naked capitalism

Owner of 44-pound cat found; foreclosed woman couldn’t care for pet McClatchy

Hungry seals ‘steer by the stars’ BBC

Citizens use YouTube to keep gov’t in check Silicon

Moscow to seize grain export controls Financial Times (hat tip reader Michael)

More Arrows Seen Pointing to a Recession New York Times. We are only one day ahead of the Times (see yesterday’s “Recession Sightings Picking Up Steam“).

Wachovia will walk-over-you Bronte Capital

Unconvinced by economic growth? Blame the deflator Reuters

Can This Planet Be Saved? Paul Krugman

Antidote du jour:

The auction rate securities market seize up has found more and more firms accused of less than upright behavior. The state of Massachusetts contends that Merrill misled investors about the risks of the instruments. A common complaint is that brokers presented the ARS as being as safe as money market funds.

From Bloomberg:

Massachusetts Secretary of State William Galvin accused Merrill Lynch & Co. of fraud, claiming the investment bank sold auction-rate securities to investors while misleading them about the market’s stability.

Merrill, based in New York, also “co-opted” its research department to help sell the securities, Galvin said in a statement today. The state’s administrative claim asks the third-largest U.S. securities firm to “make good” on sales of now-frozen holdings, compensate investors who sold their bonds or shares at a loss and pay an unspecified fine.

“This company was aggressively selling” the securities “to investors and its auction desk was censoring the research analysts to make sure they downplayed” market risks, Galvin said in the statement. “They knew the auction markets were in trouble, but the investors were the last to know.’….

Merrill decided to stop supporting bids with its own money five days after one of its analysts told financial advisers the bonds represented “a good, conservative, reasonable investment,” Galvin said.

“Our research reflected the honest belief that ARS offered higher returns in exchange for less liquidity and noted that market changes had begun to occur,” said Mark Herr, a spokesman for Merrill, using the acronym for auction-rate securities.

The securities firm, whose market value trails Goldman Sachs Group Inc. and Morgan Stanley, made about $90 million in profit during 2006 and 2007 from its auction-rate program, Galvin said in the statement.

“Time after time, when confronted with conflicts of interest, Merrill Lynch was consistent in that it placed its own interests ahead of its investor clients,” according to the complaint.

This is far from the first time that initially positive GDP readings were later revised into negative territory. Fourth quarter growth, initially posted at 0.6% of GDP, was revised down to -0.25 today and first quarter to 0.9% from 1.0%.

But what appears to have gotten the market’s attention was that the rebate checks had such little impact on the quarter just ended. Second quarter came in at 1.9% (frankly, even than appears better than it feels). Yet critics said the rebates were likely to be ineffective, since they put money in the hands of consumers less likely to spend. Indeed, by Gary Shilling’s calculus, consumers lived up to their plans to save 80%of the rebate.

From the Wall Street Journal:

The soft U.S. economy sped up in the spring but still rose less than expected despite tax rebates handed out to spur growth, a report said Thursday.

The Commerce Department reported gross domestic product climbed 1.9% in the second quarter. Wall Street expected 2.3% growth. First-quarter GDP grew 0.9% and the fourth quarter fell 0.2%….

A Labor Department report Thursday showed the number of U.S. workers filing new claims for unemployment benefits jumped to a five-year high last week. Initial claims for unemployment benefits rose 44,000 to 448,000 after seasonal adjustments in the week ended July 26.

The soft labor market is restraining labor costs, which rose 0.7% during the second quarter, another Labor Department report Thursday said. Wages and salaries grew 0.7%. Benefit costs advanced 0.6%. The mild increases are unfortunate for the average worker — but helpful for central bankers.

“For the Fed’s part, the lackluster wage growth greatly enhances their ability to control inflation without further damage to near-term growth,” said Global Insight analyst Kenneth Beauchemin.

Readers may remember that this blog broke the story, thanks to information provided by a former senior Lehman employee, that some of the asset sales in Lehman’s touted second quarter deleveraging were in fact to a newly formed hedge fund, R3 Capital, staffed by former Lehman MDs and employees, that not only has Lehman as an investor, but reportedly also has Lehman retaining an economic interest in the assets sold. Moreover, the former employee charged, based on information provided by several people at Lehman, that the R3 employees’ restricted stock was still vesting on its original schedule, as if they were still on the firms’ payroll. If true, this is both highly unusual and costly.

Jonathan Weil at Bloomberg has taken an interest in the R3 question and is not letting the investment bank off the hook. As this story makes abundantly clear, he thinks Lehman has been far less forthcoming than it needs to be. That suggests the firm may be trying to hide the fact that R3 is a related party, which in turn would mean the supposed asset sales might be viewed by investors as anything but. Note that the Bloomberg story also confirms the former staffer’s intelligence about the restricted stock.

