Those that read my stuff know I am a deflationist. This outlook is based on a couple of ideas, one that fractional reserve banking has no mathematical solution and thus through mathematics, there is a limit to credit and that without US demand, the output of the worlds factories and mines is well in excess of what would be demanded. I am of the opinion that to keep the mathematical equation from collapsing, so much credit has to be manufactured to just support the debt structure without adding to the amount that can be purchased. It is clear that society is divided into two groups, spenders and savers and that the banking system is divided into debits and credits. The problem is eventually the people that hold the deposits are an entirely different group than those that owe the debits on the bank balance sheet. Thus the bank has acted as surety for a group that cannot pay the other group. This results in a credit crunch and if not resolved, results in a depression. In Keynesian economics, a wild card has been introduced, which we are going to see played out in the next couple of years, that government can put enough credit in to prop up the debit side to the point that the credit side can be serviced. This solution worked in the early 1990's period in reflating the economy and the banks balance sheets after the banking collapses of the late 1980's. The difference between then and today is that any effort today is to prop up a bubble that has arisen through 2 decades of financial mismanagement, starting with the Rubin/Greenspan/Clinton regime and all the efforts since to keep the system from collapsing from the 2000 bursted tech bubble.
Where I am raising questions is that it appears the bank credit is continuing to expand at a double digit rate, despite much crying that bank credit and lending is too tight. One would expect that consumer spending would be falling rapidly, that home sales would be at recessionary levels rather than at historic boom levels and that imports would be declining rapidly. I sense that the balance of manufactured goods payments is in fact declining rapidly and that the trade deficit is now floating on a massive oil bill. If this is the case, then we should soon see a massive decline in growth in China and a resulting deflation of stock markets around the world.
Here is the other side of the equation. If the US persists on pushing on a string, we are going to have problems. Despite the news, economic activity is at historic levels. It might not be quite at the mania levels we have seen in the past few years, but all the same, retail sales are still increasing and home sales are coming in at a 5 million level for pre-owned homes. The prior to bubble record was 4 million and normal is around 3 million, so we are far from bread lines or a busted system. This means something is still financing this. I do believe that gasoline sales are included in retail sales, so in truth we are declining in the sale of goods.
A friend and I walked right into a Outback Steakhouse last night at 8 PM and ate. This is almost an unheard of situation on a Friday night in Addison, Texas. The Texas economy seems to be doing better than the nation and the housing bust isn't here what it is in a lot of other places. There have been 1 million people move into the DFW metroplex since 2000 according to a story on the front page of the paper yesterday and despite this, home prices have been pretty stable since 2000. There is not a sub-prime bubble here, but at the same time, there has to be some kind of supply problem here. On the contrary, if there is a Bernanke/Paulson/allow no pain Democratic congress put under housing, I fully expect a huge bubble to develop here soon if we in fact don't have a real recession. Why not if you can buy a house and stop making payments and get debt relief? I would like my free $30,000, $50,000 or $100,000 for the mistake I made. Why not go ahead and restore the stock market losses of the 2000 tech bubble collapse while they are at it? Don't people need retirement funds more than a 3000 square foot house they can't afford to heat, cool, maintain and make payments on?
The US has walked into the twilight zone and I suspect there is going to be a back lash. The chant is dollar devaluation and at some point, they are going to have to support the dollar. Housing is going to collapse, regardless of what Congress does, because there is too much excess in the system and maintaining the excess isn't going to solve the problem of too much excess. We are looking at below 6% rates on mortgages right now and if the inflationists win out short term, mortgage rates will go to 10%, which will add 50% to the payment of buying a home and housing will then deflate on those terms. If the dollar declines, demand from the US will have to decline. The banks won't continue to make sub-prime financing and I highly doubt they are going to be in the mood to take a lot of risks. The government is part of the system and not the Santa Claus they seem to be viewed as. Neither is the Fed, which requires day to day delivery of what they give out meaning they might not give the treasuries back tomorrow without sound collateral. The Fed can't allow itself to go broke.
Thus, regardless of what transpires short term, longer term we still deflate. The system won't allow for inflation beyond maximum potential. The debt service either isn't enough to carry the debt if rates are too low or it is too high for the economy to live if the rates are too high. We are well over 300% of GDP in debt. This means that the absolute limit of inflation is around 27%. Beyond that, inflation is impossible with corresponding interest rates. I would suspect that any effort to push it beyond this would result in the currency being ignored and thus demand to acquire credit or print money would collapse. This is a deep subject.
If the US was Mexico, I could buy anything going down, but the US is the US. It is kind of like having a strictly heterosexual dance without the girls showing up. Better have some good guitar and booze and forget dancing. The world economy without US demand deflates. It cannot inflate. Maybe in the next universe the world dances without America, not today.
Saturday, March 29, 2008
Monday, March 24, 2008
It is over?
Hell no it isn't over. The Fed closes a brokerage company, FNMA and FHLMC get permission to go broke and the worst credit crunch since the Great Depression goes under the rug? Only a kid would think this thing is past.
What did the Fed do? I think they opened the door for the banks to get money to pay themselves because the banks they owed didn't trust them to loan it back to them. What this means is the potential insolvency hasn't left town and is still there. The Fed isn't lending on MBS's at par or any where near par and in fact are buying treasuries to swap for MBS's. Contrary to the view on CNBC, you can bet these are the good securities, not the CDO's these idiots got stuck with before they could peddle them off to the Chinese. We are a long way from the high powered credit market that has created this rosy picture the bulls still think is in play.
There is one thing I know for certain. We won't go forward as usual. Not only will we not go forward as usual, as the economy slows down, more cracks are going to show. Part of the story Monday, March 24 was that housing sales were up 3% for February. I think the news the problem was over was running all over the place in February so it isn't surprising the sales were up a little. What I saw was something I only piece together from time to time, that we are not in a housing slump. This might come as a shock to many people, but the truth of the matter is that sales for January on an annual pace would beat every year in history prior to 1998. In fact, every year since 1996 has beaten the prior record that stood from 1978 until 1996. 1995 narrowly missed the record.
I was involved in the real estate business in 1978. It was a crazy year with rampant speculation and we had broad based inflation and were in the midst of the baby boom generation reaching home buying and family starting age. The move to 2 income families was in full swing and anything looking like a real bust was several years in the future. The slowdown that followed was significant, dropping to 2 million units in 1982. Even if we could make a case there was more people in the US today and legitimately we should have a 40% greater top sales year, 5.6 million would be peak. But, 2.8 million would constitute a down year, not 5 million. The fact that sales stayed below 4 million all through the 1980's and well into the mid 1990's lends credence to the idea that we have yet to see the housing bust if the recent stats are any indication.
Why is this important? Because anyone that can trace the flow of funds will begin to see that the entire world financial structure is now resting on the state of US housing. Doug Noland of Prudent Bear fund http://www.prudentbear.com/index.php/CreditBubbleBulletinHome
over the years has clearly made the link between the stock market bubble and the continued inflation of borrowing on homes through financing provided first by FNMA and FHLMC then by Wall Street itself. Being that this procedure hasn't slowed down to previous levels yet, despite much hardship in the financial end of housing, the worst is yet to come. It might appear to get better first, but the point here is the bubble has a hole in it and it can't help but get worse.
There is more to this story than housing, but the whole cake can be deduced from what has happened and what is happening in the housing market. What is happening is foreclosures and declining prices. The housing market didn't collapse because financing collapsed, but financing collapsed due to housing being saturated. We are seeing sales at an unsustainable level, even at the present. In fact, I sense the figures are being cooked if one is to be believed that the market is bad. If the market is falling apart with 5 million sales pace, what is going to happen when the sales pace reaches the normal bottom in the 3 million or less range?
This time isn't different. It is never different and the valley of sales, whenever they do come, is going to be much lower than were we are. This means that quite possibly 10 million people will desire to sell homes with no buyers. Those having hardships won't be able to get out from under homes and those that previously invested in homes will not be stepping forward attempting to get rich buying more of them. Instead, they will join the sellers in trying to get out of the absolute headache of being a landlord and quite possibly before the declining cashflow bankrupts them.
Why do I believe sales are still high? If you look at this chart compliments of Calculated Risk http://photos1.blogger.com/x/blogger/2825/754/1600/212275/EHSannual.jpg you will note that between 1969 and 1992, sales of homes significantly exceeded 3.5 million 1977, 1978 and 1979 and were roughly 3.5 million 1986, 1987 and 1988. Remember the post war babyboom started in 1946, so the later years were years the early boomers were 40 and over and the early years, they were 30. This wasn't a poor sales period, but historically high. So, in a period of 24 years, we saw sales significantly over 3.5 million only 3 years when demand was high and the need for inflation hedges and tax shelters were also high. All other years during that period, sales touched 3 million twice and marginally exceeded it 5 other times.
If you look at this bubble, you will see that it is quite comparable to the NASDAQ bubble in size. The United States isn't China and the idea that sales that were limited in boom years to 4 million for 4 really fast growing decades only to see them go to 4 million, then 5 million then 6 million then top at 7 million is evidence of nothing else. Looking at this chart, I see a 15 year uptrend in sales. There were a few years flat against the prior year, but nothing where sales backed off to any degree. We went right through what they called a recession with no pullback in housing. I think it only interrupted the upswing a little. In fact, sales in 2001 exceeded sales in 2000.
My point here is that money coming out of financed housing sales propels the US economy and the propeller is still spinning. What we are about to see is the propeller might be spinning, but it is out of the water. The equity is drying up rapidly and not too many experts seem to think we are near the end of this mess.
What is in part behind this rally is the delusion that the Fed is buying mortgages when they are only swapping them at a discount and that the banks are getting money to lend when in fact they are getting money to pay the other banks for what they have already loaned out. The balance sheets of these rambunctious operations are nowhere near repaired and I suspect that more than any of us care to think about are operating insolvent in fact, but covertly so. The idea that the value of all this crap they packaged is coming back is nonsense and the idea that they are going to turn sub prime borrowers into prime candidates is a bunch of nonsense even the bulls won't buy. But, to buy the bull market coming back, they have to buy the idea that the sub prime market is going to continue. Also, they are going to have to buy the idea that Wall Street alchemy financing is going to come back strong.
The other news out there is that FNM and FRE can go out and buy another $200 billion in mortgages. That is fine and dandy, but I would have a hard time believing there is enough mortgage insurance capital out there right now to get that kind of business going together with the fact that I find it doubtful that in this market FNM and FRE are going to find ready buyers for an unlimited amount of paper. I don't believe the banks are in the mood to finance hedges to carry this stuff.
The point about all of this discussion is that the market needs demand to prop up its earnings, its cash flow and all else that it so joyously is celebrating today. I doubt seriously they see 80% of the new credit going forward they saw in the past and that spells trouble for the economy, for debt service, for housing and for the international markets as well. There are going to be 2 types of sellers of homes, those with no mortgages or 15 year old mortgages in some cases and those that are hoping they get out with what they put down to start. The zero down game is done, which means the demand driver longer term is done. If anything, pre-owned home sales are being supported by the fact that there are fewer new homes being sold.
If I had to guess, my best guess is that we are in a month long or 2 month long period of everything is going to be okay. The world financial system is stacked on speculation and bad credit risks and the Fed and most likely the bank of England are taking enormous risks going forward. The fact that the Fed made the changes they made tells me where we are, one hell of a lot farther from the top than where the market stands. The delusion has set in that you make money out of holding stocks forever because they got even from the last dive in 2000-2002. They aren't going to get away with a 6 month flat in this mess. The next downturn is going to be historic and I hope it is historic to the point that we can live to write about it.
What did the Fed do? I think they opened the door for the banks to get money to pay themselves because the banks they owed didn't trust them to loan it back to them. What this means is the potential insolvency hasn't left town and is still there. The Fed isn't lending on MBS's at par or any where near par and in fact are buying treasuries to swap for MBS's. Contrary to the view on CNBC, you can bet these are the good securities, not the CDO's these idiots got stuck with before they could peddle them off to the Chinese. We are a long way from the high powered credit market that has created this rosy picture the bulls still think is in play.
