The last Thoughts from the Frontline featured an interview of me by Kate Welling. I promised another interview she did with my friend Paul McCulley, who (warning) is a consummate Keynesian. For him (paraphrasing closely), prescribing austerity for the US is like putting an anexoric patient on a diet. While Paul and I are very good friends, we do not agree on what to do about the current morass. But this is Outside the Box, and the point is to have views that I don’t agree with. And Paul is nothing if not an articulate proponent of the neo-Keynesian view. The original publication of his interview in Kate’s letter drew some very pointed comments. Right up the OTB’s alley.
Kate Welling is simply the best at doing
interviews and teasing out controversy, but her work is hard to for the average
person to access, as it is now just for institutional clients. I have convinced
her to break out of her shell and offer it to the retail world. She is working
on the “details,” such as price, etc., but in the meantime you can go to welling.weedenco.com
welling.weedenco.comand click on How to Subscribe (Individual Investors) and put in your email address and she will get the information back to you. I assume she will offer a free sample or so. Check it out.
And in the interview, Paul talks about what his new “gig” will be after PIMCO. He is working with David Kotok to launch the Global Interdependence Center Global Society of Fellows, a most worthy group and effort, which I heartily applaud. The GIC encourages the expansion of global dialogue and free trade in order to improve cooperation and understanding among nation states, with the goal of reducing international conflicts and improving worldwide living standards. You can learn more at www.interdependence.org.
Tonight I am in Geneva and was hosted by Lord Alex Bridport, founder of one of the largest bond brokerage firms in Europe (if not the largest). I will report back Friday. It is an interesting time to be in the markets. OK, one tidbit. He confirmed that banks (and not just in Europe) are really as bad as they look. And with that note, have a good week!
Your going to be 62 in a few hours analyst,
This week we visit an essay from an old friend of Outside the Box, Paul McCulley, the Managing Directpr of PIMCO. This is a speech he did at the Minsky Conference sponsored (I believe) by the Levy Institute. It was also the same speech he gave at my conference mid-April that was quite well received.
Essentially Paul argues that the cause of the recent crisis was the creation of the Shadow Banking System outside the purview of regulation. And while he did not use the line in this speech, he did at my conference, which is one of the truly great lines I have heard this year.
"The rating agencies were like the man who went to an under-age drinking party and handed out fake IDs (identification cards). They were the necessary enablers as Paul shows. This is a think piece and one you should take some time to read as when you "get it," you will have some understanding of what must be done all over the world to prevent the next crisis. Let me offer two paragraphs as teaser copy"
"And I think the first principle is that if what you're doing is banking, de jure or de facto, then you are in a joint venture with the public sector. Period. If you're issuing liabilities that are intended to be just as good as a bank deposit, then you will be considered functionally a bank, regardless of the name on your door. That's the first principle.
"Number two, if you engage in these types of activities – call it banking, without making a big distinction here between conventional banking and shadow banking, as Paul Krugman intoned this morning – in such size that you pose systemic risk, you will have higher mandated capital requirements and you will be supervised by the Federal Reserve. Yes, I just told you who I think the top-dog supervisor should be. You will have tighter leverage and liquidity restrictions: You will have to live by civilized norms. In fact, a great deal of what is on the regulatory reform table right now proceeds precisely along those lines. If you're going to act like a bank, you're going to be regulated like a bank. That simple. And maybe you just might find the time to go back to working on your golf game at 3. That is the core principle.
(Note: Paul uses the following Latin terms a lot. For those not familiar with them, Ex-post is Latin for "after the fact." Ex-ante is Latin for "before the event or beforehand".)
Have a great week!
Your rushing to yet another plane analyst,
"Why" many ask, "is the stock market going up when the bond market is telling us the recovery will be tepid? Isn't there a disconnect?" And the answer is that there is, and this week good friend and fishing buddy Paul McCulley of PIMCO fame discusses that very topic with his usual insight and wit. He poses the conundrum that those expecting a "V" shaped recovery have pushed risk assets up quite high, and that the real risk to their position is that they in fact get a "V" shaped recovery. And yet, they could go higher and into bubble territory.
