I strongly believe that this time is different from the other crises and recessions that we've experienced over the past 20 years, and probably over the past 60 years.
We've had:
1) An enormous structural overinvestment in non-productive non-tradeables;
2) Incredibly low real interest rates for a long period of time;
3) A Federal Reserve that was way too successful in convincing us all that it was irrationally printing money, and probably won't be able to do so again;
4) An immense build-up of private sector debt, with the FOR only climbing despite very low long and short real interest rates and net assets increasing in value;
5) The housing ATM;
6) A credible argument that the world is low on oil and agricultural goods;
7) A strongly suppressed currency concurrent with a very large structural balance of payments deficit, yet very strong capital inflows by non-economic actors...
I could go on all day. I did, in my "Homepage" linked below.
I don't think any other economy went through this sort of a confluence of events. It bears semblance to a lot of other situations, as observed by Reinhart-Rogoff, Stiglitz, and other giants.
I don't think it's quite the same, though, particularly because our economy is so much larger than any of the other economies in the world. It looks kinda similar to the other Reinhart-Rogoff blowups when viewed through the Mundell-Fleming model, but I think that's misleading. We have a lot of unique privileges and a lot of the decisions that led us here were made by others, e.g. pegging countries.
Yup, I too read that paper a little while ago - it meets my biases of course which are distinctly against american exceptionalism crap( that does NOT make me anti-american and certainly not anti-american-people).
Did you know that the author, Carmen Reinhart, is the wife of former Federal Reserve Monetary Affairs Head Vince Reinhart? Considering Vince was a close working pal of Governor Kohn during his Fed tenure, I'm sure such research is not lost upon the Fed staff!
For a slightly different view on what the 2008 recession might bring, here is an excerpt from John Hussman's 3Feb08 weekly market comment:
"....I don't believe we are likely to observe major declines in consumption, or capital spending such as information technology even assuming the U.S. has entered a recession. Indeed, nominal consumption has never declined year-over-year. Though consumption represents the largest share of the economy, it is also the most stable (Friedman and Modigliani were right). Yes, growth rates will probably slow for these classes of spending in a recession, but the bulk of the downward pressure is likely to fall on housing and fixed investment. Meanwhile, an already lean level of inventories should help to prevent much further decline in inventories, which should offer some support to industrial production. Since negative inventory investment or inventory runoffs represent a good portion of the output losses in a recession, it follows that losses in real economic output (and by extension, employment), though not insignificant, are unlikely to be dire....
...This is likely to be a painful economic downturn not because of massive job and output losses, but because of losses in the value of things that people count as their assets (primarily housing, non-agency mortgage debt, and equities)...."
Before I say anything, I will note that I expect the US economy to slow and the stock market to correct (it already started). So the question is how bad?
I have to say that I haven't looked at the paper fully (other than Barry Ritholdz's blog entry and what's written here) but everytime someone mentions a comparison to the past, particularly Japan, I just don't buy it.
One of the first big differences is that most assets in the US are NOT overvalued. The only one that I can think of that is really overvalued is real estate. Real estate seems to be going through a severe correction so once that is done with, that wonèt be overvalued either.
Stocks do not look overvalued to me. They are not cheap but they are nowhere near valuations in the past (2000 growth bubble; Japan in 1989; etc).
The US$ is also undervalued more than it is overvalued. This means that, contrary to some bearish views, capital should flow to the US. The reason soverign funds are investing in the US is not because assets are overvalued but because they are undervalued.
The problem right now is that the consumer is in bad shape. But corporations are in good shape. Corporate balance sheet was so good that quite a few corporations issued debt to buyback stock. So this slowdown may end up being different from others in a big way: unemployment may not materially increase. If companies do not lay off peeople en masse, then the consumer can recover much faster (this is one of the advantages of being a service economy).
Although one shouldnèt bank on hope, there is also some positive scenarios where commodity prices may decline. A decline in commodity prices will significantly improve the consumer balance sheet.
This is great - none of these were financial meltdowns like predicted by some of the commenters on this blog. We're all still here - even the Swede's.
OK - it will suck for a while if I lose my job (been there, done that). Since I rent and didn't jump into the RE mosh pit of speculation, I won't get hurt (didn't clean up either - bummer!)
So sorry for those of you who did. Caveat emptor!
I withdraw my support for stimulus or bailouts. Deal with it.
I think I'll buy porn with my "stimulus" check. (that was bad) At least I know the needy will get my money.
America has been going through a cycle of hyper-growth since the mid-80's. The recessions of '90-'91 and '00-'01 were relatively mild and never really corrected the imbalances and excesses that have built up over time. We are going to finally have to take our medicine, and bitter it will be.
Things do always revert to the mean, and CR's charts of real estate values and multi-retail construction spending tell a thousand words.
The consumer is in bad shape because the ponzi-scheme of ever increasing debt financing ever increasing consumption has finally run out of gas. The adjustment will be painful, but ultimately America will emerge better off for it.
Thanks for providing a valuable balancing voice. I think a lot of us are writing the end to this story long, long before it's actually here. We're used to doing that. The Fed has been remarkably successful over the last 20 years.
Hussman's points are well-taken, but haven't been borne out by recent data. The ISM Non-manufacturing numbers were all so bad that people thought it was a change in methodology, or a calculation mistake. The chain store sales numbers, released after his comments, were the worst on record, indicating consumption might not be so resilient after all.
I don't have the gravitas, degrees, or experience that these brilliant economists do, and neither do most of the people on this blog. However, as Paul notes, many of us saw this one coming long in advance.
Watch real long interest rates like a hawk -- no joke intended. They're the real lever of monetary policy, and they haven't moved even with 2.25% easing. If they don't kick in, we're in a liquidity trap. Credit and market conditions are still rapidly deteriorating. Money is still tight in price, if loose in quantity, and velocity is declining rapidly. It's quintessential.
The story's not over, and we should keep reading avidly.
Glenn_in_MA, Hussman's "never" isn't quite correct. The last time nominal consumption declined was in 1938. (If you want to double check, change the date range and use the annual series. Look for year-over-year declines in PCE). Also, nominal consumption declined every year from 1930 through 1933 (depth of the Depression).
But, yes, consumption in nominal terms is fairly stable as opposed to investment. Although I expect real consumption to decline in '08, it is probably unlikely for nominal consumption to also decline. My view (like Hussman) is that the recession will be mild-to-moderate in terms of rising unemployment. But I think the key is that the recovery - when it eventually comes - will probably be sluggish, and it will seem like the recession is lingering for many.
dk,
"The story's not over, and we should keep reading avidly"
Ditto on that!
Here's yet another take on the 2008 recession from the Economist:
"...YOU won't hear the R-word much in the modest governor's mansion in Helena, Montana. The occupant, Brian Schweitzer, insists that Montana's economy is in better shape than it has ever been. It has had one of the fastest rates of job growth in the country. The state is prospering on the back of booms in mining and farming, as well as steady growth in tourism. Paul Polzin of the University of Montana forecasts that the state's economy will grow by 4.1% this year, the fifth consecutive year of growth above 4%. We've been searching for realistic doomsday scenarios, he says, and we just can't find any."
"Go to Michigan, by contrast, and it is hard to find anything but gloom. The collapse of America's car industry, coupled with a nasty subprime mortgage bust, has left the state reeling. It has the highest unemployment rate in the country (7.6%) and the third-highest foreclosure rate, and was the only state to lose a large number of jobs in 2007. In the run-up to the state's Republican primary (which he won) Mitt Romney traversed Michigan, promising to save voters from a one-state recession."
"Montana and Michigan mark the divergence that lies behind America's aggregate economic figures. National statistics suggest that the country may have already tipped into a formal recession. Output rose by only 0.6% at an annual rate in the last three months of 2007, a figure that could easily be revised down to a fall. Residential construction is plunging, house prices are dropping, consumer spending is slowing and the economy shed 17,000 jobs in January, the first such decline since 2003. A monthly gauge of services activity, published on February 5th, has fallen dramatically and now suggests recessionary conditions. The big questionparticularly for those on the presidential campaign trailis where will the pain be felt most acutely, and how far it will spread
..."
This Credit Crisis Has a Long Way to Run
Interview with Jeremy Grantham, Chief Investment Strategist, GMO
By SANDRA WARD
ONE OF THE GRANDEST OF THINKERS AND MOST ELOQUENT of oracles, Jeremy Grantham has long been the voice of reason in an industry prone to excesses and embellishment. By taking the long view, blending quantitative strategies and technical analysis with sound and experienced judgment, Grantham, chairman of Boston-based GMO, consistently uncovers with his team the best values among a wide range of global asset classes.
The payoff is outstanding performance and risk management. In return, clients have entrusted the firm with about $150 billion. As the man who warned early of a worldwide bubble forming, we turned to him as that bubble has started bursting.
Barron's: You, along with George Soros, have called this the worst financial crisis we've had in the post-war era.
Grantham: This is much more global than, say, the savings-and-loan crisis was. The world is obviously much more globalized than at any time since the late 19th century and much more interrelated in almost every way, certainly financially. To have the leading economy and the reserve currency having a major-league credit crisis would by itself make it more important than earlier ones.
Secondly, this occurred at a time of what I believe is the first global bubble in pretty well all asset prices, so there is a much greater degree of broad-based vulnerability. Then it is a question of degree, and how carried away the sloppy lending was: It was very carried away. Not just in the design of needlessly complicated instruments, but in the enthusiasm -- recklessness one might say -- with which they were sold.
Can these bubbles burst if the Fed is easing the way they are?
Well, this is an amazing little tidbit. People think the Federal Reserve can stop a bear market because they can throw money at it and lower interest rates. It is even more certain we can collectively stop a bear market if some fiscal stimulus is thrown in. To which I say, 'Oh, you mean like 2000 and 2002?' -- when they threw what I call the greatest stimulus in American history, an unparalleled series of interest-rate cuts, cumulating in two, almost three, years of negative real returns, real interest rates coupled with a really substantial tax cut, which would never have happened without 9/11.
The combination would have gotten the dead to walk, and it stopped the bear market eventually. But the Standard & Poor's 500 was down 50% and the Nasdaq -- which was all anyone talked about back then -- went down 78%. And a puny five to six years later, people are saying there is not going to be a bear market because the Fed is going to lower rates and because the government is going to have a stimulus package. But we have just been there, done that, and we had a nice bear market.
...
Incidentally, it was late in '06 when [Fed Chairman Benjamin] Bernanke said he thought the high prices of homes in the U.S. merely reflected a strong U.S. economy. Was he not looking at the data? Did he not measure long-term house prices? Had he not seen how they ebbed and flowed as a multiple of family income, which they do here and in the U.K. and everywhere else? And with it being so obviously a bubble, how could he have said that?
He was taking his cue from Alan Greenspan, who said we should all be taking out adjustable-rate mortgages.
Greenspan and Bernanke have taken a hands-off approach for two consecutive great bubbles, first in TMT -- telecommunications, media and technology -- and second, in housing. A hands-off approach is a polite way of saying they facilitated this. And what is the point of a 125-basis-point rate reduction, other than to provide reinforcement for the people who borrow short and lend long? From bankers who have committed every crime you could possibly accuse a banker of, to hedge funds who borrow short, leverage, and invest long in the stock market -- that's who really benefits from the interest-rate reduction. The economy, broadly defined, does not.
I have an exhibit that shows the 30 years prior to 1982 when the debt-to-gross domestic product ratio was completely flat at 1.2 times. Total debt is defined as government debt, personal debt, corporate debt and financial debt. Then in the 25 years after 1982, the flat line goes up at a 45 degrees angle from 1.2 times to 3.1 times GDP. Massive. In the first 30 years, when debt is flat, annual GDP growth is its usual battleship, growing at 3.5% and hardly twitching. After the massive increase in debt, GDP, far from accelerating, grew at 3%. So debt in the aggregate does not drive the economy. The economy is driven by education, man-hours worked, capital investment and technology. It is not driven by what I owe you and you owe me.
As wrong as Mr. Krugman was about the return of the depression economics in 1998, he is now about the "severe financial crisis". He serves as one of the best counter indicator (apart from the CR crowd, of course) in our time.
I'm not an economist, but will also make a prediction: Nasdaq will see new ATHs within 2.5 years at declining inflation levels (average inflation rate 2008-08/2010 below 2007 levels). Now that's out of the box.
This is a bit off topic for this post, but I think it will be of general interest to CR's readership:
I live in Seattle. A couple years ago, I saw the writing on the wall so to speak and sold my house and my condo and started renting. I'm moving to a different neighborhood and have been looking at the listings on Craigslist. In the past week, there have been seven postings for new, never been occupied, townhouses in my target neighborhood. These have asking rents far below mortgage cost -- unless one put 40% down or so. That even includes the mortgage interest tax deduction.
Additionally, there are dozens of large condo developments still in the 'big pit' stage, thousands more units expected to come to market this year.
The upshot is that Seattle will likely see significant price declines. They will probably not be as severe as FL, AZ, CA, etc... but it seems it will happen here as well.
Another point Jeremy Grantham makes in that Barron's interview is that profit margins are way above historic averages and are almost assuredly going to contract in a downturn. Meaning, the current p/e ratios, which prove equities are fairly valued, are likely to rise. Not to mention the fact that profit projections are still unreasonably high.
If things stayed like they were a year ago, stocks might be fairly valued. But they haven't and under a realistic outlook for the future, they will have to fall. Especially the low-cap end. The Russell 2000 has some absurdly high p/e ratio.
"An enormous structural overinvestment in non-productive non-tradeables"
This is the key, tons of capital into non-poducive areas of the economy, housing and real estate.
That is what I dont get about the whole alternative energy bubble theory. An investment in alternative energy to avoid an environmental crisis and to replace deminishing fossil fuel supply. Also will create more weath not suck it up. And cheap energy will make US competative and stable. To me this is not a bubble, as it will result in a net increase in physical weath and productivity.
$8 Trillion dollars of Mortgage and HELOCs taken out in the last 4 years secured by homes potentially worth something less than the outstanding balance.
Not only that, with stagnant wages and rising taxes, interest, insurance, food and fuel, the amount of money the consumer can afford for housing is LESS today than it was in 2000.
Then after you capitalize the effect of the $8 Trillion dollars of debt into the economy, once that money is sucked out, the inverse multiplier effect will be SHOCKING!!!!!
Its now starting, Retail Slowing, Restaurants Slowing, Autos Slowing, Housing slowing, Tax Revenues Slowing, Corporate Profits Slowing, Layoffs Rising, Foreclosures Rising, Loan Defaults Rising, Bank Reserves.....who the heck knows?
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This Credit Crisis Has a Long Way to Run
Interview with Jeremy Grantham, Chief Investment Strategist, GMO
By SANDRA WARD
ONE OF THE GRANDEST OF THINKERS AND MOST ELOQUENT of oracles, Jeremy Grantham has long been the voice of reason in an industry prone to excesses and embellishment. By taking the long view, blending quantitative strategies and technical analysis with sound and experienced judgment, Grantham, chairman of Boston-based GMO, consistently uncovers with his team the best values among a wide range of global asset classes.
The payoff is outstanding performance and risk management. In return, clients have entrusted the firm with about $150 billion. As the man who warned early of a worldwide bubble forming, we turned to him as that bubble has started bursting.
[BA_QA_photo.jpg]
"It was late '06 when [Fed Chairman Benjamin] Bernanke said he thought the high prices of homes in the U.S. merely reflected a strong U.S. economy. Was he not looking at the data?" -- Jeremy Grantham
Barron's: You, along with George Soros, have called this the worst financial crisis we've had in the post-war era.
Grantham: This is much more global than, say, the savings-and-loan crisis was. The world is obviously much more globalized than at any time since the late 19th century and much more interrelated in almost every way, certainly financially. To have the leading economy and the reserve currency having a major-league credit crisis would by itself make it more important than earlier ones.
Secondly, this occurred at a time of what I believe is the first global bubble in pretty well all asset prices, so there is a much greater degree of broad-based vulnerability. Then it is a question of degree, and how carried away the sloppy lending was: It was very carried away. Not just in the design of needlessly complicated instruments, but in the enthusiasm -- recklessness one might say -- with which they were sold.
Can these bubbles burst if the Fed is easing the way they are?
Well, this is an amazing little tidbit. People think the Federal Reserve can stop a bear market because they can throw money at it and lower interest rates. It is even more certain we can collectively stop a bear market if some fiscal stimulus is thrown in. To which I say, 'Oh, you mean like 2000 and 2002?' -- when they threw what I call the greatest stimulus in American history, an unparalleled series of interest-rate cuts, cumulating in two, almost three, years of negative real returns, real interest rates coupled with a really substantial tax cut, which would never have happened without 9/11.
The combination would have gotten the dead to walk, and it stopped the bear market eventually. But the Standard & Poor's 500 was down 50% and the Nasdaq -- which was all anyone talked about back then -- went down 78%. And a puny five to six years later, people are saying there is not going to be a bear market because the Fed is going to lower rates and because the government is going to have a stimulus package. But we have just been there, done that, and we had a nice bear market.
What about places to hide?
That isn't something we can laugh off. Last time, there were plenty of opportunities: Bonds were cheap and TIPS (Treasury-inflation protective securities) were brilliant; real estate was cheap and REITs were brilliant. Even within equities, emerging markets were much cheaper than U.S. equities, and within U.S. equities, value stocks were only a little expensive and small-caps were only a little expensive and small-cap value was actually a little bit cheap. So you could really hide and could reasonably expect to make money, which we did in each of the three years of the bear market.
