By Jason Dowling and Peter Weekes | 6 November 2007
State Treasury has revealed that Victoria looks set to lose just $1.9 million directly from the subprime fiasco. But the chief investment officer of the Victorian Funds Management Corporation, Leo de Bever, is taking no chances, telling The Sunday Age that he is managing the risk of further losses "as best as humanly possible" by shifting investments to safer options. Mr de Bever's comments come after last week's running stoush in Parliament between Opposition Leader Ted Baillieu and Premier John Brumby over Victoria's exposure to the US financial crisis. |
Mr Baillieu warned that millions of dollars of taxpayers' money was at risk and accused the Premier of failing to come clean about potential losses.
"We know hospitals and local governments have been exposed, we know there is a level of exposure to the VFMC, and John Brumby won't even provide a basic reporting process," Mr Baillieu told The Sunday Age.
Mr Brumby told Parliament that he had not received any advice regarding the exposure of government investments and agencies to the US subprime market but reiterated that the state had a "wide range of requirements in place" concerning investments.
However, Mr de Bever— who oversees the investment of money from entities including the Royal Children's Hospital, the Royal Women's Hospital, the National Gallery of Victoria, the University of Melbourne and the Transport Accident Commission— described the subprime debacle as being "the least of our concerns". It was the "roaring bull" market that kept him awake at night, he said.
The boom of the past five years could not be sustained and mum-and-dad investors stood to lose if they did not act now.
"Nobody wants to leave the party when markets are doing what they are doing, people want to enjoy it to the fullest … (but) it's time to buckle down."
While market experts suggest moving investments into safer options— such as buying government bonds, gold or shares in consumer staples— could prove prudent, they are not predicting the downturn will be so drastic.
Shane Oliver, chief economist and head of strategic investments at AMP Capital Investors, agreed that after the strong run, the Australian sharemarket was due for a correction, but said, despite the more volatile market and further expected problems in the US financial system, he believed "the conditions are just not there for a crash".
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But some key US banks are already in trouble, with reports that regulators are investigating Merrill Lynch for trying to hide the extent of its losses.
And The Guardian newspaper has reported that another British bank, thought to be Barclays, has received an emergency loan from the Bank of England.
The Catastrophist View: A Doomsday Primer.
What It Would Take To Send The U.S. Economy Into Free Fall.
By Duff McDonald | 1 November 2007
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He stops laughing. "Why worry?" he asks. "Because we dodged a bullet but are about to step on a hand grenade."
Sitting in a corner office of a nondescript building just off I-95 in Darien, Connecticut, Schiff, the president of brokerage Euro Pacific Capital, and author of
Crash Proof: How to Profit From the Coming Economic Collapse"by Peter D. Schiff (Author), John Downes (Author)
will spend the next hour spelling out a singularly pessimistic view of the American economy. And he will do so while exhibiting a curious juxtaposition unique to the bearish prognosticator: He speaks of disaster with a smile on his face. No, he’s not happy about our impending doom. But he is happy that people are finally taking him seriously.
Some people, anyway. The recessionary fears that were sparked by the global liquidity crisis in August have eased, largely because of a resilient stock market and a belief that the Federal Reserve’s interest-rate cut in September curtailed deeper losses. When Goldman Sachs invested in its own imploding Global Equity Opportunities hedge fund in August, calling it an "opportunity" and not a "rescue," people laughed. Guess who laughed last? Goldman, which had reportedly enjoyed a $370 million gain on its $2 billion rescue by October. The optimists stay focused on stories like Steve Jobs’s next stroke of genius.
But Schiff, whom CNBC calls "Dr. Doom," has not, as bears do when winter approaches, gone off to hide in a cave. Why not? Because every single one of the underlying economic factors that he has identified as cause for concern has worsened. And his is no longer a lone voice in the woods. If you don’t care to listen to a man nicknamed Dr. Doom, you can listen to people like former Federal Reserve chairman Alan Greenspan, esteemed bond-fund manager Bill Gross, or famed money manager Jeremy Grantham. They’re part of a growing chorus of voices that are saying many of the same things as Schiff.
Their bearish arguments come in many shapes and sizes, but here’s the basic one: The past five or six years have been deceptively fortunate ones for the U.S. economy. That’s because any troublesome developments— the surge in oil prices from $28 per barrel in 2003 to about $87 today, for example— have been papered over by rising home prices. Home equity has been used to buy flat-screen TVs, SUVs, and more homes. Wall Street bought up all this debt from lenders (the banks and mortgage brokers), thereby allowing them to lend more— virtually without limit (or much in the way of constraints).
