Australian (ASX) Stock Market Forum

Best Financial Quotes of 2007

Brian Wesbury is the foremost US inflation hawk.
********************

One on One with Brian Wesbury, Chief Economist at First Trust Advisors

Friday, August 17, 2007

SUSIE GHARIB: Joining us with more analysis, Brian Wesbury, chief economist at First Trust Advisors. Hi, Brian.

BRIAN WESBURY, CHIEF ECONOMIST, FIRST TRUST ADVISORS: Hi, Susie. Good to be with you.

GHARIB: Brian, do you think that the Fed action today is going to ease the credit crunch?

WESBURY: Yeah, I want to describe it as a helping hand, though, not a bailout. It seems to me that when I look at the markets, what we have is a lot of fear and fear is driven by a lot of leverage in the system, but underneath it all, there's very little problems in the market. Up through July, commercial paper had been growing at a 22 percent rate, commercial industrial loans are up an 11 percent rate. Even consumer credit is growing at a 5 to 6 percent rate. So there hasn't been a big credit crunch. What we're seeing is a lack of pricing for many mortgage bonds and a lot of hedge funds that are having serious problems because they leveraged themselves too much.

GHARIB: Do you think that there will be banks lining up to go to the discount window and get some cash?

WESBURY: Probably not. Even though the Fed said there is no stigma, there is and if you are seen going to the discount window, that's a sign you may be weak. In this kind of market especially with hedge funds out there, you're just opening yourself up for attacks. You know, what's interesting is that Countrywide went to the market yesterday, got $11 billion from a line of credit they had already established and the ratings agencies came out and said that that put them in pretty good stead for the next year or so. So it looks to me like there's plenty of credit available. All the Fed was doing was signaling that they're ready if things get worse.

GHARIB: Now some people were criticizing the Fed saying its action helped Wall Street, but not Main Street, in that it didn't address the underlying weakness in housing or the economy, people who are having trouble getting mortgages. What's your response to that?

WESBURY: I personally know many people who have gotten mortgages in just the past few weeks. The building in my community -- I live in the Chicago area -- continues. It's not as strong as it was. There's not as many houses selling as there was, but, clearly, the market has not frozen up. I keep hearing stories of this, but I just don't see it where I travel. And not only in my neighborhood, but also all over the country where I travel.

GHARIB: Well, that's not the sense that a lot of -- the feedback that we're getting from others and particularly the economists and there were surveys all over the place today, who were saying that they now expect the Fed to cut interest rates, to deal with business and the economy and the last couple of times you've been on our program, you have been saying that you think the Fed needs to raise interest rates and you're still standing by that forecast and tell us why.

WESBURY: Right. Well, let me just say this -- the Fed may cut interest rates. I think it would be a mistake to do that because then they would be forced to come back and raise them further, which would risk a recession down the road. In 1987, when the stock market crashed, everybody said we were going to have a recession. We didn't. The Fed cut rates and they were then forced to come back and raise interest rates too far and we ended up in a recession later. The same thing in 1998.

GHARIB: I know, but--

WESBURY: . to help long-term capital. I think today if they cut rates, they would actually be stoking inflation and causing problems down the road.

GHARIB: But, Brian, even the Fed in their statement today said the downside risk to growth has increased appreciably. So it sounds like even the Fed is posturing to cut rates.

WESBURY: What the Fed said was there's risks and they haven't cut rates yet and that's the thing. They could cut rates, Susie, there's no doubt about it. They could. I think that would be a mistake. Think about this. What is a rate cut going to do? It can't help anybody. You would have to drive interest rates all the way back down to 1 percent and then the sub-prime people could get a refinance at a very low interest rate which wouldn't last because the Fed would have to drive rates right back up again. We've had a situation where credit was too easy for too long and now we're paying the price and there's really nothing we can do except accept the losses and move through them and the Fed is trying to make that easier.

GHARIB: I wish we had more time to discuss this further. We'll have to get you back. Thanks a lot, Brian, for coming on the program.

WESBURY: Thanks, Susie.

GHARIB: My guest tonight, Brian Wesbury, chief economist at First Trust Advisors.

Source: www.pbs.org
 
In the words of one July 20 Melbourne Herald Sun: “There is no systemic risk from the broader subprime mortgage losses in the US. Our financial system won’t even blink. This is not even a million miles from being 1990 revisited.”
 
Tough love on Wall Street

As lenders hunt for bad loans, Pimco founder and Fortune columnist Bill Gross says the Street is learning hard lessons about disclosure.

