from Dr. Brett--
Thanks to readers for their interest in The Daily Trading Coach. It seems as though the book, with its 101 short, practical trading "lessons", has struck a chord with traders and portfolio managers looking to improve their performance. As I write, the book is sitting near #1000 on the Amazon list, unusual for a niche trading text.
One aspect of the book that is unusual is the inclusion of a dedicated email address that readers can use to ask me questions about applying the techniques. A number of traders have taken advantage of that feature, and I'm happy to offer them tips on customizing the ideas and getting the most from them.
A theme that the book tackles is how what goes on in the body affects the mind. Indeed, many times traders use their bodies to gain control of emotional turmoil, only to lose control in a more profound way. The following segment comes from Lesson 47:
"...defenses are coping strategies that protect us from the emotional pain of past conflicts. One of the most basic defenses is repression: keeping thoughts, feelings, and memories out of conscious awareness so that they cannot trouble us. The problem with repression, of course, is that a conflict repressed is a conflict that remains unresolved. We can't overcome something if we remain unaware of its presence. Many traders use their bodies to repress their minds: their physical tension binds them, restricting the physical and emotional expression of feelings. I've met traders who were quite tight physically and yet who had no insight into the degree and nature of their emotional stresses. In an odd way, getting tense was their way of coping: they were always mobilized for danger, tightly keeping themselves in control. It is difficult to stay in touch with the subtle cues of trading hunches--the implicit knowledge we derive from years of pattern recognition--when our bodies are screaming with tension and even pain" (p. 151).
This is part of a much larger problem that impacts traders: when our modes of coping interfere with our day-to-day performance. One of the most important functions I perform when coaching traders is simply watching them when they trade and helping them stay loose mentally and physically. It's amazing how flexible we can be mentally when our bodies are not filled with tension.
Free Chapter From The Daily Trading Coach
Saturday, April 25, 2009
When the Body Controls the Mind
Regaining Self Control
from Dr. Brett-
Here is a sequence I observe among many active traders:
It begins with uncertainty. The trader isn't sure which way the market is going, but feels the need to make a trade. Instead of sitting back and letting the market show its hand, the trader is leaning forward, hand on mouse, ready to pounce.
The market moves higher by several ticks, as one or more program trades take out a few levels in the ES futures.
The trader now expresses frustration, "I should have bought there." He leans forward even more, hanging on every tick.
The market ticks down, then up. It's a slow market. The trader doesn't see that the recent move up was on minimal volume and that the midday trade is quite narrow. Suddenly the market ticks up one more time and the trader can't take it any more. He lifts the offer with his usual size, afraid of missing the move up.
There is no profit target or stop loss articulated. This is not a trade designed with good risk/reward parameters, because there *are* no parameters. This is a trade designed to minimize the discomfort associated with not being on board for a move.
The market suddenly reverses and retraces its recent gains. Now the trader either has to get out with a loss or hang in there and hope for a reversal. His frustration builds, leading him to continue his overtrading, and making it more likely that he will stick with--and even add to--losing trades.
Our trader is not trading to make money. He is trading to regulate his emotional state. Once he becomes attached to the need to trade and make money--and once his perfectionistic voice of "I should have bought there" enters the picture--he is no longer grounded in markets. It's when those frustrations build over time, becoming self-reinforcing, that traders "go on tilt".
By staying physically relaxed in one's breathing and posture and by mentally rehearsing a mindset in which it is OK to miss moves--there will always be future opportunity--traders can prevent many of these train wrecks. The practice of taking a break during the trading day, reviewing one's state of mind, and clearing one's head is remarkably effective in this regard. Clearly identifying the parameters of one's trade--the optimal size, reasonable targets given market movement, stop loss points that put risk and reward into proper alignment--also ensures that you are controlling your trading, not the reverse.
There are many ways in which the body controls the mind. If you are not physically calm and collected, it will be difficult to make calm, focused trading decisions. By working at observing yourself as you trade, you gain the ability to interrupt destructive sequences and regain control. Ultimately, going on "tilt" is the result of a loss of self-awareness. Once you remember yourself, you'll be able to access your skills and knowledge.
RELEVANT POST:
Trading Scared and Scarred
Secondary Anxiety and Trader Performance
A while back I wrote about performance anxiety as the most common emotional issue faced by traders and covered some of the techniques that are most effective in combating performance anxiety. There is, however, another variety of anxiety that affects traders that receives almost no attention. Psychologists call it secondary anxiety.
Let's say a person has a panic attack, an overwhelming experience of anxiety and dread that isn't connected to anything obvious. That panicky feeling may be so frightening that the person develops a fear of the attacks. That is how panic disorder patients often develop agoraphobia: they assume that their attacks are caused by something in their environment, so they avoid going places that (they think) might trigger further attacks.
Similarly, I've worked with students who have suffered from test anxiety, a very common form of performance anxiety. They become so fearful that they'll become anxious during a test that they generate the very fear that they hope to avoid!
When people become anxious about their own anxiety, that is called secondary anxiety. It is a particularly thorny problem, because it sets up a vicious cycle: more anxiety leads to more fears of anxiety leads to further nervousness.
A key element that perpetuates the cycle is avoidance of situations that might trigger anxiety. As long as we try to avoid what we fear, our fears control us. Psychologically, the only cure for anxiety is to directly confront our fears *while we remain under control*. That way, we learn in our experience that threatening situations are manageable.
What happens with traders is that they respond to losses (or threatened losses) with disruptive anxiety, often because they are trading excessive size/risk. As a result, they develop a fear of these disruptions and avoid situations that could lead to repeat incidents. One trader I worked with never increased his size in a way that was commensurate with his skills. He made money, but never as much as he should have. It turns out that this was his way of coping with large, painful losses early in his career. His small size was his way of keeping secondary anxiety at bay; he wasn't simply afraid of losing money, but was also afraid of losing his mind.
Another trader I worked with was so afraid of going on "tilt" that he overanalyzed trading opportunities, often missing good trades. The "tilt" that he feared had its roots in anxiety: losing control over trading, because of losing emotional control.
The approach I've found most helpful for such secondary anxiety is guided imagery, aided by biofeedback. In intensive sessions, I will have traders mentally rehearse scenarios of losing money *while they keep their bodies under control*. Heart rate variability biofeedback has been especially helpful in this regard; the Freeze Framer program that I refer to in this post is now known as emWave and has worked well for me.
The key is to use the biofeedback as a training device to help yourself stay physically calm and collected, even as you visualize the anxiety provoking situations that would normally trigger secondary anxiety. By repeating these situations in your mind again and again until you sustain physical control, you literally train yourself to master your responses, eliminating secondary anxiety by building self-efficacy.
We cannot avoid feelings of nervousness, fear, and anxiety, especially in situations that involve performance under conditions of risk and uncertainty. We can, however, avoid become nervous about our nervousness and fearful of our fear. We will always have emotions while trading; we don't have to be controlled by them.
How Trading Can Develop Character
from Dr. Brett-
For me, there's no better time than a long holiday weekend to step back and ask the big questions: those that deal with the meaning and significance of being a trader. These segments from my two books capture much of my sentiment on the topic.
