Bears Stearns bought out in a stock swap with JP Morgan Chase at $2/share; Bear opened at $53 on Friday morning after the announcement of the Fed/JP Morgan rescue before sliding to a close of $30.
As I type S&P Futures are down about 26 to 1265. The bottom is somewhere, but where and when?
And why is this a bigger crisis than the S&L collapse of the late 80's? After a few rocky years we moved on quite nicely back then.
MORE: OK, Bear Stearns opens at $3.17 and is now trading just below $4. Why? Is another bidder really likely to emerge? My stray guess is that shareholders expect that, after the stock swap with JP Morgan goes through, some entity called "Bear Stearns" will be carved out and spun off. That guess and a buck get you a cold look at a Starbucks - bring a fiver.
And why is this a bigger crisis than the S&L collapse of the late 80's? ...Bus
We are all yellow?
We are all being driven to hell, with Bush in the driver seat...
Posted by: RichatUF | March 16, 2008 at 09:58 PM
No, Bear Stearns was repackaging 'junk' as prime grade securities; they got burned more than most. By itself, it's not unlike what happened to venerable Barings Bank; in part due to Nick Leeson's trade. The last minute Fed injection to Bear Stearns, sends a bad signal; now everyone is going to expect to get bailed out. Mr. Paulson's appearance on This Week was most
dissapointing. The larger point about the S&Ls, Penn Central, Franklin National, (back in the 70s)and other debacles in recent history is on point. Which raises an interesting question, if this downturn is going to be as Mssr. Dunham, or Mrs. Rodham
think; why would they want to win this time
around.
Posted by: narciso | March 16, 2008 at 10:17 PM
I shot my wad linking all those articles throughout the week, and anyway I'm no economist. Nevertheless, I'll take a stab at a partial explanation--nothing to do with the fundamentals: world financial markets are far more integrated than they were in the 1980's, info is more available and money moves exponentially faster, borrowers and lenders of all sorts are more leveraged/extended. This leads--a theory of a non-economist--to more jitteriness and volatility.
There are no lack of comparisons out there to the S & L crisis--all you have to do is google something like "comparison credit crisis s & l crisis".
Here's one comparison, almost at random:
The Credit Crisis: Just How Bad Is It?
by Alexander Green, Chairman, Investment U
Investment Director, The Oxford Club
We all know what's been ailing the financial markets lately - record oil prices, the threat of recession and a stubborn liquidity crisis that refuses to go away.
What caused this credit crisis? What can be done about it? And how long is it likely to last? These are the questions investors everywhere are grappling with right now.
The answer to the first one, of course, is easy. In an effort to stave on a potentially debilitating Japan-style deflation, Greenspan took short-term rates all the way down to 1%.
Predictably, that stimulated the economy and the stock market. It also had unintended consequences. Borrowers were motivated to buy more home than they could afford. Lenders were motivated to make loans they shouldn't have made. And Wall Street took these bad loans - along with some good ones - and turned them into publicly traded securities.
The real problem was masked as long as real estate prices kept rising. But when the housing market rolled over, the jig was up. As foreclosures rose - eventually hitting record levels - the market value of subprime mortgages plunged. Eventually they went "no-bid." No one wanted them. And no one wanted the securitized mortgages that Wall Street created, either.
As the Housing Market Succumbs, The Credit Crisis Evolves
The end of the rising housing market has caused a severe liquidity crisis at the nation's banks. And we're now caught in a vicious circle. The value of home loans falls, forcing banks to take write-offs. That pushes the market lower, causing still more write-offs.
However, this week the Federal Reserve announced its intention to lend up to $200 billion of Treasury securities to primary dealers for a term of 28 days, rather than just overnight. The idea, of course, is to increase liquidity and ease the credit crunch.
Unfortunately, this is just a Band-Aid. The wound has still not been treated. And the credit crisis is likely to persist.
Bank Write-Offs Could Hit $600 Billion During the Credit Crunch
So far the total amount of bank write-offs comes to just over $150 billion in this continuing credit crunch. That is equal to only 1% of U.S. GDP. It is less than 1% of the market capitalization of U.S. stocks.
Two weeks ago, however, a report by UBS said losses among financial institutions could top $600 billion as world credit markets continue to freeze up. That's a lot, even measured by the free-spending ways of Washington. Still, it's not as if we haven't been here before.
As Rich Karlgaard writes in the March 10 issue of Forbes, "The nearest historical comparison we have is the savings-and-loan crisis of 1986-95. On a constant dollar basis - so we can compare apples with apples - the S&L crisis saw $700 billion in bad loans… The S&L crisis caused some damage, to be sure. But during the 1986-95 period, the U.S. economy grew and stocks went up."
Investor Tip: Don't Shrug Off The Continuing Credit Crisis
Don't get me wrong. I'm not suggesting that investors shrug off the credit crisis and get fully invested. Far from it. We're likely to see plenty more market volatility in the weeks ahead.
But when some market commentators argue that "we've never seen anything like this before," take it with a grain of salt. We have been here before. We have survived… and prospered.
Let me add one caveat, however. If housing prices continue to slide and Alt-A and prime mortgages start going the way of subprime debt, we're likely to experience more difficult times than most investors are expecting. So keep your investment posture on the conservative side.
The burden right now is on the Federal Reserve and other central banks to do what they can to help guide the economy through this tough period.
Posted by: anduril | March 16, 2008 at 10:20 PM
narciso-
The last minute Fed injection to Bear Stearns, sends a bad signal; now everyone is going to expect to get bailed out.
The horse left that barn a while ago. And if it were a "bail out" why is it that the deal is going to close with JPM acquiring Bear for 0.05473 of JPM common? Seems more like a fire sale to close up the pot smokers books before they caught all of Wall Street on fire as they had to unwind all their positions.
As I said on the other thread, today (oops, tomorrow) has that Black Monday scary feel to it.
Posted by: RichatUF | March 16, 2008 at 10:41 PM
All that to say Federal Reserve has to bail out? Bush bailed the mortgageholders and Merrill admitted to like 30 billion over a few months. Bear should go under. Merrill should have gone under. The buyers from China or wherever are going to lose and the Fed can't do anythinng about it.
Posted by: SK | March 16, 2008 at 10:49 PM
Bears Stearns bought out in a stock swap with JP Morgan Chase at $2/share; Bear opened at $53 on Friday morning after the announcement of the Fed/JP Morgan rescue before sliding to a close of $30.
$53/share to $2/share essentially overnight--OUCH! Jittery hardly begins to describe what the mood will be like when the market opens tomorrow.
Posted by: anduril | March 16, 2008 at 10:57 PM
I highlighted the scare quotes:
Dollar Doomsayers Draw Signs From Bernanke Rate Cuts (Update1)
By Bo Nielsen
Enlarge Image/Details
March 17 (Bloomberg) -- Ben S. Bernanke's interest-rate cuts have touched off a vicious circle of doom for the dollar.
The Federal Reserve reduced the rate on direct loans to commercial banks by a quarter-point to 3.25 percent before Asian financial markets opened today. It will likely lower its target rate for overnight loans between banks tomorrow to at least 2.25 percent from 3 percent, according to futures traded on the Chicago Board of Trade. Lower borrowing costs work against the dollar by making fixed-income securities issued by the government less appealing to global investors.
``The relative return on U.S. assets is not attractive enough and we have moved back into looking for dollar weakness,'' said Robert Robis, a bond fund manager in New York at OppenheimerFunds Inc., which oversees $260 billion. Robis last month was betting the dollar would rally versus the euro.
If that weren't enough to make bears out of bulls, the weakest dollar since at least 1971 based on a Fed trade-weighted index is helping push oil, grains and metals, which are priced in the U.S. currency, to record highs. That in turn is causing economists to lower growth forecasts for the U.S. and preventing central banks concerned that inflation is accelerating from cutting interest rates, further undermining the dollar.
``The whole world feels there's inflation when a good part of that is the weak dollar itself,'' said Stephen Jen, head of global foreign-exchange research at Morgan Stanley in London. ``Watching the dollar plummet like this is very dangerous.''
