Tuesday, September 30, 2008

A nice summation...

...of the current "TARP" plan.

Breaking the Moratorium, part II...

...with the dollar making appropriate gains.

Banking crash hits Europe as ECB loses traction

The global credit crisis has slammed into Europe with stunning
violence over the last two days, triggering five major bank rescues
and a near total shut-down of the region's credit markets.

By Ambrose Evans-Pritchard
Last Updated: 8:17PM BST 29 Sep 2008

"The European financial sector is on trial: we have to support our
banks." said French President Nicolas Sarkozy. He has reportedly
ordered the state investment arm Caisse Des Depots to shore up Dexia,
even though the bank is based in Belgium.

Germany's Hypo Real Estate, a commercial property lender, was rescued
with a €35bn lifeline from a consortium of local banks. The lender has
$560bn in liabilities, almost as much as Lehman Brothers.

Hypo Real's share price crashed 74pc, setting off a masse exodus from
financial stocks in Frankfurt. Commerzbank fell 23pc and Aareal Bank
was off 43pc.

Anglo Irish Bank was down 44pc in Dublin on wholesale funding fears.

Europe's credit markets have come close to seizing up as three-month
Euribor jumped to a record 5.22pc and OIS spreads rocketed to 113
basis points.

"The interbank market has collapsed," said Hans Redeker, currency
chief at BNP Paribas.

"We're now seeing a domino effect as the credit multiplier goes into
reverse and forces banks to cut back lending to clients," he said.

Monday, September 29, 2008

Breaking my moratorium...

...regarding news and the Euro area...

This (below most people's radar given today's action) does not bode well for the banks so named. The third part is particularly important - said banks having a difficult time meeting $U.S. funding requirements.

Federal Reserve Actions
The Federal Reserve announced today several initiatives to support financial stability and to maintain a stable flow of credit to the economy during this period of significant strain in global markets.

We will continue to adapt these liquidity facilities as necessary and will keep them in place as long as circumstances require.

Actions by the Federal Reserve include: (1) an increase in the size of the 84-day maturity Term Auction Facility (TAF) auctions to $75 billion per auction from $25 billion beginning with the October 6 auction, (2) two forward TAF auctions totaling $150 billion that will be conducted in November to provide term funding over year-end, and (3) an increase in swap authorization limits with the Bank of Canada, Bank of England, Bank of Japan, Danmarks Nationalbank (National Bank of Denmark), European Central Bank (ECB), Norges Bank (Bank of Norway), Reserve Bank of Australia, Sveriges Riksbank (Bank of Sweden), and Swiss National Bank to a total of $620 billion, from $290 billion previously.

Bail-out blues.

Appears as though the "bail out" bill has been defeated at the House level. Which is fine considering it was a bill that purchased securities nobody understands with ramifications no one can predict.

Volatility ahead for certain.

My own framework of thinking about this: we are seeing the response of several different Trophic levels to a forest fire.

And now, pundits are desceding upon the networks to relay more "information" about the bail-out bill. The networks have an obvious bias: their viewership increases in bullish markets.

The "guests" on these shows imparting "opinion" to the masses are simply talking their books. One right now is talking about the "creditworthiness" of the United States. Interesting. (WHAT IS OUR DEBT DENOMINATED IN???) This same person states the bill "must be passed" for the market to "stabilize". One wonders what his firm's positions are.

Ah, to be alive in during this...


In the midst of this global crisis, with reports coming every minute detailing more bailouts, more capital raisings and more shareholder-dilutive measures by once impregnable and "safe" banks, etc., its a good idea to stop and imagine you are a bird (or a satellite) and gain a larger perspective. The battlfield looks mightily different from the participant and the general.

This is the first macro-level test of the global financial markets. There are no "bi-laterals" in the present case. The entire world is committed to solving the problems that untold billions in cross-holding derivatives contracts make.

So, on one had, we have the fiancial system to thank for increasing the security around the world. When countries experience increased standards of living, they are loathe to disrupt the system. Countries are cooperating together on unprecedented levels in order to preserve the international financial architecture. Unfortunately, the crisis is also exposing not only the weakness of modern U.S.-style capitalism, but also puts into stark relief the difficulties other countries have in investing their capital given weak domestic demand.

On the other hand (channeling Truman's quote about economists and hands), the global economy is searching for answers and transparency. The same country that provided the world with the magic of derivatives that promised to spread risk to ever more diluted destinations will also serve as the leader coming out of this mess. This has been a consistent theme on this blog...slashing and burning with write-downs, misguided legislative action, general shaedenfreude, etc. is a preferable environment to sticking one's head in the sand.

The phenomenon of "capital flight" obviously is seeking to flee from something. The U.S. will remain the premier destination for capital in a world that has is experiencing a global crisis that shows the true metal of institutional power among various competing destinations.

Now ask: Given you were a foreign holder of capital, what jurisdiction would you pick to place your funds?

Thursday, September 25, 2008

Stretching the definition of "misguided"

The following wins first prize for "Silliest proposal" thus far concerning policy and regulatory responses to the Treasury plan. It shows a truly shocking level of misunderstanding by politicians.

Again, swapping Treasuries for MBS and other securities is not deficit spending. It MAY BECOME deficit spending in the future to the extent that the securities decline from their purchase price.

And the use of the word "avoidable" when describing the current malaise is an error of the 1st order. If it was so "avoidable" why did these same politicians not aggressively respond with policy prescriptions ex ante?

The perception of "doing something" and "punishing someone", no matter what tenuous causality they had to this situation, is producing some truly misguided policy measures that would be hilarious if they were not so dangerous.