"It is better to struggle in the service of one's dreams than to find instant success at meaningless work. The greatest joy in life, George Bernard Shaw once wrote, is being used for a purpose you recognize to be mighty. The greatest fields--those that are a calling and not a mere job--give one room to expand and develop oneself. There is only one valid reason for trading the markets, just as there is only one valid reason for being a psychologist, a dancer, or an architect: because it is your calling, the arena that best draws upon one's talents and passion for self-development." - The Psychology of Trading, p. 317.
"There are few arenas left in life where the independent individual can enact the heroic struggle...This, I believe is the eternal allure of the markets. With a reasonable stake and an online account, each person can undertake his or her own gold rush and enact the highest entrepreneurial quest. Like salmon that swim upstream to spawn, sperm that pursue the egg, and prospectors that dig for precious metal, many will be called and few chosen. It matters not. What matters is the dignity and the dimension of soul conferred by one's noblest impulses. It is not desirable to rule in hell or to serve in heaven; far preferable, to paraphrase Ayn Rand, is to fight for tomorrow's Valhalla in order to walk its halls today." - The Psychology of Trading, p. 318.
"Let us not forget what it means to be a trader. It means that I am free to own property: shares of a private company or contracts in a commodity. I can take delivery of my property and dispose of it as I wish, or I can trade it to others. My decisions are mine to make; I need not follow the dictates of those who would put other interests--those of gods, governments, or guns--above my own. If I lose, it is my loss. If I profit, the gain is mine...Without freedom, there is no trading. Trading is a celebration of economic and political freedom. Slaves are traded; they do not trade." - Enhancing Trader Performance, p. 253-4.
"What are we really developing when we train for expert performance in any domain? We develop skill and knowledge, to be sure, but we also develop more than that. We cultivate will: the ability to formulate goals and direct our actions toward reaching those goals. Every training session is a battle of will: a struggle to overcome our limitations and reach a particular performance goal...When you enhance your performance as a trader, you replace a small piece of randomness with intention. To that degree, your outcomes are self-determined. If you train yourself properly, you will become not only a successful trader, but a more self-determining human being." - Enhancing Trader Performance, p. 254-255.
RELEVANT LINKS AND QUOTES:
Ayn Rand and Objectivism
"Dr. Miller says we are pessimistic because life seems like a very bad, very screwed-up film. If you ask "What the hell is wrong with the projector?" and go up to the control room, you find it's empty. You are the projectionist, and you should have been up there all the time." - Colin Wilson
"Every man builds his world in his own image. He has the power to choose, but no power to escape the necessity of choice." - Ayn Rand
Friday, April 24, 2009
Influence of Leveraged ETFs
from the Daily Options Report blog:
Now I know many prefer the notion that a cabal of a few Big Evil Hedge Funds control the close each day. But perhaps it's something even more sinister, Big Evil Leveraged ETF's? Or rather, the rebalancing of swaps thereof. This, from the Journal (hat tip Don Fishback and Abnormal Returns).
I had heard this was a factor in why moves often snowball late in a day. But what I hadn't heard, but should have just known, was something like this.At 3 p.m., do you get queasy just thinking about the toll that the final hour of trading might take on your portfolio?
New research suggests that on days when the indexes make big moves, leveraged exchange-traded funds could trigger a trading cascade, turning the market close into a buying or selling frenzy.
........The excessive trading set off by releveraging is perfectly legal -- but upsetting to many people. "The market doesn't seem like a fair, level playing field," says Andrew Brooks, head of U.S. equity trading at T. Rowe Price in Baltimore.
Now a respected analyst -- Ananth Madhavan, head of trading research at Barclays PLC's Barclays Global Investors -- has released a report arguing that the potential ripple effects of releveraging have been underestimated.
Leveraged ETFs usually generate a multiple of the market's daily return by using something called a "total-return swap." Imagine a fund with $100 million in net assets and 200% leverage, meaning that it seeks to deliver twice the market's daily return. That requires the fund to maintain $200 million in swap exposure.
In a long swap, a counterparty like a bank or brokerage firm agrees to pay the fund $2 for every $1 rise in the closing value of a market index that day. On the other hand, if the market falls, the fund must pay the counterparty 2-for-1.
Now let's say the fund's net assets grow by $10 million during the day, to $110 million. The fund must raise its swap exposure from $200 million to $220 million to honor its 2-for-1 investment objective. That is $20 million in extra buy orders, all coming into the market after 3:30 p.m., typically in the final 10 minutes.
An inverse fund also must buy on a day when the market is up; since the value of its hedge has gone down, the fund must increase its exposure to keep its leverage ratio constant. Thus, all these ETFs buy in lockstep in the last few minutes of an up day for their index -- and sell in a swarm at the end of a down day.
Further amplifying the ETFs' actions: Every day, trading desks at big banks and brokerage firms blast out customized spreadsheets to favored clients. These tools, linked to live data feeds, predict whether the leveraged ETFs will be buying or selling as 4 p.m. approaches. That enables hedge funds and other big investors to trade ahead of the ETFs.So while it's "comforting" to know these funds aren't causing the melt downs or melt ups, good to know they're still using a stacked deck to profiteer off it.
As always with these sort of shenanigans, you'll go broke waiting for the SEC to reign it in. The best tack is to know it's part of the backdrop, and trade accordingly. If it walks like a trend day and talks like a trend day, it's probably a trend day. Which means you likely get a low and last, or high and last, sort of close. And in a world of popular Leveraged ETF's, and hedge funds getting The Look, it's probable that move will get exascerbated. So it pays to just trade accordingly.
Gold Rising Steadily
News that China is building its gold reserves is sending gold back into an uptrend. This has the potential to create a long and sustained rally in gold.
More Socialism Headed Our Way
| Posted: 04/21/09 05:21 PM [ET] | |
| President Obama showed his hand this week when The New York Times wrote that he is considering converting the stock the government owns in our country’s banks from preferred stock, which it now holds, to common stock.
