Hot or Cold: Two Opposing Descriptions of Our Financial Situation

Prudent Bear and Doug Noland have again said something better than I can. Below I give you the best part, which is a comparison between the bull and bear outlook.


[Thanks to steuben.com for the image.]

I definitely belong to the bear side, i.e. we have either already created, or we are about to create, History's Greatest Credit Bubble. I differ only in one way. I am not as sure as Doug that what he labels "Wall Street Alchemy" is all that bad, in and of itself. Assuming the economy can withstand the pressure from this credit collapse, which is not a given, I think that securitization is here to stay, and that it will find a way to price the risk instruments in such as way as to render them useful.

I agree with him that this Alchemy is a credit-creation machine; but so was reserve banking, and everyone thought that couldn't last. One side of the Austrian school of economics continues to blame reserve banking for all of our troubles. I'm not so quick to accuse.

I think government intervention had more to do with this predicament than people think. First, the Fed (a government-type agency in nature, even if they are supposedly independent) is at the origin of much credit creation that is the inspiration for the products and market participants that sell it. Secondly, restrictions on banking activity have caused it to grow outside the body of institutions that originally created and controlled it, into a domain where anything goes, at least for now.

As for this particular inflationary asset-price cycle, I tend to frame it inside a mix of securitization expansion and misguided Fed policy. See a speech by Governor Mishkin for a gorgeous example of Greenspan's handiwork.

Here are the two opposing outlooks on the same data. You have the bulls (Conventional View), and the bears (Prudent Bear's view):

"The Conventional View Paradigm: -- “Perfect/Efficient” Markets Paradigm
· Economic performance governs market behavior
· Underlying economic fundamentals are sound
· Fed commands system liquidity
1. Capacity to initiate reflations/reliquefications on demand
2. Disregard asset Bubbles until they come under stress
· Current Account Deficits are largely irrelevant.
· The system enjoys unlimited capacity to leverage and limitless liquidity.
· Contemporary models-based finance presumes continuous and liquid markets
·The present-day U.S. financial system is more stable, with banks actively disbursing risk throughout the markets.

"Our Paradigm – History’s Greatest Credit Bubble
· Unconstrained Credit systems are inherently unstable.
· Markets are inherently susceptible to recurring bouts of instability and illiquidity.
· Wall Street financial innovation and expansion created what evolved into a precarious 20-year Credit cycle, replete with self-reinforcing liquidity abundance and speculative excess.
· “Wall Street Alchemy” – the transformation of risky loans into enticing securities/instruments - has played a momentous role in fostering myriad Bubbles.
· Unrelenting Credit and speculative excesses have masked a deeply maladjusted U.S. “services” Bubble Economy.
· The prolonged U.S. Credit Bubble and resulting interminable Current Account Deficits have cultivated myriad global Bubbles.
· Recessions are an integral aspect of Capitalistic development – and busts are proportional to the preceding booms.
· Today, speculative-based liquidity commands the financial markets and real economy, creating unparalleled fragility.
· Late-cycle “blow-off” excesses are the most perilous because of their deleterious affects upon the underlying structure of the financial system and economy."

Barclays Desperate for Cash?

I found this e-mail yesterday. It's a first, something I've never seen in my lifetime. A bank is offering to new French customers 10% annual interest on a checking account for three months, and 3% thereafter, with a few conditions (spend 750 euros minimum a month with their credit card, stuff like that).

Here's the actual ad (click on it for a larger version):



Translation:

BARCLAYS
From September 10 to October 31 2007, discover our exceptional offer!
Barclays creates an event...

Interest-Bearing Checking Account
at 10%*

10%* interest as of the first euro,
that's so much better!

To find out more on the Interest-Bearing Checking Account
Call 0810.018.810**
or
Click here

*Checking account interest paid daily up to 30,000 euros at the promotional rate of 10% applicable for 3 months for all new accounts (with bank approval) from September 10 to October 31 2007. Beyond that, annual gross daily interest of 3% up to 10.000 euros, on the condition of 750 euros charges a month to your bank card. Offer reserved to new customers on condition of the opening of a new "forfeit" (?) account with Barclays. Annual rates not including taxes and fees, and subject to change.
**Local call fee.

So The FHA is the Best We Can Do?