Reader Marielle, who e-mailed us about this story, drily noted, “Makes you wonder why Merrill sold to Lodestar when they could have just created an S3.”

From Bloomberg:

The more you learn about Lehman Brothers Holdings Inc.’s relationship with R3 Capital Partners, the more it looks as if Lehman may not be telling investors all they need to know.

When Lehman filed its second-quarter financial statements three weeks ago, it was the first time the securities firm disclosed its $1.1 billion investment in R3, the hedge fund that Rick Rieder and other former Lehman executives started in May. Lehman’s report gave few details, though it did say Lehman sold R3 lots of assets last quarter. The big question is whether Lehman, which also is R3′s landlord, disclosed enough.

To help answer that, consider some of the disclosures R3 made in a private-placement memorandum this month for prospective investors, a copy of which I reviewed. They go to a critical issue: Are R3 and Lehman related parties?

Under the rules known as Financial Accounting Standard No. 57, the answer would be yes, if Lehman has the ability to “significantly influence the management or operating policies” of R3. Based on the statements in R3′s memo, it looks to me as though Lehman does. Lehman and R3 demur.

The 110-page memo includes six pages describing “actual and potential conflicts of interest” arising from R3′s relationship with Lehman. For instance, it says that “LB (Lehman Brothers) interests may comprise as much as 48 percent of the net asset value of the master fund.” As a result, “a withdrawal of all or a substantial portion of the LB interests could have an adverse effect on the fund as a whole and its ability to pursue its strategy.”

R3 also said its executives may continue to own Lehman restricted stock that they received during their previous jobs, which “may influence the principals’ dealings with LB as well as their investment decisions.” In other words, R3 might be prevented from fully pursuing its own separate interests.

Ed Ketz, an accounting professor at Pennsylvania State University, said Lehman’s potential 48 percent stake in R3′s master fund by itself would be “significant influence in anybody’s book,” even without voting rights.

I am quite certain that Felix Rohatyn, now a senior advisor to Lehman, has said publicly (apropos investments by sovereign wealth funds) that a passive investment would still give the owner influence. I cannot recall whether the level Rohatyn discusses was 10% or 20%, but it was way below the 48% in question.

Here’s why details like those matter. Under FAS 57, if R3 is a related party, then Lehman should have disclosed enough information about its R3 transactions so that an outside reader could gain “an understanding of the effects of the transactions on the financial statements.” Lehman didn’t do this….

Here’s what Lehman did disclose about R3: During the second quarter, it acquired “non-voting, minority ownership stakes” in R3′s master fund, general partner, special limited partner and management company. As of May 31, its investment was $1.1 billion. Lehman said it “sold assets and transferred derivative risk of approximately $4.5 billion at fair value to R3” last quarter. The assets primarily were corporate bonds and loans….

Ultimately, the question of “significant influence” is a judgment call. Even if an investor’s stake is small, that doesn’t necessarily preclude the investor from having a lot of sway. Likewise, the test for identifying related parties isn’t whether one party is influencing the other’s management or policies now. The test is whether it can.

In its memo, R3 says it will hire Lehman to perform “marketing, financing, derivatives intermediation and trading, prime brokerage, placement agent, price verification, risk control and information technology services.” Its six principals all came from Lehman, as did the 10 other key professionals it listed.

R3 also said that Lehman “may come into possession of material, non-public information” that “could limit the ability of the fund to buy and sell investments.” Consequently, “the investment flexibility of the fund may be constrained as a result of the advisor’s relationship with LB.” It’s hard to understand why any insider knowledge Lehman has would be imputed to R3 if they weren’t related.

Lehman also “will have greater access to information” than other R3 investors about the fund, which Lehman can use in deciding whether to withdraw its investment, and in recommending to clients whether they should, too.

Significant influence or not, it sure looks like Lehman has a lot of pull. Meantime, investors can only wonder what information Lehman isn’t disclosing about its dealings with R3.

They shouldn’t have to.

Something’s in the air…news of recession everywhere. Or so it seems this evening.

First, readers Michael and Scott sent us Jeremy Grantham’s latest newsletter. Grantham is known as a perma-bear, and his call that a major bank would fail in the next five years (this about two years ago) was seen as a symptom that he had a few screws loose. No more.

Several changes in this update. First, Grantham now thinks we will have a global recession (before, he thought emerging markets would escape):

Economically, most emerging countries really looked to have decoupled for 18 months as we slowed and they did not. But in a global recession no one decouples. As German, French, and British growth slowed rapidly in the last 6 weeks, a global slowdown looks more likely and more painful. To this end, we have done an about face and lowered our weightings in emerging equities to
neutral or just below. To critics of this change, I would cite the quote attributed to Keynes, caught in the same predicament: “When the facts change, I change my mind – what do you do, sir?”

