A rising wedge chart pattern and the folklore about "Sell in May and go away"

There is a rather interesting similarity emerging from a technical perspective on the chart for the S&P 500 now and the chart from almost exactly one year ago. It could add some credence to the old market adage of Sell in May and Go Away
The first chart below shows a rising wedge pattern that culminate in mid May 2008 with a blow off, as signalled by the shooting star pattern on May 19th, as marked on the chart. This preceded a severe downturn in the overall market which brought the S&P 500 down by approximately 15% over the following two months.



The daily chart of the S&P 500 below is where we stand at present with a simple projected version of the rising wedge pattern going into May. It is possible that we could get another blow off pattern at almost any time - even possibly today (April 30th) if the S&P 500 fails to hold above 875. Perhaps more tantalizing is the possibility that we extend further upwards towards the 935 area which was seen in January 2009, and which would take us probably into the mid-May time frame, and an almost identical chart configuration to that seen exactly one year ago.

Underwhelming commitment to police risky financial products

The Securities and Exchange Commission (SEC) issued a press release today (April 30) announcing that it is looking to hire "seasoned professionals" to "identify and assess risks in Financial Markets"

Here is an excerpt from the press release

Washington, D.C., April 30, 2009 — The Securities and Exchange Commission today announced a new effort to identify and assess risks in the financial markets by attracting seasoned industry professionals to the agency's Office of Risk Assessment.

The new Industry and Markets Fellows Program will help the agency expand its ability to oversee complex industry practices and products in today's markets.

"It's a great way to bring in highly-seasoned financial experts who can help us keep pace with the practices of Wall Street and protect investors," said Chairman Mary Schapiro. "Modeled on other successful fellows programs at the SEC, this program will help us strengthen oversight of the securities markets as they evolve, and provide industry veterans the unique opportunity to help us restore confidence in the markets."

Further on in the press release it talks about the kinds of skills and background that the commission is looking for

The SEC is seeking individuals with extensive experience in financial markets and in-depth applied knowledge of current industry practices. Relevant experience can be a result of work in a variety of industry segments, including but not limited to experience in trading in equity and fixed income securities, structured products, complex derivatives, financial analysis and valuation, fund management, investment banking and financial services operations. The Program is open to different types of professionals, which may include attorneys, economists, accountants, risk professionals and other experts in the securities industry.

The release also states that the immediate requirement is for three fellows and as the SEC says "Salary is commensurate with experience. In 2009, salaries for Industry and Markets Fellows range from $108,286 to $227,300."

It is worth putting this announcement into some context.

1. The estimated losses from structured products and other "complex instruments" where the risks were miscalculated, underestimated, misunderstood or all of the above, run into trillions of dollars.

2. The salaries of many of the "quants" that devised these products and the front office guys that sold them would be best measured in terms of millions of dollars.

3. Under this current SEC hiring plan the US government is making a whopping investment of perhaps little more than one half a million dollars to engage three "seasoned professionals" to help police this vitally important and hazard prone area of the financial economy.

4. Even though a lot of experienced professionals will recently have come onto the job market the salary seems unlikely to attract the brightest and most wily minds.

5. The best way to think about this is in terms of a very one-sided Intellectual Arms Race between Wall Street firms and hedge funds, hiring the most talented individuals capable of engineering the most exotic and opaque products possible, versus a public sector agency that will find it hard to entice the most driven and aspirational recruits with the remuneration being offered.

To put it politely the announcement is underwhelming.

Real estate prices and rentals out of sync

This simple graph from Nomura reveals how an index of rentals and sale prices for residential properties in the US moved completely out of sync during the first few years of this decade. The base for the index is Q1, 1991 and as can be seen the correction is clearly under way.

Although there is no compelling reason why the two indices would have to move back into sync with each other, the chart does demonstrate that to restore the previously consistent alignment between the two variables, home prices would need to retreat by another 20%.

Selling a 30 Year Treasury with a 4% coupon in a harsh environment

For those non-specialists in fixed-income mathematics (which includes myself) who do not have access to a more sophisticated modeling tool, Excel has a simple function to assess what would happen to prices in the secondary market for a 30 year bond with a current coupon on it, if the yield to maturity has to rise to reflect weak demand, high inflation or increasing skepticism that there is the political will to ever pay off the public sector debt - or, as could be the case, all three of those taken together.

The function is part of the financial set and called PRICE. It takes several parameters that are explained in the Help on this Function in Excel, and it is possible to see how much a long Treasury bond with a 4% coupon would drop in price if it was required to yield say 8% to maturity.

The following example is deliberately a simplification of the matter - so the professionals in this area may want to move on to another article now - in a number of respects.
Primarily the setup below assumes that the calculation of the re-sale price is being made across the whole life of the bond - whereas some time would obviously have to elapse before the required yield would have to go to the presumed 8%. However even making allowances for that the results are not dramatically dis-similar to those shown below.

Entering the following parameters into the PRICE function in Excel would produce the result for a 30 Year bond with a 4% coupon that had to yield 8% to maturity

Settlement date 15 May 2009
Maturity date 15 May 2039
Percent semiannual coupon 4.00%
Percent yield 8.00%
Redemption value 100
Frequency is semiannual 2
30/360 basis 0

The secondary market bond price for the above set of parameters would be 54.75

In other words the re-sale value of the bond would be just 55% of what was paid for it at issuance.

Huge supply weighing on 30 Year Treasury Bonds

Supply is weighing heavily on the U.S. Treasury market and yields across the spectrum moved up yesterday. This was especially noteworthy at the long end of the yield curve as the 30 year bond yield moved up to levels not seen since last November.

Closing with a yield just below 4% the chart above shows that a large gap from November 19th could be in the process of being filled with a move back above the four percent threshold. This will add further concerns for the Fed and the US Treasury about their continued ability to navigate their way through the massive re-funding operations that are now required to finance the deficit and structural US public debt.

Monitoring the action in the Treasury complex will be at the top of many investors' agenda in the next couple of weeks as further evidence of deficient demand for the more than $70 billion worth of new securities to be auctioned would be a worrying development for the policy mentors, especially Larry Summers who appears to be the most optimistic about steering the massively subsidized recovery through a benign interest rate environment.

Viral networks and fragile risk control systems.

It seems that the world is being treated to constant reminders of its own fragility and the susceptibility to hazards with far reaching consequences. This article hits home at the lack of preparedness in regard to the possibility of a swine flu pandemic.

The swine flu may prove that the WHO/Centres for Disease Control version of pandemic preparedness...belongs to the same class of Ponzified risk management as Madoff securities. It is not so much that the pandemic warning system has failed as it simply doesn't exist, even in North America and the EU.

Maybe a little too clever to tie in to the Madoff fiasco but in terms of highlighting the fallibility of a culture which prides itself on its "risk management" capabilities the point is valid. The one thing that is frighteningly clear about the severity of the ongoing financial crisis and the magnitude of a potential crisis from the flu outbreak is just how virally inter-connected we all are.

Nikkei and DAX suffering most in fear of flu pandemic

Charts today for The Nikkei 225 and the DAX in Germany shows that the leading export based economies would perhaps be most immediately affected if a flu pandemic causes further consumer retrenchment. This would only augment fears that any recovery in business momentum, already somewhat fragile, would have even more adversity to contend with.

This adds additional emphasis to the point that I was making in one of my posts yesterday about the weakness in the Larry Summers' notion that economic crises can be separated into discrete episodes. The point is not so much that swine flu may turn into a pandemic - let's certainly hope that it doesn't - but rather that once a system becomes vulnerable and exposes a weak link there is a danger that some other de-stabilizing factor will emerge to prolong and accentuate the crisis.

The chart above for the Nikkei is not looking at all constructive at present with a break down from the uptrend in place since early March now clearly visible.

Should the Japanese index fail to find support around the 8300/8400 level this could trigger a rather abrupt drop to lower levels last seen in March.

Will there be a mass exodus of London's market wizards?

The City boys (London's financial wizards) are not at all happy about the recently announced change to the UK tax code whereby for those earning more than £150K per year (approximately $225,000 in real money) the marginal rate of tax from next April onwards will move from 40% to 50%.

The following quote comes from a column at a UK based financial information site (and thanks to Alex for the tip). The columnist interviewed a City trader who had the following to say about the tax hike:

'The Institute of Fiscal Studies has already told these idiots that raising tax in this way will result in less revenue, not more. They just don't get that market professionals have portable careers. People and firms do not need to be in the UK to ply their trade. What with the further raid on pensions and national insurance, we now have a lousy tax regime to go with the lousy weather and the lousy state of public services. The only reason to stay is the Premier League,' he continued, 'Although, as Wenger has said, all the best players will soon be off to Spain and Italy - where they will pay significantly less tax! London will soon be a place when only crappy football players and modestly-paid back office professionals work'.

