Response to GSE Risk A 'Revelation' For Fed Chief
I posted this response on the Housingbubble2 blog to GSE Risk A 'Revelation' For Fed Chief
Here it is
I have posted Treasury Secretary Snow’s and Dr. Greenspan’s comments before congress before.
I found it hard to believe that he didn’t understand how the exponential growth rates of the GSE’s were dangerous. Dr. Greenspan has always been a big proponent of derivatives and systemic risk has been brought up many times.
In fact one man Mr. Falcon was fired for bring up the problems with the GSE’s in 2003 called Systemic Risk: Fannie Mae, Freddie Mac and The Role of OFHEO.
Dr. Greenspan has a very clear understanding of what is going on. He “jump start” the economy by encouraging real estate to appreciate. That is why William J. McDonough, the President of the New York Federal Reserve, asked the lending standard to be lowered in the aftermath of the 1998 Russian/ US bond market crisis.
“On Feb. 5, a mere 24 hours after the report's issuance, the Bush Administration demanded that OFHEO Director Armando Falcon submit his resignation. Falcon, who been appointed to this post in 1999 by President Bill Clinton, had overseen the report's release. While the Bush Administration delivered the order for Falcon to resign, both the circumstances of the firing and subsequent events make it clear that the actual order for the firing originated from inside the boardroom of J.P. Morgan Chase—the world's largest derivatives bank with $29 trillion in derivatives outstanding—and the boardrooms of other major institutions that are heavily invested in derivatives and housing market paper.”
http://www.ofheo.gov/Media/Archive/docs/reports/sysrisk.pdf
http://www.larouchepub.com/other/2003/3010ofheo_rpt.html
http://www.snl.com/financial_svc/archive/20030210sl.asp
Dr. Greenspan is just trying to play ignorant. He cannot start a panic if he can help it.
Chromatic Dispersion
Banking, Derivatives, and Systemic Risk
http://bankdersysrisk.blogspot.com/
Here it is
I have posted Treasury Secretary Snow’s and Dr. Greenspan’s comments before congress before.
I found it hard to believe that he didn’t understand how the exponential growth rates of the GSE’s were dangerous. Dr. Greenspan has always been a big proponent of derivatives and systemic risk has been brought up many times.
In fact one man Mr. Falcon was fired for bring up the problems with the GSE’s in 2003 called Systemic Risk: Fannie Mae, Freddie Mac and The Role of OFHEO.
Dr. Greenspan has a very clear understanding of what is going on. He “jump start” the economy by encouraging real estate to appreciate. That is why William J. McDonough, the President of the New York Federal Reserve, asked the lending standard to be lowered in the aftermath of the 1998 Russian/ US bond market crisis.
“On Feb. 5, a mere 24 hours after the report's issuance, the Bush Administration demanded that OFHEO Director Armando Falcon submit his resignation. Falcon, who been appointed to this post in 1999 by President Bill Clinton, had overseen the report's release. While the Bush Administration delivered the order for Falcon to resign, both the circumstances of the firing and subsequent events make it clear that the actual order for the firing originated from inside the boardroom of J.P. Morgan Chase—the world's largest derivatives bank with $29 trillion in derivatives outstanding—and the boardrooms of other major institutions that are heavily invested in derivatives and housing market paper.”
http://www.ofheo.gov/Media/Archive/docs/reports/sysrisk.pdf
http://www.larouchepub.com/other/2003/3010ofheo_rpt.html
http://www.snl.com/financial_svc/archive/20030210sl.asp
Dr. Greenspan is just trying to play ignorant. He cannot start a panic if he can help it.
Chromatic Dispersion
Banking, Derivatives, and Systemic Risk
http://bankdersysrisk.blogspot.com/
posted by Chromatic Dispersion at 7/21/2005 08:57:00 PM
20 Comments:
This article appears in the July 8, 2005 issue of Executive Intelligence Review.