This seemingly insignificant change is momentous. It means that the federal government will control all of the major banks and financial institutions in the nation. It means socialism. When the Troubled Asset Relief Program (TARP) intervention was first outlined by the Bush administration, it did not call for any transfer of stock, of any sort, to the government. The Democrats demanded, as a price for their support, that the taxpayers “get something back” for the money they were lending to the banks. House Republicans, wise to what was going on, rejected the administration’s proposal and sought, instead, to provide insurance to banks, rather than outright cash. Their plan would, of course, not involve any transfer of stock. But Sen. John McCain (R-Ariz.) undercut his own party’s conservatives and went along with the Democratic plan, ensuring its passage. But to avoid the issue of a potential for government control of the banks, everybody agreed that the stock the feds would take back in return for their money would be preferred stock, not common stock. “Preferred” means that these stockholders get the first crack at dividends, but only common stockholders can actually vote on company management or policy. Now, by changing this fundamental element of the TARP plan, Obama will give Washington a voting majority among the common stockholders of these banks and other financial institutions. The almost 500 companies receiving TARP money will be, in effect, run by Washington. And whoever controls the banks controls the credit and, therefore, the economy. That’s called socialism. Obama is dressing up the idea of the switch to common stock by noting that the conversion would provide the banks with capital they could use without a further taxpayer appropriation. While this is true, it flies in the face of the fact that an increasing number of big banks and brokerage houses are clamoring to give back the TARP money. Goldman-Sachs, for example, wants to buy back its freedom, as do many banks. Even AIG is selling off assets to dig its way out from under federal control. The reason, of course, is that company executives do not like the restrictions on executive pay and compensation that come with TARP money. It is for this reason that Chrysler Motors refused TARP funds. With bank profits up and financial institutions trying to give back their money, there is no need for the conversion of the government stock from preferred to common — except to advance the political socialist agenda of this administration. Meanwhile, to keep its leverage over the economy intact, the Obama administration is refusing to let banks and other companies give back the TARP money until they pass a financial “stress test.” Nominally, the government justifies this procedure by saying that it does not want companies to become fully private prematurely and then need more help later on. But don’t believe it. They want to keep the TARP money in the banks so they can have a reason and rationale to control them. The Times story did not influence the dialogue of the day. People were much more concerned with the death of 21 horses at a polo match. Much as we will miss these noble animals, we will miss our economic freedom more. |
Tuesday, April 21, 2009
Manipulated Markets
Today, the stock market rose on a statement by Treasury Secretary Geithner that the majority of banks are well-capitalized. But his statement doesn't pass the smell test. If this were true, then why did he say a few days ago that the majority of banks will need additional taxpayer funding? This is a contradition and leads me to believe that his statement is "spin", not truth. It is "sound bite finance", which is ultimately intended to mislead.
While the stock markets rose from negative territory into the black following his comment before Congress, his track record is so poor that I don't think many investors believe him. He is always wrong, so why would I put money on the line now? It appears to be a sound bite intended to move markets, but without any facts or foundation to back it up. I just don't believe him.
How to Change Your Self-Talk
from Dr. Brett--
From the time we become self aware, we conduct an internal dialogue. We question ourselves, berate ourselves, congratulate ourselves, and make plans for ourselves. As I emphasized in my book, our self talk represents the "I" speaking to the "me". Just as we have relationships with others, our self talk is a manifestation of our relationship to ourselves.
I often ask traders to conduct their self-talk out loud. Sometimes we even record it. The playbacks are eye-opening. That's when we hear what we sound like when we talk to ourselves. Is the talk friendly and supportive? Is it angry and perfectionistic? Is it abusive? Is it constructive? When we hear our internal dialogue, we lay bare our self esteem: how we truly feel about ourselves and how we actually treat ourselves in this relationship between "I" and "me".
A cornerstone of cognitive approaches to change is that, to change the way we feel and act, we need to change how we process information. Much of our self talk occurs automatically, without our even being aware that it is occurring. When we keep a cognitive journal, we are making the internal dialogue explicit: writing it down so that we can be aware of it and gain some distance from it. Change begins, I find, when people recognize their self talk in real time and come to the realization: "This isn't how I want to talk to myself!"
This is especially relevant to trading. How we talk to ourselves about a trade will affect how we manage that trade. When we "lose discipline" and fail to adhere to a trade plan, it's often because the information processing we engaged in to develop the trade idea has been hijacked by a very different kind of self talk during the trade.
Here's a very simple method to alter our patterns of self talk:
Recall our visit to the expert trader Marc Greenspoon. Marc keeps with him a pocket recorder for dictation. He talks to himself through the recorder, reviewing his performance. In many of the tapes, Marc sounds like a coach talking to a player. He is both critical and motivating. His tone is no-nonsense, and he hones in on what he needs to do to improve his trading. Most important of all, Marc uses the taping to achieve a certain level of emotion and motivation. Like a half-time talk from a coach, Marc's talks to himself help him sustain the alert information processing that he needs for his kind of trading.
I believe Marc's technique--talking to himself as a way of rehearsing desirable self talk--has a great deal of promise, not just at the end of a trading day, but at the start and the middle as well. The key rule when doing the taping is to not stop the tape until you have truly hit an emotional level that represents the kind of relationship you want to have with yourself.
A major shortcoming of written journals is that they can be emotionally sterile. They don't shift us into different ways of processing information and relating to ourselves. The best way to change our self talk might just be to practice talking with ourselves. We're always going to have a relationship with ourselves. The only question is whether or not that relationship is within our conscious control. Taking the time to consciously talk to ourselves is a great way of making our self talk conscious.
Finding Your Inner Trader Voice
from Dr. Brett--
Occasionally I'll meet a trader for the first time who wonders aloud why he hasn't made greater progress. He keeps a journal, he reviews his performance, he identifies what he does wrong and tries to correct his mistakes: why isn't he succeeding?
Here's a sample of dialogue from such a trader at the start of a coaching session:
"I feel like I should be so much further along than I am. There's been great opportunity in the market, and I just haven't taken advantage of it the way I should have. I'll have a good day or two and then I just go back to making the same mistakes. I'll get too aggressive and lose money. Then I get stopped out for the day and miss out on great trades. Sometimes I even wonder if I should keep doing this. I know what I need to do, but I can't seem to do it."
Now how does that sound to you? Sounds like a trader who is frustrated; a trader in some distress.
Now let's alter the dialogue by substituting "you" for "I" and pretending that the dialogue is coming from someone talking to the trader:
"I feel like you should be so much further along than you are. There's been great opportunity in the market, and you just haven't taken advantage of it the way you should have. You'll have a good day or two and then you just go back to making the same mistakes. You'll get too aggressive and lose money. Then you get stopped out for the day and miss out on great trades. Sometimes I even wonder if you should keep doing this. You know what you need to do, but you can't seem to do it."
Now how does that sound?
What sounded frustrated in the first person voice now comes across as hostile and blaming in the second person.
How would you feel if, during one of your slumps, someone spoke to you in this way? Probably not very good. One of the reasons why is that there is nothing in these statements that is a concrete idea or suggestion for constructive change.
Many traders have not found their own constructive voice; they are not consistently good at mentoring themselves. They recognize that they are frustrated, but they don't recognize that, by immersing themselves in negative, angry talk, they undercut their own confidence and motivation.
After all, how much motivation would you sustain as a rookie trader if your supervisor at a firm spoke to you that way after a few losses?
A theme I emphasize in The Psychology of Trading book is that each of us has a relationship to ourselves. That relationship is defined, in large part, by our self-talk: how we communicate to ourselves during good times and bad.
You can't advance yourself and browbeat yourself at the same time. You can't pursue success wholeheartedly if you're also telling yourself how bad you are and how badly you're doing.
Often, traders seek help simply to find their voice: the ways of talking to themselves that encourage, support, and challenge rather than blame, attack, and catastrophize. The frustrated voice, so often, is the abusive voice. Just turn those "I" statements into "You" statements and you'll see how they sound.
The way we develop a new voice starts with identifying and building upon strengths and successes, not becoming mired in weaknesses and losses. You'll succeed by more consistently enacting the best within you, not by making fewer mistakes.
And you'll succeed when you talk to yourself like a winner, not a loser. Because that's the voice you'll internalize. Once you internalize that voice, nothing short of growth, progress, and self-development will feel natural.
