Monday, December 31, 2007

Crises Of The Future

Financial Crises Of The Future

By Paolo Mauro and Yishay Yafeh | 1 January 2008

Will They Resemble The Contagious Crises Of The 1990s Or The Country-Specific Crises Of The 1890s?

The damaging financial crises of the 1990s— originating in Mexico in 1994, Asia in 1997, and Russia in 1998— spread quickly across emerging markets, prompting calls for reform of the [international] financial architecture. That was a decade ago, however. The only major, full-blown emerging market crisis of this century— in Argentina in 2001— led to little spillover, or "contagion," except in neighboring Uruguay. In recent years, commentary in the financial press and in publications by investment banks and rating agencies has often emphasized an apparent decline in international contagion risk.

That is not to say that investors are not occasionally reminded of the issue of contagion: recent episodes of financial market turbulence include the drop in equity prices in emerging markets in May–June 2006, the global equity sell-off that began with an unwinding of positions on the Chinese stock market in February–March 2007, and the most recent woes that began in mid-2007, triggered by developments in the subprime mortgage markets in the United States.

On the whole, however, over the past few years emerging markets have enjoyed abundant liquidity, low bond spreads, and surges in capital inflows. Moreover, a very long-term perspective suggests that the contagious crises of the 1990s were not the norm but an unusual phenomenon. During the last period of financial globalization— the half century prior to World War I— the world witnessed several crises, but essentially no contagion. Even the most famous financial collapse of the period, the Barings crisis that originated in Argentina in 1890, did not have much impact outside the borders of that nation.

Will future crises look more like those of the 1990s or of the 1890s? Was the Argentine crisis of 2001 a harbinger of a return to self-contained crises? And if international spillovers remain possible, are there implications for global governance in the area of financial markets? To shed light on these questions, it is useful to analyze the historical record.

A Tale Of Two Eras

The 1870–1913 period of financial globalization— characterized by free trade, nearly unrestricted migration, large international capital flows, and sophisticated financial markets— resembles, and in some respects surpasses, globalization as we know it today. The London market for bonds issued by the "emerging economies" of the day was large (with an overall capitalization amounting to more than half of Britain's GDP), liquid (with bond spreads fluctuating considerably and reported daily in the newspapers), and supported by timely and reliable information (with political and economic news about emerging economies widely available in the British press). The typical portfolio of a British investor around the turn of the 20th century was probably more internationally diversified, and included a far larger share of emerging market securities, than that of his great-grandchild living at the beginning of the 21st century.

This global integration came to an abrupt end with the outbreak of World War I and the subsequent upheaval of the Great Depression and World War II. International financial flows resumed in the 1970s, but only in the final years of the 20th century did financial globalization achieve a level and a form reminiscent of the pre-1914 period. In particular, reliance on tradable emerging market bonds was jump-started by the Brady deals of the early 1990s, which repackaged the defaulted bank debt of the 1970s and early 1980s into bonds.

Despite these similarities in scale and reliance on bond finance, a striking difference between the 1870–1913 era and the 1990s relates to the extent that asset prices— specifically, sovereign bond spreads— moved together. Sovereign bond spreads are defined, for the historical period, as the yields on emerging market countries' bonds issued in pounds sterling on the London Stock Exchange, minus yields on British consols; and, for the modern period, as the yields on emerging market countries' bonds issued in U.S. dollars, minus yields on long-term U.S. treasury bonds. Whereas bond spreads followed country-specific trajectories during the pre-1914 era (see Chart 1), emerging market bond spreads tended to move in tandem to a much greater extent in the 1990s (see Chart 2). The message is similar when one focuses on comovement in times of crisis: sharp increases in sovereign bond spreads (of, say, more than 200 basis points) often took place simultaneously in several emerging markets in the 1990s, but they were typically restricted to one country in the pre-1914 period.

Changing Influences On Asset Prices

What explains the observed differences in the extent of co-movement of asset prices between the two periods? The evidence (based on event studies and econometric analysis of data on asset prices, macroeconomic variables, and contemporary newspaper articles) shows that the determinants of asset prices were different.
Bond spreads a century ago were driven primarily by country-specific events such as droughts, rebellions, wars, other changes in the political climate, and economic fundamentals.
In particular, episodes of politically motivated violence had the most visible impact on bond spreads. By contrast, in the 1990s, country-specific macroeconomic data and events, while still relevant, had more limited power in explaining individual-country bond spreads, with developments in the overall emerging market indices (and, especially, contagious emerging market crises) playing a greater role.

To some extent, the greater degree of comovement of emerging market bond spreads in modern times than in the past is explained by greater similarity in the economic structures of emerging market economies today. Before World War I, these economies tended to be very specialized (for example, Argentina produced wheat and wool and Brazil produced coffee and rubber). Now, they are better diversified and, as a result, engage in more similar economic activities, so that their economic fundamentals tend to move together to a greater extent than they did a century ago. Nevertheless, the increased similarity in the economies of today's emerging markets cannot fully account for the rise in asset price co-movement and shared crises.

Changes in investor behavior and the way in which international investment is organized and undertaken also contribute to greater comovement of asset prices in modern times. During the 1990s, losses incurred at the outset of a crisis in a given country induced large investment funds (including mutual funds and hedge funds) to sell assets in (initially) unaffected countries to maintain certain liquidity and risk profiles. For example, when open-end mutual funds foresaw future redemptions after a shock in one country, they raised cash by selling assets they held in other countries. Similarly, leveraged investors, such as banks and especially hedge funds, faced regulatory requirements, internal provisioning practices, or margin calls that led them to rebalance their portfolios by selling their asset holdings in countries that were initially unscathed. By contrast, investors in the past operated primarily as individuals at a time when trading technologies were also slower. In times of impending crisis, investors may have responded to trouble in one emerging market by buying assets in another, thus shifting assets rather than selling them en masse.

The Strange Case Of Argentina

Why was there a near absence of contagion in the case of the Argentine crisis of late 2001 (only Uruguay was affected, mainly because of withdrawals by Argentines who had deposits in its banking system)? Here too investor behavior is the key. Whereas the crises of the 1990s took many investors by surprise, the Argentine crisis was widely expected and market players had ample opportunities to adjust their exposure. Data on international mutual funds reveal a major decline in Argentine holdings throughout 2001. By the time the Argentine currency board collapsed in December, such holdings were extremely low. At a more technical level, a timely reduction of Argentina's weight in the Emerging Markets Bond Index tracked by many market participants may have facilitated an orderly shift of investment positions out of Argentina into other emerging markets.

Although there are some who argue that the 2001 Argentine crisis indicates that contagion may have permanently "vanished," the anticipated nature of this crisis casts doubt on that view. On the contrary, the generalized surge of capital inflows into emerging markets observed in recent years is consistent with the view that in some cases investors fail to discriminate sufficiently among emerging markets, based on fundamentals.

Trouble In The Core And On The Periphery

An additional factor determining whether contagion occurs has to do with whether financial market players in the "core" advanced countries are adversely affected by developments in the country in which a crisis originates. Indeed, in many of the best-known 'contagious emerging market crises,' advanced-country financial institutions played a role in transmitting the initial shock to countries on the "periphery." For example, losses incurred by advanced-country banks and other financial institutions were an important transmission channel of contagion during the Asian crisis.

The debacle of Long-Term Capital Management was a key factor in the spread of the Russian crisis of August 1998 to other emerging market economies. And the most recent woes that began with developments in the subprime market in the United States caused concern, though not a full-blown crisis, in a number of emerging markets. In fact, prompt liquidity provision by the central banks of the main advanced countries— while obviously aimed squarely at restoring confidence domestically— may also have reduced the likelihood of contagion to the emerging markets. The importance of liquidity provision by central banks in the core financial markets has not changed much since the previous era of financial globalization. Prompt action by the Bank of England is often credited with averting international contagion that might otherwise have emanated from the collapse of the investment house of Barings in 1890.

The Future Of Contagion

The likelihood of contagious financial crises and high co-movement across global financial markets in the future is reinforced by the entry and increased importance of new financial instruments and new players on international financial markets:

  • Hedge Funds have grown tremendously in recent years and manage assets in excess of $1 trillion. As seen in the 1990s and in the recent crisis in subprime mortgages, hedge funds' operations have often added to asset price comovement. Some commentators, however, have suggested that hedge funds may also occasionally mitigate the severity of financial crises by trading "against" the market when prices fall too low for investors with lower risk appetite.

  • Private Equity Funds affect comovement and the nature of financial crises, but how they do so is less clear. Private equity funds are typically long-term investors, so their presence might mitigate crises and contribute to stability. But were they to unwind a large position suddenly, the opposite would occur. Moreover, private equity funds occasionally have shorter investment horizons, which lead them to invest in fashionable sectors in several countries at the same time, contributing to comovement across countries.

  • Sovereign Wealth Funds are sparking new interest, although they have been investing sovereign nations' international reserves for years. The sudden interest has been kindled by various factors: these funds have grown rapidly in the past decade, attaining a vast scale; they have acquired large stakes in both emerging market and advanced country corporations and financial institutions, occasionally raising concerns about the perceived strategic importance of the target companies; and several of them do not make their investments public. By some estimates, sovereign funds manage assets well in excess of $1½ trillion, with most of this amount accounted for by a handful of such funds. Although most have used conservative and long-term investment strategies, in principle they could play a destabilizing role if they reversed a position abruptly, particularly one in a small emerging market country.