G-8 Meet To `Manage'
Hedge-Fund Crisis
by Lothar Komp and Nancy Spannaus
The meeting of the Group of Eight industrialized nations, to be held in Scotland July 6 to 8, is reported as dealing with issues like debt forgiveness for the world's poorest nations, and global warming. But just a week before the scheduled meeting, the Bank for International Settlements (BIS) released its annual report, indicating that a very different set of topics is likely to be on the agenda: how to manage the barrage of risks that could devastate the global financial system. The BIS report summarized the discussions ongoing among governments and international banking circles about whether the world needs a new "international macro-financial stabilization framework," and said that three approaches to this question are being discussed:
The establishment of a single international currency;
Reverting to "a system more like that of Bretton Woods"; and
"Informal cooperative solutions," that is, crisis management.
A highly placed U.S. intelligence source has informed EIR that the discussions on returning to a Bretton Woods system, indeed reflect debate about Lyndon LaRouche's proposals, but, as the BIS report indicated, the bankers will be pushing hard to get a crisis-management arrangement, with structures defined by the bankers, who are desperately trying to preserve their control under conditions of impending meltdown.
Among the largest risk factors, according to the BIS report, is "the widening current account deficit of the United States," which "could eventually lead to a disorderly decline of the dollar, associated turmoil in other financial markets, and even recession. Equally of concern, and perhaps closer at hand, it could lead to a resurgence of protectionist pressure."
Another area of grave concern is the credit derivatives market. The "explosive growth" of CDS and other credit derivatives contracts belongs to "the most significant developments in finance in recent years." "The notional amount outstanding on CDS contracts globally reached $4.5 trillion at end-June 2004, up sixfold from end-June 2001."
In spite of the recent turmoil triggered by the downgrading of GM and Ford, the real stress test of the credit derivatives market is still to come, says the BIS: "It remains to be seen how the CDS and CDO markets would handle a string of credit blow-ups or a sharp turn in the credit cycle.... One concern is the impact of highly leveraged positions on the balance sheets of financial institutions when markets turn. Another is the nature of the systemic role played by highly leveraged institutions such as hedge funds in affecting market liquidity; two-way markets could conceivably disappear as protection sellers exit at precisely those times when default insurance is needed most." As investors were able to anticipate the downgrades of General Motors and Ford, the report states, "the events of spring 2005 might not be a true reflection of how these markets would function under stress."
To put it more plainly: The BIS says that the situation in the credit derivatives market is already precarious; however, it will get worse, and it might entirely collapse.
Hedge Funds: The Corpses Multiply
And then, there are the hedge funds, whose corpses are beginning to float to the surface. The hedge funds and derivatives trade divisions of the major banks are currently in a near panic, desperately trying to limit the shock waves of derviatives and hedge-fund losses that were apparently triggered by the collapse of General Motors. They are trying to avoid even the hint of danger for the system, but it's not working.
It's not unusual for one out of ten hedge funds to collapse in the course of a year, without fanfare. Almost always these are small or medium-sized funds. But now, suddenly, and for the first time since the LTCM drama in Fall 1998, the large hedge funds are coming onto the radar screen. Three of them have recently acknowledged their dissolution:
Bailey Coates Cromwell Fund, London. It was founded in July 2003 by Jonathan Bailey and Stephen Coates, formerly working at the London section of the U.S. securities firm Perry Capital. The fund was able to accumulate $1.3 billion in capital and another $2 billion in bank credits. Bailey Coates was exposed in particular to bets on U.S. stocks, and for the past few months, it has found itself on the wrong side of such bets. Initial losses led to large withdrawals by investors.
According to EuroHedge, a private institution that tracks the European hedge-fund "industry," the capital of Bailey Coates imploded to $635 million by early June. On June 20, the management announced the fund's immediate liquidation.
Marin Capital, California. The fund was founded in 1999 and raised $1.7 billion in capital. Marin Capital specialized in credit derivatives related to convertible bonds. Exactly these kind of bets led to extreme losses after the downgrading to junk of General Motors. In mid-June, the management decided to liquidate the fund.
Aman Capital, Singapore. The fund was set up in September 2003 by top derivatives traders at UBS (the largest bank in Europe), and Salomon Brothers, and was intended to become Singapore's "flagship" in the hedge-fund business. But by the end of March, the fund's capital already had shrunk to $242 million. In April, Aman Capital suffered large derivatives losses. In a statement, published by London's Financial Times on June 20, the managers of Aman Capital acknowledged that "the fund is no longer trading," and that they will distribute whatever is left of the capital to investors.
UBS is believed to have lost several hundred million dollars which the bank had invested in Aman Capital. Temasek, Singapore's government investment agency, reportedly also lost money at Aman Capital.