...
`Down the Tubes'
``It's hard to stimulate an economy when the currency is going down the tubes,'' said David Malpass, the chief economist at Bear Stearns & Co. The New York-based firm expects the dollar will fall to $1.60 per euro in 12 months.
The U.S. economy may expand 1.4 percent this year, according to the median estimate of 82 economists surveyed by Bloomberg News this month. The median in March was for growth of 1.7 percent. As recently as September the Fed's target rate was 5.25 percent.
Global investors see little reason to own U.S. financial assets with the two-year Treasury yielding 1.48 percent, or 1.73 percentage points less than similar-maturity German bunds. The gap reached 1.80 percent on March 6, the widest since 1992. Foreign purchases of U.S. financial assets slowed in each of the final three months of 2007, to a net $56.5 billion from $113.9 billion, according to the latest Treasury Department data.
As the currency fell, the UBS Bloomberg Constant Maturity Commodity Index of 26 commodities ranging from energy, metals, agriculture and live stock rose 43 percent in the past 12 months, the biggest increase since the index's inception in 1998. The price of a barrel of crude oil surged 89 percent in a year to an all-time high of $111 on March 13.
Commodities Hedge
``A lot of people out there are using oil and other commodities as hedge against a falling dollar,'' said Simon Wardell, manager of energy research at Global Insight Inc. in London. ``We could get to $120 in oil if we continue to see weakness in the U.S. dollar.''
...
Relief may be in sight. The International Monetary Fund in Washington said last month that oil prices may be peaking as growth slows. The median forecast of 34 analysts surveyed by Bloomberg is for the dollar to gain about 11 percent against the euro this year and 4 percent versus the yen as the Fed's rate cuts spark the economy in the second half of 2008.
``If the U.S. dollar turns higher or if the crude oil market reverses then we have a spiral working the other way,'' said Tim Evans, an energy analyst at Citigroup Global Markets Inc. in New York. The price of crude oil will at $70 by September, Evans said.
`Major Concern'
...
Inflation in the euro zone rose at a 3.3 percent annualized pace last month, the fastest in 14 years, the European Union's statistics office in Luxembourg said March 14. Consumer prices in the U.S. were unchanged in February, the Labor Department said.
Kenneth Rogoff, the former chief economist at the IMF and now a professor at Harvard University, said the greenback may drop another 12 percent on a trade-weighted basis.
``This recession will be long and deep and when we get out of it, we'll have inflation,'' Rogoff said in an interview. ``Confidence in the dollar is down.''
Posted by: anduril | March 16, 2008 at 11:08 PM
anduril-
There are no lack of comparisons out there to the S & L crisis--all you have to do is google something like "comparison credit crisis s & l crisis".
If the S&L crisis was at 700 billion nearly all in the US and the sub-prime crisis is somewhere in the neighborhood of 600 billion spread globally (with over a decade of global economic growth on top of that), isn't the reaction a bit odd. It is as if people believe that somehow the US is putting out the "Going Out of Business" sign tomorrow-ridiculous. First the "stagflation and the worst economy since the 1970's", now its "depression and worst economy since the 1930's"-if all that were true, commodities (even gold) wouldn't be anywhere near their current prices because demand globally would plumment (and probably will with the passing of the Beijing Games), deflation would be the rule of the day, and unemployment would skyrocket to double digits. And it wouldn't be contained to the US, it would spread ever where, quickly.
I suppose that some on Wall Street might be trying to get the Fed to blink so they will buy up all the rot and then they go into their books and sell all the worthless junk with the legal hassles for 10 cents on the dollar. We'll see...
Posted by: RichatUF | March 16, 2008 at 11:15 PM
They're throwing up in waste baskets in Asia this morning.
Anduril,
That's solid advice. The only thing I would add is that learning how to do cap rates for the rental value of houses will give you an idea about when the housing backed issues have gone to a real buy. Most of the junk issues average $200K per mortgage. JPM/Chase picked up a ton of value for literally pennies on the dollar.
That Great White is going to be giving off satisfied burps for years.
Posted by: Rick Ballard | March 16, 2008 at 11:17 PM
I have a particular interest in this (but sadly no particular knowledge) because I just moved my upper 80's parents into assisted living and now I'm trying to sell their condo. Even in a desirable market that will remain desirable come what may, people are leery of buying right now.
Posted by: anduril | March 16, 2008 at 11:22 PM
Rent or lease it. If cash is needed then finance against the lease. Two years from now you'll look like a genius when you sell. If you don't want to deal with tenants then hand it over to a property management outfit.
Posted by: Rick Ballard | March 16, 2008 at 11:29 PM
anduril-
``A lot of people out there are using oil and other commodities as hedge against a falling dollar,'' said Simon Wardell, manager of energy research at Global Insight Inc. in London.
Think about how many are piled into that trade, if everyone else is in that trade and no there are no more buyers, how quickly will it fall. No one is going to stand under that knife especially since this type of market behavior puts a lie to the "we are running out of oil" argument-if we were, people would not be able to buy it as a currency hedge. And if we are going into recession global oil demand is going to wane as well.
Asian market update: S&P down 32, Dow down 200, gold surging up 32, and Asian markets broadly lower in the 3.5% to 5.0% range. Its going to suck in Europe too.
Posted by: RichatUF | March 16, 2008 at 11:40 PM
as the Fed's rate cuts spark the economy in the second half of 2008.
I don't see it happenin. The Bush tax cuts, specifically the accelerated depreciation provisions, have already sparked an awful lot of upgrading and investing in businesses. I jut can't beleive that lowering the interest rate any further is going to have much effect, other than torpedoing the $.
Posted by: Pofarmer | March 16, 2008 at 11:41 PM
Rick, that's what we're having to think about.
Rich, somewhere in that article it says re the oil hedge thing, "If the U.S. dollar turns higher or if the crude oil market reverses then we have a spiral working the other way."
I've heard oil analyst after analyst say that the fundamentals just don't support these prices.
Posted by: anduril | March 17, 2008 at 12:06 AM
JP brought mortgages or penny stock? Bear has penny value, I doubt there were many mortgages. If the other buyers at Merrill etc. could have bought mortgages for that, they would have; I don't think it's the same deal. If it is, the buyers are going out of business.
The futures business sure picked up on the margin news for those mortgages. 1%? Oil is going up either way, it's neat to have it hover around like 110/115 before shooting up to 150. We're all smart.
Posted by: ece | March 17, 2008 at 01:05 AM
"A lot of people out there are using oil and other commodities as hedge against a falling dollar,''
I don't know about other commodities, but those using oil as a hedge are going to have an unpleasant surprise...watch oil prices dive real soon.
Posted by: ben | March 17, 2008 at 01:36 AM
Lehman is most likely the next shoe to drop.
Posted by: glasater | March 17, 2008 at 02:39 AM
I've heard oil analyst after analyst say that the fundamentals just don't support these prices
Well just take a squint at what's been going on in the wheat markets. Ten dollar plus a bushel?
Posted by: glasater | March 17, 2008 at 02:51 AM
Glasater
Looking at the Fundamentals.
Wheat is probably the MOST solid of the Ag commodities trading right now. What about corn that went over $6??? Beans at $16.00??? Granted, they've backed off from those positions some. There is a long ways to go down, if it decides to drop for whatever reason. If these funds have to start to remove funds from the commodities markets to make margin calls in their other investments, the whole house of cards could collapse.
Posted by: Pofarmer | March 17, 2008 at 10:00 AM
May I recommend a read of Paul Krugman's article today? The B Word. That's as in TPB or TB: Taxpayer Bailout--and Krugman says it's coming. Personally, I expect it. Krugman says the main thing is to bail out the system, not the people who screwed up. And he has harsh words for Bear Stearns.
I'm interested in reactions to Krugman's article. Here are a few grafs:
(h/t bro)
Trillions? So maybe the Street has reason to worry.
BTW, here's the WSJ's lead editorial:
The Buck Stops Where?