Wire: BLOOMBERG News (BN) Date: 2008-09-25 16:17:10
Tax on Trades Should Be Part of Rescue Plan, Some Democrats Say

By Laura Litvan
Sept. 25 (Bloomberg) -- A group of House Democrats is
proposing to make Wall Street companies and investors pay more of
the cost of any financial rescue plan through a new tax.
In a letter sent late yesterday to House Speaker Nancy
Pelosi, 16 Democrats asked her to ensure any rescue legislation
include a ``transaction tax'' on all U.S. stock trades and on
other types of trades, such as credit default swaps, options and
futures. They are proposing the tax would be at a rate of one
quarter of one percent on all trades.
``The same Wall Street speculators and investors who are
principally responsible for having caused this avoidable
financial crisis and profited from it must now be required to pay
for it, not U.S. taxpayers,'' according to the letter, which was
signed by Representative Peter DeFazio, an Oregon Democrat, and
Representative Pete Stark, a California Democrat.


The compression thesis promulgated here is happening. Rates across the G20 must drop close to zero to avoid calamatous financial asset price destruction. Daisy chains all over the world are unraveling and the speed of this is well beyond the reactive capabilities of most governments.

It is a good thing then, that the U.S. is being proactive. Intercepting as yet unforseen problems will appear very wise in hindsight. The criticism against Mr. Paulson is misplaced.

Bernanke will do anything to avoid the stagnation Japan experienced in the 90s. His formative academic training was in avoiding just this kind of outcome.

Given that his political masters in Washington have no direction, he will be forced to cut rates to avoid a deflationary asset price spiral.

The clamour over the 700bln "bailout" is misguided. The Treasury is swapping bills for mortgage securities, and is not "deficit spending" that constitutes a "bailout".

I have already trammeled on the Euro-area ad nauseum, so I will refrain from stating the obvious there.

Wednesday, September 24, 2008

The Sopoforics are finally wearing off in Europe...

Note the phrase "regulatory arbitrage". Trade conflict memes abound in this piece.

FT: European banking on borrowed time
By Daniel Gros and Stefano Micossi

The US financial system is being nationalised. The piecemeal approach followed so far had clearly not been working. Hence the US political system is working overtime to reach a bipartisan agreement on a systemic solution. The centrepiece is already known: the US government is going to buy $700bn (€480bn, £380bn) of the so-called “toxic” assets. More measures are certain to follow as the banks will require recapitalisation to the extent that they make losses. As a result, the US government will soon own a large share of the US banking system. If the details are generous enough, this should be sufficient finally to restore orderly market conditions. Can Europe be far behind?

The synchronised movements in global markets over the last few weeks have shown that contagion works on the way down and on the way up.

But the case of AIG, the US insurer, also shows the importance of another, hidden, link across financial markets, namely massive evasion of regulatory requirements. AIG’s last annual report reveals that it had written coverage for more than $300bn of credit insurance for European banks. The comment by AIG itself on these positions was that they were “for the purpose of providing them with regulatory capital relief rather than risk mitigation in exchange for a minimum guaranteed fee”. Thus, a formal default by AIG would have exposed European banks to large increases in regulatory capital requirements, with possibly devastating effects on their ratings and market confidence. Thus, the US Treasury has saved, inter alia, the European banking system.

The extent of regulatory arbitrage can also be seen in the very large gap between overall leverage ratios and the official regulatory ratios. The dozen largest European banks have now, on average, an overall leverage ratio (shareholders’ equity to total assets) of 35, which has actually increased so far this year, compared with less than 20 for the largest US banks. But at the same time most large European banks also report regulatory leverage ratios of close to 10. This is partly due to the fact that the massive in-house investment banking operations of European banks are subject only to limited regulatory capital requirements. Another part of the explanation must be regulatory arbitrage, for example, through the credit insurance offered by AIG.


How do such meme's replicate themself in light of obvious falsehood? Given the amount of foreign debt the paper dragon owns, its export customer base, the opacity of its banking system, the culture of cronyism and corruption, the paucity of real, enforceable property rights and a court system that enforces these rights with at least a semblance of objectivity, and of course a lack of domestic and regional demand.

Bond rates, debt spreads, and contingent asset pricing all confirm that this silly concept is dead.

Now we must move on to the geopolitical and enconomic implications of a destabilized Eastern Asia and what opportunities and risks will present themself.


"The collapse of emerging market economies will shake investors to the core. The great unwind has only just begun," said Albert Edwards, the bank's global strategist.

"The big surprise in store is what could happen in China. The potential for a deep recession in the US is already on the radar screen, but people will be stunned if China's economy contracts, as I believe it will. Investors could be massively caught out," he said.

"The consensus has a touching belief that emerging markets will prove resilient despite a deep downturn in developed economies. My view is that an outright contraction in global GDP is entirely possible next year."

"The emerging market boom is totally tied up with a decade of ballooning current account deficits in the US. Put that into reverse and you'll be surprised what pops out of the woodwork."

Mr Edwards said the vast accumulation of foreign exchange reserves – led by China with $1.8 trillion – had provided the "rocket fuel" of liquidity for frontier markets. This virtuous circle has now turned vicious as America tightens its belt. Countries in Asia and Latin America are intervening to prop up their currencies, causing reserves to fall.

"We could see monthly trade surpluses in the US within a year. The emerging market liquidity squeeze will intensify ferociously, and assets linked to the region will become toxic waste. That includes previously resilient banks such as HSBC, Standard Chartered and Banco Santander," he said.

The gloomy forecast comes as Fitch Ratings warns of mounting distress for banks in China, where debt has been shunted off books to circumvent state limits on credit growth.

