'Something rotten in the state of Denmark'

'..Something rotten in the state of Denmark' from Skakespeare's Hamlet has become a euphamism for anything that is not right about something, and seems pretty apt to the current finacial/capital markets crisis.

In muting a toxic/bad debt bail out plan, Paulson/Bernanke are effectively allowing reward/gain/profit to remain privatised whilst they socialise risk/debt. This seems very unfair, particularly as the Bankers know that there is probably no choice as their mistakes threaten to undermine the very system of free markets capitalism on which the west has relied for so mnay years, so that the authorities/govt and ultimately the tax payer has no choice but to step in.

Although Uk examples,...It is reported that Adam Applegarth (ex ceo Northen Rock) received a 'golden good bye' and pension in the £60k/mth region...Andy Hornby and the Board of HBOS will no doubt receive some kind of generous severance too. Compare that to the hard working diligent back office staff that will and have lost their jobs although they were in no way involved in the strategic business models employed by their firms. failure is rewarded and diligence is scoffed at/penalised.

These organisations and many more of them, led by the investment banks, bought into the new business model of financing their growth from leverage obtained by busing collateralised debt...bad debt that had been so carefully packaged in complex instruments that even the ratings agencies had no idea how to rate and got it hopelessly wrong.

I just hope that the Paulson/Bernanke demand a high price for their bail out, both in terms of corporate governance and 'supervision' of the activities of the capital markets. I fear that the weakness of regulation is that it only ever regulates to prevent something that has already happened.

Investment banking as we knew it is dead....Long live ?? well that's the question isn't it.

11:04 US GOVTS: Review of RTC Aftermath and Suggestions for Sequel London,
September 19. Now that the U.S. government has announced a second coming of
1989"s Resolution Trust Corp., it"s time to review what the implementation of
the last one meant for capital markets and the broader economy.
Since there are natural worries about what lumping the subprime debacle onto
Treasury"s books will mean for the national debt, inflation, and the dollar,
we"ll start here. Superficially, there do appear to be grounds for limited
concern about inflation; in January 1989 (when the RTC was created), the CPI was
up 4.5% y/y. It continued rising, slowly but steadily, to a high of 6.4% in
October 1990.
As far as the national debt goes, it continued rising but does not show a
significant acceleration from the uptrend which had been in place going all the
way back to 1982 (and it only really leveled off in 1995/1996).
Interest rates, however, tell a different story and a much more optimistic
one. 10-year yields at least started January 02 1989 at 9.23%, but after a
brief surge to 9.53% in Q1 that year then proceeded to fall to a low of 7.74% at
the end of July 1989. They then spent the next 2.5 years range trading between
a high yield of 9.09% and 7.74%.
The trade weighted dollar index meanwhile similarly bounced after the
formation of the RTC; it started January 1989 at 92 before rising to a high of
108 in Q3 1989. Ultimately it did deteriorate, but to a manageable 78 over an
equally manageable period of time stretching all the way out to the second half
of 1992.
Gold shows a similar patter, starting 1989 at $416.20, and then falling to a
low of $356.50. It did then rally, but only for the second half of 1989,
topping out in January 1990 at $425.00.
The stock market for its part was off in its own world, still recovering
from the crash in 1987 when the Dow Jones Industrials Average bottomed out at
1,707. It started 1989 at 2,168, and went on to rally further to a peak of
3,011 on July 16 1990.
While the RTC may have provided relief to the banking and financial system
(and by extension save the broader economy from even harder times), it did not
provide the panacea cure for the broader economy at the time. Unemployment for
instance stood at 5.4% in January 1989, proceeding on a very slow rise to a high
of 7.8% in June 1992. Personal bankruptcies in Q1 1989 registered 581k, and
scurried higher to a maximum of 941k in Q1 1992. Lastly, the median home price
in January 1989 was $113,000, and proceeded on very slow growth and a very
slight uptrend until the late 1990s, when the present bubble really started to
take off.
From the above, we can surmise there is indeed still more bad news in store
in terms of economic data; the worst is almost certainly not yet in. The extra
spending from bailing out financial institutions and hoovering up sub prime does
give ground for worry about the health of the dollar and inflation. But only to
a very limited extent and with a bit of unexpected volatility given the initial
bounce in the dollar and drop in gold. And, as judged by the drop in bond
yields, there wasn"t really that much to worry about for fixed income.
The subprime fiasco does have many differences with the RTC. It will
certainly be bigger, and there are even suggestions the Administration"s new
plan will more resemble the Reconstruction Finance Corporation of the 1930s,
which was actually quite interventionist in terms of promoting growth and direct
lending.
We think the RTC comparison however is much more applicable; it cleaned up
toxic debt just as is needed now. Unlike the 1930s, when the Great Depression
was already in full swing, the broader economy remains relatively healthy even
if it is starting to stumble.
As far as what structure to expect, there is a lot of talk about the
government holding auctions to absorb subprime loans. This makes sense and
seems the fairest way to put some sort of price on what are extremely hard to
value assets. Early estimates suggest the plan will target $500 bln; perhaps,
but we think it makes more sense for Treasury to avoid adopting a specific
target and keep things open-ended.
This may worry budget-watchers, but it should actually comfort them. The
fact that a sizeable buyer is entering the market with potentially unlimited
resources should on its own put a floor under the market and get it moving
again. If Treasury were to start with $5 bln weekly auctions, in theory it
could spend several $10s of billions of dollars to have a much greater impact
just by getting things moving again.
But what is really neat about announcing an open ended commitment is it
allows Treasury to simply do what is necessary. If several $10s of billions of
dollars prove to get things moving enough, and stabilize global capital markets
enough, it can put an early end to its operations.
Assuming the ultimate bill for cleaning up the subprime mess does cost quite
a bit more (again we refer to the early estimates of $500 bln, with a reminder
that these things always -- ALWAYS -- cost more than planned), Treasury can then
come back and start lifting the market again. But in the mean time it will be
allowed to check the status of the markets, and also keep the banks which
created and invested in these trashy assets from gaming the system.
After all, if $500 bln or any other amount is announced, Wall Street will
then certainly try to unload its junk at the most inflated prices to the
government. If the target is not defined, however, the Street will not know how
much the Treasury will actually buy in the end. And that uncertainty will keep
it honest when pricing things up into any auctions/bidding procedures the
Treasury implements. [email protected] /dc/jr

