Friday, July 29, 2011

Banks' final grab: the land

UPDATE: It's happening! Unbelievable!


Robert Wenzel comments approvingly on a course of action mooted in a meeting of primary dealers and the US Treasury held at midday today. The idea:

"Dealers suggested that the Treasury might be able to repo their MBS portfolio to raise cash."

Yes, I should think banks would like to suggest that: have the government that bailed them out, now sell the MBS (mortgage-backed securities) back to them at fire-sale prices. 31 million mortgages - about half of all the mortgages in the USA - delivered into the hands of the swindlers.

What daring. It is almost Biblical in the scale of its impudence.

For the record, let's list these players:

BNP Paribas Securities Corp.

Barclays Capital Inc.

Cantor Fitzgerald & Co.

Citigroup Global Markets Inc.

Credit Suisse Securities (USA) LLC

Daiwa Capital Markets America Inc.

Deutsche Bank Securities Inc.

Goldman, Sachs & Co.

HSBC Securities (USA) Inc.

Jefferies & Company, Inc.

J.P. Morgan Securities LLC

MF Global Inc.

Merrill Lynch, Pierce, Fenner & Smith Incorporated

Mizuho Securities USA Inc.

Morgan Stanley & Co. LLC

Nomura Securities International, Inc.

RBC Capital Markets, LLC

RBS Securities Inc.

SG Americas Securities, LLC

UBS Securities LLC.

You'll note that six of them are now Limited Liability Companies (LLC), the latest to convert being Morgan Stanley (as of May 31, 2011). Apparently, this has a tax advantage for derivatives dealers; but I wonder whether not having shareholders while also avoiding personal liability is an equally important consideration, as we approach the endgame, when bank shares may finally burn up.

Imagine what Thomas Jefferson and Andrew Jackson would say, if they could see how in the Land of the Free a tiny elite not only owns most of the cash, bonds and shares, but now aspires to seize the real estate. America is approaching a peak of wealth inequality and mass servitude comparable to the condition of England in the eighteenth century, but without the hopes offered by the Industrial Revolution.

INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Thursday, July 28, 2011

When investing, remember inflation

The lowest point (so far) in the above monthly sequence was February 2009. But we've still lost a third in real terms overall since the start of the Millennium.

And what does this shape suggest to you about future returns?

INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Wednesday, July 27, 2011

The Stock Market made simple?

A correspondent on Usenet took umbrage recently when I referred to traders as (possibly necessary) parasites on the economic system. That he used to be one probably had something to do with his outrage, but I meant the term in the biological sense, in that traders generate no wealth, nor provide any real service, at least in my simplistic understanding.

Perhaps the illuminati here can shed light on my misunderstanding by considering the following simple scenario:

1. MomandPopCo decide to expand, and so release an IPO of 2,001 shares. They keep 1001 to have majority control, and sell the rest for $100 per share. With a 1% fee charged by the brokers, they realize $99,000, and the latter get $1,000
2. A short time later, Amy sells her 100 shares for $105 per share to Bob. She gets $395 in profit, and the brokers get $105 for their service.


1. Where does all of the money come from?
2. Why does Bob pay more for the shares than Amy did?
3. Why was Amy able to charge more than she paid?

The answers are clearly(?):

1. From the investors.
2. Unless Bob is an idiot, he assumes that the stock price will either further increase, or the dividends will cover his costs.
3. Amy must be taking the discounted value of the future dividends of the company, or we are starting yet another bubble. This is easier to see if the company is buying and raising cows for sale, being a transaction of finite duration.

Notice that the company does not benefit at all from the second transaction. Even if their stock goes up, they cannot sell any more without losing control.

Hedge fund titans admit they don't know what's going to happen

George Soros is retiring, closing his fund to outside investors and returning their money.

Some say it's because he's become old (81) and cautious, other suggest it's to avoid being regulated by the Securities and Exchange Commission, but he himself has said “I find the current situation much more baffling and much less predictable than I did at the time of the height of the financial crisis.”

