than welcome. We have thick walls and a high perch from which to pick off the marauding throngs.

NYM: What's the least-bad news you've heard recently?

V: The only thing anyone on the desk can come up with is the fact that there have been a number of high-grade non-financials who have been able to raise debt in the market. That's it. GDP is going to be down 10 percent this quarter, is my guess.

NYM: Give me the bad news then.

V: I heard this yesterday: The top five U.K. banks have $10 trillion of assets and their GDP is only $2.13 trillion. The whole country could fall into the ocean. The top five U.S. banks represent only about 60 percent of GDP by comparison. The other thing is a survey that I just read about in the Times. Over six in ten Americans think that someone in their household will lose their job in the next year. That means six in ten people won't buy anything other than basics. The economy comes to a full halt even worse than now.

NYM: That means the other four out of ten better be out there buying Gucci. You're not losing your job. Are you buying any Gucci? Taking vacations? Leasing a new Mercedes?

V: I'm still taking vacations and renting a summer house but I ain't buying anything. Credit-default swaps scare me too much. For the banks, their portfolios of second-lien loans is terrifying and nobody, including the government, wants to talk about it. The banks carry them at par and have hundreds of billions of dollars of them. We just bought some at 33 cents on the dollar in the market. If they turn out to be worth 33, every bank would collapse.

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Friday, February 27, 2009


the daily eastern europe update

simon johnson's missive, tying current official beliefs that bank nationalizations can be avoided by continuing capital injections to the nascent disaster in european banking.

Economic developments in East-Central Europe are very bad. Almost everyone will get IMF loans but, be that as it may, there is a big contraction underway. Nonperforming loans will increase for the West European banks lending to East-Central Europe or lending to firms that are (or were) exporting. Prominent European governments will struggle to afford the implied bailouts - remember, back in October these governments made it quite clear they are on the hook if their banks come under pressure. At the same time, of course, we have a nose dive in property in Ireland, Spain, and the UK.

My point is not that Europe is in big trouble, with no plausible regional rescue mechanisms in place. This is completely obvious - the debate among prominent Europeans is now whether or not to send distressed eurozone members to the IMF, and on what basis.

Focus on this instead: the European banking and fiscal fiasco is a dagger pointed at the heart of major US banks, which have a great deal of exposure - one way or another - to much of Europe. Ask any U.S.-based ”global bank”.

Treasury is constructing an elaborate transfer mechanism through which big banks can be kept in business, thanks to the public purse, without the taxpayer acquiring a majority of the common stock. The contortions required are striking. But this entire approach is predicated on a rosy stress scenario, which assumes the global economy cannot get much worse, at least in the short run.

It may soon be time to wake up.

this is why every last american should actually care about latvian credit downgrades. american money-center banks are insolvent. but eastern european feedback in our globalized crossborder banking world will amplify their already-unfathomable problems until the volume is breaking windows and crumbling foundations.

the worst case screnario is that the government tosses trillions into floating the banks over the next several months -- and then has to nationalize them anyway as it becomes apparent that the hole really is too deep for even the balance sheet of uncle sam to mitigate much less fill, only after the international market for treasury bonds and the dollar tells them so with force.

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So ... 2009 may be the year that the banks collapse?

How many banks have to collapse before governments admit that they were corrupt?

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CDO recovery

important news from gillian tett in the financial times.

... [A]t long last, one shard of reality has just emerged to piece this gloom. In recent weeks, bankers at places such as JPMorgan Chase and Wachovia have been quietly sifting data trying to ascertain what has happened to those swathes of troubled CDO of ABS.

The conclusions are stunning. From late 2005 to the middle of 2007, around $450bn of CDO of ABS were issued, of which about one third were created from risky mortgage-backed bonds (known as mezzanine CDO of ABS) and much of the rest from safer tranches (high grade CDO of ABS.)

Out of that pile, around $305bn of the CDOs are now in a formal state of default, with the CDOs underwritten by Merrill Lynch accounting for the biggest pile of defaulted assets, followed by UBS and Citi.

The real shocker, though, is what has happened after those defaults. JPMorgan estimates that $102bn of CDOs has already been liquidated. The average recovery rate for super-senior tranches of debt – or the stuff that was supposed to be so ultra safe that it always carried a triple A tag – has been 32 per cent for the high grade CDOs. With mezzanine CDO’s, though, recovery rates on those AAA assets have been a mere 5 per cent.

every bit as bad as was implied by the merrill-lonestar deal seven long months ago.

krugman comments.

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treasury demand

brad setser with another important posting on the condition of united states treasury debt demand.

Total ‘marketable” Treasury issuance - if the marketable Treasuries that the Fed sold to finance its lender of last resort activities are counted as increase in the outstanding stock of marketable Treasuries — topped $1.6 trillion in 2008.

That implies, if the Pandey/Setser estimates for official purchases are right, that private investors snapped up more Treasuries than the world’s central banks. Central bank demand accounted for a far smaller share of total issuance than in the past few years. In 2007, for example, central bank purchases easily exceeded total issuance. The big increase in demand for Treasuries in 2008 came from private investors in the US. ...

Moreover, with global reserve growth slowing — total reserve growth was close to zero in q4, and it may not be all that much higher in q1 — central bank demand for Treasuries is likely to fall. Central bank purchases in the last part of 2008 were inflated by a shift out of Agencies, but that (presumably) won’t continue forever.

That implies, I think, that the ability of the US to finance large deficits at low rates depends far more than it has in the past on private investors willingness to buy Treasuries. That was in doubt a few weeks ago when the markets were focused on the risk of a Treasury bubble and the scale of the Treasury issuance associated with the stimulus and various bailouts. Now the market is more focused on the risks tied to a strong global downturn — and the remaining risks in the financial sector …

setser is here acknowledging that foreign central bank currency-management demand is drying up and will not likely be seen again very soon for so long as global trade is depressed. other countries are seeing trade surpluses collapse; we are seeing our trade deficit narrow. this means essentially counting on domestic demand for treasuries to avoid the federal reserve bank having to monetize treasury debt issuance. some straightforward but critical concepts:

A world with $1750 billion US fiscal deficit and a $500 billion US current account deficit only works if Americans are willing to buy an awful lot of Treasuries. The borrowing need of the US government is now far too big to be covered by the (much reduced) growth in the emerging world’s reserves. ...

The overarching assumption behind the stimulus is that a rise in US household savings (linked to the fall in US household wealth) will create a pool of domestic savings that will flow, given the ongoing contraction in private investment, into the Treasury market. The rise in private savings and fall in private investment will allow the US government to borrow more even as the US economy as whole borrows less from the rest of the world. The key to the Treasuries rally in 2008 was the surge in private demand, not the strengthening of official demand. My guess is that the Treasury market will be driven by developments in the US – not developments in China – in 2009.

... the math [of stimulus] only works if private investors snap up $1250 billion of Treasuries, or a little more than they bought in 2008.

and therein the difficulty. yesterday i linked to a financial times post commenting on the results of the analysis of bank of new york mellon.

... the US has no choice but to become increasingly dependent on the printing presses as debt financing from traditional dollar surplus-holding countries will fallback alongside the slowdown in the growth of their reserves. This becomes increasingly likely as domestic spending programmes take priority. Without the inflows, overdependence on quantitative easing runs the risk of tipping the economy from a deflationary to an inflationary environment very quickly.

This becomes all the more likely because the alternatives to QE are so few. BNYM highlights that according to the IMF, even if US savings rose to 8 per cent of GDP, that would only raise $830bn by 2010 - a fraction of the spending needs.

here the FT ignores another potential source of funding -- capital can be vomited out of other american capital markets, such as stocks, corporate debt, commercial paper and the rest. in other words, the treasury effect -- a crowding out of private investment. john mauldin discusses the concept with tech ticker. i don't agree with mauldin's conception of stimulus as "bogus" nor do i think tax cuts have much stimulative utility; but i do definitely agree that government, as it attempts to leverage itself to fill at least some of the widening output gap, will be soaking up capital from the private sector -- and not all of it will have been idle, the employment of which is after all the idea behind forced spending. the government is going to be creating opportunity for more and more private capital to flee the capital markets and stay under the government safety umbrella, where much of it will want to stay for the foreseeable future. in that way, these massive debt offerings constitute competition for private sector borrowers -- some of whom, particularly high-grade corporates, are themselves beneficiaries of flights to safety -- and will abet and further the private sector deleveraging they are meant to offset.

in any case, i suspect a combination of monetization and further fits of capital markets liquidation will combine to feed the treasury monster over the next couple of years. the hope, of course, has to be that the fed isn't further faced at some future point with monetizing already-outstanding foreign holdings in an international run on treasuries.

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Thursday, February 26, 2009


declining rents

courtesy of calculated risk.

and why? it could have something to do with this.



eurozone defaults "a matter of time"

zero hedge relays some depressing views on the developing eastern european situation.

"The first will certainly be a small country, so that can be managed by the bigger countries or the IMF,” he said in an interview with Sky News. “I think there are countries in Europe which are considering the possibility to leave the eurozone. But this is practically not possible. It would be very expensive."

Poehl suggests that Germany or the IMF will be forced to deal with the default... However he does not account for just how much cash it would take to pick up the pieces after the intertwined European dominoes start faltering left and right. Last time we checked, Germany couldn't issue bonds to save itself, let alone the entire Eastern European region which is on the precipice every single day. ...