There is one thing I know for certain. We won't go forward as usual. Not only will we not go forward as usual, as the economy slows down, more cracks are going to show. Part of the story Monday, March 24 was that housing sales were up 3% for February. I think the news the problem was over was running all over the place in February so it isn't surprising the sales were up a little. What I saw was something I only piece together from time to time, that we are not in a housing slump. This might come as a shock to many people, but the truth of the matter is that sales for January on an annual pace would beat every year in history prior to 1998. In fact, every year since 1996 has beaten the prior record that stood from 1978 until 1996. 1995 narrowly missed the record.
I was involved in the real estate business in 1978. It was a crazy year with rampant speculation and we had broad based inflation and were in the midst of the baby boom generation reaching home buying and family starting age. The move to 2 income families was in full swing and anything looking like a real bust was several years in the future. The slowdown that followed was significant, dropping to 2 million units in 1982. Even if we could make a case there was more people in the US today and legitimately we should have a 40% greater top sales year, 5.6 million would be peak. But, 2.8 million would constitute a down year, not 5 million. The fact that sales stayed below 4 million all through the 1980's and well into the mid 1990's lends credence to the idea that we have yet to see the housing bust if the recent stats are any indication.
Why is this important? Because anyone that can trace the flow of funds will begin to see that the entire world financial structure is now resting on the state of US housing. Doug Noland of Prudent Bear fund http://www.prudentbear.com/index.php/CreditBubbleBulletinHome
over the years has clearly made the link between the stock market bubble and the continued inflation of borrowing on homes through financing provided first by FNMA and FHLMC then by Wall Street itself. Being that this procedure hasn't slowed down to previous levels yet, despite much hardship in the financial end of housing, the worst is yet to come. It might appear to get better first, but the point here is the bubble has a hole in it and it can't help but get worse.
There is more to this story than housing, but the whole cake can be deduced from what has happened and what is happening in the housing market. What is happening is foreclosures and declining prices. The housing market didn't collapse because financing collapsed, but financing collapsed due to housing being saturated. We are seeing sales at an unsustainable level, even at the present. In fact, I sense the figures are being cooked if one is to be believed that the market is bad. If the market is falling apart with 5 million sales pace, what is going to happen when the sales pace reaches the normal bottom in the 3 million or less range?
This time isn't different. It is never different and the valley of sales, whenever they do come, is going to be much lower than were we are. This means that quite possibly 10 million people will desire to sell homes with no buyers. Those having hardships won't be able to get out from under homes and those that previously invested in homes will not be stepping forward attempting to get rich buying more of them. Instead, they will join the sellers in trying to get out of the absolute headache of being a landlord and quite possibly before the declining cashflow bankrupts them.
Why do I believe sales are still high? If you look at this chart compliments of Calculated Risk http://photos1.blogger.com/x/blogger/2825/754/1600/212275/EHSannual.jpg you will note that between 1969 and 1992, sales of homes significantly exceeded 3.5 million 1977, 1978 and 1979 and were roughly 3.5 million 1986, 1987 and 1988. Remember the post war babyboom started in 1946, so the later years were years the early boomers were 40 and over and the early years, they were 30. This wasn't a poor sales period, but historically high. So, in a period of 24 years, we saw sales significantly over 3.5 million only 3 years when demand was high and the need for inflation hedges and tax shelters were also high. All other years during that period, sales touched 3 million twice and marginally exceeded it 5 other times.
If you look at this bubble, you will see that it is quite comparable to the NASDAQ bubble in size. The United States isn't China and the idea that sales that were limited in boom years to 4 million for 4 really fast growing decades only to see them go to 4 million, then 5 million then 6 million then top at 7 million is evidence of nothing else. Looking at this chart, I see a 15 year uptrend in sales. There were a few years flat against the prior year, but nothing where sales backed off to any degree. We went right through what they called a recession with no pullback in housing. I think it only interrupted the upswing a little. In fact, sales in 2001 exceeded sales in 2000.
My point here is that money coming out of financed housing sales propels the US economy and the propeller is still spinning. What we are about to see is the propeller might be spinning, but it is out of the water. The equity is drying up rapidly and not too many experts seem to think we are near the end of this mess.
What is in part behind this rally is the delusion that the Fed is buying mortgages when they are only swapping them at a discount and that the banks are getting money to lend when in fact they are getting money to pay the other banks for what they have already loaned out. The balance sheets of these rambunctious operations are nowhere near repaired and I suspect that more than any of us care to think about are operating insolvent in fact, but covertly so. The idea that the value of all this crap they packaged is coming back is nonsense and the idea that they are going to turn sub prime borrowers into prime candidates is a bunch of nonsense even the bulls won't buy. But, to buy the bull market coming back, they have to buy the idea that the sub prime market is going to continue. Also, they are going to have to buy the idea that Wall Street alchemy financing is going to come back strong.
The other news out there is that FNM and FRE can go out and buy another $200 billion in mortgages. That is fine and dandy, but I would have a hard time believing there is enough mortgage insurance capital out there right now to get that kind of business going together with the fact that I find it doubtful that in this market FNM and FRE are going to find ready buyers for an unlimited amount of paper. I don't believe the banks are in the mood to finance hedges to carry this stuff.
The point about all of this discussion is that the market needs demand to prop up its earnings, its cash flow and all else that it so joyously is celebrating today. I doubt seriously they see 80% of the new credit going forward they saw in the past and that spells trouble for the economy, for debt service, for housing and for the international markets as well. There are going to be 2 types of sellers of homes, those with no mortgages or 15 year old mortgages in some cases and those that are hoping they get out with what they put down to start. The zero down game is done, which means the demand driver longer term is done. If anything, pre-owned home sales are being supported by the fact that there are fewer new homes being sold.
If I had to guess, my best guess is that we are in a month long or 2 month long period of everything is going to be okay. The world financial system is stacked on speculation and bad credit risks and the Fed and most likely the bank of England are taking enormous risks going forward. The fact that the Fed made the changes they made tells me where we are, one hell of a lot farther from the top than where the market stands. The delusion has set in that you make money out of holding stocks forever because they got even from the last dive in 2000-2002. They aren't going to get away with a 6 month flat in this mess. The next downturn is going to be historic and I hope it is historic to the point that we can live to write about it.
Friday, March 14, 2008
Bear bites Bear
The Bear Stearns news hit the market early and hard today. Gold passed $1000 and Oil continued its march about $110. Rumors are now the Fed cuts 1% and the latest CPI was unchanged, despite high oil and food prices. The dots are not being connected yet, but it is clear the banking sector doesn't have enough funds to transact business, even though the market has been flooded with dollars.
The problem of course is where the dollars are, not how many there are. It appears the banks screwed up the credit system so badly that the last round of fundings they did are still out there, now chasing commodities around the world. The dollar is falling against all currencies because the only mechanism the Fed has to fix things is hope that interest rates will stimulate borrowing. Borrowing to whom and for what? It appears the only borrowing that is even attempted is for speculation and for keeping mistakes afloat. The liquidations of investment firms recently that had been speculating on securities bought with huge leverage pulled into question the solvency of some of the banks that financed these transactions and Bear is the one that had the run on it. I suspect there are plenty more of them and I wouldn't be surprised if there isn't some favored fund out there with positions many times the size of Carlyle Capitals $21 billion and for that matter even more under water.
It is clear the Fed took the action of swapping treasuries for mortgage backed securities of the FNMA, GNMA type. You would think by the talk that they paid par for CDO's backed by sub-prime mortgages. If the FNMA paper isn't any good, the US is probably cooked for good as it is indirect ownership in the majority of homes financed in the US. Some people say this is risky, but I am quite sure the Fed has margin requirements on these funds and will settle up every so many days and hopefully reverse the transaction. In any case, the Fed is taking risks, but the deeds of houses is a lot more than just paper. It was clear the market wasn't going to digest the sale of $200 billion in mortgage backed securities at this time and such a sale would have called into question more leveraged funds.
There are many points here. For one, I think the big point is that the banking system is near broke. They might have pretty balance sheets, but the debts are noncollectable in a lot of ways. The economy won't be bailed out by low interest rates because the banks won't lend at these rates and people that need to borrow now in this high cash balance system are high risks. I think the speculators of the world are trying to knock over the dollar, which is actually next to impossible and the next big loss is going to be the rampant rebound as the real issues start to hit home. What are the real issues?
The number one issue that is just starting to sink in is that leverage is getting more and more dangerous and at the same time, there are more and more people engaged in it. It isn't just the United States, as the world has been awash in leveraged credit. We found out the CDO's were done on leverage and now the banks are in trouble from having to fund what they were previously borrowing from or laying off on other entities. I believe this is the source of the excess credit that is now going to speculation, also leveraged, instead of coming back to take the assets funded by this money off the books of the banks. So, the CDO pipeline is clogged, the corporate takeover finance pipeline is clogged and the GSE backed paper pipeline is also getting stopped up. There is rampant speculation on the futures market and the longs are winning for the time being. But the prices have reached levels that I am sure the shorts are going to be content in making delivery, another margin call and wipe out in the making.
I had a sort of dream where the government was promoting our dollar as being backed by our debts. The pieces of papers we call dollars are so tied to possession of literally everything in America and most world trade that few that doubt it realize how important it is. Much of this debt is going bad and what is going on is the wipe out of leveraged lender capital. The monetary base in the US has been leveraged about 12 times, 50 if you count all debt, but 12 if you go to M-3. The difference between the base and the 12 times is leverage. These losses are coming out of the leverage. To wit, look at the Carlyle deal or the Peloton deal. These are 2 leveraged players that aren't playing any more. Their capital was used by the banks to create over $30 per dollar put up by them. Indirectly, there was over $20 billion on what should be capital created out of thin air. Now that the risk is there, I highly doubt the banks want to put up the $3 billion or more that should be behind these instrument and may sell them into the market. Result? It would by itself result in a decline in the money supply of $21 billion.
In any case, I don't recall all of this dream, but it seems I was getting the message the government was egging the people on to pay their debts to keep their money. What bad debts do is wipe out the capital necessary to make more money to service more debt. The idea isn't that the debts are ever going to be paid, only that they can be serviced with nice income coming to the bankers, depositor and those drawing interest. The bankers may be broke and if so, the manufacture of extra funds in the system will cease, Federal reserve or no Federal reserve.
We are going to deflate. The inflationists are misreading what is going on because they don't understand the math involved in debt and why it was necessary to expand the debt exponentially. We are at a fork in the road where the next event is going to be a default by someone like a GMAC, an entity that makes Bear Stearns look like a pimple on an elephants butt. We are already seeing auction after auction of municipal paper fail every week. What happens when the commercial paper auctions start failing and the money market funds freeze up? Well in short order, there goes most peoples stock trading accounts right out the window. The inflationists don't really understand how this is linked and instead keep focusing on what in the end will cause deflation, not inflation, the supposed level of M-3. The supposed increase of M-3 is inflation that has already happened, not inflation that will happen. It in the end will reflect the point reached that there is nothing to be added to the inflation and now the game is over.
There isn't anything left for the game to do but deflate. The inflationists are screaming about the Fed trading what they call worthless credit for worthless mortgages. If the homes of the US are going to zero, why the hell own anything Just move out into the street. The idea that we have hyperinflaion and houses go to zero is flat stupid. It is people making statements that are contradictory. In any case, why would a bank give up its best assets for Fed cash when it can create the stuff itself on its won books by making additional loans? The additional loans are the real question. Additional loans to whom? Subprime borrowers? People with millions in their accounts? Carlyle Capital so they can burn them for more when hyperinflation blows out the value of the collateral? I hate to say it, but the gig is up.
What is the direction? For one, all involved need more money and it won't be coming from the banking system pretty soon. China and India are going to soon find the flow of dollars inadequate and have to cut back themselves. The Arabs are going to find themselves over extended. Oil might be $110 a barrel, but the supplies are piling up. Supply could drop 10% and they could cut their production 10% and maintain the price, but most likely the price would have to collapse first and it then takes a shortage to put the price back up. What if it is 10% less oil at 50% less price, well within the realm of possibility. The US trade deficit vanishes and that sucking sound is the US debt service sucking dollars right down the drain. It might take a year, 2 years, but I wouldn't gauge it on what happens in the oil markets day to day, the gold market day to day or any market day to day, as the world is still playing bubble games when game is over.