Nouriel Roubini, by contrast, never bought the decoupling thesis, as he reminds us in his latest post:

As already analyzed and discussed in detail in this blog there is now fresh evidence that at least a dozen major economies and some emerging markets are at risk of a recessionary hard landing. The list includes:

United States
Japan
United Kingdom
Spain
Ireland
Italy
Portugal
Canada
New Zealand
Estonia
Latvia
Some other South-Europe emerging markets

Moreover, even in the rest of the Eurozone (Germany, France, etc,) there is now evidence of a sharp growth deceleration as industrial production is falling in all of the Eurozone, business confidence is down, consumer confidence is down and retail sales are flat or falling….

So while we will not experience a global recession we will get close to one as the US will have a severe recession, Japan is entering one, a third of Europe will go into a recession, the rest of Europe will have a severe growth slowdown, the rest of the G-10 advanced countries is sharply slowing down and a few emerging market economies are entering a recession. And if the advanced economies are sharply slowing down or entering a recession the idea that China, India, the other BRICs and emerging markets can happily decouple from these recession or sharply slowing economies is far fetched.

Back to Grantham. Second change: he has not modified his “fair value” of a 10% to 15% fall in the S&P (1100ish) and a further 10% fall in housing prices. but he thinks the odds of overshoot on the downside have increased:

So, in general, the unexpectedly bad fundamentals have not dramatically changed our asset class forecasts. Yes, there has been an unexpectedly large bite taken out of the net worth of financial companies. But other than that, it is more that the probability has increased for longer and deeper overruns below fair value and the chance of a “meltdown” substantially more rapid than my long-held suggestion of a leisurely move to a low in 2010 or later.

Michael also pointed out that the Baltic Dry Index has fallen, as this Bloomberg chart confirms, but that sighting needs to be taken with a grain of salt. The Baltic Dry Index, which is a measure of shipping rates and hence international trade activity, is prone, like the negative yield curve, to send false signals. Still, the trend is clearly not positive:

Finally, Mish has a very good post, “Credit Crunch Reaches Critical Mass.” with a series of examples of money scarcity and resulting damage. Not conclusive, but not encouraging either.

Not only are we getting bailouts, we are now getting Chinese puzzle box bailouts, with new tricks nestled inside other vehicles. Maybe we should quit pretending and just give the American Bankers Association and the National Association of Realtors blank checks from the Treasury Department. We might as well be straightforward about what is happening.

The effect of the new legislation is to end penalties for Fed loans extending beyond a certain time limit to failed banks. The original purpose was to keep the central bank from keeping institutions that ought to be shuttered open. Think there’s any risk that might happen? But the practical effect is that this appears to be a backdoor way to shore up the FDIC.

From Bloomberg:

The Federal Reserve will be able to lend more easily to failed banks under government control because of a provision in legislation that bailed out Fannie Mae and Freddie Mac.

In the rescue signed into law by President George W. Bush yesterday, the Fed will no longer have to pay penalties on loans it makes to institutions taken over by the Federal Deposit Insurance Corp.

The measure may mean more use of the central bank’s balance sheet to prop up the U.S. financial system,…

“We are pushing forward the line on what the government will backstop, and what the Federal Reserve will backstop,” said Vincent Reinhart, former director of the Fed’s Monetary Affairs Division who is now at the American Enterprise Institute in Washington…

The Federal Reserve Act’s Rule 10B penalizes the Fed for loans to undercapitalized institutions exceeding specific time periods. The original provision was aimed at preventing the central bank from keeping failing banks open.

The exemption in the new law, which was requested by the FDIC without objection by the Fed’s Board of Governors, was aimed at making clear that once banks are taken over by the FDIC, capital rules no longer apply because they are effectively owned, operated and in liquidation by the government….

For some, the exemption opens up the Fed to more political pressure to lend to government agencies, instead of forcing Congress, the FDIC, or the Treasury to explain to taxpayers why they need more money.

“Once the Fed starts lending to a bridge bank, or indirectly to the FDIC, where is the incentive to ever stop?” said Walker Todd, a former Cleveland Fed attorney and visiting research fellow at the American Institute for Economic Research in Great Barrington, Vermont.

The FDIC had $52.8 billion in its deposit-insurance fund as of March 31. The FDIC could raise more money by tapping a $40 billion credit line it has with the U.S. Treasury, increasing assessments on its members, or turning to Congress.

“Like any open depository institution, there will be short-term borrowing needs by the bridge bank,” which may need to “tap the discount window,” Gray said, referring to the name for the Fed’s direct loans to commercial banks. “Longer-term borrowing needs would typically be met by a loan from the FDIC.”…

A request by the FDIC could always be rejected by the central bank. Still, the removal of the penalties may open up the Fed to more political pressure, possibly encroaching on its independence, analysts said.

