El-Erian’s ‘New Normal’

Friday, May 15th, 2009

Mohamed El-Erian, PIMCO co-Chief, has published an essay defining a new catch-all phrase to describe the context that markets and economy are operating under, post the credit and financial meltdown of the last year, and what the future holds based on their findings.

Here are some excerpts from The New Normal, published by El-Erian in his May 2009 Secular Outlook:

After all, recent months have been dominated by unprecedented volatility in factors that have conventionally anchored market relationships. Indeed, some of you have already heard us argue that the world is traveling on a bumpy road to a new destination – or what PIMCO has labeled the “new normal.” And, reminiscent of what happened a few years ago with Bill Gross’s concept of a “stable disequilibrium” and Paul McCulley’s “shadow banking system,” the notion of a new normal is increasingly resonating in policy circles and among market practitioners.

This reflects a growing realization that some of the recent abrupt changes to markets, households, institutions, and government policies are unlikely to be reversed in the next few years. Global growth will be subdued for a while and unemployment high; a heavy hand of government will be evident in several sectors; the core of the global system will be less cohesive and, with the magnet of the Anglo-Saxon model in retreat, finance will no longer be accorded a preeminent role in post-industrial economies. Moreover, the balance of risk will tilt over time toward higher sovereign risk, growing inflationary expectations and stagflation.

The context:

First, delineating where markets are coming from – or, to use the PIMCO phraseology, the “initial conditions.” We found ourselves drawn back to the 2008 Secular Forum’s characterization of the global system having reached a “dead end:” unable to continue on its recent path due to debt exhaustion and poorly capitalized activities, yet also incapable of embarking smoothly on a different path as the ravages of de-leveraging result in disruptive overshoots and considerable collateral damage.

Second, recognizing that since the last Secular Forum, the global economy and markets suffered what economists call a “sudden stop” after the disorderly failure of Lehman Brothers in mid-September: every section of the rich data book for the Forum highlighted the severity of this cardiac arrest, raising legitimate questions regarding the depth and duration of the underlying breakage.

Third, arguing that recent events extended the de-leveraging dynamics into a broader phenomenon with longer-term consequences: the DDR, to use the terminology of one of Bill’s recent Investment Outlooks. This potent cocktail – a self-reinforcing mix of De-leveraging, De-globalization, and Re-regulation – inevitably entails economic and political forces that disrupt the normal functioning of markets and the global economy.

Together, these factors constituted a strong unanticipated blow to the gut of virtually every economy. (See Charts 1 and 2 for an illustration). Most are still on the floor trying to regain their breath. Indeed, as one of our external speakers put it, if you were the global economy, you would not wish to start a journey from here; yet, you also cannot go back to where you were.

So what does all this mean?

This is an in-depth, longer than the usual piece which deserves to be read in its entirety.

You can read more here, or download the PDF here.

Source: PIMCO, May 2009

Tags: Abrupt Changes, Anglo Saxon, Bill Gross, Bumpy Road, Disequilibrium, Financial Meltdown, Global System, Heavy Hand, Industrial Economies, Inflationary Expectations, Market Practitioners, Market Relationships, Mohamed El Erian, Paul McCulley, PIMCO, Policy Circles, Preeminent Role, Sovereign Risk, stagflation, Unprecedented Volatility
Posted in Markets | No Comments »

Webcast: Perspectives on the markets – the new retirement paradigm

Wednesday, May 6th, 2009

The current economic environment may have affected even the most well-considered retirement plans. Wherever you are on the path to retirement, recent declines in equity and housing prices are likely to have raised concerns about whether or not you are still on track.

This webcast comprises a panel discussion featuring the views of Morgan Stanley and external strategists as they present their perspectives on the current economic outlook and discuss key retirement planning issues. The discussion is chaired by Charlie Rose and panelists include the following:

• Paul McCulley, Managing Director and Generalist Portfolio Manager at PIMCO, and member of PIMCO’s investment committee.

• Moshe Milevsky, Finance Professor at the Schulich School of Business at York University in Toronto (Canada).

• David Darst, Chairman of Morgan Stanley’s Asset Allocation Committee and Chief Investment Strategist of Morgan Stanley Global Wealth Management.

• Barbara Reinhard, Deputy Chief Investment Strategist of Morgan Stanley Global Wealth Management.

• Jim McCarthy, Head of Retirement, Equity and Planning Solutions of Morgan Stanley Global Wealth Management.

Click on the image to view the full one-hour webcast, or view the featured topics lower down.

Where are we in the economic crisis, and when will it be over?
Hear insights on where we are in the crisis and when they anticipate the environment may improve.

Is the government on the right track? Does the country have confidence in the government?
Does the US have confidence that the decisions being made now - about housing and the stimulus plan, for example - are the right ones?

Are the economy and Wall Street never going to be the same?
Hear how the panelists believe the current crisis will impact investors in the long term.

What makes you optimistic and cautious over the next 5 years?
Is there reason to be optimistic? What are the opportunities that come with market recovery?

What realities about retirement do baby boomers have to face?
The baby-boomer generation, which is so close to retirement, will be the most impacted by this crisis. What choices will they have to make?

How should you think differently about retirement savings and diversification?
How can the 78 million baby boomers think differently about their ability to meet their personal and financial goals?

Source: Morgan Stanley, May 2009.

Tags: Allocation Committee, Canada, Canada David, Charlie Rose, Chief Investment Strategist, David Darst, Economic Crisis, Economic Environment, Finance Professor, Global Wealth, Investment Committee, Jim Mccarthy, Morgan Stanley, Moshe Milevsky, Paul McCulley, PIMCO, Planning Solutions, Retirement Equity, Retirement Planning, Retirement Plans, Schulich School Of Business, Wealth Management
Posted in Markets | No Comments »

Risk appetite rekindled on hope of better days

Friday, March 27th, 2009

Following Fed Chairman Ben Bernanke’s “nuclear option” announcement of last week, the action stayed on Capitol Hill with Treasury Secretary Timothy Geithner outlining his Public-Private Investment Program as well as “new rules of the game” for the financial services industry.

Whereas Nouriel Roubini’s reaction to the administration’s new plan to buy toxic assets was surprisingly positive, James Galbraith and Paul Krugman were not impressed. These gentlemen are included in this week’s harvest of video clips, sharing the platform with the likes of Bill Gross, Paul McCulley, John Bogle, Wilbur Ross and Jeremy Siegel.

As stock markets look set for a straight third week of gains, the debate as to the longevity of the nascent rally rages on. The featured video material sees Mark Mobius saying “the next bull market has begun”, Jeff Saut arguing the “odds are pretty good stocks have seen their lows”, but Laslo Birinyi taking a bearish stance and advising to sell stocks that gained in the rally.

