It is too late to avoid a depression in the US now. If the steps taken today were taken 12 months ago, right after the collapse of Bear Sterns, there would have been some possibility of an eventual turnaround. But the authorities ignored all the signs of impending economic calamity, dismissed the gigantic and interconnected risk structures of the past era as a market mechanism, and when that mechanism attempted to correct itself, they did not allow it to liquidate the bankrupt sectors. And now, by sustaining the tumour, they ensure that the cancer will do long term damage.

The government and the Federal Reserve are trying to make the American people spend like they were doing in the past, but unlike the past, there’s no credit, no secure jobs, no appreciating asset markets to back their exhortations. In response, Americans are saving like they have not done for quite a while. The dream is that ghe government can make people spend by simply giving them money; a foolish proposition disproven by the decades-long slump of the Japanese economy, and the various stagflationary periods of different nations.

There are two types of economic boom. One is created by expanding money supply and government action. The other is caused by fundamental factors such as technological innovation, or the global spread of productivity-enhancing techniques and tools. The former only creates illusory periods of speculative inflation, and its consequences are destructive, not creative. The latter can also fuel speculative activity, but it’s impact is usually long-term, and positive for the society at large. Our pessimism for the next 5-10 years is due to the fact that there will be a lot more monetary expansion than productivity-driven growth during the period. And the consequences of that will be turmoil, conflict, poverty, and despair.

As the sole remedy, we would be much more optimistic if China could be made to unleash its potential in a healthy manner. But given the attitude of the government, and also the traditions of the China people, we have grave doubts about the credibility of the “China-saves-the-world” scenario.

Yes, the stock market is rallying right now. Commodity markets are also rallying, and even shipping rates have been rising for a while. But we ask the reader to keep our word in mind, and to come back here a while later to check if we have been right or not: these episodes in all these markets are but bouts of volatility, created by the disappearance of the many liquidity-generators. The up-up-up markets of the past were an aberrance, and now we’re back to a normal situation where volatility complicates trading decisions, and economic analyis.That the economy will be in a slump for many years to come is a certainty. How much money the governments will print in their futile endeavour to resurrect a dead banking system in a deflationary environment is uncertain. Consequently, it is not possible to know if the price of a barrel of oil will be 1 USD, 10 USD, 100 USD, or 1000 USD, but until real liquidation and consolidation reshape the global financial system, volatility will remain high, real GDP growth will be low, and ROI in general miserable. We’d willing to bet one million dollars on this conjecture.


Deflation fear will keep central banks reducing interest rates and pumping liquidity into the world economy.

Prices paid to U.S. producers plunged in October by the most on record as the faltering global economy caused demand for commodities to dry up.

The 2.8 percent drop was larger than forecast and followed a 0.4 percent decline in September. The figures from the Labor Department came after the U.K. reported the biggest decrease in its inflation rate in at least 11 years, signs that deflation may be added to the list of economic challenges facing President-elect Barack Obama in January.

A collapse in demand is forcing companies including Dow Chemical Co., the largest U.S. chemical maker, to charge lower prices and has brought automaker General Motors Corp. to the brink of bankruptcy. Central banks are likely to keep cutting interest rates, with some benchmarks approaching zero percent, as a global recession increases the threat of deflation.

“Fuel prices are falling like a stone and will continue to drop,” said Michael Gregory, a senior economist at BMO Capital Markets in Toronto, who had forecast a 2.5 percent decline in the PPI. “The drop in consumer spending is going to cause a ripple effect all along the supply chain in disinflationary pressures, if not deflationary pressures.”

Private reports today showed more deterioration in the U.S. housing market, where the financial crisis and the economic slump began. Home prices fell in 80 percent of U.S. cities in the third quarter, according to figures from the Chicago-based National Association of Realtors.

The U.K. inflation rate fell more than economists forecast in October, recording the steepest drop in at least 11 years, the Office for National Statistics said today in London. Consumer prices rose 4.5 percent from a year earlier, compared with 5.2 percent the previous month.

After contracting at a 0.3 percent annual pace in the third quarter, the U.S. economy may shrink again this quarter and the first three months of 2009, according to a Bloomberg survey conducted from Nov. 3 to Nov. 11. The slump would be the longest since 1974-75.

Europe and Japan slipped into a recession last quarter, and China’s economy, the biggest contributor to global growth in 2007, is slowing.