“Why should they be doing it?” said Robert Eisenbeis, former Atlanta Fed research director and now chief monetary economist at hedge fund Cumberland Advisors LLC. “The whole idea” of the rules in the Federal Reserve Act is “to make it costly and difficult to support an insolvent institution.”

Sad end for bear with jar on head BBC

Subprime lending not main trigger of real estate bubble PhysOrg

No Shorting. That’s the Rule Barry Ritholtz

Most Heavily Shorted ETFs Bespoke Investment Group

Fannie Mae, Freddie Mac Live to Die Another Day Caroline Baum, Bloomberg

Regrettable Comments by Bank CEOs Portfolio

Just how stabilizing? Brad Setser. This is an important post, and if I weren’t behind on a zillion fronts, I’d discuss it in a separate post. Be sure to read it.

Antidote du jour:

This exchange from Institutional Risk Analytics is a bit light on the vitriol, but the observation is acute:

The IRA: But speaking of certainty, don’t you believe that it is impossible to give our leaders a pass with respect to the mortgage bubble? How can we look at Alan Greenspan, Larry Summers or Bob Rubin and allow them to say that they were surprised by the magnitude of the bubble and the horrible consequences?

Timothy Dickinson: Well, partly because these massive egos believe that they had “fine tuned” things and would not take any of the consequences of a break. They thought that their record of qualification would distinguish them and keep them from being blamed. The reality is, in my view, than none of them had the courage to overturn a few apple carts early in the game and thereby forewarn the public before the 18-wheeler overturned.

And a great jab from Jeremy Grantham’s July newsletter (no online source):

Didn’t we all expect at least modest competence from most of our financial companies? I always thought it was the Bear Stearns of the world who knew what was going on, and that when the music stopped, the financial junk would be safely (from our point of view) in the hands of, say, Taiwanese banks. How did the guys who put some dead rats in the pot end up eating some of their own stew? (To be charitable, perhaps the head chefs did not realize that the kitchen staff was throwing in the odd rat to increase their Christmas bonus!)….

Given the growing perception of incompetence that is broadly distributed throughout the system, we run a serious risk of a meltdown in confidence in leadership totally unlike anything we have seen since World War II. And with substantial justification! Why should we trust the financial system the way we used to? We should distrust the general competence of financial management: of governments and of corporations and of all bankers, whether commercial, investment, or central bankers.

The proportion of Americans designated as “involuntary part-time” hit a record high. This development would seem to undercut the unexpectedly upbeat news from the ADP payroll report earlier this week, that an unexpected 9,000 jobs had been added. Some experts warn that these reductions in work hours are a precursor to workforce reductions.

From the New York Times (note I’ve omitted the sad stories, but some really are pretty grim):

The number of Americans who have seen their full-time jobs chopped to part time because of weak business has swelled to more than 3.7 million — the largest figure since the government began tracking such data more than half a century ago…..

On the surface, the job market is weak but hardly desperate. Layoffs remain less frequent than in many economic downturns, and the unemployment rate is a relatively modest 5.5 percent. But that figure masks the strains of those who are losing hours or working part time because they cannot find full-time work — a stealth force that is eroding American spending power.

All told, people the government classifies as working part time involuntarily — predominantly those who have lost hours or cannot find full-time work — swelled to 5.3 million last month, a jump of greater than 1 million over the last year.

These workers now amount to 3.7 percent of all those employed, up from 3 percent a year ago, and the highest level since 1995.

“This increase is startling,” said Steve Hipple, an economist at the Labor Department….

“The unemployment rate is giving you a misleading impression of some of the adjustments that are taking place,” said John E. Silvia, chief economist of Wachovia in Charlotte. “Hours cut is a big deal. People still have a job, but they are losing income.”

Many experts see the swift cutback in hours as a precursor of a more painful chapter to come: broader layoffs…

“The change in working hours is the canary in the coal mine,” said Susan J. Lambert of the University of Chicago, a professor of social service administration and an expert in low-wage employment. “First you see hours get short, and eventually more people will get laid off.”…

In decades past, when business soured, companies tended to resort to mass layoffs, hiring people back when better times returned. But as high technology came to permeate American business, companies have grown reluctant to shed workers. Even the lowest-wage positions in retail, fast food, banking or manufacturing require computer skills and a grasp of a company’s systems. Several months of training may be needed to get a new employee up to speed…

The trend toward cutting hours in a downturn lessens the pain for workers in one regard: it moderates layoffs. Many companies now strive to keep payrolls large enough to allow them to easily adjust to swings in demand, adding working hours without having to hire when business grows.

But that also sows vulnerability, heightening the possibility that hours are cut when the economy slows and demand for goods and services dries up.

Dear readers,

You may recall my mentioning that I was going to Alaska to view the splendors of Nature and watch the ice melt. That time is upon us.

