Twenty Comments on the Current Economic Scene
1) There are firsts for everything. Americans paid down debt for the first time, according to a Federal Reserve Study that started in 1952. America has always been a pro-debt and pro-debtor nation. It goes all the way back to the Pilgrims, who paid back the merchant adventurers who funded them at a rate of nearly 40%/yr over a 15-20 year period. But, the Pilgrims did extinguish the debt. Us, well, I’m amazed at the decrease, but we need more of that to restore normalcy to financial institutions.
2) Dropping to 45%, though, is the amount of aggregate home value funded by equity. With the decline in housing values, the fall in the ratio was inevitable. The low ratio puts downward pressure on home prices, because it means that more homes are underwater. Perverse, huh?
3) It’s a long interview, but Eric Hovde (my former boss) has a lot of important things to say regarding the financial sector. Few hedge funds focused on financials remained bearish on the sector, but Hovde’s funds survived to 2007-2008 where his bets paid off.
4) Is there a Treasury bubble? Yes, but it may persist for a while because of panic, central bank buying, buying from pension funds and endowments, mortgage hedging, and more.
5) Now these same low yields whack Treasury money funds. How many will close? How many will cut fees? How many will break the buck, and credit negative interest? An unintended consequence of monetary policy. Another unintended consequence reduces liquidity in the repo markets. Yet another unintended consequence is the reduction in investment from Japan and other nations that don’t want to hold dollars at low rates.
6) Brave Ben Bernanke is fighting the Depression. If his theories are right (and mine wrong), if he succeeds, he will face a difficult challenge in collapsing the Fed’s balance sheet as inflation re-emerges, without taking the wind out of the economy. But if I’m right (or London Banker, or Tim Duy, or Stephanie Pomboy) things could be considerably ugly as the situation proves too big for the Fed and the US Government to handle.
7) Inflation is the lesser evil at this point. It would raise the value of collateral over the value of the loans, dealing purchasing power losses to those that made the bad loans, but not nominal losses.
8 ) I have said before that the Fed and Treasury are making it up as they go, and Elizabeth Warren now confirms it for the Treasury. My Dad (turned 79 yesterday) used to say, “The hurrier I go, the behinder I get.” So it is for the TARP bailout. Policy made hastily rarely works. Spend more time, get it right. The market won’t die as you work it out.
9) But will AIG die, or the automakers?
- Sales are slow for assets at AIG. (no surprise valuations are crushed, and all likely buyers face lower P/Es and higher debt costs.)
- And who knows where the writeoffs end? As I said long before the failure of AIG, don’t trust the financial statements. The palce was too complex, and the culture of fear inhibited objective financial reporting.
- GM’s suppliers are seeking cash. Just one of the costs of financial stress.
- Suppliers worry over a lack of demand if the automakers fail. They should retool for Japanese and European automakers.
- From Credit Slips, the important idea is that without a good business plan the automakers are toast anyway. I predict they will be back hat in hand in half a year even with a bailout.
- A GM bankruptcy would take a long time, and a prepack would not get done before the cash runs out. Maybe, but I would still take it through bankruptcy, with the US Government as the DIP lender.
10) Even VCs are looking at the survivability of their portfolio holdings. Who can survive and become cash-flow positive in a tough environment. Who needs little additional funds?
11) Leveraged loans are attractive, but it is a situation of too many loans with too few native buyers. Watch the loan covenants, so that you can get good recoveries in a default. If you are an institutional investor, this is a place to play now that will deliver reliable returns net of defaults. For retail investors, the closed end funds typically employ too much leverage — it is possible that one could collapse before this crisis is over.
12) Residential mortgages continue to weaken along with property prices. Two examples: Alt-A loans and second mortgages.
13) I have a lot of respect for Dan Fuss. This is a tough time for anyone taking credit risk. That said, it could be a good time to take on credit risk now, if you have fresh money to deploy.
14) Two views of the crisis: one that focuses on structured finance, particularly CDOs, and one that focuses on macroeconomics. I favor the latter, but both have good things to say.
15) Michael Pettis is one of my favorite bloggers. He notes the weakness in China, and notes that the current economic situation is ripe for trade disputes.
16) You can give the banks funds, but you can’t make them lend. Would you lend if you didn’t have a lot of creditworthy borrowers?
17) The export boom is dead, for now. Fortunately, imports are falling faster, so the current account deficit is falling.
18) I blinked when I saw this Wall Street Journal Op-Ed. Sorry, but the secret to changing the residential real estate market is not lowering interest rates, but writing-off portions of loan balances. Most delinquents can’t make even reduced payments, half re-default, and can’t refinance because the property is underwater. Yes, I know that the government is pressing to have Fannie and Freddie suck down more losses by letting underwater loans refinance, but if you’re going to do that, why not be more explicit and let the losses be realized today by resetting the loan’s principal balance to 80% of the property value, and giving the GSE a property appreciation right on any growth in the home value on sale, of say 150% of the amount written down?
19) On commercial property, when do you extend on a loan vs foreclosing? In CMBS, if the special servicer has no bias, or if a healthy insurer/bank holds the loan on balance sheet, you extend when you are optimistic that this is just a short-term difficulty with the property, and you think that the property owner just needs a little more time in order to refinance the loan. More cynically, extensions can occur in CMBS because the juniormost surviving class directs the special servicer to extend because it maximizes the value that they will get out of their investment, because a foreclosure will wipe out a portion of their interests, since they are in the first loss position. With a less than healthy bank or insurer, the same procedure can happen if they feel they can’t take the loss now. (I know that in a extension/modification there should be some sort of writedown, but some financial entities find ways to avoid that.)
20) Time to go bungee jumping with the US Dollar? As Bespoke pointed out, the Dollar Index has just come off its biggest 6-day loss ever. Should we expect more as the US heads into a ZIRP [zero interest rate policy], with aggressive expansion of the Fed’s balance sheet, much of which might be eventually monetized? The best thing that can be said for the US Dollar is that it is already in ZIRP-land, and much of the rest of the rest of the world is being dragged there kicking and screaming. As the interest rate differentials narrow in real terms, the US Dollar should improve.
But, there are complicating factors. Future growth or shrinkage of the demand for capital will have an impact, as will future inflation rates. Even if the whole world is in a global ZIRP, there will still be differences in the degree of easing, and how much easing the central bank allows to leak into the money supply.
This is a mess, and over the next few years, expect to see a whole new set of metrics develop in order to evaluate monetary policies and currencies. For now, put your macroeconomics books on the shelf, because they won’t be useful for some time.
December 18th, 200812:31 pm at
Piece of trivia about item 18, the WSJ article on boosting the housing market. One of the co-authors, Chris Mayer, was a vocal bubble denyer. At the very peak of the bubble in late 2005, he co-authored a WSJ piece dismissing as “chicken littles” those who thought that home prices might fall. Link here: http://real.wharton.upenn.edu/~sinai/papers/WSJ_Bubble_Trouble.pdf
I guess I have two points here:
1. It is one of my pet peeves that the MSM never seems to hold anyone accountable… as long as you have a “name” or credential, you can be consistently wrong and the MSM will still keep coming back and asking your opinion (without ever referring back to past wrongness).
2. In this particular case, why would we expect someone who was totally blindsided by this crisis (and even denied it was a possibility) to now know how to get us out of it?
rich
December 20th, 20086:56 pm at
Hi David,
In case you haven’t read it yet, I think you’d enjoy Thomas Donlan’s editorial in Barron’s today. He covered many of the same points that you’ve been mentioning.
Hope things are well,
Steve