Beyond the emergence of new players, new investment vehicles for individual investors also have the potential to increase asset price comovement across countries. For example, the rise and growing popularity of index-based investing— through index mutual funds and, more recently, exchange-traded funds— leads to investment in aggregate country or regional indices rather than in individual securities (or countries). Exchange-traded funds are open-end mutual funds that typically seek to replicate a well-established market index. Flows into and out of them may cause all underlying securities to move together, with limited regard for country-specific information. On the other hand, the introduction of new financial instruments, such as exchange-traded funds, may help investors diversify their portfolios and increase market liquidity, contributing to investors' willingness to invest in individual stocks and bonds. The growth in cross-border banking has no doubt also played a role in increasing the potential for international transmission of financial and other shocks.

Prepare For The Future

It is difficult to predict the nature of financial crises in the 21st century, but it is quite likely that they will incorporate features from both the more distant past and the 1990s. Financial crises in the pre–World War I era occurred against the background of macroeconomic difficulties, but were typically triggered by such events as wars or other episodes of politically motivated violence, reflecting institutional deficiencies and political instability. Macroeconomic policies have improved in many emerging markets. But, in some, institutional weaknesses remain, so future crises may well also be triggered by political upheaval. And today's greater financial linkages— including those generated by the activities of new players— may lead to the rapid transmission of crises to other countries, much as happened in the 1990s.

A prudent working assumption, then, would be that contagion is likely to reemerge, suggesting the need to be prepared at both the domestic and the international level. At the domestic level, many countries have taken steps— including improved macroeconomic policies and debt management— aimed at reducing their vulnerability and at softening the blow in the event of a crisis. At the international level, to the extent that market failures and externalities require global governance and coordination, the debate has focused on the possible role of international financial or other supranational institutions, for example, in establishing mechanisms committed to providing liquidity in a crisis. Regional groups of countries have arranged to pool their international reserves to provide a backstop in case of a crisis.

Beyond increased stockpiles of official sector liquidity— whether through self-insurance in the form of international reserves, or international arrangements among countries or with international institutions— are there additional implications for global governance in the area of international financial flows? The debate is likely to concentrate on whether the official sector should increase its scrutiny of private financial market players. Although some observers have suggested forms of regulation of international financial flows, attention will probably be focused on the possible need for additional transparency and data provision, and refinements to existing prudential regulations. This will include a discussion of whether gaps were uncovered by the recent turmoil originating in the subprime market.

The implications of newly important players, such as hedge funds, private equity funds, and sovereign wealth funds, are not yet fully understood, and reasonable arguments can be made for whether— on a net basis— each of these players is likely to foster stability or volatility. Regardless, it is not difficult to imagine scenarios in which these players would be a source of volatility and contagion; a careful discussion of how to avoid such scenarios seems warranted. In particular, the policy debate is likely to concentrate on whether these players should provide additional information about their strategies and investments (that is, greater transparency), and on the possibility that new (voluntary) codes of conduct will be conceived for these new players. Progress in these areas will require identifying exactly what information is needed to permit effective prudential regulation and to facilitate informed decisions by investors without unnecessarily hampering the operation of the financial system.

What seems clear is that both advanced and emerging market countries will pay close attention to this debate. Traditionally, the importance of good governance and transparency has been emphasized with regard to avoiding hidden liabilities, and related vulnerabilities, in crisis-prone emerging markets. The focus on transparency in emerging markets has shifted to the asset side, with frequent calls for greater transparency in the operations of emerging market sovereign wealth funds. However, the financial turmoil that began during the summer of 2007 has shined the spotlight on issues related to transparency of advanced-country financial institutions and the importance of preserving stability in the core financial markets— not only for the well-being of domestic investors, but also to avoid harmful international contagion. The debate on these issues is likely to become more prominent still in the years ahead.


Mauro, Paolo, Nathan Sussman, and Yishay Yafeh, 2006, Emerging Markets and Financial Globalization: Sovereign Bond Spreads in 1870–1913 and Today (London: Oxford University Press).

Didier, Tatiana, Paolo Mauro, and Sergio Schmukler, 2006, "Vanishing Financial Contagion?" IMF Policy Discussion Paper 06/1 (Washington: International Monetary Fund).

Paolo Mauro is a Division Chief in the IMF's Fiscal Affairs Department, and Yishay Yafeh is a Visiting Scholar in the IMF's Research Department from the Hebrew University of Jerusalem and the Center for Economic Policy Research.



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Sunday, December 30, 2007

Hedge Funds: Recession in 2008

Hedge Funds Anticipate Recession In 2008: Rothstein Kass-Sponsored 'Flash Survey'
Over 61% Of Respondents Believe Recession 'Very Likely'

By PRNewswire | 30 December 2007

NEW YORK, and ROSELAND, N.J., Sept. 26 /PRNewswire/— The U.S. economy is heading for a recession in 2008, according to a poll conducted on behalf of CPA firm Rothstein Kass by Russ Prince, a leading authority on private wealth. Over 61% of hedge fund industry principals surveyed indicated that a recession in 2008 is a "very likely" scenario. Hedge fund industry principals also anticipate continuing market volatility through the remainder of 2007. Approximately 87% of those interviewed predicted that market volatility will increase or continue in the rest of the year.

"As trusted advisors to the hedge fund community, Rothstein Kass is constantly seeking insight into the economic trends impacting the industry. By combining the firm's unique expertise with our research capabilities, our Flash Surveys offer a snapshot view of how the industry is adapting to a rapidly changing business environment," said Russ Prince. "In light of increasingly widespread predictions of a recession, we decided to again speak directly with senior hedge fund principals to determine whether they feel a recession is imminent."

Mr. Prince surveyed over 239 hedge fund principals for this survey. Hedge funds polled had a minimum of $100 million in assets under management, and at least a five year track record, including some Rothstein Kass clients. Also among notable findings, only approximately 17% thought a recession would negatively impact their funds, while nearly 67% suggested that a recession would provide investment opportunities.

"An important part of hedge funds' appeal is their ability to outperform in turbulent or recessionary market conditions. It makes perfect sense that principals would be focused on the opportunities that current market conditions provide. In fact, over 81% of principals said that market volatility favors hedge funds over traditional investment vehicles." said Howard Altman, Co-Managing Principal of Rothstein Kass. "Respondents also seem undaunted by the prospects of a recession in 2008. While over 43% will likely change their fund's particular investments, fewer than 15% anticipated changes to the fund's underlying investment strategy."



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

No Recession In 2008

No Recession In 2008, Study Says
A UCLA Report Predicts The Nation And State Will Be Saved, Saying Some Of The Economy's Worst Bumps Are Past.

By Peter Y. Hong, LA Times | 6 December 2007

LEFT: The economy hits home; click to enlarge

California and the nation will escape a recession in 2008 despite rising oil prices, sinking housing prices and a turbulent stock market, a UCLA study released today predicts. "Be calm my friends. Be calm," wrote UCLA Anderson Forecast director Edward Leamer in the latest quarterly report from the group. A recession— negative economic growth for two consecutive quarters— probably will be averted next year, the forecast says, noting that the economy has already taken some of its hardest hits.

Nationwide, unemployment would have to climb to 6% from the current 4.6% to cause a recession, the forecast said. Such an increase would require the loss of 2 million more jobs. Cuts on that scale won't be possible, the Anderson report said, because job growth was weak throughout the current economic expansion.

Job losses in California will be numerous in the construction and financial sectors but total unemployment will peak by the end of next year at a 6.1% rate, the study reported. Meanwhile, real personal income will rise 1% to 2%.

"How can we lose jobs that were never found?" the report said.

  • The loss of 3 million manufacturing jobs early this decade means there is little room to cut more positions.

  • Most of the damage to the economy from the housing slump will be over by the end of next year.

  • The weak dollar will help U.S. exports, aiding manufacturers in Southern California.

  • Consumer spending will drop, but much of the effect will be shouldered by other countries as U.S. imports of their products decline.

The Federal Reserve [met] Tuesday and … cut its benchmark interest rate for a third time to help avoid a recession. That reduction— and more next year— will be needed to ward off a recession, the forecast said.

"Should the Fed fail to ease significantly, we believe our 'no recession' forecast would be at significant risk," the study said.

UCLA economists also predicted that stock prices would rise 10% to 12% next year amid calming credit markets and modest economic growth. In California, the economy will be hit hard by the weak real estate market, falling government revenue, and the Hollywood writers' strike. But like the nation, the Anderson Forecast projected that recession would be averted.

"It gets pretty ugly, but still no recession," the report said. State government will face a budget shortfall of $8 billion over the next two fiscal years because of weaker than previously expected income, sales and corporate tax collections, the study said. That shortfall would be greater than the state's spending on the University of California and California State University systems combined, the report said.

If the Writers Guild of America strike lasts as long as the 153-day action of 1988, it would lower personal income growth in Los Angeles by 0.25%, the forecast said. So the strike's effect on the overall economy will be slight but "can be very substantial and difficult for the people involved," the study said.

Ryan Ratcliff, a coauthor of the California portion of the forecast, said areas such as white-collar businesses, education, healthcare and tourism remain healthy, softening the blow of the real estate downturn. "It's not so much that there is one [paticular] sector doing so well it is offsetting real estate doing so badly," Ratcliff said, "we are seeing slow growth everywhere outside of real estate."



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Wednesday, December 26, 2007

Now What?

We Got The Oversold Rally, But Now What?

