This week I bring you two different articles as an offering for Outside the Box. As a way to introduce the first, let me give you the quote from Merrill Lynch economist David Rosenberg about the rising threat of global trade protectionism:
"The Financial Times weighs in on the rising threat of global trade protectionism in today's Lex Column on page 14 ("Economic Patriotism"). The FT points out that the stimulus packages of many countries include "buy local" provisions. At home, there is a proposed inclusion of a 'Buy American' provision in the economic recovery package and this could set off trade retaliation from importers of US goods. Here is what the FT had to say, 'It was trade protectionism that made the 1930s Depression "Great". Congress would do well to understand that it is in everyone's interest to keep trade open today.'"
I have long written that the one thing that could derail my Muddle Through (at least eventually) view point is a return to trade protectionism. Nothing could be more devastating to the hopes of a recovery. Nothing could more surely turn a recession into a depression, and a global one at that.
David Kotok of Cumberland Advisors notes the very real problem with Tim Geithner's written testimony, threatening China and calling the manipulators, clearly making the point that this is Obama's policy. I did not have time to touch last Friday on the dangerous policy if it is that and not just rhetoric, but David says everything I would want to say and does it shortly and eloquently.
Second, several people requested a chance to look at the actual paper I cited in last week's Thoughts from the Frontline by Nouriel Roubini and Elisa Parisi-Capone of RGE Monitor (www.rgemonitor.com) on how they come up with an estimated potential loss of $3.6 trillion dollars in the US financial system. It makes for rather grim reading, but they go sector by sector to show where the losses are coming from.
Tomorrow I will hold my first "conversation" with Ed Easterling and Dr. Lacy Hunt. To find out more about how to listen in and still get the half price discount for the rest of this week at http://www.johnmauldin.com/conversations. Just enter the code JM44 when asked. Have a great week.
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.
This week we will look at what will be a fairly controversial essay by good friend Michael Lewitt of HCM. In light of today's speech by Treasury Secretary Henry Paulson of the re-organization of the regulatory system in the US, Michael suggest we look at what the real problems are before we begin the process of re-arranging the deck chairs on the Titanic. For many, some of what he says will be considered economic heresy. I do not agree with all of it (though I am in solid agreement on most of it), and look forward to talking with him in a few weeks in La Jolla when we are together. But the point of Outside the Box is not to find material that I or you agree with or that makes us comfortable, but something which causes us to think through our own opinions and biases.
But this is a debate that absolutely must happen if we are to move forward and away from the current crisis and to somehow see if we can avoid yet another crisis in five years. Simply adding new regulations without changing the incentive nature of the markets will not fix the things that really matter. None of us should cry when some fund that is leveraged 30 to 1 goes down and investors get wiped out. What were they thinking anyway? But when a fund or investment bank is so big that its demise threatens the system that we participate in, something is wrong in the way our society manages risk. Simply bailing out big banks is not an adequate regulatory response. While it may work for the immediate moment, it does not solve the longer term issues.
Please feel free to forward this letter to anyone you think should be part of that debate process.
This week we look at a recent analysis from Professor Nouriel Roubini of the Stern School of Business at New York University. Nouriel has become known for his rather clear clarion calls that the housing bubble would lead to a credit crisis and possibly much worse. He has been one who has been on CNBC and was in the clear minority early last year, but now no one is laughing (I was once on the show with him, and we were not the majority view).
In this week's Outside the Box, Nouriel details for us how a worse case scenario would develop. We both hope this does not develop. It can be avoided, but realistic investors need to know what to look for to make sure we are not going there. I like Nouriel's work, as it pull's no punches. You can go to RGE Monitor at www.rgemonitor.com to see his regular work, which is geared to institutions. Like this letter, he offers Outside the Box analysis, which I think you will find useful.
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.
The subprime problem, we were told, would not spread to other markets. It would be "contained." And it has, according to Jim Grant. He quipped last week that it has been contained on planet Earth. The risks coming from rising defaults in the US (now above 600,000 and rising from just 200,000 a few years ago) are clearly spreading to markets far beyond the subprime world.