London in the Lead
More hedge funds, with capital in the range of billions, may find themselves in a declining situation and could face liquidation soon. Among these are 2 of the 16 hedge funds of GLG Partners in London, one of the largest hedge-fund groups in the world. The GLG Credit Fund, from January to the end of May, had already lost 14.5% of its capital, in the range of $1 billion; the Neutral Fund of GLG lost about 17.2%, or $2.5 billion. The latter fund had worked with the same contracts as Marin Capital. Recently, nervous investors took out about $1 billion from the Credit Fund and the Neutral, after being informed of the new situation at the end of May.
The GLG Group was established in 1995 by three partners of Lehman Brothers. A fifth of the start-up capital came directly from Lehman Brothers. The invested capital of GLG today stands at around $14 billion and exceeds that of LTCM many-fold. One could put it this way: What Argentina was for the loans of sovereign debtors, and General Motors was for investment loans, so was GLG Partners for the European hedge-fund sector.
At the beginning of June, GLG held the designation of the "most respected" hedge fund in London. The now-collapsed Bailey Coats Cromwell Fund was also winning prizes. Two of the four funds of another leading hedge-fund group in Europe, Vega Capital, also must have suffered serious losses this year.
At the same time, the leading investment banks have achieved their worst quarterly results in years. On June 18, Goldman Sachs announced a collapse in profits of 20%. On Wall Street, this has been combined with ongoing turbulence among the hedge funds and credit derivatives. Goldman Sachs's Financial Officer David Viniar tried hard to deny the situation: One can "not always be on the winning side," he said, and "rumors that the firm must have put up with quarterly losses due to bets on GM and Ford Motor, are exaggerated."
On May 22, Morgan Stanley announced a collapse of quarterly profits by 24%. Chief Executive Philip Purcell was forced out only nine days later.
Interest Rates and Loans
These events are directly linked to the so-called Greenspan "conundrum." In his address to a June 6 banking conference in Beijing, Federal Reserve chief Alan Greenspan again picked up the issue of the alleged "mystery" of the contrary movement of short-term and long-term interest rates. Although central banks, in particular the Federal Reserve and the Bank of England, had recently pushed up short-term interest rates, the yields on medium- or long-term government bonds are still falling—in some cases even below short-term rates. In a statement on June 20, Lyndon LaRouche noted that there isn't any "mystery." The discrepancy is "exactly what should have been expected as a result prompted by the way in which the General Motors crash has exposed the unstoppable character of the collapse of the marketable credibility of the already 'lame duck' George W. Bush Presidency," LaRouche said.
Obviously, the European Union, particularly in its current precarious state, cannot "provide even a relatively short-term refuge from a collapsing U.S. financial system," LaRouche said. This means that "everywhere, in the real universe, there is no longer any security for the present world monetary-financial system, even during the short term." Under such circumstances, government bonds, regardless of their yields, are now appearing as the only form of financial paper that offers any long-term value. LaRouche emphasized: "In short, it is the survival of the principal, not the rate of the premium on the relevant paper, which determines its perceptible value to any moderately sane investor."
In line with this assessment, the rush into government bonds reached dramatic dimensions in the trading week ending June 24. This panic-buying again pushed up the prices and drove down the yields of government bonds. Further contributing to this dynamic is the expectation that central banks will soon be forced to cut short-term rates in reaction to economic and financial emergencies. The Swedish Riksbank cut its prime rate from 2.0% to 1.5% on June 21, and there is speculation that the Bank of England and the European Central Bank might soon follow. On June 22, U.S. Treasury prices had their largest gain in seven months, pushing down the yield on ten-year Treasuries below the 4% mark, to 3.93%. Japan the following week saw the biggest decline of government bond yields, down to just 1.205%, since October of last year. In Britain, yields on two-year government bonds fell to 4.17%, the lowest since January 2004.
Perhaps the wildest action took place in the Euro-zone. In Germany, the yield on ten-year government bonds fell to 3.10% on June 24, the lowest since the Bundesbank records began in 1973. Since mid-March, ten-year yields have plunged by 70 basis points. According to reports, German government bond yields are now actually the lowest since the times of Bismarck in the 1890s. Since June 22, investors buying two-year German government bonds are being promised a yield of less than 2%, that is, less than the short-term interest rate set by the European Central Bank. But investors buy nevertheless. In the two days of June 21-22, Euro-zone government bond yields experienced their biggest drop since Sept. 10, 1998; that is, exactly the time between the Russian GKO default and the collapse of LTCM.