By normxxx | 26 December 2007

For the most part, the broad equity indices haven't done anything wrong since the November low— in fact, the price pattern has played out in classic fashion.

By mid-December, stocks had sold off hard. So hard, in fact, that a slew of price-based oversold signals were triggered. I spent a couple of days going over some of them, and all of those "oversold in December" stats argued for higher prices ahead... if we were willing to hold through the first couple of sessions of the new year at the latest.

We didn't have to wait long, though, as stocks quickly turned around and have gone up strongly since then. That's good confirmation of what I saw in the indicators at the time, but it has also begun to trigger a lot of short-term signs of excessive optimism. Typically, when we get those types of readings, even during seasonally positive periods, stocks have trouble holding on to much additional upside.

As for the more intermediate-term indicators, they are mostly neutral. I saw an overwhelming number of historically extreme "excessive pessimism" readings in November, which consistently precede gains of 5% - 10% over a one- to three-month period when they've occurred in the past. We've already satisfied those goals, and sentiment has understandably become more bullish because of it.

Looking at the sentiment conditions as they stand now, it's hard to make a strong case either way. The 'Smart Money Confidence' index is still relatively high, poking around 60%, but the 'Dumb Money' is also relatively high and it won't take much more to push it also over 60%. I'm going to go to 25% Long here, simply based on the idea that the models, indicators and studies I follow no longer provide as strong a bullish edge as earlier in this 'positive season.' But, this still is much more positive than the neutral position I had planned to end the year on.

Coming into this week, we had a number of short-term measures that were pointing to the idea that it was unlikely we'd see more sustained upside until the indices took a breather. ST overbought conditions, on the heels of an options expiration, have tended to precede weakness much more often than not.

The one big wildcard was (and is) seasonality, which is unmistakably positive as we all know at this time of year. Nevertheless, looking at past occurrences of the current kinds of setups heading into the end of the year, I see as much weakness as strength.

That kind of battle is not one I want to fight. It seems I can make a valid argument for being long, and an equally valid one for being short, and that's not the type of situation in which I want to risk capital, so I'm staying mostly neutral (as per plan) for trading positions here.

My thought heading into the week was that we'd have one more opportunity to trade the "oversold in December" phenomenon. The longer we go without pausing, though, the less likely it's going to present itself, simply because the clock is ticking ever closer to year-end.

The Nasdaq 100, in particular, has a very nasty habit of correcting at least 5% within a 10-day window during January, so if I'm to be tempted further to the long side, then we need to see the setup fairly quickly. The past couple of years, the index shot higher to begin the new year, but that was after weak endings to the previous December.

The bottom line is that I'm doing very little here trading-wise. I'd like to see another opportunity for a low-risk long trade heading into the first couple sessions of the new year, but if we just hang around in overbought territory, then my focus will likely shift to the short side after the end of the year.

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Cape Coral, Florida

This Is The Sound Of A Bubble Bursting

By Peter S. Goodman | 26 December 2007

Published Sunday, December 23, 2007

A model home in Cape Coral, Fla. In the wake of the real estate bust, the area is facing falling home values, foreclosures, municipal cutbacks and the loss of jobs. •  •   Phillippe Diederich for The New York Times

Cape Coral, Florida

Two years ago, when Eric Feichthaler was elected mayor of this palm-fringed, middle-class city, he figured on spending a lot of time at ribbon-cuttings. Tens of thousands of people had moved here in recent years, turning musty flatlands into a grid of ranch homes painted in vibrant Sun Belt hues: lime green, apricot and canary yellow. Mr. Feichthaler was keen to build a new high school. He hoped to widen roads and extend the reach of the sewage system, limiting pollution from leaky septic tanks. He wanted to add parks.

Now, most of his visions have shrunk. The real estate frenzy that once filled public coffers with property taxes has given way to a devastating bust over the last two years. Rather than christening new facilities, the mayor finds himself picking through the wreckage of speculative excess and broken dreams.

Last month, the city eliminated 18 building inspector jobs and 20 other positions within its Department of Community Development. They were no longer needed because construction has all but ceased. The city recently hired a landscaping company to cut overgrown lawns surrounding hundreds of abandoned homes.

"People are underwater on their houses, and they have just left," Mr. Feichthaler says. "That road widening may have to wait. It will be difficult to construct the high school. We know there are needs, but we are going to have to wait a little bit."

Waiting, scrimping, taking stock: This is the vernacular of the moment for a nation reckoning with the leftovers of a real estate boom gone sour. From the dense suburbs of northern Virginia to communities arrayed across former farmland in California, these are the days of pullback: with real estate values falling, local governments are cutting services, eliminating staff and shelving projects.

Families seemingly disconnected from real estate bust are finding themselves sucked into its orbit, as neighbors lose their homes and the economy absorbs the strains of so much paper wealth wiped out so swiftly.

Southwestern Florida is in the midst of this gathering storm. It was here that housing prices multiplied first and most exuberantly, and here that the deterioration has unfolded most rapidly. As troubles spill from real estate and construction into other areas of life, this region offers what may be a foretaste of the economic pain awaiting other parts of the country.

Cape Coral is in Lee County, across the Caloosahatchee River from Fort Myers. In the county, a tidal wave of foreclosures is turning some neighborhoods into veritable ghost towns. The county school district recently scrapped plans to build seven new schools over the next two years. Real estate agents and construction workers are scrambling for other lines of work, and abandoning the area. As houses are relinquished to red ink and the elements, break-ins are skyrocketing, yet law enforcement is resigned to making do with existing staff.

"We’re all going to have to tighten the belt somehow," says Robert Petrovich, Cape Coral’s chief of police.

Florida real estate has long been synonymous with boom and bust, but the recent cycle has packed an unusual intensity. The Internet made it possible for people ensconced in snowy Minnesota to type "cheap waterfront property" into search engines and scroll through hundreds of ads for properties here. Cape Coral beckoned speculators, retirees and snowbirds with thousands of lots, all beyond winter’s reach.

Creative finance lubricated the developing boom, making it easy for buyers to take on more mortgage debt than they could otherwise handle, driving prices skyward. Each upward burst brought more investors— some from as far as California and Europe, real estate agents say.

Joe Carey was part of the speculative influx. An owner of rental property in Ohio, he visited Cape Coral in 2002 and found that he could buy undeveloped quarter-acre lots for as little as $10,000. Nearby, there were beaches, golf courses and access to the Caloosahatchee River, which empties into the Gulf of Mexico.

Builders were happy to arrange construction loans, then erect houses in as little as six months. Real estate agents promised to find buyers before the houses were even finished.

"All you needed was a pulse," Mr. Carey said. "The price of dirt was going up. We took that leap of faith and put down $10,000."

Backed by easily acquired construction loans, Mr. Carey’s investment allowed him to buy three lots and top off each with a new home. He flipped them immediately for about $175,000 each, he recalls. Then he bought more lots, confident that Cape Coral and Fort Myers— the county seat across the river— would continue to blossom. From 2000 to 2003, the population of the Cape Coral-Fort Myers metropolitan area grew to nearly 500,000 from 444,000, according to Moody’s

"Jobs were very plentiful," Mr. Carey said. "The construction trade was up, stores were opening up, and doctors were coming in. It kind of built its own economy."

In 2003, Mr. Carey became a real estate agent. The next year, he opened a title company. Then he teamed up with seven others to open a local office for Keller Williams Realty, the national realty chain. They hired 40 agents.

By 2004, the median house price in Cape Coral and Fort Myers had shot up to $192,100, according to the Florida Association of Realtors— a jump of 70 percent from $112,300 just four years earlier. In 2005, the median price climbed an additional 45 percent, to more than $278,000.

Lots that Mr. Carey once bought for $10,000 were now going for 10 times that. During the best times back in Ohio, he once earned about $100,000 in a year. At the height of the Florida boom, in 2005, he says he raked in $800,000. "If you just got up and went to work," he says, "pretty much anybody could become an overnight millionaire."

National home builders poured in, along with construction workers, roofers and electricians. But as a kingdom of real estate materialized, growth ultimately exceeded demand: investors were selling to one another, inflating prices. When the market figured this out in late 2005, it retreated with punishing speed. "It was as if someone turned off the faucet," Mr. Carey said. "It just came to a screeching halt. When it stopped, people started dumping property."

By October this year, the median house price was down to $239,000, some 14 percent below the peak. That same month, he and his partners shuttered his real estate office. In November, he closed the title company. On a recent afternoon, he went to his old office in a now-quiet strip mall to take home the remaining furniture. He was preparing to move to the suburbs of Atlanta.

While speculators may find it easy enough to pack up and move on, they are leaving behind a landscape of vacant houses that will not be easily sold. More than 19,000 single-family homes and condos are now listed on the market in Lee County. Fewer than 500 sold in November, meaning that at the current rate it would take three years for the market to absorb all the houses. "Confusion abounds because nobody knows where the bottom is," says Gerard Marino, a commercial Realtor at the Re/Max Realty Group in Fort Myers. Commercial builders are unloading properties at sharply reduced prices, sometimes even below construction costs, which further adds to the glut.

"It’s our goal to clear out the inventory," James P. Dietz, the chief financial officer of WCI Communities, a Florida-based home builder, said in an interview two weeks ago. "We have to generate cash to make payroll." Last week, Mr. Dietz announced he would leave WCI at the end of this year to pursue a career in the vacation resort business. AT Pelican Preserve, a gated community set around a 27-hole golf course in Fort Myers, WCI has halted building, leaving some residents staring at mounds of earth where they expected to see manicured lawns. Half-built condos sit isolated in a patch of dirt, cut off from the road.

