five things you need to know to 'understand' the financial crisis
(snip)"Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:
Some "Interesting" Datapoints... Debt Crisis vs. Liquidity Crisis... Why Now?... The Fed Should Have Been Right... What It All Means...
Some "Interesting" Datapoints
Here are some interesting datapoints that all these easy-credit-addled geeks clamoring for a Federal Funds rate cut - such as Pimco's Bill Gross - may not have noticed:
Since the Federal Reserve Open Market Committee began lowering interest rates on Sep. 18, 2007 the S&P 500 has declined more than 30%.
Over that same period, the PHLX Banking Index (BKX) is down 42%.
The PHLX Housing Index (HGX) is down 57%.
The PHLX Semiconductor Index (SOX)... Whoa, stop right there. What do semiconductors have to do with subprime mortgages or credit default swaps? ... is down 44%.
Since the first special Term Auction Lending Facility was created by the Federal Reserve and offered on December 17, 2007, the SPX is down 27%, the BKX down 28%, the HGX down 19% and the SOX...Whoa, again with the SOX, what does that have to do with the TAF? ... is down 32%.
Since the Term Securities Lending Facility was created by the Federal Reserve and offered on March 27, 2008, the SPX is down 20%, the BKX is down 20%, the HGX is down 20% and the SOX... No, it can't be!... is down 20%.
Since the Treasury Department's proposal on September 19 of the Troubled Asset Relief Program (TARP), separately, a new $50 billion program to insure investments and the termination of short selling on financial stocks, the SPX is down 16%, the BKX is down 22%, the HGX is down 21%. the SOX... Do NOT Say It!... is down 17%.
Since the passage of TARP on October 3, less than two trading days ago, the SPX is down 3.8%, the BKX is down 5.5%, the HGX is down 3.5%, and yes, the SOX is down 3.5%.
For those that have noticed these declines, the most frequently asked question, naturally, is, "Why aren't the Fed's and the Treasury's liquidity attempts working?"
It's a reasonable question, after all, central banks in both the U.S. and Europe have said without equivocation for more than a year now that they will provide "as much liquidity as the market needs" to "fix" the problem. So why has this liquidity not been enough to maintain and support asset prices? Because this is not a liquidity crisis, it's a debt crisis.
Debt Crisis vs. Liquidity Crisis
The difference is important, and grasping it can help us sort through a number of market actions that appear to be counterintuitive.
During a liquidity crisis, the issue is one of supplying money to those who, for whatever reason, have suddenly shortened their time preferences.
Suppose there is a rumor that a large bank has made a bad loan. Because banks lend out more money than they have on deposit - this is called a fractional reserve banking system - if everyone goes to the bank and demands their money at the same time, a liquidity crisis can occur because the simply bank does not have enough cash on hand to satisfy the demand from its depositors. The Federal Reserve will then step in and provide liquidity, allowing the depositor demands to be satisfied. If the rumor of the bad loan proves to be false, then the issue is one of temporary liquidity. Time preferences soon return to a more normalized state, depositors return, everyone feels better. But, if the rumor turns out to be true, it doesn't matter how much liquidity the Fed provides, the bank will go bankrupt.
Similarly, the issue today is not one of temporary liquidity, time preferences being shortened out of a temporary risk aversion. The issue is too much debt supported by too little real income. As a result, global time preferences are retreating, risk aversion is growing, and access to credit is diminishing.
The battle in financial markets over the past year has been between reflation and deflation. The reason reflation has not been winning is because the Federal Reserve is powerless to make bad debt good. The Fed can only provide liquidity, and then hope that liquidity spawns credit creation. The market is fighting this by taking that liquidity and using it to "deflate," or to pay down, debt.
Why Now?
Isn't this like 1991? Or 1997? Or 1998? Or 2001? Why now? In the past, liquidity crises did not turn into full-blown debt crises because banks were able to create new products that allowed debt to be repackaged and sold very quickly.
The acronyms most of us had never heard of at this time last year - SIV's, ABCP, CDO's, RMBS's - were the result of more than a decade of financial engineering that allowed debt creation to expand, and bank profits to increase, thus masking weakness in the overall economy's ability to create enough growth to support this debt.
The process became self-reinforcing. The economy needed more debt to function, the banks needed to package and sell more debt to make money, investors needed to invest in more debt to increase returns, and so the game of musical chairs continued... until one small segment, one tiny fraction of the overall debt picture, subprime mortgage lending, failed.
The Fed Should Have Been Right
In March of 2006, the Federal Reserve and other government officials were repeatedly asserting that subprime mortgages were not a threat. In a sense, they should have been right. Subprime mortgages are/were a very small sliver of the overall mortgage pie. The Fed was correct in asserting that a healthy financial system should be able to support the total collapse of subprime mortgage lending with barely a hiccup. The Fed was incorrect in assuming our financial system was healthy.
