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19 comments on The Finance Round-Up: September 7th 2007
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Thanks Stoneleigh. Great roundup.
The statements from Governments and FEDs about this being contained is so far off (and they know it).
This stopped being a housing problem (subprime), and already is a credit market (CDO, ABCP, interbank lending)...but is rapidly becoming a carry trade and, logically, a derivatives market problem.
Hmmm...let's review:
Derivatives market is USD(NOTIONAL)298 TRILLION OTC, and 344 TRILLION exchange traded (as of 2005, BIS, http://en.wikipedia.org/wiki/Derivative_%28finance%2)
Currently, there speculation is that losses are at least 20 TRILLION...yep.
And, that is why, we see the FED(ECB, etc) injecting money daily to keep the markets from collapsing.
Play money...play mortgages...no biggie, we can just walk away from it. Just like the US Treasuries maybe?
Buffet's "Financial weapons of mass destruction".
Exactly.
What we're seeing is still the tip of the tip of the iceberg, although things could progress relatively quickly from here once the decline reaches a sort of 'critical mass' of awareness. My view is that we'll see a market crash over the next couple of months, and at some point I would also expect bank runs. IMO I don't see how that could be avoided given the scale of the losses.
The financial insiders already know this and are terrified that the general public will discover it as well. Reports are that interbank daily lending has dried up, especially in Europe but here as well with the TBill/LIBOR rate difference climbing to record highs (indicating that the banks just don't want to loan money to each other, nevermind real customers). What it looks like to me is that those with cash are hoarding it because they are afraid that no one really knows the actual risk of any of the paper currently in circulation. Very clearly certain US AAA paper was anything but AAA so now that raises the question about all other US AAA paper and below.
Bernanke is pushing on a string. He has closed the Fed discount window to all except the most "credit worthy" of banks so that the less credit worthy have to borrow from those selected inner banks . This is to account for the actual risk. But the lending doesn't appear to be happening. Instead the inner circle is largely sitting on what they have and the market is seizing up. So what is Bernanke going to do? Call up Bank of America and tell them he'll call them terrorists and have Bush arrest them if they don't make loans?
It really looks like he is screwed if the other bankers around the world have lost confidence in each other's paper instruments. And that is the real problem, isn't it? Economics is never about science. It's about a CONfidence GAME (con-game).
"The greatest shortcoming of the human race is our inability to understand the exponential function." -- Dr. Albert Bartlett
Into the Grey Zone
You're absolutely right that it's all about confidence. That's why things can change so rapidly and dramatically - an implosion rather than a steady decline. Too many people think of markets as machines responding to something akin to physical forces in linear ways, with market actors acting rationally (ie the efficient market hypothesis, which I think is bunk).
IMO markets are all about herding behaviour, emotional swings (greed/confidence versus fear) and positive feedback, creating self-fulfilling prophecies. These aspects are especially clear during a mania and its aftermath, when change is rapid, there is little real information, and our animal natures are fully engaged. Once confidence evaporates, the game is over.
Stoneleigh, Thank you for your excellent financial roundup post. As usual.I don't believe this crisis is a crisis of confidence. The internal mechanisms of the global economic system are seizing up. I found a very good description of what is happening in The Past, Present and Future In Gold by Lance Lewis at Minyanville. He gives an excellent rundown on the massive inflationary expansion of money driven by cheap credit following the 2001 recession. What I found so interesting was how inflation is critical for the survival of the system:
The system is in a crisis because it cannot longer create the money via lending, legitimate or no, to service the existing debt. People can't pay their existing debt, much less take on additional. The system is choking up.
And so this is why I think its less about a lack of confidence, but really real crisis that seems to be leading to recession (view the atrocious housing numbers). Mish at http://globaleconomicanalysis.blogspot.com/ has offers an excellent post, Moonbats Active Again in Massive Jobs Disaster, explaing how in fact the housing numbers are actually much worse than the 4.6% unemployment number show.