RELEVANT POSTS:
Changing Your Self Talk
Building Self-Efficacy
Solution-Focused Trading
IMF: Loan Losses to Reach $4.1 Trillion
from Reuters:
Global write-downs of toxic debt among banks and financial institutions in the United States, Europe and Japan could reach $4.1 trillion, the International Monetary Fund said on Tuesday.
This marks the first time the IMF has included estimates of credit losses on debt originated in Japan and Europe since the global financial crisis started in 2007.
The IMF's Global Financial Stability Report said banks needed more capital to weather the expected write-downs and to restore investor confidence in the financial system.
Banks worldwide have so far raised about $900 billion in capital, about half of it through government rescue loans.
The IMF also said it now expects the deterioration in U.S.-originated assets to reach $2.7 trillion, substantially more than the $2.2. trillion it forecast in January. The sharp increase reflects losses mainly between October and January.
Globally, banks will face the bulk of the write-downs. The IMF estimated write-downs for loans and securities held by banks could be about $2.8 trillion, and that about one-third has already been written down.
Roubini: It Ain't Over Yet!
On the U.S. economy:
This consensus optimism is, I believe, not supported by the facts. Indeed, I expect that while the rate of US contraction will slow from -6 per cent in the last two quarters, US growth will still be negative (around -1.5 to -2 per cent) in the second half of the year (compared to the bullish consensus of +2 per cent).
Moreover, growth next year will be so weak (0.5 to 1 per cent, as opposed to the consensus of 2 per cent or more) and unemployment so high (above 10 per cent) that it will still feel like a recession.
In the euro zone and Japan, the outlook for 2009 and 2010 is even worse, with growth close to zero even next year. China will have a more rapid recovery later this year, but growth will reach only 5 per cent this year and 7 per cent in 2010, well below the average of 10 per cent over the last decade.
Given this weak outlook for the major economies, losses by banks and other financial institutions will continue to grow. My latest estimates are $3.6 trillion in losses for loans and securities issued by US institutions, and $1 trillion for the rest of the world.
It is said that the International Monetary Fund, which earlier this year revised upward its estimate of bank losses, from $1 trillion to $2.2 trillion, will announce a new estimate of $3.1 trillion for US assets and $0.9 trillion for foreign assets, figures very close to my own.
By this standard, many US and foreign banks are effectively insolvent and will have to be taken over by governments. The credit crunch will last much longer if we keep zombie banks alive despite their massive and continuing losses.
On the Stock Market:Given this outlook for the real economy and financial institutions, the latest rally in US and global stock markets has to be interpreted as a bear-market rally. Economists usually joke that the stock market has predicted 12 out of the last nine recessions, as markets often fall sharply without an ensuing recession.
But, in the last two years, the stock market has predicted six out of the last zero economic recoveries -- that is, six bear market rallies that eventually fizzled and led to new lows.
The stock market's latest 'dead cat bounce' may last a while longer, but three factors will, in due course, lead it to turn south again. First, macroeconomic indicators will be worse than expected, with growth failing to recover as fast as the consensus expects.
Second, the profits and earnings of corporations and financial institutions will not rebound as fast as the consensus predicts, as weak economic growth, deflationary pressures and surging defaults on corporate bonds will limit firms' pricing power and keep profit margins low.
Third, financial shocks will be worse than expected.
At some point, investors will realise that bank losses are massive, and that some banks are insolvent. Deleveraging by highly leveraged firms -- such as hedge funds -- will lead them to sell illiquid assets in illiquid markets. And some emerging market economies -- despite massive IMF support -- will experience a severe financial crisis with contagious effects on other economies.
Bank Alchemy Makes Profits Magically Appear
from Andrew Ross Sorkin at NYT:
This is starting to feel like amateur hour for aspiring magicians.
Another day, another attempt by a Wall Street bank to pull a bunny out of the hat, showing off an earnings report that it hopes will elicit oohs and aahs from the market. Goldman Sachs, JPMorgan Chase, Citigroup and, on Monday, Bank of America all tried to wow their audiences with what appeared to be — presto! — better-than-expected numbers.
But in each case, investors spotted the attempts at sleight of hand, and didn’t buy it for a second.
With Goldman Sachs, the disappearing month of December didn’t quite disappear (it changed its reporting calendar, effectively erasing the impact of a $1.5 billion loss that month); JPMorgan Chase reported a dazzling profit partly because the price of its bonds dropped (theoretically, they could retire them and buy them back at a cheaper price; that’s sort of like saying you’re richer because the value of your home has dropped); Citigroup pulled the same trick.
Bank of America sold its shares in China Construction Bank to book a big one-time profit, but Ken Lewis heralded the results as “a testament to the value and breadth of the franchise.”
Sydney Finkelstein, the Steven Roth professor of management at the Tuck School of Business at Dartmouth College, also pointed out that Bank of America booked a $2.2 billion gain by increasing the value of Merrill Lynch’s assets it acquired last quarter to prices that were higher than Merrill kept them.
“Although perfectly legal, this move is also perfectly delusional, because some day soon these assets will be written down to their fair value, and it won’t be pretty,” he said.
Investors reacted by throwing tomatoes. Bank of America’s stock plunged 24 percent, as did other bank stocks. They’ve had enough.
Why can’t anybody read the room here? After all the financial wizardry that got the country — actually, the world — into trouble, why don’t these bankers give their audience what it seems to crave? Perhaps a bit of simple math that could fit on the back of an envelope, with no asterisks and no fine print, might win cheers instead of jeers from the market.
What’s particularly puzzling is why the banks don’t just try to make some money the old-fashioned way. After all, earning it, if you could call it that, has never been easier with a business model sponsored by the federal government. That’s the one in which Uncle Sam and we taxpayers are offering the banks dirt-cheap money, which they can turn around and lend at much higher rates.
“If the federal government let me borrow money at zero percent interest, and then lend it out at 4 to 12 percent interest, even I could make a profit,” said Professor Finkelstein of the Tuck School. “And if a college professor can make money in banking in 2009, what should we expect from the highly paid C.E.O.’s that populate corner offices?”
But maybe now the banks are simply following the lead of Washington, which keeps trotting out the latest idea for shoring up the financial system.
The latest big idea is the so-called stress test that is being applied to the banks, with results expected at the end of this month.
This is playing to a tough crowd that long ago decided to stop suspending disbelief. If the stress test is done honestly, it is impossible to believe that some banks won’t fail. If no bank fails, then what’s the value of the stress test? To tell us everything is fine, when people know it’s not?
“I can’t think of a single, positive thing to say about the stress test concept — the process by which it will be carried out, or outcome it will produce, no matter what the outcome is,” Thomas K. Brown, an analyst at Bankstocks.com, wrote. “Nothing good can come of this and, under certain, non-far-fetched scenarios, it might end up making the banking system’s problems worse.”
The results of the stress test could lead to calls for capital for some of the banks. Citi is mentioned most often as a candidate for more help, but there could be others.
The expectation, before Monday at least, was that the government would pump new money into the banks that needed it most.