The problem of course is where the dollars are, not how many there are. It appears the banks screwed up the credit system so badly that the last round of fundings they did are still out there, now chasing commodities around the world. The dollar is falling against all currencies because the only mechanism the Fed has to fix things is hope that interest rates will stimulate borrowing. Borrowing to whom and for what? It appears the only borrowing that is even attempted is for speculation and for keeping mistakes afloat. The liquidations of investment firms recently that had been speculating on securities bought with huge leverage pulled into question the solvency of some of the banks that financed these transactions and Bear is the one that had the run on it. I suspect there are plenty more of them and I wouldn't be surprised if there isn't some favored fund out there with positions many times the size of Carlyle Capitals $21 billion and for that matter even more under water.
It is clear the Fed took the action of swapping treasuries for mortgage backed securities of the FNMA, GNMA type. You would think by the talk that they paid par for CDO's backed by sub-prime mortgages. If the FNMA paper isn't any good, the US is probably cooked for good as it is indirect ownership in the majority of homes financed in the US. Some people say this is risky, but I am quite sure the Fed has margin requirements on these funds and will settle up every so many days and hopefully reverse the transaction. In any case, the Fed is taking risks, but the deeds of houses is a lot more than just paper. It was clear the market wasn't going to digest the sale of $200 billion in mortgage backed securities at this time and such a sale would have called into question more leveraged funds.
There are many points here. For one, I think the big point is that the banking system is near broke. They might have pretty balance sheets, but the debts are noncollectable in a lot of ways. The economy won't be bailed out by low interest rates because the banks won't lend at these rates and people that need to borrow now in this high cash balance system are high risks. I think the speculators of the world are trying to knock over the dollar, which is actually next to impossible and the next big loss is going to be the rampant rebound as the real issues start to hit home. What are the real issues?
The number one issue that is just starting to sink in is that leverage is getting more and more dangerous and at the same time, there are more and more people engaged in it. It isn't just the United States, as the world has been awash in leveraged credit. We found out the CDO's were done on leverage and now the banks are in trouble from having to fund what they were previously borrowing from or laying off on other entities. I believe this is the source of the excess credit that is now going to speculation, also leveraged, instead of coming back to take the assets funded by this money off the books of the banks. So, the CDO pipeline is clogged, the corporate takeover finance pipeline is clogged and the GSE backed paper pipeline is also getting stopped up. There is rampant speculation on the futures market and the longs are winning for the time being. But the prices have reached levels that I am sure the shorts are going to be content in making delivery, another margin call and wipe out in the making.
I had a sort of dream where the government was promoting our dollar as being backed by our debts. The pieces of papers we call dollars are so tied to possession of literally everything in America and most world trade that few that doubt it realize how important it is. Much of this debt is going bad and what is going on is the wipe out of leveraged lender capital. The monetary base in the US has been leveraged about 12 times, 50 if you count all debt, but 12 if you go to M-3. The difference between the base and the 12 times is leverage. These losses are coming out of the leverage. To wit, look at the Carlyle deal or the Peloton deal. These are 2 leveraged players that aren't playing any more. Their capital was used by the banks to create over $30 per dollar put up by them. Indirectly, there was over $20 billion on what should be capital created out of thin air. Now that the risk is there, I highly doubt the banks want to put up the $3 billion or more that should be behind these instrument and may sell them into the market. Result? It would by itself result in a decline in the money supply of $21 billion.
In any case, I don't recall all of this dream, but it seems I was getting the message the government was egging the people on to pay their debts to keep their money. What bad debts do is wipe out the capital necessary to make more money to service more debt. The idea isn't that the debts are ever going to be paid, only that they can be serviced with nice income coming to the bankers, depositor and those drawing interest. The bankers may be broke and if so, the manufacture of extra funds in the system will cease, Federal reserve or no Federal reserve.
We are going to deflate. The inflationists are misreading what is going on because they don't understand the math involved in debt and why it was necessary to expand the debt exponentially. We are at a fork in the road where the next event is going to be a default by someone like a GMAC, an entity that makes Bear Stearns look like a pimple on an elephants butt. We are already seeing auction after auction of municipal paper fail every week. What happens when the commercial paper auctions start failing and the money market funds freeze up? Well in short order, there goes most peoples stock trading accounts right out the window. The inflationists don't really understand how this is linked and instead keep focusing on what in the end will cause deflation, not inflation, the supposed level of M-3. The supposed increase of M-3 is inflation that has already happened, not inflation that will happen. It in the end will reflect the point reached that there is nothing to be added to the inflation and now the game is over.
There isn't anything left for the game to do but deflate. The inflationists are screaming about the Fed trading what they call worthless credit for worthless mortgages. If the homes of the US are going to zero, why the hell own anything Just move out into the street. The idea that we have hyperinflaion and houses go to zero is flat stupid. It is people making statements that are contradictory. In any case, why would a bank give up its best assets for Fed cash when it can create the stuff itself on its won books by making additional loans? The additional loans are the real question. Additional loans to whom? Subprime borrowers? People with millions in their accounts? Carlyle Capital so they can burn them for more when hyperinflation blows out the value of the collateral? I hate to say it, but the gig is up.
What is the direction? For one, all involved need more money and it won't be coming from the banking system pretty soon. China and India are going to soon find the flow of dollars inadequate and have to cut back themselves. The Arabs are going to find themselves over extended. Oil might be $110 a barrel, but the supplies are piling up. Supply could drop 10% and they could cut their production 10% and maintain the price, but most likely the price would have to collapse first and it then takes a shortage to put the price back up. What if it is 10% less oil at 50% less price, well within the realm of possibility. The US trade deficit vanishes and that sucking sound is the US debt service sucking dollars right down the drain. It might take a year, 2 years, but I wouldn't gauge it on what happens in the oil markets day to day, the gold market day to day or any market day to day, as the world is still playing bubble games when game is over.
Thursday, March 13, 2008
Where do we go next?
It is clear by the comments on the Prudent Bear board that they don't expect another rally ever in the dollar. By comparison to 1987, it appears to me that the dollar isn't under so much pressure as one would think. 87 was a hell of a move against the dollar. This move, though solid with the Euro, is mainly with the yen. The yen has been undervalued for decades and now that the interest rates are matching a little more, moves back to the 1990's highs are more like it. People forget the dollar traded as low as somewhere in the 80's in yen. I cannot recall how low in the 80's, but I can recall around 88. The effect of a low yen has been devastating on the US auto market for decades, as prices most likely haven't moved in Japan, save commodities for close to 2 decades now and yet the yen has traded down on the international market.
My point here is we have another mania in commodities. Only a few grains are really in short supply. The rest are just being chased by every available speculative dollar out there. We are nearing the stage where there is only on side of the trade to have and when a market gets to that point, it is the side you don't want. Who can take the short side in any of this stuff and not get killed except an entity that has the stuff to deliver. If I was in any of these businesses, gold, silver, copper, oil, natural gas, wheat, soybeans, you name it, my stuff would be for sale right now. I would have it sold next year as well and the next year after until the price fell to a point I know I would want to buy it back. That is where this is going to end up and people don't realize that commodities aren't stocks. The guys that want to give it to you on delivery are going to insist you take it. You can take it and throw it back in stocks. The same isn't so true in commodities. The commercial longs have company and they know the market better than the specs. I wouldn't be surprised to see the commercial longs get out as prices go higher and buy from the spot market after the specs get stuck with the stuff. None of the specs have any use for 50,000 bushels of wheat, 5000 barrels of oil or 210,000 gallons of gasoline unless they are laying in a life supply.
Gold is the same way. We are reaching prices where as recession sets in, people are going to start recycling old jewelry. I overheard a guy Thursday in a restaurant talking about some kid that wants to get something for their old gold. As the economy in India slows down, we will see it come out of there by the ton, along with silver. There is nothing new under the sun and we are reaching prices where only gangsters will show it off.
This is a deflation that is going to bite. I know this because the driver of prior borrowing is on its butt. Housing prices are slipping, which means that credit generated from home buying activities is shrinking. Auto sales are shrinking. Corporate expansion is shrinking. China is going to slow down and Europe is going to catch cold. There is a lot of stuff just going to suddenly turn insolvent. We are at the end of a cycle.
Speculating long in a credit crunch is like playing golf in a hail storm. We aren't in the late 1980's, we are in a period following the maximum financing of everything at a time when the largest generation in US history is entering retirement underfunded. We have 20 somethings that don't have a clue what a recession looks like and 30 somethings that have little clue as to what a really tough recession looks like. They called the early 1990's the worst economy in 50 years, but I think it had been so bad here that I didn't realize it until I actually read statistics about it. I think it paled in comparison to the mid 70's oil and inflation shock recession where unemployment went from near full in 1972 to almost double digit in 1975. We never saw those early 1970's unemployment rates again, not even in the late 1990's.
It is really kind of entertaining to watch people go haywire over being long goods that are supposed to do really poorly going forward. I think we are going to see a 1907 type storm before long and there are going to be thousands go broke in this commodity craze. Few know how angry the bear can get in these goods, as the market just locks down. Stops don't work when there isn't anything on the other side of the trade except limit down. You can lose your life savings when this happens, not what you have up, but everything you own.
My point here is we have another mania in commodities. Only a few grains are really in short supply. The rest are just being chased by every available speculative dollar out there. We are nearing the stage where there is only on side of the trade to have and when a market gets to that point, it is the side you don't want. Who can take the short side in any of this stuff and not get killed except an entity that has the stuff to deliver. If I was in any of these businesses, gold, silver, copper, oil, natural gas, wheat, soybeans, you name it, my stuff would be for sale right now. I would have it sold next year as well and the next year after until the price fell to a point I know I would want to buy it back. That is where this is going to end up and people don't realize that commodities aren't stocks. The guys that want to give it to you on delivery are going to insist you take it. You can take it and throw it back in stocks. The same isn't so true in commodities. The commercial longs have company and they know the market better than the specs. I wouldn't be surprised to see the commercial longs get out as prices go higher and buy from the spot market after the specs get stuck with the stuff. None of the specs have any use for 50,000 bushels of wheat, 5000 barrels of oil or 210,000 gallons of gasoline unless they are laying in a life supply.
Gold is the same way. We are reaching prices where as recession sets in, people are going to start recycling old jewelry. I overheard a guy Thursday in a restaurant talking about some kid that wants to get something for their old gold. As the economy in India slows down, we will see it come out of there by the ton, along with silver. There is nothing new under the sun and we are reaching prices where only gangsters will show it off.
This is a deflation that is going to bite. I know this because the driver of prior borrowing is on its butt. Housing prices are slipping, which means that credit generated from home buying activities is shrinking. Auto sales are shrinking. Corporate expansion is shrinking. China is going to slow down and Europe is going to catch cold. There is a lot of stuff just going to suddenly turn insolvent. We are at the end of a cycle.
Speculating long in a credit crunch is like playing golf in a hail storm. We aren't in the late 1980's, we are in a period following the maximum financing of everything at a time when the largest generation in US history is entering retirement underfunded. We have 20 somethings that don't have a clue what a recession looks like and 30 somethings that have little clue as to what a really tough recession looks like. They called the early 1990's the worst economy in 50 years, but I think it had been so bad here that I didn't realize it until I actually read statistics about it. I think it paled in comparison to the mid 70's oil and inflation shock recession where unemployment went from near full in 1972 to almost double digit in 1975. We never saw those early 1970's unemployment rates again, not even in the late 1990's.
It is really kind of entertaining to watch people go haywire over being long goods that are supposed to do really poorly going forward. I think we are going to see a 1907 type storm before long and there are going to be thousands go broke in this commodity craze. Few know how angry the bear can get in these goods, as the market just locks down. Stops don't work when there isn't anything on the other side of the trade except limit down. You can lose your life savings when this happens, not what you have up, but everything you own.
Short recession, Long recession, credit bubble?
I just witnessed a bull/bear debate. At least it was sort of a debate. It was really an opinion from one party and statistics from another about the current situation. The poor gal that was hosting the debate, usually Maria, but the Asian girl instead, was squirming. I know she was really nervous about getting the bearish side out of the man who was supposed to be presenting the bullish news. The man with the statistics agreed that a long recession wouldn't turn stocks up 12% after a few months of recession. The last one didn't, as the bottom of the market didn't happen until about a year after they said the recession was done.
