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The Bear’s Lair: Spirals of death Martin has sent me his latest Prudent Bear piece, which deserves the posting here. GW Close observers of the US housing finance disaster in recent months will have noted a curious phenomenon. Companies such as Countrywide that were in late August regarded as rock solid have recently passed clearly into the danger zone while those like Fannie Mae and Freddie Mac that were regarded as potential market saviors have come under a cloud. In Britain Northern Rock, whose September bailout was said to be modest, involving little risk to the taxpayer has now turned into an immense 25 billion pound ($51 billion) potential black hole – real money even in the US economy let alone in the much smaller British one. This illustrates a deeply troubling quality of the largest downturns: the tendency for the free market to turn into a death spiral, in which even sound well-run institutions are engulfed. Death spirals are fairly rare in financial history. The Wall Street Crash of 1929 was perhaps the most virulent example. After the first downturn, the market recovered for several months. Then the collapse of the Bank of the United States in December 1930, together with the further economic damage from the Smoot-Hawley Tariff caused a further collapse in confidence and activity that was concentrated in the banking sector, as relatively solid institutions followed the Bank of the United States into bankruptcy. The Federal Reserve failed to correct for the money supply contraction caused by the bank bankruptcies, leading the US economy further into the pit. The additional shove given by President Herbert Hoover’s 1932 tax increase was almost unnecessary; only the confidence brought by a new president (albeit with equally counterproductive economic policies) brought recovery from 1933. By the time the spiral was over, more than one fourth of the banks in the United States had gone bankrupt and the stock market had bottomed out at one tenth of its peak. A second death spiral, with somewhat less dire economic consequences, occurred in Britain in 1973-74. Edward Heath’s government had removed the quantitative controls on bank lending in 1971, which resulted in an orgy of high risk lending against real estate, very similar to the recent episode in the US except that most of the loans were made against commercial real estate rather than housing. When the first major real estate lender, London and County Bank, collapsed in November 1973 another more conservative house, First National Finance (FNFC), was used as the epicenter of the “lifeboat” rescue organized by the Bank of England. However, the decline in confidence and real estate values quickly sucked FNFC into the maelstrom. The lifeboat rescue fund grew larger and larger for more than a year as the stock market declined to record low levels, 70% below its 1972 high. Homebuilders such as Northern Developments, in no way involved in the original crash but dependent on bank lending, were dragged down. So were the two most important entrepreneurial finance houses, both internationally diversified and neither significantly involved in commercial real estate lending – Jessel Securities, founded by Oliver Jessel and Slater Walker, founded by Jim Slater. Neither Jessel nor Slater had been aggressively run – indeed Jim Slater had begun de-leveraging a year before the crash, as he saw trouble coming – and no wrongdoing was proved against the head of either organization, yet by the end of 1975 both very substantial companies had gone bankrupt and neither founder played a significant further role in the British financial sector. This was a great pity: in losing Jessel and Slater Britain had lost not only their very able founders but the most aggressive entrepreneurial teams in the City of London, who might have been best able to compete against the foreign invasion when Britain deregulated the financial services sector in 1986. The British experience of 1973-74 seems more like the current position in the United States. National policy is currently reasonably neutral, so far avoiding the twin dangers of protectionism and tax increases which caused the medium sized downturn of 1929-30 to turn into the Great Depression. The problem is concentrated in the property sector. However there are already worrying signs that the magic alchemy of modern finance, though such mechanisms as securitization vehicles whose funding falls apart and complex derivative securities that prove to be unsalable in a crisis, is causing the problem to metastasize. In the consumer sector, GMAC has reported problems with its automobile loan portfolio, while it appears that credit card debt quality is rapidly deteriorating. In the corporate loan sector, loans to aggressive leveraged buyouts have got in trouble, and loans to hedge funds and private equity funds have been sharply cut back. (The latter effect can be seen in the movement of the yen/dollar exchange rate from 120 to 108, as the hedge funds’ ”carry trade” positions have been