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AEI Subprime VI: Makin Presentation

October 31, 2009 by · Leave a Comment 

I think almost by definition we’re … I mean I would say W, because I think in the US anyway we’ll still see a 3 1/2 percent growth number in the 3rd quarter, which will be reported next week, and maybe a 3 percent number in the 4th quarter …

Doom Transcripts: Index & Guide

I do believe we have a winner.1

Housing Doom is pleased to present a fifth selection from our under-construction transcript of the American Enterprise Institute’s October 22, 2009 event "The Deflating Bubble, Part VI: The Lessons of the Bubble and Crisis".2

The event site has a number of resources, including an audio and video of the proceedings. There is as yet no official transcript.

This is the presentation by AEI Visiting Scholar John Makin

John Makin: [0:54:19] So I’m going to say that so far what we’ve heard is, it’s the lessons of the — having deflated and about to reflate bubble. And that’s a little different than the idea that the bubbles burst and it’s past us.

But, you know, I’ve taken the charge here quite literally — What are the lessons of the bubble? And I think we’ve heard that it may not be the only bubble that we’re getting, but I … The main lesson of the bubble in the US in a sentence is "You’ve got to be Too Big to Fail," because then you get bailed out.

Unfortunately, that [0:55:00] may be consistent with Nouriel’s suggestion that there may be another bubble coming. But, anyway, a few months ago I took a crack at these lessons and have refined it a little bit. It’s on the AEI website. I haven’t got a presentation here, but it’s basically, "What are the lessons of the bubble."

And I’m going to look back a little bit and then quickly look forward.

First, there are three lessons of the bubble that we’ve seen so far. The first is that disruption in the financial sector can have a devastating effect on the real economy. And we saw that last fall when; … Remember, it’s important to remeber that in August of 2008 the Fed minutes suggested that the big concern was that inflation could get out of hand. That was 6 weeks before Lehman collapsed, and we know what happened there. We had one of the sharpest economic contractions in … certainly in the post-War period.

But I think in a way we had, if you read the anecdotes or the discussions about what was going on in September or October of last year, we had a near-death experience. Anybody who was close to the crisis that we saw unfolding in September of 2008, and I was in the middle of it, saw that we could have had a systemic meltdown that would have resulted in an immediate and serious global depression.

So I think one of the lessons of the bubble is to remember that we got through that. Don’t be too critical of policymakers, they had to extemporize how to deal with a counterparty run on investment banks, which is a new phenomenon that we’ve seen in this cycle; a little different from what we were kind of expecting, which was a depositor run on commercial banks. A counterparty run on investment banks is, in a way, a little bit more toxic because it happens faster. With a very sophisticated marketplace it means that people hear that an investment bank is in trouble and won’t do business with them, [so they] withdraw their capital and the investment bank goes down. A counterparty run on investment banks, had the Fed and the Treasury not truncated it, would have eliminated not only Lehman but Goldman Sachs, Morgan Stanley and any other investment banks that might have been hanging around there.

That could have happened. We were very close to that.

So I think one of the … The sense of urgency that Chairman Bernanke and Hank Paulson felt was related to the viciousness of that activity. And again it’s still a risk out there, but I have to hand it to Bernanke and Paulson, extemporizing how to run … how to deal with a counterparty run on an investment banks in the space of a few days is quite a trick.

I wouldn’t want to try to do it again, but the first … again, the first lesson of the crisis is … be careful, this is a very, very dangerous business. And we all … It was tied, of course, to the bursting of the bubble, but when the rubber meets the road, you’re in that kind of a situation and we were lucky — skillful, but lucky.

Second lesson: The Fed was slow to move, but powerful when they did move. In that sense they would … If I had to criticize I would say to everybody on Wall Street, and a lot of people on this panel, the Bear Stearns crisis, it was totally clear that this counterparty run on inventment banks was an incipient, then an actual problem. The idea that keeping Bear nominally alive, on live support from JP Morgan, was going to solve the problem was ridiculous.

I can’t resist pointing out that it was in April of 2008, a month after the Bear Stearns crisis, that the famous Jim Cramer wrote a pieceuuuD in New York Magazine suggesting that, "Isn’t it a wonderful time to get back into the markets? Everything’s fixed." It wasn’t fixed, and in effect we’d had a warning that, if we’d heeded it more promptly, we might not have had quite such a toxic experience in the fall.

So it was sort of like — Too bad we didn’t learn about Bear, we didn’t, but somehow we managed to pull it out anyway after Lehman, but we were lucky. So there again I look back and one of the things I carry away from the crisis is … I don’t want to go there again, because it’s a real problem.

