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,
I wrote about Greece in last week's letter. Then I ran across this column in the Financial Times by my friend Mohammed El-Erian, chief executive of Pimco, and someone who qualifies to be introduced as one of the smartest men on the planet. It is short and to the point. (www.pimco.com)
And finally, many of you are probably familiar with TED Talks. If you are not, you should be. They basically get very smart, creative people to come in and do short talks Tiffani just sent me one of their latest videos. 13 minutes. It blew me away. The world of Minority Report is here, 40 years ahead of schedule. All I could do was just say "Wow!" Its young men like this that should make us all optimists that somehow we will figure out how to get through all this. http://www.ted.com/talks/view/id/685
"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.
What is fair value for stocks? Are they now cheap? You can certainly make that argument by comparing valuations based on past performance. But repeat after me, "Past performance is not indicative of future returns." The investment climate of today is almost certainly going to be quite different than that of the 80's and 90's. Thus, to expect stocks to repeat the performance of the last bull market in a climate of government intervention, deleveraging and increased regulations may not be realistic?
This week Bill Gross, the Managing Director of PIMCO (and one of my favorite analysts) moves away from his familiar neighborhood of bonds and offers a few thoughts on stock market valuations. This is not a lengthy read, but it is one you might want to read twice, as the concepts are important. And not just for stocks but for investments of all types. I trust you will enjoy this week's 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
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.)
This week in Outside the Box we look at Bill Gross's recent essay on measuring inflation. How you measure inflation makes a difference not only in social security payments but also in what your real returns on bonds are. As Bill notes, there is a significant difference in how the world measures inflation and how it is done in the US. He gives us some insights that are very thought-provoking.
In the last decade economists regularly argued the CPI over-stated inflation by 1%. Now Gross suggests that it may understate inflation by 1%. This week's OTB makes for very interesting reading. Bill Gross is managing director of PIMCO. (www.pimco.com)
This week in Outside the Box we will look at Bill Gross of Pimco's latest essay, addressing the ever expanding economic repercussions of the poorly understood CDO/CLO market, the off balance sheet structured investment vehicles (SIVs) and the economic abyss Bernanke and Company are attempting to lead the market out of with neither light nor guide. Bill sits on the top of the largest bond firm in the world, so they have some very unique insights into what is happening. I always pay attention to what Bill says, and you should too.