I'm off to Los Angeles Sunday to participate in a first time panel of econbloggers at the Milken Conference. Needless to say, I'm flattered to be in such good company.
As a result, my posting may be a bit lighter next week. If you want to help, please send interesting research, scholarly articles, and news links. Trolling to find suitable material takes a fair bit of effort, so assistance on this front is very much appreciated (and will be rewarded via better posts). I'll be back Friday evening.
As for our problems with Google, we may have declared victory too early. Even though they unlocked the blog so I could post again, they left it in a state which meant that the domain name (www.nakedcapialism.com) could not point to the Blogger address (www.nakedcapitalism.blogspot.com). The term of art is envelope, for those who are versed in such matters. Note this did not affect readers who use RSS. We are having another word with them, but at least things are largely back to normal.
Ed Wright implemented a workaround, but he result was that the blog was down today for an hour at one clip, plus a total of twenty minutes in three outages later. Sincere apologies for the inconvenience and thanks for your patience.
Recent Items
Saturday, April 26, 2008
Tech Woes Behind Us
Our recent problems with Google's Blogger hosting service seem to have been resolved. We experienced a bit over an hour of outage while resolving the last of the domain name resolution issues. Thanks for your patience.
Ed Wright
Naked Capitalism - Technical Support
Ed Wright
Naked Capitalism - Technical Support
Buffett's and Soros' Feet of Clay
Even great investors have bad days and bad calls. John Authers has a clever piece in the Financial Times on the errors Buffett and Soros have made.
According to a soon-to-be-released book by Vahan Jahigian, Buffett is astute about his picks, natch, but not so hot at selling. He argues that the Sage of Omaha has held on to some stocks that did well for many years but then underperformed.
But is this an indictment? The theorists say that trying to market time or do sector rotation is a way to overtrade and underperform. If Buffett believes his companies are still fundamentally sound, but presently out of favor, that doesn't argue for a sale. One of Buffett's maxims goes something like, "In the short term the market is a popularity contest, in the long term, a weighing machine."
Soros, who as perhaps the first global macro player, certainly the first to do so on the large scale that he did. suffers from a different Achilles heel: his fundamental calls (at least in the period under study) were spot on, but his implementation was wanting. In other words, Soros is a great seer and strategist, but ironically less adept as a trader. But the article suggests that that appearance may reflect this year's particularly treacherous markets.
From the Financial Times:
According to a soon-to-be-released book by Vahan Jahigian, Buffett is astute about his picks, natch, but not so hot at selling. He argues that the Sage of Omaha has held on to some stocks that did well for many years but then underperformed.
But is this an indictment? The theorists say that trying to market time or do sector rotation is a way to overtrade and underperform. If Buffett believes his companies are still fundamentally sound, but presently out of favor, that doesn't argue for a sale. One of Buffett's maxims goes something like, "In the short term the market is a popularity contest, in the long term, a weighing machine."
Soros, who as perhaps the first global macro player, certainly the first to do so on the large scale that he did. suffers from a different Achilles heel: his fundamental calls (at least in the period under study) were spot on, but his implementation was wanting. In other words, Soros is a great seer and strategist, but ironically less adept as a trader. But the article suggests that that appearance may reflect this year's particularly treacherous markets.
From the Financial Times:
We all make mistakes, even if our names are Buffett or Soros. But when great investors such as Warren Buffett and George Soros make a mistake, the lessons for the rest of us are so much more interesting.
Both get far more decisions right than wrong. Buffett took over as the world’s richest man this year with a fortune of $62bn, according to Forbes, while Soros managed to pull in $2.9bn as a hedge fund manager last year, according to Alpha. But new books cast light on some mistakes.
Vahan Jahigian’s forthcoming Even Buffett Isn’t Perfect does not quite live up to the iconoclastic promise of its title. He concludes that Buffett is “one of the greatest investors – if not the greatest – of all time”.
But he identifies one recurring problem with Buffett’s approach. He holds on to stocks too long. “Regardless of price,” Buffett once said in a letter, “we have no interest at all in selling any good businesses that Berkshire owns.” He even said he was “very reluctant to sell sub-par businesses” if they were at least producing some cash and had decent labour relations.
For Buffett, his investments are almost like a marriage. Meanwhile, Jahigian prompts him with the old adage, “never marry a stock”. These attitudes can be reconciled because Buffett views all investment decisions as though he is buying a business, rather than simply buying a stock, and takes very large stakes. Once invested, he is married to the business, not merely the stock.
For most of us, it probably does not. If a very good business has become overpriced, we should consider selling it. The emerging discipline of behavioural finance – which uses experimental psychology to explore investment decisions – suggests far more mistakes are made in deciding when to sell a stock than in the much more widely discussed arena of deciding when to buy.
One of Buffett’s great stock picks was Coca-Cola, which he rode all the way up to its brief stint as the world’s largest company by market value, a distinction it reached a little more than a decade ago. But he still holds it, even though Coke has been outperformed by many rivals since then. For Buffett, this might make sense; the rest of us should develop a selling discipline. When a stock has become overpriced, we should sell.
As for Soros’s mistakes, he has been honest enough to tell us about them himself, in real time. His forthcoming book, The New Paradigm for Financial Markets, on the causes of the credit crisis includes an investment diary that started at the beginning of this year. Soros gave his prognosis for 2008 and explained his investment strategy to capitalise on it. He then updated it every few weeks. The timing was fortunate: Soros’s diary took him through until the Bear Stearns fire sale last month.
Soros was the first great “global macro” fund manager, making big asset allocation bets. Most famously, he wagered that sterling would have to devalue in September 1992, forcing the UK government to leave the exchange rate mechanism.
Macro funds did well in the first quarter of this year, making an average of about 10 per cent while many other investors lost serious money. But Soros reveals in his diary that he was only flat for the period.
He failed to make money even though he was exactly correct in the way he called the global markets. In January, he predicted that the credit crisis was severe but that the acute phase would be contained because central banks would provide temporary liquidity – exactly what happened. He also saw a bubble in China. So he started the year betting on the dollar, and US and European stocks, to fall – all correct calls.
How did he fail to make money? Timing was part of it. He was heavily invested in India and China on the theory that the bubble was in its early stages. But Indian stocks fell 20 per cent in a few weeks during January, while the Shanghai Composite is now at half its level from its peak last October.
Then there was Bear Stearns. His overall prediction on US financial services was uncannily correct. But on Friday, March 14, he bought Bear Stearns stock, which closed that day at $54. The Federal Reserve had announced emergency funding and he assumed that Bear would be auctioned off to the highest bidder over the weekend.
Instead, Bear was forced into the arms of JPMorgan for $2 a share. “We forgot to take into account that Bear is disliked by the establishment,” said Soros. “The Fed would ... deal with moral hazard by punishing shareholders.”
Soros could have fared very much worse – his Bear shares were well hedged in the credit market. But by March 20,his fund was “under water for the year”, albeit to a much lesser degree than many others.
There is a belief that times of turbulence are times of greatest opportunity for those who see the big picture. But that perfectly describes George Soros. If even he can fail to make money owing to slight errors in timing and slight misreadings of individual situations, the lesson for the rest of us is sobering.
Turbulence creates risks as well as opportunities. Those of us not called Soros of Buffett should probably leave well alone.
Is Your Salad Bad for the Environment?
There's a good article at the New York Times, "Movable Feast Carries a Pollution Price Tag," on the issue of CO2 emissions resulting from the delivery of foodstuffs around the world.
The article discusses at some length how international fuel tax breaks have facilitated this trade. Let's face it, many foods are low value per unit weight products; they are not the sort that you'd expect to be transported halfway around the world. But subsidies on this scale are hard to unravel.
In the bad old days, people ate what was in season and preserved as much as they could. If we are going to be more environmentally sensitive about what we eat, we'll have to accept less variety in fresh food. And having lived for a few months in the UK in the early 1980s, when they imported far less produce than now, the choices were limited and the quality less than stellar. It will be hard to get people who live in colder climes to go back to the ancien regime.
I'm skeptical that disclosure or regulation will do the trick. Taxes (or in this case, the end of the waiver) would be effective, but as the story notes, you'd need to have near universal cooperation. It would also hit the poor, who often have trouble affording decent produce, the hardest.
From the New York Times:
The article discusses at some length how international fuel tax breaks have facilitated this trade. Let's face it, many foods are low value per unit weight products; they are not the sort that you'd expect to be transported halfway around the world. But subsidies on this scale are hard to unravel.
In the bad old days, people ate what was in season and preserved as much as they could. If we are going to be more environmentally sensitive about what we eat, we'll have to accept less variety in fresh food. And having lived for a few months in the UK in the early 1980s, when they imported far less produce than now, the choices were limited and the quality less than stellar. It will be hard to get people who live in colder climes to go back to the ancien regime.
I'm skeptical that disclosure or regulation will do the trick. Taxes (or in this case, the end of the waiver) would be effective, but as the story notes, you'd need to have near universal cooperation. It would also hit the poor, who often have trouble affording decent produce, the hardest.
From the New York Times:
Cod caught off Norway is shipped to China to be turned into filets, then shipped back to Norway for sale. Argentine lemons fill supermarket shelves on the Citrus Coast of Spain, as local lemons rot on the ground. Half of Europe’s peas are grown and packaged in Kenya/
In the United States, FreshDirect proclaims kiwi season has expanded to “All year!” now that Italy has become the world’s leading supplier of New Zealand’s national fruit, taking over in the Southern Hemisphere’s winter.
Food has moved around the world since Europeans brought tea from China, but never at the speed or in the amounts it has over the last few years. Consumers in not only the richest nations but, increasingly, the developing world expect food whenever they crave it, with no concession to season or geography.....
But the movable feast comes at a cost: pollution — especially carbon dioxide, the main global warming gas — from transporting the food.
Under longstanding trade agreements, fuel for international freight carried by sea and air is not taxed. Now, many economists, environmental advocates and politicians say it is time to make shippers and shoppers pay for the pollution, through taxes or other measures.
“We’re shifting goods around the world in a way that looks really bizarre,” said Paul Watkiss, an Oxford University economist who wrote a recent European Union report on food imports.
He noted that Britain, for example, imports — and exports — 15,000 tons of waffles a year, and similarly exchanges 20 tons of bottled water with Australia. More important, Mr. Watkiss said, “we are not paying the environmental cost of all that travel.”
Europe is poised to change that. This year the European Commission in Brussels announced that all freight-carrying flights into and out of the European Union would be included in the trading bloc’s emissions-trading program by 2012, meaning permits will have to be purchased for the pollution they generate.
The commission is negotiating with the global shipping organization, the International Maritime Organization, over various alternatives to reduce greenhouse gases. If there is no solution by year’s end, sea freight will also be included in Europe’s emissions-trading program, said Barbara Helferrich, a spokeswoman for the European Commission’s Environment Directorate. “We’re really ready to have everyone reduce — or pay in some way,” she said.
The European Union, the world’s leading food importer, has increased imports 20 percent in the last five years. The value of fresh fruit and vegetables imported by the United States, in second place, nearly doubled from 2000 to 2006.
Under a little-known international treaty called the Convention on International Civil Aviation, signed in Chicago in 1944 to help the fledgling airline industry, fuel for international travel and transport of goods, including food, is exempt from taxes, unlike trucks, cars and buses. There is also no tax on fuel used by ocean freighters.
Proponents say ending these breaks could help ensure that producers and consumers pay the environmental cost of increasingly well-traveled food.
The food and transport industries say the issue is more complicated......
Some of those companies say that they are working to limit greenhouse gases produced by their businesses but that the question is how to do it. They oppose regulation and new taxes and, partly in an effort to head them off, are advocating consumer education instead.
Tesco, for instance, is introducing a labeling system that will let consumers assess a product’s carbon footprint.
Some foods that travel long distances may actually have an environmental advantage over local products, like flowers grown in the tropics instead of in energy-hungry European greenhouses...
Some studies have calculated that as little as 3 percent of emissions from the food sector are caused by transportation. But Mr. Watkiss, the Oxford economist, said the percentage was growing rapidly. Moreover, imported foods generate more emissions than generally acknowledged because they require layers of packaging and, in the case of perishable food, refrigeration.
Britain, with its short growing season and powerful supermarket chains, imports 95 percent of its fruit and more than half of its vegetables. Food accounts for 25 percent of truck shipments in Britain, according to the British environmental agency, DEFRA.
Mr. Datson of Tesco acknowledged that there were environmental consequences to the increased distances food travels, but he said his company was merely responding to consumer appetites. “The offer and range has been growing because our customers want things like snap peas year round,” Mr. Datson said. “We don’t see our job as consumer choice editing.”
Global supermarket chains like Tesco and Carrefour, spreading throughout Eastern Europe and Asia, cater to a market for convenience foods, like washed lettuce and cut vegetables. They also help expand the reach of global brands.
Pringles potato chips, for example, are now sold in more than 180 countries, though they are manufactured in only a handful of places, said Kay Puryear, a spokeswoman for Procter & Gamble, which makes Pringles.
Proponents of taxing transportation fuel say it would end such distortions by changing the economic calculus.
“Food is traveling because transport has become so cheap in a world of globalization,” said Frederic Hague, head of Norway’s environmental group Bellona. “If it was just a matter of processing fish cheaper in China, I’d be happy with it traveling there. The problem is pollution.”
The European Union has led the world in proposals to incorporate environmental costs into the price consumers pay for food.
Switzerland, which does not belong to the E.U., already taxes trucks that cross its borders.
In addition to bringing airlines under its emission-trading program, Brussels is also considering a freight charge specifically tied to the environmental toll from food shipping to shift the current calculus that “transporting freight is cheaper than producing goods locally,” the commission said.
The problem is measuring the emissions. The fact that food travels farther does not necessarily mean more energy is used. Some studies have shown that shipping fresh apples, onions and lamb from New Zealand might produce lower emissions than producing the goods in Europe, where — for example — storing apples for months would require refrigeration.
But those studies were done in New Zealand, and the food travel debate is inevitably intertwined with economic interests.
Last month, Tony Burke, the Australian minister for agriculture, fisheries and forestry, said that carbon footprinting and labeling food miles — the distance food has traveled — was “nothing more than protectionism.”
Shippers have vigorously fought the idea of levying a transportation fuel tax, noting that if some countries repealed those provisions of the Chicago Convention, it would wreak havoc with global trade, creating an uneven patchwork of fuel taxes.
It would also give countries that kept the exemption a huge trade advantage.
Some European retailers hope voluntary green measures like Tesco’s labeling — set to begin later this year — will slow the momentum for new taxes and regulations.
The company will begin testing the labeling system, starting with products like orange juice and laundry detergent.
Customers may be surprised by what they discover.
Box Fresh Organics, a popular British brand, advertises that 85 percent of its vegetables come from the British Midlands. But in winter, in its standard basket, only the potatoes and carrots are from Britain. The grapes are South African, the fennel is from Spain and the squash is Italian.
Today’s retailers could not survive if they failed to offer such variety, Mr. Moorehouse, the British food consultant, said.
“Unfortunately,” he said, “we’ve educated our customers to expect cheap food, that they can go to the market to get whatever they want, whenever they want it. All year. 24/7.”
Links 4/26/08
Why do whales beach themselves? PhysOrg
Climate 'fix' could deplete ozone BBC
Happy spamiversary! Spam reaches 30 New Scientist
Why Haven't Existing Home Sales Fallen Further? Calculated Risk. A fascinating little post. CR does not see the not-so-bad existing home sales as a predictor of things to come.
Please... No C*#t in the Oval Office Cassandra. Quite a rant.
Could IMF Have Prevented This Crisis? Project Syndicate (hat tip Mark Thoma). Another sighting of the US being compared to a developing country.....
China May Limit Share Sales, Allow Margin Lending, Citic Says Bloomberg
Antidote du jour:
Climate 'fix' could deplete ozone BBC
Happy spamiversary! Spam reaches 30 New Scientist
Why Haven't Existing Home Sales Fallen Further? Calculated Risk. A fascinating little post. CR does not see the not-so-bad existing home sales as a predictor of things to come.
Please... No C*#t in the Oval Office Cassandra. Quite a rant.
Could IMF Have Prevented This Crisis? Project Syndicate (hat tip Mark Thoma). Another sighting of the US being compared to a developing country.....
China May Limit Share Sales, Allow Margin Lending, Citic Says Bloomberg
Antidote du jour:
Update on Tech Woes
Loyal readers may know we've had tech misery for the last 24 hours. Ed Wright, who among other things, once ran mission critical trading platforms for a major global bank does not take no for an answer and had us operational, albeit by migrating some of our recent content over.
Google came around only by virtue of a full court press (Felix Salmon and the Milken Institute were on their case) but it appears it was Michael Schrage, brother of Eliot Schrage, who broke the logjam.
It shouldn't require that level of effort to get a screw-up resolved. The inability to get through Google's switchboard (take my word, getting through bureaucracies is one of my long suits, but they had me bested) is, shall we put it, rather revealing.
Ed needs to undo what he did yesterday, but hopefully we will be back to normal later on Saturday. Thanks for your patience and continued support.
Google came around only by virtue of a full court press (Felix Salmon and the Milken Institute were on their case) but it appears it was Michael Schrage, brother of Eliot Schrage, who broke the logjam.
It shouldn't require that level of effort to get a screw-up resolved. The inability to get through Google's switchboard (take my word, getting through bureaucracies is one of my long suits, but they had me bested) is, shall we put it, rather revealing.
Ed needs to undo what he did yesterday, but hopefully we will be back to normal later on Saturday. Thanks for your patience and continued support.
Friday, April 25, 2008
Signs of Improvement in the Credit Markets
Various indicators suggest that the tone of the credit market (save the interbank market) is improving:
jck at Alea deems the latest TSLF auction to be a success.
Bloomberg tells us that government bond prices are falling, not just in the US but other major economies, signaling a return of confidence:
As a result of the improved mood, corporate issuers rushed to the market. From a separate Bloomberg story:
Note that this development is a bit of a mixed bag, since the bond issues were skewed towards thedesperate riskier issuers.
The Vix and , which many see as a proxy for market risk generally, also fell, and as did options implied volatility in financials, per VIX and More:
The Financial Ninja, who pointed to the post above, is not convinced, as his post title, "Bulltards Grow Complacent: VIX Drops", makes clear (click to enlarge):
The text says:
Love those charts, even though they make no sense to me.....
jck at Alea deems the latest TSLF auction to be a success.
Bloomberg tells us that government bond prices are falling, not just in the US but other major economies, signaling a return of confidence:
Government bonds worldwide are heading for their first monthly loss since June, as rising commodity prices stoke inflation and bankers say the seizure in credit markets is easing.
Yields on Japanese government bonds due in five years today rose the most since 1999 after consumer prices surged 1.2 percent in March from a year earlier. U.S. Treasury notes due in 2010 are poised for their biggest two-week decline since 2001 as traders add to bets the Federal Reserve will stop cutting borrowing costs after its April 30 meeting. European Central Bank President Jean- Claude Trichet said yesterday euro-region interest rates at a four-year high were adequate for curbing price growth.
``Some people seem to be thinking the credit crisis is coming to an end,'' said Ciaran O'Hagan, head of interest-rate research in Paris at Societe Generale SA, France's second-largest bank. ``The market had been expecting rate cuts from the Fed and they've been almost totally priced out, while in euro land, investors are expecting rate hikes.''.....
``There's been quite a shift in bond-market sentiment over the past few weeks,'' said Nick Stamenkovic, a fixed-income strategist at RIA Capital Market Ltd. in Edinburgh. ``The market has become increasingly confident that the worst is over for the financial sector and that the Fed is nearing the end of its easing cycle.''
Some traders anticipate fewer rate reductions into Treasury prices on speculation policy makers are concerned that lower borrowing costs will stoke inflation. Consumer prices in the U.S. rose at a 4 percent annual pace in the 12 months through March.
Demand for fixed-income securities also waned as investor appetite for riskier assets improved. The MSCI Asia Pacific Index of stocks has returned 6.9 percent this month, while the Standard & Poor's 500 Index has advanced 5.1 percent.
The cost of protecting corporate bonds against default fell to the lowest in three months today as the $76 billion of capital banks raised worldwide in April buoyed confidence.....
``The markets are moving from the panic mode of a month or six weeks,'' said Andrew Bell, head of research and strategy at Rensburg Sheppards Plc in London. ``Part of the panic of being really risk-averse in equities was to pile into the short end of the Treasury market.''
Futures contracts on the Chicago Board of Trade show there's a 26 percent chance the Fed will keep the U.S. target rate for overnight bank lending on hold at 2.25 percent on April 30, up from 2 percent a week ago. The balance of the bets are for a quarter-point reduction. The odds of a half-point cut are zero, compared with 28 percent a month ago.
As a result of the improved mood, corporate issuers rushed to the market. From a separate Bloomberg story:
Citigroup Inc. and Merrill Lynch & Co. led $45 billion of U.S. corporate bond offerings, the busiest week on record, as financial companies sold debt at the highest yields since May 2001.
Sales compare with $31.2 billion last week and an average this year of $18 billion, according to data compiled by Bloomberg. Citigroup, the biggest U.S. bank by assets, sold $6 billion of hybrid bonds in the company's largest public debt offering, while New York-based securities firm Merrill Lynch raised $9.55 billion by issuing debt and preferred securities.
Bond offerings soared as investors grew more optimistic financial companies can recover from $309 billion of writedowns and credit losses tied to the collapse of the subprime-mortgage market. Banks and securities firms sold 88 percent of investment-grade debt this week, Bloomberg data show. High-yield bond issuance swelled to the most since November.
``Investors are feeling better about banks being proactive about raising capital,'' said Mike Difley, who helps oversee $21 billion in fixed-income assets as a portfolio manager at American Century Investment Management in Kansas City. ``They're trying to get their house in order.''
The previous high for U.S. corporate bond sales was in the week ended June 22, 2007, when $42.1 billion of debt was issued, Bloomberg data show.
