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FRED
03-08-07, 10:34 PM
http://www.itulip.com/images/ej.gifWhy are we Nervous? Because We Can't Do Without

A hedge fund manager scoffs at the climbers of the cliff of doom

by Eric Janszen

A missive by a noted hedge fund manager was sent to us today in confidence. It's titled, "So Is It Time for a Recession and Market Panic?" In sum, it said that all the worry the author is hearing on the street about the economy and markets is due to "superstition and witchcraft."

He playfully suggests that, "we should follow the precedent of our early medieval ancestors and gather in a circle, hold hands and chant, then light the tribal Shaman on fire."

He gets points for noting that the tribal Shaman of the markets is still Alan Greenspan, but I don't recommend lighting the guy on fire. And the rest of the author's argument is nonsense.

In sum:

The slow demise of the yen carry-trade has nothing to do with the current market turmoil. A rounding error in global liquidity.
Sub-prime loan problems represent a $15B write-off risk in a $1.5 trillion market. Forgeddaboudit.
No recession because Bernanke says so. Ignore Greenspan–remember, he's a Shaman.
Oil price increases of 240% to 500% preceded all of the last four recessions (except the 2001 recession) since 1974. And we haven't seen anything like that.

Does the 600% increase from $12 per barrel in the late 1990s to nearly $70 per barrel today count? Never mind.

Among his various carefully selected and poorly argued points, my personal favorite is this.
"This must be the only bull market in history where P/E ratios declined over the course of a significant run up. It has left P/E ratios quite modest—almost exactly in the middle of their long term range in most markets."
Did he not get the memo? Stock buy-backs are driving P/E ratios down during this extended bear market rally? The entire 2001 - 2006 period is a 1933 - 1937 style bear market rally, driven by Keynesian economic stimulus policy, which may work out as well, although differently, this time as last.

He notes that the behind-the-scenes talk is very negative: "While the notion is that a bull market climbs a 'wall of worry' I would almost describe the current mind set of investors, and even some corporate managers, as closer to 'cliff of doom' than 'wall of worry.'

"Climbing a cliff of doom." We like that. We'll take it.

He goes on.
"Both in talking with companies, and examining the cautious tone of the forecasts that have accompanied the release of full-year 2006 results, the caution is notable. Such caution, at least on one level, is profoundly weird."
After pointing out all the obvious reasons why we've never had it so good, he concludes by asking, What the heck everyone so worried about? What a pack of neurotics!

We are worried because we can't do without.

Without cheap imports, CPI inflation will go through the roof. If Congress gets its way and forces the Chinese to re-value the yuan, or if any other of several increasingly probable events occur which cause demand for dollars to fall–such as losing the wars in Iraq and Afghanistan or getting bled dry by a protracted stalemate–or a good old fashioned panic out of the dollar, the dollar tanks as many have predicted, admittedly too early, but not wrongly.

If you think inflation is high now as you experience it when paying tuition, insurance, or medical care bills, wait until the U.S. tries to buy imports with depreciated dollars.


<object height="400" width="850"><embed src="http://www.itulip.com/video/CPIt+nt.swf" type="application/x-shockwave-flash" wmode="transparent" height="400" width="850"></object>
Watch it Again (http://www.itulip.com/video/CPIt+nt.swf)

The CPI, itself an increasingly suspect concoction created by the Bureau of Labored Statistics, delivers its magically low reading year after year–never mind the fast rising prices on the menu of your local sub shop–because the index sums low inflation traded (T) goods and services which benefit from foreign labor arbitrage with high inflation non-traded (NT) goods and services that don't. Consider how much consumer electronics figures into your monthly budget versus tuition, insurance, and medical expenses, and you decide whether the CPI is valid and what higher import costs portend.

Without continued loose and low rate lending, housing prices will continue to fall, as they have for the past few months. Lending standards will rise, restricting the pool of credit-worthy borrowers, which–in a highly competitive credit market–leads to even more limited access to lenders by borrowers. As housing prices fall, all sorts of unseemly things happen. Fewer want to buy. Fewer want to build. Fewer are employed. And so on.

The leading indicator is housing permits, as we noted in our 2007 Recession series (http://www.itulip.com/forums/showthread.php?t=550) last fall. A decline in construction and other real estate related employment is next. Unemployment is strongly correlated to housing prices. And so on.


<object height="400" width="850"><embed src="http://www.itulip.com/video/HousingPermits.swf" type="application/x-shockwave-flash" wmode="transparent" height="400" width="850"></object>
Watch it Again (http://www.itulip.com/video/HousingPermits.swf)

As we noted back in October last year (http://www.itulip.com/forums/showthread.php?t=743), a large drop in housing permits issued preceded every major recession, except for the 2001 recession, since 1974. You remember the early 1990s, don't you? This housing decline, in rapidity and depth, is much more severe.

