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Friday, January 30, 2009

 

growing difficulty for britain


nicely surmised by doug noland:

The U.K. is in trouble. Today it was reported that the British economy contracted a much worst-than-expected 1.5% during the fourth quarter (not annualized!), the steepest economic decline since the dark days of 1980. Manufacturing activity sank a dismal 4.6%, while services contracted by 1%. Some forecasts now have the British economy this year suffering the most severe economic contraction since 1946. There’s now a strong case for using “depression” when describing this deepening financial and economic malaise.

The pound today traded at the lowest level against the dollar since 1985. This currency has depreciated 30% against the dollar over the past 12 months. Against the yen, the pound has collapsed 42% during the past a year. There is little room left for conventional monetary policy. At 1.50%, the Bank of England’s (BofE) base lending rate is today at the lowest level since 1694.

Curiously, the British pound has declined 6.5% against the dollar so far this month, while the dollar index has gained about 6%. I say “curiously,” as I would argue that in key aspects of financial and economic structuring, the U.K. provides a microcosm of our own systemic vulnerabilities. In a recent Bloomberg interview, Jim Rogers stated “The pound sterling is going to be under pressure. The U.K hasn’t got much to sell the world anymore.” His comments to the Financial Times were even harsher: “I don’t think there is a sound U.K. bank now, at least, if there is one I don’t know about it… The City of London is finished, the financial centre of the world is moving east. All the money is in Asia. Why would it go back to the west? You don’t need London.”

Following our direction, the U.K. over the past decade gutted their already shrunken manufacturing base as it shifted headlong into “services” and finance. While this finance and asset inflation-driven Bubble economy seemed to work miraculously during the boom, the post-Bubble reality is a severely impaired financial system and an economic structure incapable of sufficient real wealth creation.

I feel for British policymakers. Just five short quarters ago, overheated nominal GDP was expanding at about a 6% pace. And with inflation surging to the 5% level, the Bank of England pushed its base lending rate to 5.75% (summer of ’07). I’ll give the BofE Credit for trying to tighten financial conditions. It was, however, in vain, as Acute Global Monetary Disorder overwhelmed domestic policymaking. BofE tightening only widened interest-rate differentials, especially compared to near zero borrowing rates in Japan. Finance inundated the City of London in a finale of unwieldy speculative excess, setting the stage for a reversal of flows, de-leveraging and today’s collapse.

Yesterday, U.S. insurance company Aflac dropped 37% on concerns for its exposure to European “hybrid” securities - in particular preferred-type instruments issued by the large U.K. banks. According to research by Morgan Stanley (Nigel Dally), “When it comes to capital adequacy and investment portfolio strength, Aflac has historically been viewed as the gold standard across the industry.” Accordingly, the Street responded violently to the report highlighting the company’s potentially significant exposure to securities that have suffered huge losses in market value (Aflac rallied sharply today). According to the Morgan Stanley report, some of the hybrid securities issued by U.K. lenders Royal Bank of Scotland (RBS), HBOS, and Barclays are now trading at between 15 and 45 cents on the dollar.

Not long ago during the boom’s heyday, these types of securities were viewed as low risk instruments. They were, after all, issued by major – and at the time well-capitalized –banking institutions. In the worst-case scenario, these institutions (and their hybrid securities) were viewed as too big to fail. In reality, these banks were issuing a most dangerous class of securities - higher yielding (“money-like”) instruments appealing to even the more conservative investors. Today, the entire U.K. banking system is enveloped in a vicious downward spiral. Tens of billions of securities that only a short time ago were perceived as safe are being heavily discounted for the possibility the issuing institution will be “nationalized.”

On Wednesday, troubled Royal Bank of Scotland promised to lend $8.7bn in exchange for various lines of government support. The market took the news as a huge leap toward nationalization and governmental control over the U.K. banking sector. Even RBS’s CEO was quoted as saying, “We’ll be one the first guinea pigs.” The markets now view that U.K. policymakers will have few available options other than borrowing hundreds of billions to recapitalize their banks and support the securities markets.

Ten-year government “gilt” yields spiked 29 basis points higher this week to 3.68%, with a 2-wk gain of 55 bps. On Tuesday, Britain reported a $20.5bn (14.9bn pounds) fiscal deficit for the month of December. Spending was up 6%, while tax receipts were down 5.5%. The European Commission is now forecasting the U.K. deficit to surpass 8% of GDP this year. After trading at about 20 bps this past June, the cost of U.K. Credit default swap protection has spiked to 147 bps (traded as high as 165bps Wednesday).

The U.K. gilt market seemed to lead global bond rates higher this week. As the scope of global financial sector capital shortfalls and forthcoming economic stimulus become clearer, bond market nervousness grows. U.S. 10-year yields ended the week 31 bps higher at 2.59%, about 110 bps below comparable gilts. There should be little doubt that our new Administration will move quickly and decisively to try to bolster the financial sector and stabilize the real economy.

I fully expect our Post-Bubble Financial and Economic Predicament to parallel that of Britain. At some point, our problems will likely be of much greater scope due to, among other things, our system’s larger size. So far, the U.K. has suffered a more acute crisis due to its inability to stabilize its troubled financial sector. For one, it is suffering through a more destabilizing outflow of speculative finance (unwind of carry trades). Also, the U.K. financial structure has traditionally been less government-influenced – leaving it today more vulnerable to a crisis of confidence. Outside of government debt instruments, confidence has faltered for large cross-sections of U.K.’s financial claims (“moneyness” has been lost).

Our system has to this point proved relatively more stable due primarily, I believe, to the instrumental role played by government and quasi-government institutions such as the FHA, Fannie, Freddie and the Federal Home Loan Banks. The market’s perception of “moneyness” is retained for multi-Trillions of U.S. claims – a dynamic that bolsters the view that the U.S. dollar retains its “reserve currency” and safe-haven status. And as long as this confidence holds, faith in the government’s capacity for system “reflation” endures. But it all has the look of a fragile confidence game, and I fully expect the invaluable attribute of “moneyness” to be tested at some point.

There is absolutely no doubt that a massive inflation of U.S. financial claims is in the offing. One would suspect it is only a matter of when market perceptions of “moneyness” adjust. This week’s jump in gilt yields could portend a troubling new phase in the U.K. financial crisis. It could also be a harbinger of a more general crisis of confidence for global currencies and debt markets. The long-bond suffered its worst week since 1987 (according to Bloomberg). Gold was up $43 today and $56 for the week.


UPDATE: ben bittrolff points out how close britain has already come to a systemic collapse as a result of a run by foreign depositors on the banks. a run on gilts and the pound may have come quick on the heels of a compulsory nationalization.

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Thursday, January 29, 2009

 

proposed CDS restrictions


it will be interesting to chart the course of this legislation regarding the credit default swap market.

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ok GM you are going to have to break it down to a guy with little understanding of the current situation-

is this new Obama stimulus package going to help/change things or is this just going to get worse?

 
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help? sure, in the sense of 'mitigate' -- but at the margins only. i think a lot of people are looking for a 'solution', and stimulus just isn't that.

to use clusterstock -- follow this on bill gross to this from jeremy grantham. there's nothing in stimulus that remedies these problems. it is instead designed to mitigate some of the effects of delevering. and it will take a few quarters to get out into the system -- meaning that things will continue to deteriorate for some time.

 
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btw -- here's an interesting way to see the stimulus bill.

 
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Thursday, January 22, 2009

 

civil unrest in iceland


what began as protest following the nationalization of the icelandic banks and the subsequent collapse of the krona has been morphing into civil disobedience over time as the icelandic economy has shuddered to a near-stop. video clips on youtube at first shows scenes of solidarity; later came thrown objects, broken glass and pepper spray.

only now has come fully fledged riots, with obligatory quasi-revolutionary youtube clips.

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This is particularly striking given how homogeneous Iceland is. If you've ever been there, you know it's a nation of just more than 300,000 people that is so closely knit that the first question Icelanders ask each other is, who are you related to?

It's only slightly hyperbolic to say that all Icelanders are essentially cousins to one another.

Imagine the scene in countries where the social fabric is far more tenuous. Oh wait, you won't have to imagine that for much longer. Britain, here we come....

 
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agnotology


via barry ritholtz -- wired highlights the work of robert proctor and examines the cultural phenomena i've sometimes remarked on:

more information leads to less knowledge


with a wonderful coinage as well. this is particularly easy to see in the ongoing death of the gatekeeper, which is leading to a balkanized society of self-selected information cults wallowing in comfortable ignorance.

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If the fact that...

"a lot of republicans don't believe in anthropogenic global warming, a quarter of respondents in one Texas poll were convinced that Obama is a Muslim. And a significant proportion of Americans believe God guided evolution..."

...comes as a surprise to the readers of Wired Magazine (or at least the author), one has to wonder who's the more sealed off from the world.

 
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Oh now now were is the bit of critical self reflection here that would indicate, that you, as a blogger, are part of the knowledge problem and not part of the solution.

