Never Mind?

So after the big standstill news last week from Dubai the UAE Central Bank is going to provide a liquidity facility to help support the banks in Dubai and instill confidence for foreign banks in the region. Apparently property prices have plunged and from what I can glean this will not eliminate pain and losses but will allow things to function. The idea here appears to be showing that despite the news there is liquidity for banks to function.

Extraordinary measures like liquidity facilities, debt monetization and the associated acronyms are very polarizing. These things seems to both prevent the complete collapse of the entire financial system while at the same time creating a moral hazard whereby we privatize gains and socialize losses with no consequences for incompetence.

Unfortunately neither side jibes with reality, IMO. I think that taking a pound the table stand here requires believing that the proper regulatory framework was in place that promoted reasonable use of leverage, prudent lending standards and proper oversight of all the other things that went wrong. Most people seem to now realize that the proper framework was not in place and many people doubt that congress is on the right path to creating a proper framework.

We’ve heard Obama and others talk about making sure this never happens again which if that is what they are really focused on means we will not get a proper framework but instead will get something aimed at preventing the 2007 crisis. Before going on let me just say I am not trying to turn this post into a left right debate. The President talked about making sure this never happens again, that is not in and of itself a defining political statement. The path that the leadership in congress and the whitehouse choose to take is either effective or not and political beliefs may play a role in that outcome but we are not there yet.

As the story in Dubai evolves (default, now maybe not so bad??) it will either be good or bad but if bad it will not permanently break the system. However, the action on Friday gave a great preview of what to expect if/when there is some sort of market correction. Commodities, emerging markets, developed foreign and most other relatively volatile areas of the market dropped more than the broad market. Whether it ends up being the Dubai news or something else that causes a correction the heavier you are in the above mentioned areas the more you would feel a correction. Think about that now before it happens so that you are not caught off guard and react poorly. Note that even if you are staunchly in the bull market camp we can still go down 100-150 SPX points.

On a different note I spent quite a few minutes on Saturday looking through the on-screen guide (we get a lot of channels) for the University of Montana v South Dakota State FCS playoff game. I would have had to pay quite a bit of money for it which may not have been good for marriage harmony but it turned out to be a fantastic game. South Dakota State dominated the first three quarters taking a 48-27 lead.

Perhaps the game appeared to be over but Montana didn’t think so and outscored South Dakota State 34-0 in the fourth quarter to win 61-48. The point here is a philosophical one about never giving up. Something is not over until it is over and until it is over there is still a chance for whatever outcome you are hoping for. This is most easily understood in the context of sports but I believe has broad applications in life.

8 Comments

  1. Bring back Glass Steagall !!!!!

    Also end government backed mortgages where people only need to put down 3%. They need to put down at least 10% if you do not want them to walk away.

    Similarly do not allow banks to lend at ratios over 10%. excessive Bank lending ratios are the major problem. They lie because the bad loans are mostly off balance sheet. There should be nothing off balance sheet.

    Reply
  2. Of course we could have a 100 to 1500 point decline, but I do not see this bull ending while everyone is worried about the coming declines. When my freaked out brother in law gets rid of his CDs and starts to reinvest I will get concerned about the markets, but not yet.

    Reply
  3. I have a basic question that’s sort of related. I know of currency default and its effects here (seems the world gets shaken up a bit by it), but what happens in the country of origin? I tried to google it, but all I get were political answers and extremists. So what happens if the US were to default? What does it mean for the common citizen and investors in USD denominated investments? Is there a way to hedge other than loading up on all foreign investments?

    Hope this doesn’t turn political, I’m just looking for basic info from a smart bunch of folks.

    Thanks.

    Reply
  4. Many have said that a reserve currency cannot default because they can print more money. I don’t find that to be a very tidy answer but…

    More realistically like with Russia in 1998 there would be help from other countries, bond holders may or may not get made whole, the currency may disappear in favor of the USD as has happened in Zimbabwe (combo actually of USD and some ZAR).

    The USD can’t really default but it can devalue as I understand this. Well put it this way a default would create such global chaos that it would trigger an immediate global action to intercede to prop it up somehow.