Stanley Druckenmiller, one of Soros' former fund managers, also threw in the towel last year, and he's only 58.

Closing hedge funds is a trend, and the issue now even has its own website: The Hedge Fund Implode-O-Meter. I see this as further confirmation that it is no longer "business as usual" in the investment world. It is, perhaps, like that stage in WWII when senior officials on the losing side prepared fake IDs and packed gold and art treasures for their flight; that is, it's no longer about gain, but about hanging on to what you've taken.

This, I think, is part of what's behind the current US budget crisis. Agreed, public spending is out of control, but that has been so for a very long time. What's forcing us towards disaster is the overall level of debt, of which much the greater part is private credit. Players in finance and politics colluded to encourage the housing and credit bubbles, which disguised the failure to nurture domestic production and balance imports with exports. Fees, interest and selling securitised debt, plus capital gains on inflated assets in a booming economy, made many people rich, and some super-rich; and they bought the government and regulators.

The ordinary Joe's real wages stalled for 30 years and more, but loading him with easy credit (and sending his wife out to work) kept the show on the road. Now, it seems, the objective is to get him to pay for everything, without asking his masters for any of the money they made out of the game.

If the elite succeed, they keep their extraordinary wealth and Joe suffers. Actually, it looks as though they cannot lose, since most cash, bonds and equities are owned by the top 1% of the population. Even their houses will tend to retain most of their value, since the only people who can aspire to buy them are other people with lots of money.

Inflation would hit cash and bonds, but the rich also have most of the equities and nice houses. Deflation would amplify the power of cash and (provided there is no default) attractiveness of bonds, and the rich have most of that, too.

So why do we feel that we're at some break point? I think it's because the balance of opportunity and threat has altered significantly.

Firstly, there's nothing much more to steal; expansion is no longer a prospect.

Second, the economy may not rebalance without an increase in taxation, and I should think some of the wealthy are on the lookout for the possible imposition of capital controls that would prevent them from fleeing abroad with their money. The more far-sighted are already renouncing their US citizenship.

Third, if the system cannot survive without some redistribution of wealth, but those who have it hold on too hard, there may be a breakdown in the social order. Last year, Marc Faber and Ron Paul were each predicting such problems, Faber recommending moving out of cities because they are such easy targets for attack.

I agree with them. I think that when irrational greed and resentful desperation meet, there can be no good outcome. We are planning to move soon to somewhere pleasanter, but also, we hope, safer. We are beyond knowing what to do with our savings, other than to diversify so that we don't lose everything, and not to entrust it all to third parties.

Looks like the super-rich hedge fund managers think the same way.

INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Tuesday, July 19, 2011

Gambling on sovereign default may seriously disrupt equity and bond markets

IMPORTANT: Please note the disclaimer below before continuing!

Matters are coming to a head in the financial markets.

The yields on Spanish and Italian government bonds recently exceeded 6% for a while; at 7%, it is estimated, Italian public borrowing becomes unsustainable and Italy then joins Greece in the category of countries doomed to at least partially default on their obligations.

On the other hand, it's possible that the 7% point will not be reached, or if it is, not for long. So much depends on market confidence and as is well known, fear may trigger a crisis that is otherwise avoidable.

But so can the greed of speculators. While Britain's 1992 "Black Wednesday" made George Soros a reported USD $1 billion, the cost to the UK of its attempts to support the pound against his and others' shorting is estimated at over £3 billion sterling. He has since developed a reputation as a philanthropist; we could wish for a less expensive way to fund a benefactor. *

The difficulties in Europe come at a most unfortunate time for the USA, since there is now a showdown between President Obama and Congress over raising the debt ceiling for American public borrowing. The President has indicated that a deal needs to be struck by this Friday to give time for enactment by the August 2 deadline, which I guess will really mean more last-minute hard negotiating over this weekend. Brinkmanship is a dangerous game to play: it nearly blew up the world in the Cuban Missile Crisis of 1962, and then as now, everything depends on both sides remaining sane.