de-leveraged.) The “death spiral” characteristics of the current market are pretty clear. If Fed Chairman Ben Bernanke’s original estimate of subprime loan losses of $50-100 billion had been anywhere close to accurate, there would have been no problem. The market deals with difficulties of that size all the time, without significant effect on surrounding sectors. A few fringe operators go bankrupt, a few large houses show unexpected losses, and the overall market continues without a tremor. The collapse of the Amaranth hedge fund in September 2006 or that of Refco a year earlier were substantial events, causing losses to a number of those institutions’ business partners, but there was no question of any general market disturbance. When the subprime problem first emerged in February, it appeared that it would also be limited. A number of subprime lenders, relatively insignificant institutions, were forced to shut down. However the general market appeared unaffected; its view appeared to be that the problem was localized and should have no effect on the real economy, nor even any great effect on the broader housing finance market. August’s widening in Libor spreads, at which banks lend money to each other, should have told us that this problem would be different, and altogether more important. If leading banks were unable to assess each other’s credit quality for short term transactions then something much more serious was wrong than the collapse of a modest fringe sector of the housing finance market. The Fed’s chosen solution, dropping interest rates and pumping more money into the system, did not address the real problem and was thus useless, as it has since proved. It has only postponed the denouement for a few months and stored up further trouble with inflation. Two factors are at play here. The first is sheer size. If as now appears likely the eventual losses in the home mortgage market do not total only $100 billion, but a figure much closer to $1 trillion, then the subprime debacle becomes something much more than a localized meltdown. $1 trillion of losses is 7% of US Gross Domestic Product. The market cannot absorb losses of that size without some major institutional bankruptcies or a lengthy recession. The closest equivalent problem is the savings and loan collapse of 1989-92; that caused a major housing downturn but only a minor recession. However its cost (mostly borne by the US taxpayer) of $176 billion was about 3% of 1990 US GDP, only half the size of the likely current losses on mortgage loans. The second is lack of transparency, and the blow to confidence that comes from the dawning suspicion that a large portion of the derivatives and securitization mechanisms designed in the last quarter century are faulty. The unluckily timed implementation for years beginning after November 15 of FAS Rule 157, requiring banks to divide their assets into three levels according to their degree of marketability, has thrown an unwelcome spotlight on the problem. If Level 3 assets can be valued only by reference to an internal valuation model, and have been allowed to accrue value in banks’ financial statements for a decade or more (enabling hefty bonuses to their progenitors) then how do we know they are really worth anything close to what the model says, and how do we go about realizing them, in a market where confidence has vanished? To ask those questions is to answer them. Since every incentive led bank mathematicians to devise models that maximized the reported value of the bank’s holdings, and since little or no market existed by which those values could be checked, it is likely that today those assets’ book values are highly overstated. Moreover, even in banks where the mathematicians and their bosses were scrupulously, even impossibly disinterested and intelligent, there still remains the problem that those assets are worth far less in a downturn, because their illiquidity makes them intrinsically unattractive in a market where liquidity has become once more important. Anyone who has attempted to sell venture capital positions in a bear market can attest to how rapidly and completely the value of such assets can disappear. It is thus perfectly possible that the true realizable value of “Level 3” holdings in a bear market is no more than 10% of their book value. This immediately demonstrates the problem. Goldman Sachs, generally regarded as insulated from the subprime mortgage problem, has $72 billion of Level 3 assets; its capital is only $36 billion. If anything like 90% of the Level 3 assets’ value has to be written off, Goldman Sachs is insolvent. They do not have the option of acting like Nomura Securities did recently, selling everything possible and writing the remainder down to zero, because they would be without capital. Instead they are likely to be dragged kicking and screaming, quarter by quarter, to a gradual writedown and sale of their Level 3 assets, with their true position remaining undisclosed and obfuscated by meaninglessly optimistic statements by top management. Only the bonuses