How many more skeletons will fall out of the closets?

There were two developments last week in the financial world, seemingly unrelated, that should give one pause to contemplate just how much we all really know about the true state of the severity of the rolling financial crisis.

Firstly, the Governor of the Bank of England, admitted that more than £60 billions of additional emergency financing had been granted to Royal Bank of Scotland (RBS) and Halifax Bank of Scotland (HBOS) last fall. The claim was made that to have announced this at the time would have created even more anxiety about the calamities facing the global banking system.

It has been suggested that the only reason why the news emerged was because the UK's National Audit Office would have been under an obligation to release details of this secret rescue package of $100 billion when it issues a report this week.

Secondly and moving to the Middle East, the biggest fallout from the troubles facing Dubai World is the lingering suspicion that the “books” and accounts of a lot of emerging market ventures may not be as sound as those with a positive de-coupling spin agenda would like us to believe.

The ruler of Dubai, Sheikh Mohammed bin Rashid al Maktoum, had been reassuring every one that there were no credit risk problems associated with the developers of the world's most absurdly mis-timed real estate projects, right up to the time that he had to admit that there were.

"Fundamental value" as an antidote to bubble policy - not likely any time soon

I particularly like this from today's Lex column in the FT.

Finally a central banker has admitted he is as clueless as everyone else. “It is inherently extraordinarily difficult to know whether an asset’s price is in line with its fundamental value,” said the Federal Reserve chairman in a speech on Monday. Ben Bernanke then contradicted himself, however, by adding: “It’s not obvious to me in any case that there’s any large misalignments currently in the US financial system.” Given the first statement, how can he know?

One can either give up on the notion of trying to pin down what "fundamental value" really is, and how it can be measured, in which case boom/bust is here to stay or financial technocrats are going to have to think a little bit more - to justify their ample rewards - to arrive at a basis for quantifying asset inflation and anticipating bubbles.

Chairman Bernanke seems not to be up to the second challenge.

Japan - a foretaste of what lies ahead on global recession menu?

The Nikkei 225 continues to display the most negative characteristics of any of the world's major equity indices. In trading Tuesday (November 17th) the index dropped back and the short term support line close to 9700 is in danger of being violated. The clear breaks below two recent "fan" lines also underlines the fact that the Japanese bear market which began in 1990 has almost lasted for 20 years and that the Nikkei has lost, in nominal terms, three quarters of the value seen in late 1989.

In saying "nominal terms" one has to be less concerned about adjusting the Nikkei price to account for inflation as this is not a concern for the Japanese economy. In fact, as evidenced in this interesting piece, the real problem facing the second largest economy is deflation.

Japanese deflation just keeps getting uglier. Prices dropped 2.6% year over year in the third quarter, the worst drop in 58 years. This just makes the country's crushing debt burden even heavier.

More importantly, the deflation data reminds us that the Japanese economy isn't growing. It's just deflating.

While Japanese third quarter GDP 'growth' surprised economists, notching 1.2% recently (~4.8% annualized), if everything's deflating at 2.6% then GDP really doesn't say much about growing economic activity. Economic activity is actually still falling once you factor out deflation; note that seasonally-adjusted nominal GDP officially fell 0.3% in the third quarter. Unadjusted nominal GDP fell 4.4%. See the green rows in the screen shots below, taken from the latest Japanese GDP releases.

Don't be fooled by deflation mucking up the real meaning of GDP data -- Japan's economy is still sinking.

Let us hope that the bursting of the Nikkei bubble almost 20 years ago and the ongoing slide in their asset prices ever since is not a foretaste of the next course on the global recession menu.

Sufficient "duty of care" from the custodian of the global reserve currency?

The following two sentences from Ben Bernanke's address at the Economic Club of New York on November 16, 2009 are complete gems of obscurantism.

We are attentive to the implications of changes in the value of the dollar and will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability. Our commitment to our dual objectives, together with the underlying strengths of the U.S. economy, will help ensure that the dollar is strong and a source of global financial stability.

There is no specific articulation of a commitment to support the US dollar per se but rather an opinion being expressed that dollar strength will be a fortunate by-product resulting from the pursuit of the Fed's domestically focused dual mandate.

Does this statement reflect adequate duty of care from the custodian of the global reserve currency?

Let's see how convinced the forex market is in the coming sessions.

Can UK Treasury maintain business as usual with sterling and gilt market?