By Bill Gross, Fortune
August 20 2007

Goodness knows, it's not a piece of cake for anyone over 40 these days to understand the maze of financial structures that now appears to be unwinding. They were created by youthful financial engineers trained to exploit cheap money and leverage, who showed no fear and who have, until the past few weeks, never known the sting of the market's lash.

They are wizards of complexity. I, however, having just turned 63, am a professor of simplicity. So forgive the perhaps unsophisticated explanation that follows of the way the subprime crisis swiftly crossed the borders of mortgage finance to infect global capital markets.

What Citigroup's Chuck Prince, the Fed's Ben Bernanke, Treasury Secretary Hank Paulson, and a host of other sophisticates should have known is that the bond and stock market problem is the same one puzzle players confront during a game of "Where's Waldo?" -- Waldo in this case being the bad loans and defaulting subprime paper of the U.S. mortgage market.

While market analysts can estimate how many Waldos might actually show their faces over the next few years -- $100 billion to $200 billion worth is a reasonable estimate -- no one really knows where they are hidden.

First believed to be confined to Bear Stearns's hedge funds and their proxies, Waldos have been popping up with regularity in seemingly staid institutions such as German and French banks, and that has necessitated state-sanctioned bailouts reminiscent of the Long-Term Capital Management crisis of 1998.

IKB, a German bank, and BNP Paribas, its French counterpart, encountered subprime meltdowns on either their own balance sheets or investment funds sponsored by them. Their combined assets total billions, although their Waldos are yet to be computed or even found.

Those looking for clues to the extent of the spreading fungus should understand that there really is no comprehensive data to allow anyone to know how many subprimes actually rest in individual institutional portfolios.

Regulators have been absent from the game, and information release has been left in the hands of individual institutions, some of which have compounded the uncertainty with comments about volatile market conditions unequaled during the lifetime of their careers.

Also many institutions, including pension funds and insurance companies, argue that accounting rules allow them to mark subprime derivatives at cost. Default exposure, therefore, can hibernate for many months before its true value is revealed to investors and, importantly, to other lenders.

The significance of proper disclosure is, in effect, the key to the current crisis.

Financial institutions lend trillions of dollars, euros, pounds, and yen to and among one another. In the U.S., for instance, the Fed lends to banks, which lend to prime brokers such as Goldman Sachs (Charts, Fortune 500) and Morgan Stanley (Charts, Fortune 500), which lend to hedge funds, and so on.

The food chain in this case is not one of predator feasting on prey, but a symbiotic credit extension, always for profit, but never without trust and belief that their money will be repaid upon contractual demand.

When no one really knows where and how many Waldos there are, the trust breaks down, and money is figuratively stuffed in Wall Street and London mattresses as opposed to extended into the increasingly desperate hands of hedge funds and similarly levered financial conduits.

These structures in turn are experiencing runs from depositors and lenders exposed to asset price declines of unexpected proportions.

In such an environment, markets become incredibly volatile as more and more financial institutions reach their risk limits at the same time. Waldo morphs and becomes a man with a thousand faces. All assets, with the exception of U.S. Treasuries, look suspiciously like one another. They're all Waldos now.

The past few weeks have exposed a giant crack in modern financial architecture, created by youthful wizards and endorsed for its diversity by central bankers present and past. While the newborn derivatives may hedge individual institutional and sector risk, they cannot eliminate the Waldos.

In fact, the inherent leverage that accompanies derivative creation may foster systemic risk when information is unavailable or delayed in its release. Nothing within the current marketplace allows for the hedging of liquidity risk, and that is the problem at the moment. Only the central banks can solve this puzzle, with their own liquidity infusions and perhaps a series of rate cuts.

The markets stand by with apprehension.
 
Financial markets need greater policy certainty - not lower interest rates
:::::::::::::::::::::::::::::

The Fed's Job
By BRIAN S. WESBURY
WSJ / August 20, 2007

Blaming monetary policy for economic and financial market turmoil is a time honored tradition. Maybe the most famous bashing was in 1896 when William Jennings Bryan, an original populist, ranted against hard money and for inflation: ". . . we shall answer their demands for a gold standard by saying to them, you shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold."

Monetary policy makes an easy scapegoat because printing money (like drinking a cup of coffee) is an easy way to give an economy a temporary boost. But if what ails the economy or markets was not caused by tight money in the first place, a temporary boost will not help. It may cover up the symptoms temporarily, but in the end it does not solve the underlying issue (a lack of sleep).

