Sunday, February 17, 2008

Debt Rattle, February 17 2008

Ilargi: Sunday looks like a good day to ask a -pretty fundamental- question. There are scores of people out there claiming that massive amounts of credit will soon be dropped from helicopters. But how realistic is that? The question comes from Seeking Alpha: ”Will banks lend money below the rate of inflation?”

A Bet Against the Banks
It is clear to us that this Bernanke led Fed committee is nothing but a one trick pony when it comes to solving economic turmoil. The base rate is already below the rate of inflation and although the Fed can continue to cut interest rates as much as they like, the question is: Will banks lend money below the rate of inflation? In reality this would be equivalent to throwing away money; blatant, deliberate loss of wealth.

We don’t see how the banks can escape more massive write downs and gigantic losses. If they lower the interest rates on their loans as the Fed cuts rates, the rate will drop below the rate of inflation, and so the banks will be losing money hand over fist (in real terms) everyday. If they choose to hold their loan rates as the Fed lowers the base rate, then they will be faced with more loan defaults and repossessions by people who cannot afford the payments. These repossessed properties will not fetch nearly as much needed to cover the reckless loans made the banks in the first place. So either way, they lose.

The bottom line for these reckless financial companies cannot be avoided. The bottom line is that they have made bad loans and risky investments which have turned against them and they will lose money. Big time. There is no coming back for the financial sector, not for a long time.

But its not just the banks that made bad loans that are suffering. These loans were packaged up into separate entities and then sliced up into bonds. These bonds were insured by companies such as Ambac (ABK) and MBIA (MBI) against default, insurance companies with AAA ratings from agencies such as Standard and Poors. As these “bonds” were insured by AAA rated bond insurance companies, rating agencies automatically gave the bonds AAA ratings. So investors and investment banks across the globe saw these AAA rated high yielding bonds and jumped at the chance to get aboard the doomed ship.

Home-owners started to default on their loans, which meant the insurance companies were forced to pay out on the home loan backed bonds they had insured. A multitude of pay-outs meant these insurance companies didn’t look as healthy on paper so the rating agencies started to question their AAA ratings. As the bond insurers get downgraded from AAA, so do the bonds they have insured.

Therefore these bonds are far less attractive to investors, who stop buying them, sending the value sharply south. In addition to this, many investment funds are forced to dump the bonds as soon as they are downgraded from AAA, as their brief only allows them to hold AAA rated investments. This sends their value even further down and so the balance sheets of every bank, investment bank and investor who bought into this dream money machine, get extremely ugly.

Britain nationalizes ailing Northern Rock
Britain will nationalize ailing mortgage lender Northern Rock until financial markets stabilize and it can be returned to the private sector, finance minister Alistair Darling said on Sunday. "In the current market conditions we do not believe the two proposals deliver sufficient value for money for the taxpayer,"

Finance Minister Alistair Darling told a news conference. "So the government has decided to bring forward legislation to bring Northern Rock into a temporary period of public ownership," he said. The first run on a major British bank in more than a century last year has become a headache for Prime Minister Gordon Brown, tarnishing his popularity and denting a reputation for financial stability.

Britain's fifth-largest mortgage lender already owes taxpayers 25-billion pounds and has been put on the government's books as around 90-billion pounds of public debt.

A consortium led by billionaire Richard Branson's Virgin Group had been the front-runner, ahead of an offer led by the bank's management team. Both were told last week to improve their offers because neither offered taxpayers a good enough deal.

Crowding Out
The failure of [the auction rate securities] market is an example of the crowding out problem with Trashuries. With the supply of Trashuries mushrooming and investors demanding the safest securities, they have no reason to invest in anything but Trashuries. This is self defeating behavior, as is any other kind of investment panic.

Here’s the problem, or I should say, one of the problems. As a result of this panic into “safety”, other sectors of the credit market are shutting down. Meanwhile, we’ve had a bubble in the Trashury market. This cannot continue because the cash available to invest in Trashuries is going to dry up as the commercial paper market lemon gets squeezed dry while the supply of Trashuries continues to explode. The result will be skyrocketing interest rates. Those who buy longer term Trashuries at today’s levels are going to get absolutely killed.

The Federal Budget is careening out of control. Every week the Trashury auctions are blowing out the Treasury Borrowing Advisory Committee estimates of the government’s borrowing needs by huge and growing margins. NO ONE foresaw the need to do TWO massive 2 month Cash Management Bills totalling $49 billion this week, not to mention the $27 billion in new money in the 4 week, 13 and 26 week bills. Most of that settled today. While the Fed did a huge liquidity injection it did not come close to covering the market’s needs. If you want to know why the stock market melted down today, there it is.


It is so over. So truly over.

