Posts filed under “Think Tank”
Patricia White, Associate Director, Division of Research and Statistics
Before the Subcommittee on Securities, Insurance, and Investment, Committee of Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C.
June 22, 2009
Chairman Reed, Ranking Member Bunning, and other members of the Subcommittee, I appreciate this opportunity to provide the Federal Reserve Board’s views on the development of a new regulatory structure for the over-the-counter (OTC) derivatives market. The Board brings to this policy debate both its interest in ensuring financial stability and its role as a supervisor of banking institutions. Today, I will describe the broad objectives that the Board believes should guide policymakers as they devise the new structure and identify key elements that will support those objectives. Supervision of derivative dealers is a fundamental element of the oversight of OTC derivative markets, and I also will discuss the steps necessary to ensure these firms employ adequate risk management.
Mitigation of Systemic Risk
The events of the last two years have demonstrated the potential for difficulties in one part of the financial system to create problems in other sectors and in the macroeconomy more broadly. OTC derivatives appear to have amplified or transmitted shocks. An important objective of regulatory initiatives related to OTC derivatives is to ensure that improvements to the infrastructure supporting these products reduce the likelihood of such transmissions and make the financial system as a whole more resilient to future shocks.
Centralized clearing of standardized OTC products is a key component of efforts to mitigate such systemic risk. One method of achieving centralized clearing is to establish central counterparties, or CCPs, for OTC products. Market participants have already established several CCPs to provide clearing services for some OTC interest rate, energy, and credit derivative contracts. Regulators both in the United States and abroad are seeking to speed the development of new CCPs and to broaden the product line of existing CCPs.
While still finishing up almost .03 for the week ended Sunday, AAA said the average price of a gallon of unleaded gasoline fell Sunday for the first time since April 28th, a 53 day streak without a drop. At $2.69, it is up .76 since March 18th, the day the FOMC announced they were going…Read More
After the note I just sent on the Fed, the MBA said that after raising its forecast for mortgage originations by over $800b in March after the Fed’s QE plan and the subsequent decline in interest rates, they are cutting its ’09 est by $700b. 88% of the cut is due to refi’s as the…Read More
Here are my prepared remarks for the Senate Banking Committee later today. The hearing starts at 15:00 in Room 538 DSOB (Dirkson Senate Office Building). Drinks and poetry readings at Kelly’s Irish Times afterward. — Chris
Over-the-Counter Derivatives: Modernizing Oversight to Increase Transparency and Reduce Risks
Statement by Christopher Whalen
Committee on Banking, Housing and Urban Affairs
Subcommittee on Securities, Insurance, and Investment
United States Senate
June 22, 2009
Chairman Reed, Senator Bunning, Members of the Committee:
Thank you for requesting my testimony today regarding the operation and regulation of over-the-counter or “OTC” derivatives markets. My name is Christopher Whalen and I live in the State of New York. I work in the financial community as an analyst and a principal of a firm that rates the performance of commercial banks. I previously appeared before the full Committee in March of this year to discuss regulatory reform.
First let me make a couple of points for the Committee on how to think about OTC derivatives. Then I will answer your questions in summary form. Finally, I provide some additional sources and references to help you in your deliberations.
1) Defining OTC Asset Classes:
When you think about OTC derivatives, you must include both conventional interest rate and currency swap contracts, single name credit default swap or “CDS” contracts, and the panoply of specialized, customized gaming contracts for everything and anything else that can be described, from the weather to sports events to shifting specific types of risk exposure from one unit of AIG to another. You must also include the family of complex structured financial instruments such as mortgage securitizations and collateralized debt obligations or “CDOs,” for these too are OTC “derivatives” that purport to derive their “value” from another asset or instrument.
With the crowded reflation trade showing signs of fatigue, notwithstanding the highest close in Chinese stocks today since July, the FOMC meets for a 2 day meeting and their commentary on the QE side of their monetary policy will either reignite it or further its rest. Will the FOMC follow thru with their existing programs…Read More
Caution last week crept back into investors’ vocabulary for the first time in more than three months as they faced up to President Barack Obama’s plan to reform the US financial market regulations, weighed the prospects of a global economic recovery and whether the “green shoots” needed more monetary water, and also started pondering the second-quarter earnings season.
As risk-taking moderated, profit-taking on equities and commodities set in after a colossal advance since early March. Government bonds rallied further, high-yield corporate bonds met selling pressure, spreads on credit derivative indices widened, and the US dollar marked time. “We could be seeing one of those occasional ‘all-change signals’ in short-term trends,” said Fullermoney editor David Fuller from across the pond.
From his new abode at Gluskin Sheff & Associates, David Rosenberg said: “Post-credit collapse and asset deflation cycles are always gripped with fragility; the intermittent beta trades and flashy rallies only serve to tell us that nothing moves in a straight line. In the meantime, the incoming data do suggest that recession pressures are subsiding, but it is difficult to see what the sources of recovery are going to be outside of government spending.”