In fact, easy money always leads to greater problems down the road -- either rising inflation, or a reduced sensitivity to risk, as markets come to expect rate cuts to bail them out.

Lately, modern-day William Jennings Bryans have been loudly calling on the Fed to cut interest rates and inject cash into the banking system. They believe more money would stop financial markets from seizing up any further.

This would make sense if money was already tight -- or to put it another way, if a lack of liquidity was the real issue. But trades are clearing, banks are well capitalized, commercial and industrial loans are growing, credit-worthy borrowers are getting mortgages, and the economy is still expanding.

This was not the case after 9/11, when communication lines were cut to the Bank of New York, a key clearing house for bond trades. Then, liquidity injections were clearly needed. Trades failed and overdrafts mounted, forcing the Fed to inject hundreds of billions of dollars into the banking system.

In contrast, the current turmoil in the financial markets has nothing to do with a lack of liquidity. More importantly, there is little hope that any liquidity the Fed would inject into the banking system would actually get to the sectors of the market where only sporadic, fire-sale pricing of securities is taking place.

Some are arguing that a sharp decline in the three-month Treasury bill yield, to 3.85% from roughly 5% during the past few days, shows the need for a huge infusion of cash that would force the federal funds rate down. But the drop in T-bill yields is a reflection of three issues: a flight to quality, a guess that the Fed will lower rates at its next meeting and a very liquid market.

First, fear and panic has increased demand for rock-solid Treasury debt, driving prices up and yields down. Second, expectations of Fed rate cuts always push short-term rates down. But it's a circular argument to say falling short-term rates, due to an expectation of Fed rate cuts, is any reason to cut rates.

Finally, the liquidity already sloshing around in the banking system must go somewhere and right now it is going into the T-bill market. Low T-bill rates are a reflection of the liquidity already in the system, not a clarion call for more.

The real problem with the financial markets is that extreme leverage and extreme uncertainty have met in the subprime loan market. No one knows how many loans will go bad, who owns these mortgages and what leverage they have applied. We do know that subprime lending is just 9% of the $10.4 trillion dollar mortgage market, and delinquencies are running at about 18%. The Alt-A market is about 8% of all mortgages and about 5% of this debt is delinquent.

As an example, let's take a very low probability event and assume that losses triple from here. Let's assume that 54% of all subprime loans and 15% of all Alt-A loans actually move to foreclosure. Then, assume that lenders are able to recover 50% of the value of their loans. In this scenario, total losses in the subprime market would be 27%, while total losses in Alt-A would be 7.5%.

From this we can estimate a price for the securitized pools of these assets. Without doing any actual adjustment for yields, or for different tranches of this debt, the raw value of the underlying assets would be 73 cents on the dollar for subprime pools and 92.5 cents for the Alt-A pools. Getting a bid on this stuff should be easy, right? After all, the market prices risky assets every day.

But this is the rub. A hedge fund, or financial institution, that uses leverage of 4:1 or more, would be wiped out if it sold subprime bonds at those levels. A 27% loss on Main Street turns into a 100% loss on Wall Street very easily. But because hedge funds can slow down redemptions, at least for awhile, and because they are trying desperately not to implode, they hold back from the market. At the same time, those with cash smell blood in the water, patiently wait, and put low-ball bids on risky bonds. The result: No market clearing price in the leveraged, asset-backed marketplace.

Additional Fed liquidity can't fix this problem. An old phrase from the 1970s comes to mind -- "pushing on a string." In the 1970s, no matter how much money the Fed pushed into the system, it could not create a sustainable economic recovery that did not include a surge in inflation because high tax rates and significant government interference in the economy prevented true gains in productivity.

There is a lesson here. Populism is in the air these days, and the threat from tax hikes, trade protectionism and more government involvement in the economy, is rising. This reduces the desire to take risk. Congress is working on a legislative response to current mortgage market woes as well. And as with the savings and loan industry (forcing S&Ls to sell junk bonds at fire-sale prices), and Sarbanes-Oxley, the legislative response almost always compounds the problems.

The interaction of an uncertain regulatory and tax environment with a highly leveraged, illiquid market for risky mortgage debt creates conditions that look just like an economy-wide liquidity crisis. But it's not. A few rate cuts will not help.

