The Crisis of Credit

I saw this video on BoingBoing and think that everyone should see it! It lays out the housing bubble and resulting credit crisis as good as I have ever seen it and then some with fantastic graphics and narration. CrisisofCredit.com Take a look!


The Crisis of Credit Visualized from Jonathan Jarvis on Vimeo.

Obama the Swede

Remember me saying that Obama was saying all the right things on the economy? Well here is another one, this time comparing America's way out of recession to Sweden's crisis vs. Japan's decade long disaster.

So how long and how deep a recession should the American public be ready for?

"I don't have a crystal ball, and economists are all over the map on this. I think we should anticipate that 2009 is going to be a tough year. And if we make some good choices, I'm confident that we can limit some of the damage in 2009 and that in 2010 we can start seeing an upward trajectory on the economy. But this is a difficult hole that we've dug ourselves into. You know, Japan found itself in a somewhat similar situation in the '90s, made some poor decisions, didn't squarely face some of the problems in its banking system and, despite significant stimulus, still saw this thing drag on for almost a decade. On the other hand, you've got countries like Sweden that went through this and acted forcefully and boldly and in two years were back on track and were growing at a really healthy clip. So the decisions we make are going to have an impact on it. But next year's going to be tough."

What does it mean when the pinko-commie Swedish government gets involved and nationalizes the countries largest banks? Here is how one of the architects described it after,

"We approached the problem as a commercial undertaking and determined how we could maximize profits to the government or minimize cost."

Communism! And in the end, they did turn a profit for the government and the banks are now private entities again. And the entire process only took six years, instead of the projected ten.

Japan on the other hand, fiddled after their crisis and slowly worked to fix their system while things stagnated. Bad banks were left to run poorly, and they have kept their interest rates at 0% for years. America just hit zero yesterday. It will really be up to an Obama administration to see if we are going to come out golden like Sweden or enter into a multi-decade mire like Japan.

Recession Darts

I have been attempting to write about economic stuff because I have been reading/watching so much of it since the election, but it all boils down to everything is bad, and getting worse. Not fun to write about. 

The only up side is the report that Mortgage rates for new home buyers might plunge to 4.5% to try and pick up the housing market. So if you are thinking of buying now, and assuming you still have a job, this is the best time to buy in over 35 years. Assuming that deflation doesn't make that real interest rate much higher, and the housing market doesn't drop another 30%!
And since that is the "good news" I thought I would throw another dart at the board and guess where things are going based on the scientific method of guessing and assumption. First this analysis of past resections, and then a great chart by dshort.com comparing the four big bear markets of the past 100 years (with the current one being the second worst already). By combining them and using the great depression as a time-line to follow, I came up with the chart on the left which puts the end this bear market at September 2009 and puts the DOW at 6,341, or down 65% from its peak over a year ago. That's not the nearly 90% drop of the great depression, but that is hardly a condolence. And if the market does predict the economy 6 months in advance, that would put the end of the recession at January 2010.

This is significantly worse than what I thought in late October when I said the Dow would bottom at 7,750 next October. That's a big window but either way, that is still either 10% lower than we are now or 26% lower. Roubini sees 20-30% so I am in good company I think. 

And to finish off, the one bit of real actual good news is still that President elect Obama is saying all the right things all the time with a massive stimulus in the form of American infrastructure renewal from day 1. We have spent the last several decades with the right side of deficit argument being that deficit spending is bad, but in this case a balanced US budget right now would be a disaster. Hoover did the same thing before the great depression, and it took the New Deal and WWII to get the economy back on track. So pure Keynesian economics wins when the market has failed - worry about deficit spending but do it anyway! 

Economic update

It has been a while since I wrote anything down about the economy because frankly it is a huge bummer, but I have still been watching with interest what is going on. Here is where I think we are this week:

The world has avoided a "systemic financial meltdown" after unprecedented coordinated action. The world was at the brink, but has backed off. Governments put all the chips on the table saying, "we will exist." The downside to that bet was literally the collapse of nations - but luckily they won. Even Iceland looks like it will survive. They even used the Swedish model!

The TED spread which measures how much risk banks see in other banks rose to 4.63% - 30% higher than the black Monday crash of 1987 - but has since subsided to 2.66%. It has historically been between .5-1.5% so things are not good but they are not going to explode either.