Aside from the fact that it might do me some good to learn how to take a vacation, Internet access is very limited in Alaska if you are passing through. Readers in that great state advised me that every public library offers free Internet, but that seems to underscore the notion that I should get with the program and do without while I am there. I am completely off the grid August 3-10, and posting only on a limited basis now through August 3 and August 11.

Some very able readers responded to my calls for guest bloggers. In fact, I had to turn some very talented people down for now, in part because I wanted to give first dibs to people who have helped out in various ways.

So I trust you have fun with the guest bloggers. You will hopefully find them a good mix of ideas, styles, and perspectives. In fact, I’m a bit worried you might find my return (back for real August 12) a letdown.

They are:

Cassandra of Cassandra Does Tokyo, who has, for the past 18 years, been an accidental, risk-averse, though reasonably profitable hedge fund manager, and who secretly wishes to do something more meaningful and interesting (provided it has nothing to do with professional sports, fashion, or ballroom dancing)

Paul Davis. based in New Zealand, is the founder and head of research of TechInvest, which runs three Australian-licensed funds, a global market neutral fund, a technology fund, and a global equity fund

Jim Fitch of the witty, pointed, and somewhat twisted Some Assembly Required

Scott Frew, Connecticut-based manager of hedge fund Rockingham Capital Partners who is thoughtful, discerning, and pretty plugged in

Lune, a neurosurgeon who has provided much in the way of thoughtful comments and (among other things) understands healthcare economics both via some formal training and having worked on Capitol Hill as a health policy fellow. However, he has volunteered not to write about that unless the news turns that way

Steve Waldman of the provocative economics blog Interfluidity, who not only has a trenchant writing style but also knows a thing or two about central banks

I have queued up daily Antidotes du Jour while I am away.

Have fun!

The lawsuit filed by the Connecticut state attorney general against rating agencies Moody’s, Standard & Poor’s and Fitch over their unduly tough marks for state and municipalities (their policies have claimed the ratings are uniform) is peculiar indeed. While I am sympathetic with the wronged public issuers, the fact is that the rating agencies enjoy a repeatedly upheld First Amendment exemption from liability (they have asserted, successfully, that their ratings are mere journalistic opinion, a claim that is clearly utter rubbish but that the courts nevertheless take seriously.

However, the AG is pursuing an antitrust claim. That may be a novel theory, but will it succeed? Unless the AG can surmount the First Amendment argument, this lawsuit will merely serve as harassment.

From Bloomberg:

Connecticut Attorney General Richard Blumenthal sued Moody’s Corp., Fitch Inc. and Standard & Poor’s parent The McGraw Hill Cos. for allegedly giving municipal bonds lower ratings than comparable corporate or structured debt…

Blumenthal, the state’s top law enforcement officer, has been conducting an antitrust probe of the three credit-rating companies. Last month, he said firms that rate U.S. municipal bonds “knowingly and systematically” gave the securities lower grades, raising costs for state and local governments….Blumenthal said the dual standard benefited bond insurers, investors and the agencies themselves.

“This rating charade created a Wall Street shell game constructed by the ratings agencies for the benefit of the bond insurers,” he said, adding that bond insurers profited from unnecessary premiums and interest paid by taxpayers…..

State officials and regulators have criticized New York- based Moody’s, New York-based Standard and Poor’s and Fitch, a unit of Paris-based Fimalac, for using a scale that raised borrowing costs by holding municipal bonds, whose 10-year default rate was 0.1 percent between 1970 and 2006, to a higher standard than corporate and sovereign debt.

Many issuers bought bond insurance to improve their rating, a strategy that backfired this year when some guarantors lost their AAA ratings amid subprime mortgage-related losses.

The Connecticut probe has included whether the firms rank debt against issuers’ wishes, then demand payment, or threaten to downgrade debt unless they’re awarded business to rate all of an issuer’s securities, Blumenthal has said.

He has also been scrutinizing links between Moody’s and its largest shareholder, Warren Buffett’s Berkshire Hathaway Inc.

Readers may know I am a big fan of Kenneth Rogoff and Carmen Reinhart, his frequent research partner and co-author. One of my reasons is that he is much more empirically-oriented than most Serious Economists.

One recent bit of Reinhart/Rogoff research that has gotten some attention (but in my mind, still not enough) is their in-depth study of financial crises. They went back 900 years, and studied the more recent ones (as in post 1800) more intensely. They’ve had several end products from this effort, one of which everyone should read, a comparison of our current mess with the major financial crises in developed countries after World War II.

Another reason for my fondness for Rogoff is that he does not hew to conventional wisdom. For instance, most liberal economists, and Rogoff falls in that camp, are recession-averse and are thus keen (way too keen, in our opinion) to break glass and administer stimulus at the first sign of economic weakness (Larry Summers exemplifies this posture).