Or will you now reference opposing views in your blog.

Throwing rocks in a glass house and all that is always a bit irritating. I select left leaning blogs on purpose and fully well knowing that they limit my exposure. I still watch quite a bit of TV news to compensate.

But, oh well...

 
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vendor finance: pettis v setser


with the chinese economy now collapsing in spite of the government of china halting the appreciation of the renminbi against the dollar in an effort to protect its monster export capacity, the question of continued dollar financing by china of the united states government has become imperative.

it's already been determined that china has halted its purchases of private-label securitizations (the slowing and halt precipitated the bursting of the housing bubble back in 2005/2006) and further scorned agency debt (precipiating the receivership of fannie mae and freddie mac in 2008). but its purchasing of treasuries has continued at a rate more than compensating for the stoppage of these other avenues of vendor finance as the chinese current account surplus has grown.

brad setser has pointed this out in response to the worrying of the new york times, and again more recently militated against some of the implications of a piece in the financial times (previously addressed here) where a chinese economic slowdown was said to attack the driver behing chinese forex accumulation.

If the Chinese economy collapses, or even slows dramatically, then the raison d’etre for the country’s huge FX reserves - as a sterilisation measure to dampen domestic inflation - will evaporate. With that, so will China’s US Treasury holdings. Or alternatively the Chinese could devalue the yuan.

Either way, the US will be in trouble. Treasury prices could collapse (although given the current renewed banking collapse fears, not before a significant rally has occured) and if that happens, the Fed’s yield-lowering credit easing policies will be left in tatters. As will any plans for economic stimulus packages. Hypothetically that would leave just the nuclear option: devaluing the dollar.


setser counters:

I like a good China scare as much as any one. But the first concern is, I think, off. A slump in China doesn’t mean an end to Chinese financing of the world, or even necessarily a fall in China’s reserves. ...

Suppose China’s economy slows sharply — a not-impossible development given the rather starling fall in the OECD’s leading indicators for China. How would that impact China’s balance of payments?

The first impact is rather obvious. China would import less. It would buy less. And since the rise in Chinese demand helped push the price of various commodities up, it stands to reason that a fall in Chinese demand would push prices down. It probably already has. That implies a big fall in China’s import bill, and a larger trade surplus. A slowing global economy would hurt China’s exports, but in this scenario China would slow more than the world. That means China’s imports would fall more than its exports. China’s trade surplus would rise.

But, you might say, the current account surplus is determined by the gap between savings and investment. Why would that change in a slowdown? Simple. China’s slowdown reflects a fall in investment (especially in new buildings and the like). Less investment and the same level of savings means a bigger current account surplus. In practice, though, savings would also likely fall a bit — as a slowdown would cut into business profits and thus business savings. It possible that China’s households would reduce their saving rate to keep consumption up as their income fell. But it is also possible that Chinese households might worry more about the future and save more. My best guess though is that the fall in investment would exceed the fall in savings, freeing up more of China’s savings to lend to the world. That surplus savings has gone into Treasuries and Agencies in the past. ...

... [E]ven if there are large outflows — so large that the outflows exceed China’s current account surplus and China’s government has to dip into its reserves to meet the surge in Chinese demand for dollars — China would still be financing the rest of the world. The accumulation of foreign assets by private Chinese savers would substitute for the accumulation of foreign assets by the central bank, but money would still be flowing out of China. And some of that outflow likely would still make its way into Treasuries. ...

The key point is that as long as China runs a current account surplus someone in China will be adding to their stockpile of foreign assets. It just may not be the government.



pettis has argued that the chinese trade surplus is not sustainable by virtue of what enabled its creation -- a large increase in household debt.

What was unsustainable about the current global balance, in my opinion, was not the fact of a US trade deficit (although by 2006 and 2007 it had gotten too high to last very long), but rather the level of household borrowing needed to sustain it. These are not unrelated things, of course, but I would argue that if the US trade deficit had been funded by equity inflows that resulted in an increase in domestic investment, there would not be a trade-sustainability problem. If it was funded by a household borrowing binge, then trade-deficit sustainability is necessarily constrained by the household balance sheets. This is why I have argued that a program of massive fiscal spending to replace household demand is not going to solve the current problem. It simply replaces one kind of unsustainable behavior with another, and still has to be resolved at some point with massive deleveraging.


now, in his latest missive, pettis takes the argument a step further.

With international trade falling, it is probably only a question of time before China’s trade surplus begins to shrink sharply (although a number of commentators who I respect a lot, including Brad Setser, might disagree with me on this), and as I wrote last week there is mounting evidence that some of the hot money that poured into China one year ago is now starting to leave. This suggests that China may begin to see rapid contraction of foreign currency holdings and, with it, a contracting domestic money supply.

This may be the biggest unexpected risk China faces. We must remember that as long as the main task of monetary policy is to set the value of the RMB in foreign currency terms, the PBoC has limited ability to manage the domestic money supply. If net outflows are large in 2009, the PBoC may be forced to preside over a monetary contraction, and this would be exacerbated if there were problems in the banking system that caused formal and informal banks to cut lending. This would undoubtedly worsen China’s difficult economic adjustment to the problem of overcapacity. It is vitally important that Chinese policymakers recognize the monetary constraints under which they work and prepare contingency plans. China can learn a lot from the mistakes of US policy in the 1930s.


in other words, china could quickly be forced to choose between defending the renminbi-dollar peg or managing an expansion of its internal money supply. previously, as the renminbi was in demand and appreciating, these two goals were coincident -- china was in a position of having to accumulate massive forex reserves to keep the renminbi cheap, which led to domestic inflation as sterilization of that accumulation was imperfect. now, with capital actually fleeing china in flow sufficient to render an actual reduction in china's forex pile, these ends are in opposition -- and it means a choice between loosing the dogs on its exporters or facilitating a domestic debt-deflation. in truth it may be no choice at all, as either one will try to precipitate the other. again, china can be seen to be in a very bad place.

setser anticipated the point:

I wouldn’t worry too much though about the risk that the money supply will shrink just because China’s reserves aren’t growing. Growing reserves can lead to money creation. But so can the same stock of reserves and less sterilization. And the PBoC has enormous scope to reduce the scope of its sterilization operations. The recent cut in the reserve requirement is an obvious example. Moreover, if the PBoC wants to expand its balance sheet, it always could start buying domestic Chinese bonds. The real challenge — as the US and UK are discovering — is getting the banks to lend in a shrinking economy!


for example, then, the chinese government could buy renminbi in order to sell dollars to facilitate a defence of the peg as capital flees china in search of american dollars -- but also go into the domestic market to buy back sterilization bills in even greater quantity, with the net effect of pushing renminbi into the economy.

setser notes that, while this mechanism in operation would counter monetary deflationary in china, it will be deflationary for the world as a whole as a recession in china frees up yet more excess capacity for export.

the very fact of a previous episode of a trade surplus collapse coincident with a collapse in global trade in the closest historical parallel to the current china -- that being the united states in 1930 -- gives powerful weight to pettis' argument. setser has repeatedly warned that stagnating or falling demand for american treasuries is less fearsome than a decline in china's appetite for commodities and unfinished goods as an indicator of a crashing chinese economy and yet more excess capacity -- but these are probably not independent variables, as the latter will may lead to the former through the conduit of trade warfare.

in short, though i find setser's logic impeccable, i am forced to cautiously side with pettis -- the ultimate outcome is likely to be a trade war and a decline in global trade precipitous enough to force a significant decline in the chinese trade surplus in absolute terms even if it grows relative to the amount of global trade overall.

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china growth falls to zero or worse


the widely reprted figure for chinese growth -- which were surprisingly poor in their own right, at least for the analyst community -- is a bid misleading, as nouriel roubini posts, in the context of economic statistics as one normally consumes them.

The Chinese came out today with their 6.8% estimate of Q4 2008 growth. China publishes its quarterly GDP figure on a year over year basis, differently from the U.S. and most other countries that publish their GDP growth figure on a quarter on quarter annualized seasonally adjusted (SAAR) basis.

When growth is slowing down sharply the Chinese way to measure GDP is highly misleading as quarter on quarter growth may be negative while the year over year figure is positive and high because of the momentum of the previous quarters’ positive growth.

Indeed if one were to convert the 6.8% y-o-y figure in the more standard quarter over quarter annualized figure Chinese growth in Q4 would be close to zero if not negative.

Other data confirm that China was in a borderline recession in Q4 and that it may be in an outright recession in Q1: production of electricity plunged 7.9% in y-o-y basis; the Chinese PMI has been below 50 and close to 40 for five months now.

And with manufacturing being about 40% of GDP , manufacturing is certainly in a sharp recession (negative growth) and the overall economy may be close to a recession

So the 6.8% growth was actually a 0% growth – or possibly negative growth – in Q4; and the Q1 figures look even worse. So China is in a recession regardless of what the highly massaged official numbers claim.


china is now likely contracting amid a deflationary collapse.