But that was before the government reached into its bag of tricks again. Now Treasury, instead of putting up new money, is considering swapping its preferred shares in these banks for common shares.
The benefit to the bank is that it will have more capital to meet its ratio requirements, and therefore won’t have to pay a 5 percent dividend to the government. In the case of Citi, that would save the bank hundreds of millions of dollars a year.
And — ta da! — it will miraculously stretch taxpayer dollars without spending a penny more.
Setting Ourselves Up for Bigger Trouble
“Although perfectly legal, this move is also perfectly delusional, because some day soon these assets will be written down to their fair value, and it won’t be pretty.”
-Steven Roth, professor of management at the Tuck School of Business at Dartmouth College, on Bank of America’s earnings fraud
Could TARP Lose Money? It Already Has!
from Businessweek:
A research firm says the U.S. lost $104 billion on the ownership stakes it took in financial companies in return for TARP funds. Losses could mount
While the U.S. government keeps doling out taxpayer money in a frenzied effort to save the financial system, more scrutiny is being paid to what the government is getting in return for its bailouts—and how big a loss taxpayers are likely to suffer in the end.
Elizabeth Warren, who heads the Congressional Oversight Panel responsible for keeping tabs on the Troubled Asset Relief Program (TARP), estimates that $590.4 billion of the total $700 billion approved by Congress has been spent or committed over the past six months. But economic stabilization efforts that have relied on the Federal Reserve's balance sheet have "permitted Treasury to leverage TARP funds well beyond the funds appropriated by Congress," the panel said in its Apr. 7 oversight report.
Although the Treasury has been taking stock and warrants in companies in exchange for TARP funds, from the start the value of assets it has received has been much less than the TARP money it has doled out. For every $100 of TARP money disbursed, the government has gotten stock and warrants worth just $66 at the time of issuance, Warren said in an Apr. 15 interview with Jon Stewart on The Daily Show. The value of those assets has deteriorated further since being issued, she said.
Accounting Gimmicks Due to Elimination of Mark to Market Swings Banks Stocks from Insolvent to Profitable
from Curious Capitalist blog:
On Friday I noted that Citigroup wouldn't have reported a profit if it hadn't been for a $2.5 billion derivatives valuation adjustment "mainly due to the widening of Citi's CDS spreads." Citi's CDS spreads widen when traders think Citi is more likely to default. So basically, Citi was able to report a profit because fears grew that it would go under. Weird, huh?
Today, Alea notes, Bank of America joined in the weirdness with "$2.2 billion in gains related to mark-to-market adjustments on certain Merrill Lynch structured notes as a result of credit spreads widening." This didn't make the different between profit and loss—BofA reported net income of $4.2 billion. But it does point out again that bank earnings reports have become very strange things. As commenter sulliclm explained, with reference to Citi's earnings:
Basically this is the side of mark to market accounting that nobody talks about. FAS 157 (the accounting term for mark to market accounting) applies to both assets and liabilities. So for Citigroup and other banks, they have to mark their liabilities to fair value, and in the case of their own debt (or in this case liabilities on derivative positions), they have to consider their own default potential as a component of fair value. So the more likely it becomes that Citi will default on their debt/swaps, the less those instruments are worth to the investors that hold them. Therefore the accounting guidance says that Citi should reduce the value of the liabilities on their books, and they book this reduction as a gain through the income statement. As an auditor I find the guidance to be ridiculous, but its the rule so companies are following it ...
There's a great passage in Jamie Dimon's letter to shareholders on this practice, "The theory is interesting, but, in practice, it is absurd. Taken to the extreme, if a company is on its way to bankruptcy, it will be booking huge profits on its own outstanding debt, right up until it actually declares bankruptcy–at which point it doesn't matter."
In fact, Lehman Brothers booked repeated debt valuation gains as it went down last year—although they weren't big enough to offset its other losses. And it seems clear that there really is something screwy about mark-to-market accounting that goes beyond the simple fact that markets are volatile.
Monday, April 20, 2009
All Down, All Day
from Dr. Brett's tweet:
Not a single significant (> +800) NYSE TICK reading so far today; difficult to mount a reversal if we don't see buying interest
Translation: Nobody of any size is buying today. Nobody!
We are currently very near session lows.
More Bank Losses -- and Bailouts -- Coming
from Zero Hedge:
A report by JP Morgan analyst Matthew Jozoff is putting the spotlight back on the banks, where lately everything has been seen as rosy to quite rosy. Jozoff disagrees and in fact sees another $400 billion in losses as a result of the continuing credit deterioration, and very likely major new capital infusions needed.Says Jozoff:
We find that TALF 2.0 is likely to benefit securities with the least amount of writedowns and lowest haircuts —fixed rate bonds and long-reset hybrids should have the most upside. We estimate that banks will experience about $400bn more in losses, and stress tests will reveal the need for more capital for certain institutions.Among other things Jozoff points out is that banks will need to set aside an additional $215 billion in reserves against holdings of $2.1 trillion in residential loans not packaged into securities. As banks have taken only $85 billion in loss allowances as of Q4 2008, and Jozoff estimates the total expected residential losses at $300 billion (based on 12-16% losses on the total number mentioned above), banks will be hard pressed to fund this capital deficiency, especially now that each and every bank is rushing to repay the TARP that "it never needed in the first place." Continues Jozoff:
We expect that total losses could reach $1.3 trillion. Banks so far have taken writedowns and losses of $920bn, so they are roughly 70% through with total losses. Capital raised to date ($900bn, much of which came from governments worldwide) has been close to the amount of losses realized to date. Given the amount of losses still to come, we believe the system will need more government capital (although healthier institutions may not need more and may try to raise capital from the private sector). Bank earnings will also be a source of capital and some estimate that over the next two years, the largest institutions can see around $200bn of earnings (pre-tax, pre-provisions).Regardless of the validity of earlier "leaked" stress tests, this is likely a major sticking point for the administration which is currently beating its head on how to sweep these potential large future losses under the rug.
Going forward, the bulk of bank losses will come from loan books and less from securities portfolios, which have already gone through large writedowns. Most bank loans are not required to be marked-to-market, but, rather, reserves are set aside for expected loan losses to be realized in the next year or so. That is why reserve coverage ratios (reserves vs non-current loans) have plunged. In other words non-current loans are growing at a faster pace than reserves have built-up.
Even though banks don’t have to reserve for total cumulative losses today, the question is how much more reserves will they need over the next few years to cover loan losses. In the case of residential loans, if total expected losses are $300bn and banks have set aside $85bn in reserves for these loans, we estimate that there could be over $200bn left to go, or about half
of total projected losses across all assets.
More Bad (Citi) Bank
from Baseline Scenario:
It’s a beautiful day today, and after Goldman and JPMorgan, I don’t feel like diving deep into Citigroup’s earnings release. But judging from the Bloomberg article, it’s a similar story, just not as good.
1. All the good news was in fixed income trading: $4.7 billion in fixed income trading revenues; falling revenues in credit cards, consumer banking, and private client.
2. Assets continue to deteriorate: $5.6 billion in new writedowns in trading accounts; $3.1 billion in charge-offs and reserves for bad credit card debt.