So it seems that we are past a phase I of this crisis, the banking phase. Now on onto phase II, the global recession.

As everyone has noticed, the stock market has gone insane. It is not that it has just gone down, it has going up and down violently almost every day, and sometimes even during the day there are massive swings. This is measured by the VIX Volatility index that is at an all time high since it started in 1990. And if you look at this month, even the Volatility index has been volatile! So the basic assumption that the market is driven by value has taken a leave for the foreseeable future.

The reason I started this post was because of this Bloomberg article showing the value of the Baltic Dry Index, an index that measures international freight. It has plunged 90% since May making it a bigger drop than the .com boom, or the housing bubble. Shippers can't get credit for cargo, so they are not moving goods. This is what will really drive Phase II of this crisis I believe, as developing and emerging markets (Brazil, China, etc) get slaughtered by what will be an already severe rescission in the powerful G8 nations, as their currency gets drained of value as investors flee towards the dollar.

So some "predictions." Right now everyone is apocalyptic but so far things have not been as bad as 1973-76 when the market declined 45% and then recovered over 26 months as shown here:


Right now markets have declined 41% over 13 months. If you want to correlate 1974 to today, that means the DOW hits a low of 7,750 next October, and finally recovers at the very start of 2011. That seemed like crazy talk a month ago, but now seems optimistic!

Now the pessimistic side. John Authers put forward a disturbing concept today though that is worth watching. Basically, he says that after Japan's financial crisis of the 1990s their interest rate was effectively 0% through out the 90s and is still very low today. So smart investors would borrow Japanese Yen and pump that money into the stock market to turn a free profit. This is called the "Yen Carry Trade" and it has gone bust along with everything else. But what Authers is suggesting is that we have been in a Yen Carry Trade bubble for the past 10 or 15 years that is now busting.

If that is true, that would be deeply shocking and fundamentally change the understanding of the economic landscape going back to the late 1980s. It would also mean the DOW should fall to around where it really broke off from the Japanese Nikkei stock market, which has floundered for decades.

That was in 1995, at 3,900...



And Rubbini is sounding more like he believes that even when the rescission is over it might recover "recover" in an "L" shape like Japan experienced in the 1990s as shown above. To this day 18 years later, the Nikkei has never recovered. He stresses the "might" here though. As of right now he is still thinking in "U" shapes a-la 1974.

So like I said, a bummer. The only thing I can hope for is that in the past decade, the top 1% has gained wealth in huge disproportion to the rest of us, so perhaps this downturn will disproportionally affect them too. One can hope.

EDIT: This is interesting. Draw a line using the basic trajectory of the stock market before it took off in 1995 and you get this:



So if the Dow had kept a steady climb since 1995 it would have been at about 7,500, or about 10% lower than the market is right now...

Krugman

Congratulations to Paul Krugman, the solo winner of the 2008 Nobel Prize for Economics.

And on the first day of honest good news about the financial crisis. The short version - Britain took charge, Europe followed, and the US might get dragged along pouting.

EDIT: Wow. Best day on the market since 1939, right after the worst week since 1929. Still the TED spread is at 4.57%, down just 1% from its record high, and banks are still unwilling to lend to each other. But the market just bet big that they will and soon...

ONE MORE: Get your John Authers here. 

Bail Out Passed

The house passed the bailout today in round 2, and it was law a few hours later. I have always been for some kind of intervention like this, and I do think it will save the banking industry and prevent a catastrophic global banking failure. While I would have liked to see something along the lines of the Swedish Model I linked to before (recapatalize banks by buying stock - effectively nationalizing them for about 5-10 years), but someone pointed out that in order for that plan to work you need to have a functional government to save a dysfunctional banking system.

America, unfortunately, has dysfunctional everything.

So this is what we get. An imperfect, blunt economic tool that should allow banks to keep on at least functioning for now. But, I think that is all it will do. The world is heading into, or is already in, a global recession and I don't think there is a government in the world that can stop it. Big orders are way down, no one can get any loans to keep projects going, unemployment has shot up, and all this was before banks started failing. Yikes.

But a caveat to all this optimism, the TED is now at 3.87% - a new high and almost off the chart I posted below. So even with the news of this bailout, banks are more afraid than ever before to lend to each other.

More TED

ONE MORE: The Swedish Model. Please?