Since then, all those areas appear to have read the book on mean-reversion. Ten years would be a perfectly normal period of time to go from a peak of a great bubble [like the one in 2000], based on the history of bubbles and their aftermath, to the low. I have long thought that 2010 would be when we hit the biggest discount to fair value. Trend-line value on the S&P, by the way, in 2010 is 1100. (The S&P 500 traded at 1334 late last week.)
What should we expect from the market between now and 2010?
In the fourth year of a presidential cycle, where you have a lame-duck president, the typical pattern of S&P 500 performance has been something like 10% below the normal long-term average (a 5.2% gain, inflation-adjusted), and worse if it is an overpriced market. A first year is never very pleasant: They average about 3% below normal. If they are overpriced, they do four points worse than that.
But if the party in power changes, first years tend to be eight points below normal. The following year is ugly, too. The average year two, since 1932, has been 10 points below normal and, if the market is overpriced, 15 points below normal. This is unpleasant. By a nice coincidence, those averages suggest the market will decline to 1100 in 2010, which is exactly the number we get to from a completely different technique -- building it from the grass roots through fundamental value. We do that by taking average corporate-profit margins, actually a generous average, assigning a normal market price/earnings ratio, and that gives you 1100 in 2010. This year, next year and the year after will all be uncomfortable years. One of them might be up, but my guess is it won't be up by much.
What exactly will make them more uncomfortable?
Profit margins, the great prop to the market, surprisingly defied the laws of gravity for three years in the developed world and, particularly, in the emerging world and even in Japan. That was because the global economy was stronger than any corporation counted on and, in the U.S., consumption was always higher and our savings rate was always lower than any corporate economist would have suggested, going into negative territory. But there are a few near certainties in this business -- not many, but a few -- and one of them is that abnormally high profit margins will go back to normal. The timing is unfortunately shrouded in fog. The other near certainty is that house prices will go back to a normal multiple of family income. In the end, we, the people, have to be able to afford the houses and they are affordable at something around 2.8 times family income. When they peak in Boston at 6 times and nationally at 3.9 times, you know you are in for tough times.
Incidentally, it was late in '06 when [Fed Chairman Benjamin] Bernanke said he thought the high prices of homes in the U.S. merely reflected a strong U.S. economy. Was he not looking at the data? Did he not measure long-term house prices? Had he not seen how they ebbed and flowed as a multiple of family income, which they do here and in the U.K. and everywhere else? And with it being so obviously a bubble, how could he have said that?
Let's review whether U.S. stocks are still fairly valued.
Earnings peaked at the end of the second quarter last year. Based on about 4,000 of the 5,000 largest U.S. companies, the WSJ reported total earnings at $245 billion. On a trailing 12 month (TTM) basis, total annual earnings as of Q2 07 were about $900 billion.
Since then, earnings have fallen 21% for Q3 and 37% for Q4 on a YOY basis. The comparable totals would be $187 billion for Q3 and about $160 billion for Q4. If you assume further YOY earnings declines of 10% in Q1 and Q2 of 08, total trailing 12 month TTM earnings would be about $600 billion.
If you assume stocks were fairly valued at Q2 07, when the TTM P/E of the S&P 500 was about 17, then the S&P would need to fall 33% from Q2 07 through the end of Q2 08 to keep the same valuation relative to earnings.
But P/Es don't stay the same in periods of rising and falling earnings. P/Es usually rise with upside earnings momentum and fall with downside. Investors don't pay the same multiple for cloudy or iffy future earnings. So, to maintain valuation relative to earnings, we would need another 15-25% decline in the S&P 500 and 40-50% in the Russell 2000.
There are some real uninformed amateurs posting on this board about stock market valuations, such as Sivaram.
I think that's entirely relevant: there is very little real adjustment that has taken place to date.
The decline in most real estate prices has not been significant yet. Look back at CR's chart of retail construction spending earlier today: we're virtually still at the apex. Check out the CMBX, CDX, LCDX, iTraxx, what have you. Muni's are yielding more than treasuries, and corporate spreads are still elevated.
ABCP is looking marginally healthier, and ABX is still bouncing along the bottom, but all of these other measures continue to look quite ill.
I understand full well the Pavlovian response to believe things will be better now that the Fed is scared. I just don't share the belief that their policies will have rapid traction, and at this point, I'm not thoroughly convinced they'll have traction at all. Again, watch real rates on a variety of bonds.
Even if their policies do have traction, we've got a lot of adjustment to do in the real economy, particularly if the recycling of forex reserves slows. It's barely begun.
Go to Michigan, by contrast, and it is hard to find anything but gloom. The collapse of America's car industry, coupled with a nasty subprime mortgage bust, has left the state reeling. It has the highest unemployment rate in the country (7.6%) and the third-highest foreclosure rate, and was the only state to lose a large number of jobs in 2007.
I live in beautiful Kalamazoo, MI. I'm not reeling nor is anyone I know reeling.
From Dictionary.com:
To be thrown off balance or fall back: reeled from the sharp blow.
To stagger, lurch, or sway, as from drunkenness: reeled down the alley.
To go round and round in a whirling motion: gulls reeling and diving.
To feel dizzy: My head reeled with the facts and figures.
Maybe the drunk part applies to Michigan.
Recession is a very personal thing. A mild recession is when you lose your job. A severe recession is when I lose mine.
Unskilled and uneducated people are on the edge and typically fall during recessions.
If you want to fix this problem, stop voting for Republicans. Mitt Romney wants to blame our lack of faith. Fair enough. My guess is it's all about education and resiliency.
You sound pretty ridiculous when you mock the CR comments section, especially with markets already having corrected enough to be termed a bear market, and storm clouds gathering all around us.
The problem with these indices is that financial companies receive so much weight - what would your analysis look like without including $100 billion of writedowns? I'm pretty sure earnings growth was still positive in the 4Q ex-financials.
Financials will struggle for a while, but the writedown pace is bound to abate at some point, and a lot of the bad news in financials is already priced in.
I guess my point is that we haven't yet seen an earnings contraction on average in non-financial companies (at least thats my understanding).
I believe we will, but that die hasn't been cast yet.
ShortCourage - there is a big difference between a correction and the financial "meltdown" predicted by the folks who have been commenting here. Their cheerleading for economic chaos must be embarrassing for CR and Tanta.
There is no doubt that BFNYC were in collusion behind this unfolding fiasco. NYC is a cesspool of Conflicts Of Interests (COI) as these people go to the same bar mitzvah celebrations, the same parties, the same clubs, the same synagogues, temples, churches, and their kids, future born-and-bred Crooks, go to the same schools (Cramer spilled the beans on this!). CULTURE MATTERS!
I don't know why CR and Tanta would be embarassed by us. Consider the track record of the folks here in predicting today's conditions, as compared to mainstream analysts and professional economists.
There are some here who take it to Armagedon exremes, but for the most part most we merely recognize the unprecedented odds of a huge financial calamity.
Lots of very well respected economists are recognizing those heightened risks as well (e.g. Roubini).
--
Paul, (* Edited by CR: Inappropriate comment and name calling - please stop this! *)
I believe in sensible minority that is always open to an explanation not shared by the vast majority. Majority consists of dopes, in case you don't already know.
Glenn_in_MA writes:
ndk,
"The story's not over, and we should keep reading avidly"
Ditto on that!
Here's yet another take on the 2008 recession from the Economist..."
That right. "Yet another take on the 2008 recession" is wrong. I tell it to everyone: this would be the best advertised recession in the history of mankind... from the same magazines applauding the RE boom in late 2005. As wrong as they were then, so are they now.
I believe in sensible minority that is always open to an explanation not shared by the vast majority. Majority consists of dopes, in case you don't already know.
Jas
Jas Jain
I cannot agree more. 70% of Americans stating we are in a recession or will be in one during 2008 are way wrong. The only 30% believing we will avoid one are correct. As usual.
Culture matters? Whatever. Are you some kind of religious fanatic?
Paul
You also got the basic idea wrong - of course culture matters ( you have to really careful in describing and delineating culture and what "matters" of course).
Yeah, that paper again. Don't know about other countries, but the US data is just made up. Just check on some measure of real gdp per capita (ppp) growth and compare to their graph.
Damn near every non-consumable thing we own is overvalued at the point of purchase: Cars, computers and other consumer electronics, jewelry, household furnishings, newly-released entertainment...
My proof is the relative cost of these same items if sold privately one week after purchase (or, in the case of entertainment, waiting for the DVD).
If you purchase the item on credit, add around 10% (I pulled 10% out of the air, because it sounds reasonable. Use whatever percentage you'd like).
I have a friend who just sold a million dollar house for $750K. Something is only worth what you can get for it, and if no one is buying (no demand), it's worth nothing.
I'll try. It's not too hard. Let's stick to totally risk-free things: treasuries. You're lending to the U.S. Government. If they can't pay, we'll all have bigger things to worry about than yield.
The nominal yield of something is the yield you see. If you loan your money to the Feds today for 10 years, they'll give you 3.64% interest for the life of the loan. That's about all there is too it.
However, you need to think of that nominal yield in terms of what you're really getting. Inflation means everything's more expensive, so $103.64 next year isn't going to buy $103.64 worth of this year's stuff. The real yield is how much money, after inflation, you'll get on that loan.
But how do you calculate the real yield? There are a lot of ways you can measure inflation. You can look backwards at the CPI rate, core CPI rate, or PCE deflator, measurements economists like to use for the rate of inflation. These come out to around 2-4%. That means, after inflation, you would actually lose purchasing power for lending money to the Feds for 10 years. Bad deal.
But those all look backwards and say what inflation was in the past. You're lending money now, to be repaid in the future.
A lot of economists like to look, then, at the TIPS yield. The TIPS include an agreement between you and the government that they'll compensate you for whatever the CPI inflation rate is throughout the term of repayment.
This gives you a way to calculate what the "real rate of interest" is expected to be over the next 1, 2, 5, 10, etc. years. Right now, we expect to get a 1.36% annual real return on money we lend to the government for 10 years.
That means we think that after 10 years lending your cash to the feds, you'll be able to buy ~$11,456 worth of today's goods (real return) using $14,383 of those future dollars (nominal return).
P.S. When home prices peaked, real long treasury rates were at 2%. Today, they're around 1.8%. That doesn't take into account any of the tightening in credit conditions at all.
If one were prescient and lent long-term to the USG in 1981 and reinvested the coupons in long-term USTs he, or she, would be able to buy a bigger, or better, home anywhere in the US, LOT more crude oil or gasoline, LOT LOT more gold, LOT LOT LOT more of almost all consumer goods and services.
Jas
PS: During the coming depression the 10-year USTs will yield less than 2% and most Scams would be down at least 70% from where they are. Scam Lovers are the biggest born-and-bred dopes in America.
"mp writes: Three weeks ago I was offered a fully-equipped 10,000 sq. ft. machine shop--including the building--for $50,000.
How can a fully equipped machine shop not be worth $5/sf?
I've never heard of anything like that.
sportsfan"
Sportsfan - I am not an expert about Michigan. But I have family there. And my impression is a lot of people who are directly or indirectly involved with the auto industry (including some family members) are in pretty bad shape. My BIL used to do chemical sales to the auto industry. Now he mostly does small home improvement jobs. Luckily he is a handy guy - and so many people are stuck in their houses that there is plenty of work. Also - his wife works in a non-auto related medical job at UM. Her job is fine.
Have to ask you guys/gals here. Assuming we wind up with a major slowdown - and not a catastrophe - are there not some positives for people who have been conservative or thrifty in terms of their financial lives (and I think there are more than a few of you here)? Like maybe - if you're younger - you can afford to buy that first house?
On my part - I drive an almost 9 year old car (Lexus). And every year for the last 3 years - when I've gone to the Lexus dealer to buy a new one - for cash - and I've tried to negotiate a decent price - they've brushed me off. They weren't even particularly interested in giving me a test drive. Who cares about me when people earning $40k a year are buying $70k cars at full list price with no money down - and payments that last from now until I'll be dead. Perhaps this is the year I will be able to buy a new car on my terms - and be treated as a valued customer?
On my part - I wouldn't be offended to see an environment where people who are and have been economically responsible are rewarded. Roby
"ShortCourage - there is a big difference between a correction and the financial "meltdown" predicted by the folks who have been commenting here. Their cheerleading for economic chaos must be embarrassing for CR and Tanta...)
Paul | 02.09.08 - 6:06 pm | #
Paul, I don't know what you're smoking, but I want some of that shit!
You want economic chaos, bro? Just look at any fiscal policy, budget, monetary policy, or balance sheet. Try to accurately value debt-based securities. You got your over-leveraged consumer with a stagnant or falling income and depreciating assets. You got your deficit-spending government giving tax breaks and borrowing for war. There's plenty of chaos, plus a heaping helping of fraud, chicanery, and theft by deception.
No one here is cheering the economic decline we are experiencing - just as we did not "cheer" the housing bust. Many people here saw this coming, got the hell out of the way, and tried to warn others - only to be dismissed and derided as "doom-and-gloomers."
"Predicted?" In case no one has told you, we're broke. Even when you used the fudged numbers, we're broke. If you think that this is just a bump in the road that can be managed or accounted away, you are sadly mistaken. What you see as wealth is actually debt. The expected increase in income that would pay for that debt has not materialized.
As for embarrassing, who the F are you - the Queen of England? Faux riche, prolly.
Buy a TV or DVD on credit at 10%?!
You must be kidding I could get for 0 down at 0% for at least a year after the Xmas bust.
Oh... maybe that's not a good thing ;^)
Yeah, they've already priced (some of) the credit risk and interest into what they charge (to support those who can't really afford them), but mostly they need to move the inventory or their numbers will look terrible.
A friend's sister and husband live in the midwest and make < $30k a year. He's concerned because the husband just lost his job and his sister had to move to a night shift as a nurse to make more money. They wanted my friend to buy their house since they were going to start missing payments... but when he went over the holidays to look at it he noticed to new 52in TV bought for the SuperBowl. When he asked about spending that kind of money when they were hurting... "but we saved so much, and we got it on credit!" was the response.
If this is the "heartland", we have a long way down to go.
6) A credible argument that the world is low on oil and agricultural goods;
There is something about this that might make the troubles even worse. First i fear the next season due to climat variations vill be bad. It seems to become a La Niña, year (lots of draught)
Second, Iran and some other states have begun to sell their oil in other currencies besides the dollar. (Thereby sidestepping what some people might call the dollar tax on oil) This would suggest that the united states might find it more troublesome further on to sell treasury's And with less treasury's there is less wiggleroom with economic stimulus.
Since I'm one of the dissenting views here, I can literally respond to everyone but...
GLENN_IN_MA: "Sivaram, How 'bout Treasuries?...they look overvalued to me."
I'm just a newbie and I think interest rates and currencies are one of the toughest calls in all of investing! Betting against the Treasuries is very risky IMO. I'm in the disinflation/deflation camp and although I don't expect any severe deflation, one cannot be certain that interest rates won't drop to, say, 2% and STAY THERE. I can see long bonds appreciating or at least outperforming stocks for the next 2 years.
Remember, many thought Japanese bonds were overvalued for almost a decade--and yet were wrong (Japanese bonds outperformed Japanese stocks for the last 15 years or so). I am not saying that the US is anything like Japan (it isn't) but it just goes to show that bonds can do well for long periods of time if there are economic issues and the stock market goes nowhere.
Another thing that can keep the bond bull market going is a decline in inflation. Although most bears here seem to be inflationists, people like me can see inflation declining. The bond market isn't really pricing in much inflation but even a small amount of decline in inflation expectations can help bonds.
Having said that, I do think that long bonds are going to be one of the worst investments when the recovery (especially in stocks) starts after a slowdown/recession. The problem is that we don't know when. It can be next year or 3 years from now.
The usual suspects. Obviously the financials were a big chunk of earnings. And some of the reported profits never existed and are in businesses that are now dead.
On a relative basis, Grantham likes high quality large caps. The most disturbing observation is overall profitability compared to historical averages. I agree with Grantham's observation regarding small caps. When you look at the Money Magazine recommended portfolios, they always push the prior years winners, and small caps and emerging markets are well represented for everyone and in fairly large doses for the less risk averse.
Whenever you get a new asset class showing up on the pie charts, it tends to be too late. I imagine that you could go back and when they took the 5% precious metals out of the model portfolios in the 90's would have been a great buy point.
Paul, get a clue: culture matters. There's a bit of difference (huge, actually, as you know), economically, between San Diego and Tijuana, though only 30 miles separates them.
NDK: "I don't have the gravitas, degrees, or experience that these brilliant economists do, and neither do most of the people on this blog. "
LOL neither do I... I'm just trying to make some money, that's all... economics can be harmful to your investing health--ask Warren Buffett about the latest economic opinion
NDK: "Watch real long interest rates like a hawk -- no joke intended. They're the real lever of monetary policy, and they haven't moved even with 2.25% easing. If they don't kick in, we're in a liquidity trap. Credit and market conditions are still rapidly deteriorating. Money is still tight in price, if loose in quantity, and velocity is declining rapidly. It's quintessential."
I think you are right to some degree but I don't see it being THAT bad. I'm a big fan of Warren Buffett and I think he is correct in saying that money isn't necessarily tight with interest rates being so low (read news articles when he visited Toronto earlier this week). What is tight is money for risky activities and risky borrowers. The LBO boom is over; the subprime mortgage boom is over; companies issuing debt to buy back stock is over; and so forth. Buffett pointed out that money was tight in 1984 when interest rates were something like 21%! That's tight, not what we have now.
RICH: "There are some real uninformed amateurs posting on this board about stock market valuations, such as Sivaram."