Bernanke's evaluation of the government's idea to have FHA step in to help out those naive innocents whose house is about to be foreclosed upon, is this:

"This is one promising direction" i.e. he approves.

His enthusiasm and encouragement for government intervention inspired me to finish a cartoon suggested by a good friend. (Thanks, Charlie!) Let's just hope they can get this F-agency to play its role a little better than that last one we all have heard so much about.

(Click on it for a larger version.)

Is It the Market's Fault?

Great article (in French) by Jean-Marc Vittori of Lesechos.fr, entitled "The End of the Market?"

He describes the summer of 2007 perfectly:


[Thanks to mediabistro.com for the image.]

"Rotten season! Right in the middle of summer, a thick fog obscured world finance. Then a storm broke. Impossible to see the waves that engulfed a German bank, blocked Australian and French funds, and shook the financial hallways around the globe. Lacking sufficient visibility, banks refused to lend to each other, starting a liquidity crisis. Now everyone is sitting on pins and needles waiting for the next surge, with no idea where it will come from."

Some paraphrasing:

Capitalism used to utilize that tool of great transparency that was the market; and it worked so well, or at least did up to now. The market used to give us exact figures that communicated supply and demand ratios perfectly.

The moulder of this tool was the world of finance, the very same world that now seems to be working without it. He asks: Do we really need a tool that the financial world has abandoned?

To prove his point, he gives several examples of what a researcher at Natixis (a French investment company) calls "closed capitalism." There are four types of companies that wear themselves out trying to make their stocks disappear off the screen. We can ignore the first one, those buyers of their own stocks or those of their competitors who are simply trying to improve the price.

The other three are the private equity firms that retire businesses away from the public eye in order to restructure them in peace, the businesses held in private hands (mostly family companies that have always been run close to the vest), and the state-run financial entities created with the foreign exchange surpluses of nations like Russia and China.

These last are becoming more and more hefty. For the time being, they've contented themselves with buying participations in existing companies; but by 2015, they will have enough money to buy everything listed on the stock markets of Euronext, London, Frankfort and Milan, and make them all obscure.

"As for bonds, there's another mechanism that leads to the same result. Over the space of one decade, the profession of banking has completely changed. It used to be that banks were houses of good reputation, collecting savings and issuing bonds at low interest, selling them on the marketplace in order to be able to lend money at a higher rate to make their profit.

"Now, banks have become immense debt-aggregating and -marketing machines, issuing the instruments themselves or through intermediaries. It's called 'securitization': they consolidate debt instruments, twist them around, and sort them out into 'tranches' that they sell directly to customers for a commission.

"The [precise price-determining] market has given way to a kind of approximation process. It's true that at the first level--the issuance of debt instruments--and at the second one--resale--a true market doesn't much exist, as we saw during the August panic.

"Even the role of the rating agencies has changed. It used to be that they informed the market by evaluating bond issuers' capacity to reimburse. Now, they are just rubber-stampers. They work with the banks in creating the obligations, and then they issue the certificate of approval that justifies their acquisition."

I agree with most of this, except I'm not so sure the rating agencies are such evil co-conspirators as described. However, there are several points he doesn't mention:

1. Banks and financial institutions have turned to this seeming free-for-all blind market with great enthusiasm, it is true; but he fails to mention that banks have been suffocated in their market inventiveness for centuries now by an overbearing federal bureaucracy. What the regulators forget is that you can suffocate banks, but you can't suffocate the market. It simply flows up around the impediment, as it has done in this case (with the banks' complicity, of course--they're no dummies).

2. Securitization and the credit derivatives that sprouted from them were the new kids on the block, bright and shiny, free from federal interference due to the new, more free-market orientation of the supervisors, and thus squeaky clean. Everybody and his uncle wanted some.

3. There was lots of cash to invest, probably due to a combination of excessive central-bank-issued liquidity, pegging by US trading partners, and the relative desirability of the US investment climate in the global marketplace (the tallest dwarf syndrome).

4. There was even more liquidity focused directly at these markets issued to excess by quasi-government mortgage buyers (Freddie and/or al.).

5. The combination of 1-4 created a bubble in these instruments that is only now coming to light for what it is; and those who over-consumed will have to bite the bullet if they can, or get bailed out if that's an option, or deal with their own demise. (The BIS [Bank for International Settlements] has been screaming about this for years. See my earlier post and near the bottom of this article.)

