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Monday, September 29, 2008

Great Depression of 2008 - bad politics

The US Congress has reneged on a prior commitment to bail out investment banks. The bill was rejected overwhelmingly by Republicans in the Senate whereas Democrats supported the Bank Stabilisation Bill. Congress has collectively just undermined confidence in the whole global financial system. The implication will be an ongoing freeze in lending, a run on the banks and further bank failures. The Congress believes taxpayers should not bail out badly run banks. But this is not management issue, the problem is the lack of regulation of the banks and the Republicans only monetary policy.
You would think Republicans in the US Congress would have learned something from the Great Depression. In the 1920s the Congress supported the misuse of credit for over a decade. This was not however the sole cause of that protracted depression since the Fed at that time made the same mistake of not supporting the banks. This resulted in the collapse of thousands of banks.
In this economic cycle the Congress has embraced 'easy money' for two decades. It was amazing that Congress supported the blow out in US debt. Having done so , its current decision is even more surprising. It would be nice to think that the Republicans in Congress had principles. We knew they didn't for the two decades they supported easy money. But its reported that Republicans did not support the bill because the voters didn't want it. The problem of course is that the public don't understand the issues. Economics is a complex subject, but actually its a small challenge to understand the problem.

The US banking system is highly leveraged. Investment banks rely on derivatives to insure their risks. What insurance does is limit the risk on the downside so that the investment banks can expose themselves to all the upside. The risk is covered by the counter-party in the derivatives transaction. The counter-party is fully exposed to its position. It can hedge its risk with more derivatives contracts with other financial institutions. The problem is that this spreads the exposure. Derivatives make sense if debt levels are kept at reasonable levels, but if they aren't then the whole financial system is vulnerable. One large bank failure is likely to precipitate the collapse of the whole system.

It's hard to believe that Congress will not overturn this decision. More concerning is the lack of reason in this decision. The way this issue is being handled castes dispersions upon the way our financial system is managed, not to mention the way our political process functions. I have of course been highlighting these problems publicly for several years now. It should spark a debate about the legitimacy of our fragile democracy and our financial system. Reason needs to be the standard.

This decision highlights an abysmal incapacity of this government to communicate to vested interests. More concerning still is that it highlights an incapacity for Bush to lead his party. More concerning still is that Republicans are abandoning the party in order to comply with their constituency, the voter, who just doesn't understand the issues. Of course if the media frame a question to voters "Do you want to bail out the banks with your money?" - of course a voter is going to be strongly opposed. Some I dare say would be sending emails to their Congressman. If the media have framed the question "Are you willing to support the bail out of the banks to protect the financial system and your jobs?" then the voter is likely to support this.

The implication then is that the media has precipitated this crisis as much as the Republicans in Congress. The problem of course are journalists who don't understand how the economy works framing questions in a way which is driving policy rather than following it.

May one day we live in a society wherwe reason is the standard because people - most people - have totally lost their sense of reality. The reality however is that this is just political posturing. I can guarantee that Congress will meet again in the next day and miraculously agree to terms. The whole ploy was about Republican Congressmen distancing themselves from the Bush Administrration, whilst at the same time appearing to act in the interests of their electorate. At the end of the day, its about keeping their jobs.
CNN latest update. Click here.
Andrew Sheldon

Sunday, September 28, 2008

Asset deflation - It was no surprise

It is amazing how people can be so unthinking. For the last decade people have been drawing attention to the US market being problematic, and now that its happened journalists are saying they haven't had time to prepare. I have been warning about this type of incident since 2001. In 2005 I started researching the global economy to get a better idea of the implications. Glad to say things are going pretty well as scripted. There are a lot of people running around saying they forecast it. But really there are pretty well a million people who knew what was coming. These are people who read the right internet content. Not the crappy news about Paris Hilton, but websites like

This bailout is needed because without it the banking system will deflate, which is what happened in 1929 with the Great Depression. There is no time to stall really as that will only sap confidence. The whole system needs to be supported because there are heaps of derivatives contracts outstanding which are counter-party exposures for all the derivatives being traded.
Andrew Sheldon

Monday, September 22, 2008

Dow Jones and All Ords testing downtrends

The Australian and US markets have rallied for the last 2 days on the promise of $US 700 billion in Fed/government support for derivatives and sub-prime exposure. The market is happy. There are however several issues the market has to come to terms with:
1. Higher taxes in the USA to address the slower economic activity. The US government has used tax cuts as a means of stimulating the economy. Higher taxes are going to stifle it. Clearly the capacity to raise taxes is limited.
2. Higher interest rates can be expected to rebuild savings in the USA.