It's ironic that a financial elite, having looted the economy for decades and left it pretty much unworkable, then blames the losers and expects them to pay all the costs of putting things right, and that without delay. What nonsense: America's problem is private debt, which over the last 30 years has so enriched some of these born-again pecuniary Puritans. Yes, public sector workers have enjoyed great salaries and pensions compared to the People of Walmart (though please, say nothing about the top 10 hedge fund managers whose average earnings are $1.75 billion); but what fortunes have been made on the back of arranging mortgages on their increasingly crazily-priced houses? It takes two to tango; and the same number to quarrel, as we now see.

Well, the reckoning is coming, even if some won't pay their fair share of the bill. As "Mish" reported yesterday, the yield on the US Treasury 30-year bond is increasing and he is predicting a bond market revolt "sooner than anyone thinks".

And, scarcely believably, here come the speculators again. They made money packaging debt, making sausages with as much old roadkill as fresh meat in them; then they made governments pay for the consequences; now they gamble on which countries will go bust as a result. Last month, Martin Hutchinson reminded us that he'd warned in 2008 about credit default swaps, especially the ones that are "naked", i.e. insure events that would not in themselves result in any loss to the investor. This simply gambling, and it makes a bad situation worse; it did so, he argues, with Lehman Brothers and others, and will do so with Greek debt, where the loss on default will have added to it the cost of an estimated $100 billion in side bets.

Now there are those who will argue that the CDS market, though enormous ($60 trillion in 2008, half that now), isn't a dangerous one, exactly because it's a gambling operation. Loser pays winner, so it's a zero-sum game.

But it's not.

Firstly, there's the question of mispriced risk. Hutchinson explains: "Wall Street's risk management looks at normal price fluctuations and then assesses the maximum possible risk as a modest multiple of the daily fluctuation, it was completely inadequate in measuring the risk of a CDS book. That, in a nutshell, is why AIG went bust and had to be bailed out with $170 billion of taxpayer money."

Then there's the interaction between the speculators and the authorities. Goldmans Sachs was compensated by the taxpayer for losses on AIG debt, in addition to claiming on its CDS on the same. It's like getting paid twice on an auto repair job. Rather questionable, that.

And there's the risk of outright fraud, which is how rogue trader Nick Leeson destroyed Barings, Britain's oldest investment bank: he hid his losses in a secret account and increased his bets to try to recoup them. That put Barings' capital at stake in a way that the naive, old-fashioned management failed to foresee.

Which leads us to the problem of contagion. Banks can go bust, but their depositors are protected (subject to limits) by the FDIC. Not only does that puts the taxpayer on the hook, but the FDIC, being a corporation with limited assets, may itself become insolvent if the scale of losses is too great (in fact, that was the position only two years ago). We then have either partially-busted depositors, or (if politics forces it) a further burden on what under the circumstances is likely to be an already-distressed public budget.

And what if insurance and pension funds have to pay out on CDS contracts? As Hutchinson points out, banks have limited balance sheets, but the funds that represent security for the nation's savers have much more to place at risk in contracts that many of the fund managers won't properly understand or calculate - which made them such suckers for packaged debt (CDOs and variants). "Fool me once, shame on you; fool me twice, shame on me." Hutchinson, who ran a derivatives desk in the 1980s, assessed CDS as a "sophisticated scam". So I should like to know the total downside of CDS for pension and life companies. Could this result in massive extra welfare support for retirees?

Derivatives are the fourth horseman in Michael Panzner's apocalypse, or "Financial Armageddon" as his March 2007 book titled it (reviewed here in May of that year). The market, recently estimated at $601 trillion, is worth some 8.75 times the world's GDP (or nearly 40 times that of the US), so a relatively small percentage imbalance as per some of the ways illustrated above, represents a huge potential problem. The subsector including interest rate and CD swaps is expected to grow by 10% within a couple of years, according to Citigroup (itself a name to conjure with, in the light of recent history).

Will the Dodd-Frank Act prevent all problems in future? Not, I'd have thought, with many of the nation's brightest brains employed on Wall Street and perpetually looking for ways to game the system. I don't know the loopholes and weaknesses, but I'm betting on that talent, human nature and the fabulous scale of the incentives involved, to find them out.