I don't think I have ever said I wasn't an uninformed amateur. Sorry to have misled you... if I was an informed expert, I would be rich and wouldn't be wasting my time on this board...
RICH: "If you assume stocks were fairly valued at Q2 07, when the TTM P/E of the S&P 500 was about 17, then the S&P would need to fall 33% from Q2 07 through the end of Q2 08 to keep the same valuation relative to earnings. "
I never implied that stocks can't drop a bit more. But they are not excessively overvalued... the flaw with your reasoning is that you are not even looking at interest rates. Interest rates and inflation expectations have come down materially from 2Q07 to now. The market can tolerate a higher multiple when rates (or inflation) is low.
It good to see the elite financial minds agree that excessive debt creation combined with overspending and declining wages not to mention exporting your manufacturing based is bad economics and leads to big structural problems for your society.
And of those firms that are listed, how many of them were net profitable, and what was the total profit on a per share basis for 2007?
I still state that what you are seeing is not liquid assest vaporization but just zeros from corporate assests and stock prices. Let me put it this way: if Larry Ellison loses 10% of his net worth, does it matter to him materially? If I lose 10% of my net worth, does it matter to me materially? If I don't plan on using my retirement money for another 25 to 30 years, and if I'm staying in my house for another 10 to 15 years, who the hell cares?
Credit pull back? Great. Take away some of my credit cards or make the terms so onerous I cut them up. I can last a couple of years without buying much. My mortgage is at 5.25 on one and 6 on the other. Who cares about the rates? Do I really need 50k of credit card open lines? I'll do what everyone does in bad economic times...I'll tighten the budget. The cost of heating, food, and gas for the car will impact my spending more than anything else.
And I think I represent the vast majority of people. The description of those people with the new TVs notwithstanding (people like that will always exist). Will I cut back on consumption? Sure, I have all new appliances, all the clothes I need for a while, and I can sit tight for a year or two while this flushes. If something breaks I'll replace it, like anyone else. Are my retired parents worried? Not at all. Unemployment doesn't matter and they have enough money to pay the bills and do what they want. Their generation paid cash for everything anyhow.
So I'm suspect of all of this severe recession talk. There will be one to be sure, and it is necessary, but I'm on the moderate side for these and other technical reasons. And asset prices? Might I remind everyone that my first house was underwater from 1990 to 1998. Even if we pull back to historic norms it will sell for double now what I paid for it. The same will happen this time in the long term.
Wow - Paul took a beating since his self-imposed silence for being a troll. It cost him $20 to the tip jar too! I hope all others feeling momentary remorse over intemperate commentary use the same method of repentance.
OK - here we go.
Marcus says Paul, I don't know what you're smoking, but I want some of that shit!
You want economic chaos, bro? Just look at any fiscal policy, budget, monetary policy, or balance sheet.
I'm sorry but I'm not feeling any economic chaos in Kalamazoo, MI. Black Swan Shiraz & Merlot. Very cheap - what does that tell you?
As for embarrassing, who the F are you - the Queen of England? Faux riche, prolly.
I live in MI so I can't be rich. We're reeling. I am divorced, rent, make $84K as a process engineer with big pharma. Thanks McDonalds!Seriously, I am concerned that the commentary is a little unmoored from the reality outside of Stockton, CA, Las Vegas, and Florida. I think the jury is still out on the seriousness of the problem. It is no doubt painful for many, but perhaps not at meltdown phase? I apologize if the wine affected exagerated the intensity of my rhetoric.
JG said Paul, get a clue: culture matters. There's a bit of difference (huge, actually, as you know), economically, between San Diego and Tijuana, though only 30 miles separates them.
OK, JG, you are probably correct, Since I live in MI, I will defer to your judgement on the difference between SD and Mexico.
However, Jas Jain said: NYC is a cesspool of Conflicts Of Interests (COI) as these people go to the same bar mitzvah celebrations, the same parties, the same clubs, the same synagogues, temples, churches, and their kids, future born-and-bred Crooks, go to the same schools.
My commentary was in response to this gross generalization and borderline slur. So sorry if that was not clear. There are many things that affect culture and I am sure that CR and Tanta don't want to have their business blog infected by culture wars. That is why I tipped the blog as a penalty for indulging.
I am a very liberal Democrat. I think the laizze faire economic policies of the last many years have
been misguided. They underestimate the capacity of our economy to cheat the naive.
The question, in my opinion, is whether we can solve it through regulation or religion. Since the GOP (or economic conservatives) have been in control of USA for most of the last 27 years, I tend to think that our current problems are a result of their policies. I could be wrong and am open to correction on this matter.
I guess this means I owe another $20 to the tip jar.
--
"My commentary was in response to this gross generalization and borderline slur."
I simply quoted Cramer who knows the financial culture of NYC and the people involved at the highest levels, no?
Your ignorance of the reality doesn't give you the license to attack. Got it? Ignorance and intolerance go hand-in-hand. And bigotry, or prejudice, of beliefs is not far behind.
I say what I believe to be true. I have examined BFNYC for years and they are Crooks. Period.
Ok Jas Jain - I accept your rebuke. I am ignorant, bigoted, prejudiced, and intolerant. I ignore reality and attack those who shame me for my ignorance. My opinion has no value so please ignore my foolish babbling. I am responsible for all evil in the world and have no shame.
Oh Lord, we'd be in real trouble if software engineers were normal
I meant just from an economic point of view. I think the vast majority of people lived a bit above their means, but not grossly. I think that the majority are probably where I described. And if you're around 40, you'll remember the past two busts...including when my field got decimated not too long ago.
So yes, there will certainly be a pullback that is needed. Yup, if you bought a house in the last three years you're going to have to sit on it for a while to come out on the plus side. You'll need to adjust your retirement savings. And maybe you'll have to recover from a layoff...like I did in 2001. So the "average" person will do what average people do...tighten the belt.
The financial markets? Trust me, smart people are figuring out what to do next already. A lot of capital realignment will occur. But it will occur. And for laughs, go out and pull the total net worth of the richest 100,000 people in America. Now reduce their assests by 20%. Would that have a material effect on the economy? Or would they work their remaining capital harder to recover?
Robyn, my question about the machine shop was based on the depression-like number (including land and building) that was completely outside my personal experience, but rejected by someone apparently more knowledgeable than I.
And on my part - I drive a 14 year old Lexus SC400 and I do not visit the dealer every year since the car runs perfectly and does not need to be replaced.
So neither one of us have been helping out the U.S. auto industry. Perhaps it's all been our fault.
Sivaram: "LOL neither do I... I'm just trying to make some money, that's all... economics can be harmful to your investing health--ask Warren Buffett about the latest economic opinion :)"
I can't agree more with this comment. It's almost certainly bad for my long-term financial health to even think about this stuff, and there are a hundred ways just to interpret the freakin' data. Ponder your own situation: good. Ponder the big situation: bad. Chalk one up to the invisible hand, I guess.
"What is tight is money for risky activities and risky borrowers."
Here I go beyond your opinion: I think it's tight for everyone. Check out, for example, AAA corporate bonds and the spread.
My point was that the 4Q profit evaporation was primarily concentrated in the financials, and it was the usual suspects -- ie. no surprise.
I find looking at the actual data interesting.
I would say that I am usually in the non catastrophe camp. I mean, we have had recessions before.
But back to the financials. It's amazing that the earnings were not more negative. With a little shareholder dilution, they make enough to write down a lot of assets.
BAC wrote down a lot of stuff and still had a nice profit for the quarter. So what if they have to write off $6b for countrywide. They also raised $12b in preferred stock a couple of weeks ago in an over subscribed offering.
I've never scrolled through 2,000 stocks in excel before.
Sivaram, I'm not sure how much sense it makes to A) think we're going to get deflation AND B) think most things are undervalued currently. If we get visible deflation, stocks will get slammed for being overvalued because of that deflation.
--
"I am responsible for all evil in the world and have no shame."
Paul,
You must suffer from some guilt, but BFNYC are "responsible for" most of the "evil in" America and quite a bit in "the world."
Evil occurs in many forms! In America, it took the financial form. If I may be permitted some immodesty, I do know more about debt than CR, Tanta, and few others here combined. Debt WILL lead to the death of the American system in your lifetime. That is how evil BFNYC are.
Precisely my point Ziggurat. The loses were just vaporized non-money, if you will so far.
I'm totally in the non-catostrophic camp, as you can tell. Not the o-joe quadrant, but somewhere in the middle. I have a great belief that the capitalistic system, with all the flaws, manages to recover itself in the end, as do people.
What actually is worrisome, is the fact that most of the fees generated that covered those losses have also disappeared with the financial instuments that generated them. What replaces that? And do the next rounds of losses only offset more profits or do they cause systemic trouble for the banks?
It's the bottom of the thread so the less bearish can say something without being slammed.
Anyway, regarding availability of money,
HOUSTON, Feb 8, 2008 (PrimeNewswire via COMTEX) -- SYSCO Corporation (NYSE:SYY) announced today that it has entered into an agreement to sell $750 million of Senior Unsecured Notes. The agreement provides for the notes to be issued in two tranches, comprised of $500 million due 2018 and $250 million due 2013. The bonds will bear interest rates of 5.25% and 4.2% respectively, per annum.
4.25% sounds pretty cheap to me. These are unsecured.
Jas Jain, because I am an ignorant american I do not understand the acronym BFNYC. Ok - the NYC part I assume to be New York City - but perhaps I am feeling guilty and stupid as well.
I apologize to all other commenters for being off topic. This is getting expensive!
Woohoo! Let's hear it for everybody posting on CR. Paranoid before being paranoid was cool. Next milestone, being optimistic before being optimistic is cool. Might be awhile though.
--
"I have a great belief that the capitalistic system, with all the flaws, manages to recover itself in the end, as do people."
Blind faith is necessary for most people. The current crooked capitalism of today has exceeded the Nazi-like proportions of an evil system. Only the consequences of this evil system need to be born out.
I am sure that you have no problem with the Debt Concentration Camps, built over the past 5 years, piped with the financial poison gas. Financial death of 30,000,000 American households is a foregone conclusion. Debt Pushers are evil.
4.25% sounds pretty cheap to me. These are unsecured. Ziggurat
It is pretty cheap. But, you know, capitial at rest is capital that's not making anything. So that's my interpretation of some things that are happening.
I now understand your pathology. How can I help? We should take this off of CR.
I'm just kidding, of course. It is great fun debating with you. I really do appreciate your off-beat perspective. I, too, feel that the USA has sold it's soul for nothing. When will we learn?
BFNYC = Bankrupters and Fraudsters of New York City
CCA = Corporate Crooks of America.
Together, they have an iron grip on the govt. of the US and the economic and political lives of Americans. They got control of most of Americans money and even homes!
When the bad times come they can will take their capital to China, or other countries, and leave Americans, who support them and fight their wars, high and dry. Todays Americans are the biggest born-and-bred dopes in a very long time. They cant see the evil of the Debt Pushers and financial manipulators.
For me, it is all business (telling the truth as I see it) and nothing personal. I hope that you take no offense.
It's going to be worse than you think, CR. Roubini has it right:
Believing as the consensus now does that this will be a mild two-quarter recession and that growth will recover in H2 of 2008 is wishful thinking. The last two recessions in 1990-91 and 2001 lasted almost three quarters (precisely 8 months) while the current recession looks fundamentally more severe than the latter two for three reasons: we are experiencing the worst housing recession ever in US history, a shopped-out, saving-less and debt-burdened consumer is now in financial trouble and retrenching; and we have a severe systemic financial crisis. Thus this recession will be longer, deeper and uglier than the previous two.
I'd not like to be more optimistic than Nouriel. People who were got their reputations handed to them, severed, on a platter.
Jas Jain - I have a very think skin!! I have, over the last few years, become an isolationist. If the rest of the world needs oil, let them patrol the Straits of Hormuz or pay the US Navy to do so.
Americans, like everyone else, are easy prey for con men. This, however, has been going on for a long time. That is why my comments occassionally reference the tulip mania of 1636.
I learned to draw swastikas, the right way!, in my father's accounting books at the age of four. Two swastikas are itched in stone in my late father's shop.
I could do compound interest calculations on client accounts at the age of eight. Also, I was doing field research on the subject of effects of debt on the living standards of the household at the same ripe age. I do know debt. And I know it for a fact that Pushing Debt is evil. America was turned into an evil enterprise during the past two decades. Now, Americans and the world have to suffer the consequences. The worm has turned with the credit crisis.
I'm not one of the posters waiting for the end of the world, but I did read the paper by Reinhart and Rogoff earlier today when CR linked it and I did come to the conclusion that this recession in the U.S. would be one of the 6 big financial crises since WWII and not one of the 13 lesser ones.
Did either of you see any reason to believe that it wouldn't be as bad as the Big 5 discussed there?
Jas Jain, I survived the dot com and 9/11 disasters in 2000/2001 so I have a warped perspective on the current craziness. Curiously, both the IRS and major brokerage firm forgave much of my debt at that time. Who knew?
sportsfan, I did read the papers too, and I do note that the 5 discussed survived. Heck, take a look at Japan, is it surviving? I did a deal with Softbank last year and they seemed quite able to put capital together. Have you been to Tokyo lately? Is it all gloom and doom?
I think what is changing my mind, and I admit this is not scientific, is attitude. When I start hearing armageddon from everyone it starts to sound suspiciously like the people that said the boom would go on forever only in reverse.
What is killing everyone is uncertainty. All the stuff out there isn't worth NOTHING. It's that no one knows exactly what. As some point that will unstick, but all mortgages, pier loan, and stuctured finance instruments are not WORTHLESS. Some is, but a lot isn't. So the opaqueness and uncertainty is what is killing everyone. The financial markets will unstick when the mark to market occurs. But right now, it's more prudent to let it wash out in dribs and drabs...and use profits to offest the losses, as I suggested upthread. It will take another couple of quarters to come clean, but before Q3, IMHO, we'll know what certain things are worth to the market now. As much as everyone is screaming, you don't want this all to come out at once. So far, most concerns were profitable last year and, if the offsets are done right, will be so this year.
And like most things, it's never as good, or as bad as you think.
Careful research has also revealed another stunning similarity among the crises: the heads of state, finance ministers, and central bankers in those five cases all had two hands and two feet! Just like the US now!
Unless the authors show us what non-crisis periods look like, we really can't draw conclusions about how similar things really are to the five crisis cases.
I agree with Dan. Real GDP per capita, in any series I can find, has already been zero or negative in the US for several years. I admit though to not knowing what the PPP basis is.
Figure 5 must be mislabeled: it must be t-4 that's 100, not t-10.
Why doesn't figure 3 have the breakout for the 5 crises? (I have read enough economics papers to fear I won't like the answer...)
It would be curious to see a quantity like average household net worth for the various cases.
Oh and, sportsfan, I do believe we're in for quite a contraction. I live outside of Boston and I can tell you that here we need another Dunkin Donuts or Starbucks or Lowes or Home Depot like we need another Mitt Romney But what that exactly means I can't say. What I can say is that I can't hire software engineers or IT people to save my soul. Medical staff is in short supply too. House prices are off around 20% from the boom (asking price), foreclosures are high, and there isn't panic in the streets. So my Magic8Ball is saying "answer unclear".
But ask yourself this: if half the Lowes and Home Depots and even Walmarts closed, where is that stuff made now? Who's out of a job? What impact does a retail pullback have on the effective unemployment numbers now? How many barristas are there in the US now compared to how many used to staff all the plants that made the tools that stores sold? Hmmm.....
Good comments. I agree that opaqueness and uncertainty about financial markets and assets are negative factors right now. People tend to fear that which they do not know, especially when it might affect their lives in some fundamental way.
What none of us know is exactly how bad this economic contraction will be. What has made this worse IMO is all the 'containment' talk coming out of Washington last year. That has told us that one more thing we don't know is how much our leaders don't know about how to fix whatever is broken.
I'm inclined to think this recession will be as bad as any in my lifetime, if only because the credit induced bubble affecting so many areas of the economy has been so large. It's not just the foreclosed homeowners, it's also the number of Home Depots and other new commercial, the lack of trust in financial vehicles of every sort, and, most especially, the lack of faith that anyone in Washington is going to do anything that helps many people to get through whatever is coming down the road.
How many barristas are there in the US now compared to how many used to staff all the plants that made the tools that stores sold? Hmmm.....
I didn't understand the question.
On the earlier (and probably related) question regarding what effect closing half the Lowe's or Home Depot's would have on the unemployment numbers, well, clearly there would be more unemployment unless there was an increase in some other area, whether that be IT, health care, manufacturing or even public works.
Personally I'd like to see more public works. As many have noted, our infrastructure in this country is in sad shape. We could easily do with less retail space. I don't need a Home Depot a mile from work when I have one a mile from home. I don't expect the local see-throughs will ever be occupied before they go into foreclosure. I'm not even sure they will ever get permanent financing.
We've built too much of the wrong stuff and not repaired enough of the essential stuff that we already have.
Since this is now the dead thread and we are left with the mild bears, I have one question regarding the paper. The most striking figure is the extent of housing price increases. What was the cause in the other crises? If not a housing bubble, then what?
In addition, I had previously looked up bank crises in developed economies in a paper by bis. The figures about the cost were lower then in this paper -- most of them being more like 2% or less of gdp.
Perhaps the bis paper was specifically referring only to explicit bailout funds from govt to banks.
Description of the crisis
The causes of the crisis once it had fully emerged could thus be summarised :
Banks that were used to a regime of strict quantitative regulations became exposed
to an entirely new competitive environment. The response of a large number of the
banks was to strive for larger market shares.