Tuesday, September 23, 2008


Freddie and Fannie bank losses grow
By Saskia Scholtes in New York

Published: September 23 2008 00:08 | Last updated: September 23 2008 00:08

US regulators have underestimated potential bank losses on preferred stock issued by Fannie Mae and Freddie Mac, the American Bankers Association said on Monday.

Nearly a third of US banks hold preferred stock issued by the two mortgage financiers that were taken into conservatorship this month, according to an industry survey conducted by the ABA. The average bank exposure to such securities relative to core equity capital was 11 per cent.

“The negative impact on banks – particularly Main Street community banks – is far greater than regulators first thought,” wrote Edward Yingling, chief executive of the ABA in a letter to the Treasury, the Federal Reserve and other banking regulators.

Friday, September 19, 2008

Barriers to entry.

A simple question: How can one compete with institutions (namely, large banks) or develope a competitive platform against them when they are, or may be, deemed "to big to fail", thereby invoking an implicit guarantee from the Federal Government to back its obligations?

How can regional broker-dealers compete with the same problem?

How can independent money-market funds do the same?

A simple answer: they cannot.

The actions of the past month have created massive barriers to entry for all would-be institutions waiting in line to be knighted as "too big to fail" (or "systemically essential" or whatever new fancy words the Fed and their court academics attach to them) by the new Kings of Capital.

We need a Federalist 10 for the new Global Financial Architecture, and America's role in same.

Flailing around, cont.

The SEC is, as we are quickly learning, wholly ignorant of the consequences (I will not proffer any mens rea their actions) that ad-hoc "solutions" to the "problem" that is short-selling.

Short selling adds to liquidity. Short sellers must COVER shorts and BUY BACK the underlying stock at some point.

Again, in its struggle to remain relevant, the SEC believes the perception of "doing something" is more advantageous than a sober look at the effectiveness of any putative action.

WASHINGTON (Reuters) - The head of the U.S. Securities and Exchange Commission said the agency would have more to say on short-selling rules "as early as tomorrow" and commissioners were meeting on Thursday night to address the Bush administration's proposal to calm financial markets.

"We are likely to take additional steps in the days ahead that are more particularly addressed to this urgent situation," SEC Chairman Christopher Cox told reporters after a meeting between senior administration officials and top lawmakers.

Cox said the SEC is coordinating with the United Kingdom's Financial Services Authority, which on Thursday imposed a temporary ban on short sales of financial stocks.

(Reporting by Kevin Drawbaugh and Karey Wutkowski; Editing by Tim Dobbyn)

Thursday, September 18, 2008


Major Central Banks putting their heads together.

Another situation where the announcement of assistance is just as importance as the assistance itself.

18 September 2008 - Measures designed to address elevated pressures in the short-term US dollar funding markets
Today, the Bank of Canada, the Bank of England, the European Central Bank (ECB), the Federal Reserve, the Bank of Japan and the Swiss National Bank are announcing co-ordinated measures designed to address the continued elevated pressures in short-term US dollar funding markets. These measures, together with other actions taken in the last few days by individual central banks, are designed to improve the liquidity conditions in global financial markets. The central banks continue to work together closely and will take appropriate steps to address the ongoing pressures.

ECB Decisions
The Governing Council of the ECB has decided to reinforce its joint action with the Federal Reserve by adding an overnight maturity to its operations providing US dollar funding to Eurosystem counterparties and by increasing the amounts offered in the Term Auction Facility operations.

As regards the overnight US dollar funding, the Eurosystem shall conduct US dollar liquidity-providing operations with its counterparties against Eurosystem-eligible collateral, applying a variable rate tender procedure. It is intended to continue the provision of US dollar liquidity for as long as needed in view of the prevailing market conditions. The US dollars will be provided by the Federal Reserve to the ECB, up to USD 40 billion by means of a temporary reciprocal currency arrangement (swap line). The operational details can be obtained from the ECB's website (www.ecb.europa.eu).

Wednesday, September 17, 2008

Mr. Snow is correct...

...about the complexity issue. Also remarkable is his understanding about the velocity of regulatory measures - decisions made on incomplete information in volatile environments will be wrong...especially when they are massively scaleable.

A centralized information gatherer will make decisions slower and with more error. This scaleability problem increases with complex businesses like AIG. "Risk Management" is a misnomer when you have a large exposure to a risk that has no history to be quantified. Acturarial tables are just not applicable to reflexive systems of human interaction.

By Alison Fitzgerald

Sept. 17 (Bloomberg) -- Former U.S. Treasury Secretary John Snow said credit markets are almost ``frozen'' and called the government takeover of American International Group Inc. a ``huge'' failure of risk management and regulation.

Snow, chairman of private-equity firm Cerberus Capital Management LP, said today in a telephone interview that capital markets are on the verge of seizing up.

``Our debt markets are close to frozen'' he said. ``Unless we get this fixed pretty soon, we're in for a big, big, deep slowdown.'' The economy faces a ``a tough year'' in 2009 followed by a ``good upward swing'' in 2010, he said.

Snow said insurance companies such as AIG are so complicated and their businesses so expansive that state-by- state regulation is inadequate to oversee them.

``This is a huge blowup of the risk management system,'' he said. ``How could a New York regulator possibly have a vision of all the systemic risk of that company?''

The Federal Reserve, with the support of the Treasury, late yesterday announced plans to take control of the nation's largest insurer to prevent its collapse. The U.S. government extended as much as $85 billion to AIG and took a 79.9 percent stake in the company's equity.

Snow said the U.S. needs to revamp the structure of financial services regulations. Still, he warned against moving so quickly that there are unintended consequences. ``There's a huge danger that needs to be guarded against -- that we'll have a tremendous overreaction in regulations,'' Snow said.


