Category Archives: Investment outlook

Tom Adams: How Treasury’s “Kick the Can” Strategy Exacerbates Mortgage Market Woes (Mortgage Insurer Edition)

By Tom Adams, an attorney and former monoline executive

Barron’s published a detailed take down of the mortgage insurance industry weekend that highlights how Treasury’s approach to the mortgage mess will ultimately make matters worse. As the article points out, in the fairly likely scenario that mortgage claims exceed the amount of capital the insurers have available to pay them, the parties taking the biggest hit will be Fannie Mae and Freddie Mac. That means taxpayers are probably on the hook for more bailouts.

Despite having questionable capital reserves for the future claims they face, mortgage insurers are still continuing to write significant insurance business. Why would anybody want to continue to buy insurance from such shaky companies?

The continuing business of the mortgage insurers help shed light on the fact that virtually the entire mortgage industry is run through zombie companies that ought to have expired years ago.

Chinese Real Estate Bubble Finally Imploding?

The warnings of successful shorts like Jim Chanos, old Asia hands like Frank Verneroso, and economists like Victor Shih and Michael Pettis have failed to curb enthusiasm for the belief that the rise of China is inevitable and unstoppable. As someone who was deeply involved with Japan when it was seen as destined to replace the sclerotic US, I’ve learned to regard more or less straight line growth projections with considerable skepticism.

China has accomplished the impressive feat of bringing literally hundreds of millions out of poverty in a comparatively short time frame. It has also studied the Japanese playbook and managed to avoid some of its pitfalls (of course, it has the advantage of not being a military protectorate of the US), in particular refusing to liberalize its financial markets (some accounts of the Japanese bubble and burst give considerable weight to overly rapid deregulation and the growth of what was then called zaitech, or financial speculation). is also hostile to neoclassical economists.

China escaped much of the impact of the global financial crisis by ramping up investment even higher than its pre-crisis level. It now has investment approaching 50% of GDP, an unheard of level on a sustained basis. A big chunk of that is housing related (housing is an estimated 13.5% of GDP), and prices have long been considerably out of line with incomes, a telltale sign of a bubble. In Beijing, admittedly one of the hottest markets, an average priced new apartment was equal to 57 years of average worker savings (and if you tried to pay for it with a super-long dated mortgage, you’d be in hock even longer, since you would also need to cover the interest charges).

Another warning sign is inventory overhang; the Wall Street Journal reports tonight that Standard Chartered forecasts that level of unsold apartments in secondary cities will amounts to roughly 20 months of sales by year end (and that’s before considering that many of the apartments are being acquired as investments rather than for use).

The Journal story tonight provides evidence that the Chinese housing market is going into reverse

China to Clean Up Toxic Local Government Debt?

This report by Reuters, suggesting that China was about to Do Something about its local government dud loans created a lot of chatter among investors:

China’s regulators plan to shift 2-3 trillion yuan ($308-463 billion) of debt off local governments, sources said, reducing the risk of a wave of defaults that would threaten the stability of the world’s second-biggest economy.

We Speak on BNN About the US Housing Market

This was the weirdest little booth at NASDAQ. The seat was at an off angle to the camera, and I couldn’t sit up straight without bumping my head against the glass behind me, which is curved. So I look a bit whopperjawed and uncomfortable at the top but I think it came out fine in the end.

On Short-Termism and the Institutionalization of Rentier Capitalism

Andrew Haldane and Richard Davies of the Bank of England have released a very useful new paper on short-termism in the investment arena. They contend that this problem real and getting worse. This may at first blush seem to be mere official confirmation of most people’s gut instinct. However, the authors take the critical step of developing some estimates of the severity of the phenomenon, since past efforts to do so are surprisingly scarce.

A short-term perspective is tantamount to applying an overly high discount rate to an investment project or similarly, requiring an excessively rapid payback. In corporate capital budgeting settings, the distortions are pronounced:

Commodities Tank

We’ve been sayin’ the commodities runup and the fixation on inflation looked like a rerun of spring 2008: a liquidity-fueled hunt for inflation hedges when the deflationary undertow was stronger. That observation is now looking to be accurate.

But what may prove different this time is the speed of the reversal. With investors acting as if Uncle Ben would ever and always protect their backs, markets moved into the widely discussed “risk on-risk off” trade, a degree of investment synchronization never before seen. All correlations moving to one historically was the sign of a market downdraft, not speculative froth. And as we are seeing, that means the correlation will likely be similarly high in what would normally be a reversal, and that in turn increases the odds that it can amplify quickly into something more serious.

Are the Chinese Hoarding Certain Commodities to Obtain Cheap Funding?

As much as it may sound barmy to stockpile commodities to obtain better terms on financing, Michael Pettis claims that’s one of the factors behind what looks to be unduly aggressive purchases of copper by the Chinese. An excerpt from his latest newsletter, courtesy Michael Shedlock:

Michael Pettis: Is it time for the US to disengage the world from the dollar?

