The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Fears about the intensity of the global recession and renewed skepticism regarding the beleaguered financial sector fueled a flight to safety during the past holiday-shortened trading week. President Obama’s inauguration offered only a brief respite from the dreadful economic and earnings data and pounding of the stock markets.

Commentators were in agreement that Mr O commenced his tenure against the worst economic background in living memory and had his work cut out to resurrect America from its economic morass. I wish him well with this daunting task.

As investors piled into the perceived safety of gold (+6.9%), the US dollar (+1.8% in the case of the US Dollar Index) and the Japanese yen (+2.1% against the US dollar), global stock markets recorded a third straight week of losses. West Texas Intermediate Crude (+9.2%) also ended higher, joining a broader rally in commodities (+2.1% in the case of the Reuters/Jeffries CRB Index).

The MSCI World Index and the MSCI Emerging Markets Index declined by 4.7% (YTD -10.3%) and 5.7% (YTD -10.5%) respectively. Bucking the downtrend, the Shanghai Composite Index rose by 1.9% over the week and, with a gain of 9.3%, is also the best-performing global stock market since the start of 2009.

Elsewhere, the yields of long-dated government bonds in the US, UK and Eurozone rose sharply as large issuances of sovereign debt looms. For example, the yield of the US ten-year Treasury Note jumped by 28 basis points to 2.62% and that of the 30-year Treasury Bond by 40 basis points to 3.32% – the highest weekly points rise since April 1987. On the other hand, short-dated yields in a number of European countries declined as a result of expectations of further rate cuts.

The UK was a case in point with the two-year Gilt declining by 12 basis points to 1.0% on doubts about the government’s new rescue plan for the banking system and a deterioration in the country’s public finances. The pound crumbled to a 23-year low against the greenback and an all-time low against the yen.

The financial turmoil and the various actions by central banks reminded me of a quote from 1867 by Karl Marx: “Owners of capital will stimulate the working class to buy more and more expensive goods, houses and technology, pushing them to take more and more expensive credits, until their debt becomes unbearable. The unpaid debt will lead to bankruptcy of banks, which will have to be nationalized, and the State will have to take the road which will eventually lead to communism.”

“TARP has been an abject failure,” said Thomas Barrack Jr, billionaire and founder of Colony Capital, in BusinessWeek. “I compare the situation to a fire on a Savannah plain: Let it rip and burn, and the market will rejuvenate so much faster – try to control or impede it, and there will be more and longer suffering before renewal. Japan experienced two decades of economic paralysis by experimenting with fire control of a similar unproductive sort.”

And here is Peter Schiff’s (Euro Pacific Capital) prescription for how the US can dig itself out of the current mess, as reported by Fortune Magazine: “Shrink the government radically, cancel all bailouts immediately, take plenty of tough medicine, and let the free market do its job – however harsh it may be for, say, autoworkers in the meantime.”

According to Sheila Bair of the FDIC, as reported by The Wall Street Journal, there will soon be a new government banking agency, the Aggregator Bank, to buy troubled assets from financial institutions. For a bit of fun, I tried to register this domain last week. Alas, another aspirant banker pipped me to the post. His reselling price? $100,000! Needless to say, I swiftly terminated the negotiations.

Next, a tag cloud of my week’s reading. This is a way of visualizing word frequencies at a glance. Key words such as “bank”, “government”, “economy”, “market”, “financial”, debt” and “crisis” topped the list.

The graph below shows the performance of various S&P sector SPDRs for the year to date. With Financials having declined by 28.2%, the market’s weakness was quite strongly concentrated in one sector. In addition to Financials, only Industrials (-11.9%) and Consumer Discretionary (-8.8%) have underperformed the S&P 500 Index (-7.9%) since the beginning of the year.

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Geithner, Obama and China by David Kotok
January 24, 2009

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).

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Following Treasury Secretary designee Tim Geithner’s public confirmation hearing, an extensive Q & A occurred in writing. We have posted a copy of the US Senate Finance Committee’s 100-page text on our website. See: http://www.cumber.com/special/geithnerquestions2009.pdf . This is must reading for any serious investor, economist, strategist, analyst, or observer. In this text you will find what is on the minds of the Senators, and you will gain insight into the polices that will be forthcoming from the Obama administration.

One telling example is found in the following quote that has already created international consternation. Geithner twice answered questions about currency and China. In so doing he has placed the Obama administration squarely in the middle of the tension between the United States and the largest international buyer and holder of US debt: China. This happened as the same Obama administration is unveiling a package that will add to the TARP financing needs and the cyclical deficit financing needs and cause the United States to borrow about $2 trillion this year. Two trillion dollars of newly issued Treasury debt – and this is how the question was answered. Not once but twice.

Geithner (on page 81 and again on page 95) answered: “President Obama – backed by the conclusions of a broad range of economists – believes that China is manipulating its currency. President Obama has pledged as President to use aggressively all the diplomatic avenues open to him to seek change in China’s currency practices.”