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Tuesday, January 20, 2009

 

pricing in nationalization


credit markets as well as stocks, with treasuries retreating in spite of a day of carnage in equities. government debt did rally as stock index losses progressed from (-2%) through (-4%) to (-5.5%) on the day with bank stock indeces -- not an individual issue but the indeces -- down (-15%).

meanwhile the incredible rout of the british pound took another serious leg down today, and whipsers of a currency crisis are now growing into shouts as the government faces nationalizing RBS, HSBC and barclays all -- individually and collectively enterprises with balance sheets far larger than the government.

if this run on sterling continues to gain momentum, we could be looking at what would be recalled as a, perhaps the defining event of the panic. jim rogers, with his usual blunt flair, thinks the UK is "finished".

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Monday, January 19, 2009

 

nationalization now!


i don't always see eye to eye with paul krugman, but he is spot on -- having watched the predatory ruling class rape the american people once already with the criminal abuse of the TARP, we are about to watch them shamelessly repeat the crime under the rubric of an "aggregator bank".

What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense, disguised as “fair value” purchases of toxic assets.

Why go through these contortions? The answer seems to be that Washington remains deathly afraid of the N-word — nationalization. The truth is that Gothamgroup and its sister institutions are already wards of the state, utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover. Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks.


felix salmon with more. outright nationalization on the swedish model will be expensive and painful enough, but it would be a steal in comparison with the absolute fleecing of the government and taxpayer that the "aggregator bank" will represent.

honestly -- i have grown steadily more disgusted as the non-efforts to repair the american banking system have rolled on, with every passing month becoming more obviously an exercize in financial rapine even as the country and world sink into a depression aggravated by its paralysis. and why? because the politicians are the purchased slaves of the powerful elite of this country whose status is tied to the bonds of these erstwhile financial powerhouses now best seen as zombie banks.

the problems facing the financial system (unlike those of the economy) are fairly easily resolved -- given that holders of equity and debt in the system are duly devastated as befits the idiocy of their investments. at the risk of oversimplifying, the rich were stupid and they must pay.

but they won't pay, and are instead working assiduously to shift the bill onto the government and therefore the taxpayer -- which is something they are not, at least now in anything like an appropriate proportion to the middle class thanks to the rentier-favorable skew of the american tax system which punishes income and preserves capital gains. and in order to facilitate the shift by extortion, they are (speaking broadly) threatening to spitefully destroy the global economy.

it is times like these that i am reminded of the compact struck by the founders of this nation and its people in perpetuity enshrined in the second amendment. the elite must be made to fear the consequences of their actions; in the eventuality that they would have coopted the institutions of government so thoroughly as to make the action of electoral political inefficacious, it is the right of the populace to bear arms that, in the final analysis, holds the powerful in check.

exactly these circumstances have now arisen, as the predator class ever more brazenly plunders the nation and the world to make themselves whole in spite of their undeservedness.

one hopes that the incoming obama administration understands that their mandate is in no small part to prove to the people that the powerful can be constrained for the good of the whole without have a loaded revolutionary pistol shoved in their metaphorical mouth. that could best be done in the short term by taking national possession of the banks and eradicating as much of the capital structure as is needed to restore the banks to health.

UPDATE: with the royal bank of scotland now completely imploding, it's becoming clear that momentum is building in parliament for an outright nationalization -- an effort which, bloomberg speculates, might prove an international template.

In exchange for government guarantees on losses from toxic debt, the bank will have to sign a binding agreement with the Treasury on how much it will lend and on what terms. Auditors will move in to check the bank is following the government directive.

“We’ll be one of the first guinea pigs,” RBS Chief Executive Officer Stephen Hester told reporters on a conference call yesterday. The Edinburgh-based company is in talks with the Treasury about terms of the agreement. Loans will only be made “on commercial terms and to creditworthy people,” he said.


UPDATE: felix salmon further attacks henry blodget's idea of a no-new-capital debt-equity swap. like salmon, i don't think this level of isolation is possible -- assets should be written down to below-worst-case valuations, but then pushing the entire recapitalization onto bondholders is unrealistic. instead, some combination of government recapitalization and debt-equity swap is needed. david merkel commented under blodget's post:

Debt-for equity cramdowns may not work in some cases because at larger banks the debt is usually at the holding company, and the bad assets are at the operating banks subsidiary. Better for the FDIC to force some sort of compromise where the operating subsidiary is made whole, while forcing holders of securities in the holding company (common, preferred, sub debt, sen debt) to face an uncertain future, while the healthy bank subsidiaries continue to operate.

At smaller banks with no holding companies, or with operating company debt, often the debt plus equity is less than the holes in the bad assets that are still valued at levels higher than warranted. In these cases, the FDIC will have to kick in something.


it is also noteable that it would not likely be possible to nationalize one bank -- once the precedent is established in the current environment, i can't imagine why any even mildly questionable bank would be able to fund itself. the financial system would have to be nationalized and granted government funding, likely including insurers and pension funds, with entities subsequently treated case-by-case and released from government control.

and of course the credit default swap market would likely have to be frozen and nullified prior to implementation -- but this is already the case and is not an added condition of systemic nationalization.

UPDATE: the economist clambers aboard the nationalization train.

UPDATE: the ft handily aggregates pro-nationalization arguments on the web.

UPDATE: amen, chris whalen.

"Lack of political courage [and] ignorance of finance" in Congress are the answers to these and related questions, according to Chris Whalen, managing director and co-founder of Institutional Risk Analytics. "Our friends in Washington who've been receiving a lot of money from Wall Street don't want to put these people out of work." ...

Stop the Fed's support of the OTC credit default swaps market: "When are we going to realize leverage in over-the-counter market is driving most of this crisis?" he wonders. Yet they refuse to deal with it because the Fed has been a sponsor of the OTC market in the first place."

The good news is Whalen thinks the crisis could be resolved within a year if politicians find the courage to take these steps. The bad news...well, I don't have to say it, do I?

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Yes, yes, a thousand times yes.

I urge all readers to contact their representatives in Congress and urge them to:

(1) Reject the nomination of Timothy Geithner to Secretary of the Treasury. Mr. Geithner is an insider in the TARP travesty and should not be confirmed.

(2) Express your outrage at the management of TARP to date.

TARP has been a massive transfer of wealth to the equity and bond holders of failed financial institutions at the expense of the American taxpayer. This must end.

Thanks for your article.

 
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from perrone: you've nailed it, gm. but we have to nail _them_.

 
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As a Swede I´m sick and tired of all the "hey let´s do what Sweden did" stuff. All the people involved back then will tell you that transparency was the key; how much, when and how.

As long as everyone involved in this mess keps hiding, confusing or ignoring the facts there´s no way that a Swedish style bailout will ever be an option.

 
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As a Swede I´m sick and tired of all the "hey let´s do what Sweden did" stuff.

as an american, anon, i'm sick of it too -- particularly the part where we talk all about it and forever call it the best of a bunch of bad options, and then proceed to try anything but it.

there are terrible repercussions that would emerge from nationalizing, writing down to nuclear-winter levels and then forcing debt-to-equity-conversion recapitalizations -- it will wipe out a lot of large investors, with a predictable effect on the capital markets. but that does not change the fact that such a move is not only the least-bad alternative but perhaps the only one that holds out any real hope of intermediate-term recovery.

transparency is part and parcel to making the system trustworthy again. ONLY nationalizing banks and loudly writing down their questionable assets to well under even current market levels, followed by painful recapitalization also in full view, can revive confidence in the balance sheet of these insolvent operations. anything less is going to leave open the questions which have destroyed confidence, not to mention waste unbelievable amounts of government resources.

if it destroys the capital structure of citigroup and bank of america and jpo morgan chase, SO BE IT. the problem is not in wiping out their investors (equity and debt); the problem was in the ghastly systemic ponzi scheme which they invested in and once disproportionately benefitted from.

 
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Couldn´t agree more. Now it´s just a matter of how much pain and for how long, because you will end up i roughly the same position no matter what you do.

The "clean" banks that emerged were attractive to investors, the "bad" banks (Retriva & Securum) were eventually able to recoup most of the state´s costs.

The government were forced to proceed with some impopular but necessary reforms, which benefits Sweden´s economy today.

It wasn´t a walk in the park though, try going from being argueably the number one welfare state in the world to having soup kitchens in the streets of the nation´s capital.

My own personal view is that American politics and finance are too intertvined and decisionmaking is the victim. Looks like Japan (or worse) for you.

 
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I say kill these monsters. I want to see heads of the likes of: Fuld, Blankfein, Pandit, etc., paraded on spikes up and down The Avenue of the Americas. I say no nationaialization. Point these clown to Manhattan's bankruptcy court and tell them, "No more special favors. You go bankrupt like the shoe store down the street. Oh and heaven help the members of senior management if the bankruptcy trustee finds any pre-bankruptcy finagling". We need a regime of brutal bankruptcies before we have any possibility of fixing this mess. No more TBTF anything.