For the policy wonks among you, I offer a link to a recent paper by the Cleveland Fed, which suggests that the Fed could hold rates lower for far longer than we would think normal. Which makes What Paul writes even more important to understand. http://www.clevelandfed.org/research/commentary/2009/0809.cfm
I think you will find this a very interesting read. Meanwhile, I am off to Philadelphia where a team from Dallas was treated very well last night. I hope I get the same warm reception. And then to Orlando and back to Dallas. Have a great week.
Your just trying to puzzle it all out analyst,
This week I offer two short essays for your reading pleasure in Outside the Box. The first is from Ambrose Evans-Pritchard writing in the London Telegraph. He gives some more specifics about the situation in Europe I wrote about this weekend.
He ends with the following sober quote: "My awful fear is that we will do exactly the opposite, incubating yet another crisis this autumn, to which we will respond with yet further spending. This is the road to ruin." This is a must read.
And the second piece? Last week in Outside the Box we looked at an "Austrian" (economic) view of the inflation/deflation debate from my friends at Hoisington. This week we look at the 180 degree opposite with Keynesian aficionado Paul McCulley, who argues that the Fed should be Responsibly Irresponsible and target higher inflation. This essay has brought some rather heated arguments in print and from some of the people who will be with Paul and me at the annual Maine fishing trip. And you can bet I will put them all together with a little wine to see how the argument ensues. I will report back.
And Paul ends with a great and what is a quite controversial line, "Yes, as Bernanke intoned, there are no free lunches. But no lunch doesn't work for me. Or the American people. While it is true, as Keynes intoned, that we are all dead in the long run, I see no reason to die young from orthodoxy-imposed anorexia."
And finally, this one last note on European banks: "European banks including Societe Generale SA and BNP Paribas SA hold almost $200 billion in guarantees sold by New York-based AIG allowing the lenders to reduce the capital required for loss reserves." (Bloomberg). Want to think about the US taxpayer paying to bail out Europeans banks? Think that might be a tad controversial? This could be explosive.
It is important to understand the thinking of those who are in fact making the decisions at the Fed and Treasury. In today's Outside the Box, Paul McCulley, Managing Director at PIMCO, gives us some insight into the thinking that is driving the massive stimulus and bailout programs. Whether or not you agree, it is important to have a handle on what is actually happening and the thinking behind it.
As a bonus, let me give you a link to David Kotok's excellent and very clear analysis of the Public-Private Investment Program (PPIP). The PIPP is basically a call option financed by the US tax-payer. David shows us why as tax-payers we should be concerned. You can read it for your self http://www.cumber.com/commentary.aspx?file=032909.asp&n=l_mc. Have a great week!
This week I came across two items that I think are worthy of being in Outside the Box, so I am going to give you both. The first is an essay by good friend Paul McCulley, Managing Director of PIMCO, called "Saving Capitalist Banking from Itself." The second is a recent speech by Paul Volker, former Fed Chairman and a (hopefully very) influential member of President Obama's economic advisory team. This speech is a must read. Taken together they provide a cautionary tale of what the world of banking will need to look like when we get to the end of the process. This OTB is a little longer than most, but I think it is important reading. If you don't know where we are headed, it is hard to imagine the journey.
There is an ongoing debate on the current nature of the economic environment and what should the response be by government. Today's Outside the Box by Paul McCulley takes up one view, arguing that we need a federal response and stimulus package to protect the overall economy and save capitalism from itself. Tomorrow, I am going to send yet another view arguing that by doing so we are hurting the prudent investor and businesses that did not over-leverage and behaved responsibly. Both are important to understand. And as I will argue on Friday in my 2009 Forecast Issue, both are right. And that is one of the great economic paradoxes that we are faced with today. Navigating through this period is particularly challenging, but I think it is critical that you understand what Paul says today and what Bennet Sedacca will say tomorrow. Understanding what is going to happen, whether or not we agree with the philosophy behind it should be our goal, as it will make us better able to respond with our own portfolio and business decisions.