will survive, paid in cash and draining liquidity from the struggling company. That’s what a death spiral looks like. The US survived the Great Depression, eventually, and Britain survived the 1973-74 debacle. However the market recovered only after it had plumbed depths previously thought impossible, at which even the soundest investments were trading far below their true value. After normality returned, the financial services landscape was very different, with many large and apparently solid houses having disappeared, a generation of participants reduced to driving taxis or selling apples and a generation of investors scarred by their losses and unwilling to return to the market. Emergency infusions of money, from the Fed or the taxpayers, generally do no good, only postponing the denouement and delaying the arrival of truly bargain price levels. Such spirals of death represent the final definitive triumph of the Bears. Martin Hutchinson is the author of Great Conservatives (Academica Press, 2005) Comments:2
Posted by Frank McGuckin on Tue, 27 Nov 2007 15:46 | # Guestworker There have been several major depressions in American economic history. And one of the things that the larger ones do correlate with is periods of very high immigration which correlates very highly with econimc inequality which correlates very highly with gobalized domestic labor markets via free trade and high levles of immigration. Th “experts” all seem to agree that a major recession is in th emaking. I heard the following on BBC radio world news over the weekend. The lone dissenter was the head of a hedge fund who said unequivocably that a big depression is right around the corner. I hope this guy is right. Worse is better. Pray for a major Economic Depression. I know I’ll loose the money I have under investment But it’s the only way. I’m ready to kick ..... 3
Posted by James Bowery on Tue, 27 Nov 2007 17:44 | # As I’ve been saying for over a year now, this is likely not going to be a repeat of 1930’s America, but of 1920’s Germany, with the Fed pulling out the stops on the money supply even to the point of hyperinflation as US dollars from around the world come flooding back to a moribund economy. They need to prevent too many foreclosures or they may really end up paying the costs of their centralized property rights in the form of a net asset tax—a policy of such justice that they would rather see world wars fought than let it exist anywhere. 4
Posted by Robert ap Richard on Tue, 27 Nov 2007 18:56 | # Poor Goldman Sachs, the struggling firm. Perhaps if the traders and partners would take up a collection around the office and in their synagogues and try to collect some of the money that they have sucked out of our economy using their flim-flam derivatives, they could come up with a few hundred billion to help them weather the storm. Billion-dollar bonuses, indeed. 5
Posted by Robert ap Richard on Tue, 27 Nov 2007 19:07 | # Money Matters Goldman Sachs Executives Get Billions In Bonuses http://elainemeinelsupkis.typepad.com/money_matters/2007/11/elaine-meinel-5.html ... “So…Goldman Sachs made a ton of loot this year and rewarded themselves quite handsomely by placing bets on which way interest rates would go and the effects of this on global currencies and this was easy as can be for them since they, themselves, CONTROL much of the value of various currencies in the first place. I noted the astonishing story about how Bernake in September had dinner with Goldman Sachs man Paulson, the US Treasury Secretary. And at that lunch, the GS conspiritor demanded Bernanke lower rates to a level that would suit him and the other GS criminals. When Bernake finally assented, Paulson may have run off to call his fellow pirates and give them the head’s up about this interest rate drop. They then rushed into world FX and stock markets and made tons of deals, happy with this insider information.” ... Lesson #1: Don’t let the Jews get control of your money supply—you’ll be sorry. 6
Posted by ben tillman on Tue, 27 Nov 2007 22:06 | # August’s widening in Libor spreads, at which banks lend money to each other, should have told us that this problem would be different, and altogether more important. If leading banks were unable to assess each other’s credit quality for short term transactions then something much more serious was wrong than the collapse of a modest fringe sector of the housing finance market. Interesting observation. 7
Posted by Tommy G on Wed, 28 Nov 2007 00:48 | # The first rate James Bowery says: “As I’ve been saying for over a year now, this is likely not going to be a repeat of 1930’s America, but of 1920’s Germany, with the Fed pulling out the stops on the money supply even to the point of hyperinflation as US dollars from around the world come flooding back to a moribund economy. They need to prevent too many foreclosures or they may really end up paying the costs of their centralized property rights in the form of a net asset tax—a policy of such justice that they would rather see world wars fought than let it exist anywhere.”
