Tuesday, September 30, 2008

Merrill: On Inflation or Deflation?

Those who believe that we’ve managed, in one day, to switch from a deflationary to an inflationary backdrop because of additional government debt creation are not taking into account the offsetting credit contraction in the private sector, which comes from three sources: asset liquidation, debt repayment and increased savings. The Fed and Treasury are merely cushioning the massive deflationary forces in the financial system.

We are getting asked repeatedly these days how it is that the government debt creation we are about to see is not going to be inflationary. After all, aren’t we going to see a boom in the money supply? Well, we’re sure that the money supply is going to increase, but at the same time, we are going to see the turnover rate of that money, or what is called money velocity, decline. This is exactly what happened in that 1989-93 period when the Fed massively reflated. Money velocity contracted 13% and this is the reason why the inflation rate was cut in half that cycle and bond yields rallied 400 basis points, though no doubt that downtrend in yields was punctuated by intermittent corrections – as we’ve seen take place in the Treasury market over the past week.

Monday, September 29, 2008

The Paulson Plan - Comments by Roubini, FT, & Naked Capitalism

Analysis of Roubini post by Naked Capitalism:

1. The plan is inefficient (ie, it doesn't discriminate between who ought to be saved or not, and in fact rewards those who created dud assets)

2. It runs counter to the best models of how to deal with this sort of problem [according to a study by the IMF only 7 out of 42 countries in financial crisis actually purchased bad assets/loans and only 1 did it as the sole remedy]

3. It does not punish current shareholders [or bondholders] or management

But he uses words we haven't dared to, like "rip-off", "pathetic" and "disgrace". Go Roubini! Source
Without a contraction in the financial sector, the US administration risks a debt explosion, and a sudden withdrawal of foreign financial investors. This is the other big catastrophe looming large in the background. We are facing two big tail risks from different ends. Failing to rescue the banking system could lead to a depression. But so could a rescue if it produced macroeconomic instability. Source

Sunday, September 28, 2008

Financial Apocalypse Explained

Free Will: Financial Apocalypse Explained

Arnold (once of Freddie Mac) explains the housing bubble (12:58)
A brief history of Fannie and Freddie (14:14)
Was it really so unlikely that we’d end up in this kind of mess? (05:50)
Is there a method to the bailout madness? (05:14)
Surprise! The US is ruled by a technocratic elite (04:55)
Arnold blasts the Paulson plan as essentially corrupt (09:52)

Arnold Klings Blog

Friday, September 26, 2008

Credit Markets Predictably Not Happy Right Now

The interventions we've had to date have, by any standard, been massive, yet have failed to bring lasting relief. The idea that a $700 baillout bill is a "comprehensive solution" seems more than a tad optimistic. From Brad Setser:
In the last two weeks — if I am reading the Federal Reserves’ balance sheet data correctly — the Fed has:

Increased “other loans” to the financial system by around $230 billion (from $23.56b to $262.34b);

Increased its “other assets” by about $80b (from $98.67b to $183.89b);

Increased the securities it lends out to dealers by $60b (from $117.3b to $190.5b);

That works out to the provision of something like $370b of credit to the financial system in a two week period. That may be a bit too high: the outstanding stock of repos felll by $40b (from $126b to $ 86b), leaving a $330b net change in these line items. But that is still enormous.

CDS report: Big Mac and fried in the US

The US has been so hurt by the financial turmoil that markets now view its credit worthiness as akin to - or even worse than - that of McDonald’s, a shocking fact even if you believe that both are fronted by clowns.

One broker quoted McDonald’s CDS at about 26.5 basis points, compared with 30bp for the US, on Friday morning and another desk quoted both about 25bp. The picture has worsened since the news that politicians and public servants in Washington failed to seal a financial bail-out deal on Thursday night. McDonald’s closed at 28bp versus 25bp for the US on Thursday, according to Markit.

Sunday, September 21, 2008

Saturday, September 6, 2008

Bob Shiller's Subprime Solution - Short & Long Run

Arnold King says ... Shiller is a very independent thinker. He says that what we need is more financial innovation, not less. He says that we should not have been trying to urge so many people to take leveraged positions in homes, and that we should not be trying to maintain high house prices. (He spells out this latter point more in his book.)

Contrast these eight minutes, which are enlightening and educational, with the eight minutes of Furman and Holtz-Eakin that Mankiw linked to and I snarked about.

It is not that Shiller is fantastically better as an economist than those two. But political campaigns truly cause evil things to happen.

This year, the campaign feels to me like a popular movie that, like most popular movies, is not to my taste. While the Sarah Palin character adds melodrama and is well played, the overall script does not appeal to me. It includes too many promises of energy independence and no mention of unsustainable entitlement spending. And nothing remotely as thought-provoking as what Shiller has to offer.