The Daily Telegraph has a good article on the implications for the UK government of Fitch expressing concerns about the AAA rating relating to its sovereign debt.

It is worth contemplating the possibility that the current paralysis in decisive policy recommendations, as a result of the pre-election posturings of both the UK's main political parties, is beginning to cause some anxiety not only amongst gilt traders in the UK, but is also attracting more attention from the ratings agencies who are renowned for their patience and stoicism.

According to HSBC, the Bank of England’s gilt purchases account for around 90 per cent of gilts issuance in the financial year 2009/2010. However, as QE purchases subside, there is likely to be an increase in purchases by banks in order to meet the new liquidity buffer measures which are being phased in globally to try to reduce risk in the banking system.Fortuitously enough, among all the global regulators, the Financial Services Authority is being the most proactive in its requirements and HSBC reckons that if these measures are implemented, banks could purchase around 60 per cent of gilts issuance in the next fixcal year. “Bank demand for gilts is … liekly to siphon off a large proportion of supply over the next few years at least,” according to Andre de Silva, HSBC strategist. Even a downgrade would not change that dynamic.

But neither is that sort of technical support likely to be enough in the even of a prolonged political failure to tackle the fiscal situation.

“We have no choice about whether to tighten fiscal policy,” says Michael Saunders, UK economist at Citigroup. It’s a question of whether we do so before or after a crisis.”

As is often the case with the UK, it may take a full blown sterling and/or gilt crisis before the politicians come clean with the public and articulate the unpleasant prescription for the growing crisis in the public finances.

Australian tail wagging the US equity index dog

The fate of $SPX is becoming more and more dependent on liquidity in the Australian dollar forex trade.

Poker, casinos and US capital markets

Sometimes while watching markets - especially equities and foreign exchange - during the North American session one has to wonder at what a poker game is being presented.

To call these markets casinos is a misnomer - there is more bluff and skill than the spinning of a roulette wheel. Until some other time zone develops such a battle of wits, the US capital markets will retain their dominance.

Timing the tightening

If you're a major hedge fund/trading desk, it's not a good idea to wait to cover your short dollar, carry trade positions until it's front page news that the Fed is moving towards a more restrictive monetary policy.

EURUSD - doesn't look good

From a technical perspective this chart does not look good. From a fundamental perspective, the fact that the most recent action has taken place within the context of some "good news" about the US economy is even more problematic.

Free spirits

A free spirit is someone who doesn't know what they think until they hear what they say.

Safety is at the short end of the yield curve

The following extract from a fascinating and relevant article at Zerohedge.com reveals a duration mismatch problem for the US government

One would expect that as the financial situation improved, and credit was unlocked, that investors would abandon the safety of low-yielding Bills and pursue risk. Ironically, not only has this not happened, but in the 12 months since October 2008, over half a trillion more, $560 billion to be exact, has been parked in T-Bills. Looking at the entire treasury curve, over 40% of the $7 trillion in marketable treasury securities, matures within one year, a dramatic increase from the roughly 30% a year prior.

Is the TOP in place for the US century?

When seen in a longer time frame the 2000 top in the Nasdaq stocks followed by the double top in the overall US market seven years later may seem, in the graduated terms of reference of the movement of tectonic plates in geological time, to be part of a much larger cultural topping out process for the United States?

Statistics and misinformation

The fact that US government statistics are losing their ability to be "misleading" may be one of the biggest headaches facing Washington

Prudent bankers - self regulation - and Mediterranean yachts

A recent posting at Seeking Alpha contains the following citation from a speech made by a professor of Economics at George Mason University on how we need a new rule of law to prevent financial crises in the future

"If it is known that nobody is “too big to fail”, or too well connected to fail, then lenders will not let financial firms leverage up cheaply in the belief that they will be protected."

The statement sounds very reminiscent of the doctrine that the free market is capable of regulating itself because the self-preservation interests of the relevant lender's shareholders will encourage prudent behavior. This is more or less the same doctrine which Alan Greenspan admitted not so long ago, in testimony to Congress, was his big misconception.

The problem with this laissez faire mythology is that the interests of the managers/traders/financial engineers at the big lenders are not aligned with those of the shareholders. Much of the decision making of the business lenders/financial firms is conducted by guns for hire who can have moved on to pastures new (including yachts on the Caribbean/Mediterranean) by the time that their imprudent lending judgments become evident