14:37 Policeman Paulson- Nothing Much To See Here, Move Along New York, September 19th. With Treasury Secretary doing the bare minimum at his press conference; traders, analysts, and talking heads alike are all feeling a bit short changed. One of our colleagues is gnashing at the teeth that Paulson was so terse in his delivery. He offered to answer "several" questions, and barely managed the technical definition (more than two). The basic message is that "we have to do something", it will cost the tax payer a lot of money, it will require bi-partisan support, but it is better than the alternative (US financial companies with a zero net worth?). He did emphasize that he will be working through the weekend with Congress "mulling" the alternatives, but ceded that the mortgage buying program will be "hundreds of billions of dollars". The task ahead of him is onerous, and complex, and he could be forgiven for not having all the answers, a skittish American investor base feels a few more would have been nice. [email protected]

I have a great idea re paulson taking on all the toxic/bad debt, maybe they could package it up with a bunch of other stuff, fool the rating agencies into believing it's good paper, and sell it out as collateralised T-notes/securities to the banks, who can then.........ooops, sorry , ...we've been here before haven't we!

An excellent brief article re the roots of the current banking/financial crisis is replicated below: (may be useful for Paul)



A Brief History of the Financial Crisis

The outlines of the financial and credit crisis are clear though the blame will be argued and discussed far into the future. Three primary causes played out over the past decade culminating in the tumultuous events of the past two weeks with the American Federal Government on Friday putting forth a plan to buy the housing based bad debt of the entire United States financial system.

In the early part of this decade the Federal Reserve held interest rates at historically low levels for three years. In the mortgage industry increasingly lax credit standards were encouraged by government pressure to lend to marginal customers. Finally Wall Street firms became enamored of the profitability and supposed safety of their securitized credit derivative instruments, not only originating many products but also stocking their balance sheets with them.

In the aftermath of the 9/11 attacks in 2001 the Federal Reserve cut the Fed Funds rate in half, to 1.75%. The rate would stay below 2.0% for almost three years. Those low nominal rates, negative in real inflation adjusted terms, stoked a building and buying boom in housing that developed into a huge speculative bubble.

When the Fed brought rates back to 5.25% at the end of June 2006, the bubble began to deflate; the housing based credit crisis began a little more than a year later. Market bubbles always burst. Perhaps the fall of the housing market now seems preordained. But at the time the risk of the dicey mortgages spread throughout the financial system was disguised by the financially engineered instruments that had repackaged the questionable bits with higher quality debt, supposedly insuring the whole against default.

Starting in the closing years of the Clinton Administration the Community Redevelopment Act, a Carter Era program, was used to force banks to lend to mortgage customers formerly considered ineligible for loans. In pursuit of a social goal, universal home ownership, banks either lowered credit standards and granted mortgages or faced fines and business penalties for ‘redlining’. Banks by and large complied with government dictates.

Two of the government sponsored enterprises (GSEs) in the mortgage field, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) bought much of the bank mortgage debt and sold it back to the market with their implied government guarantee behind it. The banks and loan companies used the cash obtained to sponsor more loans and keep the housing bubble inflating. As with the banks, the GSEs also brought some of this debt onto their balance sheets. All in all these two GSEs held title to or guaranteed upwards of 70% of residential mortgages in the United States . Their mortgage paper is endemic on the balance sheets of the world’s financial institutions.

The nozzle through which much of the air inflating the housing bubble passed was the asset backed collateralized debt obligation (CDO) fashioned by Wall Street’s leading investment houses and banks. Combining different types and grades of debt in one instrument these complex securities were supposed to reduce risk of the whole below the level of the individual pieces. Their complexity often rendered them opaque to the rating agencies whose rankings customers buying the securities relied on for risk measurement. Usually sold with default insurance these securities had one major flaw, their balance sheet value was assessed not by the value of the underlying income streams but by their sale price in the secondary market. If there were no market, if no one were willing to buy these securities, the theoretical book value fell to zero.

As the housing market stagnated and then fell, the value of those securities with housing components dropped as default rates on mortgages rose. But housing prices in the US have only declined on average about 20%. How could such a large but not catastrophic decline threaten the very foundations of the financial system? The crux is the mark to market nature of the security. As the financial markets progressively lost faith in asset backed securities and as housing prices continued to fall bids for these securities became scarce. The lower the prices for the securities the more capital the firm had to set aside to meet regulatory limits. The firms that owned large amounts of these securities were caught in a downward spiral of devalued securities requiring ever large amounts of the firms capital for support which progressively undermined the worth of the firms stock and market confidence in the firm’s solvency which in turn demanded more capital support.

The United States has had market bubbles before, but none shook the financial system to its core and threatened the financial system. What has been different this time? The factor that levered a serious housing market bubble and collapse into a threat to the entire US and indeed world financial system was the asset-backed derivative. These new and poorly understood instruments were embraced by the financial world for their touted safety and for their high return. Yet their safety, the quality of their financial analysis and most importantly the underlying assumptions were completely untested.