While it would be rather "blokey" to agree with such sentiments it is also not blindingly obvious why the average UK citizen would be too concerned about a mass exodus of those with "portable careers" who hold similar views.

Cleaning up messes left by banks - a nasty job but for the US Fed or for the IMF?

James Kwak makes some interesting comparisons between the recent financial crisis and the situation that US banks found themselves in the 1980's when Latin American debts were piling up in a systemically calamitous fashion. Nicholas Brady, who was Secretary of the Treasury from the end of the Reagan administration and the entire first Bush presidency, and the man for whom Brady bonds are named, has some observations about a possible structure for the financial system in the future.

Kwak quotes Brady as follows in this piece

I believe that we need a simpler system centered on deposit-based banks. Under this approach, individual accounts in the depository banks would continue to be protected up to $250,000 and these banks would have access to the country’s central bank. These institutions would not be allowed to participate in markets involving inordinate leverage or equity transactions that would risk their deposit-protecting charter. In contrast to the current mode, when asked what their primary purpose is, the banks’ chief executives wouldn’t talk first about shareholder return. Instead they would stand up and say: “Our institution’s primary purpose is to repay the depositors’ money.” . . .

The highly innovative shadow banking system with its mantra of lower transaction costs, which would continue to introduce new concepts, would fund itself from the money markets and other sources but without federal guarantees and access to America’s central bank. Institutions that currently straddle the two funding markets would have to choose which type of business to pursue.

Mr Brady's separation of the two kinds of banking sounds very sensible at first glance. But can banking and financing activities be segregated so that there is no point of contact between the two where the first set of boring banks rely on guarantees, explicit or implicit, from the more exciting shadow banking system?

There surely will be a grey zone at the interface between the two -and if the shadow system continues to conduct business in a similarly reckless fashion to the status quo ante then the same systemic problems could arise yet again as troubled assets and counter-party obligations end up being intermingled amongst the two different kinds of banks.

It's one thing to say that the shadow banks will have no federal guarantees or safety nets but when things start to go wrong and markets seize up through illiquidity will the government really take a hard line and not come to the rescue. This is especially the case if the shadow banks have cross border risks with currency instability implications.

It may come down to a choice between a Fed/Treasury clean up operation or a supra-national (IMF?) clean up operation.

I doubt whether we would see too many hands go up if we asked who favors the latter

Do crises cluster? If so it could be a problem for Larry Summers' solution to the debt crisis

In a recent article Simon Johnson provides a very interesting summary of what he takes to be the cornerstones in the thinking of Larry Summers about the current financial mess. There are five key components to the Director of the White House National Economic Council's perspectives, as spelled out in a speech that Summers gave last Friday, and Johnson, who has analyzed the speech, outlines them below including, in parenthesis, some comments of his own.

1. All crises must end. The “self-equilibrating” nature of the economy will ultimately prevail, although that may take massive one-off government actions. Such a crisis happens only ”three or four times” per century, so taking on huge amounts of government debt is fine; implicitly, we will grow out of that debt burden.

2. We will get out of the crisis by encouraging exactly the kind of behaviors that “previously we wanted to discourage” two years ago. It is “this insight, this view” particularly with regard to leverage (overborrowing, to you and me) that “undergirds the policy program in the United States.”

3. There is a critical need to support financial intermediation and to ensure it is adequately capitalized, with a view to the risks inherent in the current situation. He then said, with a straight face, that the current bank stress tests are designed with this in mind.

4. Growth in the 1990s and more recently was based too much on finance (this appears to be a relatively new thought for Summers). The high and rising share of finance in corporate profits “should have been a warning”. The next expansion should be based less on asset bubbles and more on investment in key public services.

5. The financial regulatory system “in fundamental respects has been a failure”. There have been too many serious crises in the past 20 years (yes, this statement was somewhat at odds with the low frequency of major crises statement in point 1).

The one that bothers me the most is the first. There is always a danger when considering crises - not only financial but also natural disasters - of thinking in terms of periodicity i.e. that is the reasoning behind the view of Summers that they only come along four times in a century. From this it seems to follow that since we've had the big one we won't get the next one for a generation or so. There are several problems with this view.

Firstly the sample size is too small for any meaningful application of quasi-statistical techniques to determine for example the average period between crises or the dispersion of them. We have so little to go on with regard to how they are distributed and it would be foolish to have the presumption that they are periodic and normally distributed. Just like earthquakes there is no safety in assuming that there could not be two major quakes on a fault line in quick succession even if there has not been a large seismic event for much longer than the alleged time to wait period.

How does one discretize or individuate a financial crisis? What of the 1930's - was that a single crisis event or a series of inter-related critical events?

From several academic studies of major disruptions in time series data, there is a strong case for believing that critical episodes of illiquidity and volatility have a tendency to cluster rather than to be evenly distributed across the time spectrum.

In my opinion it would be very unwise to assume that we've had our crisis and now - as Larry Summers appears to be suggesting - have a breathing space to re-build our economy and repay our debts. There might be another leg to this crisis - indeed there could be several more.

The fact that, even if turns out that we do have a breathing space, we might not take the opportunity to re-build our economy and pay back our debts - for lack of political will for example - is of course a different topic.

US Foreclosures concentrated in five states

The image above reveals the extreme concentration of foreclosures in the US, with most of the distress being felt along the entire west coast, the desert south-west and Florida.

In fact according to this very good article from Todd Sullivan, sixty percent of the foreclosures in the first quarter of 2009 were in just five states. The ones with the darkest reddish brown colors on the map.

Also in terms of the overall situation with regard to the housing market the following extract from the article cited is very illuminating:

IRVINE, Calif. – April 16, 2009 – RealtyTrac® , the leading online marketplace for foreclosure properties, today released its U.S. Foreclosure Market Report™ for Q1 2009, which shows that foreclosure filings — default notices, auction sale notices and bank repossessions — were reported on 803,489 properties in the first quarter, a 9 percent increase from the previous quarter and an increase of nearly 24 percent from Q1 2008. One in every 159 U.S. housing units received a foreclosure filing during the quarter....

“In the month of March we saw a record level of foreclosure activity — the number of households that received a foreclosure filing was more than 12 percent higher than the next highest month on record. Since much of this activity was in new foreclosure actions, it suggests that many lenders and servicers were holding off on executing foreclosures due to industry moratoria and legislative delays,” said James J. Saccacio, chief executive officer of RealtyTrac.

IMF joins the queue to issue bonds - so much for the Trillion Dollar headline

The One Trillion Dollar Headline for the IMF's future funding on the G20 press releases is already in trouble as the following news release makes clear. The IMF is now joining the queue to sell bonds to raise the money that was "pledged" at the meeting at the beginning of April in London.

WASHINGTON (AP) -- The International Monetary Fund will sell bonds as a way to raise funds to lend to struggling nations, the head of the organization said Saturday, in a victory for developing countries.

Emerging economies such as China, Brazil and India pushed for the move as an alternative to providing longer-term loans to the IMF. Those countries want a greater voice in the institution before providing additional resources.

IMF Managing Director Dominique Strauss-Kahn said China and other countries have expressed interest in purchasing the bonds. The IMF has never issued bonds before, although the idea was explored in the 1980s.

The move, announced after the IMF's annual spring meeting, indicates the world's leading economies are having difficulty following through on a pledge made in London April 2 to boost an IMF emergency lending facility by $500 billion. The bonds will contribute toward that goal but will provide shorter-term financing than the loans that Japan, the European Union and the United States have promised.

The final paragraph makes clear that one of the alleged positive contributions that arose from the G20 gathering was actually little more than a catchy headline where all of the heavy lifting still has to be done.

Could Bernanke and Paulson be prosecuted under SEC laws?

According to American Public Media's interview with a former SEC chief accountant, Lynn Turner, both Ben Bernanke and Henry Paulson could have committed serious violations of securities legislation

Here is the comment:

If Henry Paulson and Ben Bernanke really told the CEO of Bank of America to keep quiet about losses at Merrill Lynch, they were probably breaking the law. That's according to Lynn Turner, former chief accountant at the SEC

Heard on the audio clip, Lynn Turner expresses the view:

If these allegations are proven true, both Bernanke and Paulson should be prosecuted by the SEC to the fullest extent of the law.