Prudential regulation was slow to adapt to the new competitive environment.
A strong boom followed by a sharp recession enhanced by a monetary policy
regime that worked pro-cyclically.
Page 18
The total gross fiscal costs of the rescue operations were approximately 3% of GDP. By end-
1993, the net fiscal costs (gross fiscal costs minus value of governments bank shares) were
estimated to be 0.8% of GDP.17
Everything that could go wrong, went wrong. One quote that caught my eye:
Although the share prices of these institutions (Banks) began to weaken, some adopted
share-price support practices through purchases of their own shares. This increased the
volume of unproductive assets, aggravating the problems in the profit and loss account. To
maintain profits and the dividend policy (avoiding further punishment by the market) many of
these banks reduced their bad debt provisions and even changed their accounting principles,
using the accruals criterion to record income and the cash-basis criterion for payments, or
even continuing to record interest accrued (but not paid) as financial revenues.
The banks were faced with a completely
new environment, and they did not have systems for controlling the new risks. They focused
much more on market shares than on risks, which exacerbated the increase in the credit
volume.
A large share of the loans went to investors in housing or commercial real estate and most of
it was collateralised by real estate, which put an upward pressure on real estate prices. High
real estate prices led to higher asset and collateral values, which facilitated borrowing and in
turn increased the upward pressure on asset prices. As a result, especially in metropolitan
areas, real estate prices rose very quickly (see Figure 8).
Deregulation and real estate speculation seem to be the major cause.
Note: I am not doc holiday. I may be crazy commenting extensively on this paper, but it lacked details.
The bis skipped Finland and everyone knows about Japan.
Overall, most of the causes seem much more like the US S&L crisis. That is, deregulation and lending excesses.
Japan and Sweden seem most like the current US situation. I dunno about Spain -- Franco had only been dead 2 years. Finland...someone else can look that up.
One final comment:
The paper uses 6% gdp as the cost of the Swedish cleanup and the bis uses 2.1.
per the paper:
The fiscal costs of cleaning up after banking crises can be enormous. The fiscal cleanup from Swedens
1991 crisis was 6 percent of GDP
per BIS:
By 1994, the Swedish banking system as a whole
showed positive profits again. Among the factors contributing to the resolution of the crisis in
an important way was the change in the exchange rate policy. The total amount paid by the
BSA to the banks was SEK 65 billion. However, part of that money, was paid back to the
government through dividends, selling of shares, and the value of retained shares.
Jennergren and Näslund (1997) have estimated that the final bill to the taxpayer was SEK 35
billion (2.1% of GDP in 1997).
Yesterday I posted a list of major league bubbles. Some of them are relatively recent phenomena, whereas others have been building for decades; heck, some since the Great Depression. Independently none of them would warrant more than a mild recession, but together they're a lock for a new Greater Depression.
Why are they coming together now? Because the housing/credit/derivative crisis has accelerated the development of all those bubbles to the bursting stage. This isn't a tossing a rock into the pond, it's tossing a grenade into a minefield.
MIKE: "Mike writes:
Sivaram, I'm not sure how much sense it makes to A) think we're going to get deflation AND B) think most things are undervalued currently. If we get visible deflation, stocks will get slammed for being overvalued because of that deflation."
I don't expect severe deflation. It can happen but unlikely IMO. If there is going to be any serious deflation, it will be in places like China. My opinion is that China has massive bubbles in real estate, the stock market, and manufacturing. What I expect in USA is disinflation with mild deflation here and there.
My guess--and all it is is a guess--is for deflation to impact certain assets like real estate. I don't think there will be across-the-board declines in all stock prices. The reason Japanese stocks fell was because they were severely overvalued. The same isn't the case in USA so it is going to be small decline impact select sectors.
Having said that, there is nothing to say that the stock market won't go into a prolonged sideways bear market.
Given that ABK doubled in value from the 18th to the 24th I figured you would've taken the cue to exit that position. Are you a glutton for punishment?
Paul, I grew up in Kalamazoo, MI. If you do not think that Kalamazoo is in decline, you are living in some dream world. I took a cab from the airport over the holidays and the driver spends the entire trip complaining about the local economy. Radio runs ads begging people to support local businesses by not Christmas shopping online. The town's biggest employer Pfizer (most likely your employer) is hitting hard times and is closing sites. Home prices are in the dumps. Young, bright people are fleeing the area - of all my professional friends who graduated with me from UMich, only a handful remained in-state. If any place has felt the beginnings of a downturn, it's Kalamazoo.
Main issue is the USA is household debt which went from 50% of GDP to 100% of GDP over the past few years.
Talking about debt without taking about all debts (public, household, business) is just plain stupid.
You can own your house (you have the debt) or rent a government build house (government has the debt), you can ride a government built road (government has the debt) or pay a fee for a private road (business has the debt). Debts can substitute one another according to policy, talking about one in isolation is meaningless.
Economists always talk only about public debt, but it's not like economists know anything about the economy .
And MSM never ever talked about household debt doubling.
If you want data, it'all in the Federal Reserve Z1 report.
--
"And MSM never ever talked about household debt doubling [as a % of the household incomes]."
Evildoer Greenspan took the lead on this. He wanted to keep focus on the USG debt so that people wouldnt worry about the GROWTH of the household debt, the SOLE CAUSE of the GDP growth during 2002-2007. It is the unwinding of the household debt, mostly via defaults, that will sink the US economy into a long depression. Borrow-and-consume-more-now (the house one lives in is a consumption item) means you consumed the future. Is that a hard concept to grasp? I have been talking about the household debt for years.
It Is the Debt, Stupid! (That WILL take Americas crooked system DOWN).
It's hard to argue deflation or disinflation with the prices of commodities hitting records or close to.While the deflationists wait for the big K winter, prices like explained below just keep on marching higher, defying the textbook deflationists.
While debate about the de&inflation semantics plus inventive ways on how to spur growth continues (code for how do we shove more debt down households debt burdened throats) ,which of course includes the official debasement of fiat currencies, the cost of living for families is soaring-even if it ISNT getting official respect in important quarters.
Some examples;
NEW DELHI: After a gap of about six months, the inflation rate once again crossed the four-per cent mark due to rising prices of cereals, salt and bakery products.
SAN FRANCISCO (MarketWatch) A benchmark for a range of commodities hit a record high on Friday, a reminder to the Federal Reserve that inflation risks loom even as it concentrates on reviving U.S. economic growth by slashing interest rates.
Wheat, platinum lead roaring commodities rallyReuters Friday February 8 2008 By Barani Krishnan
NEW YORK, Feb 8 (Reuters) - Commodities from energy to metals and agriculture surged on Friday, with wheat and platinum hitting record highs for a straight week running on supply concerns.
Funds also plowed into markets like sugar, coffee and cocoa, making analysts believe that commodities could trump stocks and bonds in the event of a U.S. or even a global recession.
SYDNEY, Feb 08, 2008 (Thomson Financial via COMTEX)The Reserve Bank of Australia raised interest rates by a cumulative 50 basis points in August and November to rein in inflation.
and from Barrons;
This Credit Crisis Has a Long Way to Run
Interview with Jeremy Grantham, Chief Investment Strategist, GMO
By SANDRA WARD
B:So the Feds actions wont stave off a slowdown?
JG: Since when did the thought of an economic slowdown induce such hysteria? That was a response to the decline in global markets. It was aimed at the stock market. It was aimed at banking disorder and banking profits. It doesnt have that much of a powerful effect on the economy. If it had any more profound effect, there would be a positive relationship between debt increasing and GDP growth, and there is none.
B:But it is driving down the dollar.
JG:It drives down the dollar, which is inflationary, and, eventually, it could be seriously inflationary"
All of those countries, with the exception of Japan, recovered very quickly and are doing well right now.
As far as debt, yes it has increased and that is a cause for some concern. However, the absolute amount of debt is much less important than debt in proportion to income. And I think the income numbers are significantly understated. First, gains on stocks and other investments are not counted until they are sold. The same is true for equity in small business, whether Schedule C, S-corps or other. The proportion of the population owning stock and/or small businesses has increased greatly in the past 20 years. If I put a dollar into stocks or into my business that is savings just as much as if I put it into a savings account. Second, even for ordinary business income it is more difficult to measure than wages. The wage earner earns income and buys a car; the business owner has the business buy the car and deducts it and that income is not counted the same way. Third, there is the entire underground economy, both legal and illegal.
Finally, I keep hearing people say that all of the growth from 2002-2007 was illusory. In fact it was more or less in line with the long term real GDP growth of 3.5% per year, which has been in place since about 1820. If the next couple of years are below trend, which they may be, reversion to mean would suggest that there will likely be a period of rapid growth ahead to compensate.
What you are saying rings true, but what about the possibility I have heard discussed on this blog: Negative economic growth, accompanied by commodity inflation, with deflation of real estate and investment assets? This worst-case scenario seems plausible in the short term if the latter class of assets are deemed so overpriced that the reckoning of their value counteracts the devaluation of the dollar.
rich opined:
"There are some real uninformed amateurs posting on this board about stock market valuations, such as Sivaram."
Interesting statistic came out friday afternoon (cftc.gov COT reports) and that was the long exposure to equity indexes by non-reporting firms otherwise known as small specs. This particular class of 'uninformed amateurs' now has their lowest exposure to equity index futures since pre-2000.
If someone is intrepid (oh well maybe it will be me) they could download the pre 2000 data from ctfc.gov and see just how far back this record goes.
Another interesting observation is that the barry ritholtz link contains graphs 1, 3 and 5 of the paper in question. For some strange reason graph 2 was left out, and for the grizzly crew it would seem to be the most pertinent and that would be equity market values through the crisis. Oddly enough it appear that in time T0 (where we currently reside) equity markets find their trough. A curious oversight, don't you think?
Andrew: Well I like those odds. And, even with their poor economic performance, life in Japan for the average person has been fine over the last 15 years. Some would argue that the quality of life has probably been better than in the 80s in terms of the stresses of day-to-day life.
David-Yes and net insider buying is very high. In 1999 they were selling like crazy. Maybe they know something? As for Rich, he and I have a side contest pitting his favourite stock SRS vs mine, ELN. just to update, even though SRS had a great week, while ELN was flat, y-o-y ELN is up 93.6 % vs 74.1% for SRS. And 5-year performance? I don't think Rich wants to go there.
As someone who practices law in the Miami area, I'm here to tell you that the underground economy is HUGE.
But suppose the underground economy drops off even faster than the reported economy. From the fired illegals to unreported cash transactions, the underground economy is probably closer to where the rubber meets the road than the reported economy, and just because it's underground, doesn't mean it won't have real effects.
If the fired illegals go back to Mexico, they won't be buying beer or snacks at the 7-11. If they stay, they may turn to begging or illegal activities in order to survive.
TJ & the BEAR: "Given that ABK doubled in value from the 18th to the 24th I figured you would've taken the cue to exit that position. Are you a glutton for punishment?"
I'm still down a lot so there is little reason to sell. This is no comfort to me but I think some bears lost more money in the last month than the longs. For example, anyone who shorted around $5 to $7 is down -100% versus longs from the $20s who are down 50%.
In any case, the main thing is that I don't feel that anything fundamental has changed in the last month. The subprime mortgage problems are more stable now than 3 months ago. The ARM reset armageddon that some bears were predicting seems to be falling by the wayside (now that interest rates are declining). All that happened was some bears like Ackman and Jim Cramer started a panic that caused a sell off in the stock price but the fundamentals are quite similar to a few months ago (worse no doubt but nothing surprising)--it's amazing how much air time someone with a shoddy record like Ackman gets. Oh well...
Like I have always said, it will all come down to subprime default rates and loss recoveries. We won't really know until the end of this year.
Anyway, you shorted the monolines I believe, and well, good job profitting from that... but the game isn't over yet...
I don't know why you are blaming the so-called "New York bankers" for the debt problems. Let's go over how a free market works.
In a free market (we are not in a perfect one but closer to it than not), a borrower decides ON THEIR OWN whether to take on more debt or not. No one is putting a gun to anyone's head and telling them to accept increased indebtness. It's a voluntary transaction.
When someone goes and buys a car on debt, they are choosing to do it on their own. No banker or investor is forcing them to (i) buy the car in the first place, and (ii) use debt rather than cash.
The "sell-side" always caters to the market needs. If buyers want something, the sell-side will attempt to provide it.
Either you don't understand how the system works; or you want to shift responsibility to one side of the equation. I know it's fashionable--esepcially in bearish circles--to shift blame onto some 3rd party (eg. blaming the federal reserve's low interest rates for the subprime problems when in fact the borrowers chose to use ARMs instead of fixed rates and buy homes they clearly cannot afford). But the fact of the matter is that responsibility should--and always has been--with both the buyer and the seller.
If you are really concerned with debt, you will accomplish your purpose a lot more easily by educating or influencing the borrowers, more than you will by ranting and trying to criminalize voluntary free market financial transactions. You are doing no one, except overpaid lawyers, any favour by trying to criminalize any of this. Employees who work at financial institutions that profit from debt, and shareholders like me who may own such companies, accomplishes nothing...
Hey, CR, I sent you a link to this paper three weeks ago, with the abstract. I guess I'll need to increase the self-promotion a la BR.
I read that paper recently via link that someone posted here in the CR comments, and it is quite sobering, and also shocking if not surprising.
Bob_in_MA, sorry, I marked it in my inbox as a paper to read and then got too far behind. My apologies. I need to prioritize better!
Thanks again for sending it to me.
Best Wishes.
I strongly believe that this time is different from the other crises and recessions that we've experienced over the past 20 years, and probably over the past 60 years.
We've had:
1) An enormous structural overinvestment in non-productive non-tradeables;
2) Incredibly low real interest rates for a long period of time;
3) A Federal Reserve that was way too successful in convincing us all that it was irrationally printing money, and probably won't be able to do so again;
4) An immense build-up of private sector debt, with the FOR only climbing despite very low long and short real interest rates and net assets increasing in value;
5) The housing ATM;
6) A credible argument that the world is low on oil and agricultural goods;
7) A strongly suppressed currency concurrent with a very large structural balance of payments deficit, yet very strong capital inflows by non-economic actors...
I could go on all day. I did, in my "Homepage" linked below.
I don't think any other economy went through this sort of a confluence of events. It bears semblance to a lot of other situations, as observed by Reinhart-Rogoff, Stiglitz, and other giants.
I don't think it's quite the same, though, particularly because our economy is so much larger than any of the other economies in the world. It looks kinda similar to the other Reinhart-Rogoff blowups when viewed through the Mundell-Fleming model, but I think that's misleading. We have a lot of unique privileges and a lot of the decisions that led us here were made by others, e.g. pegging countries.
Particularly, we're not a small open economy. We're a very large open economy.
Yup, I too read that paper a little while ago - it meets my biases of course which are distinctly against american exceptionalism crap( that does NOT make me anti-american and certainly not anti-american-people).
I'm glad you've highlighted it.
-K
Did you know that the author, Carmen Reinhart, is the wife of former Federal Reserve Monetary Affairs Head Vince Reinhart? Considering Vince was a close working pal of Governor Kohn during his Fed tenure, I'm sure such research is not lost upon the Fed staff!
For a slightly different view on what the 2008 recession might bring, here is an excerpt from John Hussman's 3Feb08 weekly market comment:
"....I don't believe we are likely to observe major declines in consumption, or capital spending such as information technology even assuming the U.S. has entered a recession. Indeed, nominal consumption has never declined year-over-year. Though consumption represents the largest share of the economy, it is also the most stable (Friedman and Modigliani were right). Yes, growth rates will probably slow for these classes of spending in a recession, but the bulk of the downward pressure is likely to fall on housing and fixed investment. Meanwhile, an already lean level of inventories should help to prevent much further decline in inventories, which should offer some support to industrial production. Since negative inventory investment or inventory runoffs represent a good portion of the output losses in a recession, it follows that losses in real economic output (and by extension, employment), though not insignificant, are unlikely to be dire....
...This is likely to be a painful economic downturn not because of massive job and output losses, but because of losses in the value of things that people count as their assets (primarily housing, non-agency mortgage debt, and equities)...."
Link to original article:
Hussman Funds - Weekly Market Comment: A Writeoff Recession and a Dollar Crisis - February 3, 2008
Before I say anything, I will note that I expect the US economy to slow and the stock market to correct (it already started). So the question is how bad?
I have to say that I haven't looked at the paper fully (other than Barry Ritholdz's blog entry and what's written here) but everytime someone mentions a comparison to the past, particularly Japan, I just don't buy it.
One of the first big differences is that most assets in the US are NOT overvalued. The only one that I can think of that is really overvalued is real estate. Real estate seems to be going through a severe correction so once that is done with, that wonèt be overvalued either.
Stocks do not look overvalued to me. They are not cheap but they are nowhere near valuations in the past (2000 growth bubble; Japan in 1989; etc).
The US$ is also undervalued more than it is overvalued. This means that, contrary to some bearish views, capital should flow to the US. The reason soverign funds are investing in the US is not because assets are overvalued but because they are undervalued.
The problem right now is that the consumer is in bad shape. But corporations are in good shape. Corporate balance sheet was so good that quite a few corporations issued debt to buyback stock. So this slowdown may end up being different from others in a big way: unemployment may not materially increase. If companies do not lay off peeople en masse, then the consumer can recover much faster (this is one of the advantages of being a service economy).
Although one shouldnèt bank on hope, there is also some positive scenarios where commodity prices may decline. A decline in commodity prices will significantly improve the consumer balance sheet.