Source: Gary Varvel
The week’s performance of the major asset classes is summarized by the chart below. Not shown, the entire precious metals complex was again out of favor with investors, with gold bullion’s (-0.5%) high-beta cousins – platinum (-3.7%) and silver (-4.1%) – being sold off by cautious investors.
The US dollar ended the week virtually unchanged after Russian President Dmitry Medvedev told a regional summit on Tuesday that new reserve currencies, in addition to the dollar, were needed to stabilize the global financial situation. Meanwhile Brazil, Russia, India and China went on the biggest dollar-buying binge in eight months during May, adding $60 billion to their reserves, as cited by MoneyNews (via Bloomberg).
Many stock markets on Monday registered their worst single-session losses in a month. Mature markets perked up towards the end of the week, but emerging markets, in a number of instances, were down for all five trading days. After a four-week winning streak, the MSCI World Index (-3.0%) and the MSCI Emerging Markets Index (-5.0%) closed the week at their lowest levels since the last week of May.
Facing lackluster volume, the major US indices all ended the week in the red, but less so than most European and emerging bourses, as seen from the movements of the indices: S&P 500 Index (-2.6%, YTD +2.0%), Dow Jones Industrial Index (-2.9%, YTD -2.7%), Nasdaq Composite Index (-1.7%, YTD +15.9%) and Russell 2000 Index (-2.7%, YTD +2.7%).
To put the decline in context, the biggest pullback in the S&P 500 since the March 9 low happened in late March when the Index dropped by 5.9% over the course of two days. The most recent decline took the Index down by 5.0% between May 8-15. The S&P 500 is currently a more modest 2.7% off its high of June 12.
After climbing into the black for the year to date in the prior week, the Dow fell back to -2.7% last week – the only major US index in the red for 2009 – and, along with the FTSE 100 Index (-2.0%), one of the few global indices in this unenviable position.
Click here or on the table below for a larger image.
As far as non-US markets are concerned, returns ranged from top performers – mostly African countries – Sri Lanka (+10.7%), Kenya (+9.5%), Namibia (+8.5%), Uganda (+7.3) and Côte d’Ivoire (+5.0%), to Russia (-9.8%), Qatar (-9.8%), Argentina (-8.4%), Ukraine (-6.9%) and Finland (-6.8%), which experienced headwinds.
In a bullish move, the Shanghai Composite Index – one of the leading markets in the advance over the last few months – bucked the downtrend with a gain of 5.0%. However, the Russian Trading System Index – the top-performer for the year to date (+70.7%) and since the November 20 lows (+104.8%), succumbed to profit-taking, losing 9.8% on the week. Also, the Bombay Sensex 30 Index (-4.7%) declined after rising for 14 consecutive weeks. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)
Category: Think Tank
I have often written that the four most dangerous words in the investment world are “This Time It’s Different.” If memory serves me, I have written several e-letters disparaging various personages who have uttered those very words, and gone one to confirm later that it wasn’t different. It almost never is. And yet – and yet! – I am going to make the case over the next few weeks that it really is different this time, with only a lonely asterisk as a caveat. What prompts my probable foolishness to tempt the investing gods is the rather large amount of bad analysis based on unreasonable (dare I say lazy or surface?) readings of statistics that is coming from the mainstream investment media and investment types with their built-in bias for bullish analysis. Normally, gentle reader, your humble analyst is a paragon of moderate sensibilities, but I have been pushed over a mental edge and need to restore balance. I anticipate that this topic will take several weeks, as trying to cover it all in one sitting would exhaust us both. It should be fun. But first…
Peter Bernstein, R.I.P.
Sadly, Peter Bernstein passed away at 90 years young on June 5. One of the great honors and privileges of my life has been getting to know Peter and his lovely wife, Barbara. Introduced at a small dinner five years ago, I have been privileged to share many dinners and meetings with him in the years since, soaking up his wisdom. Only a month ago, he made a presentation (by satellite) to Rob Arnott’s annual conference and was at the top of his intellectual game. His writing of late has been some of his best. Peter cofounded the Journal of Portfolio Management and truly was the dean of investment analysts.
He wrote 10 books (five after the age of 75!). I am often asked what books I would recommend for insight into the economic world. At the very top of my list has always been Against the Gods: the Remarkable Story of Risk. If you have not read it, then get it and put it on top of your summer list. Capital Ideas is also brilliant. The Power of Gold is a must-read. You can get all three in a set at Amazon.
Jason Zweig wrote a very moving obituary in the Journal and reminded me of a few quotes I’ve heard from Peter. “‘What we like to consider as our wealth has a far more evanescent and transitory character than most of us are ready to admit.’ He urged investors to regard their gains as a kind of loan that the lender – the financial market – could yank back at any time without any notice.