And while practically speaking Germany bailing anyone out is a pipe dream, even the theoretical proposition is not assured. Former ECB Chief Economist Otmar Issing told Frankfurt Allgemeine Zeitunglast week that saving a profligate member would be“catastrophic” and undermine the monetary union framework. Current ECB Executive Board member Juergen Stark calls the no-bailout rule an “important pillar on which the European Union was founded.”

germany and france also shot down the idea of jointly-issued euro bonds. this could be a titanic storm in a few weeks' time.

UPDATE: a tech ticker interview with john mauldin on the topic of eastern europe and possible solutions. here is some of mauldin's letter that puts a scale on the problem:

Eastern Europe has borrowed an estimated $1.7 trillion, primarily from Western European banks. And much of Eastern Europe is already in a deep recession bordering on depression. A great deal of that $1.7 trillion is at risk, especially the portion that is in Swiss francs. It is a story that could easily be as big as the US subprime problem.

it's even worse than i had thought. as mauldin notes, potential solutions are being roadblocked by either intentionally-erected insitutional barriers or political unwillingness. and if there is no solution found before the dominoes start toppling, we may well quickly find ourselves in another terrible deflationary liquidation cycle. mauldin is ringing the bell hard. is anyone listening?

UPDATE: ft alphaville with some humorous (so far) photographic evidence connecting of eastern europe's position on the desireable side of the collapse gap.

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emergent trouble for the dollar

the ongoing shocking collapse of japan got another datapoint yesterday as new data showed the country, just a few months ago one of the world's preeminent export powers, returning to a current account deficit for the first time in 25 years. japan was only recently the largest buyer of dollar-denominated debt in the world; today, it has no need of any. japan is about to experience what is likely the most savage depression of any first-world country since the 1930s.

Japan’s exports plunged 45.7 percent in January from a year earlier, resulting in a record trade deficit, as recessions in the U.S. and Europe smothered demand for the country’s cars and electronics.

The shortfall widened to 952.6 billion yen ($9.9 billion), the biggest since 1980, the earliest year for which there is comparable data, the Finance Ministry said today in Tokyo. The drop in shipments abroad eclipsed a record 35 percent decline set the previous month.

Exports to the U.S. tumbled an unprecedented 52.9 percent from a year earlier, and shipments to Asia and Europe also posted the largest-ever declines as the global recession deepened. The collapse is likely to force Japanese companies to keep firing workers and closing factories, worsening an economy that shrank the most in 34 years last quarter.

china is unfortunately likely to follow. the latest piece of evidence via yves smith and bloomberg that china is experiencing a consumer-driven deflationary collapse is a bit of goldman sachs research on tax collections within the middle kingdom. official pronouncements of fiscal and financial health from the chinese leadership look more and more bogus with every passing week.

as such, we are witnessing the end of vendor finance. and that has severe ramifications for the united states.

spending plans for the united states are exuberant as the nation turns to neo-keynesianism in its hour of need, reinforced earlier today in a deutsche bank call on american GDP.

Deutsche Bank sees current quarter GDP at -6.5 percent and makes assertion that while it is not likely one can make a case for -10 percent.

a (-10%) decline in GDP is only possible when some really bad economic data is hitting the wire -- and it is. united states january durable goods orders came out this morning (-23.3%).

the obama administration budget proposal just released for 2009 considers a fiscal shortfall of nearly $1.8tn for this year alone. treasury is already auctioning unprecedented amounts of debt weekly, creating new maturities and reopening old issues. it will have to step up in size from even these auctions.

the reasonable paramount question is, now more than ever, "who is going to buy all this debt?"

japan is suddenly out of the picture. petrostates are dealing with the collapse in global demand for and price of oil by shutting down petrodollar reinvestment flows and, in some cases, actually shedding reserves. china is faced with shortly following japan. and, as cited in the financial times, bank of new york mellon runs the sums and notes that even 8% american domestic savings rate by the end of 2010 -- which would correspond to a depression-level contraction in spending -- would raise just $830bn in potential domestic finance for treasury against something on the order of $4tn in deficit spending plans. brad setser's notion that rising domestic savings will offset contracting vendor finance would in this scenario be found severely wanting.

it is quite possible that some of the approximately $3tn that needs to be found in 2009 and 2010 could be vomited out of other capital markets -- corporate bonds, stocks and the like.

to the extent that it is not, however, the federal reserve bank is very likely to be compelled to monetize treasury debt in terrific size -- true quantitative easing and in earnest, no later than the second half of this year.

but the fallout may be harder to predict than simply "inflation". the united states will not be alone -- indeed, in a world of competitive devaluation, the dollar might even appreciate vis-a-vis its forex crosses. furthermore, the inflation of quantitative easing may well fail to stave off declining prices (particularly in leverageable assets) simply because, even at a full $3tn of monetization, it isn't enough to offset the vaporization of moneylike credit which is ongoing. if prices are to rise, chances are much better that it would be in the realm of physical raw inputs and unfinished goods, with the depressed conditions of falling income and credit scarcity continuing to crush leverage and margins.

the conclusion? mellon suggests storing wealth in precious metals, which they see as outperforming.

UPDATE: john jansen speculates:

The indirect bidding category, which folklore holds is a proxy for central bank interest, won nearly 39 percent of the auction.

In spite of that result and in spite of economic data this morning which borders on calamitous the bond market can not get out of its own way. Tomorrow brings month end and a substantial index extension and even with that the market sits within a basis point of cycle lows.

In that regard, I think that the markets have a serious auction and supply problem. David Ader, an analyst at Greenwich Capital, in a piece he wrote this morning talks about the rolling concession which the Treasury market requires to accommodate the issuance.

He notes that the concession building makes the charts look weak and that engenders more selling. ...

I think that an era of unheard of concessions for Treasury issuance is possible too. The funding needs of the Treasury are prodigious and given the details of the budget released today it will only increase in the near term. The wholesale market ( primary dealers) has shrunk in size and the amount of balance sheet available to those in the market has contracted, too. I think that it is only a matter of time until demand slackens and the Treasury faces 10 basis point and 15 basis point tails on a regular basis (A tail is the number of basis points between the level at which the issue was trading in the brokers market and the level at which the auction stops.)

It has happened in other markets and it seems only logical to me that it should happen in this market also. If that pattern were to develop. I think it would force the hand of the Federal Reserve and would hasten their entry into the market as a buyer of Treasuries.

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on the ineffectiveness of TALF

the federal reserve bank's major foray into kickstarting the private credit securitization markets, known in the arcana as the term asset-backed securities loan facility, or TALF.

tim duy splashes some cold water on the higher hopes.

It has always seemed to me that TALF would fall short of the mark. The key constraint:

Eligible collateral includes U.S. dollar-denominated cash ABS that are backed by auto loans, credit card loans, student loans, or small business loans that are fully guaranteed by the SBA, and that have a credit rating in the highest investment-grade rating category from two or more nationally recognized statistical rating agencies and do not have a credit rating below the highest investment grade rating category from a major rating agency.

The expansion of TALF to CBMS also requires AAA-ratings. I suspected that limiting the program to investment grade securities would severely curtail the effectiveness of the program for one simple reason - that, relative to expectations of officials, investment grade borrowers are relatively few, and they have maintained that status by not accumulating excessive debt, so already they are not inclined to borrow. The spending bubble was not driven by high grade debt; it was driven by low grade debt disguised as high grade debt. Focusing on high grade debt as the solution will thus prove insufficient to give the economy much traction.

duy's concerns encompass both new and existing securitizations, many of which used to be triple-a but are now impaired. TALF is beginning in earnest now, the probability that it will do much to relieve the balance sheet pressure on lenders seems minimal.

the harder truth -- which no one in the political sphere seems prepared to accept -- is that securitization is mortally wounded for the duration of the debt unwind. the process of securitizing credit will reemerge in time as the system regains balance sheet capacity by working out the bad debts that poison so many large entities, but from a level of indebtedness far below what we have now and with an intensity unlike anything seen in the boom. washington cannot countenance the notion because it means an ongoing credit collapse, with everything that implies, for the duration. but what they can handle does not delimit reality.

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It seems to me that the biggest problem in this whole banking mess is the share holder equity piece of the puzzle that everyone has missed.

Take these banks (no nationalization though) private and let them sink or swim on the business of banking, not insurance, nor other fancy financial products. If they fail, then so be it. Those that can adapt back to the business of loaning money and taking deposits will be stronger. I tend to think that if these weren't stock companies, then the constant fees charged would be minimized.

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Wednesday, February 25, 2009


latvia, ukraine downgraded

the ball is officially rolling. ed harrison provides some bloomberg links on what looks like a rerun of the 1997-8 asian crisis writ larger. ukraine's IMF bailout package is at risk of failure.

[Ukraine's] long-term foreign currency rating was lowered to CCC+, seven levels below investment grade, the rating company said in an e-mailed statement today, saying political turmoil poses growing risks to the country’s International Monetary Fund loan. ...