Sivaram,
How 'bout Treasuries?...they look overvalued to me.
This is great - none of these were financial meltdowns like predicted by some of the commenters on this blog. We're all still here - even the Swede's.
OK - it will suck for a while if I lose my job (been there, done that). Since I rent and didn't jump into the RE mosh pit of speculation, I won't get hurt (didn't clean up either - bummer!)
So sorry for those of you who did. Caveat emptor!
I withdraw my support for stimulus or bailouts. Deal with it.
I think I'll buy porn with my "stimulus" check. (that was bad) At least I know the needy will get my money.
BTW - real estate is over-valued. It's cheaper to rent today even in recession plagued Michigan.
America has been going through a cycle of hyper-growth since the mid-80's. The recessions of '90-'91 and '00-'01 were relatively mild and never really corrected the imbalances and excesses that have built up over time. We are going to finally have to take our medicine, and bitter it will be.
Things do always revert to the mean, and CR's charts of real estate values and multi-retail construction spending tell a thousand words.
The consumer is in bad shape because the ponzi-scheme of ever increasing debt financing ever increasing consumption has finally run out of gas. The adjustment will be painful, but ultimately America will emerge better off for it.
Sivaram,
Thanks for providing a valuable balancing voice. I think a lot of us are writing the end to this story long, long before it's actually here. We're used to doing that. The Fed has been remarkably successful over the last 20 years.
Hussman's points are well-taken, but haven't been borne out by recent data. The ISM Non-manufacturing numbers were all so bad that people thought it was a change in methodology, or a calculation mistake. The chain store sales numbers, released after his comments, were the worst on record, indicating consumption might not be so resilient after all.
I don't have the gravitas, degrees, or experience that these brilliant economists do, and neither do most of the people on this blog. However, as Paul notes, many of us saw this one coming long in advance.
Watch real long interest rates like a hawk -- no joke intended. They're the real lever of monetary policy, and they haven't moved even with 2.25% easing. If they don't kick in, we're in a liquidity trap. Credit and market conditions are still rapidly deteriorating. Money is still tight in price, if loose in quantity, and velocity is declining rapidly. It's quintessential.
The story's not over, and we should keep reading avidly.
Glenn_in_MA, Hussman's "never" isn't quite correct. The last time nominal consumption declined was in 1938. (If you want to double check, change the date range and use the annual series. Look for year-over-year declines in PCE). Also, nominal consumption declined every year from 1930 through 1933 (depth of the Depression).
But, yes, consumption in nominal terms is fairly stable as opposed to investment. Although I expect real consumption to decline in '08, it is probably unlikely for nominal consumption to also decline. My view (like Hussman) is that the recession will be mild-to-moderate in terms of rising unemployment. But I think the key is that the recovery - when it eventually comes - will probably be sluggish, and it will seem like the recession is lingering for many.
Best Wishes.
dk,
"The story's not over, and we should keep reading avidly"
Ditto on that!
Here's yet another take on the 2008 recession from the Economist:
"...YOU won't hear the R-word much in the modest governor's mansion in Helena, Montana. The occupant, Brian Schweitzer, insists that Montana's economy is in better shape than it has ever been. It has had one of the fastest rates of job growth in the country. The state is prospering on the back of booms in mining and farming, as well as steady growth in tourism. Paul Polzin of the University of Montana forecasts that the state's economy will grow by 4.1% this year, the fifth consecutive year of growth above 4%. We've been searching for realistic doomsday scenarios, he says, and we just can't find any."
"Go to Michigan, by contrast, and it is hard to find anything but gloom. The collapse of America's car industry, coupled with a nasty subprime mortgage bust, has left the state reeling. It has the highest unemployment rate in the country (7.6%) and the third-highest foreclosure rate, and was the only state to lose a large number of jobs in 2007. In the run-up to the state's Republican primary (which he won) Mitt Romney traversed Michigan, promising to save voters from a one-state recession."
"Montana and Michigan mark the divergence that lies behind America's aggregate economic figures. National statistics suggest that the country may have already tipped into a formal recession. Output rose by only 0.6% at an annual rate in the last three months of 2007, a figure that could easily be revised down to a fall. Residential construction is plunging, house prices are dropping, consumer spending is slowing and the economy shed 17,000 jobs in January, the first such decline since 2003. A monthly gauge of services activity, published on February 5th, has fallen dramatically and now suggests recessionary conditions. The big questionparticularly for those on the presidential campaign trailis where will the pain be felt most acutely, and how far it will spread
..."
Here is link to full article:
Premium content | Economist.com
--
Monday, February 11, 2008
This Credit Crisis Has a Long Way to Run
Interview with Jeremy Grantham, Chief Investment Strategist, GMO
By SANDRA WARD
ONE OF THE GRANDEST OF THINKERS AND MOST ELOQUENT of oracles, Jeremy Grantham has long been the voice of reason in an industry prone to excesses and embellishment. By taking the long view, blending quantitative strategies and technical analysis with sound and experienced judgment, Grantham, chairman of Boston-based GMO, consistently uncovers with his team the best values among a wide range of global asset classes.
The payoff is outstanding performance and risk management. In return, clients have entrusted the firm with about $150 billion. As the man who warned early of a worldwide bubble forming, we turned to him as that bubble has started bursting.
Barron's: You, along with George Soros, have called this the worst financial crisis we've had in the post-war era.
Grantham: This is much more global than, say, the savings-and-loan crisis was. The world is obviously much more globalized than at any time since the late 19th century and much more interrelated in almost every way, certainly financially. To have the leading economy and the reserve currency having a major-league credit crisis would by itself make it more important than earlier ones.
Secondly, this occurred at a time of what I believe is the first global bubble in pretty well all asset prices, so there is a much greater degree of broad-based vulnerability. Then it is a question of degree, and how carried away the sloppy lending was: It was very carried away. Not just in the design of needlessly complicated instruments, but in the enthusiasm -- recklessness one might say -- with which they were sold.
Can these bubbles burst if the Fed is easing the way they are?
Well, this is an amazing little tidbit. People think the Federal Reserve can stop a bear market because they can throw money at it and lower interest rates. It is even more certain we can collectively stop a bear market if some fiscal stimulus is thrown in. To which I say, 'Oh, you mean like 2000 and 2002?' -- when they threw what I call the greatest stimulus in American history, an unparalleled series of interest-rate cuts, cumulating in two, almost three, years of negative real returns, real interest rates coupled with a really substantial tax cut, which would never have happened without 9/11.
The combination would have gotten the dead to walk, and it stopped the bear market eventually. But the Standard & Poor's 500 was down 50% and the Nasdaq -- which was all anyone talked about back then -- went down 78%. And a puny five to six years later, people are saying there is not going to be a bear market because the Fed is going to lower rates and because the government is going to have a stimulus package. But we have just been there, done that, and we had a nice bear market.
...
Incidentally, it was late in '06 when [Fed Chairman Benjamin] Bernanke said he thought the high prices of homes in the U.S. merely reflected a strong U.S. economy. Was he not looking at the data? Did he not measure long-term house prices? Had he not seen how they ebbed and flowed as a multiple of family income, which they do here and in the U.K. and everywhere else? And with it being so obviously a bubble, how could he have said that?
He was taking his cue from Alan Greenspan, who said we should all be taking out adjustable-rate mortgages.
Greenspan and Bernanke have taken a hands-off approach for two consecutive great bubbles, first in TMT -- telecommunications, media and technology -- and second, in housing. A hands-off approach is a polite way of saying they facilitated this. And what is the point of a 125-basis-point rate reduction, other than to provide reinforcement for the people who borrow short and lend long? From bankers who have committed every crime you could possibly accuse a banker of, to hedge funds who borrow short, leverage, and invest long in the stock market -- that's who really benefits from the interest-rate reduction. The economy, broadly defined, does not.
I have an exhibit that shows the 30 years prior to 1982 when the debt-to-gross domestic product ratio was completely flat at 1.2 times. Total debt is defined as government debt, personal debt, corporate debt and financial debt. Then in the 25 years after 1982, the flat line goes up at a 45 degrees angle from 1.2 times to 3.1 times GDP. Massive. In the first 30 years, when debt is flat, annual GDP growth is its usual battleship, growing at 3.5% and hardly twitching. After the massive increase in debt, GDP, far from accelerating, grew at 3%. So debt in the aggregate does not drive the economy. The economy is driven by education, man-hours worked, capital investment and technology. It is not driven by what I owe you and you owe me.
...
404 Not Found
Jas Jain,
404 Not Found
Bad link...at least it didn't work for me.
As wrong as Mr. Krugman was about the return of the depression economics in 1998, he is now about the "severe financial crisis". He serves as one of the best counter indicator (apart from the CR crowd, of course) in our time.
I'm not an economist, but will also make a prediction: Nasdaq will see new ATHs within 2.5 years at declining inflation levels (average inflation rate 2008-08/2010 below 2007 levels). Now that's out of the box.
O-Joe
This is a bit off topic for this post, but I think it will be of general interest to CR's readership:
I live in Seattle. A couple years ago, I saw the writing on the wall so to speak and sold my house and my condo and started renting. I'm moving to a different neighborhood and have been looking at the listings on Craigslist. In the past week, there have been seven postings for new, never been occupied, townhouses in my target neighborhood. These have asking rents far below mortgage cost -- unless one put 40% down or so. That even includes the mortgage interest tax deduction.
Additionally, there are dozens of large condo developments still in the 'big pit' stage, thousands more units expected to come to market this year.
The upshot is that Seattle will likely see significant price declines. They will probably not be as severe as FL, AZ, CA, etc... but it seems it will happen here as well.
CR,
OK, I forgive you.
Another point Jeremy Grantham makes in that Barron's interview is that profit margins are way above historic averages and are almost assuredly going to contract in a downturn. Meaning, the current p/e ratios, which prove equities are fairly valued, are likely to rise. Not to mention the fact that profit projections are still unreasonably high.
If things stayed like they were a year ago, stocks might be fairly valued. But they haven't and under a realistic outlook for the future, they will have to fall. Especially the low-cap end. The Russell 2000 has some absurdly high p/e ratio.
"An enormous structural overinvestment in non-productive non-tradeables"
This is the key, tons of capital into non-poducive areas of the economy, housing and real estate.
That is what I dont get about the whole alternative energy bubble theory. An investment in alternative energy to avoid an environmental crisis and to replace deminishing fossil fuel supply. Also will create more weath not suck it up. And cheap energy will make US competative and stable. To me this is not a bubble, as it will result in a net increase in physical weath and productivity.
NO KIDDING THIS IS DIFFERENT!!!!!!!!!!
$600-GIVE ME A BREAK!!!!!!!!!!!!
$8 Trillion dollars of Mortgage and HELOCs taken out in the last 4 years secured by homes potentially worth something less than the outstanding balance.
Not only that, with stagnant wages and rising taxes, interest, insurance, food and fuel, the amount of money the consumer can afford for housing is LESS today than it was in 2000.
Then after you capitalize the effect of the $8 Trillion dollars of debt into the economy, once that money is sucked out, the inverse multiplier effect will be SHOCKING!!!!!
Its now starting, Retail Slowing, Restaurants Slowing, Autos Slowing, Housing slowing, Tax Revenues Slowing, Corporate Profits Slowing, Layoffs Rising, Foreclosures Rising, Loan Defaults Rising, Bank Reserves.....who the heck knows?
Barron's article link
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This Credit Crisis Has a Long Way to Run
Interview with Jeremy Grantham, Chief Investment Strategist, GMO
By SANDRA WARD
ONE OF THE GRANDEST OF THINKERS AND MOST ELOQUENT of oracles, Jeremy Grantham has long been the voice of reason in an industry prone to excesses and embellishment. By taking the long view, blending quantitative strategies and technical analysis with sound and experienced judgment, Grantham, chairman of Boston-based GMO, consistently uncovers with his team the best values among a wide range of global asset classes.
The payoff is outstanding performance and risk management. In return, clients have entrusted the firm with about $150 billion. As the man who warned early of a worldwide bubble forming, we turned to him as that bubble has started bursting.
[BA_QA_photo.jpg]
"It was late '06 when [Fed Chairman Benjamin] Bernanke said he thought the high prices of homes in the U.S. merely reflected a strong U.S. economy. Was he not looking at the data?" -- Jeremy Grantham
Barron's: You, along with George Soros, have called this the worst financial crisis we've had in the post-war era.
Grantham: This is much more global than, say, the savings-and-loan crisis was. The world is obviously much more globalized than at any time since the late 19th century and much more interrelated in almost every way, certainly financially. To have the leading economy and the reserve currency having a major-league credit crisis would by itself make it more important than earlier ones.
Secondly, this occurred at a time of what I believe is the first global bubble in pretty well all asset prices, so there is a much greater degree of broad-based vulnerability. Then it is a question of degree, and how carried away the sloppy lending was: It was very carried away. Not just in the design of needlessly complicated instruments, but in the enthusiasm -- recklessness one might say -- with which they were sold.
Can these bubbles burst if the Fed is easing the way they are?
Well, this is an amazing little tidbit. People think the Federal Reserve can stop a bear market because they can throw money at it and lower interest rates. It is even more certain we can collectively stop a bear market if some fiscal stimulus is thrown in. To which I say, 'Oh, you mean like 2000 and 2002?' -- when they threw what I call the greatest stimulus in American history, an unparalleled series of interest-rate cuts, cumulating in two, almost three, years of negative real returns, real interest rates coupled with a really substantial tax cut, which would never have happened without 9/11.
The combination would have gotten the dead to walk, and it stopped the bear market eventually. But the Standard & Poor's 500 was down 50% and the Nasdaq -- which was all anyone talked about back then -- went down 78%. And a puny five to six years later, people are saying there is not going to be a bear market because the Fed is going to lower rates and because the government is going to have a stimulus package. But we have just been there, done that, and we had a nice bear market.
What about places to hide?
That isn't something we can laugh off. Last time, there were plenty of opportunities: Bonds were cheap and TIPS (Treasury-inflation protective securities) were brilliant; real estate was cheap and REITs were brilliant. Even within equities, emerging markets were much cheaper than U.S. equities, and within U.S. equities, value stocks were only a little expensive and small-caps were only a little expensive and small-cap value was actually a little bit cheap. So you could really hide and could reasonably expect to make money, which we did in each of the three years of the bear market.
Since then, all those areas appear to have read the book on mean-reversion. Ten years would be a perfectly normal period of time to go from a peak of a great bubble [like the one in 2000], based on the history of bubbles and their aftermath, to the low. I have long thought that 2010 would be when we hit the biggest discount to fair value. Trend-line value on the S&P, by the way, in 2010 is 1100. (The S&P 500 traded at 1334 late last week.)
What should we expect from the market between now and 2010?
In the fourth year of a presidential cycle, where you have a lame-duck president, the typical pattern of S&P 500 performance has been something like 10% below the normal long-term average (a 5.2% gain, inflation-adjusted), and worse if it is an overpriced market. A first year is never very pleasant: They average about 3% below normal. If they are overpriced, they do four points worse than that.
But if the party in power changes, first years tend to be eight points below normal. The following year is ugly, too. The average year two, since 1932, has been 10 points below normal and, if the market is overpriced, 15 points below normal. This is unpleasant. By a nice coincidence, those averages suggest the market will decline to 1100 in 2010, which is exactly the number we get to from a completely different technique -- building it from the grass roots through fundamental value. We do that by taking average corporate-profit margins, actually a generous average, assigning a normal market price/earnings ratio, and that gives you 1100 in 2010. This year, next year and the year after will all be uncomfortable years. One of them might be up, but my guess is it won't be up by much.
What exactly will make them more uncomfortable?
Profit margins, the great prop to the market, surprisingly defied the laws of gravity for three years in the developed world and, particularly, in the emerging world and even in Japan. That was because the global economy was stronger than any corporation counted on and, in the U.S., consumption was always higher and our savings rate was always lower than any corporate economist would have suggested, going into negative territory. But there are a few near certainties in this business -- not many, but a few -- and one of them is that abnormally high profit margins will go back to normal. The timing is unfortunately shrouded in fog. The other near certainty is that house prices will go back to a normal multiple of family income. In the end, we, the people, have to be able to afford the houses and they are affordable at something around 2.8 times family income. When they peak in Boston at 6 times and nationally at 3.9 times, you know you are in for tough times.
Incidentally, it was late in '06 when [Fed Chairman Benjamin] Bernanke said he thought the high prices of homes in the U.S. merely reflected a strong U.S. economy. Was he not looking at the data? Did he not measure long-term house prices? Had he not seen how they ebbed and flowed as a multiple of family income, which they do here and in the U.K. and everywhere else? And with it being so obviously a bubble, how could he have said that?
Sorry, I just meant to post the last couple paragraphs. I need to always use preview....
Let's review whether U.S. stocks are still fairly valued.
Earnings peaked at the end of the second quarter last year. Based on about 4,000 of the 5,000 largest U.S. companies, the WSJ reported total earnings at $245 billion. On a trailing 12 month (TTM) basis, total annual earnings as of Q2 07 were about $900 billion.
Since then, earnings have fallen 21% for Q3 and 37% for Q4 on a YOY basis. The comparable totals would be $187 billion for Q3 and about $160 billion for Q4. If you assume further YOY earnings declines of 10% in Q1 and Q2 of 08, total trailing 12 month TTM earnings would be about $600 billion.
If you assume stocks were fairly valued at Q2 07, when the TTM P/E of the S&P 500 was about 17, then the S&P would need to fall 33% from Q2 07 through the end of Q2 08 to keep the same valuation relative to earnings.