“Manipulation?” “Aggressively?“ This is strong language. Geithner did not do this on his own authority. These are prepared answers. He is citing the new President, not once but twice.

China’s response was fast and direct. China’s commerce ministry said in Beijing that China “has never used so-called currency manipulation to gain benefits in its international trade. Directing unsubstantiated criticism at China on the exchange-rate issue will only help US protectionism and will not help towards a real solution to the issue.”

Are we seeing the world’s largest and third largest economies calling each other names in the middle of a global economic and financial meltdown?

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Transportation experts Daniel Sperling and Deborah Gordon provide a concise history of America’s love affair with cars and an overview of the global oil and auto industries.

The authors explain how we arrived in this state, and what we can do about it. They expose the roots of the problem – the resistant auto-industry, dysfunctional oil markets, short-sighted government policies, and unmotivated consumers.

The authors contend that the places with the most troublesome emissions problems — California and China — are taking the lead in developing effective strategies that can help wean us from our reliance on petroleum-fueled cars – World Affairs Council of Washington, D.C.

World Affairs Council of Washington, D.C.
Washington, DC
Jan 6th, 2009

Princeton professor Alan Blinder identifies the 6 key policy errors that were the key elements in the financial crisis.

He especially notes that this was not a neccessary outcome of capitalism, but rather, was the result of six avoidable errors. And while the professor calls them “human errors” he himself errs — these were not merely cases of poor judgment, but rather, they were ideological errors.

As I noted in Bailout Nation, these decisions were driven not by pragmatic realism, not bad attempts at problem solving, but rather, due to an intellectual free market jihad. They were caused by a radical deregulatory zeal that could only be affected by “religious” ideologues:

WILD DERIVATIVES In 1998, Brooksley E. Born, chairwoman of the Commodity Futures Trading Commission, tried to reign in derivatives. She was shouted down by Robert Rubin, Alan Greenspan, and Larry Summers.

SKY-HIGH LEVERAGE In 2004, the S.E.C. let securities firms raise their leverage from 12 to 1 to 33 to 1 and greater.

SUBPRIME SURGE From 2003 to 2007, subprime lending grew unsupervised by the Fed into a large, dangerous credit facility. Lending standards fell disgracefully, as dubious transactions became common.

FIDDLING ON FORECLOSURES This is one where I mostly disagree with professor Blinder’s conclusions. Home prices remian dangerously elevated; Foreclosures are driving prices back to a more normalized range. Until prives revert to historical metrics, real estate will stay weak, and the economy soft.

LETTING LEHMAN GO Its not that letting Lehman Brothers fail was such a terrible decision — it was that there was no undferstandable difference between LEH and Bear Stearns. The inconsistency was part of the problem. Add to it, the idiotic managment of LEH, who should have asked for an orderly dissolution assistance from the Fed.

TARP’S DETOUR The Troubled Asset Relief Program was an on-the-fly, no strategic planning, seat of the pants, inconsistent mess.

Purchase bad assets? Recapitalize banks? Rescue homeowners? Jumpstart the economy? Just WTF was the point of TARP? Its morphed so many times no one has a clue . . .

Professor Blinder notes these were a series of largely avoidable errors — but he does not explain what types of errors they were. They were not due to greed, or miscalculation or even systemic regulatory problems. They were inavoidable errors caused by a faulty belief system.

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Source:
Six Errors on the Path to the Financial Crisis
ALAN S. BLINDER
NYT, January 24, 2009

http://www.nytimes.com/2009/01/25/business/economy/25view.html

Joe Nocera’s excellent piece in today’s Times leaves out one important point about the failure of Paulson’s initial TARP plan: price. Has so much happened since October that we’ve forgotten that the price Bill Gross and others were putting on the banks’s toxic sludge was 65 cents on the dollar, even after Merrill had effectively priced it in the single digits?

Everywhere I’ve turned these last few weeks, I’ve heard variations of the same refrain. “The original Paulson plan had it right — they had to get the bad assets off the banks,” said Ronald J. Kruszewski, the chief executive of the investment firm of Stifel Nicolaus & Company. “Before you are going to get intelligent capitalists to invest their money in the banks, you have to get these landmines off their balance sheets,” said Brett Duval Fromson, the managing partner of the Margin of Safety Fund. “The reason things are frozen is that nobody knows if the banks are insolvent or not — thanks to the bad assets on their books,” said Henry F. Owsley of the Gordian Group, an investment bank that specializes in “distressed situations.”

“If they wanted to follow the R.T.C. script, they would come to the immediate conclusion that they have to get assets out of the banks, and establish a market clearing price,” said Tim Ryan, head of the Securities Industry and Financial Markets Association. The R.T.C., of course, was the Resolution Trust Corporation, which managed (and sold) the bad assets on the books of banks during the savings and loan crisis of the 1980s and 1990s. At the time, Mr. Ryan led the Office of Thrift Supervision, and helped direct the response to that crisis.

Nocera goes on to make an implicit argument that nationalization is not only inevitable but should accelerated. In other words, the only way for the original TARP plan to succeed, and make sense, is through a nationalization process that would avoid having to buy the toxic assets from the banks for a ridiculously inflated price.