Even though we agree that recessions are Bad Things, we also think there are things worse than letting recessions occur. For instance, we are now seeing that keeping the party going way too long leads to more brutal adjustments in the end. And there is some evidence that there is no free lunch, that forestalling a recession leads to lower than potential output in the good times.

Rogoff, in a Financial Times comment, contends we need a slowdown for different reasons: he views the efforts at stimulus as a dangerous, misguided way to try to evade the need to restructure the financial system. Even though his forecast of oil falling as low as $75 a barrel may strike some readers as extreme. note that the famous Goldman research that called for a “super spike” of $150 to $200 a barrel this year also called for prices a few years out at $75. He also says, mirable dictu, that financial firms need to fail because the industry is unsustainably large.

Update: Brad Sester corrects me, saying Rogoff is not a liberal. I had mistakenly assumed he was at least somewhat to the left of center because a) he has written for Project Syndicate and the Guardian and b) I’ve no doubt missed it somewhere, but for the life of me, I can’t recall him having used the expression “free market”.

From the Financial Times:

As the global economic crisis hits its one year anniversary, it is time to re-examine not just the strategies for dealing with it, but also the diagnosis underlying those strategies. Is it not now clear that the main macroeconomic challenges facing the world today are an excess demand for commodities and an excess supply of financial services? If so, then it is time to stop pump-priming aggregate demand while blocking consolidation and restructuring of the financial system.

The huge spike in global commodity price inflation is prima facie evidence that the global economy is still growing too fast. There is nothing sinister in this. The world has just experienced perhaps the most remarkable growth boom in modern history. Given the huge cumulative rise in global growth during the 2000s it is little wonder that commodity suppliers have found it increasingly difficult to keep up, even with sharply rising prices.

For many commodities, particularly energy and metals, new supply requires long lead times of five to 10 years. In principle, the demand response is more nimble, but it has been greatly dulled by a wide variety of subsidies and distortions in fast-growing emerging markets.

Absent a significant global recession (which will almost certainly lead to a commodity price crash), it will probably take a couple of years of sub-trend growth to rebalance commodity supply and demand at trend price levels (perhaps $75 per barrel in the case of oil, down from the current $124.) In the meantime, if all regions attempt to maintain high growth through macroeconomic stimulus, the main result is going to be higher commodity prices and ultimately a bigger crash in the not-too-distant future.

In the light of the experience of the 1970s, it is surprising how many leading policymakers and economic pundits believe that policy should aim to keep pushing demand up. In the US, the growth imperative has rationalised aggressive tax rebates, steep interest rate cuts and an ever-widening bail-out net for financial institutions. The Chinese leadership, after having briefly flirted with prioritising inflation (expressed mainly through a temporary acceleration in renminbi appreciation), has resumed putting growth as the clear number one priority. Most other emerging markets have followed a broadly similar approach.

Dollar bloc countries have slavishly mimicked expansionary US monetary policy, even in regions such as the Middle East, where rapid growth is putting huge upward pressure on inflation. Of the major regions, only Europe, led by the European Central Bank, has resisted joining the stimulus party so far. But even the ECB is coming under increasing domestic and international political pressure as Europe’s growth decelerates.

Individual countries may see some short-term growth benefit to US-style macroeconomic stimulus, albeit at the expense of loosening inflation expectations and possibly paying a steep price to re-anchor them later on. But if all regions try expanding demand, even the short-term benefit will be minimal. Commodity constraints will limit the real output response globally, and most of the excess demand will spill over into higher inflation.

Some central bankers argue that there is nothing to worry about as long as wage growth remains tame. True, globalisation continues to shrink unskilled labour’s share of global income. But as goods prices rise, wage pressures will eventually follow. As Carmen Reinhart and I have shown in our research on the history of international financial crises, governments in every corner of the world showed themselves perfectly capable of achieving very high rates of inflation long before they had the assistance of modern unions*.

What of the ever deepening financial crisis as a rationale for expansionary global macroeconomic policy? It is hard to see the argument in emerging markets where inflation is raging, but even in epicentre countries it is becoming increasingly dubious. Inflation stabilisation cannot be indefinitely compromised to support bail-out activities. However convenient it may be to have several years of elevated inflation to help bail out homeowners and financial institutions, the gain has to be weighed against the long-run cost of re-anchoring inflation expectations later on. Nor is it obvious that the taxpayer should absorb continually rising contingent liabilities (such as increased backing for Fannie Mae and Freddie Mac, the giant US mortgage agencies).

Indeed, if financial firms are not going to be allowed to go out of business, how exactly do central banks and regulators intend to effect the shrinkage of the financial industry commensurate with the sharp fall in key lines of business related to mortgage securitisation and derivatives? Perhaps regulators hope firms will shrink 10-15 per cent across the board. But this is seldom how consolidation works in any industry. Rather, the weakest firms go out of business, with their healthy parts being taken over, or pushed aside by better run institutions. Is every failure evidence of a crisis?