Without continually increasing deficit spending to generate new government jobs, unemployment will rise. We can't all work either for the government or as sub-contractors to the government, but that's where the job growth has been for the past few years. Over 22 million Americans work for the government today, about the same number as work in the goods producing sector. These are the largest employment sectors of the U.S. economy.


<object height="400" width="850"><embed src="http://www.itulip.com/video/EmploymentSector.swf" type="application/x-shockwave-flash" wmode="transparent" height="400" width="850"></object>
Watch it Again (http://www.itulip.com/video/EmploymentSector.swf)

The U.S. economy employs fewer and fewer in the private sector. Within the private sector, finance and housing have been the leaders, as other sectors declined. As housing topped mid-2005 and finance topped a few weeks ago, whither new employment? Might that not feed back into housing price declines (http://www.itulip.com/housingbubblecorrection.htm)?

Without an ever increasing rate of new debt creation, key segments of the U.S. economy–especially consumption and finance–will contract.


<object height="400" width="850"><embed src="http://www.itulip.com/video/USdebt.swf" type="application/x-shockwave-flash" wmode="transparent" height="400" width="850"></object>
Watch it Again (http://www.itulip.com/video/USdebt.swf)

Outstanding debt levels–especially mortgage debt–have grown to be so outstanding that by any measure they are incomprehensible.

Without ever more rapid public and private sector debt growth, current GDP growth cannot be maintained. This measure tells you how much new debt is needed to generate economic growth.


<object height="400" width="850"><embed src="http://www.itulip.com/video/USDebtvsGDP.swf" type="application/x-shockwave-flash" wmode="transparent" height="400" width="850"></object>
Watch it Again (http://www.itulip.com/video/USDebtvsGDP.swf)

In 1983, $1 of debt was needed to generate $1 of GDP. Now nearly $3 is needed. When does this become a problem? When $5 is needed to generate $1 of GDP? $10? $100?

Without an ever more rapidly expanding money supply, the U.S. economy is ripe for a debt deflation, either via a hyper-inflation or credit defaults.


<object height="400" width="850"><embed src="http://www.itulip.com/video/trillionMZMyears.swf" type="application/x-shockwave-flash" wmode="transparent" height="400" width="850"></object>
Watch it Again (http://www.itulip.com/video/trillionMZMyears.swf)

Never mind that getting to the first $1 trillion of Money at Zero Maturity (MZM, a broad measure of the money supply used by the Fed) took 207 years, from 1775 to 1982. Next $1 trillion took a mere five years. Last $1 trillion? Ten months. Nothing alarming about that, right? When does the money supply growth rate become a problem? When MZM grows by $1 trillion a month? A week? A day? An hour?

Without the continued political support of foreign governments expressed as lending, we can't run our government, pay our existing debts, or our pensions or mortgages, or make payments on the last few hundred billion of leveraged by-outs.


<object height="400" width="850"><embed src="http://www.itulip.com/video/UStreasuryholdvsGDP.swf" type="application/x-shockwave-flash" wmode="transparent" height="400" width="850"></object>
Watch it Again (http://www.itulip.com/video/UStreasuryholdvsGDP.swf)

Relative to GDP, purchases of U.S. Treasury securities is suggestive of relative levels of tribute to the empire rather than economic need. We miss the nations of "Old Europe," which own practically no treasuries at all. Thank goodness for Asian countries, which need U.S. markets for export growth, military protection, or both. What happens when Asia and Old and New Europe form a strong trade and currency block, and reduce funding U.S. fiscal and consumer profligacy, and propping up the dollar? Uh, oh. (http://www.ek.fi/businessforums/aebf/en/index.php)

We could go on, but as our intrepid hedge fund manager author only gave us a few items to consider to peel us off the "cliff of doom," we won't go on and on, yanking out the pitons of his case, so to speak.

We conclude that our hedge fund manager author is suffering from a common ailment in the profession: the Desperate Optimism of the Invested. We suspect that the author is motivated by personal risk (owns a lot of equities), or reputation risk (has recommended large stock allocations professionally), or both.

Which fact gives us the opportunity to remind readers why we recommend diversification. Not only does diversification limit your exposure to loss when inevitable crises occur in the markets and economy. Diversification also keeps you from penning strained justifications for your over-weight position in any particular asset, whether it is dot com stocks, or real estate, or gold.

Investing is an art, requiring subtly and sensitivity to change.

Pedants need not apply.