One way or the other, the money looks as though it's going to run short. This will lead to increased reluctance on the part of lenders, and so raise interest rates and tank the market in existing bonds. Coming back to Martin Hutchinson, he wrote on Seeking Alpha at the beginning of this month, predicting an "epic" crash in September or December, though if things go wrong in current budget negotiations that date could come sharply forward. It seems inevitable that such a crash would also impact on equities, what with deleveraging and the depressing effect on demand of a severe deflation.

Will a mooted QE3 help? I'm not sure. What did QE2 do? The banks got a raft of money from government, couldn't find anyone who they wanted to lend it to and parked it at the Fed to get safe interest. In effect, the State is rebuilding the banks' reserves for them, on the drip. But as real estate continues to dwindle in price, the bank reserve ratios may actually worsen despite all this help. And whatever the outcome of current budget negotiations, the private debt ceiling seems to have been reached already, so the frightened consumer is hardly likely to shore up the economy with extra demand.

I cannot envisage how this can continue for much longer*, unless the government takes back from the Federal Reserve the right to issue money, in which case rip-roaring inflation is a possibility, followed by a total reset, as in Germany in 1923. But avoiding that is surely the point of a central banking system: not to have a Chancellor Havenstein operating 2,000 presses 24/7 printing currency with face values in the billions, truckloads of which were still waiting to move out on the day he died. Dropping dollars by helicopter might work in this terrible way (though C-5s would be more commodious); shoving money into the banks hasn't done so.

Perhaps the strategy will be debt default, but again I can't somehow picture the virtuous depositors being allowed to keep their dollars and see them multiply in spending power, even though at least one New Yorker appears to hold $100 million in a checking account. Is that a vote for cash as the best asset?*

Hutchinson's latest post advocates gold (an each way bet if you think deflation ends with a currency crisis), buying a house (even though he thinks it'll go down in value) and finally, a put option on Treasuries. Like me, he's struggling, really: gold is above its long-term inflation-adjusted trend, houses seems to be a bad investment for ready cash (unless you're one of the growing number of bottom-fishers snapping up distressed properties at 40% off) and options carry counterparty risk, which is where we came in.

In the event of a full-scale disaster, all bets are off. All I can suggest is diversification among all assets, plus holding some away from banks and other fiduciary institutions. And, of course, hope. ________________________

*Though I'm confused, it seems I'm in good company here:

"...even such "legendary" hedge funds as Soros' $25 billion Quantum are about as clueless as everyone else. Bloomberg reports that "the fund is about 75 percent in cash as it waits for better opportunities, said the people, who asked not to be identified because the firm is private."

The reason: "“I find the current situation much more baffling and much less predictable than I did at the time of the height of the financial crisis,” Soros, 80, said in April at a conference at Bretton Woods organized by his Institute for New Economic Thinking. “The markets are inherently unstable. There is no immediate collapse, nor no immediate solution."

- Zero Hedge

INVESTMENT DISCLOSURE: None, except for (UK) NS&I Index-Linked Savings Certificates (similar to US TIPS). Otherwise, still in cash, and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Saturday, July 16, 2011

A reply from Mr Allister Heath, and my attempted rebuttal

Following my recent needling of Mr Allister Heath at City AM in response to his article calling for a new Ronald Reagan, he has kindly responded thus:

I agree with you that monetary policy was too loose in the US and in the UK (disastrously so under Lord Lawson in particular). However, I was focusing on Reagan's fiscal policies and didn't mention his monetary policy in my piece. While the latter was bad, it was no worse than what we have seen later and still see today - so I don't think it's an especially anti-Reagan point (we also saw far worse prior to him; in fact, the history of modern monetary policy has been one of failure in almost all economies). In fact, it is simply wrong for you to claim that monetary over-expansion started in the 1980s - we have been plagued by it ever since fiat money (and even before, for example when gold was brought back in large quantities to Europe by Latin American explorers).