By Michael Pettis, a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management. Cross posted from China Financial Markets

The week before last on Thursday the Financial Times published an OpEd piece I wrote arguing that Washington should take the lead in getting the world to abandon the dollar as the dominant reserve currency. My basic argument is that every twenty to thirty years – whenever, it seems, that American current account deficits surge – we hear dire warnings in the US and abroad about the end of the dollar’s dominance as the world’s reserve currency. Needless to say in the last few years these warnings have intensified to an almost feverish pitch. In fact I discuss one such warning, by Barry Eichengreen, in an entry two months ago.

But these predictions are likely to be as wrong now as they have been in the past. Reserve currency status is a global public good that comes with a cost, and people often forget that cost.

Silver Down 12%, Big Default Rumored at Comex

We managed to miss out on the parabolic rise of silver, which has now been followed by a stomach-churning 12% fall in thin holiday trading. And commodity markets are less deep than securities markets. Recall that the famed peak of gold in 1980 to $850, was a violent spike up, vasty high than the level two days earlier or two days later.

Silver in particular has been closely watched due to the presence of very large short interests which were apparently partially closed out late last week leading to some very serious intraday volatility. Today we have this cheery development, courtesy Jesse:

Thomas Palley on How to Fix the Fed

The Roosevelt Institute hosted a conference yesterday on the future of the Federal Reserve, with the speakers including Joe Stiglitz, Jeff Madrick, Matt Yglesias, Joe Gagnon, Dennis Kelleher, Mike Konczal and Matt Stoller. Yours truly broke her Linda Evangelista rule to attend.

The discussion included the contradictions in the central bank’s various roles, its neglect of its duty to promote full employment, and its overly accommodative stance as a regulator, which has been enlarged thanks to Dodd Frank.

You can visit the Roosevelt site to view each of the three panels in full (they include the Q&A, which were very useful), the introductory remarks by Joe Stiglitz, or the presentations by each speaker separately. I encourage you to watch some of the panels, and to entice you, I’ve included videos from two talks I particularly liked below.

Mirabile Dictu! Economists Agree All the Fed Has Done is Goose Financial Markets!

You heard it first in the blogopshere. From the New York Times:

The Federal Reserve’s experimental effort to spur a recovery by purchasing vast quantities of federal debt has pumped up the stock market, reduced the cost of American exports and allowed companies to borrow money at lower interest rates.

But most Americans are not feeling the difference, in part because those benefits have been surprisingly small….

S&P Negative Watch Smackdown Wrap

One of the few upsides of the patently silly negative watch announcement for US Treasury bonds was that it elicited colorful and instructive commentary (see our view, along with Mark Thoma’s and Barry Ritholtz’s at the New York Times’ Room for Debate). Some sightings:

ETFs as Source of Systemic Risk?

Surprisingly little note has been paid to the discussion of ETFs in three reports issued last week by international regulatory heavyweights, namely, the IMF, the BIS, and the G20 Financial Stability Board.

Make no mistake: the authorities are worried. The BIS report, for instance, has an unflattering comparison on its first page, noting that now ETFs seem to be serving the same function for institutional investors now as structured credit products did in 2002-2003, with dealers pushing the envelope as far as “innovation” is concerned. The Financial Stability Board was more straightforward, flagging its concerns that ETFs could pose a threat to stability in its report title.

The regulators discussed the fact that “ETF” no longer stands for a single product. Most investors probably assume that an ETF is more or less a mutual fund, when in fact Eurobank affiliated groups’ products are typically synthetic (that is, they use derivatives rather than securities. There are even more structural variants, but we’ll stick to these two for the purpose of this post). And too often, the relationship between the ETF and the sponsor is not arm’s length.

Satyajit Das: Deflating Inflation/ Inflating Deflation

By Satyajit Das, author of Extreme Money: The Masters of the Universe and the Cult of Risk (Forthcoming in Q3 2011) and Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2006 and 2010)

Quantitative easing (“QE”), the currently fashionable form of voodoo economics favoured by policymakers in the US, is primarily directed at boosting asset values and creating inflation. By essentially creating money artificially, central bankers are seeking to return the world to stability, growth and prosperity.

The underlying driver is to generate growth and inflation to enable the problems of excessive debt in the economy to be dealt with painlessly. It is far from clear whether it will work

Satyajit Das: Economic Uppers & Downers

By Satyajit Das, the author of Extreme Money: The Masters of the Universe and the Cult of Risk (Forthcoming in Q3 2011) and Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2006 and 2010)

Quantitative easing (“QE”) is the currently fashionable form of voodoo economics favoured by policymakers in the US.

QE, loosely “printing money”, entails central banks buying government bonds, which are held on the central bank’s balance sheet to inject money into the banking system thatcan be exchanged by banks for higher return assets, such as loans to clients. The purchases also increase the price of governments bonds, reducing interest rates.

Advocates of QE believe that it will lower interest rates promoting expenditure, growth, reduce unemployment and increase the supply of credit to underpin a strong economic recovery. In reality, QE is primarily directed at boosting asset values, subsidising banks, weakening the currency, helping the government finance its deficits and creating inflation.