28 November 2009

A virtual interview with the WSJ and the FT - Part 4

WSJ: Earlier during this interview, you mentioned that the roots of the problem have not been properly addressed or even no at all?

M&B: Let me start by saying that I have sympathy for the Austrian school of economics but also believe that governments and central banks had to act after having closed a blind eye (or even encouraged directly or indirectly) on an irresponsible behavior (besides their even more irresponsible behavior); they however stopped short (and by a long margin) from making sure the magnitude of this crisis will not happen again (we will get other crises, but please let’s lay the ground to avoid what is avoidable) since policy makers are quick pointing the finger at scapegoats but not at themselves, and they bear their part of responsibility which is not small.

To me, the root of the problem is over-indebtedness, quasi-exclusively in the West (and mainly in the US) and Dubaï (in 2006 I was asked by a friend about investing in a real estate fund focusing 100% on Dubaï: I just told him to stay away; too many square meters built for too few buyers at the end and prices going up too far too fast), from consumers, governments (national and local) and banks; corporations were not so badly indebted.

WSJ: How did this become possible?

M&B: It became possible because of the lack of accountability and short sighting (you were better making a succession of one off deals instead of building a business). Banks magnified the problem but did not cause it: they use a favorable environment to substantially increase their Return On Equity (ROE) via leverage and proprietary trading. It is easy to
directly or indirectly encourage consumers to over-consume and forget saving: true, people have been encouraged by the irresponsible behavior from banks and, overall, governments (not least in Europe). Accountability is what will ensure we learn from past mistakes:

1) Accountability from Boards of Directors: you probably noticed that just a few chairmen/CEOs were fired (and not many) whilst boards remained more or less the same. They are the one that vested chairmen/CEOs packages/bonuses, strategy, etc.

2) Accountability from regulators: after all it is the SEC that did not act on naked shorts for so long (the SEC was not worried when banks were shorting naked small and mid cap companies, resulting in outstanding shares representing over 100% of the issued capital!!).

Capital ratios were not set up by banks, but by Governments via Basle accords.

Accounting rules were no set up by banks either, but by regulators. Yes, banks lobbied: so what? Do regulators/policy makers need to follow what lobbyists say?

3) Accountability from Central Banks: 2 months after taking the helm at the FED, in 1987, Greenspan wide opened the flow of money. There was no will to seriously tighten the belt. LTCM was too big to fail? This was opening the door to the next "too big to fail".

4) Accountability from politicians: they have always been (voluntarily) dead wrong in projecting the economy and have not laid the foundation of a sustainable growth: look at (pre financial crisis) the state of public debt, budget deficits, pension disarray and health system decay/cost in the Western world.

5) Accountability from consumers: how can a consumer with some sanity borrow at 15%, 16% or 17% to buy a plasma screen or whatever consumer good, or use a credit card for the same purpose when official CPI is in the 2-3% range? How can someone borrow 100% for a house, or worse draw equity out of it. The western world, and the US in particular, have lived on steroids called over indebtedness.

6) Accountability from media: most of them are just relying information (and the more sensational, the better, whether true or not, important or not, what matters is the scoop) without investigating. Soros says something? It must be true. Greenspan says something? It must also be true. Don't question please, or mildly. The way the media reported the "success" of the G20 summit in London or Pittsburgh is shameful: as if the tax haven scapegoat (oops! depending if you are a large country or not, you are on the grey list or on the white list - Delaware, Macao, etc.) or the bankers' bonus were at the root of the crisis and solving these “identified” problems were key to lay down the foundation of a long term sustainable growth. They were just communication aimed at the man in the street (should I say the voters) and did not bring any viable and sustainable solution.

The important point is that, what we are witnessing is the brutal adjustment to this over indebtedness. The economic growth of the past 20 years was largely built on money creation by central banks and speed of velocity by commercial banks.

Did banks (and the financial sector as whole) create this background? No! They took advantage of an existing framework (in some instances they convinced regulators and policy makers to shape it in their favor) to maximize profits.

We DO NOT need more regulation but better regulation.