But P/Es don't stay the same in periods of rising and falling earnings. P/Es usually rise with upside earnings momentum and fall with downside. Investors don't pay the same multiple for cloudy or iffy future earnings. So, to maintain valuation relative to earnings, we would need another 15-25% decline in the S&P 500 and 40-50% in the Russell 2000.
There are some real uninformed amateurs posting on this board about stock market valuations, such as Sivaram.
Pat,
I think that's entirely relevant: there is very little real adjustment that has taken place to date.
The decline in most real estate prices has not been significant yet. Look back at CR's chart of retail construction spending earlier today: we're virtually still at the apex. Check out the CMBX, CDX, LCDX, iTraxx, what have you. Muni's are yielding more than treasuries, and corporate spreads are still elevated.
Composite Bond Rates: Bonds Center - Yahoo! Finance
ABCP is looking marginally healthier, and ABX is still bouncing along the bottom, but all of these other measures continue to look quite ill.
I understand full well the Pavlovian response to believe things will be better now that the Fed is scared. I just don't share the belief that their policies will have rapid traction, and at this point, I'm not thoroughly convinced they'll have traction at all. Again, watch real rates on a variety of bonds.
Even if their policies do have traction, we've got a lot of adjustment to do in the real economy, particularly if the recycling of forex reserves slows. It's barely begun.
Go to Michigan, by contrast, and it is hard to find anything but gloom. The collapse of America's car industry, coupled with a nasty subprime mortgage bust, has left the state reeling. It has the highest unemployment rate in the country (7.6%) and the third-highest foreclosure rate, and was the only state to lose a large number of jobs in 2007.
I live in beautiful Kalamazoo, MI. I'm not reeling nor is anyone I know reeling.
From Dictionary.com:
To be thrown off balance or fall back: reeled from the sharp blow.
To stagger, lurch, or sway, as from drunkenness: reeled down the alley.
To go round and round in a whirling motion: gulls reeling and diving.
To feel dizzy: My head reeled with the facts and figures.
Maybe the drunk part applies to Michigan.
Recession is a very personal thing. A mild recession is when you lose your job. A severe recession is when I lose mine.
Unskilled and uneducated people are on the edge and typically fall during recessions.
If you want to fix this problem, stop voting for Republicans. Mitt Romney wants to blame our lack of faith. Fair enough. My guess is it's all about education and resiliency.
Montana and Michigan mark the divergence that lies behind America's aggregate economic figures
Population
Michigan = 10,120,860
Montana = 935,670
Population statistics - states compared - StateMaster
Perhaps we needed an upbeat little piece like that. Because there's a fine line between hope and despair.
YouTube - Fine Line: Sub-Prime Decline - The Richter Scales
Anonymous writes:
Montana and Michigan mark the divergence that lies behind America's aggregate economic figures.
I must be one of the drunks reeling in Michigan. I don't quite get the "divergence" argument.
O-Joe,
You sound pretty ridiculous when you mock the CR comments section, especially with markets already having corrected enough to be termed a bear market, and storm clouds gathering all around us.
Rich,
The problem with these indices is that financial companies receive so much weight - what would your analysis look like without including $100 billion of writedowns? I'm pretty sure earnings growth was still positive in the 4Q ex-financials.
Financials will struggle for a while, but the writedown pace is bound to abate at some point, and a lot of the bad news in financials is already priced in.
I guess my point is that we haven't yet seen an earnings contraction on average in non-financial companies (at least thats my understanding).
I believe we will, but that die hasn't been cast yet.
ShortCourage - there is a big difference between a correction and the financial "meltdown" predicted by the folks who have been commenting here. Their cheerleading for economic chaos must be embarrassing for CR and Tanta.
--
Glenn_in_MA,
Sorry, I don't know what haloscan did, but here it is again and I checked it:
404 Not Found
Look like someone already posted the whole thing. It is a a great read.
-x-x-x-x-x-x-x-
Another one:
Chain of fools
Feb 7th 2008
Hard evidence that securitisation encouraged lax mortgage lending in America
Premium content | Economist.com
-x-x-x-x-x-x-x-x-
There is no doubt that BFNYC were in collusion behind this unfolding fiasco. NYC is a cesspool of Conflicts Of Interests (COI) as these people go to the same bar mitzvah celebrations, the same parties, the same clubs, the same synagogues, temples, churches, and their kids, future born-and-bred Crooks, go to the same schools (Cramer spilled the beans on this!). CULTURE MATTERS!
Jas
Oh, go away Jas Jain!
Culture matters? Whatever. Are you some kind of religious fanatic?
CR and Tanat. I'm sooooo sorry. I engaged the troll (or became one). $20 to the tip jar for repentence.
OMG I even misspelled Tanta! Closing brower window now. Good night.
Paul,
I don't know why CR and Tanta would be embarassed by us. Consider the track record of the folks here in predicting today's conditions, as compared to mainstream analysts and professional economists.
There are some here who take it to Armagedon exremes, but for the most part most we merely recognize the unprecedented odds of a huge financial calamity.
Lots of very well respected economists are recognizing those heightened risks as well (e.g. Roubini).
--
Paul, (* Edited by CR: Inappropriate comment and name calling - please stop this! *)
I believe in sensible minority that is always open to an explanation not shared by the vast majority. Majority consists of dopes, in case you don't already know.
Jas
Edited By Siteowner
Seeing banner ads soliciting investment in GE corporate debt. That's something new.
Investment Opportunities: Corporate Notes from GE Interest Plus
Let's just get all these guys some Wright Model A's so they can chill out.
Glenn_in_MA writes:
ndk,
"The story's not over, and we should keep reading avidly"
Ditto on that!
Here's yet another take on the 2008 recession from the Economist..."
That right. "Yet another take on the 2008 recession" is wrong. I tell it to everyone: this would be the best advertised recession in the history of mankind... from the same magazines applauding the RE boom in late 2005. As wrong as they were then, so are they now.
O-Joe
I believe in sensible minority that is always open to an explanation not shared by the vast majority. Majority consists of dopes, in case you don't already know.
Jas
Jas Jain
I cannot agree more. 70% of Americans stating we are in a recession or will be in one during 2008 are way wrong. The only 30% believing we will avoid one are correct. As usual.
O-Joe
Culture matters? Whatever. Are you some kind of religious fanatic?
Paul
You also got the basic idea wrong - of course culture matters ( you have to really careful in describing and delineating culture and what "matters" of course).
-K
Yeah, that paper again. Don't know about other countries, but the US data is just made up. Just check on some measure of real gdp per capita (ppp) growth and compare to their graph.
--
O-Joe,
You are a sensible minority even when you are wrong! There are exceptions to all generalizations.
P-Jas! (Pessimistic-Jas)
can someone explain in REAL jsp terms how to differentiate between Real and Nominal prices?
--
Confused,
Nominal prices = prices in current dollars at any given time.
Real prices = prices adjusted for inflation, i.e., currnt price divided by CPI (consumer price index).
Jas
ty jas
Sivaram,
Damn near every non-consumable thing we own is overvalued at the point of purchase: Cars, computers and other consumer electronics, jewelry, household furnishings, newly-released entertainment...
My proof is the relative cost of these same items if sold privately one week after purchase (or, in the case of entertainment, waiting for the DVD).
If you purchase the item on credit, add around 10% (I pulled 10% out of the air, because it sounds reasonable. Use whatever percentage you'd like).
I have a friend who just sold a million dollar house for $750K. Something is only worth what you can get for it, and if no one is buying (no demand), it's worth nothing.
Confused,
I'll try. It's not too hard. Let's stick to totally risk-free things: treasuries. You're lending to the U.S. Government. If they can't pay, we'll all have bigger things to worry about than yield.
The nominal yield of something is the yield you see. If you loan your money to the Feds today for 10 years, they'll give you 3.64% interest for the life of the loan. That's about all there is too it.
However, you need to think of that nominal yield in terms of what you're really getting. Inflation means everything's more expensive, so $103.64 next year isn't going to buy $103.64 worth of this year's stuff. The real yield is how much money, after inflation, you'll get on that loan.
But how do you calculate the real yield? There are a lot of ways you can measure inflation. You can look backwards at the CPI rate, core CPI rate, or PCE deflator, measurements economists like to use for the rate of inflation. These come out to around 2-4%. That means, after inflation, you would actually lose purchasing power for lending money to the Feds for 10 years. Bad deal.
But those all look backwards and say what inflation was in the past. You're lending money now, to be repaid in the future.
A lot of economists like to look, then, at the TIPS yield. The TIPS include an agreement between you and the government that they'll compensate you for whatever the CPI inflation rate is throughout the term of repayment.
This gives you a way to calculate what the "real rate of interest" is expected to be over the next 1, 2, 5, 10, etc. years. Right now, we expect to get a 1.36% annual real return on money we lend to the government for 10 years.
U.S. Treasury - Daily Treasury Yield Curve
That means we think that after 10 years lending your cash to the feds, you'll be able to buy ~$11,456 worth of today's goods (real return) using $14,383 of those future dollars (nominal return).
P.S. When home prices peaked, real long treasury rates were at 2%. Today, they're around 1.8%. That doesn't take into account any of the tightening in credit conditions at all.
U.S. Treasury - Daily Treasury Real Long-Term Rates
Sivaram @ 4:55 -
You assume that with corporate balance sheets in decent shape, the J6P employee will survive a consumer-led downturn.
I don't think that this a safe assumption. TPTB tend to be short-sighted and will toss him under the bus in short order.
--
ndk,
If one were prescient and lent long-term to the USG in 1981 and reinvested the coupons in long-term USTs he, or she, would be able to buy a bigger, or better, home anywhere in the US, LOT more crude oil or gasoline, LOT LOT more gold, LOT LOT LOT more of almost all consumer goods and services.
Jas
PS: During the coming depression the 10-year USTs will yield less than 2% and most Scams would be down at least 70% from where they are. Scam Lovers are the biggest born-and-bred dopes in America.
"mp writes: Three weeks ago I was offered a fully-equipped 10,000 sq. ft. machine shop--including the building--for $50,000.
How can a fully equipped machine shop not be worth $5/sf?
I've never heard of anything like that.
sportsfan"
Sportsfan - I am not an expert about Michigan. But I have family there. And my impression is a lot of people who are directly or indirectly involved with the auto industry (including some family members) are in pretty bad shape. My BIL used to do chemical sales to the auto industry. Now he mostly does small home improvement jobs. Luckily he is a handy guy - and so many people are stuck in their houses that there is plenty of work. Also - his wife works in a non-auto related medical job at UM. Her job is fine.
Have to ask you guys/gals here. Assuming we wind up with a major slowdown - and not a catastrophe - are there not some positives for people who have been conservative or thrifty in terms of their financial lives (and I think there are more than a few of you here)? Like maybe - if you're younger - you can afford to buy that first house?
On my part - I drive an almost 9 year old car (Lexus). And every year for the last 3 years - when I've gone to the Lexus dealer to buy a new one - for cash - and I've tried to negotiate a decent price - they've brushed me off. They weren't even particularly interested in giving me a test drive. Who cares about me when people earning $40k a year are buying $70k cars at full list price with no money down - and payments that last from now until I'll be dead. Perhaps this is the year I will be able to buy a new car on my terms - and be treated as a valued customer?
On my part - I wouldn't be offended to see an environment where people who are and have been economically responsible are rewarded. Roby
"ShortCourage - there is a big difference between a correction and the financial "meltdown" predicted by the folks who have been commenting here. Their cheerleading for economic chaos must be embarrassing for CR and Tanta...)
Paul | 02.09.08 - 6:06 pm | #
Paul, I don't know what you're smoking, but I want some of that shit!
You want economic chaos, bro? Just look at any fiscal policy, budget, monetary policy, or balance sheet. Try to accurately value debt-based securities. You got your over-leveraged consumer with a stagnant or falling income and depreciating assets. You got your deficit-spending government giving tax breaks and borrowing for war. There's plenty of chaos, plus a heaping helping of fraud, chicanery, and theft by deception.
No one here is cheering the economic decline we are experiencing - just as we did not "cheer" the housing bust. Many people here saw this coming, got the hell out of the way, and tried to warn others - only to be dismissed and derided as "doom-and-gloomers."
"Predicted?" In case no one has told you, we're broke. Even when you used the fudged numbers, we're broke. If you think that this is just a bump in the road that can be managed or accounted away, you are sadly mistaken. What you see as wealth is actually debt. The expected increase in income that would pay for that debt has not materialized.
As for embarrassing, who the F are you - the Queen of England? Faux riche, prolly.
Marcus-
Buy a TV or DVD on credit at 10%?!
You must be kidding I could get for 0 down at 0% for at least a year after the Xmas bust.
Oh... maybe that's not a good thing ;^)
Yeah, they've already priced (some of) the credit risk and interest into what they charge (to support those who can't really afford them), but mostly they need to move the inventory or their numbers will look terrible.
A friend's sister and husband live in the midwest and make < $30k a year. He's concerned because the husband just lost his job and his sister had to move to a night shift as a nurse to make more money. They wanted my friend to buy their house since they were going to start missing payments... but when he went over the holidays to look at it he noticed to new 52in TV bought for the SuperBowl. When he asked about spending that kind of money when they were hurting... "but we saved so much, and we got it on credit!" was the response.
If this is the "heartland", we have a long way down to go.
quarterly earnings,
Wilshire 5000 - Quarterly Report (Year 2007 and Qtr 4)
YOY I get a decline of 37% from $208b to $130b.
YOU excluding financials I get
a decline of 3% from $146b to $141b
http://online.wsj.com/public/resources/documents/coearnings4q2007.csv
Robyn:
To your point, its truly an ill wind that blows no good.
I would say that anyone that exports will benefit from the weaker dollar.
Anyone with a stable job and good credit will be able to get a better deal on housing.
Maybe your lexus dealer will cut you a deal. Maybe you should try another brand or another dealer. I've always been able to get them to negotiate.
Firms that lost over $1b in 4Q07
Citigroup Inc \t-9,833,000
Merrill Lynch & Co\t-9,833,000
Morgan Stanley\t-3,588,000
Ambac Financial Group\t-3,255,626
United Parcel Svc B\t-2,576,000
MBIA Inc\t-2,302,250
LSI Corp\t-2,000,588
Washington Mutual Inc\t-1,867,000
Advanced Micro Devices\t-1,772,000
E*Trade Financial Corp\t-1,711,845
SLM Corp\t-1,635,258
Merck & Co\t-1,630,900
Sovereign Bancorp\t-1,602,983
Lennar Corp A\t-1,251,647
XL Capital A\t-1,061,786
\t-45,921,883
ndk writes:
6) A credible argument that the world is low on oil and agricultural goods;
There is something about this that might make the troubles even worse. First i fear the next season due to climat variations vill be bad. It seems to become a La Niña, year (lots of draught)
Second, Iran and some other states have begun to sell their oil in other currencies besides the dollar. (Thereby sidestepping what some people might call the dollar tax on oil) This would suggest that the united states might find it more troublesome further on to sell treasury's And with less treasury's there is less wiggleroom with economic stimulus.
Since I'm one of the dissenting views here, I can literally respond to everyone but...
GLENN_IN_MA: "Sivaram, How 'bout Treasuries?...they look overvalued to me."
I'm just a newbie and I think interest rates and currencies are one of the toughest calls in all of investing! Betting against the Treasuries is very risky IMO. I'm in the disinflation/deflation camp and although I don't expect any severe deflation, one cannot be certain that interest rates won't drop to, say, 2% and STAY THERE. I can see long bonds appreciating or at least outperforming stocks for the next 2 years.
Remember, many thought Japanese bonds were overvalued for almost a decade--and yet were wrong (Japanese bonds outperformed Japanese stocks for the last 15 years or so). I am not saying that the US is anything like Japan (it isn't) but it just goes to show that bonds can do well for long periods of time if there are economic issues and the stock market goes nowhere.
Another thing that can keep the bond bull market going is a decline in inflation. Although most bears here seem to be inflationists, people like me can see inflation declining. The bond market isn't really pricing in much inflation but even a small amount of decline in inflation expectations can help bonds.
Having said that, I do think that long bonds are going to be one of the worst investments when the recovery (especially in stocks) starts after a slowdown/recession. The problem is that we don't know when. It can be next year or 3 years from now.
That anon was me.
The usual suspects. Obviously the financials were a big chunk of earnings. And some of the reported profits never existed and are in businesses that are now dead.
On a relative basis, Grantham likes high quality large caps. The most disturbing observation is overall profitability compared to historical averages. I agree with Grantham's observation regarding small caps. When you look at the Money Magazine recommended portfolios, they always push the prior years winners, and small caps and emerging markets are well represented for everyone and in fairly large doses for the less risk averse.
Whenever you get a new asset class showing up on the pie charts, it tends to be too late. I imagine that you could go back and when they took the 5% precious metals out of the model portfolios in the 90's would have been a great buy point.
Nice P/E and TTM analysis, rich.
Paul, get a clue: culture matters. There's a bit of difference (huge, actually, as you know), economically, between San Diego and Tijuana, though only 30 miles separates them.
NDK: "I don't have the gravitas, degrees, or experience that these brilliant economists do, and neither do most of the people on this blog. "
LOL neither do I... I'm just trying to make some money, that's all... economics can be harmful to your investing health--ask Warren Buffett about the latest economic opinion
NDK: "Watch real long interest rates like a hawk -- no joke intended. They're the real lever of monetary policy, and they haven't moved even with 2.25% easing. If they don't kick in, we're in a liquidity trap. Credit and market conditions are still rapidly deteriorating. Money is still tight in price, if loose in quantity, and velocity is declining rapidly. It's quintessential."