The hryvnia has lost more than 50 percent against the dollar in the past six months as reduced demand for exports and a lack of foreign credit causes Ukraine’s first economic contraction in a decade. The situation has been aggravated by a power struggle between President Viktor Yushchenko and Prime Minister Yulia Timoshenko, delaying decisions needed to revive the economy and putting the second installment of the IMF bailout at risk.

“Hopefully S&P’s move will concentrate minds in the cabinet of ministers, the presidential palace and the central bank,” said Timothy Ash, head of central Europe, Middle East and Africa research at Royal Bank of Scotland Group Plc in London, in an e- mailed note to clients.

Ukraine is not alone in its plight. East Europe as a whole will slide into a recession this year as demand for exports collapses, the IMF, which has also bailed out Latvia, Hungary, Serbia, and Belarus, said last month. The economies will shrink 0.4 percent, the IMF predicted.

Latvia’s credit rating was cut to junk by S&P yesterday, the second European Union nation to receive such a grade, because of a “worsening external outlook” triggered by the global crisis.

The Baltic state’s government collapsed this week, a month after street protests over the deteriorating state of the economy turned violent. Latvia’s economy shrank an annual 10.5 percent in the fourth quarter.

Fitch Ratings cut Ukraine’s ratings to B, the fifth-highest non-investment grade on Feb. 12 and kept the outlook “negative,” indicating they may fall further. Moody’s said yesterday it may cut Ukraine’s ratings within three months.

poland, meanwhile, is accelerating asset sales to boost public finances.

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bank nationalization deferred

amid wide variance of opinion, it became clearer yesterday in the testimony of ben bernanke that bank stress tests were not expected to lead to any nationalizations. that reinforces the view that the outcomes of bank stress tests are predetermined, and ratehr diminishes the hopes of some (including paul krugman) that the tests might be a trojan horse by which nationalization could be introduced.

apparently, at least right now -- regardless of whether you believe it the result of a quiet coup d'etat by the banks or the real circumspection (or panic) of regulatory authorities as to unintended consequences or both -- we're going to run the tail risk of sovereign debt and currency problems in the hopes that repeated capital injections see the banks and their bondholders through without realizing losses.

good luck to the united states.

UPDATE: more from calculated risk -- the stress tests are going to be a softball.

UPDATE: via clusterstock, megan mcardle contributes something to the conversation about what nationalization would look like.

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we had a pep rally lastnite and everybody is ready for the big game!

if you ever needed proof that the politicians are as clueless as the sheep, it was on display for the whole world. while many of us fight to save our jobs and homes, they were getting the presidents autograph. good lord.

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i watched a bit of it, ccd, and i have to say i don't think it's worthy of a lot of comment. nice speech, but words mean nothing now. washington still looks very much in denial of the extent of the problems, and very much interested in protecting fiefs and paying off patrons.

particularly pathetic was bobby jindal's vapid reality-denying response. if that's the best the republicans have to put forward, they really are fucked. "a form of nihilism" -- that squares exactly with what i believe the republican party has become. how anyone identifies what they are now with tradition or religion or morality, i have utterly no idea. to think that, you cannot be watching.

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If the largest banks, who are also Fed member banks, are nationalized, don't they become owned by the taxpayers? Therefore, wouldn't the taxpayers have a corresponding ownership interest in the Fed? If that is true, why would be charge our selves interest to print our own money, collect or earn that interest, then pay back interest in the form of income taxes to ourselves for the privilege? Nationalization would eliminate the need for the private cartel that is the Fed. by owning the Fed we can eliminate the Fed. Own the Fed! Nationalize the Fed member banks.

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i think the hope is, anon, to reprivatize them as quickly as possible. if you expect the banking system to become the united states department of banking, then maybe i'd agree. but it won't.

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The Republican party has finally become a Southern regional and prty of those that vote against their own best interests. That Jindal response was just sad. After the Obama speech, I don't know that I'd had said anything.

I love the idea of healthcare reform, but this is going to be crafted by healthcare vendor lobbyists and politicians (i.e. lawyers). Not a good combination for reforming something that should have been looked at 30 years ago.

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Tuesday, February 24, 2009


EU aid for eastern europe

ed harrison relays the local reportage on efforts to relieve currency stresses.

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consumer confidence fades to black

can it get lower? bloomberg:

The Conference Board’s confidence index dropped more than anticipated to 25, the lowest level since data began in 1967, the New York-based research group said today.

a deep cut in the future expectations accompanied another decline in present situation, erasing much of the positive indication of the december report. the future expectations graph (yellow) is terrifying. one wonders how long present conditions and future expectations can conduct this race to the bottom.

UPDATE: more from calculated risk:

The Present Situation Index (not shown) is low, but not as low as in some earlier recessions (the Present Situation Index is at 21.2, it fell to 16.2 in 1982). What pulled down the overall index was that the Expectations Index was at an all time low. People are really concerned about the future.

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against FDIC resolutions

clusterstock relays a journal oped from william isaac, former FDIC man, who suggests that the FDIC really can't process a bank like C or BAC -- and so we should continue to support them as zombie banks.

Unlike the talking heads, I have actually nationalized a large bank. When I headed the Federal Deposit Insurance Corporation (FDIC) during the banking crisis of the 1980s, the FDIC recapitalized and took control of Continental Illinois Bank, which was then the country's seventh largest bank. ...

Let's begin with the fact that today our 10 largest banking companies hold some two-thirds of the nation's banking assets, and some are enormously complex. Continental had less than 2% of the nation's banking assets, and by today's standards it was a plain-vanilla bank. This is important for three reasons.

First, any bank we nationalize will be forced, both by the regulators and the marketplace, to shrink dramatically. We are in the middle of a serious economic downturn where deflation is a realistic concern. Do we really think that dismantling our largest banks would be helpful? I don't.

What's more, we won't be able to stop at nationalizing one or two banks. If we start down that path, the short sellers and other speculators that the Securities and Exchange Commission still refuses to re-regulate will target for destruction one after another of our largest banks.

Second, for nationalization to work there needs to be a reasonable exit strategy. In the case of Continental, we had scores of options for returning the bank to private hands, including a public offering or a sale to any number of domestic and foreign banks and investor groups.

Today, who has the wherewithal, legal authority, and desire to purchase our largest banks? No one comes to mind, particularly if we rule out foreign groups, which I suspect would not pass muster due to national security concerns about ceding that much power over our economy to foreign powers.

Third, who will run these companies when we dismiss the existing senior managers and board members? We had significant difficulties attracting quality people to Continental even without today's limits on compensation.

i think nationalization preprivatization is really the only option, because the alternative isaac suggests is tantamount to bankrupting the united states government. the problems are simply too large to be safely transferred to the government in the form of preferred shares. moreover, such funding of bank losses constitutes a ridiculous multitrillion-dollar gift to the bondholders of these banks from the current and next few generations of american taxpayers.

at the end of the day, an FDIC resolution is all about pushing as much of the loss resulting from bad loans onto the creditors of the bank which made them. this is right, fair and just -- and what's more, there's enough bank debt out there to absorb the losses.

but that's not to say isaac's criticisms are totally invalid. some is obvious lobbyist-speak -- i don't think anyone should much care if bank shares are nailed to a cross as a result of preprivatization, but bankers clearly do. and trying to make an argument for the need of retaining existing managerial talent based on its qualifications is rather like proposing that robert mugabe is the only person who could run zimbabwe. but some of what isaac says is not so silly.

for example -- we're seeing now that crossborder banking really is undesirable. witness what is happening in eastern europe as foreign banks pull out in order to solidify home balance sheets and leave devastated economies and currencies in their wake. this crisis and its aftermath may well end the idea of global banks entirely.

moreover, isaac is only being honest that a lot of bank assets are not saleable -- the 2005 version of banking was much too big and many bank apparatus should simply be dismantled. the FDIC can't get rid of many of the minor bank parts it already has. and resolving C is not the same as resolving a three-brancher in nevada -- who at the FDIC is going to properly evaluate the capital markets operations of the majors? FDIC simply doesn't know what it's doing in such cases -- it has no such experience and wasn't designed to resolve such banks.

moreover, i'm convinced he's absolutely right that if you wipe out the capital structure of C and BAC, the market knows already that JPM and WFC are going there -- the speculative attack will begin the moment the announcement about C comes down. and it will spread through all the majors and most of the regionals, as they're all in the same boat. what's likely needed is not isolated takeovers but a 1933-style bank holiday -- nationalize the whole system, then rerelease banks only after an FDIC audit. any bank that reopens is likely to more easily regain the trust of the public.

but in my view these are problems that have to be remedied, if only because an FDIC-style resolution process -- probably involving a long-term RTC-style bad bank to warehouse and sell assets taken over in resolution back into the private sector -- is the only remotely practicable, safe and fair way forward. it won't be painless, but it will put losses where they belong and leave in its wake a stronger and healthier banking system.

isaac's suggestion amounts to allowing slowly delevering zombie giants dominate the american banking landscape for many years to come -- peppered with bottomless pits like AIG -- and hazarding the collapse of the american treasury and the dollar as well in order to do so. what sort of option is that?

UPDATE: bill gross too is out there talking his book.

