Saturday, 31 January 2009
The fact that it now appears that Obama's new crew still cannot bring themselves to accepting the losses that are inevitable suggests that world leaders are still in a state of denial, and that the financial turmoil will continue.
Friday, 30 January 2009
This is yet more evidence that a rather concerning wave of anti-globalization and protectionism is beginning to emerge as the recession deepens. Statements by Gordon Brown about wanting to promote British Jobs for British Workers over the last few years have once again come back to haunt him.
This is the same man that has claimed that his stewardship of the British economy over all of the years when he was the Chancellor had eliminated the boom and bust culture that was endemic during the prior years.
While it is not too surprising to see these kinds of "nationalism" arising as more people are losing jobs, homes etc. there is the possibility that jingoism and the politics of exclusion and division may try to exploit this growing anger.
I quite like this comment from Arianna Huffington who is at Davos
Yesterday, I wrote about the aura of contrition surrounding the financial types here, wafting off them like cheap cologne on a disco Lothario. Today, at a gathering of international editors and reporters, the contrition had spread to financial journalists. There was the sense that many had missed the boat, failing to ask the tough questions. The widespread contrition is matched by an unnerving feeling of paralysis. The people here -- and we are talking about some of the most influential people on the planet -- seem at a loss about how to attack the financial crisis. It's as if we are watching things unravel -- but are powerless to stop the unraveling. If bankers and politicians were stocks, Davos attendees would be shorting them
The very pronounced tapering triangle formation shows that the Nasdaq 100 index (^NDX) is approaching a point where market players will have to make a tough decision.
Traders may, understandably, want to postpone a major test of support and resistance until the dust settles with respect to all of the initiatives being discussed by the new administration. However the charts are suggesting that wiggle room is disappearing.
There are a lot of problems mounting up for the Euro-zone.
Yesterday France came to a standstill in a day of protests – even tear gas used in Paris last night.
Ireland is unraveling – downgraded public debt, real estate plunge – latest joke is - What’s the difference between Ireland and Iceland – one letter and about six months.
On a similar note - What’s the capital of Iceland? About $3.95.
Greece is in disarray – Berlusconi is a very opportunistic politician – keeps hinting that Italy would be better off outside the euro.
Interestingly sterling is finding a bit of bid whereas the euro isn’t. Some are even suggesting that nervous Europeans are looking at moving into sterling because of scares about the possibility of a crisis in the whole framework of the European Monetary Union – officially what keeps the whole single currency afloat.
Perhaps some of these issues are being factored into the price of gold which is looking more likely to head back to $1000 an ounce again.
Thursday, 29 January 2009
The recent discussion here about the KBW Banking Index (^BKX) received further validation in trading yesterday. The 14% plus rise in the index has now provided, at least for the time being, a positive divergence which suggests that the sector has further gains ahead. I would not expect this to be a smooth ride at all and there will almost certainly be significant reversals. One of the topics that I have discussed in length in Long/Short Market Dynamics is the fact that gaps are often found in clusters. Yesterday’s big upward gap for the KBE fund which tracks the index as well as several of the major individual banking stocks was encouraging but the clustering of gaps phenomenon shows that there often co-occurrences of big upward and big downward gaps associated with significant turning points.
Wednesday, 28 January 2009
Making any positive comments about the technical state of the banking sector has not been advisable for a very long time for those analysts keen to preserve their reputation for any forecasting skills. So it is with much hesitation and qualification that I shall merely point out that the KBW Banking Index (^BKX) is revealing evidence that a basing price and a basing MACD pattern may be evolving.
Even more noteworthy, if the basing patterns are confirmed in coming sessions, would be the fact that in this instance the MACD would not have moved to a new low in terms of its emerging base.
This would be in marked contrast, if it happens, to the situation where the MACD confirmed, from a momentum perspective, the price low which was achieved back in November.
Evidence is emerging that the "Masters of the Universe" are listening closely again to their public relations handlers as it has been announced, in the last day or so, that the leading lights from Barclays, Citigroup and Goldman Sachs are all staying away from Davos in 2009.
