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  • Collapsing Global Credit Bubble Churns up Financial "Whales"

    Collapsing Global Credit Bubble Churns up Financial "Whales"

    As the Whales Hit the Beach, Don't Forget Where they Came From

    by Eric Janszen


    Editor's Note: We're fans of independent research and money management firm GaveKal and the writings of Charles Gave, Louis-Vincent Gave and Anatole Kaletsky based in Hong Kong. We've heard iTulip described as GaveKal's evil twin brother. Both firms strive to be rigorous and consistent, but where GaveKal surveys the financial markets scene and sees a glass half full, iTulip sees a glass of Kool-Aid.

    Louis-Vincent Gave, in his letter to subscribers today, continued with a metaphor to illuminate the global liquidity contraction, "in which the central banks keep throwing in sticks of dynamite until the ocean finally disgorges a huge dead whale," and listing as previous "whale" examples Continental Illinois, Chrysler, Brazil, Drexel Burnham, Kidder Peabody, Mexico, LTCM/Russia, and Enron/MCI/Argentina. The letter explores the idea that Northern Rock PLC, Britain’s fifth-biggest mortgage lender, may be it. We say Northern is a lead whale, and look for a lot more to hit the beach over the next year.
    _______________

    Let's compare the US and UK situations as the credit crisis progresses. Bernanke rode into the Fed in 2006 on his reputation as an asset deflation fighter, the prefect man for the job as everyone from Wall Street to Washington knew the credit party had gone on so long and reached such extremes that only a person believed to be able to deal with the inevitable crisis was suitable.

    While Bernanke's famous 2002 "dropping money from helicopters" speech is frequently cited, he has been developing a reputation as a virtuoso in the subtle arts of deflation fighting for nearly 25 years, to wit: Bernanke, B. (1983) "Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression," American Economic Review, Vol. 73, 257-276. The promise to supply copious liquidity at the drop of a hat was just the right cover for the much more prudent approach that was intended. Clearly, the actual fulfillment of that expectation would spell disaster for a Fed managing the aftermath of a nearly 20 year old credit bubble in the context of a dollar trading at 34 year lows and oil at all time highs.

    These antecedents, along with the seeds of the current credit crisis, are the legacy of Fed, Treasury Dept, and Congressional post-stock market bubble re-inflation policies 2001 - 2005: cut rates, cut taxes, debase the currency. Imagine US creditors' relief when the Fed merely changed discount window policies, as ex-Fed governor Larry Meyer told everyone they'd do (we heard it on a Goldman client call; Meyer's on the payroll) as CDOs were marked to market from mark to model. Setting such low expectations of prudence made the measures taken appear hawkish.

    The Bank of England made no such pre-crunch PR arrangements so is now stuck playing political catch-up, thus the hard line with banks in official statements that echo the words of President Hoover's Treasury secretary, Andrew Mellon, who advocated allowing the 1929 crash to "liquidate labor, liquidate stocks, liquidate the farmers and liquidate real estate." But the intention is to not take it that far. After some speculator's blood has been spilled, the necessary bailout measures will be taken. The risk, though, as the Japanese learned, is that these short term political decisions can morph into suboptimal long term monetary decisions. The politics are deterministic, so a repeat of the Japanese deflation cycle experience is possible if the hard line is maintained too long; the credit crunch may become self-reinforcing if the BoE doesn't soon start to get as creative as the Fed has been in the US. One factor holding them back is that the Brits have this class thing to deal with that makes the appearance of the BoE bailing out rich people more politically problematic than for the Fed. In the US there may be occasional noise about wealth inequality and socialism for bankers but it's restricted to academics and well-meaning journalists and isn't politically significant as long as the flat panel TVs keep flowing out of Asia and the credit keeps flowing to pay for them.