This week's Outside the Box talks about the next two dominoes that could fall: junk bonds and counterparty risk in the various credit default swap markets. Ted Seides is the Director of Investments at Protégé Partners, LLC, a hybrid fund of funds that invests in and seeds small, specialized hedge funds. He writes this week's piece in Peter Bernstein's Economic and Portfolio Strategy, one of the most respected of market analysis letters. You can learn more about the letter at www.peterlbernsteininc.com.
This piece is a little longer than most letters, but it is one of the more important editions of Outside the Box this year. This is a must read. You absolutely need to understand the nature of the systemic risk we are facing, and Ted does a great job of explaining in very clear terms the nature of the risks that we have created din our modern markets. I have left the footnotes in, and they are at the end of the letter.
What really happened last August? There was blood in the street for many hedge funds, while others did ok. But in this week's Outside the Box, Jon Sundt from Altegris Investments (and my US partner) dives you the behind the scenes details of what was going on inside the trading rooms of various quantitative hedge funds. It makes for interesting, if not sobering, reading.
I think you will find this analysis helpful in your own efforts to analyze your investment managers. How much real risk are your managers taking? Can you tell just by the performance numbers? Jon suggest different ways to look at the risk in your portfolio.
Jon is the president of Altegris Investments. He has been researching and analyzing hedge funds for many years, along with his partners and an extensive research team at Altegris. I am proud to partner with his firm, and happy to present you his essay ad this week's Outside the Box.
Stephen Roach is one of my favorite analysts. However, since he moved to Asia to take up new responsibilities, he has not written as much. Thus I was delighted to receive what will be today's Outside the Box last week. Roach argues that the US is getting ready for a subprime economy and the world, and in particular Asia, will also slow as a result. This is a particularly sobering essay, but one that should be read.
Stephen S. Roach is Chairman of Morgan Stanley Asia, serving as the Firm's senior representative to clients, governments, and regulators across the region. Prior to his appointment as Asia Chairman, Mr. Roach was Morgan Stanley's Chief Economist.
I trust you will fine this Outside the Box stimulating.
Who should we blame for the problems in the credit markets? This week in Outside the Box my good friend Barry Ritholtz takes on the task of pointing his prodigious finger at the guilty parties. As he notes, there is plenty of guilt to go around. This is a problem that is going to stay with us more than a few weeks. As I wrote last week, it is not a problem of liquidity. It is a problem of credibility. Until investors of all types feel safe getting back into the structured finance market water, US mortgages and all sorts of consumer finance are going to be severely hobbled. There is plenty of money on the sidelines, but it is going to take some work to make investors feel comfortable.
Part of that process is to figure out what went wrong and how do we avoid getting into this mess yet again? How do we restore credibility? I offer a few quick thoughts on this at the end of Barry's work. And if you have the time, you should click on some of the links Barry has to various research, especially the first link which shows that housing prices could easily drop 15% (or more in some of the bubble areas!).
Finally, I should note that I am going to be speaking yet again at the New Orleans Investment Conference (October 21-25, 2007). This is always one of the great investment conferences of the year. You can click here to learn more.
This Week in Outside the Box we Join Bill Gross of Pimco in his July 2007 Investment Outlook as he strives to address the implications of the Bear Stearns hedge fund debacle, the toxic waste that is Wall Streets' innovative derivative products and their respective valuation, rather, lack thereof.
If Dear reader you have not been party to the excess of the Wall Street you may have not heard of the two Bear Stearns hedge Funds focusing on the subprime market that were subsequently liquidated on account of their inability to meet margin calls, thus wiping out investors. Mr. Gross believes that while significant, we ought not to look to Wall Street to see the repercussions of our excess but to the heart lands of America and the real estate there financed via subprime loans to witness the true folly of our capitalist ways.
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.