Note that this development is a bit of a mixed bag, since the bond issues were skewed towards the
The Vix and , which many see as a proxy for market risk generally, also fell, and as did options implied volatility in financials, per VIX and More:
Just yesterday, in Financials Struggle to Establish Momentum, I expressed some concern that the recent relatively weak performance of the financial sector (XLF) did not bode well for any sustainable bull moves. Perhaps the sector overheard me, as today the XLF is up 2% in an otherwise flat market as I type this.
While the price action is ultimately what matters most, there is more to the story than just the prices of the financial stocks. In particular, I am watching the implied volatility of XLF, the financial sector’s bellwether ETF. As depicted in the chart below, the implied volatility (which has a significant fear and anxiety component in it) for XLF is approaching levels not seen since the first week in November.
I consider option traders to be a fairly savvy bunch; if they think that the risk premium in the financial sector is lower than any time in the past six months, I am going to listen – and watch to see what happens to the price.
The Financial Ninja, who pointed to the post above, is not convinced, as his post title, "Bulltards Grow Complacent: VIX Drops", makes clear (click to enlarge):
The text says:
Yesterday’s New Home Sales data should have DESTROYED the argument that there won’t be a recession or that it will be short and shallow. I know, I know, equities didn’t seem to mind. Wait for it. Looks like the Bulltards really want to tag 1400 on the S&P 500. Volatility (VIX) has fallen to COMPLACENCY levels (in this credit crisis environment).
Love those charts, even though they make no sense to me.....
Costly Navy Ship Screw-Up Illustrates How Not to Innovate
The New York Times has one of those "your tax dollars at work" stories in the form of "Costly Lesson on How Not to Build a Navy Ship."
The article recounts how the Navy set out to build a new type of vessel, "littoral combat ships," which would become the first line of defense in asymmetric warfare, which is military speak for "low tech can blow up our big ticket toys."
The littoral combat ships were to be fast and adaptable:
Um, what led to the need for the rethink on ship was the attack on the Cole, which was launched not by terrorist speedboats, but a rubber dingy. Never mind.
But Donald Rumsfeld's vision of "transformational warfare," of which these ships were an example, turned out to be another example of Bush Administration faith-based policies:
Where did they screw up? The story gives tons of particulars, and isfascinating appalling reading, but they can be boiled down to one major mistake: the Navy tried innovating on all axes at once. That effectively meant that everyone was making things up as they went along. To illustrate:
So how was the Navy trying to do things differently? Consider:
But do read the piece. It's yet another example of how at its core, this Administration valued staying faithful to its ideology, no matter what the cost, over achieving tangible improvements.
The article recounts how the Navy set out to build a new type of vessel, "littoral combat ships," which would become the first line of defense in asymmetric warfare, which is military speak for "low tech can blow up our big ticket toys."
The littoral combat ships were to be fast and adaptable:
To Navy planners, a ship designed for coastal combat could neutralize hostile submarines, surface warships, mines and terrorist speedboats, clearing the way for other combat ships to operate in offshore waters and support combat ashore....
The Navy also wanted ships that could travel fast, better than 40 knots. And they needed to be easily outfitted with different weapons and surveillance systems. A removable package of mine-sweeping equipment, for instance, could be replaced with a package of special-operations gear used by a Seal team.
Um, what led to the need for the rethink on ship was the attack on the Cole, which was launched not by terrorist speedboats, but a rubber dingy. Never mind.
But Donald Rumsfeld's vision of "transformational warfare," of which these ships were an example, turned out to be another example of Bush Administration faith-based policies:
“The littoral combat ship is an imaginative answer to emerging military requirements, but it has the most fouled-up acquisition strategy I have ever seen in a major military program,” said Loren Thompson, a military analyst at the Lexington Institute, a policy research center.
Where did they screw up? The story gives tons of particulars, and is
In their haste to get the ships into the water, the Navy and contractors redesigned and built them at the same time — akin to building an office tower while reworking the blueprints. To meet its deadline, Lockheed abandoned the normal sequence of shipbuilding steps: instead of largely finishing sections and then assembling the ship, much of the work was left to be done after the ship was welded together. That slowed construction and vastly drove up costs.
“It’s not good to be building as you’re designing,” said Vice Adm. Paul E. Sullivan, commander of the Navy branch that supervises shipbuilding.
So how was the Navy trying to do things differently? Consider:
1. Completely new design. This wasn't simply a new ship, this was a new type of ship, adapted from commercial high speed ferries. And the Navy fell into the same bad behaviors of clients for major new custom software: not being clear about what it wanted, changing requirements as the project was underway.
2. Innovating on methods. The Navy decided to build this never-before-anything-like-it littoral was going to be launched in record time:The first model was to be delivered no more than six years after conceptual planning began, half the normal time. Construction was to take two years, instead of the usual four or five.
But worse was that this innovation was supposed to achieve the impossible:The Navy first publicly declared its intention to build the ship on Nov. 1, 2001. In those days, the Pentagon’s defining procurement mantra was “Faster, Better, Cheaper.” From the first, the coastal ships’ defining characteristic was speed.
Have you every heard of the project triangle? Draw a triangle. At each apex, write one of these three words: Good, Fast, Cheap. The rule of the project triangle is you can have only one leg at most. You can have Good-Fast, Fast-Cheap, or Cheap-Good. You can't have all three. But the Navy clearly hoped to create the military program equivalent of cold fusion.
3. Inexperienced contractor. Bad enough to try something almost destined to fail as 1 and 2 together. But who did the Navy choose? Lockheed, which the Times tells us "had virtually no shipbuilding experience." Yes, they did hire a naval architect "and two shipyards." I can't believe the Times repeated the latter as bolstering Lockheed's credentials. Where other than a shipyard could they possibly have built a ship? In an car factory?
But do read the piece. It's yet another example of how at its core, this Administration valued staying faithful to its ideology, no matter what the cost, over achieving tangible improvements.
Links 4/25/08
Human line 'nearly split in two' BBC and Humans nearly wiped out 70,000 years ago, study says CNN. Note the difference in emphasis.
Does economics make you selfish? Greg Mankiw. The evidence can be read that way.....
The cost of a lifeline: Humbled financial groups brace for more regulation Gillian Tett and Krishna Guha, Financial Times. The piece provides a good overview, and also makes clear how hard it will be to achieve meaningful reform in the absence of an uncontrolled meltdown (say a credit default swaps crisis) that would blow away the impediments to a major overhaul.
Mark Hulbert: Contrarian analysis no longer as bullish on gold Marketwatch
Study Shows Suicide Rates Significantly Higher Among Veterinarians PhysOrg
Antidote du jour:
Adapting to the state’s growing role in global equity markets Brad Setser
The case for 2-1/4 James Hamilton, Econbrowser. Hamilton is right, of course, but will the Fed lister?
Does economics make you selfish? Greg Mankiw. The evidence can be read that way.....
The cost of a lifeline: Humbled financial groups brace for more regulation Gillian Tett and Krishna Guha, Financial Times. The piece provides a good overview, and also makes clear how hard it will be to achieve meaningful reform in the absence of an uncontrolled meltdown (say a credit default swaps crisis) that would blow away the impediments to a major overhaul.
Mark Hulbert: Contrarian analysis no longer as bullish on gold Marketwatch
Study Shows Suicide Rates Significantly Higher Among Veterinarians PhysOrg
Antidote du jour:
Adapting to the state’s growing role in global equity markets Brad Setser
The case for 2-1/4 James Hamilton, Econbrowser. Hamilton is right, of course, but will the Fed lister?
Thursday, April 24, 2008
Ambac Claims "No Liquidity Issues, Ratings Solid"
It's predictable that embattled Ambac CEO Michael Callen would claim that all is well at the bond insurer in the face of considerable evidence to the contrary in the form of first quarter net loss of $1.66 billion, which wiped out last month's highly dilutive capital raise of $1.5 billion. Ambac had to triple its common shares last go-round to raise money that was now clearly inadequate to strengthen its balance sheet, as the rating agencies demanded.
Consider further: there is no new business for the monoliines. They've sworn off the securitized credit market, and with rating agencies re-doing their grading scales for municipalities, that low-risk credit arbitrage is gone.
It gets even better: Goldman predicts that Ambac and MBIA each need to raise $3.4 billion more in capital. How, pray tell, and at what cost?
Despite these rather uncomfortable facts, Callen asserts that the ratings are "solid'. Fitch doesn't think so and already downgraded Ambac to AA. Rating agency Egan Jones doesn't think so and has been a long-time critic of the bond guarantors. The credit default swaps market doesn't think so. Even New York State insurance superintendent Eric Dinallo has doubts.
And the last time I recall a company saying its liquidity was fine was Bear, and at least at the time of its crunch, Bear's long-term prospects looked better than Ambacs' do (there is still ample debate as to whether Bear was insolvent or not: the answer in most cases depends on one's view of the credit default swaps market).
While Lehman made similar assertions, they took some steps to assuage worries, like securing bigger bank credit lines. And Lehman was in the fortunate position of having its crisis of confidence at the time of the Bear failure. The Fed simply was not gong to let two institutions go into crisis in such close succession if there was anything it could do to prevent it.
But the old dynamic still prevails: despite widespread skepticism about the Moody's and S&P AAA ratings on MBIA and Ambac, the two rating agencies will continue to be loath to downgrade until the evidence becomes overwhelming. So the monolines will limp along until it becomes impossible not to put them out of their misery.
So take this Bloomberg story with a handful of salt:
Consider further: there is no new business for the monoliines. They've sworn off the securitized credit market, and with rating agencies re-doing their grading scales for municipalities, that low-risk credit arbitrage is gone.
It gets even better: Goldman predicts that Ambac and MBIA each need to raise $3.4 billion more in capital. How, pray tell, and at what cost?
Despite these rather uncomfortable facts, Callen asserts that the ratings are "solid'. Fitch doesn't think so and already downgraded Ambac to AA. Rating agency Egan Jones doesn't think so and has been a long-time critic of the bond guarantors. The credit default swaps market doesn't think so. Even New York State insurance superintendent Eric Dinallo has doubts.
And the last time I recall a company saying its liquidity was fine was Bear, and at least at the time of its crunch, Bear's long-term prospects looked better than Ambacs' do (there is still ample debate as to whether Bear was insolvent or not: the answer in most cases depends on one's view of the credit default swaps market).
While Lehman made similar assertions, they took some steps to assuage worries, like securing bigger bank credit lines. And Lehman was in the fortunate position of having its crisis of confidence at the time of the Bear failure. The Fed simply was not gong to let two institutions go into crisis in such close succession if there was anything it could do to prevent it.
But the old dynamic still prevails: despite widespread skepticism about the Moody's and S&P AAA ratings on MBIA and Ambac, the two rating agencies will continue to be loath to downgrade until the evidence becomes overwhelming. So the monolines will limp along until it becomes impossible not to put them out of their misery.
So take this Bloomberg story with a handful of salt:
Ambac Financial Group Inc., the bond insurer struggling to hold on to its AAA credit rating, has no liquidity issues and the majority of its portfolio is performing well, interim Chief Executive Officer Michael Callen said.
The company's credit ratings ``are solid,'' Callen said in a Bloomberg Television interview from New York today.
The world's second-largest bond insurer, has been ``very aggressive'' in addressing its losses and will likely exceed ratings companies' capital targets by May, Callen said. Ambac in March sold $1.5 billion in stock and equity units after more than $5 billion of charges on its guarantees of mortgage-liked debt.
Ambac and larger competitor MBIA Inc. may need to raise more capital, New York Insurance Department Superintendent Eric Dinallo said in a Bloomberg Television interview earlier today.
``It's not time for a victory lap,'' Dinallo said. ``Mortgage losses and defaults will drive whether capital is ultimately OK.''
Goldman Sachs Group Inc. analyst James Fotheringham estimates New York-based Ambac and Armonk, New York-based MBIA may need to raise $3.4 billion each to fill capital shortfalls.....
Ambac's March stock offering was enough to persuade Moody's Investors Service and Standard & Poor's to take the AAA bond insurer rating off review, averting a downgrade that would have crippled the company's ability to guarantee bonds. It also removed the broader threat of losses for the $524 billion of municipal and asset-backed debt the company insures.
Bond insurers have posted record losses after expanding from guarantees on municipal bonds that rarely default to insuring securities tied to mortgages that are now going delinquent at the highest rate since 1985. Ambac's new business slumped 87 percent last quarter after ratings companies threatened to strip the insurer of its AAA status.
Credit Suisse Takes Bigger Than Expected Writedown
Credit Suisse, which heretofore looked somewhat immune to credit market problems, has joined its peers in having a loss-making quarter. A Sf5.3 billion writedown on leveraged loans and mortgage instruments was the proximate cause.
Note the quarterly deficit was more than three times the consensus estimate. The CEO was also loath to declare the debt crisis to be in remission.
From Bloomberg:
Note the quarterly deficit was more than three times the consensus estimate. The CEO was also loath to declare the debt crisis to be in remission.
From Bloomberg:
Credit Suisse Group, Switzerland's second-biggest bank, reported a first-quarter loss that exceeded estimates on writedowns linked to deteriorating credit markets.
The net loss, the bank's first in almost five years, totaled 2.15 billion Swiss francs ($2.1 billion), compared with a 2.73 billion-franc profit a year earlier, Zurich-based Credit Suisse said in a statement today. The median estimate of 14 analysts surveyed by Bloomberg News was for a 594 million-franc loss.
Chief Executive Officer Brady Dougan said the results were ``clearly unsatisfactory'' after 5.3 billion francs of markdowns on leveraged loans and mortgage-related securities.....
The writedowns at the securities unit included collateralized debt obligations that the bank said last month were intentionally mispriced by a ``a small group'' of traders. The bank had writedowns of 2.66 billion francs on CDOs, 1.68 billion francs on leveraged finance and 848 million francs on commercial mortgage-backed securities.
Profit at the wealth management unit fell 13 percent to 860 million francs, while earnings rose 3 percent to 464 million francs at the corporate and retail banking division...
On a number of occasions ``people had seen the light at the end of the tunnel and it's been a train coming down the tracks,'' Dougan said today. ``Things have stabilized a bit in April. While we're certainly hopeful that things will improve from here, we're not counting on it.''
"This bear growls on"
In a post at the Telegraph, Ambrose Evans-Pritchard reviews the case for why the credit markets might be on the mend and finds it wanting. While some of his arguments are familiar, the part I found interesting was his belief (contrary to Wolfgang Munchau at the Financial Times' piece "Pessimism about the eurozone is misplaced") that neither Europe's banks nor its economy will fare well: "Far from being the shock absorber, Europe may prove to be the accelerator of this post-bubble denouement."
Confirming part of Evans-Pritchard's thesis, a particularly well connected source (he reported that the Fed and Treasury were working on a quasi-nationalization plan for banks back in January) reiterated that the European banks are in at least as bad shape as their US counterparts (this is based on contact with both European regulators and senior bank executives).
From the Telegraph:
Confirming part of Evans-Pritchard's thesis, a particularly well connected source (he reported that the Fed and Treasury were working on a quasi-nationalization plan for banks back in January) reiterated that the European banks are in at least as bad shape as their US counterparts (this is based on contact with both European regulators and senior bank executives).
From the Telegraph:
No bear wants to be a perma-pessimist, ever waiting for the sky to fall.
So, sunk in a deep armchair with an optimistic bottle of Rioja (Baron De Ley Reserva), I have tried to tot up reasons why the great credit smash-up of 2007-2008 may now be safely over, heralding sunlit uplands once again.
1) Ben Bernanke has carried out the most dramatic rescue since the creation of the US Federal Reserve. His emergency rate cuts - 125 basis points over eight days in January - was a "game changer", as they say in London’s American Quarter, Canary Wharf.
By cutting rates from 5.25pc to 2.25pc since September, the Fed has averted 're-set Armaggedon' on the Greenspan mortgages – those floating rate 'teasers' taken out in 2005 to 2007. Payments will barely jump at all for most subprimers. Big difference.
The cuts are heavenly manna for the banks. These miscreants can now play the "steepening yield curve", using their monopoly privileges to borrow cheaply from the US Government and lend back expensively to the same US Government on long-dated bonds. This is the time-honoured method for rebuilding balance sheets. It works wonders. Even better (from the banks point of view), few people are aware of this massive bail-out.
2) Bernanke has accepted 'bus tickets' as collateral. The broker dealers (Bear Stearns, et al) can take their waste to the Fed’s Discount window, putting a floor under the entire shadow banking and $516 trillion derivatives nexus. Meanwhile, Fannie Mae and Freddie Mac have been armed with nuclear weapons to win the credit war. De facto, if not de jure, the mortgage industry has been nationalized. Big difference.
3) The Bank of England has woken up. Better late than never. As Professor Charles Goodhart (LSE and ex rate-setter) put it: "When you’re in a crisis, you deal with the crisis. Moral hazard comes when times are easier." Quite.
4) A dodgy one, this: China grew at 10.6pc in the first quarter. The BRICS - Brazil, Russia, India, China - are holding up. (If you ignore their galloping inflation, which you can’t, of course: current inflation merely means a future squeeze.) Actually, scrap point 4. It’s rubbish.
Still 1, 2,and 3, matter a great deal. Yet, I cannot really believe the tale of salvation. The Greenspan credit bubble and Europe’s EMU bubble (Club Med, Ireland, and ERM-fixers in Denmark and Eastern Europe) have together infused so much poison into the Atlantic economy that it will require a brutal purge - like chelating heavy metals from the brain.
America, of course, is already in recession – although the cascade of defaults, business closures, and job losses has barely begun.
Japan is in recession too, according to Goldman Sachs. It is still the world’s second biggest economy by far, lest we forget.
Britain, Ireland, Spain, Italy, and New Zealand, are tipping into housing slumps and demand implosions of varying severity.
Ontario and Quebec have stalled. Canada’s growth is the weakest in fifteen years, hence the half point cut by the Bank of Canada yesterday.
Australia is on borrowed time, whatever the price of coal and iron ore. Household debt is 175pc of disposable income, up in La La Land with England, Ireland, Denmark, and the Dutch. The wholesale funding market for mortgages that underpins this nonsense remains frozen.
Together these countries and regions make up roughly 45pc of the global economy, and over half global demand. My hunch is that this bloc will be sliding towards full-blown deflation within a year as the commodity bubble pops and job losses set off a self-feeding downward spiral.
The alleged parallel with the oil spike of the early 1970s is a snare. Debt leverage has been more reckless this time. It must contract more viciously. Inflation is less sticky (going down) in the Anglo-Saxon world, if not flexless Europe, where stagflation awaits.
If you think that core Europe - Greater Germany, Benelux, and the Scandies (France is faltering) - can somehow tough it out as the rest of the OECD’s industrial family hurtles into a brick wall, read the IMF’s “Regional Economic Outlook: Europe”, published this week.
The Fund has cut its eurozone growth forecast to 1.4pc this year, and 1.2pc next – with perma-slump pencilled in for Italy. This puts it at daggers drawn with the European Central Bank, the fervent apostle of decoupling.
Europe will suffer 40pc of the entire $940bn global losses stemming from the credit crunch. Euro banks alone will lose $123bn (compared to $144bn for the US). "Loss recognition will need to catch up," said the IMF.
"Liquidity remains seriously impaired. Lenders are tightening credit standards, particularly for loans to enterprises," it said.
"The deteriorating economic outlook could weaken European and corporate balance sheets appreciably," it said.
On it goes, more or less dire, if you adjust for the IMF’s softly-softly style.
The report contains a grim chapter on what may happen along the vast arch of over-heating silliness from the Baltics to the Black Sea, funded by Austrian, Swedish, German, Belgian, and Italian banks.
"Europe’s emerging economies are susceptible to financial shocks, which could make the situation dramatically worse," said Michael Deppler, the Fund’s Europe chief.
Last year, private credit grew 62pc in Bulgaria, 60.4pc in Romania, 55.2pc in Kazakhstan, 45pc across the Baltics. Need one say more?
Current account deficits have reached 22.9pc in Latvia, 21.4pc in Bulgaria, 16.5pc in Serbia, 16pc in Estonia, 14.5pc in Romania and 13.3pc in Lithuania. The gap has been plugged by foreign loans. These are no longer forth-coming. Spreads have ballooned by over 500 basis points.
"Banking systems that are heavily dependent on foreign borrowing to support credit growth could face a sudden shortfall," said the IMF.
Woe betide the creditors. Loans to the old Soviet bloc account for 23pc of the entire asset base of the Austrian banking system, and 10pc of the Swedish and Belgian systems.
As Europe’s drama slowly unfolds, the ECB is sticking defiantly to its orthodox line. The IMF suggests looking beyond the current food and oil spike (inflation is at a post-EMU high of 3.6pc), and preparing "some easing of the policy stance".
Axel Weber, the German Bundesbank chief and leader of the Uber-hawks, will have none of it. "I do not share the vision of the IMF," he said, tartly.
One notes that the Bundesbank was quieter when Germany was in the dumps and needed lower interest rates. It acquiesced in roaring money supply growth as inflation fuelled bubbles in the Latin Bloc – the cause of their current distress. Such is the hypocrisy of EMU. Beware the pious incantations by Mr Weber, a German nationalist in Euro-clothing. (I will return to the theme of Mr Weber in another blog.)
The ECB’s "error" will become clear over the next year as the house price crash across Club Med and Ireland combines in a lethal brew with the East Bloc credit deflation.
Germany will not be immune from the blow-back. It has funded a good chunk of Club Med’s foreign debts: Spain ($362bn), Italy ($275bn), Greece ($129bn), Greece ($98bn), and - honorary Club Med - Ireland ($123bn).
Far from being the shock absorber, Europe may prove to be the accelerator of this post-bubble denouement.
Once you add Europe to the Anglo-Saxon and Japanese sick list, you reach 60pc of world GDP, and two thirds world demand.
This leaves the global boom on tenuously narrow ground. Who is going to buy all those exports from China? Who is going to keep pushing commodity prices into the stratosphere? This bear growls on.