Sorting out the toxic assets and the Anglo-American financial axis

In a rare act of candor, almost amounting to schadenfredue, one G7 finance minister appears to be lecturing the US on how to sort out its legacy assets problem. As reported today, in connection with the G7 meeting being held in Washington, Alistair Darling, the UK Chancellor, is quoted as advising Tim Geithner to hurry up with cleaning up the toxic asset problem.

According to the article he is quoted as saying:

"I recognise that the US Government is committed to sorting out the American banks' balance sheet problems. I recognise the political difficulty any government has when people ask 'why are you doing all this for these banks?' but the fact is that we need the banking system.

"We need an effective, functioning banking system, and we need to kick-start credit and that means you've got to sort out these toxic assets, so I hope the United States can make progress as fast as it possibly can. It is an absolute imperative."

So how good is Mr. Darling's form on this matter and what gives him any license to provide such outspoken advice? Surely, within the context of the worst performance by a G7 economy and the worst state of the UK's public finances in 60 years, this is a dreadful time for the Chancellor to be lecturing his US counterpart.

Let's see.

The UK government has taken a different stance with respect to the problems on its domestic banks' balance sheets. Through its Asset Protection Scheme, it has effectively insured the banks against any losses (or at least 90% of them) if these have to be realized in the disposition of their troubled assets.

This approach has two obvious differences to the current approach of the US government.

Firstly, the UK approach is effectively an insurance underwriting provision where the size of the claim that may have to be paid out is not only unknown but may, at the moment, be essentially unknowable. However it does not have the same impact as say nationalization where the magnitude of the "bad debt" would have to be acknowledged and taken fully on to the public balance sheet - as was done in the case of Northern Rock for example. It has the one quality, that may be the ultimate finesse of the problem at hand, which can be summed up in the phrase "Don't ask and don't tell"

Secondly, it is a very simple approach which does not require anything like the complex procedures envisaged under the PPIP scheme that has been floated in the US. In fact the lack of any need for immediate action and follow through is what makes the APS so appealing. Nobody is expecting the matter to be resolved in the short term and the government is effectively "off the hook"

The US approach, as far as it is possible to understand at the moment - it is a rather movable affair - is based upon the following three initiatives

1. The stress tests - which will presumably advise on those banks with insufficient capital based upon the TCE test (not entirely transparent what that is yet)
2. The recent changes in the FASB fair value marking protocol
3. The PPIP scheme which is designed to allow some form of price discovery on the real values of the legacy assets through a rather complex private sector/public sector procedure where the risk/rewards are heavily skewed in favor of the private sector participants (assuming that there will be any such deals done)

As I commented earlier today in regard to an article by Felix Salmon

The timing of the three separate initiatives - stress test, FASB change and the PPIP could not have been planned to lead to such total paralysis unless this had been the intention! The double bind remark "Hurry up and wait" comes to mind

Reducing things to their simplest, but hopefully no simpler, it would seem that in both cases for the UK and the US - the result essentially comes down to the same thing. If the UK banks realize eventual losses from having to liquidate their toxic assets then the public sector gets to pick up the bulk of the losses. If the PPIP scheme ever gets under way then the US public sector will get stuck with the lion's share of those losses too.

So both approaches could eventually lead to the same point - a final recognition that, once the black holes have been fully eradicated, there will almost certainly have been major damage done to the national debt levels for both governments.

But surely this could impact the credit quality of the two governments and be reflected in more ominous aggregate debt to GDP ratios. Moreover this will push up the CDS rates on both sovereign borrowers, require downgrades from the credit ratings agencies and cause even more anxiety in the government bond markets.

Well actually this maybe not the case as I discussed in an article yesterday about the manner in which Moody's has reacted to the possibility of a potential downgrade to the UK's AAA rating in the light of the woeful public finances spelled out in Chancellor Darling's budget this week.

According to Pierre Cailleteau, Team MD of Moody’s sovereign risk group and as reported in this article from the FT, a safe havens’ triple-A status, “depends on two potentially unstable notions: continued public trust in government institutions, including the currency, and sustained inter-generational solidarity mechanisms.”

The most intriguing comment from the Moody's spokesman is the notion that the UK - and surely the USA would be in an even stronger position in this regard - has a "sustained inter-generational solidarity mechanism" and this would enable both governments to avoid even the tiniest risk of sovereign default - which presumably is what a re-affirmation of the AAA rating (risk free) would imply.

I suspect we would not gain a lot of clarity to pursue in earnest from Monsieur Cailleteau what a sustained inter-generational solidarity mechanism actually means other than the rather complacent notion that just like the credit ratings agencies' approach to assessing the risk of corporate defaults, there is the implicit assumption that some countries are just too well established to ever have problems repaying their debts.

Whether or not we should take comfort from the predisposition of Moody's to see no real risk of sovereign default in the case of the US and the UK is probably not really the issue at all. There could easily be endless debate about the reliability of ratings agencies based upon their recent track record and the inherent limitations of modeling techniques for measuring sovereign risk.

But at the end of the day if the ratings are not going to be downgraded, no matter what the eventual hit to the public sector balance sheets of the UK and USA turns out to be in the fullness of time, then why should there be such concern about the US being a lot more forthcoming in admitting to the true magnitude of its toxic assets?

Perhaps Mr. Darling came to his realization and expression of candor at the G7 gathering when he saw that the world did not end - and specifically that the UK does not appear to be about to lose its AAA rating - after seeing the market's and Moody's reaction to his painful budget speech.

As long as the presumption that certain sovereigns, especially the most "established", are too big to fail, the Anglo-American financial axis is unlikely to seriously change its ways.

Kerkorian's bad market timing on Ford

Kirk Kerkorian and his investment company Tracinda Investments can't be having a good day as the price of Ford shares has surged above $5 in trading today.

According to this article it would appear that he was exiting his substantial holdings in the automotive company late last year at approximately one half of the value that the stock price has today.

The inter-generational dimension to a AAA rating

A rather interesting rivalry is emerging between two of London's financial journals regarding the possibility that the UK might lose its AAA rating.

The Daily Telegraph carries a , story which carries the headline Borrowing puts UK's AAA rating in danger after Budget 2009

The article goes on to quote Arnaud Mares, who according to the article is lead analyst at Moody's for the UK:

Treasury projections that public sector net borrowing will remain above 5pc of GDP five years from now... are a cause for concern. This suggests that fiscal policy will have to be tightened much further than currently envisaged. The alternative would be that the Government chooses to live with a permanently higher debt burden which would likely have rating implications over time.

From this and other comments the Telegraph article gives the distinct impression that the AAA rating is looking vulnerable.

Meanwhile an article at FT Alphaville decides to upstage the Telegraph reporter by going to the previously quoted Moody's analyst's boss . Here is what the FT reporter Sam Jones claims Moody's really thinks about the possible downgrade

And as Pierre Cailleteau, Team MD of Moody’s sovereign risk group, and Mares’ boss, says, safe havens’ triple-A status, “depends on two potentially unstable notions: continued public trust in government institutions, including the currency, and sustained inter-generational solidarity mechanisms.”It is the latter of these that gives the US, Germany, Japan and the UK such huge room for manoeuvre. Sovereign credit risks are predicated on a whole series of qualitative as well as quantitative judgements about the strength, age, and “institutionalisation” of a country’s financial practices. That we have an age-old central banking system, a set of (mostly) sound checks and balances and a very secure financial infrastructure means that, in the top rating agencies’ views, the UK, like Germany or Japan, is well positioned relative to more politically and economically fragile peers

So it appears from the FT article and the fact that the source quoted is higher up the totem pole than the more modestly positioned Mr Mares that all is relatively safe for the UK's AAA rating.

That should be the end of the matter then. Well perhaps not.

The most intriguing comment as far as the MD of the sovereign risk group at Moody's is the notion that the UK has a "sustained inter-generational solidarity mechanism" and this should enable the UK to avoid even the tiniest risk of sovereign default - which presumably is what a re-affirmation of the AAA rating would imply. I have no idea what a sustained inter-generational solidarity mechanism actually means other than the rather stuffy and complacent notion that just like corporates, some countries are just too established to ever have problems repaying their debts. And as we all know Moody's and S&P have been very good at always getting those calls right in the corporate space.