They insist that attention should be payed to the dollar unless we want a true crash:
Obviously, I don't know the truth of all this, but I do know this: the outcome of this mess will have a profound effect not merely on the economy but also on the political future of the US. It's disturbing to me that the WSJ clearly has no confidence in the leadership. If they're wrong, I'd like to know why. I'd love to read an explanation of all this in terms I can understand.
Posted by: anduril | March 17, 2008 at 10:07 AM
Hmmm.
They're throwing up in waste baskets in Asia this morning.
...the whole house of cards could collapse.
Lehman is most likely the next shoe to drop.
Its going to suck in Europe too.
I jut can't beleive that lowering the interest rate any further is going to have much effect, other than torpedoing the $.
Buy signal.
Posted by: Charlie (Colorado) | March 17, 2008 at 10:10 AM
Interesting combination, hey? Krugman and the WSJ?
Anyway, I forgot to include this from the WSJ (but go read the whole thing):
Posted by: anduril | March 17, 2008 at 10:12 AM
So, are we still going to have our 401ks by April Fools Day?
from Steve Sailer's iSteve Blog by Steve Sailer
Just asking ...
Posted by: anduril | March 17, 2008 at 10:50 AM
Right next to Krugman's article at Real Clear Markets is this one from Bloomberg regarding housing and regulations that seems pretty reasonable.
Posted by: glasater | March 17, 2008 at 10:53 AM
glasater, I have a hard time accepting planning regulations in 10 states as a global explanation for what ails our financial system. I'm certainly always open to the idea that government regulation has screwed things up, but there's got to be more to it than what the author has to tell us.
Posted by: anduril | March 17, 2008 at 11:30 AM
So what happened in the rating agencies that this garbage got rated AAA?
==============
Posted by: kim | March 17, 2008 at 11:31 AM
Anduril,
Interesting stuff. Love it that the WSJ article quotes a Bear economist to tell us what's going on. Malpass is great but the irony is glaring.
Krugman is wrong as the BSC honchos (the ones who caused the mess, in his own words) aren't getting bailed out. Safe to assume that the average BSC employee had a very substantial portion of their net worth tied up in company stock. $2? Hardly sounds like a bail out. You could certainly make the case that Morgan will reap windfall profits, however.
Posted by: Chris | March 17, 2008 at 11:31 AM
Good to see a contrarian in the group Charlie!!!
BTW, does anybody have a handle on the inflation to wholesale producers???? I gotta tell ya, it's gotten pretty radical out here in the country. Your average joe blow consumer is just getting a little sip of the tiger we've been playing with the last 3 years.
Posted by: Pofarmer | March 17, 2008 at 11:35 AM
Oh, yes, PoF and Charlie, it looks like a buy signal to me. The prices of all the things needed to build a house aren't going to go down. Land won't, and I'll bet that wages won't fall much now.
There was a bank in Texas which tanked in the oil bust, the Feds took it over, but the underlying assets improved while the Feds were paying off depositers so that there was value left at the end. The directors sued to get their company back and the shareholders who at one time thought they'd lost it all ended up rich beyond their most avaricious dreams. Well, those contrarians who bought the stock as it tanked, doubling down everytime the stock price fell in half. Some paid one and 3/8ths for what later hit 50. Oh to be young and in love again.
=============================
Posted by: kim | March 17, 2008 at 11:42 AM
Chris, I'm not a Wall Street guy and claim no inside knowledge. I have no idea what an economist does at an investment bank--like, what effect does he have on investment policy? Does he make recommendations, or just supply an overall economic forecast? Of course I noticed Malpass' background and the irony of it. Noting that, however, is not a refutation of his argument--it's not even much of a counter argument. I'm looking for some convincing analysis that I can understand.
As for the BSC honchos, I haven't a clue as to their personal outcome from all this. Will they wind up selling pencils on street corners? Somehow I doubt it. This is probably the first Krugman article that I've read from beginning to end. $2 a share isn't great, but it still beats zero. But the bailout Krugman is talking about is still in the future, and his concerns that there should be some accountability are valid--and shared by the WSJ.
Posted by: anduril | March 17, 2008 at 11:45 AM
I moved my whole HSA account from money market funds into stock mutual funds this morning. Since the US did not follow Europe, we may well be at rock bottom. Dow Jones below 11900 and has been to 14000 previously, that is not quite 18% of upside. Not mention future growth. If its not time to buy, its real hard for me to see much more downside. A chartist would look at a triple testing of the bottom as a buy sign, just sayin...
Posted by: GMax | March 17, 2008 at 11:51 AM
Kim,
The strong buy was JPM at the open this morning - that would have netted you more than 10% in less than 4 hours. Lehman might be a buy but overall the panic level isn't quite high enough - the ten year bond still hasn't touched the January low, although it's getting close. Asia sold off early last night and then just milled around the rest of the session. A nice panic down below 11K on the Dow would be a real buy signal. We might get there in a few days but I think the economic fundamentals are probably too strong (or not weak enough) for it to happen.
Posted by: Rick Ballard | March 17, 2008 at 11:59 AM
JPMC is up 10 pct ... someone thinks buying Bear as a fire sale was good.
Posted by: Charlie (Colorado) | March 17, 2008 at 12:00 PM
A,
Yes, accountability is good. I think both are correct that we need a stable dollar. A strong dollar is not imperative but stability is, imo.
Posted by: Chris | March 17, 2008 at 12:02 PM
Not just good, Charlie. JPM made one of the all time best deals, period. If I bought equities I'd grab it right now even at plus 10% for the day.
Posted by: Rick Ballard | March 17, 2008 at 12:03 PM
Yeah, those sorts of comments look like a capitulation to me.
Posted by: Charlie (Colorado) | March 17, 2008 at 12:07 PM
Anduril--
Well, everyone (pundits/whomever) are casting about for some type of solution. Some (Schumer perhaps) are thinking more regulation by government down the road.
The article was just a counterpart--kinda--to that sort of thinking.
Posted by: glasater | March 17, 2008 at 12:16 PM
As of right now its 54 points down on the Dow. Average days of absolutely no significance have more movement than this. I see nothing other than momentary panic that allowed some folks to scoop up some bargains. Hopefully I am in the second group.
I would love to see a drop below 11k Dow for that very reason, but I just dont think its in the card.
Last I checked Oil was off pretty substantially but no one was talking about it.
Posted by: GMax | March 17, 2008 at 12:27 PM
Typo 154 points.
Posted by: GMax | March 17, 2008 at 12:28 PM
From my perspective the underlying causes of the current crisis area:
1. America's vulnerablity in the oil market. Gold has risen to over $900 largely because our economy is vulnerable to an oil shock and Russia, Iran and Venezuela are trying like crazy to create that shock.
The dollar and the "full faith and credit" of Anerican financial system are what the world relies upon for safe, low risk, predictable and profitable investments. We cannot allow our system to be vulnerable, but have done it anyway. We must defend our financial sytem. We are now paying a risk premium for our unsafe world. We should have been drilling for oil in alaska and along our coasts long ago, or at least building refineries to refine our vast oil shale deposits. We have opportunities in other energy fields like nuclear and wind energy that are largely untapped.
2. The Fed has not understood the world we live in. In the nearly 2 1/2 years since Bernacke took over the Fed, the money supply has not grown. The reason supposedly was to fight inflation and counter the rising cost of gold and other commodities. Yet, the price of gold has continued to rise. The tools available to the Fed are just insufficient to fight our oil problem.
However, the Fed forgot that there will always be a severe credit crisis if you don't have a reasonable increase in the money supply. The financial press has not reported this basic fact.
3. The sub prime crisis in itself was caused by the restriction of credit by the Fed in combination with severe relaxation of qualifications for a mortgage by lenders. A disaster waiting to happen. All of above was also accentuated by deriatives that hid the true value of the risk.
These lax standards were imposed by Congress. People forget or perhaps never knew, that the sources of the S&L crisis were also Congressional rules and lack of oversight.
4. The high cost of new housing. The cost of construction of a new home has skyrocketed in the past decade due to planning restrictions in many of the hottest markets and the ever increasing cost of construction.