First, Let's Kill All the Servicers
As the housing/mortgage crisis has progressed, homeowner advocates and legislator have to get mortgage servicers to offer more loan modifications to struggling borrowers. Even though this housing recession has a far higher proportion of borrowers seriously underwater than past downturns, the logic of loss mitigation is still valid. It's still better for the bank to keep the homeowner in place, even at a reduced payment, than foreclose (although in some communities where home valued have plummeted, the banks seem content for the moment not to take action against defaulting debtors).
Some observers have taken the view that it's impractical for banks to negotiate on a case-by-case basis (gee, that's how they used to make loans and do workouts before they decided to go for efficiency at the expense of quality). And that may be a valid objection: serivcers are factories. Even by some affordable housing experts report that they are unable to do one-offs.
Another impediment is that securitized transactions often limit the ability of the servicer to do loan modifications (although no one seems to have good estimates on how often that is operative).
Last year's Treasury sponsored Hope Now Alliance was a cosmetic rescue program to address those issue, offering a "one-size-fits-few" template that was anticipated to offer servicers a legally defensible ground for making mods. However, few have happened.
Now legislators are considering another approach: require servicers to attempt loss mitigation before foreclosing. From Credit Slips:
I
Mind you, I skimmed the text only quickly, but several thing stood out. This bill is clearly thought out, and is tough. Not only do the servicers have reporting obligations as discussed, but there are explicit requirements regarding communication with the borrower. For instance:
The bill also permits servicers to recover "reasonable fees" (although they are subject to review) and applies to any "federally related mortgage loan that is secured by a lien on the principal residence of the borrower or mortgagor" that defaults after the bill is enacted.
My initial reaction is schadenfreude: the industry has brought this sort upon themselves. If it can't figure out a way to do mods despite the mounting pressure to do so (and in cases where a mod might be possible, lose/lose to borrower and investor for failure to do so), it will be imposed on them, and as this bill delineates, in a way that offers them little wriggle room. My second is that it won't be passed; there appears to be no Senate version of this bill. My third is that that's a shame, the credible threat of the passage of a measure like this would light a fire under servicers (although that might only be to mobilize lobbying against it).
But to the more serious question: is this bill a good idea? Given the track record so far, it may be that servicers need something this confining to force them to act, and to give them cover with their investors to do so. Mods, however, typically favor certain tranches over others, so this might produce some sharp repricings.
Moreover, even if the team at the servicer has the best of intentions, it has to start with the mit plan from the income records at the time of the loan. With no docs, low docs, and generally lousy standards, that information is generally terrible. And while the debtor can provide current information, it isn't clear they will be forthcoming. Servicers aren't particularly well liked or trusted in borrower land.
But as much as I have little sympathy for companies that made a lot of money during the gravy days of the housing bubble and now plead poverty as an excuse for inaction, this bill would an industry under stress to the wall. It will have to incur the costs of notification and reporting for all defaulting borrowers, but will be able to collect fees only out of continuing cash flow from the borrower or a foreclosure sale. Most of these activities (setting up a call center, creating methods, forms, and supporting systems for borrower communication and regulatory reporting) have high fixed and low variable costs. It will be hard to determine the right fee levels up front (and you can't readily go back if you got it wrong). And its quite possible the fees will look disproportionate, even if they are costed properly.
Plus there's a big cash flow problem: the costs are incurred up front, the fees recovered over time. And servicers are already having big time cash flow problems. I have been told that servicers, which in most cases are part of large banks, are hemorrhaging cash. Notes from a conversation with informed parties:
As we noted, the banks will probably dodge this bullet. But a measure like this is an indicator of how sentiment about regulation is changing, Expect to see more tough-minded proposals, some of which will stick.
Some observers have taken the view that it's impractical for banks to negotiate on a case-by-case basis (gee, that's how they used to make loans and do workouts before they decided to go for efficiency at the expense of quality). And that may be a valid objection: serivcers are factories. Even by some affordable housing experts report that they are unable to do one-offs.
Another impediment is that securitized transactions often limit the ability of the servicer to do loan modifications (although no one seems to have good estimates on how often that is operative).
Last year's Treasury sponsored Hope Now Alliance was a cosmetic rescue program to address those issue, offering a "one-size-fits-few" template that was anticipated to offer servicers a legally defensible ground for making mods. However, few have happened.
Now legislators are considering another approach: require servicers to attempt loss mitigation before foreclosing. From Credit Slips:
I
n my prior post on mortgage servicing, I talked about the potential of mortgage servicers to be harmful barriers between homeowners and investors, both of whom may want to negotiate a loan modification. Recognizing such a problem raises the question of a solution. U.S. Representative Maxine Waters recently introduced legislation that would profoundly alter the duties of mortgage servicers. The bill, HR 5679, The Foreclosure Prevention and Sound Mortgage Servicing Act of 2008, would prohibit the initiation of a foreclosure if the mortagee or servicer has failed to engage in "reasonable loss mitigation activities." The bill lays out exactly what counts as loss mitigation and offers up non-binding guidance on standards of affordability for loss mitigation. Servicers would have to report data on their loss mitigation activities, disaggregated by the type of mitigation activity (separately accounting for things like modifications, deeds in lieu of foreclosure, or repayment plans).
The bill also takes aim at the communication problems between servicers and homeowners. The bill requires services to provide a toll-free number that provides borrowers with direct access to a person with the information and authority to fully resolve issues related to loss mitigation and specifies that such a person must be physically located in the United States. Servicers are also required to forward borrower's information to HUD-certified housing counselors whenever a borrower is 60 days or more overdue.
In the hearing last week on the bill (which you can watch as an archived webcast), Chairwoman Waters kept returning to a fundamental point--mortgage servicing is an unregulated industry. The witness testimony was essentially unanimous that mortgage servicing has a tremendous impact on American families and on the resolution of the current crisis. Of course, the debate was over whether this regulation was the right approach. The bill hasn't gotten much publicity yet, but I encourage readers who are interested in the foreclosure crisis to take a look and post their feedback.
Mind you, I skimmed the text only quickly, but several thing stood out. This bill is clearly thought out, and is tough. Not only do the servicers have reporting obligations as discussed, but there are explicit requirements regarding communication with the borrower. For instance:
`(2) INCOME USED IN DETERMINING AFFORDABILITY- In making a determination of affordability for purposes of this subsection, a mortgagee or servicer shall use the income information furnished by the borrower at the time of loan origination, except that the borrower or mortgagor may elect to provide the mortgagee or servicer with current information and, if so provided, such current income information shall be used for purposes of determining affordability. The mortgagee or servicer shall advise the borrower or mortgagor of any right under this paragraph to provide current income information. If current income information is used, all sources of income shall be verified by tax returns, payroll receipts, bank records, or other third-party verification; the best and most appropriate documentation shall be used....
`(4) WRITTEN NOTIFICATION OF AFFORDABILITY CALCULATION- The mortgagee or servicer shall notify the borrower or mortgagor in writing of the results of the determination of affordability under this subsection and the income on which the determination was based. Such written notice shall be provided by mail not later than 7 business days after such action is taken or as part of the written notice required under subsection (c)(1), whichever is earlier.
The bill also permits servicers to recover "reasonable fees" (although they are subject to review) and applies to any "federally related mortgage loan that is secured by a lien on the principal residence of the borrower or mortgagor" that defaults after the bill is enacted.
My initial reaction is schadenfreude: the industry has brought this sort upon themselves. If it can't figure out a way to do mods despite the mounting pressure to do so (and in cases where a mod might be possible, lose/lose to borrower and investor for failure to do so), it will be imposed on them, and as this bill delineates, in a way that offers them little wriggle room. My second is that it won't be passed; there appears to be no Senate version of this bill. My third is that that's a shame, the credible threat of the passage of a measure like this would light a fire under servicers (although that might only be to mobilize lobbying against it).
But to the more serious question: is this bill a good idea? Given the track record so far, it may be that servicers need something this confining to force them to act, and to give them cover with their investors to do so. Mods, however, typically favor certain tranches over others, so this might produce some sharp repricings.
Moreover, even if the team at the servicer has the best of intentions, it has to start with the mit plan from the income records at the time of the loan. With no docs, low docs, and generally lousy standards, that information is generally terrible. And while the debtor can provide current information, it isn't clear they will be forthcoming. Servicers aren't particularly well liked or trusted in borrower land.
But as much as I have little sympathy for companies that made a lot of money during the gravy days of the housing bubble and now plead poverty as an excuse for inaction, this bill would an industry under stress to the wall. It will have to incur the costs of notification and reporting for all defaulting borrowers, but will be able to collect fees only out of continuing cash flow from the borrower or a foreclosure sale. Most of these activities (setting up a call center, creating methods, forms, and supporting systems for borrower communication and regulatory reporting) have high fixed and low variable costs. It will be hard to determine the right fee levels up front (and you can't readily go back if you got it wrong). And its quite possible the fees will look disproportionate, even if they are costed properly.
Plus there's a big cash flow problem: the costs are incurred up front, the fees recovered over time. And servicers are already having big time cash flow problems. I have been told that servicers, which in most cases are part of large banks, are hemorrhaging cash. Notes from a conversation with informed parties:
The servicer has guaranteed to pay whatever interest is promised to the investors for at least 90 days after default. Some agreements also require them to pay principal during that period. Even after the 90 days, the servicer has to continue to pay real estate taxes and insurance. The servicer can use any late payment or other penalties from the borrower to offset these costs.
The idea was that if you were good at collecting and efficient at serciving, the overcollateralization would give you enough of a cushion. But they assumed 5% loss rates, not 20%.
And the cash flow drain is worse in prime or mixed pools than in subprime pools. The defaults relative to assumptions are far worse there.
As we noted, the banks will probably dodge this bullet. But a measure like this is an indicator of how sentiment about regulation is changing, Expect to see more tough-minded proposals, some of which will stick.
Derivatives Predict Further Increase in Libor
Despite the cheery tone in the press of late and the claims by quite a few senior banking executives that the credit crisis is on the mend, the money markets remain unconvinced.
As we pointed out in a post yesterday, the results of the Fed's latest Term Auction Facility auction were disappointing, leading the writer, David Kotok of Cumberland Advisors, to predict that the Fed will not only cut rates a further 25 basis points, but also increase the size of the TAF yet again.
Today, a Bloomberg story discusses the poor results of the TAF auction, and points up two other signs it depicts as troubling. The Libor-overnight index swap spread has increased dramatically since January, although it is still below its early December high just before the Fed announced the creation of the term auction facility. Open interest in Eurodollar swap futures has also fallen, which is an indicator of deleveraging.
From Bloomberg:
As we pointed out in a post yesterday, the results of the Fed's latest Term Auction Facility auction were disappointing, leading the writer, David Kotok of Cumberland Advisors, to predict that the Fed will not only cut rates a further 25 basis points, but also increase the size of the TAF yet again.
Today, a Bloomberg story discusses the poor results of the TAF auction, and points up two other signs it depicts as troubling. The Libor-overnight index swap spread has increased dramatically since January, although it is still below its early December high just before the Fed announced the creation of the term auction facility. Open interest in Eurodollar swap futures has also fallen, which is an indicator of deleveraging.
From Bloomberg:
Interest-rate derivatives are signaling that the rate banks charge for loans in dollars in London may rise further as financial institutions remain reluctant to lend.
The difference between the rate of three-month loans in London relative to the overnight index swap rate, known as the Libor-OIS spread, is 88 basis points, just below the year high of 90 basis points reached on April 21.
The London interbank offered rate, or Libor, for dollar climbed to a seven-week high amid speculation the global credit crunch prompted lenders to manipulate the rate to prevent their borrowing costs from escalating. The British Bankers' Association said last week it will speed up a review of the process by which money-market rates are set daily and ban any member providing misleading quotes.
``The correction in Libor has not completely happened,'' said Bulent Baygun, head of interest-rate strategy in New York at BNP Paribas Securities Corp., a unit of France's largest bank. ``Given the dynamics that have persisted in the past few weeks, it looks like there could be a little bit more room for an increase.''
Three-month Libor for dollars has advanced 20 basis points to 2.92 percent since April 16.
The three-month Libor-OIS spread was as narrow as 24 basis points on Jan. 24 and reached as high as 106 basis points on Dec. 4. A basis point is 0.01 of a percentage point. The OIS rate signals what traders' expect the overnight federal funds rate to average over the time period of the swap....
Use of Eurodollar futures, which are based on predictions for Libor rates, as a bet on expected changes in Fed interest- rate policy has waned amid the questions regarding Libor rates, according to Credit Suisse Securities USA LLC, one of the 20 primary dealers that trade directly with the Fed.
Eurodollar futures open interest, or the total number of futures contracts that have not been closed, liquidated, or delivered, declined by 21 percent since the end of January, according to CME Group data. It fell 4.7 percent for the week ended April 18, after the BBA announced it was monitoring banks involved in the Libor process, from the end of the prior week.
``Libor uncertainty has led to a large-scale deleveraging in the Eurodollar complex,'' wrote Dominic Konstam, head of interest-rate strategy at Credit Suisse, in a note published on April 18. ``Over the past week, the decline in open interest has been dramatic as the problems with Libor have become more publicized.''
Eurodollar futures, which trade in price terms, settle to three-month dollar Libor at expiration.
Links 4/24/08
Human brain appears 'hard-wired' for hierarchy PhysOrg
Green reaper's grave new world Sydney Morning Herald
Mortgage approvals slump nearly 50% to decade low Times Online
Debt Collection Done From India Appeals to U.S. Agencies New York Times
Sam's Club, Costco Ration Rice Amid Hoarding Worries Wall Street Journal
Dirty Economic Indicator of the Month Barry Ritholtz
Antidote du jour:
Green reaper's grave new world Sydney Morning Herald
Mortgage approvals slump nearly 50% to decade low Times Online
Debt Collection Done From India Appeals to U.S. Agencies New York Times
Sam's Club, Costco Ration Rice Amid Hoarding Worries Wall Street Journal
Dirty Economic Indicator of the Month Barry Ritholtz
Antidote du jour:
Wednesday, April 23, 2008
Bondholders "Lucky" to Recover 10% in Defaults
Bloomberg reports that the rating agency Fitch predicts that recoveries on corporate bonds that default will be far lower than in previous downturns, due to the deterioration in lending standards. The estimate is grim;
Note that there is, understandably, forecasts as to how bad the defaults will get:
Rather than receiving the historical average recovery of 42 cents on the dollar in a default, owners of a third of high- yield, high-risk bonds rated B+ or lower may get no more than 10 cents, according to New York-based Fitch Ratings. About 22 percent are likely to get 11 cents to 30 cents.
Note that there is, understandably, forecasts as to how bad the defaults will get:
Moody's anticipates defaults will quadruple to 5.9 percent in 12 months. That assumes a ``mild'' recession. Judging by the amount of distressed debt, investors expect an 8 percent default rate, said Martin Fridson, head of high-yield research firm FridsonVision LLC in New York.
Fed Continues to Treat Symptoms, Not Disease (TAF/Derivatives Edition)
In a bit of synchronicity, two items, focusing on different aspects of our continuing credit woes, illustrate how the Fed is acting like the drunk looking under a streetlamp for his keys, because the light is good there, rather than where he lost them. The central bank's version of this behavior is to continue to focus on the most superficial aspects of the crisis, even though those measures have not produced any lasting success (indeed, some have backfired) rather than go after root causes. In the initial phases, this response would be reasonable; you need to stabilize the patient before you operate, but at this juncture, the Fed's disinclination to address obvious causes of instability is mystifying.
Let's look at the two faces of this coin. The first is market commentary, "TAF results are disconcerting," from David Kotok of Cumberland Advisors. Note that Kotok by predisposition is more optimistic about the future than yours truly, and is well plugged into the Fed, so a note of this sort signals real concern:
Now this is by all accounts a very savvy individual, yet what does he recommend? Persisting in, nay redoubling, a failed strategy. That is not a sign of intelligence. And his thinking may well reflect Fed input.
Consider the alternative view, which is more persuasive, and fits the fact set of the broader problem better, but also makes clear that the path to resolution is full of pitfalls and complications.
John Dizard, in "The jerry-built derivative structure will have to go," argues that thing will not get better until OTC credit derivatives are dismantled. Lets' face it, banks are unwilling to lend to each other for perfectly good reason. They know how sizeable and prone to mishap their own exposures are. Its' a no-brainer that a significant proportion of their counterparties are in at least as bad shape as they are.
The very fact that the Fed orchestrated a rescue of Bear, who should otherwise have been too small to fail save for the size of its credit default swaps book indicates that the Fed on some level recognizes that this is a major problem. Yet there seems to be no institutional will to confront it. Admittedly, this is hugely hairy problem, but I suspect the real impediment is that confronting the industry requires considerable tough-mindedness, a quality notably lacking at the US central bank.
But further injections of liquidity in lieu of addressing the fundamental issue is akin to adminsitering more morphine to treat the pain of intestinal blockage. It not only fails to address a the real ailment, but the higher doses are every bit as dangerous as the untreated disease.
From the Financial Times:
Let's look at the two faces of this coin. The first is market commentary, "TAF results are disconcerting," from David Kotok of Cumberland Advisors. Note that Kotok by predisposition is more optimistic about the future than yours truly, and is well plugged into the Fed, so a note of this sort signals real concern:
The Term Auction Facility (TAF) results were not encouraging. Neither were they substantially discouraging but, at the margin, they actually worsened. It is clear that the demand for liquidity in the banking system is still intense....
The minimum bid in the most recent auction (April 21) was 2.05%. In the previous auction (April 7) the minimum bid was 2.11%. In the most recent auction the stop out rate which was awarded to all bidders was 2.87%. In the previous auction the awarded rate was 2.82%. So the minimum bid went down while the award rate went up. The spread widened by 11 basis points. That is not suggestive of a market returning to normalcy....
We should also note that the TAF auction rate was very close to LIBOR. And LIBOR has been the subject of much negative press recently as followers of money markets know.
Our conclusion is that credit markets are still dysfunctional and the process of normalcy restoration has a long way to go....
This latest auction cannot give any comfort to the Fed. In the reaction over LIBOR, the Fed watched market driven interest rates rise. LIBOR is the world’s most important commercial interest rate reference. It went up even as the Fed tried to ease rates down. Our central bank sees market driven interest rates moving in the opposite direction of the path that the central bank desires. This is a message that the Fed’s policy is failing.
We expect the Fed to cut interest again at the meeting at the end of this month. We also believe that the Fed will have to enlarge the TAF auction and also add more extended terms to the facility. The sooner the Fed implements those changes the sooner the credit markets will start to heal and return to more normal spreads.
We offer this final note. Various measure of spread based risk premiums have been at extraordinary levels since last June when the turmoil started. These widened spreads are taking an economic toll. We expect that the Fed will persist until it gets them to narrow.
If the Fed fails, we will have a difficult and protracted deflationary recession. If the Fed succeeds, the slowdown will be shorter and shallower....But we must admit that when we see a TAF auction result like we just saw, we become just a little more worried.
Now this is by all accounts a very savvy individual, yet what does he recommend? Persisting in, nay redoubling, a failed strategy. That is not a sign of intelligence. And his thinking may well reflect Fed input.
Consider the alternative view, which is more persuasive, and fits the fact set of the broader problem better, but also makes clear that the path to resolution is full of pitfalls and complications.
John Dizard, in "The jerry-built derivative structure will have to go," argues that thing will not get better until OTC credit derivatives are dismantled. Lets' face it, banks are unwilling to lend to each other for perfectly good reason. They know how sizeable and prone to mishap their own exposures are. Its' a no-brainer that a significant proportion of their counterparties are in at least as bad shape as they are.
The very fact that the Fed orchestrated a rescue of Bear, who should otherwise have been too small to fail save for the size of its credit default swaps book indicates that the Fed on some level recognizes that this is a major problem. Yet there seems to be no institutional will to confront it. Admittedly, this is hugely hairy problem, but I suspect the real impediment is that confronting the industry requires considerable tough-mindedness, a quality notably lacking at the US central bank.
But further injections of liquidity in lieu of addressing the fundamental issue is akin to adminsitering more morphine to treat the pain of intestinal blockage. It not only fails to address a the real ailment, but the higher doses are every bit as dangerous as the untreated disease.
From the Financial Times:
Credit market people and their regulators have been so preoccupied with defusing the more visible unexploded bombs in Wall Street that the more serious, long-term structural problems have been put off for later attention. Much later attention, in the case of those structural problems that could cause career or biography damage for senior policy people.
The epicentre of all the problems is the financial system's dependence on over-the-counter derivative contracts, which made possible all the other bubbles that have been revealed and will be revealed soon. I believe that it will be necessary to dismantle carefully most of this jerry-built structure, and replace the bank-to-bank-to-dealer-to-dealer contract structure with central clearing houses for risk instruments.
Given that these are international markets of unimaginable size, this will take multilateral official co-operation to put into effect. The US government's involvement in the Bear Stearns work-out, far from marking the end of the credit crisis, shows how any resolution to the larger systemic issues will need to have official backing.
You will notice that through all the perturbations of the financial markets over the past nine months, there have been no problems with the operations of the centrally cleared futures and options exchanges.
The character and integrity of the participants in these exchanges - the speculators, hedgers and intermediaries - is no better than you would find in the over-the-counter markets. But the scope for wrongdoing is far less, since every day, every hour, these people's assets and liabilities are more or less accurately marked, and any deficiencies in their accounts have to be made up, or the accounts liquidated.
There were advantages of the over-the-counter markets for credit default swaps, interest rate swaps, and equity derivatives. OTC derivatives required less market-making capital than exchange-traded instruments, and the conserved capital could support more real economic activity.
OTC derivatives are more flexible than exchange-traded instruments, so they can be written for the exact requirements of the counterparties. That in turn made further capital savings possible, since (apparently) precisely hedged positions did not need the same level of reserves.
But it all got too big. The model did not take sufficient account of financial markets invariably taking any sensible innovation to senseless extremes.
