Tuesday, September 30, 2008

Where will the money come from for the bailout?

Krugman thinks it won't increase the current net borrowing of the U.S. On the other hand, he also admits that "If investors lose faith in that …" with his "that", he is referring to "the [US] government’s ability to raise taxes. "

Should global investors have faith in the ability of US government to raise taxes? Are you kidding me? Neither current presidential candidate dares to say that they will increase taxes and any person who learned a little about American politics hasn't heard the famous phrase "Read my lips: no new taxes"?

Will this lesson be learned?

Neuroscience tells us we are pattern seekers and our brain thinks that "Two is a trend – three a rule." How many crises like this have happened? Three if you count the S&L crisis in the early 1980s, or two, 1929 and the current one. Regulation of the financial markets is a lesson learned from 1929 and overtime optimism takes over rational caution.

Will the politicians/regulators follow the rule below for the U.S.?

Rule No.1: Appropriate regulation and oversight is needed for a well-functioning financial market in the U.S.
Rule No.2: If you consider deregulation, refer to rule N0.1.

Monday, September 29, 2008

How about a two-stage plan

stage 1. An emergency plan put in act immediately.
stage 2. A carefully crafted plan that most people can agree on.

The emergency plan can help to calm the market.

Sunday, September 28, 2008

China's "Shenzhou(Godship) 7" Space Mission

Read more about this mission at here. It is a little bit ironical that on a day the Chinese are celebrating their first space walk, the Americans are eagerly waiting for a plan that they hate but better to have to emerge. If history is a vast spiral, then it must have the size at least as large as the earth since when people who stand on it look ahead, they think it goes straight. Also notice that the background music of this clip sounds like the soundtracks of Star War or Superman etc.

Can US treasury default?

Greg Mankiw call the "Capital flight" worrisome. Whether the story is true or not (not is the result), there is already some pressure on the Chinese government to manage their foreign reserve, mainly in the US Dollars or USD denominated assets, wisely. Should the foreign capital stop flowing into the US financial system, the only way for the treasury to finance the bailout/deficit etc, is to issue Bonds/bills directly to the Federal reserve system (which is what they do now), which is a classical recipe for hyperinflation as long as the Fed does not sterilize/recoup the injected liquidity, which according to most people, they do for these days. If the Fed still want to control inflation and refuse to inject more liquidity, the result will be that the treasury eventually run out of money. Which asset is risk-free then? The only thing that I can think about is ... GOLD.

Added on Oct 29, 2008: the current situation is this -- the credit market broken after a sequence of adverse events (Lehman Br. AIG, and bad earnings of banks etc.), the Fed is working very hard to re-inflate the liquidity flow in the economy, which is why the Fed has started to directly lend to businesses. Even if they do not sterilize the liquidity they are injecting into the economy, there may not be inflation pressure since the monetary multiplier has broken down.

However, once the order in the credit market/monetary multiplier is restored, inflation pressure will pile-up if the Fed does not shrink the monetary base fast enough. At that time, financing the deficit may be harder if the global investors are reluctant to buy US Treasury bonds/bills.

So, for now, US dollar looks good and Treasury is still safe. The danger is on the way of recovery after the credit market back-up working again. Since US Treasuries are denominated in the US dollars, if the Treasury decides to print money in order to avoid default, the default will take the form of depreciation of US dollars.

Friday, September 26, 2008

The lost of chain of trust and the stall of the negotiation

The protests in Washington against the bailout plan show the lost of trust from American people to their politicians. This lost of trust makes the republicans legislators lost trust on their president, the Bush administration. The international creditors now can clearly observe the this chain of lost trust and they may start to lost trust on the US economy as the political system of the US, which is supposed to be able to plumb the financial system, clogged up. I guess this is my hunch that leads to the worry of no bailout plan.

If no bailout plan get through this time and economic disaster does occur, will American people regret about their anger now or will they say that it is a price they would like to pay in order to punish the greedy bankers?

I am sorry for

what happened in the White house last night. The title of my yesterday's post is definitely not a good sign, even though I don't like the initial Paulson plan, it is still better to have a bailout plan. I am also sorry for the fall of WaMu. One of my friends is(was) currently working for WaMu and another of my friends started in WaMu and hired by Bear and Stern later on and eventually returned to her destiny JPMorgan Chase. While JPMorgan Chase is not a nice bank to its customer for its numerous and complicated fees, the good risk management saved its status.

