Credit, Contagion, Homes, Loans

MWF (Friday) Briefing:

Contagion from the credit crisis unexpectedly created systematic weakness on a global scale working at hyperspeed.  According to Morgan Stanley, 45% of Asia's GDP was tied into export industries that fed American consumerism.  That consumerism was based on the assumptive that their real asset savings (homes) would appreciate forever... and they borrowed against their homes to fuel their consumption.  The first wave of foreclosures has begun to peak.  Now a second wave is building up for Alt-A.  Tie into that home equity loans and credit card run ups. 

• Los Angeles had 9,100 foreclosures over the past 18 months.  More than 35,000 homes are in default. That a 300% jump in one year.  L.A. is now slated to use $1.2 billion in Fed Funds to buy foreclosed homes and resell them to consumers.  Last year, L.A. officials saw mostly sub-prime loans default.  Now "middle class" loans are beginning to default.  The second wave of Alt-A defaults should begin  in 2009 as they start to reset.  Press Telegram McClatchyDC

• One third of new home owners owe more than their homes are worth.Bloomberg

• Home equity loans outstanding went from about $1 billion in the 1980s to $1 trillion at the height of the bubble.  Borrowers are falling behind on their payments at near record levels and could lose their homes. NYT

China and the WTO; China Art Market; Damien Hirst; Open Source Altruism

MWF (Wednesday) Briefing:

China was criticized for getting protectionist with it's agriculture at WTO,but it only makes sense that it should especially if industrialized countries with a higher tech and automated agriculture industry puts Chinese farmers out of business, leaving its population vulnerable.  It's not as if displaced farmers can pick up tools a year down and produce a crop within a month's time.  It's a positive sign that they are attempting to keep sustainability and looking after their population's best interest. The one big export industry for China, still, is its art market. Everyone knows it's a bubble, especially, it seems, Chinese artists, and they will ride it until the end.  This seems to be the case for Damien Hirst as well.  He's poised to make record sales in his upcoming show.

About boundaries, money, and such, open source project seem truly altruistic.  Sometimes, they have trouble spending donated money.

• Trade talks at the WTO  broke down due to China's about face on free trade. Food prices have spiked globally, particularly for rice.  Developing countries with a food surplus have imposed limits on exports to retain supplies for their own populations. China has become focused on making sure that its farmers can continue to produce most of the food needed for the 1.3 billion people in that country, and leery of having to rely on imports. NYT  China was mostly blamed for the collapse of the talks.Guardian

•  Click to enlarge. China's art bubble only growing. Portfolio

• Open source teams, and culture, have been developed such that they’re almost money-agnostic. Open source projects run on time, not money. So, the way to convert that currency is through bounties and funded internships. Unfortunately, setting those up takes time, and since that’s the element that’s in short supply, we’re back to square one. Webmonkey

•  Click to enlarge. Damien Hirst's aesthetic - he describes another painting assistant who was leaving and asked for one of the paintings. Hirst told her to, "'make one of your own.' And she said, 'No, I want one of yours.' But the only difference, between one painted by her and one of mine, is the money.'" By February 1999, two assistants had painted 300 spot paintings.   Hirst sees the real creative act as being the conception, not the execution, and that, as the progenitor of the idea, he is therefore the artist. Wikipedia  His latest art auction is expected to raise about $120 million. FT

The Paradox of Deleveraging: Bill Gross & Paul McCulley Go into More Detail on Housing & Debt Devaluation

Widespread fear about the financial sector brought a dramatic end to the recent stock rally, as investors scrambled to take profits from bank shares and sent the Dow Jones industrials down more than 280 points, its worst loss in a month. Washington Mutual had to reiterate for a second time this week that it was financially sound.  Bill Gross continues on his July Investment Outlook letter of the trillion US dollars needed to get us out of this credit crisis in his August Letter.  Paul McCulley of Pimco sounded off on his Global Central Bank Focus,August, to Investors about what he terms "the paradox of deleveraging."