America is not building enough new homes to house it's people. The number of new units is several hundred thousand short of new family formation every year. Supply is not meeting demand, so the price goes up. The difficulty and cost of securing building permits is some area like California where I work is getting extreme.
The cost of construction has nearly tripled in the last decade. It appears the biggest increases in cost have been in those construction materials that can be sold on the world market like commodities like lumber , steel, plywood, drywall, piping etc.
This rise is still going on; the cost of drywall went up 10% just a few weeks ago in a down market.
These construction cost increases seem caused by again high regulatory costs. Makers of construction materials either cannot increase capacity to meet demand because of regulation, or have chosen because of high regulatory cost and risk not to do so. Again a short supply leads to higher cost.
Almost all of the commentary I've seen seems unaware of this construction cost problem. The cost of all housing will rise in a market where demand for housing is high because of replacement cost . The price of housing is not likely to fall that far as long as there is not a severe recession. Contrary to national reporting, the cost of housing in better areas where there is limited supply is still rising. Cost is falling in new tract, and low income areas, where there are more foreclosures.
The Fed is way late in addressing this financial crisis. They have let this problem is spiral out of control. However, the underlying problems are not just financial. The underlying problem is that we have let the Environmental loon lobby control too much of our economy. We need to produce more oil and other energy. And we need to produce more housing at a reasonable cost. Until we get back to a reasoable regulatory environment , our problems will continue to get worse.
Posted by: Paul | March 17, 2008 at 12:29 PM
Glasater,
The article you cited had more to do with reality than anything Krugman wrote. That Rubin fellow he used as his shield was pretty well known around CITI before it took its 60% haircut.
If Hassett had more room I'm pretty sure he would have gone into the current practice of loading developers fees with stuff that used to be financed by 30 year bond issues - thereby driving developed lot prices up to the point where you get a nice big phony jump in the price of housing. Theoretically, the plus side should be de minimus increases in property taxes. Somehow that never quite works out.
Posted by: Rick Ballard | March 17, 2008 at 12:32 PM
BTW
BS having to take the pain to shareholders of a $2 sale is exactly the market correction needed to end this "crisis" JPM will now have a very low basis in some of these mortgage pools and CMOs and can peddle them off. Once some sales occur and guys start bragging at the Country Club about how much they made on buying some cheap CMOs, then others will want to buy. Now several more hedge funds may need to fail but we at the beginning of the solution. Government needs to stay the hell out of the way and let markets correct themselves, it will happen.
Posted by: GMax | March 17, 2008 at 12:41 PM
anduril-
$2 a share isn't great, but it still beats zero.
It is a stock transaction in which 1 BSC share is traded for .05-ish of JPM. It isn't a bailout, Bear Stearns doesn't exist as an independent entity anymore. The Fed action on Friday in which JPM was used as a conduit for the liquidity issues surrounding an orderly wind down of Bear's positions. If they didn't adopt that structure and Bear collapsed Friday we would probably still be seeing its books unwind and spread to other banks. This is the function of the Fed-an orderly functioning of markets.
The two arguments flying around: a hands off laissez faire approach doesn't exist because of the tools all ready in existence at the Fed and Treasury. The other extreme is to create a host of new rules and regulations in a panic in the face of federal elections making the current legal uncertainty that much greater. New panic made rules (like Sar-Box)would add another level of cost uncertainty on top of the already extreme level of legal risk floating on top of the sub-prime crisis. This cost will drag the pain out, not shorten it.
Posted by: RichatUF | March 17, 2008 at 12:44 PM
GMax,
This is the the other side of that coin. Detroit and Cleveland were the real garbage dumps of sub-prime. As I mentioned the other day, JPM has had four months to assess the change to the loss ratio caused by the expiration of freebie starter rates on the 2/24 series. The very worst months (in quantity terms) were October and November.
If the hit in the worst places is 26% I don't think there's much to worry about.
Posted by: Rick Ballard | March 17, 2008 at 01:00 PM
Rick @ 12:32--"What you said":-)
That's pretty much what is going on in our community.
Posted by: glasater | March 17, 2008 at 01:01 PM
Well all the talk about rising foreclosures scares folks, but it has been confined in the main to California, Florida and Michigan in large measure. That Michigan is seeing folks snap up bargains is encouraging. That means over time the foreclosures disappear and the market price begins to firm and then rise.
Don't forget that JPM got several platforms, including a retail brokerage platform that has to have substantial value all in itself. I would think that the junk assets all had zero allocated to them with so low of a purchase price. When you have nothing invested in something and you sell it for anything you get a gain. That is why JPM stock jumped.
Posted by: GMax | March 17, 2008 at 01:12 PM
Thanks to everyone for the comments. glasater, I understood your perspective as to regulation's impact and agree in general, but I suspect there's more to what's going on--while having no expertise. We'll see, hopefully fairly soon, how things shake out.
Posted by: anduril | March 17, 2008 at 01:20 PM
One of the market commenters I sometimes follow has this nugget from his missive today:
in one fell swoop JPM could get the intellectual capital, the personnel, and a book-of-business that was decades in the making. Furthermore, with JPMorgan’s balance sheet backing them up, many of Bear’s structured vehicles will likely find better “footing.” I think it is a brilliant move on Jamie Dimon’s part. As for the equity markets, they are clearly involved in a “selling panic,” while the commodity and Treasury markets are into “buying panics.”
However, for the well-prepared investor this kind of volatility affords opportunity. Remember, the Japanese kanji symbol for the word “crisis” consists of two characters. One of them represents “danger,” the other “opportunity.” I continue to invest accordingly.
Posted by: GMax | March 17, 2008 at 01:31 PM
I have a hard time accepting planning regulations in 10 states as a global explanation for what ails our financial system.
I don't think it makes sense either--the claim is that it drives up prices by restricting new construction. But that's a local issue; the problem on the national scale has been (with hindsight) overbuilding.
I think the problem has been the Fed--first keeping interest rates so low in the early part of the decade, then overreacting by inverting the yield curve in 06-07, and waiting too long to bring rates back down again. (Full disclosure: I used to work there, and was complaining about these things at the time, but no one listened.)
Posted by: jimmyk | March 17, 2008 at 01:49 PM
jimmyk, this story seems to support your view:
Foreign investors veto Fed rescue
By Ambrose Evans-Pritchard, International Business Editor
Last Updated: 1:13pm GMT 17/03/2008
As feared, foreign bond holders have begun to exercise a collective vote of no confidence in the devaluation policies of the US government. The Federal Reserve faces a potential veto of its rescue measures.
Asian, Mid East and European investors stood aside at last week's auction of 10-year US Treasury notes. "It was a disaster," said Ray Attrill from 4castweb. "We may be close to the point where the uglier consequences of benign neglect towards the currency are revealed."
The share of foreign buyers ("indirect bidders") plummeted to 5.8pc, from an average 25pc over the last eight weeks. On the Richter Scale of unfolding dramas, this matches the death of Bear Stearns.
Rightly or wrongly, a view has taken hold that Washington is cynically debasing the coinage, hoping to export its day of reckoning through beggar-thy-neighbour policies.
It is not my view. I believe the forces of debt deflation now engulfing America - and soon half the world - are so powerful that nobody will be worrying about inflation a year hence.
Yes, the Fed caused this mess by setting the price of credit too low for too long, feeding the cancer of debt dependency. But we are in the eye of the storm now. This is not a time for priggery.
The Fed's emergency actions are imperative. Last week's collapse of confidence in the creditworthiness of Fannie Mae and Freddie Mac was life-threatening. These agencies underpin 60pc of the $11,000bn market for US home loans.
With the "financial accelerator" kicking into top gear - downwards - we may need everything that Ben Bernanke can offer.
...
Is this the moment when America finally discovers the meaning of the Faustian pact it signed so blithely with Asian creditors?
As the Wall Street Journal wrote this weekend, the entire country is facing a "margin call". The US has come to depend on $800bn inflows of cheap foreign capital each year to cover shopping bills. They may have to pay a much stiffer rent.