Russia: "How does our Flank look??"

Protect your flank.

Such a simple concept in military history, but apparantly Russia has not heeded the warnings outlined by just about every significant general in current and previous history. Liddell-Hart, Clausewitz, Belisarius, Napolean, Alexander, etc...all of them regaled the would-be commander to always protect one's flank.

But, technology and history create new vectors. Be it airforces, submerged boats, psychological warfare, and weapons of mass destruction. One must understand that there are new vectors attached to modern conflict.

So I am going to talk about Russia.

Part of this discussion is in regards to the new climate of economic conflict. Territory is no longer the means of production and the source of power. We reside in a time where countless interactive relationships produce value and are powered largely by oil. HOWEVER, the most important cog in this relationship is the de-coupling of CURRENCIES from COMMODITIES. In other words, one receives a currency in exchange for oil. The currency must be employed to purchase other assets. Since oil is priced in U.S. dollars, this provides an IMMENSE benefit to U.S. foreign policy.

Now, in this inter-related world, more abstract economic factors often have determinitive effects on the physical world. Put another way, influence and power are not about boots on the ground. This development dove-tails nicely with how Futures prices often determine the movements of underlying prices. Economic effects, be they trade agreements, tarriffs, etc., have a tremendous effect on other countries provided they adhere to the same rule set as we do.

The capital markets structure of the world is largely dominated by the United States. Now, Russia is learning about a new Vector - the ability of the capital markets to influence real wealth and indirectly effect foreign policy.

Sept. 17 (Bloomberg) -- Russian markets stopped trading for a second day after emergency funding measures by the government failed to halt the biggest stock rout since the country's debt default and currency devaluation a decade ago.

The ruble-denominated Micex Stock Exchange suspended trading indefinitely at 12:10 p.m. after its index erased a 7.6 percent gain and plunged as much as 10 percent within an hour. The benchmark fell 17 percent yesterday, the biggest drop since Bloomberg started tracking the gauge in May 2001. The dollar- denominated RTS halted trading after similar declines.

The government yesterday injected $20 billion into the interbank lending market via central bank and Finance Ministry auctions in a bid to contain soaring borrowing rates as credit dried up in the wake of the Lehman Brothers Holdings Inc. bankruptcy. The one-day MosPrime overnight rate, a gauge for monitoring liquidity demand, leapt 25 basis points to a record 11.08 percent today.

The Finance Ministry attempted to stop the selloff by offering 1.13 trillion rubles ($44 billion) of budget funds to the country's three biggest banks, OAO Sberbank, VTB Group and OAO Gazprombank, for at least three months. That measure came as KIT Finance, a Russian brokerage, said it's in talks to find a buyer after failing to meet some financial obligations related to repurchase agreements.

Flailing around...

...like I told you, dear readers, on 9/14. The below link is further evidence of the need for government to be seen doing "something". The SEC is now flailing around in an attempt to remain relevent in the post-nationalization era that has seen the Treasury and the Fed defenestrate much of its authority.

If only they studied the effect on volatility ad-hoc regulatory responses had on the markets. Limiting ANY kind of price discovery at this point is tantamount to a declaration of war in the eyes of the markets.


SEC Stiffens Rules Limiting Short-Selling Amid Market Turmoil

By Jesse Westbrook and Edgar Ortega

Sept. 17 (Bloomberg) -- The U.S. Securities and Exchange Commission stiffened rules against manipulative short-selling after a market rout pushed American International Group Inc. to the brink of collapse and triggered Lehman Brothers Holdings Inc.'s bankruptcy.

The SEC adopted two regulations today forcing traders and brokers to close out short sales, amid concern investors are driving down share prices by flooding markets with sell orders. A third rule makes it a securities fraud when short sellers deceive brokers about delivering borrowed shares to buyers.

``These several actions today make it crystal clear that the SEC has zero tolerance for abusive'' short-selling, SEC Chairman Christopher Cox said in a statement.

Lawmakers and regulators are questioning whether short sellers have contributed to a crisis by spreading false information and using abusive tactics to attack companies. Hedge funds and other investors argue that poor business strategies are to blame, not short sellers.

Tuesday, September 16, 2008


This is old news already, but it doubtlessly prevented severe "dislocation" (a favorite term of those who mean to say "Nuclear War") in the markets.

Our government now owns 80% of AIG. I for one would like a comprehensive plan as to when these assets will be sold and the Fed will return to its role of Lender of Last Resort. The obvious difficulty is once power is granted, it is very difficult to take away.

Press Release
Release Date: September 16, 2008

For release at 9:00 p.m. EDT

The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under Section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers.

The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance.

The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.

The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility.

The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.


Lehman's London Landlord Says Rent Payments Are Insured by AIG
2008-09-16 15:20:16.970 GMT

By Peter Woodifield
Sept. 16 (Bloomberg) -- Lehman Brothers Holdings Inc.'s London landlord, Songbird Estates Plc, said rent payments on the bank's offices in the Canary Wharf financial district are insured by American International Group Inc.

Lehman filed for Chapter 11 bankruptcy protection yesterday and AIG, the largest U.S. insurer by assets, is struggling to raise cash to keep the company afloat.

AIG is committed to paying up to four years of rent in the event of a default, Songbird said a statement today.

The downgrade in AIG's credit ratings means it must post collateral or have its commitment ``guaranteed by an entity with specified credit ratings,'' Songbird said.

Canary Wharf Group, a unit of Songbird, expects talks with Lehman's administrator to start shortly, the company said.

Monday, September 15, 2008

The first round...

...of competitive devaluation.

