28 February 2009

Debtors Prison

The intellectual fashion has been for companies to have “efficient” balance-sheets. If cash is not immediately needed to reinvest in the business, it should be handed back to shareholders, who can use it more profitably elsewhere. Hoarding cash for a rainy day was seen as a failure of executive imagination.

Corporate-finance theory may state that the value of a company should not be affected by its decision to finance itself with equity or debt. But, in practice, interest payments are generally tax-deductible; dividends are not. That gives companies a big push in the direction of debt.
Buttonwood in the Economist.

27 February 2009

Bill Bonner on Capitalism

What is capitalism, after all? It is not a system...not a plan...not a program. It was not decreed by any half-wit tyrant...nor written into law by any earnest assembly. It has no constitution...and no boundaries. It is merely a recognition of basic principles. 'Thou shalt not steal,' it says in the Bible. Capitalism recognizes other peoples' property. The baker has a right to his oven. The farmer has a right to his land. The capitalist has a right to his money. What they do with these things is up to them.

Will they make mistakes? Of course they will. Will they do evil and obnoxious things? No doubt about it. Will they occasionally lose their heads and overprice their assets...or run the whole economy into too much debt...or blow themselves up in a bubble? You bet.

As Adam Smith described, they will also bumble along to create the wealth of nations.
Bill Bonner on Capitalism.

26 February 2009

German Jokes

About banking.
These days, banks are happy to get robbed. It's a sign they've still got cash left!

I don't trust my bank anymore. I was talking to them about a loan, but I decided not to give them one.
Speigel Online

International Financial Crisis

In the second week of September 2008, the international banking system staggered an almost collapsed after Lehman Brothers went into bankruptcy. Bankers and governments managed to keep the system from going under, but four four major problems still haunt the clever people of the world.

1. Sub-prime Crisis
The collapse of the housing bubble has caused enormous problems for banks. This is often referred to as the subprime crisis, but the problem goes far beyond subprime sectors. Defaults have increased among all borrowers and the shocks have spread to financial institutions throughout America and Europe due to the wide spread securitisation of mortgages.

2. Eastern Europe
European banks are heavily exposed in Eastern Europe. They have fund a housing bubble in these countries, but now with house prices falling and their currencies collapsing, many will be unable to repay their loans. Ambrose Evans-Pritchard at the UK Telegraph tends to be overdramatic, but he provides a good description of the problem.
Western banks that have lent $1.74 trillion to the ex-Soviet bloc -- split between $1 trillion in foreign loans and $700bn in local currency debt through subsidiaries,
3. Synthetic CDOs
A huge problem that has not yet surfaced is synthetic CDOs. These complex financial instruments have been clearly described by Alan Kohler at the Business Spectator. He suggests that that $0.5 trillion of these could be out standing. The sting in the tail is that if eight or nine major named financial institution collapse (five or six have already gone), the holders of these securities will lose their money. This might prove to be a worse problem than the subprime debacle.

4. Private Equity
Over the large decade private equity firms undertook a huge number of leveraged buyouts. The private equity model minimises equity and maximise debt. This has left banks with huge exposure to businesses that are declining in value as their profits collapse. These chickens have still no come home to roost, so the banks are uncertain what their liabilities will be. This is one reason why they are holding extra reserves.

25 February 2009

TARP Visualised

TARP Visualised
A good laugh.

Credit Easing or Quantatative Easing

Stephanie Flanders at Stephanomics tries to find the difference between Credit Easing and Quantatative Easing.
Things are complicated - especially monetary policy things. Central bankers, of all people, have to be precise.

But it's odd that two former teachers, previously known for their crystal clarity, should decide now is the time to be wilfully complex.

I suspect that the real reason they want to distance themselves from QE is that from there, it's only a small leap for commentators to a phrase that people understand only too well: printing money.

But here's the funny thing: they may not be doing QE. But they are very definitely printing money.

24 February 2009

Quantitative Easing

Stephanie Flanders at Stephanomics explains quantative easing.
But the most popular definition of printing money - the one the politicians are terrified of - is simply central bank financing of government deficits. Also known as "monetizing the government debt".

Since the Bank will be purchasing gilts on the secondary market, not from the government directly, the government will almost certainly say that this is not monetizing the debt. To say otherwise conjures up vision of Weimar and Zimbabwe.

To preserve this distinction, the Bank of Japan was legally forbidden to buy debt directly from the Ministry of Finance when they undertook QE in the 1990s.

Funnily enough, the Bank of England faces the same legal constraint: Article 101 of the Maastricht Treaty (of all things) forbids direct central bank financing of deficits.

But it is a distinction without a difference. When the Bank of England buys up gilts, one arm of the government is buying up debt owed by another arm of the government in exchange for money created by the central bank. Whether the gilt is brand new, or issued the day before, is quite simply irrelevant.