You might wonder if the problems in the USA are over. I would say that there was really never a problem that was never going to cause a depression. That was the 'fear campaign'. The only way the economy was going to deflate was if the Fed/US government did not bail out the banks. They knew that they needed to save the major banks to prevent the unwinding of cross-counterparty derivative positions. But clearly the latter considerations place a lid on global growth, particularly in the USA. We might however look forward to a stronger Asian scenario due to pressure on governments in those areas to stimulate domestic demand.
I would advice Australian investors to watch the US market overnight to get a sense of its directions. I'm expecting a pull back, however wait for the lead. The Dow Jones Index failed to break 11,500 points, however further news might achieve that overnight.
The ASX All Ordinaries likewise failed to break its downtrend, however that might come if the USA opens strongly. The market cannot be looking for a further period of stimulus from the USA, it can't come from Japan, but might it come from the Asian tigers?
Andrew Sheldon

Saturday, September 20, 2008

How much will this global economic crisis cost?

This economic crisis is not really an economic crisis, its really a political crisis. The taxpayers of the USA are about to be called upon to pay a lot more in taxation to cover the litany of burdens from misappropriated funds resulting from a system that was designed to enrich CEOs in control of banks and other major corporations. Why? Because they have the power to make party contributions which keep parties in power.
What should happen? Well in all honesty, I think most people no longer have principals. If you believe my book (and you should), then you will understand why these state of events arise. You will also understand that people are going to continue paying taxation because they don't appreciate the extent of the waste. People don't reflect on the fact that taxpayer funds are not used to support people (welfare & services) anymore, they are used to keep people in power. If you use public transport, if you use roads, hospitals, there are discrete taxes or user charges applied in order to fund these things.
The reality is that the US financial system is only going to go bankrupt if taxpayers stop paying tax. The question is - Would they? I could see that as a possibility if taxes increased a great deal, or if inflation totally destroyed the US economy. Bush has suggested the exposure could be $US 1 trillion, thats 2x more than the cost of the Iraqi War. He's what you might call an expensive president. He's done very well on Halliburton stock though.
The US constitution actually does not permit the government to collect income tax, so what will happen if people cynically stop paying tax? Particularly if there are no bonds in their pension plan. Asian governments own a good share of the US bonds. on issue It might be wise to run your own superannuation in future. Governments just cannot be trusted.
So is Barrack Obama any different? Well I think he will be assasinated if he is. I don't see him tracking down the retirement funds of former CEOs who have ill-begotten gains. But in fairness, a lot of people knew what was happening, they just decided not to think. The reason they didn't think is the topic of my current book - A Market Theory of Values.
Andrew Sheldon