The third lesson, of course, and people mentioned this, is don’t forget China. China’s now the most [1:00:00] dynamic and largest force in the global economy at the margin, that is in terms of growth rates. Their behavior has a tremendous impact on what’s happening in the world today.

And of course they have the wherewithall to respond far more forcefully and successfully to the fallout of the financial crisis than advanced industrial countries. Remember China didn’t really have a kind of financial system meltdown problem because they didn’t have a sophisticated financial system. They were plugged into it.

China was threatened by the massive real economic fallout from the financial collapse in the industrial world. They effected a massive fiscal stimulus to … probably triple the US stimulus, and then the followed up with very aggressive monetary stimulus. The latest data that we’ve seen suggests they may have overdone it, but one of the things we’re seeing is rapidly rising commodity prices are partly a result of China’s very aggressive expansion. Shouldn’t be taken as a signal that there’s global inflation coming down the road, but rather that the Chinese are stockpiling commodities.

China has a big wealth-storage problem, and so they tend to stockpile real assets in periods of crisis. Asian investors like to own gold, and that’s another price that’s going up.

So I like to keep China in mind as we look at this. And of course one of the immediate problems we have now is that China, having effected a massive fiscal stimulus, and a domestically oriented, or a domestically based monetary stimulus, … China, which is really using the Fed as its central bank as of the … Chinese currency is pegged to the dollar. Then in effect US monetary policy is Chinese monetary policy. They’ve had huge capital inflows which they have not successfully sterilized them so China may be heading …

China may be the first bubble experience that we see in this environment where they’ve got massive stimulus in place, rapidly rising property prices and rapidly rising stock markets. So that is something that makes me nervous, because the Chinese are going to have to manage that problem. If they don’t manage it well, and it’s a tough one to manage, we could have a problem coming out of China which, of course, is not where we’re looking for problems right now.

The other lesson of the financial crisis that I started out with a little bit facetiously with, but I actually, I think it’s … it’s indicative of a problem is it’s best to be too big to fail. That’s another way of saying that we have a huge moral hazard problem after the financial crisis.

I saw a play in London about the financial crisis called "The Power of Yes." And it was … it was essentially a pretty good play. It kind of leaves the audience wondering how did these guys who screwed up so badly end up not getting crushed in the crisis.

And that leads us to other questions. In order to save the system we had to step in and underwrite some activities by financial institutions in the US and elsewhere that were certainly related to the problem. And these institutions are now happily making loans again, and in many cases, or some cases making an awful lot of money, which is OK, but I don’t think we should have investment banks essentially able to boost leverage while simultaneously being underwritten by taxpayers. And the threat of counterparty runs on investment banks has made that the case in the US. I do not think that the Fed or the Treasury dares withdraw the support that they’re implicitly supplying to former US investment banks that are now bank holding companies by saying, "You know, we’re cutting these guys loose." Which in a perfect world, where we were in some kind of equilibrium, they would do, because that would be a good way to induce them to cut leverage.

Now if this were a New York audience everyone would be jumping up and down and saying, "Well, you guys are so bearish, how come the stock market’s gone up by 56 percent, and how come commodities are rising blah-blah-blah …" And I think you have to address that question in terms [1:05:00] of understanding the aftermath of the crisis.

I mean the broad lesson is — when you fix a crisis of this magnitude that the financial sector responds a lot more rapidly than the real economy.

And what we’ve had is a strong bounce in the financial sector. In the US we have had I think ultimately a counterproductive cosmetic efforts to bump up the growth rates in the second half of this year — Cash for Clunkers and the subsidies for homeownership can do tremendous things to annualized quarterly numbers.

Now of course Tom pulled that little trick with his house prices. You’ll notice that his house price series was annualized monthly data, which does wonders for the clarity that comes out, but every … and Tom wouldn’t want to mislead you with that, but I can asure you that there are some people on Wall Street who love to use quarterly and monthly annualized data to say, "You know, the recession’s over, we’re all off to the races, I’ve got some stocks and bonds for you to buy, so please step up and buy them."

And the reason that these things have up in value is that, simply, if you’re in the business, people say, "Heh, these things are going up, and don’t be so fussy, go out and buy them." And so it’s a bubble. I mean, how does it develop some momentum of its own? Why do you want to own it? Because everybody else owns it. I share some of the concerns that Nouriel has about what is going to happen going forward.

