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In case you didn't know, Vanguard has traditionally levied a $10 annual account fee on IRAs (traditional, Roth, or SEP) and ESAs with a balance of less than $5,000, index fund accounts with a balance of less than $10,000, and all non-retirement accounts with a balance of less than $2,500. Going forward, they've decided to levy a $20 fee for each Vanguard fund in which you have a balance of less than $10,000. The good news here is that you avoid these fees entirely by signing up for electronic delivery of shareholder materials (statements, confirmations, and so on). Of course, you could consolidate funds to get over the minimums, or maintain $100,000 or more in total Vanguard investments. But if that's not your cup of tea, simply signing up for electronic delivery is your best bet. In our case, we actually signed up for this long ago to stem the flow of paperwork into our mailbox.
[Source: Vanguard.com] 6 Comments
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The kill-joys at the Commodity Futures Trading Commission today announced having pulled the plug on the not quite $7.2 billion New York Financial Co and its principal Robert J. Sucarato. Usual stuff-fraudulent solicitation, concealing trading losses, issuing false statements, embellishing the resume, manufacturing audits-not to mention a slight discrepancy in assets under management; Sucarato apparently raised "at least $1.5 million from at least five individuals [Morons, surely?-Ed]."
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For the past three decades, finance has claimed a growing share of the U.S. stock market, profits and the overall economy.
But the role of finance -- the businesses of borrowing, lending, investing and all the middlemen in between -- may be ebbing, a shift that would redefine the U.S. economy. "The role of finance in the economy is going to come down significantly in the coming years," says Carlos Asilis, chief investment officer at Glovista Investments, a New Jersey money manager. "From a societal standpoint, we got carried away with finance.
... ... ...
Mr. Philippon argues that the surge of financial activity that began in 2002 created an employment bubble that is now busting. His model suggests total employment in finance and insurance has to fall to 6.3 million to get back to historical norms, and that means losing an additional 700,000 jobs in the sector.
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Mish's Global Economic Trend Analysis
My Comment: Banks and brokers may be trying to get their houses in order, but the emphasis should be on trying. They are not succeeding. A wave of commercial real estate defaults is coming (see Shopping Center Economic Model Is History). And on top of that wave will be a wave of credit card defaults. Target wrote off a stunning 8.1% of credit card debt in March (see Card Losses Soar at Target, Bank of America). Furthermore the walk-away crisis is just picking up steam. This is more like the eye of the hurricane than anything else.
... ... ...
My Comment: The idea that the credit crunch is over is pure fallacy. The Fed Funds Rate is 2.25%, LIBOR is 2.91% and Citigroup is raising money at 8.4%, Merrill Lynch is raising money at 8.625%, and Bank of America is raising money at 8.125%.
... ... ...
My Comment: That cash is being burnt up like mad as is the destruction of capital that is fueling the issuance of preferreds. Those thinking "the bottom is in" and buying now are going to regret it later.
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Published: April 27 2008 18:46 | Last updated: April 27 2008 18:46
So this crisis is about to end, right? There are two failsafe ways to justify a solid dose of optimism: define the crisis in a sufficiently narrow way; and, even better, look at the wrong crisis. In that spirit I am happy to state my optimism about the prospective end of the subprime crisis.
But this would be disingenuous. It is no accident that our multiple crises – property, credit, banking, food and commodities – have been happening at the same time. The simple reason is that they are all part of same overriding narrative. The mother of all these crises is global macroeconomic adjustment – a rare case, incidentally, where the word "crisis" can be used in its Greek meaning of "turning point".
It is a huge global macroeconomic shock. How long the financial part of the crisis will go on will depend to a large extent on how bad the economic part of the crisis gets.
The economic part of the story started more than a decade ago with a liquidity-driven global boom. Property, credit and equity bubbles were all part of this.
So was a Ponzi scheme that later became known as Bretton Woods II, a gravity-defying design that allowed the US to run persistent current account deficits. The dollar surplus in the newly industrialised countries was recycled back to the US and European markets, where various categories of asset prices were driven up and banks lured into excessive risk-taking. It could not last, and did not.
If excess liquidity was the ultimate cause of this crisis, the real estate sector was its most important driver. Experience shows that housing cycles are long and symmetrical: downturns last as long as upturns. We also know from the past that house prices undershoot the long-term trend on the way down, just as they overshoot it on the way up. You can see this quite easily when you look at long-run time series of inflation-adjusted house prices for several countries.
The last property downturn in the US and the UK lasted some six years. This is not a prediction of what will happen this time, more like a best-case scenario – because this bubble has not only been more intense than previous ones; it has also bubbled on for longer.
But even if we take six years as an estimate of the peak-to-trough period, that means the housing downturn will last until 2012 in the US and a couple of years longer in the UK. It is difficult to see how either of these countries could grow close to trend as long as the housing market is in recession.
When you look at the global macro side, you are looking at similar timescales of adjustment. An important part of the adjustment will be a rise in the US and UK household savings rates. That, too, might take several years to accomplish, during which period economic growth could be below trend.
The really important question about the US economy is not whether the official recession starts in the first or second quarter, but how long this period of economic weakness will last overall. In Japan and Germany macroeconomic adjustment of similar scale took more than 10 years, starting in the 1990s. Even if you believe that the US is structurally stronger, the country will probably not replenish its savings in a couple years.
If global inflation rises, as I expect, this process will become even more difficult. The central banks will have less room for manoeuvre. Fiscal policy is constrained, which leaves the exchange rate as the main tool of adjustment. This would necessitate a weak real exchange rate during the entire period of adjustment.
Obviously inflation would make everything worse, and our future scenarios will depend critically on the inflation outlook. A rise in inflation might alleviate the pressure on some mortgage holders, but is not a good environment for a country to build up savings. If higher inflation were tolerated by the central bank, it would clearly prolong the macroeconomic adjustment process. If it were not tolerated, interest rates would go up and we might experience a re-run of the 1980s. It would get a lot worse before it got better.
Either way, adjustment would take time. Would you really want to predict that under any of those scenarios, the worst was already over for a fragile financial sector? There may be no global financial meltdown. But our multiple crises could easily return with a vengeance, like one of those bloodstained villains in a horror movie who rises to fight his last battle.
It will end at some point, but several pockets of the financial market remain vulnerable in the meantime: US government bonds (under an inflation scenario); US municipal bonds (if the downturn is severe and long); several categories of credit default swap; credit card debt securities among others.
Our macroeconomic adjustment is not going to be as terrible as the Great Depression. But it might last longer. There will be time for optimism, but not just yet.
Send your comments to [email protected]
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Office construction plunged 28% in March across the U.S., compared with February
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Falling U.S. home prices and a lack of available credit may result in foreclosures on 6.5 million loans by the end of 2012, according to a Credit Suisse research report on Tuesday.The foreclosures could put 12.7 percent of all residential borrowers out of their homes, Credit Suisse analysts, led by Rod Dubitsky, said in the report. That compares with a foreclosure rate of 2.04 percent in the last quarter of 2007, they said, citing Mortgage Bankers Association data.
The new forecast includes 2.7 million subprime loans whose risky characteristics sparked the worst housing market since the Great Depression. Subprime foreclosures, on top of the 676,000 already in or through the process, will hit 1.39 million in the next two years alone, an upward revision from the 730,000 predicted by Credit Suisse in October.
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April 8, 2008 | Economic Dreams - Economic Nightmares
At maverecon Willem Butier counters Alan Greenspan's latest claim the he and the US Fed not be held responsible, in large part, for our current mess. Butier's eight policy "tragedies":
Butier elaborates on each. We will bring forward only one, dealing with possibilities for moral hazard. But before we do, I just found Martin Wolf's counter-balancing position, Ft.com, April 8, still praising Greenspan, while fearing that over-zealous regulatory reform spaned by a Greenspan "blame game" will kill the "good" that free-er (my word, Wolf uses "free) market mechanisms bring. Whereas Butier lists eight "tragedies" of Fed policy/practice, Wolf highlights two: (1) regulators should have been "tougher", in subprime and elsewhere, and (2) monetary policy should have been tigher, not looser - to lean against prevailing winds of excess instead of leaning with them.
- The Greenspan Fed (August 1987 - January 2006) did indeed contribute, through excessively lax monetary policy, to the US housing boom that has now turned to bust.
- The Greenspan-Bernanke put is real. It is an example of an inappropriate monetary policy response to a stock market decline.
- The Greenspan Fed focused erroneously on core inflation, rather than using all available brain cells to predict underlying headline inflation in the medium term.
- The Greenspan Fed failed to appreciate the downside of the rapid securitisation during the first half of this decade and acted exclusively as a cheerleader for its undoubted virtues.
- The Greenspan Fed displayed a naive faith in the self-regulating and self-policing properties of financial markets and private financial institutions.
- The Greenspan Fed, by enabling the rescue of Long Term Capital Management in 1998, acted as a moral hazard incubator.
- The failure of the Greenspan Fed to press, before or after LTCM, for a special insolvency resolution regime with prompt corrective action features for all highly leveraged private financial institutions that were likely to be deemed too big and too systemically important to fail, demonstrates either bad judgement or regulatory capture.