What can help is more certainty. Tax cuts, or at least a promise not to raise taxes, and immunity -- or at least a safe harbor from criminal prosecution for above-board institutions in the mortgage business -- could help loosen up a rigid market in a more permanent way than sending out the helicopters to dump cash in the marketplace.

The best the Fed can do is to stand at the ready to contain the damage. In this vein, their decision to cut the discount rate and allow a broad list of assets to be used as collateral for loans to banks, was a brilliant maneuver. It increases confidence that the Fed has liquidity at the ready, but does not create more inflationary pressures. It was a helping hand, not a bailout.

It also buys some time, which is what the markets need. Every additional month of payment information on mortgage pools, and every mortgage that is refinanced from an adjustable rate to a fixed rate, will increase certainty and provide more clarity on pricing.

Even though many, including Alan Greenspan, continue to argue that the excessively easy monetary policy of 2001-2004 was necessary, it was this policy stance that caused the problems we face today. The current financial market stress is a result of absurdly low interest rates in the past, not high interest rates today. In fact, current interest rates are still low on both a nominal and real basis. Cutting them again causes a further misallocation of resources, and makes the Fed an enabler of the highly leveraged.

What William Jennings Bryan was really complaining about in 1896 was falling commodity prices, especially falling farm prices. What he and the other populists ignored was that these prices were falling because of productivity, not tight money. His "Cross of Gold" speech was a clear stepping stone to the creation of the Fed in 1913. Since then, inflation has been much higher than it would have been under the gold standard. But all that inflation never did save the family farm.

Similarly, even very easy money today can't put off the day of reckoning for subprime mortgage holders who bought homes with no money down and thought interest rates would stay low forever. It can't help overly leveraged investors who thought they were getting risk-free 20% annual returns. Providing enough liquidity to allow markets to function, while keeping consumer prices as stable as possible, is the best the Fed can do. It should be all we really ask.

Mr. Wesbury is chief economist for First Trust Portfolios, L.P.
 
Fed's Lacker Remains Hawkish

Richmond[USA] Fed President Jeffrey Lacker said "Financial market volatility . . . does not require" a fed funds rate cut. He added, "Policy must be guided by the outlook for real spending and inflation." Lacker has been the Fed's most hawkish official.

Source: IBD, 21 August
 
The Economist on global credit crunch
:::::::::::::::::::::::::::::::::::::::::

The world economy

Rocky terrain ahead

Aug 30th 2007 | WASHINGTON, DC
From The Economist print edition

How much will the credit crunch hurt the world economy?

THE Teton mountains jut suddenly and majestically out of the Wyoming plains near Jackson Hole. The central bankers and economists gathering there the symposium of the Federal Reserve Bank of Kansas City, an annual meeting of the macroeconomic elite that start on Thursday August 30th face a similarly breathtaking, if less beautiful, change in the global financial topography. In less time than it takes to get a good compass bearing, cheap credit and stable markets have given way to investor panic and a credit crunch.

So far the central bankers have concentrated on stemming panic by flooding financial markets with short-term liquidity and, in the case of the Federal Reserve, by loosening the rules for, and price of, banks’ borrowing from the discount window. These efforts helped stabilise the money markets last week. But many debt products, particularly asset-backed instruments, remain paralysed. Yields on ten-year Treasury bills dropped to 4.52% on August 28th while stockmarkets fell sharply, though shares bounced back the following day. Wholesale panic could quickly return.

Even if that unhappy outcome is avoided, there is much to worry about. Top of the list is gauging what effect the recent turmoil will have on the world economy.

Common sense suggests the biggest impact will be felt in America, home both to the subprime mess and the worst financial dislocations. At first sight, the economy hit the August turmoil in fine fettle. Output growth in the second quarter was strong; business spending looked perky; wage growth was solid and high petrol prices (which had dragged down consumer spending) were falling.

On closer inspection, however, the picture was less rosy. Output boomed in the second quarter thanks partly to one-off factors, such as the rebuilding of firms’ stocks. Consumption growth slowed sharply over the same period, and some areas of consumer spending stayed weak into the summer. Car sales, for instance, fell to a nine-year low in July.

Most important, the economy’s weakest link””the housing market””was in even worse shape than many realised. The pace of new-home construction plunged in July while the backlog of existing unsold houses rose to a 16-year high. House prices have kept falling.

A still-deepening housing bust left the economy vulnerable well before August’s crunch. And that crunch has made the prospects for housing much worse as mortgage instruments have disappeared, or become dramatically more expensive.