The selection starts with a great discussion across the pond on the “future of capitalism” and ends with an educational clip about the ins and outs of quantitative easing.

Financial Times: Future of capitalism - London panel
“Does the financial crisis signal the end of the Reagan-Thatcher model of free markets and globalisation? FT editor Lionel Barber leads a discussion with Howard Davies, director of the London Schoof of Economics, Donald Brydon, incoming chairman of the Royal Mail, and John Studzinski, of US private equity firm Blackstone.”

Source: Financial Times, March 26, 2009.

CNBC: Geithner & toxic assets
“Treasury Secretary Timothy Geithner discusses his plan to deal with financial institutions’ toxic assets, with CNBC’s Erin Burnett.”

Part 1

Part 2

Source: CNBC, March 23, 2009.

Financial Times: Geithner’s toxic asset plan
“The government has given the financial sector what it has wanted for a long time; it will pay investors to take the toxic assets off banks’ balance sheets. But the supercharged political environment could endager the program, says FT’s Francesco Guerrera.”

Click here for the article.

Source: Francesco Guerrera, Financial Times, March 23, 2009.

CNBC: Bill Gross buys in
“Pimco is intrigued by the potential double-digit growth from the toxic asset plan, says William Gross, co-chief investment officer/founder.”

Source: CNBC, March 23, 2009.

CNBC: Market masters wigh in on the Treasury’ plan
“The economy’s performance utimately drives stock prices, with Abby Joseph Cohen, Goldman Sachs, Paul McCulley, PIMCO, John Bogle, The Vanguard Group, and Bob Doll, BlackRock.”

Source: CNBC, March 24, 2009.

PBS News: Toxic asset plan may woo investors, but long-term impact is unclear
“While markets rose Monday on details of the toxic asset plan, critics voiced concern over taxpayer risk and the need for a long-term fix to financial sector troubles. New York Times columnist Paul Krugman and Donald Marron of Lightyear Capital debate the details.”

Click here for the article.

Source: PBS News, March 23, 2009.

Bloomberg: Roubini says Geithner plan won’t stop nationalizations
“Nouriel Roubini, economist and professor at New York University’s Stern School of Business, talks with Bloomberg’s Maithreyi Seetharaman about US Treasury Secretary Timothy Geithner’s plan to remove toxic assets from the books of the nation’s banks. Roubini, speaking in London, also discusses the outlook for the meeting between the Group of 20 leaders in London.”

Source: Bloomberg, March 26, 2009.

Tech Ticker (Yahoo Finance): James Galbraith - Geithner plan “extremely dangerous”, banks “massively corrupted”
“Professor James Galbraith didn’t pull any punches on TechTicker this morning. He hates the Geithner plan, calling it ‘extremely dangerous’. He says the banks may game the plan to bid up the prices for their own crap assets and that getting bad assets off their books won’t get them lending again. Like Paul Krugman, Galbraith thinks the FDIC should just put the banks into receivership and have the banks’ subordinated bondholders pick up some of the cost of restructuring them.

Part 1: Getting crap assets off bank books won’t save economy

Part 2: Massive corruption

Source: Tech Ticker, Yahoo Finance, March 23, 2009.

CNBC: EU politician slams US economic recovery plan
“A top EU official slams the US economic recovery plan, calling it a way to hell, reports CNBC’s Carolina Cimenti.”

Source: CNBC, March 25, 2009.

CNBC: Ross: Due diligence integral to success of US plan
“The key issue would be how much due diligence the US government allows private investors to conduct in its toxic asset plan, says Wilbur Ross, chairman & CEO of WL Ross & Co. He speaks with CNBC’s Martin Soong & Sri Jegarajah.”

Source: CNBC, March 23, 2009.

Financial Times: “New rules of the game”
“Treasury secretary Tim Geithner’s regulatory overhaul is ambitious, but the question is whether he can follow through, says FT’s Helen Thomas.”

Source: Financial Times, March 26, 2009.

CNBC: Restoring investors’ trust
“The stress test on banks is an essential step in restoring trust for investors, says Jeremy Siegel, Wharton School at The University of Pennsylvania professor of finance.”

Source: CNBC, March 26, 2009.

CNBC: AIG hearing - Timothy Geithner’s statement
“Treasury Secretary Timothy Geithner says AIG’s failure would have caused catastrophic damage.”

Source: CNBC, March 24, 2009.

CNBC: AIG Hearing - Ben Bernanke’s statement
“Fed Chairman Ben Bernanke discusses the importance of bailing out AIG.”

Source: CNBC, March 24, 2009.

Bloomberg: FDIC’s Bair says goldman should return US aid if able
“Federal Deposit Insurance Corp. Chairman Sheila Bair talks with Bloomberg’s Kathleen Hays about the possible return of government bailout funds by Goldman Sachs Group. Goldman Sachs is talking with US regulators about repaying the $10 billion it received from the government by mid-April, a person familiar with the matter said. Bair also discusses Treasury Secretary Timothy Geithner’s plan to remove toxic assets from the books of US banks.”

Source: Bloomberg, March 24, 2009.

Charlie Rose: An update on the economy with Krugman et al
“An update on the economy with Paul Krugman, Joe Nocera and Andrew Ross Sorkin.”

Source: Charlie Rose, March 23, 2009.

John Authers (Financial Times): Credit market gloom
“Perhaps the greatest cause for concern amid the equity rally is that credit markets, the target of all the rescue operations, are still working on the assumption of absolute disaster, says John Authers.”

Click here for the article.

Source: John Authers, Financial Times, March 27, 2009.

60 Minutes: President Barack Obama
“From the AIG bonuses, to the economic meltdown, to the war in Afghanistan, it has been an eventful two months in office for President Obama. Steve Kroft has the behind-the-scenes interview.”

Part 1

Part 2

Source: 60 Minutes, March 22, 2009.

Bloomberg: Mobius says stocks at beginning of a bull market
“The next bull market has begun and there are bargains in every emerging market following a record slump in stocks, Templeton Asset Management’s Mark Mobius said.”

Click here for the article.

Source: Bloomberg, March 23, 2009.

Bloomberg: Saut says odds “pretty good” stocks have seen their lows
“Jeffrey Saut, chief investment strategist at Raymond James & Associates, talks with Bloomberg’s Julie Hyman about the outlook for US stocks. Saut, speaking from St. Petersburg, Florida, also discusses the Treasury’s Public-Private Investment Program and financial stocks.”

Source: Bloomberg, March 23, 2009.

Bloomberg: Laszlo Birinyi - sell stocks that gained in rally
“Laszlo Birinyi, president of Birinyi Associates, talks with Bloomberg’s Betty Liu about his equity investment strategy. Birinyi, speaking from Westport, Connecticut, says investors who own stocks that rose as the Standard & Poor’s 500 Index rallied 20% since March 9 should consider selling them.”