- During his years as Chairman of the Federal Reserve Board, Mr. Greenspan's statements reflected a partial (in every sense of the world) understanding of how free competitive markets based on private ownership work. This partial understanding guided his actions as monetary policy maker and financial regulator. Mr Greenspan's theories have been comprehensively refuted by the financial crises of 1997/98 and 2007/08.
David Beckworth, via Macro and Other Musings, adds insight into why Butier's critique is on target:
… [T]he Federal Reserve is a monetary hegemon. It holds the world's main reserve currency and many emerging markets are pegged to dollar. Thus, it's monetary policy is exported across the globe. This means that the ECB, even though the Euro officially floats, has to be mindful of U.S. monetary policy lest its currency becomes too expensive relative to the dollar and all the other currencies pegged to the dollar. The Fed's loosening, therefore, of monetary policy in the early-to-mid 2000s triggered a global liquidity glut that set the stage the subsequent housing boom-bust cycle. This is not to say the 'saving glut' and financial innovation had no role, but rather that loose monetary policy was a key factor behind the boom. …Back To Butier:The Greenspan Fed: a tragedy of errors, Willem Butier, maverecon:Financial Times, April 8: Mr Greenspan's apologia pro vita sua in the Financial Times of Monday, April 7 2008 fails to convince. …5. The Greenspan Fed as moral hazard incubator
In 1998, the Federal Reserve System played an important role in orchestrating the private sector bail-out of Long Term Capital Management (LTCM), a hedge fund brought down by hubris, incompetence and bad luck. Although no Fed money, and indeed no public money of any kind, was committed in the rescue, the Federal Reserve System, through the Federal Reserve Bank of New York and its President, William J. McDonough, played a key role in brokering the deal, by offering its good offices and using its not inconsiderable powers of persuasion to achieve agreement among its 14 major creditor banks (ironically, Bear Stearns refused to participate in the rescue). The reputation of the Fed therefore was put at risk.The reason given by the Fed for its orchestration of this bailout was the fear that, in a final desperate attempt to forestall insolvency, a fire-sale by LTCM of its assets would cause a chain reaction. This rushed liquidation of LTCM's securities to cover its maturing debt obligations would lead to a precipitous drop in the prices of similar securities, which would expose other companies, unable to meet margin calls, to liquidate their own assets. Such positive feedback could create a vicious cycle and a systemic crisis.
This is the same vicious cycle leading to systemic risk story that was trotted out by Timothy F. Geithner, the current President of the New York Fed, to rationalise the bail out of Bear Stearns.
Notable features of the LTCM bailout were (1) that the existing shareholders retained a 10 percent holding, valued at about $400million, and (2) that the existing management of LTCM would retain their jobs for the time being, and with it the opportunity to earn management fees. A rival (rejected) offer by a group consisting of Berkshire Hathaway, Goldman Sachs and American International Group, would have had the shareholders lose everything except for a $250 mln takeover payment and would have had the existing management fired.
One reason given for allowing the existing shareholders to retain a significant share and for keeping the existing managers on board was that only these existing shareholders-managers could comprehend, work out and unwind the immensely complex structures on LTCM's balance sheet. These were the same people, including two academic finance wizards, Myron Scholes and Robert C. Merton, joint winners in 1997 of the Nobel Memorial Prize in Economics, whose ignorance and hubris got LTCM into trouble in the first place.
Any handful of ABD graduate students from a top business school or financial economics programme could have unravelled the mysteries of the LTCM balance sheet in a couple of afternoons. The bail-out of LTCM smacks of crony capitalism of the worst kind. The involvement of the Fed smacks of regulatory capture.
The nature of the bail-out of LTCM meant that there was never any serious effort subsequently to address the potential conflicts of interest arising from simultaneously financing hedge funds, investing in them, and making money executing trades for them, as many investment banks did with Long-Term Capital. Things were even worse because, apart from the inherent potential conflict of interest that is present whenever a party is both a shareholder in and a creditor to a business, the bailout created a serious corporate governance problem because executives of one of the financial institutions that funded the bailout had themselves invested $22 mln in LTCM on their personal accounts. Using shareholder resources for a bail-out of a company to which you have personal exposure is unethical, even where it is legal.
For the Fed to have been involved in this shoddy bailout was a major mistake that soiled its reputation. If the Fed becomes involved (as an 'enabler' and/or by putting its financial resources at risk) in the rescue of a highly leveraged private financial institution, be it a hedge fund, an investment bank or a commercial bank, that private institution should immediately be subject to a special resolution regime, including the appointment of a special public administrator. That is, what is needed is an arrangement for all highly leveraged private financial institutions deemed too big and too systemically important to fail, akin to the treatment of (insured) commercial bank insolvencies under the Federal Deposit Insurance Act.
Under the rules established by the FDIC Improvement Act of 1991, a legally closed bank's charter is revoked and the bank is turned over to the FDIC which serves as receiver or conservator. Typically, the old top management are fired and shareholder control rights are terminated. The shareholders do, however, keep a claim on any residual value that remains after all creditors and depositors have been paid off. {footnote in original}
From a longer-run perspective, the LTCM bail-out can be seen as a key enabler of the 2008 bailout of the investment bank Bear Stearns, another type of highly leveraged financial institution deemed too big to fail by the Fed. In the case of Bear Stearns too, shareholders were left with something 'up front' (two dollars per share initially, subsequently revised to ten dollars per share) and the old management is still in situ. In addition, in the Bear Stearns case, Fed money is directly at risk - the Fed is funding the senior $29 bn of a $30 bn off-balance sheet facility created to warehouse Bear Stearns' most toxic assets.
If the "too big and too systemically important to fail" argument for bailing out large deposit-taking commercial banks is now also applied to other highly leveraged private financial institutions, including but not limited to, investment banks and hedge funds, then a similar special resolution regime, including prompt corrective action provisions must be in place if rampant moral hazard is not to be encouraged. The Greenspan Fed failed to make the case for or press for such reforms, even after the LTCM debacle. They bear a heavy responsibility for the moral hazard created in 1998 and in 2008, and for the future financial crises that will be encouraged and exacerbated by these failures. … {emphasis added}
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Apr 21, 2008 | Economic Dreams - Economic Nightmares
For the few who tune into my musings, you may have noticed that I'm not posting much lately. This will likely continue for some time. The Epicurean Dealmaker summed up a shared blogging problem nicely yesterday. It was fun to be a Cassandra when no one would do so. But now we Cassandras grow weary of all the fuss and bother when it appears so late in the game - perhaps too late to avoid severe recession and al change for self-policing) as per: leverage, margin and reserve requirements, executive compensations, firewalls between managers and accountants, auditors, and insurance brokers, etc. Here is the ever-eloquent Epicurean Dealmaker:
Admit it, now, how many of you are enthralled to pick up your morning newspaper to read the 337th story this month on the subprime/mortgage/CDO/CDS/auction rate security crisis du jour and whether it is a) over, b) just getting started, or c) all Ben Bernanke's fault? Even the perma-bearish Bloggers of the Apocalypse, like Nouriel Roubini and pals, have become tired and tiresome to read; now, in what should be their hour of glory. They were a lot more fun to listen to when the party was in full swing, and their jeremiads carried the desperate tang of Cassandras who know they are right but can get no-one to listen.Speaking of John Paulson and Stephen Feinberg, here they are again, compliments of Andrew Samwick: Top ten hedge fund managers with the highest personal earnings in 2007Meanwhile, the rest of us soldier on, heads down, with appropriately downcast and guilty expressions painted on our faces to show that we, too, realize we were at fault in this and therefore should not be sacrificed on the General Altar of Economic Contrition. Even the profiles of potential villains of the month we read nowadays, like those of mortgage meltdown lottery winner John Paulson and evil-genius-turned-bumbling-oaf Stephen Feinberg, carry all the gustatory excitement of cold mashed potatoes on a dirty plate. Who cares?
It is against this cheerless background that your Dedicated Correspondent finds it difficult to lift the proverbial pen and dash off yet another scintillating missive from the frontiers of Vanity, Hubris, and Financial Shenanigans. …
But I have high hopes that this condition is merely temporary. Neither economic recession-whether in progress, merely looming, or just a figment of anti-capitalist scaremongers-nor a newly discovered probity and sobriety among the Captains of Finance and Industry can persuade me that Human Folly has been repealed in perpetuum. I am unshakeable in my belief that there are individuals out there, right now, who are planning their own apotheosis and subsequent self-immolation on the field of Mammon with such a grandeur and flair that my very fingertips tingle with excitement. I promise you, Faithful Readers, that as soon as they lumber out I will set forth, quill and keyboard in hand, to puncture their pomposity and skewer their self-regard as of old.
In the meantime, I can do little more than paraphrase the Immortal Bard:
"An ass, an ass! My kingdom for an ass!"