Not surprisingly, Wall Street’s seers are chalking down their projections for construction and house prices. A construction bust will continue to drag down output growth. The bigger question is what effect double-digit house-price declines would have in a country where consumer debts have soared on the back of housing wealth. Optimists take comfort from consumers’ resilience so far. That may be a mistake. Consumer spending will be crimped as homeowners feel poorer, particularly if stockmarkets continue to slide.

Most Wall Street analysts are convinced that the damage from financial distress will be limited because they expect the Fed to ride to the rescue with lower interest rates. But the bottom line seems clear. If America faces double-digit falls in house prices, the economy, despite looser monetary policy, looks set to be weak.

The impact on the rest of the world, too, may be severe. Many expect the global economy to be robust enough to shake off American weakness. Such optimism may underplay the potential channels through which the subprime mess can infect other countries. One route is financial contagion. Subprime losses are popping up from Canada to China. The broad spread of losses makes them easier to digest, but also spreads financial nervousness and risk aversion.

That risk aversion may find surprising victims. In previous financial wobbles, emerging markets often suffered most. This time rich countries, particularly in continental Europe, where some banks have been caught out by the subprime mess, may be more worried. Thanks to fat foreign-exchange reserves and current-account surpluses, many emerging economies are well placed to withstand an exodus of investors.

Even if direct financial contagion is contained, America’s subprime crisis could spawn psychological contagion, particularly a reassessment of house prices. Although the scale of reckless lending to risky borrowers was bigger in America than anywhere else, house-price inflation has been more extreme elsewhere. Countries such as Britain and Spain are particularly vulnerable to a house-price bust.

Nor should the world economy’s resilience to American weakness be exaggerated. Although America’s current-account deficit has been declining, it is still almost 6% of GDP. By spending more than they produce, Americans are still a big source of demand for the rest of the world. A sharp drop in that demand would hurt.

The severity of mountainous terrain becomes clearer as you start climbing. So, too, the economic effects of the credit crunch will become more apparent over time. But as they mull over the challenges they face, the Jackson Hole attendees might take a good look at the Tetons.
 
Australia says: Mary Ann you are n °1 !
:::::::::::::::::::::::::::::::::::::

One on One with Mary Ann Bartels, Chief U.S. Market Analyst at Merrill Lynch
Source: PBS/NBR/USA; Tuesday, September 04, 2007

SUSIE GHARIB: Despite today's rally, our guest tonight warns investors that September will be a volatile month and that the stock market could go down another 5 to 10 percent from where it's now trading. Joining us to explain, Mary Ann Bartels, chief U.S. market analyst at Merrill Lynch. Hi, Mary Ann. Nice to see you.

MARY ANN BARTELS, CHIEF US MARKET STRATEGIST, MERRILL LYNCH: Hi, Susie, same here.

GHARIB: The markets have already had a pretty serious correction this summer. Tell us why you think that there's more of a correction ahead.

BARTELS: Well, in our report, we say the V bottoms are rare, Ws are more of the norm meaning that you normally get a retest of a correction. So I'm looking for another retest of the low that we had.

GHARIB: All right. And tell us why.

BARTELS: Well, what we're seeing in our technical indicators is with the rally that we had off the low, we're starting to move into overbought territory. And we're starting to come into what we call resistance. And having that combination is starting to give us a sense that we're running out of time on this rally. So I think there's a high probability with the seasonal patterns of September -- and what I mean by that is September is what we call the rogue month of the year. It's actually the worst performing month of the year. On average over the past 25 years, the market has corrected around 1 percent. So I think we're setting up for a little bit of a continuation of the rally. Test some of these highs and then go back down and test the lows. That would indicate we could still have another 5 or 10 percent correction ahead.

GHARIB: So what's your timetable once those lows have been tested and it rebounds back up, what's the timetable on that?

BARTELS: Well, I think September is going to be the roughest month. We normally make very important lows in the month of October. Although the headlines tend to be very risky or sound very risky in October, we normally get excellent buying opportunities in the month of October. So I'm really waiting to get through this month of September. I think we're going to have more volatility and then look for an important low in October to set us up for a really nice rally going into year end.

GHARIB: All right, so a rally. You are a long-term bull. Tell us what sectors will be the leaders in that bull market.

BARTELS: We're still strong believers that this is a commodity led bull market. That positively impacts the energy sector, the materials or what's also known as basic resources and the industrial stocks. [This is the music Australia likes]

GHARIB: And what areas do you think will be weak during this bull market?

