Dec 142011
Dec 132011
Chris Martenson and Alasdair Macleod of the GoldMoney Foundation talk about Martenson’s book The Crash Course, the US dollar and gold.
THIS is the problem with the developed world today. It is quite possible that the only solution is to break the cycle with bankruptcy and economic chaos.
European banks turning to their governments to raise required capital could trigger a downward spiral of declining sovereign-debt prices and further losses for the lenders.
The European Banking Authority ordered the region’s banks on Dec. 8 to raise 115 billion euros ($154 billion) by June. Faced with dwindling profits and unable to tap capital markets to sell new shares, firms may be forced to seek government help. About 70 percent of the capital requirement falls on lenders in Spain, Greece, Italy and Portugal, countries struggling to convince the world they can pay their debts.
Dec 122011
More from Ferguson:
Dec 082011
Kent Smetters, a professor at the University of Pennsylvania’s Wharton School and a former Treasury Department economic policy official, talks about Europe’s sovereign debt crisis.
Dec 062011
We revisit a Feb 2011 presentation by Richard Koo to see how prophetic it was.
During the presentation, he discusses the ideas behind “Balance Sheet Recessions,” why QE2 didn’t work, and how China’s monetary policy was effective in the wake of the Global Financial Crisis.
Guest post by NBER
In Canada the banking system was … a system of large financial institutions whose size and diversification enhanced their robustness.
When European and North American banks teetered on the brink of meltdown in 2008, requiring bailouts and extraordinary central bank intervention, Canadian banks escaped relatively unscathed. History explains why, according to co-authors Michael Bordo, Angela Redish, and Hugh Rockoff in Why Didn’t Canada Have a Banking Crisis in 2008 (or in 1930, or 1907, or …)? (NBER Working Paper No. 17312). Starting in the nineteenth century, Canada and the United States took divergent paths: Canada set up a concentrated banking system that controlled mortgage lending and investment banking under the watchful eye of a single, strong regulator. The United States allowed a weak, fragmented system to develop, with far more small (and less stable) banks, along with a shadow banking system of less-regulated securities markets, investment banks, and money market funds overseen by a group of competing regulators.
“[T]he stability of the Canadian banking system is not a one-off event,” the authors note. “In Canada the banking system was created as a system of large financial institutions whose size and diversification enhanced their robustness…. In the [United States] the fragmented nature of the banking system created financial institutions that were small and fragile. In response the [United States] developed strong financial markets and a labyrinthine set of regulations for financial institutions.”
The contrast is striking. While in 2008 and 2009 the United States experienced bank failures, bailouts, and the worst recession since the 1930s, Canada had no bank failures, no bailouts, and its recession was less severe than either that of the early 1980s or early 1990s. Long before 2008 in the United States, there were the failures of the private investment bank Jay Cooke and Co. (the 1873 crisis), the Knickerbocker Trust (the 1907 panic), and the runs on banks that deepened the Great Depression. Although Canada’s economy suffered a collapse equally as dramatic as America’s in the 1930s, not one of its banks failed.
“The twin weaknesses of the American financial system — a commercial banking system divided along state lines and volatile financial markets in which a ‘shadow banking system’ of unregulated or lightly regulated investment banks and other financial intermediaries participated — produced a series of financial panics,” the authors write. “There were major banking panics in 1837, 1857, 1873, 1893, and 1907, and minor panics in 1839, 1884, and 1890.”
One important factor, the authors argue, is that from the outset Canada’s federal government had the authority to charter and regulate banks while the U.S. Constitution did not specifically reserve that power for the federal government. That led to constitutional disputes, an on-again-off-again national bank, and a dual system of federal- and state-chartered banks that were smaller, geographically confined, and thus more exposed to local economic conditions. The inherent weakness of the banks led to the development of stock and other securities markets that were far more robust than Canada’s and to the rise of other intermediaries — the so-called shadow banking system — that were overseen by a patchwork of regulators.
Financial crises, particularly the Great Depression, spurred reforms to strengthen regulation. In the 1930s, the government created federal deposit insurance, the Securities and Exchange Commission to regulate securities markets, and stricter bank rules encompassed in the Glass-Steagall Act, which among other things separated commercial from investment banking.