As of June 2007, foreigners owned $6,007bn of long-term US debt. (Equal to 66pc of the entire US federal debt). The biggest holdings by country are, in billions: Japan (901), China (870), UK (475), Luxembourg (424), Cayman Islands (422), Belgium (369), Ireland (176), Germany (155), Switzerland (140), Bermuda (133), Netherlands (123), Korea (118), Russia (109), Taiwan (107), Canada (106), Brazil (103). Who is jumping ship?
The Chinese have quickened the pace of yuan appreciation to choke off 8.7pc inflation, slowing US bond purchases. Petrodollar funds, working through UK off-shore accounts, are clearly dumping dollars amid rumours that Gulf states - overheating wildly - are about to break their dollar pegs. But mostly likely, the twin crash in the dollar and US agency debt reflects a broad exodus by global wealth managers, afraid that America is spinning out of control. Sauve qui peut.
The bond debacle last week tallies with the crash in the dollar index to an all-time low of 71.58, down 14.6pc in a year. The greenback is nearing parity with the Swiss franc - shocking for those who remember when it was 4.375 francs in 1970. Against the euro it has hit $1.57, from $0.82 in 2000. Against the yen it has smashed through Y100. Spare a thought for Toyota. It loses $350m in revenues for every one yen move. That is an $8.75bn hit since June. Tokyo's Nikkei index is crumbling. Less understood, it is also causing a self-reinforcing spiral of credit shrinkage throughout the global system.
Japanese investors and foreign funds are having to close their yen "carry trade" positions. A chunk of the $1,400bn trade built up over six years has been viciously unwound in weeks. The harder the dollar falls, the further this must go.
It is unsettling to watch the world's reserve currency disintegrate. Commodities from gold to oil and wheat are taking on the role of safe-haven "currencies". The monetary order is becoming unhinged.
I doubt the dollar can fall much further. What is it to fall against? The spreading credit contagion will cause large parts of the globe to downgrade in hot pursuit - starting with Europe.
Few noticed last week that the Italian treasury auction was also a flop. The bids collapsed. For the first time since the launch of EMU, Italy failed to sell a full batch of state bonds.
The euro blasted higher anyway, driven by hot money flows. The funds are beguiled by Germany's "Exportwunder", for now. It cannot last. The demented level of $1.57 will not be tolerated by French, Italian and Spanish politicians. The Latin property bubbles are deflating fast.
The race to the bottom must soon begin. Half the world will be slashing rates this year to stave off credit contraction. The dollar will have a lot of company. Small comfort.
Posted by: anduril | March 17, 2008 at 02:33 PM
The Dow is off a $1 right now, can we give the huge crisis thing a rest for awhile now?
Posted by: GMax | March 17, 2008 at 03:02 PM
A Canadian perspective, with predictions:
http://network.nationalpost.com/np/blogs/francis/archive/2008/03/17/canus-is-divided-by-common-language.aspx
Wall Street: casino meltdown
Posted: March 17, 2008, 4:16 AM by Diane Francis
Greed, Canadian Politics, U.S. Politics, China, Energ
It's looking like the perfect storm.
Wall Street, like its Sheriff Eliot Spitzer who was destroyed last week by his excesses, is a casino in meltdown mode after years of derivative and debt nonsense. Bear Stearns, its fifth largest investment bank, was bought by JP Morgan for cents on the dollar as part of a weekend emergency package cobbled together by the Federal Reserve to save the street.
But this won't stop the contagion from spreading. Euro markets fell as the currency rose. Asian markets fell overnight on the news. And the violence in Tibet against the Dalai Lama's monks has reminded the world as to how vulnerable China is too, politically and economically.
Of course, all of this will feed on itself. Always does. The derivatives are embedded throughout the global economy. More surprises will be around the corner. More bad news will scare off stock and property investors, shaken already by the fallout from the sub-prime lending practices which were enhanced and spread by the casino. In addition, there is the thoroughly unpopular and increasingly unaffordable war in Iraq along with China's vulnerability. But the toxins that have created roiling markets, and a move toward buying real things, is the derivatives that Bear Stearns and others specialized in.
What's next
No one knows what will happen, but common sense, and living through a few of these emergencies, would dictate the following likely outcomes:
-- The U.S. dollar will continue to fall against other currencies.
-- Oil will march toward $150 a barrel and other commodity prices will continue to increase, as investors race toward holding real things instead of currencies.
-- Gold will march toward $1,500 an ounce as worries about the debt contagion spread.
-- Last week, the Euro zone of 15 countries became worth more than the U.S. dollar zone, and will continue to be used as a preferred reserve currency, thus aggravating the U.S. dollar's decline.
-- Central banks outside the U.S. will be forced to cut interest rates as the Americans must to prop up economies.
-- Banks and brokers around the world will be shakier and more bailouts -- possibly another on Wall Street -- will occur.
-- Canada's spoiled chartered banks/brokers will start their whining to merge again, blaming the crisis as another lobbying technique.
-- The credit bailout plus the U.S. Presidential election will postpone the bankruptcies, foreclosures and writedowns that must be made in mortgages in order to clean up the housing market. And a lousy housing market means the recession will take root in the U.S. and elsewhere.
-- Canada and Australia are lucky. Both will continue to boom, along with commodity prices, and the Canadian dollar will move up in tandem.
-- Economics will trump Iraq in the U.S. political contests this summer, forcing McCain to choose Romney as a running mate and the Democrats to sharpen up their CEO cred too.
Posted by: anduril | March 17, 2008 at 03:10 PM
"The share of foreign buyers ("indirect bidders") plummeted to 5.8pc, from an average 25pc over the last eight weeks."
Wow! Holy Batman - that must mean... well, absolutely nothing except for the fact that Americans picked up the slack. Oh, and the Treasury paid 74 basis points less in interest than they did in November.
"As of June 2007, foreigners owned $6,007bn of long-term US debt. (Equal to 66pc of the entire US federal debt)."
Absolutely shocking.
The way they conflate an aggregated holding consisting of private and Treasury debt to put a hook on "66pc of the entire US federal debt" is dreck journalism at its worst. How ignorant do they assume the average Brit to be by peddling this tripe?
Posted by: Rick Ballard | March 17, 2008 at 03:12 PM
Oil down around $5 a barrel last time I checked. Seems like with oil reserves and storage rising, that its a lot more likely to drop than it is go up another 50%. But beat the drum.
Posted by: GMax | March 17, 2008 at 03:14 PM
I read Greenspan's article, the one in which he says "The current financial crisis in the US is likely to be judged in retrospect as the most wrenching since the end of the second world war." Basically, his position is, hey, nobody could've known--it was nobody's fault.
Posted by: anduril | March 17, 2008 at 03:17 PM
The way they conflate an aggregated holding consisting of private and Treasury debt to put a hook on "66pc of the entire US federal debt" is dreck journalism at its worst. How ignorant do they assume the average Brit to be by peddling this tripe?
No more than they usually do.
Posted by: Charlie (Colorado) | March 17, 2008 at 03:17 PM
BTW Dow now up 30 points. Some crisis.
Posted by: GMax | March 17, 2008 at 03:21 PM
And a British perspective: the Times of London beats the drum. They wrote too early in the day to know that the DOW would be stable in the middle of the day and the price of oil would come down a bit--too early to realize that our troubles are past and there never was anything to worry about. As it is, they sound slightly hysterical. Here's what they wrote:
From The Times
March 17, 2008
Bear Necessities
The collapse of Bear Stearns may herald worse to come in financial markets
The travails of the financial markets have hit a new level of seriousness with the collapse of Bear Stearns, America’s fifth-largest investment bank. It survived the Great Depression, but could not overcome the current freeze in credit markets. Even last week’s use of a Depression-era provision by the US Federal Reserve, which allowed the bank access to emergency funds, was not enough to prevent investors losing confidence.
The US authorities now face a momentous task: to restore calm in markets which are more diversified than at any time in history. Even if big banks can keep a steady nerve, many smaller investors do not have the wherewithal to sit out the crisis. Bear Stearns is unlikely to be the last American casualty: several highly geared hedge funds are rumoured to be close to collapse. The risk is that panic will ripple ever more strongly through stock markets and economies alike.