When you are a price insensitive purchaser of foreign bonds (in order to prop up your flailing export industry), this seems like a rational response...unless you also have inflation approaching 8%.


BEIJING (Reuters) - China's central bank, acting against a background of extreme stress in global financial markets, cut benchmark lending rates by 0.27 percentage point on Monday.

The cut lowers the cost of one-year bank loans to 7.20 percent.

Benchhmark deposit rates remain unchanged with the one-year rate at 4.14 percent.

The People's Bank of China also cut the reserve requirement for all except the country's five biggest banks and the Postal Savings Bank by 1 percentage point.

It is the first time that the central bank has lowered the proportion of deposits that lenders must hold in reserve since November 1999.

Sunday, September 14, 2008


With the death of Lehman, the phagocytosis of Merrill by B of A, the panic selling and a newfound respect for the (once innocuous) phrase "counter-party risk", this is, or course, a wonderful investment environment where many fortunes will be made by displaying the foresight and courage required to sift assets amongst the wreckage and ride the volatility out.

But enough normative meandering...

Tomorrow will prove an incredible day. There are several developments that illustrate how far the Fed will go in order to create stability. Unfortunately, tomorrow this line in the sand will be more Maginot than Thermopylae.

The first development is the aforesaid liquidation of Lehman Brothers. Counter-party risk and their expansive prime-brokerage activities is already causing confusion and will require time to work out. Merrill found itself in the line entering the slaughterhouse and thought better. AIG will "accelerate" a restructuring announcement.

The second is the incredible news that the Fed will take equities as collateral in dealing with the Discount window, and possibly for other loan vehicles (the acronym attack of new instruments brought about by the credit crunch). This is unprecedented and the Fed has crossed the Rubicon - swapping equities for Treasuries and retaining the equities on its balance sheet is no small matter and not one I wish to discuss here. We ain't in Kansas anymore.

So now we will have spine-crushing amounts of volatility, silly proclamations by the SEC (expect further restrictions on short selling), politicians showing frustration but no understanding...and several very sophisticated players looking at the carnage and pouncing at opportunity.

Wall Street is dead. Long live Wall Street.

Friday, September 12, 2008

Communists of the Caribbean...


Venezuela and Russia are holding Naval exercises in the Caribbean for the first time since the end of the cold war. A nice trial balloon to see the reaction from our presidential candidates...scenario planning is already underway.

Thursday, September 11, 2008

The big swing producer...

...walks out of OPEC.

The connections between the U.S. and the Saudis is obvious.


Saudi Arabia walked out on OPEC yesterday, saying it would not honor the cartel's production cut. It was tired of rants from Hugo Chavez of Venezuela and the well-dressed oil minister from Iran.

As the world's largest crude exporter, the kingdom in the desert took its ball and went home.

As the Saudis left the building, the message was shockingly clear. “Saudi Arabia will meet the market’s demand,” a senior OPEC delegate told the New York Times. “We will see what the market requires and we will not leave a customer without oil."

OPEC will still have lavish meetings and a nifty headquarters in Vienna, Austria, but the Saudis have made certain the the organization has lost its teeth. Even though the cartel argued that the sudden drop in crude was due to "oversupply", OPEC's most powerful member knows that the drop may only be temporary. Cold weather later this year could put pressure on prices. So could a decision by Russia that it wants to "punish" the US and EU for a time. That political battle is only at its beginning

Monday, September 08, 2008

The market and discounting...

In light of my previous post, it it clear by the market's reaction that the Treasuries proposal is a positive outcome going forward.

There are dead-fall traps in the next six months, to be sure, and the nationalization of the U.S. housing market is no small matter, but it would seem the actions taken today marks a line in the sand that global financial markets will not cross.

As for the GSEs, there will be perp walks - it is difficult to maintain the stance that 5.3 Trillion in guarantees did not require more capital to reserve against potential loss...


The proposal to place both mortgage giants, which own or back $5.3 trillion in mortgages, into a government-run conservatorship also grew out of deep concern among foreign investors that the companies’ debt might not be repaid. Falling home prices, which are expected to lead to more defaults among the mortgages held or guaranteed by Fannie and Freddie, contributed to the urgency, regulators said.

The details of the deal have not fully emerged, but it appears that investors who own the companies’ common stock will be virtually wiped out; preferred shareholders, who have priority over other shareholders, may also wind up with little. Holders of debt, including many foreign central banks, are expected to receive government backing. Top executives at both companies will be pushed out, according to those briefed on the plan.

Sunday, September 07, 2008


...will be made at 11:00 a.m. Eastern time tomorrow.

I will not pretend to know what the Treasury/FED balance sheet implications are from the announcement that two of the major GSE's will be taken over by the Government. Nor do I know what will happen to the common/preferred equity holding and the eventual capital structure of the surviving entities.

My only point is this: Given the multitude of possibilities relating to Fannie and Freddie, has the market thought the present proposal to be the best or worst outcome?

FWIW, The Recapitulator believes this outcome is positive, and will calcify the status quo going forward...(a cynical echo: "just prior to the elections")

Good luck to all tomorrow.

Friday, September 05, 2008

The Paper Dragon, post Olympics...

Much like my incessant posting of articles on the EU/$ cross, I will likely not post any more news relating to my "Paper Dragon" thesis. It appears that the liquidity crunch started on NY time and rotated counter-clockwise across the planet. The EU first, now Asia.

This article is the opening salvo of their putative problems.


Now the central planners have some explaining to do and difficult choices to make. Economics is the cause of most of the world's upheavals.

If a country with over a Billion people could not find enough spectators for Olympic events, I doubt they will be able to engineer a recovery out of this malaise.