I've been reading the Massachusetts state government's administrative complaint against Bear Stearns Asset Management, and its administration of the now bankrupt High Grade Structured Credit Strategies Fund, and the Enhanced Leverage Fund. The complaint has been filed in order to commence court proceedings against Bear Stearns.
No one can believe that Bear Stearns Asset Management was uniquely self-serving and careless; in fact, it may have been better than many of its counterparts on the Street. It's just that the poor behaviour of the Bear management is now a matter of public record....
For example, according to the Massachusetts complaint, related party transactions were poorly administered. "The result of this poor conflict management was that hundreds of transactions did not obtain the approvals required by federal law and promised in the offering documents," the complaint claims.
Also, mis-priced derivatives instruments were allegedly transferred, or "novated" in the legal jargon, on the investors by Bear management. The transfers of value took place at cost rather than market value, the complaint claims, not to the advantage of the investors in the funds.
Referring to just two sets of transactions, the complaint says, "on information and belief, the net decrease in value to the funds as a result of the May 3 novation of credit default swaps . . . was $6,199,587 [and] . . . as a result of the May 8 novation of credit default swaps was $10,9111,290".
Multiply this sort of behaviour across the thousands of funds, vehicles, accounts and so on, around the world, and you see the scale of the problem. Exchange-traded and centrally cleared instruments may be less flexible and more capital intensive, but at least everyone sees the same prices.
How did this come to pass? Christopher Whalen of Institutional Risk Analytics blames the Federal Reserve and other regulators. "The Fed knows that banking is a commodity business, and by allowing the banks to migrate off the exchanges they allowed them to enhance their profitability. The Fed people knew risk management was a problem, but they thought they could deal with all the risks created by the over-the-counter model through the Basel 2 rules."
I guess not.
US-China Co-Dependent Behavior Worsens
Alliance: When two thieves have their hands so deeply plunged into each others' pockets that they cannot separately plunder a third party.
Ambrose Bierce, The Devil's Dictionary
The US and China bicker like an unhappily married couple, but Brad Setser warns us that the squabbling is getting nastier. And worse, both parties seem to fail to recognize how deeply enmeshed they are, and how divorce is not a realistic option.
Brad Setser, in "Uh-oh! Is China starting to blame the US for its currency losses?" notes that China is unhappy with how the US is trashing the dollar:
Setser notes (in more polite terms) that the value of the dollar is secondary at best to the Fed right now. He continues:
While this is narrowly correct, if you widen the frame of reference, it isn't clear how the blame should be apportioned. China has pursued an openly mercantilist trade policy. The US was happy to pursue a macroeconomic policy described by Thomas Palley as one based on borrowing and cheap exports. In co-dependent terms, the chronic alcoholic, um, overspender, had found an enabler.
Worse, as this relationship was clearly entering the danger zone, many people who should have know better were sanguine about ever-worsening global imbalances. The flash point should have been when the US current account deficit to GDP ratio passed 4%, which is usually the limit of the currency markets' tolerance. And indeed, as the gap has worsened, the dollar has come under more pressure. Yet pundits repeatedly argued that China would of course continue to lend to us; to fail to do so would hurt them, since they were funding our purchases of their exports. Note that Setser has not been part of this camp; he noted fairly early on that the China (and other kind buyers of our financial assets) were not only financing our present-year funding gap, but also the interest on all the prior years too. The implication was clear: at some point, this would become unsupportable.
And in a curious lack of empathy, we are driven by internal considerations above all others, yet fail to recognize that our trade partners will be too. China's escalating inflation is a direct result of its massive Treasury purchases; it can't sterilize them fully. I have no idea whether the government is playing this line internally, but it would not be inconceivable for them to blame the stock market crash on the US (after all, they had to raise interest rates to combat US generated inflation. Yes, rising commodity prices play a role too, but it is made worse by China's' maintaining a loose dollar peg).
Whether this strategem is being employed or not, I have been told that the Chinese public is unhappy about the losses on the investment in Blackstone and on US Treasuries. So a weakening dollar will almost certainly lead to harsher rhetoric; whether it goes beyond that is an open question.
But neither party is willing to deal with the fundamental problem: the US needs to consume less and save more. That means fewer goodies from China and more US exports. While China in theory could increase exports to Europe. the Europeans place much greater stock in preserving employment than does America. so will likely encounter formal and informal protectionism.
Although Setser argues from a funds flow perspective, he reaches a similar conclusion:
Ambrose Bierce, The Devil's Dictionary
The US and China bicker like an unhappily married couple, but Brad Setser warns us that the squabbling is getting nastier. And worse, both parties seem to fail to recognize how deeply enmeshed they are, and how divorce is not a realistic option.
Brad Setser, in "Uh-oh! Is China starting to blame the US for its currency losses?" notes that China is unhappy with how the US is trashing the dollar:
Mei Xinyu, a senior researcher under the Chinese commerce ministry writing in a personal capacity for the Shanghai Daily, argues that China needs to put pressure on the US at the Strategic Economic Dialogue to do more defend the dollar. With the dollar at 1.60 against the euro, it isn't hard to see why.
Mei goes on to argue that if the US doesn't do more to defend the dollar, it is effectively defaulting on China.The negative results of the US dollar's decline are evident: the rising prices of all primary products, the intensified pressure on inflation globally, the confusion in the settlement of international transactions, etc. Worst of all, this is the US' disguised way of avoiding paying off its debts to foreign countries.
It should be noted that the US is the biggest debtor country in the world.... By the end of 2006, the US' accumulated net debt overseas hit US$16 trillion. As most of the debts were calculated in US dollars, the US is actually welshing on its debts malignantly by allowing the devaluation of US dollars. Since China is the country with the world's biggest foreign exchange reserves, most of which are calculated in US dollars, China thus is hurt most greatly from the US dollar devaluation.
One man's exorbitant privilege is another man's disguised default.....
What's more, Mei Xinyu's argument isn't entirely wrong.
Setser notes (in more polite terms) that the value of the dollar is secondary at best to the Fed right now. He continues:
But Mei Xinyu's argment is still a bit off. China invested in the US knowing quite well that the US wasn't committed to defending the dollar's external value. It invested in the US even though the US had a large trade deficit. It invested in the US even though the IMF indicated the dollar was overvalued and would tend to depreciate over time. It invested in the US even though a gloomy American academic and a former Treasury staff economist quite explicitly warned that China would lose money on dollar holdings back in 2004.
Mei's complaint, in other words, should be directed in part at China's own policy makers.
While this is narrowly correct, if you widen the frame of reference, it isn't clear how the blame should be apportioned. China has pursued an openly mercantilist trade policy. The US was happy to pursue a macroeconomic policy described by Thomas Palley as one based on borrowing and cheap exports. In co-dependent terms, the chronic alcoholic, um, overspender, had found an enabler.
Worse, as this relationship was clearly entering the danger zone, many people who should have know better were sanguine about ever-worsening global imbalances. The flash point should have been when the US current account deficit to GDP ratio passed 4%, which is usually the limit of the currency markets' tolerance. And indeed, as the gap has worsened, the dollar has come under more pressure. Yet pundits repeatedly argued that China would of course continue to lend to us; to fail to do so would hurt them, since they were funding our purchases of their exports. Note that Setser has not been part of this camp; he noted fairly early on that the China (and other kind buyers of our financial assets) were not only financing our present-year funding gap, but also the interest on all the prior years too. The implication was clear: at some point, this would become unsupportable.
And in a curious lack of empathy, we are driven by internal considerations above all others, yet fail to recognize that our trade partners will be too. China's escalating inflation is a direct result of its massive Treasury purchases; it can't sterilize them fully. I have no idea whether the government is playing this line internally, but it would not be inconceivable for them to blame the stock market crash on the US (after all, they had to raise interest rates to combat US generated inflation. Yes, rising commodity prices play a role too, but it is made worse by China's' maintaining a loose dollar peg).
Whether this strategem is being employed or not, I have been told that the Chinese public is unhappy about the losses on the investment in Blackstone and on US Treasuries. So a weakening dollar will almost certainly lead to harsher rhetoric; whether it goes beyond that is an open question.
But neither party is willing to deal with the fundamental problem: the US needs to consume less and save more. That means fewer goodies from China and more US exports. While China in theory could increase exports to Europe. the Europeans place much greater stock in preserving employment than does America. so will likely encounter formal and informal protectionism.
Although Setser argues from a funds flow perspective, he reaches a similar conclusion:
That strikes me as a recipe for future trouble.
Debasing the Dollar Will Accelerate America's Decline
We've said before that the US is in the same position as Thailand and Indonesia circa 1996, except we have the reserve currency and nukes. Some prominent commentators are making more polite observations along these lines.
An article, "A rising euro threatens US dominance" in the Financial Times, by Benn Steil, director of international economics at the Council on Foreign Relations, covers old and new ground in a discussion of the implications of a further decline in the dollar.
His well reasoned analysis contains some pointed observations, for instance, that the dollar's standing heretofore permitted it to have loose monetary policy without paying the usual consequences of capital flight and inflation, but no longer. Like a developing economy (ahem, banana republic), the more the Fed eases, the higher long term rates go.
Steil enumerates the implications of what happens when the US falls into banana republic category, and they aren't pretty. The "lender of the last resort" function breaks down in developing economies because investors withdraw funds from domestic accounts. Similarly, he raises the possibility that the US will have to issue foreign-currency-denominated debt. That is even more likely an outcome; the US briefly was forced to issue Deutchemark denominated bonds under Carter. Large scale non-dollar issuance would considerably constrain our formerly free-wheeling ways. He also notes a less widely noted cost: if the euro becomes more important, the US threat of sanctions as a tool of policy is neutered.
Note that these troubling scenarios are presented in an anodyne tone, and the author reminds us the US does not need to go down this path. But all indicators say that it will.
From the Financial Times:
An article, "A rising euro threatens US dominance" in the Financial Times, by Benn Steil, director of international economics at the Council on Foreign Relations, covers old and new ground in a discussion of the implications of a further decline in the dollar.
His well reasoned analysis contains some pointed observations, for instance, that the dollar's standing heretofore permitted it to have loose monetary policy without paying the usual consequences of capital flight and inflation, but no longer. Like a developing economy (ahem, banana republic), the more the Fed eases, the higher long term rates go.
Steil enumerates the implications of what happens when the US falls into banana republic category, and they aren't pretty. The "lender of the last resort" function breaks down in developing economies because investors withdraw funds from domestic accounts. Similarly, he raises the possibility that the US will have to issue foreign-currency-denominated debt. That is even more likely an outcome; the US briefly was forced to issue Deutchemark denominated bonds under Carter. Large scale non-dollar issuance would considerably constrain our formerly free-wheeling ways. He also notes a less widely noted cost: if the euro becomes more important, the US threat of sanctions as a tool of policy is neutered.
Note that these troubling scenarios are presented in an anodyne tone, and the author reminds us the US does not need to go down this path. But all indicators say that it will.
From the Financial Times:
As the dollar continues its relentless six-year slide against the euro and other main currencies, the question is being asked more and more: what would it mean if the dollar ceded its global dominance to the euro?
The question is a serious one because the US Federal Reserve is pumping new dollars into the global economy at an astounding pace. A broad measure of US money supply growth is increasing at a rate not seen since 1971 when President Richard Nixon imposed price controls and ended the dollar’s convertibility into gold, which recently roared above $1,000 an ounce. With consumer prices having climbed 4 per cent from a year ago, and wholesale prices having soared 6.9 per cent, presaging higher consumer price inflation around the corner, we are living witnesses to Milton Friedman’s famous dictum that “inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output”.
The Fed is acting with the best of intentions to head off a recession. But in a rapidly globalising financial marketplace it is in fact accelerating the demise of its own unique powers. Virtually all national economies show a positive link between currency depreciation and inflation and between depreciation and interest rates, meaning that their central banks cannot use loose monetary policy to stimulate their economies – it only fuels capital outflows and a rise in market interest rates to attract it back. Not so the US, whose currency has commanded a unique premium as the global store of value and the transaction vehicle for international trade. But this may be changing. The dollar is looking more and more like a typical developing country’s currency, with long-term market interest rates, crucial to determining borrowing and investment behaviour, climbing as the Fed pushes hard in the other direction.
If international use of the euro were to continue to rise, the Fed would lose other important powers. In a financial crisis, central banks are supposed to act as “lenders of last resort”, printing money to prop up banks and reassure their depositors. This does not work in developing countries. People withdraw money anyway, not because they fear the governments will let the banks collapse but because they fear the inflation and depreciation that printing money brings. So they exchange it for dollars, undermining the putative powers of their central banks. But what if Americans were to do the same, selling dollars for euros in a crisis? The Fed would become impotent. This is not science fiction. American investors have lately been pouring money into foreign bond funds at a record rate.
What about currency crises, the bane of developing countries? These happen when investors, local as well as foreign, fear that the country may face a shortage of foreign money, necessary to pay off its debts. If America were to become obliged to trade and borrow in euros, rather than dollars, it would face the very same risks.
What about America’s political power in the world? A continuing fall in the dollar means a fall in the global purchasing power of all its foreign assistance, whether for humanitarian, economic or military purposes.
But it means much more than that. The US has exploited the unique role of the dollar in international trade and investment to disrupt the financial flows of its adversaries, such as North Korea and Iran. If such transactions switched to euros and were funnelled through institutions not doing business in the US, this power would be neutered. The US would likewise lose influence over both friends and enemies facing financial problems, as they would be looking increasingly to Europe for euros, rather than to America for dollars.
None of this is inevitable. America is blessed to be the master of the dollar’s fate, in the sense that the world has no incentive to move to another monetary standard as long as the dollar’s long-term value appears secure. But it means that the US government needs to address the country’s economic problems deriving from the housing market collapse and the credit crunch “on-balance-sheet”, through direct, targeted, explicitly funded interventions, rather than “off-balance-sheet”, with the Fed undermining global confidence in the dollar by continuing to flood the market with new dollars. This can only lead to greater damage to America’s prosperity and global influence.
Links 4/23/08
Regulators Back Away From Changes to Commodity Hedging New York Times. The CFTC held off on easing rules to help specualtors.
Commodities and the Fed: answering the skeptics James Hamilton, Econbrowser
Appeals court upholds search of laptop at LAX Daily Breeze
U.S. to Insist That Travel Industry Get Fingerprints Washington Post. Airlines are supposed to become part of the enforcement apparatus.
Why College Men May Hear 'Yes' When Women Mean 'No' PhysOrg
Profits of Doom Macro Man
The Wal-Mart Conquest (hat tip 26econ). Eeek, a disease vector at work:
Antidote du jour:
Commodities and the Fed: answering the skeptics James Hamilton, Econbrowser
Appeals court upholds search of laptop at LAX Daily Breeze
U.S. to Insist That Travel Industry Get Fingerprints Washington Post. Airlines are supposed to become part of the enforcement apparatus.
Why College Men May Hear 'Yes' When Women Mean 'No' PhysOrg
Profits of Doom Macro Man
The Wal-Mart Conquest (hat tip 26econ). Eeek, a disease vector at work:
Antidote du jour:
Tuesday, April 22, 2008
The Credit Crunch is Dead! Long Live the Credit Crunch!
What a difference five weeks makes.
Around the ides of March, we had the mind-focusing spectacle of the possible implosion of Bear Stearns, which was feared to take down a lot of the financial system. But Fed and JP Morgan to the rescue, Lehman presents earnings that depend entirely on accounting rather than business activity, namely, widening credit spreads that made its own outstanding debt worth less, and everything is hunky dory. Oh, yes, UBS announces losses equal to 5% of Swiss GDP, but that too is rationalized as a sign that the Swiss giant has gotten past its bad patch. And while the earnings reports from Bank of America and National City were less than stellar, the Bank of England has thrown in the towel, and following the Fed, will accept £50 billion of mortgage debt as collateral (actually, they are on-upping the Fed; the BoE's loans have an one-year term). And while critics in the UK say this program won't revive the housing market, that may not be the point of this exercise.
Most observers have deemed the credit crisis to be over, and are now focusing on such pressing questions as how fast the recovery will be and how bad inflation might get.
Perhaps I am inflexible and unable to adapt to new information, but I don't see what has been accomplished beyond kicking the can down the road three to nine months. As reader Scott noted:
Let's consider just a few unpleasant realities. The Journal today points out that banks are increasing reserves, which means they need more capital (um, guess regulators are riding them to provide for likely losses ex ante rather than when they can no longer avoid taking them). The US consumer at some point is going to have to reduce spending as a percent of GDP; the open question is whether that happens in time to avert a dollar crisis (given the Fed determination to reflate assets and preserve demand, we seem to have an answer as far as the intent of policy is concerned). But then again, as reader Steve pointed out, Fed governor Frederic Mishkin testified before Congress last week that small businesses, the big engine of job growth, are starting to have trouble getting credit (they are heavily dependent on loans collaeralized by real estate and credit card borrowing, both of which are scarce and costly now).
And our old litany of woes has merely retreated from the fore rather than gone away: we still have the monolines almost destined to come apart at some point, the fact (as John Dizard pointed out) bigger GSEs are systemically destabilizing due to their pro-cyclical hedging, the not trivial problem that the housing market won't bottom till 2010 at the earliest, with more writedowns resulting, and my pet worry, CDS. As I understand it (and better informed readers can chide me if I am wrong), the CDS market basically has to keep growing to stand still. Again, perhaps I am too old school, but with inadequate margining/equity provisions, it seems guaranteed to go into crisis. You don't get happy endings with ever mushrooming bets on underlying equity that fails to show corresponding growth.
Today, we had the biggest bank fundraising announced to date, RBS's hugely dilutive £12 billion equity sale (and that's in addition to £4 billion of asset sales). Reader Steve pointed us to a key item from the press release: the Scottish bank's writedowns are markedly deeper than those taken by US banks to date, suggesting that the worst is not over on this side of the Atlantic. They have marked their US Alt-As at 50% of face, subprime at 38%, and CMBS at 83%.
Eeek. Steve's remarks:
With this prelude, we came across some wide-ranging forecasts that we thought we'd share, just in case readers wanted to hear different points of view.
There is one at the Financial Times, which I sadly can't re-access now (the FT server is not responding) but I believe I can recount reasonably accurately. The gist is that the credit crisis is an Anglo-Saxon, credit markets phenomenon. Neither Asia nor Europe is big on capital market intermediation, hence they will not be affected much, if at all, by the credit crisis. Thus emerging markets will be unscathed, making inflation the far bigger risk.
While the risk of inflation may well be underestimated, I have trouble with the notion that the credit crisis is as contained as the authors suggest. Spain and Germany are seeing more than a wee bit of banking stress; Eastern Europe, my sources tell me, is having a serious real estate contraction which is certain to have an impact on credit availability and the economy. We have reader Scott's comments on emerging markets, which seem sound to me:
Loyal Prudent Bear readers no doubt caught Doug Noland's weekly article; I usually prefer the Asia Times version simply because they edit it a tad. Noland is predictably pessimistic; he now thinks we are going to enter an inflationary crisis that will lead to an even more wrenching (but not fully spelled out) ending than if the authorities had not intervened. The whole piece is worth reading, but here are some key bits:
Last but not least, we have a fact filled, very informative, and somewhat curious piece from the Financial Times, "Road to ruin? America ponders the depth of its downturn."
The article goes through the cases for whether the US will have a V, U, or L shaped recession. The Fed believes in the V, based on its rate cuts and the stimulus package (gee, when it was proposed, most respectable economists viewed it as costly window dressing), but the "great unknown" is what happens to housing (really?).
What is striking about the piece is the number and range of not-positive views and factoids. A sampling:
The part I found the most surprising was when it acknowledged that a doomsday scenario seemed less likely given aggressive central bank action, but then started undercutting even that idea:
If you believe Noland, that next crisis is waiting in the wings.
Around the ides of March, we had the mind-focusing spectacle of the possible implosion of Bear Stearns, which was feared to take down a lot of the financial system. But Fed and JP Morgan to the rescue, Lehman presents earnings that depend entirely on accounting rather than business activity, namely, widening credit spreads that made its own outstanding debt worth less, and everything is hunky dory. Oh, yes, UBS announces losses equal to 5% of Swiss GDP, but that too is rationalized as a sign that the Swiss giant has gotten past its bad patch. And while the earnings reports from Bank of America and National City were less than stellar, the Bank of England has thrown in the towel, and following the Fed, will accept £50 billion of mortgage debt as collateral (actually, they are on-upping the Fed; the BoE's loans have an one-year term). And while critics in the UK say this program won't revive the housing market, that may not be the point of this exercise.
Most observers have deemed the credit crisis to be over, and are now focusing on such pressing questions as how fast the recovery will be and how bad inflation might get.
Perhaps I am inflexible and unable to adapt to new information, but I don't see what has been accomplished beyond kicking the can down the road three to nine months. As reader Scott noted:
Basically what's happened is that we've moved bad paper from the banks, where it needed to get marked to market, at least at some point, to the Fed, where that doesn't have to happen. It's a sort of out of sight out of mind phenomenon. But all those CDOs and MBS and CLOs are made up of individual mortgages, and of hung LBO loans. They will either be paid off in the end, or they'll go into default. Assuming, as I think seems right, that some of them default, the Fed will have another line item on its balance sheet, REO. So as I see it, it's absurd to say the credit risk has been "disappeared"; it's just been moved from the banks to the public.
Let's consider just a few unpleasant realities. The Journal today points out that banks are increasing reserves, which means they need more capital (um, guess regulators are riding them to provide for likely losses ex ante rather than when they can no longer avoid taking them). The US consumer at some point is going to have to reduce spending as a percent of GDP; the open question is whether that happens in time to avert a dollar crisis (given the Fed determination to reflate assets and preserve demand, we seem to have an answer as far as the intent of policy is concerned). But then again, as reader Steve pointed out, Fed governor Frederic Mishkin testified before Congress last week that small businesses, the big engine of job growth, are starting to have trouble getting credit (they are heavily dependent on loans collaeralized by real estate and credit card borrowing, both of which are scarce and costly now).