Chief among the assumptions underpinning these derivative securities was the mark to market rule for valuation. Imposed by regulators in the aftermath of the failure of Enron it posits, natural enough in normal times, a functioning secondary market. Its purpose was to insure realistic pricing for securities. All is fine with the rule unless there is no market. As with the failure of Long Term Credit, it was the assumption that there will always be a functioning orderly market that was at fault. Markets are not always rational, they are voluntary and they are psychological. People and firms do not have to participate. When enough market participants choose abstinence the market collapses and all calculations that depend on market pricing are void.

Markets are reflections of the faith and credit of their participants. When that is lost no amount of financial engineering can make up for the loss of liquidity. In a panic the market vanishes. The asset backed derivative made the stability of the entire financial system beholden to its least stable component, the psychology of the market.



Joseph Trevisani
FX Solutions, LLC
Chief Market Analyst

[email protected]

Buffett knew what was what back in 2003 already didn't he.

"BBC

4 March, 2003

Buffett warns on investment 'time bomb'

The rapidly growing trade in derivatives poses a "mega-catastrophic risk" for the economy and most shares are still "too expensive", legendary investor Warren Buffett has warned.

The world's second-richest man made the comments in his famous and plain-spoken "annual letter to shareholders", excerpts of which have been published by Fortune magazine.

The derivatives market has exploded in recent years, with investment banks selling billions of dollars worth of these investments to clients as a way to off-load or manage market risk.

But Mr Buffett argues that such highly complex financial instruments are time bombs and "financial weapons of mass destruction" that could harm not only their buyers and sellers, but the whole economic system.

Contracts devised by 'madmen'

Derivatives are financial instruments that allow investors to speculate on the future price of, for example, commodities or shares - without buying the underlying investment.

Derivates like futures, options and swaps were developed to allow investors hedge risks in financial markets - in effect buy insurance against market movements -, but have quickly become a means of investment in their own right.

Outstanding derivatives contracts - excluding those traded on exchanges such as the International Petroleum Exchange - are worth close to $85 trillion, according to the International Swaps and Derivatives Association.

Some derivatives contracts, Mr Buffett says, appear to have been devised by "madmen".

He warns that derivatives can push companies onto a "spiral that can lead to a corporate meltdown", like the demise of the notorious hedge fund Long-Term Capital Management in 1998.

Derivatives are like 'hell'

Derivatives also pose a dangerous incentive for false accounting, Mr Buffett says.

The profits and losses from derivates deals are booked straight away, even though no actual money changes hand. In many cases the real costs hit companies only many years later.

This can result in nasty accounting errors. Some of them spring from "honest" optimism. But others are the result of "huge-scale fraud", and Mr Buffett points to the US energy market, which relied for most of its deals on derivatives trading and resulted in the collapse of Enron.

Berkshire Hathaway, the investment group led by Mr Buffett, is pulling out of the market, closing down the derivatives trading subsidiary it bought as part of a huge reinsurance company a few years ago.

In his letter Mr Buffett compares the derivatives business to "hell... easy to enter and almost impossible to exit", and predicts that it will take years to unwind the complex deals struck by its subsidiary General Re Securities.

Warren Buffett, dubbed "the sage of Omaha", from where he controls Berkshire Hathaway, is well-known for both his blunt assessments of the markets and the high returns he delivers to shareholders.

This year, he remains cool towards further share investments, despite the sharp correction in stock market values. Mr Buffett says this "dismal fact is testimony to the insanity of valuations reached during The Great Bubble".

Berkshire backyard barbecues

A good friend of Bill Gates, he famously refused to invest in technology shares during the boom years that came to a sudden end in March 2000. As a result, Berkshire was sitting pretty after the technology bubble burst.

In marked contrast to the hubris of former managers at fallen firms like Enron and WorldCom, Mr Buffett is known for his down-to-earth style, summoning shareholders not to glitzy hotels but "Berkshire backyard barbecues" and baseball games in out-of-the-way Omaha, Nebraska.

But his strategy of identifying undervalued companies with good management in unfashionable retail sectors or the insurance industry and investing in them for the long-term has produced spectacular returns.

During the past 37 years, the company has delivered an average annual return of 22.6%. Since 1965 the company's book value has gone up by 194,936%.

However in 2001, the last year for which detailed numbers are available, heavy losses in the insurance industry worldwide resulted in a $3.77bn loss at Berkshire Hathaway - the first loss in the firm's history under Warren Buffett."


LINK:
BBC NEWS | Business | Buffett warns on investment 'time bomb'

Lifted from Robert Preston's Blog (BBC Business Editor) BBC NEWS | The Reporters | Robert Peston

New York State wants to bring law and order to the last wild frontier of global finance, the credit default swaps market.

It's yet another attempt to close a stable door after a galloping herd has not only bolted but has already crossed the state line.

Credit default swaps are - in essence - contracts to insure debt, especially debt in the form of bonds, against the risk of default.

They began life as a sensible initiative by banks to reduce the risks they were running in lending to companies. Banks used them to lay off the risks of default to specialist insurers and other financial firms.

But as with all good things in global finance, especially the unregulated things, the market then binged on these credit derivatives.

Their use exploded with the boom in collateralised debt obligations made out of subprime loans, because the vendors of these toxic securities took out credit-default-swap contracts to secure cherished AAA ratings - or to turn poo into gold (most of it's since turned back into poo, occasioning great pain for the banking system).

And, in the corporate markets, credit default swaps became an instrument of pure speculation. If hedge funds wanted to speculate on the fortune of a big business, they would often buy and sell these credit derivatives as an alternative to shares.

Why?

Well this was - for a while at least - a huge, liquid and unregulated market, a true Wild West, almost free from the nosey attention of sheriffs and regulators who take an annoying interest in what goes on in stock markets.

Anyway the notional value of extant credit derivatives, in terms of the underlying value of the debt insured, was something over $60,000bn at the end of 2007, or more than five times the value of the entire US economy.

