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EJ
02-15-07, 09:51 PM
http://www.itulip.com/images/punchbowl.jpgHow to read the main stream press wearing your Finance Economy hat

Today Alan Murray makes an admirable attempt to deal fairly with a topic we've been reporting on for a while now, the crazed money party in private equity (http://www.itulip.com/forums/showthread.php?t=724). Funny thing is, when we talk to private equity guys, they tell us the madness is in the securitized debt and credit derivatives markets that have been fueling the now collapsing housing bubble. Talk to the securitized debt and credit derivatives guys and they tell us to keep an eye on private equity. It's gonna blow! Unfortunately, we think they're both right.

Alan gets a lot of this right, to his credit.

A Question for Chairman Bernanke: Is It Time to Yank the Punch Bowl? (http://online.wsj.com/article/SB117141575581507898-search.html?KEYWORDS=punch&COLLECTION=wsjie/6month)
February 14, 2007 (Allan Murray - WSJ)

Less than a week after completing the Equity Office deal, Blackstone is well on its way to selling off half the property it bought, locking in billions of dollars in profit. Insiders believe the massive buyout will yield 30%-plus returns for Blackstone and its investors.

Should any of Blackstone's moves concern policy makers? Join the forum and give us your thoughts.

In normal times, a decision to dump $20 billion of office buildings onto the market might depress prices. Anyone remember the law of supply and demand? But these aren't normal times. Some analysts have argued with a straight face that Blackstone's gambit may actually accelerate office-price increases. That suggests buyers are willing to pay Mr. Schwarzman more because they think he knows something they don't.

AntiSpin: No, these are finance economy times. The reason that monetary authorities don't take away the punch bowl that's causing asset inflation is because in the Fed's view, asset inflation is an objective, not a problem. Wage inflation. Now there's a problem. High rents–those are bad, too.

And in normal times, tapping the mortgage-debt markets for four or five times as much money as has ever been raised there before, to finance a $39 billion real-estate extravaganza, might cause a meltdown. But today, that money flows like cheap champagne.

So think of Mr. Schwarzman's 60th birthday as a sign of the times. There is a big, bubbly investment party going on out there, rolling from one asset class to the next, inflated by remarkably easy credit. Or as Mr. Zell puts it: "We have a massive excess of capital."

AntiSpin: Yes, the Finance Economy is alive and well, and doing exactly what it is supposed to do: generate large capital gains at low tax rates for owners of assets, profits from the sales of which are in turn channeled back into the capital markets to create yet new sources of money for leverage. The process is not unlike the venture capital, dot com, IPO money amplifier of the 1990s, except the speculative asset in question is office buildings and EBITDA positive companies versus parodies of technology companies. That makes this finance economy money machine all the more dangerous, as far as we're concerned. A lot of people are employed by these now debt laden companies.

A venture capital firm is a bank that funds losses. We expect they are going to get a lot of competition soon, at least with respect to opportunities to fund losses. Big ones, and lots of them.

Ben Bernanke wasn't going to go to Mr. Schwarzman's party either. Instead, the U.S. Fed chairman had to prepare for his semiannual testimony before Congress, where he is likely to address two serious questions that arise from all this.

The first: Should the Fed take away the punch bowl before the party gets out of hand?

AntiSpin: Too late. The PE (LBO) party was "out of hand" two years ago (http://www.itulip.com/riskpollution.htm).

Mr. Bernanke is an economic historian and knows that when the Fed tries to stop investor speculation, it gets in trouble. Witness the Fed's tightening in the late 1920s, and the dismal decade that followed.

AntiSpin: Greenspan tried that in 1994 (http://www.itulip.com/forums/showthread.php?t=360). Didn't work.

Moreover, the Fed chief argues the liquidity flooding today's markets isn't really a monetary phenomenon. The world's central banks, he believes, are doing a good job keeping money creation in check. And ultimately, it is excess money creation that leads to inflation -- the Fed's No. 1 enemy.

Instead, Mr. Bernanke argues that the funds flowing into investments are coming from what economists call the "real" economy. Fast-growing countries in Asia, and the oil-rich nations of Russia and the Middle East, are growing and earning money faster than they can spend it. The result is what Mr. Bernanke has called a "savings glut." The world's newly affluent, who might have stuffed their money in a mattress in an earlier era, now are parking funds in U.S. Treasury securities and driving down interest rates. That leads other investors, unhappy with low rates, to chase after higher returns, wherever they can find them.