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DemonD
03-08-07, 11:46 PM
I have officially turned bearish. In the polls section I voted for the start of a bear market. I knew it was going to turn this year, just not this early. It looks like the BoJ raising interest rates is the beginning catalyst. Maybe not the exogenous event, but it will be the first in a line of many noteworthy events that will bring this process on.

Here is a random prediction: within the next 12 months, there will be at least one story of a hedge fund manager either committing suicide or going postal and murdering either a business partner or a spouse (or both).

Sapiens
03-09-07, 12:25 AM
Superb post!

Except for the fact that I have a container loaded with rabbit's feet amulets sailing over the Pacific. :eek: :D

-Sapiens

sparki
03-09-07, 06:01 AM
excellent! wunderbar!

here is a story from the economist that sounds like the "hedge funds manager"

it´s behind you.... (but overall they take a critical look)

http://immobilienblasen.blogspot.com/2007/03/its-behind-you-economist.html

and here some important news from china

china is shifting $ reserves to equities

http://immobilienblasen.blogspot.com/2007/03/china-is-shifting-reserves-to-equities.html

Rajiv
03-09-07, 09:37 AM
Good article by Jerry Mazza - <a href="http://onlinejournal.com/artman/publish/article_1833.shtml">Japanese interest hike sparks market plunge</a>


The market plunge started with the decision of the Japanese central bank to raise interest rates from 0.25 to 0.5 percent. It was supposed to have little or no impact on the “carry trade,” the low-rate for borrowing capital via the yen and investing it in places other than Japan. Yet it turns out there is nothing in the global financial system that is not connected vitally to this yen carry trade.

In fact beyond Japan, there is $500 to $600 billion in investments which came about with the benefits of the cheap yen credits. And if the yen started to rise because of the rise in interest rates, the worldwide ripple effect was much greater than 0.25 percent.

The big winners of the carry trade are big banks and notably hedge funds and equity funds, whose derivatives trading (pieces of debt sold off separately), turn into a floating mountain of debt throughout all segments of the markets. This mountainous bubble of the “carry trade” gets bigger and bigger, in fact, it is driven to keep growing and make profits while it calls for a constant flow of liquidity.

Without liquidity, that is, when the money flow turns down, even due to a bump in low interest and exchange rates, the reaction is chemical: panic, an interwoven series of risks that could break the system apart. Then do we blame it all on the Japanese? Or are there some other merry pranksters at work?

Hedge funds magnify the hike

Rajiv
03-09-07, 09:47 AM
Another article by Mike Whitney - <a href="http://onlinejournal.com/artman/publish/article_1830.shtml">“Black Tuesday”; aprčs le deluge</a>


“Ring around the rosy
A pocket full of posies
Ashes, ashes,
We all fall down” --Children’s lyric

US Treasury Secretary Hank Paulson is sweating bullets right now.

In fact, a shrewd investor could probably make a fortune just figuring out what type of high-blood pressure medication he’s on and then betting the farm on the manufacturer.

Last week the stock market bull plopped down on an I.E.D. and wound up in intensive care, sucking food from a straw and drifting in and out of consciousness. That put Paulson on the road to South Korea, Japan and China, where he’ll meet up with his foreign counterparts to strategize on the deteriorating state of world markets. It’s a daunting task. The sudden rise in the yen has set off a brushfire that’s swept through the global system clearing out the deadwood and sending panicky fund managers out into the streets.
.
.
.
This is the most overextended, over-leveraged, debt-plagued stock market in the history of the world; a sudden gust from Tokyo or Beijing and down-it-goes like a straw house in a wind tunnel. That’s what happened last week when the yen lurched upward and Wall Street suddenly plummeted 416 points. That’s why Paulson quickly tossed his toothbrush and an extra pair of astronaut diapers in his duffle bag and scampered off to the Far East.

miju
03-09-07, 10:21 AM
I agree with you that these HF comments sound very unprofessional. but looking at the risk for the banking system (which is the only real problem to guess today) how can we be absolutely negative ? total size of the mortgate loans (without ABS, the risk being directly supported by investors) is about 7700 billions. Precedent bankging crisis have produced on average a loan losses ratio of about 2 % that translates in a today's loan loss of about 150 billions. Is the banking system unable to absorb this amount ? this amount represents the total cost of the Savings and Loans crisis in the 80's. i assume that banks are bigger and far more solid in terms of equity than 17 years ago. Why not assume that the mortgage problem will only cause a write off problem (bad earngings for the banks) and not a serious financial crisis ?
regards
miju

grapejelly
03-09-07, 10:38 AM
I agree with you that these HF comments sound very unprofessional. but looking at the risk for the banking system (which is the only real problem to guess today) how can we be absolutely negative ? total size of the mortgate loans (without ABS, the risk being directly supported by investors) is about 7700 billions. Precedent bankging crisis have produced on average a loan losses ratio of about 2 % that translates in a today's loan loss of about 150 billions. Is the banking system unable to absorb this amount ? this amount represents the total cost of the Savings and Loans crisis in the 80's. i assume that banks are bigger and far more solid in terms of equity than 17 years ago. Why not assume that the mortgage problem will only cause a write off problem (bad earngings for the banks) and not a serious financial crisis ?
regards
miju

how are banks more solid in terms of equity than 17 years ago?