 
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Saturday, January 17, 2009

 

aftermath


carmen reinhart and kenneth rogoff, december 2008, "the aftermath of financial crises", national bureau of economic research working paper.

Paper prepared for presentation at the American Economic Association meetings in San Francisco, Saturday, January 3, 2009 at 10:15 am. Session title: “International Aspects of Financial Market Imperfections.

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Friday, January 16, 2009

 

the business plot


via jesse -- an interesting bbc historical documentary visiting the archives of the mccormack-dickstein congressional committee.

i've previously ruminated near to the 1951 near-miss coup d'etat to have been staged against harry truman by the allies of douglas macarthur in the aftermath of his relief in korea while commenting on the ongoing politicization of the military. it is a rarely discussed episode of american history that macarthur and many ardent anti-communists who supported him were all for carrying the war to the heart of china following the landing at inchon, even to the point of initiating a nuclear war with the communist-controlled state. when truman fired him for his open insubordination in the media with criticisms of truman's "limited war" doctrine, macarthur rallied support among congressional republicans and promptly went on a speaking tour with the support of much of the GOP in an attempt to build on his already-massive popularity. the tour was a disaster, thankfully, and truman's popularity and support among the ruling elite rose from its low ebb before any attempt was made to supplant him.

but i have to confess to being previously unaware (though now unsurprised) at the assertion of a business plot to overthrow FDR in 1933.

jesse's comment is i think completely apropos:

This is an interesting topic for us, not because we think we know the truth behind it, but because it helps to portray the early days of the Great Depression in a more realistic light. They were not a time of dignified suffering and tremendous acts of kindness and compassion. They were often mean-spirited, violent, and dangerous times.

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bad banks: citi broken into pieces, BoA fed $20bn to digest toxic merrill


following on earlier rumors of a dismantling, vikram pandit's team has chosen to try to split citi to collect performing assets into an unencumbered unit in the aftermath of posting a worst-case-scenario $8.3bn loss in q4.

“It looks like a kitchen-sink quarter,” said Peter Sorrentino, who helps manage $16 billion at Huntington Asset Advisors Inc. in Cincinnati, including Citigroup shares. “Sweep it all in there and get this behind us.”


that would be the fourth consecutive "kitchen sink" quarter, if i'm counting properly. as the wits at ft alphaville quipped on analyzing her majesty's treasury's nascent plan for bad bank restructuring: so where's the good bank? even more so than the aggregate of british banking, it will be hard even for citi's good bank to survive the losses on assets now in the pipeline.

which is why the incoming administration is said to also be considering a good bank/bad bank restructuring of the entire american banking system. per bloomberg:

“They need to do something dramatic,” said Harvard University Professor Kenneth Rogoff, a former chief economist at the International Monetary Fund, and member of the Group of Thirty counselors on financial matters, a panel that includes Treasury Secretary-designate Timothy Geithner and Lawrence Summers, incoming director of the National Economic Council.

Federal Reserve officials are focusing on the option of setting up a so-called bad bank that would acquire hundreds of billions of dollars of troubled securities now held by lenders. That may allow banks to reduce write-offs, free up capital and begin to increase lending. Paul Miller, a bank analyst at Friedman Billings Ramsey & Co. in Arlington, Virginia, estimates that financial institutions need as much as $1.2 trillion in new aid.

Switzerland in October relied on the mechanism to aid UBS AG. ... It isn’t clear how stockholders or bond owners would be treated in a bad-bank scenario. In the case of UBS in Switzerland, there was no direct impact on either. ...

A more radical alternative would be the nationalization of some banks. Sweden used that option during a crisis in the 1990s. It took over two of the most troubled banks, Nordbanken AB, now part of Nordea AB, and Gota Bank, which later became a unit of Nordbanken. In addition, the government created a bad bank that bought troubled assets at a discount, while leaving financial institutions to manage their more-liquid holdings.

[FDIC head Shiela] Bair indicated government takeovers aren’t being actively considered. “I’d be very surprised if that happened,” she told reporters in New York.


nationalization has the advantage, however, of definitively ending the fear of the banks. backing or removing assets to leave the banks private is only good if you know what the extent of the problems are and where the bodies are buried. this is precisely the problem at the moment -- if anyone knew what the extent of the damage was, the crisis would already be over. what's more, it is insanely expensive for the government in comparison to a nationalization, which would likely be characterized (as sweden's was) by forced debt-to-equity conversions which recapitalized the banks in preference to government capital injections.

meanwhile, as testament to the potential insanity of the expense, another $20bn was sunk down the hole to bank of america, and titanic asset guarantees made besides.

In the Bank of America deal, the government will protect a $118 billion pool of assets that a U.S. official said includes residential and commercial real-estate holdings and credit- default swaps. The official spoke to reporters on a conference call on condition of anonymity.

The $20 billion purchase of preferred shares, which carry an 8 percent dividend, will be made later today. The funds come from the first half of the Treasury's Troubled Asset Relief Program. The U.S. Senate voted yesterday to allow the release of the next $350 billion of the program.


it seems than ken lewis couldn't see back in september what everyone else suspected -- that merrill was in need of being flushed. and that on top of actually paying money for countrywide! to be fair, BoA is rumored to have wanted to back out of the acquisition of merrill only to have a gun pointed at its head by hank paulson.

Bank of America officials then told regulators last month that the Merrill deal might be abandoned because of worse-than- expected results, Lewis said. The government insisted the transaction proceed because its collapse would create new turmoil in the financial system, he said.


i suppose this kind of supersized bailout is the quid pro quo of that transaction. but ken lewis' instinct to close deals has nevertheless been an utter disaster for the bank.

“This thing is unraveling so fast Lewis may know his job is lost,” said Paul Miller, an analyst at Friedman Billings Ramsey Group Inc. in Arlington, Virginia, who has an “underperform” rating on Bank of America. The management team has “lost credibility,” he said before results were announced.

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"The management team has “lost credibility,”..": golly, how lucky that they haven't been paid much, then.

 
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lol -- and wait until you see the parachutes they get, dm!

 
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Thursday, January 15, 2009

 

marshall & ilsley: devastating q4


via calculated risk -- looks like the C&I loss engine has fired to life.

In a bad sign for other regional banks, Marshall & Ilsley Corp said it was slashing its dividend and cutting its workforce and posted a surprising fourth-quarter loss as bad loans surged.
...
In the fourth quarter, Marshall & Ilsley increased the amount set aside for bad loans to $850.4 million from $235.1 million, as commercial and construction loan losses surged, especially among residential developers and in the states of Arizona and Florida. Net charge-offs more than tripled to $679.8 million.

"The nation's current recessionary climate is unlike any we have experienced," Chief Executive Mark Furlong said in a letter to shareholders.


CRE is a problem not only for the regionals but, of the big banks, particularly JPM and much of the insurance industry as well (standing out, life insurers). there is a lot of desperate capital raising still to come.

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how stimulus might lead to trade war


martin wolf's latest piece in the ft has touched off some very thoughtful commentary which, to complete the circle, is summed up at ft alphaville.

starting out with the mathematics of stimulus:

Last week, President-elect Barack Obama duly unveiled his American recovery and reinvestment plan. Its title was aptly chosen, for Mr Obama spoke, astonishingly, as if the policies of the rest of the world had no bearing on the fate of the US. He spoke, too, as if a large fiscal stimulus would be enough to restore prosperity. If that is what he believes, Mr Obama is in for a shock. The difficulties he confronts are much deeper and more global than that. ...

First, the Japanese policymakers who told everyone the US was in danger of falling into a prolonged period of economic weakness were right. ...

Any complacency about US recovery prospects is perilous. Moreover, the fact that the US has a structural current account deficit has bearing on the second point Mr Obama’s advisers must make. Fiscal stimulus is a necessary palliative for a debt-encumbered economy afflicted by falling asset prices. But the likely longevity and scale of the needed fiscal deficits are quite scary. ...


indeed, yves smith does the sums and finds

So if I have this right, "needed" stimulus is the 10% (full employment" deficit + 7%, or 17% in each of the next two years. What Obama is delivering is 5% over two years, or 2.5% a year, plus a baseline of 8.3%, for a total of 10.7%.

So to get where we need to get (if you buy the logic of this sort of exercise) is an additional 6.3% PER ANNUM deficit as a % of GDP. Remember, Obama's plan is roughly 2.5% per year. 6.3/2.5= 2.5 times.

Read that again, If you believe the math, Obama's program would need to be 2.5 times bigger to live up to its billing. And that is before you get into details like "tax cuts are likely to be less effective than other measures".


which is what wolf means when he says

As long as the private sector seeks to reduce its debt and the current account is in structural deficit, the US must run big fiscal deficits if it is to sustain full employment. That leads to the third point Mr Obama’s advisers must make. This is that running huge fiscal deficits for years is indeed possible. But the US could get away with this only if default were out of the question. ...