The previous "new paradigm" in many ways hid the relative demise of the Western world towards Emerging markets, and among them the largest: China. The economic and financial fragility of the West came to light with this crisis.

This will sooner or later result in a confrontation with the West since both sides are going to be increasingly at odd on many subjects, starting with a competition for the same limited resources to spur their growth and at least maintain (the West) / foster (emerging markets – haven’t they already emerged?) in real terms the standard of living of their populations (I unfortunately have doubts for the Western world to rebound looking 15 years forward with all the challenges we are facing - public debt and budget deficits, pensions and the health service, to name a few). This is already the case in some parts of the world ( starting with Africa - Soudan for example) spilling over into confrontation at a geopolitical level.

This crisis has revealed at least one thing for the ones who were not aware of it: this shift of power is unstoppable in the current environment. People of the West need to point the finger at the right responsibilities to make sure that, we, in the West, will be able to reshape the economic, financial and geopolitical environment to our advantage: don't be mistaken, we are not in a nice people world, but a world of domination (as it has been for a couple of thousand years and longer). there, too, there is not, and there will no be, a new paradigm: either you are on the side of the dominant or on the side of the dominated.

P.S. Wait for the next bubble to deflate, the Mother of all Bubbles: Government debt


The Economist

19 November 2009

The 27 heads of European states meet: joke of the day!

The Lisbon Treaty (as its failed twin predecessor, the European constitution), was meant to provide the EU with more transparency in its decision making process as well as provide a stable and strong leadership by creating the jobs of President and Foreign Minister, and was "marketed" as such by politicians to voters. Bullshit! Once again, people in Europe are left naked.

Tonight decision to appoint Herman Van Rompuy, the Belgian prime minister, for the presidential job, and Catherine Ashton of Britain, the European Union’s trade commissioner, as foreign minister, the two low-profile candidates with no international clout and little or no international experience just exemplify that large European countries have no intention to give away their prerogatives. I could laugh about it if it were a funny joke with no consequence. But I cannot: does anybody believe that these two will have any credibility on the international stage with the Chinese, Indians, Russians, Americans, Brazilians, OPEC, etc? And this at a time of worldwide power shifting? No way: this is just a shameful failure.

The decision process itself was totally opaque and the choice of the two appointees was the result of a mix bag of vetoes, bargaining, bullying being close doors. Next appointee? Michel Barnier for the internal-markets post, which writes financial-services rules and Christine Lagarde to head up the Eurogroup. The big loosers? Jean-Claude Junker, the Luxembourg Prime Minister, and the UK (not surprising with "Moron" Brown who was at the helm of the sale of the BoE gold when Chanceler of the Exchequer and gold at the lowest over the past 20 years). The winners: Nicolas Sarkozy and to a lesser extent Angela Merkel (the German will get the Presidency of the BCE when Jean-Claude Trichet steps down).

[emphasis mine]
As reported by the NYT, Jean Quatremer predicted in the French newspaper Libération that “The E.U. will not wake up Friday morning to the George Washington called for by Valéry Giscard d’Estaing, but with a René Coty, the last president of the Fourth Republic. Or even worse. All strong personalities will be eliminated by a crossfire of vetoes. And the secrecy of the deal gives the worst image possible, that of petty arrangements between friends that will produce a mediocre compromise.”

Unfortunately, Europe (its institutions and politicians) is indeed mediocre at best and getting worse as time passes by.

10 November 2009

A virtual interview with the WSJ and the FT - Part 3

FT: There is a debate about whether we are in a deflationary or inflationary environment: what are your views on this?

:My answer is yes to both. It looks contradictory but it is not. It depends of the time frame you choose. Let me explain. Short term we are in a deflationary environment for three main reasons:
  1. Banks are deflating their balance sheets and rebuilding their equity leading to less credit available that is definitely deflationary. It is more profitable and less risky to invest in Treasuries instead of lending to businesses and consumers with a financing cost near zero.
  2. Unemployment is above 10% in the US (add 10% more for underemployed and unemployed so discouraged they are not even looking for jobs), and rising. Therefore there is no pressure on wages (to the contrary) and there is no example of a sustained inflation period without wage inflation.
  3. There have been a massive wealth destruction (housing, bear markets) that not only left many in an extremely difficult financial situation but also resulted in a real psychological shock for many more, the pensioner or soon to be retired not being the least. They have to rebuild their savings and regain confidence; it will take time. This will be detrimental to consumption.
If short term I do not see any inflation threat, longer term I do.

