Got an audience? Want to put them to sleep? Talk of interest rates will do the trick every time. This is a tad ironic as this topic impacts all of us personally.
World markets trade bonds just like anything else. There is a key relationship between price and interest rate. Let’s start there.
Assume that company A wishes to borrow and issues an IOU, a bond ($1000 minimum denomination). Assume lenders require A to pay a 6% coupon for that loan, or $60/yr, say for 10 years. Now assume over the next 12 months economic conditions slow so that when B, an identical credit to A needs to borrow, B needs only to offer 5% to acquire the funds. But assume you are a holder of bond A and wish to sell after one year. Will you ask only $1000, face value? Naturally not as the interest rate associated with similar credits to A is now 5%. Instead you will price your bond at $1200, making the attached coupon of 6% worth 5%, or the market rate. Nice little profit.
Instead of general conditions, there may be some extraneous factor(s) which make A’s bonds attractive - say a cure for cancer. Thus investors will drive A’s bond price up steeply and quickly even though the general interest rate environment has not changed.
Thus, interest rates down, prices up. Or, interest rates up, prices down. That’s all there is to it.
Conditions of individual bond pricing are far more complex but it is only necessary for most of us to understand this simple relationship or axiom to acquire a long leg over most laymen.
Now let us look at the current situation, at the US instead of company A as a borrower. Given the latest world financial turmoil large investors (China, Saudis, St of Cal pension, college endowment funds, etc) seek shelter. The safest place to shelter one’s funds is in short-term US treasuries. This tremendous demand, something we call "flight-to-quality" (could be a cure for cancer) has driven treasury prices through the roof. And so we know that yields must correspondingly take a nose dive. They have. The yield on 90 day treasury bills is 0.02% for goodness sake. So in a bit of a twist the US is paying next to nothing to finance the billions in rescue packages orchestrated in Washington.
Robert Craven
Sunday, December 7, 2008
Thursday, November 27, 2008
Banks - Useless At Best
Policy initiatives in place have eased the credit crisis. As Fed Governor Kevin Warsh pointed out last week: "We have had a forceful response from monetary, fiscal and financial policymakers. There are some notable signs of improvement. Short-term funding spreads are retreating from extremely elevated levels. Funding maturities are being extended beyond the very near term. Money market funds and commercial paper markets are showing signs of stabilization. And credit default swap spread of banking institutions are narrowing significantly."
Translation - the liquidity crisis, inter-bank, is over. Fine. Great. What’s it mean for us? Next to nothing. Banks won’t lend. Banks are essential but they refuse to act. As Willem Buiter puts it, "After years of excess and anything goes, the bean counters and risk controllers now rule supreme in the banking world. There is little upside to lending and taking a risk, but a lot of downside. Rolling over an old loan or extending a new one won’t help your bonus and it may cost you your job."
This is critical folks. Unless the banks start lending in normal volumes very soon, this recession could indeed become another great depression. We did not label our sketch of Oct/9 - "1929?", on a whim.
It’s not just US banks. In the UK, legal curbs may be imposed on banks if they fail to abide by a new code of practice on lending. They will also be compelled to open their books to the government so that their lending can be monitored. Whoa! But good businesses and consumers are starved of credit so why not. "I am in no doubt that the single most pressing challenge to domestic economic policy is to get the banking system to begin lending in any normal sense. That is more important than anything else at present," Bk of Eng gov Mervyn King said this week. King (the very best of all central bank gov’s, our view) also held the threat of wholesale nationalization over these banking clowns!
From Buiter, "We have no longer just a crisis in the financial system. We have gone even beyond the stage where there is a crisis of the financial system."
Getting banks to lend again is even more essential than establishing primary and secondary markets for garbage assets. In the US as elsewhere, small and medium enterprises rely overwhelmingly on banks for external finance. We all know that. Without access to bank loans, credit lines and overdraft facilities, countless small and intermediate sized businesses that would be perfectly viable with a functional financial and banking system, that are great credits, are threatened with bankruptcy. They’re innocent for goodness sake!!
What is to be done? 1) The US may have to set aggregate lending targets to the domestic non-financial business sector for each bank (last year’s total plus 7 percent, say). The banks themselves can decide who to lend to and on what terms. Any shortfall of actual lending from the target is translated dollar for dollar into some kind of tax. Since not meeting the target amounts to throwing money away, the banks will probably lend. Or, 2) nationalize those that don’t (paying as little as possible to the existing shareholders), fire the existing management and board of directors, and have the government appoint a new executive and a new board that are serious about meeting lending targets.
This is nonsense.
Robert Craven
Translation - the liquidity crisis, inter-bank, is over. Fine. Great. What’s it mean for us? Next to nothing. Banks won’t lend. Banks are essential but they refuse to act. As Willem Buiter puts it, "After years of excess and anything goes, the bean counters and risk controllers now rule supreme in the banking world. There is little upside to lending and taking a risk, but a lot of downside. Rolling over an old loan or extending a new one won’t help your bonus and it may cost you your job."
This is critical folks. Unless the banks start lending in normal volumes very soon, this recession could indeed become another great depression. We did not label our sketch of Oct/9 - "1929?", on a whim.
It’s not just US banks. In the UK, legal curbs may be imposed on banks if they fail to abide by a new code of practice on lending. They will also be compelled to open their books to the government so that their lending can be monitored. Whoa! But good businesses and consumers are starved of credit so why not. "I am in no doubt that the single most pressing challenge to domestic economic policy is to get the banking system to begin lending in any normal sense. That is more important than anything else at present," Bk of Eng gov Mervyn King said this week. King (the very best of all central bank gov’s, our view) also held the threat of wholesale nationalization over these banking clowns!
From Buiter, "We have no longer just a crisis in the financial system. We have gone even beyond the stage where there is a crisis of the financial system."
Getting banks to lend again is even more essential than establishing primary and secondary markets for garbage assets. In the US as elsewhere, small and medium enterprises rely overwhelmingly on banks for external finance. We all know that. Without access to bank loans, credit lines and overdraft facilities, countless small and intermediate sized businesses that would be perfectly viable with a functional financial and banking system, that are great credits, are threatened with bankruptcy. They’re innocent for goodness sake!!
What is to be done? 1) The US may have to set aggregate lending targets to the domestic non-financial business sector for each bank (last year’s total plus 7 percent, say). The banks themselves can decide who to lend to and on what terms. Any shortfall of actual lending from the target is translated dollar for dollar into some kind of tax. Since not meeting the target amounts to throwing money away, the banks will probably lend. Or, 2) nationalize those that don’t (paying as little as possible to the existing shareholders), fire the existing management and board of directors, and have the government appoint a new executive and a new board that are serious about meeting lending targets.
This is nonsense.
Robert Craven
Tuesday, November 18, 2008
Detroit - Drop Dead
We all have witnessed the begging; it continues today before the Senate Banking Comm.. Yesterday GM took this behavior offshore, pleading for a billion-euro credit guarantee from the German government to help its Opel subsidiary. Too much.
And, we all know the story: All three vehicle companies were heavily into producing trucks and SUV's when the sharp run up in gas prices induced consumers to shift to smaller and more fuel-efficient cars. Yet the huge cost resulting from the big three’s obsequious, compliant response to UAW demands made it impossible for the companies to sell for a profit ANYTHING BUT the big cars and SUVs that, after gas prices hit $4 a gallon last spring, almost no one wanted to buy.
The only money GM for example made recently came not from car production but from its automobile credit business - GMAC. The financial crisis has dried up the money available to auto financing companies and hence eliminated the major source of their income.
From Gary Becker, Univ of Chicago econ prof and ‘92 Nobel recipient: "The main problem with American auto companies is that during the good times of the 1970s, 1980s and 1990s, they made overly generous settlements with the United Auto workers (UAW) on wages, pensions, and health benefits. Only a couple of years ago, GM was paying $5 billion per year in health benefits to retirees and current employees because their plans had wide health coverage with minimal co-payments and deductibility on health claims by present and retired employees." They caved to the UAW parasites because they could pass the cost right on to us. Now they’re broke and want $25 bln more than the $25 bln loan negotiated in September.
"Keeping the Detroit Three in their present form, with their extravagant health care benefits and the union's 5,000 pages of work rules, is an exercise in preserving in amber the America of the past," Mike Barone explains. It is not that cars cannot be produced profitably with American workers for goodness sake: the American plants of Toyota and other Japanese companies, and of German auto manufacturers, have been profitable for many years. The foreign companies have achieved this mainly by setting up their factories in Southern and border states where they could avoid the UAW and thereby introduce efficient methods of production. Their workers have been paid well but not excessively, and these companies have kept their pension and health obligations under control while still maintaining good morale among their employees.
Will taxpayers allow Pelosi, Obama and the rest to reward the UAW for its political support and permanently damage America’s economy in doing so? Will politics trump sound economics? Let us hope not. As we argued earlier, allowing GM to go bankrupt would enable the courts to order changes in the company's onerous labor and supplier contracts. Meanwhile, just as the airlines continued to fly while in bankruptcy, GM could continue to produce such cars as it might be able to sell. But the status quo clearly won’t work, and, every literate American knows it. A study by the Center for Automotive Research found that UAW compensation is 68 percent higher than the average for the U.S. manufacturing sector. And some 40 million American taxpayers who do not have health insurance, some because they can't afford it are not pleased at the prospect of watching their tax dollars finance the lavish health-care plan that the UAW extracted from a compliant General Motors in the good old days.
Finally, recall that the big three make fewer than half the new vehicles sold in the United States. If one or two were to fail the big foreign makers are established enough, many experts say, to take control of the industry and its supplier network, perhaps more quickly than is widely understood. Then the new kings of the auto industry would presumably be Toyota, Honda, Nissan, Volkswagen, Daimler, Bayerische Motoren Werke and Hyundai-Kia. (Volkswagen has not yet opened a plant in the United States, and BMW and Hyundai each have one plant.)
So sorry Big Three, it’s been good to know ya but it’s time to go. Nothing personal. There should be some decent public provision for the losers and there is: unemployment benefits, welfare. But welcome to the healthy process of creative destruction. We are a nation of risk takers and adventurers, taking our chances with life and fate. As one observer put it, when we stop being that, we become some smug, placid welfarist haven of security and egalitarianism — a big Sweden.
Robert Craven
And, we all know the story: All three vehicle companies were heavily into producing trucks and SUV's when the sharp run up in gas prices induced consumers to shift to smaller and more fuel-efficient cars. Yet the huge cost resulting from the big three’s obsequious, compliant response to UAW demands made it impossible for the companies to sell for a profit ANYTHING BUT the big cars and SUVs that, after gas prices hit $4 a gallon last spring, almost no one wanted to buy.
The only money GM for example made recently came not from car production but from its automobile credit business - GMAC. The financial crisis has dried up the money available to auto financing companies and hence eliminated the major source of their income.
From Gary Becker, Univ of Chicago econ prof and ‘92 Nobel recipient: "The main problem with American auto companies is that during the good times of the 1970s, 1980s and 1990s, they made overly generous settlements with the United Auto workers (UAW) on wages, pensions, and health benefits. Only a couple of years ago, GM was paying $5 billion per year in health benefits to retirees and current employees because their plans had wide health coverage with minimal co-payments and deductibility on health claims by present and retired employees." They caved to the UAW parasites because they could pass the cost right on to us. Now they’re broke and want $25 bln more than the $25 bln loan negotiated in September.
"Keeping the Detroit Three in their present form, with their extravagant health care benefits and the union's 5,000 pages of work rules, is an exercise in preserving in amber the America of the past," Mike Barone explains. It is not that cars cannot be produced profitably with American workers for goodness sake: the American plants of Toyota and other Japanese companies, and of German auto manufacturers, have been profitable for many years. The foreign companies have achieved this mainly by setting up their factories in Southern and border states where they could avoid the UAW and thereby introduce efficient methods of production. Their workers have been paid well but not excessively, and these companies have kept their pension and health obligations under control while still maintaining good morale among their employees.
Will taxpayers allow Pelosi, Obama and the rest to reward the UAW for its political support and permanently damage America’s economy in doing so? Will politics trump sound economics? Let us hope not. As we argued earlier, allowing GM to go bankrupt would enable the courts to order changes in the company's onerous labor and supplier contracts. Meanwhile, just as the airlines continued to fly while in bankruptcy, GM could continue to produce such cars as it might be able to sell. But the status quo clearly won’t work, and, every literate American knows it. A study by the Center for Automotive Research found that UAW compensation is 68 percent higher than the average for the U.S. manufacturing sector. And some 40 million American taxpayers who do not have health insurance, some because they can't afford it are not pleased at the prospect of watching their tax dollars finance the lavish health-care plan that the UAW extracted from a compliant General Motors in the good old days.
Finally, recall that the big three make fewer than half the new vehicles sold in the United States. If one or two were to fail the big foreign makers are established enough, many experts say, to take control of the industry and its supplier network, perhaps more quickly than is widely understood. Then the new kings of the auto industry would presumably be Toyota, Honda, Nissan, Volkswagen, Daimler, Bayerische Motoren Werke and Hyundai-Kia. (Volkswagen has not yet opened a plant in the United States, and BMW and Hyundai each have one plant.)
So sorry Big Three, it’s been good to know ya but it’s time to go. Nothing personal. There should be some decent public provision for the losers and there is: unemployment benefits, welfare. But welcome to the healthy process of creative destruction. We are a nation of risk takers and adventurers, taking our chances with life and fate. As one observer put it, when we stop being that, we become some smug, placid welfarist haven of security and egalitarianism — a big Sweden.
Robert Craven
Thursday, November 13, 2008
Still Confused?
Still Confused? We’ve taken a shot at explaining the crisis, including the heart of the matter - the Democrat’s party-line blockage of intended ‘06 Rep reform of the twins, for which only one elected Democrat has so far apologized - Arthus Davis, D-Ala. Every one of these clowns owe every one of us Americans an apology. When our friends from the left vote the ticket, it’s the same as saying - we forgive you for tanking our 401K’s.
Still, most remain confused or, in the case of the Marin County kelp eaters - willfully blind. Perhaps we were too partisan. PJ O’Rourke may be better suited as a tutor, and, takes a more practical approach. Here’s his take:
"The left has no idea what's going on in the financial crisis. And I honor their confusion. Jim Jerk down the road from me, with all the cars up on blocks in his front yard, falls behind in his mortgage payments, and the economy of Iceland implodes. I'm missing a few pieces of this puzzle myself.
Under constant political pressure...... a lot of lousy mortgages that would never be repaid were handed out to Jim Jerk and his drinking buddies and all the ex-wives and single mothers with whom Jim and his pals have littered the nation.
Wall Street looked at the worthless paper and thought, "How can we make a buck off this?" The answer was to wrap it in a bow. Take a wide enough variety of lousy mortgages--some from the East, some from the West, some from the cities, some from the suburbs, some from shacks, some from McMansions–bundle them together and put pressure on the bond rating agencies to do fancy risk management math, and you get a "collateralized debt obligation" with a triple-A rating. Good as cash. Until it wasn't.
Or, put another way, Wall Street was pulling the "room full of horse s--" trick. Brokerages were saying, "We're going to sell you a room full of horse s--. And with that much horse s--, you just know there's a pony in there somewhere."
Anyway, it's no use blaming Wall Street. Blaming Wall Street for being greedy is like scolding defensive linemen for being big and aggressive. The people on Wall Street never claimed to be public servants. They took no oath of office. They're in it for the money. We pay them to be in it for the money. We don't want our retirement accounts to get a 2 percent return. (Although that sounds pretty good at the moment.)
What will destroy our country and us is not the financial crisis but the fact that liberals think the free market is some kind of sect or cult, which conservatives have asked Americans to take on faith.That's not what the free market is. The free market is just a measurement, a device to tell us what people are willing to pay for any given thing at any given moment. The free market is a bathroom scale. You may hate what you see when you step on the scale. "Jeeze, 230 pounds!" But you can't pass a law making yourself weigh 185. Liberals think you can. And voters--all the voters, right up to the tippy-top corner office of Goldman Sachs--think so too.
Although I must say we're doing good work on our final task--attaching the garden hose to our car's exhaust pipe and running it in through a vent window. Barack and Michelle will be by in a moment with some subsidized ethanol to top up our gas tank. And then we can turn the key."
Still, most remain confused or, in the case of the Marin County kelp eaters - willfully blind. Perhaps we were too partisan. PJ O’Rourke may be better suited as a tutor, and, takes a more practical approach. Here’s his take:
"The left has no idea what's going on in the financial crisis. And I honor their confusion. Jim Jerk down the road from me, with all the cars up on blocks in his front yard, falls behind in his mortgage payments, and the economy of Iceland implodes. I'm missing a few pieces of this puzzle myself.
Under constant political pressure...... a lot of lousy mortgages that would never be repaid were handed out to Jim Jerk and his drinking buddies and all the ex-wives and single mothers with whom Jim and his pals have littered the nation.
Wall Street looked at the worthless paper and thought, "How can we make a buck off this?" The answer was to wrap it in a bow. Take a wide enough variety of lousy mortgages--some from the East, some from the West, some from the cities, some from the suburbs, some from shacks, some from McMansions–bundle them together and put pressure on the bond rating agencies to do fancy risk management math, and you get a "collateralized debt obligation" with a triple-A rating. Good as cash. Until it wasn't.
Or, put another way, Wall Street was pulling the "room full of horse s--" trick. Brokerages were saying, "We're going to sell you a room full of horse s--. And with that much horse s--, you just know there's a pony in there somewhere."
Anyway, it's no use blaming Wall Street. Blaming Wall Street for being greedy is like scolding defensive linemen for being big and aggressive. The people on Wall Street never claimed to be public servants. They took no oath of office. They're in it for the money. We pay them to be in it for the money. We don't want our retirement accounts to get a 2 percent return. (Although that sounds pretty good at the moment.)