Paradox of Aggregation - Double Bubbles Bust. Once the double bubbles in housing valuation and housing debt burst a little over a year ago, everybody, and in particular, every levered financial institution – banks and shadow banks alike – decided individually that it was time to delever their balance sheets. At the individual level, that made perfect sense.

At the collective level, however, it has given us the paradox of deleveraging: when we all try to do it at the same time, we actually do less of it, because we collectively create deflation in the assets from which leverage is being removed. Put differently, not all levered lenders can shed assets and the associated debt at the same time without driving down asset prices, which has the paradoxical impact of increasing leverage by driving down lenders’ net worth.

 This process is sometimes called, especially by Fed officials, a negative feedback loop. And it is, though I prefer calling it the paradox of deleveraging, because the very term cries out for both a monetary and fiscal policy response, not just a monetary one. Lower short-term interest rates via Fed easing are, to be sure, useful in mitigating deflating asset prices, particularly if they serve to pull down long-term rates, which are the discount rates for valuing assets with long-dated cash flows.

George Soros on Bubbles and Credit

Jim Rogers, George Soros, & Goldman Sachs Have a Thing or Two to Say about Financial Markets & the Credit Crisis.

What was once considered rare  becomes the norm.  More changes ahead. Legendary currency trader Jim Rogers has called plans to bail-out of Fannie Mae and Freddie Mach an "unmitigated disaster". George Soros said banks were only the beginning of the "most serious financial crisis of our lifetime."  He noted that Fannie Mae and Freddie Mac have a solvency problem not a liquidity problem.  Sounds like we might have already gone over that precipice.

• The S&P 500 Financials sector had its worst day of the credit crisis today, declining 6.1%.  The one-day declines in many of the banks today reminded us of the worst days during the bursting of the Tech bubble. Bespoke

• The survey confirms that these strategies—now established components of many institutional portfolios—are no longer “alternative” at all. In fact, alternatives now play an essential role in institutional portfolio strategies, and we expect across-the-board allocation increases despite recent market turmoil. All About Alpha

• With Goldman Sachs, George Soros and Jim Rogers all coming out skeptical about the government plans for Fannie and Freddie, skittish markets look for more input. Telegraph  Seeking Alpha

Fed Speak on Interest Rates; Frankenfood; Bubbles and Commodities

MWF (Wednesday) Briefing:

U.S. stocks ended lower yesterday lower in anticipation of the Fed announcement later this morning. Congress is going to town on introducing new housing legislation.  Though it's understood the importance of keeping a steady economy, it doesn't make sense that bad decisions and excessive greed should be rewarded with a bailout.  Wall Street goes mainstreet.  As prices of agriculture commodities increase, European purists are looking to buying cheaper genetically modified food. 

• GMO Foods or Frankenfood are gaining wider acceptance in Europe as prices increase. istockanalyst

• A Monet sold for $80.4 million. NYT
• 

• Congress is set to pass sweeping housing legislation to rescue hundreds of thousands of homeowners in danger of foreclosure.  This is the biggest overhaul of mortgage financing since the New Deal. NYT

Billionaire George Soros: Bubbles Perculating; Food Commodities Crisis in Emerging Markets; Demand Elasticity of Oil

George Soros, in his current book, The New Paradigm for Financial Markets: The Credit Crash of 2008 and What It Means, states that the world is in the worst financial crisis since the 1930s. We're still in the stages of deleveraging after a quarter century of credit expansion. Though he believes regulation is necessary to keep the bubbly froth off commodity prices, he's not really quite sure how much there should be either from government or within the industry.  There is a lag effect as to when people will start to feel the fallout. Much of that capital has rotated in to commodities.  His testimony before the U.S. Congress in May reflected themes from his book. He mentions the credit crisis as being part of a super bubble economy that started in the 1980s, at the same time, he stresses that within commodities, there are still strong underlying reasons for prices to be as high as they are...only the froth is added by speculators.