6. In the future, the securitization and dependent credit-derivative markets will become more transparent as these instruments are traded in a more orderly fashion, and as (hopefully) central banks get a handle on the money supply, hopefully by leaving it alone. (I don't think I'll hold my breath on that last part.)

Paulson Cartoon

Here's my Paulson cartoon. See my last post for the reference.

(Click on it for a larger version.)

It's Helicopter Ben... No, It's Helicopter George... Wait... No, It's FHA Secure

Just watched a video over at Bloomberg entitled "Paulson Urges Mortgage Lenders to Help Homeowners" (Sept.12).

If you want to get some goose bumps, take a look at our government in action. Paulson is in the hot seat now. He's feeling the heat, the pressure to "do something." Watch him girding his loins for this subprime challenge.


[Thanks to countway.harvard.edu for the image.]

The answer, says he, is for government to step in, locate all those poor schnooks who got taken by dishonest mortgage brokers, and save their homes. Honorable enough intentions, as usual.

But remember the proverbial road to hell. I say, good luck separating the innocent wheat from the snookering chaff that will slip into the line at the bail-out window.

And keep in mind who is paying for all of this. Who, you ask? Why, yourself.

If you thought FEMA was bad, what do you suppose the FHA will be like? After all, it's just another government agency, and for those of you who are Democrats, the agencies are still under the Bush administration's control. (For you big-government Republicans, you might want to reflect on this. For you small-government Republicans, you and I know that it doesn't matter who is in control; a big-government agency is a big-government agency, i.e. incompetent.)

Why is it that every time the government screws up the clean-up of one mess, people throw more messes at it? Boggles the mind. Or maybe it's just the government that thinks the people are throwing the messes at them. How paternalistic. I guess they presume that clean-up is part of the big-government job description.

And Now Big-Ticket Cars?

Just an anecdote:



My friend is trying to sell an XK8 Jaguar 2001. He placed ads in several of the most popular venues, and the Bluebook is presently $27,100.

He started the bidding at $28,900 about two months ago. Not one call....

Since then, to make a long story short, the price has fallen to $22,900. Still not one call....

This is very unusual, in my experience. Do you suppose the mortgage blues are contagious?

Another Real Estate Disaster in the Making?

I took a little walk today near Marina Del Rey, the yacht harbor of Los Angeles. I started at one corner of a block that's about two streets east of Lincoln Boulevard and one street south of Washington Boulevard. Here is some running commentary with the photos I took. (Click on the photo for a larger version.)

Photo 1



Hey, look. Let's go see what this is all about. You'd think that with the real estate market tanking in California, these might sit on the shelves a bit; but then again, sales of high-end units are still holding value here, even though the inventory is piling up.

Photo 2



Oh, looks like a series of loft-style units. Oh yeah, I remember. This is technically Culver City. They've been doing a lot of rethinking about their city planning over the last ten years. Hmm. Don't know if the timing of this was well thought out.

Photo 3



Hm. More lofts. I don't really get this loft thing. I do get the cost of construction savings, though.
Photo 4



More of same. Not very attractive. Reminds me of the projects. Well, I guess the City was thinking about the potential tax revenue. Just goes to show why city bureaucrats shouldn't go into the housing development business.

Photo 5



Gosh, more lofts. What about parks? What about the view out your window?

Photo 6



Guess this answers that question.

Photo 7



Another good living room view, and it looks like the units go all the way across the block width.

Photo 8



Oh. I see they got their "mixed use" in. But a body shop, I would have thought that stinks up the neighborhood. (It does.)

Photo 9



Another building, even better vis-a-vis. Ugh.

Photo 10



Now I've come around the edge of the block and I'm walking down the street at the "back" side. More of same, but maybe not lofts, at least.

Photo 11



Oh yes, these seem nicer, but ... they're also almost completed, which helps. But still, the views....

Photo 12



Looks like they've calculated a huge demand for these apartments. And I hear they're priced at around, e.g., $700,000, for 1,200 sq.ft. or so., two bedrooms. Someone's going to make a killing, right?

Photo 13



Another mixed use. I suppose it could be nice to be able to get your oil changed right out of bed.

Photo 14



Another new one. Gosh, that makes about twenty huge new buildings or so. There must be 1,000 new apartments going in on this block alone. I hope they can sell them when the time comes. Maybe they're trying to empty out the Inner Empire.