I think you are right to some degree but I don't see it being THAT bad. I'm a big fan of Warren Buffett and I think he is correct in saying that money isn't necessarily tight with interest rates being so low (read news articles when he visited Toronto earlier this week). What is tight is money for risky activities and risky borrowers. The LBO boom is over; the subprime mortgage boom is over; companies issuing debt to buy back stock is over; and so forth. Buffett pointed out that money was tight in 1984 when interest rates were something like 21%! That's tight, not what we have now.
CR, thanks for the link to the paper.
Nice analysis by the economists.
Too bad they did not chart (though they mention) the comparative run up and down in household debt. I would love to see that one.
RICH: "There are some real uninformed amateurs posting on this board about stock market valuations, such as Sivaram."
I don't think I have ever said I wasn't an uninformed amateur. Sorry to have misled you... if I was an informed expert, I would be rich and wouldn't be wasting my time on this board...
RICH: "If you assume stocks were fairly valued at Q2 07, when the TTM P/E of the S&P 500 was about 17, then the S&P would need to fall 33% from Q2 07 through the end of Q2 08 to keep the same valuation relative to earnings. "
I never implied that stocks can't drop a bit more. But they are not excessively overvalued... the flaw with your reasoning is that you are not even looking at interest rates. Interest rates and inflation expectations have come down materially from 2Q07 to now. The market can tolerate a higher multiple when rates (or inflation) is low.
It good to see the elite financial minds agree that excessive debt creation combined with overspending and declining wages not to mention exporting your manufacturing based is bad economics and leads to big structural problems for your society.
Firms that lost over $1b in 4Q07
And of those firms that are listed, how many of them were net profitable, and what was the total profit on a per share basis for 2007?
I still state that what you are seeing is not liquid assest vaporization but just zeros from corporate assests and stock prices. Let me put it this way: if Larry Ellison loses 10% of his net worth, does it matter to him materially? If I lose 10% of my net worth, does it matter to me materially? If I don't plan on using my retirement money for another 25 to 30 years, and if I'm staying in my house for another 10 to 15 years, who the hell cares?
Credit pull back? Great. Take away some of my credit cards or make the terms so onerous I cut them up. I can last a couple of years without buying much. My mortgage is at 5.25 on one and 6 on the other. Who cares about the rates? Do I really need 50k of credit card open lines? I'll do what everyone does in bad economic times...I'll tighten the budget. The cost of heating, food, and gas for the car will impact my spending more than anything else.
And I think I represent the vast majority of people. The description of those people with the new TVs notwithstanding (people like that will always exist). Will I cut back on consumption? Sure, I have all new appliances, all the clothes I need for a while, and I can sit tight for a year or two while this flushes. If something breaks I'll replace it, like anyone else. Are my retired parents worried? Not at all. Unemployment doesn't matter and they have enough money to pay the bills and do what they want. Their generation paid cash for everything anyhow.
So I'm suspect of all of this severe recession talk. There will be one to be sure, and it is necessary, but I'm on the moderate side for these and other technical reasons. And asset prices? Might I remind everyone that my first house was underwater from 1990 to 1998. Even if we pull back to historic norms it will sell for double now what I paid for it. The same will happen this time in the long term.
--
"Too bad they did not chart (though they mention) the comparative run up and down in household debt. I would love to see that one."
jg,
Here you go:
http://research.stlouisfed.org/fred2/fredgraph?chart_type=line&s[1][id]=CMDEBT&s[1][transformation]=ch1
You need to come to right source. For ten years I have been signing off some of my commentaries with: It Is the Debt Stupid!
My negativity on Americans and BFNYC has everything to do with Debt. Only dopes do not understand this most foul of the four-letter words.
Jas
Wow - Paul took a beating since his self-imposed silence for being a troll. It cost him $20 to the tip jar too! I hope all others feeling momentary remorse over intemperate commentary use the same method of repentance.
OK - here we go.
Marcus says Paul, I don't know what you're smoking, but I want some of that shit!
You want economic chaos, bro? Just look at any fiscal policy, budget, monetary policy, or balance sheet.
I'm sorry but I'm not feeling any economic chaos in Kalamazoo, MI. Black Swan Shiraz & Merlot. Very cheap - what does that tell you?
As for embarrassing, who the F are you - the Queen of England? Faux riche, prolly.
I live in MI so I can't be rich. We're reeling. I am divorced, rent, make $84K as a process engineer with big pharma. Thanks McDonalds!Seriously, I am concerned that the commentary is a little unmoored from the reality outside of Stockton, CA, Las Vegas, and Florida. I think the jury is still out on the seriousness of the problem. It is no doubt painful for many, but perhaps not at meltdown phase? I apologize if the wine affected exagerated the intensity of my rhetoric.
JG said Paul, get a clue: culture matters. There's a bit of difference (huge, actually, as you know), economically, between San Diego and Tijuana, though only 30 miles separates them.
OK, JG, you are probably correct, Since I live in MI, I will defer to your judgement on the difference between SD and Mexico.
However, Jas Jain said: NYC is a cesspool of Conflicts Of Interests (COI) as these people go to the same bar mitzvah celebrations, the same parties, the same clubs, the same synagogues, temples, churches, and their kids, future born-and-bred Crooks, go to the same schools.
My commentary was in response to this gross generalization and borderline slur. So sorry if that was not clear. There are many things that affect culture and I am sure that CR and Tanta don't want to have their business blog infected by culture wars. That is why I tipped the blog as a penalty for indulging.
I am a very liberal Democrat. I think the laizze faire economic policies of the last many years have
been misguided. They underestimate the capacity of our economy to cheat the naive.
The question, in my opinion, is whether we can solve it through regulation or religion. Since the GOP (or economic conservatives) have been in control of USA for most of the last 27 years, I tend to think that our current problems are a result of their policies. I could be wrong and am open to correction on this matter.
I guess this means I owe another $20 to the tip jar.
--
At the Heart of Deepening Monetary Disorder:
404 - Error: 404
Jas
--
"My commentary was in response to this gross generalization and borderline slur."
I simply quoted Cramer who knows the financial culture of NYC and the people involved at the highest levels, no?
Your ignorance of the reality doesn't give you the license to attack. Got it? Ignorance and intolerance go hand-in-hand. And bigotry, or prejudice, of beliefs is not far behind.
I say what I believe to be true. I have examined BFNYC for years and they are Crooks. Period.
Jas
ipodius,
You just explained why the recession will be worse than you imagine, if software engineers represent most Americans.
2nd order effects and all that.
Ok Jas Jain - I accept your rebuke. I am ignorant, bigoted, prejudiced, and intolerant. I ignore reality and attack those who shame me for my ignorance. My opinion has no value so please ignore my foolish babbling. I am responsible for all evil in the world and have no shame.
Oh Lord, we'd be in real trouble if software engineers were normal
I meant just from an economic point of view. I think the vast majority of people lived a bit above their means, but not grossly. I think that the majority are probably where I described. And if you're around 40, you'll remember the past two busts...including when my field got decimated not too long ago.
So yes, there will certainly be a pullback that is needed. Yup, if you bought a house in the last three years you're going to have to sit on it for a while to come out on the plus side. You'll need to adjust your retirement savings. And maybe you'll have to recover from a layoff...like I did in 2001. So the "average" person will do what average people do...tighten the belt.
The financial markets? Trust me, smart people are figuring out what to do next already. A lot of capital realignment will occur. But it will occur. And for laughs, go out and pull the total net worth of the richest 100,000 people in America. Now reduce their assests by 20%. Would that have a material effect on the economy? Or would they work their remaining capital harder to recover?
Robyn, my question about the machine shop was based on the depression-like number (including land and building) that was completely outside my personal experience, but rejected by someone apparently more knowledgeable than I.
And on my part - I drive a 14 year old Lexus SC400 and I do not visit the dealer every year since the car runs perfectly and does not need to be replaced.
So neither one of us have been helping out the U.S. auto industry. Perhaps it's all been our fault.
Sivaram: "LOL neither do I... I'm just trying to make some money, that's all... economics can be harmful to your investing health--ask Warren Buffett about the latest economic opinion :)"
I can't agree more with this comment. It's almost certainly bad for my long-term financial health to even think about this stuff, and there are a hundred ways just to interpret the freakin' data. Ponder your own situation: good. Ponder the big situation: bad. Chalk one up to the invisible hand, I guess.
"What is tight is money for risky activities and risky borrowers."
Here I go beyond your opinion: I think it's tight for everyone. Check out, for example, AAA corporate bonds and the spread.
http://research.stlouisfed.org/fred2/fredgraph?chart_type=line&s[1][id]=AAA&s[1][range]=5yrs
I don't see much movement here on the way up or on the way down. I don't think the Fed's in control at all.
ipodius writes:
Firms that lost over $1b in 4Q07
My point was that the 4Q profit evaporation was primarily concentrated in the financials, and it was the usual suspects -- ie. no surprise.
I find looking at the actual data interesting.
I would say that I am usually in the non catastrophe camp. I mean, we have had recessions before.
But back to the financials. It's amazing that the earnings were not more negative. With a little shareholder dilution, they make enough to write down a lot of assets.
BAC wrote down a lot of stuff and still had a nice profit for the quarter. So what if they have to write off $6b for countrywide. They also raised $12b in preferred stock a couple of weeks ago in an over subscribed offering.
I've never scrolled through 2,000 stocks in excel before.
I think I'm the 80th person to be caught between HaloScan and the St. Louis Fed's URL parameter choices. An array in a query string... sheesh.
http://tinyurl.com/2xmw9a
Sivaram, I'm not sure how much sense it makes to A) think we're going to get deflation AND B) think most things are undervalued currently. If we get visible deflation, stocks will get slammed for being overvalued because of that deflation.
--
"I am responsible for all evil in the world and have no shame."
Paul,
You must suffer from some guilt, but BFNYC are "responsible for" most of the "evil in" America and quite a bit in "the world."
Evil occurs in many forms! In America, it took the financial form. If I may be permitted some immodesty, I do know more about debt than CR, Tanta, and few others here combined. Debt WILL lead to the death of the American system in your lifetime. That is how evil BFNYC are.
Jas
Precisely my point Ziggurat. The loses were just vaporized non-money, if you will so far.
I'm totally in the non-catostrophic camp, as you can tell. Not the o-joe quadrant, but somewhere in the middle. I have a great belief that the capitalistic system, with all the flaws, manages to recover itself in the end, as do people.
What actually is worrisome, is the fact that most of the fees generated that covered those losses have also disappeared with the financial instuments that generated them. What replaces that? And do the next rounds of losses only offset more profits or do they cause systemic trouble for the banks?
ipodius
It's the bottom of the thread so the less bearish can say something without being slammed.
Anyway, regarding availability of money,
HOUSTON, Feb 8, 2008 (PrimeNewswire via COMTEX) -- SYSCO Corporation (NYSE:SYY) announced today that it has entered into an agreement to sell $750 million of Senior Unsecured Notes. The agreement provides for the notes to be issued in two tranches, comprised of $500 million due 2018 and $250 million due 2013. The bonds will bear interest rates of 5.25% and 4.2% respectively, per annum.
4.25% sounds pretty cheap to me. These are unsecured.
Jas Jain, because I am an ignorant american I do not understand the acronym BFNYC. Ok - the NYC part I assume to be New York City - but perhaps I am feeling guilty and stupid as well.
I apologize to all other commenters for being off topic. This is getting expensive!
Woohoo! Let's hear it for everybody posting on CR. Paranoid before being paranoid was cool. Next milestone, being optimistic before being optimistic is cool. Might be awhile though.
"4.25% sounds pretty cheap to me. These are unsecured."
Sounds cheap to me too, and I'm glad they can find financing so easily at such low rates. We just interpret the meaning of that fact very differently.
--
"I have a great belief that the capitalistic system, with all the flaws, manages to recover itself in the end, as do people."
Blind faith is necessary for most people. The current crooked capitalism of today has exceeded the Nazi-like proportions of an evil system. Only the consequences of this evil system need to be born out.
I am sure that you have no problem with the Debt Concentration Camps, built over the past 5 years, piped with the financial poison gas. Financial death of 30,000,000 American households is a foregone conclusion. Debt Pushers are evil.
Jas
4.25% sounds pretty cheap to me. These are unsecured. Ziggurat
It is pretty cheap. But, you know, capitial at rest is capital that's not making anything. So that's my interpretation of some things that are happening.
dr strangemoney, optimism is the new black
Jas Jain, I can imagine you must have been disturbed by the German Nazis misappropriation of the swastika from Jainism.
JAIN SYMBOL
I now understand your pathology. How can I help? We should take this off of CR.
I'm just kidding, of course. It is great fun debating with you. I really do appreciate your off-beat perspective. I, too, feel that the USA has sold it's soul for nothing. When will we learn?
--
Hello Paul,
BFNYC = Bankrupters and Fraudsters of New York City
CCA = Corporate Crooks of America.
Together, they have an iron grip on the govt. of the US and the economic and political lives of Americans. They got control of most of Americans money and even homes!
When the bad times come they can will take their capital to China, or other countries, and leave Americans, who support them and fight their wars, high and dry. Todays Americans are the biggest born-and-bred dopes in a very long time. They cant see the evil of the Debt Pushers and financial manipulators.
For me, it is all business (telling the truth as I see it) and nothing personal. I hope that you take no offense.
Jas
It's going to be worse than you think, CR. Roubini has it right:
Believing as the consensus now does that this will be a mild two-quarter recession and that growth will recover in H2 of 2008 is wishful thinking. The last two recessions in 1990-91 and 2001 lasted almost three quarters (precisely 8 months) while the current recession looks fundamentally more severe than the latter two for three reasons: we are experiencing the worst housing recession ever in US history, a shopped-out, saving-less and debt-burdened consumer is now in financial trouble and retrenching; and we have a severe systemic financial crisis. Thus this recession will be longer, deeper and uglier than the previous two.
I'd not like to be more optimistic than Nouriel. People who were got their reputations handed to them, severed, on a platter.
Jas Jain - I have a very think skin!! I have, over the last few years, become an isolationist. If the rest of the world needs oil, let them patrol the Straits of Hormuz or pay the US Navy to do so.
Americans, like everyone else, are easy prey for con men. This, however, has been going on for a long time. That is why my comments occassionally reference the tulip mania of 1636.
Tulip mania - Wikipedia, the free encyclopedia
Good night.
--
Paul,
I learned to draw swastikas, the right way!, in my father's accounting books at the age of four. Two swastikas are itched in stone in my late father's shop.
I could do compound interest calculations on client accounts at the age of eight. Also, I was doing field research on the subject of effects of debt on the living standards of the household at the same ripe age. I do know debt. And I know it for a fact that Pushing Debt is evil. America was turned into an evil enterprise during the past two decades. Now, Americans and the world have to suffer the consequences. The worm has turned with the credit crisis.
Jas
Ziggurat and ipodius,
I'm not one of the posters waiting for the end of the world, but I did read the paper by Reinhart and Rogoff earlier today when CR linked it and I did come to the conclusion that this recession in the U.S. would be one of the 6 big financial crises since WWII and not one of the 13 lesser ones.
Did either of you see any reason to believe that it wouldn't be as bad as the Big 5 discussed there?
Jas Jain, I survived the dot com and 9/11 disasters in 2000/2001 so I have a warped perspective on the current craziness. Curiously, both the IRS and major brokerage firm forgave much of my debt at that time. Who knew?
Hope you didn't learn too much from that, Paul.
sportsfan, I did read the papers too, and I do note that the 5 discussed survived. Heck, take a look at Japan, is it surviving? I did a deal with Softbank last year and they seemed quite able to put capital together. Have you been to Tokyo lately? Is it all gloom and doom?
I think what is changing my mind, and I admit this is not scientific, is attitude. When I start hearing armageddon from everyone it starts to sound suspiciously like the people that said the boom would go on forever only in reverse.
What is killing everyone is uncertainty. All the stuff out there isn't worth NOTHING. It's that no one knows exactly what. As some point that will unstick, but all mortgages, pier loan, and stuctured finance instruments are not WORTHLESS. Some is, but a lot isn't. So the opaqueness and uncertainty is what is killing everyone. The financial markets will unstick when the mark to market occurs. But right now, it's more prudent to let it wash out in dribs and drabs...and use profits to offest the losses, as I suggested upthread. It will take another couple of quarters to come clean, but before Q3, IMHO, we'll know what certain things are worth to the market now. As much as everyone is screaming, you don't want this all to come out at once. So far, most concerns were profitable last year and, if the offsets are done right, will be so this year.
And like most things, it's never as good, or as bad as you think.
NDK - I rent and now have a positive net worth! Woohoo!
Everything is negotiable.
ipodius is so right when says What is killing everyone is uncertainty. All the stuff out there isn't worth NOTHING.
The vast majority are sending that monthly payment somewhere.
A couple of comments on the paper itself:
Unless the authors show us what non-crisis periods look like, we really can't draw conclusions about how similar things really are to the five crisis cases.
Is it a certainty that the SYSCO debt is going to be priced at par?
Oh and, sportsfan, I do believe we're in for quite a contraction. I live outside of Boston and I can tell you that here we need another Dunkin Donuts or Starbucks or Lowes or Home Depot like we need another Mitt Romney
But what that exactly means I can't say. What I can say is that I can't hire software engineers or IT people to save my soul. Medical staff is in short supply too. House prices are off around 20% from the boom (asking price), foreclosures are high, and there isn't panic in the streets. So my Magic8Ball is saying "answer unclear".