What will destroy our country and us is not the financial crisis but the fact that liberals think the free market is some kind of sect or cult, which conservatives have asked Americans to take on faith.That's not what the free market is. The free market is just a measurement, a device to tell us what people are willing to pay for any given thing at any given moment. The free market is a bathroom scale. You may hate what you see when you step on the scale. "Jeeze, 230 pounds!" But you can't pass a law making yourself weigh 185. Liberals think you can. And voters--all the voters, right up to the tippy-top corner office of Goldman Sachs--think so too.
Although I must say we're doing good work on our final task--attaching the garden hose to our car's exhaust pipe and running it in through a vent window. Barack and Michelle will be by in a moment with some subsidized ethanol to top up our gas tank. And then we can turn the key."
Tuesday, November 11, 2008
The Week Ahead
First, a follow-up on Detroit. We wrote earlier that GM and the rest must be allowed to fail, figuring why pour good $ after bad. There is no way we taxpayers can finance their cash burn rate. Let them go into bankruptcy, taking their miserable unions with them. The world liquidity crisis is not the cause of their problem. The Three Stooges started losing billions years ago when the economy was healthy. And there is no equivalent in the scope of contagion compared to that of the just-past liquidity crisis. Naturally failure will impact the rubber, carpet, iron, glass industries, all the rest. But we are not yet Western Europe. Bite the bullet.
But wait cautions one acquaintance, be realistic. That is not politically viable. It’s not going to happen in Washington Bob. And what about owners of cars with no warrantee for example?
OK, maybe our friend has a point. A better option may be that detailed in yesterday’s WSJ: Paul Ingrassia, the paper’s Detriot bureau chief agrees that giving GM (apparently in the worst shape of the three, with the other two close behind) a blank check would be a grave mistake. "The company would just burn through the money and come back for more. Even more jobs would be wiped out in the end" (our earlier point). "Instead, in return for government aid, the board and the management must go. Shareholders should lose their paltry remaining equity. And a gov’t-sponsored receiver - someone hard-nosed and nonpolitical - should have broad power to revamp GM with a viable business plan and return it to private operation as soon as possible." Ingrassia continues, "That will mean tearing up existing contracts with unions, dealers and suppliers, closing some operations and selling others, and downsizing the company. The same basic rules should apply to Ford and Chrysler." And we might add that when in the process of restructuring, look to the so-called Detroit South where Toyota, Hyundai, and other foreign auto makers have expanded car production in recent years, although in states where unions are practically non-existent and labor is cheap.
Thus, if our plan is not politically viable, then as Ingrassia concludes, "a complete restructuring under a government overseer or oversight board has to be the price". Fine. Let’s do it. Democrats, are you listening?
The Week Ahead
World leaders will meet Nov/15. Watch the price of oil as an indicator of the odds for success. Crude is a useful tool in this regard. For example, one key reason crude rose just under 3% in after-hours trading Sun was the news that China has enacted a massive stimulus package, the view she might remain an engine for global demand. Oil is now softer, partly on today’s poor world corporate earning news which has temporarily at least, trumped that view. The price will reflect the tug-of-war between economic reality, and, hope for international cooperation to re-fire economic activity.
Friday’s Oct Retail Sales is this week’s key focus in the mind of the mkt crowd. Expectations are for a dismal figure. If there is a risk to this release, the figure may not be as bad as expected but it will be plenty bad nevertheless. Until Friday, look for more signs of corporate grief.
In the meantime, inter-bank liquidity continues to thaw, that initial crisis on the way to becoming history.
Robert Craven
But wait cautions one acquaintance, be realistic. That is not politically viable. It’s not going to happen in Washington Bob. And what about owners of cars with no warrantee for example?
OK, maybe our friend has a point. A better option may be that detailed in yesterday’s WSJ: Paul Ingrassia, the paper’s Detriot bureau chief agrees that giving GM (apparently in the worst shape of the three, with the other two close behind) a blank check would be a grave mistake. "The company would just burn through the money and come back for more. Even more jobs would be wiped out in the end" (our earlier point). "Instead, in return for government aid, the board and the management must go. Shareholders should lose their paltry remaining equity. And a gov’t-sponsored receiver - someone hard-nosed and nonpolitical - should have broad power to revamp GM with a viable business plan and return it to private operation as soon as possible." Ingrassia continues, "That will mean tearing up existing contracts with unions, dealers and suppliers, closing some operations and selling others, and downsizing the company. The same basic rules should apply to Ford and Chrysler." And we might add that when in the process of restructuring, look to the so-called Detroit South where Toyota, Hyundai, and other foreign auto makers have expanded car production in recent years, although in states where unions are practically non-existent and labor is cheap.
Thus, if our plan is not politically viable, then as Ingrassia concludes, "a complete restructuring under a government overseer or oversight board has to be the price". Fine. Let’s do it. Democrats, are you listening?
The Week Ahead
World leaders will meet Nov/15. Watch the price of oil as an indicator of the odds for success. Crude is a useful tool in this regard. For example, one key reason crude rose just under 3% in after-hours trading Sun was the news that China has enacted a massive stimulus package, the view she might remain an engine for global demand. Oil is now softer, partly on today’s poor world corporate earning news which has temporarily at least, trumped that view. The price will reflect the tug-of-war between economic reality, and, hope for international cooperation to re-fire economic activity.
Friday’s Oct Retail Sales is this week’s key focus in the mind of the mkt crowd. Expectations are for a dismal figure. If there is a risk to this release, the figure may not be as bad as expected but it will be plenty bad nevertheless. Until Friday, look for more signs of corporate grief.
In the meantime, inter-bank liquidity continues to thaw, that initial crisis on the way to becoming history.
Robert Craven
Saturday, November 8, 2008
Obama's Test #1
One more rescue and a new consciousness will be permanently embedded in the fabric of American culture. We will indeed have joined in lock step with Europe’s social democracies, where the bureaucracy has assumed most normal adult responsibilities.
"A healthy automobile manufacturing sector is essential to the restoration of financial market stability, the overall health of our economy, and the livelihood of the automobile sector's workforce,'' Pelosi and Reid said in a letter urging Paulson to use some of the $700bln for a $50bln loan to the Three Stooges. What Pelosi really meant was "Preserving an antiquated industry is essential...." Even then, her first point is false; the second point is only true if one’s horizon in measured in months; the third is true - but so what? Let them find other jobs for goodness sake. Taxpayers owe vehicle assemblers a living? Why? How are they singled out?
Sure vehicle sales are slow; we all know that. Here, auto sales are at the lowest level since 1961. Daimler sales worldwide are off something like 20%, y/y. Vehicle sales in the UK were down 23% last month from Sep. An Essex online car dealer last week offered two Dodge Avenger models for the price of one, an offer as the Guardian put it, "...is more usually seen on washing powder or packets of bacon." Change goes with the territory in a free mkt economy. It’s tough times for a lot of folk.
There can be no credible contagion argument favoring this industry. None. The same arguments supporting taxpayer repair of a world liquidity crisis do not apply. Let the unseen hand do its work. Failure, then the American phoenix of creativity. Out of this spontaneous order will spring a new invigorated vehicle industry. Out of taxpayer enabling will spring nothing but more problems, calling for an even more painful solution, end of the next cycle.
We expect Bush to hold the line. For the sake of his legacy, he better. Then it's up to Obama. A year ago in Detroit Obama assailed the US industry for failing to meet global demand for fuel-efficient cars. "The need to drastically change our energy policy is no longer a debatable proposition," he said. "It's not a question of whether, but how; not a question of if, but when. For the sake of our security, our economy, our jobs and our planet, the age of oil must end in our time." Well Mr Obama, the time has arrived. Will you adhere to this vision, or simply cave as you did with the Chicago machine? We’ll soon find out.
Robert Craven
"A healthy automobile manufacturing sector is essential to the restoration of financial market stability, the overall health of our economy, and the livelihood of the automobile sector's workforce,'' Pelosi and Reid said in a letter urging Paulson to use some of the $700bln for a $50bln loan to the Three Stooges. What Pelosi really meant was "Preserving an antiquated industry is essential...." Even then, her first point is false; the second point is only true if one’s horizon in measured in months; the third is true - but so what? Let them find other jobs for goodness sake. Taxpayers owe vehicle assemblers a living? Why? How are they singled out?
Sure vehicle sales are slow; we all know that. Here, auto sales are at the lowest level since 1961. Daimler sales worldwide are off something like 20%, y/y. Vehicle sales in the UK were down 23% last month from Sep. An Essex online car dealer last week offered two Dodge Avenger models for the price of one, an offer as the Guardian put it, "...is more usually seen on washing powder or packets of bacon." Change goes with the territory in a free mkt economy. It’s tough times for a lot of folk.
There can be no credible contagion argument favoring this industry. None. The same arguments supporting taxpayer repair of a world liquidity crisis do not apply. Let the unseen hand do its work. Failure, then the American phoenix of creativity. Out of this spontaneous order will spring a new invigorated vehicle industry. Out of taxpayer enabling will spring nothing but more problems, calling for an even more painful solution, end of the next cycle.
We expect Bush to hold the line. For the sake of his legacy, he better. Then it's up to Obama. A year ago in Detroit Obama assailed the US industry for failing to meet global demand for fuel-efficient cars. "The need to drastically change our energy policy is no longer a debatable proposition," he said. "It's not a question of whether, but how; not a question of if, but when. For the sake of our security, our economy, our jobs and our planet, the age of oil must end in our time." Well Mr Obama, the time has arrived. Will you adhere to this vision, or simply cave as you did with the Chicago machine? We’ll soon find out.
Robert Craven
Friday, November 7, 2008
Lao Tsu
The Oct Payroll figure fell more than expected (240k vs 200k consensus), unemp printed 6.5% vs expectations of 6.3%. Losses were widespread across most categories. Much of these losses (aggravated by the Boeing strike, -27k, which is now settled) are due to the collateral effects of the credit crunch, now slowly being repaired. So far in ‘08 1.18 million jobs have been lost, half those in the last 3 months.
As we predicted Nov/3, by today, the view for a full blown recession will be set in stone. It is. Our readers have known we are in a recession for a few weeks now. That is not news any more.
The Tao
Following yesterday’s loss in the US equity mkt, one news service declared, "Dow drops 443 in reaction to retail sales report." This is utter nonsense. World markets move for a whole range of reasons, too complex and complicated for any one mortal or organization to understand. After work, home and enjoying a cocktail, TV is on and the commentator assures you that this is why the mkt did this today. Fine. You go to bed secure, that must be it. This has nothing to do with insight but with selling advertising.
Lao Tsu said, "Those who know, do not speak; those who speak, do not know." Certainly Lao Tsu was not thinking of TV anchors; there were few around in his day. Instead, he was focused on core knowledge or wisdom; however, we have taken license to apply his wisdom to the mkt and why not? It works.
Whether through the medium of TV or radio or newsprint, no matter - analysts all talk to each other, and, the same sources. They all look at the same statistics and they all reach similar conclusions. Forecasters (mostly economists, ill equipped for the task) gather together for security in times of maximum price violence. The greater the uncertainty, the greater the similarity of predictions as the experts shout together in the dark. And in turn, the greater will be the collective surprise when their estimates miss the mark.
As Alan Watts noted, there is indeed a wisdom to insecurity. This is esp true in the financial world. There should be a fail safe - when we feel absolutely certain about being right there should be a gremlin assigned to the task to say, "OK, it is highly likely that you are wrong." Or, when the herd is supremely confident in one direction, it is time to take the other.
Robert Craven
As we predicted Nov/3, by today, the view for a full blown recession will be set in stone. It is. Our readers have known we are in a recession for a few weeks now. That is not news any more.
The Tao
Following yesterday’s loss in the US equity mkt, one news service declared, "Dow drops 443 in reaction to retail sales report." This is utter nonsense. World markets move for a whole range of reasons, too complex and complicated for any one mortal or organization to understand. After work, home and enjoying a cocktail, TV is on and the commentator assures you that this is why the mkt did this today. Fine. You go to bed secure, that must be it. This has nothing to do with insight but with selling advertising.
Lao Tsu said, "Those who know, do not speak; those who speak, do not know." Certainly Lao Tsu was not thinking of TV anchors; there were few around in his day. Instead, he was focused on core knowledge or wisdom; however, we have taken license to apply his wisdom to the mkt and why not? It works.
Whether through the medium of TV or radio or newsprint, no matter - analysts all talk to each other, and, the same sources. They all look at the same statistics and they all reach similar conclusions. Forecasters (mostly economists, ill equipped for the task) gather together for security in times of maximum price violence. The greater the uncertainty, the greater the similarity of predictions as the experts shout together in the dark. And in turn, the greater will be the collective surprise when their estimates miss the mark.
As Alan Watts noted, there is indeed a wisdom to insecurity. This is esp true in the financial world. There should be a fail safe - when we feel absolutely certain about being right there should be a gremlin assigned to the task to say, "OK, it is highly likely that you are wrong." Or, when the herd is supremely confident in one direction, it is time to take the other.
Robert Craven
Thursday, November 6, 2008
Update
Reflecting official concern with slowing conditions, the Bank of England and the European Central Bank both cut their base rates today (as expected). The surprise was the magnitude of the BkofEng cut - 1 ½% (150 bp’s) - intended shock treatment for that economy. Immediately after, the gov’t urged lenders to pass on all of the cut to borrowers (mortgages pegged to the base rate) and almost immediately lenders explained why they will have trouble doing so. Only Lloyds pledged to pass on the entire cut at this writing. Nevertheless, the magnitude of the cut, putting the benchmark at the lowest level since 1955, will impact positively. This is a good thing because as we highlighted earlier, UK banks (and those of the EU) have a far scarier exposure to developing credits, ongoing, than we do.
At home, this am we saw so-called Chain Store sales for Oct (representing about 10% of total Retail Sales); they were below expectations for 60% of the stores reporting. This is not really news; much of this weakness is already priced in. Tomorrow’s Oct Payroll report is key. The employment data give the most comprehensive report on how many people are looking for jobs, how many have them, what they're getting paid and how many hours they are working. The number is expected to be lower by 200,000, and unemp higher at 6.3%. This would be the 10th consecutive decline in total employment; we last saw 6.3% in 6/03, then to a cyclical low of 4.4% in 3/07, last 6.1% (Sep). At one time we could generally predict the result of this key release for our clients, vs economists’ expectations; we are a tad rusty at the moment so we’ll have to wait and see.
Violence will continue in the equity mkt - really just a freak show. We have inquiries by those who wonder - is it time to buy? We only try to close the pattern early on general fundamentals. A rule we learned the hard way is this: in the financial mkts one must be right at the right time. One’s view re a stock, or stocks in general, or interest rates, or currency or sovereign credits may be correct and for the correct reasons. Yet if the mkt crowd does not agree they can convert you to crow bait in nothing flat as they rush the other direction, then just when you are getting up, they realize you were right, and flatten you a second time. Or from another prospective - how long can you hold your breath.
Robert Craven
At home, this am we saw so-called Chain Store sales for Oct (representing about 10% of total Retail Sales); they were below expectations for 60% of the stores reporting. This is not really news; much of this weakness is already priced in. Tomorrow’s Oct Payroll report is key. The employment data give the most comprehensive report on how many people are looking for jobs, how many have them, what they're getting paid and how many hours they are working. The number is expected to be lower by 200,000, and unemp higher at 6.3%. This would be the 10th consecutive decline in total employment; we last saw 6.3% in 6/03, then to a cyclical low of 4.4% in 3/07, last 6.1% (Sep). At one time we could generally predict the result of this key release for our clients, vs economists’ expectations; we are a tad rusty at the moment so we’ll have to wait and see.
Violence will continue in the equity mkt - really just a freak show. We have inquiries by those who wonder - is it time to buy? We only try to close the pattern early on general fundamentals. A rule we learned the hard way is this: in the financial mkts one must be right at the right time. One’s view re a stock, or stocks in general, or interest rates, or currency or sovereign credits may be correct and for the correct reasons. Yet if the mkt crowd does not agree they can convert you to crow bait in nothing flat as they rush the other direction, then just when you are getting up, they realize you were right, and flatten you a second time. Or from another prospective - how long can you hold your breath.
Robert Craven
Tuesday, November 4, 2008
Optimism
We gave reason for optimism, Oct/23 and Oct/29, that the worst of the liquidity crisis may be behind us. At this writing we are further encouraged that this is so, noting for example that interbank lending rates are tumbling, 90 LIBOR last at 2.71% from 4.82% just a little over three weeks ago. As expected Australia’s central bank cut its benchmark rate. Look for the EU and Bk of Eng to follow on Thursday. The heart of the system is beating again. There is a ton of work to do, many, many unknowns (at least to us), but the free-fall is history.
Our banking system is in relatively good shape compared to some others. Be thankful we are not Europe. As we highlighted earlier, here is the next potential avalanche (but it too is at least partially priced in by now). European and UK banks are five times more exposed to emerging markets than US banks. They alone hold what one observer called "the collective time-bomb of $1.6 trillion (£990bn) in hard currency loans to Eastern Europe – now starting to detonate in Hungary, Ukraine, Romania, and even Russia." This is their very own credit bubble. This will slow the world's recovery to be sure but it will not create another free fall; a system is now in place to prevent that.
The other prime consideration for all of us of course remains the US real sector. Yesterday’s manufacturing and veh sales data were worse than expected. Here of course we see the results of contagion. For example, the seizing up of the credit markets, plus course weakness in the labor markets put vehicle sales in the out house, sales of autos down over 10% to the lowest level since 1961. We have the key Oct payroll release on Friday. It will be very weak but at this point such weakness is priced in so that it will not be a shocker, our view.
In spite of lower US eco growth, lower Treasury yields and lower employment, the $ continues to strengthen vs all other major world currencies except the Yen. Why? Much is so-called "flight-to-quality" - world institutions seeking safety in US securities (still the world’s safest). And part is the great deleveraging as it has become known - problems elsewhere. Many investors have been following a version of the "carry trade," borrowing money in a low-yielding currency. All they had to do was earn a higher return from assets in higher yielding currencies than the cost of their financing. Since the two currencies with the lowest yields over the past year have been the dollar and the yen, those were the natural ones to borrow. However, when asset prices fall in Brazil, Russia, the Ukraine, Indonesia and elsewhere, this strategy is disastrous. Investors dash to sell assets and repay their debts. Since those debts were incurred in dollars and yen, that means they have to buy back those two currencies—hence their sharp recent rises.