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I've been meaning to post up a cut-down version Paul McCulley's recent assessment of our current plight: "Reverse Minsky Moment" interview with Kathryn M. Welling, but haven't yet. So yesterday I was glad to see Floyd Norris do a spot on McCulley's talk at the Hyman Minsky Conference for the NY times, titled Ponzi Squared:
… Minsky argued there were three levels of investment as the cycle progresses. First comes hedging, in which investments are made to reduce risk. Then comes the speculative phase, and finally the Ponzi phase, in which the investment can be justified only by the assumption that prices will keep rising, not by the expected income.Paul McCulley of Pimco, the big bond manager, gave an interesting speech in which he said the recent subprime mortgage fiasco proceeded to a fourth level - one that he called "Ponzi-squared" - before it collapsed.
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As we transit to a world of resource depletion and the reversal of the Permagrowth model, what is the proper monetary and currency regime? Clearly, not the existing fiat/credit currency, which depends entirely on financing present consumption by discounting future growth that may never occur. Just as bad would be a throwback to precious metals. It would suppress economic activity without providing incentives for developing alternative energy resources.Instead, I believe we should implement a monetary system that uses renewable, "green" energy as a benchmark. In previous posts I have called the new currency the "Greenback", an allusion to the fact that for most people nothing would change in their daily routine. Same dollars, same bank accounts, same credit cards. The monetary institutions would also be retained: the Fed and the fractional banking system. The only change - admittedly a big one - would be the rate at which money supply is allowed to expand. Let's call this rate "M green", or M(g) for short and see how it will be calculated.
To begin with, we have the following energy consumption data from the US Energy Information Administation (EIA, see chart below). The discrepancy in percentages is in the original data, but it is very minor.
We see that of the total 99.4 quadrillion BTU the US consumed in 2006, 86% was produced by "black" fossil fuels, the rest from nuclear and renewable sources. Adding the last two together gives us the percentage of "green" energy. Though I hesitate to call nuclear "green", it is an indispensable energy source in transiting away from fossil fuels.
Data: EIA (2006)
For any given period, then, the allowed growth in money supply would be calculated by this formula:
M(g) = ΔE(g)/E(b)
where:
- ΔE(g) is the change in "green" energy consumption from the previous period, in BTU.
- E(b) is the total "black" energy consumed in the previous period, in BTU.For example: let's say that in 2008 we consume 85 black BTU and 15 green BTU. The following year, we consume the same 85 black BTU but increase green to 17 BTU.
Therefore:
M(g) = (17 - 15)/85 = 0.0235 = 2.35%
i.e. broad Greenback money supply (the equivalent to M3 today) would be allowed to expand by 2.35%.
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This is a follow-up post on common sense evidence that easily accessible crude oil is in depletion and its relationship to debt and central bank policies.
I just watched a TV documentary about the Alberta tar sands and the way oil is mined by Syncrude. Some facts:
- The teeth of the giant shovels that scoop up the tar sands have to be replaced every 12 hours. That's a lot of steel to chew through in half a day - it surely isn't beach sand...
- Imagine rubbing #40 sandpaper on your skin. Now guess what happens to every pipe, vessel, pump and valve that handles the tar sand slurry. The company has two separate process trains working in parallel, switching from one to the other in order to constantly replace worn parts.
When it comes to evaluating resource depletion, deeds speak louder than words. Oil isn't available for the price of a straw stuck in the sand any more. Back when "gushers" were common, easily accessible crude had EROEI of as much as 100-to-1. Saudi crude is now extracted at 10-to-1 and tar sand oil at 5-to-1. We can argue dollar prices forever, but a kilowatt is always a kilowatt. Try this simple thought experiment: instead of thinking of oil prices in dollars per barrel, reverse the point of view and think in terms of barrels per dollar. That is, price the artificial entity (dollars) in terms of the real item (oil). Do you see the difference?
- The giant 400-ton trucks that carry the sands cost $6 million. Their 3,550 HP engines have to be replaced every two years, at $1+ million a pop. Tires cost $60,000 - each.
As I see it, our global human society has two choices. We can keep our heads buried in the (tar) sands, perma-consuming until all we have left to bequeath our children are dregs. Or we can stop right now and start moving towards a sustainable regime. The current debt "crisis" is not only a warning sign that we have already consumed too much of our future. It is also a golden opportunity to reverse some of the excess, to un-mortgage humanity's future by letting some of the debt go bust.
In this sense, repeated bailouts by central banks (BOE is the latest addition) are profoundly wrong, misbegotten and ultimately dangerous. Speaking in thermodynamic terms, they are trying to convince us that their kilowatt is worth more than one kilowatt. They are just drilling their heads deeper into the sand, forcing us along for the ride. Unfortunately, we will have to work that much harder to dig ourselves out - assuming we will still have some food left over.
_____________________________________
Note: A reader asked for a book recommendation on Thermoeconomics: Try "The Entropy Law and The Economic Process". It's now on the Amazon bar on the right.
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April 23, 2008 | The Mess That Greenspan Made
Given the advantage of the passage of time, historians will surely note that one of the less appreciated long-term effects of the Greenspan term at the Fed was the impact on the American culture. Few are able or willing to make this association today (and certainly no one can prove it) but a link certainly exists, at least to some extent.
Things are now changing rather dramatically (and certainly for the better), but up until the housing boom went bust a year or two ago, we were a nation overflowing with leveraged speculators and everyone seemed OK with that whole idea.
Why not? What's wrong with everyone getting rich?
You'll probably never read in the history books that European Central Bank President Jean-Claude Trichet "looked the other way" or was somehow negligent in his duties when he mumbled about something (e.g., "froth") when maybe he should have used his bully pulpit or regulatory power to discourage bad behavior (e.g., poor lending practices) that would surely, in the long-run, end badly (e.g., the bursting of the largest asset bubble in the history of mankind).
But in America, it was clearly different.
So when you read a comment like the one made by Robert Shiller the other day, you have to wonder if it was a throw-away line or if there was a darker meaning intended, more than what most people would ever read into it.
When talking about the current "housing slump" (aren't we beyond that sort of characterization yet?) Dr. Shiller noted that there's a good chance home prices will fall more than the 30 percent decline experienced during the Great Depression.
Then he commented:
Basically we're in uncharted territory. It seems we have developed a speculative culture about housing that never existed on a national basis before.You could have said the same thing about stocks in 2001.Equities, however, weren't quite inclusive enough. After the turn of the century, those who didn't know the difference between Cisco Systems and Pets.com seemed more than willing to take the plunge on something they did understand - real estate.
This sort of thing doesn't just happen by itself. It takes an entire society changing the way they think to get an asset bubble as big as the one we had in real estate.
Real estate was (and always should be) a place to live - not an ATM machine or a retirement plan. If you work hard enough, you should be able to make a living buying houses and fixing them up or if you have good connections in the local community and plenty of "positive mental attitude", it's reasonable to expect that you could make a decent living as a realtor.
You have to wonder where we go from here now that the culture has been completely transformed - everyone expects another bubble.
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"the dramatic slowing in the U.S. economy"
Chief Executive Scott Davis:
UPS's first quarter results illustrate the dramatic slowing in the U.S. economy. At our investor conference on March 12th, we told you that volume growth in January had been up 3%. But in the six weeks prior to the conference, it had been negative. We also said if these trends persisted through March, we would not achieve the earnings guidance we had provided for the quarter. [The] trends did continue. Many have become sharply more negative in the last two months. ... The great unknowns are the severity and the duration of the current economic slowdown. Many of our customers have tightened their belts resulting in a shift away from our premium air products to ground shipments.
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Yale University economist Robert Shiller ... said there's a good chance housing prices will fall further than the 30% drop in the historic depression of the 1930s. Home prices nationwide already have dropped 15% since their peak in 2006, he said."I think there is a scenario that they could be down substantially more," Mr. Shiller said during a speech at the New Haven Lawn Club.
Mr. Shiller, who admitted he has a reputation for being bearish, said real estate cycles typically take years to correct.
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Shocked? Homebuyer's were speculating with no money down. Mortgage brokers didn't care because they would sell the loans immediately and collect their fees. Wall Street didn't care because they could package the loans and sell them to investors. Investors would have cared, except they trusted the rating agencies. And as this article describes, the rating agencies weren't evaluating the underlying loans - they were performing statistical analysis using models based on lenders that cared if the borrower would repay the loan.
At the same time, regulators - despite numerous warnings - mostly ignored the problem, apparently for ideological reasons ("let the free market work"). What a mess.
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Although Japan was rapidly printing money, a destruction of credit was happening at a far greater pace. There was an overall contraction of credit in Japan for close to 5 consecutive years. Property values plunged for 18 consecutive years. The stock market plunged from 40,000 to 7,000. Cash was hoarded and the velocity of money collapsed. Those are classic symptoms of deflation that a proper definition incorporating both money supply and credit would readily catch. Those looking at consumer prices or monetary injections by the bank of Japan were far off the mark.
Yes, there was deflation in Japan. Furthermore, if deflation can happen in Japan, then there is no reason why it cannot happen in the US as well.
Economist Paul Kasriel Weighs In
I discussed how a Japanese style deflation might occur in the US in an Interview with Paul Kasriel.
Mish: Would you say that consumer debt in the US as opposed to the lack of consumer debt in Japan increases the deflationary pressures on the US economy?