Not surprisingly this year's World Economic Forum in the Swiss mountains will be primarily attended by politicians, presumably being advised by their spin doctors that it is good for politicians to look very busy during these very troublesome economic times.
Anyone planning to go ski-ing in the Davos locality over the next few days should be extra vigilant as there is an increased likelihood of avalanches as a result of all of the hot air emanating from the conference.
Despite all of the intellectual sophistication on hand at the Fed, changing the fed funds rate from time to time seems like a rather blunt and simplistic way of regulating monetary policy. The shadow banking system exploited this poverty in policy instruments and were the real force that determined the monetary environment during most of the last years of the Greenspan era.
Tuesday, 27 January 2009
Monday, 26 January 2009
The situation reminds me of the, perhaps apocryphal, story of when T-Bond Futures contracts were first introduced on the floor of the CBOT back in the 1970's.
The soybeans traders were initially puzzled - Do these T Bond futures go up and down?
When they saw that they did they immediately knew how to trade them
Sunday, 25 January 2009
There were some suggestions on the charts that Tuesday’s (Jan 20) sell-off lacked the conviction of the November sell-off.
The numbers that the taxpayer would be effectively underwriting in the bad bank would be staggering but the private sector might look at banking stocks again if they know that they only have to worry about an economic recession rather than a financial meltdown.
To redress this and to see a new momentum/panic low we would almost certainly need to see yields below 2% which could happen but seems a bit of a stretch.
By way of illustration, last week there was a noticeable lack of interest in the German Bund auction with the Bundesbank retaining 32% of the issue. The US government was able to sell a huge new issue of three year bonds with a bid to cover ratio of 2.2:1, which admittedly was somewhat weaker than the average bid to cover ratio, but nevertheless it turned out a lot more successfully than the fears that are beginning to surface in the eurozone market. In addition the UK government in coming months will almost certainly face similar difficulties to those seen in Germany last week as it tries to finance its massive deficits and has to rely on international investors' appetite for a currency which is arguably even less robust than the euro.
Perhaps we should expect that, Too big to fail will begin to emerge in the way that sovereign debt is valued and allocated in global capital markets.
Of course the ultimate beneficiary in that kind of struggle will be the US Treasury. With foreign governments holding trillions of dollars worth of US government debt - both explicitly underwritten and agency debt that has an implicit guarantee – these governments can be relied upon to show up at US government auctions, even if they do bear a remarkable similarity to a Ponzi scheme.
The big difference to other Ponzi schemes is that the existing clients of the US Treasury market have vital self-preservation interests at stake that will cast aside any nagging doubts about the wisdom of continuing to feed new money to this voracious financial beast.
That’s the good news.
The bad news is that the price that will have to be paid in terms of yields offered by the US Treasury will have to go a lot higher. Whether this all leads to a systemic breakdown and hyper-inflationary collapse I shall leave to those with a more apocalyptic imagination.
The one thing I am pretty confident about is that if the dollar collapses along with the Treasury market then there are not going to be too many safe places, where the rule of law is respected, to hide, and not even possession of gold bars is going to provide much of a security blanket
Routine banking businesses should be run like utility companies. Nothing sexy, no corporate jets and no great surprises when they release their earnings statements.
Creative banking should be separated into different entities for those who prefer high risk/possibly high reward investments but the taxpayer should never be exposed to their inevitable misjudgments.
Not a very pleasant process and it will take a very long time - maybe that's what the policy makers are hoping for i.e. it will take so long to ascertain just how scary the number is that they will have exited their positions and be enjoying their lavishly endowed pension plans.
Let's translate this through into a problem that I see arising for the typical home owner on an adjustable rate mortgage. The declines in interest rates currently payable on tracker mortgages is surely at a major inflection point but those who want to get out of their property obligations before a steady increase in their mortgage payment outgoings becomes an established trend are going to feel "trapped" by the current low valuations on real estate.
When the uptick in mortgage rates becomes widely acknowledged there could be a lot of homeowners who will try to time their exits from their property commitments at the first evidence of an upward turn in prices...which, of course, will be self-defeating for some considerable time as the recovery attempts to gain traction.