Robert Craven
Our banking system is in relatively good shape compared to some others. Be thankful we are not Europe. As we highlighted earlier, here is the next potential avalanche (but it too is at least partially priced in by now). European and UK banks are five times more exposed to emerging markets than US banks. They alone hold what one observer called "the collective time-bomb of $1.6 trillion (£990bn) in hard currency loans to Eastern Europe – now starting to detonate in Hungary, Ukraine, Romania, and even Russia." This is their very own credit bubble. This will slow the world's recovery to be sure but it will not create another free fall; a system is now in place to prevent that.
The other prime consideration for all of us of course remains the US real sector. Yesterday’s manufacturing and veh sales data were worse than expected. Here of course we see the results of contagion. For example, the seizing up of the credit markets, plus course weakness in the labor markets put vehicle sales in the out house, sales of autos down over 10% to the lowest level since 1961. We have the key Oct payroll release on Friday. It will be very weak but at this point such weakness is priced in so that it will not be a shocker, our view.
In spite of lower US eco growth, lower Treasury yields and lower employment, the $ continues to strengthen vs all other major world currencies except the Yen. Why? Much is so-called "flight-to-quality" - world institutions seeking safety in US securities (still the world’s safest). And part is the great deleveraging as it has become known - problems elsewhere. Many investors have been following a version of the "carry trade," borrowing money in a low-yielding currency. All they had to do was earn a higher return from assets in higher yielding currencies than the cost of their financing. Since the two currencies with the lowest yields over the past year have been the dollar and the yen, those were the natural ones to borrow. However, when asset prices fall in Brazil, Russia, the Ukraine, Indonesia and elsewhere, this strategy is disastrous. Investors dash to sell assets and repay their debts. Since those debts were incurred in dollars and yen, that means they have to buy back those two currencies—hence their sharp recent rises.
Robert Craven
Monday, November 3, 2008
The Week Ahead
Over the near term we have two fronts to monitor; that is, two economic arenas, both of which will impact our individual lives. First of course is the so-called world sub-prime crisis, the liquidity panic/now solvency crisis, birthed due to lack of proper regulation of Fannie & Freddie. A flood of less-than-prime mortgage paper, collateralized for the final investor, is all over the world. No one knows what any of it is worth. Readers recall from past postings the chronology of this event. Key - trust evaporated between major world banks. They lied to each other and to their regulators. Inter-bank lending ceased, and with it, the heart of the world’s financial system nearly stopped beating. We know that temporary dams have been erected, most major world credits, to stop the free fall. We applaud this accomplishment. Most of these mechanisms followed Darling’s lead. Banking institutions are receiving capital injections from the US taxpayer. The taxpayer is receiving preferred stock in return. In the UK and EU there are similar measures. Next, in countries without the resources to rescue their own the IMF is extracting tough terms for money lent.
Second, we have the US economy in isolation - just how weak is it; what can we do, what ammunition does the Fed have left? These then are the two prime considerations for the US consumer. Let us address this second concern first.
This week we will have two important eco releases, one on the health of manufacturing and one of the overall employment situation. Today we will see the Inst For Supply Mgmt manufacturing survey for Oct (new orders, order backlogs, prices received, employment & inventories). This is a key release; it was through the floor for Sep - far below expectations after being flat for most of the year. On Fri we will see the Employment release for Oct. Although a coincident indicator, this remains the key release for each month. It is expected to be very weak and will no doubt cooperate. By Friday the view for a full blown recession will be set in stone.
What can the Fed do? Not much. It has already injected floods of $ into the system but this is little more than pushing on a string at the moment. Impact now is mostly psychological. We must look to Washington. The assistance of a corporate tax cut to 25% and a cap gains cut to 10% will go out the door if McCain does not win; the period of recovery will then be extended.
Next, beginning Nov/15 we will gain some idea of what finance ministers have in mind for the new world financial landscape. The IMF seems to have inherited the lead role for now. Just this weekend Brown urged the Saudi’s to kick up their contribution as Iceland and others have already used up $30 bln of the IMF’s reserves, with Belarus, Turkey, Pakistan and Serbia, Hungary and Ukraine waiting in line.
Meanwhile, other policy tools are easing the liquidity panic at home. The Fed's new commercial paper facility, which began on Tuesday, helped to reignite that vital source of corporate funds. Treasury's capital injections into banks as noted above are also restoring confidence as they reach some of the struggling regional banks. And the key 90 day LIBOR rate continues to decline, last at 2.86% vs 3.50% just a week ago. This is very good news and means activity between US banks, and between US banks and other major foreign banks, continues to thaw. Look for the UK, the EU and Australia to join the global easing cycle this week (following moves in the US, Japan, HK, Norway, China, Tawain & India last week) which should push this rate even lower.
What shocks may be offered up this week? Look perhaps to emerging markets, where gathering economic woes are bound to lead to more bank losses, but primarily banks in Europe, no so much the US. An analyst at the Royal Bank of Scotland points out that European banks have more than seven times the claims on developing countries than their American rivals; in eastern Europe, the ratio is 25 to 1.
Robert Craven
Second, we have the US economy in isolation - just how weak is it; what can we do, what ammunition does the Fed have left? These then are the two prime considerations for the US consumer. Let us address this second concern first.
This week we will have two important eco releases, one on the health of manufacturing and one of the overall employment situation. Today we will see the Inst For Supply Mgmt manufacturing survey for Oct (new orders, order backlogs, prices received, employment & inventories). This is a key release; it was through the floor for Sep - far below expectations after being flat for most of the year. On Fri we will see the Employment release for Oct. Although a coincident indicator, this remains the key release for each month. It is expected to be very weak and will no doubt cooperate. By Friday the view for a full blown recession will be set in stone.
What can the Fed do? Not much. It has already injected floods of $ into the system but this is little more than pushing on a string at the moment. Impact now is mostly psychological. We must look to Washington. The assistance of a corporate tax cut to 25% and a cap gains cut to 10% will go out the door if McCain does not win; the period of recovery will then be extended.
Next, beginning Nov/15 we will gain some idea of what finance ministers have in mind for the new world financial landscape. The IMF seems to have inherited the lead role for now. Just this weekend Brown urged the Saudi’s to kick up their contribution as Iceland and others have already used up $30 bln of the IMF’s reserves, with Belarus, Turkey, Pakistan and Serbia, Hungary and Ukraine waiting in line.
Meanwhile, other policy tools are easing the liquidity panic at home. The Fed's new commercial paper facility, which began on Tuesday, helped to reignite that vital source of corporate funds. Treasury's capital injections into banks as noted above are also restoring confidence as they reach some of the struggling regional banks. And the key 90 day LIBOR rate continues to decline, last at 2.86% vs 3.50% just a week ago. This is very good news and means activity between US banks, and between US banks and other major foreign banks, continues to thaw. Look for the UK, the EU and Australia to join the global easing cycle this week (following moves in the US, Japan, HK, Norway, China, Tawain & India last week) which should push this rate even lower.
What shocks may be offered up this week? Look perhaps to emerging markets, where gathering economic woes are bound to lead to more bank losses, but primarily banks in Europe, no so much the US. An analyst at the Royal Bank of Scotland points out that European banks have more than seven times the claims on developing countries than their American rivals; in eastern Europe, the ratio is 25 to 1.
Robert Craven
Wednesday, October 29, 2008
Update
The Fed is expected to cut their key rate by 50 basis points today (½ of 1% to 1%), this following the coordinated 50 bp rate cuts of Oct/8 (ECB, BofE, Fed & 4 others). Japan may follow Friday, then the BofE and the ECB most certainly next week. China cut its key rate today, the third time in six weeks, claiming it does not want to join the funeral march.
Over the near term, the stock market will remain a freak show, maybe fun to watch but providing little insight. World credit markets remain key and these continue to thaw gradually, today’s 90 day LIBOR rate at 3.42% indicating modest to fair activity in world inter bank lending. The commercial paper market is moving thanks to Fed purchases of this short-term business credit. These are good things.
Government rescue packages are beginning to kick in, US, UK, EU. Other countries, originally laggards, are now coming around. Japan will increase its bank bailout scheme, S Korea will take "drastic steps," Kuwait’s central bank just rescued the Gulf Bank. Those governments lacking the resources to rescue their own are applying to the IMF, the most recent hike in Iceland’s key rate the price that country was required to pay for the assistance. A proposed new liquidity fund at the IMF may be approved as soon as next week, offering countries up to 5 times their IMF quota. Hungary, Iceland, Belarus, Ukraine and Serbia and Pakistan are in line. The politics of application of all of this - beyond our pay grade.
Background: As Bernanke’s bubble has burst, world commodity prices have collapsed and with that, so too the economies of developing countries who primarily exported these goods (and the whining ethanol lobby) This activity had been financed by western banks, not so much US but EU and Brit. So the vicious circle. With credit and demand scarce, shipping has collapsed, as good an indicator of world health as we can get. For example, a few months ago one payed about $240,000 as daily rental for a large container ship. That last printed $7340! Empty ships are everywhere. To see how things are intertwined, Greek families control a third of the global freight market for bulk goods. Thus, there is flight from Greek bonds. The UK’s Royal Bank of Scotland and HSBC financed the share of the shipping activity. Both these banks are this instant taking major chunks of UK taxpayer cash. And so it goes.
We continue to be fairly optimistic. We have no idea which bank will be next, but world authorities have moved quickly to address these situations. Only a sovereign default (Russia, Argentina) at this point would open new windows of risk.
We had earlier broached the idea of a Bretton-Woods-like conference; sure enough we will have such an event Nov/15 in Washington. A regional pre-event was recently concluded in Asia and things seemed surprisingly cooperative. We don’t know what to expect other than the world’s financial landscape will change forever, or at least, during our lifetime.
Robert Craven
Over the near term, the stock market will remain a freak show, maybe fun to watch but providing little insight. World credit markets remain key and these continue to thaw gradually, today’s 90 day LIBOR rate at 3.42% indicating modest to fair activity in world inter bank lending. The commercial paper market is moving thanks to Fed purchases of this short-term business credit. These are good things.
Government rescue packages are beginning to kick in, US, UK, EU. Other countries, originally laggards, are now coming around. Japan will increase its bank bailout scheme, S Korea will take "drastic steps," Kuwait’s central bank just rescued the Gulf Bank. Those governments lacking the resources to rescue their own are applying to the IMF, the most recent hike in Iceland’s key rate the price that country was required to pay for the assistance. A proposed new liquidity fund at the IMF may be approved as soon as next week, offering countries up to 5 times their IMF quota. Hungary, Iceland, Belarus, Ukraine and Serbia and Pakistan are in line. The politics of application of all of this - beyond our pay grade.
Background: As Bernanke’s bubble has burst, world commodity prices have collapsed and with that, so too the economies of developing countries who primarily exported these goods (and the whining ethanol lobby) This activity had been financed by western banks, not so much US but EU and Brit. So the vicious circle. With credit and demand scarce, shipping has collapsed, as good an indicator of world health as we can get. For example, a few months ago one payed about $240,000 as daily rental for a large container ship. That last printed $7340! Empty ships are everywhere. To see how things are intertwined, Greek families control a third of the global freight market for bulk goods. Thus, there is flight from Greek bonds. The UK’s Royal Bank of Scotland and HSBC financed the share of the shipping activity. Both these banks are this instant taking major chunks of UK taxpayer cash. And so it goes.
We continue to be fairly optimistic. We have no idea which bank will be next, but world authorities have moved quickly to address these situations. Only a sovereign default (Russia, Argentina) at this point would open new windows of risk.
We had earlier broached the idea of a Bretton-Woods-like conference; sure enough we will have such an event Nov/15 in Washington. A regional pre-event was recently concluded in Asia and things seemed surprisingly cooperative. We don’t know what to expect other than the world’s financial landscape will change forever, or at least, during our lifetime.
Robert Craven
Thursday, October 23, 2008
Small World
We are in a recession even if it has not been officially announced. Technically, that means two consecutive negative Qts. Details, details.
The so-called sub-prime crisis cut off the economy’s life blood in that it did away with trust. Bankers lied to each other, and, to their regulators. One banker in the UK suddenly regarded his counterpart in the US as a leper. The heart of the world credit system - inter-bank lending - came to an abrupt halt. A few weeks of this is enough to convert a slowing but positive growth rate into a corrosive event. However, the near-miraculous quick fix of two weeks ago put a floor under the free fall. How bad would it have been? The finance ministers knew; no way they would have sculpted a deal so quickly if they had not. We would have experienced a near depression (not a full depression in the sense of ‘29 - soup cans - only because of the lesson taught by Friedman and Schwartz some 40 + years ago).
The US plan is not perfect. "In the long run, Americans will always do the right thing after exploring all other alternatives," Winston Churchill said during WWII, as Americans were debating whether or not to enter the European theater. We are still grouping. For example, in the case of the 9 banks initially selected the injection of capital is through (non-voting) preference shares yielding an absurdly low 5%. In the UK, the taxpayers are getting 12%, and, with a gov’t-appointed board. Without voting shares, the gov’t has no voice in running these banks. And, it has no seats on their boards. And the whole shebang will be managed by a 35 year old. What?
Still, we know by monitoring the 90 day LIBOR rate that $’s are flowing again between banks. US, UK and EU banks have started to lend rather than hoard cash. We’re seeing the worst of the seizure in money markets come to an end. Clearly the global rescue effort is having an effect. This is a very good thing.
Over the near term we will watch world events because they impact most of us directly these days. Thus, we need to know that shipping is slowing world wide, that freight rates for grains, coal and iron are down substantially. We need to know that deliveries dropped 15% in Long Beach last month. We need to know that the IMF just had to rescue Hungary and the Ukraine. We need to know that the German economy is stagnant. We need not be surprised if we see Russia fail to pay its debts (again). We need to know that Brazil is in a free-fall, that Argentina may go into default next week. This and more will give us a clue about what is in store over the near term. But at this juncture there is reason for optimism. Here is why: The mkt crowd, after missing entirely what could have been a fatal flaw now feels suddenly enlightened, given to original insight even, and, as is almost always the way has rushed to the other extreme, that is, has priced in a far worse scenario for next year than reality, our view. Once again, more psychology than economics.
Robert Craven
The so-called sub-prime crisis cut off the economy’s life blood in that it did away with trust. Bankers lied to each other, and, to their regulators. One banker in the UK suddenly regarded his counterpart in the US as a leper. The heart of the world credit system - inter-bank lending - came to an abrupt halt. A few weeks of this is enough to convert a slowing but positive growth rate into a corrosive event. However, the near-miraculous quick fix of two weeks ago put a floor under the free fall. How bad would it have been? The finance ministers knew; no way they would have sculpted a deal so quickly if they had not. We would have experienced a near depression (not a full depression in the sense of ‘29 - soup cans - only because of the lesson taught by Friedman and Schwartz some 40 + years ago).
The US plan is not perfect. "In the long run, Americans will always do the right thing after exploring all other alternatives," Winston Churchill said during WWII, as Americans were debating whether or not to enter the European theater. We are still grouping. For example, in the case of the 9 banks initially selected the injection of capital is through (non-voting) preference shares yielding an absurdly low 5%. In the UK, the taxpayers are getting 12%, and, with a gov’t-appointed board. Without voting shares, the gov’t has no voice in running these banks. And, it has no seats on their boards. And the whole shebang will be managed by a 35 year old. What?
Still, we know by monitoring the 90 day LIBOR rate that $’s are flowing again between banks. US, UK and EU banks have started to lend rather than hoard cash. We’re seeing the worst of the seizure in money markets come to an end. Clearly the global rescue effort is having an effect. This is a very good thing.
Over the near term we will watch world events because they impact most of us directly these days. Thus, we need to know that shipping is slowing world wide, that freight rates for grains, coal and iron are down substantially. We need to know that deliveries dropped 15% in Long Beach last month. We need to know that the IMF just had to rescue Hungary and the Ukraine. We need to know that the German economy is stagnant. We need not be surprised if we see Russia fail to pay its debts (again). We need to know that Brazil is in a free-fall, that Argentina may go into default next week. This and more will give us a clue about what is in store over the near term. But at this juncture there is reason for optimism. Here is why: The mkt crowd, after missing entirely what could have been a fatal flaw now feels suddenly enlightened, given to original insight even, and, as is almost always the way has rushed to the other extreme, that is, has priced in a far worse scenario for next year than reality, our view. Once again, more psychology than economics.
Robert Craven
Sunday, October 19, 2008
Anna Schwartz Disagrees
Anna Schwartz does not feel compelled to impress people with her grip on yard-long equations and cosmic economic theory. She is naturally inclined, in the spirit of this blog, to explain complex problems in simple terms - the greatest gift any of us can make to our friends. (We are not always equal to the task but we give it our best shot.)
Readers recall that Schwartz in 1963 co-authored with Milton Friedman, "A Monetary History of the United States", a book which placed conventional wisdom about the cause of the Depression, squarely on its head. The last time we saw Schwartz was 10/93 when we two testified before the House Banking Committee on Fed reform. At 92 and still working at the NBER she remains an icon in the profession.
We heralded the administration’s about face in adopting Darling’s plan. We knew that the Fed had flooded the market in vain - no trust, no lending. We figured then that taxpayer capitalization would work to thaw the inter bank market, key to our troubles, and anyway, we didn’t think banks would cooperate with the other plan - endless arguing about the best price to sell their rubbish to us taxpayers. Recall that the 90 day LIBOR rate best reflects banks’ willingness to lend; prior to Paulson’s decision that rate was 4.82% but last it was 4.42% so indeed, there has been some improvement, some movement in money lent bank to bank since that announcement.