There is one major thing wrong with all markets today, in that they have it all broken down from the past what the market will do in the future. This means there really isn't any use for the current picture, just hold on and you will get rich in a year or at least well. The bull case forgets that the gain after the recession starts is geared to short recessions and geared to markets that discounted themselves significantly before the recession started. This one made a new peak when it was clear we were having credit crunch troubles and the recession was likely coming. There is no thought of a recession because the traders have no experience of recessions and because they studied the past so accurately, they know they can't get out now because they are going to miss 12%.
This holds in the gold market as well. 1980 was 28 year mistake, meaning if you bought at the top that seems to be the natural target, you spent 28 years with your money devaluing and no interest waiting to get even nominally. Instead of seeing 1980 as it was, they see it as the real value of gold. In fact, they seem to be oblivious to the idea that gold can have a speculative valule more so than a real value. It went to $800 in 1980 dollars, so it should go back to $800 in 1980 dollars again. Gold should be $2400 and the recession should be over and bulls be rich in a matter of months. Both won't happen and if one doesn't happen, it is quite likely the other doesn't happen too.
The Asian analyst, the one with the post recession start statistics, noted the 1988-1990 recession. He fails to note that it was 1992 before the market really took out the 1987 highs and stayed up there. Second, the 1987 trough was lower than any trough after that and third, stock valuations were 50% of what they are now. Fourth, a credit bubble started building in the late 1980's and blew up in the 1990's and has created the values today Anyone with a brain, as the other analyst tried to indicate, has to recognize the credit bubble has burst and it probably isn't going to be resurrected again. There is likely $20 trillion in debt in the US and much more worldwide that has to be wiped out and we are just starting. Most of it will come out of the earnings and defaults of SPX companies. Stocks depend on credit for their valuation. Without the capacity to increase the after interest real money supply, there is no growth in corporate earnings. In fact, they probably decline along with the capacity to pay dividends.
It hasn't occurred to most folks what is going on. What is going on in the world is a speculative craze that ignores everything. They keep talking bad news on CNBC. I remember what bad news was, it was 9% unemployment. Instead, they spin anything that is good news and only talk about the bad news in light of the good news they just received. An example is the mono-line insurers who were hardly mentioned except in indicating they were undergoing a successful bailout. Meanwhile, the decline in retail sales isn't even posted this afternoon on the Prudent Bear page.
The structured finance business is breaking down. This means we not only won't import as much from Asia, but most likely will scale down consumption of everything. The system is seeking capital and it is only a matter of time before prices have to decline to meet the available capital, as what has been floated on credit is now seen as to risky for the banks and for the entities and people leveraging their capital.
We have a problem in that everyone is bullish. They might be bearish for a few days, but the first time some idiot indicates we are finished with the bad stuff (SP saying we were near the end of the subprime write downs, like that is the entire ball of wax out there), the markets are off to the races. When the Fed says they will help the system digest forced liquidation of FNMA mortgage backed securities, the whole world takes it as if the Fed gave away something. The truth is the banks owe them back the treasuries and any margin in the meantime. The Fed printed nothing and gave away nothing. The system is that much in hock on a cash basis.
The effects of a credit bubble can only be replicated by another credit bubble. The system has taken some losses, but they had home equity to blow up the leaking bubble during the dotcom meltdown. There isn't any home equity this time and there won't be much left of the credit bubble. We have trillions of losses and debt shrinkage ahead of us.
There is one major thing wrong with all markets today, in that they have it all broken down from the past what the market will do in the future. This means there really isn't any use for the current picture, just hold on and you will get rich in a year or at least well. The bull case forgets that the gain after the recession starts is geared to short recessions and geared to markets that discounted themselves significantly before the recession started. This one made a new peak when it was clear we were having credit crunch troubles and the recession was likely coming. There is no thought of a recession because the traders have no experience of recessions and because they studied the past so accurately, they know they can't get out now because they are going to miss 12%.
This holds in the gold market as well. 1980 was 28 year mistake, meaning if you bought at the top that seems to be the natural target, you spent 28 years with your money devaluing and no interest waiting to get even nominally. Instead of seeing 1980 as it was, they see it as the real value of gold. In fact, they seem to be oblivious to the idea that gold can have a speculative valule more so than a real value. It went to $800 in 1980 dollars, so it should go back to $800 in 1980 dollars again. Gold should be $2400 and the recession should be over and bulls be rich in a matter of months. Both won't happen and if one doesn't happen, it is quite likely the other doesn't happen too.
The Asian analyst, the one with the post recession start statistics, noted the 1988-1990 recession. He fails to note that it was 1992 before the market really took out the 1987 highs and stayed up there. Second, the 1987 trough was lower than any trough after that and third, stock valuations were 50% of what they are now. Fourth, a credit bubble started building in the late 1980's and blew up in the 1990's and has created the values today Anyone with a brain, as the other analyst tried to indicate, has to recognize the credit bubble has burst and it probably isn't going to be resurrected again. There is likely $20 trillion in debt in the US and much more worldwide that has to be wiped out and we are just starting. Most of it will come out of the earnings and defaults of SPX companies. Stocks depend on credit for their valuation. Without the capacity to increase the after interest real money supply, there is no growth in corporate earnings. In fact, they probably decline along with the capacity to pay dividends.
It hasn't occurred to most folks what is going on. What is going on in the world is a speculative craze that ignores everything. They keep talking bad news on CNBC. I remember what bad news was, it was 9% unemployment. Instead, they spin anything that is good news and only talk about the bad news in light of the good news they just received. An example is the mono-line insurers who were hardly mentioned except in indicating they were undergoing a successful bailout. Meanwhile, the decline in retail sales isn't even posted this afternoon on the Prudent Bear page.
The structured finance business is breaking down. This means we not only won't import as much from Asia, but most likely will scale down consumption of everything. The system is seeking capital and it is only a matter of time before prices have to decline to meet the available capital, as what has been floated on credit is now seen as to risky for the banks and for the entities and people leveraging their capital.
We have a problem in that everyone is bullish. They might be bearish for a few days, but the first time some idiot indicates we are finished with the bad stuff (SP saying we were near the end of the subprime write downs, like that is the entire ball of wax out there), the markets are off to the races. When the Fed says they will help the system digest forced liquidation of FNMA mortgage backed securities, the whole world takes it as if the Fed gave away something. The truth is the banks owe them back the treasuries and any margin in the meantime. The Fed printed nothing and gave away nothing. The system is that much in hock on a cash basis.
The effects of a credit bubble can only be replicated by another credit bubble. The system has taken some losses, but they had home equity to blow up the leaking bubble during the dotcom meltdown. There isn't any home equity this time and there won't be much left of the credit bubble. We have trillions of losses and debt shrinkage ahead of us.
Wednesday, March 12, 2008
Asset Inflation?
The gold bulls say the fed is printing money? http://www.federalreserve.gov/releases/h3/Current/
The link above shows that printing has been very minimal according to Fed statistics. In fact, the most recent monetary base was lower than it was in August 2007. No new hundred dollar bills floating out the window here is there Ma.
http://www.federalreserve.gov/releases/z1/Current/z1.pdf
This link is the most recent Fed Z1. If you go to page 14, you will note that credit creation fell significantly in 2007. Consumer borrowing fell significantly while business borrowing rose significantly, but the total percentage gain was down from 2006. Where borrowing was up was in the financial sector. Where are we having trouble right now? The financial sector.
This is one of the keys to what is happening at this time. Where is the really bad news? It is the financial sector. What was the financial sector doing? My observation was it was borrowing money to buy the debt the banks issued, thus keeping it off the books of the banks. This sector is broken.
We are in the midst of a huge deflation that is being disguised as an inflation. The system that supported the inflation has broken down and there isn't one to replace it. Financial lending is illustrated by the $21 Billion borrowed by Carlyle Capital Corp. to finance leveraged longer term loans. It is the money borrowed by Peloton that ended up in the implosion of that company. These loans are being liquidated now and the system doesn't have the capital to take on this debt, meaning someone is either going to have to replace the credit or the assets are going to be written down.
Now we have this huge commodity inflation going on. This is a remnant bubble due to the risk in paper and the decline in what drives the stock market. There is one asset here that has huge monetary value, gold. If gold is money, then gold is actually inflating the nominal money supply. That is, the inflation here just might be gold and the gold bull market instead of an actually declining dollar. The currency differentials of major nations are generally a reflection of interest rate differentials and not purchasing power differentials. Part of what launched the gold bull wasn't a decline in the worth of the dollar, but a decline in the interest rates. Lower interest rates this time won't equate to higher borrowing for a couple of reasons.
Before I go to those reasons, lets examine what $1000 gold is in relation to $500 gold? Well, for the main part, this now represents around $5.3 trillion in money in the system. You can trade this stuff as if it is actual cash, maybe with a little more effort. When gold was $500 an ounce, this represented only $2.6 trillion, an increase of $2.7 trillion (I am adding a little for the gold mined). The monetary base of the United States is $822.4 billion, merely 1/6th of the current value of all the worlds gold. Don't get into M-2 and M-3 because these have nothing to do with the monetary base, but with bank liabilities. In any case, I find it highly doubtful that the world gold supply is worth even a minor fraction of the housing in the US, much less all the homes, factories, streets, educations, and minerals in the US.
There is one thing that the M-2 and M-3 will do right now, buy gold and gold will acquire the monetary base of the US 6 times over. What gold will do right now is buy a lot more assets on the market than it would, being an inflated asset itself. Being that it is money to the point of meeting the definition of money, we are now experiencing through a bull market, a massive inflation with gold. It isn't the currency inflating gold, it is the bull market inflating gold.
The gold bulls forget one thing, the sellers? I saw a post on the Prudent Bear page that said "Gold shorts report to your local homeless shelter". Who does this guy think these shorts are? They are clearly the very few people that hold about all the gold in the world, being that the pissants on the Prudent Bear board in sum couldn't come up with the interest earned on the gold one of these guys holds for a month. Remember, the monetary base of the US is flat to falling and who do you think will have it all when the longs have bought all the gold they can stand to have?
The banks aren't in shape to make new loans. The financial boom is over, as we are now seeing the mere beginnings of the liquidation of that bubble. Banks are going to have a harder and harder time relating their liabilities and their reserves to this monetary base. Banks are hocking their stuff to the Fed, not the Fed printing and giving cash to the banks as is assumed. The only giving the Fed does is in forcing the interest rate on the overnight money down. The banks are insolvent and their capacity to produce more money is falling and the amount of liabilities they can carry on their balance sheet is also declining. The system is keeping secrets to keep this net worth as high as possible and filter out the losses over time instead of all at once. In the meantime, it appears that gold is going to serve as the inflation for the system.
Why won't lower interest rates equate to higher borrowing? For 2 reason mainly. One is the public is out of credit and usually doesn't get much lower rates in a situation like this in the first place. The other reason is risk. The prime borrowers of money recently was the financial system outside the banks. Hedge funds, finance companies and the such who leveraged debt against higher yielding debt. The asset base has broken down and the banks this time around aren't going to lend the carry to these guys to get fat on these borrow short and lend long situations. Plus, the idea that the Fed is going to have to raise rates as soon as possible is also in the works right now. Not too many badly burned risk takers wants to walk into that situation in a system that won't ever have the liquidity it had in the past. The system is leveraged up and low rates won't fix it this time.
The link above shows that printing has been very minimal according to Fed statistics. In fact, the most recent monetary base was lower than it was in August 2007. No new hundred dollar bills floating out the window here is there Ma.
http://www.federalreserve.gov/releases/z1/Current/z1.pdf
This link is the most recent Fed Z1. If you go to page 14, you will note that credit creation fell significantly in 2007. Consumer borrowing fell significantly while business borrowing rose significantly, but the total percentage gain was down from 2006. Where borrowing was up was in the financial sector. Where are we having trouble right now? The financial sector.
This is one of the keys to what is happening at this time. Where is the really bad news? It is the financial sector. What was the financial sector doing? My observation was it was borrowing money to buy the debt the banks issued, thus keeping it off the books of the banks. This sector is broken.