PIMCO would not dispute the need to further capitalize systemically important banks via convertible bonds held by the government, which unfortunately dilute shareholders’ interests. To go further, however, and “haircut” senior debt or even existing preferred stock similar to that issued via the TARP would create an instability policymakers should not want to risk. In turn, forcing creditors to take haircuts would undermine other financial sectors such as insurance companies and credit unions. The goal of future policy should be to recapitalize lending institutions while maintaining the basic infrastructure of credit markets. Outright nationalization and haircutting of creditors will do just the opposite.

PIMCO is utterly screwed if losses are passed up the bank capital structure as it owns a hell of a lot of bank debt. it thought it could safely buy ahead of the government and realize profits as rescue plans materialized by scalping the taxpayer. oops! perhaps that's not such an easy arbitrage after all....

but again, that's not to say his criticism is entirely invalid. instability is a possible result. but the alternative gross proposes is essentially to continue to make it possible for him to rake the taxpayer ad infinitum while the society suffers a thoroughly japanese denouement -- if it's lucky.

UPDATE: more from jck at alea -- he too thinks the systemic risk of nationalization, at least of only a few banks, is prohibitively large.

some excellent thoughts from the atlantic's megan mcardle on the appearance of impropriety.

UPDATE: felix salmon on AIG -- it strikes me that salmon's argument in defense of AIG's receivership is also an argument against sending C or BAC to resolution, at least in the conventional sense.

There is no doubt that, absent nationalization, AIG would be bankrupt by now. And the systemic consequences of an AIG bankruptcy would have made Lehman look like a walk in the park. For starters, Wall Street would be in much worse shape than it's in right now, since AIG Financial Products insured hundreds of billions of dollars of assets on banks' balance sheets, and has been putting up precious magin as the value of those assets has continued to decline.

On top of that, AIG's bonds would be largely worthless at this point, and the write-downs on those bonds would have caused another few hundred billion dollars in wealth destruction at precisely the financial entities which most need healthy assets.

And most importantly, the failure of AIG would probably have caused what the failure of Lehman brothers didn't -- a catastrophic cascade of counterparty failures in the multi-trillion-dollar CDS market, from which the global financial system might never have been able to recover.

Against all that, we have some very large and painful losses for the US taxpayer, which will never fully recover the money it's put into AIG. But compared to the alternative, we're all much better off.

that is, until or unless saving the AIGs of the world precipitates a run on the dollar. said gross:

Much like we are the world’s strongest nation militarily, we entered this crisis with certain economic and fnancial strengths relative to all other nations. Our reserve currency status was the primary one which means that we can write checks in our own currency and they are accepted all over the world – sort of like American Express Travelers Cheques. This privilege, however, can be and is being abused. Travelers Cheques are acceptable only when redeemed at 100 cents on the dollar. Lately, quasi-American dollars in the form of Aaa CDOs, corporate bonds, and even national champion bank stocks have foundered closer to zero than par. There is fear on foreign shores that even U.S. agency debt may not be honored and that U.S. Treasury debt itself, when “repoed” as in prior years, may now suffer from counterparty risk. Global willingness to accept American dollars is being tested. Granted, the U.S. currency has appreciated strongly against its counterparts during most of this crisis, but technical short covering as opposed to a fight to quality may have been the dominant consideration. Watch the dollar. If it falls hard, there may be nothing policymakers can do to restore the ensuing fnancial chaos.

UPDATE: via clusterstock, megan mcardle with more on what nationalization could precipitate.

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don't worry gm, bernanke says it's almost over.

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Bernanke said he "hoped" it was almost over...

And, Bill Gross has been talking his positions for as long as I can remember. When they were overweight Treasuries it was "yields could go to 1%." Now it's about credit, so the song changes but the goal is the same.

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"national security concerns about ceding that much power over our economy to foreign powers": my how I laughed.

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home price declines still accelerating

so far from a bottom, house prices are falling faster now than ever -- but at least the rate of acceleration may finally be slowing. calculated risk:

These are the worst year-over-year price declines for the Composite indices since the housing bubble burst, although only slightly worse (on a year-over-year basis) than November.

i wouldn't be so optimistic as henry blodget -- it seems a touch irrational to call the highwatermark based on what we see here.

still some poor deluded folks talk about putting some kind of floor under housing. there's still a deep denial among many of what exactly has happened. but the hard truth is that, short of utterly debauching the currency and rendering tomorrow's dollar worth today's dime, there is no relief for nominal home prices anywhere to be found. home prices will stop falling eventually; but it won't be very soon. see robert shiller for more. and indeed, in real terms, even dollar devaluation can not help -- prices are reverting now with extreme prejudice to their longstanding relations to incomes and rents with a high probability of significantly overshooting into real cheapness.

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Monday, February 23, 2009


credit contracts as government dissembles

tim duy notes the continuing collapse of consumer credit in the face of all efforts to halt it.

American Express Co., the largest U.S. credit-card company by purchases, is paying some cardholders $300 each to close accounts so the lender can reduce the risk of defaults as the recession deepens. ...

“What AmEx is trying to do is move to the front of the line in terms of getting paid back” by customers who owe debts to multiple lenders, said Michael Taiano, an analyst at Sandler O’Neill & Partners with a “hold” rating on the company. “They clearly grew loans faster than their competitors in the years leading up to this financial crisis.”

American Express was a recipient of TARP funding, albeit a "nominal" $3.39 billion. What makes this interesting is that not only is American Express not expanding lending - the selling point of the original TARP proposal - they are using the funds (money is fungible) to explicitly contract lending. Such a vivid illustration of the industry's challenges.

but the really critical commentary illustrates the massive change in conditions that is now evident in the economy.

And those challenges are only building. As the US government is goading investors with a line in the sand, consumer defaults are swelling:

Consumers are falling behind on credit-card payments as U.S. unemployment reached 7.6 percent last month, the highest rate since 1992.

This is just consumer debt; commerical debt pressures, including real estate, are building as well. With the situation rapidly deteriorating, the anticipated stress tests look like a smoke screen to buy time in yet another emphemeral effort to restore the elusive confidence that policymakers hope will magically restore the system.

Whatever news comes out of Washington regarding the plan of the day for the banking system, I hope one thing is soon made clear to the public - fixing the financial system is not the same thing as expanding lending. We are way past that point; you can't fix the system with more bad loans. If Treasury Secretary Geithner tries to sell his plans as the solution that will revive credit growth, I suspect he will further test the already strained credibility of the government. A more honest approach: We are simply trying to prevent the financial system from outright collapse.

indeed the government looks increasingly ineffectual before the scale of the disaster underway. bank stress tests are, as yves smith says again, more information dissemination than information gathering -- the government along with everyone else well knows these banks are as fucked as the day is long. the only point of conducting conspicuous but obviously sham tests would seem to be to set the stage for some remotely credible propaganda. the ever-less credible variety is flooding out of treasury on a daily basis now -- here's today's dose -- as it becomes ever more apparent that the government is just exactly the deer in the headlights that michael pettis describes.

Not only am I pessimistic, then, about Chinese policymakers’ willingness to confront reality, but my trip to Washington also left me very worried about US policymakers. ... my great hope has been that the new US administration surges forward and begins to design not just a short term solution that addresses the current collapse ... but also a longer term plan about what the new institutional framework will look like. But I don’t think this is happening.

Many people I spoke to last week were really bewildered by China’s role, and although many of them were extremely sophisticated in their understanding, they gave me the impression that policymakers are going through an almost existential crisis and have lost all confidence. The world needs US leadership more than ever, and the US is in a very strong position to provide it ... [but] This seems to be something that not many people in Washington believe. The lack of confidence is so deep that several times I heard people refer knowingly to the Chinese fiscal stimulus (yes, that vague, risky, and hard-to-understand stimulus package) as the “gold standard” of economic stimulus packages. Gold standard? Really? The only way this can be true is if every other stimulus package in the world is total garbage. Perhaps it is.

with government paralyzed and credit outfits on to very desperate measures, it seems ever more certain that the financial system will spiral lower and with it the economy.


AIG to report $60bn loss, file bankruptcy

that's the rumor, via zero hedge and others. would the obama government have the stones to let AIG go? do they have a choice?

UPDATE: new terms but perhaps not bankruptcy, it would seem. more from yves smith and cafe americain, linking to this incendiary piece in widely-distributed newsmagazine time. what a complete travesty. there is no better example of the complete cognitive regulatory capture of the panicked united states government than the absolute rape being perpetrated by AIG on the taxpayer. some folks should end up in front of a firing squad for allowing this to happen, and i don't mean that metaphorically.

as jesse suggests, the stink of the credit default swap market is all over the delaying actions being proposed by the government. it would seem that preserving the banks and the financial system from the consequences of their CDS positions has become the order of the day.

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Cut your (expensive) losses

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government soliciting DIP financing for automakers

the journal.

Outside advisers to the U.S. Treasury have started lining up the largest bankruptcy loan ever, talking with banks and other lenders about at least $40 billion in financing for General Motors Corp. and Chrysler LLC, in case the two auto makers need it, said several people familiar with the matter.

While acknowledging the grimness of the task, administration officials involved in the auto talks said they are trying to find a way to restructure the two companies without resorting to bankruptcy proceedings. They stressed the latest efforts were "due diligence" on the part of the government advisers, and that bankruptcy financing may not be necessary.