[Therefore] It is necessary to make structural changes in the US and world economies first. This is the last point Mr Obama’s advisers must make.


those changes -- which smith labels "sobering" -- are, first, a credible programme for what Americans call “deleveraging”, involving banking system nationalization and forced debt-to-equity swaps as well as the punishment of holders of all manner of securitized receivables; and second, a reduction in the structural current account deficit ostensibly through a reduction in consumption and the encouragement of exports.

the former is something i've harped on for what seems a very long time now -- as smith says

The US has not been willing to inflict pain on lenders and investors, even though over-their-heads borrowers will go bust and deliver losses. But too many holders of the paper seem to derive false comfort from having the losses show up a tad later than they would anyhow.


that must end, however painful for the ruling elite of this nation, if the financial system is to emerge from its terminal paralysis.

but smith further cites michael pettis, getting to the issue of whether massive deficits over even the handful of years that would be needed to effect a restructuring of the american current account problem.

... I would argue that if the US trade deficit had been funded by equity inflows that resulted in an increase in domestic investment, there would not be a trade-sustainability problem. If it was funded by a household borrowing binge, then trade-deficit sustainability is necessarily constrained by the household balance sheets. This is why I have argued that a program of massive fiscal spending to replace household demand is not going to solve the current problem. It simply replaces one kind of unsustainable behavior with another, and still has to be resolved at some point with massive deleveraging.

To get back to China and current issues, the problem with the US trade deficit now is sort of a “Keynesian” problem. US demand has the impact of generating both US production (and employment) as well as foreign production (and employment), and in a world of contracting demand, it is natural that countries that export demand – i.e. trade deficit countries – are going to be a lot less eager to do so. Anything that brings imports closer into balance with exports is likely to have a demand-enhancing impact similar to fiscal expansion, with the benefit that this isn’t achieved by running up fiscal debt. On the other hand it will have a demand-reducing impact for trade surplus countries. That is why trade disputes are likely to be very attractive to trade deficit countries who have – I will continue to insist but it seems recently that this has become a much less “surprising” claim – the upper hand in any dispute with the “virtuous” countries with high savings rates and trade surpluses.


this again is the beggar-thy-neighbor scenario -- few of the economists who have filled the seventy intervening years since the last depression with invective against trade restrictions explained how terribly attractive a trade war might appear. back to alphaville:

The below graph is from Albert Edwards at Societe Generale. It’s frightening (click to enlarge):



The OECD’s leading indicators are pointing to a total and swift collapse in Chinese GDP growth. Edwards produces two more graphs, using another indicator not included in the OECD’s calculations - electric power output:



And the relationship between electric power output and GDP:



this seems to be the collapse of the chinese economy i've been waiting on. edwards mimics the analysis of vitaliy katsenelson on electricity output.

If the Chinese economy collapses, or even slows dramatically, then the raison d’etre for the country’s huge FX reserves - as a sterilisation measure to dampen domestic inflation - will evaporate. With that, so will China’s US Treasury holdings. Or alternatively the Chinese could devalue the yuan.

Either way, the US will be in trouble
. Treasury prices could collapse (although given the current renewed banking collapse fears, not before a significant rally has occured) and if that happens, the Fed’s yield-lowering credit easing policies will be left in tatters. As will any plans for economic stimulus packages. Hypothetically that would leave just the nuclear option: devaluing the dollar.


ergo, competitive devaluation facilitated by a pyrrhic trade war in an attempt to get china to abandon its dollar peg.

Why would the Chinese let that happen?

…surely the authorities have learnt the lessons of the 1930s and we can rely on them to do the right thing? It depends what the alternative is. A Yuan devaluation would undoubtedly be likely if the alternative was the overthrow of the Communist Party. As The Economist pointed out recently, economists and bankers begged President Hoover not to sign the 1930 Smoot- Hawley Tariff Act.


the plausibility of this well-reasoned decision tree is absolutely depressing. at this time i think this is the preliminary road map by which we will be able to interpret first a disproportionate contraction in capacity in the united states accompanied by devastation in germany and japan as china weakens the RMB; then a sino-american trade war resulting in a much deeper and longer depression whose weight falls primarily on asian trade-surplus nations like china.

UPDATE: more via yves smith on china's increasingly bleak outlook, including a citation to ambrose evans-pritchard's question, "will china lead the world into depression?", discussing albert edwards' terrifying forecast.

"Technicals say it is time to bail out. Cut equity expose and prepare for rout. US depression looking likely. While China's 2009 implosion could get ugly. ...

"The Chinese economy is imploding and this raises the possibility of regime change. To prevent this, the authorities would likely devalue the yuan. A subsequent trade war could see a re-run of the Great Depression.... Do you really trust politicians to 'do the right thing'? ...

"We continue to emphasize our long-held view that emerging economies are particularly vulnerable to a reversal in the global liquidity pump. ...

"Could the economic situation in China become so bad that it threatens the regime itself? Of course it could. But before being swept away in a tidal wave of worker unrest it has one key tool in its economic armoury it has used before. MEGA-DEVALUATION. China has a track record of such things. At the end of 1993 the authorities devalued the yuan by 33pc. ...

"Amid confidence that the ongoing, massive, monetary and fiscal stimulus will prevent a repeat of the Great Depression, will it instead be competitive devaluation and implosion of world trade that we should watch out for."

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buy-rent calculator


to buy or to rent? over the next few years, with any probable outcome, rent.

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Wednesday, January 14, 2009

 

the beginning of the end of ben bernanke


someday not too far from now i expect i will have to write a similarly titled post for barack obama. holding center stage in a titanic crisis breaks public figures with casual abandon, and the chairman of the federal reserve during a nascent depression is invariably in the line of fire -- all the more so if his academic background makes his operating hypothesis available for scrutiny as it fails to work in the real world.

yves smith links to what is sure to be the first of a fusillade directed at chairman bernanke and his neoclassical work on the great depression of the 1930s.

as an added bonus, links are provided to both hyman minsky's revolutionary paper "the financial instability hypothesis" and irving fisher's seminal "the debt-deflation theory of great depressions". professor steve keen of the university of western sydney places bernanke's work contra fisher's, and finds it -- and, by extension, bernanke's credentials and policies -- divorced from the reality of our current long-wave disequilibrium and terribly wanting.

i won't bother to quote at length as ms smith does. the ramifications are, of course, not entirely without hint -- policy response has treated the problem as a liquidity crisis from the start, a conclusion only reachable from the initial presumptions of rational economic actors and prevailing economic equilibrium precluding a massive debt bubble in need of catastrophic liquidation. but as these policies fail -- and as, eventually, bernanke is ignominiously scuttled and made scapegoat for the disaster now befalling the global economy and its american subset -- i'd wager such criticisms will grow loud and resound in the empty halls of commerce.

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citi to be dismantled


via bloomberg -- but dismantled to whom? i'd wager C ends up in the arms of the government long before it can divest itself. the telegraph all but hopes for "the equivalent of the retreat from gallipoli" as vikram pandit has sold of smith barney for 10% of what it may have got just a year ago.

mish surveys the end of a banking empire, highlighted this bloomberg piece.

Time and again, big banks such as Citigroup Inc. argued that irrational and seized-up markets, not the woeful state of their balance sheets, were to blame for convulsing share prices.

For more than 18 months, the government went along with that thinking. Instead of demanding that banks recognize their losses, overhaul operations and quickly raise equity from private sources, regulators bet a flood of money would unclog credit markets.

When that didn’t work, the government doled out billions of dollars to more than 100 banks through the Troubled Assets Relief Program, or TARP, again with few demands that banks take harsh medicine. That hasn’t done the trick either.

The reason is pretty simple. This has never been a liquidity crisis. It’s a capital crisis. Namely, investors don’t think banks have enough of it, especially when it comes to tangible common equity.

Citigroup is a dramatic example. Its tangible common equity was 2.41 percent of tangible assets at the end of the third quarter. That was too low for investors’ liking and below peers such as JPMorgan Chase & Co. and Wells Fargo & Co.


that sliver of real equity is itself a fiction of level 3 accounting, to be sure. an honest appraisal of the situation of C and some of its peer group would leave them already insolvent and facing immense further losses. mish reads ben bernanke as saying exactly as much -- meaning that we are headed toward the nationalization of the bulk of the american banking system.

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the death of retail sales


the corresponding story to a disastrous collapse in the global trade of finsihed goods is a disastrous collapse in the sales of those goods. and that's exactly what we got today -- accompanied, thanks to calculated risk, by a chart that should be on the front page of every financial journal in the world, so important is it to understanding that we have gone through the looking-glass into a global depression.

Although the Census Bureau reported that nominal retail sales decreased 10.2% year-over-year (retail and food services decreased 9.8%), real retail sales declined by 11.3% (on a YoY basis). This is the largest YoY decline since the Census Bureau started keeping data.


they started keeping the data in 1967, though CR's chart dates only to 1993. but it won't be the record for long, as sales will continue declining from here as unemployment continues to accelerate.