CD,
Good to have met you in person the other evening.
Your arguments are solid, the implications severe. A question not of how, but of when, and whether anything the Fed or Congress can do will soften the impact.
Voltaire said that the art of medicine consisted of amusing the patient while nature cured the disease. I'm curious if any political sleight of hand will succeed in distracting the consumer when economic forces take their natural course. I can't imagine that, but if a sufficiently devastating crisis could be manufactured...
Chromatic,
Followed you here from housingbubble2. Your material is a bit over my head, but I am interested to learn more. Keep up the good work!
Chris
Chromatic,
do you think the current situation in the financial world (which is responsible for the current asset bubble) means death to Monetarism?
Chromatic,
your comments are WAY over my head, but I'm picking up a thing or 2 and not liking 1 but of it...
Strange you don't hear word one of this in the news...
Question for Chromatic:
It looks like all this is shaping up to be one ginormous cluster f###, do you think it'll be as bad as the Great Depression of the 1930's (which took WWII to get out of, ominous...) or will it be a 1970's inflation redux, or will we get the American version of the Japanese Stagflation?
Or too early to say at this point?
Did you ever get a chance to look at commodities again? Gold or silver any good to buy in times of world wide financial crisis or should I just kiss my paycheck good bye (I've got Direct Deposit actually so I can't even do that...)?
Thanks!!
Max,
Interesting question, will this lead to the death of monetarism. Richard Duncan writes about this in his book “The Dollar Crisis”.
I like his quote.
“While it is true that you can fight fire with fire, it has never been suggested that you can fight water with water.”
I don’t think we shall see the end of fiat (let it be) currency.
Gold as a currency failed several times due to excess credit creation. This is what led to the Great Depression after countries went off the gold standard to finance the war. Gold does have problems, and governments, even on a gold standard, cannot help but to hyper-borrow.
Fiat money or paper money based on supply and demand has problems, but will probably still be here even after all the fiat money hyper-inflates.
Has the world gone without a currency before and did the human race survive.
Yes, it’s called the Middle Ages. That is how Feudalism was introduced when currency was unstable after the Roman Empire fell. It is very interesting to note is that after currency came back, the merchants bought out the knights and became knights themselves.
I don’t think we will be going that direction either.
I am afraid we are stuck with fiat currency, even if we hyper inflate it every 20 years or so.
Chromatic Dispersion
Brent,
I would like to point out that nobody talks about their currency. This is especially true of Central Bankers, i.e. The Federal Reserve.
When banking and currency was much simpler it was easy for people to grasp what a currency was and how it impacted your life.
Now the subject of currency is very complex with exchange rates, derivatives, fractional reserve system, and international borrowing.
News and media don’t tend to report on issues that are difficult to understand because they want people to watch the news. It is a very hard story to put on “60 Minutes” as it would take much longer than 60 minutes to educate people on how the monetary system works.
However, this has been discussed by educated people for a very, very long time.
Chromatic Dispersion
Brent,
I don’t understand commodities, as investors in commodities are experts or very educated in the commodities they deal with. I don’t think gold and silver will ever be a currency again, but I think you could use it as a hedge against hyper-inflation of the currency.
In order to have “Stagflation” or another “Great Depression” you need one element that both of these times had and we will not have this time. The ability to borrow money from other countries.
If other countries are hyper-borrowing as your country is, then you cannot effectively borrow from them because it just becomes printing money. It doesn’t matter that your bank didn’t print the money, the inflation will be imported.
This will not be “stagflation”, but we may experience a period of “stagflation” as an intermediate step. I personally think we are in stagflation now if you look at the real inflation numbers.
We will not experience something like “The Great Depression” as we are a huge debtor nation with a huge military in a nuclear world. I think unemployment will skyrocket, the banks will go into crisis en mass, but after that no one knows.
We will use our military and political might that only the US can muster right now. We will try to bully our way to health.
One thing is for certain, the social pressures caused by hyper-inflating the currency will have a very direct affect on the American people.