Still, people involved in talks with senior Obama administration officials said that the administration believes that the option of Chapter 11 filings by the two auto makers needs to be seriously considered.

this locks in that the carmakers, unlike the banks, will be hustled into bankruptcy. given the general incompetence on display in both washington and detroit these days, i am hardly sanguine about the prospect. the hope is for reorganization, but the chance of liquidation is not small. either way, massive tranches of jobs will be cut, denting already-strange government notions of demand management. and i'm half certain no one in congress or the administration has considered the potential fallout to synthetic CDOs.

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i'm sure glad 'change' came to america!

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ooops, anon was me gm.

i wonder where all the lefties who criticized everything bush did for 8 years will be on this one, when the new administration proves to be just as clueless and incompetent as the last one.

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i voted for the man, ccd, as you know -- there was no real choice, given the alternative -- but the early performance of the obama administration has been incredibly bad.

summers and geithner look ever more like a terrible mistake at the key pivot. your resume doesn't matter if you're just a cipher for the busted money center banks. both should be hustled out of office on a rail before they're allowed to devastate the american economy by refusing to actually proactively fix the problems rather than sit around and concoct ways to be sure their patrons can be bailed out by the taxpayer. the depression will be bad enough without delaying the financial system fixes you actually can do something to effect.

unfortunately, the one thing summers does well is politics -- it will take a change of heart from obama himself. let's hope rahm emanuel can knock summers off.

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"unfortunately, the one thing summers does well is politics..": someone should get him on tape talking about women in science again.

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Sunday, February 22, 2009


the pension disaster materializing

it's been an ugly little open secret for some years among the financial community that defined-benefit retirement funds, both corporate and government, were just as woefully underfunded compared to the net present value of their obligations as social security and medicare. one of the predictable results in recent seasons has been the migration of pension funds from truly safe investing to ever greater degrees of yield chasing -- up to and inclunding deep end-user involvement in the very worst aspects of the securitization market and even taking up the ass end of the capital structure in preferred and common equities.

for a while, the rosy assumptions of high returns as a result of such yield chasing allowed pension funds to pretend that they were not in trouble. but now that the great crash of 2008 has forever demolished the securitization bubble and cut half or more out of a diversified equity portfolio, the fatal weakness of pension systems has become undeniable. zero hedge examines, as a proxy for the dying fund-of-funds industry, the deathly condition of the new york state retirement systems.

As the financial system collapses and states' budget deficits skyrocket, the lives of citizens are about to get very ugly as legislators' only options are to cut state employees (i.e. police officers, healthcare workers and educators) and raise taxes through the roof. One need look no further than California which is on the brink of collapse, as absent federal assistance, it will be unable to fund its $42 billion state deficit. New York is in no better position, and David Paterson has had numerous media appearances attempting to warn New Yorkers just how difficult lives in the state are about to become. In the meantime, public workers, current and retired, of troubled states will shortly begin receiving very disturbing news, as their pensions and benefit packages are about to be drastically reduced if not eliminated altogether. The culprit? The falling market. ...

Pension funds' calculations for actuarial purposes presume a roughly 8% annual growth in perpetuity, the result of which funnel through into the over- or under-funding estimates for a State's budget for any given period of time. The current dislocation implies that absent an approximately $50 billion injection of new capital, New York's Pension Funds are guaranteed to be unable to keep up with increasing cash outflow requirements. As we mentioned, New York is not alone in this predicament, with all major public employee reitrement funds currently down anywhere between 40% and 50%. While public anger is still focused merely on the huge deficit in the state's income statement, soon all hell will break loose when millions of current police, healthcare and educational retirees realize they will have go back to work as their pensions disappear. The speed of the market's collapse will determine how quickly that day comes.

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Sunday Night Coffee - Analysis of Market For Upcoming Week -

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Friday, February 20, 2009


economic collapse severity intensifying

two posts from econobrowser.

first industrial production and manufacturing output -- this is the most severe contraction since the second world war through february, and the philly and new york surveys indicate further deterioration in february.

second the early view on q1 GDP -- E-forecasting's estimate is that January real GDP was declining at an 11.8% at annual rates.

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Doomsday advice: if the economy collapsed (op, did I say that?) and you couldn’t buy toilet paper what would you do? Get a bathroom bidet sprayer from and you won’t have to worry about it. The water will still be running long after the toilet paper stops reaching the store shelves and in the mean time you’ll be saving money that you can use to stock up on canned soup.

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Bah, the Romans made do with a sponge on a stick and their empire lingered on until 1457.

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Bah? Is that supposed to be an intelligent response? Well, at least we have the decline of Western Civilization covered.

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two points

john jansen is as ever the trenchant commentator upon all things credit, and there are two observations of his from this post to remember.

Treasury supply is a constant theme and has come to dominate trading. The Philadelphia Fed Manufacturing survey touched a cycle low yesterday. The initial claims data and the continuing claims data reflect an ever weakening economy. We can not even say that we are scraping along the bottom as the bottom has not been set yet.

And take a look at the equity market here and around the globe. Markets are at multi year lows. In concert with the economic data one would expect yields of be galloping lower. They are not and remain well off the historical lows attained in December when the 10 year traded to 2.05 percent and the 30 year traded around 2.50 percent. The failure to approach the lows simply reflects the enormous appetite of the Treasury for funding.

Observe what they are issuing next week. On Monday they will auction $31 billion 3 month bills and $30 billion 6 month bills. Tuesday will bring a sale of $42 billion 2 year notes and Wednesday brings $32 billion 5 year notes. Thursday the Treasury will reintroduce the 7 year note to investors with a chunky $22 billion offering. In total the Treasury will raise an incredible $ 155 billion next week. Admittedly, a chunk of it is low risk bills but the point is that the supply is there and it will be a challenge for the markets for some time.

the flight to safety bid is there as the s&p tests 740 -- but treasury is simply overwhelming it with new supply and preventing yields from falling. what happens when treasury tries to sell these sorts of schedules into a calm market? or is that possible?

secondly --

there had been talk earlier in the week of Germany bailing out some of the weak sisters in Europe. Various speakers have squelched that thought.

The German Finance Ministry has said that counties facing deteriorating fiscal conditions must take their own actions.

ECB Council member Stark noted the Maastricht Treaty prohibits such bail outs.

Mr Trichet noted that there are no weak links in Europe, including Ireland.

who knows how this brinksmanship ends. but if germany will not step into the breach the prospect for a cascading collapse feeding from eastern europe to west increases dramatically. the swiss franc is decoupling from the dollar on concerns over the sovereign exposure through its massive banks to poland et al.

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hey gm have a banking question for you.

I've arranged to buy a wind turbine from Germany. I have been following the exchange rate between the dollar and euro for a few weeks and this morning it was in my favor. So I stroll on down to BOA and they have an exchange rate almost .08 cents higher than the market. Is this normal? I would have thought that a bank couldnt do that since they are a country. Shows my youth and how naive I am I suppose.

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yes -- they ding you for what amounts to a transaction fee, just like any currency exchange. :(

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social collapse best practices

i've mentioned dmitry orlov before in conjunction with his 2006 presentation 'closing the collapse gap' and his 2005 series 'post-soviet lessons for a post-american century' (parts two and three). he more recently penned in early 2008 'the five stages of collapse', of which he suspects we are in the first stage. he has also published a book, "reinventing collapse", to articulate his ideas better. his sporadically-updated blog is here.

orlov gave an intriguing talk this month titled 'social collapse best practices' which tries to provide, as the title implies, a framework for adopting tested survivability methods in the aftermath of a worst-case outcome.

If you thought that the previous episode of uncontrolled debt expansion, globalized Ponzi schemes, and economic hollowing-out was silly, then I predict that you will find this next episode of feckless grasping at macroeconomic straws even sillier. Except that it won’t be funny: what is crashing now is our life support system: all the systems and institutions that are keeping us alive. And so I don’t recommend passively standing around and watching the show – unless you happen to have a death wish.

no doubt, this is maximum pessimism. worse than japan? surely -- i readily accept it. but worse than the soviet union?

nevertheless, i do think orlov's basic point is essentially inarguable and in fact is seconded by nassim taleb and benoit mandelbrot and michael panzner. orlov is diagnosing the united states as an overoptimized society -- too specialized, too interdependent, too tightly coupled, too fragile -- on the brink of a very radical change in its environmental backdrop. overoptimization makes the united states uniquely strong so long as the environment does not shift in a discontinuous manner; but it also makes our society uniquely vulnerable to such a shift.

the determinant is not whether orlov could be right. it is whether the shift in the environment to which we have become so finely tuned is profound and radical enough to precipitate the kind of self-feeding collapse he envisions.

UPDATE: video link via paul kedrosky.

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Thursday, February 19, 2009


the threat to switzerland

as the eastern european spiral continues down, ed harrison of credit writedowns translates an article from the domestic swiss press interviewing economic journalist artur p. schmidt and highlighting the massive potential sovereign solvency problems facing switzerland should eastern europe collapse.

What Switzerland must do now?

Now, the possible losses caused by these loans must be made transparent. Above all, all of the Eastern European risks must be fully disclosed. Together with the loan losses from UBS and Credit Suisse, the entire writedown for Switzerland could exceed the Swiss gross domestic product.

That is to say?