Chicken feed argues Schwartz. She says that resuscitating flawed institutions sets the wrong precedent, carrying a chronic infection with it. Recapitalize all you want; the so-called toxic securities will remain - no one knows how little they’re worth and despite the Fed’s or the adm’s efforts, if they remain we’re going nowhere quickly.
That is why Schwartz welcomed Paulson’s original plan when we did not. And why did Paulson abandon that plan and join Darling’s? Because if this garbage is priced at current market levels, selling this stuff, as Schwartz in quoted in a recent WSJ editorial, "would be a recipe for instant insolvency at many institutions." (Which is why we suspected they would not cooperate) Yet Schwartz argues that keeping insolvent firms afloat just prolongs the crisis. "Firms that made wrong decisions should fail," she says. "You should not rescue them. And once that’s established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished...." .
Tough to argue with this, at least the theory. Well, perhaps with implementation. But what about "systemic risk" you may ask Schwartz, that risk originating from the opaque web connecting most of the world’s major financial institutions, the domino effect? She doesn’t buy that either, dismissing most of that noise to market whiners.
Finally this from Schwartz, an anchor no matter how we view the details: "I think if you have some principles and know what you’re doing, the market responds. They see that you have some structure to your actions, that it is not just ad hoc—you’ll do this today but something different tomorrow. Now, instead of looking principled, the authorities looked erratic and inconsistent. The market respects people in supervisory positions who seem to be on top of what’s going on. So I think if you’re tough about firms that invested unwisely, the market won’t blame you."
Robert Craven
Readers recall that Schwartz in 1963 co-authored with Milton Friedman, "A Monetary History of the United States", a book which placed conventional wisdom about the cause of the Depression, squarely on its head. The last time we saw Schwartz was 10/93 when we two testified before the House Banking Committee on Fed reform. At 92 and still working at the NBER she remains an icon in the profession.
We heralded the administration’s about face in adopting Darling’s plan. We knew that the Fed had flooded the market in vain - no trust, no lending. We figured then that taxpayer capitalization would work to thaw the inter bank market, key to our troubles, and anyway, we didn’t think banks would cooperate with the other plan - endless arguing about the best price to sell their rubbish to us taxpayers. Recall that the 90 day LIBOR rate best reflects banks’ willingness to lend; prior to Paulson’s decision that rate was 4.82% but last it was 4.42% so indeed, there has been some improvement, some movement in money lent bank to bank since that announcement.
Chicken feed argues Schwartz. She says that resuscitating flawed institutions sets the wrong precedent, carrying a chronic infection with it. Recapitalize all you want; the so-called toxic securities will remain - no one knows how little they’re worth and despite the Fed’s or the adm’s efforts, if they remain we’re going nowhere quickly.
That is why Schwartz welcomed Paulson’s original plan when we did not. And why did Paulson abandon that plan and join Darling’s? Because if this garbage is priced at current market levels, selling this stuff, as Schwartz in quoted in a recent WSJ editorial, "would be a recipe for instant insolvency at many institutions." (Which is why we suspected they would not cooperate) Yet Schwartz argues that keeping insolvent firms afloat just prolongs the crisis. "Firms that made wrong decisions should fail," she says. "You should not rescue them. And once that’s established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished...." .
Tough to argue with this, at least the theory. Well, perhaps with implementation. But what about "systemic risk" you may ask Schwartz, that risk originating from the opaque web connecting most of the world’s major financial institutions, the domino effect? She doesn’t buy that either, dismissing most of that noise to market whiners.
Finally this from Schwartz, an anchor no matter how we view the details: "I think if you have some principles and know what you’re doing, the market responds. They see that you have some structure to your actions, that it is not just ad hoc—you’ll do this today but something different tomorrow. Now, instead of looking principled, the authorities looked erratic and inconsistent. The market respects people in supervisory positions who seem to be on top of what’s going on. So I think if you’re tough about firms that invested unwisely, the market won’t blame you."
Robert Craven
Thursday, October 16, 2008
VIOLENCE
In the markets the business of the future is to be dangerous. For example, we don’t have a clue regarding short term fluctuations in the most watched of indicators - the stock market. World wide that market has been just a tad violent. Some of this is due to the inevitable second guessing of the rescue, that if not impotent it is at the very least lacking in horsepower. We did not anticipate this crisis, find it all too easy to criticize those who are trying to rectify it - simply shots from the cheap seats. Instead, we need to develop some notion of economic underpinnings, those anchors which will hold past the chaos and confusion. The rescue plan as sculpted last weekend is one of those; it is substantive. Economic ministers kept the secret. The choice was this: either come up with the money needed to allow them to nationalize the bulk of their banking systems by Monday or come up with the money needed to nationalize the bulk of all listed companies by the end of the week.
Yesterday’s reaction in the world equity markets was also triggered by a US Sep retail sales release that was over double the decline expected, and by the Fed’s dismal appraisal of near term economic conditions, both of these raising the notion of a recession (already baked in the cake, our view, and meaning two consecutive negative Qts). Other indicators included rocketing unemployment in the UK, slowing demand in China and signs that the highly levered economies of Easter Europe will need a bail out soon (Iceland acting perhaps as the canary). Finally, there is in the mix a whole myriad of factors that none of us can isolate. That does not stop the talking heads from telling an anxious audience exactly why we had a dive, knowing that the listeners will go home feeling (falsely) secure.
Robert Craven
Yesterday’s reaction in the world equity markets was also triggered by a US Sep retail sales release that was over double the decline expected, and by the Fed’s dismal appraisal of near term economic conditions, both of these raising the notion of a recession (already baked in the cake, our view, and meaning two consecutive negative Qts). Other indicators included rocketing unemployment in the UK, slowing demand in China and signs that the highly levered economies of Easter Europe will need a bail out soon (Iceland acting perhaps as the canary). Finally, there is in the mix a whole myriad of factors that none of us can isolate. That does not stop the talking heads from telling an anxious audience exactly why we had a dive, knowing that the listeners will go home feeling (falsely) secure.
Robert Craven
Wednesday, October 15, 2008
Simply Stunning
Throw a dart; it lands in the middle of a Des Moines pig farm. Ask the proprietor - "Do housing prices always go up?" "What? You nuts sonny? Been around much? Everything goes in cycles you dumb bunny." Indeed, and yet despite the fancy conduits, models, and the rest of the Rube Goldberg contraptions employed in the sub-prime crisis, no one factored in that truth.
Now we have seen the weekend decision to copy Darling’s plan. In Britain the government can decide to do something and, thanks to the parliamentary system, it becomes law in an instant. That is what happened.. Most striking about what might now be called the Brown-Bush, Darling-Paulson plan is that it represents an explicit repudiation of the first US administration proposal that passed through Congress two weeks ago. The old country to the rescue!
Now we have not just US and UK partial or majority ownership of their lending institutions, but world wide sovereign support of their respective lending institutions. This is simply stunning. How did we get here? What lies ahead?
Over the next week we will offer three installments, simplifying and explaining just what happened, and in some detail. However, in the most distilled sense: Greenspan’s mismanagement of the Fed created excess liquidity; it had to go somewhere. Most went into the best inflation hedge around - housing (not business investment). The twins under pressure from Congress supported the sub-prime mortgage market, converting risky loans into the near equivalent of Treasury bonds - but with higher returns. Lenders first resisted intimidation from ACORN and the like, but then went along willingly, discovering that the profits were as easy to come by as they were bloated. Wall St did its part to package the stuff; end line investors were happy. Problem is that no one bothered to call the Des Moines farmer.
Over the near term our core concern is that some nations themselves will have to be bailed out in order to bail out their own financial sector! Iceland of course comes to mind. In Iceland, the funding gap of the banking sector exceeds the fiscal capacity of the government. Period. There may be others; we will know before the year is out. If so this will call for an entirely new world bureaucracy.
Past that we want to believe that the state-ownership-and-control phase be as short as possible. History tells us that government is a dreadful owner and manager of anything. But then the idea is that this is all temporary. We want to believe that. And in the intermediate term the taxpayer may make a killing. This is certainly a real possibility. Yet key for now is to anticipate the new world financial landscape. Since the near collapse was due in large part to the old system of soft-touch regulation, or self regulation, or, in the case of the Democrats refusal to reform the twins - toothless supervision, we can assume that all will change before governments hand back the banks. What the banking industry now hopes will be necessary but minimal reform will likely be a comprehensive overhaul. We expect a world conference something on the order of the Bretton Woods of 64 years ago (created the IMF & World Bank) to sort these things out.
Robert Craven
Now we have seen the weekend decision to copy Darling’s plan. In Britain the government can decide to do something and, thanks to the parliamentary system, it becomes law in an instant. That is what happened.. Most striking about what might now be called the Brown-Bush, Darling-Paulson plan is that it represents an explicit repudiation of the first US administration proposal that passed through Congress two weeks ago. The old country to the rescue!
Now we have not just US and UK partial or majority ownership of their lending institutions, but world wide sovereign support of their respective lending institutions. This is simply stunning. How did we get here? What lies ahead?
Over the next week we will offer three installments, simplifying and explaining just what happened, and in some detail. However, in the most distilled sense: Greenspan’s mismanagement of the Fed created excess liquidity; it had to go somewhere. Most went into the best inflation hedge around - housing (not business investment). The twins under pressure from Congress supported the sub-prime mortgage market, converting risky loans into the near equivalent of Treasury bonds - but with higher returns. Lenders first resisted intimidation from ACORN and the like, but then went along willingly, discovering that the profits were as easy to come by as they were bloated. Wall St did its part to package the stuff; end line investors were happy. Problem is that no one bothered to call the Des Moines farmer.
Over the near term our core concern is that some nations themselves will have to be bailed out in order to bail out their own financial sector! Iceland of course comes to mind. In Iceland, the funding gap of the banking sector exceeds the fiscal capacity of the government. Period. There may be others; we will know before the year is out. If so this will call for an entirely new world bureaucracy.
Past that we want to believe that the state-ownership-and-control phase be as short as possible. History tells us that government is a dreadful owner and manager of anything. But then the idea is that this is all temporary. We want to believe that. And in the intermediate term the taxpayer may make a killing. This is certainly a real possibility. Yet key for now is to anticipate the new world financial landscape. Since the near collapse was due in large part to the old system of soft-touch regulation, or self regulation, or, in the case of the Democrats refusal to reform the twins - toothless supervision, we can assume that all will change before governments hand back the banks. What the banking industry now hopes will be necessary but minimal reform will likely be a comprehensive overhaul. We expect a world conference something on the order of the Bretton Woods of 64 years ago (created the IMF & World Bank) to sort these things out.
Robert Craven
Monday, October 13, 2008
MONDAY MORNING
We predicted in Saturday’s sketch (Thank You Darling) that if adopted by other major world credits, that Darling’s plan would place a floor under the free fall. After an extraordinary series of meetings this weekend, most of the G-20 (G-7, the EU & 12 countries) have accepted that plan of action; initial reactions, both in European and UK equity markets and LIBOR indicate a warm acceptance.
Of course, the treatment scares the living daylights out of all of us. Like early 19 century inoculations for smallpox, this could kill us, or at least make us very sick. For example, although the temporary nationalization of a good part of the G-7 banking sectors is unavoidable and indeed necessary, we hope we can avoid the introduction of the other trappings of comprehensive state ownership of the means of production, distribution and exchange. Should economists begin to dust off their manuals on central planning, cast Hayek into the recycling bin?
Robert Craven
Of course, the treatment scares the living daylights out of all of us. Like early 19 century inoculations for smallpox, this could kill us, or at least make us very sick. For example, although the temporary nationalization of a good part of the G-7 banking sectors is unavoidable and indeed necessary, we hope we can avoid the introduction of the other trappings of comprehensive state ownership of the means of production, distribution and exchange. Should economists begin to dust off their manuals on central planning, cast Hayek into the recycling bin?
Robert Craven
Saturday, October 11, 2008
THANK YOU DARLING
If you strike a king you had better kill him. Or, as a UK Treasury official noted Friday, "The lesson of the US plan is that you only get one shot at this. When you fire the bullet it has to hit its target." Indeed. World citizens must acknowledge a debt to UK Chancellor Alistair Darling for the concept, Bank of England governor Mervyn King for the support and Prime Minister Gordon Brown for the implementation of a (now model) strategy which if adopted by other major nations will first retard, then halt the world’s credit market free fall.
The total shutdown of interbank markets (see earlier posts) has begun to impact the real sector - honest to goodness businesses - and with death-ray speed. This key development, all too clear by late last week, panicked world governments. Earlier, the US team reacted in incremental fashion. Last week the UK team adopted the shock and awe approach.
The G-7, the G-20 - great big clubs; these guys all talk to each other, and all the time, perhaps the 15 or 20 most powerful people in world finance. Instead of many little things they all know one big thing - lending in the money markets must re-start soon or it’s all over (we did not select 1929 as a past headline with a dart throw). If banks do not start lending to each other we are guaranteed a depression. It gags most of us but partial nationalization is the only option left now. If that doesn’t work - full nationalization.
Darling’s rescue package has taxpayers effectively becoming shareholders in troubled banks. The government may even take seats on these banks’ boards. The package makes $340bln available to provide liquidity to the money markets so that banks will lend to each other again. It provides $42.5bln immediately to invest in the 8 biggest banks in the UK; in turn, the taxpayer receives preferred shares, paying anywhere from 8% to 10%. There is $42.5 bln behind that if needed. Originally Darling looked to own minority stakes. Developments at this writing indicate the UK may take majority stakes in some, perhaps RBS, HBOS, Lloyds & Barclays. Finally, the government will guarantee all loans that UK banks make to each other, up to around $425bln; it will charge the banks a fee for the guarantee. This is the biggest peace-time intervention the free world has ever seen. Truly stunning.
This will do the trick, or would except for the minor inconvenience that all the major world credits are linked. To rescue US or UK banks in isolation won’t cut it. Thus, the G-7, then the IMF took Brown’s plan under consideration this weekend. The IMF chief economist, one Olivier Blanchard, claimed yesterday that world equity markets may fall another 20%. This is nonsense; Oliver (there are no "Oliviers" where we come from) doesn’t have a clue, any more than my mule Speedy. However, it might happen if he and the rest of these clowns don’t get off their butts and actually do something for once.
Some countries will nationalize a few banks; some the entire banking system, our view. Within a few days, all major countries have to back taking stakes in their banks or we’re sunk. Next, all must in one form or another guarantee their banks’ loans made in the inter bank market, provided the banks sign up for each government’s recapitalization program and pay for the privilege. It’s a good bet that most will comply.
The US has already changed tack to follow the Brits, Paulson allowing he too will inject capital directly into banks, taking some stakes in return (goodbye Land Of The Free).
Let’s monitor developments with G-20 compliance tomorrow and Monday.
Robert Craven.
The total shutdown of interbank markets (see earlier posts) has begun to impact the real sector - honest to goodness businesses - and with death-ray speed. This key development, all too clear by late last week, panicked world governments. Earlier, the US team reacted in incremental fashion. Last week the UK team adopted the shock and awe approach.
The G-7, the G-20 - great big clubs; these guys all talk to each other, and all the time, perhaps the 15 or 20 most powerful people in world finance. Instead of many little things they all know one big thing - lending in the money markets must re-start soon or it’s all over (we did not select 1929 as a past headline with a dart throw). If banks do not start lending to each other we are guaranteed a depression. It gags most of us but partial nationalization is the only option left now. If that doesn’t work - full nationalization.
Darling’s rescue package has taxpayers effectively becoming shareholders in troubled banks. The government may even take seats on these banks’ boards. The package makes $340bln available to provide liquidity to the money markets so that banks will lend to each other again. It provides $42.5bln immediately to invest in the 8 biggest banks in the UK; in turn, the taxpayer receives preferred shares, paying anywhere from 8% to 10%. There is $42.5 bln behind that if needed. Originally Darling looked to own minority stakes. Developments at this writing indicate the UK may take majority stakes in some, perhaps RBS, HBOS, Lloyds & Barclays. Finally, the government will guarantee all loans that UK banks make to each other, up to around $425bln; it will charge the banks a fee for the guarantee. This is the biggest peace-time intervention the free world has ever seen. Truly stunning.
This will do the trick, or would except for the minor inconvenience that all the major world credits are linked. To rescue US or UK banks in isolation won’t cut it. Thus, the G-7, then the IMF took Brown’s plan under consideration this weekend. The IMF chief economist, one Olivier Blanchard, claimed yesterday that world equity markets may fall another 20%. This is nonsense; Oliver (there are no "Oliviers" where we come from) doesn’t have a clue, any more than my mule Speedy. However, it might happen if he and the rest of these clowns don’t get off their butts and actually do something for once.
Some countries will nationalize a few banks; some the entire banking system, our view. Within a few days, all major countries have to back taking stakes in their banks or we’re sunk. Next, all must in one form or another guarantee their banks’ loans made in the inter bank market, provided the banks sign up for each government’s recapitalization program and pay for the privilege. It’s a good bet that most will comply.
The US has already changed tack to follow the Brits, Paulson allowing he too will inject capital directly into banks, taking some stakes in return (goodbye Land Of The Free).
Let’s monitor developments with G-20 compliance tomorrow and Monday.
Robert Craven.
Thursday, October 9, 2008
The Equity Market - A Side Show
Difficulties with the equity mkt pale when compared to what’s implied by the state of the inter-bank lending market (LIBOR, and readers now know what this is).
As our acquaintance Willem Buiter, Prof at the London School of Economics and (when we knew him) past policy maker at the Bk of England illustrates, "Gordon Brown is absolutely right in his proposal that the G7 offer state guarantees, on ‘commercial’ terms (really terms that provide the state with an adequate risk-adjusted return on the funds it commits) to restore life to interbank lending. Banks today don’t lend to each other without high-grade security at any but the shortest maturities. When banks don’t lend to each other, they don’t lend to the real economy - non-financial businesses and households. That is the road to economic disaster."