I think almost by definition we’re … I mean I would say W, because I think in the US anyway we’ll still see a 3 1/2 percent growth number in the 3rd quarter, which will be reported next week,uuuF and maybe a 3 percent number in the 4th quarter …

Alex Pollock: … Also a quarterly number annualized …

John Makin: [laughs] … I should add that these are quarterly numbers annualized, and it’s again … the arithmetic is powerful if you get people to go out and buy cars at a 14 million unit rate in production. But you’ll notice if you watch the US data is the production side numbers tend to be stronger than the demand side numbers, which are all weak.

The problem is there’s a hangover. So in the first half of next year I think we’ll have downside surprises which I would call the W. And maybe at that time, as we’re starting to see audited earnings reports from the 4th quarter, the euphoria in the markets will evaporate.

But I would guess that you could continue to see that upside continue for a while with folks on CNBC waving their arms around, jumping up and down. But I’m guessing that by the end of the year and into next year people may want to be edging toward the exits.

So that’s the last of the last lesson I had is that financial markets can respond far more quickly to rescues than the real economy. And that the underlying probability that the real economy won’t respond implies substantial risk in the financial sector. I’ll stop there. [1:08:08]

Notes and References

[1]: "U.S. GDP rises 3.5% as stimulus kicks in: Gains in consumer spending, inventories, housing drive growth", by Rex Nutting, MarketWatch, October 29, 2009.

WASHINGTON (MarketWatch) – The U.S. economy expanded at a 3.5% annual pace in the third quarter, as massive government stimulus helped drag the economy out of the longest and deepest recession since the 1930s, the Commerce Department estimated Thursday.

[2]: "The Deflating Bubble, Part VI: The Lessons of the Bubble and Crisis", AEI event homepage, October 22, 2009.

Read more….

In Slow October, Two More Banks Take TARP Funds

October 31, 2009 by · Leave a Comment 

By Chris Carey, Bailout Sleuth

Two more banks received funding under the Troubled Asset Relief Program, closing out the slowest month in bailout history.

Washington State-based Regents Bancshares Inc. took home $12.7 million in assistance. In exchange it gave the Treasury Department an equal amount of stock shares and exercised warrants.

Cardinal Bancorp II, based in Missouri, also received bailout funding. It received $6.2 million in exchange for subordinated debentures and exercised warrants.

Only four banks have received bailout assistance in October, and the two recent allocations were the first in three weeks, the longest period without one.

Overall, the Treasury Department has dispensed $204 billion in assistance to financial institutions. Of that, $70.7 billion has been returned by banks seeking to escape the program’s regulatory strictures on executive pay and the distribution of dividends.

More articles from the Bailout Sleuth….

Congressman Watt Guts Bill to Audit the Fed

October 31, 2009 by · Leave a Comment 

Zero Hedge

Washington’s Blog.

Ron Paul tells Bloomberg that Congressman Watt has just more or less killed the bill to audit the fed:

Ron Paul, the Texas Republican who has called for an end to the Federal
Reserve, said legislation he introduced to audit monetary policy has
been “gutted” while moving toward a possible vote in the
Democratic-controlled House.


The bill, with 308 co-sponsors,
has been stripped of provisions that would remove Fed exemptions from
audits of transactions with foreign central banks, monetary policy
deliberations, transactions made under the direction of the Federal
Open Market Committee and communications between the Board, the reserve
banks and staff, Paul said today.


“There’s nothing
left, it’s been gutted,” he said in a telephone interview. “This is not
a partisan issue. People all over the country want to know what the Fed
is up to, and this legislation was supposed to help them do that.”..


a member of the House Financial Services Committee, said Mel Watt, a
Democrat from North Carolina, has eliminated “just about everything”
while preparing the legislation for formal consideration. Watt is
chairman of the panel’s domestic monetary policy and technology

Contact Congressman Watt and tell him what you think.

More articles from Zero Hedge….

Chairman of the Department of Economics at George Mason University: Politicians Are NOT Prostitutes … They Are Pimps

October 31, 2009 by · Leave a Comment 

Zero Hedge

Washington’s Blog.


Many people have called politicians prostitutes.

True, Obama has received more donations from Goldman Sachs and the rest of the financial industry than almost anyone else.

And Summers, Geithner and the rest of Obama’s economic team have made many millions – even recently – from the financial industry.

And Congress has largely been bought and paid for, and two powerful congressmen have said that banks run Congress.

So yes, they have certainly sold their goods to the highest bidders.

Indeed, at least some people trust prostitutes more than elected officials.

But the prostitution analogy is inaccurate.

Specifically, as the chairman of the Department of Economics at George Mason University (Donald J. Boudreaux) points out:


whores, after all, personally supply the services their customers seek.
Prostitutes do not steal; their customers pay them voluntarily. And
their customers pay only with money belonging to these customers.