As to the statistical dispersion of post-tax incomes you refer to, I agree that it has increased since the 1980s - but I do not believe inequality of outcomes as a goal, evidently unlike you. I do not believe that this kind of inequality causes crime. I'm much more worried bythe fact that some groups and individuals in society lack opportunity, for example because of poor state schools or because of perverse incentives created by the benefits system. But I think that low marginal tax rates maximise opportunities and economic growth, and hence welcome what Reagan did on that front.

To which I have framed a reply, as follows:

Dear Mr Heath

Thank you for responding. I am sorry to reply late but must plead pressure of work. May I perhaps take up a couple of your points?

1. I accept that Reagan's successors tended to permit the same disastrous over-expansion (I said "acceleration") of the money supply that, I must insist, did indeed begin on his watch. I shan't bore you with the graphs but the facts are undeniable. Yes, the money supply has had previous bursts - e.g. in the lead up to the 1929 debacle (and I'm familiar with the gold-supply-boosted inflation of the 16th century) - but 1980-ish was definitely a watershed in the postwar era. It's reaching a bit too far back to make tu quoque an excuse. However, I certainly don't exonerate his successors, either.

2. I also accept that when tax rates are high, tax cutting does help increase tax revenue as well as stimulating enterprise. But I'm not sure how much more tax rates should be cut from the 15% or so that effectively the American rich are currently paying. At the other end, I seem to recall research by - was it the IFS? - that shows the poorer sort are paying proportionately nearly as much tax as the middle class (something like 40%), thanks to indirect taxation.

3. You don't have to be a socialist - and I am certainly not - to query how (for example) the top ten US hedge fund managers can now be averaging $1.75 billion earnings p.a. This sort of thing is hardly the only alternative to "equality of outcome", a phrase whose implications are somewhat mischievously deployed by you in a discussion that ought really to be rather more nuanced.

4. Fiscal policy that focuses solely on State spending and debt is what has led us to this pretty pass. The Flow of Funds data shows that US local and national government debt declined from 52% of total credit market debt in 1952, to under 15% in 2007. That is not what has blown up the economy. Australian economist Steve Keen maintains, plausibly in my view, that what we have seen is a private debt crisis, not a public one. And this was stoked by the ability of banks to inflate asset prices through reckless lending; as well as government interference in the housing market, on both sides of the Atlantic. The failure to control the egregious greed of bankers must be laid at the door of governments, who doubtless saw votes for themselves in an overstimulated financial environment.

5. As the late Sir James Goldsmith (no slapstick socialist he, either) observed as long ago as 1993 when GATT was under way, it is globalisation that is destroying opportunities for those sectors of society for which you express some concern. Indeed he foresaw the breakdown of social cohesion in the West which we are now beginning to witness, and which the extremely high and growing disparities of wealth and income are doing nothing to heal. Certain clever and unscrupulous individuals have exploited the massively enriching (to themselves) opportunities latent in this situation, so I think it's fair to suggest that there is a causal relation between the prosperity of the super-wealthy in the modern financialized economies, and the impoverishment and social decay in the same.

6. You say that poverty does not cause crime (though recent UK statistics are showing a significant increase in burglaries). I would suggest that the underclass has, to some extent, been bought off by the payment of various kinds of social benefits, although there has been a concomitant deterioration in morale and behaviour, the effects of which are becoming increasingly difficult to manage and which is breeding a growing number of angry and confused children. Schools are doing what they can, but people must have hope of a better life and the prospects of meaningful employment and self-determination. This is unlikely to be achieved when our government exploits economic migration to hold down wage rates. More exam passes (inflated grades or no) may merely create a class of Eliza Doolittles with attitude.

INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Tuesday, July 12, 2011

Some European debt ratings

CMA Datavision reports on credit default swaps for sovereign debt and so its information, based on market rates, is not quite so compromised as that of some major rating agencies. The global rankings are for 67 countries. The eurozone includes 4 of the 6 best, and 3 of the 4 worst. It is not surprising that the euro garment cannot fit all sizes in this range and the problem was identified by some commentators over a decade ago when the Euro was introduced.