Source: Bloomberg, March 26, 2009.

John Authers (Financial Times): Reading copper leaves
“Recovering commodity prices may signal that we have reached the bottom of this bear market.”

Click here for the article.

Source: John Authers, Financial Times, March 24, 2009.

Financial Times: Benita Ferrero-Waldner on eastern Europe
“Benita Ferrero-Waldner, the EU’s external affairs commissioner, says eastern Europe is important to the European Union. Ms Ferrero-Waldne also says the EU must re-engage in a broad dialogue with Russia to avoid another energy crisis.”

Source: Financial Times, March 23, 2009.

Marketplace: Quantitative easing
“Now the Federal Reserve has effectively cut the target lending rate to zero, it only has one more weapon in its arsenal. Quantitative easing. Senior Editor Paddy Hirsch explains what this ‘nuclear option’ is, and what the Fed hopes it’ll do.”

Source: Marketplace (via Vimeo), December 2008.

Tags: Ben Bernanke, Birinyi, Cnbc, Galbraith And Paul, Howard Davies, Incoming Chairman, James Galbraith, Jeremy Siegel, John Bogle, John Studzinski, Lionel Barber, Nouriel Roubini, Paul Krugman, Paul McCulley, Private Equity Firm, Risk Appetite, Royal Mail, Timothy Geithner, Treasury Secretary, Wilbur Ross
Posted in Bonds, Emerging Markets, Gold, Markets | No Comments »

Stocks Between a Rock and a Hard Place

Sunday, February 22nd, 2009

Stock markets remain caught between the actions of central banks frantically trying to fend off a total economic meltdown on the one hand, and a worsening economic and corporate picture on the other.

Meanwhile, the Dow Jones Industrial Index has fallen to its lowest level since October 2002. It is noteworthy that it took five years for the Index to increase from 7,500 to 14,000, but only 16 months to wipe out the entire 2002-2007 advance.

I have just returned from a business visit to a rather morbid Europe, with the sight of thousands of people queuing for unemployment benefits in Ireland still foremost in my mind. The fact that a number of this week’s video clips refer to the dire situation in Europe, and specifically the crisis in a few Eastern European countries, therefore comes as no surprise.

But although gloom prevails, money-making opportunities do exist as highlighted by John Murphy (StockCharts.com) and Dennis Gartman (The Gartman Letter) who expect gold bullion to keep shining.

CNBC: McCulley & Leuthold - investment strategies for a volatile market
“Paul McCulley, managing director at PIMCO, and Steven Leuthold, chairman of Leuthold Weeden Capital Management, share their best strategies for this market environment.”

Source: CNBC, February 18, 2009.

Bloomberg: Obama pledges $275 billion to stem mortgage foreclosures

Click here for the article.

Source: Bloomberg, February 18, 2009.

CNBC: Dimon - housing plan “well designed”
“President Obama’s housing plan is very elegant and well-designed, according to JPMorgan Chase CEO Jamie Dimon.”

Source: CNBC, February 18, 2009.

Yahoo Tech Ticker: Whalen - “nationalization” of Citi and BofA inevitable
“In the past few months, an increasing number of economists have become convinced that the best ‘fix’ for the banking system is a government takeover and restructuring of companies like Citigroup. And some voices in the government are finally supporting this idea. Over the weekend, Senator Lindsey Graham said he thought ‘nationalization’ has to be considered, because he doesn’t want to throw good money after bad.

“What would this mean, exactly? The government running our banks for the next decade? No, says our guest Chris Whalen of Institutional Risk Analytics. ‘Nationalization’ is a poor word to describe the process. ‘Receivership and restructuring’, along the lines of what the FDIC did with WaMu, is the right way to think about it.”

Source: Yahoo Tech Ticker, February 18, 2009.

TheStreet.com: Peter Schiff slams TARP 2
“Peter Schiff, president of Euro Pacific Capital, takes on Treasury Secretary Tim Geithner’s banking relief plan in a special ‘lightning round’ session.”

Source: TheStreet.com, February 15, 2009.

CNN: Stimulus plan irks Ron Paul
“Former presidential candidate Ron Paul is angered at being left in the dark about the details of the stimulus plan.”

Source: CNN, February 16, 2009.

CNBC: Greenspan on the financial crisis
“Former Federal Reserve Chairman Alan Greenspan delivers a speech on the financial crisis at The Economic Club of New York.”

Source: CNBC, February 18, 2009.

CNBC: Whitney on the banking sector
“Banking stocks are all lower today as the outlook for the industry fails to brighten. Meredith Whitney, CEO of the Meredith Whitney Advisory Group, has been on point with her outlook for financials and tells CNBC what’s next for the sector.”

Source: CNBC, February 19, 2009.

Bloomberg: Ross says investors will wait for bank writedowns

Click here for the article.

Source: Jason Kelly and Carol Massar, Bloomberg, February 12, 2009.

Charlie Rose: A conversation with IMF’s Dominique Strauss-Kahn

Source: Charlie Rose, February 13, 2009.

Charlie Rose: Mishkin, Roubini, Zandi & Easton - discussion about the economy

Source: Charlie Rose, February 18, 2009.

Financial Times: Martin Wolf - the slow path to recovery
“Martin Wolf on how countries will extricate themselves from the global financials crisis.”

Source: , Financial Times, February 17, 2009.

Bloomberg: Bernanke speaks on the economy
Fed Chairman Ben Bernanke reveals the Fed’s long-term economic forecast to the National Press Club in Washington.

Click here for Part 2 of Bernanke’s speech.

Source: Bloomberg (via YouTube), February 18, 2009.

Bloomberg: In-depth look - the housing crunch
“Analysis and discussion with Nicolas Retsinas of Harvard University.”

Click here for Part 2 of the discussion.

Source: Bloomberg (via YouTube), February 18, 2009.

Bloomberg: Biggs bullish on US stocks
“US stocks are poised to rise because economic indicators are starting to improve, said Barton Biggs, managing partner at Traxis Partners LLC in New York. ‘There’s too much bearishness and the market is poised for a big, big rally,’ said Biggs.”

Click here for the article.

Source: Bloomberg, February 18, 2009.

Bloomberg: StockCharts’ John Murphy - gold to outshine

Source: Bloomberg (via YouTube), February 14, 2009.

Bloomberg: Gartman sees gold as world’s “second reserve currency”
“Dennis Gartman, economist and editor of the Gartman Letter, talks with Bloomberg’s Erik Schatzker and Deirdre Bolton about the outlook for gold prices. Gartman also discusses the state of the Japanese economy and why he favors selling the yen.”