However many analysts say the better measure of the size of market is the $2,000bn fair value of outstanding contracts - because that's an attempt to assess potential losses and gains.

Both numbers are big, even if one of those falls into the too-big-to-fathom category.

Perhaps the more important point is that over just the past three years, the size of the market has increased by 15 times.

Which simply tells you that a lot of stupid contracts have been written at the wrong price, since in the two years to August last year most bankers and financial firms were pricing financial risk as though it were a myth from a bygone age.

Anyway it was AIG's exposure to credit derivative contracts that did it in just a few days ago: one of its subsidiaries had to find a colossal amount of cash in a hurry under its credit derivative contracts, because of a contractual requirement to post collateral after its credit-worthiness was marked down by rating agencies.

All of which is to explain why the New York Governor David Paterson issued a statement yesterday saying that his state will regard as insurance, in a formal sense, those contracts sold to investors who own bonds they want to protect from default.

It will therefore require proof from the entities selling the insurance that they have the resources to actually pay possible claims under the relevant contracts.

Doh!

I'd laugh if I didn't want to cry.

Paterson is implying that many of the writers of credit default swaps don't have the means to make good on their liabilities, that they were taking a punt, hoping to make easy money from insurance they thought would never be claimed on.

It's one of those "emperor's new clothes moments" that leaves me almost lost for words (almost).

To state the bloomin' obvious (as is my wont), we should be worried about this because we are entering a pronounced economic slowdown in which many companies will have difficulties servicing their debt.

And so we will start to see a raft of claims under credit derivative contracts, to add to those already triggered by the collapses of Lehman, Fannie and Freddie.

If the insurers can't pay, well that could lead to losses and pain all over the place, for hedge funds, for pension funds and for banks - which may still be living in the fools' paradise of thinking that their balance sheets are stronger than they are, thanks to all that lovely insurance they've taken out.

PS. Yesterday was a truly horrific day for the US Treasury.

First it learned that investors aren't in love with its bank bailout plan, because of the way that all those liabilities damage the credit-worthiness of the US.

Second, the opposition of influential legislators to the $1.1 trillion bailout has demonstrated in the reaction of markets that no bailout would be worse for the financial system than an unaffordable bailout.

It's going to be another hairy day.

Get this: The BBcCand others reporting last night that Morgan Stanley have bid to 'manage' the Fed's proposed 'Bad debt bank' (for want of a better phrase) and think they can illicite $1bn worth of fees from the operation.

The cheek of it, although on the other hand, at least it's an investment bank returning to what they do best, taking fees, lol.

Interbank hysteria
Robert Peston 24 Sep 08, 04:26 PM

Until money markets go wrong, the rest of us barely know they exist.

But something has gone seriously awry in the interbank market, which is where banks lend colossal sums to each other.

The measure of what's gone wrong is the record gap of almost 1 ½ percentage points - or 145 basis points to be precise - between the interest rate for lending between banks in sterling for three months (what's called three month Libor) and the market's expectation of the average overnight interest rate for the coming three months (or the three month OIS rate).

The gap has never been as wide as that, though it has periodically been over one percentage point since the credit crunch began last August.

Before the crunch, the average gap was 0.1 percentage points (10 basis points).

What that gap shows is that banks are happy to lend for 24 hours, but not for any longer than that.

In fact, banks have more money to lend overnight than they know what to do with.

They are depositing a ton of it with the Bank of England in its standing deposit facility, which pays a paltry penal interest rate of 4%.

Think about that for a second.

Our banks are prepared to lend to the Bank of England overnight at 4%, but not to each other for three months at more than 6%.

What on earth is going on?

Well the background is that banks are rebuilding their balance sheets to cope with the economic downturn we're experiencing, and they're doing that by lending less (and raising new capital).

But the more immediate cause is a sudden flare up - post the debacles at Lehman, AIG and the rest - of fears that no financial institution is safe from collapse.

So bank chief executives and treasurers think it's wiser to hoard cash (or liquidity) than to lend it out, even if that leads to a reduction in profits (which it does).

Also, there's a significant potential funding problem for all banks in the growing risk aversion of US money market mutual funds, which are increasingly reluctant to lend their trillions of dollars for more than a few days at a time (because they were burned on Lehman and because their shareholders are withdrawing cash on a significant scale).

The rise in interbank rates for lending longer than overnight is the most palpable sign of crisis in the global banking system, a crisis engendered principally by fear.

Banks aren't fulfilling their core function, of transmitting money to where it's needed.

It's why Hank Paulson and Ben Bernanke may not be guilty of hyperbole when they claim that their $700bn banking bailout plan may be the difference between life and near death for the global financial economy.

Good background reading re current economic situation, pdf and 'money as debt' vid attached.

Money As Debt

Everything is fair and equitable?? (or is it?)

The Federal Reserve

and in case you ain't got it yet;

The President and the Press - Kennedy Warns America of New World Order

What do you think happened to the only 3 presidents to warn of subjects contained in this thread, and as the vid above reminds us, to the only president that paid off any national debt??

Monetary Reform Act - A Summary (in four paragraphs)

This proposed law would require banks to increase their reserves on deposits from the current 10%, to 100%, over a one-year period. This would abolish fractional reserve banking (i.e., money creation by private banks) which depends upon fractional (i.e., partial) reserve lending. To provide the funds for this reserve increase, the US Treasury Department would be authorized to issue new United States Notes (and/or US Note accounts) sufficient in quantity to pay off the entire national debt (and replace all Federal Reserve Notes).

The funds required to pay off the national debt are always closely equivalent to the amount of money the banks have created by engaging in fractional lending because the Fed creates 10% of the money the government needs to finance deficit spending (and uses that newly created money to buy US bonds on the open market), then the banks create the other 90% as loans (as is explained on our FAQ page). Thus the national debt closely tracks the combined total of US Treasury debt held by the Fed (10%) and the amount of money created by private banks (90%).