"It bugs the hell out of my wife," says Paul Bliss, 61, whose three-bedroom town house is next to a half-built home site. "She looks out and sees that concrete slab." But the builder makes no apologies. "There was such a falloff in demand that it made no sense to build new units," says Mr. Dietz, adding that the pause in construction "doesn’t in any way detract from the property."

Throughout Lee County, a sense of desperation has seized the market as speculators try to unload property or lure renters. On many lawns, a fierce battle is under way for the attention of passers-by, with "for rent" signs narrowly edging out "for sale." In Cape Coral, foreclosure filings in the first 10 months of the year reached 4,874, more than a fourfold increase over the same period the previous year, according to RealtyTrac, an online provider of foreclosure information.

Elaine Pellegrino and her daughter, Charlene, see no way to avoid joining that list. Seven years ago, Ms. Pellegrino and her husband bought their three-bedroom house in northwestern Cape Coral for $97,000, without having to make a down payment. The land was mostly empty then. But as construction crews descended and a thicket of new homes took shape, values more than doubled. The Pellegrinos’ mailbox brimmed with offers to convert that good fortune into cash by refinancing their mortgage. They bit, borrowing against the inflated value of their home to buy two businesses: an auto repair shop and a lawn service. "We were thinking we were on the way up," Ms. Pellegrino says. But last December, Ms. Pellegrino’s husband died unexpectedly, leaving her with the two businesses, both deeply in debt, and $207,000 she owed against her home, which is now worth about $130,000, she says.

Disabled and 53 years old, Ms. Pellegrino does not work. She says she lives on a $1,259 monthly Social Security check. Her daughter, a college student, receives $325 a month for child support for one child. Charlene Pellegrino has been looking on the Web for office work for months, but with so many people being laid off, she has come up empty, she says. They have not paid their mortgage in four months. "What can we do?" Charlene Pellegrino asks, as dusk nears and her driveway lights glow into a void. The rest of the block lies in shadows, with little light emanating from surrounding homes. "We’re probably going to lose the house," she says.

But not anytime soon. The Pellegrinos have joined a new cohort offered up by the real estate unraveling: they are among those waiting in their own homes for the seemingly inevitable. The courts are so stuffed with foreclosures that they assume they can stay for a while. "We figure we have at least six months," Elaine Pellegrino says. "We haven’t heard a thing from the bank for a long time."

As construction and real estate spiral downward, the unemployment rate in Lee County has jumped to 5.3 percent from 2.8 percent in the last year. With more than one-fourth of all homes vacant, residential burglaries throughout the county have surged by more than one-third. "People that might not normally resort to crime see no other option," says Mike Scott, the county sheriff. "People have to have money to feed their families." Darkened homes exert a magnetic pull. "When you have a house that’s vacant, that’s out in the middle of nowhere, that’s a place where vagrants, transients, dopers break a back window and come in," the sheriff adds.

The county’s Department of Human Services has seen a substantial increase in applications for a program that helps pay rent and utility bills for those in need. Half the applicants say they have lost jobs or have seen their work hours reduced, said Kim Hustad, program manager. At Grace United Methodist Church in Cape Coral, Pastor Jorge Acevedo normally starts aid drives this time of year for health clinics in places like India and Africa. This year, the church is buying Christmas presents for about 50 children in the congregation, many who are are in families suffering through job losses.

At Selling Paradise Realty, a sign seeks customers with a free list of properties facing foreclosure and "short sales," meaning the price is less than the owner owes the bank. Inside, Eileen Rodriguez, the receptionist, said the firm could no longer hand out the list. "We can’t print it anymore," she says. "It’s too long." In late November, more than 2,600 of the 5,500 properties for sale in Cape Coral were short sales, says Bobby Mahan, the firm’s owner and broker. Most people who bought in 2004 and 2005 owe more than they paid, he says. "Greed and speculation created the monster."

As much as anything, the short sales are responsible for the market logjam. To complete a deal, the lender holding the mortgage must be persuaded to share in the loss and write off some of what is due. "A short sale is a long and arduous process," Mr. Mahan says. "Battling the banks is horrendous." Kevin Jarrett is stuck in that quagmire. In 1995, freshly arrived from Illinois, he put down $1,000 to buy a house in Lehigh Acres, in eastern Lee County. Three years later, Mr. Jarrett left his mental health-counseling job and began selling real estate. He bought progressively nicer homes, keeping the older ones to rent, while borrowing against the rising value of one to finance the next.

Mr. Jarrett acquired a taste for $100 dinners. He bought a powerboat and a yellow Corvette convertible. (In a photograph on his business card, Mr. Jarrett sits behind the wheel, the top down, offering a friendly wave.) Last summer, he paid $730,000 for a 2,500-square-foot home in Cape Coral with a pool and picture windows looking out on a canal. But Mr. Jarrett hasn’t closed a deal in three months. He is on track to earn about $50,000 for the year, he said. Yet he needs $17,000 a month just to pay the mortgages, insurance, taxes and utility bills on his four properties— all worth less than half what he owes. Rental income brings in only about $3,500 a month.

Mr. Jarrett has not paid the mortgage on two of his properties in six months and is behind on the others as well, he says. His goal is to sell everything, move into a rental and start over. He is supplementing his income by selling MonaVie, a nutritional juice that retails for $45 a bottle. He recently dropped health insurance for his family, saving about $680 a month. He is applying for a state-subsidized health plan that would cover his 9-year-old daughter. "I’m in survival mode," he says.

Many others are in similar straits, and the situation has had a ripple effect on the local economy. Scanlon Auto Group, a luxury car dealer, says it has seen its sales dip significantly— the first time that’s happened in 25 years. Rumrunners, a popular Cape Coral restaurant with tables gazing out on a marina, says its business is down by a third, compared with last year. Furniture dealers are folding. Hardware stores are suffering. At Taco Ardiente in Lehigh Acres, business is down by more than three-fourths, complains the owner, Hugo Lopez. His tables were once full of the Hispanic immigrants who filled the ranks of the construction trade. The work is gone, and so are the workers.

At the state level, Florida’s sales tax receipts have slipped by nearly one-tenth this year, and by 14 percent in Lee County. That is a clear sign of a broad economic slowdown, said Ray T. Kest, a business professor at Hodges University in Fort Myers. "It started with housing, the loss of construction jobs, mortgage companies, title companies, but now it’s spread through the entire economy," Mr. Kest says as he walks a strip of mostly empty condo towers on the riverside in downtown Fort Myers. "It now has permeated everything."

In recent years, Bishop Verot Catholic High School in Fort Myers had raised as much as $200,000 by selling goods at a dinner auction. Michael Pfaff, a Cape Coral mortgage broker, used to donate a weekend cruise on his 40-foot catamaran. But Mr. Pfaff’s business has all but disappeared, and he recently sold the boat. This year, the school canceled the auction and is deferring building maintenance.

The county school district’s decision to cancel construction of new public schools reflects a broader diminishing of resources. Developers have to pay so-called impact fees to the district to help fund new facilities. Two years ago, the district took in $56 million in such fees. Next year, it expects only $25 million. New schools are no longer needed anyway, says the schools superintendent, James W. Browder. Many families connected to construction and real estate have moved away, so school enrollments are growing more slowly than expected. This could generate a snowball effect all its own: the new schools were to cost as much as $60 million each to build, so canceling them could mean further job cuts for the already reeling local building industry.

Mr. Browder points out an upside of the housing downturn: Hiring people has become easy. In recent years, the school system struggled to find bus drivers, given the abundance of jobs at twice the pay driving dump trucks in home construction. "Now, we get 14 applicants for every job," he says. The county government depends on property taxes for a third of its general funding. Since taxes are assessed based on the previous year’s real estate values, it has yet to feel a dent. But agencies are under significant pressure to pare back in anticipation of a dip in next year’s funds.

Tax-cutting advocates cheer this prospect. Governments have gotten fat on the boom, they say. A constitutional amendment facing Florida voters in January would expand tax caps for many residences statewide. "All the local governments were drunk with money," says Mr. Kest, the finance professor. "Now, they’re going to have to cut back and learn how to manage."

But local officials counter that they are already being forced to contemplate significant changes that could affect everyday life. The county’s public safety division, which operates ambulance services, says it could be obliged to cut staff. The county’s Natural Resources Department recently delayed a $2.1 million project to filter polluted runoff spilling into the Lakes Regional Park— a former quarry turned into a waterway dotted by islands and frequented by native waterfowl.

People who were priced out of the earlier boom here could wind up the winners. "We had an affordable-housing crisis," says Tammy Hall, a Lee County commissioner. "The people who were here for a fast buck are gone. You’re going to see normal people go back into that housing." When Andrea Drewyor, 24, moved to Cape Coral from Ohio this year to take a teaching job, she found a brand-new two-bedroom waterfront duplex in a gated community with a fitness center, a swimming pool and a Jacuzzi— all for $875 a month in rent.

At night, most of the units around her are dark. The developer can moan. Not Ms. Drewyor.

"I like not having a lot of people living here," she said. "This place is awesome."

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.


Home Of "Pictures Of A Stock Market Mania"

By Alan M. Newman, Editor, Crosscurrents | 26 December 2007

These excerpts from the December 17th issue have been posted to coincide with receipt by snail-mail subscribers.

