Dark Clouds

Despite the announcement by the Fed of Operation Twist, where it will buy $400BN in 6-year to 30-year Treasurys by June 2012 and over the same period sell $400BN of Treasurys maturing in 3 years or less, markets are in free fall.

For why?

The inclusion of more 30-year bonds than expected means that the Fed wants to keep very long-term rates lower for a long period. This means that the Fed views America's economic problems as being long term (they rubbed salt into the wounds by stating that the economy has "significant downside risks").

Aside from American economic woes, the shambles that is the Eurozone continues to sap the global economy.

Chris Williamson, chief economist at PMI compiler Markit, summed up the reality:

"The recovery has finished, we are now contracting. 

The forward looking indicators suggest that things will deteriorate further in the coming months."

Meanwhile, has anyone seen the Greek Prime Minister George Papandreou since he abruptly turned his plane around mid air and aborted his trip to the USA?

Read More

Why Do More?

Ben Bernanke, the Federal Reserve Chairman, has given the first ever Fed press conference.

In it he said that quantitative easing will end in June.

Quoted by the Telegraph he said:

"Why do more?"

However, as the Dollar continues to fall and debt continues to increase, the only large scale buyer of US debt on the market is the US government. As such, quantitative easing is destined to continue in some form or another.

Read More

Inflation Near To 2% In Two years

The Bank of England has stated that, in its view, inflation will be near to the 2% mark within the next two years.

This view is contrary to some of the prophets of doom who have recently been predicting (for media sound bite purposes) that interest rates will have to be raised significantly (8%), in order to counteract an inflationary disaster.

Additionally, given the better than expected growth figures for the UK economy, the Bank has held back from another round of quantitative easing (unlike the Federal Reserve).

This, in terms or international politics, is probably no bad thing. The US QE2 package of $600BN has provoked a barrage of criticism from both Europe and Asia Pacific, and brought the world one step closer towards "currency wars" (capital restrictions, protectionism etc).

Read More

Outlook - Stormy G20 Predicted

The atmosphere at the forthcoming G20 summit in Seoul later this week is likely to be somewhat heated, following on from pre summit soundbites issued by the Chinese and then Barack Obama over the recent move by the US Federal reserve to print $600BN (Quantitative Easing 2).

China, and some other countries, are not happy that this tactic pushes the Dollar lower, thus making their exports to the US more expensive and the lessening the value of their Dollar based investments.

Barack Obama responded, during a press conference in India, by saying that QE2 would bring about higher US growth rates which would be "good for the world as a whole". The US is also of the view that the Chinese Yuan is undervalued, and are pressing the Chinese to let it float higher.

The G20 will see an intensification of this "spat", as various countries begin to draw battle lines over possible future "currency wars".

Read More

Steady As She Goes?

Despite the fact that the US has launched a new round of quantitative easing ($600BN), the Bank of England has decided not yet to follow the American lead.

The Bank of England's monetary policy committee (MPC) has kept interest rates at 0.5%, and has not increased quantitative easing.

The "steady as she goes" approach is a consequence of better than expected UK economic data. As to whether the economy continues to recover, once government cuts and the new VAT rate kicks in next year, remains to be seen.

It should also be noted that the $600BN quantitative easing package in the US may not actually be enough to kick start that economy which, if it doesn't pick up, will have ramifications in the UK and the rest of the world.

Read More

Murky

Despite Vince Cable's speech to the Liberal Democrat conference today, in which he refers to "murky corporate practices" and notes that "capitalism kills competition"; the capitalist world to which he refers is the world that he, and the rest of us, live in and rely upon for our survival.

To this end, ie the survival of our capitalist economy, the Bank of England are considering a further economic stimulus.

The recent Monetary Policy Committee (MPC) minutes show that there is a gradual movement within the committee towards doing more to support the economy. Given that interest rates are at 0.5%, the main alternative open to the Bank is that of further quantitative easing.

The US Federal Reserve has already signaled that it may restart purchases of government debt, ie quantitative easing. Given that the US and UK central banks are coordinating their monetary policy, it is highly likely the the Bank of England will follow suit.

Read More

Virtual Zero

The Federal Reserve put its money where its mouth is, wrt making all efforts to kick start the economy, by cutting interest rates to between zero and 0.25% yesterday.

This puts pressure on the laggardly Bank of England to do what it should have done before, and cut rates further. Ironically it seems that the Bank of England did consider a larger rate cut, but was worried about the destabilising effects of such a cut (source The Times).

Does the MPC not realise that the recession and collapse of the banking system is in itself destabilising?

The Fed's action has made fools of the MPC.

Read More

Rates Heading To Zero

Ben Bernanke, the Chairman of the Federal Reserve, gave a clear signal to the markets that rates are moving towards 0%.