Switzerland, like Iceland, is threatened with a potential national bankruptcy. One consequence would be that the Swiss currency could fall massively in value — possibly even crash. Another would be that Switzerland’s credit rating would be massively downgraded. That would be a trauma for the country: Switzerland was always as a stronghold of stability. The franc could become an unstable soft currency. Then Switzerland would perhaps be forced to abandon the franc and take on the euro.

this is potentially an alarmist view -- but problems in switzerland are less than they are in austria, which might give one some sense of the desperation in vienna. harrison further notes that germany, softening on previous rumblings, seems more likely to intervene to bail out austria.

willem buiter also notes the return of capital controls is likely in eastern europe.

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The Blessed Willem Buiter had a whinge the other day about the FT's new comments sytem. It's certainly new enough to fox me; I now have no idea how to submit a comment on his blog. Ain't progress dandy?

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Roubini,today on Bloomberg TV, mentioned that the liabilities of the Swiss banking sector as a percent of GDP stand at 1,000%. To put that in context he also mentioned this ratio for Iceland,which has already collapsed, was 1,200%. I suppose that says nothing about the 'quality' of the liabilities of the banks of the respective countries; but the number for CH does look rather ominous.

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japan was successful, cont'd

following on yesterday's lengthy excerpt and comments, i should also link to an excellent comparison of the japanese and american situations in the economist.

... the history of bank failures suggests that Japan’s slump was not only the result of policy errors. Its problems were deeper-rooted than those in countries that recovered more quickly. Today’s mess in America is as big as Japan’s—and in some ways harder to fix.

... The scale of the bubble — a doubling of house prices in five years — was about as big in America’s ten largest cities as it was in Japan’s metropolises. But nationwide, house prices rose further in America and Britain than they did in Japan (see first chart). So did commercial-property prices. In absolute terms, the credit boom on top of the housing bubble was unparalleled. In America private-sector debt soared from $22 trillion in 2000 (or the equivalent of 222% of GDP) to $41 trillion (294% of GDP) in 2007 (see second chart).

Judged by standard measures of banking distress, such as the amount of non-performing loans, America’s troubles are probably worse than those in any developed-country crash bar Japan’s. According to the IMF, non-performing loans in Sweden reached 13% of GDP at the peak of the crisis. In Japan they hit 35% of GDP. A recent estimate by Goldman Sachs suggests that American banks held some $5.7 trillion-worth of loans in “troubled” categories, such as subprime mortgages and commercial property. That is equivalent to almost 40% of GDP. ...

What is worse, today’s bust is not just about banking. America faces twin financial crashes (as, to a lesser degree, do other Anglo-Saxon countries): one in the regulated banking sector and a simultaneous collapse of the “shadow banking system”, the universe of hedge funds and investment banks responsible for much of the recent securitisation boom as well as for the sharp rise in financial leverage.

... What is worse, today’s bust is not just about banking. America faces twin financial crashes (as, to a lesser degree, do other Anglo-Saxon countries): one in the regulated banking sector and a simultaneous collapse of the “shadow banking system”, the universe of hedge funds and investment banks responsible for much of the recent securitisation boom as well as for the sharp rise in financial leverage.

As a result, standard measures of banking distress, such as the level of non-performing loans, understate the contractionary pressure. So far most of the credit collapse in America has come from the demise of securitisation. In 2007, for instance, $668 billion of non-traditional mortgages were securitised. Last year that figure dropped to $40 billion. Rapid deleveraging outside traditional banks also means that cleaning up banks’ balance-sheets may not break the spiral that is driving down asset prices and stalling financial markets. As the lower chart shows, financial-sector debt was the fastest-growing component of private-sector debt in recent years. Many of those excesses are being unwound at warp speed.

mind you that loss estimates are still rising with every new quarter. as earlier noted, jeremy grantham's back-of-napkin estimate is for some $10tn will have to be unwound, or over 70% of GDP. in the end, the problems in america are likely to be significantly greater than those of japan as a percentage of GDP. this is evidenciary confirmation that we are emerging from the greatest credit boom of all time into the greatest credit bust of all time.

the economist further notes the unusual similarity to japan in that the currency has not (yet) crashed -- which is rare among preceding banking collapses.

As the world’s biggest debtor, America headed into this bust in a very different position from Japan, a creditor nation rich in domestic savings. Nonetheless the macroeconomic trends in America look more like those that existed in Japan than other crisis-hit countries. Most big banking failures, from Sweden’s to South Korea’s, were created or worsened by a currency crash. Tumbling exchange rates raised the real burden of foreign-currency loans, forced policymakers to keep interest rates high and pushed up the fiscal costs of bank rescues. (Because of the rupiah’s collapse, for instance, the clean up of Indonesia’s failed banks in 1998 cost more than 50% of GDP.) But, by boosting exports, a weaker currency also offered a route to recovery. In Japan, by contrast, the yen stayed strong as the economy slumped, deflation set in and the banking problems grew.

In some ways America’s macroeconomic environment is even trickier than Japan’s. America may have a big current-account deficit, but the dollar has strengthened in recent months. America’s reliance on foreign funding means the risk of a currency crash cannot be ruled out, however. That, in turn, places constraints on the pace at which policymakers can pile up public debt. And even if the dollar were to tumble, the global nature of the recession might mean it would yield few benefits.

... [B]uoyed by strong demand in the rest of the world, particularly America, [previously afflicted] countries’ exports soared, allowing a quick recovery. Even Japan eventually built its economic recovery on the back of booming exports. Today demand is falling rapidly across the globe and most big developed economies face simultaneous banking crises. With demand weak everywhere, the familiar route to recovery is blocked.

that is bleak indeed -- and portends a long L-shaped global depression until or unless east asian savers can be compelled (likely with the aid of appreciated currencies) to consume, but with little enough intermediate-term relief for the united states even with a depreciated dollar.

and that is not all.

A final difference between today’s bust and most other big banking crises is the importance of household debt. Historically, serious banking busts have mainly involved overborrowing by firms. In Japan, for instance, corporate borrowing soared in the 1980s against the collateral of rising share and property prices.

Today, however, household profligacy, which underpins much of the other debt, has been the problem. After the dotcom bust, American firms held back. Virtually all the rise in non-financial debt since 2000 was among households, as Americans tapped into the rising equity in their homes. Although troubled business debts, such as commercial property, are rising, households are the worst hit.

That has important implications. Household balance-sheets are more difficult to restructure than corporate ones, which involve far fewer people. Politically, the process raises questions of fairness. How far, for instance, should taxpayers bail out reckless homeowners who bought mortgages they could not afford? On the other hand, the economic dislocation from unwinding a household-debt binge may be less disruptive than restructuring swathes of firms. As Anil Kashyap of the University of Chicago points out, one reason Japan was so loth to acknowledge the depths of its banking problems was the knowledge that a banking clean-up would require a large-scale restructuring of Japanese firms which, in turn, would throw many people out of work. Restructuring household debts may be political dynamite, but it would not require a wholesale remaking of corporate America.

Nonetheless, the rebuilding of American households’ balance-sheets is likely to force a reliance on government demand that is bigger and longer-lasting than many now imagine. In the aftermath of Japan’s bubble, firms spent more than a decade paying down debt and rebuilding their balance-sheets. This sharp rise in corporate saving was countered by a drop in the savings rate of Japanese households and, most importantly, by a huge—and persistent—increase in budget deficits.

A similar dynamic will surely play out in America’s over-indebted households. With their assets worth less and credit tight, people will be forced to save much more than they used to. The household saving rate has risen to 3.6% of disposable income after being negative in 2007. For much of the post-war period it was around 8%, and in the short-term it could easily exceed that. But, whereas dis-saving by Japanese households countered the corporate balance-sheet adjustment, American firms are unlikely to invest more while consumers are in a funk. Propping up demand may therefore require more persistent, and sustained, budget deficits than in Japan.

in other words -- it isn't just that the stimulus package recently agreed upon is far too small to counter the yawning collapse in private consumption, or that it is stupidly overweighted in tax cuts which are unlikely to achieve an increase in monetary velocity, or even that stimulus without a repaired financial system is highly unlikely to ripple through the economy to kickstart private consumption. it is furthermore that, until household balance sheets are repaired, the corporate sector is highly unlikely to even try to grow -- indeed, it will likely continue to contract in the interest of prudence, perpetuating the debt-deflationary spiral -- and any effort to offset that spiral is likely going to have to be far larger than anything so far countenanced in public. taken in conjunction with earlier warnings about the underestimated possibility of a dollar collapse, this presents a massive catch-22 for government efforts at keynesian policy.

the economist also contributed a skeptical view of the efficacy of the swedish resolution pattern. beyond noting that bad loans were just 13% of swedish GDP, it further said:

Administratively, today’s crisis is far more complex than it was in countries where the clean-ups are presently being praised. In Sweden’s highly concentrated banking system, one firm—Nordbanken—accounted for a quarter of all loans. The government dealt with a big part of the problem by taking over two banks. America’s finance industry is more diffuse. Even after a wave of government-induced consolidation, there are at least a dozen systemically important commercial banks.

More important, Sweden’s much-praised bad banks, into which the government shovelled troubled loans, dealt with straightforward credit backed by clear collateral. Even then the success was unusual. According to the IMF, asset-management companies were set up in 60% of banking crises, but were generally “ineffective”. That seems more likely today when the complexities of securitisation have left “toxic assets” that range from pools of car loans to fiendishly complex collateralised-debt obligations, which are much harder to unravel, value and manage.

indeed, that is a very salient criticism.