Buiter continues, "Large-scale fiscally financed injections of capital into the banking systems of the US and the EU (sans UK) are required immediately. In addition, there is an urgent need for direct interventions in the financial markets, targeted directly at the blockages/distortions preventing these markets from functioning. That means either unsecured lending by the central bank to the banks (i.e. the central bank interposing itself as counter party of last resort in the interbank market) or Treasury guarantees of interbank transactions. The banks participating in the interbank markets are inherently border-crossing institutions. Only if all EU members, the EU orphans (Switzerland, Norway, Iceland), the US, Japan and Canada decide on a common approach to getting interbank lending going again is there a realistic chance of success."
Translation for our friends: Continental European governments, the UK and US authorities better stop hoping for a miracle. Systemically important markets have failed. Now, only the power of the state offers sanctuary. How sad.
Robert Craven
As our acquaintance Willem Buiter, Prof at the London School of Economics and (when we knew him) past policy maker at the Bk of England illustrates, "Gordon Brown is absolutely right in his proposal that the G7 offer state guarantees, on ‘commercial’ terms (really terms that provide the state with an adequate risk-adjusted return on the funds it commits) to restore life to interbank lending. Banks today don’t lend to each other without high-grade security at any but the shortest maturities. When banks don’t lend to each other, they don’t lend to the real economy - non-financial businesses and households. That is the road to economic disaster."
Buiter continues, "Large-scale fiscally financed injections of capital into the banking systems of the US and the EU (sans UK) are required immediately. In addition, there is an urgent need for direct interventions in the financial markets, targeted directly at the blockages/distortions preventing these markets from functioning. That means either unsecured lending by the central bank to the banks (i.e. the central bank interposing itself as counter party of last resort in the interbank market) or Treasury guarantees of interbank transactions. The banks participating in the interbank markets are inherently border-crossing institutions. Only if all EU members, the EU orphans (Switzerland, Norway, Iceland), the US, Japan and Canada decide on a common approach to getting interbank lending going again is there a realistic chance of success."
Translation for our friends: Continental European governments, the UK and US authorities better stop hoping for a miracle. Systemically important markets have failed. Now, only the power of the state offers sanctuary. How sad.
Robert Craven
1929 ?
Radical measures taken yesterday have yet to impact. The 90 day LIBOR rate jumped to 4.75% this am ( http://www.bloomberg.com/markets/rates/keyrates.html). Take our word for it - this means that aside from a little O/N activity, banks are not lending to each other.
Central banks continue to lower key rates. Our problem has nothing to do with rates at this juncture, but lack of trust.
The WSJ editorialized this morning that there is "Progress Amid the Ruins." Maybe so. They’re smarter than we are. We just don’t see it.
KEY - Banks are not raising enough capital to offset losses.
Certainly yesterday’s UK Treasury mandate appears to be a positive - injections in return for partial gov’t ownership. Certainly Paulson’s flirting today with a similar rescue (US taxpayers inject capital and take a position), although it would gag Hayek and please Marx, may be a positive. There are other plans afoot.
May the force be with us.
Robert Craven
Central banks continue to lower key rates. Our problem has nothing to do with rates at this juncture, but lack of trust.
The WSJ editorialized this morning that there is "Progress Amid the Ruins." Maybe so. They’re smarter than we are. We just don’t see it.
KEY - Banks are not raising enough capital to offset losses.
Certainly yesterday’s UK Treasury mandate appears to be a positive - injections in return for partial gov’t ownership. Certainly Paulson’s flirting today with a similar rescue (US taxpayers inject capital and take a position), although it would gag Hayek and please Marx, may be a positive. There are other plans afoot.
May the force be with us.
Robert Craven
Wednesday, October 8, 2008
CONTAGION
The loss of confidence in financial institutions, as of yesterday pm, was complete. Today’s globally coordinated package aims to insert trust into a world wide financial web that has been completely without it. In addition to the Fed, the European Central Bank, the Swiss, Canada, China, Hong Kong - all cut rates drastically. The UK announced their rescue plan which among other things partially nationalizes major banks. German, Ireland and Greece pledged to guarantee savers deposits. Iceland took over two of its largest banks. Spain agreed to bail out its banks by taking on $68 Bln of their assets. My goodness.
What was at first a liquidity problem, triggered by the US mortgage mess (and key within that, the failure of Fan/Fred) has now become a world wide solvency crisis. All the world’s major banks are intertwined and in incredibly complex ways, many of these unregulated and hidden. Now funding has evaporated; no one trusts anyone else not knowing what’s on their books. Interbank lending, the life blood of the system, is unsecured. If one bank lends to another it relies (or relied) on trust that it will get it back with interest. Central banks have been flooding the markets with cash but to little avail. Banks simply hoarded anything they can get their hands on because of fear of counter party risk. Hoarding cash to rebuild one’s balance sheet quickly becomes a habit, a state of mind. This is one reason part of today’s UK package in effect guarantees banks’ debt to, hopefully, restore confidence and get banks lending to one another again.
Contagion has moved quickly in the US from the financial to the non-financial sector. The so-called commercial paper market provides corporations with short term funds - anywhere from a few days to a few months. This is how they fund their day-to-day operations (not capital operations). This was a well established (over 90 years), deep and liquid market. Last week this market became frozen. Nobody wanted to take any risk at all, not even to GE. So with the recent announcement the Fed is now backing that market too, meaning the Fed is in the direct business of making loans to the private sector. This is a stunning development.
Look at this as a very large wicked loop. Weakness spreads from the financial arena quickly to consumer and capital spending, from a global slowdown to US exports (until recently a real strength), promoting further and more intense declines in employment, then pressuring income, consumers and lenders, on and on.
Robert Craven
What was at first a liquidity problem, triggered by the US mortgage mess (and key within that, the failure of Fan/Fred) has now become a world wide solvency crisis. All the world’s major banks are intertwined and in incredibly complex ways, many of these unregulated and hidden. Now funding has evaporated; no one trusts anyone else not knowing what’s on their books. Interbank lending, the life blood of the system, is unsecured. If one bank lends to another it relies (or relied) on trust that it will get it back with interest. Central banks have been flooding the markets with cash but to little avail. Banks simply hoarded anything they can get their hands on because of fear of counter party risk. Hoarding cash to rebuild one’s balance sheet quickly becomes a habit, a state of mind. This is one reason part of today’s UK package in effect guarantees banks’ debt to, hopefully, restore confidence and get banks lending to one another again.
Contagion has moved quickly in the US from the financial to the non-financial sector. The so-called commercial paper market provides corporations with short term funds - anywhere from a few days to a few months. This is how they fund their day-to-day operations (not capital operations). This was a well established (over 90 years), deep and liquid market. Last week this market became frozen. Nobody wanted to take any risk at all, not even to GE. So with the recent announcement the Fed is now backing that market too, meaning the Fed is in the direct business of making loans to the private sector. This is a stunning development.
Look at this as a very large wicked loop. Weakness spreads from the financial arena quickly to consumer and capital spending, from a global slowdown to US exports (until recently a real strength), promoting further and more intense declines in employment, then pressuring income, consumers and lenders, on and on.
Robert Craven
Saturday, October 4, 2008
This Time - It Is That Simple
A frustrated Thomas Sowell inquired this morning, "Do facts matter any more?". Indeed they do, yet they require explanation, to be made simple, in little bites so the masses may digest leisurely and at their own pace. Surely the McCain campaign understands that facts matter yet it is about to squander that very key fact, one which is undeniable, not in shades, but black from white and upon which the fate of the election rests - the role of liberal Democrats as the agent of the current crisis. This is not judgement; it is a fact. For those liberal friends of ours who nonstop whine about their 401K, their house price and are in search of the villain - they need only look to their own party. This time - it is that simple.
From early Sep we have highlighted the complicity of Fannie/Freddie and the Democrats, how those agencies became a cash cow for Barney Frank, Dodd, Clinton, Obama and others. It was liberal Democrats led by Dodd and Frank who for years, even this year, denied that the twins were taking outsized risks. It was liberal Democrats who for years push the twins for go further and further into sub-primes, into poorer and poorer neighborhoods. It was the same bunch who for years refused requests from the Bush adm to set up an agency to regulate Fan/Fre, the same bunch who defeated S-190, the bill co-authored by McCain which carried major reform and would have prevented this very crisis. If that bill would have become law, today’s world would be different. That such a reckless stand could have been taken by one party is obscene, unforgivable. The Democrats who opposed portfolio limitations could not possibly have gotten away with it if their constituents understood what they were doing. But then Obama, Clinton, Dodd and others of the left received mind-boggling amounts of $ support from the twins, the twins’ private profit finding its way back to the left, who then killed the fix.
We have already demonstrated that it was the gov’t that pressured banks and others to lend to poor credits through the CRA, coupled with threats of legal action from Janet Reno if they did not. And it was the gov’t, not free enterprise, that encouraged the twins to go along. It was Fan/Fre which played THE key role in the creation of sub-primes AND, through their incestuous relationship with wall st, the sub-prime mortgage-backed securities themselves. For the left, this was win / win: by pressuring banks to serve poor borrowers in poor regions Frank and Dodd and others could go on record pushing for an increase in home ownership and urban development, and by working with the twins, encouraging them to take more risk, they effectively could subsidize low income housing off budget. Off budget that is, until just a few days ago.
Robert Craven
From early Sep we have highlighted the complicity of Fannie/Freddie and the Democrats, how those agencies became a cash cow for Barney Frank, Dodd, Clinton, Obama and others. It was liberal Democrats led by Dodd and Frank who for years, even this year, denied that the twins were taking outsized risks. It was liberal Democrats who for years push the twins for go further and further into sub-primes, into poorer and poorer neighborhoods. It was the same bunch who for years refused requests from the Bush adm to set up an agency to regulate Fan/Fre, the same bunch who defeated S-190, the bill co-authored by McCain which carried major reform and would have prevented this very crisis. If that bill would have become law, today’s world would be different. That such a reckless stand could have been taken by one party is obscene, unforgivable. The Democrats who opposed portfolio limitations could not possibly have gotten away with it if their constituents understood what they were doing. But then Obama, Clinton, Dodd and others of the left received mind-boggling amounts of $ support from the twins, the twins’ private profit finding its way back to the left, who then killed the fix.
We have already demonstrated that it was the gov’t that pressured banks and others to lend to poor credits through the CRA, coupled with threats of legal action from Janet Reno if they did not. And it was the gov’t, not free enterprise, that encouraged the twins to go along. It was Fan/Fre which played THE key role in the creation of sub-primes AND, through their incestuous relationship with wall st, the sub-prime mortgage-backed securities themselves. For the left, this was win / win: by pressuring banks to serve poor borrowers in poor regions Frank and Dodd and others could go on record pushing for an increase in home ownership and urban development, and by working with the twins, encouraging them to take more risk, they effectively could subsidize low income housing off budget. Off budget that is, until just a few days ago.
Robert Craven
Tuesday, September 30, 2008
Lights Out, or Darn Close
Warren Buffet and I have something in common after all - we both figured this deal would pass yesterday, both it seems demonstrating the need for a lesson in politics.
It was a given that libertarian types would resist on principle. But as the AP noted this am, 2/3's of Congress’ most vulnerable members decided to protect their seats, notwithstanding what most of them knew would be the implications of a "No" vote. One Rep Congressman noted that, "Most of us say, ‘I want this thing to pass, but I want you to vote for it, not me.’" Their calculation - the date of their election will be before the full impact of the financial collapse made likely by their vote, that is, before this events wallops their constituents’ jobs and businesses. These folk yesterday put re-election before the health of the nation and the intermediate to long-term interests of their constituents. Since the masses see this as a bail out of wall st types, not as a means to an end, this was a pretty risk-free approach (given emails and phone calls at nearly 200:1 against). They don’t understand that if in the next day or two (Sen - Wed, Hse - Thur) zero is accomplished, we will experience nothing less than a financial melt down, impacting each and every one of us.
We highlighted in the Sep/19 sketch the interconnection of the world’s financial institutions. Just one step away from these institutions are major businesses. Most do not realize how critically these guys rely on short-term loans for routine operations like payroll for example, and there is a very well established market (commercial paper) for that purpose. But credit is nearly frozen, between financial institutions first, and between financial institutions and the rest of the world’s borrowers secondly.
What happened to these credit markets yesterday converts an equity mkt 700 pt loss into a side show. We predicted earlier that Tbill rates would drop to 0.0% on a fail to pass. Pretty close! The 90 day Tbill rate went to 0.132%. What’s that mean? It means an immense rush to safety on the part of major world pools of $, that the Saudis, and GE, and Boeing, all of them accepted essentially no return on their funds in exchange for protection.
For a litmus test, a gauge or measure of the all encompassing nature of this emergency, ignore the equity market and look instead at the London Interbank Offered Rate, or LIBOR. This a the rate set by the British Bankers Assoc after a daily survey of 16 world banks, and it is a long-time benchmark, the benchmark that reflects banks’ short term borrowing costs. On hearing the news, the O/N rate more than doubled to 6.88%. This may seem a "So what?" to those of us not involved in these markets. (The one, and two months rates also set records.) Instead, this spike reflects catastrophic conditions, a near complete freeze. The O/N LIBOR rate exploding in such a fashion is the equivalent of news that unless repairs are made now, the entire US naval fleet will sink in perhaps two weeks. And the world’s financial system can take perhaps two weeks more of this, and that’s it.
Robert Craven
It was a given that libertarian types would resist on principle. But as the AP noted this am, 2/3's of Congress’ most vulnerable members decided to protect their seats, notwithstanding what most of them knew would be the implications of a "No" vote. One Rep Congressman noted that, "Most of us say, ‘I want this thing to pass, but I want you to vote for it, not me.’" Their calculation - the date of their election will be before the full impact of the financial collapse made likely by their vote, that is, before this events wallops their constituents’ jobs and businesses. These folk yesterday put re-election before the health of the nation and the intermediate to long-term interests of their constituents. Since the masses see this as a bail out of wall st types, not as a means to an end, this was a pretty risk-free approach (given emails and phone calls at nearly 200:1 against). They don’t understand that if in the next day or two (Sen - Wed, Hse - Thur) zero is accomplished, we will experience nothing less than a financial melt down, impacting each and every one of us.
We highlighted in the Sep/19 sketch the interconnection of the world’s financial institutions. Just one step away from these institutions are major businesses. Most do not realize how critically these guys rely on short-term loans for routine operations like payroll for example, and there is a very well established market (commercial paper) for that purpose. But credit is nearly frozen, between financial institutions first, and between financial institutions and the rest of the world’s borrowers secondly.
What happened to these credit markets yesterday converts an equity mkt 700 pt loss into a side show. We predicted earlier that Tbill rates would drop to 0.0% on a fail to pass. Pretty close! The 90 day Tbill rate went to 0.132%. What’s that mean? It means an immense rush to safety on the part of major world pools of $, that the Saudis, and GE, and Boeing, all of them accepted essentially no return on their funds in exchange for protection.
For a litmus test, a gauge or measure of the all encompassing nature of this emergency, ignore the equity market and look instead at the London Interbank Offered Rate, or LIBOR. This a the rate set by the British Bankers Assoc after a daily survey of 16 world banks, and it is a long-time benchmark, the benchmark that reflects banks’ short term borrowing costs. On hearing the news, the O/N rate more than doubled to 6.88%. This may seem a "So what?" to those of us not involved in these markets. (The one, and two months rates also set records.) Instead, this spike reflects catastrophic conditions, a near complete freeze. The O/N LIBOR rate exploding in such a fashion is the equivalent of news that unless repairs are made now, the entire US naval fleet will sink in perhaps two weeks. And the world’s financial system can take perhaps two weeks more of this, and that’s it.
Robert Craven
Sunday, September 28, 2008
We're All Hedge Fund Managers Now
Aside from the far left, most of us understand the words of Hayek as highlighted in our Sep/19 sketch, that government intervention of any sort is suspect, that the foundation to government planning means a limited group of individuals deciding the relative importance of different ends for the rest of us. Unfortunately we have arrived at a point in time when we must ignore that warning, confronted with events of such gravity that to ignore them would mean a near-immediate decline in the personal net worth of every one of us. Really.
We all now run a hedge fund, the largest in the world. Pauslon is president of that endeavor. Maybe we’ll do alright.
Taxpayers have rescued the twins and taken a near 80% stake in the business. That means at least $25bln down the drain, already allocated to fiscal ‘09 and ‘10. We may never recover a cent, who knows. Taxpayers "rescued" Bear and through the Fed took on the risk that $29Bln in sub-par assets, which may eventually regain some value (unlike most hedge funds, we don’t have a problem with just sitting on stuff; we can weather it). As taxpayers we tossed Lehman to the hyenas. And now as taxpayers we orchestrated the largest bail out ever of some of the most miserable dogs on wall st, the kind that wouldn’t bother to pxxs on you if you were on fire. We are about to begin buying their so-called toxic assets to deliver relief. But is this necessarily a bad deal for us. Are we out $700bln? I mean, never more, a loss, history?
The answer is no. First, our fund may be able to eventually sell this stuff at a profit. Maybe. But in the meantime we will do just fine on the "carry," that is, the difference between what we will pay to borrow to get the $ with which to buy these assets, and their yield. Where do we get the $700bln? We borrow it, through a range of Treasury securities that practically every large international investor wants to own right now - still the securest investment in the world, all the more attractive in times of trouble. So we may have to pay 3 or 4%. But the paper we will own yields anywhere from 7% to 10% or higher (no one knows yet because it depends on the price we pay). We can hold it to maturity if we have to, or, until the housing market recovers. As Bloomberg illustrated, if we borrow at 3 or 4% and buy assets at 10 or 12% on an investment of $700 bln this will generate some $40 to $60 bln annually.
Peter Orszag, the director of the CBO told the House on Sep/24 that the budget would not reflect the $700 bln "bailout". Instead, there would be an estimate of the net cost to the government equal to the purchase price minus the expected value of future earnings from holding these assets, and minus the proceeds from eventual sale. So that is good for our books, reported results.
I think we’ll do alright.