Hahahahahaha!!!! Drops and increases in the Dollar are a normal phenomena of a market based world economy. It is a “rebalancing” of economics associated with over demand. This to me is all healthy, though it does require some management to soften the impact of quick movements. 8
Posted by James Bowery on Wed, 28 Nov 2007 02:32 | # I don’t think the second rate Tommy G gets it, even though he’s laughing him self silly: When those dollars from round the world pour back into the US they are going to be pouring into the _businesses_—not the employees—and if there is one thing the stagflation of the 1970s should have taught us about inflation it is that employers raise their prices far faster than they raise their employees salaries. That was the trick that enriched so many early boomers with so many dumpsters filled with fetuses behind abortion clinics as the mid boomer females reached their prime marrying years. Real estate prices skyrocketed along with energy and everything else but wages remained relatively stagnant. So, no, the dollars flooding back will _not_ go into the pockets of the people paying mortgages—they will simply support the market value of the houses, which are already inflated sky high over the last several years (proof alone that Tommy G has no clue what “inflation” really means when he denies its been going on after the recent near-hyperinflation of real estate prices), but they will also increase the prices of everything else as they are exported. Yes, there will be lots of dollars ending up in the hands of _some_ people—just not the middle class. 9
Posted by Maguire on Thu, 29 Nov 2007 22:17 | # “Moreover, even in banks where the mathematicians and their bosses were scrupulously, even impossibly disinterested and intelligent, there still remains the problem that those assets are worth far less in a downturn, because their illiquidity makes them intrinsically unattractive in a market where liquidity has become once more important. Anyone who has attempted to sell venture capital positions in a bear market can attest to how rapidly and completely the value of such assets can disappear. It is thus perfectly possible that the true realizable value of “Level 3” holdings in a bear market is no more than 10% of their book value.” Or zero value. Or even has real negative economic value. Here at Ground Zero of this Global Crisis, as London’s Financial Times labeled SW Florida awhile back, this is precisely the case. Developers, builders and individual real estate gamblers have gone teats up in a mass Die-Off. They have left behind them vast tracts of half-finished ‘developments’ which are not complete enough to build homes in. Some are mere seas of sand and gravel with pre-cast street curbs laid, utilities in progress but not finished, empty holes that were intended to be future small lakes, and no street paving. Others feature dozens of half-finished houses on which all work has ceased and whose construction financing has disappeared to points unknown. In these cases an individual house could possibly be finished, but obvously these spots are not the most desirable neighborhoods. Especially with an 8-12 month ‘supply’ of existing real estate in similar neighorhoods that don’t like the set for a science fiction movie like “Soldier”. But they are also far enough along they cannot be reverted back to their former uses, such as cow pasture land or grass sod farms, without major investment. What do they represent to a potential buyer? They represent an opportunity to pay property taxes and carry liability insurance for unforeseeable period in the hope market conditions will improve enough to justify resuming work. And at that time additional capital must be obtained to resume work. This was the ‘collateral’ for very large ‘commercial’ loans given by entities like Bank of America, Wachovia, Fifth Third and numerous others. These banks tried having one large auction of such properties last spring. At that time they discovered most of these properties had no market or value. In some cases Enron style accounting was then used to move these onto the books of wholly-owned non-bank subsidiaries. Since then the banks have generally ceased attempting such public auctions of foreclosed commercial properties. A public auction in fact provides transparency to a portfolio’s market value, and this is the entire problem. The real value in many cases is -0- or negative. 10
Posted by Al Ross on Thu, 29 Nov 2007 23:53 | # In Florida, with its 30% of immigrants being illegals, the condo market has, as Maguire noted, gone flat. However, personal security, the main raison d’etre of condo living, will face increased threats from non-Whites, both domestic and imported, so this downturn may be just a repeat of the 70’s Florida residential property bust which turned around when Carter got the boot. 11
Posted by DavidL on Fri, 30 Nov 2007 01:14 | # Maguire or Al Are these banks/developers paying property taxes on the unfinished Has Florida become an Izzy state over the last 30 years? I had a co-worker several years ago tell me he grew up in Florida Good luck to you both down there ! 12