Source: Bloomberg, February 17, 2009.

The Wall Street Journal: China’s billion-dollar hunger for resources
“WSJ’s Rebecca Blumenstein and Andrew Browne discuss China’s recent investment in natural resources, including a $25 billion deal with Russia for oil.”

Source: The Wall Street Journal, February 18, 2009.

Financial Times: Austria’s central banker on the EU economic crisis
“Austria’s central bank governor Ewald Nowotny talks to economics editor Chris Giles about possible ‘unconventional measures’ by the European Central Bank, how EU states are more united on policy, and the need to help eastern European countries outside the EU.”

Source: Financial Times, February 17, 2009.

The Wall Street Journal: A grim forecast for Eastern Europe
“Is Eastern Europe on the brink of economic collapse? WSJ’s Nik Deogun and Joanna Slater discuss the reasons for worry amid the slump in Eastern European currencies.”

Source: The Wall Street Journal, February 18, 2009.

Bloomberg: Faber says Germany, France may have to bail out nations
“Marc Faber, publisher of the ‘Gloom, Boom & Doom Report’, talks with Bloomberg’s Deirdre Bolton about the possibility that France and Germany may have to bail out entire nations as European government budgets buckle under the weight of recession. Faber also discusses the outlook for the US stock market.”

Source: Bloomberg, February 18, 2009.

Tags: Bofa, Central Banks, Cnbc, Dennis Gartman, Dow Jones Industrial, Dow Jones Industrial Index, Eastern European Countries, Economic Meltdown, Gartman Letter, Gold Bullion, Government Takeover, Jamie Dimon, Jpmorgan Chase, Management Share, Mortgage Foreclosures, Paul McCulley, Place Stock, Steven Leuthold, Stockcharts, Unemployment Benefits
Posted in Economy, Gold, Markets, Oil and Gas, Outlook, US Stocks | No Comments »

Risk Appetite Fades on Stimulus Gloom

Friday, February 13th, 2009

Events this week were dominated by the announcement of US Treasury Secretary Geithner’s Financial Stability Plan and a deal reached in the Senate on the Economic Stimulus Bill. However, the big bail-out bang soon whimpered as investors were disappointed about the lack of detail.

While markets remained mired in uncertainty, a barrage of video footage on the ins and out of the various plans was produced. Commenting on the financial rescue packages were the likes of Bill Gross, Paul Volcker, Steve Forbes, Frederic Mishkin, Mark Zandi, Robert Shiller, Byron Wien, Martin Feldstein, Paul McCulley, Jim Rogers, Nouriel Roubini, Peter Schiff and John Silvia.

In lighter vein, this week’s compilation kicks off with a message from Jon Stewart to Wall Street: “I suggest that you don’t complain about whether or not you get a window seat on the rescue boat.” Also, don’t miss the “Stimulus” item at the end of the post.

The Daily Show: Wall Street bailout
“Wall Street doesn’t like how the trillion dollars will be distributed to save them.”

Source: Jon Stewart, The Daily Show, February 11, 2009.

ABC News: Obama - no “easy out” for Wall Street

Source: Terry Moran, ABC News, February 10, 2009.

Financial Times: Big bail-out bang whimpers
“The Treasury’s financial rescue plan lacks detail and was unwelcome by the markets, says FT’s Francesco Guerrera.”

Click here for the article.

Source: Financial Times, February 10, 2009.

CNBC: Deal reached on economic stimulus bill
“A deal has been reached on an economic stimulus bill, according to Senate Majority Leader Harry Reid.”

Source: CNBC, February 11, 2009.

Bloomberg: Gross, Volcker, Mishkin and Forbes on stimulus
“Bill Gross, co-chief investment officer of Pacific Investment Management Co. and former Federal Reserve Chairman Paul Volcker speak about the prospects for a US economic stimulus package. President Barack Obama is demanding Congress to pass a stimulus bill before its February 16 President’s Day holiday. This report also includes comments from former Fed Governor Frederic Mishkin, Steve Forbes, chief executive officer of Forbes Inc., Charles Calomiris, a professor at Columbia University, Mark Zandi, chief economist of Moody’s Economy.com, and Joel Prakken, chairman of Macroeconomic Advisers.”

Source: Bloomberg, February 10, 2009.

CNBC: Shiller and Wien discuss stimulus
“Insight on how human psychology drives the economy, with Robert Shiller, Yale School of Management’s professor, and Byron Wien, Pequot Capital chief investment strategist.”

Source: CNBC, February 11, 2009.

CNBC: Feldstein on stimulus deal
“Martin Feldstein, Harvard University professor and a member of Obama’s economic recovery advisory board, discusses the stimulus deal reached by Congress and today’s bank CEO hearings on Capitol Hill.”

Source: CNBC, February 11, 2009.

CNBC: Pimco’s McCulley - a Treasury plan short on details
“Investors are searching for more detail than Tim Geithner was willing to provide, with Paul McCulley, PIMCO portfolio manager/managing director.”

Source: CNBC, February 11, 2009.

CNBC: Rogers - let banks fail
“It’s not the first time in the world that investment banks and commercial banks have gone bankrupt, this has been going on for hundreds of years,” Jim Rogers, CEO of Rogers Holdings, told CNBC Tuesday.”

Source: CNBC, February 10, 2009.

Bloomberg: Roubini expects US to play stronger role in banks
“Nouriel Roubini, a professor at New York University, talks with Bloomberg’s Kathleen Hays about the banking industry and housing market. Roubini, who forecast the US recession two years ago, says the US government will have to nationalize some of the biggest banks because they are now ‘effectively insolvent’.”

Source: Bloomberg, February 9, 2009.

Fox Business News: Peter Schiff - economic Armageddon?

Click here to view Part 2.

Source: Fox Business News (via YouTube), February 5, 2009.

The Wall Street Journal: Silvia on the prospects for a US recovery
“John Silvia, chief economist at Wachovia, talks about his expectations for the future of the country’s gross domestic product, employment data and whether government stimulus will work.”

Source: The Wall Street Journal, February 10, 2009.

CNBC: Dr Doom - US inflation could hit 200%

Click here for the article.

Source: CNBC, February 6, 2009.

Bloomberg: Inside look - January foreclosures top 250K
“Foreclosures exceeded 250,000 for 10th straight month in January; analysis and discussion with RealtyTrac’s Rick Sharga.”

Source: Bloomberg (YouTube), February 11, 2009.

John Authers (Financial Times): The importance of dividends

Click here for the article.

Source: John Authers, Financial Times, February 10, 2009.

Bloomberg: Gross bought mortgages, sold US debt

Click here for the article.

Source: Bloomberg, February 11, 2009.