Robert Craven
We all now run a hedge fund, the largest in the world. Pauslon is president of that endeavor. Maybe we’ll do alright.
Taxpayers have rescued the twins and taken a near 80% stake in the business. That means at least $25bln down the drain, already allocated to fiscal ‘09 and ‘10. We may never recover a cent, who knows. Taxpayers "rescued" Bear and through the Fed took on the risk that $29Bln in sub-par assets, which may eventually regain some value (unlike most hedge funds, we don’t have a problem with just sitting on stuff; we can weather it). As taxpayers we tossed Lehman to the hyenas. And now as taxpayers we orchestrated the largest bail out ever of some of the most miserable dogs on wall st, the kind that wouldn’t bother to pxxs on you if you were on fire. We are about to begin buying their so-called toxic assets to deliver relief. But is this necessarily a bad deal for us. Are we out $700bln? I mean, never more, a loss, history?
The answer is no. First, our fund may be able to eventually sell this stuff at a profit. Maybe. But in the meantime we will do just fine on the "carry," that is, the difference between what we will pay to borrow to get the $ with which to buy these assets, and their yield. Where do we get the $700bln? We borrow it, through a range of Treasury securities that practically every large international investor wants to own right now - still the securest investment in the world, all the more attractive in times of trouble. So we may have to pay 3 or 4%. But the paper we will own yields anywhere from 7% to 10% or higher (no one knows yet because it depends on the price we pay). We can hold it to maturity if we have to, or, until the housing market recovers. As Bloomberg illustrated, if we borrow at 3 or 4% and buy assets at 10 or 12% on an investment of $700 bln this will generate some $40 to $60 bln annually.
Peter Orszag, the director of the CBO told the House on Sep/24 that the budget would not reflect the $700 bln "bailout". Instead, there would be an estimate of the net cost to the government equal to the purchase price minus the expected value of future earnings from holding these assets, and minus the proceeds from eventual sale. So that is good for our books, reported results.
I think we’ll do alright.
Robert Craven
That Was Close
We have a package, the heart of which remains Bush’s original idea. In the absence of an agreement, tomorrow’s equity markets would have melted, Tbill rates hitting 0.0%. That’s for starters. Next would have been the beginning of a bank run (we’ve already seen isolated instances). Financial institutions would fail at an accelerating pace, savings would have been wiped out, jobs evaporate, the economy tank. This would cost us a hell of a lot more than $700bln.
For pure libertarian types - how long can you hold your breath? Until the market regains its sanity? What’s the sense of being right if the markets don’t agree and convert you to crow bait in the process? We can argue about "obscene pay packages," golden parachutes, the notion of socializing losses while privatizing gains, all of it. We agree but save that for later. This is not GM or Wall Mart; this is the financial web and by its very nature it is a house of cards.
Recall from Econ 1-A that roughly 80% of bank deposits are backed not by cash on hand, but faith. No bank could cover all its deposits given a panic by savers, not close. Recall that banks borrow (from us) short term and lend long term, making a profit on the spread. That’s why they can’t honor all their deposits at once - no way to quickly liquidate this stuff. But given a panic, the banks begins to sell - fire sale. Vultures sense the opportunity. Those assets, bank assets drop in value in a hurry and most banks hold the same kind of assets. The draconian accounting practice of "mark-to-market" forces all banks to mark down theirs too - right now, and take the losses.
Such a run was until this morning just around the next corner. People are darn nervous, despite the commendable handling of Wash Mutual by the FDIC. (There was only a small "run" of depositors withdrawing their money from WaMu branches earlier in the week. The FDIC moved in Thursday night, rather than waiting until Friday night as it usually does. It probably feared that the depositor run would get worse on Friday, and it didn't want images of depositor lines outside WaMu branches in newspapers, newscasts and Web sites over the weekend.)
The administration’s plan may be flawed; there are plenty of others being bandied about including going to 0 on capital gains, repeal Sarbanes-Oxley, suspend mark-to-market rules for 6 months, extend the Bush tax cuts, the compulsory conversion of some of the banks’ debt into equity and so on. Flawed or not, the present package as we understand it will be enough to stave off what otherwise would have been a catastrophe. Fine tune later. Fortunately we may not have to stomach Dodd and Frank’s proposal to put 20% of any profits from re-sale into an "affordable housing" fund for their pals, instead of retiring our, US taxpayer, debt. Apparently that has been dropped.
Finally, for those who still advise nothing, from today’s WSJ: "Anyone who thinks capitalism will fare better after a crash should recall that the 1930's didn’t end politically until 1980."
Robert Craven
For pure libertarian types - how long can you hold your breath? Until the market regains its sanity? What’s the sense of being right if the markets don’t agree and convert you to crow bait in the process? We can argue about "obscene pay packages," golden parachutes, the notion of socializing losses while privatizing gains, all of it. We agree but save that for later. This is not GM or Wall Mart; this is the financial web and by its very nature it is a house of cards.
Recall from Econ 1-A that roughly 80% of bank deposits are backed not by cash on hand, but faith. No bank could cover all its deposits given a panic by savers, not close. Recall that banks borrow (from us) short term and lend long term, making a profit on the spread. That’s why they can’t honor all their deposits at once - no way to quickly liquidate this stuff. But given a panic, the banks begins to sell - fire sale. Vultures sense the opportunity. Those assets, bank assets drop in value in a hurry and most banks hold the same kind of assets. The draconian accounting practice of "mark-to-market" forces all banks to mark down theirs too - right now, and take the losses.
Such a run was until this morning just around the next corner. People are darn nervous, despite the commendable handling of Wash Mutual by the FDIC. (There was only a small "run" of depositors withdrawing their money from WaMu branches earlier in the week. The FDIC moved in Thursday night, rather than waiting until Friday night as it usually does. It probably feared that the depositor run would get worse on Friday, and it didn't want images of depositor lines outside WaMu branches in newspapers, newscasts and Web sites over the weekend.)
The administration’s plan may be flawed; there are plenty of others being bandied about including going to 0 on capital gains, repeal Sarbanes-Oxley, suspend mark-to-market rules for 6 months, extend the Bush tax cuts, the compulsory conversion of some of the banks’ debt into equity and so on. Flawed or not, the present package as we understand it will be enough to stave off what otherwise would have been a catastrophe. Fine tune later. Fortunately we may not have to stomach Dodd and Frank’s proposal to put 20% of any profits from re-sale into an "affordable housing" fund for their pals, instead of retiring our, US taxpayer, debt. Apparently that has been dropped.
Finally, for those who still advise nothing, from today’s WSJ: "Anyone who thinks capitalism will fare better after a crash should recall that the 1930's didn’t end politically until 1980."
Robert Craven
Thursday, September 25, 2008
RESCUE
The Treasury’s plan is not perfect but it will work (and perhaps make the taxpayer $ over the intermediate to longer term) but it’s got to be put to press in 4 to 5 days or we are in for trouble so severe that most of us will have to learn to enjoy car camping.
Don’t understand that institutional funding has all but ceased; don’t even know what institutions are; don’t understand the overnight markets and what it means when these "freeze up"; don’t know how or why we are moving very quickly from a crisis of illiquidity to one of insolvency? Then take our word for it.
If there is delay, then the crisis we know now - that confined to the world’s financial system, will mutate to one that impacts lending by banks to households and non-financial corporations, that is, all the rest of us. If this happens our economy is toast.
Upset with the wording of this deal as some of our friends seem to be? For example, "..decisions by the Secretary ...are non-reviewable....may not be reviewed by any court..." Fine, put in a nod to accountability, make Paulson promise he won’t donate the $700bln to the Nature Conservancy for goodness sake.
Bothered by the ornaments that Congress wants to hang on this deal? Good. So are most reasonable people. But there is nothing on the books prohibiting greed; the trade off between keeping a few of the Street types on salary, or at the very least a severe recession, is not a trade off at all. Our guess is that Congress will finally come to understand the scale and gravity of this situation and retreat.
Every one of us better hope so.
Robert Craven
Don’t understand that institutional funding has all but ceased; don’t even know what institutions are; don’t understand the overnight markets and what it means when these "freeze up"; don’t know how or why we are moving very quickly from a crisis of illiquidity to one of insolvency? Then take our word for it.
If there is delay, then the crisis we know now - that confined to the world’s financial system, will mutate to one that impacts lending by banks to households and non-financial corporations, that is, all the rest of us. If this happens our economy is toast.
Upset with the wording of this deal as some of our friends seem to be? For example, "..decisions by the Secretary ...are non-reviewable....may not be reviewed by any court..." Fine, put in a nod to accountability, make Paulson promise he won’t donate the $700bln to the Nature Conservancy for goodness sake.
Bothered by the ornaments that Congress wants to hang on this deal? Good. So are most reasonable people. But there is nothing on the books prohibiting greed; the trade off between keeping a few of the Street types on salary, or at the very least a severe recession, is not a trade off at all. Our guess is that Congress will finally come to understand the scale and gravity of this situation and retreat.
Every one of us better hope so.
Robert Craven
Sunday, September 21, 2008
Heart of Darkness
If Conrad were alive today he just might author a companion issue to the first. Yet instead of a journey into the savage heart of Africa, Kurtz would find himself in the bowels of FannieMae, there to find his dark and evil soul.
A stretch? Not to most Americans when they eventually come to understand that core operation which, when coupled with Greenspan’s gross mis management of the Fed cooked up what we are served today. That would be the Fannie/Freddie horror show.
We highlighted these GSE’s (gov’t sponsored enterprises) in an earlier post to explain their designed purpose and how that became corrupted through connections to Congress. Pressure was exerted from the majority of Democrats in the House for Fannie/Freddie to lower standards to access low-income families. The political dividend was obvious. Franklin Raines, the Clinton-appointed head of Fannie from 1998 to 2004 made it a priority to make mortgages easier to get, with little credit, few assets and next to nothing down.
As background, Jonah Goldberg of the National Review notes that, "The fine print to this noble intent was an ill-conceived loosening of standards." For example, the Clinton administration reinterpreted the Carter-era Community Reinvestment Act to politicize lending practices. Goldberg continues, "Under the CRA the government forced banks to prove they weren’t ‘redlining’ - discrimination against minorities - by approving loans to minorities and various left-wing ‘community group’ shakedown artists whether they were bad risks or not." (A young Obama got his start with exactly these sort of groups) It was extortion but no problem; the banks were happy to pass the risky loans to a Fannie being transformed by Raines from the stable institution FDR intended into the equivalent of a hedge fund. Fannie accepted this stuff, bundled it together with good loans, and sold the lot to Wall St types who in turn were happy to oblige since Fannie was deemed to be too big to fail.
This worked perfectly for Raines who enriched himself to the tune of some $40million. Yet things began to get a tad dicey - in 2005 Fannie revealed that it had overstated earnings by $10.6 bln and that it didn’t really know what was going on. The Bush administration pushed for reforms for what had become largely a Democratic cash cow; those efforts were rebuffed by Congress with Barney Frank and Chris Dodd in the lead. Why? Because Fannie and Freddie had spent millions on campaign contributions to these clowns and their pals.
Also in 2005 McCain sponsored legislation to thwart what he later called "the enormous risk that Fannie and Freddie pose to the housing market, the overall financial system and the economy as a whole." It went down in defeat, naturally.
Oh, and we almost forgot - Obama, the Senate’s second-greatest recipient of donations from Fannie and Freddie after Dodd, did nothing. My, my.
Robert Craven
A stretch? Not to most Americans when they eventually come to understand that core operation which, when coupled with Greenspan’s gross mis management of the Fed cooked up what we are served today. That would be the Fannie/Freddie horror show.
We highlighted these GSE’s (gov’t sponsored enterprises) in an earlier post to explain their designed purpose and how that became corrupted through connections to Congress. Pressure was exerted from the majority of Democrats in the House for Fannie/Freddie to lower standards to access low-income families. The political dividend was obvious. Franklin Raines, the Clinton-appointed head of Fannie from 1998 to 2004 made it a priority to make mortgages easier to get, with little credit, few assets and next to nothing down.
As background, Jonah Goldberg of the National Review notes that, "The fine print to this noble intent was an ill-conceived loosening of standards." For example, the Clinton administration reinterpreted the Carter-era Community Reinvestment Act to politicize lending practices. Goldberg continues, "Under the CRA the government forced banks to prove they weren’t ‘redlining’ - discrimination against minorities - by approving loans to minorities and various left-wing ‘community group’ shakedown artists whether they were bad risks or not." (A young Obama got his start with exactly these sort of groups) It was extortion but no problem; the banks were happy to pass the risky loans to a Fannie being transformed by Raines from the stable institution FDR intended into the equivalent of a hedge fund. Fannie accepted this stuff, bundled it together with good loans, and sold the lot to Wall St types who in turn were happy to oblige since Fannie was deemed to be too big to fail.
This worked perfectly for Raines who enriched himself to the tune of some $40million. Yet things began to get a tad dicey - in 2005 Fannie revealed that it had overstated earnings by $10.6 bln and that it didn’t really know what was going on. The Bush administration pushed for reforms for what had become largely a Democratic cash cow; those efforts were rebuffed by Congress with Barney Frank and Chris Dodd in the lead. Why? Because Fannie and Freddie had spent millions on campaign contributions to these clowns and their pals.
Also in 2005 McCain sponsored legislation to thwart what he later called "the enormous risk that Fannie and Freddie pose to the housing market, the overall financial system and the economy as a whole." It went down in defeat, naturally.
Oh, and we almost forgot - Obama, the Senate’s second-greatest recipient of donations from Fannie and Freddie after Dodd, did nothing. My, my.
Robert Craven
Friday, September 19, 2008
A Personal Dilemma
We are in a dilemma this pm. Certainly we know that government intervention of any sort is suspect, that the foundation to government planning which Hayek so well illustrated means a limited group of individuals deciding the relative importance of different ends, thus the relative importance of different groups and persons. A rescue was fashioned for Bear but Lehman was abandoned; the world’s largest insurance company was acquired wholesale and now quite likely the mother-of-all-bailouts is just around the corner by the way of an RTC-like rescue of Wall Street firms in the main; that is, Paulson’s proposal to create a government-financed agency to take the most toxic assets (such as subprime mortgage backed securities) off the balance sheets of the US banking system. Together with today’s government’s blanket guarantee of the $3.4 trillion money market mutual funds the socialism of the financial sector appears to be proceeding apace.
This new entity would, unlike the RTC of the 80's, put taxpayers at risk. That is because the new entity would purchase illiquid assets at a discount from solvent institutions, then eventually try to sell them back to the market at a profit. Maybe so, maybe not. With the original RTC the government wasn’t exposed; the assets fell into its hand from failed institutions.
We have illustrated the perils, the addiction provided to abusers when gains are privatized but losses are socialized. Hey, why not? Yet today we are told that results of the cataclysmic sort will result if we don’t. Clearly in the case of some investment banks, certainly in the case of the auto makers their whining is just that. The fact I spent 25 years working for investment banks gives me a bit of a leg up over a salvage diver; still, when Bernanke warns Congress as he did today that without a bailout of a new order, we will have a financial meltdown, I just don’t know; I find it dangerous to doubt that. Can we make a case today as we have the past several that government intervention is always a bad thing? What if he’s right? In letting the system purge itself, our remedy all along, could it be that the heaves would prove fatal?
What startled us this week, specifically Wed evening is that the funding market for major world-wide institutions froze up. Not the bond market. Not the stock market. The O/N and short-term market, that which in the past provided liquidity for major operating institutions. This market provides funding for day-to-day operations; it has been around for 50 years. Normally the Royal Bk of Scotland (for purposed of illustration) is flush funds; these are lent out O/N or for short periods to Washington Mutual (for purposes of illustration) which is normally in need of short-term funds. If the RBS suddenly fears it won’t get it’s three day loan back, it will refuse to lend. That is what happened this week. But there was mass panic Thursday morning and the market locked up - nothing, only distrust. Even credit-worthy borrowers could not obtain their working capital. We agree that this would cause a rapid succession of failures; Paulson and Bernanke understood that.
If financial mastodons like AIG and the rest of these clowns are too large and too interconnected to fail yet not too smart to get themselves into situations where they need to be bailed out, then why let private firms engage in such activity in the first place? (I didn’t say that.)
Robert Craven
This new entity would, unlike the RTC of the 80's, put taxpayers at risk. That is because the new entity would purchase illiquid assets at a discount from solvent institutions, then eventually try to sell them back to the market at a profit. Maybe so, maybe not. With the original RTC the government wasn’t exposed; the assets fell into its hand from failed institutions.
We have illustrated the perils, the addiction provided to abusers when gains are privatized but losses are socialized. Hey, why not? Yet today we are told that results of the cataclysmic sort will result if we don’t. Clearly in the case of some investment banks, certainly in the case of the auto makers their whining is just that. The fact I spent 25 years working for investment banks gives me a bit of a leg up over a salvage diver; still, when Bernanke warns Congress as he did today that without a bailout of a new order, we will have a financial meltdown, I just don’t know; I find it dangerous to doubt that. Can we make a case today as we have the past several that government intervention is always a bad thing? What if he’s right? In letting the system purge itself, our remedy all along, could it be that the heaves would prove fatal?
What startled us this week, specifically Wed evening is that the funding market for major world-wide institutions froze up. Not the bond market. Not the stock market. The O/N and short-term market, that which in the past provided liquidity for major operating institutions. This market provides funding for day-to-day operations; it has been around for 50 years. Normally the Royal Bk of Scotland (for purposed of illustration) is flush funds; these are lent out O/N or for short periods to Washington Mutual (for purposes of illustration) which is normally in need of short-term funds. If the RBS suddenly fears it won’t get it’s three day loan back, it will refuse to lend. That is what happened this week. But there was mass panic Thursday morning and the market locked up - nothing, only distrust. Even credit-worthy borrowers could not obtain their working capital. We agree that this would cause a rapid succession of failures; Paulson and Bernanke understood that.