23 February 2009

Whisky is a Cure for Alcoholism

Robert Higgs on The Government’s Cure for Alcoholism — Whiskey, More and More Whiskey.
For nearly a decade, Americans acted as though taking on more debt posed no problem. After all, they owned real estate, and all the experts told them that real-estate prices always go up. The mightiest magnates of finance acted as if they believed this stupid story — I say stupid because the merest child might easily have confirmed that real-estate prices have always risen and fallen cyclically and that real-estate booms have often been the precursors of financial crashes and economic recessions. But things are always different this time, are they not?
And his nightmare.
I have this recurring nightmare in which Tim Geithner is lying in a dark corner of a saloon. His bosom buddy Ben Bernanke comes in, sees him lying there in a heap and rushes to his side. He finds his comrade breathing heavily and reeking of a warehouse worth of booze. He shouts for help: “Bartender, get over here quick. Bring this man a whiskey. And make it a double!”

22 February 2009

Economic Miracles

Bill Bonner on Economic Miracles.
In the bubble era people spent too much money they didn’t have on too many things they really didn’t need. Then came the credit crunch. Now, they hallucinate that if they spend even more money they don’t have, on things they hardly even want, they will get what they really need - jobs, growth and inflation. Even respected economists say they believe in miracles.

Resources have been made “idle” by the depression, they claim, like strong backs in an unemployment line. Government spending is just putting them to work. By this reasoning, things that were too expensive even in the boom years miraculously become cheap at any price. And things that weren’t worth spending money on in the fat years become miraculously indispensable in the lean ones.... They are only taking up ‘idle resources’ that would otherwise go to waste, explain the miracle workers.

21 February 2009


Peter Schiff on securitisation and credit.
In the worldview of Geithner and like-minded economists, credit, rather than savings, is the central figure in the economic equation. Therefore, he sees anything that eases the process of lending to be an effective economic policy. With such a view in mind, the centerpiece of Geithner’s plan is the commitment of up to $1 trillion to revive the collapsed market for securitized debt. In the lead up to the Crash of 2008 securitization, more than anything else, permitted Americans to borrow more than they had ever borrowed before.

Developed primarily over the last 10 years, securitization permitted loans of all shapes and sizes to be packaged into investment-ready securities. The system worked, fueling unprecedented levels of lending in the home, auto, student, and credit card sectors. But in the last few years as the collateral underpinning these securities has collapsed in value, the trillions of dollars of securitized debt now in circulation has become the toxic sludge at the bottom of our financial pit. Geithner is making the false assumption that cleaning up and rebuilding the securitization market is a prerequisite for a healthy economy.

Our nation’s short history with wide securitization has simply shown that the process can lead to massive mispricing of assets and risk. By artificially rebuilding the securitization market, and committing taxpayer funds as collateral, the U.S. economy will be pushed farther and farther out on a leveraged limb, until no amount of market medicine can prevent a total economic collapse.

In truth, the only vital function provided by securitization was that it offered foreign savers a pathway to lend directly to American consumers, and Wall Street executives a new asset class to over-leverage for massive profits. Our economy must dispense with these gimmicks if it hopes to pursue a meaningful recovery.

After more than a decade of unsustainable borrowing and spending, the private sector is currently attempting to restore balance through reduced consumer and mortgage credit, greater savings, and lower asset prices. With its trillions of dollars of credit injections and stimulus programs, the government hopes to allay this process by force-feeding Americans a diet of more borrowing. They feel that a restored securitization market will help. It won’t. It will just grease the skids for a quicker collapse.

Credit, whether securitized or not, cannot be created out of thin air. It only comes into existence though savings, which must be preceded by under-consumption....

Geithner stated that government should replace the demand lost by the private sector. However, those with even a marginal grasp of economics know that demand is unlimited. It is the ability to spend that is not. While Americans still want all the things they wanted years ago, they have made the rational choice that they can no longer afford to buy at the same levels they once did. Using a printing press to replace this lost ‘demand’ will simply cause consumer prices to rise. Printed money does not create new purchasing power, but merely redistributes it from savers to borrowers.

19 February 2009

Quantitative Easing

The Bank of England has asked the Treasury for the powers to engage in what is known as quantitative easing -- boosting the money supply. The is true dinkum printing of money.

18 February 2009

Crisis in Europe

Ambrose Evans-Pritchard of the Telegraph reports on problems faced by European Banks.
The region’s banks were coming under severe stress as the property bust combines with a rising debt burden. “Local currency depreciation is a major risk to East Europe banks.

There are contagion worries for Western banks that have lent $1.74 trillion to the ex-Soviet bloc -- split between $1 trillion in foreign loans and $700bn in local currency debt through subsidiaries.

Austria’s banks are the most exposed with the share of risk-weighted assets tied to the region reaching 54pc for Raffeisen and 38pc for Erste Bank. The exposure of Germany’s Bayern Bank is 48pc, Italy’s UniCredit is 45pc, and Swedbank is 29pc.

The region needs to roll over $400bn in foreign debts this year, equivalent to a third of total GDP, raising concerns that it may need a massive rescue programme from the International Monetary Fund and the European institutions.
Many of these banks are also exposed to the American subprime problem.

Reckless Banking

Liam Halligan wrote,
We need desperately to re-impose the split between commercial banks (where you and I deposit money, and which then lend to ordinary businesses) and investment banks (which carry-out higher risk strategies).

The removal of the "Glass-Steagall" firewall in both the US and UK is the prime reason for the current crisis. By merging with commercial banks, leveraging their taxpayer-guaranteed deposits and using them to place reckless bets, the investment banks have destroyed the financial strength of the Western world. Any schoolboy economist can see that. Why can't Gordon Brown or Barack Obama?