Financial Times: Martin Fridson on default rates and distressed debt
“Martin Fridson, chief executive of Fridson Investment Advisors, which invests in corporate debt, expects corporate default rates in the US to peak around 15% or 16%, the highest level since the Great Depression. More dire economic conditions could push this level higher. The reason for the soaring default rates is that the quality of outstanding bonds is so much worse than in previous cycles. Investors lent money to companies that were a lot riskier to lend to than they have in the past. This expectation assumes the financial system will get back on its feet, but the outlook could worsen again for the financial system, and that would mean expectations have to be reviewed.

“In Part 2 Martin says a higher default rate combined with structural changes in the debt markets such as changes to the bankruptcy code could push recover rates to 15 cents on the dollar. The average recovery rates over the cycle tend to be in the range of 40 to 45 cents, with recovery at the low point usually at 25 cents. These could be lower this time around. Losses could also come to holders of bonds in banks, especially in banks that could fail or get taken over by the government.

Click here to view part 2.

In Part 3 Martin says the best time to buy distressed debt is when default rates peak, which is not expected until the end of 2009 or the first half of 2010.

Click here to view part 3.

Source: Aline van Duyn, Financial Times, February 8, 2009.

CNBC: Mr. Yen on crisis response - a “behind the curve”
“Eisuke Sakakibara, the former finance minister for Japan, believes moves to counter the financial crisis have been a little slow. ‘So far, the authorities have been a little bit behind the curve,’ he told CNBC. ‘You should have infused capital a little bit earlier.’”

Source: CNBC, February 12, 2009.

BBC News: BoE’s Mervyn King says UK “in deep recession”

Click here for the article.

Source: BBC News, February 11, 2009.

YouTube: Stimulis - because all economies have performance issues
“Are you an economy with performance issues? If you find it hard to achieve and maintain growth, maybe Stimulis is right for you. Take Stimulis once every election cycle or whenever you’re in need …

Source: YouTube, February 4, 2009.

Tags: Chief Investment Officer, Economic Stimulus Bill, Economic Stimulus Package, Federal Reserve Chairman, Frederic Mishkin, John Silvia, Jon Stewart The Daily Show, Mark Zandi, Martin Feldstein, Nouriel Roubini, Pacific Investment Management Co, Paul McCulley, Paul Volcker, Peter Schiff, Risk Appetite, Robert Shiller, Senate Majority Leader, Senate Majority Leader Harry Reid, Steve Forbes, Wall Street Source
Posted in Bonds, Economy, Markets, Outlook | No Comments »

McCulley: The Paradox of Deleveraging will be Broken

Monday, November 24th, 2008

Paul McCulley, Managing Director and Portfolio Manager, PIMCO, earlier this year wrote a landmark discussion piece titled, “The Paradox of Deleveraging,” in which he postulated that the deleveraging of the credit market would have a profoundly negative impact that only a government sponsored plan could subdue, as no other party could be big enough to slay the affliction of credit abuse in the housing, investment and banking industries. Here is the follow up:

I’ve only written this essay once since the Kansas City Fed’s annual symposium in late August.1 But it hasn’t been because I’ve been lazy. Rather, I’ve been working virtually around the clock ever since, in my day job as head of PIMCO’s Money Market and Funding Desk. On Wall Street, this desk is frequently viewed as a backwater, a temporary home for new MBAs getting their feet wet before moving on to higher-value-added desks, or a retirement home for those with more senior moments than fresh ideas.

That’s never the case here at PIMCO, even though a number of now PIMCO partners spent their first days trafficking in the money markets and I, of ever-graying hair, still make my home here in the early hours of the day. Money markets frequently are a backwater, except when they are not, in which case they are cascading rapids. Liquidity pressures inevitably are the precursor of solvency and/or going-concern problems. Just ask Wall Street’s independent investment banks.

We here at PIMCO have always known this. Accordingly, we’ve always been conservative beyond conservative in our money market operations, on both sides of the balance sheet - no asset-backed commercial paper (ABCP) for us, and no tri-party repo without regard to collateral types or haircuts either. Meat and potatoes only, no fancy garnishes necessary. But the meat and potatoes must be cooked properly.

Hence, the work load of PIMCO’s money market and funding desk. My new deputy, Jerome Schneider, hit the ground running in early August, a most propitious time, just before the global money markets became not just cascading rapids, but roaring waterfalls. The financial world will never be the same after the U.S. Treasury and Federal Reserve’s fateful decision of the weekend of September 13-14 to stand aside as Lehman Brothers plummeted to death on the rocks below.

Whether that decision was the right one or not, we will never know. Yes, I know that many are quick to take the Treasury and the Federal Reserve to task, maintaining that the on-going global financial crisis - and, thus, growth crisis - would not be nearly so severe if Lehman had been tossed a life line. I simply don’t know. What I do know is that the global financial system was fundamentally broken long before Lehman’s watery death.

Thus, I believe the powerful, systemic policy responses that have unfolded in the post-Lehman world were destined to come about. Lehman was but the unfortunate tipping point. My heart still aches for the pain suffered by my many friends there. Fate is not always fair and at times, is arbitrary and capricious.

But what ailed Lehman was but a manifestation of what ailed, and ails the global financial intermediary system: the presumption that grossly levered positions in illiquid assets can always be funded, because those doing the funding will always assume the borrower is a going concern.

To understand the nature of this systemic malady, we need to return to first principles. Bear with me, please; this is going to be a bit academic. But, I submit, it was the loss of understanding of first principles that lies at the heart of the on-going paradox of deleveraging, which is the proximate cause of the on-going downward spiral of asset and debt deflation.

The Nature of Banking
When I studied the origins of banking in college, we started with the Medici Family of 15th century Italy. I’m quite sure banking existed long before then, just that I haven’t studied it. But regardless of the origins of banking, its founding premise has always been the same: In normal times, the public’s collective, ex ante demand for access to at-par, immediately-available bank money is always greater than the sum of the public’s individual, ex post demand for access to such liquidity.

Thus, the genius of banking, if you want to call it that, is simple: a bank can take more risk on the asset side of its balance sheet than the liability side can notionally support, because a goodly portion of the liability side, notably deposits, is de facto of perpetual maturity, although it is notionally of finite maturity, as short as one day in the case of demand deposits.

It’s the same alchemy that permits mutual funds to commit to next-day redemption at tonight’s NAV, even though all reasonable people know that a mutual fund - with the possible exception of a money market fund - could not possibly liquidate all assets on the wire tomorrow at tonight’s NAV marks. Systemically, it’s the illusion of liquidity, as so elegantly described by John Maynard Keynes:

“The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave cause, might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only. But a little consideration of this expedient brings us up against a dilemma, and shows us how the liquidity of investment markets often facilitates, though it sometimes impedes, the course of new investment.