The financial crisis has been resolved - everyone will pay

Markets rallied on Friday in the USA as George Bush unveiled plans for a $US 1 trillion bail out of the financial sector. This is no exaggeration because basically the Fed will be forced to cover the losses or exposure of most financial institutions. The reason for this is that the investment banks have counter-party exposure to other investment banks. The bigger problem is that its not just banks. AIG is one of the largest insurance group in the world. It was involved in derivatives trading. This is not surprising. The problem is that exposure is not spread around as they say, its anywhere and everywhere, and its just hard to know where exactly the risk is. Of course it lies with the taxpayer. It always lies with the taxpayer. Those CEOs who made billions playing the market for all they could get to keep their realised gains, including all those options pay-outs. The taxpayer and smaller passive investors just get screwed. That is the redistributive model of our time. The money flows to the banks, the power goes to the politicians, and negotiations between those two 'counterparties' ensure that the major political parties get financed, and the CEOs get to keep their payout, and I can bet you they will be spared prosecution.
The Fed has effectively stepped in as the lender of last resort at least to all the US financial intermediaries. I'm unsure what will happen in the case of British and European central banks, though a similar position can be expected for the financial institutions they manage. The problem is mostly in the USA one would think, but really its not because derivatives are needed by all groups. So what will be the cost? Bush has said it will be $US 1 trillion. The reality is that it could be far more.
The question is - What now? Do banks stop engage in derivatives trading? Does the Fed retain its position as the funder or insurer of last resort? Who knows? Its fair to say that the political system gains a great deal from this system, and so they are likely to fight to save it. Are we going to see a return to a gold standard? Its safe to say no politician is going to voluntarily liquidate these derivative contracts which have added so much liquidity to the market. I would suggest the only thing that would result in a gold standard would be a politician who supported it. Otherwise the issue is too technical for voters to campaign against. A soluition is unlikely to get voter support because its a 'conceptual' problem. The only thing that could change this travesty is a voter revolt. If voters take to the streets to campaign that they are not going to pay taxes to support the banking system, you can bet that would cause problems because it would result in banks again questioning the central banks ability to deliver.
Without a voter backlash, the world will continue under the current system, but it will need to live with higher inflation, higher taxation and subdued earnings. You might wonder how probable is the possibility of a taxpayer strike. I would suggest that its not probable unless there is a financial crisis which would place the burden on taxpayers. Currently there is no great burden on taxpayers. Inflation is another factor that could insight political upheaval. The threat is greatest in the USA because US citizens are actually not obliged to file income tax returns in the USA, but they do. In fact the US courts have occasionally recognised this illegality in the law, but on occasion they have chosen to breach the U.S. Constitution. Breaching the Constitution is considered good sport these days by politicians wanting to retain power. President Roosevelt was the first evil monger in the 1910s. But all politicians to my knowledge seem to celebrate the existence of the welfare state, and thus the system of government that finances it. Ron Paul is the only (Republican) presidential candidate who rejects the current paper money standard.
Andrew Sheldon

Wednesday, September 17, 2008

Nikkei-225 has found support

The Nikkei-225 is another market that has found a support level and is likely to recover after the US market finds support tonight. We know that markets often look for support on prior resistance anf the 12,000 level is strong resistance. It is also a bottom reached earlier in the year.
The question is what stocks to buy. I think the best entries are likely to be Sumitomo Metals since gold is likely to be stronger, nickel is close to its bottom, and copper is doing ok.
Andrew Sheldon

The Dow Jones will support at 10,000 pts

I think the Dow Jones is likely to be unsettled by the rash of institutional failures this week - Lehmans, AIG, Merril Lynch, as well as Fred & Fanny Mae. This will undermine confidence and have the market wondering whether there is more to come. I am thus expecting another bad day. I am expecting the Dow Jones Index to reach 10,000 pts overnight, but I am expecting it to recover in the afternoon. I thus think the time to buy in Asian markets (and Australia offers the best buying) is before closing tonight, because once investors see that the Dow recovered overnight they will read this as a time to buy. The message for American investors is to buy tomorrow around lunchtime. The times of stocks to buy are of course those with exposure to staples like utilities, food, and I would also suggest commodity based stocks, since the weaker USD outlook will be good for those, particularly in the food arena.
Andrew Sheldon

Australian ASX falls to 4620 support

Last week I suggested that the All Ordinaries Index was likely at a support level. In the wake of the financial fiasco over the course of last week, the market has fallen even further to a new support level of 4620 points. I do not expect this market to fall further again. In fact its 2:20pm and I think over the next 1.5 hours we are going to see the ASX fall back to its morning lows before we see bargain hunters to move in. So I see the last half hour as a time to buy in the Australian market.
I have considerable confidence that this is not the end of this 'super cycle', though I do believe the US will have to raise interest rates to increase savings. We are looking at a higher interest rate environment, we are looking at more subdued levels of economic activity, but there is not a huge overhang of capacity, so I see a full recovery within a few years, and likely a new rally being built within a year. I don't see any reason why people should not start buying.
It will be interesting to see how the market closes today. Its not good for the market to close at its low. It shows the Australian market is uncertain and looking to the US market for direction. I will be buying before the close because there will not be an opportunity when the US market shows its bottom tomorrow. I already identified my target stocks last week.
Andrew Sheldon

