Thursday, 31 July 2008

Quotable: To Infinity and Beyond!

"The difference between stupidity and genius is that genius has its limits."
-Albert Einstein

Hattip to P1AQL (the blogger formerly known as Print 1st Ask Questions Later)

Credit Cards Contracting

From Javelin Strategy and Research:

“The sharp decline in credit card spending challenges the popular belief that more Americans are charging basic goods in order to sustain their quality of life,” said Jim Van Dyke, president of Javelin Strategy & Research. “Consumers are making deliberate cutbacks like shopping at superstores, eating out less and watching what they charge. We believe this is because most people have already been impacted by the downturn or they’re anticipating that we haven’t seen the worst of it. It’s very cautious behavior.”

Javelin analysts also found significant cutbacks among credit card issuers. Seven out of ten issuers have reduced efforts to solicit new customers and 62% have cut back the lines of credit they make available to consumers.

“From declining consumer use, rising risk levels, and possible new merchant fee legislation, the credit card industry is taking several hits right now, which could have unintended consequences on Americans,” said Bruce Cundiff, director of payments research and consulting at Javelin Strategy & Research. “If the economy continues to decline, consumers will likely be forced to turn to credit, but find it unavailable when they need it most.”

Tomorrow I'll be writing about debt deflation and how contractions in credit intensify into a deflationary spiral. Hint: It starts when the middle class gets squeezed so hard by wage stagnation that it can't support any more debt.

Monday, 28 July 2008

Signs of Debt Deflation in Commercial Lending

A while back I said that one of the things to watch for was contraction of commercial and trade credit as that would signal the contagion of the financial crisis from the financial economy to the real economy. Here is more evidence that it is going to be ugly out there - and definitely deflationary in due course:

U.S. banks sharply reduce business loans
By Peter S. Goodman, International Herald Tribune

Banks struggling to recover from multibillion-dollar losses on real estate are curtailing loans to American businesses, depriving even healthy companies of money for expansion and hiring.

Two vital forms of credit used by companies — commercial and industrial loans from banks, and short-term "commercial paper" not backed by collateral — collectively dropped almost 3 percent over the last year, to $3.27 trillion from $3.36 trillion, according to Federal Reserve data. That is the largest annual decline since the credit tightening that began with the last recession, in 2001.

The scarcity of credit has intensified the strains on the economy by withholding capital from many companies, just as joblessness grows and consumers pull back from spending in the face of high gas prices, plummeting home values and mounting debt.

I'll be writing more about Irving Fisher's theory of debt deflation as causing the Great Depression in my Friday RGE blog, which I'll cross-post here. Fisher was marginalised and neglected by the Chicago School free marketers, but is well worth reappraising given the way history is repeating itself.

Saturday, 26 July 2008

Quotable: Bastiat, Jefferson and Gandhi

I love good quotes. Now with this blog I have a place to highlight them as I come across them. Some good ones are appearing today over on RGE Blog:

“The law perverted! And the police powers of the state perverted along with it! The law, I say, not only turned from its proper purpose but made to follow an entirely contrary purpose! The law become the weapon of every kind of greed! Instead of checking crime, the law itself guilty of the evils it is supposed to punish!

“If this is true, it is a serious fact, and moral duty requires me to call the attention of my fellow-citizens to it.”

-- Frederic Bastiat, The Law (1848)

Hattip: Guest on 2008-07-25 15:18:16 on RGE Blog

"I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs."

-- Thomas Jefferson, Letter to the Secretary of the Treasury Albert Gallatin (1802)
3rd president of US (1743 - 1826)

Hattip: Mike C on 2008-07-25 17:40:32

"The Roots of Violence: Wealth without work, Pleasure without conscience, Knowledge without character, Commerce without morality, Science without humanity, Worship without sacrifice, Politics without principles"

-- Mahatma Gandhi: Indian leader, 1869-1948

Hattip: PeterJB on 2008-07-25 18:24:58

Friday, 25 July 2008

What's up with the covered bond push?