Sell Your Real Estate Immediately! - Asset Price Deflation Crash

Sell it now. Now. Get rid of it. All of it!

"I always felt very secure and very safe with real estate. Real estate always appreciates." ~ Ivana Trump

Before we begin our next hair-raiser, I notice a lot of people scratching their heads as global stock markets decline in the face of a "strong global economy." What you are seeing is the "pricing in" of approximately $2 trillion of lost homeowner equity in the U.S. (soon to be $3 trillion, then $4 trillion and so on). And it's only a matter of time before that equity squeeze wreaks havoc across the economic board and takes down the stock market and commodities, too. Picture a five year old trying to beat back an elephant with a Wiffle bat -- eventually that will be the metaphor for a declining global economy trying to chase from the living room the growing, immovable force that is asset deflation.

Meanwhile, sell your real estate now. Sell it now. Now. Get rid of it. All of it. Even if you can't get 2005 prices (and you won't). Get what you can now, set the money safely aside and buy the property back (or one like it) several years from now, for a lot less money. You might make a case to retain your personal residence, particularly if you bought it prior to 2002 and/or have a very large equity (60% or more). You need to live somewhere, and that stability (and home ownership) can be worth more than money. But whatever equity you can pull out of any other property now will pay greater dividends later on, when the mother of all credit/liquidity crunches -- continuing to unfold right before our very eyes -- makes safe cash King in a way few of us can fathom right now.

At this point, the cancer -- now exacerbated by a pronounced, continuing, anticipatory drop in retail, office and apartment REIT values and a developing storm in securitized commercial mortgage markets -- is spreading unfettered and ALL U.S. property values are poised to take an increasingly substantial dive in the next 24 months, followed by an even greater one the next several years after that. Japan-style real estate deflation -- only worse -- has arrived; it is no longer a matter of speculation.

I now expect every property category to become significantly affected -- houses, condos, fourplexes, apartment buildings and complexes, shopping centers, office buildings, industrial complexes, lots, land -- you name it. The evidence (and a growing and overwhelmingly negative real estate buying psychology) has me convinced that no property type will be spared.

Thus, the time has come to sound an even more definitive and clarion call: Sell your real estate now!

Given my grave doubts that a combined Fannie Mae, Freddie Mac crisis plus credit-derivatives-nightmare can be averted as asset deflation intensifies, I now expect a frightening systemic event in the U.S. at some point, possibly within the next few years, which will take property values out at the knees and cause transactions to come to an utter standstill for a time. At that point I expect loans to become almost impossible to get and buying psychology to be so damaged, a generation of people will tell you "you should never buy real estate." Regardless, the economy will be shaken by these unfolding events to the extent that the mere thought of buying real estate (absent a massive cash discount) will be considered by most a preposterous notion.

Swaps: Arcane Market Is Next to Face Big Credit Test
Few Americans have heard of credit default swaps, arcane financial instruments invented by Wall Street about a decade ago. But if the economy keeps slowing, credit default swaps, like subprime mortgages, may become a household term. Credit default swaps form a large but obscure market that will be put to its first big test as a looming economic downturn strains companies’ finances. Like a homeowner’s policy that insures against a flood or fire, these instruments are intended to cover losses to banks and bondholders when companies fail to pay their debts.

The market for these securities is enormous. Since 2000, it has ballooned from $900 billion to more than $45.5 trillion — roughly twice the size of the entire United States stock market. No one knows how troubled the credit swaps market is, because, like the now-distressed market for subprime mortgage securities, it is unregulated. But because swaps have proliferated so rapidly, experts say that a hiccup in this market could set off a chain reaction of losses at financial institutions, making it even harder for borrowers to get loans that grease economic activity.

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It is entirely possible that this market can withstand a big jump in corporate defaults, if it comes. But an inkling of trouble emerged in a recent report from the Office of the Comptroller of the Currency, a federal banking regulator. It warned that a significant increase in trading in swaps during the third quarter of last year “put a strain on processing systems” used by banks to handle these trades and make sure they match up.

Placing accurate values on these contracts is just one of the uncertainties facing the big banks, insurance companies and hedge funds that create and trade these instruments. In a credit default swap, two parties enter a private contract in which the buyer of protection agrees to pay the seller premiums over a set period of time; the seller pays only if a particular credit crisis occurs, like a default. These instruments can be sold, on either end of the contract, by the insurer or the insured.

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But during the credit market upheaval in August, 14 percent of trades in these contracts were unconfirmed, meaning one of the parties in the resale transaction was unidentified in trade documents and remained unknown 30 days later. In December, that number stood at 13 percent. Because these trades are unregulated, there is no requirement that all parties to a contract be told when it is sold.

