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

Since I have been mocking W on his way out, we may as well tag O on his way in:

via Keven Depew, Minyanville

US Markets followed Europe and Asia lower, with the Dow off 4%.

The financials continue to weigh on everything:  Citigroup (down 20%) looks like it wants to go to zero; Bank of America (down 29%) doesn’t look much better.

IBM beat their number after the bell, so perhaps tomorrow might be a better day . . . >

Dow Industrials, January 20, 2008

Yesterday, we discussed an ongoing Marketwatch chart on historical trend regressions (Is the Market Bottom in Sight (Again?)).

Peter Brimelow and Edwin S. Rubenstein have argued that markets bottom when they fall to 40-42% below trend.

Doug Short disagrees. As he shows in the chart below, markets have dropped as much as 67% below trend, with bottoms at levels of more than 50% below trend.

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Bill King cites the following precise articulation of the definition of Credit:

“This is a delusion about credit. And whereas from the nature of credit it is to be expected that a certain line will divide the view between creditor and debtor, the irrational fact in this case is that for more than ten tears debtors and creditors together have pursued the same deceptions. In many ways, as will appear, the folly of the lender has exceeded the extravagance of the borrower.

The general shape of this universal delusion may be indicated by three of its familiar features.

First, the idea that the panacea for debt is credit…The aggregate of this increase is prodigious, and a very high proportion of it represents recourse to credit to avoid payment of debt.

Second, a social and political doctrine, now widely accepted, beginning with the premise that people are entitled to certain betterments of life. If they cannot immediately afford the, that is, if out of their own resources these betterments cannot be provided, nevertheless people are entitled to them, and credit must provide them…

Probably one half of all government, national and civic, in the area of western civilization is either bankrupt or in acute distress from having over-borrowed…

Third, the argument that prosperity is a product of credit, whereas from the beginning of economic thought it had been supposed that prosperity was from the increase and exchange of wealth, and credit was its product.

This inverted way of thinking was fundamental. It rationalized the delusion as a whole. Its most astonishing imaginary success was in the field of international finance, where it became unorthodox to doubt that the use of credit in progressive magnitudes to inflate international trade the problem of international debt was solved…

Was it possible for nations to sell to one another more than they bought from one another…? Certainly. But How? By selling on credit. By lending one another the credit to buy one another’s goods…

Who was the sagacious observer that penned this trenchant analysis?

Garet Garret, in A Bubble That Broke The World – a book published in 1932!

With all inauguration coverage, all the time today, I thought we might try to keep the focus on erconomic/market related matters.

Time magazine has an article on Bush’s economics mistakes that I would direct you to except for the annoying 9 page clicks required (click whores!).

Rather than send you there, I’ll give you the 8, with excerpts of their commentary:

1. The Return to Deficits: Bush’s tax cuts and spending increases — and clear disdain for the pay-as-you-go approach that had brought deficits down in the 1990s — brought a return to permanent deficits.
2. Iraq: Even if you think the war did bring benefits to the U.S., they would have to be pretty gigantic to justify the costs of $1-3 trillion dollars;
3. Tax Cuts for the Rich: Bush came to Washington facing almost diametrically opposing economic conditions, yet he offered up the same solutions as Reagan.
4. Financial Regulation: What is true is that most Bush-era financial regulators were less than enthusiastic about the very act of regulating, and that Bush’s “ownership society” push glossed over a lot of potential dangers.
5. Telling Us to Go Shopping: After the 9/11 terrorist attacks, President Bush didn’t call for sacrifice. He called for shopping.
6. Energy Policy: Not much to say here, except that there wasn’t an energy policy.
7. A State of Denial: Every Administration spins and sugarcoats the economic truth. But the Bush White House took this disingenuousness to new levels.
8. The Muddled Bailout: The main problem has been the ambivalence with which both Paulson and the White House have approached the financial rescue.

Pretty straightforward analysis . . .

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Source:
A Look Back at Bush’s Economic Missteps
JUSTIN FOX
Time, January 2009

http://www.time.com/time/specials/packages/article/0,28804,1872229_1872230_1872231,00.html

The whole world will be watching when Barack Obama delivers his inaugural address. Expectations are high especially as he got to this point largely based on his speaking ability.

