Was it only last week I was expressing outrage that US taxpayers would have to pick up the check for Greek profligacy in the form of IMF guarantees? This morning we wake to up the sound of $250 BILLION in IMF guarantees for a European rescue fund, most of which will go to countries that are eventually (in my opinion) going to default. That is $50 billion in US taxpayer guarantees. Not sure what that translates into for Britain or Canada or Australia.
I can swallow the Fed dollar swaps to the ECB. Don't really like it, but I can deal with it, as I don't think it will ultimately put US tax-payers at risk, as long as the swaps are in dollar terms. But the IMF bailout is just wrong.
Interestingly, the euro shot up on the announcement in what was now clearly short covering. As I write this, it is almost back down to where it started. That seems to me to be a vote of "I don't believe you." We will see. But if the ECB actually goes ahead and floods the market with liquidity, that will be very good for all types of risk assets.
Note that in last Friday's letter I quoted Trichet where he said we would not do what he agreed to do over the weekend. What a turn-about. So much for ECB independence. The European leadership must have realized the wheels were coming off and brought out the nuclear option in order to stave off a very serious crisis. In my opinion, this buys time but does not solve the problem.
The eurozone leaders assume that this is a liquidity problem. It is not. It is a solvency and balance sheet problem. You do not solve a debt problem with more debt. This only shoves the football a few yards (or maybe I should say meters) down the field. And it is going to cause a MASSIVE misallocation of capital once again which will create more imbalances that will have to be dealt with. Ugh.
Now, with that off my chest, let's turn to this week's Outside the Box, which is an essay by a name that is familiar to readers, Michael Lewitt. He has written a brilliant book, the Death of Capital, which should be on your short reading list. I asked him to give us a note for Outside the Box and he graciously complied. It is a thoughtful and fun read with wonderful lines you will want to read again peppered all the way through this all-too-short piece. The book is a ringing indictment of both the regulatory and money management worlds. Get it at Amazon.com.
Your how can I get even more outraged analyst,
Yesterday I sent you an Outside the Box from Paul McCulley who supports the government and Fed activity (in general) in the current economic crisis. Today we look at an opposing view from Bennet Sedacca of Atlantic Advisors. He asks some very interesting questions like:
- Shouldn't the consumer, after decades of over-consumption, be allowed to digest the over-indebtedness and save, rather than be encouraged to take risk?
- Shouldn't companies, no matter what of view, if run poorly, be allowed to fail or forced to restructure?
- Should taxpayer money be used to make up for the mishaps at financial institutions or should we allow them to wallow in their own mistakes?
I think you will find this a very thought-provoking Outside the Box.
We are clearly not having as much fun taking off leverage as we had putting it on, or at least the vast majority are not. This week in Outside the Box we look at some very thought-provoking insights from my good friend Paul McCulley, who helps us think about how we got here and what will be the end point. From the letter:
"But what ailed Lehman was but a manifestation of what ailed, and ails the global financial intermediary system: the presumption that grossly levered positions in illiquid assets can always be funded, because those doing the funding will always assume the borrower is a going concern."
You need to read this when you have the time to think. The quotes from Keynes are important.
Paul is a managing director, generalist portfolio manager, and member of the investment committee in the Newport Beach office of PIMCO. In addition, he heads PIMCO's short-term bond desk. And is an avid fisherman
The weekend has brought us events that can only be described in large, over-the-top terms. The Fed agreeing to take equity on its balance sheet? How bad can things really be? Clearly much worse than most people thought last Friday. Moral Hazard has been re-introduced as Lehman is allowed to go down. I will admit to being surprised. I thought Paulson and Bernanke would put it in the too big too fail category. I think they did the right thing by refusing taxpayer money for a bailout, but it is clearly going to roil the credit markets for weeks and months. It will be interesting to see how long it lasts.
I am in La Jolla today, working with my partners at Altegris, and looking over their shoulders while they monitor the performance of some of our managers. Interesting times. But I have had the time to read two short but very interesting commentaries on the current crisis. I will have more to say on Friday, but for now let's read old friends (to Outside the Box readers) Michael Lewitt of Hegemony Capital Management (www.hcmmarketletter.com) and Barry Ritholtz of Fusion IQ (www.fusioniqrank.com).
As I send this, credit default swaps spreads are simply blowing out. I have been writing about how we would see significant problems in the CDS markets for almost two years. This is something that you could see coming yet nothing was done. I know we are now in crisis, but let's hope that the authorities learn some lessons and put in place some sensible regulations of the CDS market soon. And for the love of Pete (insert your favorite expletive here) put these (more expletives) things on a regulated exchange.
And I agree with Michael below. This is not a time to try and catch a falling knife. That time will come, but not yet. And remember things will get better and we will get through this. As I just said to Barry, "We do live in interesting times."