AntiSpin: Correct on the first point. It ain't Fed money–it's money created by the latest Finance Economy money machine. Rich Chinese are not buying U.S. treasuries. Global central banks are, to prevent their nations' currencies from appreciating. Why aren't rich Germans buying? Italians, French, Dutch? Don't they get as much joy from placing their "excess savings" into U.S. debt? (http://www.itulip.com/images/treasuryholdingvsgdp.jpg)

Even if it isn't a purely monetary phenomenon, however, Mr. Bernanke surely sees the danger for the economy in this scenario. A glut of savings pushes interest rates down, bids up risky assets and prods investors to do things they otherwise wouldn't -- and probably shouldn't do. Moreover, measuring the central bank's creation of "money" is an imprecise art. Such measures aside, at some point plentiful credit buoys the economy and greases the way to higher inflation.

AntiSpin: Creates desirable Finance Economy asset inflation without the undesirable traded goods type, but even the good inflation can spill over into the Industrial Economy, to the extent that those of us who live in it have to eat, and sleep in a dwelling that we have to heat and insure.

The second question is more political than economic, and more difficult to answer: Will disaffected workers crash the party? Mr. Schwarzman's birthday party, and the swelling private-equity fortunes it symbolizes, are manifestations of the rising inequality that Mr. Bernanke referred to in a speech in Omaha, Neb., this month, and that he will certainly be asked about today and tomorrow.

Americans have long been willing to tolerate unequal economic outcomes, because of a faith that they, too, might someday have a shot at the brass ring. Recently, however, there are signs that faith is fraying. Financiers who celebrate fast fortunes made while workers face stagnant pay and declining job security risk becoming targets for a growing dissent.

AntiSpin: Ten points for Mr. Murray. As concluded in Economic Cognitive Dissonance (http://www.itulip.com/forums/showthread.php?t=936), the long term problem with the Finance Economy racket is that it produces wealth inequality that can turn into a political nightmare if and when the music stops and the 90% of the population comprised of debtors looks for political solutions to their plight.

That is why investors will likely conclude, after listening to the Fed chief's two-day talkathon, that he is far more likely to raise short-term interest rates in the coming months than cut them.

AntiSpin: Don't tell that to Goldman Sachs. Today GS issued a report to clients today that predicts GDP will grow 2.3% this year, slightly below the 2.5% consensus. GS expects the Fed Funds rate to end the year at 4.25%, implying not one or two but three quarter point rate cuts this year.

GS sees the Industrial Economy slowing, with the rate of growth in Business Fixed Investment to decline from 7.4% in 2006, to 4.3% in 2007 and 4.0% in 2008. This causes the rate of increase in consumer spending to decline from 3.2% in 2006, to 3.0% in 2007 and 2.4% in 2008.

This prediction contradicts the consensus among those we talk to in the collateralized debt market, who are expecting, if any change, a rate hike or two. There is also an apparent internal contradiction in GS's expectations. We observe the not too hot, not too cold Bernanke body language on inflation and hear the upbeat blah, blah, blah on the economy. GS expectations take us from this benign outlook land to a scary place where the rates are cut and then back again to an expanding economy, with the story ending happily with 2.3% growth, full circle all in the span of ten months.

Does GS see something to trip the U.S. economy that no one else sees? It wouldn't be the first time.

ablevin
02-16-07, 10:07 AM
Questions for the iTulip community:

1. Does the recent relative strength in the Japanese economy mean that rates will be raised there from 0.25% in the short-term? If so, how serious of an impact will that have on various asset markets, considering the magnitude of the carry trade?

2. Did I see something recently that said that China increased its banks' reserve requirement to 10% from 9.5%? What is the reserve requirement for U.S. banks? 10% sounded really low to me.

bart
02-16-07, 01:16 PM
2. Did I see something recently that said that China increased its banks' reserve requirement to 10% from 9.5%? What is the reserve requirement for U.S. banks? 10% sounded really low to me.

To the best of my knowledge, it's still 9.5%. (edit/add: oops, just checked and it indeed was raised to 10% just today)

Reserve requirements for U.S. banks are here (http://www.federalreserve.gov/monetarypolicy/reservereq.htm#table1).

You won't be happy about this severely underreported item either:


"The Chairman noted that the President had recently signed the Financial Services Regulatory Relief Act of 2006, which among its provisions gave the Federal Reserve discretion, beginning October 2011, both to pay interest on reserve balances and to reduce further or eliminate reserve requirements. The Act potentially has important implications for many aspects of the Federal Reserve's operations"

Source: Fed minutes from Oct 2006

JoeSixpack
02-16-07, 01:52 PM
1. From what i gather, many economists lean toward a 0.25 hike during Q1, some say possibly as soon as next week. Its quite political as you know.

Im no way an expert on the carry trade stuff. Some call it the end of the world as we now it, some, like Morgan Stanley, say its not all that important and not nearly as large as the mainstream media and doomists want their readers to believe. It is a quite complex thing imo. Sometimes its important to gather the finest details of a complex thing to be able to judge an outcome, like in a physics experiment (or, speaking of finance, arbitrage concepts).