Saturday, September 13, 2008

The outlook for the US market

The following commentary comes from a Japanese forum I have contributed to.

I don't dismiss the fact that the US is going through pain, and I certainly appreciate that the world is looking at higher interest rates and inflation, but that does not spell depression, nor is the credit bubble going to unwind just yet. The sad reality is that people will recover from this thinking there will be no depression in future because people called 'wolf' on this occasion. That cannot be helped.
So why is the credit bubble not going to unwind? Because the mechanisms for expansion are still in place. China, India and other countries still have a lot of capacity to expand their output. Developing markets aside from China and a few Eastern European countries are not overvalued. So there is more scope for asset inflation, cost of living deflation, as we have become accustomed to. For this reason, I say there is another leg to this bull, and I would expect the Fed to support it. The evidence is they are doing just that.
I do agree with your comments on the Fed, just disagree on your premature diagnosis of mayhem.
Pachipro: "The reason why the world and the US did not go into recession in 2000 during the bubble bust was the implementation, by the Fed, of low cost housing loans to anyone who breathed and could sign their name at very low teaser rates of 2-3%. Thus, the US did not go into recession and housing prices went through the roof as many people hoped to make a huge profit flipping houses. Also, it enabled many people to buy more house than they could afford. This is the sole reason why the US did not go into recession in 2000 when it most definitely should have".
This is all true, but you have to make a case for why inflation should persist as a problem. It is rising because asset prices are falling. So I'm saying they will fall to a point, but they will turn around. Europe is already lowering its interest rates, Japan's are low, Australia is falling, NZ will. Just America is raising its rates. The US needs to attract savings, so US rates will be relatively high, but I don't think too excessive. The lack of returns in the US will cause an Asian property boom. China and India will be investing in global commodity projects.
Pachipro: "Now they are all broke and way in debt and the world back then was also duped into believing that the US economy was sound when the truth is, it was far from sound. The result today is the sad fact that the average American is upside down in their home and car and have more than, on average, more than $8,000 in credit card debt and 7 out of 10 households are 1 - 2 paychecks away from bankruptcy".
Those statements make for a great human interest story but actually they do not constitute statistics that support your argument. The reason the global economy will turn around is because of the critical issue you have missed - there is no big or significant capacity shortage. On the contrary, a lot of markets are tight. I'm focused on commodities, but notice how the prices for iron ore, coal, alumina and copper are still quite high. Even your precious housing stock will be absorbed within 2-3 years. Mass migration will bail the world out, and the credit tap will keep flowing. Sure few Americans will jump in at first, but they will.
Pachipro: "Sadly, Shouganai, you need to do a little more research as the majority of homeowners today are upside down in their mortgages and have no equity whatsoever; have not only a mortgage, but also a HELOC (Home Equity Line of Credit) and cannot afford to pay two mortgages today".
More sensational headlines. Where is the statistics showing that its so bad that we need to worry about depression. The depression was marked by a period of mass over-supply. Where is it - other than US housing stock? This was just an asset price correction causing a spike in inflation. It will recede.
Pachipro: "The simple fact is that real income for the average American DOES NOT support housing prices even at their currently depressed levels. 9% of US mortgages are either in default or foreclosure and the economy is worsening on a daily basis. Therefore, the government had no choice but to take over Fannie and Freddie".
Well I wouldn't be surprised if real income is falling at the moment, but unemployment is 6.1%, and I doubt it will breach 9%, which is a recession number, but it will be absorbed in 2-3 years tops. This boom will continue. Oil prices have already cooled, so those people in default or foreclosed (you say 9%, but have not sourced it and you dont even seem to differentiate. So let me cite Bloomberg's numbers are a lot lower than yours. See Bloomberg.