3. Accounting fictions save the day (the new bit): $0.6 billion in losses that don’t have to be classified as other-than-temporary (and therefore affect the income statement) thanks to FASB; $2.5 billion in “profits” because of the fall in the value of Citigroup’s own debt. The theory behind the latter is that Citi could go into the market and buy back all of its distressed debt, which would be cheaper than paying it off at 100 cents on the dollar. Also: $0.4 billion in litigation expenses avoided (previously reserved) and tax benefits from an IRS audit.
Point 3 adds up to $3.5 billion, which dwarfs Citi’s $1.6 billion profit. Why is everyone so optimistic about banks these days?
The Three-Legged "Safe Haven" Stool
It is really only a two-legged stool. And one of those legs is deformed and weak. The three safe havens of gold, U.S. treasuries, and the US Dollar are only two legs. The Dollar and U.S. debt are both fools gold and are a bet on the same thing -- just twin legs of the same thing. If one of those two legs collapses, the other one will also. I will trade treasuries and occasionally the Dollar, but I will own gold.
The Rising Tide of Fresh Bearish Economic Data -- Swept Under the Rug!
from VIX and more's Bill Luby:
I have been bullish since March 5th (SPX at 687; Intermediate Bottom Potential Is High), but a number of factors have turned my bias back to the bearish side in the course of the past few days.
Apart from some technical indicators which suggest equities are overbought at present, there has been a recent wave of economic data, much of it swept under the rug, which suggests that bullish headlines may soon be on the wane. The news spans housing starts to foreclosures to credit card charge-offs to retail sales and industrial production. Frankly, none of it looks promising.
Joined at the hip to the industrial production report is capacity utilization data. Essentially, this statistic measures how much of the national production capacity is being used and how much is sitting idle.
This week’s chart of the week looks at the full history of total capacity utilization in the United States, based on data available from the Federal Reserve. Total capacity utilization for March was just 69.3%. This is the lowest number in the history of this statistical series, which dates back to 1967. While not shown in the graph below, manufacturing capacity utilization fell to 65.8%, which is the lowest number since records were first gathered in 1948.
In terms of interpreting the capacity utilization data, it is probably best to think of the number as a broad measure of demand relative to existing infrastructure. Of course the current record low numbers reflect a historic weakness in demand. Capacity utilization is also a strong predictor of inflationary and deflationary pressures. With so much slack in the system, deflationary pressures are sure to increase as prices get slashed in order to offset the high fixed costs of so much idle productive capacity.
In addition to the current bad news, there are some complicating factors which may make it difficult to reverse the recent trend. Looking ahead, a stronger dollar and weaker consumer does not bode well for future production data – and should raise new concerns about the possibility of deflation.
Industrial production may steal most of the headlines, but capacity utilization is an often overlooked important piece of the economic puzzle.
Gold Goes Goliath!
The three safe havens -- gold, treasuries, and the Dollar -- are sharply higher today. However, only one leg of this safe haven stool -- gold -- doesn't depend upon government. It is also sharply higher today. If the other two legs of the stool ever collapse, then gold will be the only one left. This could be a consequence of hyperinflation. When the U.S. government debt bubble pops, then gold would be the only safe have left. If hyperinflation occurs, I suspect we would also see other physical commodities take off higher also, despite soft demand.
Government Suggests It May Refuse TARP Repayments, Exchange for Common Stock Instead
This news is also not reassuring the market today. This smells like a de facto nationalization! It stinks!
From Baseline Scenario:
The New York Times is reporting that the administration is thinking of stretching its TARP funds further by converting its preferred shareholdings to common stock.
The change to common stock would not require the government to contribute any additional cash, but it could increase the capital of big banks by more than $100 billion.
I hope this is one of those trial balloons they float and later think better of. Most importantly, it makes no sense. That is, there’s nothing fundamentally wrong with converting preferred for common, but it doesn’t create anything of value out of thin air. I wrote a long article about preferred and common stock a while back, but here are some of the highlights.
- If you don’t give a bank any more money, it doesn’t have any more money. By converting preferred into common, you haven’t changed the chances of the bank going bankrupt, because its assets haven’t changed, and its liabilities haven’t changed. If it had enough money to cover its liabilities, but it couldn’t buy back its preferred shares from Treasury, it’s not like the government would have forced it into bankruptcy anyway.
- If you accept the idea that converting preferred into common creates new capital, then you are implying that those preferred shares weren’t capital in the first place. From a capital perspective, then, the initial TARP “recapitalizations” did nothing, and nothing happens until the conversion. You can’t say that JPMorgan got $25 billion of capital last fall and it’s going to get another $25 billion now just by virtue of the conversion.
- Tangible common equity and Tier 1 capital are just two ways of measuring the health of a bank. Taking money that wasn’t TCE and calling it TCE doesn’t serve any economic purpose. There is a minor benefit to the bank because now it doesn’t have to pay dividends on the preferred. But otherwise you’ve just shuffled together the claims of the last two groups of claimants - the preferred and the common shareholders. You’ve made things look better from the perspective of the common shareholders as a group, because they no longer have preferred shareholders standing in front of them, but the total amount available to all shareholders hasn’t changed.
Dow Drops Below 8000 Again
The Dow 8000 level didn't have a chance. We're at around 7850 at this moment. However, the bulls are trying to put in a bottom for the day. It looks "iffy" to me. We're near the lows of the day right now. Another break below the earlier low could result in a new round of selling. The big money has been taking profits and selling earlier today. The smaller day-style traders -- like me -- have reversed to the short side!
Reversible Rally?
from Zero Hedge:
Some more invigorating early am thoughts from David Rosenberg on the fate of the rally.
Either way, the test is the key.
We are witnessing a reflexive rebound, in our view What we are going to do today is provide some perspective on this impressive rally over the past five weeks. In our view, what we are witnessing, at best, is the famed reflexive rebound that occurs between the down-legs of the secular bear market, as so eloquently referenced in Rule #8 of Bob Farrell’s Market Rules to Remember (it goes like this – “Bear markets have three phases: sharp down, reflexive rebound, and a long fundamental drawn-out decline”). By “reflexive rebound” what is meant is a real bear market rally that can last between four to eight months and have the capacity to rebound between 25% and 50%, as opposed to the countless flashy but not particularly tradable rallies that typically last four to eight weeks and post a 10% to 20% bounce.
The test remains the most appropriate near-term focus
So, the question is whether this is just a more intense version of the other spasms we saw this cycle or something a little more durable like we had between September 2001 and January 2002, when the Nasdaq surged 45%, but was retesting the lows by June 2002 (and the test failed, as we know with hindsight), or perhaps something along the lines of the 43% bounce in the S&P 500 from 98 in March 1980 to 140 in November 1980. That low was tested by August 1982, as we went through the ‘drawn out fundamental downtrend’, and, in this case, the test was successful. But we had the retest nonetheless, and we think we have to be reminded that the test remains the most appropriate focus over the near term.
