George Magnus on the Economic Outlook

George Magnus, a strategist for UBS, was one of the early popularizers of Hyman Minsky and was similarly one of the lonely few to worry about the financial and economic fallout of dealing with unsustainable levels of debt.

His comment in today’s Financial Times, “Is there time to avert a Minsky meltdown?” is cautiously optimistic that the global financial system can be kept from collapsing, but he stresses that governments need to persist with coordinated, timely action, since major banks have hundreds of billions of short term debt maturing in the next few weeks (hhm, yet another use of the TARP?)

But even if those efforts succeed, Magnus does not see smooth sailing ahead:

Even if a financial meltdown is averted, we should be under no illusion that the deleveraging in the financial and household sectors will stop. As a result, four big battlegrounds remain. First, there is a high possibility of further bouts of financial stress and failures. Money markets are still broken and recovery will take time. Second, illiquidity, a preference for cash-type instruments, even over government bonds, and a considerably ex panded supply of government bonds raise the threat of an untimely increase in bond yields. Third, the global recession that has started may yet turn out to be sharper than expected – and certainly longer. This will bring sustained, and some new, credit risks. Fourth, much slower growth and the risk of some home-made financial crises in emerging markets warrant close scrutiny.

It would be churlish not to welcome the UK government’s trailblazing initiative and note the European response. The US must also move to contain deleveraging and forced asset sales quickly. This comprehensive assault on financial instability is the only solution that Minsky himself would have approved.

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  1. Heit Yoas

    LOL! Yves.. you are sooo short this market. I can almost tell you were not in a good mood after the >10% gains. I know how you feel, because I am sitting in cash and missed this bounce. Hoping doom and gloom resumes soon!

  2. Yves Smith

    I started in the securities industry in 1980. No one wanted to hear about stocks then, save the real diehards. Investors had had years of having been burned. So I am waiting for that sort of mood before I would believe that stocks in general were a buy. And I don’t have the time and patience to be a stock picker, but I have no doubt that there are particular stocks that could be a buy now.

    It is more that I am a skeptic about stocks in general. I am more a dour credit market type by temperament. Paul Kedrosky (who is a bullish sort) put up a chart showing the Dow from 1982, It started deviating markedly from trend in 1996 (hhm, around when Greenspan said “irrational exuberance”). If you project out the trend line to now, it suggests the Dow should be at 7000.

    Benoit Mandelbrot, the mathematician who discovered what is now called “fat tails”, that markets have a propensity to extreme price moves, said that market are much, much riskier than the standard theories assume (the two “much” are his, not mine). I believe most retail investors are complacent about risk and do not understand the downside sufficiently well.

    I like investments like private equity and real estate that you can evaluate properly and develop an information advantage. Stocks are too often irrational.

    Having said that, the very few times I have been asked to make calls regarding public companies, my recommendations have proven correct. But note I do not give investment advice on this blog!

  3. Anonymous

    For me, the great unchronicled crime of the current disaster is the highly successful 25-year campaign to make average Americans completely ignore stock market risk, carried out by the IRA and 401K machine. This machine is responsible for travesties such as convincing 60-year olds they should be 100% in equities.

    An anecdote: Because I’m up 500%+ since 11/30/07 and because a few people know this, an acquaintance recently told me his IRA was down 20% and asked me what he should do with his money. I said he should put it in short-term Treasuries and cash.

    Without a trace of irony, he responded: “But then you’re not keeping up with inflation.”

  4. Thomas

    Unfortunately no view from Magnus on how long the Reverse Minsky journey is (i.e. how far we need to delever) or how long it will take.

    He did however alert us to the dangers facing the PIIGS (Portugal/Italy/Ireland/Greece/Spain) which all had housing bubbles and are in for a rough ride.

  5. Yves Smith

    And truth be told, what has me hugely upset is the way the Fed and Treasury have opened the floodgates. The Fed is basically, through swap lines, funding the ECB’s version of the Term Auction Facility. Between that, the TARP (oh, and a reader sent me a link to Congressional Register saying that the Pentagon is thinking about asking for another $450 billion), we are going to have massive borrowing. We need to be decreasing aggregate debt and instead we are adding to it. Now Bernanke’s playbook is “when in doubt, reflate”. Right now, that can be defended, given the massive deleveraging. However, he assumes he can mop up excessive liquidity once the crisis is past, but I very strongly suspect that will not prove possible on the scale needed. Once the liquidity water mains are patched, there will be a lag before it hits, but we’ll at least have bad inflation. That is very destructive to financial assets. Bye bye savings.

    I have an 81 year old mother. Her funds ought to be enough to see her through the rest of her life nicely, but if we have serious inflation, she could be on a bread line (I don’t see gold as a realistic option, given the risks in paper gold and buying it in the US, and buying it overseas and repatriating is impractical). There are other hedges, but none are great, and if you are capital R retail, your choices are limited. That’s why I am upset, if you want to know the real reason.