As investors who have purchased such swaps try to cash them in, they may have trouble tracking down who is supposed to pay their claims. “This is just a giant insurance industry that is underregulated and not very well reserved for and does not have very good standards as a result,” said Michael A. J. Farrell, chief executive of Annaly Capital Management in New York. “I think unregulated markets that overshadow, in terms of size, the regulated ones are a real question mark.”

Ilargi: A portrait of drooling vultures, and a huge tragedy in the making. Let’s hope for Mexico’s sake that the entire system crashes before too many Mexicans get sucked into mortgage debt slavery: ”just 6 percent of Mexico's homes are financed with mortgages, compared with about 67 percent in the U.S”

Mexico enjoys a housing boom
In her bustling corner real estate brokerage, Ana Laura Pulido is doing her best business in years, enjoying a sort of Mexican immunity from the U.S. housing crash. "It's a time of hope," said Pulido, who has sold hundreds of homes to middle-income families since 1992. "The buyer today is more aware. People buy with more ease. They can plan long-term." Long thrashed by swings in the U.S. economy, Mexico now boasts a thriving housing sector whose record growth leads Latin America — a sign of increased economic stability and an outlet for investors looking to escape the U.S. downturn.

Giants including the California Public Employees Retirement System, the largest U.S. public pension fund, are already bankrolling projects in Mexico, where they see "more bang for the buck," said Clark McKinley, spokesman for CalPERS, which has invested more than $300 million in Mexican real estate funds. The trend could even slow emigration from Mexico by generating millions in jobs and personal savings as a fresh supply of loans gives many their first chance to own a house.

President Felipe Calderón has set a national goal of a million new mortgages a year by 2010. Behind the boom are six years of economic growth and stability and a national shortage of 6 million dwellings. Although interest rates are falling, just 6 percent of Mexico's 25.7 million homes are financed with mortgages, compared with about 67 percent in the U.S. Most Mexicans inherit their homes, buy them with cash, or build them by hand.

That pent-up demand in a nation of 108 million means lenders can be choosy, enforcing strict standards that held delinquency rates below 4 percent in third quarter-2007, compared with 5.6 percent in the U.S. "Mexico is in the early stages of expansion," said Juan P. De Mollein, managing director for Latin American structured finance at Standard & Poor's. "There are still plenty of points for evolution because there's still plenty of demand”.

Canada slides into trade deficit: High energy prices are not enough
High energy prices are no longer enough to mask the deterioration of Canada's international trade picture. Canada's trade surplus for 2007 dwindled to its lowest level in eight years, as sales in two pillars of Canada's economy – automotive products and forestry – plummeted.

Economists now expect Canada to register a current account deficit some time this year, a stark reversal in Canada's international standing after a decade of boasting about its surpluses. The reasons for the reversal of fortunes are the U.S. slowdown and its gradual spread to the rest of the world economy, analysts say.

“Canada's underlying trade position has been deteriorating for quite some time,” said David Wolf, chief economist at Merrill Lynch Canada. Until now, much of the erosion has been masked by the high prices for oil and many metals. “That offset is clearly now not enough,” Mr. Wolf added. For all of 2007, Canada's trade surplus narrowed to $49.7-billion, down from $51.3-billion in 2006. And in December, the trade surplus shrank abruptly from a month earlier to $2.4-billion, its lowest monthly level since the Asian financial crisis in 1998.

Exports fell 3.1 per cent from November, with declines recorded for every sector except energy. And once prices are factored out, even the volume of energy exports fell. “The non-energy trade deficit is increasing, while the energy trade surplus is, at best, stagnant,” said David Watt, senior currency strategist at RBC Dominion Securities Inc.

'Fear factor' sees investors fleeing equity funds
Jittery investors, worried about plunging stock prices, yanked their money out of equity mutual funds in January. New numbers from the Investment Funds Institute of Canada showed net redemptions of $3.1-billion of equity funds in the month, a sharp contrast from the previous January when $1.1-billion went into that category of funds. Those willing to put money into mutual funds loaded up on lower-risk money market products, which saw a surge in sales to $4.8-billion in January.

Over all, however, the value of funds managed by the industry fell a dramatic 3.7 per cent between December and January, knocking almost $26-billion off total assets. In mid-January the S&P/TSX composite index took a steep plunge, falling about 1,500 points in the space of a week. That, combined with increasingly bleak economic news out of the United States, spooked retail investors into pulling their money out of equity funds and parking it in relatively safe money market instruments, economists and advisers said.

“The fear factor is pretty substantial” said Frank Hracs, chief economist at Credo Consulting Inc. in Toronto. He noted that the drop in assets occurred in what is usually a very busy time for fund buying – RRSP season. The bad markets “overshadowed people's inclination to save taxes,” he said.