Because this two-part action (increasing bank reserves to 100% and paying off the entire national debt) adds no net increase to the money supply (the two actions cancel each other in net effect on the money supply), it would cause neither inflation nor deflation, but would result in monetary stability and the end of the boom-bust pattern of US economic activity caused by our current, inherently unstable system.

Thus our entire national debt would be extinguished – thereby dramatically reducing or entirely eliminating the US budget deficit and the need for taxes to pay the $400+ billion interest per year on the national debt - and our economic system would be stabilized, while ending the terrible injustice of private banks being allowed to create over 90% of our money as loans on which they charge us interest. Wealth would cease to be concentrated in fewer and fewer hands as a result of private bank money creation. Thereafter, apart from a regular 3% annual increase (roughly matching population growth), only Congress would have the power to authorize changes in the US money supply - for public use -not private banks increasing only private bankers' wealth.

Read the full text here
The Money Masters

Ron Paul: Who Owns You (Narrated By George Carlin)
YouTube - Ron Paul: Who Owns You (Narrated By George Carlin)

The New Capitalism

Good blog post by Robert Peston entitled the New Capitalism, replicated below;

It's a discvussion about the type of capitalism that may emerge as a result of the massive tax payer / govt rescues of the financial system, as well as an overview of the causes....worth a read.

