Friday, August 29, 2008

Why does it linger?

The Economist brings out a brilliant analysis of why the liquidity crunch refuses to die down.

It’s a long article. Here is my synopsis –

The double shock of decline in house prices and the sudden slump in prices of ABS have come at a time when the global economy is also witnessing a surge in commodity prices. This limits the power of the central banks to cut interest rates as it could stoke inflation further up.

The double shock entails uncertain direction of monetary and regulatory policy. When inflation targets are revised upwards, central banks will crack down so hard on inflation pushing the economies into recession. Further the effect of investment bank rescues will let in a harsh new regulatory regime that will stifle credit and hence future growth.

Then it is the nature of the previous boom fueled by indiscriminate borrowing by people to buy houses that they couldn’t clearly afford hoping to cash in on capital gains and investors buying complex high yield debt products they hardly understood. Both the lenders and investors were beholden to banks and that former wellhead of finance has now run fairly dry. In turn, that explains the absence of bargain hunters, particularly in the debt markets.

Investment-grade debt might look attractive on a five-year view, if all you have to worry about is the risk of default. But most investors in that market have a three- or six-month view; they cannot afford for things to get worse before they get better, in case they are forced into a fire-sale of their assets.

"So the markets (and the developed economies) are waiting for a catalyst for recovery. Lower commodity prices helped for a while, and may help further if they encourage central banks to cut rates. Evidence of a bottom in the American housing market may also do the trick. But the crisis seems certain to linger into 2009, and could even make it into the following year. Successful horror movies tend, after all, to have several sequels."


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Friday, August 22, 2008

Tune in to the Shorts

No more regulations. Just listen to the short sellers.

Would the ghastly global economic crisis been avoided had the regulators listened to the short sellers? Seems likely.

In July, Christopher Cox, chairman of the SEC announced a plan to curb improper (naked) short-selling to limit the activity of short-sellers. Mr Cox seems to be implicitly blaming the shorts for the unprecedented fall of bank, ­government-sponsored agency and brokerage stocks over the past year – even though they were the very group that warned of the dangerous credit cycle and its consequences.

Now for a little history on shorts. Perhaps the first case dates to 1609 when the Dutch trader, Isaac Le Maire, targeted the shares of the shipping company Vereenigde Oostindische Compagnie (the Dutch East India Company). VOC was the first multinational corporation in history and had broad powers. Nonetheless, Le Maire, concerned about threats of attack by English ships, sold VOC’s shares short. After learning about Le Maire’s tactics, the stock exchange governing VOC’s trading banned short-selling (although the ban was later revoked).

In the early 1630s, the Dutch economy fell into a depression following a speculative peak in the trading of tulips. Again, short-selling raised the ire of regulators, many of whom saw it as magnifying the effect on the Dutch economic downturn. As a result, England banned short-selling outright.

Hedge fund manager Douglas Kass thinks instead of more regulation, the chairman and investors should begin listening to what short-sellers have to say about our economy and credit markets.
What do you think?

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Sunday, August 10, 2008

Why I back Larry Summers

They say a miracle is not the suspension of natural law, but the operation of a higher law. As I notice the dollar hitting a five-month high of $1.5055 against the Euro and climb 1.3 per cent to $1.9189 against the GBP (even as oil prices decline to $115 a barrel levels), I know I am witnessing miracle. Yes, I can vouch for that.

The violence of the move was testimony to the extent to which the market had been surprised by economic weakness outside the US. UK economic data has shown increasing weakness this week; officials in Japan have warned that their economy was headed for a recession; and the Reserve Bank of Australia said it was planning to cut interest rates to ward off an impending economic slowdown. And we in India were hiking rates to rein in inflation!

So there it goes. The world economy is a mixed bag with no uniform outlook – supply shocks, financial dislocations and concern about rising inflation – are present at once. The future is as uncertain as ever to all and there lies my optimism. No one knows what to do next. Everyone could be right or nobody is. Ain’t that queer enough? I think so.

That’s why I back Larry Summers views in FT. Excerpts –

“Perhaps unsurprisingly in the face of so many adverse surprises, the policy debate has become cacophonous. Some emphasise the necessity of the painful adjustments under way, while others urge their mitigation. Some focus on product price inflation, others on asset price deflation as the principal problem. Some focus on assuring that imprudent lending by financial institutions is discouraged, others on assuring that financing for investment by households and businesses remains available. Some focus on slowing market adjustments to prevent panic, others on the need for rapid adjustment of prices to true fundamental levels, even if this is painful in the short run.”
Imagine the plight of the huge bets against a strong dollar? The street’s gonna’ be littered with blood for sure.