The airline industry often goes through periods of excess capacity, with giant companies going out of business or merging. Yet, we have grown accustomed to these traumas and learned to live with them, as in many other industries. Is it right to let the banking industry hold nations hostage each time they experience consolidation? As major central banks extend their discount windows to complex investment banks whose business lines are evolving and churning constantly, “crises” of consolidation are surely going to become more frequent.

For a myriad reasons, both technical and political, financial market regulation is never going to be stringent enough in booms. That is why it is important to be tougher in busts, so that investors and company executives have cause to pay serious attention to risks. If poorly run financial institutions are not allowed to close their doors during recessions, when exactly are they going to be allowed to fail?

Of course, today’s mess was many years in the making and there is no easy, painless exit strategy. But the need to introduce more banking discipline is yet another reason why the policymakers must refrain from excessively expansionary macroeconomic policy at this juncture and accept the slowdown that must inevitably come at the end of such an incredible boom. For most central banks, this means significantly raising interest rates to combat inflation. For Treasuries, this means maintaining fiscal discipline rather than giving in to the temptation of tax rebates and fuel subsidies. In policymaker’s zealous attempts to avoid a plain vanilla supply shock recession, they are taking excessive risks with inflation and budget discipline that may ultimately lead to a much greater and more protracted downturn.

Thai school offers transsexual toilet BBC

Women end up less happy than men PhysOrg

Paterson: State Deficit Up $1.4B Over Last 90 Days Governor Says Damage On Wall Street ‘Infecting’ State CBS (hat tip reader Michael)

Nameless “Experts” Mourn Failure of WTO Round Dean Baker

Economics of catastrophe Paul Krugman

Super-Senior Tranches of CDOs are Worth Much Less than 22 Cents on the Dollar: Another Ponzi Scheme of “Selling” Toxic Garbage with More Leverage Nouriel Roubini. In case you had any doubts as to where he stands on this matter….

Dealers may change some CDS contract terms Reuters (hat tip Alea)

The Button Men Skeptical CPA. Useful case precedent on an issue that has troubled many relative to the Bear hedge fund indictments.

The repugnant bailout nation Bill Fleckenstein (hat tip The Nattering Naybob)

Covered by whom? Bonds on what? Steve Waldman. Steve is back! And he is pretty skeptical of covered bonds for some not-standard reasons.

Antidote du jour:

If Starbucks, which sells an addictive staple at an only somewhat upmarket price point, is having to retrench, it’s a no-brainer that other consumer discretionary spending is taking an even bigger hit. But to date, the results are mixed. Movies, which in many places don’t require much driving, are holding up well. And they did very well in the Depression, although that may have been due in part to the fact that many (or so my mother reports) were air conditioned.

But restaurants take it on the chin early. Even so, rising food costs have taken them out earlier than might normally occur in a slump. In supposedly-not-too-badly-affected Manhattan, quite a few restaurants are shuttered, some with the storefronts still vacant, some with completely different merchants in the space, and a brave few with replacement eateries.

The Times tells us the same pattern is playing out nationally, with the price point above fast food suffering the most.

From the New York Times:

Several national restaurant chains were shuttered on Tuesday…The parent company of Bennigan’s, an Irish-themed bar and grill with about 200 sites across the country, filed for bankruptcy…

A sister brand, Steak & Ale, will also close. Franchise units of Bennigan’s will remain open for now….

The restaurants are the latest casualties in the so-called casual dining sector, considered a cut above fast food. Soaring food costs and a surfeit of locations have hurt the companies’ bottom lines just as Americans are choosing to take more meals at home….

Trips to the mall or the local tavern — the casual outings that provide much of the business for midtier retailers — are falling by the wayside, analysts said, as gas prices reach record highs and Americans tighten their household budgets….

Another hurdle facing these restaurants is their copycat nature. Though Bennigan’s modeled itself as an Irish pub, its menu had Black Angus steaks, Southwestern-style appetizers and tempura shrimp, items that would not be unfamiliar to patrons of, say, T.G.I. Friday’s or Ruby Tuesday.

“All these bar and grill concepts are very, very similar,” said Bob Goldin, executive vice president of Technomic, a restaurant industry consulting group. “They have the same kind of menu, décor, appeal,” which makes it more difficult to establish brand loyalty among customers…

The Ponderosa and Bonanza restaurants, which operate under another entity, Metromedia Steakhouses, were not covered in the bankruptcy…

“It’s not going to be easy to replace a tenant at this time, given the status of the industry,” Mr. Goldin, of Technomic, said. “It’s much trickier when you have to retrofit the whole place to fit in another kind of retailer.”