How can we know what counterparty risk is present on their balance sheets?

My feeling is it is unknowable.

Typically though when these things unravel they go much further and deeper than was ever anticipated when things were going so wonderfully.

If the S hits the fan with these loans, it will affect the banks more than 2% of total amount loaned...because this finance bubble is far steeper and far bigger than the earlier one you allude to. That's because the "business of finance" is a much higher percentage of the US economy than it was before and there isn't as much "real" economy anymore.

Spartacus
03-09-07, 12:39 PM
The banks have no reserves thanks to a technique called "program sweeps".

ZERO, or IOW, a big fat ZIP.

There's an article by Aaron Krowne on the subject on this site somewhere.

A $150 Billion pill will be hard to swallow through a zero-diameter straw,
or defecate through a zero diameter lower intestine -
pick your analogy.


I agree with you that these HF comments sound very unprofessional. but looking at the risk for the banking system (which is the only real problem to guess today) how can we be absolutely negative ? total size of the mortgate loans (without ABS, the risk being directly supported by investors) is about 7700 billions. Precedent bankging crisis have produced on average a loan losses ratio of about 2 % that translates in a today's loan loss of about 150 billions. Is the banking system unable to absorb this amount ? this amount represents the total cost of the Savings and Loans crisis in the 80's. i assume that banks are bigger and far more solid in terms of equity than 17 years ago. Why not assume that the mortgage problem will only cause a write off problem (bad earngings for the banks) and not a serious financial crisis ?
regards
miju

jk
03-09-07, 07:44 PM
the index sums low inflation traded (T) goods and services which benefit from foreign labor arbitrage with high inflation non-traded (NT) goods and services that don't. it does not sum these things. it finds the geometric mean, which tends to produce a lower number than the arithmetic mean. just another little gimmick.


Within the private sector, finance and housing have been the leaders, as other sectors declined. As housing topped mid-2005 and finance topped a few weeks ago, whither new employment?
i met someone who lost a job as a mortgage processor, and found a new one working in a bank's loss mitigation department. foreclosures and work outs should be a new growth industry.

EJ
03-09-07, 08:13 PM
it does not sum these things. it finds the geometric mean, which tends to produce a lower number than the arithmetic mean. just another little gimmick.


i met someone who lost a job as a mortgage processor, and found a new one working in a bank's loss mitigation department. foreclosures and work outs should be a new growth industry.

Like bankrupcty biz for lawyers after the dot com crash. Problem is, the volume of business and pay are a fraction, as a company I was advising at the time learned.

I was being generous on sum vs geometric mean. Call me an optimist.

Christoph von Gamm
03-10-07, 11:06 AM
Ed - your CPI chart is impressive and already depicts the big fake of hedonistics in CPI. The CPI is skewed dowards because of this effect and the incalculation of headonistic goods such as cars and consumer electronics.

To give you an example: If you buy a TV set you pay ca 2000 $ for a good living room class TV since quite a while, of course if you enfactor the hedonistics of using a Plasma TV, the price has deflated. If you share the view of business technologists that technology andvances only come to reduce costs or to help increase revenues, then for end consumers this would mean that technology advances ought to be cost-neutral.

Same goes with cars. If instead of simply asking the car industry "What is your headonistic and improvement factor in your price increase?" to rather go to the point "How much does simply a state-of-the-art car cost?" then you quickly come to the conclusion that simply the price increases of a "state-of-the-art" car are highly overblown, therefore driving inflation numbers upwards...

akrowne
03-10-07, 08:58 PM
Nice.

I would add that you are probably being generous with the "government debt" levels, which I see from the debt components graph is given as around $8 trillion. That is now closer to $9 trillion (on-balance-sheet, of course), and if you add in another $2 trillion of state debt, is much more sizeable at $11 trillion.

As I like to point out, if you subtract the nearly $1 trillion of annual borrowing we are doing from abroad from the GDP, the national income is within a trillion dollars of this.

I'm not sure where to get a state debt series to help display the trend.