In contrast, members of Congress routinely truck and barter with other people’s property…


of Congress are less like whores than they are like pimps for persons
unwillingly conscripted to perform unpleasant services.


for example, agricultural subsidies. Each year a handful of farmers and
agribusinesses receive billions of taxpayer dollars. These are dollars
that government forcibly takes from the pockets of taxpayers and then
transfers to farmers.


The customers, in this case, are the
farmers and agribusinesses. The suppliers of

the services performed for
these customers are taxpayers, for it’s the taxpayers who possess the
ultimate asset — money — that farmers and agribusinesses lust after.
And the intermediaries who oblige the suppliers to satisfy the base
lusts of the customers are politicians. Just as pimps facilitate their
customers’ access to prostitutes’ assets, politicians facilitate their
customers’ access to taxpayers’ assets.


We taxpayers have less
say in the matter than we like to think. Sure, we can vote. But if even
just 50.00001 percent of voters cast their ballots for the candidate
proposing higher taxes, the assets of not only our pro-tax citizens,
but also those of the remaining 49.00009 percent of us anti-tax
citizens are put at the disposal of our pimps’ customers. (And note
that many of those who vote for higher taxes are not among those
persons actually subject to higher taxation)…


Politicians force
taxpayers to pony it up — just as the services rendered for a pimp’s
customers are rendered not by that pimp personally, but by the ladies
under his charge. The pimp pockets the bulk of each payment; he’s
pleased with the transaction. His customer gets serviced well in
return; he’s pleased with the transaction. The only loser is
the prostitute forced to share her precious assets with strangers whom
she doesn’t particularly care for and who care nothing for her.


like the ladies under pimps’ power, taxpayers who resist being
exploited risk serious consequences to their persons and pocketbooks.
Uncle Sam doesn’t treat kindly taxpayers who try to avoid the
obligations that he assigns to them. Government is a great deal more
powerful, and often nastier, than is the typical taxpayer. Practically
speaking, the taxpayer has little choice but to perform as government


So to call politicians “whores” is to unduly insult
women who either choose or who are forced into the profession of
prostitution. These women aggress against no one; like all other
respectable human beings, they do their best to get by as well as they
can without violating other people’s rights.


The real villains
in the prostitution arena are those pimps who coerce women into
satisfying the lusts of strangers. Such pimps pocket most of the gains
earned by the toil and risks involuntarily imposed upon the prostitutes
they control. No one thinks this arrangement is fair or justified. No
one gives pimps the title of “Honorable.” Decent people don’t care what
pimps think or suppose that pimps have any special insights into what
is good or bad for the women under their command. Decent people don’t
pretend that pimps act chiefly for the benefit of their prostitutes.
Decent people believe that pimps should be in prison.


Americans continue to imagine that the typical representative or
senator is an upstanding citizen, a human being worthy of being feted
and listened to as if he or she possesses some unusually high moral or
intellectual stature.


It’s closer to the truth to see
politicians as pimps who force ordinary men and women to pony up
freedoms and assets for the benefit of clients we call
“special-interest groups.”

Note: There are a handful of honest politicians, fighting for the American people. But the exception proves the rule.


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Halloween 2009

October 31, 2009 by · Leave a Comment 

Observations On Black Swans In Money Markets

October 31, 2009 by · Leave a Comment 

Zero Hedge

The attached presentation, from John Taylor of Stanford and John Williams of the SF FRB, prepared in the weekend before the Lehman bankruptcy, and thus in the eye of last year’s hurricane, provides some additional insights into money markets, the Fed’s TAF program, OIS spreads, and how everything can go spectacularly wrong at mere whiff of that greatest black swan of all, and the one concept all in the financial business take for granted: counterparty risk. With the Fed now actively pursuing the extraction of capital out of money markets instead of primary dealers, the potential liquidity imbalance will be a major threat to the system and will be actively monitored by Zero Hedge. If the Fed’s soothing admonition that it has things in control serves any purpose, it is that sooner rather than later risk flaring and six sigma events will once again be a daily occurrence.


Attachment Size
Money Market Black Swan.pdf 219.04 KB

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While Going Broke Has its "Benefits," Ford Workers Reject Contract Changes

October 31, 2009 by · Leave a Comment 

Zero Hedge

According to an AP source and an article in the Wall Street Journal the United Auto Workers gave local Ford unions the weekend to review and ratify contract changes, but as of today, it’s a no go.

The UAW and Ford agreed to contract changes weeks ago, but the workers needed to approve the deal, some 41,000 UAW-represented Ford employees.