And Ms. Greene, of Avondale Partners, said that financing was also starting to dry up for ailing restaurant chains. “Banks have become less willing to lend to restaurants and franchisees,” she said. “The business fundamentals just do not support it right now.”

Merrill’s surprising, mere ten days after its last investor combo writedown/fundraising announcement still has financial analysts toting up the collateral damage. Remarkably, the US stock market staged a peppy rally, clearly choosing to ignore the implications.

The cause for pause was the sale of $30.6 billion in face amount of super senior CDOs at a ostensible price of 22 cents on the dollar. But the sale was 75% financed, non-recourse, and could almost be characterized as a call rather than a sale. Worse, the CDOs were mainly 2005 vintage, and thus should have better quality underlying assets than 2006 and 2007 deals.

Barry Ritholtz argues that the real sales price was 5.47%, the amount paid in cash. That’s debatable (you’d need to look at the financing terms and do a bit of math), but the general point is well taken: the real number is lower than 22%. But even that figure has knock-on consequences.

Reader Saboor was so kind as to provide links to stories that discuss the broader ramifications. The Financial Times cites Goldman Sachs analyst William Tarona saying that if Citi were to mark its $22.7 billion of CDOs on the same basis, it would take a $16.7 billion writedown (note this is nearly twice Michael Mayo’s estimate earlier today),

However, the low price paid by Lone Star Funds, a distressed debt investor, to buy Merrill’s CDOs sparked fears that the financial system could enter another spiral of huge writedowns followed by highly dilutive capital raisings…

Mike Mayo, Deutsche Bank analyst, said Merrill’s action, a fortnight after John Thain, chief executive, said that it did not need more capital, “raises ongoing credibility issues for the industry”.

William Tanona, Goldman Sachs analyst, said that if Citi were to write down its $22.7bn of CDOs to the levels implied by the Merrill deal, it would have to take a $16.2bn writedown. Citi said this month that it valued its CDOs at about 61 cents on the dollar. Citi declined to comment. However, people close to the company said that the bulk of its CDOs dated to years prior to 2005 – before the onset of the housing crisis. As a result, they said that Citi was comfortable valuing them at current levels.

I find the claim about Citi’s CDOs hard to swallow. The CDO market grew explosively starting in roughly 2003; the vast majority of the deals were closed in 2005 or later. Why would they have kept the paper on their books if it was any good? The reason most banks wound up stuck with CDOs was that the market started getting indigestion as underwriters kept churning out paper in the face of weakening demand for certain tranches. The retained super senior slice was reported unsold underwriting inventory. And my impression further was that most CDOs had lives of five years or less, that the underlying assets matured or were paid off (for instance, mortgages were paid off via sales or refinancings).

The Times had a dire article, featuring Michael Mayo’s forecast of an $8 billion writedown for Citi and another grim perspective:

Sean Egan, of Egan Jones, called the sale a watershed moment, with implications that would trigger huge additional writedowns on CDOs and related assets worldwide. “This sends a loud and clear signal that the issue with CDOs is not liquidity in the market but problems with the value of their underlying assets,” he said.

Many owners of CDOs have marked down their value insufficiently, believing that such assets were sound and that the market’s appetite for them had dried up temporarily amid nervousness about all but the safest forms of debt.

Mr Egan said that Monday’s sale indicated that the problems were not temporary and that there needed to be widespread devaluation of CDOs. Mr Egan said: “The accountants will have to put significant pressure on their clients to write down these assets — Fannie Mae and Freddie Mac in particular — as this high-profile transaction has underscored the losses that are inherent in these kind of asset-backed securities.”

Freddie Mac disclosed at the end of March that it had $32 billion of losses on various securities that it deemed “temporary” and which were not reflected in its accounts. Fannie Mae reported $9 billion of similar losses at the same time. However, the writedowns will need to be much greater than that, Mr Egan said, in part because the market for CDOs has deteriorated significantly since March….

The extra losses that Mr Egan forecasts could double writedowns that financial institutions have taken so far in relation to the credit crisis, which stand at $400 billion.

It seems noteworthy that, at least of this hour, the UK press is taking keener interest in the downside that its US counterparts.

Update 1:20 AM: One important point I failed to make, A reason that Citi and others might legitimately have CDOs that could e marked higher (or lower) is that the structure of each deal is custom, and there is a very high degree of variability among deals. Since each is pretty much sui generis, Merrill’s trade can only be used as a mark in a very general sense. While it does call valuations of, say, 50 cents on the dollar and higher very seriously into question, there is still a good deal of artwork in determining what the Merrill sale means for other firms.

That clearly implies they probably have ample wriggle room to fudge if they wanted to…..the open question is how hard a time will the analysts give them? So far, some seem to be saber-rattling, but if a bank could tell a persuasive story as to how their CDOs were better than Merrill’s, they’d probably back down.