The softening of real-estate prices in most parts of the United States put a crimp in this system, but it hasn’t stopped it. The question is, what, if anything, will? What will bring on the apocalypse that Schiff and others believe is inevitable? They see it like this:
THREAT NO. 1: The Bottom Continues to Fall Out of the Housing Market
Manhattan’s and D.C.’s gravity-defying real estate aside, it’s quite clear the nation is experiencing a genuine housing crisis. In August, pending home sales dropped 6.5 percent, and they currently sit at their lowest level since 2001. The National Association of Realtors conducted a recent survey that showed more than 10 percent of sales contracts fell through at the last moment in August, primarily owing to disappearing loan commitments from banks. The crisis will only deepen, when more borrowers see their adjustable-rate mortgages adjusted upward. There was a foreclosure filing for one of every 510 households in the country in August, the highest figure ever recorded, and by one estimate, more than 1.7 million foreclosures will occur in the country by the end of 2008. That’s not just subprime borrowers: According to the Federal Housing Finance Board, while nearly 35 percent of conventional mortgages in 2004 used ARMs, some 70.7 percent of jumbo loans— those above $333,700 (the jumbo threshold in 2004; it’s now higher)— did too.
Historically, bond-market investors have been the boring counterparts to their equity-market brethren. But in his October Investment Outlook, famed bond investor Bill Gross was anything but. The managing director of money management firm pimco pointed out that the Federal Reserve is caught in a bind: It must continue to lower interest rates to ameliorate this burgeoning housing crisis, but in doing so, it "risks reigniting speculative equity market behavior, and … a run on the dollar." (More on the dollar later.) Gross doesn’t have the answers but observes that the Fed is "in a pickle, and a sour one at that." Worse yet, concerns that a rate cut might be inflationary actually caused long term bond yields to rise in the wake of the Fed ST rate cut, something that doesn’t normally happen. The Fed’s influence, always overstated, might turn out to be nonexistent in a credit market that remains on edge.
Hedge-fund veteran Rick Bookstaber, the author of
A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation"by Richard Bookstaber
spells out a potentially disastrous scenario that could unfold regardless of what the Fed does: Continued foreclosures result in a further drop in housing prices, which results in further foreclosures, which result in a further drop in housing prices. Even for those of us not selling, reduced home values result in a reduced sense of security, which results in reduced consumption, which results in a slowing economy, which … you get the point.
THREAT NO. 2: The Derivatives-Related Meltdown
Anybody who glances occasionally at the financial pages these days knows that mortgages issued to home buyers are packaged together (in a process called securitization) into a collateralized-debt obligation, or CDO. That’s what’s known as a derivative, a security whose value depends on the value of other securities. The price of the CDO, you see, is "derived" from the prices of the underlying mortgages. (It works with credit cards, too, or bank loans— any kind of debt will do.)
In principle, the idea of a CDO makes perfect sense. In buying $5 million worth of a CDO, an investor has essentially lent money to an entire portfolio of homeowners, instead of placing all his eggs in one basket, say, by funding a single $5 million mortgage. In the real-estate-crazy environment of the past decade, the CDO market took off like a rocket. But the buyers of these derivatives made a critical error— they confused the spreading of risk with the elimination of risk. A booming economy made this confusion not just possible but irresistible. With relatively few defaults in the first half of the decade, investment firms, including many hedge funds, came to see CDO returns as a sure thing and loaded up on them, often borrowing money to do so, taking on debt to buy debt and thereby setting up a potentially deadly chain reaction.
The readiness of the secondary market to buy all these mortgages encouraged the lenders to run wild and lend to anyone who walked through the door, leading— inevitably, in retrospect— to a substantial decline in loan quality. Analyst Christopher Wood of Asia-Pacific investment house CLSA succinctly defines the problem in his highly readable newsletter Greed & Fear: "[Securitization] has one fatal flaw, which will ultimately prove to be its undoing … it removes the incentive of those making the loan to worry about whether the loan is a good credit."
Still, it all held together until mortgage defaults began to cut into the yields of these CDOs and holders looked to sell them, only to realize their value had slipped. Forced liquidations as a result of that "price discovery" were a primary factor in Bear Stearns’ hedge-fund calamity in August. And it’s not over yet: The aftershocks of the mortgage meltdown are still being felt, as banks such as Citigroup and Deutsche Bank announce multibillion-dollar write-downs [[and the successive waves of sub-prime, Alt-As, ARMs, etc. will not abate before 2012: normxxx]].