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from perrone: well, I don't know that it's so terribly salient. seems to me so much of the talk of the godawful complexity of these (bad) assets is ultimately just horseshit, propounded by vested interests desperate to forestall mortal losses. look, it's pretty ironic and hypocritical, no, for all these priests of the free market to be saying this. you want to know how much this crap is worth? SEE WHAT YOU CAN FETCH FOR IT. and government's role, as you yourself have (rightly) argued, gm, ought to be to force the banks to do just that.

we've wasted enough time, and every bit of time we waste takes us further down the hole. shit or get off the pot. if the banks won't open their books for all to see and get rid of the stuff for whatever's offered, then public servants (and their agents) must do it for them. complexity, shmexity. the buyers will tell you how much its worth. let the market do what it's supposed to do: arbitrate, wipe the slate so we can at least start over.

and these won't be six year-olds handling the takeovers, anyway. a little complexity probably won't make them curl up and wet themselves. they're bound to be a hell of a lot less stupid and short-sighted than the wizards who got us into this, that's for sure.

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here's the trouble with complexity as i see it, p -- you're right on some level. this stuff is severely impaired, and those who don't accept that, who toss around canards about m2m accounting, are largely in denial over what banks hath wrought.

but in order for the government to effect a cleansing FDIC-type resolution, someone has to know what the assets are worth -- not approximately, but very closely. if that isn't known, the consequences are twofold:

1) buyer pays too much even at 50 cents on the dollar. buyer suffers losses, likely on top of existing impairments (as the buyers of bank assets are most likely banks). such moves could precipitate further problems.

2) buyer pays too little. this is what a lot of us hope to see, i think -- buyers rewarded for stepping into uncertain times. but the fallout could well be that there isn't enough debt in the capital structure to cover the losses realized on the asset sales, and the cost has to be picked up by the FDIC/treasury.

this is not improbable. C, for example, has $1.9tn in liabilities, of which something like $1tn is debt. losses on C's $2tn in assets, if put to sale, could very easily be greater than $1tn. who, after all, can buy the stuff in this environment?

repeat this process through C, BAC, JPM, WFC -- and suddenly the treasury (through the FDIC) is on the hook (again) for a big number. and maybe the resolutions of these assets take years, not months -- the FDIC is having trouble, after all, selling the relatively minor assets it has already taken over.

and here's another thought -- no one at FDIC has ever seen capital markets operations like exist at C. they won't know what the hell to do with it, how to evaluate it or how to sell it.

beyond that, there are political questions. the holders of bank debt are insurers, pensioners, banks, foreign central banks and foreign sovereigns. there are plenty of parties out there who cannot suffer the 100% loss -- resolution will send them to bankruptcy as well. one might pithily observe that a lot of them are dead anyway, but the point of all this is not to trigger another self-reinforcing global wave of collapses.

anyway -- i (like you) personally advocate hazarding the risks of resolution. the money-center banks have to be broken up anyway -- they've proven to be a systemic risk. to me the real potential disaster is not depression but killing the dollar. in my view, our government has been much too willing to hazard the tail-risk possibilities in order to experiment. a japan-style outcome isn't pleasant; but a dollar collapse is a godforsaken mad-max outcome. if money-center bank resolutions feed a global deflationary spiral, that might not be the worst possible outcome.

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Wednesday, February 18, 2009


more on eastern europe

minyan peter:

I would offer that ... major European nations face a very real and looming Sophie’s (or should I say Nicholas and Alexandra's) choice – either help bail out their troubled EU brethren, and thereby risk burdening their own domestic economies with significant new debt; or let the other nations fail, and risk the collapse of the EU.

Now, I'm sure there are some reading this who would say there is no choice - the strong must save the weak. But I would offer that, in this environment, that may be too quick a conclusion - one need only look at what's happened to Bank of America (BAC) and Wells Fargo (WFC) in the aftermath of their bailouts of Merrill Lynch and Wachovia, respectively.

Ordinarily, size and reputation would delineate the strong from the weak. But in these turbulent times, a great many lifeguards can be, and are, drowned each year trying to save drowning swimmers. (That's why, here in the US, there will be no more large scale bank mergers.)

fil zucchi:

Eastern European countries are on the verge of collapsing, 1990s Asia-style.

If they go, countries like Austria are likely to follow - and just look at Austrian sovereign CDS rates if you don't believe me.

... Gold is telling a story. It's not an inflationary story per se, rather the story of the impending demise of fiat currencies. The only instrument countries cannot manipulate are their currencies.

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RE the Zucchi article, what example(s) are there in history of competitive currency devaluations, if any?

If you read my final comment on the 'rising treasury yields' post I'm curious whether you thought it was potentially accurate or way off base in some way. If you tell me the latter and leave it at that I won't be offended :)

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japan was successful

martin wolf in today's financial times makes what is from my perspective a nearly perfect assessment of japan since 1989 and its relevance to our current situation. i copy it here in toto with while admonishing you, dear reader, to subscribe to the financial times. my caveats follow.

What has Japan’s “lost decade” to teach us? Even a year ago, this seemed an absurd question. The general consensus of informed opinion was that the US, the UK and other heavily indebted western economies could not suffer as Japan had done. Now the question is changing to whether these countries will manage as well as Japan did. Welcome to the world of balance-sheet deflation.

As I have noted before [as have i] the best analysis of what happened to Japan is by Richard Koo of the Nomura Research Institute. His big point, though simple, is ignored by conventional economics: balance sheets matter. Threatened with bankruptcy, the overborrowed will struggle to pay down their debts. A collapse in asset prices purchased through debt will have a far more devastating impact than the same collapse accompanied by little debt.

Most of the decline in Japanese private spending and borrowing in the 1990s was, argues Mr Koo, due not to the state of the banks, but to that of their borrowers. This was a situation in which, in the words of John Maynard Keynes, low interest rates – and Japan’s were, for years, as low as could be – were “pushing on a string”. Debtors kept paying down their loans. [the same is true today -- gm.]

How far, then, does this viewpoint inform us of the plight we are now in? A great deal, is the answer.

First, comparisons between today and the deep recessions of the early 1980s are utterly misguided. In 1981, US private debt was 123 per cent of gross domestic product; by the third quarter of 2008, it was 290 per cent. In 1981, household debt was 48 per cent of GDP; in 2007, it was 100 per cent. In 1980, the Federal Reserve’s intervention rate reached 19–20 per cent. Today, it is nearly zero.

When interest rates fell in the early 1980s, borrowing jumped (see chart). The chances of igniting a surge in borrowing now are close to zero. A recession caused by the central bank’s determination to squeeze out inflation is quite different from one caused by excessive debt and collapsing net worth. In the former case, the central bank causes the recession. In the latter, it is trying hard to prevent it.

Second, those who argue that the Japanese government’s fiscal expansion failed are, again, mistaken. When the private sector tries to repay debt over many years, a country has three options: let the government do the borrowing; expand net exports; or let the economy collapse in a downward spiral of mass bankruptcy.

Despite a loss in wealth of three times GDP and a shift of 20 per cent of GDP in the financial balance of the corporate sector, from deficits into surpluses, Japan did not suffer a depression. This was a triumph. The explanation was the big fiscal deficits. When, in 1997, the Hashimoto government tried to reduce the fiscal deficits, the economy collapsed and actual fiscal deficits rose.

Third, recognising losses and recapitalising the financial system are vital, even if, as Mr Koo argues, the unwillingness to borrow was even more important. The Japanese lived with zombie banks for nearly a decade. The explanation was a political stand-off: public hostility to bankers rendered it impossible to inject government money on a large scale, and the power of bankers made it impossible to nationalise insolvent institutions. For years, people pretended that the problem was downward overshooting of asset price. In the end, a financial implosion forced the Japanese government’s hand. The same was true in the US last autumn, but the opportunity for a full restructuring and recapitalisation of the system was lost.

In the US, the state of the financial sector may well be far more important than it was in Japan. The big US debt accumulations were not by non-financial corporations but by households and the financial sector. The gross debt of the financial sector rose from 22 per cent of GDP in 1981 to 117 per cent in the third quarter of 2008, while the debt of non-financial corporations rose only from 53 per cent to 76 per cent of GDP. Thus, the desire of financial institutions to shrink balance sheets may be an even bigger cause of recession in the US.

How far, then, is Japan’s overall experience relevant to today?

The good news is that the asset price bubbles themselves were far smaller in the US than in Japan (see charts). Furthermore, the US central bank has been swifter in recognising reality, cutting interest rates quickly to close to zero and moving towards “unconventional” monetary policy.

The bad news is that the debate over fiscal policy in the US seems even more neanderthal than in Japan: it cannot be stressed too strongly that in a balance-sheet deflation, with zero official interest rates, fiscal policy is all we have. The big danger is that an attempt will be made to close the fiscal deficit prematurely, with dire results. Again, the US administration’s proposals for a public/private partnership , to purchase toxic assets, look hopeless. Even if it can be made to work operationally, the prices are likely to be too low to encourage banks to sell or to represent a big taxpayer subsidy to buyers, sellers, or both. Far more important, it is unlikely that modestly raising prices of a range of bad assets will recapitalise damaged institutions. In the end, reality will come out. But that may follow a lengthy pretence.