Chromatic Dispersion
Chromatic,
Thanks for detailed responses, kinda good to know that we probably won't end up in a Great Depression or Stagflation like situation but mass bank crises and unemployment is bad enough thank you very much...
You mention that you think we'll "bully" our way out of this situation, do you mean you think the US will default on its debt and most other countries will be forced to ignore/work with us managing the inflation or risk nuclear war/massive conventional war?
If so very worriesome to say the least, a return to pre WWI-like detantes (EU vs. Chinese currency basket countries vs. US vs. 3rd world?) as a response to this do you think? Somethng even more unstable??
UN certainly is a farce as it is, too much politicking and BS, poorly structured too. ;(
I'd agree that the modern economy is certainly not something you could cover in 1 episode of 60 min (or even in a hour...), still I'd wish they'd try to educate people about this stuff better...
I myself even learned there was such a thing as a housing bubble last month, thank god I watch my credit cards closely, got my car paid off, and while my house is a dump its almost paid off too.
Brent,
The US is in very advantageous positions with the debt that we owe. It is all in terms of our own currency. Therefore we do not need to default upon our sovereign debt (treasury bonds, bills, notes), we can effetely inflate the debt away. We are the only country that can do this.
Good idea to pay down debt to get through the squeeze, your income will not keep pace with inflation for a while.
I foresee an end to a Fractional Reserve system as it stands today. But I also guarantee that within at least one or two generations that it is effetely put back. The US had all kinds of laws on the books to protect us from this situation we are now in, the laws were all changed or repealed.
Because most of the major countries are hyper-inflating their currencies through borrowing their currencies shall also hyper-inflate when they are forced to print money to save their own banking systems.
Historically, countries borrow to get out of crisis. This time since everyone is in crisis it comes down to printing money.
Since World War II nuclear weapons have solidified borders between major countries. I don’t, and hope we don’t go into a major war because nothing good can come from it. The US has historically been a big bully with its international policy. This has given American’s the best standard of living on the planet. I hope that when push comes to shove we solve thing economically instead of using military with real countries with real weapons.
I would agree that a basket of currencies will be used in the future. The biggest unknown is what the new banking system would look like. We have to get away from a Fractional Reserve System, if even for a little while to restore balance to the economic system.
Also consider this. If the US started printing money and just lied about it, how would anyone figure it out at first? It may take some time as international finance is very tricky to deal with. Right now I depend on The Federal Reserve to tell me what they are doing. I don’t think I could tell if the US just started printing money until it became just too obvious there was too much money floating around.
Chromatic Dispersion
Chromatic,
I too think fiat currency is here to stay. I was referring to Friedman's response to Keynes that you can give incentives to the financial sector, instead of the real one, to stimulate the latter - the modern version of Monetarism in vogue since Jimmy Carter.
I was reading a lot of Krugman, and I am beggining to get a feeling that we cannot stimulate the real economy through the financial economy. Maybe Greenspan is beginning to think this way too.
Chromatic,
one more thing: do you think that pure Keynesianism and pure Monetarism have their Achilles' heels - stagflation for one and liquidity trap for the other? In trying to stabilize the essentially unstable economic system, we seem to avoid one set of problems only to inflict another - if we stick with the formula for too long...
BTW, I enjoy your posts at Ben's, Chrome.
Max,
I am amazed at how long the US financial system has survived using liquidity as the bandage to solve our fiscal problems. If the US dollar wasn’t the world’s defacto currency, then our banking system would have gone into crisis a long time ago.
I am thinking in 1971 when Nixon put the US on a fiat currency system.
The US dollar is artificially elevated in buying power at this time due to foreign countries dependency on the financial system the US has created during World War I. The US is truly driving the world’s economies in a very unhealthy way for it depends on the US carrying an ever increasing and accelerating debt burden and widening trade balance.
So far we have been successful with stimulating our’s and the world’s economies through purely financial manipulations. Other countries don’t even care that we can never hope to pay the debt they buy back. They seem to be happy with the periodic payments made, even if the payments are made using debt.
It is not like a foreign country thinks that we shall have less than 5% inflation for 10 years when they buy our 10 year treasuries. They don’t, they just don’t know how to deal with this situation, so they follow the same pattern until their own economic and political system cannot handle it any longer.