Ilargi: For the uninitiated: Canada’s real estate market has been driven by Alberta’s oil sands craze, and the even crazier bubble in Vancouver. As they crash down to gutter level, the rest will soon follow. It will be a bloodbath, and hardly anyone has any idea what’s going on: the Canadian main press is so bad, it’s hard to believe.

'The great boom is winding down'
Resale home activity caught a case of the winter sniffles in January, a further sign Canada's mighty residential real estate market is finally in a slowdown. Last month, seasonally adjusted unit sales declined by 0.4 per cent from the month before and 8 per cent from January, 2007, according to data released Friday by the Canadian Real Estate Association (CREA).

“With the further dip in January, Canadian home sales are now well below year-ago levels, adding further evidence that the great boom is winding down,” said Douglas Porter, deputy chief economist at BMO Nesbitt Burns Inc., in a research note. Steadily rising home prices have benched potential buyers, particularly in Alberta. In January, unit sales in Calgary dropped by 30.9 per cent from the year before and by 21 per cent in Edmonton. At the same time, new listings in those markets surged by 35.3 per cent and 61.1 per cent, respectively.

Across the country, new listings hit a new record 51,716 units in January, rising 9.3 per cent from the previous month. It was the largest month-over-month increase in seven years, and puts the market into “more balanced” territory than it has been at any other point during that time, according to CREA.

Prices across the country did cool somewhat, with the average price rising 8.6 per cent year-over-year to $325,183. This was the smallest year-over-year price increase since December, 2006, and compares with an increase of 11 per cent for all of last year. “The overall increase in new listings stemmed mainly from a jump in listings in some of Western Canada's most active markets. Price increases in those markets will be more modest compared to what we saw last year,” Gregory Klump, chief economist at CREA, said in a statement.

Ilargi: And along with its press, Canada’s politicians keep on misleading their public with nonsensical drivel, that will sound all too familiar to Americans. The only difference is a time lag, all else is the same. In reality, Canada is not at all ”... well positioned in terms of fiscal and monetary policy to weather the storm”. Don’t believe what these people say. Don’t get caught in this maelstrom of don’t worry. DO worry, and act accordingly.

Ontario economy a growing concern: Flaherty
The Canadian economy still has “solid” fundamentals, despite recent reports that show a dive in exports and manufacturing activity, the federal Finance Minister said Friday. While Canada should weather the deepening U.S. slowdown, Jim Flaherty said he's increasingly concerned about Ontario, the country's largest economy. And he urged the provincial government to curb spending and cut taxes to spur economic activity.

“My most significant worry is with respect to my home province,” he said at a Toronto press conference. “There's a danger Ontario's economy will slow down more dramatically than elsewhere in Canada.” The provincial government should lower the tax burden for business and investment to make the province more competitive, he added.

His comments came after a report Friday showed manufacturing sales skidded to a three-year low, and a day after data revealed Canada's trade surplus shrank to a nine-year low in December. Even so, the country as a whole will likely withstand turmoil south of the border, Mr. Flaherty said. “Canada's well positioned in terms of fiscal and monetary policy to weather the storm,” he said.

Economists are not so sanguine. Canada continues to export about three quarters of its goods to the U.S. and several economists Friday cut their outlook for the economy. “We now think that there is a substantial risk that December gross domestic product growth will come in at below zero,” said Millan Mulraine, economics strategist at TD Securities, in a note. “The impact of the Canadian dollar and the U.S. slowdown (evident in this unfavourable report), plus yesterday's trade numbers strengthens our case for a 50 basis-point cut by the Bank of Canada next month.”

Ilargi: Are Canada's bank deposits more secure than those in the US? We've seen some serious doubt about US FDIC guarantees surface lately, and we worry equally about the CDIC, since we see no evidence that any of these types of programs were set up for large scale bank failures. Also, we keep in mind that Northern Rock has cost the UK taxpayer 91 billion pounds so far, even without the matter being resolved. That's for one little bank, which never was worth more than 10% of that.

Canada: Bank's losses shouldn't affect money you keep there
In the wake of mounting writedowns of losses by financial institutions from exposure to the subprime mortgage debacle and credit crisis, readers have become concerned about the security of their own investments. Asked one senior: "After hearing and reading so much re: CIBC, should I continue to leave my money there?"

Most personal assets deposited with an institution should be safe. Most firms are taking credit losses out of their corporate profits, without threatening personal assets under management. For example, losses to National Bank Financial's money-market funds were absorbed in the bank's bottom line. Thus, your biggest concern might be if you own shares in a financial institution whose profits figure to be hit hard. Most institutions are members of the Canadian Deposit Insurance Corp., a federal Crown corporation created by Parliament to insure the savings of Canadians in case their bank fails or goes bankrupt.