The prices Dow charges for two of the most-used plastics, polyethylene and polypropylene, fell as much as 40 percent since September, giving up gains achieved since June, the company said. Midland, Michigan-based Dow is closing more factories as sales decline.

“This is as bad as we have ever seen it in our lifetimes,” Chief Executive Officer Andrew Liveris said in a Nov. 13 interview. An increase in prices “is probably going to be near impossible in the next three to six months.”

Private equity will soon discover how bad it can get for leveraged buyouts in a deleveraging environment. Many of them are managed by seasoned, reliable individuals, but if I’m allowed to extrapolate from a statement by Cerberus during the earlier part of this year, private equity wasn’t expecting the economy to deteriorate this badly. No one can complain about a lack of warnings, however.   

Meanwhile, despite all the fears of an imminent collapse, the CDS market has been holding its own ground remarkably well since the collapse of Lehman. The oncoming tests are likely to be even severer, however, and the best outcome would be a contraction in this market, without contagion in peripheral areas, such as bank failures, and the like.

Masonite International Corp., taken over by Kohlberg, Kravis, Roberts & Co. three years ago, may file for bankruptcy unless the company’s lenders agree to ease the terms of its bank loans, people familiar with the matter said.

The door and fiberboard maker, which KKR bought for $1.9 billion, is negotiating with a group led by Scotia Capital for a reprieve of at least 30 days in exchange for higher interest payment and fees, according to the people, who declined to be identified because the talks are confidential. Masonite and lenders holding $1.5 billion of the debt postponed until tomorrow a call that was scheduled for this morning, two people who planned to participate said.

Private equity firms including Apollo Management LP and Madison Dearborn Partners LLC have seen companies they own succumb this year to the slowing economy and the worst housing and financial crisis since the Great Depression. KKR partner Paul Raether said on Nov. 3 that the New York-based buyout firm had marked down the value of its equity investment in Masonite to zero.

“Masonite had a lot of leverage going into a really bad housing market,” Paul Aran, analyst with Moody’s Investors Service in New York, said in a telephone interview. “Demand for doors decreased and that in itself is a big enough problem. Add in the leverage covenants and you get into major issues,” he said, referring to terms of the loans. Moody’s yesterday lowered the company’s debt one grade to Ca, the second-lowest junk rating.

In the second quarter, Masonite breached loan covenants prohibiting the company from incurring debt seven times greater than its earnings before interest, tax, depreciation and amortization, according to a filing. The ratio surged to 8.25 times as of June 30 after the earnings figure declined 44 percent to $56 million, the filing said. In September, Masonite arranged a bank-loan forbearance agreement that expired Nov. 13.

Credit Event

Lenders blocked an interest payment to bondholders on Oct. 15, according to Moody’s. The company failed to pay the interest within a 30-day grace period, Moody’s said.

Failure to make interest payments on its bonds triggered a so-called credit event in derivatives contracts linked to Masonite’s loans. Traders of credit-default swaps on loans linked to Masonite will settle contracts on the company in “the next few weeks,” the International Swaps & Derivatives Association said today in a statement. The auction will be administered by Markit Group Ltd. and Creditex Group Inc., the statement said. Masonite is one of 100 companies in the Markit LCDX index.

KKR’s Loans

Bondholders holding 92 percent of the company’s $412 million of notes due in 2015 agreed to not demand repayment of the securities Nov. 17 through Dec. 31, the statement said. The notes were quoted yesterday at 14.75 cents on the dollar to yield 68 percentage points, according to Trace data, the bond-price reporting system of the Financial Industry Regulatory Authority.

Holders of 53 percent of the $358 million notes issued by Masonite, also due in 2015, also agreed to hold off on demanding immediate payment.

More  and more commercial mortgages are defaulting:

Two commercial mortgage borrowers with $334 million of loans bundled into bonds are about to default on their debt, according to Credit Suisse Group AG.

The $209 million Westin Portfolio loan and the $125 million loan for Promenade Shops at Dos Lagos were among the 10 largest in debt offerings sold by JPMorgan Chase.

The threat of nonpayment caused the cost to protect top- rated commercial mortgage bonds from default to soar 130 basis points to 570 basis points on Markit Group Ltd’s CMBX credit default swap index as of 4:05 p.m. in New York, according to a note to clients from Goldman Sachs Group Inc.