This is a different kind of crisis from those which have gone before. The extent of the contagion is greater, and the damage has been less visible. There has been no single 9/11-style shock: this situation is home-grown within the banking system. Abetted by complacent regulators and rating agencies, financial institutions have indulged in a reckless game of pass-the-parcel with securitised loans. The fact that so many of these dubious securities are still hidden in balance sheets makes it difficult for the public to understand the scale of the problem.
So why let greedy bankers off the hook? Last week’s move by the Federal Reserve effectively ripped up the rule book of central banking by giving broker-dealers like Bear Stearns the kind of help that was previously available only to retail and commercial banks. Few people will weep for Joe Lewis, a big investor in Bear Stearns, who is thought to have lost almost $1 billion, though Spurs fans will – he also owns Tottenham Hotspur, the North London football team.
The answer is that this crisis is now far too deep to indulge in the academic concerns about moral hazard which made the Governor of the Bank of England so reluctant to help Northern Rock last year. The financial system is intimately connected with every other. At stake is the world economy and the living standards of millions of people. To lose one hedge fund might be mildly unfortunate but to lose a financial intermediary like Bear Stearns, at the heart of a complex web of global transactions, is a calamity. It is impossible to know how many more dominoes may fall as a result. It is important that financial institutions learn the lessons of their folly. But this crisis needs to be resolved quickly and explained later. The decisive and creative actions of Ben Bernanke, Chairman of the Fed, have been impressive. He is expected to cut interest rates tomorrow, perhaps to 2.25 per cent, down from 5.25 per cent only six months ago.
A big move will be the right move, not only for America but for all the other nations now hanging in the balance. For the argument that America’s economy has been “decoupled” from the rest of the world looks increasingly theoretical, as stock markets gyrate and banks the world over face higher costs of borrowing. Alistair Darling’s repeated statements about Britain’s “resilience” in last week's Budget look increasingly naïve. The only way out of this crisis – and the word has rarely been better applied – is for the US authorities, acting in concert with central banks elsewhere, to continue their forthright assault on the panic.
Posted by: anduril | March 17, 2008 at 03:29 PM
Oh, just piffle..anduril--go get a stiff drink, have fun and come back next week.
Posted by: clarice | March 17, 2008 at 03:31 PM
Almost self explanatory: if we're to believe Phil Flynn, the pullback of oil prices from record highs is a sign of increased worries.
AP
Oil Plummets on Economy Worries
Monday March 17, 3:24 pm ET
By John Wilen, AP Business Writer
Oil Prices Plunge on Concerns That the Crisis Facing Bear Stearns Will Widen
NEW YORK (AP) -- Oil prices plunged Monday, pulling back at least temporarily from record levels as investors feared that the financial crisis that forced the sale of Bear Stearns Cos. is a sign of deep economic trouble.
Crude's plunge came even as diesel prices rose to a new record above $4 a gallon, and gas prices remained high. Diesel, used to transport the vast majority of the nation's goods, rose 1.3 cents to a national average of $4.002 a gallon Monday, according to AAA and the Oil Price Information Service. The national average price of a gallon of gas, meanwhile, dipped slightly to $3.283 a gallon, but remains 73 cents higher than a year ago.
Oil's steep decline -- falling $4.53 to settle at $105.68 a barrel on the New York Mercantile Exchange -- came hours after futures reached a new trading high of $111.80 on the Federal Reserve's move Sunday to lower a key interest rate by a quarter point.
In the past several months, Fed rate cuts have fed rallies in oil prices. Crude futures offer a hedge against a falling dollar, and oil futures bought and sold in dollars are more attractive to foreign investors when the dollar is down. Interest rate cuts, and even the prospect of future cuts, tend to weaken the dollar further.
But the mass selling Monday -- despite the Fed's Sunday rate cut, the prospect of another cut at the Fed's regular Tuesday meeting, and the fact that the dollar dropped to new lows against the euro on Monday -- could be a sign that the oil market's momentum has turned negative, analysts say.
"People are saying, well, things are a lot worse than we thought," said Phil Flynn, an analyst at Alaron Trading Corp. in Chicago.
Posted by: anduril | March 17, 2008 at 03:37 PM
Almost self explanatory: if we're to believe Phil Flynn, the pullback of oil prices from record highs is a sign of increased worries.
AP
Oil Plummets on Economy Worries
Monday March 17, 3:24 pm ET
By John Wilen, AP Business Writer
Oil Prices Plunge on Concerns That the Crisis Facing Bear Stearns Will Widen
NEW YORK (AP) -- Oil prices plunged Monday, pulling back at least temporarily from record levels as investors feared that the financial crisis that forced the sale of Bear Stearns Cos. is a sign of deep economic trouble.
Crude's plunge came even as diesel prices rose to a new record above $4 a gallon, and gas prices remained high. Diesel, used to transport the vast majority of the nation's goods, rose 1.3 cents to a national average of $4.002 a gallon Monday, according to AAA and the Oil Price Information Service. The national average price of a gallon of gas, meanwhile, dipped slightly to $3.283 a gallon, but remains 73 cents higher than a year ago.
Oil's steep decline -- falling $4.53 to settle at $105.68 a barrel on the New York Mercantile Exchange -- came hours after futures reached a new trading high of $111.80 on the Federal Reserve's move Sunday to lower a key interest rate by a quarter point.
In the past several months, Fed rate cuts have fed rallies in oil prices. Crude futures offer a hedge against a falling dollar, and oil futures bought and sold in dollars are more attractive to foreign investors when the dollar is down. Interest rate cuts, and even the prospect of future cuts, tend to weaken the dollar further.
But the mass selling Monday -- despite the Fed's Sunday rate cut, the prospect of another cut at the Fed's regular Tuesday meeting, and the fact that the dollar dropped to new lows against the euro on Monday -- could be a sign that the oil market's momentum has turned negative, analysts say.
"People are saying, well, things are a lot worse than we thought," said Phil Flynn, an analyst at Alaron Trading Corp. in Chicago.
Posted by: anduril | March 17, 2008 at 03:39 PM
STOP READING AP STORIES ON THE ECONOMY..You are only making yourself crazy..By the AP's calculations we were in a depression the minute Bush took office.
The UAE BTW haa decided to continue with a dollar peg.
Posted by: clarice | March 17, 2008 at 03:40 PM
I can't pretend to understand much of this from the FT:
With trading floors awash with worries about who could be next, the CDS spreads of financial institutions were moving wider. The correlation market began to fall too, implying that the market is shifting from predicting general, systemic risk to “single-name” risk — the idea that some institutions are more vulnerable than others.
With many credit investors sitting on the sidelines, the only catalyst for performance in credit markets is likely to be intervention from the Fed or US government, said Jim Reid at Deutsche Bank, in a note to clients.
“The Fed has now stepped up a gear and ultimately we probably need the US Government to do so too. Even though we believe in free markets and believe that pain should be felt after such an unruly credit binge, we also think we are close to a financial system meltdown. At this stage moral hazard arguments need to be put in a wider perspective.”
But Mehernosh Engineer, credit strategist at BNP Paribas, said that intervention efforts would not be effective until the Fed recognised the nature of the crisis.
The core problem is that the Fed is still not acknowledging that triple A rated CDOs are not triple A. Until it does, the market is just seeing through all of its interventions. The Fed is trying to portray this as a liquidity problem but it’s an insolvency problem based on deteriorating assets.
This entry was posted by Sarah OConnor on Monday, March 17th, 2008 at 12:23
Posted by: anduril | March 17, 2008 at 03:41 PM
Dow now up 111 almost 1%, PROBABLY A SIGN OF WORSE THINGS TO COME!
Posted by: GMax | March 17, 2008 at 03:43 PM
UAE BTW haa? Huh?
If I knock of the AP, is FT OK?
Posted by: anduril | March 17, 2008 at 03:43 PM
Dow's up 110 points now, Gold is below 1000, JPM up over 10 pct.
Posted by: Charlie (Colorado) | March 17, 2008 at 03:44 PM
Nobody wants to be wrong more than I do--I want to sell my parents' condo.