Posted by Maguire on Fri, 30 Nov 2007 01:59 | # Al, “In Florida, with its 30% of immigrants being illegals, the condo market has, as Maguire noted, gone flat.” I was talking about single family homes, and horizontal duplex to quadplex type courtyard homes with their own yards in fairly spacious developments. The real hi-rise condo markets in Miami, Tampa, Naples and elsewhere are just as bad and worse. Miami in particular presents a breathtaking panorama right now. Drive in on SR 826 from the airport. A spectacular landscape of 20 or more half-completed hi-rises will greet your eyes as you near downtown and Key Biscayne Bay. Just about everyone who bought into these in 2003 or later is already negatively amortized. Many have lost large deposits. >>However, personal security, the main raison d’etre of condo living, will face increased threats from non-Whites, both domestic and imported, so this downturn<< Is very likely permanent for all our lifetimes. That is, unless someone figures out how to grow all their food on a hi-rise condo’s balcony. I think the price peak reached in late 2005 early 2006 probably won’t be reached again on an inflation adjusted basis in any of our lifetimes. Talking about any kind of price recovery is theoretical because price depreciation is still underway. As this crisis deepens many of these hi-rise dwellers will be confronted with stark choices to stay in their urban condos. This is either stop eating due to spiraling food prices or abandon private vehicle ownership due to spiraling fuel, repair parts and insurance costs. People in suburban Florida living on any kind of land do have some great advantages. They can get 4-6 ‘crops’ per year. Having even 1/3 an acre here is equal to two acres further north. If you’re on fresh water you can use to irrigate it’s closer to four acres equivalent. Too few condo dwellers, despite the example of New Orleans - Katrina, will exercise the proper choice. This is get into their cars now and flee permanently while fuel is still commonly available. They will thus seal their fate. Maguire 13
Posted by Al Ross on Fri, 30 Nov 2007 02:09 | # DavidL, I’m not a FL resident although I did buy a condo in Fort Lauderdale some sixteen years ago with a view to possibly retiring there but I think the demographic change since then has considerably lessened that city’s attraction for me. I dont know the developers’ tax position re unfinished projects but FL law treats bankrupts better than most places inasmuch as someone declared insolvent is allowed to retain, free from creditors demands, his primary residence and a surrounding land area of up to 50 acres. The reason I know this arcane fact is because my father’s cousin, a Scots immigrant to Florida, was a condo developer who whose impending bankruptcy was averted at the eleventh hour by an end to recession in that state. His wife told me that at least they would have kept their house, an ambassadorial-style residence in which he entertained his fellow senior Freemasons and Rotarians. 14
Posted by Maguire on Fri, 30 Nov 2007 02:28 | # DavidL, >>Are these banks/developers paying property taxes on the unfinished The banks tend to keep current. The developers will keep paying as long as they make their loan payments. And sometimes the liens pile up on foreclosed and abandoned ‘development’ properties. >>Has Florida become an Izzy state over the last 30 years?<< This state is run by Miami-West Palm Beach Jews, drug financiers, real estate developers and big commercial farmers who are really plantation operators. From Collier County running up the middle of the peninsula, and minus the narrow 10 mile wide coastal strips, this state is one vast farm. “Middle Florida” is a pastiche of white and Cuban planters living in fortified estates, mainly white technocrats keeping the machinery operating and water flowing and an agrarian Mestizo peasantry. “Middle Florida” is also the location of a lengthy series of gulags housing much of Florida’s young non-white male urban population. ‘Liberal’ legislators and judges have racistly incarcerated them by the tens of thousands to support the egalitarian lie that non-white people are identical to whites and can meet white behavioral norms. >>He said Kennedy ruined the state with his Cuban That mainly afflicted Dade County. What happened is those Cubans replaced the whites as the middle class. The upper class there was and remained Jewish. Disney under Eisner imported its own low cost Tower of Babel labor force to Orange County. But there are still reasonable areas to live in Florida outside of Miami-Palm Beach, Orlando and metropolitan Tampa. Maguire 15
Posted by Tommy G on Fri, 30 Nov 2007 03:14 | # “I dont know the developers’ tax position re unfinished projects but FL law treats bankrupts better than most places inasmuch as someone declared insolvent is allowed to retain, free from creditors demands, his primary residence and a surrounding land area of up to 50 acres.”—Al Ross Here’s a link that explains Florida’s Homestead exemption law: http://en.wikipedia.org/wiki/Homestead_exemption_in_Florida “This state is run by Miami-West Palm Beach Jews…”—Maguire True. In fact, Palm Beach County has more Jews per capita than New York City. 16