  6. Richard Kline

    That’s a nice concise capsule summary by Magnus, and I agree with him completely, particularly with regard to his first two points. The credit freeze _will not_ be thawed out until and unless the money markets resume some semblance of normal functioning. They should receive a targeted government intervention to that effect immediately, though the form it takes is more debatable. Liquidity geysers alone will in no way fix MM, not least due to the term compression problems in funding. And Magnus’s second point, in effect that we are at increasingly severe risk of a bubble in the bond markets with severe potential when rates all but certainly rise, is a matter of great concern. The Fed will try to sterilize to minimize this rist: good luck and little hope. The funding being pushed into the banking system is going to have to stay there long enough that it stand likely to have macroeconomic side effects, but the funding can’t be pulled without throwing the banks into the gutter again. We are early in a five year crisis, and may be no means have seen it’s worst phases.

    If the market ‘rally’ was progressive over several weeks to the same level, one might have some support for delusional bullism. Going up what, 1300 pts for the Dow from last Friday’s low simply affirms that we are still on the expansionary phase of price volatility. Increasing volatility does not correlate with sustained recovery, but rather with ultimate capitulation. Make money while the Fed shines, friends, but the twister part of the storm front is still to come, in my view.

    Re: those bought and sold out brokers speculating with the 401ks of the masses, yeah _my_ pension had me 100% in equities less than nine months ago, and was losing money faster than twas being payed in. Suffice it to say, I changed that, not that the sum is large enough to really matter at this point, but still.

  7. tourist

    Magnus fails to address the main obstacle to any efforts on the part of the monetary authorities to “avert a Minsky meltdown”.

    And that is the massive loss of confidence and trust by retiring Boomers in the tenets of faith based investing and the ownership society. The Boomers are increasingly and painfully aware of the ponzi like units underlying the global financial system that is suppose to finance their retirements. And they are teaching their children accordingly.

    That confidence and trust will not be restored until such time as the entire cast of miscreants and sociopaths currently running the political and financial machinery are thrown out on their ears.

    Until that happens we will continue to witness wave after wave of selling. Only when Pandit and Mack are walking out of Treasury meetings with grimaces rather than smiles will faith begin to be restored.

    We are still far from that moment.

  8. David Habakkuk

    On stock prices, it may be of interest to look at what the devotees of Tobin's 'q' have been saying. The basic premise of this way of valuing the stock market, as I understand it, is that the value of the market as a whole cannot in the long run deviate radically from the replacement value of assets and has historically has not done so — superior returns are in the end competed away.

    A leading champion of this method of valuation, Andrew Smithers, maintains on his company's website information and graphs relating current market valuations to 'q', and also to CAPE, the cyclically-adjusted P/E ratio. These, he argues, are the intellectually respectable methods of assessing likely long-run real returns on stocks, and the results they give are very similar.

    His most recent comments on the U.S. market:

    'Updating q for the 2008 Q2 data, while deducting “statistical discontinuities’ shows that non-financials were 35% overvalued, as at 24th September 2008 and that all companies according to CAPE were 35% overvalued (see CAPE & q chart).

    'We should emphasise some points:-

    '(i) That the S&P 500 was 20% higher at its peak at the beginning of September, 2000 than it is today in nominal terms and over 50% higher in real terms.

    '(ii) If “statistical discontinuities” are included in the calculation of q, the US stock market is no longer overpriced. However, these “statistical discontinuities” are the result of “mark to market” accounting which, if taken to its logical conclusion, would mean that net worth was always equal to the stock market’s value of non-financial companies, and would thus cease to be any use as a criterion of value.

    '(iii) Value is a poor guide to forecasting market movements and, after the recent extremes of overvaluation, the market seems likely to become cheap, not just reasonably valued.'


    The S&P closed at 1207.09 on September 24, as compared with 1003.35 last night, so it would have lost a bit under 17% of the 35% which Smithers claims it needs to lose to find fair value.

    But, as Smithers stresses, after prolonged overshooting prolonged undershooting would be likely.

    As he is using the S&P 500 rather than the Dow, direct comparison with Yves's 7000 is not possible. However, for what it is worth, the Dow closed on September 24 at 1105.69. A 35% fall from that would take one to 7,16020 — rather close to the 7000 figure she gives on the basis of the pre-1996 trend. The fall from September 24 to last night's figure of 9387.61 is 14.78%.

    If the undershooting is anything remotely comparable to the overshooting since 1996, then I would have thought that Dow 5000 looked a reasonable medium-term prognostication.

    What would be the economic implications of this, I wonder — also the political implications, particularly given the effects on pensions?

  9. Jojo

    Silicon Valley VC’s are also getting worried!

    Sequoia Rings the Alarm Bell: Silicon Valley Is in Trouble
    Om Malik, Wednesday, October 8, 2008 at 4:53 PM PT

    Updated: Sequoia Capital, arguably the smartest venture capital investor in business, is sounding the alarm and asking its portfolio companies to buckle down for what could be the worst economic downturn of their relatively short lives.


    And here is the actual presentation:


  10. Mencius Moldbug

    risks of paper gold

    Briefly, Comex gold futures have considerable counterparty risk, but the ETFs are 100%-reserve instruments. Barring reallyatrocious government behavior (far beyond today’s level), they are safe.