“Asked in 2004 to name the most important lesson he had to unlearn, he said, ‘That I knew what the future held, that you can figure this thing out. I’ve become increasingly humble about it over time and comfortable with that. You have to understand that being wrong is part of the investment process.’”
Peter and I chatted several times during the last year, and he continued to tell me that those who thought we were in for a typical recovery were probably going to be wrong. In private conversations he was very worried about the world, and added much wisdom to those of us privileged to sit at his feet.
Isaac Newton once said, “If I have seen further it is only by standing on the shoulders of giants.” In the world of investment wisdom, there is no shoulder higher than that of Peter Bernstein. Rest in gentle peace, my friend. You will be greatly missed.
This Time It’s Different*
Ben Bernanke’s career will be analyzed and written about for many years. But the one thing that has caused me the most pain is his bringing of the term “green shoots” into the investment lexicon. These may be the two most overused and annoying words of my investment career. Every possible sign of a recovery is anointed with the phrase.
Of late, there has been a tendency for analysts to see numbers or statistics that are “less bad” and interpret them as signs that we are in recovery or at least almost there. They glance back at previous recoveries and say, “Doesn’t this look like the last time? When such and such happens it means that recovery is on the way. We should therefore buy stocks” (or whatever).
That we are condemned to read such musings is part of the investment landscape. But that does not mean we shouldn’t take the time to look at what the writer of those words is actually looking at. All too often of late, I find these people grasping at straws or failing to understand the data.
My premise for uttering the heresy “This Time It’s Different*” is that the fundamental nature of the economic landscape has so changed that comparisons with post-WWII recoveries is at best problematical and at worst misleading.
Category: Think Tank
My friend David Grais has started a blog devoted to structured finance and the law. David is a very skilled litigator who spent most of his career doing corporate defense work, but has defected from the Dark Side to become a plaintiff lawyer working on a number of very important ABS cases.
David just posted a comment on the his firm’s blog [http://www.absinvestoradvocate.com] that has some interesting insights about the Obama Administration’s plans for “reforming” the securitization markets. His comment follows below. — Chris
Proving yet again that it has become a puppet of its sell-side parent SIFMA, the American Securitization Forum has just released a 241-page study that it commissioned from National Economic Research Associates, Inc. (here) to prove that securitization increases the amount and lowers the cost of consumer credit. It is as though the White Star Line commissioned a book on the RMS Titanic in which the author was told to extol the power of Titanic’s engines, the elegance of the china in its dining rooms, and the verve of its dance bands, while strictly ignoring its shortage of lifeboats.
There is only one question worth asking about securitization: why did securitization become the seedbed of the broadest and costliest epidemic of fraud in history? Until we face that question squarely and answer it honestly, securitization will remain in its coma. Unfortunately, the Obama Administration missed a chance to address that question in its plan to regulate the securitization market. (See the post immediately below.) ASF’s sponsorship of the NERA report is more insidious. By a combination of forbidding mathematics and emollient prose (“Recent experience appears to demonstrate readily that securitization is not inherently ‘good’ or ‘bad.’”), ASF tries to whisk us past that looming question and past the one measure that will best restore confidence in securitization: effective redress for investors against those that turned securitization from a useful financial tool into an orgy of misconduct.
Before we get into this week’s Outside the Box, let me give you a few pieces of data that came across my desk this morning, which will help set the stage for the OTB offering.
Fitch (the ratings agency), in a downgrade of yet another 543 mortgage-backed securities of 2005-07 vintage, gives us the following side notes: “The home price declines to date have resulted in negative equity for approximately 50% of the remaining performing borrowers in the 2005-2007 vintages. In addition to continued home price deterioration, unemployment has risen significantly since the third quarter of last year, particularly in California where the unemployment rate has jumped from 7.8% to 11%… The projected losses also reflect an assumption that from the first quarter of 2009, home prices will fall an additional 12.5% nationally and 36% in California, with home prices not exhibiting stability until the second half of 2010. To date, national home prices have declined by 27%. Fitch Rating’s revised peak-to-trough expectation is for prices to decline by 36% from the peak price achieved in mid-2006. The additional 9% decline represents a 12.5% decline from today’s levels.”
So, what does an aging population do that has seen its retirement nest egg in the form of housing and stocks go literally nowhere for 12 years? You go back to work! David Rosenberg, now with Gluskin Sheff, offers us this insight:
“What really struck us in the employment report of a few weeks ago was the fact that the only segment of the population that is gaining jobs is the 55+ age category. This group gained 224,000 net new jobs in May while the rest of the population lost 661,000. In fact, over the last year, those folks 55 and up garnered 630,000 jobs whereas the other age categories collectively lost over six million positions. This is epic.” [See chart below.]