For the fact that each individual investor flatters himself that his commitment is ‘liquid’ (though this cannot be true for all investors collectively) calms his nerves and makes him much more willing to run a risk. If individual purchases of investments were rendered illiquid, this might seriously impede new investment, so long as alternative ways in which to hold his savings are available to the individual. This is the dilemma.

So long as it is open to the individual to employ his wealth in hoarding or lending money, the alternative of purchasing actual capital assets cannot be rendered sufficiently attractive (especially to the man who does not manage the capital assets and knows very little about them), except by organizing markets wherein these assets can be easily realized for money.”2

Yes, liquidity for all at last night’s marks is an illusion. But for banks, unlike mutual funds, it’s not so much an illusion after all, for two simple reasons: banks have access to deposit insurance underwritten by fiscal authorities and to a discount window underwritten by the monetary authority (and one step removed, the fiscal authority). Thus, banks are unique institutions, providing a “public good:”

*
Liquidity on demand at par for their depositors, because of the safety net underwritten by the sovereign, yet
*
The ability to invest in longer-dated, more risky, not-always-at-par loans and securities, because the existence and credibility of the public safety net systemically renders the public’s ex post demand for liquidity at par below the public’s ex ante demand.

Yes, banking with a sovereign safety net against deposit runs is a really cool business. Indeed, the difference between the public’s ex post and ex ante demand for at-par liquidity could be called the banking system’s “float,” similar to that of a Buffet-style insurance company.

But since it’s a really cool business and since the sovereign providing the liquidity safety net is a de facto equity partner in the business, the sovereign quite rationally wants a say in how the business is run - the degree of leverage, corporate governance, risk management controls, etc. Kinda like I do when I pay the insurance premium on my 19-year old son’s car. Jonnie doesn’t like it, and neither do bankers. Or would-be bankers.

Thus, both bankers and would-be bankers have, from time immemorial, sought to get the benefits of the sovereign’s liquidity safety net without shouldering the associated regulator nuisance. And I’m sure that 19-year old sons and daughters, too, have been doing the same for just as long.

Over the last three decades or so, the growth of “banking” outside formal, sovereign-regulated banking, has exploded, in something that I dubbed the Shadow Banking System.3 Loosely defined, a Shadow Bank is a levered-up financial intermediary whose liabilities are broadly perceived as of similar money-goodness and liquidity as conventional bank deposits. These liabilities could be shares of money market mutual funds; or the commercial paper of Finance Companies, Conduits and Structured Investment Vehicles; or the repo borrowings of stand-alone Investment Banks and Hedge Funds; or the senior tranches of Collateralized Debt Obligations; or a host of other similar funding instruments.

The bottom line is simple: Shadow Banks use funding instruments that are not just as good as old-fashioned sovereign-protected deposits. But it was a great gig so long as the public bought the notion that such funding instruments were “just as good” as bank deposits - more leverage, less regulation and more asset freedom were a path to (much) higher returns on equity in Shadow Banks than conventional banks.

And why did the public buy such instruments as though they were “just as good” as bank deposits? There are a host of reasons, not the least of which was lust for yield. But most fundamentally, Keynes again gives us the systemic answer (his italics, not mine):

“In practice we have tacitly agreed, as a rule, to fall back on what is, in truth, a convention. The essence of this convention - though it does not, of course, work out quite so simply - lies in assuming that the existing state of affairs will continue indefinitely, except in so far as we have specific reasons to expect a change. This does not mean that we really believe that the existing state of affairs will continue indefinitely. We know from extensive experience that this is most unlikely.

The actual results of an investment over a long term of years very seldom agree with the initial expectation. Nor can we rationalize our behavior by arguing that to a man in a state of ignorance errors in either direction are equally probable, so that there remains a mean actuarial expectation based on equi-probabilities. For it can easily be shown that the assumption of arithmetically equal probabilities based on a state of ignorance leads to absurdities.

We are assuming, in effect, that the existing market valuation, however arrived at, is uniquely correct in relation to our existing knowledge of the facts which will influence the yield of the investment, and that it will only change in proportion to changes in this knowledge; though, philosophically speaking, it cannot be uniquely correct, since our existing knowledge does not provide a sufficient basis for a calculated mathematical expectation. In point of fact, all sorts of considerations enter into the market valuations which are in no way relevant to the prospective yield. Nevertheless the above conventional method of calculation will be compatible with a considerable measure of continuity and stability in our affairs, so long as we can rely on the maintenance of the convention.

For if there exist organized investment markets and if we can rely on the maintenance of the convention, an investor can legitimately encourage himself with the idea that the only risk he runs is that of a genuine change in the news over the near future, as to the likelihood of which he can attempt to form his own judgment, and which is unlikely to be very large. For, assuming that the convention holds good, it is only these changes which can affect the value of his investment, and he need not lose his sleep merely because he has not any notion what his investment will be worth ten years hence.

Thus investment becomes reasonably “safe” for the individual investor over short periods, and hence over a succession of short periods however many, if he can fairly rely on there being no breakdown in the convention and on his therefore having an opportunity to revise his judgment and change his investment, before there has been time for much to happen. Investments which are “fixed” for the community are thus made “liquid” for the individual.

It has been, I am sure, on the basis of some such procedure as this that our leading investment markets have been developed. But it is not surprising that a convention, in an absolute view of things so arbitrary, should have its weak points. It is its precariousness which creates no small part of our contemporary problem of securing sufficient investment.”4

And so, Keynes provides the essential - and existential - answer as to why the Shadow Banking System became so large, the unraveling of which lies at the root of the current global financial system crisis. It was a belief in a convention, undergirded by the length of time it held: Shadow Bank liabilities were viewed as “just as good” as conventional bank deposits not because they are, but because they had been. And the power of this conventional thinking was aided and abetted by both the sovereign and the sovereign-blessed rating agencies.

Until, of course, convention was turned on its head, starting with a run on the ABCP market in August 2007, the near death of Bear Stearns in March 2008, the de facto nationalization of Fannie and Freddie in July, and the actual death of Lehman Brothers in September 2008. Maybe, just maybe, there was and is something special about a real bank, as opposed to a Shadow Bank!

And indeed that is unambiguously the case, as evidenced by the on-going partial re-intermediation of the Shadow Banking System back into the sovereign-supported conventional banking system, as well as the mad scramble by remaining Shadow Banks to convert themselves into conventional banks, so as to eat at the same sovereign-subsidized capital and liquidity cafeteria as their former stodgy brethren.

The new conventional wisdom: levered capitalism is good, and made even better with a bit of socialism to protect the downside.