Thursday, September 04, 2008

Global Warming

(The following a response by yours truly to my incredibly intelligent brother as we argue about global warming. I tend, as always, to fall on the side of economic determinism)


I think its an unfalsifiable intellectual bubble. Pundits utilize a wide swath of scenarious which all "confirm" global warming...but what about a condition or set of conditions which would falsify the claim of global warming?

Let us speak about definition. What is "Global Warming"? Is this an increased global temperature on average? Can we even calculate the average temperature for the entire planet? Do we have reliable data from all parts of the globe? From the Jungles of Brazil to the Steppes of Mongolia? I tend to approach problems with as much objectivity I can muster...this often leads to silly but useful mantras such as the following: How would a super-intelligent alien who never heard of internal combustian engines think about fluctuations in temperature on a 5 billion year old planet? How would it measure, verify, and make decisions on the findings?

I certainly see the commercial applications - biofuels, energy alternatives, books, articles, research, grants, teaching positions, etc. I am always skeptical when such a complicated conclusion is simply assumed.

People always and everywhere seek to maximize their self-interest. No sooner than the assumption of global warming is made, the hand comes out from either the public or private sector instructing you to relinquish YOUR self interest. "In the name of the PLANET, good sir, pay more taxes or purchase this enviromentally conscious item."

so, qui bono?

Global warming has been great for large corporations - any extra level of regulatory expense can be decreased at the margin in one enjoys economies of scale. manufacturers and stores cannot mass produce anything "environmentally sensitive".

In addition, environmental regulation serves as a massive barrier to entry with increased fixed costs and possibly increased costs of capital due to legal and regulatory risk.

/end rant

The Quants are dead...long live The Quants

As I have alluded to before on this blog, the proliferation of cheap computational power and access to algorithmic trading platforms has changed trading, money management, and indeed global financial markets. Quantitative traders ("Quants") are simply not immune from the quotidian business processes of competition, maturity, and commoditization.

We have obvious evidence of the trajectory of firms that base their trading skills on computers and the fantastically intelligent people who program them. This paper by Andy Lo gives a nice explanation of what happened and why during the credit crunch of last year and how it effected hedge funds.


Many Hedge Funds are simple. They employ computers to search for anamolies in the markets (such as the NAV of closed-ended funds vs. book value, credit spreads of similar debt products, identical equity securities in different jurisdictions, and debt convertible into equity). This type of trade used to be wonderful for sophisticated Quants. Large, expensive overhead was needed to run the models, but profits where simply there for the taking.

Like all businesses that make overplus profits, competition formed. Associates of these funds left to set up their own Quant shops, using very, very similar models.

Soon, thousands of funds were using the same algorithms which searched for the same anomalies. Opportunities appeared and then vanished in seconds instead of minutes. Margins on trades shrank. The competitive advantage for most funds was speed.

The Quant space grew larger. Institutional funds gazed the low-volatility, non-correlated positive returns of Quants and thought "panacea", then invested heavily to seek more market anomalies. With more entrants and huge increases in assets under management, time and profits were both being crushed by the gravity of capital.

And so to combat the thin returns, leverage was employed. A tiny anomaly levered 30 or 40-1 was not so tiny anymore. Competitors copied this practice. Once again, thousands of funds were using leverage to trade on the same anomalies, and devil take the hindmost.

But leverage works both ways. A 1% decline in an investment levered 40-1 is painful. A 10% move in such an investment may require a letter of apology to your investors for losing their capital.

So, once volatility increased across the whole panoply of financial instruments, many, many funds and strategies would be unraveled.

The Victors of this process are those Quants that can maintain and intellectual AND technological advantage. There are always anomalies and strange correlations in the markets. Those funds that can be creative in their use of algorithms, ask the market the most intelligent questions (based on a more scientific curiosity), and have the most sophisticated software will have the lion's share of success going forward.

So, in a certain sense, Quants as we knew them are dead. Long live the Quants.

Tuesday, September 02, 2008


This, dear readers, is the last article I will post concerning the strengthening dollar. I think I have made my point. The market has informing us that U.S. financial assets are the preferred units of account when storing wealth for future consumption (i.e., "investing".)

And, right on schedule, oil is down.

OPEC member countries are not stupid. For global growth to proceed (and, more importantly for them, their global investment portfolios to achieve good returns) oil prices need to fall. A temporary loss in revenue from oil is partially offset by better investment returns in local currency from the stronger dollar.

Crashes are dangerous - it becomes impossible for the Saudis to plan their generous fiscal spending packages when oil and investment revenue is volatile.

Sept. 2 (Bloomberg) -- The dollar rose to the highest level against the euro in almost seven months as crude oil fell and traders speculated that the Federal Reserve's monetary policy will help the U.S. economy outperform Europe and Asia.

The pound fell to a two-year low versus the greenback on evidence a recession in the U.K. is looming. Australia's dollar declined to the weakest level in almost a year after the country's central bank cut interest rates for the first time since 2001 and said economic growth will slow.

``Growth and monetary-policy differentials are beginning to shift in favor of the U.S. dollar,'' said Meg Browne, vice president of foreign-exchange research at Brown Brothers Harriman & Co. in New York, in an interview on Bloomberg Radio. ``The oil story certainly helps.''

The U.S. currency increased 0.6 percent to $1.4528 per euro at 1 p.m. in New York, from $1.4617 yesterday. It touched $1.4467, the strongest since Feb. 8. The dollar rose 0.6 percent to 108.81 yen, from 108.14. The dollar appreciated as much as 1.3 percent to $1.7783 per pound, the highest level since April 2006. The euro traded at 158.07 yen, compared with 157.95.