In addition to the FT and Telegraph trying to decode what Moody's really thinks about all of this there is another amusing dimension to this story from Willem Buiter at his blogsite. Under the headline Darling is doing his best to clean up Brown’s mess Buiter, who is a Professor of Economics at the LSE, provides a good account of the dire state of the public finances in the UK and suggests that it "would behove the UK to apply for an IMF Flexible Credit Line (FCL)."
Alas it seems that the UK would not qualify for one for the following reasons:

Unfortunately, the criteria for qualifying for an FCL arrangement include “ . . . (iv) a reserve position that is relatively comfortable . . . ; (v) sound public finances, including a sustainable public debt position; . . . (vii) the absence of bank solvency problems that pose an immediate threat of a systemic banking crisis; (viii) effective financial sector supervision.” It is questionable whether criteria (iv) and (v) are met. Criteria (vii) and (viii) are obviously not met.

It would appear then that the UK is unable to meet the criteria for the kind of aid from the IMF which is usually made available to emerging and less established economies, and yet, according to the wonderful piece of waffle about "inter-generational solidarity mechanisms", it may still be considered safe enough for a AAA rating from Moody's.

There is certainly an "inter-generational" aspect to the UK's financial position but unfortunately it is the fact that the current malaise is likely to still be with the present generation's grandchildren.

UK should be stress tested

One has to wonder whether the UK economy and Bank of England could pass a proper stress test based on actual performance figures (today revealing a 1.9% decline in GDP in Q1) and growth forecasts for the future which are not from "cloud cuckoo land"

Running the numbers properly through a modeling tool should not be seen as just an exercise for Treasury anoraks but should actually be undertaken by Moodys and S&P.

But then again their track record in forecasting has not been much better than Mr. Brown's.

Why the US prefers quasi-nationalization for banks

Steve Waldman writes an excellent blog called Interfluidity on financial matters and has a very good post concerning the pressure that was put on Ken Lewis by Henry Paulson and Ben Bernanke to complete the acquisition of Merrill Lynch.

The allegations which have been documented, and are available all over the web, are that Lewis was threatened by Paulson and Bernanke that if he failed to complete on the acquisition of Merrill at the end of last year then he (Lewis) and his board (i.e. the Board of B of A) would have been dismissed.

This is a very troubling allegation and as Waldman points out what makes it most egregious is the complete lack of accountability that was enjoyed by Paulson especially during the last quarter of 2008.

An assertive Treasury secretary has tremendous leverage over zombie bank managers. Instead, what we have is control without accountability. An informal, unauditable, hydra-headed set of private managers and public officials controls how quasinationalized banks behave. Neither taxpayers nor shareholders have reason to believe that decisions are being taken in their interest. The informality and disunity of control impedes the kind of hands-on, detail-oriented supervision and risk management that ought to be the core preoccupation of bank managers.

Waldman is right to insist that the issue highlights the absurdity of the "twilight" zone in which many major banks in the US currently occupy. They have neither been nationalized or taken through receivership by the FDIC ,nor have their current management been fully held to account for their stupendous mismanagement.

Why has the US government tolerated this Twilight Zone existence for Citigroup, B of A and others?

There are several reasons why "quasi-nationalization" has been chosen as the preferred route and the fact that Administration officials can intimidate current management, as evidenced by the revelations now appearing with regard to Bank of America, without having to take on full control and responsibility is certainly one of them.

Another is that it avoids having to deal with the debt-holders and the third is that it prevents triggering lots of CDS contracts.

Seen in this light it is not surprising that the government is doing all it can to avoid putting those troubled banks into receivership. Only in the fullness of time will the error of this approach be confirmed.

Henry Paulson meets Hercule Poirot

Documents are surfacing from Andrew Cuomo's office in New York and elsewhere that suggest that overwhelming pressure was put on Bank of America's Ken Lewis to keep the deal to buy Merrill Lynch (ML) alive after Lewis and his due diligence crew were becoming increasingly uneasy about the financial health of ML.

There are some interesting documents supporting these allegations that can be found here .

Although there is undoubtedly a lot more to come out on this story it is fascinating how, despite all of the circumstantial evidence suggesting that Messrs Paulson and Bernanke were absolutely desperate to use any tactic to stop the unraveling of the financial system during those crisis filled weekends of last September and October, it is only when there is discovery - to use the quasi legal vernacular - of actual documents providing evidence of what purports to be a smoking gun confirming threats and intimidation, that the possibility of heads rolling, or at least some very awkward inquiries being instigated, begins to mount.

One can think back to the Watergate incident and Iran contra amongst so many others to get the flavor of the media's thirst for the minutiae of forensic analysis. Deep down all good journalists have fantasies of being like Agatha Christie's Poirot.

This story has the capacity to grow into something rather big and since Paulson is gone the main guy in the firing line would appear to be Ben Bernanke. Now that could really rock the boat

The simple compounding formula behind the Chancellor's forecast rate of growth

Further to my post on why 3.5% was selected as the growth rate in the UK budget forecast it is interesting to do some simple compounding arithmetic.

Chancellor Darling mentioned, in interviews today, that his expectation is that the world economy will double in the next 20 years - just how he came up with that number was not explained.

However if you quickly run the following on your calculator or in Excel - 1.035^20 - it comes out as close to the desired 2 or doubling as you could hope for.

Probably just a coincidence.

3.5% growth in the UK - a reverse engineering job

Yvette Cooper is the Chief Secretary to the UK Treasury and as such she was very much in the firing line today after the UK budget confirmed the worst suspicions about the state of the public finances.

She was challenged on Channel 4 News (which is the best TV news service in the UK) to justify the Chancellor's belief that from 2011 onwards the UK economy will grow at 3.5 percent. Her reasoning was pathetic and added to the sense that the number was selected on the basis of a reverse engineering job performed by the Treasury to come up with a number which would make the capital markets less panicky than they already are about the UK government's need to borrow more than £200 billion this fiscal year and for years to come.

Tim Geithner's problem

Does Tim Geithner lack confidence? Yes, probably - but does it matter?
Secretary Paulson had lots of confidence - anyone who could ask the US Congress for $700 billion with a piece of paper than only ran to a few paragraphs certainly had tons of it as well of lots of something else as well.

Problem with Geithner is that he cannot imagine a world in which the opinions of those running Goldman Sachs and JP Morgan Chase are not sacrosanct and beyond dispute. He was stamped out from the template of the perfect financial technocrat and as such, from their perspective, he is a safe pair of hands.

CDS spreads through the looking glass

Sometimes a blog posting has such delicious irony, as this one does from Professor Krugman, that it is worth repeating in full.

So the accounting rules say that a decline in the market value of a bank’s debt thanks to increased credit default swap spreads — that is, because investors think you’re more likely to fail — counts as a a profit. On the other hand, if your bank looks stronger, the spreads fall, and you book a loss.

FT Alphaville has the story. Citigroup reported

A net $2.5 billion positive CVA on derivative positions, excluding monolines, mainly due to the widening of Citi’s CDS spreads

while Morgan Stanley reported

Morgan Stanley would have been profitable this quarter if not for the dramatic improvement in our credit spreads - which is a significant positive development, but had a near-term negative impact on our revenues.

So Citigroup is profitable because investors think it’s failing, while Morgan Stanley is losing money because investors think it will survive. I am not making this up.

The only point I would make is that Lewis Carroll would have loved this story but might have favored it more for Alice Through the Looking Glass rather than Alice in Wonderland .

The brain drain and marginal rates of tax

Here's a really easy way of thinking about the proposed new marginal tax rate of 50% for those earning more than £150K per year.

To simplify matters, if one is earning £250K per annum, and one is unable to find a smart enough accountant to figure out how to avoid paying the new marginal tax rate, one would end up paying an additional £10K per year to HMRC.

Will this contribute to a brain drain as alleged by City wizards?

Yes it might at the margin - to use a pun.

But on the other hand, if the tax had been in effect a few years ago and had lead to the threatened brain drain, the RBS, Northern Rock, Lloyds TSB etc. accidents could well have been some other jurisdiction's problems. That way UK citizens might have avoided a lot of the pain that is to come from the dreadful state of the public finances revealed in today's budget.

UK Treasury should offer a PSBR calculator at its website

In the interests of transparency, the UK Treasury should offer an interactive page at its website - a PSBR calculator - where one could plug in different rates for annual growth other than the ludicrously optimistic 3.5% forecast from the Chancellor and see the ripple through effects on the state of the public finances.
I suspect that using a number like 1.5% for the average rate over the next five years would push the expected debt to GDP ratio well above 100% even using the Treasury's selective view of what actually counts as part of the public debt (it's understated of course).

UK Budget - trampolines and a smirking Gordon Brown

Some quick reflections on the UK Budget delivered by Chancellor Alistair Darling.