• Institutional investment in essential products, like food and oil is reminiscent to what happened in 1987 when institutions bought portfolio insurance. It was the Tulipmania of that era. Everybody jumped on the wagon and created a crash. With or without increased regulation for stocks, we're entering into a time period where the outcome for stocks isn't good.b

• The dollar has weakened and it has had a twofold affect.  It exported the recessionary forces from the U.S. to the rest of the world. That has added one percent to the U.S. GNP, which is a positive outcome.The weak dollar is also importing inflation - goods cost more at stores.  There is no real alternative to the dollar and so there has been a general flight from currencies, which has contributed to the commodities boom. The dollar will no longer be the unquestioned reserve currency.  It will, though, still be the most widely used currency according to Soros, but it will depend more on the willingness of the rest of the world to hold dollar reserves.

• That limits the Fed's ability to lower interest rates. If the U.S. continued lowering interest rates beyond this, the dollar would suffer further decline, so you can't go anywhere in that direction.

There is a very strong fundamental trend in place for a continual increase in oil prices, but also, there is a "froth super-imposed" on the fundamental trend. Institution market buying commodity indexes only has distorted the upward move into hyperbole.  That makes it a difficult environment to navigate for both investments and trading. He is in favor of fine tuning regulations and not necessarily adding more regulation e.g. more bureaucracy and the attendant slowness of response time to anything.

Emerging Markets; Agricultural Commodities; Oil; Disappearing Homes; Social Networks

MWF (Wednesday) Briefing:

There is more pressure on agriculture commodities and gas due to flooding.  Proven business models get a boost and the housing bubble continues to deflate effecting much more than subprime.

• The Department of Agriculture stated half of the U.S.'s corn crop is in good or excellent condition this year due to floods in the midwest.  This will add more pressure on prices, including gas (ethanol).

• LinkedIn, the social network for business, is now valued at $1 billion. Bain Capital Ventures, Sequoia Capital, Greylock Partners and Bessemer Venture Partners announced they are taking a 5 percent stake for $53 million. LinkedIn 

• Housing crisis is still trickling up. In some parts of the U.S. foreclosed homes make up the majority of the sales.  SeekingAlpha

• An offshore drilling agreement in the South China Sea was reached between Japan and China.  President Bush is seeking to end the ban on offshore oil drilling.  NYT

• Inflation in Europe came in higher than expected at 3.7% level in May. Le Monde

Pop Goes Some Economic Bubbles. That & Inflation Aren't Necessarily a Bad Thing.

MWF (Friday) Briefing:

The G-8 will make an announcement next week to express concern over commodities being a challenge to the global economy.  Inflation is often the side product of growth, related to bubbles and innovation so it is a matter of trying to keep in check.  The dollar is coming back, though still quite weak against other major currencies.  That might not be all bad considering it makes American exports look like a deal.  The trade imbalance with China is still massive standing at $20 billion.  A lot of tough talking by fiscal types over this.  Asian markets took big losses, many of the indices down by half since Fall 2007.

• Economic bubbles, man's best friend.  Speculative fevers often emerge during times of major innovations and technological change. By definition, the impact of innovation is unpredictable. What will win out is impossible to predict. A bubble is capitalism's way of rapidly transforming an economy. Businessweek

• Asset allocation expert says go big on commodities exposure. Hard Assets

• The deal is officially dead. After first rebuff, Microsoft came back with a proposal to buy 16% of Yahoo at $35.  Yahoo then announced a search deal with Google that will add $250-$450 million per year to its bottom line WSJ  Wired or is it?