Source:

First Bailout Formula Had It Right
JOE NOCERA
New York Times; January 24, 2009

http://www.nytimes.com/2009/01/24/business/24nocera.html

Truly awesome photo:

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via How the Common Man Sees It

In today’s Barron’s, Alan Abelson discusses a Reinhart & Rogoff paper (The Aftermath of Financial Crises) which (quite oddly) was the subject of the last speaker’s presentation on Thursday’s Cayman Business Outlook.

Note that we have discussed the fine work of R&R previously (here and here)

Abelson quotes broadly from their most recent paper:

They cite three defining elements of the aftermaths of severe financial crises. First, asset markets of just about every kind suffer a bruising and prolonged battering. On average, for instance, real housing prices plunge 35%, and the agony stretches out over six years, while equity prices lose a whopping 55% over roughly 3½ years.

Second, output and jobs take it on the chin: The unemployment rate shoots up (again, on average) 7 percentage points over four years. Meanwhile, gross domestic product suffers losses averaging more than 9%, but — scant consolation — it happens more quickly, typically in two years or so.

Third, the real value of government debt tends to explode, shooting up an average 86% in the major post-war slumps. Reinhart and Rogoff contend that the huge swelling of such debt owes not, as commonly believed, primarily to bank bailouts and handouts (see, the banks aren’t even very good at raiding the Treasury). What really kites government IOUs, they say, is the drastic shrinkage in tax revenues generated by faltering economies and the “often ambitious countercyclical fiscal policies aimed at mitigating the downturn.” (A timely, obvious example is that $825 billion stimulus package the new administration has its heart set on.)”

But for the full effect, you should go read the original — that’s your weekend homnework assignment. Meanwhile, here’s a paragraph

“Broadly speaking, financial crises are protracted affairs. More often than not, the aftermath of severe financial crises share three characteristics. First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment. Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post–World War II episodes. Interestingly, the main cause of debt explosions is not the widely cited costs of bailing out and recapitalizing the banking system. Admittedly, bailout costs are difficult to measure, and there is considerable divergence among estimates from competing studies. But even upper-bound estimates pale next to actual measured rises in public debt. In fact, the big drivers of debt increases are the inevitable collapse in tax revenues that governments suffer in the wake of deep and prolonged output contractions, as well as often ambitious countercyclical fiscal policies aimed at mitigating the downturn.”

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Sources:
The Aftermath of Financial Crises
Carmen M. Reinhart
University of Maryland. NBER and CEPR
Kenneth S. Rogoff
Harvard University and NBER
December 19, 2008

http://www.economics.harvard.edu/faculty/rogoff/files/Aftermath.pdf

Woe Is Us
ALAN ABELSON
UP AND DOWN WALL STREET
Barron’s JANUARY 24, 2009

http://online.barrons.com/article/SB123275464233911671.html

Charlie Rose has a conversation with Senator Chuck Schumer

via NYT

Floyd Norris on comparing President’s Economies:

“The economic record of President George W. Bush was largely a disappointing one. During his administration, the country grew at the slowest overall pace of any recent president, whether measured in gross domestic product or employment. The last president to preside while the stock market did worse was Herbert Hoover.

Economic performance was actually good for much of the middle years of Mr. Bush’s eight-year term, but it began and ended with recessions. Some of the disappointment with Mr. Bush may stem from the fact that he took office at the end of a huge boom, in both the economy and the stock market . . .

President Bush’s administration was marked by a recession that began two months after he took office and another downturn in his final year of office. In the end, the economy during his term added enough jobs to employ only 14 percent of the added number of working-age Americans, the lowest proportion of any postwar administration. Employment grew at a compound annual rate of only 0.3 percent, half the 0.6 percent rate that his father had recorded in what had previously been the worst post-World War II performance.”

The main problem I see in Bush’s economic approach was an odd form of Reagan worship. Despite wildly disparate economies, Bush adopted Reagan’s approach. That the market had just collapsed, rather than was in year 14 of a secular bear market, rates were low and going lower, and the biggest Tech boom known to man were all but ignored.

Imagine a doctor who was once successful prescribing Penicillin to a patient with an infection. The next sick person comes in with diabetes — and he prescribes Penicillin again. The Penicillin supply-side school of medicine is genuinely shocked when the patient dies.

I wrote about this back in 2002-03: The epitome of the Bush approach to the economy was to vigorously apply Reagonomics directly to the forehead, despite a very different set of fiscal and economic conditions.

Surprise! The patient died!

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Source:
Economic Setbacks That Define the Bush Years
FLOYD NORRIS
NYT, January 23, 2009

http://www.nytimes.com/2009/01/24/business/24charts.html

Amusing video from NealF –

As the title implies, this is not safe for work . . .

Info:

Think the Federal Reserve is a government institution? Think again. It’s a group of privately owned banks that Congress illegally gave the right to print money. Now they print it, loan it to us, then we pay it back with interest. What a scam!