The battle between bulls and bears last year at this time was over the following question: did loose underwriting standards and excessive credit creation in the subprime residential mortgage market exist in a vacuum?
Bulls believed that it did and, consequently, that loose underwriting standards and excessive credit creation were isolated to that small segment of the market. Therefore, according to that thesis, overall credit conditions were too tight and higher-quality segments of the market were being unfairly punished.
However, many of us believed that the subprime segment was simply a weaker version of the larger credit market paradigm - that loose underwriting standards and excessive credit creation was the norm across all market segments, not just subprime - and that was/is just the first inning of these credit issues.
What It All Means
One aspect of a debt crisis, as opposed to a liquidity crisis, is that a debt crisis reduces access to credit, and so we begin to see credit availability for even productive areas of the economy dry up; Salle Mae (SLM) cutting back on lending to students due to a combination of credit market turmoil and changes to federal law, for instance, American Express (AXP) cutting back business loans, commercial paper market becoming more fearful and even locking up, and on, and on, and on.
What must be remembered about what I have characterized as "the inevitable failure of the Bailout Bill" is what that failure means. It is not a "failure" in the absolute or idealogical sense; that ANY proposal or government intervention must be viewed as a failure. It is a failure in the sense that it will not return this broken economy to "normal" as so many are hoping.
After two full decades of credit expansion, having finally reached the point where debt is abhorrent, the new reality will be a more NORMALIZED credit market, not a return to the grossly abnormal market many of us have come to view as typical.
Think about it this way; it is not "normal" to be able to walk into virtually any retail store in the country and within 10 minutes be able to access $2,000 in credit by simply showing a drivers' license. It is not "normal" to buy a home with zero money down. This is not "normal" behavior. Adjusting to the new reality of normalcy will be a painful process.
On the one hand, Federal Reserve officials, Federal Government officials, many Wall Street executives and salespeople, believe it is "necessary for our economic security" to return to that place of easy credit. I disagree with that. I believe the American people disagree with that. And so the disagreement over the Bailout Bill, though pegged in the Mainstream Media as a war between battling economic classes, might really be a much deeper and more significant faceoff; a battle for the economic soul of this country. "(snip)
Re: five things you need to know to 'understand' the financial crisis
^^^ a position where the Bank of England and the IMF concur ...
(snip)Yesterday's unparalleled peace-time extension of state ownership and control, and the interest-rate cut was given only a nervous welcome. Researchers at Capital Economics said: "The provision of massive amounts of liquidity and enhanced depositor protection are all very well, but they do not get to the root of the problem. We are dealing with a crisis of solvency that is not going to disappear until banks are adequately recapitalised. The UK Government has finally got the message, albeit late in the day. But this is not a domestic problem. It is a global problem. And until the financial sector in the world's largest economy is recapitalised, there will be negative spill-over effects in equity markets around the world."
Pressure is growing on the US Treasury to take more equity stakes or make more loans to the large American banks and even other, non-bank corporations.
Yet such measures may not be enough to prevent recession and further financial meltdown.
Yesterday was a day when the world woke up to the historic nature of the times, and the realisation that the downturn will almost certainly now turn into recession and may even turn into a slump of a kind not seen since the Great Depression. The real fear is that no bank rescue plan or internationally co-ordinated interest-rate cut or programme of tax reductions and public spending can do much now to stave off the inevitable unemployment and company failures as the credit crunch spreads. The IMF's latest World Economic Outlook said "the major advanced economies are already in or close to recession" with "a cascading series of bankruptcies, forced mergers and public interventions" battering the West's banks.
Perhaps the only bright news is the belief that inflation will soon peak and then decline rapidly. Few disagreed with yesterday's Bank of England statement that: "Inflation is likely to rise further, to above 5 per cent in the next month or two. But inflation should then drop back, as the contribution from retail energy prices wanes and the margin of spare capacity in the economy increases." On the back of such an upbeat assessment, many City economists see interest rates falling to as low as 2.5 per cent, their lowest since 1951. For those in secure, well-paid work and with good credit ratings, the credit crunch may not hurt too much; for everyone else, the pain will be intense. "(snip)
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Re: five things you need to know to 'understand' the financial crisis
Man this week's been giving me a headache. Every morning I wake up and some crazy new thing has happened. More bailouts! More rate cuts! VIX hits a new high! Banks still reckon the other banks will go broke! More market rules changes! What's happened since I left the office...
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WASHINGTON (MarketWatch) -- The Federal Reserve announced Wednesday it was lending billions of additional funds to cash-strapped American International Group Inc.
http://www.marketwatch.com/news/stor...&dist=hplatest
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HONG KONG (MarketWatch) -- South Korea's central bank cut its benchmark lending rate a quarter-point Thursday, joining a similar move by Taiwan, participating in the coordinated monetary easing announced late Wednesday by other central banks.
http://www.marketwatch.com/news/stor...%7D&siteid=rss
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The Fed and Treasury are perplexed. Liquidity schemes like the TAF, PDCF, TSLF, TARP, ABCPMMMFLF, and the CFFF did not help stimulate bank.