Ohio, no matter how low key it is in the U.S. economy now as it is, provided some biggest political riddles starting from the second term of George W. Bush and now another Ohio man, John Boehner, from the west part of Ohio just helped to created another dismey on wall street in years. I cannot imagine what will happen after today's opening bell, not to mention this shock comes with together with the fall of WaMu. Or let's just say that the falling knee of the former CEO of Goldman Sachs says it all. Who have deep pockets should just buy anything and Warren Buffet is going to make more money.

The long term credit problem for the U.S. economy now is materializing day by day. Various liquidity drains show up in the economy. If this economic disaster actually happens, it states that the interruption of the flow of wealth from the rest of the world to the US leads to an immediate drop in the U.S. consumption. Market economy really has its own way to make everything happen just according to what it should be, except that this time the should-be event is really bad. I am sorry for the fact market economy has to work in its own way and the title of my yesterday's post.

Thursday, September 25, 2008

What if there is no bailout plan?

Whether the Paulson plan get passed does not matter in my opinion.

1. If it get passed, the rest of the world may loss their trust on the US government and raising money to finance fiscal deficit will become problematical.
2. If it cannot pass and no other bailout plan get passed, the above problem still exist.

It seems that Japanese firms are stepping in and we have to wonder how they will manage this wind-fall of management responsibility and liabilities in the future. The track record for Japanese is that they changed their wealth into a bubble and after the bubble burst, they got stuck in recession and stagnation for almost two decades. Do they have a big plan for their future? Doesn't seem to be the case if you look at Japan's political turmoils these days. But let's hope Japanese can once again be as innovative as they are for electronics.

So, if there is a good bailout plan get passed and the rescue of the economy is successful, the US economy may be able to hold on longer and experience a slower period of transforming. The problem is not even which bailout plan is good, people like an easy plan!

An excellent post from Barry L. Ritholtz

Latest Bailout Plan Spin: Its a Money Maker!
by Barry L. Ritholtz

Most people are unfamiliar with the evolution of financial management over the years. It began as a clubby old boys network, who you knew mattered more than what you knew. It evolved over time. Starting in the late 1970s, retail stock brokerage became a telemarketing sales business. Although that model is clearly changing, there is still trillions of assets under management today that got that way via the cold call.

Successful_telephone_selling_in_t_2 The cold calling sales approach was developed and refined at Lehman Brothers (perhaps their collapse was Karma). It was encapsulated by a man named Martin D. Shafiroff, who wrote up, refined and perfected various phone techniques. These include the straight line, the first trade, the trust close. All of his various techniques were published in the book "Successful Telephone Selling in the '80s" and subsequent editions ('90s, etc.)

Having worked on the Sell side for the first decade of my Wall Street career, I am intimately familiar with the various pitches the retail world uses to obtain clients and assets. There is not a single retail broker of my acquaintance that does not have Shafiroff's how-to on his bookshelf.

The reason I bring this up today is due to the latest sales pitch from various people, aggressively pushing the bailout plan. The newest spin on the massively expensive plan is "Hey, its a jumbo money maker!"

The spin reminds me of the classic retail stock jockey. The guy has buried his clients in a series of bad trades, bad judgment, poor risk management -- all motivated by his self-interested, commission-generating trades. The only way out of the money losing mess, pitches the broker, is a big, Hail Mary trade.

Sound familiar?

This technique is one of the last ones in the the Shafiroff book. Once an aggressive retail broker is upside down, the plea goes out for raising more money from the mark client. "Believe me, I hate being under water more than you. I pulled in some favors, this is the trade that makes it all back for us and then some. I could even get in trouble telling you this, so don't mention this to your pals. This is the one -- but I need you to send in more capital so we can recoup the prior trades that went bad on us."

I guess Paulson read the book in the early days of his career. That line of bullshit is identical to what the public is now being fed. A series of OpEds in the Washington Post and the Wall Street Journal (and who knows where else) are all pushing the same nonsensical line: The bailout plan is a big money maker:

Andy Kessler in the WSJ:

"My analysis suggests that Treasury Secretary Henry Paulson (a former investment banker, no less, not a trader) may pull off the mother of all trades, which could net a trillion dollars and maybe as much as $2.2 trillion -- yes, with a "t" -- for the United States Treasury...

Now Mr. Paulson is pitching Congress for $700 billion or more to buy distressed loans and CDOs from the rest of Wall Street, injecting needed cash onto balance sheets so that normal loans for economic activity can be restored. The trick is what price he will pay. Better mortgages and CDOs are selling for 70 cents on the dollar. But many are seriously distressed (15-25 cents on the dollar) because they are the last to be paid in foreclosures. These are what Wall Street wants to unload the quickest.

Firms will haggle, but eventually cave -- they need the cash. I am figuring Mr. Paulson could wind up buying more than $2 trillion in notional value loans and home equity and CDOs for his $700 billion."