The New Capitalism
There's next year, and then there's the next decade.
Economic conditions in 2009 will be treacherous. There'll be a formal recession in
most developed economies, and the economic contraction is highly likely to be more
severe in the UK than almost anywhere else.
Companies and consumers will continue to tighten their belts. There'll be a sharp rise
in unemployment. The extraordinary volatility we've experienced in the price of
sterling, commodities, energy, shares and capital - which makes it so hard for
businesses and investors to plan - is unlikely to dissipate.
Many businesses, especially big ones, will become unviable - and will present the
Government with an appalling dilemma of which ones to put on life support.
So it’s understandable that most of us, including ministers, central bankers and
regulators, are planning for the next few months. We're building the economic
equivalent of bomb shelters and mobile hospitals.
But this is no downturn like any we've seen since the Second World War, for two
reasons: it's global; and its primary cause is the pricking of a massive debt bubble.
We borrowed too much, especially in the US and the UK. And the process of paying
the money back is not only leading to a fall in living standards but is also precipitating
very significant changes in how the global financial economy operates.
Capitalism is changing in fundamental ways. For many years to come, what's
happening will affect the relationship between business and government, between
taxpayers and the private sector, between employers and employees, between
investors and companies.
Arguably the global economic crisis will turn out to be more significant for us and
other developed economies than the collapse of communism.
A New Capitalism is likely to emerge from the rubble. And although it’s impossible
to be precise about how the reconstructed economy will operate, parts of its outline
are taking shape. What lies ahead can be determined from an understanding of what’s
gone wrong with the existing model.
This, in itself, is no reason for gloom or despair. For many, the New Capitalism may
well seem fairer and less alienating than the model of the past 30 years, in that the
system's salvation may require it to be kinder, gentler, less divisive, less of a casino in
which the winner takes all.
Here are some of the numbers that tell us what’s gone wrong. For the UK, if you
aggregate together consumer, corporate and public-sector debt, the ratio of our
borrowings to our annual economic output is a bit over 300%, or over £4000bn.
That’s a similar ratio of debt to GDP as that of the US, and it’s a record. Over the past
decade, we borrowed and we borrowed and we borrowed: we assumed that the day
when we had to pay it back would never arrive, that there would always be an
opportunity to roll over the debt.
Households borrowed too much, £1200bn on mortgages alone. Big companies
borrowed too much, especially those taken off the stock market in private equity deals.
Note however that for all the political fuss about the need for banks to maintain lines
of credit to small companies, they're the unsung heroes of our tale of monumental
financial folly: even today, the aggregated savings of small companies exceed their
debt.
One of the best ways of understanding how all our debts were accumulated is to look
at the gross foreign current liabilities of our banks. These rose from £1,100bn in 1997
to £4,400bn this year (again, about three times the size of our annual economic
output).
This trend tells two stories. It shows the massive and unsustainable growth in the City
of London and our financial services industry - which is now shrinking with a
vengeance, at the cost of massive job losses and evaporating tax revenues (perhaps
£30bn to £40bn of income for the Exchequer gone forever).
But it also shows that our debts are, to a large extent, the recycled savings of other
countries, notably the massive savings and surpluses of China, other Asian economies
and the Middle East (one note of caution here: a sizeable proportion of these foreign
currency liabilities, but by no means all, were used to buy foreign currency assets).
To put it in crude terms, for much of the past decade, millions of Chinese slaved away
on near subsistence wages and still managed to save, both as a nation (China swanks
£1,400bn in foreign exchange reserves) and as individuals. And to a large extent they
were working to improve our living standards, because they made more and more of
the stuff we wanted at cheaper and cheaper prices - and clever bankers took their
savings and lent the cash to us, so that we could buy the houses we cherished, the cars
we desired, the flat-screen TVs.
This imbalance - between the savings of China, India, Japan and Saudi and our
indebtedness, between their massive trade surpluses and our deficits - was never
sustainable. At some point, the Chinese were bound to say, “we’d like some of the
cake now please, which means you’ll have to have a bit less”.
Tragically, they toiled for our prosperity – or we lived high on the hog while they
fattened the pigs for us – for too long. Which is partly why the return to equilibrium,
to a more balanced global economy, is happening in a horribly painful way that's
impoverishing millions of people.
For me, therefore, the most important event of the past week was the chastising of the
US Treasury Secretary, Hank Paulson, by Zhou Xiaochuan, governor of the Chinese
central bank. Zhou said that "over-consumption and a high reliance on credit is the
cause of the US financial crisis" and "as the largest and most important economy in
the world, the US should take the initiative to adjust its policies, raise its savings ratio
appropriately and reduce its trade and fiscal deficits."
This seemed a pretty unambiguous statement by the Chinese that they're no longer
prepared to finance the spendthrift ways of the US and UK: they don't want to lend
more and they want to be confident that what they have lent won't disappear in a puff
of bad debts and inflation.
So the big question is how much debt will we have to repay until our economy is
returned to some kind of stability.
This is tricky to calculate.
One important number, which gives us a clue, is the difference between what our
banks have lent and what they've borrowed from British households, businesses and
institutions that are too small to be players in global financial markets. It's what the
Bank of England calls the customer funding gap. And it matters because it's a guide to
the dependence of British banks on funds from overseas that are diminishing and
could well, over time, drop to zero.
This customer funding gap was nil in 2001. But by the end of June this year,
according to the Bank of England, the gap had soared to £740bn. To be more specific,
a typical British bank has been raising the funds for 40% of all the loans it makes to
you and me from big financial institutions, money managers, giant companies and
other so-called wholesale sources.
The problem for British banks (and for those in many other countries) is that this
source of funds dried up in August 2007 and it’s not at all clear that the tap will ever
be turned on again in the way that it was. The trigger of the closing down of
wholesale markets was the horrifying realisation by financial institutions in every
country that hundreds of billions of dollars lent to US homeowners in the form of low
quality subprime loans – and repackaged into putatively high quality investments as
collateralised debt obligations – were going bad. This undermined trust within the
financial system, in that none of the players could be confident which of them had
been poisoned beyond rehabilitation by subprime. And this trust disappeared
altogether in September of this year, when the US Treasury chose not to rescue one of
the world’s biggest investment banks, Lehman Brothers.
This malfunctioning of money markets has also been the trigger for the end of the
recycling of the surpluses from China, or others parts of Asia or the Middle East, into
loans to us. Over the longer term, it would be a very good thing if these great
exporting nations were to consume more of the wealth they generate. That would, for
example, create great opportunities for our trading companies. But in the transitional
period it’s something of disaster for our financial system, because there’s a
progressive and painful withdrawal of funds from our banks (although this withdrawal
of overseas funding from our banks happens in an indirect way, via assorted financial
institutions, since China – for example – rarely lends directly to them).
Our banks have been forced to reduce their dependence on these diminishing sources
of wholesale funds, which is why they’ve been lending less to us. And it’s also why
they’ve had to turn to taxpayers for financial succour on an unprecedented scale.
Since the summer, as an ever increasing number of money managers, huge companies
and financial institutions demanded their money back from our banks, the entire
banking system came perilously close to collapse. Our banks didn't and don't have the
readies, for the obvious reason that the cash had all been lent out in the form of
mortgages and loans to companies and consumers.
So you and I, as taxpayers, came to the rescue and filled the gap. Over just the past
few months, British taxpayers have provided loans, commitments, guarantees and
capital to our banks in excess of £600bn (in the US, the equivalent figure for taxpayer
support is around £5,500bn). Which is probably just the beginning.
In the UK, taxpayer funding for our banks is very likely to rise, probably to more than
£1000bn, perhaps more still. And the reason is that many of our banks are still some
way from equilibrium between the borrowing needs of British companies and
households and the deposits and loans they receive from British companies and
households.
Here it’s necessary to take a detour into the way that credit was created in the boom
years and is in the process of being destroyed.
The recycling of Asian and Middle Eastern surpluses to the UK, Europe and the US in
the form of loans wasn't a simple conversion of a pot of savings into an identical pot
of debt. When loans were used to buy houses, or to support property developments, or
to finance hedge funds that trade in every imaginable security and commodity, or to
fund the buyouts of companies by private equity firms, these loans pushed up the
value of assets. This rise in the value of assets sparked yet more lending, often at
higher ratios of the loan to the value of the asset, to do more deals – which in turn
pushed up asset prices further.
As we entered 2007, whether you were borrowing several billion pounds to buy a
company or £250,000 to buy a house, lenders were prepared to lend you almost 100%
of the purchase price with few strings attached.
There's a subtle but important point here. There were twin connected bubbles in assets
and credit. Both of those bubbles have burst. Falling asset prices are leading to losses
for those who borrowed to buy those assets (hedge funds, private equity firms,
billionaire corporate raiders, banks, homeowners). And as they struggle to pay their
debts, they sell other assets, driving down the price of those assets and causing losses
for other borrowers. And when they can’t repay banks, the resources of banks are
depleted, which means there's less credit available – and no 100% mortgages or other
loans – which drives down asset prices further, which leads to a further contraction of
lending, and so on in vicious cycle of decline.
So it is unrealistic to expect our banks to cease the insidious process of contracting the
volume of credit they'll provide - whatever the coaxing and bullying of politicians -
unless and until the price of property, shares, commodities and other assets stops
falling. Or to put it another way, asset prices have to find a floor – and they haven’t
found the floor yet – before the financial economy can rebuild itself and the real
economy can receive the necessary finance that will allow the recovery to begin.
As for alleviating the burden of all that debt, history would suggest that’ll necessitate
the printing of money on a colossal scale, a revival of inflation, to reduce the real
value of the debt. But as a deliberate strategy, that would be fraught with risks for the
Government, since the influential babyboomer generation is now old enough to
consist mainly of savers rather than borrowers – who would be the victims of
spiralling prices rather than the beneficiaries.
A couple of questions follow. Who's to blame? And where will all this taxpayer
support for banks - and probably, before long, for real companies and the real
economy too - lead us?
It takes a whole book to assign culpability. But the short answer is that we’re all at
fault to varying degrees.
The authorities in the US and the UK were aware of the dangers of allowing the
financial and trade deficits with China and other exporting nations to persist. They
could have corrected these deficits by using tax and interest rate policies to reduce our
rampant consumption. But they chose not to do so, because it all looked too difficult.
Our own Government turned a blind eye to all the evidence that a rampant lending
binge was taking place, because the Exchequer was receiving all those lovely tax
revenues from the housing and City bubbles – and because there was kudos to be had
from the world renown of our financial services industry.
In 2006 and 2007, I had long conversations with ministers, officials and regulators
about how the hedge-fund and private-equity booms – the mind-bogglingly huge
rewards available to the stars of these industries - were symptomatic of a
malfunctioning in markets. I saw the frenetic activity of these young financial firms as
a manifestation that too much debt was available on ludicrously cheap terms that
didn’t remotely reflect the risks – and this seemed to me to be worrying. The standard
response from those who now know better was that it would all come out in the wash
in a painless way, that these new firms were a great asset to the UK, and I was fussing
about nothing.
A corollary of precisely this complacency was that central banks, such as the Bank of
England, were hopelessly wrong in believing that the explosive growth of credit and
the surge in the price of assets such as houses was somehow hermetically sealed from
the rest of the economy, such that it wouldn’t damage everything when the bubble
was finally popped. That said, most would say that Alan Greenspan, the former
chairman of the Federal Reserve, the US central bank, was the most benighted of all
about how the global economy had become safer and sounder.
Also regulators were negligent in allowing the creation of what’s become known as a
shadow banking system, in which trillions of pounds of long term loans in the western
economies were financed with credit that could be withdrawn far too quickly.
As for the media, we certainly could have shouted louder about the risks of all that
debt being accumulated – but perhaps the volume control was set a little too low
because of all the splendid advertising revenue that was generated by the property
boom.
And, to repeat, most of us were prone to forget that if you borrow £100, or indeed
£4000bn, you have to pay it back one day.
But it’s quite hard to hard to mount a convincing argument against the notion that
most at fault were the banks and bankers – because they systematically failed to do
what they were handsomely remunerated to do, which was to properly assess the risks
of all that lending.
Their survival as institutions now wholly depends on the goodwill of governments
and taxpayers around the world. From Australia, to South Korea, to Germany, France,
the UK and the US – inter alia – taxpayers financial support for the banking system is
now equivalent to more than one quarter of global GDP, or more than £9,000bn.
There are reasons to believe that credit from taxpayers can’t and won’t be repaid for
many years, in that this credit is financing the correction of huge financial and trading
imbalances between the western and eastern economies. So if we’ve witnessed a
semi-permanent nationalisation of the banking system and will soon see significant
taxpayer support for real companies in the real economy, then our banks and privatesector
companies will have to work much harder to sustain the goodwill of those who
are keeping them alive: millions and millions of taxpayers.
That means, I think, that those running our biggest commercial businesses will have
to be more visible. They’ll have to manifest a genuine understanding not only of the
anxieties of their employees but of all taxpayers. Those chief executives who succeed
will be those who imbue in their businesses very simple, commonsense standards of
decency. And they’ll almost certainly be paid less for doing more, because the
pricking of the debt bubble has undermined the institutions – the private-equity firms,
hedge funds and investment banks – that were ratcheting up the pay of all business
leaders.
But the biggest lesson of all is that we are a million miles from having created the
political and regulatory institutions to help us contain the risks of globalisation. We
and most of the world may well have been beneficiaries of the open global economy.
But as millions lose their jobs in Europe and the US in the coming year, the benefits
will be forgotten.
If the unfettered movement of capital, goods and services is going to survive, if
there’s not going to be a retreat into national fortresses that could impoverish all of us
over the longer term, we’ll have to find a far better way of monitoring global risks and
of bringing governments together to deal with these risks.
Some may see this as a threat to national sovereignty, as the thin end of an antidemocratic
wedge that’ll see the world ruled by unaccountable bureaucrats.
Reconciling our political traditions with the imperative of making safe the globalised
world will be a challenge, to put it mildly. But it’s not a challenge we can shirk.
Robert Peston, 8 December 2008
BBC NEWS
bbc.co.uk/robertpeston
© BBC MMVIII