The end game for this is hyper-inflation through printing money. This situation does not require panic, a housing bust, or anything else. This is due to the fact that it takes more and more money in an exponential fashion to keep growing the financial economy to support artificial growth. This induces a need for acceleration in the amount of money supplied, outstripping a countries ability to produce real economic growth at the same rate.
Therefore, the weakness of providing liquidity is simply the quicksand it creates underneath your economic system. You will eventually be sucked under the sand, it just amazes me how long it is taking this time.
Chromatic, I'm surprised you're surprised the liquidity runaway train hasn't stopped yet. Wall Street has been quite adept at coming up with ever inventive securitization and derviatives products. I have no idea how you could even unwind this. The ratings agencies are over their head in keeping up with the myriad of products with their simplistic models. I've heard this from more than a few folks who I know at Fitch and S&P.
How this house of cards comes crashing down will be totally out of left field in my opinion. Some event will trigger it, and then it'll all unwind. I have zero idea what the negative effects will be, but there will be some pain to go around, particularly for investors who think they're holding healthy collateralized products.
Richard,
I have been very busy so I now have a chance to answer your question.
I am not surprised at the ingenuity of Wall Street. Who else could have come up with derivatives in the first place.
What I am surprised of is the collusion of all of these other countries in order to keep the US dollar standard afloat. The US could not have done this alone.
In international politics, it seems the only thing these countries can agree upon is that they want the US dollar standard to survive. Even though there is no chance the US could ever hope to repay its debt with money which was worth anything near the spending power when these countries accepted our debt.
It is as if they don’t expect to be paid back, therefore we borrow to service our debt. I think of it as surfing a wave. You can never control the wave, you can only we moved by it.
As for the government bailing out housing, in order to save the banks they will have to assume the loans. The government has done this in both major banking crisis, the S&L scandal and the Great Depression
chrome, how is the government going to assume the potential scale of defaults if this housing bubble goes pop? the numbers could be astounding. on top of this, we're still borrowing $2 billion a day, heavily from abroad to fund operations. if the government did provide a sizable bailout, you're looking at a serious currency devaluation. how attractive will T-bills be then? if you're right our trading partners will continue to support them.
collusion. this isn't about countries, it's about the collusion of bankers. there's no difference between the central and private bankers. they all move in and out of the same jobs.
Richard,
How is the government going to assume the mortgages with a potential monetary value in the trillions of dollars?
Good question. If the government want to try to stabilize the banks it will have to assume the distressed loans from the domestic banks as it has in the past. However, this will not prevent bank failures induced from foreign exposure.
With so many countries either financially weak or hyper-inflating their currencies through borrowing it would also require these other countries to obtain the defaulting loans in their own countries. This has also happened in the past.
Therefore I would reason that each of these countries would either try to borrow their way out of hyper-borrowing, which is impossible if their partners are also hyper-borrowing, so in the end it comes down to printing money.
In a competition between the failure of the banking system and the dangers of hyper-inflation, governments will find it politically acceptable to have inflation than mass banking failures.
Will our trading partners continue to support us after this? Germany is still issuing loans to this day. Are they not still buying sovereign debt from Argentina. It would seem that memories are short.
I also find it interesting that when looking at the past bankers and money changers, including the Knights Templar had considerable power. However, governments have always destroyed the banking system for interests that are political and not financial.
The Knights Templar, often thought of as inventors of international banking, were destroyed in order to get their assets. Bankers are powerful, but not as powerful as the selfish needs of governments. The looters always destroy the currency for personal gain.
Chromatic Dispersion
good points chromatic. i think we agree hyperinflation seems to be the only way out of dodge once the shots start firing.
i'm particularly fascinated with how the CDO's are going to hold up. as we talked about earlier, the securitized products today are far more complex than in the past. many of the CDO's i've been seeing recently are managed market value deals. that is, we're expected to trust the person running the portfolio to manage market risk. even senior tranches aren't guaranteed to get paid off first with such arrangements.
a recent article in the WSJ showed 75% of the non-traditional mortgages being held by smaller banks and 25% by larger banks. what would be interesting to understand is how each group is managing their risk via instruments like credit default swaps. i have to imagine the bigger banks have advantages in their credit risk simulation models.
ok i'm wandering off topic ;)
Post a Comment
<< Home