If financial mastodons like AIG and the rest of these clowns are too large and too interconnected to fail yet not too smart to get themselves into situations where they need to be bailed out, then why let private firms engage in such activity in the first place? (I didn’t say that.)
Robert Craven
Thursday, September 18, 2008
The New Despotism
The British Labour government which followed the end of WWII, after some period of dormancy, has taken life in these United States. F.A. Hayek warned in The Road To Serfdom that those six years of socialist government in England would provide only despair. He explained that the attempts at economic planning would lead to a new form of despotism, "A despotism exercised perhaps by a conscientious and honest bureaucracy for what they sincerely believe is for the good of the country...but it is nevertheless an arbitrary government..... In deciding the relative importance of the different ends, the planner also decides the relative importance of the different groups and persons." The socialist government, "must of necessity take sides, impose its valuations on people and instead of assisting them in the advancement of their own ends, choose the ends for them."
We praised Paulson but just hours after that writing he and Bernanke came to the aid of the world’s largest insurer. We are told that the failure of AIG could have brought the financial world to its knees and perhaps all of us with it. This stretch is based on AIG’s being on the hook for $441 billion of "credit default swaps" - contracts to reimburse holders of mortgage-backed and other debt securities if that paper goes bad, a relatively new invention of Wall St, something in which AIG took a fling. That is, AIG got in trouble through poor management and risk taking in the provision of default insurance on securities it turns out it did not understand. As taxpayers all we get out of this deal is that we are now in the insurance business. Well, ok, the government drove a hard bargain; if AIG rebounds the taxpayer could make a killing, but, that is neither here nor there. Why the ad hoc decision, why take sides with AIG and abandon Lehman, why protect AIG employees and toss others out in the street? Because AIG sold more swaps to more banks and investment companies than Lehman did. Again thanks to the government’s arbitrary decision the banks and others which actually held these sweet-pea securities are now off the hook.
The Fed invoked a loophole which allows it to lend (rescue) non banks under "unusual and exigent" circumstances. The Fed apparently has the authority to rescue a pizza parlor if things get touchy in that industry. Decisions are being made ad hoc after firms find themselves in hot water. Certainly we have witnessed the undermining of the free market system - arbitrary swings of human judgment not grounded on any set of principles; there is no adherence to a rule of law. We have no rule of law then we have no democracy. "Nothing distinguishes more clearly conditions in a free country from those in a country under arbitrary government than the observance in the former of the great principles know as the Rule of Law," Hayek explains. "Stripped of all technicalities this means that all its actions are bound by rules fixed and announced beforehand - rules which make it possible to foresee with fair certainty how the authority will use its coercive powers...to plan one’s individual affairs on the basis of this knowledge."
Robert Craven
We praised Paulson but just hours after that writing he and Bernanke came to the aid of the world’s largest insurer. We are told that the failure of AIG could have brought the financial world to its knees and perhaps all of us with it. This stretch is based on AIG’s being on the hook for $441 billion of "credit default swaps" - contracts to reimburse holders of mortgage-backed and other debt securities if that paper goes bad, a relatively new invention of Wall St, something in which AIG took a fling. That is, AIG got in trouble through poor management and risk taking in the provision of default insurance on securities it turns out it did not understand. As taxpayers all we get out of this deal is that we are now in the insurance business. Well, ok, the government drove a hard bargain; if AIG rebounds the taxpayer could make a killing, but, that is neither here nor there. Why the ad hoc decision, why take sides with AIG and abandon Lehman, why protect AIG employees and toss others out in the street? Because AIG sold more swaps to more banks and investment companies than Lehman did. Again thanks to the government’s arbitrary decision the banks and others which actually held these sweet-pea securities are now off the hook.
The Fed invoked a loophole which allows it to lend (rescue) non banks under "unusual and exigent" circumstances. The Fed apparently has the authority to rescue a pizza parlor if things get touchy in that industry. Decisions are being made ad hoc after firms find themselves in hot water. Certainly we have witnessed the undermining of the free market system - arbitrary swings of human judgment not grounded on any set of principles; there is no adherence to a rule of law. We have no rule of law then we have no democracy. "Nothing distinguishes more clearly conditions in a free country from those in a country under arbitrary government than the observance in the former of the great principles know as the Rule of Law," Hayek explains. "Stripped of all technicalities this means that all its actions are bound by rules fixed and announced beforehand - rules which make it possible to foresee with fair certainty how the authority will use its coercive powers...to plan one’s individual affairs on the basis of this knowledge."
Robert Craven
Tuesday, September 16, 2008
The Purge and the US Taxpayer
The US government through the person of Hank Paulson drew the line this weekend on European-style state capitalism, forcing failing street firms to go cold turkey, calling the bluff of those who maintained that without a rescue our economy would implode. As Jeff Randall of the Telegraph put it, "In throwing Lehman to the dogs....Paulson is betting heavily that dire warnings of contagion, systematic risk and domino effect are little more than special pleading from hitherto Masters of the Universe who would like the taxpayer to save their over-priced skins."
Observers in the press today including Barron’s, the FT and WSJ agree with our earlier assessment that the trigger to all this mess can be traced to Greenspan’s mismanagement of the Fed. "The Fed kept interest rates too low for too long, creating a subsidy for debt and a global commodity price spike," notes the WSJ. "The excess liquidity and capital flows this spurred became the fuel for the wizards on Wall St who created new financial instruments that in turn fueled the housing bubble." Indeed, these seers worked out so many ways and instruments to make billions off the less-than-prime mortgage market that we could never keep up, really didn’t have a clue what they were talking about. As it turns out, neither did they.
So the purge begins. It will be painful yet it marks the beginning on the path to sobriety. Since the key problem as Paulson noted yesterday is based on housing prices which are in decline, we will see the end of the tunnel only when these prices stabilize. In the meantime, we may heed the WSJ’s suggestion for another Resolution Trust Corporation to buy, stabilize and liquidate these assets, just as the first one did during the 80's S&L crisis aftermath.
Over the next few weeks we can be more confident as taxpayers that the Treasury heard the message. We can be less confident however that the Fed has learned anything. We highlighted earlier how the Fed put us at risk in the Bear deal. Now we know that last weekend Bernanke opened the Fed lending window even further, and to institutions which are not even deposit takers, which were before not entitled to Fed largess. And in doing so the Fed now accepts all kinds of new risky collateral, including for the first time, equities in exchange for taxpayer’s credit. This is something to monitor closely in the days ahead.
Robert Craven
Observers in the press today including Barron’s, the FT and WSJ agree with our earlier assessment that the trigger to all this mess can be traced to Greenspan’s mismanagement of the Fed. "The Fed kept interest rates too low for too long, creating a subsidy for debt and a global commodity price spike," notes the WSJ. "The excess liquidity and capital flows this spurred became the fuel for the wizards on Wall St who created new financial instruments that in turn fueled the housing bubble." Indeed, these seers worked out so many ways and instruments to make billions off the less-than-prime mortgage market that we could never keep up, really didn’t have a clue what they were talking about. As it turns out, neither did they.
So the purge begins. It will be painful yet it marks the beginning on the path to sobriety. Since the key problem as Paulson noted yesterday is based on housing prices which are in decline, we will see the end of the tunnel only when these prices stabilize. In the meantime, we may heed the WSJ’s suggestion for another Resolution Trust Corporation to buy, stabilize and liquidate these assets, just as the first one did during the 80's S&L crisis aftermath.
Over the next few weeks we can be more confident as taxpayers that the Treasury heard the message. We can be less confident however that the Fed has learned anything. We highlighted earlier how the Fed put us at risk in the Bear deal. Now we know that last weekend Bernanke opened the Fed lending window even further, and to institutions which are not even deposit takers, which were before not entitled to Fed largess. And in doing so the Fed now accepts all kinds of new risky collateral, including for the first time, equities in exchange for taxpayer’s credit. This is something to monitor closely in the days ahead.
Robert Craven
Sunday, September 14, 2008
Monday Morning End to Wall St Socialism?
Last week found the Treasury literally on its knees begging the UK bank Barclays to rescue Lehman. Reports this am are that the Treasury, Fed and other regulators (working overtime at our expense) have given up on finding a buyer for an intact Lehman and now look to sell off parts of the firm, winding down the balance. Well find out soon enough, probably tomorrow.
Here we go again. What is this all about? What does this mean to US taxpayers? Is the preservation of these investment banks in the public’s interest?
One may consider the simplicity of the Chrysler bailout or the complexity of Wall St deals; they reflect the same change of order - government-sponsored socialism directed at frail or failing private industry. "We’re too big to fail," regulators are told by victims of poor judgement or other nuisances. Those who have losses want help; naturally a disaster of unimaginable consequences will be the result if they don’t get it. And most of the time - in the case of Wall St, because of the complicity, the near incestuous, clubby connection between the Federal Reserve, Treasury and the street’s major firms, and the pressure from major offshore investors such as China or the Saudis - they get it.
This time Treasury Secretary Paulson has resolutely stuck to his position that no taxpayer money goes to the Lehman bailout. Not really. Some of it already has. Still, this statement delivers hope. And if there is to be a change in government largess toward Wall St types it is because the growing public outrage is deafening. One may argue with the Treasury’s role but the Fed’s involvement, a mission-creep far from its original mandate of price stability, the role of Wall St deal maker at risk, is to some observers like retired St Louis Fed president Bill Poole, nothing if not appalling.
In March the Fed - in our view without any authority to do so - stepped in to manage the sale of a distressed Bear Stearns. The Fed extended a loan of $29bln to JPMorgan as an enticement for them to buy Bear. As collateral Morgan offered troubled mortgage-backed securities that were marked-to-market at $30bln but no one really knows what they are worth (at this writing there is no market for these securities). That is the problem for the taxpayer. The Fed will lose something, maybe eventually a lot. The Fed is a government bank and usually earns a surplus which is remitted to the Treasury. The losses will come out of that surplus, a taxpayer loss.
Next was the Fannie/Freddie bailout. This one was not so much the moral stretch due to the quasi governmental nature of both yet it will still cost us a fortune.
Finally, we will hear from other Wall St firms in the near term, perhaps next week as they too cry for help.
Why is it that we as taxpayers are asked to socialize the losses of fat cats whose third home was bought on the back of our recent mortgage, the same clowns who are now in a panic? Part is as noted above - the incestuous relationship between Wall St and its regulators, especially the Fed; it is done by reflex, aiding your pals. The factor driving the panic is the recent boom in what one keen observer called financial instruments of mass destruction - derivative securities. These are such things as "default swaps" and other arcane exercises that banks, hedge funds and other use to bet for or against certain market moves. The value of these instruments is in the trillions of dollars; most of this activity is unregulated. The fear is due to the size and complexity of it all. One party’s inability to honor its commitment could topple the rest. Or so we are told.
This fear is not as real as it is manufactured, and by guess who? Wall St types. A boatload of observers outside the club maintain otherwise - painful yes but a cataclysm? No way. One of the most credible of these being professor Alan Meltzer, a veteran economist at Carnegie Mellon. "I’ve heard this so many times," says Meltzer. "I don’t believe it." Janet Tavakoli, a Chicago-based consultant on derivative securities scoffs at the idea. Let’s find out she says, "It’s a good time to have a test case."
How then did we get into this mess? Greenspan’s mis-management of the Fed provides the beginning (see our Sep/2 sketch). The US government’s lack of understanding and lack of regulation of the derivatives market provides the ending. So things got tough for the financial masters of the universe. They now look to us for sustenance. As taxpayers we can no longer enable this behavior. Firms that may fail after doing stupid things should fail. There will certainly be more pain for the speculator, including the homeowner, but, the adjustment will be accelerated and then we can recover with a clean slate and a healthier economy. Finally, the government’s role is not to dole out our money to failing firms but to come to better understand the "maneuverings" of Wall St types and affect reasonable regulations aimed to prevent the mess in the first place. Where is Henry Gonzalez when we most need him?
Robert Craven
Here we go again. What is this all about? What does this mean to US taxpayers? Is the preservation of these investment banks in the public’s interest?
One may consider the simplicity of the Chrysler bailout or the complexity of Wall St deals; they reflect the same change of order - government-sponsored socialism directed at frail or failing private industry. "We’re too big to fail," regulators are told by victims of poor judgement or other nuisances. Those who have losses want help; naturally a disaster of unimaginable consequences will be the result if they don’t get it. And most of the time - in the case of Wall St, because of the complicity, the near incestuous, clubby connection between the Federal Reserve, Treasury and the street’s major firms, and the pressure from major offshore investors such as China or the Saudis - they get it.
This time Treasury Secretary Paulson has resolutely stuck to his position that no taxpayer money goes to the Lehman bailout. Not really. Some of it already has. Still, this statement delivers hope. And if there is to be a change in government largess toward Wall St types it is because the growing public outrage is deafening. One may argue with the Treasury’s role but the Fed’s involvement, a mission-creep far from its original mandate of price stability, the role of Wall St deal maker at risk, is to some observers like retired St Louis Fed president Bill Poole, nothing if not appalling.
In March the Fed - in our view without any authority to do so - stepped in to manage the sale of a distressed Bear Stearns. The Fed extended a loan of $29bln to JPMorgan as an enticement for them to buy Bear. As collateral Morgan offered troubled mortgage-backed securities that were marked-to-market at $30bln but no one really knows what they are worth (at this writing there is no market for these securities). That is the problem for the taxpayer. The Fed will lose something, maybe eventually a lot. The Fed is a government bank and usually earns a surplus which is remitted to the Treasury. The losses will come out of that surplus, a taxpayer loss.
Next was the Fannie/Freddie bailout. This one was not so much the moral stretch due to the quasi governmental nature of both yet it will still cost us a fortune.
Finally, we will hear from other Wall St firms in the near term, perhaps next week as they too cry for help.
Why is it that we as taxpayers are asked to socialize the losses of fat cats whose third home was bought on the back of our recent mortgage, the same clowns who are now in a panic? Part is as noted above - the incestuous relationship between Wall St and its regulators, especially the Fed; it is done by reflex, aiding your pals. The factor driving the panic is the recent boom in what one keen observer called financial instruments of mass destruction - derivative securities. These are such things as "default swaps" and other arcane exercises that banks, hedge funds and other use to bet for or against certain market moves. The value of these instruments is in the trillions of dollars; most of this activity is unregulated. The fear is due to the size and complexity of it all. One party’s inability to honor its commitment could topple the rest. Or so we are told.
This fear is not as real as it is manufactured, and by guess who? Wall St types. A boatload of observers outside the club maintain otherwise - painful yes but a cataclysm? No way. One of the most credible of these being professor Alan Meltzer, a veteran economist at Carnegie Mellon. "I’ve heard this so many times," says Meltzer. "I don’t believe it." Janet Tavakoli, a Chicago-based consultant on derivative securities scoffs at the idea. Let’s find out she says, "It’s a good time to have a test case."
How then did we get into this mess? Greenspan’s mis-management of the Fed provides the beginning (see our Sep/2 sketch). The US government’s lack of understanding and lack of regulation of the derivatives market provides the ending. So things got tough for the financial masters of the universe. They now look to us for sustenance. As taxpayers we can no longer enable this behavior. Firms that may fail after doing stupid things should fail. There will certainly be more pain for the speculator, including the homeowner, but, the adjustment will be accelerated and then we can recover with a clean slate and a healthier economy. Finally, the government’s role is not to dole out our money to failing firms but to come to better understand the "maneuverings" of Wall St types and affect reasonable regulations aimed to prevent the mess in the first place. Where is Henry Gonzalez when we most need him?
Robert Craven
Thursday, September 11, 2008
Fannie & Freddie
Background: The Federal National Mortgage Assoc (Fannie) and the Federal Home Mortgage Corporation (Freddie) were created as conduits between the home buyer (borrower) and a greater pool of funds than just the immediate lender could supply. Roosevelt birthed Fannie as a pure government agency in 1938 to spark the depression era home market. Johnson privatized Fannie in 1968 to get it off the books; Freddie was created two years later, also off the books. It was understood that these two were not a direct US credit but had "drawing rights", an opaque near guarantee.
Business types, shareholders and politicians working together through Fannie and Freddie naturally exploited public backing. Both became a profit center in their own right and as part of that, the past few years accumulated sub-par mortgages on speculation. Bad behavior was encouraged by Congress because the mortgage giants returned some of their profits directly as campaign funds or as "contributions" to favored constituents.
Democrat Barney Frank, chairman of the House Financial Services Committee, could be called the patron saint of these two. From the WSJ : "He encouraged the companies to guarantee more ‘affordable’ mortgages, thus abetting their disastrous plunge into subprime and Alt-A loans. He also pushed for, and got, an increase in the conforming-loan limits to allow Fan and Fred to securitize and guarantee larger mortgages. And he pressured regulators to ease up on their capital requirements -- which now means taxpayers will have to make up that capital shortfall."
The chartered purpose of both Fannie and Freddie is simply to buy loans from original lenders, take on the mortgage default risk, place a guarantee on that paper and then package it and sell it to institutional buyers. But because both took unnecessary risks it left them in bad shape for doing their real job. All the while Bernanke assured us there was no problem, telling Congress a few months ago that Fannie and Freddie were "adequately capitalized" and in "no danger of failing". Not quite. Both were insolvent, or close to it with an absurdly slender capital cushion given their exposure - perhaps roughly half the US market, that is, they hold or back more than $5trillion in mortgages.
Treasury Secretary Paulson sought powers in July to mount a rescue operation. Paulson was motivated by pressure from China, other sovereigns and central banks which had bought Fannie and Freddie debt by the truck load because the interest was higher than the rock low interest on direct US debt. These folks suddenly found themselves massively exposed. Thus, Paulson pulled the trigger Sep/6, taking control of both, firing incompetents, suspending dividends. The Treasury, all of us, own almost 80% of their stock.
Implications: As Alaska Governor Palin noted over the weekend, both now represent a substantial burden to taxpayers. The Congressional Budget Office has already placed $25 billion of estimated costs for Fannie and Freddie over fiscal ‘09 and ‘10. The final price tag will run much higher. The WSJ puts the figure at $200 billion. Our friend Bill Poole (former St Louis Fed Pres) reckons taxpayer losses will approach $300 billion.