Note: Spain is the 21st worst - consider it deep orange!

INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Sunday, July 10, 2011

The end of democracy

I often read on the Net that "the people" won't stand for this or that. Fantasy. As I have commented elsewhere:

How would the people raise a hue and cry?

- The papers and TV don’t represent us, we are merely a market sold to their advertisers
- MPs and Lords similarly have little interest in us, pursuing their own agendas and in some cases actually bought and paid for by powerful interests such as the EU with its revokable pensions
- Americans can demonstrate outside the White House but here it is now against the law to do so (even peacefully, such as reading aloud the names of recent war dead) within a measured distance of Downing Street
- public houses are no longer the gathering places and discussion centres they were
- the market places have been replaced by one-stop, fast-moving commercial fleecing operations like Tesco (when is the last time you stopped for a good natter and grumble there, on the way to the checkout? We stand in line like immigrants at the airport and are processed in near-silence).
- Internet, email and phone calls are mass-scanned by powerful computers for any sign of dissent.

Any means by which people used to assemble, discuss and become collectively activated has been neutralised. Most of us bloggers don’t know each other, where we live or what we look like. We merely raise a feeble protest and the powers that be, knowing that many of us are of a demographic that will not trouble them for many more years, permit our impotent grumbling.

I shall continue, not in hope that it will change things much, but as a standing reproach to those who have sold the freedoms that took our predecessors centuries of blood and toil to achieve.

Tuesday, July 05, 2011

A reply to Mr Allister Heath

UPDATE: No answer as at 12 July. Are journalists even more arrogant than politicians?

Allister Heath at City AM has written a piece in praise of Ronald Reagan and tax cuts. I have emailed him as follows and look forward to his rebuttal:

Dear Mr Heath

Bring back Reagan? You'd have to be amazingly selective about which policies. It was under him and Mrs Thatcher that the reckless acceleration of monetary expansion began, and if you track money supply against GDP you'll see that the response of the latter, though statistically significantly positive, was also significantly less than the increase in the money supply. We got roaring inflation, but this time in the stockmarket and housing, turn and turn about. These two and their successors have led us to the present, tragically debt-laden pass.

We also got, thanks to the cuts in income tax, an enormous increase in inequality, now the subject of much well-informed comment in the USA. We'll be lucky if we don't end up with a Colombia-type society where the rich live in gated compounds (sorry, "communities") and go shopping in armoured cars, though that appears to be trending here.

I don't suppose that either the affable Reagan or the honourable and principled Thatcher, both of them fervent patriots, intended any of this, but their financial naivety was grossly exploited by the money men.

Perhaps you could submit something on how "conservatives", aren't. Or how politicians generally need to be taught far more thoroughly on the E bit of PPE.

Yours faithfully

Rolf Norfolk

INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Monday, July 04, 2011

Liberty, subjection and destruction

Happy Fourth of July, America!

The same date is also the anniversary of the battle of Mantinea (362 BC), in which the Theban leader Epaminondas inflicted his second (after Leuctra) decisive defeat on the Spartans. A victory, one could have hoped at the time, for the democratic city-states of Attica and Boeotia.

Previously, warlike Sparta had overcome Athens and gone even further, crossing the Hellespont and seizing Persian territory in modern Anatolia. Now they were bottled up again in their Peloponnesian peninsula.

Bur alas for Thebes! Epaminondas died at Mantinea, together with his two possible successors, and when the weakened city of Thebes requested the help of the Macedonian Philip II in the quarrel with their neighbouring Phocians, they found an ally more dangerous than their foe.

In Athens Demosthenes, the greatest of orators, stirred his fellow citizens to resist Philip and persuaded Thebes to join them. Thus Athens lost her liberty; but it was worse for the Thebans, who when they revolted in 335 BC were all slaughtered or enslaved, and the city razed.

Who today is Sparta, who Thebes, and who the Macedonians? And who are the fatal orators?