Each time one of these write-downs has been announced, the market has had a curiously positive response, taking the news as a sign that the worst was over and the banks were cleaning up their books. But because these derivatives are linked to other debt, there’s no reason to be certain that trouble won’t bleed into other markets. Among other things, the liquidity crisis froze the market first in all Asset Backed Securities (ABSs/ABBs)— which froze the Commercial Paper (CP) market used by all of commerce for very short term loans— threatening a total collapse of the international financial system— but finally zeroing in On Mortgage Backed Securities (MBSs/MBBs) only, and On Structured Investment Vehicles (SIVs) which are stuffed with MBSs, a nifty bit of financial engineering that banks used to profit from the spread between short-term debt and long-term debt— off-the-books! No one yet knows how nasty these losses could turn out to be because SIVs are created, Enron style, off the books.
THREAT NO. 3: Consumers Run Out of Steam (and Take the Economy Down With Them)
The U.S. economy, for all its worldly sophistication, is driven by mall shoppers and late-night Amazon addicts— 70 percent of the gross domestic product is accounted for by consumer spending, which is buttressed by debt. According to the Federal Reserve, total U.S. household debt was, as of August, $2.5 trillion— a 24 percent increase in the past five years. Total credit-card debt, including gas cards and the like, was $915 billion.
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In a recent interview, John Santer, a district director of NeighborWorks America, a community-based nonprofit, pointed out that 43 percent of American households spend more than they earn each year, and fewer than six in ten have enough savings to last them three months if they were suddenly out of a job. So where’s the money coming from? From 1991 to 2005, Americans borrowed $530 billion against the value of their homes each year.
James Glassman, a senior economist at JPMorgan Chase, told a Tulsa, Oklahoma, luncheon crowd in early October that before 1985, consumer spending grew in line with income, but since that time, it’s grown half a percent faster on an annual basis. As a result, household savings, which once reached 10 percent of income, is now literally negative. "My guess is that in five years we’ll look back and realize … that the consumer we knew for twenty years is coming to an end," he said.
Roger Ehrenberg, an ex–Wall Streeter and author of the financial blog Information Arbitrage, forecasts extreme financial pain.
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THREAT NO. 4: That the Rest of the World Decides They Don’t Need Us and the Dollar Tumbles Hard
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Here’s why catastrophists see that as a major problem: About 25 percent of our government debt is held by foreign governments, with the major holders being Japan ($610.9 billion), China ($407.8 billion), the U.K. ($210.1 billion), and our friends in the Middle East, the oil-exporting countries ($123.8 billion). When the current Fed chairman, Ben Bernanke, cuts rates to soften the housing blow for Americans, he also weakens the dollar, making dollar-based investments less attractive. And when the dollar weakens, so, too, does the value of these gigantic positions held by the foreign governments. At some point, they’re no longer going to tolerate the losses we inflict on them by lowering rates, and if that happens and they start dumping dollars, watch out for the peso-dollar.
The bulls will tell you that foreign governments understand the American economy is the key to global economic health, and that they’ll suck it up and take it when we devalue their debt. To which Schiff offers another analogy. Imagine if five people were washed up on a desert island: four Asians and an American. In splitting up their duties, one Asian says he’ll fish; another will hunt, another will look for firewood, and another will cook. The American assigns himself the job of eating.
"The modern economist looks at this situation and says the American is key to the whole thing," says Schiff. "Because without him to eat, the four Asians would be unemployed." The alternative: Without the American, the Asians might eat a little more themselves and even spend some time building a boat. This is happening as we speak: With the rise of the Chinese consumer class, the local citizenry is now spending, and the country is no longer totally dependent on exports. Which means they’re no longer totally dependent on us.
Readers of the financial press are surely familiar with the buzzword of the moment, decoupling. It’s used to describe how U.S.-Europe and U.S.-Asian trade relationships are becoming less dependent at the same time as European-Asian ties are growing. Most Asian nations, including China, are seeing more rapid growth in exports to Europe than to the U.S. And the U.S. now accounts for a declining share of European exports. The bearish interpretation: that the longtime global embrace of the dollar is loosening.
THREAT NO. 5: That We Don’t See It Happening Because It’s a Slow-Motion Train Wreck
Last but not least, we can circle back to the Dow Jones Industrial Average making new highs in October— 14,087.55 on October 1— offering hope that our equity portfolios will carry us through to the other side of whatever it is we’re on the wrong side of. Before addressing the fact that the equity market might just be clueless, there’s one last dollar-related point to make. The true value of a stock portfolio isn’t really its quoted worth in 'dollars'— it’s what you could buy with that portfolio if you were to sell it.