Derivative Uncertainties

To further solidify our analysis of a derivative crisis in progress, Bloomberg's David Evans recently reported (see that Florida local governments and school districts had pulled $8 billion out of a state run investment pool, representing 30% of the pool's assets, after realizing one of their money market investments contained more than $700 million of defaulted debt. Of the $42 billion in short term assets managed by the State Board of Administration, almost 6%, or $2.4 billion consists of defaulted commercial paper. The State Board also manages the state's $137 billion pension fund. We are concerned that if speculation about pensions threatened by deteriorating derivative contracts does not abate quickly, there is a distinct possibility of a run on assets of every kind and description, not just in Florida but in many other locales. The Bloomberg article goes on to quote John Coffee, a securities law professor at Columbia Law School in New York, predicting investment pools will likely file lawsuits to recover losses.

Most of the now defaulted asset-backed commercial paper was sold to Florida by Lehman Bros. The company declined to comment on the matter but Coffee is on record saying that since the risks were hidden, "I'd expect the pool is going to sue the people who sold them the commercial paper." We would expect that the Florida situation has the potential to be played out literally thousands of times over across the nation as school, fire, water and other local districts find that supposedly safe short term investments were in reality, tainted derivatives. Clearly, as we have shown in these pages since late summer, the chart patterns of many major banks and brokers were (and still are) evidence of a rapidly deteriorating environment for structured finance. In the process, those who have been first in line to liquidate holdings of the pools have gotten out intact. The others behind them have been and still are at risk. Joseph Mason, a professor of finance at Drexel University who has studied the history of bank failures, says, "Since nobody wants to be at the end, you get a run on the pool."

While we would love to shove these ugly developments under a rug or find a way to stress only positive aspects (there are none), we cannot ignore the growing refrain of concern, uncertainty and even fear voiced by observers. In a span measuring only a few minutes on Tuesday, December 4th, we found stories claiming a "Dire Credit Market" (see, "Could Citadel's valuation of E*Trade's CDOs wipe out capital at three big banks?" (see, and "Dangerously Close to a Money Panic" (see The pattern of waning confidence is already having an extremely negative impact.

As startling a development as any may turn out to be the refusal of auditors to verify the results of the major banks when they are due to report results in January. As related by the NY Post's John Crudele (see more than a month ago, under a rule enacted in early 2006, banks can no longer indemnify auditors for mistakes. Given the recent mess and uncertainty over derivatives, auditors may simply step back, which would only serve to heighten apprehensions further.

Add to the mix potential problems with structured finance covering consumer credit card loans and auto loans and you have the potential for a mess unlike any seen since the Roaring Twenties ended with a whimper. Since the market for derivatives is so opaque, there is no completely accurate method to gauge counter-party risks or even to judge precisely who may be on hook to whom for how much if defaults and writedowns continue at their now frenetic pace.

Now, toss in the administration's plan that hopes to freeze mortgage rates for five years and you have the makings of an even uglier mess. The "plan" really changes nothing at all, but ironically, will likely make it even more difficult to structure or value mortgage derivatives. Therein lies the crux of the issue. Last week, our colleague Jim Bianco, one of the savviest minds on Wall Street, commented, "The real problem is investors in structured securities have lost confidence in the securities they own. They are too complicated to understand and they have stopped buying new ones. Consequently, existing structured securities are losing value as bids and offers are non-existent." Bianco goes on to cite the 20,000 ratings downgrades of ‘structures’ and in our view, correctly states that "Delinquencies and defaults are not a problem if you understand what you own. Defaults and delinquencies create a panic when operating in the dark— which is what has been happening in the credit markets this year."

The most gut-wrenching uncertainty that has surfaced may be that quite a few participants are rooting for a worsening environment by shorting the ABX indexes, which were recently pricing in a replay of the Great Depression. If Goldman Sachs did not game the index (see, they clearly gave the impression of a horrific conflict of interest. Financial engineering has created a brave new world, one that was tested quite severely in 1987 and 1998. And now in 2007, structured finance has again laid out a very uncertain future.

Rationales & Targets

In the last issue, although we were confident the risk/reward ratio favored the downside, the "Current Forecast" assumed a "brief rally" was probable over the "short term." It would have been unrealistic to expect to forecast the extremes exactly as they played out but we believe our take was accurate and timely. The Dow actually bottomed the following day and then rallied strongly into December 10th before finally turning down again last week. Sentiment presents a very mixed bag. Option indicators could support additional brief rally attempts but longer term sentiments imply the bears are giving up and walking away from any possibility that a protracted downside might be in store. To wit: total assets in Rydex Bear Index funds has plunged to its lowest level since the October 2002 bottom! While we must grant that assets in Rydex Bull and Sector funds has gone mostly sideways for four years, the contraction in pessimism is one of the most surprising developments, given the Dow Theory bear market signal and the ongoing corrective mode. We interpret this as an extremely negative long term development and remain in bear mode.

Market Indicators

The perspective below has correctly called all meaningful tops over the last few years. We ran the chart and placed it on the front page of the November 6th issue, only four days after Nasdaq’s high. Propitious, to say the least. In theory, when Nasdaq volume picks up substantially relative to everything non-Nasdaq, we have entered a speculative phase and risk looms large. What now? We note the prior four circled reversals resulted in worse corrections than now. The first instance from the end of January to mid-August ’04 encompassed 18.6% on the downside. The second correction was 12.6% from the end of December ’04 to the end of April ’05. The third was 14.8% from mid-April to late July ’06. The 11.1% recent drawdown seems way too tame given the run in "Speculative Intensity." Our long held 15% downside target is still quite viable and equates to 7.7% below Friday’s close.


The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Tuesday, December 25, 2007

1929: A 'Walk In The Park'

Crisis May Make 1929 Look A 'Walk In The Park'

By Ambrose Evans-Pritchard | 23 December 2007

As central banks continue to splash their cash over the system, so far to little effect, things are rapidly spiralling out of their control.

Twenty billion dollars here, $20bn there, and a lush half-trillion from the European Central Bank at give-away rates for Christmas. Buckets of liquidity are being splashed over the North Atlantic banking system, so far with meagre or fleeting effects.

As the credit paralysis stretches through its fifth month, a chorus of economists has begun to warn that the world's central banks are fighting the wrong war, and perhaps risk a policy error of epochal proportions.

Click Here, or on the image, to see a larger, undistorted image.

Faces of power: The Fed’s Ben Bernanke, the BoE’s Mervyn King, the ECB’s Jean-Claude Trichet

"Liquidity doesn't do anything in this situation," says Anna Schwartz, the doyenne of US monetarism and life-time student (with Milton Friedman) of the Great Depression. "It cannot deal with the underlying fear that lots of firms are going bankrupt. The banks and the hedge funds have not fully acknowledged who is in trouble. That is the critical issue," she adds.

Lenders are hoarding cash, shunning peers as if all were sub-prime lepers. Spreads on three-month Euribor and Libor— the interbank rates used to price contracts and Club Med mortgages— are stuck at 80 basis points even after the latest blitz. The monetary screw has tightened by default.

York professor Peter Spencer, chief economist for the ITEM Club, says the global authorities have just weeks to get this right, or trigger disaster. "The central banks are rapidly losing control. By not cutting interest rates nearly far enough or fast enough, they are allowing the money markets to dictate policy. We are long past worrying about moral hazard," he says. "They still have another couple of months before this starts imploding. Things are very unstable and can move incredibly fast. I don't think the central banks are going to make a major policy error, but if they do, this could make 1929 look like a walk in the park," he adds.

The Bank of England knows the risk. Markets director Paul Tucker says the crisis has moved beyond the collapse of mortgage securities, and is now eating into the bedrock of banking capital. "We must try to avoid the vicious circle in which tighter liquidity conditions, lower asset values, impaired capital resources, reduced credit supply, and slower aggregate demand— all feed back on each other," he says.

New York's Federal Reserve chief Tim Geithner echoed the words, warning of an "adverse self-reinforcing dynamic", banker-speak for a downward spiral. The Fed has broken decades of practice by inviting all US depositary banks to its lending window, bringing dodgy mortgage securities as collateral.

    Quietly, insiders are perusing an obscure paper by Fed staffers David Small and Jim Clouse. It explores what can be done under the Federal Reserve Act when all else fails.

Section 13 (3) allows the Fed to take emergency action when banks become "unwilling or very reluctant to provide credit". A vote by five governors can— in "exigent circumstances"— authorise the bank to lend money to anybody, and take upon itself the credit risk. This clause has not been evoked since the Slump.

Yet still the central banks shrink from seriously grasping the rate-cut nettle. Understandably so. They are caught between the Scylla of the debt crunch and the Charybdis of inflation. It is not yet certain which is the more powerful force.

America's headline CPI screamed to 4.3 per cent in November. This may be a rogue figure, the tail effects of an oil, commodity, and food price spike. If so, the Fed missed its chance months ago to prepare the markets for such a case. It is now stymied.

This has eerie echoes of Japan in late-1990, when inflation rose to 4 per cent on a mini price-surge across Asia. As the Bank of Japan fretted about an inflation scare, the country's financial system tipped into the abyss. In theory, Japan had ample ammo to fight a bust. Interest rates were 6 per cent in February 1990. In reality, the country was engulfed by the tsunami of debt deflation quicker than the bank dared to cut rates. In the end, rates fell to zero. Yet, still it was not enough.