They are big loans and they went bad fast,” said Kent Born, a senior managing director in the commercial lending group at PPM America Inc. in Chicago. “In the current market environment, any negative news is going to cause an outsize reaction.”

The potential failures are the latest signs of cracks in the commercial mortgage market where default rates are low compared with the subprime home-loan market. Sales of bonds backed by commercial mortgages slumped to $12.2 billion this year, compared with a record $237 billion in 2007.

Delinquencies on commercial real estate debt were at 0.78 in October, RBS Greenwich data show. About 35 percent of all subprime mortgages backing bonds are least 30 days late, according to data complied by Bloomberg.

Arizona, California

The Westin loan is backed by two hotels located in Tucson, Arizona, and Hilton Head, South Carolina. The slowing economy has led customers to curb travel, reducing revenue for companies in the hospitality industry. Bookings growth at Expedia Inc., the world’s biggest online travel agency, fell to 7 percent in the third quarter from 21 percent a year earlier.

The Promenade Shops are located in Corona, California, one of the regions hardest hit by the worst housing crisis since the Great Depression. Rising foreclosures in Southern California sent home prices down 33 percent in October from a year earlier, MDA Dataquick said today.

Loans made to be sold into the CMBS market were the predominant form of financing for commercial real estate buyers between 2004 and 2007, when U.S. commercial property prices rose almost 60 percent, according to the Moody’s/REAL Commercial Property Price Index. That index has fallen about 12 percent since peaking in October 2007, according to data compiled by Bloomberg.

How low can homebuilder confidence go? Apparently, zero…There were those who thought 19 was a the bottom. We’re now at 9.

Confidence among U.S. homebuilders in November dropped to the lowest level since record-keeping began in 1985, a sign that the deepening credit crisis is preventing prospective buyers from purchasing new homes.

The National Association of Home Builders/Wells Fargo index of builder confidence decreased to 9, lower than forecast, from 14 in October, the Washington-based association said today.

Prices Falling

Home prices fell in four out of every five U.S. cities in the third quarter, a record spurred by distressed foreclosure sales across the country, the Chicago-based National Association of Realtors also said today. The median price of a U.S. home fell 9 percent from a year earlier and sales of properties with mortgages in default accounted for at least a third of all transactions.

The builders’ confidence gauge, which was first published in January 1985, averaged 27 last year.

Sales, Traffic Slump

The group’s index of current single-family home sales fell to 8 this month from 14 in October. The index of buyer traffic decreased to 7 from 11. A measure of sales expectations for the next six months were unchanged at 19.

Confidence slipped in all four regions, led by a slump in the Midwest.

U.S. foreclosure filings in October rose 25 percent from a year earlier, compared with average monthly gains of about 50 percent so far in 2008, after California passed a law delaying foreclosures for some borrowers, according to RealtyTrac, a seller of foreclosure data. Filings increased 5 percent from September.

Record-Low Starts

 “It’s safe to say October was a significant drop from September, which was an awful month and an awful period for everyone,” Ara Hovnanian, chief executive of Hovnanian Enterprises, New Jersey’s largest homebuilder, said in a Bloomberg Television interview Nov. 13.

“When our sales drop, and when we see it in the public arena, that means the starts and the closings that are going to come in the next couple of months are going to be far worse than what’s out there today,” he added.

Deflation or Inflation?

September 23, 2008

In general, there’re two opinions on where money supply and the dollar are headed:

1. The world and the US are headed for a “nasty” recession, quite possibly a depression. A universal contraction in demand will cause the services sector to shrink very strongly in the US, leading in turn to a halt to manufacturing expansion in Asian nations, and, eventually, to a large number of bankruptcies, as a large part of industrial capacity becomes idle. This will lead to higher unemployment across the globe, and cause deflation in commodities, goods and services, leading to higher dollar.

2. The world economy is headed for a one-two year long recession, as the US government continually bails out increasing segments of the economy, starting with banks. That the Treasury has moved so fast from rescuing the GSE’s to rescuing the entire banking industry of the US, and then some more in the rest of the world, shows that the Americans have no interest in paying the price of the excesses of the past decades, and will instead do whatever they can do save the day, regardless of what happens in the longer term. They will print more and more Treasury bonds to sustain the US consumer and to prevent the necessary adjustment in the consumer’s spending habits, which will prevent the rest of the world from suffering a severe slowdown, but will create inflation and crush the dollar in the process.