CDIC covers the following accounts and products held with its members: savings and chequing accounts; guaranteed investment certificates and other term deposits that mature in five years or less; money orders, certified cheques and bank drafts; and accounts that hold realty taxes on mortgaged properties. You are insured for up to $100,000 per account, up from $60,000 as of the 2005 federal budget, so if you have more than $100,000 you might want to split it into different accounts or even different institutions for added security.

CDIC does not insure mutual funds and stocks; GICs and other term deposits maturing in more than five years; bonds; treasury bills; and accounts or products in foreign currencies. That means that some investments in your registered retirement savings plan might be insured and others might not. Most credit unions are covered by a provincial insurer. Meanwhile, the credit crisis is starting to weigh on customer confidence in the banking system.

People wonder why BMO would get involved in trading natural-gas futures and taking a bath that cost trader David Lee and his boss Bob Moore their jobs, and why CIBC would hold $11 billion US in exposure to U.S. subprime credit. "CIBC's problem was that the mortgage insurer went bust; the triple-A insurers are now being downgraded," said Sherry Cooper, chief economist with BMO Capital Markets. "It wasn't that CIBC was imprudently investing in junk, because the securities on their books themselves were triple-A rated. The bond rating company also is to blame. There's so much blame to go around -- the borrowers were wrong, the lenders were wrong."

India: Saved by the sub-prime crisis?
No, I haven’t got a touch of spring fever (any case spring seems to be sometime in coming this year)! But the more one reads about the sub-prime crisis and the way financial sector players, banks, commercial, investment banks, mortgage lenders, bond insurers had gone truly overboard, one can only be thankful for our providential escape. We were at the fringes and would have been sucked under too but for the fact that the entire edifice of credit default swaps, collateralised bond obligations and other derivatives, each with a fancy name, collapsed before that could happen. Let me explain.

‘There are distinct phases in investment madness in emerging markets. Phase one is growth. You get a lot of foreign investment — The locals deregulate everything because the World Bank tells them it will attract foreign investment. Government-owned businesses are sold cheaply to the favoured sons and their foreign cronies. Government controls are relaxed as the foreigners tell the locals that it will create jobs and wealth.

‘In phase two, living standards improve for the fortunate. For the bulk of the people, nothing changes, of course. A middle class develops chasing McDonald’s and Wal-Mart consumer heaven. Property prices and shares go crazy. More and more money comes in. Local banks lend recklessly. Foreign banks lend recklessly to local banks. The foreign banks think the local banks won’t fail because of government support. Investors dive in. They talk about “growth” and “portfolio diversification”. People are excited: Prices spiral up as the tidal wave of money pours in. ‘Phase three. Costs rise to levels that make the economies uncompetitive.

They are not cheap any more. Alas, the capitalist caravan must move on. Everything is over priced. Politicians talk bravely about the “need to move up the value chain”. They launch ambitious initiatives — the world’s tallest building, the world’s longest building, a new port in a country which has no sea access. Locals bristle at any criticism.

‘Prices don’t make any rational sense. You only buy because you think you can sell it tomorrow to someone else at a higher price. You are caught in an endless spiral of higher and higher prices. Fear and greed rule financial markets. You are afraid that you might miss out. Your greed is endless. Foreigners develop a peculiar hubris. They are bulletproof. Fundamentals of value are irrelevant in this world. Then, of course, kaput. It all collapses.’

A description of what we’re witnessing today? No, an extract from Satyajit Das’ much-acclaimed ‘Traders, Guns and Money’ describing the first lesson he received as a trader with a hi-fi investment bank in the years just before the Asian crisis. If the events sound familiar enough to send a chill down your spine, lesson number two is not much better. ‘If you arrive at a country and discover limousines waiting to transfer foreign investors and their investment bankers to five star hotels, then generally speaking it is time to sell.’

Ilargi: Need any more proof that the US banking system is dysfunctional?

Bangladesh bank offers loans to US poor
Bangladesh’s Grameen Bank has made its first loans in New York in an attempt to bring its pioneering microfinance techniques to the tens of millions of people in the world’s richest country who have no bank account.

The bank’s entry into the US, its first in a developed market, comes as mainstream banks’ credibility has been hit by the mortgage meltdown and many people are turning to fringe financial institutions offering loans at exorbitant interest rates.
“Now is a good time because of . . . the subprime crisis and that highlights the issue that the financial system is not perfect,” Muhammad Yunus, the bank’s Nobel Prize-winning founder, told the Financial Times.

