WRFest 4Apr08(Economy II): Economy vs the Credit Markets
Another big piece of economic news from last week were the proposed changes, the most sweeping since the Great Depression, in the regulatory regime for the Finance Industry. In some senses this is both industry and markets news but the credit markets have moved to being the most urgent and important issue in overall economic performance since last summer. Hence we provide this seperate set of excerpts.
As usual we'll suggest that the punditocracy continues to miss some, though not all, of the implications. "Fortunately" enough folks have picked up on their versions of the 'collapse of Western Civilization" meme that the point is getting thru to folks who follow the economic and business news. We say fortuntaly advisedly of course - we doubt our neighbors are paying much attention. Let's hope they don't have to considering what that'd imply.
Up until St. Patrick's Day though none of the efforts of the Fed and the other central banks appear to have been working. Our view since then is that between the BSC buyout (forced liquidation) and the opening of the discount windown to the non-bank banks as well as the extremely rapid innovation and introduction of new policy instrments the Fed is starting to unkind and unplug the terribly clogged pipes of the economy Whew....the alternatives being as we said.
This'll take a while to sort out of course as we're going to have to go thru more writedowns, more bad credit problems are coming, there will be a massive de-leveraging of the markets and risk will have to start being priced correctly. All of that will be very painful.
But at least it's now possible for the great unraveling to beging instead of being locked up - or more correctly seized up. At least some of the early indicators are beginning to show signs of favorable responses. And oddly, for all the sturm und drang, it is the BSC liquidation that seems to have turned the trick. Though in our judgement the opening of the window is structurally more important. Whatever the case may be we appear to have avoided catastrophic disaster. Now we can enjoy the merely painful one that excesses and bad business practice have earned.
Addendum: the excerpt below from John Mauldin's newsletter (thoughts on the continuing crisis) gives you just a flavor of the whole thing. It's probably the best, shortest, simplest but still accurate description of the risks we faced, who saved what and what's to come I've read. HIGHLY RECOMMENDED.
READINGS
Paulson the plumber A plan to fix America’s financial regulation. MUCH of it will take the best part of a decade to see the light of day, if it ever does. Even the short-term recommendations face a rocky path to implementation. Yet a plan unveiled by America’s Treasury on Monday March 31st is an important first salvo in a fight over the future of financial regulation in the world’s biggest capital market. The review began a year ago in response to fears about America’s waning financial competitiveness. Then came the mortgage-inspired credit crunch and a host of new problems. The result is a hybrid document—albeit a keenly argued one—that emphasises agency consolidation, while advocating deregulation in some areas and new rules and institutions in others. The system could certainly be slicker. Its important features date from the 1930s and subsequent changes have lacked any over-arching vision. Supervision of banks, brokers and derivatives is divided up among half a dozen agencies (in contrast to Britain where a super-regulator, the Financial Services Authority, oversees the entire market). Dozens of state regulators sit beneath them. Turf wars are common, duplication rife. Even those who run the agencies use words such as “antiquated” and “dysfunctional”. The answer, reckons the Treasury, is to redraw lines. It suggests creating three new regulators, one to keep an eye on overall market stability, a prudential regulator for banks, thrifts and credit unions, and a business-conduct agency to oversee disclosure, consumer protection and the like. Treasure Summary pdf. Complete Blueprint pdf.
- Leveraged Planet Exploring what a global game dealmaking is, with Andrew Ross Sorkin, NY Times and CNBCs Becky Quick
- Cramer on Clinton Mad Money host Jim Cramer sheds light on what he makes of the Presidential race right now
- Greenbergs Global $trategy, Pt. 1 Hank Greenberg, the former head of AIG and the current head of CV Starr, shares his global strategy with CNBCs Maria Bartiromo.
- Wilbur Ross on Regulation Insight on regulation in the financial markets, at the ELA, with Wilbur Ross, W.L. Ross and Co. CEO
Thoughts on the Continuing Crisis Several times in the past few months I have reminded readers of the problem that developed in 1980 when every major American bank was technically bankrupt. They had made massive loans all over Latin America because the loans were so profitable. Argentina, Brazil and all the rest put the US banking system in jeopardy of grinding to a halt. The amount of the loans exceeded the required capitalization of the US banks. Not all that different from today, expect the problem is defaulting US homeowners. So what did they do then? The Fed allowed the banks to carry the Latin American loans at face value rather than at market value. Over the course of the next six years, the banks increased their capital ratios by a combination of earnings and selling stock. Then when they were adequately capitalized, one by one they wrote off their Latin American loans, beginning with Citibank in 1986. So, let's sum it up. The problem is so severe with the financial companies assets that the SEC is going to allow some of them to "cook the books" so they can survive. That means there are going to be large and continuing write-downs for many quarters to come. There is a minimum of another $3-400 billion in write-downs (and maybe a lot more) coming from mortgage related assets, not to mention credit cards and other consumer related debt. And the investment banks may be forced to reduce their leverage and thus their profitability? Putting money in the major financial stocks is not investing. It is gambling on a very uncertain future. There is simply no way to know what the value of the franchise is. There are other places to put your money.
Good News for Bernanke From Bond Market Brings Bad News on Interest Rates For the first time since December, the bond market is closing the credibility gap with Ben S. Bernanke and signaling its agreement with the Federal Reserve chairman that an economic collapse has been averted and that interest rates are bottoming. Treasury yields rose 0.33 percentage point on average through April 4 from this year's low of 2.49 percent on March 17, according to Merrill Lynch & Co. indexes. The increase is the first since December, when the Fed cut its target rate for overnight loans between banks and said lower borrowing costs ``should help promote moderate growth.'' The turning point came when the Fed promised $30 billion to back New York-based JPMorgan's bailout of Bear Stearns, preventing the biggest collapse of an investment bank. The central bank lowered its pledge to $29 billion on March 24 after JPMorgan quadrupled the purchase price to about $2.4 billion. Treasuries, which tend to perform the best when the economy and inflation are slowing, lost 1.59 percent on average since March 17, according to Merrill's indexes. They had gained 14.5 percent since June 12 as gross domestic product growth slowed to a 0.6 percent annual rate in the fourth quarter, home prices fell 14 percent and bank losses swelled. High-yield, high-risk corporate bonds returned 2.46 percent following the Bear Stearns rescue, after losing 4.58 percent this year through March 17, the Merrill indexes show.