    The experience for net debtor versus net creditor nations is different in the circumstance of a debt deflation. In the case of the US in the 1930s and Japan in the 1990s, as net creditors debt deflations have a tendency to reinforce processes that increase the purchasing power of the currency, exacerbating asset and commodity price deflation. In the case of the US today, in its role as the world's largest debtor with massive military and entitlements bills still piling up, a self-reinforcing debt deflation could eventually lead to a repudiation of the currency unless arrangements can be worked out to sell assets to US creditors at very favorable prices, such as the oil and other resource companies that China desires above US Treasury bonds, but is blocked by Congress from purchasing.

    Whether Northrock is "a" whale of "the" whale remains to be seen, but I suspect the former will be proven in time. Recall that the current credit problems originated in the US housing market and that has a long way to go down. Greenspan admits in his new book "The Age of Turbulence" that might be better titled "Duh" that there was indeed a housing bubble and housing prices are still closer to a top than a bottom for the cycle. More importantly from a whale counting perspective, the housing bubble, while it gets lots of press today, is just the start. A similar fate awaits the US commercial real estate market, which financing via Commercial mortgage-backed securities was even more outlandish (see 1031 Exchanges: More FIRE Economy Hijinks and Curtains for Commercial Real Estate? iTulip Select, Sept. 16, 2007).

    Then there's the private equity deals funded by CLOs that have left many US companies with impaired balance sheets even in good times. A modest decline in demand, even without outright recession, will make many of those deals uneconomical (see Interview with John Challenger, CEO, Challenger, Gray & Christmas, iTulip Select, June 13, 2007). While the optimists opine that these deals are benignly re-negotiable, recent experience in the mortgage lending industry, which offered similar assurances as recently as Q1 2007, provides evidence that in practice when the money dries up, PE firms will need their cash flow as much as anyone else, and at the same time as everyone else.

    As duration of unemployment grows and fuel demand by air carriers declines along with freight shipping volumes, the US economy shows itself on a descent path into recession, which we modeled October 2006 as due to start in Q4 2007. The only serious questions are how fast and how far. Policy options are limited and raise further questions. What can the Fed do with one hand tied behind its back by inflation? What options are available for additional foreign borrowing given Treasury Dept. head Henry Paulson's recent unfruitful bond sales trips to Asia? And what kind of fiscal stimulus can be supplied by a Democratic Congress on the hook with voters to stop spending the US into oblivion so Hillary Clinton can get elected President in 2008. In fact, a recession in 2008 would probably seal a Clinton win.

    The whale metaphor in this context reminds me of the joke about the Bostonian who was stopped by an environmental activist at Logan Airport and asked, "Please, sir, will you help us save the whales?" The Bostonian replies, "Save the whales? How? I can see saving stamps and coins, but where am I gonna put a collection of whales?"

    Not a whale but a collection of whales is what we'll have before the credit bubble Greenspan made is finally unwound.

    iTulip Select: The Investment Thesis for the Next Cycle™
    __________________________________________________

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    Last edited by FRED; 09-17-07, 06:51 PM.

  • #2
    Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

    The most interesting quote this evening here in the UK is to the effect that the underlying "credit" of the UK Government is "unlimited".

    That was a comment following the government action to give an unlimited guarantee to all depositors in Northern Rock.

    That guarantee surely is a moot point if they have to cover the majority of all depositors for all banks? I ask that as we see already that the first signs are appearing of the stock market run on other banks named over the weekend to be vulnerable.

    So far the Whales are mere sprats when compared to the major players in the US market. And how many are now prevented from telling anyone that they have a problem by the sight of the run on Northern Rock?

    One last point, I do not detect any form of "class" comment. Everyone is affected. Here in the UK many otherwise poor people are good at saving for a rainy day and there is no bias in the queues outside the bank.
    _________
    Chris.
    Last edited by Chris Coles; 09-17-07, 03:40 PM. Reason: Minor edit

    Comment


    • #3
      Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

      Originally posted by Chris Coles View Post
      The most interesting quote this evening here in the UK is to the effect that the underlying "credit" of the UK Government is "unlimited".