We are in the midst of a huge deflation that is being disguised as an inflation. The system that supported the inflation has broken down and there isn't one to replace it. Financial lending is illustrated by the $21 Billion borrowed by Carlyle Capital Corp. to finance leveraged longer term loans. It is the money borrowed by Peloton that ended up in the implosion of that company. These loans are being liquidated now and the system doesn't have the capital to take on this debt, meaning someone is either going to have to replace the credit or the assets are going to be written down.
Now we have this huge commodity inflation going on. This is a remnant bubble due to the risk in paper and the decline in what drives the stock market. There is one asset here that has huge monetary value, gold. If gold is money, then gold is actually inflating the nominal money supply. That is, the inflation here just might be gold and the gold bull market instead of an actually declining dollar. The currency differentials of major nations are generally a reflection of interest rate differentials and not purchasing power differentials. Part of what launched the gold bull wasn't a decline in the worth of the dollar, but a decline in the interest rates. Lower interest rates this time won't equate to higher borrowing for a couple of reasons.
Before I go to those reasons, lets examine what $1000 gold is in relation to $500 gold? Well, for the main part, this now represents around $5.3 trillion in money in the system. You can trade this stuff as if it is actual cash, maybe with a little more effort. When gold was $500 an ounce, this represented only $2.6 trillion, an increase of $2.7 trillion (I am adding a little for the gold mined). The monetary base of the United States is $822.4 billion, merely 1/6th of the current value of all the worlds gold. Don't get into M-2 and M-3 because these have nothing to do with the monetary base, but with bank liabilities. In any case, I find it highly doubtful that the world gold supply is worth even a minor fraction of the housing in the US, much less all the homes, factories, streets, educations, and minerals in the US.
There is one thing that the M-2 and M-3 will do right now, buy gold and gold will acquire the monetary base of the US 6 times over. What gold will do right now is buy a lot more assets on the market than it would, being an inflated asset itself. Being that it is money to the point of meeting the definition of money, we are now experiencing through a bull market, a massive inflation with gold. It isn't the currency inflating gold, it is the bull market inflating gold.
The gold bulls forget one thing, the sellers? I saw a post on the Prudent Bear page that said "Gold shorts report to your local homeless shelter". Who does this guy think these shorts are? They are clearly the very few people that hold about all the gold in the world, being that the pissants on the Prudent Bear board in sum couldn't come up with the interest earned on the gold one of these guys holds for a month. Remember, the monetary base of the US is flat to falling and who do you think will have it all when the longs have bought all the gold they can stand to have?
The banks aren't in shape to make new loans. The financial boom is over, as we are now seeing the mere beginnings of the liquidation of that bubble. Banks are going to have a harder and harder time relating their liabilities and their reserves to this monetary base. Banks are hocking their stuff to the Fed, not the Fed printing and giving cash to the banks as is assumed. The only giving the Fed does is in forcing the interest rate on the overnight money down. The banks are insolvent and their capacity to produce more money is falling and the amount of liabilities they can carry on their balance sheet is also declining. The system is keeping secrets to keep this net worth as high as possible and filter out the losses over time instead of all at once. In the meantime, it appears that gold is going to serve as the inflation for the system.
Why won't lower interest rates equate to higher borrowing? For 2 reason mainly. One is the public is out of credit and usually doesn't get much lower rates in a situation like this in the first place. The other reason is risk. The prime borrowers of money recently was the financial system outside the banks. Hedge funds, finance companies and the such who leveraged debt against higher yielding debt. The asset base has broken down and the banks this time around aren't going to lend the carry to these guys to get fat on these borrow short and lend long situations. Plus, the idea that the Fed is going to have to raise rates as soon as possible is also in the works right now. Not too many badly burned risk takers wants to walk into that situation in a system that won't ever have the liquidity it had in the past. The system is leveraged up and low rates won't fix it this time.
Tuesday, March 11, 2008
Fed to the rescue?
I think it is time we have a debate here instead of the Bear Board. The posts of the debate get lost too quickly. It appears there is a massive difference of opinion as to what is going on here and I am going to add my two cents worth as I usually do.
As most of you know, I am a deflation guy. It has been my supposition for a long time that the mechanism of lending would break down and the stuff would freeze up and assets and monetary support would start going bad. It is clear to me that has happened. Those that disagree with me are too interested in what the Fed is doing and what commodities are doing to see what is happening. It hasn't occurred to them that operations like Carlyle are folding like cheap metal chairs, but instead like to claim the Fed is throwing money in the streets, just printing it up and throwing it out there with nothing in exchange. We couldn't be further from the truth.
The world has run out of good credit. The United States has been the last resort since 1944, but the world cannot see that. The world has accepted dollars because they needed them to expand their own economies and they have little to do with price levels. The flow of dollars has to do with price levels and the world is addicted to them.
First to the commodities. They have been bulled for a long time and the world is now afraid to recycle their dollars for the paper Wall Street has been putting on them. The float on commodities, once you get past gold, are ridiculously thin. If the company Microsoft changes in value $1 per share, the value of it changes $10 billion. Before the price run up, you could buy almost 2 days supply of oil on the world market for $10 billion. If one was to put in a position to hoard on a permanent and rolling basis 2 days supply of oil, they could drive the price about as high as could be imagined. It would be kind of like pulling 30 minutes supply of oxygen out of a room for a complete day. Someone is going to have to leave the room. The surplus supply of grains and most other commodities is even thinner.
To illustrate, there was rumored to be a 600 million ounce supply of silver in the world. I know this to not be true because if there was, the market would have been out of it a decade ago, the first time someone wanted to corner it. The bulls claimed the shorts just sold more of it to keep the price down. This is absurd. There is nothing ever said that could be more absurd, as the longs were the ones that weren't in the market. All the contracts expired and all the longs had to do is demand delivery. It would have taken all of $3 billion to pick up the entire rumored supply of silver in the world. Of course, the real supply is probably 30 times that, but the bulls would never let you know there was a 30 year supply of silver out there. I should get some debate on this, but I will only say that if the 600 million ounce supply was correct, then the market should have been cornered years ago.
The point here is that it is probably easier to squeeze the world supply of commodities higher than it is to squeeze the world supply of Microsoft higher. The SWF's in Asia are without use for the dollars they previously recirculated through the credit markets here and are instead laying in a supply of commodities. Thus they are paying a price with dollars they sold manufactured good or oil for. Being we do have a shortage of grains, due to more people being able to eat better food, driving the price of these grains higher isn't hard to do.
This move in commodities is being viewed as inflation. But, people forget what inflation is, the creation of debt to buy what was on the market before someone else could buy it. The confusion isn't over inflation, but when the inflation happened. I venture we are watching another bubble, the last bubble. The easiest bubble of all to blow up and the most risky when it deflates. What caused it?
The same thing that has caused the banks problems, unmarketable securities. The banks funded all kinds of stuff they were basically creating for resale. This included mortgage backed securities, debt to take over corporations put together for firms like Blackstone, KKR, Carlyle and others that I won't or can't name. The habit was fund this debt, put the credit out there, usually through an asset backed commercial paper game and liquidate it out to the world. So much of it was CDO's backed by sub-prime mortgages that all of a sudden, they couldn't move it, as word got out this stuff was almost unidentifiable and that certain portions of these CDO's were literally worthless. Then the ABCP market froze and the banks had to create credit on assets they were now stuck with. This is like pulling yourself up by your own bootstraps, in that you can't be your own creditor. Banks don't have accounts, they have assets and liabilities. The liabilities are accounts, so they were using their net worth to acquire this stuff that was falling in value. This created a lack of funds in the system and excess credits outside the system, as the banks couldn't cancel the credit they had to create to fund this stuff they previously funded out of ABCP.
This is where I am going to part company with those that think we are suddenly headed for hyperinflation in a system where lending to any significant degree has frozen up in the most important trade partner in the world. It is clear that this insolvency extends to Europe and the next banking system to implode is going to be Britain. To illustrate what I am saying here, I am going to put up what it seems the sky is falling inflationists believe and what I believe and understand about the banking system. These infusions are different than the past ones.
First of all, the banks are exchanging assets. The Fed is getting good assets. It appears that many of you want to dispute this and that the Fed is just printing money on junk. The Fed has a right to a margin call. http://www.frbdiscountwindow.org/required.cfm?hdrID=19&dtlID=42
There are other documents here, just surf the site and you will find them. What you will find is the Fed requires more collateral than they will loan funds and the stuff has to have a market value, even though the chart infers it doesn't. I don't think you are going to find them taking any level 3 assets and if they do, it will be on solid evidence they have value and I believe the LTV will be 80% of estimated value.
When a bank gives up its assets to the fed, What it gets is other assets called cash or something like cash. Cash don't pay any interest to start. Second, they now have non interest bearing assets to back their liabilities. This won't allow them to create a single dime of extra credit, only service their liabilities between them, their customers and other banks. I think we will find this problem is going to get worse unless the securities they are stuck with suddenly become marketable.
So, why isn't this inflationary? It isn't inflationary because it is to fund money already created, not allow for the creation of more money. This is the money they need to pay their bills for taking the SIV's on their books. It is the money they need to raise because their creation of deposits to fund their own stuff that exceeded their net worth was a fraud in a sense. You might look at http://www.federalreserve.gov/releases/h3/Current/
In this report you might note that there was an excess of $17.265 billion in borrowed reserves over reserves. It shows an excess reserve of $1.8 billion, but I highly doubt this is accurate. The Fed isn't reflecting the true financial position of the banks, which is probably better reflected by the $17.265 deficit in reserves on their books. For those that believe they are printing money here, you might examine the monetary base. Though the auctions have raised $60 billion, monetary base has changed all of $7 billion for the past year, less than 1%.
Why is this not raising the monetary base? Because these invented funds are already in the money supply. The banks can't fund their own liabilities is why they are borrowing the liquidity. This evidently hasn't registered to most of those out there, that the $60 billion or $200 billion or whatever amount you want to talk about has been out there for awhile. This is more like a grocery store going to the bank to get cash to cash more checks.
Here is the deal. Lets say the Fed buys everything out there? What do they have if they buy everything out there? They have all the collateral available to create good credit. The banks then have non interest bearing cash and they owe all the money in the banks to those that are their depositors. At this point, the system might as well shut down and go home because the casino is out of chips. The depositors would remove their cash, go form combines and buy the assets that were worth a damn back from the Fed. In the meantime, the banks would be out of business.
What is going on is clearly being misunderstood. We haven't seen the result of what is going on because the fundings of the SIV's are still floating around the system. This money is chasing commodities, but it is stuff that has already been funded. The system is going to keep getting tighter, as it has no capacity to create new credit. In a month, the Fed will probably roll this new liquidity in the system after asking the banks for their interest payments and reassessing the collateral. The system will have less money in it and the squeeze will start again. We are at the tip of the iceberg here.
At some point, we are going to see the effects of this on world trade. I think we are going to see oil consumption drop. The next shoe to drop is going to be a panic in the Asian markets, as the dollar gravy train is coming to an end. There is going to be a massive retrenchment in US consumer spending because there is going to be a retrenchment in consumer credit. The bottom end consumer is going to be left out of the game on a greater and greater basis. Who will you sell your used car to? How about the starter homes, financed previously by sub-prime? What about the junk credit cards? Hard to see how they lose money with their terms, but my guess is they will just go flat.
Lost in this shuffle is the capacity of the system to create new credit instruments. We can't refund the auction debt of municipalities and other entities. We can't fund anything but prime mortgages and that market is getting tough. The insurers are far from being out of the woods. The next bomb is right around the corner. Lower demand will lead to lower capital spending and lower demand for commodities.
I am making one assumption here, that the world isn't going to ditch the United States. I don't know who they can. It would be like taking first and second gear out of a 3 speed transmission. If you floorboard the car, you can get it moving maybe.
As most of you know, I am a deflation guy. It has been my supposition for a long time that the mechanism of lending would break down and the stuff would freeze up and assets and monetary support would start going bad. It is clear to me that has happened. Those that disagree with me are too interested in what the Fed is doing and what commodities are doing to see what is happening. It hasn't occurred to them that operations like Carlyle are folding like cheap metal chairs, but instead like to claim the Fed is throwing money in the streets, just printing it up and throwing it out there with nothing in exchange. We couldn't be further from the truth.