Paulson is foolish enough to force the issue and is Threatening To Take Ownership Stake In Banks to do it.
http://globaleconomicanalysis.blogsp...-stake-in.html
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REYKJAVIK, Iceland - This volcanic island near the Arctic Circle is on the brink of becoming the first "national bankruptcy" of the global financial meltdown.
http://news.yahoo.com/s/ap/20081007/...and_meltdown_1
Governments trying to call a do-over but it's not working because of all the unknowns embodied in CDOs, CDSs and counterparty risk. What a pain.
Re: five things you need to know to 'understand' the financial crisis
^^^ and based on the above, all of these actions you have pointed out are not working because they are not addressing the REAL problem. In other words, they are not magically able to convert 'bad' debts into 'good' debts.
From the standpoint of a 'dumb blonde with big boobs', in order to convert 'bad' debt into 'good' debt one of the following must occur ...
- currency inflation must reach levels high enough that it makes the outstanding balance of a mortgage loan look like the outstanding balance of a car loan, and make the outstanding balance of a car loan look like pocket change !
- 'bad' debts must be converted into NONEXISTANT debts via foreclosures / repos , via auction recovery , and by writing off the remaining balance
- the gov't must buy up 'bad' loans with taxpayer money, at which point (and at taxpayer expense) the magic wand can be waved via the gov't changing the terms of the 'bad' loans that they now own outright.
Unfortunately, it would appear that all of the bailout efforts to date have failed to actually deal with 'bad' debts. Instead they have dealt with allowing the holders of 'bad' debts to remain solvent ( well some of them - bye bye Lehman ), they have REDUCED the ability of 'bad' debt holders to foreclose, auction, and write off the remaining balance, and they have allowed the gov't to only halfway purchase 'bad' debts (i.e. 'bad' debts have been accepted as collateral)
Re: five things you need to know to 'understand' the financial crisis
Further devaluation of the dollar is necessary to ease paying off the debts. Which will present the problem to Americans who will continue to be paying more for food and energy.
Our foreign creditors might not be very happy to continue buying the US Treasuries. I suspect the Chinese may have ordered the US to raise the value or the dollar "OR ELSE"?
Re: five things you need to know to 'understand' the financial crisis
^^^ a plausible theory given that the Japanese yen has increased even more than the US dollar ... which helps the Chinese re world competitiveness and hurts the profitability of Japanese exporters to the US.
Re: five things you need to know to 'understand' the financial crisis
Aiyiyi we went down 8% today
Re: five things you need to know to 'understand' the financial crisis
As terrible as this may sound as horrified as I am in regards to the plunge of the economy, I'm fascinated. I'm fascinated by the reaction of the market, by the reaction of the people, and the LACK of reaction of many common folk.
Re: five things you need to know to 'understand' the financial crisis
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the LACK of reaction of many common folk
It amazes me as well. But you are absolutely correct that quite a few working Americans won't really concentrate on the impact of the stock market nosedive on their personal finances until their 401k statement arrives at the end of this month !
Re: five things you need to know to 'understand' the financial crisis
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Originally Posted by
Melonie
It amazes me as well. But you are absolutely correct that quite a few working Americans won't really concentrate on the impact of the stock market nosedive on their personal finances until their 401k statement arrives at the end of this month !
See, where I grew up most people didn't have anything of the sort, so they are kinda 'meh' about the entire thing, and figure it will come back around eventually.
Re: five things you need to know to 'understand' the financial crisis
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Originally Posted by
Melonie
It amazes me as well. But you are absolutely correct that quite a few working Americans won't really concentrate on the impact of the stock market nosedive on their personal finances until their 401k statement arrives at the end of this month !
And, according to NPR, less credit card offers, reduced credit limits (and thereby smaller credit scores on existing debt), and less favorable terms on balance transfers.
Re: five things you need to know to 'understand' the financial crisis
Hopefully Americans will learn to consume less and SAVE more.
Re: five things you need to know to 'understand' the financial crisis
^^^ it will probably not be a matter of learning to consume less ... rather a matter of being FORCED to consume less. As to savings, much there depends on interest rates and tax policies which might actually allow savers to come out ahead of inflation in terms of after-tax interest earnings.
Re: five things you need to know to 'understand' the financial crisis
^^^ I would like to see the taxes on savings disappear. Stupidest tax ever. Spend hundreds of thousands of dollars and they let you write it off. Try to save a little for yourself and they ding ya.
Re: five things you need to know to 'understand' the financial crisis
^^^ not if you're rich enough to put your savings into triple tax free municipal bonds !!!
Re: five things you need to know to 'understand' the financial crisis