1. No major stimulus measures were announced. Clearly Gordon Brown's enthusiasm for further tax give-aways or for increases in public expenditures were tempered by the recent comments of the Governor of the B of E and quite possibly by push-backs from the capital markets as to how difficult it is going to be to finance the extraordinarily large deficits announced.

2. The PSBR (Public Sector Borrowing Requirement) will be £175 billion this fiscal year, and £173 billion next year. The £2 billion difference strikes one as a rather laughable example of spurious accuracy. Both years represent approximately 12% of the national income and (perhaps coincidentally) allowed the Chancellor to point out that this was below the projected 13% figure for the US.

3. These deficits are the largest ever announced by a UK government other than during wartime.

4. Over the next four years the government forecasts an aggregate £600 billion PSBR but this all needs to be considered in the light of the forecast for economic growth in coming years and in turn the amount of taxation revenue raised.

5. The Chancellor now reckons that the economy will contract by 3.5% this year as compared to previous forecast of only a 1.25% decline from last November.

6. Claim is that UK will pull out of recession in late 2009 and growth is forecast at 1.25% for fiscal 2010.

7. Remarkably a 3.5% annual growth rate is assumed from 2011 onwards. Indeed if this wildly optimistic level is not achieved the PSBR numbers will be far more serious than already outlined.

8. The top rate of tax - pre-announced in the mini budget last November at 45% and due to start in 2011 - has now been increased to 50% at the margin and will come into effect one year earlier in 2010.

9. Various measures were announced to assist students and unemployed youth and various measures were re-announced relating to assisting the real estate market and small businesses.

10. Amongst the more amusing remarks in the post budget delivery debate came from David Cameron the leader of the Opposition who talked about the Chancellor's overly optimistic forecasts for future growth in terms of the "trampoline recovery"

11. Also part of Cameron's lively remarks was a rather pointed suggestion that the UK may have to seek out assistance from the IMF - which is not as implausible as it may seem.

12. Sterling is selling off after the budget as the need to sell boatloads of gilts to pay for all of this are beginning to sink in.

13. Gordon Brown sat through the whole budget speech beside his Chancellor with an expressionless look on his face but during Cameron's response his face took on that rather irritating smirk which will not win hearts and influence votes amongst the UK electorate

14. Overall this was an unpleasant task for the Chancellor and an easy prey for the opposition parties. It also did little to improve the prospects for those facing unemployment or the possibility of having their homes repossessed.

Why is AIG in an African slum?

Watching a news program on television this evening in the UK brought a wonderfully iconic image which reflects the absurdity of our culture. The program featured a report about a slum neighborhood in South Africa with a man being interviewed who was wearing a Manchester United football shirt. Emblazoned across the shirt are the letters AIG who, for the benefit of those who do not follow soccer and specifically Man U, are the current (but soon to be abandoned) sponsors of the team and its merchandise.

Boom and bust and central banks

I just finished reading a very opinionated article which concludes with the following remark that is offered as if it is self evidently true:

Severe boom-bust cycles are entirely a man-made event created and precisely controlled by Central Bankers.

I find such remarks to be ultimately patronizing, as they suggest that the author is in possession of some superior knowledge or insight that mere mortals have not attained. Anyway just for fun here is the comment that I submitted:

Your thesis subscribes to the "conspiracy" view rather than the more mundane and more likely "cock-up" view

Even if one was to agree that boom and bust may be "created by" central bankers (without the capital letters) it could just as easily be claimed that it is a result of their screw ups rather than through any "precise control". In fact the notion that the central bankers precisely manipulate such events is in contradiction to the point being made about keeping your enemy confused. Precise control would leave footprints that smart market players would eventually recognize and be able to anticipate and that, in turn, would subvert the very control of events that you are alleging.

New global reserve currency based on industrial metals !

I have previously enthused about the maverick reporting skills of Ambrose Evans Pritchard from the Daily Telegraph and wanted to share this fascinating piece which was published recently.

The article addresses the shift in policy by the Chinese government away from holding the vast majority of its foreign reserves in US dollars and Treasury bonds and much more towards an accumulation of industrial metals, primarily copper.

Pritchard, in his piece, quotes Nobu Su, head of Taiwan's TMT group and which ships commodities to China, who gets straight to the point

"China has woken up. The West is a black hole with all this money being printed. The Chinese are buying raw materials because it is a much better way to use their $1.9 trillion of reserves. They get ten times the impact, and can cover their infrastructure for 50 years."

Also discussed is the enthusiasm from the head of the Bank of China for a resuscitation of the Keynesian idea of the "bancor" which would be a new global unit of account and potential reserve currency founded upon natural resources, which is something that I have discussed here previously .

The beauty of recycling China's surplus into metals instead of US bonds is that it kills so many birds with one stone: it stops the yuan rising, without provoking complaints of currency manipulation by Washington; metals are easily stored in warehouses, unlike oil; the holdings are likely to rise in value over time since the earth's crust is gradually depleting its accessible ores. Above all, such a policy safeguards China's industrial revolution, while the West may one day face a supply crisis.

What may have seemed like an academic issue when tabled as a topic for the G20 meeting just a few weeks ago is starting to look like it needs to be taken a lot more seriously by the current financial oligarchs. The Anglo-Saxon financial elite may have to adapt their thinking on this with more agility than they had hitherto realized.

Energy sector fund worth tracking

Reviewing many of the exchange traded sector funds over the weekend, one of the Ichimoku patterns which is well formed and caught my attention is for XLE, which tracks a variety of energy companies and assets.

Point A indicated on the chart above illustrates a failure in early January to emerge from the pink cloud, point B confirms the break down which then culminated in the early March low, and as can be seen the point C on the right hand side is the most bullish indication on the chart as price is poised to emerge from the pink cloud.

One more close above the pink cloud in coming sessions would be encouraging for an intermediate term long position on the sector.

Euro breaks below $1.30

In European trading on Monday morning (20th) the euro has dropped below the $1.30 on its cross rate with the US Dollar and perhaps more ominously it is now losing contention with the green cloud on the Ichimoku chart above, which, if validated in the remainder of today's session, would suggest a re-visit to the $1.25 area.

On fundamental grounds there is a growing sense that the ECB have been the least focused of the major central banks in addressing the troubles besetting the banking and monetary climate of its member states - although the structure of the EMU is far less conducive to the kinds of unconventional policies being followed by the B of E, the Fed, and the B of J.

Protecting consumers from their credit card companies - an idea whose time has come

The following, which comes from a WSJ article , is a really good idea for consumers if not for banks.

The president is "going to be very focused, in a very near term, on a whole set of issues having to do with credit card abuses, having to do with the way people have been deceived into paying extraordinarily high rates that they wouldn't have paid if they knew what they were getting themselves into," Mr. Summers said on NBC's "Meet the Press."

Let's see how well it is implemented but the scandalous abuses in credit card charges, penalty fees is just one of many abusive practices of the financial services industry.

A simple look at scary numbers

Large number fatigue is setting in and it is beginning to give rise to intellectual complacency and misleading rhetoric.

We need to distinguish between different ways of thinking about scary numbers.

The first kind occurs in articles and commentary where it is claimed that so many trillions of dollars have been wiped off the stock market, real estate market or national wealth. In fact in the current circumstances, after a few weeks of rallying in equities, it is not uncommon to see talk of supposed massive increases in our wealth, for example in an article entitled The Seven Trillion Dollar Rally .

The fallacy with both the bad and good news in this regard - the trillions that have allegedly disappeared or are now reappearing in asset values - is that the valuation of the whole market, in the case of the above article it is specifically the US stock market, is being made by determining an aggregate value by extrapolating from the current pricing at the margin.

To make it simple and concrete, the last price on say the S&P 500 is being used to determine the market capitalization of those entire 500 large enterprises. This really makes little sense as the number is erratic and does not reflect anything other than a snapshot in the trading history of the financial instruments and not the underlying value of the companies. One is not talking about a liquidation value for these companies or for the market as a whole. Thinking about this for one moment it makes no sense even to talk about the liquidation value of the entire S&P 500. If everyone was looking to sell there is an obvious problem which can highlighted by asking the simple question - to whom would they be selling?

Can the same argument be made about the value of the legacy assets - CDO's, CMO's, RMBS's etc. - that are on bank's balance sheets? My suggestion is that the marginal liquidity of these assets, i.e. what they would command in the market place at any moment in time, is far more critical in that the nature of banking and creditworthiness depends upon the perception of confidence at the margin. Why do I say that? Because confidence is either all or nothing in the case of banks. If one was to be told that Bank A had less liquidity and more questionable assets on its books than Bank B which bank would you rather do business with? If all banks are considered to be even slightly suspect then the whole banking system could crash. And that's what very nearly happened last October.