The world has run out of good credit. The United States has been the last resort since 1944, but the world cannot see that. The world has accepted dollars because they needed them to expand their own economies and they have little to do with price levels. The flow of dollars has to do with price levels and the world is addicted to them.
First to the commodities. They have been bulled for a long time and the world is now afraid to recycle their dollars for the paper Wall Street has been putting on them. The float on commodities, once you get past gold, are ridiculously thin. If the company Microsoft changes in value $1 per share, the value of it changes $10 billion. Before the price run up, you could buy almost 2 days supply of oil on the world market for $10 billion. If one was to put in a position to hoard on a permanent and rolling basis 2 days supply of oil, they could drive the price about as high as could be imagined. It would be kind of like pulling 30 minutes supply of oxygen out of a room for a complete day. Someone is going to have to leave the room. The surplus supply of grains and most other commodities is even thinner.
To illustrate, there was rumored to be a 600 million ounce supply of silver in the world. I know this to not be true because if there was, the market would have been out of it a decade ago, the first time someone wanted to corner it. The bulls claimed the shorts just sold more of it to keep the price down. This is absurd. There is nothing ever said that could be more absurd, as the longs were the ones that weren't in the market. All the contracts expired and all the longs had to do is demand delivery. It would have taken all of $3 billion to pick up the entire rumored supply of silver in the world. Of course, the real supply is probably 30 times that, but the bulls would never let you know there was a 30 year supply of silver out there. I should get some debate on this, but I will only say that if the 600 million ounce supply was correct, then the market should have been cornered years ago.
The point here is that it is probably easier to squeeze the world supply of commodities higher than it is to squeeze the world supply of Microsoft higher. The SWF's in Asia are without use for the dollars they previously recirculated through the credit markets here and are instead laying in a supply of commodities. Thus they are paying a price with dollars they sold manufactured good or oil for. Being we do have a shortage of grains, due to more people being able to eat better food, driving the price of these grains higher isn't hard to do.
This move in commodities is being viewed as inflation. But, people forget what inflation is, the creation of debt to buy what was on the market before someone else could buy it. The confusion isn't over inflation, but when the inflation happened. I venture we are watching another bubble, the last bubble. The easiest bubble of all to blow up and the most risky when it deflates. What caused it?
The same thing that has caused the banks problems, unmarketable securities. The banks funded all kinds of stuff they were basically creating for resale. This included mortgage backed securities, debt to take over corporations put together for firms like Blackstone, KKR, Carlyle and others that I won't or can't name. The habit was fund this debt, put the credit out there, usually through an asset backed commercial paper game and liquidate it out to the world. So much of it was CDO's backed by sub-prime mortgages that all of a sudden, they couldn't move it, as word got out this stuff was almost unidentifiable and that certain portions of these CDO's were literally worthless. Then the ABCP market froze and the banks had to create credit on assets they were now stuck with. This is like pulling yourself up by your own bootstraps, in that you can't be your own creditor. Banks don't have accounts, they have assets and liabilities. The liabilities are accounts, so they were using their net worth to acquire this stuff that was falling in value. This created a lack of funds in the system and excess credits outside the system, as the banks couldn't cancel the credit they had to create to fund this stuff they previously funded out of ABCP.
This is where I am going to part company with those that think we are suddenly headed for hyperinflation in a system where lending to any significant degree has frozen up in the most important trade partner in the world. It is clear that this insolvency extends to Europe and the next banking system to implode is going to be Britain. To illustrate what I am saying here, I am going to put up what it seems the sky is falling inflationists believe and what I believe and understand about the banking system. These infusions are different than the past ones.
First of all, the banks are exchanging assets. The Fed is getting good assets. It appears that many of you want to dispute this and that the Fed is just printing money on junk. The Fed has a right to a margin call. http://www.frbdiscountwindow.org/required.cfm?hdrID=19&dtlID=42
There are other documents here, just surf the site and you will find them. What you will find is the Fed requires more collateral than they will loan funds and the stuff has to have a market value, even though the chart infers it doesn't. I don't think you are going to find them taking any level 3 assets and if they do, it will be on solid evidence they have value and I believe the LTV will be 80% of estimated value.
When a bank gives up its assets to the fed, What it gets is other assets called cash or something like cash. Cash don't pay any interest to start. Second, they now have non interest bearing assets to back their liabilities. This won't allow them to create a single dime of extra credit, only service their liabilities between them, their customers and other banks. I think we will find this problem is going to get worse unless the securities they are stuck with suddenly become marketable.
So, why isn't this inflationary? It isn't inflationary because it is to fund money already created, not allow for the creation of more money. This is the money they need to pay their bills for taking the SIV's on their books. It is the money they need to raise because their creation of deposits to fund their own stuff that exceeded their net worth was a fraud in a sense. You might look at http://www.federalreserve.gov/releases/h3/Current/
In this report you might note that there was an excess of $17.265 billion in borrowed reserves over reserves. It shows an excess reserve of $1.8 billion, but I highly doubt this is accurate. The Fed isn't reflecting the true financial position of the banks, which is probably better reflected by the $17.265 deficit in reserves on their books. For those that believe they are printing money here, you might examine the monetary base. Though the auctions have raised $60 billion, monetary base has changed all of $7 billion for the past year, less than 1%.
Why is this not raising the monetary base? Because these invented funds are already in the money supply. The banks can't fund their own liabilities is why they are borrowing the liquidity. This evidently hasn't registered to most of those out there, that the $60 billion or $200 billion or whatever amount you want to talk about has been out there for awhile. This is more like a grocery store going to the bank to get cash to cash more checks.
Here is the deal. Lets say the Fed buys everything out there? What do they have if they buy everything out there? They have all the collateral available to create good credit. The banks then have non interest bearing cash and they owe all the money in the banks to those that are their depositors. At this point, the system might as well shut down and go home because the casino is out of chips. The depositors would remove their cash, go form combines and buy the assets that were worth a damn back from the Fed. In the meantime, the banks would be out of business.
What is going on is clearly being misunderstood. We haven't seen the result of what is going on because the fundings of the SIV's are still floating around the system. This money is chasing commodities, but it is stuff that has already been funded. The system is going to keep getting tighter, as it has no capacity to create new credit. In a month, the Fed will probably roll this new liquidity in the system after asking the banks for their interest payments and reassessing the collateral. The system will have less money in it and the squeeze will start again. We are at the tip of the iceberg here.
At some point, we are going to see the effects of this on world trade. I think we are going to see oil consumption drop. The next shoe to drop is going to be a panic in the Asian markets, as the dollar gravy train is coming to an end. There is going to be a massive retrenchment in US consumer spending because there is going to be a retrenchment in consumer credit. The bottom end consumer is going to be left out of the game on a greater and greater basis. Who will you sell your used car to? How about the starter homes, financed previously by sub-prime? What about the junk credit cards? Hard to see how they lose money with their terms, but my guess is they will just go flat.
Lost in this shuffle is the capacity of the system to create new credit instruments. We can't refund the auction debt of municipalities and other entities. We can't fund anything but prime mortgages and that market is getting tough. The insurers are far from being out of the woods. The next bomb is right around the corner. Lower demand will lead to lower capital spending and lower demand for commodities.
I am making one assumption here, that the world isn't going to ditch the United States. I don't know who they can. It would be like taking first and second gear out of a 3 speed transmission. If you floorboard the car, you can get it moving maybe.
Sunday, March 9, 2008
Ramblings from September 5, 2007 Prudent Bear page
This was posted on the Prudent Bear page September 5, 2007. It references the liquidity problems at the time and what are still present today
SuperCycleBear posted this on the previous page. It pretty much cuts to the chase. I'm going to write some of my own below.
I posted this earlier today. Now the author has been identified, I post it again for the benefit of the board...
SCB
Two weeks away and little seems to have changed. Equities, commodities
and credit are slightly better and bond yields are little changed,
along with FX. The only change of note is short term interest rates as
the money market crisis that I wrote about three weeks ago persists.
Three month libor continues to rise. Yesterday it fixed 99 basis
points over the repo in GBP, almost 75bp over in euro and today
expectations are that 3 month dollars will fix at 5.69%, a level more
synonymous with Fed Funds at 5 1/2 percent.
So far other markets have treated these developments with a remarkable
degree of insouciance. Indeed they seemed to have completely ignored
the deteriorating situation. I can't help believing that this casual
approach is a mistake and largely due to the widespread ignorance of
many financial market participants about the functioning of money
markets, yet ultimately everything comes down to money and it's
availability. And that is the point about what is going on now.
There is a credit crunch going on. Believe it. It just has taken on a
different guise to previous forms. It's not a run on banks but on
non-banks, institutions that have become quasi-banking operations but
lack the capital and depth to ride the storm. The sheer size of the
positions of many of those entities (I can't bring myself to call them
businesses) is staggering. Tiny XYZ bank suddenly has a $20bn dollar
exposure along with numerous "conduit" vehicles and then there are the
SIV lites and the various hedge fund CP based mutants. In short things
are a mess and unless central banks start to properly recognise the
dangers, the situation could reach critical.
This may sound overly dramatic but the risk of a significant failure
is building and LTCM may come to be regarded as a walk in the park.
The problem is of course is that central banks don't seem to recognise
the dangers. Equities et al are not flashing red and the current
situation is unprecedented in recent financial history. Just look at
the chart of 3 month libor versus base rates over the past twenty
years. The spread has occasionally been as wide but this was back in
the late eighties when rates were moving dramatically higher and
interest rates moved in 1 percent steps. The reality is that central
banks don't know how to do to deal with the current situation within
the confines of their existing rule books. [[UK CREDIT CRUNCH.gif]
Fixed rate term repo is an obvious solution, but that doesn't itself
address the problem of financing all the rubbish out there. Ultimately
that will mean a continued liquidity unwind which will inevitably act
on risk asset valuations and economic activity. Rate cuts are
inevitable against this background and the Fed should move by a
minimum of 50 basis points on September 18th and another 50bp on
October 31st. The danger is of that even such aggressive action may
come to be seen as merely pushing on a string.
More later.
Good Luck,
PPG
Patrick Perret-Green
Director
European Derivatives & Bond Trading
RE: Post from previous page mannfm11
NEW 9/5/2007 12:09:46 AM
Post Your Reply
I think some of you recognize this and others don't. By this, I mean the reasoning in this post. It is something the doom sayers have been talking about for awhile, but the CNBCers seem to fail to report except maybe in a one liner from time to time.
The problem here is the whole paper game is tied together in the hands of operations that act like they are banks. They are leveraging capital rather than lending it. Thus bonds and other capital instruments are now nothing more than credit of some sort, maybe from a repo agreement where the differential in interest rates is utilized. The yen carry trade,contrary to much talk is going to go on until the Japanese raise their rates or the entities carrying on the trade lose their net worth in their speculative lending. This is all a credit game, but it appears tobe a capital game.
The problem here is the same capital is leveraged over and over again, the dollars recycled, borrowed and re-loaned. You can't borrow capital and re-loan it like that, you just can't unless you are an insurance company or a pension. I suspect that the collateral behind this entire mess is STOCKS. This is where liquidity is easiest to find. It explains all this crap and how wild the stock market can get out of the blue. I remember the LTCM market because I traded it. I think it had some of the wildest 20 minute swings in history, but I don't recall the sands of the market shifting like this market. I watched the bug roll on CNBC and when it would leave and come back, it had 20 points quite often, stopped and went back 10 to 15 by the time it rolled again. I'm talking about maybe 10second intervals. This is a shaky animal out there and the bull are out of their minds playing in a game where the liquidity of the players can collapse over night.
This is our credit machine that has been feeding the worlds appetite for credit cards, capital and infrastructure expansion in China and India and Eastern Europe, Housing booms all over the world. It isn't our fathers credit machine, to coina Chevrolet phrase. This is something from outer space and it is hidden. We missed the last credit crunch, the Enron and WCOM debacles because they were covered up by 9/11. In fact, I think it is a good conspiracy to explain 9/11 by these 2 huge failures. Enron has positions that made LTCM look like a couple of kids playing bank intheir back yard. How did they get all that unwound? How many of these SIV and SIV lites are there? They sound kind of like the double books that ENE ran with the help of the banks involved, JPM, C and I believe Bank of America. How much more of this double dealing is hidden in the depths of places like the Caymans?