And our old litany of woes has merely retreated from the fore rather than gone away: we still have the monolines almost destined to come apart at some point, the fact (as John Dizard pointed out) bigger GSEs are systemically destabilizing due to their pro-cyclical hedging, the not trivial problem that the housing market won't bottom till 2010 at the earliest, with more writedowns resulting, and my pet worry, CDS. As I understand it (and better informed readers can chide me if I am wrong), the CDS market basically has to keep growing to stand still. Again, perhaps I am too old school, but with inadequate margining/equity provisions, it seems guaranteed to go into crisis. You don't get happy endings with ever mushrooming bets on underlying equity that fails to show corresponding growth.
Today, we had the biggest bank fundraising announced to date, RBS's hugely dilutive £12 billion equity sale (and that's in addition to £4 billion of asset sales). Reader Steve pointed us to a key item from the press release: the Scottish bank's writedowns are markedly deeper than those taken by US banks to date, suggesting that the worst is not over on this side of the Atlantic. They have marked their US Alt-As at 50% of face, subprime at 38%, and CMBS at 83%.
Eeek. Steve's remarks:
{The] RBS summary is damn sobering and is likely the first example of the greater transparency that BOE/Treasury are demanding from UK banks in exchange for the new borrowing facility. RBS may have exaggerated the marks to give themselves wiggle room, since they really can't go back to the cap markets for a while. But still, the difference from marks at US banks (particularly commercial banks) is sobering and a sign that the crisis is going to drag on `in full opacity' in the US for quite some time.
With this prelude, we came across some wide-ranging forecasts that we thought we'd share, just in case readers wanted to hear different points of view.
There is one at the Financial Times, which I sadly can't re-access now (the FT server is not responding) but I believe I can recount reasonably accurately. The gist is that the credit crisis is an Anglo-Saxon, credit markets phenomenon. Neither Asia nor Europe is big on capital market intermediation, hence they will not be affected much, if at all, by the credit crisis. Thus emerging markets will be unscathed, making inflation the far bigger risk.
While the risk of inflation may well be underestimated, I have trouble with the notion that the credit crisis is as contained as the authors suggest. Spain and Germany are seeing more than a wee bit of banking stress; Eastern Europe, my sources tell me, is having a serious real estate contraction which is certain to have an impact on credit availability and the economy. We have reader Scott's comments on emerging markets, which seem sound to me:
[]n a very broad sense that emerging economies will at some point be stronger than developed ones. But I expect them to suffer a bunch of pain--at least as much, and perhaps more, than we do--before they rebound more strongly than we will. I see China in a more or less analogous spot to where, say, the semi manufacturers were at the end of the tech bubble. They were way down the supply chain, far removed from the ultimate customers, so they didn't see the slowdown until it clobbered them in the face. In the same way, China's been building capacity sufficient for a world with limitless credit and capital at its disposal, and we're now in a world very different from that.
Loyal Prudent Bear readers no doubt caught Doug Noland's weekly article; I usually prefer the Asia Times version simply because they edit it a tad. Noland is predictably pessimistic; he now thinks we are going to enter an inflationary crisis that will lead to an even more wrenching (but not fully spelled out) ending than if the authorities had not intervened. The whole piece is worth reading, but here are some key bits:
....we live in a unique world of unregulated credit. Excess has evolved to the point of being endemic to an apparatus that operates without any mechanism for adjustment or self-correction. There is, of course, no gold reserve system to restrain domestic monetary expansions. Some years back, the dollar-based Bretton Woods global monetary regime lost its relevance. And, importantly, the market-based disciplining mechanism ("king dollar") that emerged at times to ruthlessly punish financial profligacy around the globe throughout the nineties has morphed into a dysfunctional dynamic that these days nurtures self-reinforcing excesses.
The "recycling" of our "bubble dollars" (in the process inflating local credit systems, asset markets, commodities and economies across the globe) directly back into our securities markets rests at the epicenter of global monetary dysfunction.
A historic inflation in dollar financial claims was the undoing of anything resembling a global monetary system, and now this anchorless "system" of wildcat finance is the bane of financial and economic stability. To be sure, massive and unrelenting US current account deficits and resulting dollar impairment have unleashed domestic credit systems around the globe to expand uncontrollably. Today, virtually any major credit system can and does inflate domestic credit to create the purchasing power to procure inflating global food, energy, and commodities prices....
....there are reasons to expect this uninhibited global credit bubble to instead run to precarious extremes, and for resulting monetary disorder to become increasingly problematic. Destabilizing price movements and myriad inflationary effects are poised to worsen. The specter of yet another year of near $800 billion current account deficits coupled with huge speculative outflows of dollars is just too much for an acutely overheated and unstable global currency and economic system to cope with.
in the face of a rapidly weakening economic backdrop, global inflation dynamics coupled with our highly maladjusted economy ensure intractable trade deficits. I would further argue that the current inflationary backdrop will prove an impetus to credit creation that then begets only more heightened inflationary pressures.
There are certainly indications that the over-liquefied global system is not well situated today to handle more dollar liquidity (akin to throwing gas on a fire). Inflation and its consequences have quickly become major issues around the world.
With crude hitting a record $117 at the end of last week, there is every reason to expect that newly created global liquidity will further inflate energy, food, and commodity prices generally. The Goldman Sachs Commodities index has gained 21% already this year. But when it comes to monetary instability, our financial markets might just prove the unappreciated wildcard.
When the Fed and Washington radically altered the rules of US finance last month, they placed in jeopardy huge positions that had been put in place to hedge against and profit from systemic crisis. With the end of stage one arises a major short squeeze in the credit, equities, and derivatives markets. And when it comes to contemplating the scope and ramifications of today’s hedging activities, we’re clearly in uncharted waters. It is not beyond reason that a disorderly unwind of bearish credit market positions could incite a mini bout of liquidity, speculation, and credit excess that exacerbates global monetary instability while setting the backdrop for stage two of the crisis.
Last but not least, we have a fact filled, very informative, and somewhat curious piece from the Financial Times, "Road to ruin? America ponders the depth of its downturn."
The article goes through the cases for whether the US will have a V, U, or L shaped recession. The Fed believes in the V, based on its rate cuts and the stimulus package (gee, when it was proposed, most respectable economists viewed it as costly window dressing), but the "great unknown" is what happens to housing (really?).
What is striking about the piece is the number and range of not-positive views and factoids. A sampling:
Alan Blinder, a professor of economics at Princeton and a former Fed vice-chairman, says the economy will struggle to return to normal growth in the face of “super-headwinds” emanating from the financial sector.
With banks under balance-sheet pressure and the financial system as a whole deleveraging, the credit squeeze on the real economy could continue even after the risk of a systemic crisis in the banking sector recedes.
Moreover, the impact of the tightening to date is only now beginning to be felt in the economy. Richard Berner, chief US economist at Morgan Stanley, who expects a lacklustre recovery, says that “given the time lags between when financial conditions tighten and when it shows up in the economy we still have a long way to go.”....
“The trillion-dollar question is what happens to consumption – is the US household going to rein back its spending?” says Raghu Rajan, a professor at the University of Chicago’s Graduate School of Business. As results from US retailers indicate, the consumer is already pulling back. “But the real question is has it got much further to go?”
Mr Rajan says economists do not fully understand why the savings rate collapsed from the early 1980s, making it hard to be sure at what rate it might rise again. Most explanations suggest some combination of increasing wealth (first from equities, then housing) and financial innovation, which made it easier to access the wealth represented, for instance, by home equity.
Kenneth Rogoff, a professor at Harvard, says US consumer spending would have to adjust following the reversal in house prices, even if there had been no accompanying credit crisis. As things stand, “even if we take away the immediate financial crisis, we are still left with a story where the whole credit structure that propagated the housing boom and credit boom has been seriously compromised,” he says.
Most experts believe the US savings rate will rise as households start to repair their balance sheets, but that this will happen gradually, muting rather than derailing economic recovery. There is a risk, however, that under stress this adjustment could be more abrupt.
Moreover, the longer an economic downturn lasts, the greater the strain on the financial system. The IMF already estimates that losses and writedowns on all debt and securities – not just subprime mortgages – could total $945bn.
Nouriel Roubini, a professor at New York University and chairman of RGE Monitor, an economic research firm, argues that underwriting standards deteriorated across a wide range of credit products during the boom, and that economic stress will result in a sharp rise in defaults and delinquencies on non-mortgage debt such as car loans, credit cards and leveraged loans.
The part I found the most surprising was when it acknowledged that a doomsday scenario seemed less likely given aggressive central bank action, but then started undercutting even that idea:
Policy activism is not a guarantee of success. The US’s large current account deficit increases the risk of a dollar crisis and a sudden pick-up in inflation expectations – a threat that has looked worryingly real at moments in recent months.
Moreover, there are some financial risks – such as multiple ruptures in the credit default swaps market, which banks and other financial institutions use to trade and hedge credit risk with each other – that would be very difficult for the Fed and Treasury to contain even if they wanted to.
The US government is also in a worse fiscal position than it was in 2001, making it harder to sustain an aggressive fiscal policy such as the Bush tax cuts and increased government spending that helped pull the US out of recession last time. Yet the likelihood is that the US – with even its external debts denominated in its own currency – has both the economic capacity and political will to prevent an L-shaped recession taking hold. In an election year, the pressure is for action.
The US should manage to avoid an L-shaped recession – and may even escape with a short V-shaped recession. The danger is that the extreme measures taken – already including the extension of the safety net to investment banks and the loosening of constraints on government-sponsored enterprises to support the housing market – could lay the seeds for the next financial and economic crisis.
If you believe Noland, that next crisis is waiting in the wings.
Commodity Volatility Creates Problems for Farmers (and May Explain an Inventory Mystery)
A good piece in the New York Times today, "Price Volatility Adds to Worry on U.S. Farms," describes how the runup in agricultural crop prices is making life harder for farmers.
The recent upswing, and the entry of speculative capital, has led to a sharp increase in volatility (note that that's the reverse of what theory says you ought to expect. More liquidity is purported to lower volatility). And that has created new problems, Crop insurance is more expensive when prices are erratic. Worse, grain elevators refusing to buy crops in advance, forcing more farmers to hedge themselves, which is particularly risky since they might not have enough cash on hand to meet margin calls.
Aside: would a forward sale to a grain elevator be counted as inventory by the elevator company? If so, some of the apparent inventory tightening might be an accounting phenomenon (although the US may not be a big enough player in the commodities in which this is happening for that factor to have much impact).
Aside from the difficulties that the farmers are facing, the article does contain signs that speculation is overwhelming fundamental activity. One big warning sign mentioned in passing: trading has outgrown the delivery system. If I read this correctly, it means that the volume of futures contracts is so large relative to the actual deliverable commodity that arbitrage (via taking physical delivery) won't force convergence of futures prices to cash prices at contract maturity.
The article notes that some farmers who cannot sell to elevator companies and are frustrated with the ways the options and futures markets are misbehaving are doing deals outside the exchanges, directly with sponsors of commodity funds such as AIG. AIG buys the commodity, the farmer stores it for a fee, and the farmer buys it back later at a pre-set price.
Again, does the inventory held with the farmer by a commodity index fund get recorded anywhere?
Paul Krugman asked in a post yesterday, if speculative activity had anything to do with the commodity run-up, where were the inventories? Others had commented that speculators were carrying inventories without describing a mechanism. Looks like we've found one.
From the New York Times
The recent upswing, and the entry of speculative capital, has led to a sharp increase in volatility (note that that's the reverse of what theory says you ought to expect. More liquidity is purported to lower volatility). And that has created new problems, Crop insurance is more expensive when prices are erratic. Worse, grain elevators refusing to buy crops in advance, forcing more farmers to hedge themselves, which is particularly risky since they might not have enough cash on hand to meet margin calls.
Aside: would a forward sale to a grain elevator be counted as inventory by the elevator company? If so, some of the apparent inventory tightening might be an accounting phenomenon (although the US may not be a big enough player in the commodities in which this is happening for that factor to have much impact).
Aside from the difficulties that the farmers are facing, the article does contain signs that speculation is overwhelming fundamental activity. One big warning sign mentioned in passing: trading has outgrown the delivery system. If I read this correctly, it means that the volume of futures contracts is so large relative to the actual deliverable commodity that arbitrage (via taking physical delivery) won't force convergence of futures prices to cash prices at contract maturity.
The article notes that some farmers who cannot sell to elevator companies and are frustrated with the ways the options and futures markets are misbehaving are doing deals outside the exchanges, directly with sponsors of commodity funds such as AIG. AIG buys the commodity, the farmer stores it for a fee, and the farmer buys it back later at a pre-set price.
Again, does the inventory held with the farmer by a commodity index fund get recorded anywhere?
Paul Krugman asked in a post yesterday, if speculative activity had anything to do with the commodity run-up, where were the inventories? Others had commented that speculators were carrying inventories without describing a mechanism. Looks like we've found one.
From the New York Times
Fred Grieder has been farming for 30 years on 1,500 acres near Bloomington, in central Illinois. That has meant 30 years of long days plowing, planting, fertilizing and hoping that nothing happens to damage his crop.
“It can be 12 hours or 20 hours, depending,” Mr. Grieder said.
But Mr. Grieder’s days on the farm in Carlock, Ill., are getting even longer. He now has to keep a closer eye on the derivatives markets in Chicago, trying to hedge his risks so that he knows how much he will be paid in the future for crops he is planting now. And the financial tools he uses to make such bets are getting more expensive and less reliable.
In what little free time he has, Mr. Grieder attends Illinois Farm Bureau meetings to join other frustrated farmers who are lobbying officials in Chicago and Washington to fix a system that was designed half a century ago to reduce uncertainty for food producers but is now increasing it.
Mr. Grieder, 49, is shy about complaining amid so much prosperity. Prices for his crops are soaring on the updraft of growing worldwide demand, and a weak dollar is making the crops more competitive in global markets.
But today’s crop prices are not just much higher, they also are much more volatile. For example, a widely used measure of volatility showed that traders in March expected wheat prices to swing up or down by more than 72 percent in the coming year, three times the average volatility for that month and the highest level since at least 1980. The price swing expected in March for soy beans was three times its monthly average, and the expected volatility in corn prices was twice its monthly average.
Those wild swings in expected prices are damaging the mechanisms — like futures contracts and options — that in the past have cushioned the jolts of farming, turning already-busy farmers into reluctant day traders and part-time lobbyists.
One measure of the farming industry’s frustration is the overflow crowd expected at a public forum on Tuesday at the Commodity Futures Trading Commission in Washington. Interest is so high that the commission, for the first time ever, will provide a Webcast of the forum, which it says is being held to gather information about whether crucial markets for hedging the price of crops “are properly performing their risk management and price discovery roles.” The Webcast link is available on the commission’s Web site, www.cftc.gov.
The additional costs that stem from volatility in grain prices — higher crop insurance premiums, for example — are not just a problem for farmers. “Eventually, those costs are going to come out of the pockets of the American consumer,” said William P. Jackson, general manager of AGRIServices, a grain-elevator complex on the Missouri River.
Prices of broad commodity indexes have climbed as much as 40 percent in the last year and grain prices have gained even more — about 65 percent for corn, 91 percent for soybeans and more than 100 percent for some types of wheat. This price boom has attracted a torrent of new investment from Wall Street, estimated to be as much as $300 billion.
Whether new investors are causing the market’s problems or keeping them from getting worse is in dispute. But there is no question that the grain markets are now experiencing levels of volatility that are running well above the average levels over the last quarter-century.
Mr. Grieder’s crop insurance premiums rise with the volatility. So does the cost of trading in options, which is the financial tool he has used to hedge against falling prices. Some grain elevators are coping with the volatility and hedging problems by refusing to buy crops in advance, foreclosing the most common way farmers lock in prices.
“The system is really beginning to break down,” Mr. Grieder said. “When you see elevators start pulling their bids for your crop, that tells me we’ve got a real problem.”
Until recently, that system had worked well for generations. Since 1959, grain producers have been able to hedge the price of their wheat, corn and soybean crops on the Chicago Board of Trade through the use of futures contracts, which are agreements to buy or sell a specific amount of a commodity for a fixed price on some future date.
More recently, the exchange has offered another tool: options on those futures contracts, which allow option holders to carry out the futures trade, but do not require that they do so. Trading in options is not as effective a hedge, farmers say, but it does not require them to put up as much cash as is required to trade futures.
These tools have long provided a way to lock in the price of a crop as it is planted, eliminating the risk that prices will drop before it is harvested. With these hedging tools, grain elevators could afford to buy crops from farmers in advance, sometimes a year or more before the harvest.
But that was yesterday. It simply is not working that way today.
Futures, for example, are less reliable. They work as a hedge only if they fall due at a price that roughly matches prices in the cash market, where the grain is actually sold. Increasingly — for disputed reasons — grain futures are expiring at prices well above the cash-market price.
When that happens, farmers or elevator owners wind up owing more on their futures hedge than the crops are worth in the cash market. Such anomalies create uncertainty about which price accurately reflects supply and demand — a critical issue, since the C.B.O.T. futures price is the benchmark for grain prices around the world.
“I can’t honestly sit here and tell you who is determining the price of grain,” said Christopher Hausman, a farmer in Pesotum, Ill. “I’ve lost confidence in the Chicago Board of Trade.”
David D. Lehman, director of commodity research and product development for the C.B.O.T.’s owner, the CME Group, said: “We know that the current global environment is creating challenges for many of the traditional users of our markets, and we are very concerned. But there are a lot of things that are changing and there is no silver bullet, in terms of a solution.”
Many farmers and people in related businesses blame the tidal wave of investment pouring in from hedge funds, pension funds and index funds for the faulty futures contracts and rising volatility. But those institutional investors’ money actually adds liquidity to the market, which in theory should reduce price volatility, Mr. Lehman noted.
In any case, at current levels of volatility, options trading becomes riskier, and therefore more expensive — too expensive for many farmers like Mr. Grieder, who now has to hedge with the recently less reliable futures contracts.
That exposes him to the risk of having to put up more cash — to maintain his price protection — whenever a weather threat, shipping disruption or a fresh surge of money from Wall Street suddenly pushes up grain prices.
“If you’ve got 50,000 bushels hedged and the market moves up 20 cents, that would be a $10,000 day,” he said. “If you only had $10,000 in your margin account, you’d have to sit down and write a check. You can see $10,000 disappear overnight.”
On an unusual day, he said, he might get four phone calls a day from his broker seeking additional margin. “But usually, the margin calls come in the mail, in a little blue envelope,” he said. “You don’t have to open it to know what it is.”
When it arrives, he sometimes has to rely on his bank to advance him the margin he needs to keep those hedges in place — a worrisome requirement even for a successful farmer in an economy already struggling with a credit squeeze.
“The nightmare scenario is when you have to make margin and you’re looking out your back door and seeing, maybe, a crop problem,” he said. “Everybody has a story about a guy they know getting blown out of his hedge” by unmet margin calls.
Farmers used to leave the market-watching to traders who work for big grain elevator companies. But with some of those companies now refusing to buy crops in advance because hedging has become so expensive and uncertain, farmers have to follow and trade in those markets themselves.
“This is something the farmer didn’t have to worry about before,” said Curt Kimmel, a commodity broker at Bates Commodities, the advisory service Mr. Grieder uses. “It’s a cruel and unforgiving market.”
John Fletcher, a grain elevator operator in Marshall, Mo., started pressing the C.B.O.T. to address the flaws of futures contracts almost two years ago — even before his futures hedge on a million bushels of soybeans failed to fully protect him last September, hitting him with a cash loss of $940,000.
Mr. Fletcher does not blame the big institutional investors stampeding into the market. “But they have contributed to the problem by making these markets so much larger — so large that they have outgrown their delivery system,” he said. “And that has detached the futures market from the cash market.”
Frustrated over the flawed futures contract, Mr. Fletcher is voting with his feet. Last year, he entered into a contract with A.I.G. Financial Products, a leading sponsor of commodity index funds, which allows him and the index fund to hedge their risks without using the C.B.O.T.
Instead of using futures or options, A.I.G. simply buys the commodity directly from Mr. Fletcher, who stores it for a fee and buys it back six months later. His storage fee is lower than the one built into the C.B.O.T. contract, so A.I.G. pays less for its stake in the market. And he has a hedge he can rely on.
“I did a deal with them for corn a year ago, and this year I’m doing a deal on soybeans,” he said.
But private deals like these do not provide pricing data to other farmers and to the rest of the food industry, which has long relied on the Chicago Board of Trade as the best measure of supply and demand. If such bilateral contracts become more common, it will be harder for everyone in the industry to anticipate costs and potential profits — which could also push prices up.
This growing uncertainty about prices and hedging “just makes the market less efficient,” said Jeffrey Hainline, president of Advance Trading, an agricultural advisory and brokerage service in Bloomington, Ill. “And anything that makes these markets less efficient increases the cost of food.”
Robert E. Young II, chief economist for the American Farm Bureau Federation, has held meetings on this topic around the Farm Belt over the last month and has gotten an earful from distressed food producers and elevator owners, he said.
“I tell people, ‘You are not going to market the 2009 crop the way you marketed the 2007 crop. You may never market grain that way again.’ ”
RBS to Sell $24 Billion in New Shares
The numbers keep getting bigger and bigger, first of bank losses, then of capital raises to try to get things back on a semblance of an even keel.
Even so, the $24 billion (£12 billion) raise is nevertheless a stunner, hugely dilutive to existing shareholders. And note this comes in addition to a dividend cut and £4 billion in asset sales.
From Bloomberg:
Even so, the $24 billion (£12 billion) raise is nevertheless a stunner, hugely dilutive to existing shareholders. And note this comes in addition to a dividend cut and £4 billion in asset sales.
From Bloomberg:
Royal Bank of Scotland Group Plc, the U.K.'s second-biggest lender, will sell 12 billion pounds ($23.7 billion) of new shares to investors to boost capital depleted by writedowns.
The Edinburgh-based bank marked down 5.9 billion pounds of assets and said it will cut its 2008 dividend, according to a statement today. The board defended Chief Executive Officer Fred Goodwin, who has come under pressure from investors, saying it has ``full confidence that the executive team will be able to lead RBS through the current challenging conditions.''