Grameen has lent $50,000 in the past month to groups of immigrant women in Jackson Heights in New York’s borough of Queens. During the next five years, it plans to offer $176m in loans within New York city, and then expand to the rest of the US. In Bangladesh, Grameen lends to poor women seeking to start small enterprises who cannot borrow from banks because they do not have accounts or a high enough credit rating. The bank, which started with $27 in loans Mr Yunus made to 42 women in Bangladesh in 1976, has now made more than $6.5bn in loans to 7m people in the country.

In the US, about 28m people have no bank accounts and 44.7m have only limited access to financial institutions. People often do not hold bank accounts because they have had credit problems, have no access to a local branch or they distrust the mainstream financial system, said Jonathan Morduch, a microfinance expert at New York University.

Some microfinance experts doubt that Grameen could make an impact in the US where credit is widely available, and businesses and tax systems are much trickier to navigate than in developing countries. After beginning with small loans to micro-entrepreneurs, Grameen plans to expand into other businesses such as remittances and mortgages.

[ The US presents a ripe market for Grameen, Mr Yunus claims, because it has a large population that sits outside the formal banking system. As many as 28m people, earning $510bn a year, do not have any relationship with a financial institution, according to the Federal Deposit Insurance Corporation]

See also: Yunus takes microfinance to New York

Ilargi: TIME Magazine proves once more (not that we had any doubts) that it is always possible to find an “expert” willing to cheerlead your team, even if it’s 0 for 100. Central banks will save the day any day now, and lead us into the promised land of “a stronger economic recovery”.

Is a collapse in the cards?
Myth: The blame for the bubble in the housing market rests with former U.S. Federal Reserve Chairman Alan Greenspan, who kept interest rates too low for too long.
Reality: While it certainly can be argued that Greenspan mismanaged short-term interest rates, that was not the major cause of the bubble. Soaring home prices were a worldwide phenomenon driven by demographics and low long-term interest rates, which were caused by low inflation and the huge buildup of savings in Asia. In fact many countries completely outside the dollar sphere, such as the U.K. and Spain, experienced an even greater real estate bubble than the U.S.

Myth: Because the current slowdown is due to the sharp cutback in the willingness of financial firms to lend, central banks can do little to improve the situation.
Reality: Central banks can and have done much to stabilize credit markets. The crisis was marked by a sharp increase in interest rates on bank lending over the targeted cost of funds set by central banks. Partly by injecting reserves into the market, central banks have ensured there is sufficient liquidity and reduced the "risk premium" attached to loans. The London Interbank Offered Rate (LIBOR), the peg for trillions of dollars of bank loans, has fallen from 5.75% last August to just over 3% today because of actions by the U.S. Federal Reserve. These declines have eased the anxiety in the credit markets.

Myth: Since almost all stock markets went up and down in unison during this crisis, international diversification is no longer an effective strategy for investors.
Reality: Although it is true that in the very short run stock markets have become increasingly correlated, there is no evidence that over longer time periods correlations between markets have increased. The speed of international communications means that traders instantly transmit both fear and euphoria across global markets, leading to similar day-to-day volatility. But longer-term movements depend on economic and profit trends within each country. Since more than half of the world's equity capital is now headquartered outside the U.S., maintaining a diversified international portfolio is as important as ever.

Myth: Most of the decline in the prices of financial stocks can be explained by the huge write-offs of mortgage-backed debt.
Reality: The decline in financial stocks far exceeds even the most bearish estimates of loan losses from mortgage-backed securities. From May 2007 to its recent low in January, financial stocks in the S&P 500 Index have declined by more than 35%, erasing more than $1 trillion in market capitalization. The market value of financial stocks headquartered outside the U.S. have also declined substantially. These losses far exceed the worst-case scenario of $200 billion in mortgage write-downs.

The only possible rationale for these huge price declines is that investors believe an economic downturn will significantly impair other assets of the banking industry and there will be a permanent decline in income from lending. The truth is that banks have greater access to central-bank liquidity now than before the crisis and will likely recapture some of the lending that has been lost over past years to the asset-backed commercial-paper markets.

Certainly over the past few years there was much foolish lending that had led to severe losses, and the economy will suffer in the short run. But actions by central banks will assure that this credit crisis does not morph into a full-blown recession or worse. And in the long run, saner lending and more reasonable home prices will lead to a stronger economic recovery.

Jeremy Siegel is the Russell E. Palmer professor of finance at the University of Pennsylvania's Wharton School

Central Bankers Fueling Global Commodity Inflation
Central bankers and finance ministers from the world’s top-10 economic powers huddled behind closed doors in Tokyo last weekend, trying to work out a joint strategy to rescue the global stock markets from another possible meltdown. Roughly $6-trillion was lost on global stock markets in the month of January, triggered by the biggest financial crisis since the Great Depression, and a US housing slide, that could topple the giant US economy into recession.