“And as we kick this can down the road,
I ask our foreign friends to continue
to lend us as they have for so long,
–blindly and unstintingly,
not just for their sake but for ours.”

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via Grants

There is a reason I call this column Outside the Box. I try to get material that forces us to think outside our normal comfort zones and challenges our common assumptions. And this week’s letter from Hoisington Investment Management Company does just that.

Let me give you two quotes to pique your interest: “Monetary policy works by creating the environment for a renewed borrowing and lending cycle. This cycle would require that the debt to GDP ratio, which is already at a record level, grow even higher. Would such an outcome really be that desirable when the controlling problem of the U.S. economy is too much improperly financed debt? If the Fed were able to engender an increase in the debt to GDP ratio, this might merely serve to postpone the reckoning of the current debt levels while laying the foundation for an even more vicious unwinding down the road.”

And: “The only really viable option for federal stimulus is a permanent reduction in the marginal tax rates, as highlighted in the research of Christina Romer, incoming Chair of the Council of Economic Advisors. This would have the benefit of raising after tax rates of return, but the drawback in the short run of still having to be financed by an increased budget deficit. Over time, a massive reduction in marginal tax rates would be beneficial, but the operative word is time. Refunds, or transitory tax relief, will have no better results in stemming the recessionary tide in 2009 and 2010 than it did in the spring of 2008.”

Van Hoisington and Dr. Lacy Hunt give us a seminar on the current bailout programs that is not the usual analysis we see in mainstream media. This week’s letter requires you to think, but it will be worth the effort. Hoisington Investment Management Company (www.hoisingtonmgt.com) is a registered investment advisor specializing in fixed income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $4-billion under management, composed of corporate and public funds, foundations, endowments, Taft-Hartley funds, and insurance companies. And now let’s jump right in to the essay.

John Mauldin, Editor Outside the Box

THE GREAT EXPERIMENT

Quarterly Review and Outlook — Fourth Quarter 2008 Hoisington Investment Management Company

The late Nobel Laureate, Milton Friedman, noted in his 1963 book, Monetary History of the United States (coauthored with Anna Swartz), that the money stock decreased by a massive 31% in the Great Depression. The turnover of that money, called velocity, fell 21%. Nominal GDP equals money multiplied by velocity. Consequently, from 1929 to 1933 the breakdown of both measures resulted in a contraction in nominal GDP of approximately 50%. However, Friedman postulated that if the Fed had not let money shrink, velocity would have been steady and the Great Depression would have been averted, i.e., nominal GDP would not have collapsed. Our current Fed Chairman, Ben Bernanke, is an expert on the Great Depression, and he has, in fact, adopted Friedman’s strategy to greatly expand the money supply. Whether this prescription for economic stability will work in a period of over indebtedness, such as now exists in the U.S., is most uncertain. Indeed, this could be called the “great experiment” since this economic theory has yet to be thoroughly tested in the real world.

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Presently, major sectors of the U.S. economy are experiencing a debt deflation that is causing a massive destruction of wealth, thereby curtailing jobs, income and spending. Irving Fisher who, according to Friedman, was the most brilliant of all U.S. economists has noted that when the economy enters a period of “debt and price disturbances”, those forces will eventually engulf the economy. Fisher developed that concept by examining the 1929-33 depressionary period, as well as the depressions of 1837 and 1873, as examples of when excessive debt and subsequent price declines controlled “all or nearly all” other economic variables. This theory of excessive debt and its pernicious and unrelenting deflationary impulse to the economy has been best chronicled by other notable economists: Charles P. Kindleberger (1910-2003), Hyman Minsky (1919-1996), Nikolai Kondratieff (1892-1938) and Joseph A. Schumpeter (1883-1950). Fisher contends that once extreme over indebtedness occurs, fiscal and monetary policy become impotent in spurring economic growth because money velocity will decline — something that is currently happening. Individuals and businesses struggle to repay debt with harder dollars, and saving begins to rise as caution prevails.