Photo 15



Last shot, another mixed use.... looks like a punch line.... I guess the Arabs did well to go elsewhere with their petrodollars. (See previous post.) They didn't have to do anything to cause this future fiasco. I wonder if it's happening all over the USA--or even all over the world. Good grief, what a thought.

And the Boom Goes On

But not in the usual places. This article (in French) at the LeMonde.fr newspaper website describes new real estate projects going up in Morocco.


[Thanks to morocco-property.com for the image.]

Yes, it seems that since 9/11 the petrodollars are not as welcome as they used to be in the Western world, so the Arab Emirates, Kowait, Bahrein, and Qatar have turned their attention elsewhere.

Morocco is expecting some $3 billion dollars worth of investments in 2007 alone, two-thirds of which come from the European Union, mainly France and Spain. The Moroccan Economic and General Affairs Ministry expects the Arab nations to equal Europe by 2008.

There will be Tinja, a whole village of 2,500 luxury homes, a sports club, hotels, stores, worth about $billion. They will rehabilitate a well-known site in Rabat for $12 billion over seven years, and carry on three other tourism projects around Marrakech.

Then Dubai will develop similar projects between Rabat and Sale, as well as one in the port of Tangiers.

Near Tangiers it's the Qataris who will build a competitive luxury project 1.5 miles along the Atlantic. There will be a golf course, a equitation center, a conference center, and a casbah (Moroccan marketplace).

Gee, we could have used some of that money in Los Angeles to repair the potholes.

Jackson Hole: Saving Us From Themselves

'As Nathan Mayer Rothschild was fond of saying, “I care not what puppet is placed upon the throne of England to rule the Empire on which the sun never sets. The man that controls Britain’s money supply controls the British Empire.” '

Interesting quote from this article at SeekingAlpha.com, by one of my favorite gold bugs, Gary Dorsch, blogger at sirchartsalot.com.

Gary's article points out some of the data you don't get from the dailies and makes my case look all the more scientific. (Gadflies can always use a little support.)

What I find the scariest element of our present quandary is that top economists, including 34 central bankers, are in complete opposition to each other on (1) the problem, and (2) the solution. Take a look at this article if you care to watch how our top-notch economic-scientist central bankers are scrambling for their next move.


[Thanks to thebestlinks.com for the image.]

Mishkin thinks that, due to positive "[r]apid financial change, triggered by innovation and deregulation", all this wonderful lending has simply "outstripped the available information sources"; and so he wants to lower the target rate. Feldstein of the NBER [National Bureau of Economic Research, the major supplier of much of the statistics available] sees the bad writing on the wall and agrees the Fed should lower it by 1 percent. Shiller decries a classic housing bubble and seems to want something to be done. Leamer warns about the coming recession. Fisher from Israel says do something about the bubble before it explodes.

Then you have Mayer flipping off everyone's worries, saying this whole housing-boom thing was simply a sign that it's now cheaper to own a home than to rent one. (Sure.) Others say that the bubble is simply an effect of monetary policy but not the cause of any recession. (Right.)

Bernanke himself walks the tightrope between one side and the other, saying the economy can handle this and maybe we'll do something, maybe we won't.

The consensus seems to be summed up this way: We'll have to "rely on judgment more than models." Okay. But whose judgment are you gonna pick? I admit there's a consensus that now is not the time to raise rates; but whether to lower or not (and/or pump more credit into the system), they're all over the charts but seem to be leaning towards easing/pumping.

I get the heebie-jeebies when I read that a year ago "the Bernanke Fed ... heavily inflate[d] the broad US M3 money supply, after it decided to hide the figures from the general public in March 2006. Since then, the US M3 money supply has expanded at a 13% annualized clip, up from 8% when the Bernanke Fed stopped reporting the key figure." (Look at the charts if you don't believe him.)

I thought they were holding money supply steady. Why would they increase it, when they've supposedly been combatting the inflationary pressure all this time?

And then I cringe again when I read this:

"[China] has been a net seller of US T-bonds for three straight months by a record amount of $14.7 billion, the longest period of sales by China since November 2000."

This is not the time for China to bail out on our T-bonds (although I don't think they really will, given the amount they hold.)