By the way, Paul McCulley, the Managing Director of Pimco, always features a "conversation" he has with his pet rabbit at the end of each year. Not only is it instructive, but it can also be downright funny. I think you will enjoy this letter a lot. And sorry about the Outside the Box coming later this week. We lost power for the day yesterday due to a mild ice storm here in Dallas.
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
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.
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.)
Today's Outside the Box will feature one of the better pieces written in the last few years by my good friend Paul McCulley. In his article "The Plankton Theory Meets Minsky," Paul shows the importance of why the problem with sub-prime mortgages will affect the entire housing market rather than just a small sector of it. He goes on to further point out that the excess liquidity in housing and the ability to borrow against home equity over the last couple of years was more than just the doing of the Fed as the loosening of credit lending standards played a significant role. This topic is important because it is at the heart of why I think a housing slowdown will affect the nation's economy.
For a little background on Paul, he is a Managing Director at PIMCO where he writes a monthly commentary titled "Global Central Bank Focus." He is a very intelligent thinker but what I enjoy the most about Paul is his ability to take seemingly complex data and transform it into an easy to understand analysis.
The sub-prime sector has been a hot topic as of late but I trust that you will find this piece to be an "outside the box" take on how it happened and what it will affect in the coming year.
Last Friday, I wrote about That Stubborn Yield Curve in my Thoughts from the Frontline letter. In it, I quoted a few paragraphs by Pimco's Paul McCulley, but upon reflection, I feel that his whole letter is worthy of taking a look at more in-depth. Paul writes a monthly commentary, the Global Central Bank Focus that, because of its well-researched and unique perspective, is always at the top of my reading list. As a Managing Director at PIMCO, Paul is an intelligent economist and a self-proclaimed "religious Keynesian."
In his article "Time-Varying Variables Vary" (quite the tongue twister), Paul looks back upon his forecast for the Fed Funds rate and evaluates the "Taylor" formula. But one of the things that I like best about Paul is that, despite his lengthy analysis, he is a bottom-line kind of guy who always boils it down to the end result, which in this case, is the future decision making of the Fed.
With Morgan Stanley and Goldman Sachs each weighing in on opposing sides of the interest rate debate, I believe that you will find Paul's piece to be a truly "outside the box" point of view.
So exactly how far is the Fed going to go? Are they done? Perhaps another raise in August? Could that not even be enough? These are all questions of uncertainty that have the faces of investors looking more puzzled than ever over Fed policy. In my Friday letter I commented on how the Fed is concerned about inflation, and how it is still making them uncomfortable pegged in the high end of their range. In this week's "Outside the Box," Paul McCulley, to much surprise, confesses that he wears Austrian shoes (as in Austrian economics), and explains the risks to the markets of central banking policy.
A current Managing Director at fixed income powerhouse PIMCO, Paul is an intelligent thinker and economist who always provides an insightful perspective on the markets. He is a self-confessed "religious Keynesian" with respect to his views on monetary policy. In his July "Global Central Bank Focus," Paul discusses his thoughts on targeting asset prices and its affects on inflationary pressures.
I think you will find this piece helps shed some light on the problems facing the Fed and the reasons for the fog surrounding Fed policy.
Any time a central bank speaks there are scores of investors lined up and waiting to listen. Each is interested in any number of tidbits that might have a plethora of implications affecting his positions and portfolio. Even after the long-winded speeches and discussions, that action does not stop as investors continue to try and anticipate the next set of policies.
My readers are well aware of how keen I find the writing to be of Paul McCulley, managing director of PIMCO. In his global central bank focus article, Paul ventures beyond the normal apparatus to discover what he labels a "moral hazard."
My Friday letter, Thoughts from the Frontline, has been written about some of the data variables that affect the decision making policies of the Fed. I believe that Paul's piece will shed some light on what the Fed might be facing, as well as add some global perspective to the central banks as a whole. May you find this editorial to be helpful in your outside the box thinking.