Kasriel: Yes, absolutely. The latest figures that I have show that banks' exposure to the mortgage market is at 62% of their total earnings assets, an all time high. If a prolonged housing bust ensues, banks could be in big trouble.
Mish: What if Bernanke cuts interest rates to 1 percent?
Kasriel: In a sustained housing bust that causes banks to take a big hit to their capital it simply will not matter. This is essentially what happened recently in Japan and also in the US during the great depression.
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...the Fed is acting like the drunk looking under a streetlamp for his keys, because the light is good there, rather than where he lost them.
From the Financial Times:Credit market people and their regulators have been so preoccupied with defusing the more visible unexploded bombs in Wall Street that the more serious, long-term structural problems have been put off for later attention. Much later attention, in the case of those structural problems that could cause career or biography damage for senior policy people.The epicentre of all the problems is the financial system's dependence on over-the-counter derivative contracts, which made possible all the other bubbles that have been revealed and will be revealed soon. I believe that it will be necessary to dismantle carefully most of this jerry-built structure, and replace the bank-to-bank-to-dealer-to-dealer contract structure with central clearing houses for risk instruments.
Given that these are international markets of unimaginable size, this will take multilateral official co-operation to put into effect. The US government's involvement in the Bear Stearns work-out, far from marking the end of the credit crisis, shows how any resolution to the larger systemic issues will need to have official backing.
You will notice that through all the perturbations of the financial markets over the past nine months, there have been no problems with the operations of the centrally cleared futures and options exchanges.
The character and integrity of the participants in these exchanges - the speculators, hedgers and intermediaries - is no better than you would find in the over-the-counter markets. But the scope for wrongdoing is far less, since every day, every hour, these people's assets and liabilities are more or less accurately marked, and any deficiencies in their accounts have to be made up, or the accounts liquidated.There were advantages of the over-the-counter markets for credit default swaps, interest rate swaps, and equity derivatives. OTC derivatives required less market-making capital than exchange-traded instruments, and the conserved capital could support more real economic activity.
But it all got too big. The model did not take sufficient account of financial markets invariably taking any sensible innovation to senseless extremes.
OTC derivatives are more flexible than exchange-traded instruments, so they can be written for the exact requirements of the counterparties. That in turn made further capital savings possible, since (apparently) precisely hedged positions did not need the same level of reserves.
...Confronting the industry requires considerable tough-mindedness, a quality notably lacking at the US central bank.
...Christopher Whalen of Institutional Risk Analytics blames the Federal Reserve and other regulators. "The Fed knows that banking is a commodity business, and by allowing the banks to migrate off the exchanges they allowed them to enhance their profitability. The Fed people knew risk management was a problem, but they thought they could deal with all the risks created by the over-the-counter model through the Basel 2 rules."
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We've said before that the US is in the same position as Thailand and Indonesia circa 1996, except we have the reserve currency and nukes. Some prominent commentators are making more polite observations along these lines.
An article, "A rising euro threatens US dominance" in the Financial Times, by Benn Steil, director of international economics at the Council on Foreign Relations, covers old and new ground in a discussion of the implications of a further decline in the dollar.
His well reasoned analysis contains some pointed observations, for instance, that the dollar's standing heretofore permitted it to have loose monetary policy without paying the usual consequences of capital flight and inflation, but no longer. Like a developing economy (ahem, banana republic), the more the Fed eases, the higher long term rates go.
Steil enumerates the implications of what happens when the US falls into banana republic category, and they aren't pretty. The "lender of the last resort" function breaks down in developing economies because investors withdraw funds from domestic accounts. Similarly, he raises the possibility that the US will have to issue foreign-currency-denominated debt. That is even more likely an outcome; the US briefly was forced to issue Deutchemark denominated bonds under Carter. Large scale non-dollar issuance would considerably constrain our formerly free-wheeling ways. He also notes a less widely noted cost: if the euro becomes more important, the US threat of sanctions as a tool of policy is neutered.
Note that these troubling scenarios are presented in an anodyne tone, and the author reminds us the US does not need to go down this path. But all indicators say that it will.
See also http://www.huffingtonpost.com/max-keiser/us-dollar-euthanasia-whil_b_97371.html
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..[A] half-century of financial stability lulled advanced economies into complacency. That stability reflected a simple quid pro quo... Governments brought commercial banks under prudential regulation in exchange for public provision of deposit insurance and lender-of-last-resort functions. Equity markets were subjected to disclosure and transparency requirements.
But financial deregulation in the 1980s ushered us into uncharted territory. Deregulation promised to spawn financial innovations that would enhance access to credit, enable greater portfolio diversification, and allocate risk to those most able to bear it. Supervision and regulation would stand in the way, liberalizers argued...
What a difference today's crisis has made. We now realize even the most sophisticated market players were clueless about the new financial instruments..., and no one now doubts that the financial industry needs an overhaul.
But what, exactly, needs to be done? Economists who focus on such issues tend to fall into three groups.
First are the libertarians... If you are selling a piece of paper..., it is my responsibility to know what I am buying... If my purchase harms me, I have nobody to blame but myself. I cannot plead for a government bailout.
Non-libertarians recognize the fatal flaw in this argument : Financial blow-ups entail ... "systemic risk" - everyone pays a price..., the government may need to bail out private institutions to prevent a panic that would lead tos elsewhere. Thus, many financial institutions, especially the largest, operate with an implicit government guarantee. This justifies government regulation of lending and investment practices.
For this reason, economists in both the second and third groups - call them finance enthusiasts and finance skeptics - are more interventionist. But the extent of intervention they condone differs...
Finance enthusiasts tend to view every crisis as a learning opportunity. While prudential regulation and supervision can never be perfect, extending ssides. If things get too complicated for regulators, the job can always be turned over to ... rating agencies and financial firms' own risk models. The gains from financial innovation are too large for more heavy-handed intervention.
Finance skeptics disagree. They are less convinced that recent financial innovation has created large gains..., and they doubt that prudential regulation can ever be sufficiently effective. True prudence requires ... a broader set of policy instruments, including quantitative ceilings, transaction taxes, restrictions on securitization, prohibitions, or other direct inhibitions... - all of which are anathema to most financial market participants. ...
In effect, finance enthusiasts are like America's gun advocates who argue that "guns don't kill people; people kill people." The implication is clear: Punish only people who use guns to commit crimes, but do not penalize others by restricting their access to guns. But, because we cannot be certain that the threat of punishment deters all crime, or that all criminals are caught, our ability to induce gun owners to behave responsibly is limited.
As a result, most advanced societies impose direct controls on gun ownership. Likewise, finance skeptics believe that our ability to prevent excessive risk-taking in financial markets is equally limited.
Whether one agrees with the enthusiasts or the skeptics depends on one's views about the net benefits of financial innovation. Returning to the example of drugs, the question is whether one believes that financial innovation is like aspirin, which generates huge benefits at low risk, or methamphetamine, which stimulates euphoria, followed by a dangerous crash.
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The economics profession has an unfortunate tendency to view recent experience in the narrow window provided by standard datasets. With a few notable exceptions, cross-country empirical studies of financial crises typically begin in 1980 and are limited in other important respects.[2] Yet an event that is rare in a three-decade span may not be all that rare when placed in a broader context.
In a recent paper co-authored with Kenneth Rogoff, we introduce a comprehensive new historical database for studying debt and banking crises, inflation, currency crashes and debasements.[3] The database covers sixty-six countries across all regions. The range of variables encompasses external and domestic debt, trade, GNP, inflation, exchange rates, interest rates, and commodity prices. The coverage spans eight centuries, going back to the date of independence or well into the colonial period for some countries.
In what follows, I sketch some of the highlights of the dataset, with special reference to the current conjuncture. We note that policymakers should not be overly cheered by the absence of major external defaults from 2003 to 2007, after the wave of defaults in the preceding two decades. Serial default remains the norm; major default episodes are typically spaced some years (or decades) apart, creating an illusion that "this time is different" among policymakers and investors. We also find that high inflation, currency crashes, and debasements often go hand-in-hand with default. Last, but not least, we find that historically, significant waves of increased capital mobility are often followed by a string of domestic banking crises.
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And a question from analyst Meredith Whitney on how far along BofA is in the write down process:
A: ...I think we're not in the last inning or the last few innings, and we have at least the rest of this year to go.
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S&P said that 9.19% of lines issued in 2005 and 11.45% of loans issued in 2006 are delinquent, up 6.49% and 6.51% from February.
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From an interview with Warren Buffet in Fortune Magazine: What Warren thinks...
Q: Are we a long way from turning a corner?Buffett talks about not timing the market based on macroeconomics, but he did time the housing market perfectly. He bought a Laguna Beach, CA house in 1996 for $1.05 million (at the market bottom), and sold in 2005 for $3.5 million. It's not like he needed the money.Buffett: "I think so. I mean, it seems everybody says it'll be short and shallow, but it looks like it's just the opposite. You know, deleveraging by its nature takes a lot of time, a lot of pain. And the consequences kind of roll through in different ways. Now, I don't invest a dime based on macro forecasts, so I don't think people should sell stocks because of that. I also don't think they should buy stocks because of that."