For more than a century, the Canadian system has proven itself far more stable than its U.S. counterpart, the authors conclude. “[B]ut there is a caveat to keep in mind: greater stability may have come at a cost. A more concentrated and regulated financial system may have been slower to innovate, may have been slower to invest in emerging sectors, and may have provided services at monopoly prices.”
–Laurent Belsie
Dec 042011
Guest post by Stephen Johnston
Partner – Agcapita Farmland Investment Partnership
“Never, ever take counterparty risk. It is the one risk you are almost never rewarded for taking.” Joshua Brown summarizing a recent presentation by bond guru Jeffrey Gundlach. Sage but largely unheeded advice as the emerging winner of the “Unexpected Risk of 2011″ competition is surely counter-party risk.
For the longest time, counter-party risk has not been something that the average investor gave much consideration. State backed financial insurance schemes and the ostensibly strong balance sheets of financial service providers combined to create an unwarranted sense of safety. Lets address these two supposed bulwarks in turn.
- State backed financial insurance schemes are insufficient to protect depositors/beneficiaries from a systemic crisis, particularly a crisis of sovereign solvency. If state funded schemes could protect from a sovereign default we would have discovered something akin to perpetual motion in the form of the insolvent bailing out the insolvent.
- It is increasingly apparent that many financial intermediaries only appear to be well capitalized because risks, where apparent, are thought to be hedged/offset via a range of derivative instruments – CDS, interest rate swaps – the list goes on. Via such hedge transactions, intermediaries argue that net exposure, rather than gross, is the key measure for investors to consider.
Though not entirely accurate, I would suggest that this reasoning is akin to building a larger and larger pile of gunpowder kegs while at the time stock-piling fire extinguishers so as to try to make the argument that while a large pile of gunpowder might be unsafe by itself, a large unsafe pile behaves like a small safe pile if you can put out the fire in time – maybe, maybe not.
If recent events have taught us anything it should be the obvious principle that hedging cannot eliminate risk, it can only re-allocate risk – an important distinction. Whether because this has been conveniently forgotten or perhaps willfully ignored, there has been a tendency for some entities to take concentrated gross positions in certain risks with the view that any unwanted/excess risk can be reduced at any time via hedges rather than an outright reduction in the underlying position itself. However, recent events prove that where there is a concentration of risk in critical counter-parties (e.g. AIG), in a world of high positive correlations across markets and asset classes, hedges can fail leaving catastrophic gross rather than net exposure behind.
When losses arise – e.g. Greek defaults – some participant(s) in the system must ultimately suffer those losses. In such a structure if a critical counter-party fails – and of course they do – the concentration of risk starts to increase unexpectedly and the magnitude of the true losses is revealed suddenly.
Financial entities continue to report on net rather than gross exposures for risk purposes. Investors need to be alive to the issue that the net position may not reflect the true risk if there is tendency to strong themes amongst both the entities’ and their counter-parties’ positions – e.g. we don’t think Italy will default. Ask account holders of MF Global how they feel about unexpected counter-party failure and the efficacy of financial risk reporting.
Why are apparently solvent institutions suddenly subject to failure? The late economist, Murray Rothbard provides a simple and compelling answer with the concept of subsidized malinvestments accumulating in the system:
“The longer the boom of inflationary bank credit continues, the greater the scope of malinvestments in capital goods, and the greater the need for liquidation of these unsound investments. When the credit expansion stops, reverses, or even significantly slows down, the malinvestments are revealed. [Ludvig von] Mises demonstrated that the recession, far from being a strange, unexplainable aberration to be combated, is really a necessary process by which the market economy liquidates the unsound investments of the boom, and returns to the right consumption / investment proportions to satisfy consumers in the most efficient way. Thus, in contrast to the interventionists and statists who believe that the government must intervene to combat the recession process caused by the inner workings of free-market capitalism, Mises demonstrated precisely the opposite: that the government must keep its hands off the recession, so that the recession process can quickly eliminate the distortions imposed by the government-created inflationary boom.”