  1. The FED and the likes will do everything they can to avoid a deflationary spiral. Money will continue flowing. It is however not flowing to the real economy (at least in the Western world) but to risky (equities) and non-risky assets (Treasuries/fixed income). There is an apparent contradiction here, since the surge in equity markets imply a V shape recovery whilst bonds imply a U shape recovery. I will come back on this later.
  2. The long term rise of developing economies will again spur demand for commodities and energy. The pause we have witnessed with the current crisis is only temporary. In the meantime many exploration projects have been postponed or canceled due to diminishing demand and a move away from riskiest assets; due to the time frame to develop mines and wells to bring them to production (a couple of years), we will see a new rise in commodities that will dwarf the 2006-2008 one.
    This may even go beyond: China has taken advantage of the crisis to use its financial might to secure reserves all around the world and are better placed than the West (and Europe in particular): the access to commodities may add to price surge.
  3. The wage deflation (stricto sensu or via high unemployment) cannot carry for too long without having long term destructive effects on the economy: consumers need purchase power to consume.
  4. Inflation is the politically less painful way to pay down ballooning public debt.
Medium to long term money creation coupled to growth in the developing world will lead to inflation (I do not expect hyperinflation however). This will lead mainstream investors to add fund to hard assets. Before this comes watch the mother of all bubbles to deflate: fixed income instruments.

Going back to the apparent contradiction between equity and bond markets, I refer to an interesting paper written by PIMCO, the world largest fixed income manager. Two extracts summarize it:
Thus, while rich risk asset prices can certainly be viewed as a consensus expectation for a strong recovery, such lofty valuations can also be viewed as a consensus expectation about the Fed's commitment to erring on the side of being too late, rather than too early, in starting a Fed funds tightening cycle. Indeed, one could actually be agnostic, even antagonistic, about a big-V recovery and still be favorably disposed to risk assets, in the short run. Historically, what pounds risk asset prices is either a recession or unexpected Fed tightening; or worse, both. Right now, it is hard to get wrapped around the axle about recession, since we've just had one, which might not even be over.
In turn, a bull flattening bias of the Treasury curve, with longer-dated rates falling toward the near-zero Fed policy rate, can be viewed as a consensus view that the level of the output/unemployment gap plumbed during the recession is so great that disinflationary forces in goods and services prices, and perhaps even more important, wages, will be in train, even if growth surprises on the upside. Accordingly, Treasury players, like their equity brethren, need not fear the Fed, as there is no economic rationale for an early turn to a tightening process.
I totally subscribe t0 their conclusion (emphasis mine):
Simply put, big-V'ers should be wary of what they wish for. U'ers, meanwhile, must be mindful of just how bubbly risk asset valuations can get, as long as non-big-V data unfold, keeping the Fed friendly. But that's no reason, in our view, to chase risk assets from currently lofty valuations. To the contrary, the time has come to begin paring exposure to risk assets, and if their prices continue to rise, paring at an accelerated pace.


Federal Reserve Bank of St Louis

The Uncomfortable Dance Between V’ers and U’ers

03 November 2009

Gold, gold and gold!

This afternoon, gold futures reached an all-time high at 1,085.30/oz (COMEX Dec contract), following the purchase of 200 tonnes of gold by India from the IMF for about $6.7 billion. Well done India!

The last gold hangover is now withdrawn: gold sales by the IMF will easily be absorbed by emerging economies. I also doubt China will stay on the sidelines watching India catching all this gold against worthless paper without getting their piece of the cake. Whatch gold and take any fallback as a buy opportunity. Gold is on its way to it record high, at 2009 prices US CPI deflated, of $1,600/oz.