When a credit system implodes, it can feed on itself with lightning speed. Current rates in America (4.25 per cent), Britain (5.5 per cent), and the eurozone (4 per cent) have scope to fall a long way, but this may prove less of a panacea than often assumed. The risk is a Japanese denouement across the Anglo-Saxon world and half Europe.

Bernard Connolly, global strategist at Banque AIG, said the Fed and allies had scripted a Greek tragedy by under-pricing credit long ago and seem paralysed as post-bubble chickens now come home to roost. "The central banks are trying to dissociate financial problems from the real economy. They are pushing the world nearer and nearer to the edge of depression. We hope they will eventually be dragged kicking and screaming to do enough, but time is running out," he said.

Glance at the more or less healthy stock markets in New York, London, and Frankfurt, and you might never know that this debate is raging. Hopes that Middle Eastern and Asian wealth funds will plug every hole lifts spirits. Glance at the debt markets and you hear a different tale. Not a single junk bond has been issued in Europe since August. Every attempt failed. Europe's corporate bond issuance fell 66% in the third quarter to $396bn (BIS data). Emerging market bonds plummeted 75%.

"The kind of upheaval observed in the international money markets over the past few months has never been witnessed in history," says Thomas Jordan, a Swiss central bank governor. "The sub-prime mortgage crisis hit a vital nerve of the international financial system," he says.

The market for asset-backed commercial paper— where Europe's lenders from IKB to the German Doctors and Dentists borrowed through Irish-based "conduits" to play US housing debt— has shrunk for 18 weeks in a row. It has shed $404bn or 36%. As lenders refuse to roll over credit, banks must take these wrecks back on their books. There lies the rub.

Professor Spencer says capital ratios have fallen far below the 8 per cent minimum under Basel rules. "If they can't raise capital, they will have to shrink balance sheets," he said. Tim Congdon, a banking historian at the London School of Economics, said the rot had seeped throughout the foundations of British lending. Average equity capital has fallen to 3.2 per cent (nearer 2.5 per cent sans "goodwill" [[of which there is hardly any left!: normxxx]]), compared with 5 per cent seven years ago. "How on earth did the Financial Services Authority let this happen?" he asks. Worse, changes pushed through by Gordon Brown in 1998 have caused the de facto cash and liquid assets ratio to collapse from post-war levels above 30 per cent to near zero. "Brown hadn't got a clue what he was doing," he says.

The risk for Britain— as property buckles— is a twin banking and fiscal squeeze. The UK budget deficit is already 3 per cent of GDP at the peak of the economic cycle, shockingly out of line with its peers. America looks frugal by comparison. Maastricht rules may force the Government to raise taxes or slash spending into a recession. This way lies crucifixion. The UK current account deficit was 5.7 per cent of GDP in the second quarter, the highest in half a century. Gordon Brown has disarmed us on every front.

In Europe, the ECB has its own distinct headache. Inflation is 3.1 per cent, the highest since monetary union. This is already enough to set off a political storm in Germany. A Dresdner poll found that 71 per cent of German women want the Deutschmark restored.

With Brünhilde fuming about Brot prices, the ECB has to watch its step. Frankfurt cannot easily cut rates to cushion the blow as housing bubbles pop across southern Europe. It must resort to tricks instead. Hence the half trillion gush last week at rates of 70bp below Euribor, a camouflaged move to help Spain.

The ECB's little secret is that it must never allow a Northern Rock failure in the eurozone because this would expose the reality that there is no EU treasury and no EU lender of last resort behind the system. Would German taxpayers foot the bill for a Spanish bail-out in the way that Kentish men and maids must foot the bill for Newcastle's Rock? Nobody knows. This is where eurozone solidarity stretches to snapping point. It is why the ECB has showered the system with liquidity from day one of this crisis.

Citigroup, Merrill Lynch, UBS, HSBC and others have stepped forward to reveal their losses. At some point, enough of the dirty linen will be on the line to let markets discern the shape of the debacle. We are not there yet [[indeed, far from it!: normxxx]].

Goldman Sachs caused shock last month when it predicted that total crunch losses would reach $500bn, leading to a $2 trillion contraction in lending as bank multiples kick into reverse. This already seems humdrum.

"Our counterparties are telling us that losses may reach $700bn," says Rob McAdie, head of credit at Barclays Capital. Where will it end? The big banks face a further $200bn of defaults in commercial property. On it goes.

Meanwhile, the International Monetary Fund still predicts blistering global growth of 5 per cent next year. If so, markets should roar back to life in January, as though the crunch were but a nightmare. Then again, the credit soufflé may be hard to raise a second time.


The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Chrysler: We're 'Bankrupt'

Chrysler Ceo: We're 'Operationally' Bankrupt
Automaker Scrambling To Sell Assets Just Months After Private Equity Buyout As Credit Crunch Deepens

By | 25 December 2007

NEW YORK (— Chrysler Corp., the troubled automaker bought by private equity just four months ago, is scrambling to sell assets amid indications of huge losses, as access to cash becomes increasingly scarce, according to a published report Friday.

"Someone asked me, 'Are we bankrupt?'" the Wall Street Journal quoted Chrysler boss Robert Nardelli telling employees at a meeting earlier this month. "Technically, no. Operationally, yes. The only thing that keeps us from going into bankruptcy is the $10 billion investors entrusted us with." To raise money, Chrysler is looking to sell over $1 billion in land, old factories, and other holdings, even if it has to let those properties go for under book value, the Journal said.

In an interview with the Journal, Nardelli confirmed the comments and declined to give a financial forecast for 2008, saying only that Chrysler "will make a pretty significant improvement" over the $1.6 billion the company is set to lose this year. The Journal said Nardelli originally hoped to turn a profit in 2008. The rush to raise capital comes amid constricting access to money as more banks and other lenders face heavy losses related to subprime mortgages.

Chrysler's owner, Cerberus Capital Management, is now facing serious subprime-related losses from GMAC Financial Services, which it bought from General Motors (GM, Fortune 500) for $12 billion, and is also trying to walk away from a now pricey deal to buy United Rentals Inc., (URI) the Journal said.

Cerberus bought Chrysler from German automaker Daimler in a deal that closed in August.

In the arrangement, Daimler (DAI) essentially paid Cerberus to take the automaker, which fell to No. 4 in U.S. sales behind Toyota Motor (TM) in 2006, in an effort to get out from under a $1.5 billion loss from last year, along with continued obligations to union members and retirees.


The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Monday, December 24, 2007

Blindly Into The Bubble

Blindly Into The Bubble

By Paul Krugman, NYT | 21 December 2007

    When announcing Japan's surrender in 1945, Emperor Hirohito famously explained his decision as follows: "The war situation has developed not necessarily to Japan's advantage."

    There was a definite Hirohito feel to the explanation Ben Bernanke, the Federal Reserve chairman, gave this week for the Fed's locking-the-barn-door-after-the-horse-is-gone decision to modestly strengthen regulation of the mortgage industry:
    "Market discipline has in some cases broken down, and the incentives to follow prudent lending procedures have, at times, eroded."

That's quite an understatement. In fact, the explosion of "innovative" home lending that took place in the middle years of this decade was an unmitigated disaster.

But maybe Mr. Bernanke was afraid to be blunt about just how badly things went wrong. After all, straight talk would have amounted to a direct rebuke of his predecessor, Alan Greenspan, who ignored pleas to lock the barn door while the horse was still inside— that is, to regulate lending while it was booming, rather than after it had already collapsed.

I use the words "unmitigated disaster" advisedly.

Apologists for the mortgage industry claim, as Mr. Greenspan does in his new book, that "the benefits of broadened home ownership" justified the risks of unregulated lending.

But homeownership didn't broaden. The great bulk of dubious subprime lending took place from 2004 to 2006— yet homeownership rates are already back down to mid-2003 levels. With millions more foreclosures likely, it's a good bet that homeownership will be lower at the Bush administration's end than it was at the start.

Meanwhile, during the bubble years, the mortgage industry lured millions of people into borrowing more than they could afford, and simultaneously duped investors into investing vast sums in risky assets wrongly labeled 'AAA.' Reasonable estimates suggest that more than 10 million American families will end up owing more than their homes are worth, and investors will suffer $400 billion or more in losses.

So where were the regulators as one of the greatest financial disasters since the Great Depression unfolded? They were blinded by ideology.

"Fed shrugged as subprime crisis spread," was the headline on a New York Times report on the failure of regulators to regulate. This may have been a discreet dig at Mr. Greenspan's history as a disciple of Ayn Rand, the high priestess of unfettered capitalism known for her novel "Atlas Shrugged."

In a 1963 essay for Ms. Rand's newsletter, Mr. Greenspan dismissed as a "collectivist" myth the idea that businessmen, left to their own devices, "would attempt to sell unsafe food and drugs, fraudulent securities, and shoddy buildings." On the contrary, he declared, "it is in the self-interest of every businessman to have a reputation for honest dealings and a quality product."

It's no wonder, then, that he brushed off warnings about deceptive lending practices, including those of Edward M. Gramlich, a member of the Federal Reserve board. In Mr. Greenspan's world, predatory lending— like attempts to sell consumers poison toys and tainted seafood— just doesn't happen.

But Mr. Greenspan wasn't the only top official who put ideology above public protection. Consider the press conference held on June 3, 2003— just about the time subprime lending was starting to go wild— to announce a new initiative aimed at reducing the regulatory burden on banks. Representatives of four of the five government agencies responsible for financial supervision used tree shears to attack a stack of paper representing bank regulations. The fifth representative, James Gilleran of the Office of Thrift Supervision, wielded a chainsaw.