So by preventing the timely and orderly liquidation of mal-investments, government intervention allows them to accumulate to catastrophic levels creating the raw material for a highly unstable and discontinuous financial system. In such an environment “sudden and unexpected losses” occur with alarming frequency.
It is because we believe that counter-party risk remains opaque and non-trivial that a key part of our investment approach is to find assets that capture our desired returns but as much as practical eliminate or reduce counter-party risk – e.g. farmland rather than wheat futures to capture agriculture returns.
Kind Regards
Stephen Johnston
Agcapita Partners
By Ambrose Evans-Pritchard
The interwoven banking and sovereign debt crisis in the eurozone has become so dangerous for the world that the US Federal Reserve has been forced to take emergency action, acting as global lender of last resort to shore up Europe’s banking system.
That it should have to do so as Germany and the European Central Bank hold back for legal reasons and refuse to commit decisive power adds a strange diplomatic twist.
Guest post by Jesse Eisinger ProPublica, Nov. 29, 2011, 5:35 p.m.
Yesterday, federal judge Jed Rakoff slammed the Securities and Exchange Commission for making a toothless settlement with Citigroup over financial crisis misdeeds, arguing that it obscured the basic facts of what actually happened. Today, Bloomberg Markets Magazine has an important story [1] by Richard Teitelbaum that, from a very different vantage point, demonstrates the same infuriating point: Despite the economic wreckage we are still trying to repair, we have yet to have an adequate accounting of how the financial crisis happened, what caused it, and who knew what when.
According to the story, on July 21, 2008, then-Secretary of the Treasury Hank Paulson met with 201Ca dozen or so hedge- fund managers and other Wall Street executives201D and discussed 201Ca possible scenario for placing Fannie [Mae] and Freddie [Mac] into 2018conservatorship.2019201D That2019s a fancy term for a government seizure that would have allowed the entities to keep operating, but would have caused severe adverse consequences to holders of the Frannies2019 equity and, possibly, debt. A fund manager told Bloomberg he was 201Cshocked that Paulson would furnish such specific information — to his mind, leaving little doubt that the Treasury Department would carry out the plan.201D After the meeting, this manager consulted a lawyer, who told him to cease trading immediately in the Frannies, lest he later be accused of 2013 here2019s the rub 2013 insider trading.
The Bloomberg story cites law professors to say that Paulson did not break the law. But the story2019s implicit allegation is that the former head of Goldman Sachs was so clueless 2013 or contemptuous 2013 of his role as Secretary of the Treasury of the United States of America that he engaged in a clubby tête-à-tête with his former peers and handed them what Bloomberg says 201Camounted to inside information.201D
It2019s actually worse, because as Bloomberg also reports, Paulson was publicly playing down the possibility of dramatic government action — practically the opposite of what he confided behind closed doors to those elite traders.
Paulson didn2019t comment for the Bloomberg story, and his spokesperson referred questions to his book, On the Brink: Inside the Race to Stop the Collapse of the Global Financial System [2] 2013 which, Bloomberg points out, doesn2019t mention the meeting.
There are limits to what a reporter can get 2013 starting with whether any of those powerful and canny Wall Street sharks profited on the information. They may have shorted the Frannies, but, as the Bloomberg story points out, “tracking firm-specific short stock sales isn2019t possible using public documents.” We need a more powerful entity — perhaps a Congressional committee? –to find that out. And, here are a few more questions that cry out for answers:
1. What is the justification for such a meeting? Former St. Louis Federal Reserve bank president William Poole suggests that the Treasury needs to be able to prep the market with information.
Fair enough. A Treasury Secretary should talk to smart market participants, and needs to know how the market might react to any given action.
But there2019s a difference between meeting to receive information and telling a chosen few market-moving plans. Hank Paulson and now Timothy Geithner should receive information from all types of parties. If they want to float a trial balloon, they have to float it in such a way that doesn2019t give select participants market sensitive information.
2. Why did Paulson meet with these people specifically? The Bloomberg piece notes that Eric Mindich, a hedge fund manager who is a former Goldman Sachs employee, hosted the meeting. Several Goldman Sachs executives attended.