Ohmigod--the DOW WAS at 111 and now is at 110--that means it's turning DOWN!
Posted by: anduril | March 17, 2008 at 03:46 PM
Anduril, you just need to remember Tierney's Maxim: Just because an idea appeals to a whole lot of doesn't mean it's wrong --- but that's the way to bet.
Posted by: Charlie (Colorado) | March 17, 2008 at 03:48 PM
If Lehman doesn't fall, today will be the bottom of the recession. (Someone told me that earlier, personally I'm clueless)
Charlie, I'm reminiscing with Anon about Boulder in the spin cycle thread. Did you ever dance on the tables at Tulagi's?
Posted by: Jane | March 17, 2008 at 03:48 PM
anduril, Have youu spoken to a realtor? To others in the building to see what the sales record has been? Are you simply pinned to this Board making yourself more worried than you need to be?
You can lease/lease with an option to purchase/ borrow against the equity ..there are a number of options to consider.
Posted by: clarice | March 17, 2008 at 03:53 PM
Brent crude down $5
Posted by: Charlie (Colorado) | March 17, 2008 at 03:54 PM
Charlie, I'm reminiscing with Anon about Boulder in the spin cycle thread. Did you ever dance on the tables at Tulagi's?
No, but I ended up underneath them more than once.
Posted by: Charlie (Colorado) | March 17, 2008 at 03:54 PM
Here's some guys writing at Forbes who buy into the WSJ line (if reading the WSJ and Forbes is still allowed). Of course, they were writing before the DOW turned up for a day:
Memo To The Fed: Stop Those Rate Cuts
Robert P. Murphy and Lee Hoskins 03.17.08, 6:00 AM ET
The markets rallied last Tuesday in response to the Fed's growing assistance to holders of mortgage-backed securities. Yet many onlookers are convinced that an aggressive cut in the federal funds rate at the upcoming March 18 meeting is still necessary to avoid a painful recession. In our view, further loosening at this time would be a mistake, and would also send an alarming signal regarding future monetary policy.
The Fed needs to quit chasing declining GDP growth and instead focus on curbing inflation and anchoring inflation expectations. Recent allusions to the stagflation of the 1970s are appropriate. Gold has been hitting all-time nominal highs, and oil prices have shattered the inflation-adjusted record set in 1980 during the Iranian hostage crisis. The dollar, meanwhile, is trading at all-time lows against the euro.
Consumer price inflation was 4.1% in 2007 (the highest in 17 years) while the producer price index rose 7.4%--the most since 1981. Amid these alarming trends on the inflation side, output has stalled. Real GDP grew at a meager rate of 0.6% in the last quarter of 2007, and the private sector shed 101,000 jobs in February. The beginnings of stagflation are upon us.
In response, the Fed has slashed its target rate 2.25 percentage points since September, and has engaged in all manner of novel auction schemes to bolster liquidity, particularly among those holding the bag on soured mortgages. Yet despite momentary blips upward, the stock market and the overall economy continue to slide. Even as the Fed's actions pushed many short-term interest rates below the inflation rate, fixed mortgage rates have begun rising. As inflation expectations gather steam, the Fed will find itself painted into an ever-shrinking corner.
The explanation for all of this is simple yet sobering.
The Fed has abandoned the one thing it can truly control--the long-run increase in price levels--in a self-defeating attempt to keep the economy growing. A good portion of the housing mess itself is the result of Fed policy: In response to the 2000-2001 recession, chairman Alan Greenspan brought the federal funds rate down to a shocking 1% by June 2003, then held it there for a full year. The rate was then steadily ratcheted back up, reaching 5.25% by June 2006.
These actions first helped inflate the home-price bubble and then helped burst it. Naturally, there are many factors--and perhaps even villains--that helped create the housing bubble, but excessively low interest rates were surely a necessary ingredient.
Regardless of past mistakes, the Fed must now make the best of a bad situation. It must stop chasing the financial markets, and even the broader economy. Creating more dollar bills will not add to the nation's wealth, or make workers more productive.
The alleged trade-off between inflation and unemployment--the Phillips Curve--is no guide for action. Yes, an unexpected injection of new money can temporarily boost real output. But once people come to expect the higher rates of price inflation, the Phillips Curve simply shifts; it takes greater and greater injections to achieve the same stimulus. That is how a country becomes trapped in a stagflation spiral.
The painful and costly recessions of the early 1980s were the result of the inflationary policies of the Fed during the 1970s. In contrast, Fed policies during the 1980s and 1990s focused on curbing inflation and maintaining price stability; this shift in focus produced both low inflation and strong, steady real growth. It would be a terrible mistake to throw out that costly victory in an effort to avoid a recession today--one that's already baked in the cake.
The Fed should commit to long-term price stability, and it needs to back up that commitment with action. Recessions will always be with us, but they will be shallow and short when the Fed keeps inflation low and evenly paced. If the Fed continues cutting rates, we will simply get the worst of both worlds: prolonged recession and excessive inflation.
Robert P. Murphy is a senior fellow in business and economic studies at the Pacific Research Institute. Lee Hoskins is a senior fellow at the Pacific Research Institute and a former Cleveland Federal Reserve president.
Posted by: anduril | March 17, 2008 at 03:55 PM
Speaking of Tulagi's....
Posted by: Charlie (Colorado) | March 17, 2008 at 03:56 PM
One thing that is a truism about the financial markets and pundits on the financial markets is that you can find someone who believes every single event is bad to cataclysmic and another who thinks every single event foreshadows the beginning of a long bull run.
Financial reportage has a lot of the same problems that regular reporting, does, that being reporters not being very bright and not be economics or finance majors but journalism majors.
Plus you have the added wrinkle of folks who actively try to influence markets by their touts, to their own benefit or for their employers.
Posted by: GMax | March 17, 2008 at 03:57 PM
BTW Dow now up 30 points. Some crisis.
There may be no crisis, but the fact is that the stock market is off 15-20% to where it was roughly two years ago or more, and the bloodbath in the housing sector continues. This was what I was blaming the Fed for. (I realize you weren't directing your remarks at me, but just for the record....)
Posted by: jimmyk | March 17, 2008 at 04:00 PM
Charlie, in general I'd accept Tierney's Maxim--especially in philosophy, where what I call Platonism carries the field. And is wrong. The reason I'm so fascinated with this financial crisis is partly because I don't understand most of it, and wish I did. The other reason is that I lived through the stagflation period and was transferred around the country with interests rates over 13% and cost of living nowhere near making up for inflation. I'd hate for that to happen to the country again.
Jane, that's what I heard, too. If the line on failures can be held at Bear, we could avoid a meltdown, but if another big investment bank goes there could be a real panic. However, I'm concerned with the long term implications of all this, including 1) inflation and 2) the effect this will have on China. Chaos in China could have severe repercussions that we're ill equipped to deal with. That's why I posted that article from Canada, much as I disagreed with a lot of it.
clarice, I'm not pinned to this Forum. My worries are mostly theoretical in nature, anyhow, since if I really had anything to worry about personally Armageddon would be upon us. I spent most of the morning shopping granite countertops and in a minute or so will devote myself to music. We've only had the condo listed for about two months and have had lots of lookers--even a few offers, but financing keeps falling through. It's too early to rent.
Posted by: anduril | March 17, 2008 at 04:12 PM
Thanks, jimmyk, I appreciate your injections.
Posted by: anduril | March 17, 2008 at 04:16 PM
Ok--I was starting to worry about your well-being.
Posted by: clarice | March 17, 2008 at 04:17 PM
Jimmy
You are correct about 18% as measured by the Dow and not two years but just over 6 months. Its been rough ride down. But markets go up and go down and longterm trend is ever higher.
Now on the housing cycle.
It is a boom and bust industry. Always has been. Homes get built by a bunch of smaller builders who never see the slowdowns coming. Then a period of little construction while the market corrects the imbalance. Then another boom.
I was ground zero for the S & L crisis and this really is nowhere even close. And homes never have zero value, but they can be worth less than the mortgage. And if you lend more than 80%, the costs of foreclosure and market turns can and do occasionally eat into your corpus.