Mr Bernanke is quoted in The Times:

"Although conventional interest-rate policy is constrained by the fact that nominal rates cannot fall below zero, the second arrow in the Federal Reserve’s quiver, the provision of liquidity remains effective.

Secondly, the Federal Reserve can backstop liquidity not only to financial institutions but also directly to financial markets, as we have recently done for the commercial paper market."

That is a very clear assurance to markets that rates will fall to zero, and that other tools over and above rates will also be used.

The pressure is now on the dithering and laggardly Bank of England to wake up and cut rates further, as they should have done much earlier in this recession. The MPC will meet this week, and are expected to announce a further cut in rates of 1% to 2%.

Behind the curve as usual!

Read More

Madness

Yesterday I wrote that "Bush has done to the US economy what no terrorist or hostile country could ever do, that's quite a legacy!"

I was wrong, Bush merely loaded the gun; Congress, in an act of collective madness, has in effect destroyed the US economy by voting against the bailout plan.

Given that the plan was the only one on the table, one might ask why they jettisoned their only hope. Regrettably partisan politics outweighed commonsense and selflessness, as the Republicans used a speech by Nancy Pelosi (seemingly she hurt their feelings) as their excuse for voting "nay".

The result of this collective madness was entirely predictable, Wall Street suffered its worst ever one day fall in history (down 778 points).

The essential truth that those who cite "moral hazard" fail to grasp is this.

If your neighbour's house is buring down, even if he started the fire himself, you do not stand idly by watching it burn; you try to put it out.

Once the fire is out, you can punish him afterwards.

The "good people" in Congress will have a lot of explaining to do, when their constituents realise that falling shares mean that their savings and pension plans are going down the toilet.

Thursday is now slated for a rerun of the vote, let us trust that some commonsense now enters the minds of Congress.

Read More

The Great Bailout

US President George Bush has said that Democrats and Republicans will come together to pass the bailout plan to rescue the US economy.

All well and good, if what he says actually comes to pass. However, the bailout was never a matter of merely throwing billions at the problem to make it go away but of injecting confidence into the economy.

The bailout plan had the possibility of working, until it became apparent that Paulson in fact had no plan and McCain pushed himself in front of the cameras in a bid to appear as a dealmaker (thus wrecking any possibility of th deal being passed last week).

Bush then publicly said that the world economy was in gave danger if the plan was not approved, and privately said during the disastrous McCain inspired meeting that "this sucker is going to go down". Paulson, pouring petrol on the flames, then got down on bended knee to Nancy Pelosi (House Speaker) begging her to pass the bill.

Those actions and words send a very clear signal that those in office are not in power. No matter how many billions of dollars are now thrown at this issue the markets have had the confidence kicked away from beneath them by the failed leadership in Washington, and the desire of a very old angry man to become president.

The road ahead is uncharted and dangerous. Bush has done to the US economy what no terrorist or hostile country could ever do, that's quite a legacy!

Read More

FBI Investigation

The Times reports that the FBI is investigating a number of executives from Fannie Mae, Freddie Mac, Lehman Brothers and AIG.

The Times states that are investigating as to whether the executives lied to shareholders, and whether fraud helped caused some of the troubles at these organisation.

The investigation includes whether executives deliberately misled the stock market about the state of their businesses.

Needless to say the politicians who oppose the $700BN Paulson bailout have latched onto this as another reason not to give money to greedy Wall Street bankers.

All well and good.

However, moral hazard and regulation can be addressed after the crisis has been dealt with.

When your neighbour's house catches fire (even if he started it deliberately) you do not stand idly by watching it burn (remonstrating with him about his stupidity), you help him put it out.

Another point that those who hate greedy bankers should remember is this, people were happy enough to borrow the money when it was cheap and to saddle themselves with debt; no one put a gun to their heads.

Read More

The Dead Cat Bounce II

Lats week I wrote about the rebound in shares, in response to the US bailout of the financial system, being a "dead cat bounce".

It would seem that I was right.

Shares in London and Asia have fallen sharply, as doubts grow about whether the $700BN bailout will work. At the time of writing:

-The FTSE is down 2%
-The CAC down over 1%
-The MSCI index of Asia-Pacific shares (excluding Japan) down 2%
-The Dow down over 3%

The package proposed by Henry Paulson, US Treasury Secretary, is expected to face opposition from members of Congress about how to pay for the plan.

Additionally, other American industries outside Wall Street have begun to ask for similar assistance; eg bans on short-selling have been requested by car and real estate companies.

Senator Richard Shelby, the leading Republican on the Senate Committee on Banking, Housing and Urban Affairs, said in a statement yesterday that the proposal was "neither workable nor comprehensive".

"I am concerned that the Treasury's proposal is neither workable nor comprehensive, despite its enormous price tag. In my judgment, it would be foolish to waste massive sums of taxpayer funds testing an idea that has been hastily crafted, and may actually cause the Government to revert to an inadequate strategy of ad hoc bailouts.