Robert Craven
Business types, shareholders and politicians working together through Fannie and Freddie naturally exploited public backing. Both became a profit center in their own right and as part of that, the past few years accumulated sub-par mortgages on speculation. Bad behavior was encouraged by Congress because the mortgage giants returned some of their profits directly as campaign funds or as "contributions" to favored constituents.
Democrat Barney Frank, chairman of the House Financial Services Committee, could be called the patron saint of these two. From the WSJ : "He encouraged the companies to guarantee more ‘affordable’ mortgages, thus abetting their disastrous plunge into subprime and Alt-A loans. He also pushed for, and got, an increase in the conforming-loan limits to allow Fan and Fred to securitize and guarantee larger mortgages. And he pressured regulators to ease up on their capital requirements -- which now means taxpayers will have to make up that capital shortfall."
The chartered purpose of both Fannie and Freddie is simply to buy loans from original lenders, take on the mortgage default risk, place a guarantee on that paper and then package it and sell it to institutional buyers. But because both took unnecessary risks it left them in bad shape for doing their real job. All the while Bernanke assured us there was no problem, telling Congress a few months ago that Fannie and Freddie were "adequately capitalized" and in "no danger of failing". Not quite. Both were insolvent, or close to it with an absurdly slender capital cushion given their exposure - perhaps roughly half the US market, that is, they hold or back more than $5trillion in mortgages.
Treasury Secretary Paulson sought powers in July to mount a rescue operation. Paulson was motivated by pressure from China, other sovereigns and central banks which had bought Fannie and Freddie debt by the truck load because the interest was higher than the rock low interest on direct US debt. These folks suddenly found themselves massively exposed. Thus, Paulson pulled the trigger Sep/6, taking control of both, firing incompetents, suspending dividends. The Treasury, all of us, own almost 80% of their stock.
Implications: As Alaska Governor Palin noted over the weekend, both now represent a substantial burden to taxpayers. The Congressional Budget Office has already placed $25 billion of estimated costs for Fannie and Freddie over fiscal ‘09 and ‘10. The final price tag will run much higher. The WSJ puts the figure at $200 billion. Our friend Bill Poole (former St Louis Fed Pres) reckons taxpayer losses will approach $300 billion.
Robert Craven
Tuesday, September 2, 2008
Greenspan and the Home Mortgage Crisis
American homeowners are not a happy bunch. First, the party began to end two years ago; next some Wall St types got caught with their pants down early this year, then home prices really took a dive. Credit vanished. Finally, as taxpayers homeowners just might be asked to bail out the very clowns that helped get them into this mess. What in the world is going on? Where did this all start?
Professor Anna Schwartz (92 and still working at the National Bureau of Economic Research) is a revered figure in central banking circles. She with Milton Friedman wrote the joint opus - A Monetary History of the United States, which revolutionized thinking about the great depression. The book was a bombshell, turning conventional wisdom upside down. What Friedman/Schwartz demonstrated was that incompetent Fed officials caused the depression, not the free market. I met Schwartz in Oct/93 as the two of us testified before the House Banking Committee. And what does she have to say now? According to Schwartz the original sin of the Greenspan Fed was to hold rates at 1% from 2003 to 2004, long after the dotcom bubble was over. "Rates of 1% were bound to encourage all kinds of risky behavior," says Schwartz.
By "risky behavior" Schwartz means that of both lenders and borrowers in the housing market, and the lenders’ Wall St counterparts. Looking for higher yields in the artificially low rate environment of ‘03 and ‘04, encouraged by politicians to direct more lending to poorer neighborhoods, encouraged by the lack of supervision (50% of subprime loans were made by state chartered but not federally supervised companies), encouraged too by Wall St, lenders increased risky subprime lending through nontraditional loans. Brokers originated the loans with little concern for quality and lenders went along as they could simply peddle the loans to Wall St underwriters who in turn packaged the loans as securities to sell to unwary investors. We all know what happened next.
Greenspan has looked to clear his name by blaming the period of artificially low rates and the bubble this created on the Asian saving glut which supposedly created stimulus beyond the control of the Fed. Schwartz says this is nonsense. "This attempt to exculpate himself is not convincing. The Fed failed to confront something that was evident. It can’t be blamed on global events," she says. And in fact Greenspan did not understand the situation. His skill has always been a remarkable ability to charm politicians coupled with a gift to say absolutely nothing at great length with no real position of any kind. He got where he did because of his political promiscuity; his "strength" is that he could be trusted not to rock the establishment boat, which includes maintaining a near incestuous relationship with Wall St. His skill at predicting events tied to policy change is about nil. CNBC one described Greenspan’s forecasting record as "the worst". Worth mag in 1995 said that, "...most of his predictions have turned out to be wrong." Indeed, as a private economist and a hired gun for Charley Keating’s Lincoln S&L (his fee was $40,000) Greenspan told California banking regulators that Lincoln management, "...was seasoned and expert...with a long tack record of outstanding success." He told the regulators that Keating’s S&L would pose no risk of loss to federal insurers (i.e. taxpayers). In fact, Lincoln cost the taxpayer $3 billion bucks. Keating was convicted of securities fraud, conspiracy and racketeering.
Chairman Bernanke’s intellectual honesty detaches him from the Greenspan mold yet he has for the most part carried on the tradition. His Fed remains too close to Wall St and financial institutions - responding to their needs to the detriment of the wider economy. The Fed overreacted to the crisis, misjudging the importance of financial stability to the overall economy and created a deeper inflation problem as a result. Another acquaintance of ours - Bill Poole, until recently head of the St Louis Fed, called the Bernanke-Paulson decision to take some of the banks’ diciest loans onto it own balance sheet "appalling," the worst mistake of a generation.
Well, most of us recall the Chrysler debacle of 1979. It like Bear Stearns was "too big to fail". Free market thinkers worried not that the bailout would fail but that it would work. It did, thus lowering any resistance to future flights of Wall St socialism. Of course Fed seers argued that Bear was so connected to the financial system in opaque ways that the radiating consequences would be a catastrophe. We doubt that is true. We do know that the Fed now has a mandate to be the deal makers for Wall St’s brand of socialism - socializing losses while privatizing gains.
And so the irony is that the mortgage crisis is in large part the fault of the Fed’s own reckless monetary policy. Low real interest rates for too long created a subsidy for debt that spurred the housing and credit bubbles that have now burst. Prices got higher than they should have been. The only healthy recovery is to let those prices settle on their own, to let those firms which reaped great benefits now accept the consequences of their overreaching. Fed-Treasury interference in the process of price discovery will only prolong the process and increase the odds that losses are in fact dumped onto taxpayers - a very real possibility.
Robert Craven
Professor Anna Schwartz (92 and still working at the National Bureau of Economic Research) is a revered figure in central banking circles. She with Milton Friedman wrote the joint opus - A Monetary History of the United States, which revolutionized thinking about the great depression. The book was a bombshell, turning conventional wisdom upside down. What Friedman/Schwartz demonstrated was that incompetent Fed officials caused the depression, not the free market. I met Schwartz in Oct/93 as the two of us testified before the House Banking Committee. And what does she have to say now? According to Schwartz the original sin of the Greenspan Fed was to hold rates at 1% from 2003 to 2004, long after the dotcom bubble was over. "Rates of 1% were bound to encourage all kinds of risky behavior," says Schwartz.
By "risky behavior" Schwartz means that of both lenders and borrowers in the housing market, and the lenders’ Wall St counterparts. Looking for higher yields in the artificially low rate environment of ‘03 and ‘04, encouraged by politicians to direct more lending to poorer neighborhoods, encouraged by the lack of supervision (50% of subprime loans were made by state chartered but not federally supervised companies), encouraged too by Wall St, lenders increased risky subprime lending through nontraditional loans. Brokers originated the loans with little concern for quality and lenders went along as they could simply peddle the loans to Wall St underwriters who in turn packaged the loans as securities to sell to unwary investors. We all know what happened next.
Greenspan has looked to clear his name by blaming the period of artificially low rates and the bubble this created on the Asian saving glut which supposedly created stimulus beyond the control of the Fed. Schwartz says this is nonsense. "This attempt to exculpate himself is not convincing. The Fed failed to confront something that was evident. It can’t be blamed on global events," she says. And in fact Greenspan did not understand the situation. His skill has always been a remarkable ability to charm politicians coupled with a gift to say absolutely nothing at great length with no real position of any kind. He got where he did because of his political promiscuity; his "strength" is that he could be trusted not to rock the establishment boat, which includes maintaining a near incestuous relationship with Wall St. His skill at predicting events tied to policy change is about nil. CNBC one described Greenspan’s forecasting record as "the worst". Worth mag in 1995 said that, "...most of his predictions have turned out to be wrong." Indeed, as a private economist and a hired gun for Charley Keating’s Lincoln S&L (his fee was $40,000) Greenspan told California banking regulators that Lincoln management, "...was seasoned and expert...with a long tack record of outstanding success." He told the regulators that Keating’s S&L would pose no risk of loss to federal insurers (i.e. taxpayers). In fact, Lincoln cost the taxpayer $3 billion bucks. Keating was convicted of securities fraud, conspiracy and racketeering.
Chairman Bernanke’s intellectual honesty detaches him from the Greenspan mold yet he has for the most part carried on the tradition. His Fed remains too close to Wall St and financial institutions - responding to their needs to the detriment of the wider economy. The Fed overreacted to the crisis, misjudging the importance of financial stability to the overall economy and created a deeper inflation problem as a result. Another acquaintance of ours - Bill Poole, until recently head of the St Louis Fed, called the Bernanke-Paulson decision to take some of the banks’ diciest loans onto it own balance sheet "appalling," the worst mistake of a generation.
Well, most of us recall the Chrysler debacle of 1979. It like Bear Stearns was "too big to fail". Free market thinkers worried not that the bailout would fail but that it would work. It did, thus lowering any resistance to future flights of Wall St socialism. Of course Fed seers argued that Bear was so connected to the financial system in opaque ways that the radiating consequences would be a catastrophe. We doubt that is true. We do know that the Fed now has a mandate to be the deal makers for Wall St’s brand of socialism - socializing losses while privatizing gains.
And so the irony is that the mortgage crisis is in large part the fault of the Fed’s own reckless monetary policy. Low real interest rates for too long created a subsidy for debt that spurred the housing and credit bubbles that have now burst. Prices got higher than they should have been. The only healthy recovery is to let those prices settle on their own, to let those firms which reaped great benefits now accept the consequences of their overreaching. Fed-Treasury interference in the process of price discovery will only prolong the process and increase the odds that losses are in fact dumped onto taxpayers - a very real possibility.
Robert Craven
Wednesday, July 23, 2008
Fed Policy - An Update
In the last sketch (July/7) we highlighted the Fed’s apparent lack of concern for a weak US currency and the consequences, using the price of oil as an example.
Since then there has been a change in Fed rhetoric designed to indicate a growing willingness to support the $. First, Bernanke assured lawmakers that inflation is a concern for the central bank. Then Gary Stern, the long-time president of the Minneapolis Fed and a voting member of the FOMC said that, "We’re pretty well positioned for the downside risks we might encounter from here. I worry a bit more about the prospects for inflation. Headline inflation is clearly too high."
These two statements were enough to birth a change in view among Fed watchers and currency, bond and commodity traders. We had advised in the last post that either a rate lift or jawboning to that effect was necessary to firm the $. That was the result, the $ improving against most other currencies, especially the Euro. That is also one key reason that crude prices have dropped considerably, past few days.
Robert Craven
Since then there has been a change in Fed rhetoric designed to indicate a growing willingness to support the $. First, Bernanke assured lawmakers that inflation is a concern for the central bank. Then Gary Stern, the long-time president of the Minneapolis Fed and a voting member of the FOMC said that, "We’re pretty well positioned for the downside risks we might encounter from here. I worry a bit more about the prospects for inflation. Headline inflation is clearly too high."
These two statements were enough to birth a change in view among Fed watchers and currency, bond and commodity traders. We had advised in the last post that either a rate lift or jawboning to that effect was necessary to firm the $. That was the result, the $ improving against most other currencies, especially the Euro. That is also one key reason that crude prices have dropped considerably, past few days.
Robert Craven
Monday, July 7, 2008
Bernanke - Out Of His League
Say the words "Federal Reserve" and you’ve lost your audience. As one friend noted, "These are the guys who have meetings every couple of months, do something or other with the money supply or interest rates or whatever. Fine. Now, as I was saying, the White Sox slugger Manny Ramirez..."
With this new site we intend to provide a layman’s guide to the Fed. And from that, something on the economy. A similar comment may appear under our Presidential Election blog given the preeminence of this topic in the electoral debate.
A dear friend responded to our recent post on oil; she wondered how if Fed-directed lower interest rates drive oil prices, may not this be self-defeating? That is, won’t higher oil prices restrain an expansion and isn’t, just the opposite of what the Fed is after? This provides a good start.
The Fed controls only the Fed Funds rate - the rate on short-term loans between prime banks. The idea is that by making liquidity available lenders will lend, borrowers will borrow and off to the horse race. The fed funds market can be considered the heart of the system under today’s operating procedure; or better yet, the horse trough; the Fed can fill ‘er up but no way to force ‘ol Jimmy (my Dad’s last horse) or Speedy-the-mule to drink.
The Fed has slashed fed funds from 5.25% to 2.00% in an attempt to spur the economy. Traditionally that works but this time not much happened. Why? Because 1) housing, responsible for perhaps 40% of all eco activity, has not responded as it traditionally does due to the bloated inventory of homes, and 2) the credit mkt is completely dysfunctional. Yet lower interest rates DO mean world investors are less likely to hold the $, especially as they have seen higher and higher signs of US inflation and a less-than-vigilant Fed, making the $ even less valuable in the future, THEIR VIEW. So they have been selling $'s, fleeing that market for other currencies with higher yields, and, for commodities (cheap to inventory with low short-term rates). Hence the weaker dollar. Hence the food/commodity price spike. Sure enough, the Producer Price Index is soaring.
But back to oil: Most oil contracts are in $'s. The weaker the $, the more expensive for US buyers as it takes more and more dollars to a given contract. The $ price of oil is up roughly 70% from late Q4, 07. I don't have the resources here but maybe 40% of that price spike at the pump is currency related - weakness vs the Euro, other currencies; much of the rest, as we indicated in the last sketch under the Robert Craven Report can be tagged to the perceived conflict and the accompanying dislocations in the Middle East given Iranian intransigency and the US/ Israel response.
So yes, our friend is on to something, but just half of something. Lower short-term rates don’t mean higher oil prices by definition. This is only true now because of $ weakness, the world’s perception that the Fed is behind the curve. The Fed’s duty as set out in the charter is to preserve the integrity of the US dollar. The Fed’s duty is NOT to avoid a recession at all costs. Although he doesn’t know it yet, Bernanke is now taking a moderate slow down and is close to creating a bruiser. So until Bernanke’s Fed begins to lift short-term rates, or at least jawbone to that effect we will experience a still weaker $ and higher commodity prices. The FOMC has to commit to long-term price stability or they will turn a slowdown into the worst of both worlds: a prolonged recession and excessive inflation.
Robert Craven
With this new site we intend to provide a layman’s guide to the Fed. And from that, something on the economy. A similar comment may appear under our Presidential Election blog given the preeminence of this topic in the electoral debate.
A dear friend responded to our recent post on oil; she wondered how if Fed-directed lower interest rates drive oil prices, may not this be self-defeating? That is, won’t higher oil prices restrain an expansion and isn’t, just the opposite of what the Fed is after? This provides a good start.
The Fed controls only the Fed Funds rate - the rate on short-term loans between prime banks. The idea is that by making liquidity available lenders will lend, borrowers will borrow and off to the horse race. The fed funds market can be considered the heart of the system under today’s operating procedure; or better yet, the horse trough; the Fed can fill ‘er up but no way to force ‘ol Jimmy (my Dad’s last horse) or Speedy-the-mule to drink.
The Fed has slashed fed funds from 5.25% to 2.00% in an attempt to spur the economy. Traditionally that works but this time not much happened. Why? Because 1) housing, responsible for perhaps 40% of all eco activity, has not responded as it traditionally does due to the bloated inventory of homes, and 2) the credit mkt is completely dysfunctional. Yet lower interest rates DO mean world investors are less likely to hold the $, especially as they have seen higher and higher signs of US inflation and a less-than-vigilant Fed, making the $ even less valuable in the future, THEIR VIEW. So they have been selling $'s, fleeing that market for other currencies with higher yields, and, for commodities (cheap to inventory with low short-term rates). Hence the weaker dollar. Hence the food/commodity price spike. Sure enough, the Producer Price Index is soaring.
But back to oil: Most oil contracts are in $'s. The weaker the $, the more expensive for US buyers as it takes more and more dollars to a given contract. The $ price of oil is up roughly 70% from late Q4, 07. I don't have the resources here but maybe 40% of that price spike at the pump is currency related - weakness vs the Euro, other currencies; much of the rest, as we indicated in the last sketch under the Robert Craven Report can be tagged to the perceived conflict and the accompanying dislocations in the Middle East given Iranian intransigency and the US/ Israel response.
So yes, our friend is on to something, but just half of something. Lower short-term rates don’t mean higher oil prices by definition. This is only true now because of $ weakness, the world’s perception that the Fed is behind the curve. The Fed’s duty as set out in the charter is to preserve the integrity of the US dollar. The Fed’s duty is NOT to avoid a recession at all costs. Although he doesn’t know it yet, Bernanke is now taking a moderate slow down and is close to creating a bruiser. So until Bernanke’s Fed begins to lift short-term rates, or at least jawbone to that effect we will experience a still weaker $ and higher commodity prices. The FOMC has to commit to long-term price stability or they will turn a slowdown into the worst of both worlds: a prolonged recession and excessive inflation.
Robert Craven
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