UPDATE: Oh. TED closes at 3.59% - highest ever, and the S&P fell 8.4% - the sharpest decline since 1987. It seems that if anyone can find a hill, they are running for it. I updated the chart below to reflect today. The TED line is off the chart!

I mentioned the financialy wonky TED spread before here, but a small update. For review, the TED spread is a measure of how hard it is for a bank to get a loan from another bank. Normally a bank-to-bank loan is super safe, so the real rate is around or below 1%. In the 1987 crash it hit 3.35%. Today it has hit 3.5% already.

Since that is hard to visualize, I found a graph of TED (red bars) since 1985 compared to the S&P 500 (blue line), and I updated it for today. Shocking.

TED

As my friend from the FT John Authers notes, the "TED Spread" has shot up again, and is at 3.37% as I write. I wanted to mention the TED spread (despite its financial nerdiness) because I discovered it a week ago when the market crashed and every one was talking about this odd number, and have been watching it ever since.

The TED spread is the difference between the safest investment out there, the 1 month T-Bill interest rate, and the rate that banks lend to each other, called the London Inter Bank Offered Rate. When the gap between those two increase, it is an indication that banks are having a hard time moving money and that they consider it a risk to lend to other banks.

On the day of the crash last week, the TED was at 3.13% and that was the highest since 1987. If John is to be believed the only thing holding up the celling is the belief that banks are about to get $700 Billion in free money.

Happy 10,578 Day

I have been watching the Dow Jones Industrial Average since I posted on the 16th to see when it would cross the magic number of 10,578 and it just did!

Happy 8 years every one.

UPDATE: Now things are up! That didn't last long. And have produced this great headline, "Kraft to Replace AIG in Cheesier Dow"

Economy

John McCain earlier today,

You know that there's been tremendous turmoil in our financial markets and Wall St. And it is -- people are frightened by these events. Our economy, I think still -- the fundamentals of our economy are strong. But these are very, very difficult times.

And the walk back a few hours later,

Our workers are the most innovative, the hardest working, the best skilled, most productive, most competitive in the world. My opponents may disagree, but those fundamentals of America are strong. No one can match an American worker. Our workers sell more goods to more markets than any other on earth. Our workers have always been the strength of our economy, and they remain the strength of our economy today.

Italics mine. Of course, that seems to beg the question, what would it take for the fundamentals of the American economy to be weak? Flu pandemic? Asteroid strike? It seems like a low bar to me.

Trepidation

It is 7:49 AM with 10 min before the markets open, and it certainly feels like a dangerous time.

WaPost: The U.S. financial system this weekend faced its gravest crisis in modern times, as regulators resorted to triage on Wall Street to contain the spreading damage from a meltdown in the housing and mortgage market.

NYT: But even as the fates of Lehman and Merrill hung in the balance, another crisis loomed as the insurance giant American International Group appeared to teeter. Staggered by losses stemming from the credit crisis, A.I.G. sought a $40 billion lifeline from the Federal Reserve, without which the company may have only days to survive.

Angry Bear: Had Bear [Stearns] gone out of business, about 30% of the hedge funds in the country would not have been able to execute virtually any transaction for the following thirty days. Not a payment. Not a redemption. Not a trade on a listed exchange. Not a receipt. Not a de-leveraging. Not a swap payment, not a CDS payment, not fulfilling an option exercised against them.

There's not just a "maybe" about financial collapse in such a scenario; [statistical] probably well in excess of 0.9944. $30 billion is a "bargain" in such a situation.

Yikes. Black monday in 1987 saw the Dow drop 22.6% and was largely based on electronic markets going out of control, not some of the worlds largest institutional banks failing. To compare, a redux would have the Dow dropping 2,580 points today, down to 8,840. Keep your hats on!

UPDATE: The Lehman Brothers bankruptcy is mind boggling in size:

The 158-year-old firm, which survived railroad bankruptcies of the 1800s, the Great Depression in the 1930s and the collapse of Long-Term Capital Management a decade ago, filed a Chapter 11 petition with U.S. Bankruptcy Court in Manhattan today. The collapse of Lehman, which listed more than $613 billion of debt, dwarfs WorldCom Inc.'s insolvency in 2002 and Drexel Burnham Lambert's failure in 1990.

.6 Trillion dollars?  Thats 4% of the entire GDP of the United States. WorldCom's 2002 bankruptcy, who today is bumped down to the second largest in history,  was a paltry $41 billion..