The distinctions between intra-government and external Federal debt, and Federal and state debt, have been the sources of much confusion and legerdemain.

akrowne
03-10-07, 09:11 PM
Right. Not zero; but even in terms of conventional reserves-to-Fed-system-money, the reserves capitalization is less than 1%.

The reserves ratio to mortgage assets might be even lower.

And the loss percentages are sure to be much higher, especially in a declining housing market where total loan values were inflated and recovery will happen on a much lower basis.

Look at what happened to coast financial already (http://www.heraldtribune.com/apps/pbcs.dll/article?AID=/20070303/BUSINESS/703030353).

~12% losses on a $110mln mortgage pool; swinging the company to unprecedented negative cash flow, and causing it to receive a FDIC downgrade to "adequately capitalized".


The banks have no reserves thanks to a technique called "program sweeps".

ZERO, or IOW, a big fat ZIP.

There's an article by Aaron Krowne on the subject on this site somewhere.

A $150 Billion pill will be hard to swallow through a zero-diameter straw,
or defecate through a zero diameter lower intestine -
pick your analogy.

metalman
03-11-07, 05:42 AM
Right. Not zero; but even in terms of conventional reserves-to-Fed-system-money, the reserves capitalization is less than 1%.

The reserves ratio to mortgage assets might be even lower.

And the loss percentages are sure to be much higher, especially in a declining housing market where total loan values were inflated and recovery will happen on a much lower basis.

Look at what happened to coast financial already (http://www.heraldtribune.com/apps/pbcs.dll/article?AID=/20070303/BUSINESS/703030353).

~12% losses on a $110mln mortgage pool; swinging the company to unprecedented negative cash flow, and causing it to receive a FDIC downgrade to "adequately capitalized".

finkel in his interview alludes to this. he says that CDOs work when all of the credits in the portfolio are paying their "rents," enough to create positive cash flow net of interest on the money being paid on the money borrowed to buy the credits. but... at come point, if enough can't pay, the CDO goes cash-flow negative. he's says that if national housing prices fall more than 14% cumulative (3% - 4% a year for 4 - 5 years) all of the B grade tranches "get hammered" and if it goes below 20% cumulative (4% - 5% a year for 4 - 5 years) that the A gets hammered. then he quotes greenspan as why he's not worried... big Al said that can't happen.

here's a refresher course on what really happens. get ready to open up your wallets, again...

http://dharmajoint.blogspot.com/2007/03/too-big-to-bail-out-case-of-humpty.html

jk
03-11-07, 09:22 AM
here's a refresher course on what really happens. get ready to open up your wallets, again...

http://dharmajoint.blogspot.com/2007/03/too-big-to-bail-out-case-of-humpty.html

great link, metalman. thanks.

Rajiv
03-11-07, 05:24 PM
NYTimes on mortgages - <a href="http://www.nytimes.com/2007/03/11/business/11mortgage.html?_r=1&hp=&oref=slogin&pagewanted=all">Crisis Looms in Market for Mortgages</a>


On March 1, a Wall Street analyst at Bear Stearns wrote an upbeat report on a company that specializes in making mortgages to cash-poor homebuyers. The company, New Century Financial, had already disclosed that a growing number of borrowers were defaulting, and its stock, at around $15, had lost half its value in three weeks.

http://graphics8.nytimes.com/images/2007/03/11/business/0311-biz-MORTGAGE.gif

What happened next seems all too familiar to investors who bought technology stocks in 2000 at the breathless urging of Wall Street analysts. Last week, New Century said it would stop making loans and needed emergency financing to survive. The stock collapsed to $3.21.

The analyst’s untimely call, coupled with a failure among other Wall Street institutions to identify problems in the home mortgage market, isn’t the only familiar ring to investors who watched the technology stock bubble burst precisely seven years ago.

Spartacus
03-13-07, 03:15 AM
Poetic and rhetorical license.

If not these, then at least Internet board hyperbole license.

Gimme a break, Aaron. (I did know that it's NOT exactly zero, but decided to (harumph) "punch up" the point).


Right. Not zero; but even in terms of conventional reserves-to-Fed-system-money, the reserves capitalization is less than 1%.

The reserves ratio to mortgage assets might be even lower.

And the loss percentages are sure to be much higher, especially in a declining housing market where total loan values were inflated and recovery will happen on a much lower basis.

Look at what happened to coast financial already (http://www.heraldtribune.com/apps/pbcs.dll/article?AID=/20070303/BUSINESS/703030353).

~12% losses on a $110mln mortgage pool; swinging the company to unprecedented negative cash flow, and causing it to receive a FDIC downgrade to "adequately capitalized".