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trade collapse moves from raw inputs to finished goods


the horrifying simultaneous downturn in imports and exports being seen around the globe, long evident in raw materials as commodity prices collapsed, is finally turning up in shipping rates on finished goods. in spite of whole fleets being idled at anchor in global shipping hubs, freight rates have completed their epic collapse by migrating to container ships and running all the way to zero. via the telegraph:

Freight rates for containers shipped from Asia to Europe have fallen to zero for the first time since records began, underscoring the dramatic collapse in trade since the world economy buckled in October.

"They have already hit zero," said Charles de Trenck, a broker at Transport Trackers in Hong Kong. "We have seen trade activity fall off a cliff. Asia-Europe is an unmit­igated disaster."

Shipping journal Lloyd's List said brokers in Singapore are now waiving fees for containers travelling from South China, charging only for the minimal "bunker" costs. Container fees from North Asia have dropped $200, taking them below operating cost.

Industry sources said they have never seen rates fall so low. "This is a whole new ball game," said one trader.

The Baltic Dry Index (BDI) which measures freight rates for bulk commodities such as iron ore and grains crashed several months ago, falling 96pc. The BDI – though a useful early-warning index – is highly volatile and exaggerates apparent ups and downs in trade. However, the latest phase of the shipping crisis is different. It has spread to core trade of finished industrial goods, the lifeblood of the world economy.


it is important to note that this is new news, not a continuation of earlier reported difficulty in letters of credit.

It became difficult for the shippers to obtain routine letters of credit at the height of financial crisis over the autumn, causing goods to pile up at ports even though there was a willing buyer at the other end. Analysts say this problem has been resolved, but the shipping industry has since been swamped by the global trade contraction.


this is sure sign of a global depression taking hold. it is now no-holds-barred, and america is in the midst of it.

Outbound traffic from Long Beach and Los Angeles, America's two top ports, has fallen by 18pc year-on-year, a far more serious decline than anything seen in recent recessions.


talk of a depression is very well founded, and even speculations on a Great Depression such as that experienced in 1873-79 or 1929-37 are not at all farfetched. indeed, on this view, that's exactly what is happening.

UPDATE: calculated risk with an excellent chart of los angeles port traffic.



really says it all.

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ireland as the new iceland?


via the ft:

The government is preparing for drastic public service cuts: the kind of measures that are being undertaken to try and preserve the government’s [triple-A sovereign credit] rating. As the Irish Times reported yesterday:

THE MAJORITY of the €2 billion that must be cut from exchequer spending this year will have to come from pay cuts for civil and public servants, unions will be told by the Government next week.

Meanwhile, a public service union leader has warned members that the International Monetary Fund could be brought in if the Government cannot cut borrowing and bring the State’s finances back under control.


Yes, it’s serious enough that the IMF is being banded about as a possible saviour. Idle speculation? No. Here’s the Irish Times today (emphasis ours):

The Taoiseach Brian Cowen has endorsed the warning of a senior trade union official that the State’s borrowing figures are unsustainable and could possibly lead to the International Monetary Fund ordering mass dismissals of public sector workers in the future.

Mr Cowen said the comments of Dan Murphy, the general secretary of the Public Service Executive Union (PSE) were based on the evidence that has been provided by Government in its discussion with the trade union movement.

The IMF could, of course, be being used as a stick to subdue the Unions with. On the other hand, if S&P downgrades Ireland, as they are understood to be considering, then the situation will get rather bad. Borrowing costs will increase further. Not just for the government, but for Irish companies too.


Tension in the eurozone? Watch this space.


as the irish tiger economy unwinds, local economists are warning of 80% declines in housing prices, with predictable effects on large mortgage lenders.

IRELAND WILL see more demolition than construction of houses over the next decade, as the economy struggles to recover from the collapse of the housing market and the emergence of “zombie” banks, UCD economist Morgan Kelly told the conference.

In a presentation that drew several collective intakes of breath, Mr Kelly predicted that house prices would fall by 80 per cent from peak to trough in real terms.

“Construction, but not demolition, of residential and commercial property will fall to zero for the foreseeable future,” he said. ...

“The guarantees of Anglo and [Irish] Nationwide liabilities have a strong chance of being called in over the next 21 months,” he said. Extending the Government guarantee to these two financial institutions was “extraordinarily unwise” and could produce losses that the State cannot afford to repay.

The global financial crisis may have been positive for the Irish economy as it “stopped us dragging ourselves even deeper into our hole,” he said. “If it had taken another year or two, we would have ended up in an Icelandic-shaped hole, which is not to say that we won’t end up in one.”


UPDATE: and more on britain as iceland, a theme i fear we have not revisited yet again for the last time.

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Metropolitan Houston, TX has a million+ more people than the entire country of Ireland.

 
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Tuesday, January 13, 2009

 

FHLBs in distress


via credit writedowns -- seattle's federal home loan bank has suspended its dividend and is on the brink of collapse. this is the logical consequence of the rapacious use of the FHLB system to bail out insolvent mortgage lenders earlier in this crisis.

Last week, we heard from Moody’s that 4 of the 12 FHLBs were likely bankrupt. Now, Bloomberg is reporting that the Seattle FHLB has suspended its dividend because it is going to fail.

The Federal Home Loan Bank of Seattle joined its San Francisco counterpart in suspending dividends and “excess” stock repurchases, after devalued mortgage bonds dropped its capital below a regulatory requirement.

The likely shortfall on Dec. 31 was caused by “unrealized market value losses” on home-loan securities without government backing, the Seattle bank cooperative said in a filing with the U.S. Securities and Exchange Commission today.

The Federal Home Loan Banks, or FHLBs, face potentially “substantial” losses, and in a worst-case scenario only four of the 12 would remain above capital minimums, Moody’s Investors Service said last week.


The fact is the FHLBs have been undermined by the need to help out the weak U.S. banking system. For example, the Seattle FHLB is the home loan bank to Washington Mutual which failed late last year. It also is taking on enormous amounts of credit from Bank of America, an active West Coast bank with many dodgy assets on its books from the Merrill and Countrywide acquisitions.

As financial shares have come under pressure in anticipation of a very weak earning s season, this is only going to add fuel to the fire. Trouble in America’s financial sector is far from over.


moody's did not downgrade any FHLB debt as they view implicit support from the government along the lines of fannie mae and freddie mac as inevitable. and it is. but the cost to the taxpayer is ramping up in every direction as government attempts to mitigate the fallout of what is becoming the greatest debt collapse of all time.

UPDATE: more from ft here and here.

A bailout would be a big deal — as we noted last week, the FHLBs have something like $1.25 trillion worth of debt between them. According to Bloomberg they’re the US’s biggest collective borrowers — bigger even than Fannie or Freddie. Their contribution to liquidity in recent months was second only to the Federal Reserve. So neither the US government, nor the FHLBs themselves, likely want an outright bailout or failure.

One other option would be altering the rules of the capital requirement — and this seems to be what the FHLBs are now aiming for.

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"the greatest debt collapse of all time": quite - and still people prattle about things getting back to normal. A better thing to prattle about would be "Will it be possible to salvage anything?"

 
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yeh, dm, unfortunately as time goes on and it becomes apparent that the remnants of the bush admin botched the eary response as badly as did the hoover admin, what optimism rang forth from hammering into s&p 740 is quickly dissipating.

nor should i imply, i suppose, that -- had paulson seen fit to solve problems rather than provide parachutes to cronies in investment banking -- it would have solved the problem. the structural correction of global flow of funds imbalances now underway was inevitably going to be very painful all around.

let's hope, however, that someone understands that a global trade war, whatever its short-run ramifications, is now decidedly in our interest and will likely lessen the impact of a global depression on the united states and britain while concentrating its effects in japan, china and germany. it's not what i would have chosen, but china effectively fired the first salvo in july 2008 by halting RMB appreciation and moving to a hard dollar peg. chinese mercantilism managed through their peg must be broken, or we are going to experience something very like a social collapse as we bear the brunt of liquidating excess capacity.

 
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dm -- this is excellent related reading.

Comparing what might be in store to the US to the UK after the Napoleonic Wars is a polite way of saying that level of indebtedness is a non-starter (I've also noted other commentators suggest the US could run the sort of fiscal deficits we incurred during World War II)...

the size of the debts now crashing are boggling.

 
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why it's tough to be a landlord today...


... and tougher still to imagine property investors coming into the market to buy up excess housing supply. john hempton of bronte capital:

In Australia it became absolutely standard practice to buy real estate with negative carry. The idea was that you could buy a house for 100 thousand using 7% money and have a 3% rental yield. You made a 4% loss each year. The 4% loss could offset other tax. But everyone accepted it because house prices rose more than 4% a year and the capital gains tax was (slightly) concessional. The negative yield was sustainable so long as people continued to expect property prices to rise.