Also in attendance were representatives of financial industry trade associations, which had been lobbying for deregulation. As far as I can tell from press reports, there were no representatives of consumer interests on the scene.

Two months after that event the Office of the Comptroller of the Currency, one of the tree-shears-wielding agencies, moved to exempt national banks from state regulations that protect consumers against predatory lending. If, say, New York State wanted to protect its own residents— well, sorry, that wasn't allowed.

Of course, now that it has all gone bad, people with ties to the financial industry are rethinking their belief in the perfection of free markets. Mr. Greenspan has come out in favor of, yes, a government bailout. "Cash is available," he says— meaning taxpayer money— "and we should use that in larger amounts, as is necessary, to solve the problems of the stress of this."

    [ Normxxx Here:  Of course, since the profits made from all of this wheeling and dealing are long gone into the pockets of that "top 1% - 5%" whose taxes were so conveniently reduced in time to collect that largesse!  ]

Given the role of conservative ideology in the mortgage disaster, it's puzzling that Democrats haven't been more aggressive about making the disaster an issue for the 2008 election. They should be: It's hard to imagine a more graphic demonstration of what's wrong with their opponents' economic beliefs.


The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Sunday, December 23, 2007

Economic And Market Considerations

Considerations Of Our Current Economic And Market Climates

Questions by [BoltonCT]; Answers largely by normxxx | 16 December 2007

    [BoltonCT]: Norm, Al and others... what do you think we need to do to get the economy back on track? We hear contradictory analysis. The FED says they are increasing liquidity. Others say the facts show they are not. They are only maintaining current liquidity.

The question of what the Fed is doing was answered above. But I will begin by expanding on my comment, "Note that neither John nor Gary seems to be considering the non-bank money centers, which have been the Principal source of money for mortgages, etc."

Consider first the invention of mortgage backed securities, which has since morphed into asset backed securities of every stripe. In 1968, Congress established the Government National Mortgage Association, commonly known as Ginnie Mae, as a government-owned corporation within the Department of Housing and Urban Development (HUD). Even today, Ginnie Mae securities are the only mortgage-backed securities (MBSs) that offer the full faith and credit guaranty of the United States government. These MBSs were created to solve a problem: a lack of available, consistently priced capital, which put a ceiling on the number of new mortgages that Ginnie Mae could issue, since the mortgages generally don't return much of the principal until they are near due— for perhaps 20 years or so.

Ginnie Mae solved this problem and revolutionized the American housing industry in 1970 by pioneering the issuance of mortgage-backed securities. Today, 'intermediate lenders' (such as Fannie Mae and Freddie Mac) pool packages of 'qualifying' FHA, VA, RHS or PIH mortgages and convert them into securities (the lesser mortages are packaged by the banks and other 'private' creators of MBSs and CDOs), which are then resold to the final lenders (pension funds and the like). Ginnie Mae guarantees investors the timely payment of principal and interest on these securities (the 'private' packagers may use 'private' insurers).

In a single step, the issuance of mortgage-backed securities converted individual mortgages into liquid securities for investors around the world. It would not be a large leap for others to do the same with mortgages and other forms of debt. All manner of debt had become fungible! For what happened next, see We're heading toward financial chaos

By immediately selling off their mortgages (or other loans) as packages of MBSs/ABSs to others, including "off-the-books" Funds (such as SIVs and similar) set up by the banks themselves explicitly for that purpose, the banks were immediately able to relend the same money over and over again to other mortgagees. What did the banks gain in such a transaction? Fees. These became so profitable, as the money turnover sped up, that even the really "prime" mortgages, which the banks had retained simply to collect the "safe" interest on, were eventually sold to regain funds with which to turn over other mortgages and loans. Banks had become mortgage and loan "originators" only— and no longer figured very prominently in a loan once it was sold.

The description of how the "fractional reserve" money and banking system works is well described by Gary and John for as far as it goes. But it neglects this direct access of the commercial money markets by banks and others in order to gain funds to support highly risky ventures. These funds were never loaned out under the auspices of the "fractional reserve" money system, since the money was used either simply to replace funds that were part of the system— by the reserve banks— or was just directly re-lent by non-[reserve]bank 'money centers', e.g., F&F, Countrywide, etc. who were never part of the system. All of this was outside of the "fractional reserve" money and banking system!

In the diagram below, start with the bank and follow the arrows around to gain some idea of how this "off-the-books" process worked— until it didn't. The picture is the similar for the non-bank money centers such as F&F, and the so-called "mortgage brokers" (e.g., Countrywide), which act a bit like banks and a bit like the Funds set up by the banks, except that they cannot call on a parent bank or the CB when there is a run on their assets— so they go bankrupt! (Though I seriously don't think that F&F will go BK.)

Click Here, or on the image, to see a larger, undistorted image.

The source of low cost short-term funding for all of these extra-bank and non-bank money center lending was the commercial paper market, until it largely imploded. The SIVs fell back on funds from their parent or other banks; the smaller non-bank money centers have largely gone bankrupt; the rest are hanging on by a thread.

So the banks (the newly created "loan originators") neatly bypassed/circumvented the Fed/bank money system so carefully described by Gary and John. And F&F and the many lesser non-bank money centers (such as Countrywide) were never part of that banking system, but still originated loans and lent out money— until they suddenly could not sell any more MBSs or CDOs, to anybody.

See Conduits, SIVs, cash-hoarding, commercial paper restructuring and such for a handle on how the banks' sponsored funds are doing currently.

    [BoltonCT]: Premise 1 There is a worldwide imbalance and polarization between saving (East) and investment (West).

Only partly true. In the past, even the most supposedly "risk free" investments in third world countries carried plenty of risk, so it was fairly common for the rich folk in those countries and in the developed countries to send their funds to supposedly "safe havens"— such as the U.S. and other Western countries. These funds were then mostly locally relent (in the developed world, that is). I doubt if that trend will survive this credit collapse. See Citibank SIVs Hit Norway Townships— Several Norway townships are caught up in the international credit crisis.

    [BoltonCT]: Premise 2 There is now a reported worldwide credit crunch.

So far, it has been mostly contained to MBSs in the commercial paper market; but even bank "paper" and other so-called "safe" funds are rapidly drying up or are being subjected to far greater scrutiny and suspicion. The CP market has become a shadow of what it was just a year or so ago. See Calculated Risk: Discount Rate Spread Increases, America’s shrinking asset-backed market tells us…., Market looks to Fed as commercial paper falls and The Great Commercial Paper Meltdown of 2007

    [BoltonCT]: Premise 3 Greenspan is right in saying the sub-prime collapse is the trigger not the cause of the crunch and that the crunch was an accident waiting to happen. The credit markets melted down in August because "risk had become increasingly under priced as market euphoria, fostered by an unprecedented global growth rate, gained cumulative traction."

Yes, but "Easy Al" still was a large proximate cause of the present collapse. It is amazing how wild "financiers" can get with 'almost free' money! Al's artificially easy money (at 1%) was the immediate cause of the "risk [becoming] increasingly under priced as market euphoria gained cumulative traction." The overall risk has been growing for over 20 years (gee; just about as long as Al was Fed Head!) and was the reason that I predicted TEOTWAWKI in 2009 during the last market meltdown, which I rightly averred was not IT (aka, "the BIG one")!

    [BoltonCT]: Premise 4 The FED and world banks are trying to ease credit.

Well, they're trying to ease the "credit crunch." But, it is unclear how they can do that. The problem is not so much a loss of direct bank liquidity as that investors (and even other banks!) have lost trust in the system! When "AAA" rated securities can drop by half of face value, or even default, whom or what can you trust[!?!]

    [BoltonCT]: Premise 5 Dr. Hussman concludes that no new money is actually flowing to ease the credit crunch.

That's largely true. The problem with this credit crunch, however, is that it is largely due to major investors holding back funds from the credit markets (better safe than sorry). And this lending is many times what the banks can lend.

    [BoltonCT]: Therefore QED:
    Conclusion 1, This is a similar situation to the Great Depression where the FED/Banks push on a string and nothing happens. Reducing interest rates have no effect when risk gets too high. The crunch may be a lack of demand and not lack of supply for solid investments. When risk is too high only the credit unworthy still want credit. Logic-Why buy a house now when prices will be lower in 2 years?

There is a certain truth to what you say. But, today, the problem is not a lack of demand, but the lack of a way to close the gap between the investors with the money and those who need it, that the investors can trust! However, the Great Depression also saw deflation, and deflation causes real interest rates to rise (even as nominal interest rates go to zero), so it is easier/safer just to hold on to your money. That is not yet true today.

    [BoltonCT]: Conclusion 2, Risk is now either properly priced or over priced and lowering the discount rate cannot ease the crunch or help the stock market any more. It can only weaken the dollar.

The only purpose to lowering the discount rate is to increase the spread between short term and long term rates (a common panacea when the banks get into trouble), so the banks can earn more money with which to pay off their liabilities. In any event, risk is still way underpriced, which is why we have a "credit crunch." At seriously higher long rates, there would be enough lenders; but how many ARM mortgagees, credit card holders, and marginal businesses set up during the 'easy money' era could afford those much higher rates? This is known as a vicious circle!

    [BoltonCT]: Conclusion 3, Fiscal (Keynesian) policy (deficit spending) can no longer stimulate spending and investment because of the risk overhang of bubbles ready to burst. The financial mine field practically guarantees a loss on future investments.