Here was Buffett's comment at the time:
"People go crazy in economics periodically. Residential housing has different behavioral characteristics, simply because people live there. But when you get prices increasing faster than the underlying costs, sometimes there can be pretty serious consequences."
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Bloomberg.com
Allan Meltzer, a Fed historian and economics professor at Carnegie Mellon University in Pittsburgh, agrees that Bernanke is swatting a fly with a sledgehammer. ``In monetary policy, he has not been good,'' Meltzer, 80, says. ``It is a silly policy designed to head off a recession that may come but hasn't come yet.''
Meltzer says the Fed, by ignoring the inflationary potential in its latest rate cuts, is creating the possibility of negative real interest rates. He also says the Fed should never take credit risks, especially to save floundering banks. ``We can't have a system that continues to work well if the bankers make the profits and the public, the taxpayers, take the losses,'' he says. ``That is not a viable system.''
Meltzer says Paulson's plan for expanded Fed oversight of the financial industry is both overreaching and impractical. ``It's hard to see how the Fed is going to do it,'' he says. ``The Fed's record of anticipating and heading off crises is poor. Now they are going to go out and examine investment bank portfolios? Most of the people who are buying and selling this stuff don't fully understand it. How is some Fed auditor going to figure it out?''
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Bloomberg.com
President Jean-Claude Trichet said the financial-market crisis is not over as banks remain reluctant to lend, while he indicated policy makers are still intent on keeping inflation in check.
The ``present significant market correction is not over,'' Trichet said in the foreword to the ECB's 2007 annual report published in Frankfurt today....
... ... ...
The dollar was at $1.5931 per euro by 10:33 a.m. in New York, from $1.5817 on April 18. It was at 103.24 yen, from 103.67.
A stronger euro benefits Europe by helping to temper inflation. Maintaining price stability is ``of paramount importance,'' European Central Bank President Jean-Claude Trichet said in Frankfurt on April 15.
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Computerworld
LONDON -- Reductions in technology spending could result in up to 11,000 jobs being cut from the U.K.'s financial services industry over the next three months, according to a forecast released last week by the Confederation of British Industry (CBI).
That prediction is based on the results of the London-based lobbying group's U.K. Financial Services Survey. PricewaterhouseCoopers conducted that survey for the CBI, polling executives at 79 companies between Feb. 20 and March 5.
The survey found that "plans for capital investment in the year ahead are very weak, with plans for spending on IT flat," the CBI said in a statement.
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Today Roubini wrote: The worst is ahead of us rather than behind us in terms of the housing recession and its economic and financial implications.
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Economist's View
George Will thinks:
The Fed's mission is to preserve the currency as a store of value by preventing inflation. ... The Fed should not try to produce this or that rate of economic growth or unemployment
He ends his column by putting his analytical skills to work:
If Congress cannot suppress its itch to "do something" while markets are correcting the prices of housing and money, Congress could pass a law saying: No company benefiting from a substantial federal subvention ... may pay any executive more than the highest pay of a federal civil servant ($124,010). That would dampen Wall Street's enthusiasm for measures that socialize losses while keeping profits private.
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Will increasing world demand for limited resource supplies pose a threat to world economic growth, or will technology keep peak oil and other such commodity peaks safely out in front of us?:Running Out of Planet to Exploit by Paul Krugman, Commentary, NY Times: ...Last week, oil hit $117. It's not just oil... Food prices have also soared, as have the prices of basic metals. And the global surge in commodity prices is reviving a question we haven't heard much since the 1970s: Will limited supplies of natural resources pose an obstacle to future world economic growth?
How you answer ... depends largely on what you believe is driving the rise in resource prices. Broadly speaking, there are three competing views.
The first is that it's mainly speculation - that investors ... at a time of low interest rates have piled into commodity futures, driving up prices. On this view, someday soon the bubble will burst and high resource prices will go the way of Pets.com.
The second view is that soaring resource prices do, in fact, have a basis in fundamentals - especially rapidly growing demand from newly meat-eating, car-driving Chinese - but that given time we'll drill more wells, plant more acres, and increased supply will push prices right back down again.
The third view is that the era of cheap resources is over for good - ...we're running out of oil, running out of land to expand food production and generally running out of planet to exploit.
I find myself somewhere between the second and third views.
There are some very smart people ... who believe that we're in a commodities bubble... My problem with this view...: Where are the inventories? ...inventories of food and metals are at or near historic lows, while oil inventories are only normal.
The best argument for the second view, that the resource crunch is real but temporary, is the strong resemblance between ... now and ... the 1970s.
What Americans mostly remember about the 1970s are soaring oil prices... But there was also a severe global food crisis...
In retrospect, the commodity boom of 1972-75 was probably the result of rapid world economic growth that outpaced supplies,... bad weather and Middle Eastern conflict. Eventually, the bad luck came to an end, new land was placed under cultivation, new sources of oil were found..., and resources got cheap again.
But this time may be different: concerns about what happens when an ever-growing world economy pushes up against the limits of a finite planet ring truer now than they did in the 1970s.
For one thing, I don't expect growth in China to slow sharply anytime soon. That's a big contrast with ... the 1970s, when growth in Japan and Europe ... downshifted - and thereby took ... pressure off ... resources.
Meanwhile,... Big oil discoveries ... have become few and far between, and in the last few years oil production from new sources has ... barely ... offset declining production from established sources.
And the bad weather hitting agricultural production this time is starting to look more fundamental and permanent... Australia, in particular, is now in the 10th year of a drought that looks more and more like a long-term manifestation of climate change.
Suppose that we really are running up against global limits. What does it mean?
Even if it turns out that we're really at or near peak world oil production, that doesn't mean that one day we'll say, "Oh my God! We just ran out of oil!" and watch civilization collapse into "Mad Max" anarchy.
But rich countries will face steady pressure on their economies from rising resource prices, making it harder to raise their standard of living. And some poor countries will find themselves living dangerously close to the edge - or over it.
Don't look now, but the good times may have just stopped rolling.
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Mike Morgan has another long awaited update on the Florida housing situation called In the Eye of the Housing Hurricane.
Here's a lesson many Floridians have learned the hard way: All hurricanes have three parts-the front half, the eye and the back half. The eye is a deceiving quiet period at the center of the hurricane. The eye lulls you into believing the storm has passed and all is well.In fact, the back half of a hurricane can be far more devastating than the front half. The front half of a hurricane does a lot of damage and weakens many structures. Then, when the back half hits, houses, buildings and personal property teetering on the brink of failure are utterly destroyed. Moreover, since the wind is coming from the opposite direction, anything strong enough to resist the first half is tested again by the back half.
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From Financial Week: Big rise seen in unoccupied office space
According to the real estate services firm Grubb & Ellis, first-quarter office vacancies rose to an average 13.6% nationally, up from 13% in the previous three quarters.
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Yesterday I posted three videos of an interview with Professor Nouriel Roubini on Canadian TV. Professor Roubini believes the U.S. is currently in a recession, and that the recession will be deep and long - "the most severe recession and financial crisis that the US has experienced for decades" - lasting 12 to 18 months.I agree that the economy is probably already in a recession, but I think Roubini may be too pessimistic. My view is the recession will be less than severe (with unemployment peaking at less than 8%), although I agree the effects - especially related to employment - will probably linger for some time.
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Mish's Global Economic Trend Analysis
The bottom line is this: The U.S.' major banks are barely holding on to life itself. Citi's financial condition will keep them from making money for a long time even if they do not bust. As speculators pile into the financial stocks again, maybe they should sharpen their pencils a little more.
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From the LA Times: California unemployment hits 6.2%; worse than Ohio, Pennsylvania
California's unemployment rate rose by a whopping half a percentage point in March, reaching 6.2% as a weakening economy shed jobs in the ailing construction and financial activities sectors. In all, 1.13 million were unemployed.And on the Inland Empire, it was almost two years ago I wrote Housing: Inverted Reasoning?
...
California is doing worse than Pennsylvania and Ohio ... the two Rust Belt states that have figured prominently in the presidential primary elections because of their lost manufacturing jobs.As the housing bubble unwinds, housing related employment will fall; and fall dramatically in areas like the Inland Empire. The more an area is dependent on housing, the larger the negative impact on the local economy will be.That seemed obvious to most of us! And now from the LA Times on unemployment in the Inland Empire:The rise in unemployment during March affected all of Southern California, with the worst effects in the Inland Empire. The rate in Riverside County -- not seasonally adjusted -- rose to 7.4% from 7.0%, while in San Bernardino County it rose to 6.7% from 6.3%.
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The New York Times, in "Workers Get Fewer Hours, Deepening the Downturn," presents data and anecdote that indicate that low unemployment masks a deteriorating labor market. Some employers are cutting their workers' hours; the self employed are finding less demand for their services.
While this article provides some useful insight into the state of the economy, it fails to acknowledge that underemployment is a problem separate and apart from the economic slowdown. There is often perilous little difference between being self employed and unemployed, but that distinction is rarely captured. As I have mentioned before, a large number of people in my peer group are either retired but would prefer to be working full or part time, or have their own businesses but are less busy than they would like to be. In this narrow sample, underutilization has been widespread since the dot com bust.