The third kind of scary numbers have to do with the state of the public finances and the debts that are accumulating on the balance sheets of many sovereign borrowers. Leave aside the guarantees that have been put in place for possible losses on legacy assets, and just consider the massive deficits that say the US and UK governments are facing (spelled out numerically elsewhere and with much greater precision than I am focused on in this piece). These kinds of scary numbers, in terms of annual operating deficits (now in the region of 12-15% of GDP) and the accumulating national debt (at least 100% of GDP) are truly scary numbers. And they are real - they are not based on any fallacy of valuing the national debt at some hypothetical margin. These are actual obligations and incurred expenditures that have either already been paid out or must be paid out in the future.

Two things in particular make them worthy of any citizen's or investor's top of the mind attention.

Firstly, how much debt service will be have to be paid on these debts? This, of course, raises the awkward issue of what is the interest rate environment going to look like in the future? To which an even more awkward question needs to be asked - to what extent are governments planning to inflate their way out of their public finance crises?

Needless to say this issue has a vicious circularity to it.

Secondly, is their the will and discipline to really address the pay-down and prudent management of these mountains of debt by the political and financial elite?

Now that really is an awkward question with scary implications.

Can we inflate ourselves out of the crisis in the public finances?

Clusterstock has an article in which the case is made for rampant inflation as the way forward for the US government to solve the pending crisis in its public finances.
While it may be an amusing idea for an article it clearly won't work, notwithstanding any moral issues about a policy deliberately designed to debase the currency.

My comment to the posting was as follows

Only problem with inflation as the path to feeling better about all this (not passing it on to the kids) is that it is not a solution.

With the kind of inflation required to do that job the coupons that would then have to be attached to all those Treasury bonds that the government is going to have to issue would go far higher than in the current long term budgets.

The higher the debt service costs the longer it would take to pay it all back, which is something that is looking increasingly unlikely.

Who knows maybe we've probably passed the tipping point already.

An Ichimoku view of London's FTSE

Unlike many of the key global stock indices the FTSE has still not emerged above the pink cloud on the Ichimoku chart which would provide further evidence of bullish price action ahead.

As can be seen the level for the index to move above the pink cloud is 4068 which also is exactly the 50% retracement level of the fibonacci grid that I have been super-imposing on this chart in recent commentaries.[An archive of my Daily Form commentaries can be found here ]

The 4200 level would be the 62% retracement level for the FTSE as the 875 level is for the S&P 500.

Gold stocks at critical level

As anticipated in my Daily Form commentary yesterday which is available at no charge from here the Gold and Silver index (XAU) was ripe for corrective action in the context of a bearish flag formation. The index dropped by five percent in yesterday's session.

The Ichimoku chart reveals that the index has not yet dropped below the green cloud, which would be a significant bearish development, but the precious metals sector is at a critical juncture as is the price of gold itself.

Circularity and risk

There is something rather circular about one bit of investor folklore which is usually called "the greater fool theory" and this often backs into a related matter of smart and dumb money. This circularity is especially the case if one equates risk with volatility and is considering relatively short term investment horizons.

The so called "smart money" maybe nothing other than those with the deepest pockets who can sustain periods of systemic illiquidity and wait for less volatile trading conditions to re-appear.

The ultimate market failure - a true systemic breakdown without a public sector safety net - would be when everybody becomes the "dumb money". Let's hope that that is not in our future.

Chairman Bernanke's Gotchas

Henry Blodget has a really good article on Chairman Bernanke's four big challenges:

First, it will be hard to confidently assert that the economy in full recovery. Remember, in 2007, Ben (and most other people) thought the economy was in great shape as far as the eye could see. He and most other observers missed that disastrous turning point. So why do we think he'll correctly spot the next one? Especially because, if he blows it by jacking up rates too early, he'll kill the recovery.

Second, there will be intense political pressure to MAKE SURE that the economy is in rip-roaring health before hammering consumers and businesses by raising interest rates. Everyone loves low interest rates. And they'll only stop screaming about your taking them away when they're fat and happy (which will be long after inflation really gets going).

Third, the US government desperately needs low interest rates to fund its soon-to-be-monstrous debt load, so there will be another source of pressure on Ben to keep rates low. When we finish with all this stimulus, we're going to owe a boatload of money. We're really going to allow our Fed chief to send interest rates to the moon and jack up our refinancing costs?

Fourth, many of the assets that Bernanke has been buying to print money won't be easy to sell. This time around, the Fed isn't just buying easy-to-sell Treasuries. It's buying trash mortgage assets, et al. To reduce the money supply, it will need to sell them to someone. But who?

The real "gotcha" is the third reason - the massive debt that will need to be financed as far as the eye can see.

It is becoming increasingly apparent that if you don't want to take an apocalyptic view of this issue you have to buy completely into the underlying assumption in the government forecasts that the US will remain in a benign environment as far as long term rates are concerned for years to come.

I don't think even Bill Gross believes that.

London's FTSE preparing for a big move?

Since late March the U.K.'s FTSE index has been behaving more erratically than US equity indices with two large reversal candlesticks observed in the neighborhood of the pivotal 3900 level.

The recent technical condition suggests that a big move lies ahead, and although it may well be influenced by local conditions such as the horrendous state of the public finances in the UK, it is more likely to be driven by global factors. On that score several key markets are showing signs of intermediate term topping patterns. But we shall have to see whether the US financial sector can continue to perform its magic in massaging the numbers.

Can the B of E print enough to finance the UK government's borrowing requirement?

As predicted here on previous occasions the shocking magnitude of the public sector borrowing requirement in the UK is finally emerging as Alistair Darling prepares his budget for delivery next week.

According to this piece in the Guardian the government will require £175 billion in each of the next two years.

Just to indicate the mind-numbing needs of Her Majesty's government the article points out that

....because generous departmental budgets are fixed until April 2011, public spending will reach a staggering 48% of national income in the next financial year.

Just as well Mr. Darling put the Quantitative Easing policy in place a few weeks ago.

But will even that "very flexible policy response " be enough to finance all of the borrowing required? I'm sure Mr. Brown will think of something.

Mall collapses and the changing retail landscape

It is hard to disentangle the numerous threads that are part of this global recession, especially as they relate to the specter confronting commercial real estate and retailing,

News today that General Growth Properties Inc., the second-largest U.S. shopping-mall owner, has filed for bankruptcy after failing to refinance more than $27 billion of debt, could seem to be just another symptom of the overall disappearance of the voracious US consumer.

While this is undoubtedly true just how big a component of the lack of final demand at the physical retailing level is due to consumers migrating to online shopping? In addition how much is due to the notion that consumers are less motivated to travel out to major malls and the increasingly generic nature of their offerings?

The UK is also witnessing a rather alarming decline in footfall at major malls and the most visible example at present is the very disturbing lack of interest in the recently opened Westfield Shopping Center in west London. The mall is owned by the Westfied Group which claims on its website to be "the world’s largest listed retail property group by equity market capitalisation" and based in Sydney it operates in North America and Europe. Some of the woes that this company is experiencing in its London operations can be found in this piece from the Australian press

Let's interview the Black Swan Man

An article at Clusterstock.com, which is a site that I visit frequently, gives a roasting to Nassim Taleb for some rather odd remarks that he made in regard to private equity and Ponzi schemes.

The author of the piece ends with the comment.

But, honestly, trying to refute this nonsense seems like a waste of time, except that it's Nassim Taleb saying this stuff, and everyone thinks he's an oracle (he's not).

I enjoyed Taleb's book Fooled by Randomness when it was published several years ago and was disappointed by The Black Swan as it seemed to re-iterate what was in the previous book with tiresome repetition.

David Hume, the Scottish philosopher, pointed out the problems of what is called the inductive fallacy more than 200 years ago but full marks to Taleb for spicing it up with some "sizzle", banging on about it for ten years and making some serious dosh in the process.

The fact that journalists now want to ask Taleb his opinions on areas that he may not be qualified to speak about is more indicative of the failings of many in the mainstream financial media than any fault of Taleb's.

The dark sides of Gordon Brown and Richard Nixon

Gordon Brown is compared to Richard Nixon in this op-ed piece in the London Evening Standard written by Dominic Sandbrook.