- U.S. (and UK) governments should provide an irresistible deal to the banks to dump all of their bad assets into a public warehouse at prices and with terms and conditions that they will fall over each other to obtain.
- US Treasury/taxpayers will be on the hook for trillions of dollars for several years – not really such a big problem as foreigners will always show up at US Treasury actions ensuring that the US will not default. (Alas same cannot be said for the UK)
- Policy makers should engage in lots of tough talk about stringent rules on capital adequacy for the private sector banks, greater oversight etc.
- Continue to pay meager salaries at the regulatory agencies ensuring that they are staffed with people that aren’t quite cunning enough to make their fortunes in the private sector.
- Once liberated from the dead-weight of all the CDO's and other exotic bits of paper, the newly confident banks can be expected to do an excellent job of of reflating the economy.
- Eventually there will be another asset price boom, especially in real estate.
- The bad bank warehouse can then upload all of the assets, previously described as toxic but now attractive again, back into the private sector
- That process should keep us all occupied for a few years and allow the current policy makers to look good, some investors with good timing to make a killing etc.
- Eventually the ensuing boom will go bust
- REPEAT steps 1 through 10
As reported in the Guardian newspaper on January 22nd 2009:
Failure to participate in the formation of the new Taskforce on Financial Integrity and Economic Development, launched in Washington DC this week, is part of a pattern of UK opposition to key financial transparency reforms. Richard Murphy, the forensic accountant who is a key member of the taskforce, said: "The UK was invited to participate. They haven't and they show no indication that they will engage with this. Other European partners are interested and we've seen what's happened in the States. It's obvious Obama is interested yet the UK remains coolly indifferent."
If the Obama administration and the Europeans, especially the French and German governments, are serious about cracking down on the labyrinth of offshore tax havens and the conduits that allow corporations and individuals to avoid paying tax and having to be transparent about their accounts, this will put them on a collision course with the Brown government. UK governments have for years have remained intransigent on the idea of cleaning up all of the offshore wheezes that favor the City of London.
Mr. Brown has paid lip service to the need for greater transparency and his government has made token gestures to supposedly address the anomalies of the non-domicile rules whereby a person can live and work in the UK for many years and yet, if they can claim to be non-domiciled, only have to pay taxes on that portion of their global income that is brought into the UK for pocket money. There is even the egregious situation where members of Parliament in the UK have claimed and been able to maintain non-domicile status, and thereby avoid having to pay their fair burden of the taxes that they, as legislators, impose on all other UK citizens.
UK governments, of both parties, have shown no interest in dismantling the “supportive arrangements” that encourage foreigners to want to conduct business in London. Indeed during recent years when the City was booming it was often claimed that the regulatory “light touch”, which included keeping quiet about the UK’s special neo-colonial links to many offshore financial centers, had been of great benefit to the overall UK economy.
We shall have to see how firm Mr. Obama is about his desire to tackle offshore shenanigans, but if he is serious he will find that he will almost certainly bang heads with policymakers in the UK. Mr. Brown and his successors will fight very hard to protect London’s appeal as a financial center by continuing to turn a regulatory blind eye to all of the various financial strategies that are favorable to corporate structures that integrally involve tax- havens, and which have been nurtured as part of London’s financial infrastructure over many years.
Friday, 23 January 2009
The webs that have been spun are for too complex to unravel and that is why governments are unable to implement a bad bank or ring fencing of the bad assets. Having to declare the magnitude of this mess, in all of its glory, might just be too much for Joe taxpayer to digest.
Wednesday, 21 January 2009
Yesterday the S&P 500, having failed to regain its footing above 850 last week took the path of least resistance which is to re-test the lower boundaries of the trading range that has been in place since the November low.
The suggestion that markets reacted poorly to the new President's oratory is part of the journalistic need to find some kind of narrative to "make sense" of beneath the surface market dynamics.
While on the topic of Mr. Obama's speech - the one thing that struck this contributor, who watched the events in Washington from the UK, was the man's desire to refrain from the usual politician's posturing. He knows that the things he has to deal with are immense and complex but rather than displaying false bravado and a show of contrived confidence he seemed very down to earth about the task ahead. He is a man who seems not to believe in all of the Obama hype unlike most of the people who, unfortunately, will be surrounding him.