Reflexive rebound vs. flashy bear market rally
What makes the reflexive rebound different than a flashy bear market rally is that it’s not just short-covering and other buying on the part of the ‘pros’, but real money sitting on the sidelines that is put to work. This is why the reflexive rebound tends have more staying power. This is really a debate best left to the technical analysts, but for our two cents worth, history tells us that we have to be cognizant of the re-test possibility. With the market up 28% and 85% of the stocks trading above their 200-day moving averages, the inevitable test is something we should spend more time thinking about than trying to chase the last leg of this rally, assuming it comes at all.
Durable bull markets need macroeconomic inflection point
No durable bull market has ever occurred without their being a macroeconomic inflection point within reasonable proximity of the market low. For example: the national highway network in the 1950s, the space program in the ‘60s, and the spectacular household formation of the baby boomers and consumer balance sheet expansion that sharply bolstered domestic demand in mid-‘70s. The post-1982 bull market was driven by massive reductions in top marginal tax rates, deregulation and declining unionization rates. The 1990s was led by tech induced productivity gains and rapidly diminishing fiscal deficits; and the last bull cycle from 2003 to 2007 was a function of leverage and a speculative debt-fueled plunge into residential real estate – ill-timed as it turned out.
What we have to look forward to
This time, as we gaze into the crystal ball, what we have to look forward to for the foreseeable future is an unprecedented incursion of government in the economy and capital markets, a much more regulated financial system, where the contribution of credit to spending, output, employment and profits will be far lower than has been the case for the past two decades, higher environmental-related costs, less free trade, rising union membership, and higher marginal tax rates to pay for the fiscal mess we’re in. Most importantly, what we are looking at is a secular contraction in the household balance sheet as it relates to the baby boomer cohort – secular meaning many years. Keep in mind that it is this 78 million US boomer population that has been the critical driver of global economic activity, not to mention the pace-setter for consumer spending behavior – or lack thereof as the pendulum swings toward frugality.
Economic underpinnings not in place for a true bottom
Unless emerging markets in general or China in particular, can manage to pull the developed world out its torpor, it is difficult to identify what the next macroeconomic underpinning is going to be that will generate a sustained bull market in equities. Sorry, but government sector expansion, hybrid cars, green technology and digitized medical records just don’t do it for us. While we are willing to keep an open mind over the possibility that this reflexive rebound could have more legs, we simply do not have the economic underpinnings in place for a true fundamental bottom, which is why we think, like Japan, the dominant theme will be the third part of Bob Farrell’s’ Rule #8, which is the drawn-out fundamental downtrend to the true low.
It’s only the bottom of the fourth inning
To finish up, we have an old saying that, “when in doubt, use someone else’s research” and with that in mind, we point to a brilliant report by Ken Rogoff and Carmen Reinhart published late last year. This epic report examined 15 other credit contractions and asset deflations in the past, and found that the bear markets in equities last an average of 3-1/2 years, with the bear market in house prices lasting an average of roughly six years. So, when asked “what inning are we in?”, the answer we’ve been giving, on this basis, is “the bottom of the fourth”.
It's an Equity Bull Run -- for the Exits!
There appears to be a real bull run today in equities, but they are headed for the exit signs in a stampede. Other positive news, like the buy-out of Sun by Oracle, is a casualty in the stampede out of financials on the news that credit quality is rapidly degrading in all sectors. Reality has come home!
Leading Indicators Leading LOWER!
from Marketwatch:
The index of leading economic indicators fell 0.3% in March, following an upwardly revised dip of 0.2% in February. Building permits were the largest negative contributor in March, while the real money supply was the largest positive contributor. "There have been some intermittent signs of improvement in the economy in April, but the leading economic index and most of its components are still pointing down," said Ken Goldstein, economist at the Conference Board. Overall, six of the 10 indicators were negative contributors, three were positive, and one was steady.It is not coincidental that the only indicators pointing higher are the ones the government manipulates -- like money supply!
B of A Sends Stock Traders Running for Cover
Stocks are down over 200 on the Dow in the first 30 minutes of trading! Bank of America this morning released earnings that were better than expected, but also indicated that credit quality in all of its portfolios continues to degrade, including commercial, industrial, and consumer sectors of debt borrowing.
Crude Oil Drops Below Trading Range
Crude oil has lost $3.50 overnight, and has broken through support.
Wheat Holding Lows -- By a Hair
Intraday shows overnight collapse mirroring equity markets.
But the daily chart shows wheat barely hanging on above recent support levels.
Bruce Knorr:
The struggles of the wheat market to rally recently speak volumes about the state of the futures trade in 2009. Rallies, big ones, are still possible, but only for the favored few that have strong fundamentals.
In a normal year, wheat likely would be rallying. While the soft red winter wheat crop in the eastern Midwest is in good shape, hard red wheat on the Plains faces greater unknowns. Farmers on the northern Plains are still trying to get the spring wheat crop in the ground, and the forecasts don’t look all that promising. While warmer weather is helping reduce flood threats, regular storms are moving through, and the long-range forecasts out last week call for above normal precipitation over much of the growing region.
To the south the hard red winter wheat crop is still reeling from the freeze earlier this month. Crop ratings dropped sharply in Oklahoma last week, though less damage emerged in Kansas. Other areas, including Texas, are suffering from long-term drought that last week’s rains won’t help. And the forecast into summer is for warmer than normal temperatures over the region.
Still, with demand relatively lackluster, the market lacks a spark. There’s still a little time seasonally for a rally, so with the market down, it’s worth the wait. Besides, crop insurance and the new ACRE program likely will provide significant downside protection.
Corn Crumbles
from Bruce Knorr:
Bulls in the corn trade cursed outside markets over the fall and winter, when each day seemed to bring reminders that supply and demand were mere bit players in a larger drama. But last week bulls could have used some outside influence. While other markets were looking stronger, corn suffered. Where are your friends when you need them?
Corn appeared to be falling under the pressure of its typical seasonal trend. While rain from a slow moving weather system will slow fieldwork early the week, overall the pattern appeared to be improving, leaving the path of least resistance lower.
I don’t expect a free-fall at this point. Few acres are actually in the ground, soybean prices are not providing any incentives to plant corn, and weather models continue to flip flop on when and how rains will return. While fields could dry out later this week, especially in the west, forecasts over the weekend suggested potential for regular storms to move across the Corn Belt.
When all is said and done, the crop likely will be planted more or less on time. Areas north and south of the winter storm track are dry, but much of the region is in good shape. As a result, producers likely will need patience before rallies emerge over the summer. While the long-term forecast out last week looks mostly favorable, areas in the western Corn Belt look like they’ve face enough heat to keep alive hopes for some type of rally. Fundamentals also look stronger into 2010 for corn that must be stored.
Beans Back to Reality
from Bruce Knorr:
Bulls and bears both love the soybean market, realizing it can have a Dr. Jekyll and Mr. Hyde personality.
Now the question is which one will show up this week, the good bean or the bad one?
Certainly bulls had a few doubts on Friday, when futures surged to new highs for the year only to retreat
on profit-taking, posting a bearing reversal lower for the day. Still, the selling wasn’t the complete rout that
usually accompanies a top, and futures were able to hold support at the old resistance line shattered last
week.