This week's letter is by good friend Paul McCulley, Managing Director of PIMCO. About once a year he puts together an economic debate between his favorite friend and family pet rabbit, Morgan Le Fay. It always presents a very readable look at global economics and a forecast of what could be ahead.
My Friday letter, Thoughts from the Frontline, included a graph that looked at GDP growth and mortgage equity withdrawals (MEW) and Paul explores what could happen if MEWs come to an end, or at least slow down. McCulley once again takes a look at Bretton Woods II, the housing marketing in the US and what might lead to a slowdown in the economy for 2006.
This is an important piece to help you in your understanding of the issues surrounding the debt, trade and housing bubbles. I am going to touch on a few of his ideas next Saturday in my weekly letter, particularly the quote from around the middle of this essay that has his rabbit asking the following question (MLF throughout are the initials for Morgan Le Fay:
"MLF: So, the housing bubble, or whatever you want to call it, ain't America's fault, but rather the Emerging World's fault?
"PM: No, Morgan, it isn't anybody's fault; it just is. When the Emerging World decided to shift from being a net user to a net provider of savings, those savings had to go somewhere, they had to finance something. Otherwise, the entire world would have fallen into a liquidity trap, triggering a global depression."
Read this when you have some time to think about it. In a few weeks I will be putting together my forecast for next year and I am on the lookout for opinions, like McCulley's, that can help us think Outside the Box.
This week we take a look again at my good friend Peter Bernstein, the venerable editor of Economics and Portfolio Strategy. Peter is the dean of economic writers. (Actually, he is more like the Pope of economic writers, except of course, that he is Jewish.) The first and long time editor of the prestigious Journal of Portfolio Management (now serving as a consulting editor), Peter has been observing the investment world for almost 60 years, after serving as a captain in the Air Force in WW2. During his career, he has rubbed shoulders and influenced the movers and shakers in our world. He is the author of nine books in economics and finance plus countless articles in professional journals such as The Harvard Business Review and the Financial Analysts Journal, and in the popular press, including The New York Times, The Wall Street Journal, Worth Magazine, and Bloomberg publications.
His book, Against the Gods - the Remarkable Story of Risk is one of my top five, you gotta read it books. (www.Amazon.com) His latest book, Wedding of the Waters is a powerhouse of historical economic story-telling about the Erie Canal.
Several weeks ago in Outside the Box we looked at Paul McCulley's piece called "Phyrric Victory" and Bernstein offers his views on the subject by critiquing McCulley. Bernstein sees the expectations on inflation being much different than in the past and adverse surprises may be in our future. It is the risk we don't see that always causes the problems and that is why this article became this week's Outside the Box.
You can find out more about my friend Peter by going to http://www.peterlbernsteininc.com/. His newsletter is a must read for serious investors and institutions.
Readers know that Paul McCulley of Pimco, and his cohort Bill Gross, are two of my must read economic analysts. Pimco is in Newport Beach, California, and oversee more than $400 Billion in assets, predominately in fixed income.
This is Paul McCulley's August 2005 Fed Focus letter. Several weeks ago I talked about Greenspan's remarks that the Fed was targeting asset prices. There is nothing more he would like to see than the ten-year bond yield rise, but to this point it has been flat or down. McCulley looks at why the ten-year yield has not gone up, in what he calls the "Greenspan Put" and why an inverted yield curve may be in our future. That is why this was picked for this week's Outside the Box.
Readers know that Paul McCulley of Pimco, and his cohort Bill Gross, are two of my must read economic analysts. Pimco is in Newport Beach California and oversee more than $400 Billion in assets, predominately in fixed income.
Last week my weekly letter called "The Problem with the Endgame" quoted some of Paul McCulley's January 2005 Fed Focus letter. This article was so interesting that I decided to make it this week's Outside the Box. The letter is a little longer than normal, but well worth your attention as it explores what might be in the economic future for the global imbalances, risk taking and the Fed.