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Thursday, February 19, 2009


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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