For once, beans seemed to trade in a world of their own last week, ignoring day in and day out moves in
stocks and crude oil. Indeed, beans were the headline, with both funds and end users rushing into buy,
according to the latest CFTC data.
Fund buying was driving by money managers emboldened by the rising tide on Wall Street to take more
risk. While the hot money is being more selective about which markets to enter, when it finds one, the
response is pedal to the metal. End users, meanwhile, fear lower South American production, especially
from Argentina, will leave world markets squeezed. U.S soybean exports remain strong in the latest
weekly report, and USDA announced more sales, primarily of new crop, on Friday.
also from Bruce Knorr this morning:
Bulls of all stripes are in retreat this morning, taking profits from the recent rally in stocks and commodities. That should lead to a lower open across the board in the grain trade.
Sunday, April 19, 2009
More Talk of Treasury Bubble
from the Washington Times:
America has seen a lot of speculative manias during the past decade — whether the wild buying spree in technology stocks in the late 1990s, the euphoric boom in housing in the middle of this decade, or the seemingly unstoppable rise in oil and other commodities last year.
Now there may be a bubble developing in the market for Treasury debt, if only because there is no safer place for investors to park their cash and escape the collapse in stocks, commodities, mortgage debt and other stricken markets.
As in the past, a stream of money turned on by the Federal Reserve to prime the economy is flooding the market most favored by investors — this time, the $6.9 trillion Treasury securities market rather than oil or housing.
The administration and Congress have been happy to oblige the enormous burgeoning of worldwide demand for Treasury debt in the last six months by enacting massive stimulus, bank rescue and budget plans that are due to rack up unheard-of debts and deficits over $1 trillion annually for years to come. Treasury borrowing is well on its way to $2 trillion this year alone.
But there are big differences between this and earlier events. While the housing and oil bubbles were fed by irrational exuberance, speculation and greed on the part of investors, the current flight to Treasuries is being fed largely by fear and an aversion to taking risks in other markets.
And, if the rush to Treasury debt turns out to be unsustainable, it will be the U.S. government and taxpayers — not investors — who will pay the biggest price.
"There is a danger, and it could easily get out of hand," said hedge fund mogul George Soros in recently discussing the string of bubbles that has plagued the U.S. and world economies. The turn to Treasury investing got started for seemingly good reasons last fall when the private credit, stock and commodity markets tanked and investors rushed into safe havens.
"In order to make up for the collapse of credit, we are effectively creating money," Mr. Soros said. The Fed and Treasury have stepped in, with the Treasury now borrowing on behalf of banks, auto companies, small businesses and consumers — just about everyone having trouble obtaining credit — through a variety of recently established programs. The problem is, "if and when credit is restarted [in private markets], you will then have an incredibly swollen monetary base" that could lead to "an explosion of inflation," he said.
The danger cannot be seen right now, when the economy is experiencing deflation, or falling prices, as a result of the deep recession, he said. But when the economy starts to pick up again, then the Fed will be "faced with the task of draining the money supply as fast as credit is created" to avoid an inflationary spiral and other problems.
It is when the world economy and markets return to normalcy and health that the Treasury bubble is in most danger of bursting and raining down dire effects on the U.S. economy, analysts say. As investors abandon Treasuries for other markets, the Fed, Treasury and Congress must successfully negotiate their way back to a world of smaller public debts and tighter money. If they don't, the result could be a huge jump in inflation and interest rates for the Treasury and every other borrower in the United States — potentially triggering another financial crisis.
Flocking to safety
One clue that the Treasury market may be in a bubble is the extreme drop in Treasury rates since September, when the global financial crisis broke out. The clamor for short-term Treasury bills by investors seeking safe havens got so heated at points last fall that the yields on those bills fell to zero and even below — meaning that investors were willing to pay Treasury to keep their money rather than the other way around. The yield on Treasury's bellwether 10-year bond also plunged from about 4 percent before the crisis to as low as 2.54 percent in recent weeks.
Timothy A. Canova, a dean at the Chapman University School of Law, said a bubble is developing not only in Treasuries, but in the U.S. dollar, which for decades has been seen as a safe haven by investors. The dollar has risen by nearly a third against other major currencies since the onset of the crisis.
"A bursting bubble in the dollar in general and Treasuries in particular would be a catastrophe," he said. It likely would involve "a sudden drop in Treasuries and dollar-denominated assets" that would produce a "contagion" in markets around the world akin to the collapse seen last fall.
The Fed has taken a lot of the blame from economists for nursing bubbles with loose monetary policies. Then-Federal Reserve Chairman Alan Greenspan has been skewered widely for stoking the housing and credit bubbles by pushing interest rates to record lows in 2003 out of fear the United States was entering a period of potentially destructive deflation. While deflation never proved a threat, the housing and mortgage markets took off in a euphoric climb that sent house prices soaring at double-digit rates, created a mountain of bad debt, and ended in today's monumental bust and recession.
"The Federal Reserve alone is the father of the mess that the economy now confronts," said Walter M. Cadette, visiting research fellow at the American Institute for Economic Research and a former vice president of J.P. Morgan. He swept aside other culprits fingered in the crisis, such as banks and investors taking inordinate risks with little-understood derivative securities. "The cheap money was the 'sine qua non,' the only necessary condition for the bubble," he said.
Fed feeds Treasury mania
The Fed since last fall has been nurturing the Treasury bubble in its drive to revive the economy from a deep recession. The Fed's role in the Treasury boom does not appear to be as inadvertent as it was in past bubbles. Not only has the Fed under Chairman Ben S. Bernanke been printing money at prodigious rates, but it has pushed short-term rates close to zero — dramatically lowering the Treasury's borrowing costs — while taking the unprecedented step of purchasing Treasury bonds to encourage borrowing and help finance the debt.
Peter Schiff, president of Euro Pacific Capital, said the Fed's announcement last month that it will purchase up to $300 billion of Treasury bonds was ill-advised, as it sent a message to investors that the Fed is prepared to print money and absorb the Treasury's increasing load of debt at any cost.
"The move will push the U.S. government debt bubble into its final stages of expansion," he said. "When it finally bursts, the supports holding up the U.S. dollar will be utterly removed."
The Fed says its goal, of course, is not to spur a debt binge by Congress — something Mr. Bernanke has consistently warned against — although that has been the unintended effect of the Fed's efforts. The central bank's stated goal is to drive down long-term interest rates — particularly 30-year mortgage rates — to try to reverse the collapse in the housing market, which the Fed believes is a core cause of the recession.
The Fed has accomplished its goal of driving mortgage rates to record lows near 4.6 percent, touching off a big refinancing wave and easing the way for people with adjustable-rate mortgages that are resetting by the millions this year and next. But so far, the Fed's efforts have produced only a muted response in the housing market. Economists hope the Fed is putting a floor under cratering home sales.
World Must Boost Food Production or Face Social Unrest
from FT.com
The US agriculture secretary has warned that unless countries take immediate steps to sharply boost agricultural productivity and food output and reduce hunger, the world risks fresh social instability.
In an interview with the Financial Times, Tom Vilsack indicated that food security and global stability were tied, in a sign that Washington’s worries about the global food crisis go well beyond its humanitarian implications.