What does Washington want? I believe that the answer is very clear. At all costs, they want to prevent a demand contraction, and they have the means to achieve this, albeit only in the short term. “Live today, forget the rest” is more or less the modus vivendi of the American, and it now seems that this will also be how they manage this problem.

To be fair however, the administration is only willing to consider reflating the economy because it believes that the results would be more controllable and orderly than a depression and a collapse in demand. It’s not illogical to think that an artificially induced inflationary environment is easier to live with than a sudden, severe and unpredictable contraction of the economy. Those who oppose this argument suggest that it’s far from clear that the inflationary remedy can resolve the problem, that is, it’s not clear that by resorting to inflation we will not end up with both inflation and a depression. It must be mentioned that there’s no real example of an economy that has averted depression through easy monetary policy.

But I believe that the government at least has the power to devalue its currency: they can create such a great supply of dollars that even the most fearful investor sees little value in holding an asset which is likely to shrink at great speed as soon as the fear factor that is upholding it lessens.

That is why I support number two of the above options. I believe that the dollar is sentenced and damned. The US, as a nation, has chosen to sacrifice its tomorrow for saving the day, and the first to pay the price will be the dollar.

How to avoid a depression?

September 16, 2008

Wilbur Ross has told CNBC yesterday that one thousand regional banks could fail. He’s basing his opinion on historical record in light of recent developments.


What does this mean for the Federal Budget? Morgan Stanley believes it is manageable. (See bottom of the page) 


The government is expected to create stimulus packages, take over bank failures, finance the restructuring of the GSE’s, bailout failed financial firms, pursue two wars in Iraq and Afghanistan, provide or maintain tax cuts, and keep spending in order to sustain economic activity in general; and each of those items is at least a hundred billion dollar item.


At the same time the government’s revenues are likely to shrink as more bankruptcies and higher unemployment will be a feature of the next few years.  


How will the government get out of this without monetising some of these problems? Can the US avoid higher inflation in the long term?


Liquidity and the money supply are seen to be the solution by the Federal Reserve, but neither the government nor the private sector have a solid financial position to provide that liquidity. This is a solvency problem, and the cash is in the pockets of exporters, the debt is in the US Treasury. And as the debtor was the creator, and originator of a vast part of global economic activity in the past years, if the world wants to avoid a general economic cataclysm, it will have to bailout the American economy, arguably by continuing to buy increasing amounts of treasuries and other government paper.


This is not unprecedented in history. When, after the first world war, Germany faced financial catastrophe, it was the US that organised the bailout of the German state, as it was realised that a complete collapse of that nation was threatening the health of the American and international economies. In today’s case the Chinese and others are sitting on trillions of dollars, which are likely to depreciate significantly, if, as expected, the US does decide to solve its problems through monetisation. More importantly, neither the Chinese economy, nor in fact any other economy in the world is sophisticated enough to create or absorb those enormous sums without creating financial instability: it was a mistake on the part of the Chinese to accumulate that much in reserves, now they must at least make use of them. If they don’t, the US will depreciate its currency in the middle of a global recession, creating more insecurity, more contraction, and no one knows where this would lead us. 


In the long run, as I said, in the absence of an international solution, I believe that political reasons will lead the Congress and the administration to choose the path of monetisation, that is, inflation as the cure-all for the private sector’s problems. This is even likelier under Obama, and just today Barney Frank has been urging the government to begin to buy debt and other assets in the market. Indeed there does not appear to be any other solution to this issue. So far I have not heard a single voice providing a solution to the issues facing the economy: usually the suggestion is to let the markets solve their own problems, but politically the costs of this are going to be enormous: certainly double digit unemployment, and thousands of bankruptcies will be the outcome. But more importantly, if panic is allowed to take hold, the feedback loop can create problems that are not imagined today.


The United States escaped from the depression of the thirties only through war: the needs of a war economy, coupled with the psychological stimulus of a warlike mentality, allowed the system to grow out of its pessimistic stupor and create economic dynamism. Why did the recovery take so long? Because the collapse in confidence and goodwill after a long and severe bottoming, instead of creating new momentum and optimism, perpetuates the negative attitudes of the previous contraction. People are likely to enter the market to pick bottoms many times over many months, even years, and eventually it will be confidence that suffers the greatest damage. No amount of financial loss can account for the damage that confidence will suffer in a long term financial collapse. And that phenomenon is one of the reasons of Japan’s decades long slump too.