I am not sure I understand the gist of this conclusion. But the problem as I see it is that income for those below the top 5% - 1% has stagnated since about 2000. So there is no way that current mortgagees can afford the houses they are now living in if they bought in the last several years or so (or if they foolishly tapped it as a source of funds to spend on 'free' living— pun intended). Moreover, now that we can no longer tap our houses for loans, or our credit cards, etc., we may just have to live within that stagnated income. But that sounds like a repeat of the '30s in the current economy; we have lived for too many years on the savings of foreigners— that well is now dry.

Just printing money will no longer work because we are at the point where inflation would rise as fast as (or faster than) the increase in money supply.

For a theory of endless bubbles, see iTulip's Ka-Poom Theory. (The 2006 update is shown at the bottom, with a long description of the theory here: "Ka-Poom Is A Rhyme Not A Repeat Of History". See "Dollar’s Last Lap As The Only Anchor Currency" for the most recent comments on the theory.)

    [BoltonCT]: Conclusion 4, The U.S. currency will likely come under attack as the East-West balance is resolved as long as America continues to lower interest rates and maintain deficits. Current policies are making the situation worse causing inflation.

It depends on which calamity you are considering. The fascinating dilemas of the end-game are such that addressing one invariably makes another— equally dire— get worse. The usual approach (à la Alan Greenspan) was/is to leave inflation as the last thing to address, since "it is something we know how to control"[!?!] Unfortunately, while that may have been true for Paul Volcker, it was never true for AG. All of the paper currencies are inflating, just at different rates. Invest in physical assets, but be prepared for wild swings as we reverbrate from boom to bust and then finally reach some sort of equilibrium. For a beautiful explanation of hyperinflation, deflation, and how they are related, see Hyperinflation: Creating Repulsive Money by Paul Tustain.

    [BoltonCT]: Conclusion 5, Bailouts place America in the Japanese conundrum. They postpone reckoning so they never put risk behind them. They just face perpetual economic risk. Bailouts are how governments create a legacy of corrupt and ineffective polices as can be seen throughout much of the world.

While that is largely true, if we get to deflation, then the Fed (or other CB, such as the BoJ) has lost control, and we have a repeat of our 'never ending '30s' in the U.S. or Japan's 17 year off-again on-again off-again economy. That was why AG was so terrified of deflation (even a hint got him to drop rates to 1% and seemingly hold them there forever.) The Fed is most comfortable with an inflation rate between 1% and 2%, and gets mightily nervous if it drops below 1% or rises above 2%. However, the "doctored" inflation rate of recent years is running around 4% to 6% higher than the "historical" (pre-Clinton) rates. See How do You Spell Stagflation? by John Mauldin. The pre-Clinton rates probably were/are somewhat high— as long as we can out-source to Asia and others at below domestic costs— but now I believe we have overcompensated in the other direction.

    [BoltonCT]: Potential solutions:
    Potential Solution 1:
    "There are also, I should admit, forces which one might fairly well call automatic which operate under any normal monetary system in the direction of restoring a long-run equilibrium between saving and investment[[1]]. The point which I cast into doubt— though the contrary is generally believed— is whether these `automatic' forces will... tend to bring about not only an equilibrium between saving and investment but also an optimum level of production.[[2]]" (John Maynard Keynes, Collected Writings, Vol. 13, 1973: p.395)

    This probably will not help, for while America under-saves, China, Japan, and Germany balance it out globally. In the high-risk environment it is better not to have anything worth losing individually. But America has a lot to lose corporately. America is becoming more vulnerable to China and others buying our corporate natural resources and suppliers with cheap dollars under current FED policies. The danger is inflation.

[[1]] You have largely answered this first assertion: under "globalization" of trade, the economy has gone global. But as the wages and costs in the second and third world countries rise (and the credit they extend to us falls), the costs of those imports to Americans will rise— so, we are net-net no longer importing deflation, but exporting inflation!

[[2]] Keynes was concerned with overproduction due to limited demand. Incomes in the '30s among the vast numbers of consumers, just as now in the U.S. (with the cut-off of credit), had gotten too low— it took WWII to raise wages and pent up demand so that the economy was able to take off and never look back from the late '40s on.

Currently, we are again (temporarily?) suffering from overproduction in the second and third world countries.

However, as the 'boomers' in Europe, the U.S., and Japan retire, demand in these countries will swell— more than enough to keep the second and third world countries— with their huge under 30 populations— producing happily. But what thing of value do we give them in exchange for their production?

    [BoltonCT]: Potential Solution 2:
    [[1]] Let it go and get the correction behind us. Fear of high and increasing economic and social risks from other meltdowns is the probable cause of the credit crunch that results in little demand for new investments. Who wants to invest in a house now when in two years a 25% decline can wipe out the owner's entire equity? Yes new money is drying up but who wants to invest it in a guaranteed loss as the stock market and other bubbles pop. Ultimately a recession is necessary to clear out the waste and corruption. The recession in 2001 was mild and corrected the market distortions and popped all the bubbles.

    [[2]] Raise the FED rate and let the stock market bubbles pop around the world. The EU is maintaining their rate, as we should be doing. China's bubble is the biggest and the threat of them controlling world resources would pop just as Japan's threat popped 17 years ago. Unlike Japan we should put our economic cleansing behind us and virtually eliminate risk in the USA as we have done in the past. Then unlike Japan our economy will grow rapidly again. Much of the Old World cannot part with the legacy of fears and hatreds they harbor from their past.

[[1]] This is a question that I have raised before:how do you let go of "the tail of the tiger" without risk of being eaten before you can make good an escape[!?!] I think you misread the temper of the average American today; conditions such as the '30s would surely incite a revolution (as they very nearly did in the early '30s). You can argue that if FDR had "toughed it out," the depression would have been over with probably no later than '35 or '36. But would there still have been a U.S. by then? Japan and the Japanese may be 'suffering'— but you'd hardly notice it. Between the natural acceptance of things as they are by the Japanese (and the abhorrence of any sort of radical protest) and their 'social welfare' programs, things never got/get so bad that there is much protest. Much the same is true in the EU, which is why they can tolerate unemployment of around 10% for years and years. Our social catastrophe nets are full of holes!

    [BoltonCT]: Who wants to invest in a house now when in two years a 25% decline can wipe out the owner's entire equity?

Despite what you may think; there is no lack of demand; only a lack of the wherewithal. And, I don't think we will once again try to put people into homes with mortgages they cannot afford (once the teaser rates run out) on the insane assumption that house prices can only rise, and so the increased value of the home will allow them to refinance on more favorable terms. But you are right in the sense that the lenders will no longer lend to someone "in a house now when in two years a 25% decline can wipe out" a good chunk of the lender's "equity?" So, you'd better have a hefty downpayment and golden credit, especially if you are looking for a Jumbo mortgage loan.

    [BoltonCT]: The recession in 2001 was mild and corrected the market distortions and popped all the bubbles.

Well, it was the popping of the bubble that brought on the puny recession of 2001; but beyond that it was not deep enough nor long enough to clear out many (if any) market distortions. Just look how eager and quickly "investers" were once again to jump into the stock market once the housing market really took off! If there had been a serious correction, it would have taken about a half to a full generation (10 to 20 years) to get the stock market going again!

    [BoltonCT]: [[2]] Raise the FED rate and let the stock market bubbles pop around the world[!?!]

[[2]] Disabuse yourself of the notion that the Fed is looking out for the housing or stock markets, or even the economy; there is only one thing the Fed concerns itself with: the health of the banks of which it is made up. (Remember that famous 'old' saying [only slightly altered] "What's good for the banks is good for the USA") Remember, also, the only government official in the Fed (outside of the worker peons) is the Fed Head. All of the other members are heads of private banks.

As I noted above in answer to a previous point, "The only purpose to lowering the discount rate is to increase the spread between short term and long term rates (a common panacea when the banks get into trouble), so the banks can earn more money with which to pay off their liabilities."

But, aside from that, how long do you think Congress and/or the President would sit still if the Fed were seen to raise rates during a recession? Volcker got away with it, because (1) everyone was suffering from the runaway inflation, (2) Volcker only raised rates to an extreme for a very brief period (shock therapy), and (3) President Reagan (the man of iron convictions) was willing to go along and back him! (But the howls were still ferocious, and Reagan lost his Republican Senate!)

    [BoltonCT]: The USA prospers because we have the most transparent and uncorrupted political and economic systems in the world. The Japanese laughed at us in the early 90's and said we had "Cowboy Economics" when we started downsizing as the building and banking bubbles were popping. It is time for this cowboy to pull in the belt again and start another fresh uncorrupted economic expansion.

I am uncomfortable with "the most ... uncorrupted political and economic systems in the world." Would you settle for least corrupted "political and economic systems in the world"?

My money on why we have prospered so (above and beyond what a cornucopia of natural resources have bought us) is that no other region in the world promotes, rewards, and treasures its innovators like the U.S.— From those who "made do" on the frontiers, to Eli Whitney, to Thomas A. Edison, to the computer innovators, to the internet and innovators, to the banking and other financial innovators who gave us our present alphabet soup of financial products (yes, even if they did overdo it— 'originators' operate without brakes— which is why we need government or somebody to slow things down when they get too heated)! Moreover, our society is attuned to novelty (possibly too much so) and change. And, yes, as a country we were never worried much about "saving face" when it came to cleaning up after financial or other disasters (such as slavery or Jim Crow).