RBS, which bought ABN Amro Holding NV with partners Banco Santander SA and Fortis for about 72 billion euros ($114 billion) in mostly cash last year, has had its capital cushion eroded by the acquisition and credit markdowns. The company said the outlook still is ``inevitably clouded'' by market turmoil sparked by the U.S. subprime mortgage market meltdown.
``They have overpaid for acquisitions and have had a weak capital base but there's nothing in this statement which confesses that they have made significant mistakes over recent years,'' said Simon Maughan, an analyst at MF Global Securities Ltd. in London. ``We would like to see disposals from the global banking and markets portfolio which got them into trouble.''
The company, which has cut jobs and sold assets, has lost more than a third of its market value since the start of the credit turmoil in August. It plans to issue 11 new shares for every 18 existing shares at 200 pence a share.
It will raise 4 billion pounds in asset disposals and plans to raise its Tier 1 capital ratio, a measure of capital strength, to more than 8 percent from 7.3 percent and its core equity Tier 1 ratio to more than 6 percent from 4.5 percent by the end of the year, it also said..
Quelle Surprise! National Association of Realtors Says Many Housing Markets Doing Well
A MarketWatch story "Home prices aren't tanking everywhere," has the all the earmarks of being a National Association of Realtors plant. Note that it's even told from the perspective of supposedly well-meaning (as opposed to commission-motivated) brokers trying to educate clients that the press is wrong, things really aren't that bad.
Here's the gist of its bullish message:
Now why is that factoid, that average prices are rising, utterly misleading? Well, consider the nature of the crisis we are in. A lot of people overextended themselves (per Tanta's "We are all subprime now") but it's the most marginal borrowers that have been hit the hardest. And in most cases, they aren't buying the biggest ticket houses.
So if you have a lot of low priced sales disappear, the average price goes up, even if average prices among the more costly houses falls.
Further confirmation that the article is hogwash: the average price figure was the ONLY metric cited to support the assertion that housing is doing just fine in a lot of markets. You'd expect them to be able to marshal other indicators of market strength, such as declining inventories or shrinking average time on the market. But those indicators were notably absent.
Now that isn't to say that there aren't pockets of strength in the US. No doubt there are, most likely due to local incomes holding up well and a lack of overbuilding. But to imply that nearly half the markets in the US are doing better than last year is patently ridiculous. Housing, even in markets that did not run up like the boom areas, still rose to levels considerably out of line with incomes and rental prices. A reversion is inevitable.
And some of the areas the article highlights as being strong are not terribly populous states:
And for the one market I can verify directly, Manhattan, the article is utter rubbish:
One of those "two luxury condo developments" was guaranteed to be the Plaza, which is a special situation.
For at least the last two months, if not longer, the Sunday New York Times real estate section has said loud and clear that the market is softening. And given brokers' propensity to always say now is the time to buy, the fact that they are 'fessing up that things are bad says they are REALLY bad. I see many blocks with more than one townhouse for sale, a clear sign of stress at the top end (townhouses became popular as more families wanted to stay in the city, particularly among the Wall Street set that would be quite affluent by anyone's standards save that of the highly restrictive boards of tony Park and Fifth Avenue co-operatives).
I simply went to the most recent Sunday section and found this example, "Take My Condo, Please":
Here's the gist of its bullish message:
The housing problems largely aren't national but regional in nature, said Susan Wachter, a real estate professor at the University of Pennsylvania's Wharton School.
"The interesting thing is that there are parts of the country where housing prices are doing fine, thank you," she said. In fact, only five states are in what she would consider a housing recession: California, Arizona, Nevada, Florida and Michigan.
In the fourth quarter of 2007, 73 out of 150 metropolitan areas showed an increase in the median existing single-family home price compared with the same quarter in 2006, according to statistics from the national Realtors group.
Now why is that factoid, that average prices are rising, utterly misleading? Well, consider the nature of the crisis we are in. A lot of people overextended themselves (per Tanta's "We are all subprime now") but it's the most marginal borrowers that have been hit the hardest. And in most cases, they aren't buying the biggest ticket houses.
So if you have a lot of low priced sales disappear, the average price goes up, even if average prices among the more costly houses falls.
Further confirmation that the article is hogwash: the average price figure was the ONLY metric cited to support the assertion that housing is doing just fine in a lot of markets. You'd expect them to be able to marshal other indicators of market strength, such as declining inventories or shrinking average time on the market. But those indicators were notably absent.
Now that isn't to say that there aren't pockets of strength in the US. No doubt there are, most likely due to local incomes holding up well and a lack of overbuilding. But to imply that nearly half the markets in the US are doing better than last year is patently ridiculous. Housing, even in markets that did not run up like the boom areas, still rose to levels considerably out of line with incomes and rental prices. A reversion is inevitable.
And some of the areas the article highlights as being strong are not terribly populous states:
Utah -- where home prices rose 9.27% in the fourth quarter of 2007 compared with the fourth quarter of 2006 -- was the state with the highest appreciation rate, according to the Office of Federal Housing Enterprise Oversight. Utah was followed by Wyoming, where prices rose 8.27% over the year, North Dakota, where prices rose 7.87%, and Montana, where prices rose 6.90%.
And for the one market I can verify directly, Manhattan, the article is utter rubbish:
Manhattan, however, tends to be a real-estate juggernaut all its own.
The average price of a Manhattan apartment was up 47% in the first quarter, compared with the first quarter of 2007, according to Brown Harris Stevens, a provider of real-estate services in the area. The boost was largely due to an increase in high-end sales that occurred at two luxury condo developments.
But the median price of a Manhattan apartment, which is less impacted by high-end activity, also rose 13% over the year, according to the firm.
One driver of the market: A rising demand for three- and four-bedroom units in Manhattan, said Jim Gricar, executive vice president of Brown Harris Stevens. More families are opting to live in the city as opposed to seeking larger homes in the suburbs, as was common in the 1980s and early 1990s, he said.
One of those "two luxury condo developments" was guaranteed to be the Plaza, which is a special situation.
For at least the last two months, if not longer, the Sunday New York Times real estate section has said loud and clear that the market is softening. And given brokers' propensity to always say now is the time to buy, the fact that they are 'fessing up that things are bad says they are REALLY bad. I see many blocks with more than one townhouse for sale, a clear sign of stress at the top end (townhouses became popular as more families wanted to stay in the city, particularly among the Wall Street set that would be quite affluent by anyone's standards save that of the highly restrictive boards of tony Park and Fifth Avenue co-operatives).
I simply went to the most recent Sunday section and found this example, "Take My Condo, Please":
They've offered buyers swimming pools, stretch limousines, movie theaters and automated parking garages. Lately, they’re even covering closing costs.
But the condominium developers at “Luxury Living” in SoHo, a recent sales event sponsored by The New York Observer that combined elements of a trade show and a Tupperware party, used a cheaper and lower-tech gimmick to hawk their products: candy.
Safety-orange M&M’s filled a glass bowl at the booth for 45 John in the financial district. Gumballs, in rainbow hues, sat ready to be dispensed for 80 Metropolitan, in Williamsburg, Brooklyn. Not to be outdone, the Harrison on the Upper West Side offered both a dish of foil-wrapped bonbons and a masseuse, who sympathetically kneaded stressed-out backs.
Brokers, perhaps mindful of first-quarter reports showing that sales volumes have slipped, lined up for back rubs.
“I needed this because I just started my job,” said Tony DiPietro, 39, of University Heights in the Bronx, who has been a sales agent for Mara & Company for one month. “But even if the market’s turning, people will always be looking for housing.”
Links Earth Day
Europe’s bear rally is over Financial Times
Australia extends rights over sea BBC
Deutsche Bank crackdown on expenses of elite financiers Times Online
Rebuilding Loan Loss Reserves Hurts Bank Profits Dean Baker
The Coming Tsunami of Equity Supply Michael Panzner
Brain reacts to fairness as it does to money and chocolate EurekaAlert (hat tip Mark Thoma). So why aren't we doing more to maximize fairness and chocolate?
Puzzled Menzie Chinn, Econbrowser. Chinn does not like the proposal for a gas tax holiday this summer, and with good reason.
Antidote du jour:
Australia extends rights over sea BBC
Deutsche Bank crackdown on expenses of elite financiers Times Online
Rebuilding Loan Loss Reserves Hurts Bank Profits Dean Baker
The Coming Tsunami of Equity Supply Michael Panzner
Brain reacts to fairness as it does to money and chocolate EurekaAlert (hat tip Mark Thoma). So why aren't we doing more to maximize fairness and chocolate?
Puzzled Menzie Chinn, Econbrowser. Chinn does not like the proposal for a gas tax holiday this summer, and with good reason.
Antidote du jour:
Monday, April 21, 2008
DNA Turns Relatives Into Genetic Informants
A Washington Post article, "From DNA of Family, a Tool to Make Arrests," points to the increasing efforts to look for partial matches in DNA databases that might implicate close relatives.
This is a disturbing development, since DNA, like other forensic evidence, isn't as foolproof as its image in the popular imagination indicates. There have been cases of false matches of DNA, such as this one in England, this one in Germany, and one I recall in New Zealand. Worse, since US lab error rates (false positives and technician error, such as switching samples or miscataloguing someone in a database) are not captured, errors are almost certain to be higher than widely believed. Without this information, the public and defendants cannot know for certain whether this is a cause for concern. An article from the Observer on the UK's experience suggests the reservations are warranted:
Needless to say, expanding the scope of searches by looking for partial matches compounds the potential for false positives. However, at least for now, this procedure is sufficiently controversial that it doesn't have a green light everywhere. Yet. Welcome to our total surveillance society.
More troubling, I did not see a mention in this article of the issue of errors, so it unwittingly promotes the idea that DNA testing is infallible . From the Washington Post:
This is a disturbing development, since DNA, like other forensic evidence, isn't as foolproof as its image in the popular imagination indicates. There have been cases of false matches of DNA, such as this one in England, this one in Germany, and one I recall in New Zealand. Worse, since US lab error rates (false positives and technician error, such as switching samples or miscataloguing someone in a database) are not captured, errors are almost certain to be higher than widely believed. Without this information, the public and defendants cannot know for certain whether this is a cause for concern. An article from the Observer on the UK's experience suggests the reservations are warranted:
The DNA database is not a perfect weapon. Last year 1,500 administrative mistakes were discovered and at least 100 inaccuracies pertaining to individuals. That means there is a real possibility of people being convicted of crimes they did not commit. Given the chaotic state of government databases, it must be obvious..... that administrative errors would be vastly increased if the database were to be expanded by a factor of about 13, from 4.5m to 60m.
Needless to say, expanding the scope of searches by looking for partial matches compounds the potential for false positives. However, at least for now, this procedure is sufficiently controversial that it doesn't have a green light everywhere. Yet. Welcome to our total surveillance society.
More troubling, I did not see a mention in this article of the issue of errors, so it unwittingly promotes the idea that DNA testing is infallible . From the Washington Post:
He was a church-going father of two, and for more than 30 years Dennis Rader eluded police in the Wichita area, killing 10 people and signing taunting letters with a self-styled monogram: BTK, for Bind Torture Kill. In the end, it was a DNA sample that tied BTK to his crimes. Not his own DNA. But his daughter's.
Investigators obtained a court order without the daughter's knowledge for a Pap smear specimen she had given five years earlier at a university medical clinic in Kansas. A DNA profile of the specimen almost perfectly matched the DNA evidence taken from several BTK crime scenes, leading detectives to conclude she was the child of the killer. That allowed police to secure an arrest warrant in February 2005 and end BTK's murderous career.
The BTK case was an early use of an emerging tool in law enforcement: analyzing the DNA of a suspect's relatives. In the BTK example, police had a suspect and were looking to tie him to the crime. But now, states are moving to conduct familial searches of criminal databases, looking for close-to-perfect matches with DNA from crime scenes. A partial match with a convicted criminal could implicate a brother or daughter or father of the convict. Such searches, advocates say, constitute a powerful law enforcement tool that, experts say, could increase by 40 percent the number of suspects identified through DNA.
As things stand in some states, lab analysts who discover a potential suspect in this way may not be permitted to share that information with investigators. Such a policy, said William Fitzpatrick, a New York state district attorney, "is insanity. It's disgraceful. If I've got something of scientific value that I can't share because of imaginary privacy concerns, it's crazy. That's how we solve crimes."
But the technique is arousing fierce objections from privacy advocates, who maintain that it turns family members into genetic informants without their knowledge or consent. They complain that it takes material collected for one purpose and uses it for another. And with the nation's DNA database disproportionately comprised of minority offenders, they say, it amounts to placing a class of Americans under greater scrutiny merely because their relatives have committed crimes.
"If practiced routinely, we would be subjecting hundreds of thousands of innocent people who happen to be relatives of individuals in the FBI database to lifelong genetic surveillance," said Tania Simoncelli, science adviser to the American Civil Liberties Union.
Nonetheless, California, which maintains the world's third-largest criminal DNA database with more than 1 million samples, will soon become the first state to adopt a protocol to allow for familial searches. Last week, Colorado performed a test run of familial search software on its criminal database. In Massachusetts, officials say they plan to develop a policy to allow familial searches.
The technique is being adopted as states and the federal government expand their databanks to include profiles of people who have been arrested but not convicted of certain crimes.
Only Maryland has expressly banned familial searching in a law adopted this month to expand its DNA database to include anyone charged with a violent crime. The FBI, which maintains the world's largest forensic DNA database with almost 6 million profiles, said it has so far refrained from adopting the technique because of concerns about constitutional challenges....
An advisory group to the FBI has proposed a final policy that goes further, recommending that partial matches be subjected to additional DNA testing and statistical analysis that would help investigators home in on relatives of people in the federal database.
The key is intent, Callaghan said. The bureau is "not deliberately trolling the database looking for relatives," he said.
Heightening privacy concerns are the growing number of local jurisdictions that maintain DNA databases not restricted to criminals. Some include the DNA of victims, suspects or even lab workers. Such collections, which critics call "rogue databases," are barred from inclusion in state and national databases, but rules about their use by law enforcement agencies are unclear.
The Supreme Court has repeatedly held that authorities may not conduct searches for general law enforcement purposes without suspicion about individuals. Although convicted criminals have a diminished expectation of privacy, searching a database for unknown relatives might violate that principle, said Jeffrey Rosen, a George Washington University law professor.
"The idea of holding people responsible for who they are rather than what they've done could challenge deep American principles of privacy and equality," he said. "Although the legal issues aren't clear, the moral ones are vexing."....
Other states and localities maintain "offline" DNA databanks of samples taken from victims or suspects never charged with a crime. Such databases, which also exist in New York, are a violation of the constitutional ban on unreasonable search and seizure, said Barry Scheck, a commissioner on New York state's Forensic Science Review Board. "If I get a sample from you and I don't tell you I want to put it in the database, that violates the scope of the Fourth Amendment," he said.
Prince George's County, for example, maintains a database with DNA profiles of both victims and suspects. Such local databases "have literally no oversight and regulation and yet are pushing the boundaries farther than anyone could imagine," said Patrick Kent, chief of the Maryland public defender's forensic division. "I do not think that victims of crime would be pleased to know that in addition to having been a victim, their DNA profile has been surreptitiously placed into a DNA database."
Housing Bubble and Inflation: What About the Carry Trade?
OK, that isn't what Wolfgang Munchau said in his Financial Times article today. His piece, "The princess’s cake gets an added crunch," starts with the theory that inflation and our asset bubbles were ultimately monetary phenomena.
While the rest of Munchau's piece, which focuses on why we should be worried about inflation, is useful, I wish he had spent more time on the discussion of its roots. Perhaps I am being a bit of a stickler, but my understanding is inflation in goods, which is a monetary phenomenon, has a different transmission mechanism than asset inflation, which is most often the result of an expansion in credit beyond the level needed for productive investments (however one might define that). While that level could conceivably be very large in an emerging economy, one should look at increases in systemic leverage (simple measures like debt/GDP) with considerable concern, particularly in a country like the US, which has not had a very high savings rate to begin with.
That is one reason I am a bit perplexed by the discussion to extend the Fed's mandate to managing asset bubbles. As Australiia's former Reserve Bank governor Ian Macfarlane pointed out, it's hard for a central banker to know when an asset bubble has started, and even if he is correct, he will be unable to prove he was right:
That suggests that a potentially less controversial way to deal with this problem is more regulatory than monetary: to gain a better understanding of how much variance in leverage is healthy over an economic cycle, and what increases look likely to produce bubbles. This would also provide a better basis for communicating with the public. Saying "housing/stocks/wampum prices increased 18% last year, we think that's too much" is a hard position to defend. Saying "leverage [however defined] increased x%, that puts the institutions and economy at risk" is far less controversial. But my impression is that regulators only have a partial picture of the sources and extent of borrowings.
Which gets back to the carry trade, What complicates the problem of understanding leverage is international capital flows. As the thorough analyses of Brad Setser show, we can track foreign flows into US assets with to a reasonable degree. But I wonder if we understand the mechanisms and operation of the carry trade as well. I am not certain that we fully capture the degree to which US domiciled entities (read certain hedge funds) fund in Japan. Similarly, a fair amount of private purchases out of London, the Caymans, and other hedgie ports of call benefit from low yen-based interest rates.
Back to Munchau. From the Financial Times:
While the rest of Munchau's piece, which focuses on why we should be worried about inflation, is useful, I wish he had spent more time on the discussion of its roots. Perhaps I am being a bit of a stickler, but my understanding is inflation in goods, which is a monetary phenomenon, has a different transmission mechanism than asset inflation, which is most often the result of an expansion in credit beyond the level needed for productive investments (however one might define that). While that level could conceivably be very large in an emerging economy, one should look at increases in systemic leverage (simple measures like debt/GDP) with considerable concern, particularly in a country like the US, which has not had a very high savings rate to begin with.
That is one reason I am a bit perplexed by the discussion to extend the Fed's mandate to managing asset bubbles. As Australiia's former Reserve Bank governor Ian Macfarlane pointed out, it's hard for a central banker to know when an asset bubble has started, and even if he is correct, he will be unable to prove he was right:
There was a time when we felt that monetary policy, by returning the economy to low inflation, would have a stabilising effect on asset markets.... But the broader evidence does not support the view that low inflation will prevent booms and busts developing in asset markets....Some have even gone as far as to suggest that low inflation may encourage the build-up in asset prices.
So, if low inflation does not provide any insurance, what should a central bank do if it suspects that a potentially unsustainable asset price boom is forming, particularly when the boom is being financed by debt?...
Many people have pointed out that it is difficult to identify a bubble in its early stages, and this is true. But even if we can identify an emerging bubble, it may still be extremely difficult for a central bank to act against it for two reasons.
First, monetary policy is a very blunt instrument. When interest rates are raised to address an asset price boom in one sector, such as house prices, the whole economy is affected.....
Second...[e]ven if the central bank was confident that a destabilising bubble was forming, and that its bursting would be extremely damaging, the community would not necessarily know that this was in prospect, and could not know until the whole episode had been allowed to play itself out. If the central bank went ahead and raised interest rates, it would be accused of risking a recession to avoid something that it was worried about, but the community was not. If in the most favourable case, the central bank raised interest rates by a modest amount and prevented the bubble from expanding to a dangerous level, and it did so at a relatively small cost in terms of income and employment growth forgone, would it get any thanks? Almost certainly not...In all probability, the episode would be regarded by the public as an error of monetary policy because what might have happened could never be observed....
That suggests that a potentially less controversial way to deal with this problem is more regulatory than monetary: to gain a better understanding of how much variance in leverage is healthy over an economic cycle, and what increases look likely to produce bubbles. This would also provide a better basis for communicating with the public. Saying "housing/stocks/wampum prices increased 18% last year, we think that's too much" is a hard position to defend. Saying "leverage [however defined] increased x%, that puts the institutions and economy at risk" is far less controversial. But my impression is that regulators only have a partial picture of the sources and extent of borrowings.
Which gets back to the carry trade, What complicates the problem of understanding leverage is international capital flows. As the thorough analyses of Brad Setser show, we can track foreign flows into US assets with to a reasonable degree. But I wonder if we understand the mechanisms and operation of the carry trade as well. I am not certain that we fully capture the degree to which US domiciled entities (read certain hedge funds) fund in Japan. Similarly, a fair amount of private purchases out of London, the Caymans, and other hedgie ports of call benefit from low yen-based interest rates.
Back to Munchau. From the Financial Times:
“I remembered the way out suggested by a great princess when told that the peasants had no bread: ‘Well, let them eat cake.’”
Jean-Jacques Rousseau, Confessions
When I saw reports of food riots, I was reminded of these immortal words, often attributed to Marie Antoinette, although there is no evidence that she used them. The modern equivalent to “let them eat cake” is: “Core inflation is well contained.” Core inflation is a measure that excludes goods whose prices are currently rising the most – food and oil. It is a popular concept among some central bankers and academics, and an insult to consumers: let them eat refrigerators.
The global rate of headline inflation is 4.5 per cent and rising. Some economists had us believe a year ago that the rise in inflation was just a blip. But it kept on blipping. They predicted it would fall back in 2008. Now, they say it will fall next year.
We can waste a lot of time talking about the mechanics of the oil market or about speculators. Persistent inflation is not caused by oil sheikhs, ethanol producers or retailers, but by monetary authorities. A point Milton Friedman once made, and accepted even by many of his detractors, is that “inflation is always and everywhere a monetary phenomenon”. The rise in commodity prices is the consequence of a credit-financed economic expansion that has hit natural supply constraints. It is a very familiar story, except for geography. This time it is truly global.
In a recent empirical study using data from the Organisation for Economic Co-operation and Development, the economists Ansgar Belke, Walter Orth and Ralph Setser* claim to have found a statistical link between the global liquidity glut, the real estate boom and inflation. The emphasis here is on global. The key result is that both house and consumer prices are determined by global monetary conditions – but at different speeds: the housing market reacts first, with consumer prices following after some delay. Too much money is still chasing too few goods – except that it creates an asset price bubble on the way.