However, in the market, some common sense might just point you in the right direction without arguing about global liquidity.

So heres my very simple point:
I read a very interesting comment on the carry lately, saying that YEN rates could rise to 2% without the carry stopping to make sense, so the problem would be marginal for years to come. That got me thinking.
I agree that this is true for someone entering a carry at the then prevailing levels under the assumption the exchange rates stay constant. But we know they dont. So whats going to happen to all the existig trades that pick up, say 4% yield, when their investment currency devalues by 4% ? In May, the USD devalued 7ish% against the YEN, and we all know what happened, looking at the May06 charts JPY/SPX tells a story. Add yield compression in P/E and a recession induced dollar yield drop in 2007 if you wish. The utmost iportant issues is: When and if the market decides it is likely a long-term and large exchange rate movement has started, things could get interesting very quickly for leveraged asset classes.

2. Aaron had an article here titled "What really happened in 1995" or such, i recall he argues the reserve requirement is virtually zero.

jk
02-16-07, 02:57 PM
i agree that although the yen carry trade might still make sense at [relatively] much higher japanese rates, the market doesn't always act sensibly. if enough people head to the door, trying to be among the early leavers of the trade that could start a stampede.

Spartacus
02-16-07, 03:16 PM
Last May's precipitous drop in Gold and Silver was blamed on the Japanese liquidity withdrawal.

So I'm VERY, VERY nervous about precious metals.

But seeing as how the Icelandic Krona and several stock markets in India and the Middle East (remember the articles about traders committing suicide in Mumbai after losing 50% of their net worth?) started dropping in almost free-fall mode well before the liquidity withdrawal I'm skeptical of the easy explanation.

Skeptical, but still nervous as all h*ll. C'est la vie.


Questions for the iTulip community:

1. Does the recent relative strength in the Japanese economy mean that rates will be raised there from 0.25% in the short-term? If so, how serious of an impact will that have on various asset markets, considering the magnitude of the carry trade?

2. Did I see something recently that said that China increased its banks' reserve requirement to 10% from 9.5%? What is the reserve requirement for U.S. banks? 10% sounded really low to me.

Spartacus
02-16-07, 03:21 PM
Wow. How non-sensical can you get?

If the FED needs that power, why does it kick in in 2011?

If the FED doesn't need it til 2011, why does it EVER need it?

Doesn't that put the royal kibosh on the notion that

"the FED can provide liquidity, but not capital"

If the interest payments are being made by the FED, and those interest payments are not being added to a balance sheet as having to be paid back to the FED, how is that not capital - ? It seems to me to be brand-new, non-debt money.


To the best of my knowledge, it's still 9.5%. (edit/add: oops, just checked and it indeed was raised to 10% just today)

Reserve requirements for U.S. banks are here (http://www.federalreserve.gov/monetarypolicy/reservereq.htm#table1).

You won't be happy about this severely underreported item either:

bart
02-16-07, 03:40 PM
Wow. How non-sensical can you get?

If the FED needs that power, why does it kick in in 2011?

If the FED doesn't need it til 2011, why does it EVER need it?

Doesn't that put the royal kibosh on the notion that

"the FED can provide liquidity, but not capital"

If the interest payments are being made by the FED, and those interest payments are not being added to a balance sheet as having to be paid back to the FED, how is that not capital - ? It seems to me to be brand-new, non-debt money.

If you know your political and Fed history, you know that they setup stuff like the zero requirements way ahead of time.
There is also absolutely nothing that says they'll delay until 2011. I suspect it'll be implemented before the end of 2008, at the latest.

The Fed seldom uses more than a very small fraction of its power, either behind the scenes of not.

That "the FED can provide liquidity, but not capital" has always been true... and effectively in the brave new world of finance, there is little difference between the two.

As far as "brand-new, non-debt money", I think it's also a null point. There are so many ways for the Fed and banking system to add money that it matters little whether its non debt money or not... and I hope I haven't misunderstood your points.

Ishmael
02-16-07, 03:53 PM
At first I thought that photo had Bernache eating a piece of watermelon.

miju
02-20-07, 08:04 AM
We do not know if the "financier" capitalism is bad or good for the development of an economy. probably good in the short term. but we know that everytime that this kind of capitalism has developped, everytime stong anti free market answers were brought in the streets. Leninism was a reaction to that. Corporatism and nationalism as well (as financier are internationalist by definition). the development of this capitalism is the worst we can expect from a political point of view.
but what can do the US ? do they have the ability to be again industrialists ?

c1ue
03-02-07, 09:27 PM
but what can do the US ? do they have the ability to be again industrialists ?

Miju,

Read up on the Weimar Republic and how this gave rise to National Socialists and Hitler.

And this was a strong but relatively small country.