Yet what is happening inside the US is far from the worst news. That is the global reach of the crisis. Japan was able to rely on exports to a buoyant world economy. This crisis is global: the bubbles and associated spending booms spread across much of the western world, as did the financial mania and purchases of bad assets. Economies directly affected account for close to half of the world economy. Economies indirectly affected, via falling external demand and collapsing finance, account for the rest. The US, it is clear, remains the core of the world economy.

As a result, we confront a balance-sheet deflation that, albeit far shallower than that in Japan in the 1990s, has a far wider reach. It is, for this reason, fanciful to imagine a swift and strong return to global growth. Where is the demand to come from? From over-indebted western consumers? Hardly. From emerging country consumers? Unlikely. From fiscal expansion? Up to a point. But this still looks too weak and too unbalanced, with much coming from the US. China is helping, but the eurozone and Japan seem paralysed, while most emerging economies cannot now risk aggressive action.

Last year marked the end of a hopeful era. Today, it is impossible to rule out a lost decade for the world economy. This has to be prevented. Posterity will not forgive leaders who fail to rise to this great challenge.

this is justice delayed for the macroeconomic policymakers of 1990s japan, whom have been arrogantly and wrongly derided for the better part of a generation in the west. a lost decade, given the leverage that had to be worked off, represents a significant policy success insofaras it achieved its goal of preventing an outright depression. whether a sharp four-year depression is preferable to a now-18-year malaise is another question entirely.

importantly, wolf notes some ways in which our situation differs from that of japan. the great luxury which japan had that we do not was a fairly strong global economy to which it was already suited to export. much of the lost decade represents the development of a dual economy in japan -- a chronically depressed domestic piece, and a roaring export piece. japan today is faced with the collapse of exports, revealing its domestic weakness in a terrible way. the united states, however, won't have the luxury of exporting its way out to stability in the midst of a global depression.

another negative for the current situation is the very high degree of financialization in the western economy, which wolf notes as the titanic bubble in financial debt. this if anything understates the degree of the problem significantly, as the shadow banking system exists largely off balance sheet and is in the process of collapsing completely. there is really no analogue to such a system in 1990s japan that i'm aware of, and that makes questionable any direct comparison of the size of japan's asset bubble to our own. the pile of ABS levered into CDOs and then into SIVs, CDO-squareds and all the other instruments of securitization causes similar schemes from the late 1920s in the united states -- then called investment trusts, with bucolic names like shenandoah and blue ridge -- to pale in comparison. it is that collapse and its potential as a devastating accelerant which gives market philosophers like nassim taleb sleepless nights.

and then there is the danger to the dollar. even if one accepts that leveraging the government to offset the deleveraging of the financial, corporate and household sectors is possible -- and i think that is, regardless of manifest republican idiocy, more or less a fact -- one must then ask if doing so is wise. this is not merely a restatement of the question of whether short depressions are better or worse than long malaises; it seems to me that such a levering was inherently much safer to execute in japan as the savings of the society from the outset was very high and there was no question as to whom the government bonds could be sold. that is very much a open question today for the united states. brad setser has been keen to point out that increased american savings will help to fund the government's borrowing plans; but others have pointed out that even greatly increased savings rates may not cover what the government is planning to borrow, and that will mean monetization. already rising treasury yields have sparked early concern, particularly given that taylor rule implications are for a policy rate of something like (-6%).

on the positive side, we are not like 1990s japan as much as 1930s europe -- of the immense pile of global excess capacity, relatively little is in the united states. we've been importing large amounts of goods for years, utilizing foreign manufacturing capacity rather than building out our own, thanks in large part to the mercantilist currency management policies practiced in asia. with global trade plummeting and eventually dollar weakness, the united states will find itself with a much reduced standard of living -- but also capable of building out domestic capacity for its own market as well as improved competitiveness in exporting in some industries. this can work as a buffer, as it did for the european colonial economies in the 1930s.

UPDATE: part 2.

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the permanent change in consumer behavior

via tech ticker, howard davidowitz recites a familiar litany but from the retail persepctive which he knows so well -- and most importantly, calls it as the good and necessary thing it is.

also referring to davidowitz is cafe americain, with some political editorial.

The gloomy long-term Depression outlook becoming so popularly accepted that we find ourselves rebelling against it. Perhaps unjustifiably so.

It will come down to what the Obama Administration does about the Banks. If the big Wall Street banks are allowed to absorb the capital vitality of the economy and limp along as insolvent zombies it is highly possible that we will have our own 'lost decade' like the Japanese experience.

Larry Summers is in command as the economic advisor with young Tim as his minion. We can barely imagine the infighting that must be going on between the practical politicos around Obama, probably led by Rahm Emanuel, who must be simply frothing at the boneheaded policy blunders that Geithner and Summers are creating.

A chart of W's popularity shows a decided peak just after 911, and then a steady decline into political oblivion and one of the worst popularity ratings in modern presidential history. It is now being revealed that there was a feeling in the White House that Cheney and Rumsfeld misled the president and cost him, dearly. W became very cool and detached with Cheney and his circle in the last two years, He ignored personal pleas to pardon Cheney's man, Scooter.

There is a real possibility that Larry Summers and Tim Geithner could be the spoilers for Obama despite the enormous wave of popular support which he enjoys today. Betting on the over/under, we suspect that eventually Rahm will put him in a political body bag, with Larry providing plenty of personal assistance in his own demise. But that's just an opinion and it could be wrong. Their failure is definitely not in the best interests of the country.

more from davidowitz on tech ticker: "get ready for mass retail closings" and "american retail goods: on sale now -- and forever?".

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Tuesday, February 17, 2009


the war on wisdom


What on earth is the point of wearing a suit and not a tie? If you're going for comfort and practicality, dump both; for conventionality, retain both. His dress is a self-indulgence.

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The lecturer's other indulgence is an unwillingness to address the underlying cause of the "Mike's Hard Lemonade" incident, and boy did he do some serious dancing ("jazzy") to get around it. The elephant in the room is this: America differs from all other western democracies in its refusal to recognize the principle that the losing side in litigation should contribute toward making whole its prevailing opponent.

The "disaster" most likely to appear is the expense of settling a frivolous lawsuit, not an actual harm done. If we limit de facto extortion by implementing a "loser-pays" system for civil remedies, "wise" folk can piece together that the subject's giving his kid hard lemonade was just an "honest mistake".

Lack of virtue? It is not that our society has become a bunch of scoundrels, it is the fact that the current legal system makes it prohibitively expensive to act virtuously, i.e., your ability to provide for your family can be compromised by reaching out and making a "wise" judgment call.

What do you expect from a guy who doesn't wear a tie with his suit?

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general electric

option armageddon does the math.

UPDATE: paul kedrosky questions.

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stanford financial shut by SEC

the financial times outlined the concept of stanford financial complex a while back. the SEC today shuttered the works, alleging a fraud on the same order of magnitude as bernie madoff.

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carmakers likely headed to bankruptcy now

between the obama administration's refusal to name a "car czar" and rumors that GM and chrysler have been told to address issues stemming from bankruptcy in their upcoming congressional testimony, it seems that the jig may be up for the big three and some version of the "orderly bankruptcy" idea involving government DIP financing is in the cards.

i hope they're ready for the potential fallout in the CDS and synthetic CDO markets, but i suspect the political structure isn't even aware of the problem.

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california faces bankruptcy

as the onset collapse of eastern europe feeds back through the global capital markets -- which is i expect the big story of the first quarter at least -- there are several other ongoing disasters as the full impact of the depression begins to take hold. one of those sidelights is the default of american states. zero hedge comments on the cheapness of state of california credit default swaps.

California CDS offered at 355 seem cheap, especially when one considers that the one year default prob per the spread is 17.7% at a 80% recovery rate and drops to 9% if one assumes 60% recovery. Of course the question is whether the federal govt will bail out Cali, and just how an event of default will be defined for General Obligation securities, although all signs point to a test very soon in the future. Either way, it is very likely the CDS will soon retest recent wides of 455.

california is taking drastic steps -- such as cutting 20,000 state workers, issuing IOUs and suspending tax refunds -- and yet cannot pass a budget as it mires itself ever deeper in a fiscal disaster.

to my mind one of the big surprises of the recent stimulus bill deliberations was the reduction of funds allocated to the states, largely to satisfy some small-state republican senators. i fear this -- both california's inability to address its problems and the federal inability to preempt the state's crisis -- will end up another example of how ill-suited our compromise-driven domestic political system is for dealing with a real collective crisis in its early stages, when something materialy helpful could be done but well before the undeniable fallout of disaster forces the more delusional or misanthropic parties into the consensus. too many politicians are, in the aftermath of so many good years, in too deep a state of denial as to how bad things are about to get.

by no means, it should be said, is this crisis limited to california. yves smith yesterday highlighted the state of kansas -- not exactly an epicenter of the financial crisis -- suspending tax refunds. but the problem is really national, encompassing 46 of the 50 states.

UPDATE: the journal reports as california is "days away from financial collapse".

UPDATE: paul kedrosky expects the 11th-hour resolution.

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