I've been particularly busy this week, nonetheless, I hope to convey enough background on the topic of covered bonds to start a discussion that I think may lead to interesting ideas.

Whenever Henry Paulson at Treasury, Ben Bernanke at the Fed and Shiela Bair at FDIC agree on anything, American taxpayers should check for their wallets to see if they are being mugged. As a result, my eyebrows rose a bit when these three started pressing in concert for covered bond issuance in US markets some weeks ago.

Covered bonds are a huge market of over $3 trillion in Europe, but have never been popular in the USA where securitisation was the preferred model for financing banks. They are perfectly legal and raise no issues, they just haven't been as profitable as securitisation so haven't been supported by the US markets. Covered bonds allow for extension of credit to a bank SIV or trust that will be serviced by income from hypothecated assets on the bank's balance sheet. The assets stay on the bank's balance sheet unless there is a default on the bonds, at which time the assets are forfeit as collateral to the trust vehicle servicing the covered bond.

Last week the FDIC released a policy statement on covered bonds that provides for "expedited release of collateral" if an issuing bank is taken into FDIC receivership or liquidation. The Treasury is expected to release a protocol on best practices for covered bond issuance in a high profile event next week. Hmmmm. What could be up?

If I had to guess, I suspect what we will soon see is something near to the following scenario:

Lists will circulate of troubled banks likely to go into FDIC receivership. Blogs have been full of such lists as of this week, quite suddenly, as it happens. The FDIC has to have a list because there are so many banks approaching insolvency that they are queued for FDIC receivership rather like planes circling Heathrow waiting for runway clearance to land.

Several of the central players in the recent market dramas - particularly those investment banks and hedge funds on close terms with Mr Paulson (naming no names, but initials GS comes to mind) - will go strong and aggressive for the covered bond market. They will go around to their list of troubled banks, which of course they will have compiled independently using Texas Ratio maybe, rather than having any foreknowledge of FDIC concerns. They will issue covered bonds to these trouble banks against any assets with real, proveable value left on the banks' balance sheets. They will be praised to the heavens by their friends in Washington as providing timely and necessary liquidity to a troubled banking system, proving the efficiency of the free market, bravely bearing the risk of new credit in exchange for troubled bank assets.
When the troubled bank nonetheless fails, our golden circle creditors get the good collateral in an expedited release from FDIC under its new policy statement. The FDIC is left with all the toxic waste assets and liability for depositor insurance claims, with no prospect of recovery of any value from the insolvent bank liquidation.

In the corporate sector, we could see the same kind of issuance. Covered bonds will be used to render profitable assets off soon-to-be-bankrupt corporates, leaving pensioners and other creditors with the stripped carcass in the liquidation.

When the FDIC itself becomes insolvent, which it surely must do as this game gets played to its obvious outcome, then the FDIC gets a GSE-style bailout via Treasury finance and the poor taxpayers get reamed again.

Am I too cynical? Is this a genuine attempt to realistically help improve liquidity and prosperity for America's banks? Or are the banks already destined to fail going to be looted and pillaged by the insiders before being burnt, leaving smouldering ruins for taxpayers to contemplate?

I'm not sure on this one, so I'm looking forward to views from those more expert here.

Thursday, 24 July 2008

RGE Refugees Welcome!

It seems that free access to Professor Nouriel Roubini's blog may soon be coming to an end as some regulars have received cryptic e-mails this week. I've set up this blogsite for refugees from the Professor's blog who want to carry on our dialogue over here. I'll be posting my weekly RGE blog here, and probably more informal content in the interim as I feel motivated.

Mostly I just want us to keep those in the sandbox playing happily together.

[UPDATE]: Professor Roubini commented over on my RGE blog as follows:

great you will have your own blog. I am not sure about the source of the rumor that my blog will soon be restricted to only paid users of RGE. That is utterly false; the blog is always free subject to free registration. But it is good you have your own forum. Many congrats. Nouriel
Written by Nouriel Roubini on 2008-07-25 15:39:46

So, no purge! Stop worrying! But come here to chat if you want anyway.