But ask yourself this: if half the Lowes and Home Depots and even Walmarts closed, where is that stuff made now? Who's out of a job? What impact does a retail pullback have on the effective unemployment numbers now? How many barristas are there in the US now compared to how many used to staff all the plants that made the tools that stores sold? Hmmm.....
shake shake shake....
"reply hazy try again"
Ugh! I think this thing is stuck. At least mp has conjure...I just have this magic 8 ball!
ipodius,
Good comments. I agree that opaqueness and uncertainty about financial markets and assets are negative factors right now. People tend to fear that which they do not know, especially when it might affect their lives in some fundamental way.
What none of us know is exactly how bad this economic contraction will be. What has made this worse IMO is all the 'containment' talk coming out of Washington last year. That has told us that one more thing we don't know is how much our leaders don't know about how to fix whatever is broken.
I'm inclined to think this recession will be as bad as any in my lifetime, if only because the credit induced bubble affecting so many areas of the economy has been so large. It's not just the foreclosed homeowners, it's also the number of Home Depots and other new commercial, the lack of trust in financial vehicles of every sort, and, most especially, the lack of faith that anyone in Washington is going to do anything that helps many people to get through whatever is coming down the road.
How many barristas are there in the US now compared to how many used to staff all the plants that made the tools that stores sold? Hmmm.....
I didn't understand the question.
On the earlier (and probably related) question regarding what effect closing half the Lowe's or Home Depot's would have on the unemployment numbers, well, clearly there would be more unemployment unless there was an increase in some other area, whether that be IT, health care, manufacturing or even public works.
Personally I'd like to see more public works. As many have noted, our infrastructure in this country is in sad shape. We could easily do with less retail space. I don't need a Home Depot a mile from work when I have one a mile from home. I don't expect the local see-throughs will ever be occupied before they go into foreclosure. I'm not even sure they will ever get permanent financing.
We've built too much of the wrong stuff and not repaired enough of the essential stuff that we already have.
What about Figure 2? If you are to believe Figure 2, the equity markets correction is already over or almost over.
Since this is now the dead thread and we are left with the mild bears, I have one question regarding the paper. The most striking figure is the extent of housing price increases. What was the cause in the other crises? If not a housing bubble, then what?
In addition, I had previously looked up bank crises in developed economies in a paper by bis. The figures about the cost were lower then in this paper -- most of them being more like 2% or less of gdp.
Perhaps the bis paper was specifically referring only to explicit bailout funds from govt to banks.
ipodius,
You just explained why the recession will be worse than you imagine, if software engineers represent most Americans.
2nd order effects and all that.
Norwegian Bank Crisis:
Description of the crisis
The causes of the crisis once it had fully emerged could thus be summarised :
Banks that were used to a regime of strict quantitative regulations became exposed
to an entirely new competitive environment. The response of a large number of the
banks was to strive for larger market shares.
Prudential regulation was slow to adapt to the new competitive environment.
A strong boom followed by a sharp recession enhanced by a monetary policy
regime that worked pro-cyclically.
Page 18
The total gross fiscal costs of the rescue operations were approximately 3% of GDP. By end-
1993, the net fiscal costs (gross fiscal costs minus value of governments bank shares) were
estimated to be 0.8% of GDP.17
S&L fiscal cost was 2.1% GDP (PDF file; table 6)
Spain:
Everything that could go wrong, went wrong. One quote that caught my eye:
Although the share prices of these institutions (Banks) began to weaken, some adopted
share-price support practices through purchases of their own shares. This increased the
volume of unproductive assets, aggravating the problems in the profit and loss account. To
maintain profits and the dividend policy (avoiding further punishment by the market) many of
these banks reduced their bad debt provisions and even changed their accounting principles,
using the accruals criterion to record income and the cash-basis criterion for payments, or
even continuing to record interest accrued (but not paid) as financial revenues.
Sweden:
This is most similar to the US current situation.
The banks were faced with a completely
new environment, and they did not have systems for controlling the new risks. They focused
much more on market shares than on risks, which exacerbated the increase in the credit
volume.
A large share of the loans went to investors in housing or commercial real estate and most of
it was collateralised by real estate, which put an upward pressure on real estate prices. High
real estate prices led to higher asset and collateral values, which facilitated borrowing and in
turn increased the upward pressure on asset prices. As a result, especially in metropolitan
areas, real estate prices rose very quickly (see Figure 8).
Deregulation and real estate speculation seem to be the major cause.
Note: I am not doc holiday. I may be crazy commenting extensively on this paper, but it lacked details.
The bis skipped Finland and everyone knows about Japan.
Overall, most of the causes seem much more like the US S&L crisis. That is, deregulation and lending excesses.
Japan and Sweden seem most like the current US situation. I dunno about Spain -- Franco had only been dead 2 years. Finland...someone else can look that up.
One final comment:
The paper uses 6% gdp as the cost of the Swedish cleanup and the bis uses 2.1.
per the paper:
The fiscal costs of cleaning up after banking crises can be enormous. The fiscal cleanup from Swedens
1991 crisis was 6 percent of GDP
per BIS:
By 1994, the Swedish banking system as a whole
showed positive profits again. Among the factors contributing to the resolution of the crisis in
an important way was the change in the exchange rate policy. The total amount paid by the
BSA to the banks was SEK 65 billion. However, part of that money, was paid back to the
government through dividends, selling of shares, and the value of retained shares.
Jennergren and Näslund (1997) have estimated that the final bill to the taxpayer was SEK 35
billion (2.1% of GDP in 1997).
Is the Current Financial Crisis So Different?
I'm surprised this question even has to be asked.
Yesterday I posted a list of major league bubbles. Some of them are relatively recent phenomena, whereas others have been building for decades; heck, some since the Great Depression. Independently none of them would warrant more than a mild recession, but together they're a lock for a new Greater Depression.
Why are they coming together now? Because the housing/credit/derivative crisis has accelerated the development of all those bubbles to the bursting stage. This isn't a tossing a rock into the pond, it's tossing a grenade into a minefield.
PAUL: "I apologize to all other commenters for being off topic. This is getting expensive!"
Would you mind contributing to my Ambac recovery fund? Maybe if you were tipping me instead of CR, I would break even within a day
MIKE: "Mike writes:
Sivaram, I'm not sure how much sense it makes to A) think we're going to get deflation AND B) think most things are undervalued currently. If we get visible deflation, stocks will get slammed for being overvalued because of that deflation."
I don't expect severe deflation. It can happen but unlikely IMO. If there is going to be any serious deflation, it will be in places like China. My opinion is that China has massive bubbles in real estate, the stock market, and manufacturing. What I expect in USA is disinflation with mild deflation here and there.
My guess--and all it is is a guess--is for deflation to impact certain assets like real estate. I don't think there will be across-the-board declines in all stock prices. The reason Japanese stocks fell was because they were severely overvalued. The same isn't the case in USA so it is going to be small decline impact select sectors.
Having said that, there is nothing to say that the stock market won't go into a prolonged sideways bear market.
Siv,
Given that ABK doubled in value from the 18th to the 24th I figured you would've taken the cue to exit that position. Are you a glutton for punishment?
I don't think there will be across-the-board declines in all stock prices.
What's that saying? Oh yeah... "pissing into the wind".
Paul, I grew up in Kalamazoo, MI. If you do not think that Kalamazoo is in decline, you are living in some dream world. I took a cab from the airport over the holidays and the driver spends the entire trip complaining about the local economy. Radio runs ads begging people to support local businesses by not Christmas shopping online. The town's biggest employer Pfizer (most likely your employer) is hitting hard times and is closing sites. Home prices are in the dumps. Young, bright people are fleeing the area - of all my professional friends who graduated with me from UMich, only a handful remained in-state. If any place has felt the beginnings of a downturn, it's Kalamazoo.
Main issue is the USA is household debt which went from 50% of GDP to 100% of GDP over the past few years.
Talking about debt without taking about all debts (public, household, business) is just plain stupid.
You can own your house (you have the debt) or rent a government build house (government has the debt), you can ride a government built road (government has the debt) or pay a fee for a private road (business has the debt). Debts can substitute one another according to policy, talking about one in isolation is meaningless.
Economists always talk only about public debt, but it's not like economists know anything about the economy
.
And MSM never ever talked about household debt doubling.
If you want data, it'all in the Federal Reserve Z1 report.
Hello from Finland.
Interesting to see, that we are number 1 in that big five list.
Our gdp dropped 10% 1989-1993. Interest rates were 15%, unemployment 16%, house prices dropped 40% in Helsinki.. so on.
I see many similarities in U.S. now, but also differences. Exports led us out of misery quite fast (!)... thats not going to happen in U.S.
--
"And MSM never ever talked about household debt doubling [as a % of the household incomes]."
Evildoer Greenspan took the lead on this. He wanted to keep focus on the USG debt so that people wouldnt worry about the GROWTH of the household debt, the SOLE CAUSE of the GDP growth during 2002-2007. It is the unwinding of the household debt, mostly via defaults, that will sink the US economy into a long depression. Borrow-and-consume-more-now (the house one lives in is a consumption item) means you consumed the future. Is that a hard concept to grasp? I have been talking about the household debt for years.
It Is the Debt, Stupid! (That WILL take Americas crooked system DOWN).
Jas
It's hard to argue deflation or disinflation with the prices of commodities hitting records or close to.While the deflationists wait for the big K winter, prices like explained below just keep on marching higher, defying the textbook deflationists.
While debate about the de&inflation semantics plus inventive ways on how to spur growth continues (code for how do we shove more debt down households debt burdened throats) ,which of course includes the official debasement of fiat currencies, the cost of living for families is soaring-even if it ISNT getting official respect in important quarters.
Some examples;
NEW DELHI: After a gap of about six months, the inflation rate once again crossed the four-per cent mark due to rising prices of cereals, salt and bakery products.
SAN FRANCISCO (MarketWatch) A benchmark for a range of commodities hit a record high on Friday, a reminder to the Federal Reserve that inflation risks loom even as it concentrates on reviving U.S. economic growth by slashing interest rates.
Wheat, platinum lead roaring commodities rallyReuters Friday February 8 2008 By Barani Krishnan
NEW YORK, Feb 8 (Reuters) - Commodities from energy to metals and agriculture surged on Friday, with wheat and platinum hitting record highs for a straight week running on supply concerns.
Funds also plowed into markets like sugar, coffee and cocoa, making analysts believe that commodities could trump stocks and bonds in the event of a U.S. or even a global recession.
SYDNEY, Feb 08, 2008 (Thomson Financial via COMTEX)The Reserve Bank of Australia raised interest rates by a cumulative 50 basis points in August and November to rein in inflation.
and from Barrons;
This Credit Crisis Has a Long Way to Run
Interview with Jeremy Grantham, Chief Investment Strategist, GMO
By SANDRA WARD
This Credit Crisis Has a Long Way to Run - Barrons.com
From an interview with Jeremy Grantham;
B:So the Feds actions wont stave off a slowdown?
JG: Since when did the thought of an economic slowdown induce such hysteria? That was a response to the decline in global markets. It was aimed at the stock market. It was aimed at banking disorder and banking profits. It doesnt have that much of a powerful effect on the economy. If it had any more profound effect, there would be a positive relationship between debt increasing and GDP growth, and there is none.
B:But it is driving down the dollar.
JG:It drives down the dollar, which is inflationary, and, eventually, it could be seriously inflationary"
All of those countries, with the exception of Japan, recovered very quickly and are doing well right now.
As far as debt, yes it has increased and that is a cause for some concern. However, the absolute amount of debt is much less important than debt in proportion to income. And I think the income numbers are significantly understated. First, gains on stocks and other investments are not counted until they are sold. The same is true for equity in small business, whether Schedule C, S-corps or other. The proportion of the population owning stock and/or small businesses has increased greatly in the past 20 years. If I put a dollar into stocks or into my business that is savings just as much as if I put it into a savings account. Second, even for ordinary business income it is more difficult to measure than wages. The wage earner earns income and buys a car; the business owner has the business buy the car and deducts it and that income is not counted the same way. Third, there is the entire underground economy, both legal and illegal.
Finally, I keep hearing people say that all of the growth from 2002-2007 was illusory. In fact it was more or less in line with the long term real GDP growth of 3.5% per year, which has been in place since about 1820. If the next couple of years are below trend, which they may be, reversion to mean would suggest that there will likely be a period of rapid growth ahead to compensate.
GSM -
What you are saying rings true, but what about the possibility I have heard discussed on this blog: Negative economic growth, accompanied by commodity inflation, with deflation of real estate and investment assets? This worst-case scenario seems plausible in the short term if the latter class of assets are deemed so overpriced that the reckoning of their value counteracts the devaluation of the dollar.
Aheadofthecurve writes:
All of those countries, with the exception of Japan, recovered very quickly and are doing well right now.
Put another way, right now there's a 20% chance of a Japan-style depression.
rich opined:
"There are some real uninformed amateurs posting on this board about stock market valuations, such as Sivaram."
Interesting statistic came out friday afternoon (cftc.gov COT reports) and that was the long exposure to equity indexes by non-reporting firms otherwise known as small specs. This particular class of 'uninformed amateurs' now has their lowest exposure to equity index futures since pre-2000.
If someone is intrepid (oh well maybe it will be me) they could download the pre 2000 data from ctfc.gov and see just how far back this record goes.
Another interesting observation is that the barry ritholtz link contains graphs 1, 3 and 5 of the paper in question. For some strange reason graph 2 was left out, and for the grizzly crew it would seem to be the most pertinent and that would be equity market values through the crisis. Oddly enough it appear that in time T0 (where we currently reside) equity markets find their trough. A curious oversight, don't you think?
Andrew: Well I like those odds. And, even with their poor economic performance, life in Japan for the average person has been fine over the last 15 years. Some would argue that the quality of life has probably been better than in the 80s in terms of the stresses of day-to-day life.
David-Yes and net insider buying is very high. In 1999 they were selling like crazy. Maybe they know something? As for Rich, he and I have a side contest pitting his favourite stock SRS vs mine, ELN. just to update, even though SRS had a great week, while ELN was flat, y-o-y ELN is up 93.6 % vs 74.1% for SRS. And 5-year performance? I don't think Rich wants to go there.
As someone who practices law in the Miami area, I'm here to tell you that the underground economy is HUGE.
But suppose the underground economy drops off even faster than the reported economy. From the fired illegals to unreported cash transactions, the underground economy is probably closer to where the rubber meets the road than the reported economy, and just because it's underground, doesn't mean it won't have real effects.
If the fired illegals go back to Mexico, they won't be buying beer or snacks at the 7-11. If they stay, they may turn to begging or illegal activities in order to survive.
What about Fig.2 of the Rogoff paper. If you believe that figure, the equity markets have already corrected or are close to it.
It's not the illegal Mexicans, it's those Canadians you have to watch. They can blend in and you'd never even know, eh?
TJ & the BEAR: "Given that ABK doubled in value from the 18th to the 24th I figured you would've taken the cue to exit that position. Are you a glutton for punishment?"
I'm still down a lot so there is little reason to sell. This is no comfort to me but I think some bears lost more money in the last month than the longs. For example, anyone who shorted around $5 to $7 is down -100% versus longs from the $20s who are down 50%.
In any case, the main thing is that I don't feel that anything fundamental has changed in the last month. The subprime mortgage problems are more stable now than 3 months ago. The ARM reset armageddon that some bears were predicting seems to be falling by the wayside (now that interest rates are declining). All that happened was some bears like Ackman and Jim Cramer started a panic that caused a sell off in the stock price but the fundamentals are quite similar to a few months ago (worse no doubt but nothing surprising)--it's amazing how much air time someone with a shoddy record like Ackman gets. Oh well...
Like I have always said, it will all come down to subprime default rates and loss recoveries. We won't really know until the end of this year.
Anyway, you shorted the monolines I believe, and well, good job profitting from that... but the game isn't over yet...
Jas Jain,
I don't know why you are blaming the so-called "New York bankers" for the debt problems. Let's go over how a free market works.
In a free market (we are not in a perfect one but closer to it than not), a borrower decides ON THEIR OWN whether to take on more debt or not. No one is putting a gun to anyone's head and telling them to accept increased indebtness. It's a voluntary transaction.
When someone goes and buys a car on debt, they are choosing to do it on their own. No banker or investor is forcing them to (i) buy the car in the first place, and (ii) use debt rather than cash.
The "sell-side" always caters to the market needs. If buyers want something, the sell-side will attempt to provide it.
Either you don't understand how the system works; or you want to shift responsibility to one side of the equation. I know it's fashionable--esepcially in bearish circles--to shift blame onto some 3rd party (eg. blaming the federal reserve's low interest rates for the subprime problems when in fact the borrowers chose to use ARMs instead of fixed rates and buy homes they clearly cannot afford). But the fact of the matter is that responsibility should--and always has been--with both the buyer and the seller.
If you are really concerned with debt, you will accomplish your purpose a lot more easily by educating or influencing the borrowers, more than you will by ranting and trying to criminalize voluntary free market financial transactions. You are doing no one, except overpaid lawyers, any favour by trying to criminalize any of this. Employees who work at financial institutions that profit from debt, and shareholders like me who may own such companies, accomplishes nothing...
I apologize one again for the little troll I produced hijacking this thread. I am so ashamed, so deeply ashamed.
The public probably has a better take on whether we are in a recession or not than the professional economists:
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Siv-Well said. It's always easier to blame someone else.
Try this one:
Nouriel Roubini:
"The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster"
on naked capitalism's blog 2/5/08
O-Joe:
And out of your mind. But you knew that...