Bill Gross (who just volunteered to manage the bailout for free) in the Washington Post:

"The extreme measures are extended government guarantees and the formation of an RTC-like holding company housed within the Treasury. Critics call this a bailout of Wall Street; in fact, it is anything but. I estimate the average price of distressed mortgages that pass from "troubled financial institutions" to the Treasury at auction will be 65 cents on the dollar, representing a loss of one-third of the original purchase price to the seller, and a prospective yield of 10 to 15 percent to the Treasury. Financed at 3 to 4 percent via the sale of Treasury bonds, the Treasury will therefore be in a position to earn a positive carry or yield spread of at least 7 to 8 percent. Calls for appropriate oversight of this auction process are more than justified. There are disinterested firms, some not even based on Wall Street, with the expertise to evaluate these complicated pools of mortgages and other assets to assure taxpayers that their money is being wisely invested. My estimate of double-digit returns assumes lengthy ownership of the assets and is in turn dependent on the level of home foreclosures, but this program is, in fact, directed to prevent just that."

Now, I have a few question for Messrs. Kessler & Gross: What does this say about the private sector? Why can't the all of the private equity funds, sovereign wealth funds, and enormous pools of capital do this themselves? There are trillions of dollars sitting around in cash, yet none of it that sees any value here?

I guess that Hank Paulson, George Bush and Ben Bernanke -- all of whom have been been unequivocally, expensively, tyrannically wrong about the entire crisis from the beginning -- are smarter than both the markets, and all of the private equity pools, about this paper?

Does that sound right to you? The guys who missed this from day one -- despite many many admonitions from many people -- only they see the value in this paper, whereas the smart guys who saw the shitstorm coming in advance, and bet against it, don't?

I am in the same camp as Michal Lewis, who writes at Bloomberg "the Treasury plan also creates this wonderful hidden opportunity for Goldman Sachs to make a killing, and thus preserve its bonus pool for a long time to come."

Put me down as sympatico with Anatole Kaletsky, who writes in the London Times:

"Mr Paulson may be a former chairman of Goldman Sachs, but as US Treasury Secretary he does not know what he is doing. His recent blunders, starting with the “rescue” of Fannie Mae, have triggered unintended consequences around the world, resulting in the death-spiral of financial values. But last Friday Mr Paulson outdid even these Rumsfeldian achievements, when he demanded $700 billion from Congress for a “comprehensive and fundamental” solution to the global financial crisis, without apparently having any idea of what he would actually do."


I have a 10 year bet for those folks now pushing the "Trust me, we will make it all back on this one trade" spin. If you who think the Paulson plan is a money maker, a cash winner, and a net after-fees taxpayer surplus creator, put your money where your mouth is. I bet you one million dollars, to the charity of the winner's choice, that the current plan is ginormous money loser.

Any takers?

Wednesday, September 24, 2008

What market is good for you?

Market is good. Free market is good. This is what used by some politicians when they are trying to convince American people about their plans. However, classical economics proves that in perfect competition, the market outcome is efficient, not necessarily fair. The problem is: today's market or even the so called free market is not really in perfect competition. In perfect competition, there should be perfect and symmetric information about the market condition and no monopoly power. Today's US economy, asymmetric information is typical and monopoly powers are protected by various laws (in the name of protecting America's competitive advantage.) So, market alone cannot be good in the U.S. and the government has to function well in protecting consumers. So, don't be fooled: perfect competition =\= "Free" market =\= market.

Free market is some time is used synonymously with perfect competition but today's politicians have abused this term and it no longer means perfect competition but a market without government oversight.

This is why: Democrats Are Better Republicans than Republicans Are, copied from Brad Source: Doug Henwood, Liscio Report.

Tuesday, September 23, 2008

Who can save the US?

Princeton and Paul Krugman? Or Madonna and Justin? I have to emphasize the importance of international finance aspect of the financial crisis in the fall of 2008. On public radio today, the audience are questioning Hank's intention and question why the government move so fast to save rich people and never showed any urgency in dealing with common people's problem. With his connection to Wall Street, people in Asian countries such as Japan, China and South Korea can easily see the conflict of interest where close business-government tie is a norm for corruption. Think about why GW Bush keep trying to ask for drill more and the fact that Bush has never been a really successful drill man for his business life. Should the Paulson's bailout plan get passed, the American people will have deep doubts to their government and should the creditors around the world understand that the Uncle Sam is loosing support from his people, they will worry the AAA credit rating on the US government debt and the depreciation of dollar will happen again and again and again. To prevent that from happening, the American people have to show their determinacy to be a responsible nation and stop Paulson's bailout plan from happening.