Ford was seeking to reduce labor costs, bringing them more in-line with rivals GM and Chrysler- both having won concessions from the UAW being bankrupt and all. 

Ah, the perils of not being bankrupt.



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You Can’t Possibly Be Serious (CRE)

October 31, 2009 by · Leave a Comment 

By Karl Denninger, The Market Ticker

I am speaking of the notion that went up the flagpole on allowing banks to refinance commercial real estate loans at more than 100% LTV – and having this “overlooked” by regulators.

Oh, but they are!

Regulators, in a significant step, also said they won’t penalize banks for performing loans where the value of the underlying property is now worth less than the loan balance.

Who did this?

The guidelines, released on Friday by agencies including the Federal Deposit Insurance Corp., the Federal Reserve and the Office of the Comptroller of the Currency, provide guidance for bank examiners and financial institutions working with commercial property owners who are “experiencing diminished operating cash flows, depreciated collateral values, or prolonged delays in selling or renting commercial properties.”

Their comment?

“Financial institutions that implement prudent [commercial real estate] loan workout arrangements after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for engaging in these efforts,” the agencies said in a policy statement.

One of the definitions of “prudent lending” is not to lend beyond the current value of a given asset, with any such “excess amount” requiring a dollar-for-dollar reserve of the bank’s own capital.

Of course the others are knowing that the borrower can pay, which they appear to be covering.

But just as in residential real estate when you lend in commercial real estate beyond asset value you’re doomed, because it is not possible to have a reasonable expectation that the borrower will continue to perform!


Primarily because demanded rents cannot be maintained.

Take two strip malls across the street from one another.  Both started with a “value” of $10 million.  Both now have a “present value” of $5 million.  Both are identical – in the same location, on opposite sides of the same road, both have the same square footage and amenities.

One loan is foreclosed and the property sold – for $5 million.  That buyer finances the $5 million purchase.

The second is “worked out” instead of demanding that the borrower either be foreclosed or pony up the other $5m (which he doesn’t have), and the bank rolls the note at a negative equity position of $5m.

What happens?

Tenants start to go out of business.  As space opens in the $5m note mall, those in the $10m note mall see the open space.  So do potential new tenants. 

Is the rent in the $5m note property going to be higher or lower than the rent in the $10m note property?

How many of the $10m note property spaces will be rented one, two, three or five years from now, compared to the $5m property?

What is going to happen to that $10m loan?

This is an out-and-out scam that is simply going to end up costing the FDIC even more money, because the banks will be even further underwater when the note on that “worked out” property inevitably blows up.

Every time I see the government come up with some hair-brained scheme that will (1) never work and (2) will explode in the taxpayer’s face, I maintain that I’ve seen the dumbest thing yet.

Unfortunately the FDIC and other regulators keep outdoing themselves.

More articles from the Market Ticker….

White House LIES: CFC

October 31, 2009 by · Leave a Comment 

By Karl Denninger, The Market Ticker

This is ridiculous and anyone who believes it deserves to eat The White House Dog’s used food:

The administration’s blog post argued that Clunkers helped to lower auto prices on the rest of the vehicle market as well, a fact the administration said Edmunds ignored.

What a total load of crap.

First, I personally walked into dealerships during the “CFC” program time, and every single one of those dealers was literally screwing everyone who walked into the door.

Normally, you can buy an American car for $100 or so over invoice price.  I have, in fact, not purchased one vehicle for more since I started buying cars!  My last “new” American vehicle, a 2002 Suburban, was bought during the 0% “craze” following 9/11 and even with the 0% financing I bought it for $1,000 UNDER factory invoice.  I saw no dealer willing to sell at anything approaching that number this time – they were all selling at full sticker, and two had their own “supplemental rip-off stickers” on the windows that they refused to negotiate on yet were full of junk (the usual “undercoating” and “fabric protection” for $250 garbage.)  People literally got robbed to the tune of $2,000, $3,000 and sometimes more than the rebate was worth on these so-called “deals.”

Second, this “program” destroyed the low end resale market.  It literally took all those cars and crushed them!  If you were in the market for such a clunker as the only car you could afford they all disappeared for the duration of that program.  This did severe damage to sections of the used-car market and the consumers dependent on it.

This program was nothing other than a royal screwing of the American Consumer and a sop to the UAW, and that’s a fact.  Edmunds got this exactly right and the White House is pissed off that they got called on their incessant lies by a very influential auto industry publication.

Well, boo-freaking-hoo Barry.

More articles from the Market Ticker….


October 31, 2009 by · Leave a Comment 

By Karl Denninger, The Market Ticker

Time to drag this out…. from quite some time ago…..

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