      That was a comment following the government action to give an unlimited guarantee to all depositors in Northern Rock.

      That guarantee surely is a moot point if they have to cover the majority of all depositors for all banks? I ask that as we see already that the first signs are appearing of the stock market run on other banks named over the weekend to be vulnerable.

      So far the Whales are mere sprats when compared to the major players in the US market. And how many are now prevented from telling anyone that they have a problem by the sight of the run on Northern Rock?

      One last point, I do not detect any form of "class" comment. Everyone is affected. Here in the UK many otherwise poor people are good at saving for a rainy day and there is no bias in the queues outside the bank.
      _________
      Chris.
      What's meant by the political class issue is not the composition of the line at the bank but the perception by voters of preferential bailing out of bankers over borrowers, like this:

      Ed.

      Comment


      • #4
        Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

        Ed,

        No!

        The whole problem is seen as being caused by EXACTLY the opposite; no one has been prepared to do ANYTHING to help any bank.

        At the retail level, today, banks here do not have any friends at all. And, may I say from my own experience, this is a general view.

        Interbank lending has stopped dead in its tracks.

        I will go so far as to suggest that any UK government that bailed out the investors would guarantee to lose the next election.
        _________
        Chris.

        Comment


        • #5
          Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

          Originally posted by Chris Coles View Post
          Ed,

          No!

          The whole problem is seen as being caused by EXACTLY the opposite; no one has been prepared to do ANYTHING to help any bank.

          At the retail level, today, banks here do not have any friends at all. And, may I say from my own experience, this is a general view.

          Interbank lending has stopped dead in its tracks.

          I will go so far as to suggest that any UK government that bailed out the investors would guarantee to lose the next election.
          _________
          Chris.
          Yes, that's exactly the point. The BoE isn't doing anything to help investors because it is politically unpopular to do so. Rather they are taking a populist stance and bailing out depositors, the opposite of what the Fed is doing.

          Or maybe it's long standing British tradition:
          The actions of governments after a crash may also influence the severity of its effects. Many economists argue that after October 1929 President Hoover should have followed the advice of his Treasury secretary, Andrew Mellon, who advocated allowing the crash to "liquidate labor, liquidate stocks, liquidate the farmers and liquidate real estate." Instead, Hoover led a campaign to maintain wage levels in the face of falling prices. Japanese authorities committed the same error in the early 1990s with their futile attempts to prevent asset prices from falling.

          They would have done better to follow the example of the British authorities who remained benignly laissez-faire in the face of the South Sea Bubble and all 19th-century crashes.

          When the Bubble Bursts
          By Edward Chancellor
          author of "Devil Take the Hindmost: A History of Financial Speculation"
          (Farrar, Straus & Giroux, 1999).
          Ed.

          Comment


          • #6
            Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

            It's not completely clear to me where the GaveKal stuff ends and the iTulip starts.

            Comment


            • #7
              Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

              The (long standing) BoE rules seem to have been designed to inflict the maximum possible pain on the shareholders of Northern Rock whilst removing all but minor pain from depositors (early withdrawl fees). Indeed the rules seem specifically designed to completely wipe out all shareholder capital (http://www.bbc.co.uk/blogs/thereport...t_be_sold.html).
              It seems Northern Rock can only be transfered to new ownership when the the existing shareholders have lost everything, so expect a sale for £1 to someone like HBOS, ala Barings (http://en.wikipedia.org/wiki/Barings_Bank).

              The only new aspect of this is the fuller than promised protection for depositors, this was officially only up to £32,000 ($65,000) and is now unlimited. The overall thrust of the BoE policy is unchanged and seems unlikely to change.

              My understanding of the problem in Japan was that the megabanks were allowed to continue trading whilst insolvent, to companies that themselves were insolvent. (http://en.wikipedia.org/wiki/Deflati...ation_in_Japan) The BoE certainly can't be accused of this with Northern Rock, it will be gone within the week.