So, recession hah!

Bernanke said something like "approve bailout or risk recession" Woooo......so, so, s0000 scary! I am totally afraid of recession!

Wait a minute, I thought Hank and Ben were saying the economic system will collapse into a depression if this bailout plan did not get passed by the congress. Now, its only about have a high risk of recession? No need to bailout then. There has been several recessions and people are still alive.

Balance Sheet and the Bailout Plan

One thing I learned from the Balance Sheet in the financial statements is that the responsibility (Liability and Equity) and rights (Assets) should be kept in balance. The bailout plan by the Bush Administration intentionally avoid put responsibilities on the financial firms shoulder when handing over the rights of using detoxified capital (for the purpose of encouraging auction participation). This is why people don't feel its right.

Why not to use a complete override plan and mandate every institution that holds toxic assets to participate the auction. How much different is there between a partial market bailout and a complete government takeover bailout? The later may be more reasonable and effective for now and the government can release the tight control of financial institutions after the housing market recovers. Since everybody already agree to reform the financial system, why don't the government just do it now: cap the executive pay, setup renegotiation rules for the home owners facing foreclosure and order the banks to conduct business viewing each other as a government owned entity until the conditions get back to normal. This way will set a good precedent to deter future moral hazard since the CEOs will know that if they again recklessly take risk and put the whole financial system on the edge of total collapse, they will be punished by the government in a ruthless manner so as for the shareholders of these banks and future shareholders of banks will watch carefully on the risk-taking behaviors of the CEOs. "Hank" is simply too nice to his old buddies.

Monday, September 22, 2008

The consequences of this financial crisis

As the treasury trying to pay cash for trash (by Paul Krugman), the troubling deleveraging process of the financial institutions make me wonder how the USA will deleverage. Even though the central banks around the world and other financial authorities are helping the US to stablize the global markets in the recent several days, how they view the role of US in the long-run is problematic. The safe heaven status of the US market, the risk-free status of US treasury bonds and bills will become questionable and the dollar will prune to have depreciation crsis in the future. Again, without much to offer to the world but still liable for the large resources borrowed, how low the US economy will sink to?

Things US can offer to the world have been movies, English, education, food and IT product. It is hard to sell cultural product once US lose her status of an admirable country. It is very hard to believe American heroes can actually save the world after 9/11, and Hollywood has been repeating its stories for several years by now with the mentality getting lower from Napoleon Dynamite to Superbad. The high-tech movie making skills can be transferred easily. In the development of the their own economy, the rest of the world would want to maintain food security and their own technological independence and advantage. It seems that education is still valuable at college and graduate level in the US but the dim job prospectus make the foreign students more reluctant to come and with the huge amount of US PhD produced, the education level in the rest of the world will also catch-up. The financial sector used to the be largest in the US economy and now its in peril, what's next?

The game has been the financial sector of the US channeling the wealth from the world to the US so that Americans can consume what are provided from the rest of the world without pay it back for a while, evidence from the huge trade deficits. Deleveraging this debt is a taunting task!

Gone, inventment banks gone!

I thought Henry Paulson will retire back to Goldman Sachs and benefit big from the monopolistic status in the IB industry he created from slashing the competitors and his bailout plan. But GS and MS just could not hold on until the good time come. They lost too many talents to the hedge funds, rejected too many prudent and wise people, the only timbers left in the firms are the arrogant, aggressive and smart-stupid (AASS).

The investment banking industry dead on Sept 21, 2008 and today, Sept 22, 2008 let's hold a solemn funeral for this suicidal industry and speculate some day in the future it will resurrect.

The post is named after this movie.

Saturday, September 20, 2008

Money and Power, or something else?

"Power corrupts and absolute power corrupts absolutely"

A gentleman from the post office recited this to me today when he was delivering my package and he thought the current turmoil was a result of corruption from power fostered by money. May be the big picture can be viewed as "the get rich fast = American dream" leads money to seek power and use power to get more money and when the money-making is in trouble, power now come to rescue. Like Luigi Zingales said: "The time has come to save capitalism from the capitalists."

The observation I would like to make is that, actually, nobody has really shown obvious sign of corruption in the after mess. Two trouble makers to blame are the kept-too-long low interest rate by Greenspan and the predatory lending. People who are now trying to prevent the system from collapsing have good reasons for doing what they are trying to do. The problems lie more in the social-economic system itself than something can be simply attributable to power and corruption. What people are worrying about is that it is very possible the quick fixes for the current crisis are only short term patches with hidden agenda to even rob more from the poor or middle class and feed the riches. If things go better in next week, next month and next year but no fix for the social-economic system itself, a bigger crisis can still be looming and the U.S. can be totally wracked. I think that's the problem most people worry and I think it is very hard to fix, which is the reason I start to write this blog.