And this is an interesting quote:

' “At some point, you have to choose between trusting the natural stability of Gold, and the honesty and intelligence of members of the government. With due respect for these gentlemen, I advise you, as long as the capitalist system lasts, to vote for Gold,” said George Bernard Shaw in 1928.'

GBS is not my paragon of economic virtue, but I like his occasional common sense and wit. I might just add that today the marketplace is more savvy and may have already factored in much of this wisdom. No one can really predict how things will play out. But we can take our chances....

And this:

'Should you place your faith in Federal Reserve notes? “Money is too important to be left to central bankers. You essentially have a group of unelected people who have enormous power to affect the economy. I’ve always been in favor of replacing the Fed with a laptop computer, to calculate the monetary base and expand it annually, through war, peace, feast and famine by a predictable 2%,” said Milton Friedman.'

He's another one whose gift of gab--indeed in his case genius of gab--got him places; but I note that he had the remarkable ability to say opposite things within the same paragraph. Here we have a committed devotee of small government saying both "power is bad" and "use the power anyway." Why not just be consistent and recommend we get rid of both the central bankers and the central bank (i.e. throw out the centralized computer, too)? Why can't we just let it all go and allow people to write contracts in gold? End of problem. (Perhaps an oversimiplification....)

Bernanke's job at the head of our monetary policy is an impossible one; but he wanted the job, so now he's got to at least pretend he can handle it. I don't envy him. The higher you fly, the harder you fall.

The Fed: "Don't Make Me Do It!"

So the Fed and their buddies (Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the National Credit Union Administration, and CSBS [Conference of State Bank Supervisors]) have issued a bulletin of advice to servicers of residential mortgages.

The idea is basically that creditors would be well advised to work out their problems with debtors, rather than respect the terms of the contract signed by both parties. Apparently, the notion of a contract is no more sacred to the Fed than that of private property is to the Supreme Court.


[Thanks to ejmas.com for the image.]

I get their point; but it would be nice if the Fed didn't try to twist arms, and instead just came clean about their part in this drama. They hand out cash; and then they wonder why the price of a home triples in eight years. Is it so difficult to accept the obvious?

Then, surprise, surprise: The housing market bottoms out. Well, that's what bubbles do. They burst.

Solution: Force the creditors to swallow the losses by wiping their derrieres with the contracts. (Can it even be done, at this point? Those contracts have been sold, and are themselves part of a multitude of other contracts. I don't think it's even feasible; but the threat of more government regulation and/or sanctions can sometimes work miracles.)

The nation is ... well, let's say "unsettled." The more high-roller mortgage brokers are already dead. The more prudent are now next in line at the gallows.

The hedge funds are worried that their quants and sure-thing speculations will not self-realize before they get the "Game-Over."

The bankers should be worried, if they're not, that the over-leveraging of their conduit and credit-derivative divisions will wipe out their reserves, and then some. (Too late to get those bonuses back; dang.) They're also worried about more government interference in the banking industry.

Freddie and Fanny are praying that they won't be required to absorb all these failing loans into their already shaky portfolios, which would probably put them over the edge and require a Treasury bail-out (and change a few managers' names, even though it's not their fault).

The FHA, FDIC, PBGC (Pension Benefit Guaranty Corporation), et al. are sweating the potential claim scenario should their services ever actually be needed.

The President is worried that the government-appointed-Fed's mistake will cause innocent taxpayers to vote Democrat next year. (He is also probably hopeful that his Helicopter George idea will save face for his administration's miserable handling of Katrina, which is not even their fault, because they didn't create FEMA in the first place; but that's the nature of politics.)

The legislators are afraid that they won't get reelected if they don't pass some law to bail out the poor bastards who can't afford the house they live in (or don't live in, as the case may be).

The Fed is fearful that admitting their own mistake could cause innocent taxpayers and home buyers to revolt and call for the Fed's demise.

Ah, the domino effect. Thank goodness the job market is still strong (isn't it?), and the Fed won't have to succumb to pressure to lower the target rate, adding insult to injury......

Can't Decide Whether To Laugh or to Cry

Rob Peebles, one of my favorite writers over at Prudent Bear, writes this parody of a White House press memorandum regarding image control.


[Thanks to wolfhazmat.de for the image.]

You've love the humor, while at the same time you'll be forced to enjoy the points he scores against our dear Fed.

Come to think of it, he scores two: One against the Fed, and one against politics.