• Mass transit surge: Most riders since 1957. CNNMoney

• Consumer Price Index (CPI) rose .06% in May due to higher fuel and food costs. Department of Labor

• Gold ends the week with stiff losses as the dollar strengthens against major currencies lessening demand for precious metal as an inflation hedge.  Marketwatch

George Soros' Senate Commerce Committee Oversight Hearing on Oil Market Manipulation

Hearing on FTC Advanced Rulemaking on Oil Market Manipulation.  George Soros' Testimony before the U.S. Senate Commerce Committee Oversight

To summarize, Mr. Soros states the following in his transcript:

Soros is a keen student of bubbles [and has profited from them handsomely]. His ideas contradicts prevailing wisdom.  He states that he is not an expert in oil, but has his opinion.  With that...For bubbles in general, in regards to the oil market, there are four major factors at play and mutually reinforcing each other.

1.  Rising cost of discovery and development of reserves and increasing depletion of existing oil fields.

2. Backward-sloping supply curve. As the price of oil rises, oil-producers have less incentive to convert their oil reserves underground, which are expected to appreciate in value, into dollar reserves above ground, which are losing their value.  High price of oil has allowed political regimes, which are inefficient and hostile to the West, to maintain themselves in power, notably Iran, Venezuela and Russia. Oil production in these countries is declining.

3. Countries with the fastest growing demand, some major oil producers, and China and other Asian exporters, keep prices artificially low by providing subsidies. This creates demand inelasticity in those subsidized markets.

4. Trend-following speculation and institutional commodity index buying reinforce the upward pressure on prices. Commodities have become an asset class for institutional investors and they are increasing allocations to that asset class by following an index buying strategy. Spot prices have risen far above the marginal cost of production and far-out, forward contracts have risen faster than spot prices.

He finds commodity index buying similar to craze for the portfolio insurance that led to the stock market crash of 1987. Now as then, institutions are piling in on one side of the market and they have sufficient weight to unbalance it. If the trend were reversed and the institutions as a group exited as they did in 1987 there would be a crash.

Soros doesn't believe an oil market crash is imminent.  Only when a recession is well and truly in place is a decline in consumption in the developed world likely to outweigh his factors.  He'd like to discourage institutional investors pursuing a commodity index buying strategy is intellectually unsound and distinctly harmful in its economic consequences.  Though there is danger is this strategy, regulation of markets may have unintended, adverse consequences.

Possible remedies include:

Commodities should be disqualified as an asset class for ERISA institutions.

Various techniques for circumventing speculative position limits should be banned, provided the ban can be made to apply to unregulated as well as regulated markets.

Varying margin requirements and minimum reserve requirements are tools that ought to be used more actively to prevent asset bubbles from inflating. 

He would be hesitant of raising margin requirements and definitely wary of regulation of markets.

Ne Bubble: It's a Secular Bull Market in Commodities.

Regardless of all the recent rhetoric about a commodities bubble and the un-sustainability of oil prices, food and other utilitarian commodities will continue to see price appreciation. 

• Metals.  Utilitarian metals aluminum, platinum, and silver used in products and industrial processes should see continued growth. Growth for these metals should be steady due to structural shifts in the greening of the developed world and the increased dependence on electronics and technology for industry, business, and personal living. go to article

• Oil.  Soros is a keen student of bubbles [and has profited from them handsomely]. His ideas contradicts prevailing wisdom.  He states that he is not an expert in oil, but has his opinion.  With that, for bubbles in general, in regards to the oil market. Soros doesn't believe an oil market crash is imminent. Only when a recession is well and truly in place is a decline in consumption in the developed world likely to outweigh his factors. He'd like to discourage institutional investors pursuing a commodity index buying strategy is intellectually unsound and distinctly harmful in its economic consequences.  Though there is danger is this strategy, regulation of markets may have unintended, adverse consequences. go to article

• Agricultural commodities prices may  become more volatile, but since food stock levels are expected to remain low, and whole populations in emerging markets are shifting from agricultural to industrial to post industrial in one generation, demand for commodities becomes less responsive to price changes going up. go to emerging markets article

Secular Bull Market. World population is booming and emerging markets are shifting demand.  That effects the broad spectrum of commodities.  Unlike oil, there is demand inelasticity with many necessary commodities.