Given that we as Americans don’t manufacture that much anymore (we’re a 'service' economy— i.e., we take in each others wash!), we are largely talking about foreign-made goods, such as flat-screens from Korea or cars from Germany. Over time, if the dollar continues to slump, foreign manufacturers will raise prices to compensate for what they’re losing in the exchange rate. In that light, a Dow at 14,000 with the euro at $1.42 is really no different from a Dow at 13,000 with the euro at $1.33. (One reason the price of oil has risen so high is that it is quoted in dollars, and the sellers thereof have had to continually jack up the per-barrel price to maintain their own purchasing power at home and elsewhere.)
Still, a rising Dow is better than a falling Dow, and the bulls are piling into every rally. Which still doesn’t impress Jeremy Grantham, chairman of Boston-based money manager GMO, in the least. "The equity market is always slow to pick up on someone else’s crisis," he says, referring to the turmoil in both the housing and fixed-income markets. "And so you’ve got a slow-motion train wreck that has to work itself through the system."
How will it work itself through? Grantham points to the recent strength in profit margins, fueled by— you guessed it!— our plummeting savings rate, and says there’s nowhere to go but down. "If you start with an overpriced market and bring profit margins down, that’s more than enough to bring stock prices down," he says. "It is the most certain mean-reversion in all of finance." Grantham calculates that the U.S. stock market will have to fall by a full third before it gets to its "fair value." At which point we will likely be in full-blown recession. And when that happens, Schiff says, we will see a country in downsizing mode, "selling the consumer goods we’ve been buying back to the Chinese. It will be one big, giant repossession."
So assuming all this is true, that Schiff and his fellow doomsayers are right about the rotten core of the U.S. economy, how will this affect the local economy? Mostly, we’ve grown accustomed to the idea of our local economy (with a few exceptions), being inherently stronger than the nation’s and possibly immune to whatever woes strike the rest of America (something like Lake Wobegone's children— 'all above average'). Wall Street, after all, makes money on downs as well as ups, and the stampede of foreigners and foreign cash to our shores could, if anything, be aided by the weak dollar.
Last week, though, Merrill Lynch announced a larger-than-expected write-down of $7.9 billion dollars in its third quarter alone, primarily due to losses in the credit markets. Numbers as large as that can paradoxically seem trivial due to the abstract nature of accounting— a "write-down" involves no movement of real-life cash, just a readjustment of some theoretical values— but here’s something nontrivial to consider: Merrill Lynch is a major employer in many U.S. cities. While so far only a few Merrill bigwigs have been shown the door, it’s almost certain that a chunk of the company’s rank and file will soon follow. All told, financial companies had already announced large numbers of layoffs as of October, and the pace could pick up through the end of the year. That’s people who won’t be bidding up new apartments, who won’t be going out to dinner five times a week, who won’t be testing the outer limits of their credit cards at the local malls. The knockon effects of this could be even more severe, as every 'financial' job is estimated to support another 1.3 to 2 jobs downstream, meaning that additional job losses could be even more substantial.
Meanwhile, the public sector is feeling it, too. A recent report forecast that budget deficits for many major U.S. cities and states will begin as early as this year and further predicted that the string of budget surpluses enjoyed by many until recently, will likely change into looming debt and deficits. Of course, the catastrophists could be dead wrong, as they have been for going on a decade now— but to them, it sure smells like the seventies all over again.
Hedge fund legend Julian Robertson said Friday he expects the U.S. economy is heading for a "doozy of a recession." [¹]
Click here for a link to complete article:
By CNBC | 27 October 2007
"I think we are going to have a doozy of a recession," Robertson told CNBC's Erin Burnett. "I think the credit situation is worse than anybody realizes, and...I think we're getting little inklings of that. I don't think any of the normal indicators you would look at in the economy are really very strong. As a matter of fact, they are weak, and not really getting any better."
Robertson, founder of the investment firm Tiger Management [[one of the first to go bust in the tech bust, I believe: normxxx]], also expressed some concerns about the devaluation of the dollar.
Robertson explained that a weak dollar helps companies that export products outside the U.S. He believes Bernanke is doing what he can to help the economy. "I think in a sense, he is trapped in the sins of his forefathers," Robertson said. "I think he is doing exactly what he can do: ease ease, ease; cut, cut, cut; print, print, print." |
Robertson also discussed some of the stocks he likes, including budget airline Ryanair Holdings, with Burnett, and talked about his interest in "greener" sources of energy such as nuclear power.
Robertson is credited with turning $8 million in start-up capital into more than $22 billion at the peak of the tech boom [[wonder where he wound up: normxxx]].
Normxxx
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