Given that markets have recently taken confidence in the prospect of government involvement, I believe Congress must immediately undertake a comprehensive, public examination of the problem and alternative solutions rather than swiftly pass the current plan with minimal changes or discussion. We owe the American taxpayer no less."

That is all very well, but the issue is one of confidence. A lengthy review will sap the confidence and destroy the financial system before any "cure" is discovered.

I noted last week:

"The actions taken may well soften the blow from the fallout of the sub prime crisis. However, the market cannot be bucked. There is a massive repricing of risk being undertaken which will negatively impact the share prices of financial institutions and, by definition, their willingness and ability to take on risk.

No matter what governments do this repricing will happen and the effects will be felt by everyone, from the CEOs of the leading banks to the ordinary man in the street seeking credit to buy a car or home.

The market will not be bucked. The surge in share prices is in effect a dead cat bounce, not a long term rally."

The bailout will not stop shares falling, but it will stop the world wide financial system from collapsing by giving it a much needed boost of confidence.

Testing times require bold measures.

Now is not the time for dithering and navel gazing.

Read More

The Dead Cat Bounce

Share prices are surging today on reports of a massive bailout of toxic debt by the US government, coupled with the ban by the FSA on short selling of financial stocks.

At the time of writing, the FTSE is up over 7%, the DAX up by almost 4% and the CAC up by 6%.

Talks are being held between the US Treasury Department and the Federal Reserve to examine proposals to move illiquid toxic assets, backed by mortgage debt into a government backed vehicle; ie they will be taken out of the balance sheets of the banks and financial institutions that created them.

In the event that this this scheme is put into action, this will be the largest bailout in American history.

The actions taken may well soften the blow from the fallout of the sub prime crisis. However, the market cannot be bucked. There is a massive repricing of risk being undertaken which will negatively impact the share prices of financial institutions and, by definition, their willingness and ability to take on risk.

No matter what governments do this repricing will happen and the effects will be felt by everyone, from the CEOs of the leading banks to the ordinary man in the street seeking credit to buy a car or home.

The market will not be bucked. The surge in share prices is in effect a dead cat bounce, not a long term rally.

Read More

Emergency Aid

The world's leading central banks, including the Bank of England, have joined forces and injected approximately £100BN into the world's financial system.

The action is US funded, whereby the US Federal Reserve is lending the Bank of England, the European Central Bank (ECB), the Swiss National Bank and the central banks of Canada and Japan the money to pump into their financial systems.

The question is, given that the US government allowed Lehman Brothers to go to the wall on Monday, will this restore confidence into the system?

Read More

The Law of The Jungle

The death of Lehman Brothers has not sated the market's appetite for fresh corpses.

AIG teetered on the brink and has been bailed out, at the eleventh hour, after the US Federal Reserve agreed an $85BN bailout of the company. The deal gives the US Government a 79.9% stake, ie they nationalised it.

Somewhat ironic that the world's leading advocate of free market economics resorts to old fashioned socialist policies of nationalisation, in order to save a capitalist institution.

Now comes the turn of HBOS.

The Times reports that Lloyds TSB is in advanced talks to buy HBOS.

The disclosure followed a statement issued by the Financial Services Authority (FSA) about the strength of HBOS' business, in order to stop the 50% freefall in its share price.

Quote:

"Since the beginning of the current extreme difficulties in the financial markets, the Financial Services Authority has worked intensively with all major UK banks to ensure they have credible capital and liquidity plans.

We are satisfied that HBOS is a well-capitalised bank that continues to fund its business in a satisfactory way".

How can seemingly impregnable institutions find themselves so quickly consigned to the dustbin of history?

Confidence.

The capitalist system and banks rely on confidence in the future; when that dissipates, the bedrock on which the system and its constituent parts is based collapses.

Fear, rather than fundamental weaknesses, are eating away at the bedrock of our financial institutions.

Read More

Ruined Reputations

The US, with characteristic speed and vigour, moved to steady the finances of Freddie Mac and Fannie Mae yesterday.

The LA Times reported:

"Acting to prevent a severe disruption of the mortgage market, the federal government stepped in Sunday with plans for a sweeping aid package designed to bolster confidence in battered home-loan giants Fannie Mae and Freddie Mac.

The Bush administration said it would ask Congress to authorize the Treasury Department to lend Fannie and Freddie more money than current limits permit and buy stock in the two companies.

Also Sunday, the Federal Reserve agreed to permit the companies to borrow directly from the central bank, as investment firms were allowed to do after the near-collapse of Bear Stearns Cos. in March. The money would tide Fannie and Freddie over while the administration and Congress rush the emergency measures through."