This is debt and there isn't a market for it. There isn't a market for it because the funds to create it in the first place were created out of thin air, but not out of the printing press or the banking business. They were created by pretending. Selling the same securities over and over again with apromise to buy them back, a short sale backed by the ability to mark tomarket.
There is always a problem with this type of debt. For one, the repayment with interest is impossible. We aren't talking about rent on capital. The money has to come from somewhere and my pea brainat this time can only guess how this stuff is really structured. But,if I owned $1 billion in stock, something tells me that not only could I write all this credit against it, much larger than the margin on stock, but that maybe I could also do some delta neutral stuff, maybeby contract.
The point is there isn't any way to liquidate this stuff and it has to be liquid to some point to move. There was another post on here about the banks just holding what they have untilit gets right again. Well, it isn't getting right again and the banks are the only entities that can create the liquidity to hold the stuff.Look at the huge decline in money supply that could be tied merely tothe mortgage market shutting down? CFC has something like $80 billionby themselves. That is hard money. Plus the operations that have been clearing their books of this warehouse debt are now in deep freeze.
The Fed isn't going to solve this mess. I think what this guy is saying is that LTCM is small potatoes compared to this and that the central bankers need to get busy pulling these failing entities out of the fire long enough to stop them from seizing up the system. The credit system has reached its peak performance and has thrown a rod. I seriously doubt once the top comes off this mess that it is going to be allowed to operate in this fashion again. The result will be that never again in our lives will we see credit availability as it has been the past decade.
RE: debt escalation withering simeon
NEW 9/5/2007 2:25:43 AM
Post Your Reply
problem is that the debt based system MUST expand or die. It is now dying due to its not being able to expand. That is not a joke of logic. The system must increase indebtedness or else even a flat lining of debtwill cause the system to eat itself due to the interest repayment problem. That is, interest has to be paid but the only way it can bepaid is by borrowing it (idrectly or otherwise), which means an overall increase in total indebtedness.
RE: debt escalation withering mannfm11
NEW 9/5/2007 9:55:13 AM
Post Your Reply
It has always been a debt based system. Only the collateral and where it is kept has changed.
SuperCycleBear posted this on the previous page. It pretty much cuts to the chase. I'm going to write some of my own below.
I posted this earlier today. Now the author has been identified, I post it again for the benefit of the board...
SCB
Two weeks away and little seems to have changed. Equities, commodities
and credit are slightly better and bond yields are little changed,
along with FX. The only change of note is short term interest rates as
the money market crisis that I wrote about three weeks ago persists.
Three month libor continues to rise. Yesterday it fixed 99 basis
points over the repo in GBP, almost 75bp over in euro and today
expectations are that 3 month dollars will fix at 5.69%, a level more
synonymous with Fed Funds at 5 1/2 percent.
So far other markets have treated these developments with a remarkable
degree of insouciance. Indeed they seemed to have completely ignored
the deteriorating situation. I can't help believing that this casual
approach is a mistake and largely due to the widespread ignorance of
many financial market participants about the functioning of money
markets, yet ultimately everything comes down to money and it's
availability. And that is the point about what is going on now.
There is a credit crunch going on. Believe it. It just has taken on a
different guise to previous forms. It's not a run on banks but on
non-banks, institutions that have become quasi-banking operations but
lack the capital and depth to ride the storm. The sheer size of the
positions of many of those entities (I can't bring myself to call them
businesses) is staggering. Tiny XYZ bank suddenly has a $20bn dollar
exposure along with numerous "conduit" vehicles and then there are the
SIV lites and the various hedge fund CP based mutants. In short things
are a mess and unless central banks start to properly recognise the
dangers, the situation could reach critical.
This may sound overly dramatic but the risk of a significant failure
is building and LTCM may come to be regarded as a walk in the park.
The problem is of course is that central banks don't seem to recognise
the dangers. Equities et al are not flashing red and the current
situation is unprecedented in recent financial history. Just look at
the chart of 3 month libor versus base rates over the past twenty
years. The spread has occasionally been as wide but this was back in
the late eighties when rates were moving dramatically higher and
interest rates moved in 1 percent steps. The reality is that central
banks don't know how to do to deal with the current situation within
the confines of their existing rule books. [[UK CREDIT CRUNCH.gif]
Fixed rate term repo is an obvious solution, but that doesn't itself
address the problem of financing all the rubbish out there. Ultimately
that will mean a continued liquidity unwind which will inevitably act
on risk asset valuations and economic activity. Rate cuts are
inevitable against this background and the Fed should move by a
minimum of 50 basis points on September 18th and another 50bp on
October 31st. The danger is of that even such aggressive action may
come to be seen as merely pushing on a string.
More later.
Good Luck,
PPG
Patrick Perret-Green
Director
European Derivatives & Bond Trading
RE: Post from previous page mannfm11
NEW 9/5/2007 12:09:46 AM
Post Your Reply
I think some of you recognize this and others don't. By this, I mean the reasoning in this post. It is something the doom sayers have been talking about for awhile, but the CNBCers seem to fail to report except maybe in a one liner from time to time.
The problem here is the whole paper game is tied together in the hands of operations that act like they are banks. They are leveraging capital rather than lending it. Thus bonds and other capital instruments are now nothing more than credit of some sort, maybe from a repo agreement where the differential in interest rates is utilized. The yen carry trade,contrary to much talk is going to go on until the Japanese raise their rates or the entities carrying on the trade lose their net worth in their speculative lending. This is all a credit game, but it appears tobe a capital game.
The problem here is the same capital is leveraged over and over again, the dollars recycled, borrowed and re-loaned. You can't borrow capital and re-loan it like that, you just can't unless you are an insurance company or a pension. I suspect that the collateral behind this entire mess is STOCKS. This is where liquidity is easiest to find. It explains all this crap and how wild the stock market can get out of the blue. I remember the LTCM market because I traded it. I think it had some of the wildest 20 minute swings in history, but I don't recall the sands of the market shifting like this market. I watched the bug roll on CNBC and when it would leave and come back, it had 20 points quite often, stopped and went back 10 to 15 by the time it rolled again. I'm talking about maybe 10second intervals. This is a shaky animal out there and the bull are out of their minds playing in a game where the liquidity of the players can collapse over night.
This is our credit machine that has been feeding the worlds appetite for credit cards, capital and infrastructure expansion in China and India and Eastern Europe, Housing booms all over the world. It isn't our fathers credit machine, to coina Chevrolet phrase. This is something from outer space and it is hidden. We missed the last credit crunch, the Enron and WCOM debacles because they were covered up by 9/11. In fact, I think it is a good conspiracy to explain 9/11 by these 2 huge failures. Enron has positions that made LTCM look like a couple of kids playing bank intheir back yard. How did they get all that unwound? How many of these SIV and SIV lites are there? They sound kind of like the double books that ENE ran with the help of the banks involved, JPM, C and I believe Bank of America. How much more of this double dealing is hidden in the depths of places like the Caymans?
This is debt and there isn't a market for it. There isn't a market for it because the funds to create it in the first place were created out of thin air, but not out of the printing press or the banking business. They were created by pretending. Selling the same securities over and over again with apromise to buy them back, a short sale backed by the ability to mark tomarket.
There is always a problem with this type of debt. For one, the repayment with interest is impossible. We aren't talking about rent on capital. The money has to come from somewhere and my pea brainat this time can only guess how this stuff is really structured. But,if I owned $1 billion in stock, something tells me that not only could I write all this credit against it, much larger than the margin on stock, but that maybe I could also do some delta neutral stuff, maybeby contract.
The point is there isn't any way to liquidate this stuff and it has to be liquid to some point to move. There was another post on here about the banks just holding what they have untilit gets right again. Well, it isn't getting right again and the banks are the only entities that can create the liquidity to hold the stuff.Look at the huge decline in money supply that could be tied merely tothe mortgage market shutting down? CFC has something like $80 billionby themselves. That is hard money. Plus the operations that have been clearing their books of this warehouse debt are now in deep freeze.
The Fed isn't going to solve this mess. I think what this guy is saying is that LTCM is small potatoes compared to this and that the central bankers need to get busy pulling these failing entities out of the fire long enough to stop them from seizing up the system. The credit system has reached its peak performance and has thrown a rod. I seriously doubt once the top comes off this mess that it is going to be allowed to operate in this fashion again. The result will be that never again in our lives will we see credit availability as it has been the past decade.
RE: debt escalation withering simeon
NEW 9/5/2007 2:25:43 AM
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problem is that the debt based system MUST expand or die. It is now dying due to its not being able to expand. That is not a joke of logic. The system must increase indebtedness or else even a flat lining of debtwill cause the system to eat itself due to the interest repayment problem. That is, interest has to be paid but the only way it can bepaid is by borrowing it (idrectly or otherwise), which means an overall increase in total indebtedness.
RE: debt escalation withering mannfm11
NEW 9/5/2007 9:55:13 AM
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It has always been a debt based system. Only the collateral and where it is kept has changed.
Saturday, March 8, 2008
What is the Fed doing?
This is a good question because they are talking about putting a lot of funds into the market. For one, I tend to believe the imbalance of deposits in the system are such that the NY and Wall Street banks owe the rest of the banks literally billions of dollars. It was last summer that I saw that Citi had a Fed funds liability of some $400 billion, meaning they were basically financing their massive lending through the Fed funds system instead of attracting and keeping deposits. Now, I am not privy to how the funds system works, if one bank lends directly to another or if the money is just piled into a pool and it naturally balances out with one bank being compensated for their surplus by banks that have a liability? I would like to be a little more versed on this idea, but in my day to day life it isn't that important. I do know that the actions of the Fed have to do with buying and selling securities and not merely printing money and giving it away, as some on market boards would have us believe. I also know this is for between banks and little else.
One thing I glean out of Fed statistics and many others have made light of before I was aware of this is that the amount of unloaned reserves in the banking system are now negative. What this means is the new auction is going to actually take this number even more negative. What else is going on?
Well, I think these banks need this money to maintain their balance sheets in reality and to keep their liabilities with their customers solvent. Being that Citi is so much in debt on the Fed funds market, they might even have a worsening position there. But, what about the banks that Citi owes? Do they now sit around with all this money on their books or do they go out and buy t-bills? If they buy t-bills, then the real adjustment is only to who hold the securities and draws interest. Something is keeping securities out to 2 years at rates well below the fed funds rate which makes me think that is where all this Fed money is going, cycling back to where it came from.
There is also the drain of money that must be going on in the US due to trade deficits and low interest rates. Being that the internationals don't want the bad stuff floating around, it has to be liquidated in some fashion for the time being and the Fed is doing that. I doubt anyone would want something that JPM, Citi, Bear Stearns, Goldman Sachs or Merrill Lynch would sell them right now. In this sense, the books have to be balanced or there is an accounting problem.
There is an accounting problem anyhow and it reads long term investments and assets held for resale. Wall Street put out a lot of bags, but they got left holding some of their own. It was not likely that the world was going to continue to trade on the scale it had been with the United States for long. It amazes me that Wall Street was able to pull off what they did, which basically was build China and India, bankrupt the United States and destroy the dollar while impoverishing the next generation of Americans in a Ponzi scheme of finance to line their own pockets. This was only minimal a Fed deal, but it was a deal where the door was opened around the world in order to construct it. I think the system of credit is in danger of breaking down and if it doesn't this time, it will next time. There is nothing to change the fact that credit has been rolled over and over again and the system has expanded or inflated on the idea that what was already accumulated was real and could be liquid while being actual. It is my opinion and to the best of my knowledge true that we are about to see what was believed to be liquid funds seize up and literally disappear from the scene. I believe the China banking system is next if anything I have heard about it is true, as it is supposed to be a house of cards. I sense they are financing Wall Street not only because Wall Street has been a big time profit center in the past, but that Wall Street is the liquidity arranger for the world. At least between they, London, Hong Kong, and Switzerland about all liquidity is created and all schemes are too. The schemes are falling apart and China and Arabia can no more let them fall apart than Washington DC.
So, right now there is money that hasn't been drawn in that financed all this crap just floating around for speculation. The foreigners are engaged in a commodity spending spree since they don't want to touch the last round of debt to finance the American trade deficit. This might work for a little while, but I highly doubt the well to do in the US are going to give up their assets because they are blowing their money. It occurs to me that most Americans that have assets to any extent have them because they held onto their money, not because they were great speculators or fantastic earners. The ones that are speculators are about to lose all of theirs, save the few that are on the side of the big money, which I think is selling out. The difference is that the big money is selling stuff they already possess and will have the cash when it means something.