              If we're going to have fun speculating about "Who's the dead whale?" I'd put my money on Goldman Sachs, they seem eerily similar to Enron:
              • No one understands how they make money
              • High connections in government
              • Hubris
              • On-both-sides-of-trades and,
              • They aren't what they say they are (Hedge fund, not investement bank).
              There will be plenty more dead sea creatures bobbing to the surface in the UK, all of our asset bubbles are still fully inflated and those bubbles are more extreme than those found in the USA in 2006/7 or in Japan in 1989.

              Simon Galbraith

              ps. My folks had all of their cash savings in NR until about 4pm this afternoon. They are probably writing thank you cards to the BoE right now.

              Comment


              • #8
                Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

                24 hours is a long time in banking here in the UK. To start, a small comment on BBC Radio this morning is that the Treasury has widened the guarantee to all depositors of any such bank. I believe this has been made on the basis that as the regulatory authorities have ascertained that all banks are sound then the guarantee can be given.

                I quote from the UK Treasury web site page: http://www.hm-treasury.gov.uk/newsro...ress_94_07.cfm

                "In its role as lender of last resort, the Bank of England stands ready to make available facilities in comparable circumstances, where institutions face short-term liquidity difficulties."

                You can find all of the press releases here:

                http://www.hm-treasury.gov.uk/newsro...007_index2.cfm

                Northern Rock has been, effectively, nationalised with a full guarantee from the UK Government and I know what I would do if I were in charge of a financial institution in difficulties and had problems, I would move all my funds to Northern Rock immediately. In fact, I suspect that is exactly what is happening as the stock market is reporting that Northern Rock shares are taking off again.

                So the next question must be how long does the present guarantee stand if that is correct? I ask that as Northern Rock will very quickly become the strongest bank in the world with unlimited funds available to lend and a very competitive interest rate to depositors.

                We are into totally new ground this morning and I feel that the guarantee has been given without enough thought as to the consequences in a total world market for money.
                _________
                Chris.

                Comment


                • #9
                  Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

                  One other small point. Here in the UK we use the term "investor" when we talk about a saver in any of the smaller banks outside of the big four. The reason is that before they became banks they were what we called Building Societies that made their savers shareholders as a part of the mechanism of saving for the purchase of a house.

                  When you hear reports of "investors", you will need to sort the wheat from the chaff.
                  _________
                  Chris.

                  Comment


                  • #10
                    Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

                    A £28bn cheque to stop the panic

                    http://business.timesonline.co.uk/to...7.ece?EMC-Bltn

                    Comment


                    • #11
                      Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

                      Originally posted by Spartacus View Post
                      It's not completely clear to me where the GaveKal stuff ends and the iTulip starts.
                      You can access the GaveKal article at John Mauldin's website here:

                      http://www.investorsinsight.com/

                      Comment


                      • #12
                        Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

                        Originally posted by simon galbraith View Post
                        The (long standing) BoE rules seem to have been designed to inflict the maximum possible pain on the shareholders of Northern Rock whilst removing all but minor pain from depositors (early withdrawl fees). Indeed the rules seem specifically designed to completely wipe out all shareholder capital (http://www.bbc.co.uk/blogs/thereport...t_be_sold.html).
                        It seems Northern Rock can only be transfered to new ownership when the the existing shareholders have lost everything, so expect a sale for £1 to someone like HBOS, ala Barings (http://en.wikipedia.org/wiki/Barings_Bank)...