“Moreover, the number of 55 year olds and up who have two jobs or more has risen 1.1% in the last year, the only age cohort to have managed to gain any multiple jobs at all. Remarkable. These folks have seen their wealth get destroyed by two bubble-busts less than seven years apart — the Nasdaq nest egg back in 2001 and the 5,000 square foot McMansion in 2007. Both bubbles ended in tears … and so close together.”
With that as backdrop, what are we to make of the prospects for recovery over the next decade? Not much, if we listen to Professor Paul Krugman of Princeton. He suggests that the developed world could be entering a lost decade, just like Japan after their crash. Let me quickly point out that I routinely disagree with Krugman on a large number of issues. And I usually know why I disagree and believe his policy suggestions are wrong.
That being said, one purpose of Outside the Box is to look at ideas and thinkers that we may not always agree with. Krugman certainly qualifies on that front for me. However, it must be admitted that he is a very smart man. Further, his thinking is important, because it somewhat reflects the thinking of that part of the establishment that is in charge of the Fed and the Treasury. And while we are not getting gloomy long-term forecasts from either the Fed or the Treasury, I find it remarkable that Krugman is less sanguine than his peers. And there is much (certainly not all!) within this interview that I find myself in surprising agreement with. This one made me think as I read and reread it.
If he is correct, the rosy recovery assumptions built into the already bloated budget projections are going to be far too optimistic, not just for the US, but throughout Europe as well. Krugman is interviewed very capably by Will Hutton, a veteran writer and economist for the UK Guardian (a bastion of liberal politics). The direct link is http://www.guardian.co.uk/business/2009/jun/14/economics-globalrecession.
Green shoots? Really? I invite you to read and think about what this interview means for the road to recovery. I will take this up more in next Friday’s missive. (Note, I did not write a letter last week. There was a new Mauldin grandchild on Friday, and I decided that some things just take precedence.) Have a great week.
John Mauldin, Editor
Outside the Box
Fear for a Lost Decade
As analysts and media hailed the tentative emergence of green shoots last week, Nobel Prize-winning economist Paul Krugman caused international shock with a prediction that the world economy would stagnate just as badly, and for just as long, as Japan’s did in the 1990s. In an exclusive interview, he talks to Will Hutton about his anxiety for the future.
Will Hutton: You are warning that what happened to Japan could happen to the whole world. Japan’s GDP at the end of this year will be no higher than it was in 1992 — 17 lost years. You are saying that this is an ongoing risk, certainly for the North Atlantic economy – – maybe the world economy.
Paul Krugman: Yes. It’s not that the risk of the Japan syndrome has receded very much. The risk of a full, all-out Great Depression – – utter collapse of everything – – has receded a lot in the past few months. But this first year of crisis has been far worse than anything that happened in Japan during the last decade, so in some sense we already have much worse than anything the Japanese went through. The risk for long stagnation is really high.
WH: So what is the heart of your pessimism? The bust banking system? A critic would say: “Hold on, Paul Krugman. Japan is a special case. It had an overblown export sector that had become too large for an American market it had saturated. The yen was very, very overvalued. And this interacted with a credit crunch and bust banking system. Its policy response was consistently behind the curve. That’s not the story of the United States or the United Kingdom.”
PK: The thing about Japan, as with all of these cases, is how much people claim to know what happened, without having any evidence. What we do know is that recessions normally end everywhere because the monetary authority cuts interest rates a lot, and that gets things moving. And what we know in Japan was that eventually they cut their interest rates to zero and that wasn’t enough. And, so far, although we made the cuts faster than they did and cut them all the way to zero, it isn’t enough. We’ve hit that lower bound the same as they did. Now, everything after that is more or less speculation. For example, were the problems with the Japanese banks the core problem? There are some stories about credit rationing, but they are not overwhelming. Certainly, when we look at the Japanese recovery, there was not a great surge of business investment. There was primarily a surge of exports. But was fixing the banks central to export growth? In their case, the problems had a lot to do with demography. That made them a natural capital exporter, from older savers, and also made it harder for them to have enough demand. They also had one hell of a bubble in the 1980s and the wreckage left behind by that bubble – – in their case a highly leveraged corporate sector – – was and is a drag on the economy. The size of the shock to our systems is going to be much bigger than what happened to Japan in the 1990s. They never had a freefall in their economy – – a period when GDP declined by 3%, 4%. It is by no means clear that the underlying differences in the structure of the situation are significant. What we do know is that the zero bound is real. We know that there are situations in which ordinary monetary policy loses all traction. And we know that we’re in one now.
Category: Think Tank
According to AAA, as of last night, the average price of a gallon of regular unleaded gasoline has been either flat or higher for 51 straight days and has reached $2.69 per gallon, up almost .03 on the week. The .03 doesn’t sound like much but it’s an extra $4b annualized out of consumer pockets…Read More