What a momentous weekend. I was pounding the table about the need to move quickly on Fannie and Freddie in my last few letters, and especially this last letter. And then they did it. There are a lot of details that have yet to come out, and it is likely to be far more expensive the Savings and Loan crisis was for the US taxpayer, but it did get done. Hopefully, we can get some real regulation for part of our costs, as well as get rid of the implicit guarantees by US taxpayers so that something like this never happens again. The fact that it did was the fault of the regulatory environment and Congress. They fired the heads of Fannie and Freddie (with multi-million dollar parting gifts), but sadly, the truly responsible parties will be re-elected to perpetrate yet more frauds.
This week in Outside the Box we will look at two essays, one by Paul McCulley, Managing Director of PIMCO (www.pimco.com). The second is a quick shot by Michael Lewitt of Hegemony Capital Management on the Freddie and Fannie nationalization (www.hcmmarketletter.com). They both make points that there is a lot of work still to be done by the authorities. This crisis is not over...
And on that note, I agree with this paragraph from Greg Weldon:
"There is talk that yesterday's 'event' signals an end to the credit crisis ... nothing could be further from the truth. The take over of Fannie and Freddie implies that the credit contraction continues to INTENSIFY, as the government will likely NOT ... EXPAND ... the balance sheets of these two entities. More importantly, the take-over does NOTHING in terms of bank lending standards, which continue to tighten. Nor does it do anything for Ma and Pa Kettle, as it relates to their ability to continue to take on more debt, which continues to worsen in line with intensifying erosion in the housing market and the labor market as was WELL EVIDENCED by ALL the macro-data released last week ... and the horrific labor market report. Indeed, today's markets move might provide the best "FADE" opportunity of the year!!!"
And Now, on to the essays by Paul and Michael.
Last Friday's letter was about the fact that it is not just Freddie and Fannie. There are other problems. The Weekend Edition and today's Wall Street Journal are filled with stories about the problems with Freddie and Fannie. The assumption in so many quarters is that they will soon need government assistance. The only questions seem to be when and in what form? Can this wait until a new president is in place? Congress is leaving town soon. Can it wait until the lame duck session?
As I have been writing for well over a year, the credit crisis is going to be deeper and take longer to correct than the main stream media and economists think. Losses at banks are going to be much larger, and they are going to bleed for a long time. That means we are going to see more banks failing.
Bennet Sedacca, who I quoted in last week's letter, sent out a new letter this morning, providing a list of stocks he thinks may also be in trouble, his "Dead Men Walking" list. He also notes several banks that will be the beneficiaries of the crisis as they gobble up weak competitors.
Caveat: I am not a stock guy, and can't comment on any of the specifics of what Bennet writes about, but I thought it is important for my readers to understand that this crisis is not going to be over when Freddie and Fannie are nationalized. There are still some whales out there left which are coming to the surface. Warning: this is not pleasant reading.
Bennet is the president of Atlantic Advisors in Winter Park, Florida.
It is indeed a very interesting time in which to live, especially watching the financial markets. The disconnect among authorities, regulators, companies and investors is almost too much to comprehend. There are no precedents for the turmoil we are in. This week we read an essay by a name familiar to readers of Outside Box, Michael Lewitt of Hegemony Capital Management (www.hegcap.com). As usual he offers us some very cogent comments on the continuing efforts by those in authority to bail out the system, along with insights on the deal by Merrill and the woes at GM. It is a very interesting letter, so I will stand aside and let Michael jump in.
I have often commented about the problem of personal savings. We worry about the lack of savings here in the US, but many do not understand that if everyone started to save 5% of there income immediately that it would seriously impact consumer spending, pushing the US into a recession. It is a paradox, as Paul McCulley points out, that what may be good for the individual may not be good for the collective country.
And in this week's Outside the Box, good friend and this week's Maine fishing buddy Paul McCulley writes about another paradox called the Paradox of Deleveraging. This Paradox is at the heart of the credit crisis. Many of you will not like his conclusions, as it calls for the government to step into the breach created by the problem he describes. But as I often point out, the purpose of Outside the Box is to make us think about ideas which may not be in our usual sources of information. Paul is the Managing Director at PIMCO, the world's largest bond manager. (www.pimco.com for more information.)
How do you spell short-selling rally, gentle reader? In this week's Outside the Box we look at several short items (pardon the pun) from various sources, which paint a not pretty picture. The first hit my inbox this morning from Art Cashin (of CNBC fame and also Head Floor Trader for UBS).
"Deconstructing The Rally - The sharp rally that sprang from the new short sale restrictions has been spiky and, in several ways, very powerful. The impact of the short rule change was evident. As Barron's notes, the 150 stocks with the heaviest short interest rallied a stunning 15%. The stocks with the smallest short positions rose only 2%. That may be a function of existing shorts scrambling to cover to pass the new, belated, scrutiny. That thesis got added weight from a couple of areas. The Merrill Lynch results got mostly panned by several analysts and TV pundits. Nonetheless, the stock closed 24% above its lows for the week. Also, the financial sector ETF rose nearly 25% from the lows.
"All of the above suggests that the rally is based on the two pronged government move. First, put a safety net under the financials, especially Fannie and Freddie. Second, restrict opportunities to sell the financials short. We'll wait to see if those efforts have further legs this week."