What A Dollar Buys

Michael Covel: Trend Following

One year ago Royal Bank of Scotland (RBS) paid $100bn for ABN Amro. For this amount it could now buy:

- Citibank $22.5bn
- Morgan Stanley $10.5bn
- Goldman Sachs $21bn
- Merrill Lynch $12.3bn
- Deutsche Bank $13bn
- Barclays $12.7bn

And still have $8bn change which would allow you to pick up:

- GM
- Ford
- Chrysler and
- The Honda F1 Team

Jim Rogers calls most big U.S. banks "bankrupt"

Jim Rogers calls most big U.S. banks "bankrupt"

By Jonathan Stempel

NEW YORK (Reuters) - Jim Rogers, one of the world's most prominent international investors, on Thursday called most of the largest U.S. banks "totally bankrupt," and said government efforts to fix the sector are wrongheaded.

Speaking by teleconference at the Reuters Investment Outlook 2009 Summit, the co-founder with George Soros of the Quantum Fund, said the government's $700 billion rescue package for the sector doesn't address how banks manage their balance sheets, and instead rewards weaker lenders with new capital.

Dozens of banks have won infusions from the Troubled Asset Relief Program created in early October, just after the Sept 15 bankruptcy filing by Lehman Brothers Holdings Inc (LEHMQ.PK: Quote, Profile, Research, Stock Buzz). Some of the funds are being used for acquisitions.