                        ...If we're going to have fun speculating about "Who's the dead whale?" I'd put my money on Goldman Sachs, they seem eerily similar to Enron:
                        • No one understands how they make money
                        • High connections in government
                        • Hubris
                        • On-both-sides-of-trades and,
                        • They aren't what they say they are (Hedge fund, not investement bank).
                        Simon Galbraith

                        ps. My folks had all of their cash savings in NR until about 4pm this afternoon. They are probably writing thank you cards to the BoE right now.
                        It's not BoE rules that are designed to inflict pain. It's the nature of fractional banking. In every banking crisis first goes the liquid capital reserves (withdrawals), then shareholder equity, followed by unsecured lenders and depositors (over the deposit insurance limit) and finally secured lenders which include other banks and the BoE (or Fed as the case may be). Because banks are so heavily levered it takes only a small change in the value of their assets (loan book) before their equity is completely wiped out. This time we have the Mother of all Credit Bubbles due to the magic of derivatives - essentially an already heavily levered business, is now hyper-levered for those banks caught up in the derivative game. There is no valid reason bank shareholders should be bailed out any more than the shareholders of Enron or Parmalat.

                        Further, if the banks won't lend to each other what reason would an unsecured depositor have to keep their money exposed in ANY bank? Glad to hear your parents got their money out. Although the Exchequer announced a 100% guarantee, they probably sleep better now...unless they went across the street and put the money into an account at Barclays.

                        In the run-up to the crash of '29, Goldman Sachs, with the same attributes listed above, was at the forefront of creating pyramids of levered investment trusts. In his book "The Great Crash" economist John Kenneth Galbraith has an entire chapter - "In Goldman Sachs We Trust" - devoted to the whole amusing episode. Goldman survived and thrived after that, and no doubt they will again...
                        Last edited by GRG55; 09-18-07, 08:29 AM.

                        Comment


                        • #13
                          Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

                          Originally posted by Chris Coles View Post
                          24 hours is a long time in banking here in the UK. To start, a small comment on BBC Radio this morning is that the Treasury has widened the guarantee to all depositors of any such bank. I believe this has been made on the basis that as the regulatory authorities have ascertained that all banks are sound then the guarantee can be given...

                          ...Northern Rock has been, effectively, nationalised with a full guarantee from the UK Government and I know what I would do if I were in charge of a financial institution in difficulties and had problems, I would move all my funds to Northern Rock immediately. In fact, I suspect that is exactly what is happening as the stock market is reporting that Northern Rock shares are taking off again.

                          So the next question must be how long does the present guarantee stand if that is correct? I ask that as Northern Rock will very quickly become the strongest bank in the world with unlimited funds available to lend and a very competitive interest rate to depositors.

                          We are into totally new ground this morning and I feel that the guarantee has been given without enough thought as to the consequences in a total world market for money.
                          _________
                          Chris.
                          Extending the deposit guarantee to other banks was inevitable, or there would have been runs on every bank with a mortgage business or an investment arm potentially carrying mortgage related paper. The banks still won’t lend to each other because they don’ know who is sound. There is no possible way the regulatory authorities know that answer either. If the authorities are actually making that claim then, to paraphrase Mandy Rice-Davies “Well they would, wouldn’t they”.
                          I don’t see how Northern Rock is now “nationalized” as nowhere does it say that Her Majesty’s Loyal Government is taking possession of the stock. The BoE has agreed to provide short term loans to the NR, at a penalty rate of interest, in exchange for collateral from NR’s loan book. The BoE is risking their balance sheet to some degree, and it is not clear how they are assessing the credit risk of the collateral they intend to accept (do they have their own internal expertise?). Nothing here seems to directly protect the shareholders - the BoE is buying time to engineer a take over of Northern Rock, which is unlikely to survive the month as an independent bank.

                          Comment


                          • #14
                            Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

                            Call me Ishmael.

                            Comment


                            • #15
                              Re: Collapsing Global Credit Bubble Churns up Financial "Whales"

                              Originally posted by GRG55 View Post
                              I don’t see how Northern Rock is now “nationalized” as nowhere does it say that Her Majesty’s Loyal Government is taking possession of the stock.
                              GR,

                              I was only quoting a reporter with the BBC who made that comment.
                              _________
                              Chris.

                              Comment

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