Bloomberg says "new foreclosures increased to 1.19%, rising above 1% for the first time in the survey's 29 years, the Mortgage Bankers Association said in a report today. The total inventory of homes in foreclosure reached 2.75 percent, almost tripling since the five-year housing boom ended in 2005. The share of loans with one or more payments overdue rose to a seasonally adjusted 6.41 percent of all mortgages, an all-time high, from 6.35 percent in the first quarter".
Now those figures will not take into account the falling oil prices and broader fall in some commodity prices, eg. zinc, lead, nickel. Some good new don't you think. Notice that foreclosures only marginally increased. The reason is that people are in default not because of failure to pay debt but because of falling asset values. So they are being forced to sell 2nd homes, knowing full well they have fully paid off one home. We are talking 2.75% of homes - not your 'scary 9%'.
Pachipro: "This amounts to bankruptcy and nationalization".
Actually there is a world of difference between foreclosure, debt delinquency and bankruptcy. You ignore the assets they hold. There is also a world of difference between absorbing a private banks debts and your presumption that they would be redeeming the housing stock.
Pachipro: "According to recent Treasury figures, foreign holdings of US Agency debt, that is debt of Fannie Mae and Freddie Mac, rose from $107 billion in 1994 to $1.304 billion as of June 30, 2008. Foreigners own about $800 billion of that debt. Thus, you can see why bondholders were bailed out. In addition, Fannie and Freddie are responsible for $5.3 trillion in mortgages, that impact, by comparison, is 13 times greater than the Bear Stearns failure".
I guess you are quite impressed by those numbers. I think you mean $1.3 trillion. The twin [quasi-government) underwriting agencies for the bulk of US housing debt, so of course their liabilities have grown considerably. Yes, the US government has over-stretched. Its just not going to cause more than 2-3 years of recessed US market, and the US will resume its growth.
Pachipro: "Now that the majority of homeowners have no equity, are "upside down in their mortgages, and many are being foreclosed upon, including the "flippers", they are just walking away and, if the US government did not step in to help Fannie and Freddie, foreigners would be very upset and may have sold their treasuries to make up for their losses. This would bankrupt the US".
Well I've established that 2.75% are in foreclosure, so I don't know how you get 'majority' have no equity. I assure you banks foreclose before they have no equity, so the implication is that less than 2.75% have no equity. We have to remember that some of these are 2nd home owners. A bit too early to hit the panic button don't you think.
Pachipro: Maybe you should think about investing in US foreclosures as anyone with cash is most welcomed today by banking institutions. However, the end is not in sight yet and may not be for at least two more years as now ALT-A mortgages are beginning to default.
Well I wouldn't invest in US foreclosures unless I was living there because the economy is going sideways for 2-3 years. I prefer the Philippines because it has far better dynamics. I guess all the US foreclosed you are talking about can afford to retire there.
Pachipro: "You don't have to believe me or call me names like "Pachipronomics". The partial story is here on Bloomberg "US Foreclosurers Hit Record in August As Housing Prices Fell".
Actually this article does not support your point, they say 11% increase, not 11% foreclosures I didn't call you any names.
Andrew Sheldon

Tuesday, September 09, 2008

Does the market know the full story - Lehmans

Its interesting that Lehmans is in 'free fall'. I was talking to a consultant to the Asian Development Bank and Macquarie Bank about 4 weeks ago, and he was saying that Lehmans was in real trouble. Its interesting how this information doesn't find its way onto the market for so long. Great opportunity to short sell I guess. :)
Someone suggested that this credit crunch would result in the failure of about 40 small banks. So far it seems to be the larger banks which are failing. SocGen, Lehmans. Fannie Mae, Freddie Mae.
Anyway, you get the impression that senior people in the market know the extent of the problems, just this information is not conveyed to the market. I guess that shouldn't surprise anyone.
Andrew Sheldon

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