But during the S & L crisis, there were folks who literally were just mailing their keys back to the lender, since they had lost so much market value that they did not see the market ever recovering to a point to where they would have equity. The VA utilizes their statutory authority to "No Bid" on a house for the first time in their history. They wrote checks to the mortgage holder for their statutory maximum and walked away, since they thought that was cheaper than owning and reselling.
We dont have that kind of crisis here. But watch and see if a few Hedge funds dont go belly up soon similar to Bear Stearns. Bulls and Bears do fine, but pigs get slaughtered and there were some folks being quite piggish in this one.
Posted by: GMax | March 17, 2008 at 04:21 PM
Speaking of slaughtered pigs. He teamed up with Soros in the early '90's for the run on the pound. I've been wondering if there's a link to some sort of speculative play involved in this.
GMax - I'd call the dismantling of Carylye Capital the death of a hedge fund. I agree that a few more going over the falls without a barrel would be a pleasure to watch and a very good indicator that the bottom has been reached.
Posted by: Rick Ballard | March 17, 2008 at 04:36 PM
anduril-
The comment regarding UAE and their dollar peg is the 800 lb gorilla in the room. The rumor that was floating around was that the OPEC oil exporters were going to reprice in euro's in mass. This is why I was kicking around the Hunt Brothers cornering silver idea as an analogy.
It bothered me in a way how everyone was reading from the same set of talking points and figured that someone made some comments at the WEF (ie the commentary with the buzzwords "de-coupling" and "stagflation") and the near joyous reaction of some of the perma-bears and US dollar haters.
I don't remember if I posted the comment regarding the reasons why OPEC and ME oil exports won't and in some ways can't reprice, but if I did it was a few days ago. It is far too many articles to go through completely and the articles are really all over the map. One maybe able to call the last couple of months a coordinated run at the dollar and the Fed and Treasury action regarding Bear Stearns calling everyones bluff. I'm watching the commodities tape and notice that not only did oil tick down but some ag commodities as did too (coffee especially, down 10%). It is worth remembering that the Hunt Brothers used rice contracts to try and hide what they were doing in the silver markets.
Posted by: RichatUF | March 17, 2008 at 04:38 PM
I see that Rick said my punchline better and with a link.
I would also say that it might be a good time to re-read this little gem from Soros and look over the last couple of months and see if we might find some of his "reflexivity".
Posted by: RichatUF | March 17, 2008 at 04:50 PM
"NEW YORK - Oil prices plunged Monday, pulling back at least temporarily from record levels as investors feared that the financial crisis that forced the sale of Bear Stearns Cos. is a sign of deep economic trouble."
You read about it here last night....
Posted by: ben | March 17, 2008 at 04:52 PM
Rich and Rick, yes, I've wondered about involvement on the part of Soros--he has to be doing something with his money at all times, so what's he doing now?
ben, sorry if I repeated you. That seems to be the idea: using oil as a hedge against the weak dollar was, in a sense, attempting to conduct business as usual. The collapse of Bear was a sign to investors that this is not business as usual.
Back to music.
Posted by: anduril | March 17, 2008 at 05:03 PM
But markets go up and go down and longterm trend is ever higher.
Now on the housing cycle.
It is a boom and bust industry.
I basically agree, though housing has been much less boom and bust since the early 1980s when Reg Q was done away with. Still, the Fed should be at least doing no harm, not exacerbating the cycle. Bush & co. should be focusing on the long term instead of mucking around with useless tax rebates and the like. This would have been a great time to make the case for getting control of spending and making the tax cuts permanent.
Posted by: jimmyk | March 17, 2008 at 05:27 PM
Rick
If Soros got into a "hair cut" situation ala Joe Lewis, my joy and celebration would exceed Other Tom's over any bad news regarding RW.
Charlie
Your "trash" link is just a hoot. Thank you for some nostalgia and lots of chuckles. Welcome comic relief on a day when one's teeth can be somewhat on edge.
Posted by: glasater | March 17, 2008 at 05:37 PM
Rich, UAE staying with the dollar for the time being isn't necessarily a robust vote of confidence in the dollar. It could simply be a recognition that there isn't really much choice. Pritchard's article stressed that this crisis is global and that Europe has plenty of problems too. I believe that it will be a while yet before we see the full shape of things.
Posted by: anduril | March 17, 2008 at 05:42 PM
That's a bar in which Jane, Anon, and I all have spent wasted hours...
Posted by: Charlie (Colorado) | March 17, 2008 at 05:42 PM
Here's a comment of Greenspan's article:
In the most bizarre, ill-timed, and poorly considered opinion column I have read in some time, ex- Fed guy Alan Greenspan blames the current meltdown on Richard Thaler. Okay, not Richard Thaler by name, but on behavioral economics, the en vogue body of work that shows how humans don't conform very well to rational economic models -- and doubly so when you most want them to. Sayeth Alan:
This, to me, is the large missing “explanatory variable” in both risk-management and macroeconometric models. Current practice is to introduce notions of “animal spirits”, as John Maynard Keynes put it, through “add factors”. That is, we arbitrarily change the outcome of our model’s equations. Add-factoring, however, is an implicit recognition that models, as we currently employ them, are structurally deficient; it does not sufficiently address the problem of the missing variable.
If I wasn't so irritated, I might briefly be amused. Because not once in his column did Greenspan, the blower of the credit market bubble, talk about his own culpability, or even about his efforts to improve the models he now criticizes. Instead we get this wise-man, rearview-mirror critique of his predecessor and of market participants. He should be ashamed. Truly.
Posted by: anduril | March 17, 2008 at 05:49 PM
Anduril
Greespan is not at this point going to do a mea culpa or "my bad" here.
Could be some over thinking going on in a bunch of quarters--including me:-)
Posted by: glasater | March 17, 2008 at 06:01 PM
Roland Arnall, the billionaire who helped create Ameriquest Mortgage and later emerged as a symbol of the struggling sub-prime mortgage industry, has died at UCLA Medical Center.
That's 2 "sub-prime related deaths" in one day.
Posted by: Neo | March 17, 2008 at 06:10 PM
Perspective:
(h/t bro)
I read that Lehman was down 45% and that people are taking a hard look at Merrill Lynch:
Posted by: anduril | March 17, 2008 at 06:46 PM
Haven't read this yet but it looks promising: Reflections on the International Dimensions and Policy Lessons of the US Subprime Crisis. Maybe this is the big picture I'm looking for. Here's the author:
Carmen M. Reinhart
Professor of Economics, University of Maryland; former VP at Bear Stearns, and former Deputy Director at IMF Research Department
Woops!
Posted by: anduril | March 17, 2008 at 06:51 PM
It is a boom and bust industry. Always has been. Homes get built by a bunch of smaller builders who never see the slowdowns coming. Then a period of little construction while the market corrects the imbalance. Then another boom.
Tell me right before the next one starts, I want in on it.
Posted by: Pofarmer | March 17, 2008 at 07:23 PM
Think Reinhart is just now on Kudlow.
Posted by: glasater | March 17, 2008 at 07:28 PM
Whoops--wrong egg head:-)
Posted by: glasater | March 17, 2008 at 07:30 PM
I agree with Gmax on this one.
Posted by: maryrose | March 17, 2008 at 08:09 PM
So I read Reinhardt--and she was both instructive and mercifully concise. Some lessons:
So, let's see. If the average duration of the decline in output is two years and we're at March, 2008, then we'll have this in the rear view mirror come March, 2010--using the average scenario. Now, when's the next national election? Oh. 8 months from now. Betcha this mess will be an issue. Voters houses declining in value? Big issue. McCain better be ready for this.
Wishful thinking, as I'm sure Reinhardt is aware.
Posted by: anduril | March 17, 2008 at 08:50 PM
Tell me right before the next one starts, I want in on it.
You can be pretty sure that "now" is before the next one starts. If you want someone to call the bottom for you, I'd be happy to sell you a subscription to my special investment letter.
Posted by: Charlie (Colorado) | March 17, 2008 at 09:01 PM