The author rightly claims that both men had moments of brilliance but also both have revealed deeply flawed personalities. It is an interesting comparison and the most illuminating part is in the way that the article compares the way that John Kennedy overshadowed Nixon for many years and Tony Blair eclipsed Gordon Brown's claim to the the top job in the UK government for ten years. There is something rather dark about Brown and it will undoubtedly haunt him when UK voters next go the polls. It sometimes need to be re-stated that Brown was never elected to his office - he replaced his predecessor unopposed when Blair stepped down - and the current mood of the electorate in the UK suggests that a lot of people would not be sad to see him retire from politics after the next general election.

Here is a pertinent extract from the piece:

Politics can never be separated entirely from spin. But there is a clear line between public relations and dirty tricks - a line that both Nixon and Brown, for all their great political gifts, seem not to have recognised, as though their antennae, so sensitive in other areas, were no longer working. Perhaps that is the most compelling parallel of all- two glowering men, so brilliant at politics in many ways, yet so inept in others.

The tragedy is that after relying on the hatchet men for so long, the Prime Minister now seems unable do without them. We cannot, it appears, have the good Gordon without the bad.

Does the UK need help from the IMF?

The following comes from an article in today's New York Times. It underlines the severity of the downturn in the public finances in the UK and raises one of the more sensitive issues facing the Brown government (apart from all of the "business as usual" political sleaze) - how will they be able to finance annual deficits that will be at least 150 Billion Pounds this year and probably even worse in the coming years?

After a recent failed auction for gilts and with Brown having to seek re-election within a year the capital markets may get even more uneasy about the appetite for financial discipline and prudence from the man who has been at the helm of the British economy for the last 12 years.

Speculation that Britain may once again seek I.M.F. assistance — and become the first major western European country to do so during this crisis — rests upon a crucial, uncertain assumption: that the combination of its steep debt and wounded banking sector will bring too much pressure to bear on its currency, the already wobbly pound.

Britain currently runs a budget deficit of 11 percent of its gross domestic product — compared with 13 percent forecast for the United States this year. Analysts say they expect that without severe spending cuts and tax increases, government debt will jump to 80 percent of the overall economy in the coming years from today’s level of about 40 percent, a ratio that approaches that of troubled economies like Greece and Italy.

Hernando de Soto on Anglo-Saxon education

One of the themes of the book that I am currently writing is the challenge now being faced by the dominant financial model of the last 250 years - the Anglo-Saxon banking model or to extend that notion to just the 20th century and beyond the financial technocracy model promulgated by the Axis Of Spin - London And Washington (New York).

Hernando de Soto is an non-mainstream economist who has been making some very perceptive observations about the nature of the global financial meltdown. Most recently he wrote an op-ed piece in the Los Angeles Times in which he touches on one of the most egregious features of the crisis - i.e. the fact that the magnitude of the toxicity on the balance sheets of the banks has not (can not) been quantified.

The article is well worth reading but I shall just give some context as a teaser to one of the themes which is being developed in my own thinking at present.

As a Peruvian educated by British and American teachers, I learned never to embark on a major task without first "doing the math." No more of that Latino "happy go lucky, trust your gut and say three Hail Marys" approach to life.

Without measurement, my teachers advised, I wouldn't be able to identify and disentangle the very reality before my eyes. By doing the math, I would see order and coherence, the way things were organized; invisible relationships would come into view, and right behind order would come meaning, followed by confidence. Thanks to my Anglo-Saxon education , I learned the lesson: You cannot manage what you have not previously measured.

Get Well Soon messages from pension fund managers

I have been watching Abby Cohen's cheerful pronouncements on US equities for more years than I care to remember and she is sounding more perky again as overall market sentiment is improving.

Her target of 1000 on the S&P 500 is still a long way off but given the massive injections of anti-depressants and the flood of "Get well soon" messages, coming in from pension fund managers and insurance companies sitting on 30-40% losses from last fall, this rally/bubble could have a way to go yet and may hit her target sooner rather than later.

I am still persuaded though that the faster the ascent the more scary the subsequent decline.

Underwriting systemic failure - not likely to get cheaper in the future

We are not even able to determine the magnitude of the damage done by the most recent debacles and that is after several months of intense scrutiny (just how transparent that process has been is open to debate). The recovery plans call for trillion dollar public deficits in the US for years to come and that is based on benign assumptions about long term interest rates and not factoring in any major "dislocation" in the Treasury bond markets in future budgets.

The nominal value of the financial economy (even now after substantial de-leveraging has taken place) is staggeringly out of sync with the size of the real economy (think national income without factoring in all of the phony money in the financial services sector) and when confidence and liquidity disappear the vulnerability of the edifice upon which promissory notes and global IOU's is fully exposed.

There really has been no serious debate about whether the role of the state should absolutely be one of protecting the interests of those deemed by financial technocrats as "Too Big to Fail" - i.e.major Wall Street firms, PIMCO, insurance companies, and pension funds and maybe even key municipalties - it has just been taken as a given. Until and unless there is such a debate we should continue to assume that systemic accidents, which are an inevitable consequence of the boom/bust tendency at the core of the human psyche, will be colossally expensive. Financing the cleanups from such accidents will prove ever harder to accomplish in the future.

Financial innovation and a free lunch

The following is a thread from some comments I made earlier in response to an interesting piece by Felix Salmon about potential for downsizing the financial services sector through increased regulation.
My first comment to this was as follows:

Ironically the pace of financial innovation is often driven by the need to circumvent regulations. There could be even more stacking of layers of financial intermediation and complex products rather than less.
They will probably not be as profitable to any individual firm as they were during the last several years (until the bubble burst), and to that extent I agree with your comment on Goldman Sachs. But it may be even more expensive to clean up the mess when they go wrong again.

One of the other commenters replied at length to my observation stressing that certain kinds of financial activity should be forbidden (he uses the word several times in block capitals)

My second comment in response was along the lines of what I have been writing extensively about recently for a new book.

You suggest in response to my comment that we should "make banking the utility it was until the 1970's and should be again"
If only it was so simple... the financial landscape is totally different today to the 1970's.

The biggest step towards the world of modern finance and all of its associated risks was the abandonment of the Bretton Woods stability framework and fixed exchange rates that took place in the 1970’s and Nixon's final nail in the coffin for gold convertibility with the US Dollar.
Increased risk was not for the reason that many believe i.e. the creation of fiat currencies but because of the creation of a new era of financial complexity. Suddenly the world had a plethora of new financial variables - exchange rates, floating rate instruments denominated in euro-currencies and I do not mean the Euro of today but the euro market that originated for dollar based deals that were outside the US jurisdiction and based in London, financial futures and swaps etc. etc.

Not only was there an explosion in the number of variables but innovative financiers began to exploit relationships within this new web of financial variables eventually creating layers of derivatives etc. This opened up the era of financial arbitrage – and allowed the smart money to think they were getting a free lunch....

Thirty years later we know that the lunch was rather expensive

US Dollar replacement unlikely to emerge through calm deliberation

My guess is that the SDR (or any surrogate instrument) will not replace the US Dollar as a result of calm deliberation - it will take another phase of the global debt crisis.

Only when policy makers are staring at the precipice again and realizing that the game is up will they come up with a new global unit of account and store of wealth - as before it will probably happen over a weekend with an announcement late Sunday before Tokyo opens.

On second thoughts it might be announced in Shanghai early Monday before New York opens.

Market timing advice from President Obama

As reported yesterday President Obama urged American families to seize the advantage of the lowest mortgage rates in decades to re-finance their homes.
AP reported him as saying "The main message we want to send today is there are 7 to 9 million people across the country who right now could be taking advantage of lower mortgage rates...That is money in their pocket."

Perfectly sensible advice and taken at face value it would undoubtedly be to the benefit of the families involved and for the US economy as a whole.

The President's choice of the term "right now" suggests that perhaps his team of advisers were trying to instill just a little urgency into the briefings that they are providing to Mr. Obama which was then reflected in the advice he was giving to homeowners yesterday.

If the tide is turning as many equity investors seem to believe then the downturn in both long and short rates and the degree of quantitative easing being contemplated could be undergoing some re-thinking.

On one interpretation it is possible to see that the old adage about the train leaving the station and for stock-market investors not get left behind, is now being morphed into new market timing advice for doing a "refi" from no less than the President himself.

Falling in love with banks again!

Tyler Durden, the author of the Zero Hedge blog, and one of the most prolific commentators on the financial sector, is someone whose articles I follow closely. A number of his recent pieces have been extremely insightful and thoroughly original pieces of investigative reporting.

What is rather interesting is that the negative comments being appended to his posts are getting noticeably more hostile.