The Australian dollar fell as much as 2.8 percent to 82.70 U.S. cents, the lowest level since September 2007, after the Reserve Bank of Australia lowered the overnight cash target by a quarter-percentage point to 7 percent.

Standard Chartered Plc and BNP Paribas SA raised their forecasts for the dollar. London-based Standard predicts the dollar will rise to $1.44 per euro by year-end and $1.36 by the end of the first quarter, compared with previous forecasts of $1.49 and $1.42. BNP, based in Paris, forecasts the dollar will rise to $1.42 versus the euro and $1.71 per the pound by year- end, stronger than $1.45 and $1.88 previously.

`Double Top'

A break through $1.4555, an extension of a decline from a ``double top'' in the euro-dollar, signaled the European currency may fall to $1.4310, a level last reached in December, wrote Kevin Edgeley, an analyst at Goldman Sachs Group Inc. in London who uses charts to predict currency movements, in a research note today.

A double top occurs when a currency makes two successive peaks, often indicating a trend's reversal. The euro reached $1.6019 on April 22, dropped to a two-month low of $1.5285 on May 8, and rose to the record of $1.6038 on July 15.

The U.S. currency surged 6 percent versus the euro in August, its biggest monthly gain since the European currency's debut in 1999. The economies of Europe and Japan shrank in the second quarter, while U.S. gross domestic product expanded at a 3.3 percent annual pace.

Monday, September 01, 2008

Choose your illusion...

Human beings are fond of choosing illusions in order to keep a carefully constructed view of reality intact.

The spectrum of human behavior is narrow, and has not changed in thousands of years. Fukuyama's "The End of History" was a Hegelian mish-mash of concepts that never persuaded me to jettison the importance of power in the affairs of man.

Melioration and power plays are akin to leptokurtic distributions in statistical analysis - long periods of progress are perforated by violent periods of chaos.

The below article is timely and expounds on these themes. I don't normally post full articles, but this one merits zero editorial interference.

August 30, 2008

Where are the realists?

When Russian tanks rolled into Georgia, it ought to have been their moment.

Here was Vladimir Putin, a cold-eyed realist if ever there was one,
taking advantage of a favorable opportunity to shift the European
balance of power in his favor -- a 21st century Frederick the Great or
Bismarck, launching a small but decisive war on a weaker neighbor
while a surprised and dumbfounded world looked on helplessly. Here was
a man and a nation pursuing "interest defined as power," to use the
famous phrase of Hans Morgenthau, acting in obedience to what Mr.
Morgenthau called the "objective law" of international power politics.

Yet where are Mr. Morgenthau's disciples to remind us that Russia's
latest military action is neither extraordinary nor unexpected nor
aberrant but entirely normal and natural, that it is but a harbinger
of what is yet to come because the behavior of nations, like human
nature, is unchanging?

Today's "realists," who we're told are locked in some titanic struggle
with "neoconservatives" on issues ranging from Iraq, Iran and the
Middle East to China and North Korea, would be almost unrecognizable
to their forebears.

Rather than talk about power, they talk about the United Nations,
world opinion and international law. They propose vast new
international conferences, a la Woodrow Wilson, to solve intractable,
decades-old problems. They argue that the United States should
negotiate with adversaries not because America is strong but because
it is weak.

Power is no answer to the vast majority of the challenges we face,
they insist, and, indeed, is counterproductive because it undermines
the possibility of international consensus.

They are fond of citing Dean Acheson, Reinhold Niebuhr and George
Kennan as their intellectual forebears, but those gentlemen would have
found most of their prescriptions naive. Mr. Acheson, as Harry
Truman's Secretary of State, had nothing but disdain for the United
Nations and for most international efforts to solve world problems. As
his biographer, Robert L. Beisner, has shown, he considered such
efforts evidence of the naive hopefulness of "people who could not
face the truth about human nature" and "preferred to preserve their
illusions intact."

He strongly supported the NATO alliance but ultimately put his faith
not in international institutions but in "the continued moral,
military and economic power of the United States." He aimed to build a
"preponderance of power" and to create "situations of strength" around
the world. Until the United States acquired this predominant power, he
believed, negotiations and international conferences with adversaries
such as the Soviet Union were worthless. He opposed talks with Moscow
throughout his entire time in office.

Those early realists had little faith in the persuasive influence of
the community of nations or world opinion. "The prestige of the
international community," Mr. Niebuhr argued, was "not great
enough...to achieve a communal spirit sufficiently unified, to
discipline recalcitrant nations."

The great mid-century theologian warned against "a too uncritical
glorification of co-operation and mutuality" between powerful nations
with opposing interests.

Yet it is precisely the prospect of cooperation and mutuality that
present-day realists glorify.

They revere President George H. W. Bush, who spoke of a "new world
order" in which "the nations of the world, East and West, North and
South, can prosper and live in harmony," where "the rule of law
supplants the rule of the jungle," where nations "recognize the shared
responsibility for freedom and justice."

Today the elder Bush is hailed by realists because he went to the
United Nations Security Council, while the younger George W. Bush is
condemned because he treated the U.N. as the delusion Dean Acheson
said it was.

Realism has pulled itself inside out.

Leading realists today see the world not as Mr. Morgenthau did, as an
anarchic system in which nations consistently pursue "interest defined
as power," but as a world of converging interests, in which economics,
not power, is the primary driving force.

Thus Russia and China are not interested in expanding their power so
much as in enhancing their economic well-being and security. If they
use force against their neighbors, or engage in arms buildups, it is
not because this is in the nature of great powers. It is because the
United States or the West has provoked them. The natural state of the
world is harmonious; only aggressive behavior by the United States
disturbs the harmony.