It appears there is a lot of liquidity out there because the markets are trading like there is a lot of liquidity, but I suspect that most of it is there to support debt already created and the market for such debt and very little is actually free to buy anything. Any kind of rush out of money markets to buy equities I think is prone to meet a liquidity crisis.
In the end, the Fed is the lender of last resort, unless we can expect the IMF to come in. That is the ultimate disgrace of a country to have the IMF come in and dictate terms. How is anyone going to dictate terms to the country that has been the demand for the world? Put the US on an austerity program and the rest collapses inside of a year. As I have read on another site, I think we are in a position where either we find a way to wipe out enough debt that we have some rope back or it will be all they can do to keep this from melting down to maximum deflation.
One thing I glean out of Fed statistics and many others have made light of before I was aware of this is that the amount of unloaned reserves in the banking system are now negative. What this means is the new auction is going to actually take this number even more negative. What else is going on?
Well, I think these banks need this money to maintain their balance sheets in reality and to keep their liabilities with their customers solvent. Being that Citi is so much in debt on the Fed funds market, they might even have a worsening position there. But, what about the banks that Citi owes? Do they now sit around with all this money on their books or do they go out and buy t-bills? If they buy t-bills, then the real adjustment is only to who hold the securities and draws interest. Something is keeping securities out to 2 years at rates well below the fed funds rate which makes me think that is where all this Fed money is going, cycling back to where it came from.
There is also the drain of money that must be going on in the US due to trade deficits and low interest rates. Being that the internationals don't want the bad stuff floating around, it has to be liquidated in some fashion for the time being and the Fed is doing that. I doubt anyone would want something that JPM, Citi, Bear Stearns, Goldman Sachs or Merrill Lynch would sell them right now. In this sense, the books have to be balanced or there is an accounting problem.
There is an accounting problem anyhow and it reads long term investments and assets held for resale. Wall Street put out a lot of bags, but they got left holding some of their own. It was not likely that the world was going to continue to trade on the scale it had been with the United States for long. It amazes me that Wall Street was able to pull off what they did, which basically was build China and India, bankrupt the United States and destroy the dollar while impoverishing the next generation of Americans in a Ponzi scheme of finance to line their own pockets. This was only minimal a Fed deal, but it was a deal where the door was opened around the world in order to construct it. I think the system of credit is in danger of breaking down and if it doesn't this time, it will next time. There is nothing to change the fact that credit has been rolled over and over again and the system has expanded or inflated on the idea that what was already accumulated was real and could be liquid while being actual. It is my opinion and to the best of my knowledge true that we are about to see what was believed to be liquid funds seize up and literally disappear from the scene. I believe the China banking system is next if anything I have heard about it is true, as it is supposed to be a house of cards. I sense they are financing Wall Street not only because Wall Street has been a big time profit center in the past, but that Wall Street is the liquidity arranger for the world. At least between they, London, Hong Kong, and Switzerland about all liquidity is created and all schemes are too. The schemes are falling apart and China and Arabia can no more let them fall apart than Washington DC.
So, right now there is money that hasn't been drawn in that financed all this crap just floating around for speculation. The foreigners are engaged in a commodity spending spree since they don't want to touch the last round of debt to finance the American trade deficit. This might work for a little while, but I highly doubt the well to do in the US are going to give up their assets because they are blowing their money. It occurs to me that most Americans that have assets to any extent have them because they held onto their money, not because they were great speculators or fantastic earners. The ones that are speculators are about to lose all of theirs, save the few that are on the side of the big money, which I think is selling out. The difference is that the big money is selling stuff they already possess and will have the cash when it means something.
It appears there is a lot of liquidity out there because the markets are trading like there is a lot of liquidity, but I suspect that most of it is there to support debt already created and the market for such debt and very little is actually free to buy anything. Any kind of rush out of money markets to buy equities I think is prone to meet a liquidity crisis.
In the end, the Fed is the lender of last resort, unless we can expect the IMF to come in. That is the ultimate disgrace of a country to have the IMF come in and dictate terms. How is anyone going to dictate terms to the country that has been the demand for the world? Put the US on an austerity program and the rest collapses inside of a year. As I have read on another site, I think we are in a position where either we find a way to wipe out enough debt that we have some rope back or it will be all they can do to keep this from melting down to maximum deflation.
Capital Crisis
There is talk about monetizing the debt. Well, I think it is being seen right now that the debt is already monetized or have you guys figured this out yet? Thornburg along with the Peloton blow up are showing the cracks.
This is a worldwide phenomenon and its origin is probably the US and European banks. When I went to college, there was a distinct difference preached between money market and capital market assets. Banks really weren't supposed to hold capital market assets, which were meant more for insurance companies and pension funds. Banks were at best supposed to fund the origination and the funding be closed out by a sale to one of these organizations. This is clearly not the method used today.
The skeletons are coming out of the closet. First it was the New York banks. Next it seems to be the hedge funds which were playing the carry trade, leveraging a minimal amount of capital against borrowed funds in a carry trade against bank credit or Japanese bonds to finance a wide variety of what should be savings vehicles. This works as long as the value of the collateral holds up and the rates on the carry stay down. In the case of the Japanese bonds, we are now looking at an appreciation of 3 or 4 points as the yields have moved from the 1.7% range to the 1.35 range, being discount at that rate is almost 100% of interest change. So there is double stress here as the bonds go higher and so does the yen and the American paper collateral shrinks.
How are the banks recapitalized? The only way I know is to take what amounts to bank credit out of circulation and put it on the balance sheet of the bank as some kind of paid in capital. It has to come out of an account that way, meaning the money is actually drained from the system. Another way is to trade bonds to the bank in exchange of stock. In this case, it wouldn't shrink the money supply, but it would remove capital from outside the banking system to inside it.
It is all leveraged. In the case of the mortgage game, the mortgage is leveraged on both sides, one side 10 to 20 to 1 in a lot of cases in the form of financing the purchase of a house and on the other side, maybe 5 or 10 to 1 generally. It appears the Carlyle situation was leveraged 30 to 1, maybe even more, but this was probably a sweetheart bank deal rather than the norm.
In any case, these loans have to be liquidated or the bank is stuck with them further limiting lending and tying up bank capital. There will be no cash raised if they take these mortgages and if the public does step up and buy them unfinanced, the supply of cash in the system will fall.
So what if the Fed comes in and buys this stuff? All it would be doing is making deposits already created liquid. Remember, the bank don't have a money account in reality, only capital to service the money liabilities against them. The Fed does nothing more than keep this part of banking liquid. It is necessary for the banks to have capital to extend credit.
So, we have evolved into a system where finance has replaced capital and the system is lacking in capital. Theoretically the liabilities of the bank represent capital, but only in the sense that they can be converted to capital. They are the liabilities of the bank, which has to have the capital to make good on them. The true capital is the house financed, the inventory financed, the job of the credit card debtor, the undepreciated value of the automobile or the bank interest in financed debt.
Now for the shocker. We are in a position where the US is going to be forced to repatriate all this money around the world. The problem here is that for most countries, the dollar is the capital behind the issue of their own central bank credit. Most of these currencies have nothing to stand on with dollar backing. Can you own property outright in China? Russia? Not really. My best guess is these funds, once the situation stabilizes will come back and buy the mortgage debt. But this isn't going to stop the deflation. It will be the deflation, as the entire world is going to have to recapitalize. The leveraged community will be bankrupt by the time this is done. It is a delusion that to any great extent that hedge funds retain their place in financial matters. We will go back to the old days, maybe all the way back to gold for you guys looking for maximum pain and total bankruptcy.
This is a worldwide phenomenon and its origin is probably the US and European banks. When I went to college, there was a distinct difference preached between money market and capital market assets. Banks really weren't supposed to hold capital market assets, which were meant more for insurance companies and pension funds. Banks were at best supposed to fund the origination and the funding be closed out by a sale to one of these organizations. This is clearly not the method used today.
The skeletons are coming out of the closet. First it was the New York banks. Next it seems to be the hedge funds which were playing the carry trade, leveraging a minimal amount of capital against borrowed funds in a carry trade against bank credit or Japanese bonds to finance a wide variety of what should be savings vehicles. This works as long as the value of the collateral holds up and the rates on the carry stay down. In the case of the Japanese bonds, we are now looking at an appreciation of 3 or 4 points as the yields have moved from the 1.7% range to the 1.35 range, being discount at that rate is almost 100% of interest change. So there is double stress here as the bonds go higher and so does the yen and the American paper collateral shrinks.
How are the banks recapitalized? The only way I know is to take what amounts to bank credit out of circulation and put it on the balance sheet of the bank as some kind of paid in capital. It has to come out of an account that way, meaning the money is actually drained from the system. Another way is to trade bonds to the bank in exchange of stock. In this case, it wouldn't shrink the money supply, but it would remove capital from outside the banking system to inside it.
It is all leveraged. In the case of the mortgage game, the mortgage is leveraged on both sides, one side 10 to 20 to 1 in a lot of cases in the form of financing the purchase of a house and on the other side, maybe 5 or 10 to 1 generally. It appears the Carlyle situation was leveraged 30 to 1, maybe even more, but this was probably a sweetheart bank deal rather than the norm.
In any case, these loans have to be liquidated or the bank is stuck with them further limiting lending and tying up bank capital. There will be no cash raised if they take these mortgages and if the public does step up and buy them unfinanced, the supply of cash in the system will fall.
So what if the Fed comes in and buys this stuff? All it would be doing is making deposits already created liquid. Remember, the bank don't have a money account in reality, only capital to service the money liabilities against them. The Fed does nothing more than keep this part of banking liquid. It is necessary for the banks to have capital to extend credit.
So, we have evolved into a system where finance has replaced capital and the system is lacking in capital. Theoretically the liabilities of the bank represent capital, but only in the sense that they can be converted to capital. They are the liabilities of the bank, which has to have the capital to make good on them. The true capital is the house financed, the inventory financed, the job of the credit card debtor, the undepreciated value of the automobile or the bank interest in financed debt.
Now for the shocker. We are in a position where the US is going to be forced to repatriate all this money around the world. The problem here is that for most countries, the dollar is the capital behind the issue of their own central bank credit. Most of these currencies have nothing to stand on with dollar backing. Can you own property outright in China? Russia? Not really. My best guess is these funds, once the situation stabilizes will come back and buy the mortgage debt. But this isn't going to stop the deflation. It will be the deflation, as the entire world is going to have to recapitalize. The leveraged community will be bankrupt by the time this is done. It is a delusion that to any great extent that hedge funds retain their place in financial matters. We will go back to the old days, maybe all the way back to gold for you guys looking for maximum pain and total bankruptcy.
Hello everyone
I haven't arrived until I have my own blog. I figure one day I will put mannfm11 up in lights I have written so much crap on the net that some of it has to be so insightful that I will look like Nostradamus. Of course, most of it will go right to the sewer for processing, as even a broken clock is right twice a day. I have had an interest in economics since before a kid should be interested in such boring crap, which may be why I have been single all my life. We live in very interesting times as far as economics go and the new rules will be seen, but probably not recorded. I believe we are in a history changing period of asset values and coming monetary deflation that will possibly change the course of history and nations. I seem to debate this subject in other forums every day, as being in the minority that believe that credit will deteriorate to the point that paper money actually gains in value. I am quite certain that it will buy a greater amount of domestic assets in the United States at some time and quite likely raw materials as well. With the current situation of declining dollars and rising commodity prices, I am in the minority that feels this way. But, being that our money is nothing more than an exchange of claims of debt, the holder of the money is basically the owner of the properties secured by the debt. This is not advantageous while the system can provide enough new debt to keep the payment on collateral loans current, but once we enter the current twilight zone, this option comes into play.
Now I am going to be famous
I have never had a blog. Prudent bear chat has been my blog for 7 years now and maybe I need to move to a place where people can play on my venue. I hope all that come will enjoy what I write and what I post and will feel free to post what they like. I don't know anything about putting up a website so this will be a learning experience.
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