Well Maybe
I’m quite sure that last sentence is not going to sit well with some of you. It’s not supposed to sit well. It doesn’t sit well with me, I must acknowledge, nay confess. Like most of us, I’ve always had a separation in my mind between strictly capitalist activities and strictly public activities. Not that the demarcation is always clean. But it’s a useful way of thinking.

As far as I know, the place where I buy my fishing tackle is a capitalist outfit. If we customers don’t buy enough rods and reels, the owner will go broke; his operation is simply not systemically important enough to be bailed out by the taxpayers, including my neighbors who don’t fish. In contrast, the local Department of Motor Vehicles, sometimes called the DMV, is unambiguously not a capitalist outfit, but a public outfit. It cannot go broke, as evidenced by our tolerance of its fluctuating service level, because it provides a public service that the private sector can’t provide. To be sure, AAA can get you new plates for your car, but you can’t renew your driver’s license at the AAA; for that, you have got to go to the monopoly called the DMV.

Well actually, that’s not entirely true, either. The DMV is actually an oligopoly, with offices in many surrounding neighborhoods. And rumor has it here that the service is a lot quicker at the San Clemente office than the Costa Mesa office, which serves Newport Beach. So the consumer does have the choice of driving to San Clemente, a form of time arbitrage versus going to the Costa Mesa office. However, rumor also has it that this rumored better service in San Clemente is so widespread that, as Yogi Berra might say, the San Clemente office has become so popular nobody goes there anymore.

But you get the point: there is private enterprise and there is public enterprise. And then there is banking, a hybrid of the two. There is no way ‘round this, for good or bad, because fractional reserve banking depends upon the sovereign’s safety net against liability runs, a safety net that the private sector definitionally can’t universally supply. In this sense, the safety net is like national defense: we all need it, but since nobody individually has the incentive to pay for it, we collectively tax ourselves to pay for it.

Yes, sometimes we collectively end up paying $800 for military toilet seats, as was the case about 25 years ago. But that doesn’t change the proposition that public goods do exist, and a stable system of intermediation of private savings into private investment is indeed a public good. The maturity transformation power of a fractional reserve banking system provides an unambiguous benefit to society and as such, must be underwritten by society.

Bottom Line
I could regale you yet again about the power of the analytical thinking of Hyman Minsky, complete with his Forward Journey turning into his Moment, followed by his Reverse Journey.5 But I don’t need to do that any more: we’ve collectively lived it and are now caught in the debt-deflationary pathologies of “the paradox of deleveraging.”6 Not everybody in the private sector can delever at the same time without creating a depression. Accordingly, the sovereign must go the other way, levering up the public balance sheet. And Washington has finally started to do so with appropriate vigor and enthusiasm.

It’s not a pretty picture. In fact, it’s repugnant, giving proof to the proposition that breaking the paradox of deleveraging does involve socializing the downside of previously profitable private sector activities. In a recent speech, I called it “creeping socialism” and was interrupted by an irate, older man in the back of the room bellowing, “It ain’t creeping socialism, it’s galloping socialism!” I really didn’t have a soothing come back, noting that many things are what they are only in the eye of the beholder. But his point wasn’t lost on me or anybody else in the room.

And it is not lost on Washington, DC either, I can assure you. If the sovereign must backstop a private sector activity that produces a public good, then the sovereign will, at least in a democracy, rightfully demand both bottom-up and macro-prudential rules to harness the greed that lubricates the invisible hand of capitalism. Yes, the visible fist of government and the invisible hand are presently engaged in a massive arm wrestling contest in the provision of financial services. And the fist is winning.

At least for now. Capitalism, and especially financial market capitalism, brought this outcome upon itself through greed and hubris. Capitalism is now re-grouping and learning how to play by new rules, which are still being written. And ultimately, I’m sure, capitalistic bankers will once again bend those rules in the pursuit of higher profitability. And that’s okay, I think. In the end, we really don’t want to turn our banking system into the DMV. At the same time, we also don’t want our banking system to be nothing more than a betting parlor.

Or, in the famous words of Keynes again:

“Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”

Paul A. McCulley
Managing Director
November 13, 2008

You can download a complete PDF here.

Tags: Banking System, Banks, Bear Stearns, Blog, BRIC, capitalism, Credit, Credit Market, Desc, Fed, Federal Reserve, Focus, Hedge Fund, Hedge Funds, Investment Banks, Italy, Journey, Lehman Brothers, liquidity, Market Cap, Markets, Mutual Funds, oil, Paul McCulley, PIMCO, risk, Valuations, Value, Wall Street, Water, wisdom
Posted in Credit Markets, Markets, Oil and Gas | No Comments »

Is There a Bull Market Somewhere?

Wednesday, September 24th, 2008

Not likely, according to PIMCO’s Bill Gross. In his most recent Investment Outlook, Gross, reasons and opposes (for now) the idea that in the very different worlds of Louis Rukeyser, Jim Cramer, and Jim Grant, “There’s always a bull market somewhere!”

While he does agree that there are always stocks, bonds, and currencies that can be found to be going up, while markets are going down, Gross cautions:

So the lesson must be to go forth and find the bull market, wherever it is. Almost always – but NOT NOW, because in a global financial marketplace in the process of delevering, assets that go up in price are rare diamonds as opposed to grains of sand. For the past several months our PIMCO Investment Committee blackboard has continued to display the following lesson plan:

What Happens During Delevering

1. Risk spreads, liquidity spreads, volatility, term premiums – they all go up.
2. Delevering slows/stops when assets have been liquidated and/or sufficient capital has been raised to produce an equilibrium.
3. The raising of sufficient capital now depends on the entrance of new balance sheets. Absent that, prices of almost all assets will go down.

Essentially, Gross’ thesis is that as the GSEs, banks, investment banks and global hedge funds delever their balance sheets, they also lower the prices of all securities that can be arbitraged within the marketplace. 

The 10% year over year decline in prices has not been witnessed since the great depression, and that is a red flag.

a 10% aggregate asset price decline does more than make us all 10% less wealthy. Because many of these assets are leveraged and margined, the more they decline, the more frequent and frenzied the margin calls, and if the additional cash flow is not provided, not only an asset liquidation but a debt liquidation follows. It is the debt liquidation that potentially turns a stagnant/recessionary economy into something much worse.

This rare event of systematic debt liquidation is the central issue in both the US and globally. If central bankers are unable to take effective measures, the campfire could turn into a forest fire, and a mild asset bear market could turn into a destructive financial tsunami. Gross points out that even they and their SWF and central bank counterparts who have been doing their part to stem the tide, and in some cases bought into debt issues too early, only to see those issues now priced “underwater,” are now reluctant to make additional commitments.

Paulson and Bernanke have consulted PIMCO regularly throughout the credit market debacle, and have apparently acted on some of that advice as well as that of others like Pershing Square’s Bill Ackman, who floated a Frannie bailout plan prior to the Fed’s that was eerily similar.