This action provides an opportunity to reflect on what the British authorities and Bank of England would have done under similar circumstances. To some extent we already know, using Northern Rock as an example, they would have done very little and it would have been too late.

Our monetary authorities have been proven to be asleep at the wheel and, like rabbits frightened in the headlights, frozen with fear when confronted with a serious issue that needs resolute and muscular action.

As I recently noted, leading British banks have met with the Bank of England to ask for more help in stabilising the lending market; the £50BN injection, made earlier this year by the Bank of England, was simply not enough and the actions taken by the Bank and government since then have been too cautious and slow to have any meaningful impact on the confidence of the banks.

However, let me make it clear, whilst the inaction of the monetary authorities has contributed to this crisis the primary blame can be laid at the feet of our "respected" banks.

They willingly chose to buy and sell toxic sub prime debt from the US, in the hope that they could make a fast buck. The sub prime scheme was a classic pyramid selling scam, so long as you could keep selling the debt on without it crystallising the pyramid would keep growing. However, as with all pyramid scams, there is always an end.

Either the directors of our banks were incredibly stupid and did not know/understand what they were buying/selling (what were the risk and compliance departments doing during this period?), or they knowingly participated in the pyramid scam in the full knowledge that at some point it would collapse.

Either way, the reputation of the banks and those who run them has been ruined; it will take many years for the banks to restore their reputations.

The reputations of the British government, monetary authorities, financial services industry, City of London and banks have all been ruined by this scam.

Lessons will need to be learned and senior people removed from office if trust and confidence are ever to be restored.

Read More

We're Alright Jacques

Jean Claude Trichet, the president of the European Central Bank, warned that the credit crunch will worsen, and that there would be a "very significant market correction".

Despite this, Trichet and the ECB have steadfastly refused to lower European rates in concert with the Fed and Bank of England.

Trichet is of the belief that there are no risks of a recession in Europe.

Would that all bankers and economists have his gift of "perfect" foresight!

Notwithstanding Europe's alleged immunity to recession the ECB, by its inaction, has ensured that the credit crunch will be deeper and more protracted that it needs to be.

The world needs a co-ordinated response by the central banks, not an isolationist "we're all right Jacques" response.

Read More

Hopeless and Helpless

Gordon Brown met with the chief executives of Barclays, HBOS, HSBC and Royal Bank of Scotland, as well as leading investment bankers from the City of London today. This meeting comes against a backdrop of dismal news that equates the dire situation in today's housing market to the grim days of 1978.

Brown called the meeting to urge banks to reduce the costs of loans and to pass on interest rate cuts.

Ironically the Royal Institution of Chartered Surveyors (RICS) released figures today that show that the downturn is worsening.

Approximately 78% more of surveyors said that house prices fell in March than reported increases, its highest level since the the poll began in 1978.

The banks will not have heeded his lecture, as they know that it is not the Bank of England interest rate that matters but the availability of liquidity.

Until banks are able to lend to each other at a rate that equates to the Bank of England rate, the situation will not ease. The government and Bank of England need to open their eyes to the fact that monetary policy alone will not address this problem, and is akin to "pushing a piece of string".

The Bank of England needs to follow the paths mapped out by other central banks, eg the US Federal Reserve, and accept mortgage backed securities as collateral in exchange for government backed bonds.

Until Brown and the Bank of England start to act in a proactive manner, they will appear nothing more than hopeless and helpless observers wringing their hands as the British economy and banking system collapses around them.

Read More

The ECB Ostrich Policy

The European Central Bank (ECB) yet again has refused to cut base rates, despite the current melt down in the financial markets and the cut by the Bank of England of 0.25% yesterday.

Jean-Claude Trichet, the ECB president, yesterday held the eurozone rate at 4%.

Notwithstanding the ostrich policy of the ECB, and lacklustre action of the Bank of England, the US Federal Reserve is expected to cut at least another 0.25% from its 2.25 per cent rate this month.

However, until the leading central banks co-ordinate their policies (not just interest rates) this crisis will not be abated.

When will the Bank of England and ECB wake up?

Read More

Staring Into The Abyss

Anatole Kaletsky states in The Times today that there is a risk that house prices may fall by between 20%-30%.

The ongoing turmoil in the international credit markets is now affecting the lives of ordinary people in Britain, not just the small number who work for City institutions.

The Fed, in the US, has shown leadership and courage in trying to deal with this mess.

Today the Bank of England decides about how much it will cut interest rates, as Keynes said under these current circumstances:

"That's rather like pushing a piece of string"

The Bank of England and government need to wake up to the fact that tinkering with interest rates alone will not be enough to address this crisis. There needs to be an effective and co-ordinated policy set out and enacted by the Bank of England/government now.

The trouble is these two organisations have yet to grasp the reality of the crisis, and are still comforting themselves with past economic glories.

The past is another country, we have long since left that country!

Read More