In such a world, the task of the United States is not to check the
rising powers but to steer them gently along the path that the
realists insist they are already on, toward the embrace of an
international community with laws and rules to govern their behavior
in ways that benefit all. As the self-described realist Fareed Zakaria
explains, "The single largest strategic challenge facing the United
States in the decades ahead is to draw in the world's new rising
powers and make them stakeholders in the global economic and political
order." China and Russia, along with India and Brazil, are "embracing
markets, democratic government...and greater openness and
transparency." America's job "is to push these progressive forces
forward, using soft power more than hard, and to try to get the
world's major powers to solve the world's major problems." The world,
after all, "is going the United States' way."

The original realists had no patience for such Candide-like optimism
about the inevitable upward progress of mankind. "Whoever thinks the
future is going to be easier than the past is certainly mad," wrote
Mr. Kennan in 1951, six years after the most destructive war in
history, five years into the Cold War, and one year into what was
widely seen at the time as disastrous and seemingly hopeless American
intervention in Korea. Mr. Kennan's provocative assertion aimed to
jolt Americans out of their yearning to believe that the future would
be different.

But now it is leading realists who embrace The End of History, with an
unshakable faith in the inevitable convergence of humanity around
shared values and common interests. These were exactly the hopes and
dreams Mr. Morgenthau set out to vanquish decades ago.

The original realists were not without their flaws, some of them
fatal. Mr. Morgenthau's insistence that ideology and regime type are
irrelevant to a nation's behavior was a terrible blind spot for
realism, then and now. Mr. Putin's turn toward autocratic rule at home
and his revival of old imperial pretensions abroad are intimately
related. Mr. Putin himself argues that strength and control at home
allow Russia to be strong abroad. He and his ruling clique clearly
believe that avenging the demise of the Soviet Union will help keep
them in power.

And who but a Russian autocrat would have regarded the "color
revolutions" in Georgia and Ukraine as intolerable provocations?

Alexander I took quite the same view of liberal rumblings in Poland
and Spain in the early 19th century. To ignore ideology and regime
today is to misunderstand gravely the motives of autocratic leaders,
whether in Moscow or in Beijing.

Nor is the realists' own hostility to democracy, including American
democracy, particularly edifying. Mr. Kennan and the columnist Walter
Lippmann flaunted their disgust at what they regarded as the stupidity
and ignorance of the American public -- Mr. Kennan likened American
democracy to "one of those prehistoric monsters with a body as long as
[a] room and a brain the size of a pin."

Mr. Acheson was the great exception because he harbored no
antidemocratic prejudices and actually believed the messy American
democracy would nevertheless prove stronger in the long run. But most
realists throughout the decades, including today, have complained
bitterly about the influence of domestic political constituencies and
the various ethnic groups that allegedly distort America's
understanding of its "true" interests.

Even so we could use a little dose of the old realism now, at least
the part that would recognize a great grab for power like Mr. Putin's
and understand that it will take more than offers of cooperation and
benevolent tutelage to address Russia's revived appetites.

Perhaps a bit of realism can challenge the widespread belief that a
liberal international order rests on the triumph of ideas alone or on
the natural unfolding of human progress.

This deterministic conviction that Francis Fukuyama popularized is an
immensely attractive notion, deeply rooted in the enlightenment
worldview of which all of us in the liberal world are the product.
Many in Europe still believe the Cold War ended the way it did simply
because the better worldview triumphed, as it had to, and that the
international order that exists today is but the next stage in
humanity's march from strife and aggression toward a peaceful and
prosperous coexistence.

It is a testament to the vitality of this enlightenment vision that
hopes for a brand-new era in human history took hold with such force
after the fall of Soviet communism. But a little more skepticism, and
realism, was in order.

After all, had mankind truly progressed so far?

The most destructive century in all the millennia of human history was
only just concluding. Our modern, supposedly enlightened era produced
the greatest of horrors -- the massive aggressions, the "total wars,"
the famines and the genocides -- and the perpetrators of these horrors
were among the world's most advanced and enlightened nations.

Recognition of this terrible reality -- that modernity had produced
not greater good but only worse forms of evil -- was a staple of
philosophical discussion in the 20th century. It was the great problem
that Mr. Niebuhr wrestled with and which led him to conclude that for
moral men to do good, they would sometimes have to play by the same
rules as immoral men -- and yes, he believed he could tell the
difference. What reason was there to imagine that after 1989 humankind
was suddenly on the cusp of a brand-new order?

The focus on the dazzling pageant of progress at the end of the Cold
War ignored the wires and the beams and the scaffolding that had made
such progress possible.

The global shift toward liberal democracy coincided with the
historical shift in the balance of power toward those nations and
peoples who favored the liberal democratic idea, a shift that began
with the triumph of the democratic powers over fascism in World War II
and that was followed by a second triumph of the democracies over
communism in the Cold War.

The liberal international order that emerged after these two victories
reflected the new overwhelming global balance in favor of liberal
forces. But those victories were not inevitable, and they need not be

After the Second World War, another moment in history when hopes for a
new kind of international order were rampant, Mr. Morgenthau warned
idealists against imagining that at some point "the final curtain
would fall and the game of power politics would no longer be played."
Moscow's invasion of Georgia has opened a new act in the endless

The only question now is whether the United States will play its part,
and with the appropriate blend of realism about the world as it exists
and idealism about what a strong and determined democratic community
can do to shape it. As Mr. Niebuhr put it six decades ago, "the world
problem cannot be solved if America does not accept its full share of
responsibility in solving it."

Robert Kagan is Senior Associate at the Carnegie Endowment for
International Peace and an informal adviser to the McCain campaign.
His most recent book is "The Return of History and the End of Dreams."