Unsurprisingly, not everybody agrees. There are four common, and not very convincing, arguments. First, core inflation is under control. Yes, incredibly, people are actually making that argument. There is an economic theory that says core inflation is leading headline inflation. If the two diverge, headline should adjust to core. Unfortunately, the opposite is happening now. Higher oil prices are pushing up prices of final goods, and workers are demanding higher wages, as they sensibly ignore core inflation.
Second, financial market indicators do not show any strong evidence of a rise in long-term inflationary expectations. These indicators include the yield difference between Treasury inflation-protected securities and ordinary Treasuries and their respective European equivalents. In fact, some of these indicators have actually gone up a little. But more importantly, they are not really forward-looking. The yield difference tells us more about liquidity conditions in those markets than about future inflation.
Third, the expected slowdown of US and global economic growth will take care of the inflation problem. A devastating global depression would probably have that effect. But fortunately, the world economy will be spared this calamity. There is no reason to suspect that Asia will suffer a recession, rather than a moderate slowdown. As I explained last week, the eurozone may also be a little stronger than the consensus forecasts suggest. The US recession will put a temporary lid on US inflation but, once the recession is over, prices will go up.
Finally, there is an argument I have been hearing a lot more recently: why bother? Let inflation go up a little. It oils the wheels of the adjustment, in particular for house owners.
Unfortunately, this may work for people with high levels of mortgage debt, but not for the poor and those on fixed incomes. In Europe, and especially in the south, there are people who have difficulty paying the vastly increased prices for bread and grains. Since poorer people spend a higher proportion of income on food and petrol than middle-class people, the inflation rise hits them hard. Higher inflation is the transfer of wealth from the poor to the middle classes. You might as well say: if you cannot afford the bread, let me eat the cake.
What about the fact that the US has a negative savings rate? Surely the country would be better off with higher inflation, as this transfers wealth from foreign creditors to US debtors? My guess would be that under such a scenario the US bond market would implode, the current account deficit would become impossible to finance, the dollar would collapse, inflation would rise even more and the Federal Reserve would have to raise interest rates to high single digits or higher. In that scenario, nobody eats cake anywhere.
I expect that the biggest danger to global economic stability will be not the credit crisis, but the way we are overreacting to it. Both in the US, and increasingly in Europe as well, monetary policies are no longer consistent with price stability. Since a pre-revolutionary contempt for the poor is a side effect of this policy, I suspect Rousseau’s unnamed princess would have found our early 21st century most congenial.
Henry Kaufman Proposes a New Regulator for Uber Banks
Henry Kaufman, aka Dr. Doom in his heyday as Salomon's chief economist when the firm was at the peak of its power, argues in "Finance’s upper tier needs closer scrutiny," that the very biggest financial institutions need a regulator with the savvy and reach to supervise them effectively. Kaufman put the number at roughly the top 15 in the US; this would represent a broader universe than what the Bank of England called "large complex financial institutions" (16 globally made the cut).
Some readers have taken umbrage at earlier remarks by Kaufman on the regulatory front, noting that he is on the board of the awfully-close-to-edge Lehman. Let me take issue with that view. If Lehman were private and Kaufman were on its management committee, the criticism would be well founded. But public boards are an odd beast. Operational decisions are explicitly the preserve of management. The board's duties are limited to matters such as hiring and setting compensation for the CEO, making sure there are adequate succession plans, setting broad policies. Thus a board member might express concern about undue risk-taking, but his only remedy if he felt his concerns were ignored would be to fire the CEO (which would require the support of other board members) or quit.
Interestingly Kaufman's article spends a great deal of time on the boards, He sees the new supervisor as playing an important role in improving the competence of directors (!) and in emboldening them in asking tough questions (although the good doctor does not put it that baldly, it's the drift of his recommendations). The fact that Kaufman suggests that supervisors meet with board members about their duties has another implication of which he is no doubt aware but did not spell out: the fact that the directors would have a relationship with the top supervisor would give boards more leverage in dealing with management.
From the Financial Times:
Some readers have taken umbrage at earlier remarks by Kaufman on the regulatory front, noting that he is on the board of the awfully-close-to-edge Lehman. Let me take issue with that view. If Lehman were private and Kaufman were on its management committee, the criticism would be well founded. But public boards are an odd beast. Operational decisions are explicitly the preserve of management. The board's duties are limited to matters such as hiring and setting compensation for the CEO, making sure there are adequate succession plans, setting broad policies. Thus a board member might express concern about undue risk-taking, but his only remedy if he felt his concerns were ignored would be to fire the CEO (which would require the support of other board members) or quit.
Interestingly Kaufman's article spends a great deal of time on the boards, He sees the new supervisor as playing an important role in improving the competence of directors (!) and in emboldening them in asking tough questions (although the good doctor does not put it that baldly, it's the drift of his recommendations). The fact that Kaufman suggests that supervisors meet with board members about their duties has another implication of which he is no doubt aware but did not spell out: the fact that the directors would have a relationship with the top supervisor would give boards more leverage in dealing with management.
From the Financial Times:
The performance and behaviour of leading participants in our financial system must be improved if we are to avoid future calamities. What is urgently needed, as I have proposed for decades, is a new kind of institution we can provisionally call the Federal Financial Oversight Authority. This regulatory body would oversee only the largest US-based financial institutions – the giant conglomerates engaged in a broad range of on and off-balance sheet activities. It would monitor and supervise these conglomerates – assessing the adequacy of their capital, the soundness of their trading practices and their vulnerability to conflicts of interest as well as other measures of their stability and competitiveness.
I am not proposing comprehensive supervision of most or all financial institutions, but rather of the upper-tier players. In the US, the 15 largest institutions have combined assets of $13,000bn. They dominate many areas of trading, underwriting and investment management. Several command leading positions in derivatives and in the esoteric financial instruments that have grown so rapidly. The current regulatory and supervisory authorities should remain in place for smaller financial institutions. But assuring the soundness of the dominant companies would go a long way towards preventing systemic risks, even if smaller institutions occasionally failed.
The new authority should be a bipartisan body operating under the auspices of the Federal Reserve. The FFOA chairman also should serve as a voting member of the federal open market committee in order to bring valuable input about the well-being of the largest private institutions. Members of the FFOA should possess recognised expertise across a broad range of financial services. Finally, the chairmen of the Fed board and the FFOA should co-sign an annual report to Congress on the safety and soundness of the institutions under their purview.
Other leading economies should be encouraged to consider a similar approach. Such institutions would be effective if they supervised the functions of only the top five to 30 financial conglomerates in each country. That more consolidated and rigorous oversight might be limited to the largest financial institutions in the European Union, Canada and Japan. Moreover, because of the transnational reach of many financial conglomerates, FFOAs would need to co-operate closely. Unified supervision is essential.
One main focus of the new authority should be the training and competence of board members in financial corporations. Qualifications should include a better than working knowledge of accounting as well as competence in quantitative risk analysis techniques and proficiency with information technology. The information that reaches directors should be detailed and forthright. Directors need to be educated about transactions with affiliated companies and about transfers of assets and debts to special-purpose entities in order to achieve “off balance sheet” treatment.
New board members should be required to meet representatives of the supervisory organisation. Through these meetings, new directors should be informed of their responsibilities from the perspective of the supervising authorities. These authorities should also meet the board periodically to review the results of examinations and to be assured their recommendations are understood and will be followed. Independent directors should have separate, periodic meetings chaired by the designated lead director, with outside legal counsel present. These meetings should be guided by prepared agendas that address critical issues including the company’s risk policies, growth aspirations and succession planning.
Today’s compensation packages often favour aggressive risk-taking. Instead, managers in leading financial companies should be compensated on the basis of the long-term and sustainable profits. This can be achieved in several ways. Stock option awards should have long maturities. They should be exercisable not on termination of employment but years after termination. Contractual cash settlements on employment termination should not be paid on termination; they should be paid out later and include claw-back arrangements.
Finally, I urge that supervisory organisations be made responsible for issuing credit ratings for the institutions under their supervision. I doubt that the private rating agencies can obtain enough information – especially about large, integrated conglomerates – to enable them to render meaningful and timely ratings. The Fed already rates quite a few of the institutions under its supervision. It is called a “Camel rating,” taking the first letters from capital, assets, management, earnings and liquidity. The new authority should be charged with a similar task rather than outsourcing the function to private agencies.
Singapore Wealth Fund: Global Recession May Be Worst in 30 Years
Bloomberg gives us a pretty downbeat assessment from the Government of Singapore Investment Corp. (note that Singapore has two sovereign wealth funds, the other being Temasek):
Um, wonder if "long term" means that's how long they expect it will take them to be made whole.
A more positive view comes from Tim Duy at Economist's View, who argues that we may be near to a bottom in the economic downturn. Even if that proves to be true, note that the dot come bust recession ended as of 4Q 2001, but credit spreads remained elevated for the next year. Markets don't always anticipate recoveries, as Barry Ritholtz reminds us. And Duy's forecast is far from optimistic: while he expects the downturn to be shallow, the recovery will be anemic.
From Duy:
Duy and the markets are on the same page as far as the outlook for further Fed cuts is concerned. The central bank's continued timidity is a shame. If the Fed had the nerve to forego a rate reduction at the end of April, that could reveal a good deal as to how much of the rise in commodities was driven by speculation (Jim Hamilton has argued forcefully for holding pat).
Government of Singapore Investment Corp., a sovereign wealth fund that manages more than $100 billion, said the world economy may be facing its worst recession in three decades as the U.S. credit crisis spreads.
``We could be facing a recession which is longer, deeper and wider than any recession that we have encountered in the last 30 years,'' Tony Tan, deputy chairman of GIC, as the company is known, said in a speech to more than 500 employees in Singapore today.
The International Monetary Fund earlier this month cut its forecast for global economic growth this year and said there's a 25 percent chance of a world recession, citing the worst financial crisis in the U.S. since the Great Depression.
The world economy will expand 3.7 percent in 2008, the slowest pace since 2002, according to the IMF. In January the fund projected growth of 4.1 percent. The reduction is the third by the Washington-based lender since last July, when it predicted the world economy would cope with the U.S. credit squeeze and grow 5.2 percent this year.....
GIC has invested about $18 billion in Citigroup Inc. and UBS AG as banks raise capital after writing down investments linked to the U.S. subprime market. GIC is studying an additional investment in UBS through a rights offer after the bank wrote down a further $19 billion. Tan said today the investment in the two banks is ``long term.''
Um, wonder if "long term" means that's how long they expect it will take them to be made whole.
A more positive view comes from Tim Duy at Economist's View, who argues that we may be near to a bottom in the economic downturn. Even if that proves to be true, note that the dot come bust recession ended as of 4Q 2001, but credit spreads remained elevated for the next year. Markets don't always anticipate recoveries, as Barry Ritholtz reminds us. And Duy's forecast is far from optimistic: while he expects the downturn to be shallow, the recovery will be anemic.
From Duy:
It is easy to fall into “the world is ending” trap. But economic downturns do not last forever, and the current episode is no exception. Ever since last summer, the yield curve, particularly the 10-2 steepness, has been sending a signal that I find difficult to ignore – a signal that the technical recession will be rather shallow and short-lived. Indeed, the 10-2 spread currently is consistent with the end rather than the beginning of a downturn:
Converted this into recession probabilities, the spread predicts improving conditions throughout the year and into 2009:
......
Just to be clear, while the technical recession may be relatively short lived, I am not optimistic about the other side of this downturn – no V-shaped recovery is in my forecast. Instead, I look for something between the U and the L shapes. My baseline scenario is that housing starts move sideways after bottoming, neither contributing nor subtracting from GDP. The housing sector will likely remain in disarray until prices contract to their historical relationship with incomes. Assuming the mortgage industry returns to historical underwriting conditions, the capital simply will not be available to support prices higher than roughly 3 times local median incomes. I have trouble seeing a way around such a constraint short of continued, substantial taxpayer support that would effectively amount to a policy decision that the average household should be expected to devote 40-50% of its income to housing costs. I really cannot see this as a socially optimal outcome, and I expect that it would be met with a backlash sooner than later.
Similarly, I expect the job market to remain challenged; recall the period of soft job growth though 2004 following after the technical end of the previous recession....
I anticipate the current cycle to be similar. Jobs will continue to be shed in the housing sector as capacity falls in line with a reduced demand. Moreover, these displaced workers will not easily regain employment in expanding sectors such as health care or export industries. Soft job growth and declining access to credit via home equity should keep a lid on consumer spending growth, similar again to the post-2001period....
So how does one reconcile the so-so ISM data with the consumer data, the latter of which is more clearly dire? Again, I believe the data reflects an adjustment away from a growth path that depends upon the external imbalance. A portion of the consumer slowdown will be off-shored to foreign producers, and exporters (primarily manufacturers) will benefit from the weaker Dollar. The consequence should be a relatively muted downturn and an expected improvement in the current account deficit....
Best that this adjustment occurs slowly, considering the enormous pressure on the consumer already evident from the gradual improvements to date. Of course, the slower the pace of the adjustment, the longer as well (again, somewhere between the U and L-shapes), and therein lays the danger for policy. Policymakers will be hard pressed to allow the process continue unabated, as they lack the courage to tell Americans that the country needs to learn to live within its means. Given a growing populist sentiment on the back of stagnating median incomes, I see little but a river of red ink from the Federal government.....
Bottom Line: I suspect the cessation of rate cuts is near at hand. The Fed will likely pull the trigger on another 25bp at the next FOMC meeting, and send a signal that they intend to pause soon. I believe they could pause now, but see this as unlikely given their tendency toward dovishness of recent months. Another 25bp in June is not out of the question, but I think unlikely as well. It will soon be time to turn our attention to timing the next tightening cycle. Expected job market/housing weakness argues for an extended period of low rates similar to the last cycle; continued strength in commodity prices argues for a more rapid reversal of recent policy. I believe that a rapid reversal of policy will be politically difficult for the Fed given that Congress will tend toward resisting any protracted structural adjustment that is painful for US households.
Duy and the markets are on the same page as far as the outlook for further Fed cuts is concerned. The central bank's continued timidity is a shame. If the Fed had the nerve to forego a rate reduction at the end of April, that could reveal a good deal as to how much of the rise in commodities was driven by speculation (Jim Hamilton has argued forcefully for holding pat).
Links 4/21/08
Captive tigers 'may save species' BBC. It's better for the tiger to be saved than not (they breed well in captivity) but sad that they are on their way to being zoo and game preserve curiosities.
Book by metallurgists blames rivets for Titanic tragedy PhysOrg
House price falls won’t send the UK into a recession Telegraph
New Fannie/Freddie "Con" Jumbos Already a Bust Mr. Mortgage. It seems that, by virtue of having realistic appraisals, lower permitted LTV and debt to income means most borrowers don't qualify. For those opposed to the Federal government becoming the mortgage lender of first resort, this is good news.
Saudis put oil capacity rise on hold Financial Times
Running Out of Planet to Exploit Paul Krugman
MMMMMMM! Chocolate! Bank Lawyer's Blog
Costs and Benefits in Education Felix Salmon
Is Fund Size Leading to Perverse Decision-Making? Roger Ehrenberg. SWF and private equity investments in banks are his case studies....
Antidote du jour. On the subject of tigers in captivity.....
Book by metallurgists blames rivets for Titanic tragedy PhysOrg
House price falls won’t send the UK into a recession Telegraph
New Fannie/Freddie "Con" Jumbos Already a Bust Mr. Mortgage. It seems that, by virtue of having realistic appraisals, lower permitted LTV and debt to income means most borrowers don't qualify. For those opposed to the Federal government becoming the mortgage lender of first resort, this is good news.
Saudis put oil capacity rise on hold Financial Times
Running Out of Planet to Exploit Paul Krugman
MMMMMMM! Chocolate! Bank Lawyer's Blog
Costs and Benefits in Education Felix Salmon
Is Fund Size Leading to Perverse Decision-Making? Roger Ehrenberg. SWF and private equity investments in banks are his case studies....
Antidote du jour. On the subject of tigers in captivity.....
Sunday, April 20, 2008
"Eight hundred years of financial folly"
Carmen Reinhart has provided a synopsis of a paper she did with Kenneth Rogoff looking at financial crises over a longer time frame than most analyses, which have limited themselves to recent history (the economist's version of the drunk looking under the street light for his keys because that's where the light is good, as opposed to that is where he lost them).
Note that this is the second work along this line of thought; the Reinhart/Rogoff team also wrote a sobering paper on post-war financial crises, "Is the 2007 US Sub-Prime Financial Crisis so Different? An International Historical Comparison." If you haven't read it yet, you must do so, immediately. The Reinhart/Rogoff paper is elegant; it identifies 18 postwar banking crises in advanced economies and identifies a subset of 5 big nasty ones for separate comparison, then looks at the two data sets versus the state of affairs in the US so far.
Although the new paper is descriptive, the implications are not pretty for the US. Recurrent financial crises are the norm; it seems that countries get drunk regularly on too much capital inflows, go bust, sober up, and fall off the wagon again. In fairness, individual countries aren't necessarily recidivists, but the financiers and policymakers, who ought to know better, instead rationalize that each time that current circumstances differ from the not-too-distant past.
Although the entire article is below, let me highlight these sections:
The idea that the US would default on its debt seems inconceivable. Nevertheless, we are in the same position as Thailand and Indonesia, circa 1996, except we have the reserve currency and nukes. It will be interesting to see how those two assets influence the end game.
From VoxEU:
Note that this is the second work along this line of thought; the Reinhart/Rogoff team also wrote a sobering paper on post-war financial crises, "Is the 2007 US Sub-Prime Financial Crisis so Different? An International Historical Comparison." If you haven't read it yet, you must do so, immediately. The Reinhart/Rogoff paper is elegant; it identifies 18 postwar banking crises in advanced economies and identifies a subset of 5 big nasty ones for separate comparison, then looks at the two data sets versus the state of affairs in the US so far.
Although the new paper is descriptive, the implications are not pretty for the US. Recurrent financial crises are the norm; it seems that countries get drunk regularly on too much capital inflows, go bust, sober up, and fall off the wagon again. In fairness, individual countries aren't necessarily recidivists, but the financiers and policymakers, who ought to know better, instead rationalize that each time that current circumstances differ from the not-too-distant past.
Although the entire article is below, let me highlight these sections:
Serial default on external debt—that is, repeated sovereign default—is the norm throughout nearly every region in the world, including Asia and Europe.
Our dataset also confirms the prevailing view among economists that global economic factors, including commodity prices and centre country interest rates, play a major role in precipitating sovereign debt crises.....
Another regularity found in the literature on modern financial crises is that countries experiencing large capital inflows are at high risk of having a debt crisis. Default is likely to be accompanied by a currency crash and a spurt of inflation.
Periods of high international capital mobility have repeatedly produced international banking crises, not only famously as they did in the 1990s, but historically. (italics hers)....
The idea that the US would default on its debt seems inconceivable. Nevertheless, we are in the same position as Thailand and Indonesia, circa 1996, except we have the reserve currency and nukes. It will be interesting to see how those two assets influence the end game.
From VoxEU:
In the context of the last thirty years, the present period appears to be unlikely to produce a wave of sovereign debt defaults. But a new database spanning eight centuries reveals that history has many lessons for those studying financial crises. Contrary to conventional wisdom, today may not be very different.
History is indeed little more than the register of the crimes, follies, and misfortunes of mankind. – Edward Gibbon1
The economics profession has an unfortunate tendency to view recent experience in the narrow window provided by standard datasets. With a few notable exceptions, cross-country empirical studies of financial crises typically begin in 1980 and are limited in other important respects.2 Yet an event that is rare in a three-decade span may not be all that rare when placed in a broader context.
In a recent paper co-authored with Kenneth Rogoff, we introduce a comprehensive new historical database for studying debt and banking crises, inflation, currency crashes and debasements.3 The database covers sixty-six countries across all regions. The range of variables encompasses external and domestic debt, trade, GNP, inflation, exchange rates, interest rates, and commodity prices. The coverage spans eight centuries, going back to the date of independence or well into the colonial period for some countries.
In what follows, I sketch some of the highlights of the dataset, with special reference to the current conjuncture. We note that policymakers should not be overly cheered by the absence of major external defaults from 2003 to 2007, after the wave of defaults in the preceding two decades. Serial default remains the norm; major default episodes are typically spaced some years (or decades) apart, creating an illusion that “this time is different” among policymakers and investors. We also find that high inflation, currency crashes, and debasements often go hand-in-hand with default. Last, but not least, we find that historically, significant waves of increased capital mobility are often followed by a string of domestic banking crises.
The big picture
What are some basic insights one gains from this panoramic view of the history of financial crises? We begin by discussing sovereign default on external debt.
Default cycles
For the world as a whole (or at least the more than 90 percent of global GDP represented by our dataset), the current period can be seen as a typical lull that follows large global financial crises. Figure 1 plots for the years 1800 to 2006 the percentage of all independent countries in a state of default or restructuring during any given year. Aside from the current lull, one element that jumps out from the figure is the long periods where a high percentage of all countries are in a state of default or restructuring. Indeed, there are five pronounced peaks or default cycles in the figure. The first is during the Napoleonic War while the most recent cycle encompasses the emerging market debt crises of the 1980s and 1990s.
Figure 1.
Source: Reinhart and Rogoff (2008a).
Serial default on external debt—that is, repeated sovereign default—is the norm throughout nearly every region in the world, including Asia and Europe.
Our dataset also confirms the prevailing view among economists that global economic factors, including commodity prices and centre country interest rates, play a major role in precipitating sovereign debt crises.
During the past few years, emerging markets have benefited from low international interest rates, buoyant world commodity prices and solid growth in the United States and elsewhere.4 If things can’t get better, the odds are that they will get worse. US interest rates are likely to remain low, which helps debtor countries enormously.