Central bankers from the United States, Japan, Germany, France, Canada, Britain, Italy, China, South Korea, and Russia, collectively control the money spigots in three-quarters of the world’s $65 trillion economy. “We are not yet at the end of the market crisis,” warned Euro-group finance chief Jean-Claude Juncker. “The corrections will drag on for a few weeks, or months".

Asked what type of collective action the G-7 might take during another stock market meltdown, Juncker said, “Whoever has a strategy should not lay it out. Otherwise it will lose its effect, if it is explained.” Russian Finance Minister Alexei Kudrin hinted at a coordinated round of G-7 rate cuts. Other weapons in the G-7’s arsenal to counter a bear market for equities include brainwashing investors through the media, fudging economic and inflation data, inflating the money supply, managing the “yen carry” trade, and outright intervention in stock index futures, championed by the US “Plunge Protection Team.”

Wall Street fueled the growth of sub-prime lending by packaging $1.8 trillion of risky home loans into bundled securities, and then marketing them as high-grade investments. But with US mortgage foreclosures set to top 1 million this year and home prices falling at the fastest pace since the Great Depression, the same Wall Street investment banks who profited by putting buyers into properties they couldn’t afford, are begging central banks and governments to manage the bust.

The G-10 central banks will tolerate an upward creep in global inflation, because the pain required to kick the money printing habit is deemed too high. “Downside risks to the US economy are the most important factor for Federal Reserve interest rate policy for the time being,” said Chicago Fed chief Charles Evans on Feb 14th. “The Fed’s focus needs to be on those risks, even though inflation has been running a bit higher than we would like,” he said.

G-10 central bankers are ignoring the deleterious side-effects of their super-easy money policies. The Fed and G-7 central bankers have injected hundreds of billions of dollars into the global money markets, fueling the “Commodity Super Cycle,” and intensifying global inflation. Central bankers in Canada and the UK have joined the Fed’s rate cutting spree. But the big surprise for G-7 central bankers might be how high commodities can fly, even in the face of a global economic slowdown.

Buffett role similar to one Morgan once played
The U.S. stock market had been cut in half by over-expansion and speculation, the economy was in recession, credit was tight, and the Treasury Department was pumping money into the financial system to avert disaster. Sound familiar?
The year was 1907.

In most historical accounts of the Panic of 1907, financier J.P. Morgan is given credit for staving off disaster by gathering leading bankers and financial experts at his home. The group provided capital that kept banks afloat, obtained lines of credit and purchased the stock of healthy companies. The panic passed within a few weeks, and Morgan was hailed as a savior. The panic led to the formation of the Federal Reserve.

Fast-forward a century, and the bank that still bears Morgan's name is one of the largest in the world. Last year, J.P. Morgan Chase & Co. was part of a group of large banks that attempted to organize a "superfund" to buy distressed assets, thereby stabilizing the financial system. The plan ultimately failed. This past week, another potential solution emerged. Just as it did a century ago, it came from a man in his 70s whose long history of business success made him one of the country's wealthiest men.

Warren Buffett appeared on CNBC on Tuesday to describe an offer his company, Berkshire Hathaway, had made to the nation's three largest municipal bond insurers: MBIA Inc., Ambac Financial Group Inc. and Financial Guaranty Insurance Co. The stock market jumped Tuesday after Buffett's interview. To greatly simplify the matter, a subsidiary of Berkshire Hathaway agreed to provide reinsurance to the three companies' $800 billion municipal bond portfolio for a hefty premium.

Municipalities sell bonds to pay for projects such as sewer systems and schools. Backed by the Triple-A ratings of the bond insurers, the municipalities are able to pay lower interest rates to investors. In recent years, bond insurers strayed from the safe world of municipal bonds to the murkier waters of complex asset-backed securities. Losses on these products have threatened the insurers' Triple-A ratings. Should they lose them, municipalities could have to pay higher interest rates on their bonds, which in turn could drive up taxes.

Berkshire Hathaway, whose cash horde recently surpassed $40 billion, is at no such risk of losing its Triple-A credit rating. Buffett said on CNBC that his company's offer, if accepted, would restore stability to the municipal bond market.
Ambac and another of the bond insurers have rejected Buffett's offer. Municipal bonds rarely default, so the three insurers would be giving away the safest parts of their shaky portfolios.

So is Buffett, 77, a latter-day white knight riding in amid the financial wreckage, as Morgan did 100 years ago?

U.S. consumer confidence gauge slumps to 16-year low
U.S. consumer sentiment fell sharply in early February to levels associated with previous recessions, dragged down by concerns a bleak economic outlook would raise the unemployment rate, a survey showed Friday.