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According to UBS, thanks to Bernanke having driven short rates so low, there won't be much reset shock this year (I'd like to see the full analysis on this one, needless to say). The increases reportedly will be only 5% on average for resets this year. In fact, a lot of lenders are trying to get their resets to go into fixed mortgages so they will earn more.
However, resets last year were at higher rates, and it takes 15 months on average from first default to foreclosure, so those loans are the ones hitting the wall this year. Your point well taken with them.
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And the cause of what looks like colossal stupidity is simple: bad incentives. Why be prudent when shareholders have no influence on your pay and the higher ups look only at calendar year results? Even though the US and other societies have seen this movie before, we seem compelled to repeat our experience rather than learn from it. George Akerlof and Paul Romer described the pathology in a 1993 Brookings paper:
Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.Bankruptcy for profit occurs most commonly when a government guarantees a firm's debt obligations. The most obvious such guarantee is deposit insurance, but governments also implicitly or explicitly guarantee the policies of insurance companies, the pension obligations of private firms, virtually all the obligations of large or influential firms. These arrangements can create a web of companies that operate under soft budget constraints. To enforce discipline and to limit opportunism by shareholders, governments make continued access to the guarantees contingent on meeting specific targets for an accounting measure of net worth. However, because net worth is typically a small fraction of total assets for the insured institutions (this, after all, is why they demand and receive the government guarantees), bankruptcy for profit can easily become a more attractive strategy for the owners than maximizing true economic values...
Unfortunately, firms covered by government guarantees are not the only ones that face severely distorted incentives. Looting can spread symbiotically to other markets, bringing to life a whole economic underworld with perverse incentives. The looters in the sector covered by the government guarantees will make trades with unaffiliated firms outside this sector, causing them to produce in a way that helps maximize the looters' current extractions with no regard for future losses...."
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Norris uses the Paul Volcker's speech at the Economic Club of New York this week as a point of departure, covering it in more detail than other commentators:
Paul Volcker, the former Federal Reserve chairman whose legacy has not crumbled since he left office, was right this week when he said the financial engineers had created "a demonstrably fragile financial system that has produced unimaginable wealth for some, while repeatedly risking a cascading breakdown of the system as a whole."...."Any return to heavily regulated, bank-dominated, nationally insulated markets is pure nostalgia, not possible in this world of sophisticated financial techniques made possible by the wonders of electronic technology," he said.
In any case, the banks are not all that healthy anyway, thanks to their losses from the strange securities created under the new system.....
Regulation needs to be strengthened, particularly for investment banks. Providing a safety net brings, in Mr. Volcker's words, "a direct responsibility for oversight and regulation." He forecast that "investment banks are going to end up with a leverage ratio imposed upon them." And one lesson of this disaster is that having parallel financial institutions - one regulated and one not - simply drives activity to the unregulated area, at least until something blows up....
It is also clear that the efforts being made to cut back American regulation, in the name of making our markets more competitive, are attempts to deal with the wrong issue. To quote Mr. Volcker again, "For financial regulation in general, competition in regulatory laxity cannot be a tolerable approach."....
Mr. Volcker, who knows how inflation can get out of hand, said the current situation reminds him of the early 1970's, when inflation began to accelerate. The Fed's moves to slash short-term interest rates and bail out Wall Street, however necessary they may be, could easily raise inflation and cause more damage to the weak dollar.
Volcker puts his finger on the central problem, the the securitization model, aka "originate and distribute," has broken down. New issuance volumes are off dramatically in all product areas. But what is more troubling is that many types of securitized products depended on credit enhancement, and that does not appear to be coming back anytime soon, if ever (at least in anywhere near the same volumes). Note how many "rescue the housing market" plans rely on federal guarantees (Fannie, Freddie, FHA), an indirect acknowledgment of the problem.Yet the consensus view, which increasingly appears to be wishful thinking, is securitization will come back once the credit crisis is past the acute phase. Yet look at the elements that appear irretrievably damaged: monolines, key providers of credit touch-ups, have renounced the structured finance business. Credit default swaps, another important source of credit improvement, are suffering from a shortage of protection-writers (among them the bond guarantors) and other former sources of credit enhancement (hedge funds and investment banks) are now correctly regarded as less secure. That leaves overcollateralization as the only readily available means for creating the desirable AAA tranches out of pools of less than stellar assets. It isn't yet clear what that means for the structured credit business going forward,
In addition, with rating agency reputations in tatters and many investors burned by buying pseudo AAA paper, it may be a very long time before investor confidence is restored. It may not occur in the absence of reforms that have teeth.
Yet even the astute Volcker does not appear to have considered the possibility that the securitization process will remain largely non-operative until root-and-branch re-regulation is in place to entice investors back into the pool (no pun intended). That implies that in the meantime, on-balance-sheet credit intermediation will assume a large role. But that requires far more financial firm capital (the resulting bigger balance sheets dictate larger equity bases) precisely at a time when losses are shrinking bank capital and new equity is costly and hard to procure.
... ... ...
I can't fathom where Norris' concern about an excess of "finger pointing" (except perhaps at Greenspan) comes from. If anything, there has been too little, rather than too much, investigation of how we got where we are.
Consider the contrast. In 1987, after the stock market crash, the so-called Brady Commission (formally, the Presidential Task Force on Market Mechanisms) was established a bit more than two weeks after the crisis. Admittedly, the stock market meltdown was a discrete event, while our credit crisis has been an slow-moving train wreck. Nevertheless, the Brady Commission working oars were not part of the regulatory apparatus; its executive director was a Harvard Business School finance professor, Robert Glauber; the staffers came heavily from the private sector. This gave them the freedom to look at deficient practices without incurring the ill will of people in their field.
By contrast, consider Bernanke's in a speech yesterday, "Addressing Weaknesses in the Global Financial Markets," of the measures taken to understand the roots of our current financial mess:
In the United States, policymakers' efforts to identify the sources of the financial turmoil and the appropriate public- and private-sector responses have been coordinated through the President's Working Group on Financial Markets (PWG), chaired by the Secretary of the Treasury. The group's other principals include the heads of the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission, and the Board of Governors of the Federal Reserve System. With the support of the staff of the respective agencies, the PWG began to address these issues last fall, as the severity of the financial turmoil became increasingly apparent; in mid-March, we issued a brief statement outlining our tentative conclusions and policy recommendations.1 At the international level, the Financial Stability Forum (FSF), whose membership consists of central bankers, regulators, and finance ministers from many countries, including the United States, will also soon release a report on the causes of and potential responses to the turmoil.
There has been no independent investigation by people who had access to the key actors and relevant documents. No matter how well intended the regulators and government officials looking into the credit crunch might be, it simply isn't human nature to point fingers at oneself.
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Storied investor George Soros believes that the credit crisis is far from over, and sees regulatory failure as a major cause. From Bloomberg:Billionaire George Soros said the global credit crisis will get worse before it gets better.Soros, who said lack of oversight is partly responsible for problems in the financial markets, criticized regulators and the U.S. administration for not ``responding fully enough.'' He was speaking on a teleconference call with reporters today....
``Authorities have not accepted the responsibilities to try to control asset bubbles from going too far,'' Soros said. Recently established markets, including for credit-default swaps, are ``totally unregulated, that's the cause of the troubles.''...
Total losses for banks, hedge funds, pension funds, insurance companies, and sovereign wealth funds may swell to $945 billion, the International Monetary Fund said in a report on April 8.
``I think it's a pretty accurate estimate of the loan losses,'' Soros said. ``But we have not yet seen the full effect of possible recession.''
Uncertainty about the ability of investors and traders to meet contract obligations is creating ``mistrust'' in the markets that ``will not be fully cleared up until you have a regulated delivery mechanism and oversight over this market,'' he said.
Morgan Stanley Chief Executive Officer John Mack said on April 8 that the credit crisis will last a couple of quarters longer and that the markets are facing the most difficult conditions he's seen in 40 years.
Soros said the crisis will last longer than authorities predict.
``They claim that there will be a pickup in the second half of the year,'' he said. ``I cannot believe that. I don't see any reason to believe it because it will take much longer for the full effect of the decline in the housing market to be felt.''
``This is a man-made crisis and it's made by this false belief that markets correct their own excesses,'' Soros said. ``That's the job of the regulators. And the regulators failed to perform their job.''
Separately, Soros said China was not immune to worldwide market conditions. China's inflation has peaked and may be abating, he said.
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April 9, 2008 | nakedcapitalism.com
Goldman, under Chief Executive Officer Lloyd Blankfein, depends on trading for 68 percent of the New York-based firm's revenue, more than either Morgan Stanley or Lehman. While Goldman's first-quarter trading revenue slumped 27 percent to $5.66 billion from a year ago, it remained higher than Morgan Stanley's $5.13 billion or Lehman's $1.67 billion.
The filings also show that Goldman lost $100 million or more on five trading days during the quarter. Morgan Stanley lost more than $100 million on one day, while Lehman reported that it lost more than $60 million on three separate occasions.