    Reply
  5. The US can not default because the US debt is in dollars and the US has a dollar printing press, but we can go bankrupt from to much debt. If the debt gets so large that we can not pay it back the only alternative is the massive printing of dollars that will make the currency essentially worthless. If the currency is worthless we are essentially bankrupt. Excessive debt can bankrupt the next generation and still will not solve today’s problems.

    Excess debt did not work in the 1930’s and it has not worked in Japan. Keynesian economic fantasy does not work and will bankrupt our children.

    SEG

    Reply
  6. I am reading “This Time is Different” which is about 8 centuries of sovereign defaults. After seeing the author’s data, the Dubai news made me think “uh-oh this could be the tip of the iceberg for coming defaults since the seem to come in waves”.

    From this book it sounds like countries have a very long history of defaulting on foreign and domestic debt. If a country changes the rate it will pay on its bonds or devalues its currency doesn’t matter much to the bond holders – they still loose money.

    In my view bailing out banks or putting them into receivership is just about mopping up the blood after a shooting. Good or bad the damage has already been done. What is concerning is when you give a briefcase full of cash to the shooter… At the very least I think that equity investors should never be bailed out: that really is a crime.

    Calomiris is an economist who has about as much knowledge of banking panics as anyone. He has looked at different regions and across history to see what sets up banking panics.
    http://www.econtalk.org/archives/2009/10/calomiris_on_th.html

    A few surprising points include: deposit insurance, unit banking laws, shareholder holding limits, government backstops. A big problem with our system is that we create cheap lending rates and all kinds of lending rules and moral hazards on the input side of the banking industry, then we have a weeny little regulatory effort to try to make sure all that rot doesn’t blow things up.

    I commented about FDR’s lack of economic sense a few weeks ago, but in this interview Calomiris reports that FDR at least had the good sense to oppose federal deposit insurance as a sure fire way to cause bank failures!!

    @Bill B: I think that a US default would have some subtlety. If the regime in power has strong domestic political support, then they might do something like extending the term on 5yr treasuries to 15 years for domestic holders. If the regime is weak at home then maybe they will choose to stiff the foreign holders first maybe with a rule change instead of missed interest payments.

    The citizens of a country that defaults basically have to make do with what they can produce domestically for a while. There is no more foreign borrowing to enable deficit spending, and earnings potential on exports are lousy for a while.

    One other consequence is that gold and silver could become very valuable. Here is a hypothetical national AD council campaign: “Our troops put their lives on the line and now they need fuel for the vehicles, do your patriotic and turn your gold in when the IRS comes to your door this month. Don’t desert our troops!”

    Reply
  7. Dubai has brought to the forefront the vulnerability of Islamic sukuk bonds. These are bonds that comply,technically, with Islamic Law that forbids the direct payment of interest. Rather, “guaranteed” assets underly the bond and throw off money in a fashion that complies with the religious principle. Many times, the underlying asset is real estate.

    Usually, an Islamic cleric – compensated, I might add- is the sanctioning and blessing authority for the bond to be assumed investible by those of the Islamic faith.

    Dubai has been a shock, since many sukuk bonds eminated (pun intended)
    there and were real estate backed.

    FT reports that sukuk investors are beginning to lawyer-up, and that the basis for sukuk bonds is being thrown into question above and beyond Dubai.

    So much for trying to do an endaround on a religious principle.

    T

    Reply
  8. Interesting thread: I hadn’t heard of sukuk bonds before but always wondered how a culture forbidden to charge interest could manage credit. Have to check into the details of that (but rather doubt I’ll be a buyer [g]).

    Personally I plan for the possibility of a $USD panic (acute crisis) but don’t waste much time on the possibility of anything like a default scenario. As Roger correctly points out, a major reserve currency held in very high quantities worldwide (e.g., Eurodollars) and central to global trade transactions is not going to collapse the way the Argentina Peso did much less bear any resemblance to the Zimbabwe Dollar: Such comparisons are spurious.

    As an empirical matter, the current debt-service burden in the US is approximately the same as it was under the first President Bush. I don’t recall much hysteria or hand waving about it at the time but my memory is not as good as it was and folks may have been paying less attention to such things in those days [shrug].