The growth of the money supply via credit has hit a wall. We're getting right now high inflation, with more to come in the near term. How long can the system resist the downward pull of the deflationary depression ? The lesson here again is that whether or not we can attribute the current crisis to high energy prices, the fact that the end of growth spells the end of credit expansion spells system economic crisis is very likely to be what we would see if it were.
Hi Stoneleigh,
Thanks for the great roundup articles on finance.
I've noticed you raise the spector of bank runs on more than one occasion. Can you expand on that. Do you expect people to go and pull out possibly hundreds of thousands or millions in cash? What would a bank run look like?
-Don
I expect people to try to withdraw cash, and to find that it is not possible to do so, beyond the first few anyway. I doubt if banks have even as much as 1% of their depositors money to hand back to those who ask for it, and deposit insurance won't be worth the paper it's written on if the problem becomes widespread.
Bank runs are self-fulfilling prophecies in that fear of not being able to cash out drives more people to try to cash out at once, and it is that which causes the bank to close its doors. In the 1930s, banks did not close until 1933 when the market bottomed, but I doubt if we will have that long to wait this time.
Hi Stoneleigh,
In 1933 personal transactions were all in cash or check, now there are cash cards (debit cards) how do you think this device will be affected by or effect a bank closure? Did check transactions still work in 33?
BTW what the H. do you plan to do for Halloween? It will have to really go some to top the past month's economic stuff.
Then again, maybe that will be easy as falling off a log jam#:)
Stoneleigh, another question if you please:
If I hold a solid metal loony what fluctuations in buying power will it have, in your estimation, over the next twenty years? Maybe consider it in the purchase of a Coke? Right now the local Gasateria sells a bottle of it at about 2 bucks, so that's about half a bottle for my dollar now. How is my bottle going to look in retrospect during those fluctuations, half empty or half full?
I would expect money to increase in value relative to goods and services during a deflation, so your loonie should do well initially. If you are one of the few who sill have money during a deflation, then an awful lot of things will seem very cheap. During the depression, people were forced to sell all manner of assets to pay debts and living expenses, and with so many things offered for sale and so few buyers willing to part with precious cash, prices fell off a cliff.
After the deflationary phase things get considerably murkier. No one can give you chapter and verse on purchasing power over the next 20 years. My guess is that deflation and a derivatives meltdown will eventually destroy the current system of global financing. If the propspect of international financing of government budget deficits no longer exists, then governments may well be tempted to fire up the printing presses (as opposed to manipulating the cost of credit in order to stimulate borrowing and lending as they do now). At that point the dollar would go the way that all fiat currencies go eventually. We could see deflation followed some time later by hyperinflation (my guess would be about 10 years later, but that's pure speculation).
I think there's a significant potential for disruption of most kinds of transactions. In a full-blown credit crunch, I wouldn't expect to be able to use either credit cards or debit cards, or to be able to access funds in a bank, beyond perhaps a small maximum amount per week. Exactly how bad the worst of the disruption gets and how long it continues for is anyone's guess at this point. I would suggest you have some cash on hand to tide you over - probably enough for several months if you can manage it.
I don't expect things to return to what we presently consider normal even once the dust has settled. Easy credit the like of which we have become accustomed to (and dependent on) is an exceptional historical anomaly. Manias that produce these kinds of conditions are very rare and I wouldn't expect to see another one in my lifetime.
Thank you very much Stoneleigh,
I am digging a hole under the old apple tree as I type, all I got to do then is find the fiat to throw in it:(. Had a Fiat once, I didn't have to dig a hole for it, it did it itself. But that's another story the likes of which I wont see in my lifetime again. Painted a sort of picture of it and called that 'The final Ride of the Last Candy Apple Red Convertible'. Yes I know it's a long title but the picture was largish too and as far as cars go I gave it that long title as I rather liked it. I think mainly because when you leave the top off a car it is sort of like being in the great out of doors, real cowboyish and so not half bad.