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Bank holding companies including Citigroup Inc., Bank of America Corp. and Wells Fargo & Co. have the thinnest safety cushion against losses in seven years.
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Dole Food Co., the world's largest fresh-fruit and vegetable producer, is selling land in Hawaii and California to avoid default on $350 million in bonds.
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The freeze in leveraged buyouts is slashing fees for investment banks by more than 75 percent as Blackstone Group LP and Kohlberg Kravis Roberts & Co., the industry's two biggest firms, put takeover plans on hold.
Private-equity companies paid $1 billion to securities firms in the U.S. and Europe during the first quarter, down from $4.3 billion a year earlier, data compiled by New York-based research firm Freeman & Co. and Thomson Financial show. Revenue from loan underwriting plunged more than 91 percent, and fees from advising on takeovers dropped 51 percent.
... ... ...
No buyout firm has announced a deal worth more than $3.1 billion since borrowing costs started climbing last July, according to data compiled by Bloomberg. Banks are now in the process of clearing about $230 billion of loans that they committed to finance acquisitions, sapping their interest in funding new deals.
... ... ...
Deutsche Bank AG, Europe's biggest investment bank by revenue, earned less than $5.8 million from private equity firms in Europe in the first three months of 2008, a fraction of the $165 million it received a year earlier. In the U.S., New York- based Goldman Sachs Group Inc., the country's largest securities firm, suffered the biggest decline, with fees from private-equity firms dropping 83 percent to $42.1 million, the Freeman data show
... ... ...
In all, buyout firms paid $162 million for arranging loans in the first quarter, down from $1.9 billion a year earlier when syndicated loans were the most lucrative area of business for the banks, the Freeman data show.
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Summary: Americans generally belittle the role of ethnic nationalism in politics. But in fact, it corresponds to some enduring propensities of the human spirit, it is galvanized by modernization, and in one form or another, it will drive global politics for generations to come. Once ethnic nationalism has captured the imagination of groups in a multiethnic society, ethnic disaggregation or partition is often the least bad answer.
Projecting their own experience onto the rest of the world, Americans generally belittle the role of ethnic nationalism in politics. After all, in the United States people of varying ethnic origins live cheek by jowl in relative peace. Within two or three generations of immigration, their ethnic identities are attenuated by cultural assimilation and intermarriage. Surely, things cannot be so different elsewhere.
Americans also find ethnonationalism discomfiting both intellectually and morally. Social scientists go to great lengths to demonstrate that it is a product not of nature but of culture, often deliberately constructed. And ethicists scorn value systems based on narrow group identities rather than cosmopolitanism.
But none of this will make ethnonationalism go away. Immigrants to the United States usually arrive with a willingness to fit into their new country and reshape their identities accordingly. But for those who remain behind in lands where their ancestors have lived for generations, if not centuries, political identities often take ethnic form, producing competing communal claims to political power. The creation of a peaceful regional order of nation-states has usually been the product of a violent process of ethnic separation. In areas where that separation has not yet occurred, politics is apt to remain ugly.
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Whether politically correct or not, ethnonationalism will continue to shape the world in the twenty-first century.
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Tett sounded early alarms that the debt boom could end badly, and she is similarly not optimistic about finding a clear path though the credit contraction. From the Financial Times:
So the essential question remains this: can banks really cut their leverage levels effectively and calmly via furtive asset sales or ringfencing? Or are we heading for more stop-start turmoil?
Personally, I would love to believe in the Goldilocks scenario.
However, history is sadly not on the side of this fairytale. After all, very few episodes of deleveraging have occurred in the banking sector before in a manner that was "just right".
Stand by, in other words, for plenty more market lurches – accompanied by plenty more growling from the credit bears, as investors are scalded and frozen, all at once.
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Market fundamentalists (otherwise known as financial authorities and institutions) believe in a tendency toward equilibrium. However, says Soros' column in Thursday's FT, this belief in the market's supposedly random deviations from equilibrium and it's ability to self correct is basically false.It is the boom-bust sequence that characterises the market. Soros notes that regulation is not the key, as it can only ever respond after the fact. Authorities need to point their gaze toward the next issue that will arise, CDS and mortgage defaults. Soros suggests that credit default swap contracts could be submitted through a clearing house or exchange with a sound capital structure. For mortgages the bankruptcy laws could be adjusted to allow for mortgage terms to be modified. Another suggestion "would provide Federal Housing Administration guarantees that would enable mortgage holders to be paid off at 85 per cent of the current appraised value".
Making the media rounds, Soros commented to Bloomberg that this is the worst financial crisis since the great depression. In a moodily lit interview with Robert Peston, Soros suggests that current market turmoil is in fact the result of the demise of one of the biggest bubbles - the WW2 bubble that resulted in the long term increase in the use of leverage. There are asymmetric incentives, leveraging is encouraged, but when a crisis occurs, authorities intervene.
In his Bloomberg interview Soros says that he expects the markets to fall more this year, with the current rebound lasting no more than three months.
Soros has bet on declines in the dollar, 10-year Treasuries and U.S. and European stocks. He expected foreign currencies to rise, as well as Chinese and Indian equities. The latter bet helped Quantum return 32 percent in 2007.
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It may be that the Great Credit Crunch has not yet arrived. Witness this chart dug up by Sempra Metals' John Kemp:
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A dire warning from Kemp:
If there IS going to be a credit crunch and a substantial decline in the ratio of financial activity to real-sector activity, it is still in future. The real impact of the credit crunch on real-side business activity has yet to be felt fully and will only be manifest in H2 2008, when restrictions on credit availability and falling profits will likely translate into a downturn in business investment, employment and growth.
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March 31, 2008 | Sudden Debt
Now, throw in resource depletion plus environmental degradation. Debt is a one-way bet on rising future activity; scarcity and climate change are already forcing us to rethink the outdated Permagrowth model and we will soon be forced to abandon it altogether.
Therefore, it is better to liquidate excess debt quickly, instead of wasting precious resources attempting to keep it afloat. Referring to a post from last July: putting patches on threadbare tires may temporarily prolong the Bong Bus trip, but will result in a catastrophic accident later. Better to stop now and force all the dopeheads to change the tires.
But what about the innocents, those middle-class depositors and investors who may see their lifetime savings disappear in a generalized credit melt-down? Fortunately (well, un-fortunately) they don't have all that much to lose: the vast majority of Americans (latest data from 2004) had much less than $100,000 in financial assets, including bank deposits, securities, 401(k)'s (see chart below, click to enlarge). Current programs in force like FDIC and SIPC will more than adequately cover them.
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Sudden Debt
Looking at stocks in particular, I sense a heightened willingness by leveraged speculators to go bottom fishing. They interpret the bad employment data as lagging indicators that will soon peak, and at lower levels than previous recessions. Their optimistic reasoning is that Fed and Treasury initiatives have the power to provide the economy with enough fuel to keep demand going, even under current conditions.
The efforts currently being undertaken by the authorities are not directed at them. They aim at helping the very top, where most financial wealth resides: those debt instruments (and their issuers) that are owed by the bottom 90% of the people, but owned by the top 10% of them. I am most definitely no sans-culotte, but even to me this smacks of "Let them eat cake".
In whose interest is it to make our currency the harlot of the "free world"? Not the 90%, that's for sure. But here's the rub: pretty soon it won't be in the interest of the 10%, either.
In the early stages of the Great Depression then Secretary of the Treasury Andrew Mellon made the mistake of advocating liquidation because that was the way previous boom-bust business cycles worked ("Liquidate labor, liquidate stocks, liquidate farmers"). Like most short-sighted generals, he assumed he was fighting the previous war. It is the same with Bernanke, Paulson and Co. : like the Polish generals of 1939 they are stubbornly throwing masses of cavalry against Guderian's Panzers.
It is a familiar pattern of incompetence: the Iraq and Afghan wars are wasting hundreds of billions of dollars and hundreds of thousands of lives to prolong the Oil Era. The Fed and Treasury are destroying the good faith and credit of the USA to prolong the Debt Era. We will all suffer for it.
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Mish's Global Economic Trend Analysis
Ron Paul vs. Bernanke
Ron Paul was the only one who stood up to Bernanke during the Fed's testimony before the Senate Banking Committee on the Fed's role in the Bear Stearns debacle. Click here to play a video of the exchange.
Partial Transcript
Ron Paul: Does the Federal Reserve contribute to the business cycle?
Bernanke: It has. It has at times ....
Ron Paul: Does excessive credit and artificially low interest rates cause malinvestment?
Bernanke: The question is, [what] is the judgment as to where interest rates ought to be? Of course we have a mandate for maximum employment and price stability and we try and balance those obligations. So we could make mistakes and put the interest rate at the wrong place and that would have negative impacts, I agree. So we are doing the best we can to find the right place to put the interest rate, the one that's consistent with the neutral rate, the rate that establishes a full employment economy.
Ron Paul: And some day we may try the market to determine the interest rates. Thank You.Suggestions For Ron Paul
These exchanges are welcome given that no one else is willing to stand up to Bernanke. However, I am frustrated every time because Ron Paul does not make good use of his time. Instead of starting with a long dialog, a shorter dialog and more pointed questions would serve everyone far better.