Monday, 19 January 2009
While the US economy may be at an inflection point so are the economies of everyone else and it is hard to see a real rival to the greenback in the forseeable future. Although the Euro is just celebrating 10 years of history there are some very awkward divergences within the eurozone economy that could make it difficult to continue with a single central bank and monetary policy for the diverse set of states that have adopted the Euro.
Sterling is hardly a contender and I suspect that looking towards the Japanese yen as a reserve currency would have even more damaging unintended consequences than staying with the dollar
It does not look feasible for the Chinese currency to take on any leadership role until it develops much greater depth in its capital markets which is probably a generation away at least.
There has been a lot of commentary about the reasons why so many of the experts did not see the coming crisis and many well documented examples of the irresponsible and negligent failures of those should have been managing risks for the banks and the financial services industry. What is far less commented on is the fact that the underlying financial theory of risk and the probability of financial accidents arising is not just wrongly conceived, but dangerously so. None of us, including the test pilot, would entrust our lives to a new airliner which had not been robustly stress tested under the most extreme modelling conditions for aerodynamics and metal fatigue etc. and yet financial products were sold that not only were not thoroughly tested but, in assessing the likelihood of accidents or failures, the financial engineers used the wrong modelling techniques.
There is a serious conceptual problem in modelling a financial product with techniques from the physical sciences because of the sudden and dramatic discontinuities in financial time series data. Sharp gaps and other severe dislocations show that price, and economic behavior in general, cannot be adequately represented as following a trajectory which can then be analyzed in any standard statistical theory. One of the most severe consequences of this conceptual error is the fallacy, which has been more than amply demonstrated by the current financial meltdown, that the probability of large moves in asset prices can in any sense be mapped according to any kind of normal distribution, Gaussian or otherwise.
A simple example can illustrate the inappropriateness of standard statistical theory to the world of finance. There is no meaningful sense to even estimate the probability of discovering a man who is 25 standard deviations from the average height of male human beings, and yet in a well known quote by a senior Goldman Sachs executive who, when asked why one of their funds had lost more than 30% during the onset of the financial crisis, is reported to have said
“We were seeing things that were 25-standard deviation moves, several days in a row. There have been issues in some of the other quantitative spaces. But nothing like what we saw last week.”
From this quotation alone it should be clear to orthodox risk managers educated within the traditional notions of academic finance theory, that there is something profoundly ill conceived with using probability theory based upon a normal distribution, and all the Value at Risk baggage that comes with it, in order to quantify risk in portfolio construction and risk management.
What is needed is a new foundation for the understanding of how to quantify risk and the likelihood of financial collapses and contagion. There have been some promising developments in this field by writers such as Mandelbrot, Hyman Minsky and even Nassim Taleb but the field is still in its infancy. Perhaps there is no underlying logic to financial behavior and that we have to accept that financial meltdowns are as unpredictable as massive earthquakes. But the fact that many people did see our current “falling off a cliff” coming suggests that we may be in a much better position than seismologists.
Sunday, 18 January 2009
Apart from the obvious issue regarding the conflict of interest where S&P, Moody's etc were paid by the issuers of the instruments rather than the purchasers - (where does the fiduciary responsibility reside in this situation?), there is the larger problem which is what models should the credit ratings agencies have used to properly estimate the risks of complex derivatives?
If the intellectual/academic framework for modelling financial asset prices and in turn the likelihood of crises and contagion arising is deeply flawed - which it is and which ultimately must be attributed to sloppy thinking by orthodox academics and teachers of finance - where should we be looking for prudent advice about how to price these instruments?
The comment by Ferguson that "The average investor relies on the rating agencies to use experience to evaluate risk." highlights the troublesome nature of the role of credit ratings agencies. There should be a government warning - similar to that seen on tobacco products - that relying on assessments of risk by such agencies can be hazardous to your wealth.
Continuing to believe that there are bankers that walk on water is an indication that as a culture we are still in the denial phase regarding the severity of the financial crisis.