Posted by Maguire on Fri, 30 Nov 2007 15:01 | # Martin Hutchinson’s piece overall is good as a description of the present financial crisis. This was because it was reality based. However, this extraneous advertisement for ‘Free Trade’: “The British experience of 1973-74 seems more like the current position in the United States. National policy is currently reasonably neutral, so far avoiding the twin dangers of protectionism and tax increases” is irrelevant and just plain wrong from most people’s perspectives. The essence of real science is theories are continuously revised to take account of new facts. The field of economics fails this test. This ‘discipline’ will always remain a weapon of political-biological struggle in which ‘theory’ is always articulated to maximize the advantage of the theory’s advocates. From the viewpoint of a City of London merchant banker ‘Free Trade’ (and no taxes on the profits) undoubtedly has great utility. And it’s useful for those who personally grow fat on such profits to demonize as idiots or worse anyone who would oppose the ‘great humanitarian benefits’ of it. The principle case for Free Trade was articulated in the late 18th and early 19th Centuries by Adam Smith and the Jew David Ricardo. To understand this archaic concept it’s necessary to understand the historical context. ‘Free Trade’ was implemented in an era when England was the only industrialized economy on Earth. The Jew Ricardo’s supporting theory of “comparative advantage” was consciously designed to benefit intermediary factotums. These are the classic ‘buy low sell high’ middleman traders who produce nothing. The intermediary group cannot exist and thrive unless ‘producers’ are both highly specialized and also separated from each other by enough barriers (distance, language, race, different political jurisdictions and artificial legal restrictions) to prevent direct bartering. In the Jew Ricardo’s time the English wheat trade was subject to the “Corn Laws”. These were tariffs on imported wheat designed to maximize domestic farm production. If these laws could be repealed then the price of wheat (i.e. the prices paid to yeomen farmers) and also the wages paid to artisans producing goods for export could be reduced. A long distance trade could be set up to maximize the profits of the money factotum “buying low” and “selling high” on both ends. The political struggle was naturally portrayed as a battle of ‘progress’ against the uber-rich landed aristocracy. The small British yeoman farmer and his family were the ultimate losers. They traded the clean air of the countryside for this: This http://www.leeds.gov.uk/armleymills/armdark.html is the great ‘benefit’ that was brought to British whites by Jewish ‘Free Trade’ economic theory. British agriculture entered a 90 year depression which was only relieved by Grand Admiral Karl von Donitz and the German submarine service. ‘Free Trade’ never was and never will be ‘free’. The phrase itself is an Orwellian abuse of the English language on a par with ‘racial equality’, ‘the dictatorship of the proletariat’, ‘preemptive wars to stop aggression’ and all other Jewish-originated concepts. ‘Free trade’ is only ‘free’ to those with banks in the exact same sense that the ‘free press’ only exists for those with presses. An example is the Jewish Asper family in Canada. These Jews enjoy ‘freedom of the press’. For the rest it’s Richard Warman time. Organizing ‘Free Trade’ in the 19th Century required substantial imperialist adventures abroad as well as domestic impoverishment of English whites. These included non-stop gunboat diplomacy actions by the Royal Navy, covert insurgency war organized through the agency of Scottish Rite Freemasonry to overthrow Spanish colonial rule in South America and the American Civil War, also heavily organized via the Masonic influence networks. 17
Posted by GT on Fri, 30 Nov 2007 17:27 | # GW, “For 25 years, he was an international merchant banker in London, New York and Zagreb …” Sorry, but I have great difficulty in perceiving a pro-White ally in Martin Hutchinson. He could easily be an enemy. His goal might be to promote the reemerged supremacy of the “City of London” over “Wall Street.” ————- Maguire, Whites in England produced manufactured goods under slave conditions in exchange for ‘cheap’ food from South America and ‘cheap’ cotton grown by African slaves. Jew Judah P. Benjamin scampered away to D’Israeli and the City of London at the end of the American Civil War. Post a comment:
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Posted by Al Ross on Tue, 27 Nov 2007 09:23 | #
One of the biggest surprises for me was the exposure of HSBC to sub-prime loans, not just by normal course of business but by a deliberate policy of acquisition in the US. The prudent Scottish founders of the old Hongkonk & Shanghai Bank must be spinning like dervishes in their graves at what has befallen a once admired institution. The bank used to lend YK Pao money to build supertankers and Li Ka Shing funds to develop Hong Kong property projects but now they lend Diego Suarez, proud Mestizo, formerly of Tijuana, a few thousand to purchase a double-wide mobile home for his family of six.
HSBC should send their management trainees for secondment to the Grameen Bank to prepare them for America’s future financial plight.