Weaker growth in the US and other advanced economies soften growth prospects for export-dependent emerging Asia and elsewhere; inflation is on the rise. Is this cycle different?
Financial liberalization, capital inflows and financial crises
Another regularity found in the literature on modern financial crises is that countries experiencing large capital inflows are at high risk of having a debt crisis. Default is likely to be accompanied by a currency crash and a spurt of inflation. The evidence here suggests the same to be true over a much broader sweep of history, with surges in capital inflows often preceding external debt crises at the country, regional, and global level since 1800, if not before.
Also consonant with the modern theory of crises is the striking correlation between freer capital mobility and the incidence of banking crises, as shown in Figure 2. Periods of high international capital mobility have repeatedly produced international banking crises, not only famously as they did in the 1990s, but historically. The figure plots a three-year moving average of the share of all countries experiencing banking crises on the right scale. On the left scale, we employ our favored index of capital mobility, due to Obstfeld and Taylor (2004),5 updated and backcast using their same design principle, to cover our full sample period; while the index may have its limitations, it nevertheless provides a summary of de facto capital mobility based on actual flows.
Figure 2.
Sources: Reinhart and Rogoff (2008a), Obstfeld and Taylor (2004).
Domestic debt and the “this time it’s different” syndrome
As noted, our database includes long time series on domestic public debt.6 Because historical data on domestic debt is so difficult to come by, it has been ignored in many empirical studies on debt and inflation. Indeed, many generally knowledgeable observers have argued that the recent shift by many emerging market governments from external to domestic bond issues is revolutionary and unprecedented.7 Nothing could be further from the truth, which has implications for today’s markets and for historical analyses of debt and inflation.
The topic of domestic debt is so important, and the implications for existing empirical studies on inflation and external default are so profound, that we have broken out our data analysis into an independent companion piece.8 Here, we focus on a few major points. The first is that contrary to much contemporary opinion, domestic debt constituted an important part of government debt in most countries, including emerging markets, over most of their existence. Figure 3 plots domestic debt as a share of total public debt over 1900 to 2006. For our entire sample, domestically issued debt averages more than 50 percent of total debt for most of the period. Even for Latin America, the domestic debt share is typically over 30 percent and has been at times over 50 percent.
Furthermore, contrary to the received wisdom, these data reveal that a very important share of domestic debt – even in emerging markets – was long-term maturity.
Figure 3.
The inflation-default cycles
Figure 4 on inflation and external default (1900 to 2006) illustrates the striking correlation between the share of countries in default on debt at one point and the number of countries experiencing high inflation (which we define to be inflation over 20 percent per annum). Thus, there is a tight correlation between the expropriation of residents and foreigners.
As noted, investment banks and official bodies, such as the International Monetary Fund, alike have argued that even though total public debt remains quite high today in many emerging markets, the risk of default on external debt has dropped dramatically because the share of external debt has fallen.
Figure 4.
This conclusion seems to be built on the faulty premise that countries will treat domestic debt as junior, bullying domestics into accepting lower repayments or simply defaulting via inflation. The historical record, however, suggests that a high ratio of domestic to external debt in overall public debt is cold comfort to external debt holders. Default probabilities depend much more on the overall level of debt.
Policy issues
This brings us to our central theme – the “this time is different” syndrome. There is a view today that both countries and creditors have learned from their mistakes. Thanks to better-informed macroeconomic policies and more discriminating lending practices, it is argued, the world is not likely to again see a major wave of defaults. Indeed, an often-cited reason these days why “this time it’s different” for the emerging markets is that governments are managing public finances better, albeit often thanks to a benign global economic environment and extremely favourable terms of trade shocks.
Such celebration may be premature. Capital flow/default cycles have been around since at least 1800. Technology has changed, the height of humans has changed, and fashions have changed. Yet the ability of governments and investors to delude themselves, giving rise to periodic bouts of euphoria that usually end in tears, seems to have remained a constant.
On a more positive note, our research at least raises the question of how a country might “graduate” from a history of serial default. Interesting cases include Greece and Spain, countries that appear to have escaped a severe history of serial default not only by reforming institutions, but by benefiting from the anchor of the European Union. Austria, too, managed to emerge from an extraordinarily checkered bankruptcy history by closer integration with post-war Germany, a process that began even before European integration began to accelerate in the 1980s and 1990s. We shall wait and see which emerging markets can graduate from serial default.
Women as Regulators?
I am probably going to get myself in a heap of trouble with this one, but I am responding to a reader's request. I left a comment on another blog and have been asked to elaborate on it.
Yesterday, I featured and commented upon a post by Willem Buiter, in which he 'fessed up that, contrary to usual form, he didn't have any great ideas for what to do to reform the financial sector once the crisis had passed. In particular, he despaired of being able to find regulators up to the task:
As an aside, I'm not certain Buiter's plutocratic assumption that pay scales equal ability to be persuasive. Lowly Nick Leeson, who blew up Barings, and Jerome Kerviel of SocGen did a great job of snookering handsomely-compensated higher ups. I imagine a lot of regulatory work would be with admin and back office types, with trading desk heads hauled on the carpet only to explain anomalies. And those explanations might be cross-checked with risk managers, which means that clever chatter would still need to comport with observable facts.
By way of analogy, a former district attorney told me that FBI detectives are not the brightest bulbs, but they often get their man by virtue of tenacity. I suspect with a regulator that belief in one's mandate and doggedness can do a lot to level what might otherwise appear to be a very uneven playing field.
But nevertheless accepting Buiter's observations as having some validity, I commented:
Let me digress a bit. I am loath to single out women merely because I routinely read dumb generalizations in the business press about how women managers are more affiliative, more nurturing.
These stereotypes are galling as the Larry Summers "women are no good at math" because when you are talking about groups as large as men and women, the variations within each group are going to be far larger than the variations between groups. And since a comparatively small sub-set winds up going into Wall Street jobs, serious corporate roles, or scientific research, you can reasonably expect to find a sample that is quite different from the norm (even if we assume the norm is a product of genetics rather than culture).
Now admittedly, my own sample by nature is pretty skewed too, but I haven't met a single woman manager or executive I'd call nurturing. I've met some who are highly competent and polished, some who are control freaks, some who are completely disorganized and terrible to their subordinates, but are so good with clients it doesn't matter how much havoc they created internally. And I've met a couple, one in M&A, who are as tough as they come. And my impression is that the killer types didn't adopt that behavior to keep up with the boys; instead, they found an environment where they could give their inner sadist free rein.
So the notion that women might be good candidates for these roles is not based on any romanticization about the fair sex, but in the recognition that (with a very few exceptions who figure out how to overcome considerable odds) they are outsiders who nevertheless would have gotten a good deal of product and industry knowledge. And the difficulty most competitive firms have in creating mommie tracks means that a regulatory job, which would keep them current and give them a lot of contacts, could look very attractive to women during their childrearing years.
As the reader who urged me to elaborate observed, "Think of the FSA being run by a British equivalent of Tanta :)."
Yesterday, I featured and commented upon a post by Willem Buiter, in which he 'fessed up that, contrary to usual form, he didn't have any great ideas for what to do to reform the financial sector once the crisis had passed. In particular, he despaired of being able to find regulators up to the task:
If regulation is to be effective, it may have to be hands-on and quite intrusive, if only for the regulator to acquire the information (s)he requires to make an informed judgement.
Effective supervision runs into some rather impenetrable obstacles.
First, a $5 million dollar a year trader will run rings around a $150,000 a year regulator.
Second, regulators involved in intrusive and hands-on regulation are virtually guaranteed to be captured by the industry they are meant to be regulating and supervising. This regulatory capture need not take the form of unethical, corrupt or venal behaviour by the regulators or members of the private financial sector. It could instead be an example of what I have called cognitive regulatory capture, where the regulator absorbs the culture, norms, hopes, fears and world-view of those whom he regulates. We cannot just appoint ethical Vestal Virgins to be regulators, regulators who start out pure and stay pure despite their daily associations with people who don’t instinctively play by the rules of the House of the Vestals.
As an aside, I'm not certain Buiter's plutocratic assumption that pay scales equal ability to be persuasive. Lowly Nick Leeson, who blew up Barings, and Jerome Kerviel of SocGen did a great job of snookering handsomely-compensated higher ups. I imagine a lot of regulatory work would be with admin and back office types, with trading desk heads hauled on the carpet only to explain anomalies. And those explanations might be cross-checked with risk managers, which means that clever chatter would still need to comport with observable facts.
By way of analogy, a former district attorney told me that FBI detectives are not the brightest bulbs, but they often get their man by virtue of tenacity. I suspect with a regulator that belief in one's mandate and doggedness can do a lot to level what might otherwise appear to be a very uneven playing field.
But nevertheless accepting Buiter's observations as having some validity, I commented:
The issues you raise regarding how to attract and retain individuals who can stand up to traders and executives and avoid absorbing their charges’ mindset seems insurmountable, but let me offer a partial solution.
Women who’ve been in the industry.
I hate bringing up gender (the stereotyping is pervasive) but women have much lower odds of making it to the top and getting the same comp for their work as the boys and they are acutely aware of it. Many of the women I know who are in or have been in the industry don’t buy into the culture because they are ever and always outsiders.
Reports from boards in the US and Australia say that women directors are far more inclined to do their homework and ask tough questions than men are. Boards are as clubby as you get. If women aren’t cowed in those settings, that suggests they might also stand their ground in regulatory roles (the horrific example of Sheila Bair notwithstanding).
Women who’ve performed well in the City or the Street often find it impossible to work out part-time positions when they want to have children, except in those rare admin jobs that require substantive knowledge. You can get good women on the cheap with well-designed mommie track roles. Regulators should sit up and take notice.
Let me digress a bit. I am loath to single out women merely because I routinely read dumb generalizations in the business press about how women managers are more affiliative, more nurturing.
These stereotypes are galling as the Larry Summers "women are no good at math" because when you are talking about groups as large as men and women, the variations within each group are going to be far larger than the variations between groups. And since a comparatively small sub-set winds up going into Wall Street jobs, serious corporate roles, or scientific research, you can reasonably expect to find a sample that is quite different from the norm (even if we assume the norm is a product of genetics rather than culture).
Now admittedly, my own sample by nature is pretty skewed too, but I haven't met a single woman manager or executive I'd call nurturing. I've met some who are highly competent and polished, some who are control freaks, some who are completely disorganized and terrible to their subordinates, but are so good with clients it doesn't matter how much havoc they created internally. And I've met a couple, one in M&A, who are as tough as they come. And my impression is that the killer types didn't adopt that behavior to keep up with the boys; instead, they found an environment where they could give their inner sadist free rein.
So the notion that women might be good candidates for these roles is not based on any romanticization about the fair sex, but in the recognition that (with a very few exceptions who figure out how to overcome considerable odds) they are outsiders who nevertheless would have gotten a good deal of product and industry knowledge. And the difficulty most competitive firms have in creating mommie tracks means that a regulatory job, which would keep them current and give them a lot of contacts, could look very attractive to women during their childrearing years.
As the reader who urged me to elaborate observed, "Think of the FSA being run by a British equivalent of Tanta :)."
Rodrik on Financial Regulation
Now that the credit markets for the moment have been moved out of intensive care, some commentators have shifted their attention away from "what should the powers that be do to prevent a meltdown" to the broader question of "what can we do to prevent this sort of mess from happening again?"
Dani Rodrik, in "Financial innovation: a case of aspirin or amphetamines?" via Project Syndicate, decides to categorize the solutions offered so far: the libertarian, which he dismisses, finance enthusiasts, who prefer a light hand and self-regulation whenever possible, and finance skeptics who want powerful regulators with a broad range of tools at their disposal. Rodrik observes that the degree of regulation needed depends on one's view of the net gains from financial innovation.
Although this is a complex problem, let me single out two elements that may help focus discussion. First is that we have a highly integrated financial system that grew up on its own. That is big problem. It's like having an electrical grid with no map of the network, none of the usual redundancies, shunts and switches built in. Because so many parts are OTC, cross international boundaries, and also feature unregulated entities as important players, no one has a model of the system. This is a considerable handicap in figuring out what to do.
This makes the Fed's panic about Bear a bit more defensible. As with the minor electrical failure that brought down much of the East Coast in 2004, the authorities have no idea how great the damage would be if a major or medium sized player went down, but they have cause to think it could be bad, and the industry has every reason to fan those fears.
But (extending the grid metaphor) a second problem is not acknowledged: the securitization mechanism has broken down, due to a combination of lack of faith in the product and a reduction in sources for credit enhancement, which is essential for many of the products (as discussed elsewhere, that is why the GSEs, with their implicit Federal guarantee, are being asked to step up their activities. De facto, we have Federal credit enhancement in place of diminished private capacity). It's if the transmission lines aren't working because low temperatures have reduced conductivity. Everyone's hoping the mini Ice Age will be over soon, but there's no assurance that it will.
But we've learned the hard way that securitization and the absence of predatory lending rules is an explosive combination. The end investors don't have the means to do detailed due diligence on securitized credits (management fees on bonds won't support that level of expenses). The parties in the food chain have rejected an elegant solution, assignee liability, which would make the packagers liable for the any subprime deal that was "mis-sold."
But if you aren't going to make the critical players in the food chain liable somehow, the bad incentives and potential for abuse remains. And the name of the game this credit cycle has been to create as much product as possible, which meant leaning heavily on those with the greatest propensity to go into debt, such as the economically marginal and the optimistic (one might say imprudent). So the other way to go about reviving securitization would be either to toughen up predatory lending laws considerably or restrict the credit quality the assets that can be securitized. The industry will howl about how the poor will be hurt by restricted access to credit, which is not the real issue (it's their loss of income), but a system that encourages people to get into what is many cases is an escalating debt habit is hardly a benefit either individually or for society as a whole.
From Project Syndicate:
Dani Rodrik, in "Financial innovation: a case of aspirin or amphetamines?" via Project Syndicate, decides to categorize the solutions offered so far: the libertarian, which he dismisses, finance enthusiasts, who prefer a light hand and self-regulation whenever possible, and finance skeptics who want powerful regulators with a broad range of tools at their disposal. Rodrik observes that the degree of regulation needed depends on one's view of the net gains from financial innovation.
Although this is a complex problem, let me single out two elements that may help focus discussion. First is that we have a highly integrated financial system that grew up on its own. That is big problem. It's like having an electrical grid with no map of the network, none of the usual redundancies, shunts and switches built in. Because so many parts are OTC, cross international boundaries, and also feature unregulated entities as important players, no one has a model of the system. This is a considerable handicap in figuring out what to do.
This makes the Fed's panic about Bear a bit more defensible. As with the minor electrical failure that brought down much of the East Coast in 2004, the authorities have no idea how great the damage would be if a major or medium sized player went down, but they have cause to think it could be bad, and the industry has every reason to fan those fears.
But (extending the grid metaphor) a second problem is not acknowledged: the securitization mechanism has broken down, due to a combination of lack of faith in the product and a reduction in sources for credit enhancement, which is essential for many of the products (as discussed elsewhere, that is why the GSEs, with their implicit Federal guarantee, are being asked to step up their activities. De facto, we have Federal credit enhancement in place of diminished private capacity). It's if the transmission lines aren't working because low temperatures have reduced conductivity. Everyone's hoping the mini Ice Age will be over soon, but there's no assurance that it will.
But we've learned the hard way that securitization and the absence of predatory lending rules is an explosive combination. The end investors don't have the means to do detailed due diligence on securitized credits (management fees on bonds won't support that level of expenses). The parties in the food chain have rejected an elegant solution, assignee liability, which would make the packagers liable for the any subprime deal that was "mis-sold."
But if you aren't going to make the critical players in the food chain liable somehow, the bad incentives and potential for abuse remains. And the name of the game this credit cycle has been to create as much product as possible, which meant leaning heavily on those with the greatest propensity to go into debt, such as the economically marginal and the optimistic (one might say imprudent). So the other way to go about reviving securitization would be either to toughen up predatory lending laws considerably or restrict the credit quality the assets that can be securitized. The industry will howl about how the poor will be hurt by restricted access to credit, which is not the real issue (it's their loss of income), but a system that encourages people to get into what is many cases is an escalating debt habit is hardly a benefit either individually or for society as a whole.
From Project Syndicate:
The sub-prime mortgage crisis has demonstrated once again how hard it is to tame finance, an industry that is both the lifeline of modern economies and their gravest threat. While this is not news to emerging markets, which have experienced many financial crises in the last quarter-century, a half-century of financial stability lulled advanced economies into complacency.
That stability reflected a simple quid pro quo: regulation in exchange for freedom to operate. Governments brought commercial banks under prudential regulation in exchange for public provision of deposit insurance and lender-of-last-resort functions. Equity markets were subjected to disclosure and transparency requirements.
But financial deregulation in the 1980s ushered us into uncharted territory. Deregulation promised to spawn financial innovations that would enhance access to credit, enable greater portfolio diversification, and allocate risk to those most able to bear it. Supervision and regulation would stand in the way, liberalizers argued, and governments could not possibly keep up with the changes.
What a difference today's crisis has made. We now realize even the most sophisticated market players were clueless about the new financial instruments that emerged, and no one now doubts that the financial industry needs an overhaul.
But what, exactly, needs to be done? Economists who focus on such issues tend to fall into three groups.
First are the libertarians, for whom anything that comes between two consenting adults is akin to a crime. If you are selling a piece of paper that I want to buy, it is my responsibility to know what I am buying and be aware of any possible adverse consequences. If my purchase harms me, I have nobody to blame but myself. I cannot plead for a government bailout.
Non-libertarians recognize the fatal flaw in this argument: Financial blow-ups entail what economists call a "systemic risk" - everyone pays a price. As the rescue of Bear Stearns shows, the government may need to bail out private institutions to prevent a panic that would lead to worse consequences elsewhere. Thus, many financial institutions, especially the largest, operate with an implicit government guarantee. This justifies government regulation of lending and investment practices.
For this reason, economists in both the second and third groups - call them finance enthusiasts and finance skeptics - are more interventionist. But the extent of intervention they condone differs, reflecting their different views concerning how dysfunctional the prevailing approach to supervision and prudential regulation is.
Finance enthusiasts tend to view every crisis as a learning opportunity. While prudential regulation and supervision can never be perfect, extending such oversight to hedge funds and other unregulated institutions can still moderate the downsides. If things get too complicated for regulators, the job can always be turned over to the private sector, by relying on rating agencies and financial firms' own risk models. The gains from financial innovation are too large for more heavy-handed intervention.
Finance skeptics disagree. They are less convinced that recent financial innovation has created large gains (except for the finance industry itself), and they doubt that prudential regulation can ever be sufficiently effective. True prudence requires that regulators avail themselves of a broader set of policy instruments, including quantitative ceilings, transaction taxes, restrictions on securitization, prohibitions, or other direct inhibitions on financial transactions - all of which are anathema to most financial market participants.
To grasp the rationale for a more broad-based approach to financial regulation, consider three other regulated industries: drugs, tobacco, and firearms. In each, we attempt to balance personal benefits and individuals' freedom to do as they please against the risks generated for society and themselves.
One strategy is to target the behavior that causes the problems and to rely on self-policing. In essence, this is the approach advocated by finance enthusiasts: Set the behavioral parameters and let financial intermediaries operate freely otherwise.
But our regulations go considerably further in all three areas. We restrict access to most drugs, impose heavy taxes and marketing constraints on tobacco, and control gun circulation and ownership. There is a simple prudential principle at work here: Because our ability to monitor and regulate behavior is necessarily imperfect, we need to rely on a broader set of interventions.
In effect, finance enthusiasts are like America's gun advocates who argue that "guns don't kill people; people kill people." The implication is clear: Punish only people who use guns to commit crimes, but do not penalize others by restricting their access to guns. But, because we cannot be certain that the threat of punishment deters all crime, or that all criminals are caught, our ability to induce gun owners to behave responsibly is limited.
As a result, most advanced societies impose direct controls on gun ownership. Likewise, finance skeptics believe that our ability to prevent excessive risk-taking in financial markets is equally limited.
Whether one agrees with the enthusiasts or the skeptics depends on one's views about the net benefits of financial innovation. Returning to the example of drugs, the question is whether one believes that financial innovation is like aspirin, which generates huge benefits at low risk, or methamphetamine, which stimulates euphoria, followed by a dangerous crash.
Links 4/20/08
'Mortgage holidays' for hard-up homeowners Guardian. Now it's the UK's turn to contemplate desperate measures to save underwater borrowers
Citigroup May Need to Sell Assets to Bolster Capital Bloomberg
McCain Does Not Want Free Market Health Care Dean Baker
Are Markets Leading or Lagging Indicators ? Barry Ritholtz
Too many choices may not be good Aaron Schiff
Class Warfare? Or Fair Shares? Linda Beale. I've had to deal with vituperative trolls on this topic. She handles it nicely.
Losing Your Job? Losing Your House? Call a Psychologist PGL Angry Bear
The On-the-Run Premium on Treasury Securities Brad DeLong
Behind TV Analysts, Pentagon’s Hidden Hand New York Times. This is a must read. I was in Australia immediately before and during the Iraq war, and the disparity in news coverage there and in the US was staggering (and remember, Australia sent troops). This in part explains it: it was the propaganda, stupid.
Antidote du jour:
Citigroup May Need to Sell Assets to Bolster Capital Bloomberg
McCain Does Not Want Free Market Health Care Dean Baker
Are Markets Leading or Lagging Indicators ? Barry Ritholtz
Too many choices may not be good Aaron Schiff
Class Warfare? Or Fair Shares? Linda Beale. I've had to deal with vituperative trolls on this topic. She handles it nicely.
Losing Your Job? Losing Your House? Call a Psychologist PGL Angry Bear
The On-the-Run Premium on Treasury Securities Brad DeLong
Behind TV Analysts, Pentagon’s Hidden Hand New York Times. This is a must read. I was in Australia immediately before and during the Iraq war, and the disparity in news coverage there and in the US was staggering (and remember, Australia sent troops). This in part explains it: it was the propaganda, stupid.
Antidote du jour:
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