Paul McCulley stated in late July, that the only thing that was viable given the delevering of the market that was well underway, was for government to lever up its balance sheet, much the way it is proposing to this week, with the $700-billion TARP plan.

Tags: Bailout, Banks, Bear Market, Bernanke, Bill Ackman, Bill Gross, Blog, Chart, Credit, Credit Market, Economy, Fed, Grain, GSE, Hedge Fund, Hedge Funds, Investment Banks, liquidity, Markets, Paul McCulley, Paulson, Pershing Square, PIMCO, Recession, risk, spreads, Thesis, UK, Water
Posted in Bonds, Credit Markets, Economy, Markets, Outlook | No Comments »

Credit Crisis Observations

Tuesday, September 23rd, 2008

Niels Jensen and Jan Wilhelmsen of Absolute Return Partners (www.arpllp.com) produced an informative analysis of the credit crisis and provide the following observations. Here is our summary:

Loans and Mortgages are getting much harder to come by on average, globally.

This has bold and negative implications for property prices everywhere.

Observation # 1

It all began with housing and it will end with housing.

The current overhang caused by the tightness of credit (mortgages) will take years not months to unwind and housing prices will not begin to rise again until this occurs.

Observation# 2

Don’t trust central banks to always do the right thing.

Evidence suggests that while their intent seems to be genuine, central banks around the world have not been very effective at taming inflation. For example, simply raising interest rates in the underlevered economies of the BRIC countries has been futile, since most consumers and companies do not employ credit to the extent that those of us in the west do.

In the case of the BRIC countries, it appears the problem does not consist of sustaining growth, but rather containing growth. China, for instance, has a record of under-reporting both real and nominal GDP growth, and may have only recently more accurately stated inflation owing to the fact that they could not hide from skyrocketing oil and food prices.

Observation # 3

Policy mistakes are likely to be repeated.

The US is currently at risk of making the same policy making mistakes Japan made 10-15 years ago. US residential property prices have risen more during 2000-2006 boom than did the Japanese during the late 80s boom.

Japan too, though more rapidly, reduced the cost of money dramatically to fend off its crisis.

Japan bailed out many of its institutions and used taxpayers money to fund the activity of fixing the ‘unfixable,’ and this could have profound implications for the US GDP growth in years to come.

Observation # 4

The golden era of investment banks is over.

The biggest independent investment banks have just become banks. The US investment banking business is becoming more like Canada’s where the business is dominated by the large schedule “A” chartered banks and America’s “free” market just became a little more socialist. How ironic…The folding of GS and MS into banks also has valuation considerations for the venerated firms as their revenues and earnings are sure to decline under the auspices of Fed regulation. Further de-levering also has negative implications for the market as it entails more liquidation. Hopefully this will be done in an orderly fashion now that the conversion is underway.

Observation # 5

The final shoe hasn’t dropped yet.

There is more to come. For instance, the financial system has yet to deal with $1-trillion in Alt-A securities and further degradation of the CDS market and counter-party risks.

Absolute Return Partners states that the commodity bull is just the final leg of the liquidity super-cycle: take a look the Economist’s VAR-VAR-Voom chart.

Observation # 6

Leverage is ‘dead’ but capital is not.

Global savings rates now exceed 20%, except in the US, and while this is a positive for global stability, the question remains about whether investors are willing to invest money where it is most needed, the shore up the world’s banks. Failing that, property prices will need to stabilize before we can expect better times.

Observation # 7

The end of the crisis looks further away than it did a year ago.

Its complicated, very complicated.

Commodity price induced inflation has made it hard for policy makers to reduce interest rates. Despite this, interest rate cuts may not be the magic bullet and in 20 of the 36 countries recently surveyed by Morgan Stanley, real short-term interest rates are currently negative.

At this point the $700-billion Treasury/Fed proposal appears to be a solid response, as does the stimulus injections of cash into markets around the world.

This problem remains possibly years away from being done with.

Observation # 8

Traditional risk management has lost its way.

Paul McCulley of Pimco touched on the subject in the July 2008 issue of Global Central Bank Focus:

“[...] every levered financial institution - banks and shadow banks alike - decided individually that it was time to delever their balance sheets. At the individual level, that made perfect sense. At the collective level, however, it has given us the paradox of deleveraging: when we all try to do it at the same time, we actually do less of it, because we collectively create deflation in the assets from which leverage is being removed.”

In fact, while it is known that PIMCO was regularly consulted by Secretary Paulson, it was Paul McCulley who rightly proposed in his newsletter during the summer, that the only real solution would consist of the formation of a new government agency to create a market to thaw frozen or cemented assets.  This would be the only viable long term solution.

Conclusion

Where is the opportunity? According to Absolute Return Partners, real value is to be found in credit instruments. This is where the most damage has been inflicted and it is where the biggest bargains are to be found in today’s markets.

What would you rather own? Equities which trade at 15-20 times earnings or credit instruments trading at a fraction of that cost? Deutsche Bank estimates that senior secured loans are trading at an implied PE ratio of 5-less than a third of the cost of equities.

You may read the full original version, at Observations on a Crisis, Courtesy John Mauldin

Tags: Banks, Blog, BRIC, BRICs, Canada, CDS, Central Banks, Chart, China, Commodity, Credit, Credit Crisis, Earnings, energy, Fed, Focus, Food prices, GDP, GDP Growth, Gold, inflation, interest rates, Investment Banks, Japan, John Mauldin, liquidity, Markets, Mortgage, oil, Paul McCulley, Paulson, PIMCO, risk, Savings Rate, Trading, Trillion, Value
Posted in Credit Markets, Gold, Markets, Oil and Gas | 1 Comment »

The Paradox of Deleveraging

Friday, August 1st, 2008

This week, John Mauldin features the thesis by Pimco’s Paul McCulley, on the subject of the deleveraging of the financial system. Here are a few excerpts:

The Paradox of Thrift:

For me, a simple concept brought this realization: the paradox of thrift. For those of you who might not recall, the paradox of thrift posits that if we all individually cut our spending in an attempt to increase individual savings, then our collective savings will paradoxically fall because one person’s spending is another’s income – the fountain from which savings flow.

On Monetary Easing:

But monetary easing is of limited value in breaking the paradox of deleveraging if levered lenders are collectively destroying their collective net worth. What is needed instead is for somebody to lever up and take on the assets being shed by those deleveraging. It really is that simple.

Read the complete article here - The Paradox of Deleveraging, Paul McCulley

Source: John Mauldin

Tags: Excerpts, John Mauldin, Paul McCulley, Php, PIMCO, risk, Thesis, Value
Posted in Markets | No Comments »