If the Treasury secretary is going to hold meetings with market participants, the attendees should be chosen based on 2013 you are going to laugh here 2013 merit, not connections. And they should be transparently disclosed at the time.
3. How many other meetings like this were there? As Felix Salmon recalls, Andrew Ross Sorkin in his book 201CToo Big To Fail201D revealed that Paulson met with the board of Goldman Sachs in June 2008 in Moscow — a month before the meeting Bloomberg has revealed — and discussed market conditions, and even contemplated that Lehman Brothers might fail.
Here2019s how Sorkin wrote about this [3]:
201CFor the nearly two years that Paulson had been Treasury secretary he had not met privately with the board of any company, except for briefly dropping by a cocktail party that Larry Fink’s BlackRock was holding for its directors at the Emirates Palace Hotel in Abu Dhabi in June.
Anxious about the prospect of such a meeting, [Paulson Chief of Staff Jim] Wilkinson called to get approval from Treasury’s general counsel. Bob Hoyt, who wasn’t enamored of the “optics” of such a meeting, said that as long as it remained a “social event,” it wouldn’t run afoul of the ethics guidelines.
Still, Wilkinson had told Rogers, “Let’s keep this quiet,” as the two coordinated the details. They agreed that Goldman’s directors would join him in his hotel suite following their dinner with Gorbachev. Paulson would not record the “social event” on his official calendar.201D END OFFSET
One possible defense for Paulson floating government conservatorship of Fannie and Freddie is that by the time of his July meeting with traders and executives, the market was widely anticipating the government would take that action. But what if the market only anticipated this because there were other, previous meetings between Treasury officials and well-connected investors in which such plans were floated?
4. What did this meeting do for the Treasury?
My sense of Paulson2019s approach 2013 act first, act boldly, move on and dwell no more 2013 is that his actions weren2019t well thought out at all.
But let2019s concede, arguendo, that Paulson and the Treasury held this meeting as part of a carefully thought-out strategy to prep the market for the Frannie conservatorship. What did that get the government? If anything, the prepping only would make the investors more likely to extrapolate and short or sell other financial stocks.
If preparation was indeed the rationale and justification, then Paulson and Treasury needed to have a contingency plan for investor reaction. Which they almost certainly didn2019t, since Lehman then failed and they were forced into a series of desperate actions. Over the next weeks, they scrambled to create the Troubled Asset Relief Program, or TARP, and then remake it into the preferred equity-buying program (rather than the toxic asset purchasing program).
Without a full and convincing accounting, we are left with a picture of a Treasury Secretary who took care of his buddies while allowing the system to blow up. This is the kind of thing that a crony capitalist system 2013 and only such a corrupt system 2013 would allow.
Nov 212011
This is classic Rosenberg:
1. Hedge funds have not piled into the equity market to play catch-up.
2. The Super Committee did not come to a compromise (and remember Moody’s has the U.S. debt rating on “credit watch” and Standard & Poor’s still with a “negative outlook”.., shades of August).
3. The Europeans have not managed to resolve let alone contain their credit crisis.
4. Germany has not acquiesced and agreed to having poor sovereign credits ride off its AAA rating via a “Eurobond”.
5. The ECB has not moved towards QE. Nor will it — have a look at today’s WSJ editorial on the matter. Brilliant.
6. Mr. Market saw through the Q3 earnings season and recognized the lack of visibility in the guidance provided.
7. China did not start to ease policy just because inflation rolled off the 6%-plus peak.
8. U.S. recession risks, as per the San Francisco Fed, did not recede and actually stayed above 50% even with the better statistical tone to Q3 and Q4 GDP.
For all the relentless noise about the banking system, are we really just experiencing the symptoms of a resource constrained economy?
Good backgrounder by the New York Times on the genesis of the European financial crisis:
As the bets that European banks made on United States mortgage investments went bust a few years ago, bankers piled into what they saw as a safe refuge: bonds issued by countries in Europe’s seemingly ironclad monetary union.
Now, the political and financial crisis engulfing the Continent has turned much of that European sovereign debt into the latest distressed asset, sending tremors through global financial markets not seen since the demise of the investment bank Lehman Brothers more than three years ago.