    I really doubt anyone’s mom is buying Comex futures, but no one should. The ETFs (eg, GLD) are superior in every way. It is very easy to imagine a scenario in which the price diverges in GLD’s favor – all you need is a delivery default.

  11. ciccocicco

    “That confidence and trust will not be restored until such time as the entire cast of miscreants and sociopaths currently running the political and financial machinery are thrown out on their ears.”

    I beg to differ. This is 2008, the attention span of the population is close to zero. In a year from know nobody will remember.

    And greed will push people to earn more from their money, and trust again.

  12. Sean Maher

    As someone who called the crash in commodities and then equities on my blog, and advised going long at the end of last week, I think it’s important to understand the tenets of behavioural finance, as much as the insightful theories of Hyman Minsky. Markets swing to emotional extremes, and a wise investor will sell euphoria and buy despair…buying a market like Japan at sub book value is highly likely to generate decent medium term returns, regardless of further inevitable volatility.

  13. tourist

    cic said: I beg to differ. This is 2008, the attention span of the population is close to zero. In a year from now[sic] nobody will remember.

    “Rafael and Carroll Aguirre from Paola Place had sold their house in San Jose’s east foothills to move to Manteca to be closer to family. They put more than 25 percent down on a $547,000 house. They depleted their 401(k)s to spend $120,000 improving their backyard. Aguirre lost his job and, with no income for 11 months, the bill collectors started calling and he no longer could pay the mortgage. Selling the Town Car and the diamond ring barely made a dent. In July, they received a notice from the bank that they had 72 hours to leave. Their $270,000 investment was gone, and they were filing for bankruptcy.”

    Somehow I think this family will remember.

  14. Hubert

    Reg: money market
    For months now a I have a nagging suspicion that the high Libor rates are not unwelcome to the banks themselves. Sure, it shows distress but that we knew anyway. And the real rates, if any lending would have gone on in 3-or-more-month-LIBOR, would have been higher, much higher, anyway.
    So looking forward I do not see them the spreads they are making up, bringing in. Or only under sophisticated political pressure.
    I think politicians first not realize how much banks profit from a bigger spread while borrowing at central banks or state secured senior subordinated.
    ONce they understand they will tolerate it to make up for losses. Only when business lobbying and some Pecora hearings really step up in 2009, we might finally bring LIBOR really down back to 20-50 points spread.

    Some thoughts ?

  15. ruetheday

    thomas – Regarding how far we need to delever – Minsky broadly defined three different financial positions: hedge, speculative, and ponzi. We’ll need to get back to the hedge position where current period income covers current period financing costs, without requiring rollover of interest or asset sales. We still have some way to go.

  16. Anonymous

    GDP/economy spiked by years of excess credit growth certainly needs a new playbook but the emphasis on bailing the financial sector from its own excess makes it dificult to imagine a healthy productive economy driving income growth for the citizens anytime soon. Can’t imagine any decline in deleveraging until this problem is addressed.

  17. Carlosjii

    from Louise Yamada
    …..We made comparisons to as far back as 2004 to this structural bear market that began in 2000. It has been very parallel to the 1932 to 1942 period and right now we are in something very similar to the 1937-38 period decline, which was 49% for the Dow.

    The credit bubble is so large that the deleveraging process, this unwinding of the bubble can take quite sometime. Whether or not we have seen the lows is questionable. But once we have the degree of the damage it’s just that it’s going to take long time to repair. 1938 to 1942 saw about three-four years of up and down movement and we may have something very similar to look forward to.

    …..I think the 7,200 level would bring you right back to the 2002 lows and it is looking more like that maybe a possibility since it broke below the 9,000 level which was where the Dow broke in 2003. Till now all the gains that people have made from 2003 to 2007 have been reversed.
    AND my personal take is Sir Alan suffered a health problem is 1996 causing some kind of brain damage or some thing – akin to Clinton’s heart problem and it’s attendant manifestations. Simplistically Sir A has been functionally senile for a long time. He is – after J Edgar – the best reason I can think of for AGE and term limits
    see on diminished blood flow to the brain

  18. Anonymous

    Anon of 3.20

    I suppose off-topic here, but am very curious as what your strategy has been to generate an envious 500%?

    Would be very keen to hear if you would be kind enough to explain, even in general terms???

  19. luther

    “And that is the massive loss of confidence and trust by retiring Boomers in the tenets of faith based investing and the ownership society. The Boomers are increasingly and painfully aware of the ponzi like units underlying the global financial system that is suppose to finance their retirements. And they are teaching their children accordingly.”

    tourist, great paragraph worth repeating…with one caveat…

    in many instances, it’s the children teaching the parents.

    either way, the generations-long esoteric is rapidly becoming exoteric indeed.

  20. luther

    “Somehow I think this family will remember.”

    and the thousands others like them now and in the near future.

  21. luther

    hubert: “ONce they understand they will tolerate it to make up for losses.”

    well, when the ‘make up for losses’ is on the backs of increased interest charges on those ARM mortgages tied to LIBOR, they have to the end of October to tolerate.

    remember, election day is right after the November mortgage payment for quite a number of voters.

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