The Reuters/University of Michigan Surveys of Consumers index of consumer sentiment dropped to 69.6, the lowest reading since February 1992, and below analysts' median forecast for a preliminary reading of 76.3. The index was at 78.4 at the end of January. “The sentiment index has only been this low during the recessions of the mid 1970s, the early 1980s and the early 1990s,” survey director Richard Curtin said in a statement.

The report pushed the dollar lower versus the euro, while short-term interest rate futures raced to fresh session highs as the market priced in a half-percentage-point Federal Reserve interest rate cut in March.
Pessimism was widespread among households of all incomes and age groups, with half the consumers surveyed expecting declines in real incomes and higher unemployment in the year ahead.

In addition, 86 per cent of consumers believed the economy was in decline, the highest number since 1982. The current economic conditions index fell to 85.4 in early February, the lowest level since October 1992, and below a reading of 94.4 at the end of January. The expectations index, a component of the index of leading economic indicators dived to 59.4, a 16-year low. The index was at 68.1 at the end of January.


madhatter said...

Thanks for the Canadian content. (In addition to all of the rest)

I have my galoshes on and my umbrella out - ready to face the deluge that has already submerged many and appears to be bearing down on all of us. (Building an ark might be more appropriate but I do not have the requisite skills.)

Anonymous said...


Re: Will banks lend money below the rate of inflation?

what about BOJ and yen? with the food and fuel prices on the rise, is Japan's real rate of inflation at 0.3%?

Anon e Nony said...

Also re: Will banks lend money below the rate of inflation?

What happens to that argument if we are entering a period of deflation?

Anonymous said...

What do you guys think of Calgary and Alberta getting through this?

You should see the upgrades they are doing to Chinook centre Mall here in town. 275 million to be finished fall of 2010. They are just breaking ground on it now and they just re-did the mall in 1998 for another 250m.

The unconstrained city(no body of water) makes me wonder about Calgary Real estate too, there really is double the supply of a normal city. It's not like there are a bunch of little companies making a killing finding a bunch of new oil. They already found it. A big sand pit full of oil.

Ilargi said...

what about japan? what's the question?

anon e nony
which argument are you referring to?

btw japan's deflation goes back many years. what it is today is less relevant to the example it sets. it's still a large problem in the country, but they have new ones on the way.

Stoneleigh said...

Anon e nony,

In a period of deflation (negative inflation) banks would hardly lend at all due to the very high risk of default, and only to the wealthiest individuals or corporations at very high rates of interest (hence the name credit crunch). The real rate of interest (the nominal rate minus negative inflation) would be very high - the opposite of recent years when the real rate of interest was negative, so that people were effectively being paid to borrow. Periods of negative real interest rates are a trap as they encourage indebtedness that quickly becomes unmanageable once rates rise, as they inevitably do.

People are so used to the credit society that they forget that access to credit by anyone other than the wealthy is a historically recent phenomenon. This is especially true of non-self-liquidating credit (credit to fund consumption rather than to expand production and thereby generate the means to repay the loan). During the financial crisis that's already well on its way, don't count on any access to any credit at all, and that goes for existing loans as well as any potential new borrowing. Existing loans may well be called in by creditors while the collateral still has some value (which would amount to getting a margin call on your house, among other things).

Stoneleigh said...


I think Alberta is in for an almighty crash. Apart from the effects of the financial crisis we discuss here at TAE, Alberta is facing a water crisis and an environmental crisis due to the tar sands - projects that actually generate very little revenue for the province but have a tremendous negative impact. Conventional oil and gas have been funding provincial coffers, but those are depleting quickly.

Check out William Marsden's book Stupid to the Last Drop if you'd like to know more. The effects on aquifers (much of it due to fracing chemicals used to extract coal bed methane) are particularly alarming.

Anonymous said...


the question was about if BOJ is lending below the rate of inflation there?


will FED lend to the major banks?

Stoneleigh said...


I don't see the Fed offering to be a true lender of last resort. Their standards for collateral for new loans have slipped a bit recently, but not as much as the ECB in Europe. They won't saddle themselves with toxic waste, and high value collateral will be becoming scarcer by the day. While the Fed is being 'miserly', liquidity is being withdrawn from the system at a rapid rate as financial asset value falls across the board. The liquidity crisis is already morphing into a solvency crisis, and the Fed has no answer for that IMO (at least on the systemic scale we're facing here). My guess is that a full blown banking crisis is not very far away.

Anon e Nony said...

Excuse me, ilargi, that was unclear and I should have put my comment in the form of a question: will banks lend money during a deflation

Thanks Stoneleigh for your clearing the muddy thoughts of mine up. Also thank you both for the translation of GEAB ... you would think the end of the world was coming you two are working so hard:)