Flow: for the love of water

See the Bob Edwards Show Blog
On the radio, the director of the documentary said (largely): "A small piece of the war spending bread can provide clean water and save lives....We spend more money on death than on lives."


Water Crisis Part I

Water Crisis Part II

Friday, September 19, 2008

How about the Tax Payers?

Well, the real interest rate will be driven up for the rest of the world have doubt on the credibility of U.S. government now. The risk-free asset has been abused and become risky. The U.S. government has to offer extremely attractive return so that eventually American people will start to save and curb their spending enthusiasm. To pay for the high returns, tax must be increased and government spending must be cut. Since it is hard to increase tax at a matching rate, the government spending at all levels will probably fall by a significant amount. Ultimately, the diminishing role of the government should boost the economy since the federal government is the largest employer in the U.S. and its inefficiency is well known.

In sum, the American people have to save more and slowly retire their debt to the world with what ever American products that they are willing to export, such as food or movies.

The long-term view of the Fall, 2008 Financial Crisis

Since the early 1990s, China has relied on exporting to grow her economy, and the high speed economic growth in turn helps to maintain the stability of transitions of the Chinese political system. For the CCP to protect its power, the growth thus exporting is very important. On the supply side of the export, the Chinese producers are very close to perfect competition and some people think its over-competition. On the demand side, the buyers are close to monoposony who can press the price as much as possible. So, cheap Chinese product flooded the U.S. market, supporting the U.S. consumers' high living standards and the U.S. economy used the recourse surplus built two bubbles: the internet bubble at the end of 1990s and and the housing bubble in the middle of 2000s. The result of this economic relationship is that U.S. has accumulated a large amount of liability to the rest of the world denoted in the U.S. dollars. If the U.S. repay the debt gradually and orderly, it is possible there will be no disruption in the relative closing up of the living standard differential between China and the U.S. One example of the closing up can be the slowing down of U.S. living standard growth and the speeding up of the Chinese living standard growth.

The domestic political sentiment of the U.S. focused on the manufacturing job loss and the trade deficits to China, which a country viewed by the U.S. not as a friend. So, the U.S. politicians started to demand the Chinese currency, Yuan or RMB, to appreciate. There is domestic demand for the appreciation of Yuan in China as well. In more recent years, China's wealth has accumulated to a level that can feed its own bubble in the stock market and her domestic housing market. The Chinese officials hope the appreciation of Yuan can help to keep the wealth produced by the cheap domestic labor remain in the country and benefits Chinese people, and they also passed a labor law to protect workers' rights for the same purpose. This consensus between the Chinese and Americans led to the depreciation of US dollar. The devaluation on the US dollar denominated assets owned by the Chinese government make the Chinese realize the depreciation of dollar is actually a default on the liability owed by the U.S. to China thus the wealth flow from China to the U.S. is disrupted abruptly both intentionally by the underweighting of USD denominated assets holding by the Chinese government and unintentionally by the higher labor costs for the Chinses suppliers. It is generally thought that to shift production of the exporting goods out of China will take time and incur higher production costs. Ultimately, very soon the cost of living in the U.S. will be higher than had the Sino-US trade relationship not been broken abruptly.

The U.S. can repay its debt by transferring wealth through trade or selling its assets to the Chinese or the Arabs, which is a choice that neither the U.S. government nor business leaders would like to make. However, when there is no obvious way to repay the debt through international trade, the U.S. have to sell its assets one way another once the process of wealth transfer from China to the U.S. is disrupted. The U.S. authorities realized that cheap dollar lead to higher oil price and higher inflation eventually a deep recession so they decided to reverse the depreciation of dollar. Then the only way to sell US assets is the the prices of these assets to collapse, as seen in the stock market and the housing market in the U.S. Even so, the barrier for Chinese to purchase U.S. assets is still extremely high due to the Chinese capital flow restriction and the reluctance of the U.S. government to accept this choice. So the U.S. government step in and bailed out the U.S. assets by either have direct stakes in some U.S. firms or now, an entity to hold toxic MBS derivatives. The question remains, however, how the U.S. economy will repay the liability to the rest of the world in general and China or OPEC countries in particular.

In the short term, if the U.S. economy is stabilized through the above government actions, the depreciation of dollar is inevitable since the market still needs to enforce the repayment of the liability owed by the U.S.