John Authers Poses Four Financial Passover Questions

John Authers of the Financial Times uses Passover as a pretext for discussing four perplexing questions related to the markets. They’ve been bugging me too, so I appreciate him having a go at them.

From the Financial Times:

Passover starts tonight. The world’s Jews gather to commemorate the Hebrews’ flight from Egypt and eat a stylised dinner known as the Seder .

Central to the undertaking are four questions, which must be asked by the youngest participant, on the meaning behind different Passover traditions.

In the Passover spirit, here are four questions that demand to be asked about the confusing state of the markets, and some attempts to answer them. The answers to the Passover questions are straightforward; the problems with the markets, less so.

* Why has the S&P 500 barely fallen 10 per cent from its all-time high, when other markets are behaving as though the world were in deep crisis ?

Stocks’ resilience is often cited by bulls. There was a (questionable) perception as the crisis started that stocks were cheap. If brokers’ estimates for this year’s earnings are accurate, they are much cheaper now, as earnings are supposed to grow at double digits starting in the next quarter.

Then there is a widespread belief that the fire sale of Bear Stearns last month was a moment of catharsis. Folk wisdom is that such moments are the ideal moment to buy.

The argument is self-contradictory: so many people believe this that it is obvious the market has not reached catharsis.

Also, stocks are not as resilient as they look. International indices tend to be quoted in dollars and are inflated by the dollar’s weakness. In local currency terms, world industrial stocks are down 17 per cent from their top, and consumer discretionary stocks are down 26 per cent, according to MSCI.

Mining and energy stocks, buoyed by commodity prices – which have their own issues – help mask this.

* Why are money markets sinking into severe trouble again, when central banks have done so much to force them them to return to normal?

When they are working, nobody notices the money markets, which banks use to lend to each other. One of the painful lessons of the past months is that any sign of their malfunctioning must be taken very seriously.

The clearest indicator of trouble is when the Libor rate – the benchmark at which banks lend to each other – rises significantly above the official government interest rate. This indicates banks are hoarding cash or are unprepared to lend to each other.

Co-ordinated action by central banks in December was meant to address this, and the spread of Libor over official rates came down.

But since the Bear Stearns debacle, which should have been an emphatic signal that the Federal Reserve was there to stand behind dodgy-looking collateral from other banks, money markets have seized up again.

Libor’s spread over official rates has widened by about 0.25 percentage points.

It is hard to explain this unless the bankers are afraid of something that has not yet reached the light of day. It strikes a bizarre contrast with the returning confidence in other sectors.

* Why are commodity prices rising when, with people so worried about the economy, we should expect them to be falling?

This is also critical, on many levels. In the aftermath of the Bear Stearns debacle, commodity prices tumbled, with the main indices for the sector falling more than 10 per cent in less than a week. But that turned out not to be a turn but merely an interruption.

Oil has regained its losses to set all-time highs. Other commodities have regained about half of their lost ground. The S&P GSCI commodity index is back at an all-time high, and up more than 11 per cent since its post-Bear low.

No explanation is encouraging. The sector may be in a bubble as investors look for an inflation hedge. Or they are reacting to scary signs that global supply of commodities from oil to rice is knocking up against capacity constraints. That would depress economic activity.

* Why do so many believe that the US economy will make a swift recovery, when the credit problems are only just starting to affect the real world?

In the US, no indicators yet show anything more than a light recession. If employment falls more, that will change. But the bulls’ argument is that the US is getting such a jolt – from tax rebates, base rate cuts and the weak dollar – that it can scarcely help recovering.

Further, the precipitous decline in housing activity, with starts down almost 60 per cent in two years, cannot go on much longer. It has taken a huge bite out of economic growth. If it merely stabilises at a low level, that will be enough for growth to start improving.

The arguments against are clear: the credit squeeze has yet to hit Main Street, while the wealth effects from lower house prices and higher food and fuel prices could kill off the consumer.

Traders hope the economy can make a V-shaped recovery. If there is clear evidence of this, shares will go far higher. If it is only a U, or even the dreaded L, watch out.

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  1. Steve

    These are really good questions. The point that credit problems `are only starting to affect the real world’ is supported by Mishkin’s Congressional testimony this week on small business lending (copy at He’s concerned that small business is being crowded out as banks hold more assets from broken conduits and lost securitization channels. And he draws attention to a direct connection between the RE market and small business lending: in 2003, 45% of total small business lending was collateralized by real estate, both commercial and personal. And although he doesn’t mention the home ATM, he notes that in 2003 47% of small businesses used personal credit cards for funding. It would be interesting and perhaps frightening to see what both numbers look like in 2008.

  2. Anonymous

    If you are a banker you do not want to be the next to bare your stern, at least not unless at a good price, with someone else’s money or in plenty of in good company.

  3. Anonymous


    Thanks for the link and the info. Very enligtening and informative.

    I was perusing a post at the other day and three separate bloggers, all small business people, commented on the difficulty they were experiencing getting credit.

    Though annecdotal, these set me to wondering just how small businesses would be impacted by the ongoing credit crisis. Reading Mishkin’s comments, it appears that, like all that is presently going on in the world of finance, there is a lot more unknown than is known.

    I think it is worth pasting an excerpt of Mishkin’s remarks that give an idea as to the disaster that would ensue if this sector falls on hard times:

    “Small businesses, generally defined as firms having fewer than 500 employees, are critical to the health of the U.S. economy. For example, small businesses employ more than half of private-sector workers, generated well over half of net new jobs annually over the past decade, and create more than half of nonfarm business gross domestic product. Moreover, larger firms often begin as smaller firms that prosper and grow. If small businesses are to continue to provide major benefits to the economy, their access to credit is clearly a high priority.”

    Mishkin also indicated that small businesses disproportionately borrow from small banks with “assets of $250 million or less.” In the current environment in which the Fed has made it fairly clear that it will bail out only those banks which are “too big to fail,” what does this portend for small business?

    In at least one instance in the past, small businesses have not fared well in the face of economic hardship:

    “Business as a whole lost between five and six billion dollars in 1932. (The government figure for all the corporations in the country–451,800–was a net deficit of $5,640,000,000.) To be sure, most of the larger and better-managed* companies did much better than that. E.D. Kennedy’s figures for the 960 concerns whose earnings were tabulated by Standard Statistics–mostly big ones whose stock was active on the Stock Exchange–show that these 960 leaders had a collective profit of over a third of a billion.” (Frederick Lewis Allen, “Since Yesterday”)

    *Allen goes on to explain that inherent in the rubric “better managed” was that “employees had been laid off in quantity.”

  4. jest

    wow, i always thought those answers were obvious. maybe i’m being too simplistic:

    1) the s&p fell the least because it went up the least.

    by extension, the shanghai market fell the most b/c it rose the most. there wasn’t much international flow of funds into the s&p, so there’s less hot money to leave.

    2) the shadow banking system was behind the money market mess, and the fed can’t do anything about them.

    also, there’s too much perceived risk.

    3) commodity prices are rising b/c of a lack of capacity throughout the production structure, as well as structural imbalances caused by inflation, biofuels, and other things.

    the 70’s proved stagnating economies don’t mean lower commodity prices.

    4) the only people who believe this will be short-lived are mutual fund salesmen, real estate professionals, and the uber-upperclass.

    the rest of us think we’re in a mess.

    they have to believe things will turn around, b/c they will lose their jobs otherwise.

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