    If US industrial productivity were falling I might pay more attention to public debt service issues because that would imply the US could not grow its way out — a growing economy generates more future revenue so projecting debt burden based upon current revenue stream is misleading — but industrial capacity is increasing now so, the deeply worrying unemployment situation aside, a problem there is not imminent (however I expect the problem to grow as deficit scaremongering increases while the stimulus effect fades in mid-2010).

    But assuming for the sake of argument that we don’t simply become more Japanese and instead actually do enter a collapsing industrial capacity environment that reduces revenues to the point where public debt service must be delayed then Matthew’s scenario seems reasonable; i.e., many of the effects may be rather subtle and US citizens not traveling abroad or purchasing imported goods might not notice much, at least until services they rely upon are cut and the price of hothouse tomatoes doubles.

    Kicking it up a notch to roughly an order of magnitude worse than that implies a depression/deflation which would probably develop into chronic stagflation. This is basically an early Weimar Germany scenario and, rather than lengthen this comment much further, I’d recommend a first-hand, ordinary citizen account such as Sebastian Haffner’s books for that; e.g., http://tinyurl.com/ylnr398 — guaranteed to make you think while shivers run down your spine. Bottom line in that scenario is all spare cash goes immediately to anything w/ more stable value — food, assets of countries w/ less exposure to your domestic economy, precious metals, skills, black market goods, you name it — because it’s effectively a barter economy w/ everyone a trader.

    Reply

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Never Mind?

So after the big standstill news last week from Dubai the UAE Central Bank is going to provide a liquidity facility to help support the banks in Dubai and instill confidence for foreign banks in the region. Apparently property prices have plunged and from what I can glean this will not eliminate pain and losses but will allow things to function. The idea here appears to be showing that despite the news there is liquidity for banks to function.

Extraordinary measures like liquidity facilities, debt monetization and the associated acronyms are very polarizing. These things seems to both prevent the complete collapse of the entire financial system while at the same time creating a moral hazard whereby we privatize gains and socialize losses with no consequences for incompetence.

Unfortunately neither side jibes with reality, IMO. I think that taking a pound the table stand here requires believing that the proper regulatory framework was in place that promoted reasonable use of leverage, prudent lending standards and proper oversight of all the other things that went wrong. Most people seem to now realize that the proper framework was not in place and many people doubt that congress is on the right path to creating a proper framework.

We’ve heard Obama and others talk about making sure this never happens again which if that is what they are really focused on means we will not get a proper framework but instead will get something aimed at preventing the 2007 crisis. Before going on let me just say I am not trying to turn this post into a left right debate. The President talked about making sure this never happens again, that is not in and of itself a defining political statement. The path that the leadership in congress and the whitehouse choose to take is either effective or not and political beliefs may play a role in that outcome but we are not there yet.

As the story in Dubai evolves (default, now maybe not so bad??) it will either be good or bad but if bad it will not permanently break the system. However, the action on Friday gave a great preview of what to expect if/when there is some sort of market correction. Commodities, emerging markets, developed foreign and most other relatively volatile areas of the market dropped more than the broad market. Whether it ends up being the Dubai news or something else that causes a correction the heavier you are in the above mentioned areas the more you would feel a correction. Think about that now before it happens so that you are not caught off guard and react poorly. Note that even if you are staunchly in the bull market camp we can still go down 100-150 SPX points.

On a different note I spent quite a few minutes on Saturday looking through the on-screen guide (we get a lot of channels) for the University of Montana v South Dakota State FCS playoff game. I would have had to pay quite a bit of money for it which may not have been good for marriage harmony but it turned out to be a fantastic game. South Dakota State dominated the first three quarters taking a 48-27 lead.

Perhaps the game appeared to be over but Montana didn’t think so and outscored South Dakota State 34-0 in the fourth quarter to win 61-48. The point here is a philosophical one about never giving up. Something is not over until it is over and until it is over there is still a chance for whatever outcome you are hoping for. This is most easily understood in the context of sports but I believe has broad applications in life.

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