Well there was a point where Japan was the reverse of this. Banks would fall over themselves to lend you money at 1% to buy property with a 4% yield. You got 3% positive carry in a land where almost everything yielded something close to nothing. And yet people wouldn't do it. Why not? Because everyone knew that property prices fell more than 3% per yield. Positive carry was not enough to offset property price deflation.

When things deflate at 3-5% per year then money in the bank at zero interest (of which the Japs have plenty) is a very fine investment – it yields 3-5% per year post tax real – and it is very low risk. Obviously that was a better investment than almost everyone made in 2008. In reality it is an investment better than is available to most people anywhere.

And if everyone thinks this way (cash is good, borrowing bad, don't buy assets because they fall in price) then the situation is self-sustaining. Welcome to Japan.


this is a good reason to believe that not just positive carry but a very significant positive carry in investment property will be required before house prices hit bottom. prospective landlords, in light of what may turn out to be years of high vacancies and declining rents, will need a huge margin to compensate them for the perceived risk of further price declines.

hempton explains that the alternative is to shock savers into spending -- though i suspect this can't be done now in the united states, as there are in aggregate no savers yet to shock. the fed could be said to be trying to make savers by printing money -- but that won't work.

Japan deflated because – well everyone thought it would continue to deflate. And that led to a lack of domestic investment and (eventually) the Japanese – like the Chinese – managing to fund a whole lot of really dumb lending in America. It was just bad.

Lots of people could see this – Krugman and Ben Bernanke to name just two. And a simple shock to the system which convinces people that holding the money in the bank is stupid and that they better go out and buy real assets would fix it.

What you needed was to credibly convince the population that deflation was over – and that there would be inflation. What the BOJ needed to do was credibly promise to be irresponsible.

You have to convince that cash-is-trash.

How do you do this? Well the first answer is just print money.

And that is what the BOJ did – and what central banks around the world are still doing. And it doesn't work. The reason that it doesn't work is that people are more than happy to hold the money idle in enormous quantity. It yields 3-5% post tax real after all.

Just printing money is not enough. You need a real shock
.

... Giving money in one-off tax breaks (as per Australia or Bush's various plans) is not the same thing. That money isn't freshly printed cash. You need to credibly convince the populace that you are prepared to risk the Zimbabwe outcome. You have to credibly promise to be reckless.

Bernanke knows this. He is on the record for suggesting it.

So when do you short treasuries?


and that's why, while planning for deflation now is prudential, one should also fear inflation -- and a lot of it -- further out. chatter on the eventual collapse of the treasury bubble is already loud, though what is immediately before us is something else, as evans-pritchard notes:

we may already be so deep into debt deflation that bonds will rally regardless. Fresh data suggest that Japan's economy contracted at a 12pc annual rate in the fourth quarter of 2008; the US, Germany, and France shrank at a 6pc rate, and Britain shrank at 5pc.

If sustained, these figures are worse than 1930, though not as bad as the killer year of 1931. The UK contraction from peak to trough in the Slump was 5pc. Gordon Brown will be lucky to get off so lightly.

The Fed's December minutes reek of fear. The Bernanke team is no longer sure that stimulus will gain traction in time.

The Fed's "Monetary Multiplier" has collapsed, falling below 1. This is unthinkable. We are in a liquidity trap.


evans-pritchard presumes that the "bernanke blitz" will in time take effect, as does hempton. but neither, it should be said, knows exactly how. and in the meantime hempton's inexorable deflationary logic regarding the attractive real return of idle cash and government bonds rules -- not least for banks, as the ft analyzes.

Shorting JGB’s was a also popular pundit play in the 1990s. For very much the same reason as now, the bonds were said to be wildly overvalued. ZIRP could not last, it was said. It was a theoretical policy. Inflation would result.

Unfortunately, the ZIRP did last. And yields stayed low. The yield curve stayed flat.

Part of the reason: For Japanese banks, faced with bleeding balance sheets; ravaged by the worst effects of deflation, JGBs were a sound buy. The banks made happy returns from the carry and rolldown on the government bonds: knowing that they would all continue to buy huge amounts of them and keep prices depressed.

Indeed, it’s not quite fair to label, as Grant does, Treasuries return-free risk: If you can borrow at 0 per cent, and then buy 10 or 30 yr notes yielding around 2.32 and 3 per cent respectively, then the return - unlevered - really isn’t so bad based on the carry and roll alone.

And as Bred Setser has previously noted, US institutions are buying Treasuries. Did they do so purely in response to the September crisis? Or are they doing so with a longer timeframe in mind? More specifically: two years of deflationary pressures that will make carry and roll trades on Treasuries attractive.


it might pay, however, to further examine the situation in international terms. american quantitative easing will obviously not occur in a vacuum -- competitive devaluation is already underway, per the ft. japan, with its globe-leading rate of contraction, marks out the danger of a strengthening currency in these times of excess capacity. as the race to the bottom takes hold, particularly as the currencies of the major surplus nations are managed against the dollar, the contraction in excess manufacturing capacity will inevitably be shifted to the united states to a much greater degree than was true in 1930s europe (who benefited from the hoover administration's allegiance to "sound money"). america could be particularly vulnerable as much of the debt that is contracting globally is dollar-denominated, and this delevering has some considerable time and distance yet to run. as setser relays, november's contraction in american trade deficit may be short-lived as the dollar strengthens and fiscal stimulus bleeds over -- and china's december trade surplus gives little reason to think otherwise.

as businesses close to effect the contraction in capacity, unemployment continues to rise, consumers default or revert to saving, and banks suffer and are driven to government resolution, it is hard to imagine an inflation taking hold. i would wager that the relative prices of raw inputs handily outperform financial assets and finished products -- and, with fiat currency debasement the rule, perhaps precious metals are a haven once again. such a cycle would further pressure profitability, feeding the downward cycle of liquidation. in other words -- the deflationary cycle in the united states could be more powerful than many currently suspect, even with quantitative easing in full effect.

but eventually, the dollar is in for a fall -- the current account will in the long run (the same one in which we are all dead) approach balance, china will cultivate domestic consumption, american export capacity will become competitive and a larger part of the american economy. if that fall is mismanaged, today's excess reserves could translate into a powerful surge of inflation.

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from perrone: gm, can you give me a really quick brief on the M1 multiplier, tracked in the graph evans-pritchard offers? thanks.

 
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hi perrone -- here's a simple definition -- it's essentially a proxy for the rate of turnover (velocity) of the monetary base.

normally, banks take monetary base (high-powered money) and make a multiple of its value in loans based on it through the magic of fractional reserve banking, which end up as deposits at other banks. m1 is the aggregate of the monetary base plus all demand (ie checkable) deposits.

it has now crashed because banks are now hoarding nearly a trillion in cash as excess reserves at the fed -- that is, monetary base is skyrocketing as the fed expands its balance sheet, but loans that result in demand deposits are nowhere near keeping up -- because banks are very reticent to lend and also consumers and businesses are increasingly reticent to borrow.

 
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Monday, January 12, 2009

 

hospital spending rattled


via calculated risk.

"The severe and rapid economic downturn, result[ed] in a decline in hospital spending ... we witnessed an unprecedented decline in demand for capital equipment at the end of the quarter ... Hospital systems across the country have responded to tightening access to capital by restricting capital expenditures, implementing tight spending controls and reducing personnel."


a recent boston globe article examined the possible look of a 21st century depression, noting that the economy has changed since the 1930s.

Unlike the 1930s, when food and clothing were far more expensive, today we spend much of our money on healthcare, child care, and education, and we'd see uncomfortable changes in those parts of our lives. The lines wouldn't be outside soup kitchens but at emergency rooms, and rather than itinerant farmers we could see waves of laid-off office workers leaving homes to foreclosure and heading for areas of the country where there's more work - or just a relative with a free room over the garage. Already hollowed-out manufacturing cities could be all but deserted, and suburban neighborhoods left checkerboarded, with abandoned houses next to overcrowded ones. ....


Housing, health insurance, transportation, and child care are the top expenses for American families, according to Elizabeth Warren, a bankruptcy law specialist at Harvard Law School; along with taxes, these take up two-thirds of income, on average. And when those are squeezed, that could mean everything from more crowded subways to a proliferation of cheap, unlicensed day-care centers.

Health insurance premiums have risen to onerous levels in recent years, and in a long period of unemployment - or underemployment - they would quickly become unmanageable for many people. Dropping health insurance would be an immediate way for families to save hundreds of dollars per month. People without health insurance tend to skip routine dental and medical checkups, and instead deal with health problems only when they become acute - meaning they get their healthcare through hospital emergency rooms.

That means even longer waits at ERs, which are even now overtaxed in many places, and a growing financial drain on hospitals that already struggle to pay for the care they give uninsured people. And if, as is likely, this coincided with cuts in money for hospitals coming from cash-strapped state and local governments, there's a very real possibility that many hospitals would have to close, only further increasing the burden on those that remain open. In their place people could rely more on federally-funded health centers, or the growing number of drugstore clinics, like the MinuteClinics in CVS branches, for vaccines, physicals, strep throat tests, and other basic medical care. And as the costs of traditional medicine climbed out reach for families, the appeal of alternative medicine would in all likelihood grow.