Some of those commenting on his postings are tiring of his sarcasm and what they view as overly negative judgments regarding specific banks. For example here are just a couple of excerpts from comments to a posting he made today at his own blog site and which can also be found at SeekingAlpha which discusses Bank of America (BAC) and its likely need (from his perspective) for a major capital injection.

So Mr. Durden has identified a $150 billion capital deficiency at BofA, about 4 times the mere $36.6 billion deficiency identified by Mr. Kotowski. My, what big numbers you use, Mr. Durden! Maybe you could supply us with the spreadsheet analysis, or envelope back, on which you quantified this shocking capital deficiency

And these two quips (which I have tidied up for spelling errors)

As usual, the author is long on sarcasm and short on facts....Rather than writing a critical, insightful article about Bank of America (I mean geeze there's so much to pick on them about) the author makes some bold statements, not supported by any facts...

And there are a couple of others which are too offensive (and grammatically ungraceful) to want to repeat.

A few thoughts on this:

1. I suspect that a growing number of American readers especially are becoming irritated by too much overt criticism and sarcasm about the US financial landscape. The difference now is that with signs of a real rally beginning in the sector they are no longer timid in expressing more upbeat views about the banking sector and taking a swipe at people like Tyler Durden who had been getting things pretty much their own way during the "dog days" for the sector.

2. There is also a rather discomforting notion that the renewed enthusiasm for the sector, as evidenced by today's huge opening gap on the shares of nearly all of the financials, fuelled by the news from Wells Fargo, could easily get too frothy and ahead of itself as serious problems remain for several critically exposed banks.

3. In browsing through my own archived material I came across this posting from January 29th which now seems remarkably prescient in terms of calling a momentum bottom for the sector. Indeed the language I used was somewhat tentative and the capacity to rally, and the eventual magnitude, was greater than I realized at the time.

4. Even if it is expedient to lighten up on the sarcasm about the banks, if one is looking to remain popular in the blogosphere, it may be quite expedient to be lightening up steadily on exposure to the long side across the financial sector as this new love affair for the banks unfolds.

A screen-saver image for the head of the Chinese central bank

The following graphic illustrates the forecast for annual deficits of the US government over the next decade. Remember each year the number is below the line means that overall national debt is increasing by that amount. Of course that additional debt has to be serviced as well.

If I was running the Bank of China (now there's a novel thought) I would require that this be downloaded and used as the desktop image or screen saver for all of the diligent and thrifty workers at the bank.



The source of the graphic was The Washington Post An acknowledgment is made to the CBO, White House Office of Management and Budget, so presumably this is in the public domain. And if it isn't, it certainly should be.

The piece in the Washington Post includes the comment that

President Obama's ambitious plans to cut middle-class taxes, overhaul health care and expand access to college would require massive borrowing over the next decade, leaving the nation mired far deeper in debt than the White House previously estimated, congressional budget analysts said yesterday.

Asset class correlations and inverse ETF's

It is easy to get confused about statistical correlation and the behavior of inverse funds as is found in this article . The author applauds the availability of inverse ETF's and proposes that these will enable retail investors to reduce risk through a process of diversification

One of the simplest ways to do this is through the use of non-correlated investments that zig when everything else zags. In the old days, that meant having exotic futures accounts or taking positions opposite to the markets entirely, using margin accounts to sell individual stocks short - one stock at a time.

Inverse funds, as their name implies, go up in value when the markets go down. There are plenty of choices to consider, with everything from the S&P 500 to specific sectors available in the mix.

Unfortunately the author seems to blow his argument apart about the usefulness of inverse funds as sources of non-correlation of assets in a portfolio when he also says later on:

Of course, if the markets go up, the reverse is true and these things can lose money in a real hurry, so one can’t just pile in indiscriminately.

If you are long an inverse index fund and the market goes up your returns will be highly correlated with the index fund - it's called negative correlation.

The take-away is that it's harder to immunize a portfolio from system risk than it may appear. Correlation based strategies are also hazardous for many other reasons which I have discussed in Long/Short Market Dynamics . The most insidious reason is that during periods of liquidity crises the co-variance of asset classes rises dramatically towards unity i.e. they all go down together.

Irish woes and the future of the euro

[Author's disclosure]
The following piece is written with tongue in cheek and in no way is intended to show any disrespect for the home of my ancestors and for the undoubted suffering being endured within the Irish economy.

Why can't Ireland take a bridge loan from the IMF to build bridges to stimulate their economy?
Hopefully by the time that the bridge loans become due for repayment the activities of the Federal Reserve and other central banks will have reflated property prices around the world enough so that Ireland's banks can be taken private again and the Irish government can pay back the IMF.

If not they can always take another bridge loan to build even more bridges.

If the euro does fall apart - which certainly Germany, France etc will do their utmost to avoid but which may well hinge on how other troubled EMU members react to their domestic crises - e.g. Portugal, Greece and Spain - the systemic consequences would be like a magnitude 8 seismic event.

Surely part of the reason for extending the mandate of the IMF was to avoid such a disaster.

El Erian plays long/short game

The FT has an interview with Mohamed El-Erian from PIMCO on the PPIP program and how PIMCO will participate.

He raises the interesting point that the recent changes to the M2M rules in the US may make banks even less willing to part with their "legacy" assets and therefore diminish the supply of product into the PPIP scheme. To that extent the taxpayers may breathe some sigh of relief that the massively unfavorable risk/reward ratio and funding asymmetry for the public sector which is proposed under the PPIP may not be that effective.

Amusingly at the end of the interview he is asked to play the Long/Short game with the interviewer in which he is given an asset class or company and asked to indicate whether he would be long or short - somewhat like a thumbs up or down game. Asked about the US dollar he would be short, and asked about gold he would be long. But very diplomatically when asked about both Citigroup and Bank of America he declared himself to be neutral.

No wonder PIMCO has such a fertile relationship with the US Treasury.

Financial innovation and simplicity can go hand in hand

There is an article at SeekingAlpha entitled In Defense of Financial Innovation which is worth looking at.

The author makes the case for continuing to favor financial innovation as opposed to some loosely defined simplistic view of banking which he also describes as financial Luddism.

The author claims that this simple approach "would relegate the US financial institutions to a dumbed-down version of finance completely at odds with a globalized world and economic system (not to mention the unintended consequences of assets flowing to other, more forward-thinking markets)."

Apart from a pretty crude characterization of the positions of the Luddites which seems to include Paul Krugman and Meredith Whitney among others, he also conflates two different strands into a false polarization.

My comment to his post was as follows

You seem to be setting up two separate polarities - simplicity versus complexity and traditional versus innovative. But then you align the simple and the traditional and suggest that, it logically flows from this that innovation would no longer be an available option for a simpler financial system. It's a non-sequitur.
One can certainly have, in the future, financial derivatives that are innovative but they do not need to be complex and outside the scope of more established rules of risk management and financial prudence.

Larry Summers - a believer in a pre-Copernican cosmology

A very good piece from Arianna Huffington on why the financial technocracy is part of the problem rather than part of the solution.

Reading it - where she talks about the bank-centric universe which is the paradigm held by those in Washington in the same manner as the Ptolemaic cosmological view of the world was held by all intelligent people until Copernicus - reminded me of the book "The Structure of Scientific Revolutions" by Thomas Kuhn and his theory of "paradigm shifts".

Not much discussed these days but influential in its time

Investigative news coming from authors that are not on the payroll of moguls.

There is an interesting piece at SeekingAlpha about the decline of newspapers and the complaints from Rupert Murdoch, among others, about the way that Google and other search engines/micro-blogging platforms are "stealing" content.

It is a complex and obviously emotion charged debate which I am not going to venture into on this occasion. While I do not wish to question the valuable contributions that have been made by many fine journalists who are currently being made redundant by the collapse of venerable newspapers there are some opinions being expressed that are just not easy to agree with.

For example one of the commenters in regard to the SA article laments the demise of print journalism and goes on with the claim that "Truth, Accuracy, and Neutrality will be the big casualties of all of this."

Many of Mr. Murdoch's publications, to name just one proprietor that has enjoyed way too much power for too many years (on both sides of the Atlantic), have not exactly been big contributors to truth, accuracy and neutrality.

News discovery and investigation, and meaningful decoding/debunking of the PR efforts of governments, is increasingly moving to the blogosphere and written by people that are not on the payroll of moguls.

I would point readers to the blog authors listed in the blogroll on this site as some of the best journalists and analysts (that I am aware of) of current events in matters financial and beyond.

Many of these authors are independents and as such do not have to comply with the wishes of proprietors who have axes to grind and political favors to return.