For the US and Europe, they have no money left and over all would not like to send a signal of lack of confidence in fiat currencies (and the USD in particular) and expose to the public the wrong policy followed by many European central banks: selling the jeweleries for hot air. Don't forget that Mr. Brown, the current UK Prime Minister and then Chancellor of the Exchequer, initiated this irresponsible policy in the UK during the second half of the nineties when gold prices were at the lowest (in the $250-300/oz range) at the same time Tony Blair was dramatically increasing the number of civil servants and digging deep in the fantastic work undertaken under the tenure of Margaret Thatcher and to a lesser extent John Major...

What best than the shift in gold possession is exemplifying the shift of power from the West to the developing world?! It also says a lot on the lack of understanding of challenges faced and short sighting by policy makers in the West. Worrying.


US gold hits record high $1,081.70/oz on IMF sale

Gold Climbs to Record as India’s Central Bank Buys From IMF

A virtual interview with the WSJ and the FT - Part 2

FT: From early April to early July you saw the glass half full, and have seen it half empty since against improving economic indicators. Could you explain us why?

M&B: My view was that the sentiment was so negative and central banks providing so much money at near no cost that markets could only improved. Since the bottom of equity markets in March (China and Brazil excluded: they bottomed end October 2008, the MSCI emerging markets index in November) to 27Th October, the DJ is 50% up, S&P +57%, NASDAQ +70%, FTSE +48%, DAX +53%, NIKKEI +43%, SENSEX + 95%, SHANGHAI +75%, BOVESPA +70% and the MSCI emerging markets +102%. In the meantime, the economy has not really improved, whilst no longer in a nosedive. The improvement noticed during Q2 and Q3, was mainly due to Government money (car industry and the financial sector in the US and Europe, tax credit for first-time owners for residential real estate in the US, etc.) and inventory rebuilding after having been crushed late 2008 and early 2009. However, if unemployment does not improve in the coming months (which I doubt), I believe that retail sales will be flat or nearly flat towards the end of the year (I do not see how sales could improved when consumers are fearing for their jobs and need to rebuild their balance sheets). In my opinion, this could lead to a second wave of adjustments by companies or at least delay investments and hiring. Interesting enough, last week, Goldman Sachs cut its US GDP prevision from 3% to 2.7%.

I have also been worried about the commercial real estate situation where prices dropped 40% between August 2009 (latest data available) and October 2007 (peak of the cycle) – I remember well what happened in the early 1990’s. The outstanding face value of US commercial real estate loans amounts to USD 2-3.5 trillion depending on sources, including USD 270-275 billion due next year and over USD 1 trillion by 2015. Banks own 45% of commercial real estate loans, compared to only 21% of single-family loans and U.S. Office Vacancies Reach Five-Year High of 16.5%. In September, the FED noticed that banks were slow to take losses on their commercial real-estate loans.

Undoubtedly, banks will have additional large losses coming from this sector and the rest of the economy will be impacted, whilst probably not to the same extent as the residential real estate that had a huge psychological effect in additional to the financial one: this may stall any recovery in 2010-2011. Banks will need either to further reduce their balance sheet to be in adequacy with prudential ratios and/or raise new capital. Just look at all the cash call that banks in Europe and the US have done over the past few months or are attempting to do, besides selling assets.

I will not come back to changes that occurred on rule FSA 115 regarding fair value accounting (and my opposition to it since it increased opacity): whilst giving some breathing space for banks, it did not solve the problem and may compound it in the future.

To summarize: too far too fast. Markets have been sustained by liquidity that has not been channeled to the real economy (i.e. most of it!). I am not however in the camp of the gloom and doom for the world economy, whilst I am rather negative on the Western world economy.


U.S. Office Vacancies Reach Five-Year High of 16.5%

Wall Street Journal
Local Banks Face Big Losses

Foresight Analytics
Commercial Mortgage Outlook: Growing Pains in Mortgage Maturities

Congressional Oversight Panel
August oversight report: The continuing risk of troubled assets

MIT Center for Real Estate