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Friday, January 09, 2009

 

updating the risk appetite index


catching up with credit suisse's jonathan wilmot and his risk appetite index in a note appropriately titled "the year finance failed". as a timing tool the signal would've drawn you in january and again in march -- only to hold for the great crash of 2008. so while an interesting barometer of the risk environment, it may not be a trading tool well adapted to a depressionary environment.

also of interest are a set of long-run comparisons that make clear the extreme environment we have faced and continue to face. what is happening in corporate bonds is really without parallel in this country since the great depression, although it almost certainly has other parallels in previous depressions such as 1873-79 and in other economies at times of depression. not that that provides much comfort.

also of interest are the ramps in real oil prices shown -- big spikes leading into 1873, 1877, 1893, 1921, 1974, 1981, and now 2008 all anticipated extremely difficult times.

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part-time jobs


calculated risk with a critical insight that must accompany any reading of the jobs scenario.

Not only has the unemployment rate risen sharply to 7.2%, but the number of workers only able to find part time jobs (or have had their hours cut for economic reasons) is now over 8 million.


this is why it is critical to look at BLS unemployment reporting which includes the underemployed in the calculation in order to get an accurate picture of household economic stress. the u-6 rate reported by the BLS does so, and as noted in november this is likely the appropriate measure to examine for historical comparisons.

the december reading for u-6 shot up to 13.5%, from a revised 12.6% in november and 12.0% in october. one in seven american workers are now either unemployed or have been forced into reduced hours/benefits -- and for good measure, as one can tell from the chart as well as the figures, the rate of change in umemployment is still accelerating. the forecast for coming months indicates further acceleration is in the pipeline. the silver lining, if any, is that the trend in unemployment has broken rather suddenly at the top -- in other words, unemployment will likely accelerate until it stops going up at all.

UPDATE: todd harrison asserts that, if we went back to the method of unemployment calculation which prevailed prior to the clinton administration adjustments, the unemployment reading might be as high as 15-16% already. that's almost incidental, however, next to a call for a "seismic adjustment" in currency markets against the dollar, which should it come to pass will be the story of 2009.

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start with the indictments


the ramifications of the points made in this interview with structured finance guru janet tavakoli are profound.

first, late-stage receivables securitizations were a criminal fraud perpetrated by the investment banks in conjunction with mortgage lenders. tavakoli asserts that was no confusion on wall street and investment banks were not at all duped by rating agencies -- indeed, they knowingly exploited the conflicted interests and moral weakness of those agencies to sell trillions of loss-making loans onto unsophisticated investors. they did so in an effort to pass off investment bank losses while collecting fees on the packaging and distribution of those losses.

second, if this is so, these securities are not mispriced at zero -- indeed, MBS and CDOs were likely designed to be worth as little as possible. these same securities, of course, packaged in asset-backed securities and collateralized debt obligations now underlie a large portion of the banking system of western civilization and further afield.

third, in bailing out these same investment banks, congress is essentially giving aid and comfort to the enemy of the people as a function of their capture by the financial lobby. this is critical to understand. as tavakoli (rightly, in my view) asserts, our financial system problems can be fixed relatively quickly. the problem is that the ones who would have to take the pain in order to do so are the same people who are not only shadow-writing the legislation but whose agents are leading the treasury and the fed.

perhaps much of this was already presumed, but it’s nevertheless rather shocking to hear someone of tavakoli’s tremendous knowledge base call for indictments -- indictments that could easily and probably should include treasury secretaries robert rubin and hank paulson for their roles in the investment banking swindle.

to sum up -- wall street isn't a basically good place afflicted with a few bad apples -- instead, wall street taken as a whole is an institutional bad apple that has intentionally wrecked the economy of the western world in search of incrementally greater fee profits.

so much for deregulation. nail not only their bankrupt leadership but these outfits themselves to a tree and light it on fire. i'll more than gladly accept permanently lower growth as the price paid for the modest semblance of moral rectitude, culpability and worthiness that might ensure that 'banker' is not merely a euphemism for 'parasite'.

UPDATE: more on janet tavakoli's book from david merkel.

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'not a black swan, but black barts'.

i find her interview very very interesting. i may actually pickup her book.

funny how we have heard so little about possible indictments on this (she is convinced they are in order). do you expect we will ever see the mass indictments she talks about gm? usually in the u.s. when anything goes wrong we are playing the blame game and going after the people responsible. not this time? later? hmmmmm.

 
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i think we're likely to get a pecora commission analogue at some point, ccd. prison is very unlikely for more than a scapegoat or two in my view -- these people are either the national power-elites or their representatives. the probability is similar to that of george w. bush and dick cheney being convicted of war crimes or crimes against the constitution -- both are guilty beyond any reasonable doubt, neither have any chance of actually being prosecuted. as cheney has brazenly implied time and again, crime simply isn't crime and sin just isn't sin IF you're powerful. their behavior is an extension of the machiavellian resuscitation of the ancient doctrine of civitas, and the christian moral rules that govern the rest of us do not apply (in their view) to their special status.

 
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Thursday, January 08, 2009

 

more on china and the dollar


on the heels of yesterday's revelation that china is actually defending the renminbi from depreciating against the dollar, more current account balance debate is storming around the web.

the new york times today reports on the prospect of slowing chinese funding for american government debt...

The declining Chinese appetite for United States debt, apparent in a series of hints from Chinese policy makers over the last two weeks, with official statistics due for release in the next few days, comes at an inconvenient time.


... which provokes a response from brad setser...

The TIC data for November and December isn’t available. But I suspect that the $136b increase in Fed’s custodial holdings of Treasuries over the last two months provides some clues about the evolution of China’s portfolio. Central bank holdings of Treasuries at the Federal Reserve Bank of New York continue to rise rapidly. As of now, I would argue the available evidence suggests that China’s appetite for Treasuries has increased in q4 — largely because of a fall in its appetite for Agencies.


... while conceding that, going forward, chinese accumulation of treasury debt will probably slow.

FDI inflows will slow and hot money flows clearly have reversed, so overall reserve growth (counting the increase in China’s hidden reserves) should slow.


indeed that complements his earlier view that an unexpectedly severe contraction in china would likely contribute to a smaller current account surplus. moreover, it's important to note where the financing of treasury's massive issuance schedule is going to have to come from. setser in the comments:

China isn’t able to buy $1.2 or 1.4 trillion in treasuries. Deficits on this scale have to be financed by Americans and only make sense in a context where private spending is falling (i.e. consumption is falling) and private investment is falling. Even if china purchased as many treasuries in 09 as in 08 ($300b in my view including flows trough london, $200b in the existing unrevised data) it would finance a smaller share of the deficit.


in other words, the treasury effect, which some large corporate borrowers are already seeing and which will certainly encourage further corporate deleveraging as well as household thriftiness. as he notes, the numbers in play indicate a steep dropoff in private spending in the united states.

for 09, a 8% of GDP fiscal deficit and a 4% of GDP current account deficit only works if the private sector’s net savings is around 4% of GDP (v a deficit of 2% of GDP). That implies a big fall in private spending and investment even with the stimulus …


yves smith also wades into the mix.

Separate and apart from China's changing fortunes, the continued purchase of US debt was becoming controversial in bureaucratic and popular circles. The tone increasingly was that China had been snookered into buying lousy US paper. And since the regime had depended on continued growth to maintain legitimacy and social cohesion, the officialdom will need to find scapegoats for the downturn. Regardless of where one thinks the truth really lies, it's a no-brainer that the US will become a leading culprit.


the wild card may be the prospect of large-scale civil unrest in china, a topic which the ft delves into. china could be on the brink of something truly awful.

dean baker in foreign policy as part of a five-part prospective ruminating on the eventual (but not immediate) collapse of the dollar bubble.

[O]nce the financial situation begins to return to normal (which might not be in 2009), investors will be unhappy with the extremely low returns available from dollar assets. Their exodus will cause the dollar to resume the fall it began in 2002, but this time, its decline might be far more rapid. Other countries, most notably China, will be much less dependent on the U.S. market for their exports and will have less interest in propping up the dollar.

For Americans, the effect of a sharp decline in the dollar will be considerably higher import prices and a reduced standard of living. If the U.S. Federal Reserve becomes concerned about the inflation resulting from higher import prices, it might raise interest rates, which could lead to another severe hit to the economy.


a net outflow of foreign investment is a position compatible with that of henry c.k. liu in the asia times back in october.

Either wage income must rise or asset prices must fall to restore financial equilibrium. Government intervention to prop up inflated asset prices without compensatory wage rise will only end in hyperinflation.


more on inflationary consequences here and by liu here.

and on an exit strategy from quantitative easing, the ft reports on dissent within the fed already.

UPDATE: todd harrison cites a high probability of a "seismic readjustment" agains the dollar in 2009 -- expounding a little more here.

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