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The debt level of the U.S. has reached unprecedented proportions (Chart 1). More important than the level, however, is the fact that for the last few years the debt was improperly loaned and financed. In the words of the late economists Minsky and Kindelberger, this type of lending activity implies there is little likelihood of repayment of principal and interest. Stock prices have plunged, and with home prices plummeting, and commercial and industrial properties losing value, a deflation of assets has clearly begun while the underlying debt remains constant. Will this deflation overwhelm the best efforts of the Federal Reserve, invalidate Friedman’s theory and prove Fisher correct? Most naturally feel and hope that the superiority of unbridled monetary and fiscal stimulus will overwhelm incipient price declines and stem the expanding cyclical downturn in economic growth. Our judgment is that the power of monetary policy revolves around the ability to initiate a new borrowing and lending cycle. This can only happen if lenders are willing to lend and borrowers are wanting and able to borrow. Presently, neither are so inclined (Chart 2). If price declines in assets continue, then Shakespeare’s admonition of “neither a borrower nor a lender be” will become the economic mantra, meaning that a period of very low nominal growth will likely extend for a decade. Moreover, fiscal policy actions may not be helpful either and could produce unintended negative consequences. Conventional wisdom is that the current economic contraction is nothing more than a typical post war recession. In the ensuing paragraphs we intend to frame an argument that is contrary to this conventional wisdom.

Read the rest of this entry »

Recently, I’ve been mocking the fools who have been claiming the TARP is showing a profit. Their absurd conclusion was based on a few TARP holdings going up, while the entire portfolio has yet to reach breakeven (forget being paid back any time soon).

Today, we look at another Bailout disaster: The decaying balance sheets of the U.S. Federal Reserve Bank. The size of the Fed’s balance sheets are huge: They will be at least three times their size from just 18 months ago, when they were primarily US Treasury securities.

Looking at the holdings, its no mystery why:

“It has loads of subprime-mortgage bonds, souring commercial real-estate debt and collateralized debt obligations worth a fraction of their original value. This isn’t Citigroup Inc. or Merrill Lynch. It is the Federal Reserve.

In the past year, the Fed lent out more than $1 trillion in its efforts to stabilize the financial and credit markets. A chunk of that was used to buy mortgage-related securities and loans in the rescues of Bear Stearns Cos. and American International Group Inc., as well as other debt shunned by investors.

Now, the government’s recent aid packages for Bank of America Corp. and Citigroup have the Fed playing the additional role of a backstop guarantor for portfolios of about $400 billion in troubled assets that were dragging down those banks. Those assets include residential- and commercial-mortgage loans, mortgage securities, corporate leveraged loans and credit-derivative positions…

Some of the assets on the Fed’s balance sheet already have lost substantial value over the past six months. In the next several weeks, the Fed will provide an update on the value of assets in Maiden Lane LLC, a company it lent $29 billion last June to purchase $30 billion in assets formerly held by Bear Stearns. Those assets included securities backed by shaky Alt-A residential mortgages — a category of loans between prime and subprime — and commercial real-estate loans tied to companies, such as Hilton Hotels Corp., that are in slowing industries.”

Last quarter, Triple-A rated securitized commercial mortgages declined 11%, single-As lost 49%, Alt-A bonds collapsed as loan defaults spiked.

And the future risks? 4 main factors put the Fed’s balance sheet at further risk:

• The economy is still slowing;

• Mortgage foreclosures are rising:

• Corporate defaults continue to climb;

• Asset prices are declining.

The WSJ looks for the Fed’s lending to rise “by another $1 trillion or more in 2009 as its liquidity programs are tapped further by borrowers and it purchases more bonds, such as those issued by Fannie Mae and Freddie Mac, as well as securities backed by student loans, auto loans, credit-card receivables and small-business loans.”

The Fed’s advantage over the Citis and Wamus:  No shareholders, no reporting requirements, zero transparency, and no mark-to-market.

To quote Mel Brooks, “Its good to be the king . . .”

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Source:
Fed Grapples With a New Risk Reality
SERENA NG and LIZ RAPPAPORT
WSJ, JANUARY 20, 2009, 5:54 A.M.

http://online.wsj.com/article/SB123240756817995723.html

The Bush presidency has aged everyone including Stephen. (The clip of Colbert’s first show is priceless)

(02:39)