"Without giving specific names, most of the significant American banks, the larger banks, are bankrupt, totally bankrupt," said Rogers, who is now a private investor.

"What is outrageous economically and is outrageous morally is that normally in times like this, people who are competent and who saw it coming and who kept their powder dry go and take over the assets from the incompetent," he said. "What's happening this time is that the government is taking the assets from the competent people and giving them to the incompetent people and saying, now you can compete with the competent people. It is horrible economics."

Rogers said he shorted shares of Fannie Mae (FNM.P: Quote, Profile, Research, Stock Buzz) and Freddie Mac (FRE.P: Quote, Profile, Research, Stock Buzz) before the government nationalized the mortgage financiers in September, a week before Lehman failed.

Now a specialist in commodities, Rogers said he has used the recent rally in the U.S. dollar as an opportunity to exit dollar-denominated assets.

While not saying how long the U.S. economic recession will last, he said conditions could ultimately mirror those of Japan in the 1990s. "The way things are going, we're going to have a lost decade too, just like the 1970s," he said.

Goldman Sachs & Co analysts this week estimated that banks worldwide have suffered $850 billion of credit-related losses and writedowns since the global credit crisis began last year.

But Rogers said sound U.S. lenders remain. He said these could include banks that don't make or hold subprime mortgages, or which have high ratios of deposits to equity, "all the classic old ratios that most banks in America forgot or started ignoring because they were too old-fashioned."

Many analysts cite Lehman's Sept 15 bankruptcy as a trigger for the recent cratering in the economy and stock markets.

Rogers called that idea "laughable," noting that banks have been failing for hundreds of years. And yet, he said policymakers aren't doing enough to prevent another Lehman.

"Governments are making mistakes," he said. "They're saying to all the banks, you don't have to tell us your situation. You can continue to use your balance sheet that is phony.... All these guys are bankrupt, they're still worrying about their bonuses, they're still trying to pay their dividends, and the whole system is weakened."

Rogers said is investing in growth areas in China and Taiwan, in such areas as water treatment and agriculture, and recently bought positions in energy and agriculture indexes.

(For summit blog: summitnotebook.reuters.com/)

(Reporting by Jonathan Stempel; Additional reporting by Jennifer Ablan and Herbert Lash)


© Thomson Reuters 2008. All rights reserved.

Stocks To Fall Another 60% And Bottom In 2014 -- Guru

Stocks To Fall Another 60% And Bottom In 2014 -- Guru
Henry Blodget | Dec 10, 08 1:44 PM
As we've noted frequently over the past couple of months, the stock market has finally fallen back to its long-term valuation average. Of course, after bubbles like the one we just had, stocks often fall far beyond their long-term average, into severely undervalued territory.

Jeremy Grantham and others think the S&P 500 will likely fall to 600 or so (vs. today's 900) before bottoming. This would represent another 35% downside from here.

Another guru, an expert in "Tobin's Q" valuation (a measure of replacement cost), thinks the S&P 500 will bottom at 400. (See chart below, which maps the S&P 500 on Q and cyclically adjusted earnings).

That's a horrible thought.

Just as bad, the guru, Russell Napier, thinks the market could take until 2014 to get there. And don't laugh. His logic is perfectly reasonable.

Bloomberg: The [Q] ratio, developed in 1969 by Nobel Prize-winning economist James Tobin, shows the Standard & Poor’s 500 Index is still too expensive relative to the cost of replacing assets, said [Russell] Napier. While the 39 percent drop in the index this year pushed equity prices below replacement cost, history suggests the ratio must sink further as deflation sets in, he said. The S&P may plunge another 55 percent to 400 by 2014, Napier said.

“The Q has come down to its average, however it’s not always stopped at the average,” said Napier, Institutional Investor’s top-ranked Asia strategist from 1997-1999. “It has tended to go significantly below that in long bear markets...”

Napier, who teaches at Edinburgh Business School... based his S&P 500 forecast on the Q ratio for U.S. equities as well as the 10-year cyclically adjusted price-to-earnings ratio, another measure of long-term value...

The Q ratio on U.S. equities has dropped to 0.7 from a peak of 2.9 in 1999, and reaching 0.3 has always signaled the end of a bear market, said Napier, 44, the author of “Anatomy of the Bear,” a study of how business cycles change course. The Q ratio for U.S. equities has fluctuated between 0.3 and 3 in the past 130 years.

When the gauge is more than one, it indicates the market is overvaluing company assets, while a Q ratio of less than one signifies shares are undervalued because it is cheaper to buy companies than to build them from the ground up.

At the end of the four largest U.S. bear markets in 1921, 1932, 1949 and 1982, the Q ratio fell to 0.3 or lower, and history is likely to repeat, said Napier. From the 1982 trough, the S&P 500 grew more than 14-fold to the middle of 2000, when Napier says the last bull market ended.



“Bear markets always end for exactly the same reason, and that is the market begins to price in deflation,” he said. “Equities will be incredibly cheap.”

Just as interesting: Napier thinks that we'll get a major bear-market rally lasting two years or more before we resume our decline. This, too, would be in keeping with previous bear markets, which have taken their own sweet time (see Japan).

Before the trough in 2014, investors are likely to see a so- called bear market rally for the next two years as central bank actions delay the onset of deflation, Napier said...



Federal Reserve Chairman Ben S. Bernanke’s indication that he will use “quantitative easing” to prevent deflation points to a stock market rally that may last for the next two years, Napier said. With quantitative easing, a tool pioneered by the Bank of Japan, central banks can stimulate inflation by printing money and flooding the market with cash in order to encourage consumers to spend.

The government’s efforts will eventually fail as ballooning government debt devalues the dollar, causes investors to flee U.S. assets and takes the S&P 500 to its eventual bottom in 2014, Napier said...