I propose a question like "You have blown bigger bubble after bigger bubble and we have neither price stability nor full employment to show for it. Instead of micromanaging interest rates, why don't you simply let the market set the interest rates? You don't really have any idea where interest rates should be, do you?"
"Now you are in a power grab in a mad attempt to bail yourselves out of a crisis a free market would never have created."
That's something that needs to be heard. And phrased that way, it might have made front page news.
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The Mess That Greenspan Made
Now we know why Fed Chairman Ben Bernanke was such a Negative Nellie this week when testifying before Congress - after the latest employment report, it looks as though the wheels are falling off the economy.
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Calculated Risk
San Francisco Fed President Janet Yellen spoke today: The Financial Markets, Housing, and the Economy. Yellen points out that delinquency are more closely correlated to falling house prices as opposed to interest rate resets
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These exchanges are welcome given that no one else is willing to stand up to Bernanke. However, I am frustrated every time because Ron Paul does not make good use of his time. Instead of starting with a long dialog, a shorter dialog and more pointed questions would serve everyone far better.
I propose a question like "You have blown bigger bubble after bigger bubble and we have neither price stability nor full employment to show for it. Instead of micromanaging interest rates, why don't you simply let the market set the interest rates? You don't really have any idea where interest rates should be, do you?"
"Now you are in a power grab in a mad attempt to bail yourselves out of a crisis a free market would never have created."
That's something that needs to be heard. And phrased that way, it might have made front page news.
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Behavioral Finance abandoned the quest of the efficient markets theory to find a rational, mathematical model to explain fluctuations in asset prices. Instead, behavioral finance looked to psychology to explain asset valuation and why prices rise and fall. The primary representation of market behavior postulated by behavioral finance is the price-to-price feedback model: prices go up because prices have been going up, and prices go down because prices have been going down. If investors are making money because asset prices increase, other investors take note of the profits being made, and they want to capture those profits as well. They buy the asset, and prices continue to rise. The higher prices rise and the longer it goes on, the more attention is brought to the positive price changes and the more investors want to get involved. These investors are not buying because they think the asset is fairly valued, they are buying because the value is going up. They assume other rational investors must be bidding prices higher, and in their minds they "borrow" the collective expertise of the market. In reality, they are just following the herd.
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Mish's Global Economic Trend Analysis
Most think the Fed follows market expectations. Count me in that group as well. However, this creates what would appear at first glance to be a major paradox: If the Fed is simply following market expectations, can the Fed be to blame for the consequences? More pointedly, why isn't the market to blame if the Fed is simply following market expectations?
This is a very interesting theoretical question. While it's true the Fed typically only does what is expected, those expectations become distorted over time by observations of Fed actions.
For example: If market participants are expecting the Fed to cut on weakness and the Fed does, market participants gets into a psychology of expecting more cuts on more weakness. Here is another example: If market participants expect the Fed to cut rates when economic stress occurs, they will takes positions based on those expectations. These expectation cycles can be self reinforcing.
The Observer Affects The Observed
The Fed, in conjunction with all the players watching the Fed, distorts the economic picture. I liken this to Heisenberg's Uncertainty Principle where observation of a subatomic particle changes the ability to measure it accurately.
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Financial TimesThe proposal from Hank Paulson, US Treasury secretary, for reorganising government regulation of financial institutions misses the point. We need new thinking, not a reshuffling of regulatory agencies. The Federal Reserve has long had authority to issue rules for the mortgage industry but failed to exercise it. For the past 25 years or so the financial authorities and institutions they regulate have been guided by market fundamentalism: the belief that markets tend towards equilibrium and that deviations from it occur in a random manner. All the innovations – risk management, trading techniques, the alphabet soup of derivatives and synthetic financial instruments – were based on that belief. The innovations remained unregulated because authorities believe markets are self-correcting.
Regulators ought to have known better because it was their intervention that prevented the financial system from unravelling on several occasions. Their success has reinforced the misconception that markets are self-correcting. That in turn allowed a bubble of excessive credit to develop, which extended through the entire financial system. When the subprime mortgage crisis erupted it revealed all the weak points. Authorities, caught unawares, responded to each new disruption only after it occurred. They lacked the ability to foresee them because they were in the thrall of the market fundamentalist fallacy. They need a new paradigm. Market participants cannot base their decisions on knowledge, or what economists call rational expectations. There is a two-way, reflexive interaction between the participants' biased views and misconceptions and the real state of affairs. Instead of random deviations, reflexivity may give rise to initially self-reinforcing but eventually self-defeating boom-bust sequences or bubbles.
Instead of reshuffling regulatory agencies, the authorities ought to prepare for the next shoes to drop. I shall mention only two. There is an esoteric financial instrument called credit default swaps. The notional amount of CDS contracts outstanding is roughly $45,000bn. To put it into perspective, that is about equal to half the total US household wealth and about five times the national debt. The market is totally unregulated and those who hold the contracts do not know whether their counterparties have adequately protected themselves. If and when defaults occur, some of the counterparties are likely to prove unable to fulfil their obligations. This prospect hangs over the financial markets like a sword of Damocles that is bound to fall, but only after some defaults have occurred. That must have played a role in the Fed's decision not to allow Bear Stearns to fail. One possible solution is to establish a clearing house or exchange with a sound capital structure and strict margin requirements to which all existing and future contracts would have to be submitted. That would do more good in clearing the air than a grand regulatory reorganisation.
The other issue is rising foreclosures. About 40 per cent of the 6m subprime loans outstanding will default in the next two years. The defaults of option-adjustable-rate mortgages and other mortgages subject to rate reset will be of the same order of magnitude but occur over a longer period. With single family home sales running at an annual rate of 600,000, foreclosures will overwhelm the market and cause prices to overshoot on the downside. This will swell the number of homeowners with negative equity who may be tempted to turn in their keys. The fall in house prices will become practically bottomless until the government intervenes. Cutting foreclosures should be a priority but the measures so far are public relations exercises.
The Bush administration has resisted using taxpayers' money because of its market fundamentalist ideology. Apart from a bipartisan fiscal stimulus, it has left the conduct of policy largely to the Fed. Yet taxpayers' money will be needed to reduce foreclosures. Two proposals by Democrats in Congress strike a balance between the right to foreclosure and discouraging the exercise of that right. One would modify the bankruptcy laws allowing judges to modify the terms of mortgages on principal residences. Another would provide Federal Housing Administration guarantees that would enable mortgage holders to be paid off at 85 per cent of the current appraised value. These proposals will not solve the housing crisis, but go to the heart of the issue. They should be given serious consideration.
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The Mess That Greenspan Made
An honest answer would have been, "Get used to a lower standard of living", but the Fed chairman pulled the Federal Reserve trump card that can never be beaten - improve education so we can better compete globally.
That always works.
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naked capitalism
The actions taken by the Federal Reserve Bank of New York during the week of March 10, culminating with the March 16 announcement of the acquisition of BSC by JPM and the creation of an emergency loan facility for broker dealers, was not to rescue BSC but instead everyone else on Wall Street, particularly LEH, GS and JPM. In the case of JPM, a BSC bankruptcy filing could have started a chain reaction in the credit default swaps ("CDS") market that might have seriously damaged this huge derivatives dealer.
Some BSC partisans tell The IRA that the firm was the victim of a concerted "bear raid" by a number of hedge funds, which actively worked to undermine the BSC's liquidity while shorting the firm's stock and debt. Hedge funds reportedly were buying counterparty risk positions with BSC from other parties, and then demanding immediate payment or the return of collateral, deliberately accelerating the firm's collapse. Note: It is illegal to take such actions against a commercial bank, but not against a broker dealer.
On Wednesday March 12, BSC CEO Alan Schwartz told investors that the firm remained liquid and solvent, but by the market close on the following day BSC's fate was sealed by the hedge fund mafia, at least according to this version of events. Strange, is it not, that the managers of BCS's mortgage and repo desks did not give Schwartz a friendly heads up on the Wednesday.
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Last modified: March 12, 2019
Want to save the $? Then reverse all of those conditions, except the asset deflation which is irreversible. That would mean: a) raising the Fed funds to put a floor under the currency, c) some form of tariffs or taxes to drive down demand for some of those things we import but can't afford, d) rationing most likely of crucial commodities, though other suggestions are welcome, e) raise frickin' taxes 'cause we need some revenue, natch, and f) put the boys on the boat and sail for home, leaving all the junk stuck in the sand.
Can you imagine any policy maker in the US doing this? Well, I can: FDR. But he's dust in the tomb, and nobody on hand or on the way has the cojones or vision to tell the country it is in a life-threat kind of situation. So nothing will be done. More accurately, all the wrong things will be done because that is exactly what is being done now.
It is not inconceivable that after a major crisis the $ might recover as the reserve currency in a decade or three. I'm skeptical, but this potentiality shouldn't be ruled out. Our economy is large, and ultimately will substantially recover if we make the effort. But the world will be a (much) different place by then, and we're out of practice playing catch up.