BARTELS: Well, consumer staple stocks and health care have underperformed and I still think they'll be underperformers. But during this market volatility, if investors are looking to invest in the markets and looking for lower volatility opportunities, those would be the sectors that we would go into right now. But I think for the long term, I think you're going to get better performance from the sectors, the energy, the industrial and materials.

GHARIB: And what about international stocks? They have been outperforming U.S. stocks, at least over the last couple of months. What's your outlook in that area?

BARTELS: We've been long-term believers that non-U.S. markets will outperform the U.S. They have for several years. We think there's another at least two years of ability for overseas markets to outperform the U.S. So we do think that there's good opportunities overseas.

GHARIB: So Mary Ann, what's your advice to investors? If it's a good time, if you have money on the side, is this a good time to put new money into the markets?

BARTELS: Well, obviously I'm looking for a better entry point in October, but it's always very difficult to time the markets. I think investors that have a much longer term view, I think we're set up for a major bull market where we can continue to reach new highs into 2009.

GHARIB: All right. That's a good place to leave it. Thank you so much, Mary Ann.

BARTELS: Thank you, Susie.

GHARIB: My guest tonight, Mary Ann Bartels, chief U.S. market analyst at Merrill Lynch.
 
Drill's Must Read
::::::::::::::::::::

Credit turmoil ‘has hallmarks of bank run’
By Krishna Guha in Jackson Hole, USA
Financial Times /// September 2, 2007

The current turmoil in the financial markets has all the characteristics of a classic banking crisis, but one that is taking place outside the traditional banking sector, Axel Weber, president of the Bundesbank, said at the weekend.

“What we are seeing is basically what we see underlying all banking crises,” said Mr Weber, one of the most influential members of the governing council of the European Central Bank.

The comments mark the first time that a top central banker has endorsed the notion that the non-bank financial system is seeing an old-style bank run.

Some Federal Reserve policymakers also privately see comparisons between the current distress in credit markets and the bank runs of the 19th century, in which savers lost confidence in banks and demanded their money back, creating a spiralling liquidity crisis for institutions that had invested this money in longer-term assets.

That scenario ultimately led to the creation of the US Federal Reserve and other central banks as lenders of last resort for the banking system.

The Bundesbank president said that the market had completely over-reacted to the credit losses in the US subprime mortgage sector.

“What we are seeing at the moment is a total overreaction,” he said. “There is no overall problem in terms of solvency – it is one of liquidity.” He said the challenge for central banks – which cannot supply liquidity directly to the non-bank sector – was to help banks absorb the influx of assets onto their balance sheets.

However, the tools that modern central banks possess to address liquidity problems can only directly address such runs inside the traditional banking sector, and do not directly touch the non-bank financial sector, which has been hardest hit by the current credit crisis.

Mr Weber’s analysis highlights the dilemma facing central banks, which cannot channel funds directly to the non-bank financial sector, and may therefore have to resort to easing monetary policy instead. The ECB is due to set its key interest rate on Thursday and the Federal Reserve on September 18.

Mr Weber told fellow central bankers and economists at the Federal Reserve’s Jackson Hole symposium that the only difference between a classic banking crisis and the turmoil under way in the markets is that the institutions most affected at the moment are conduits and investment vehicles raising funds in the commercial bond market, rather than regulated banks.

These entities were inherently vulnerable to a sudden loss of confidence on the part of their funders because “there is a maturity mismatch” on the part of financial institutions that have invested in long term mortgage-backed or asset-backed securities using short-term finance.

“Most of the conduits are owned by the banks,” he said. In many cases, sponsoring banks are being forced to take risky assets back onto their balance sheets, in turn causing banks to keep hold of their own cash, putting pressure on short-term money markets, he argued.

His comments came as Frederic Mishkin, a Fed governor, argued for a rapid and aggressive monetary policy response to any fall in house prices.

His diagnosis of the financial crisis was echoed by other experts.

James Hamilton, a professor at the University of California, warned that – as in old-fashioned bank runs – sudden demand for liquidity can lead to a firesale of assets that depresses their price, making otherwise solvent institutions insolvent.

Paul McCulley, managing director of Pimco, said there was a “run on the shadow banking system”. He said the shadow banking system held $1,300bn of assets that now had to be put back onto the balance sheets of the banks.

The issue, he aid, is “how it is done and at what price”.
 
Drill's Must Read

Rogoff foresees interest rate cuts by the FED
::::::::::::::::::::::::::::::::

The Fed vs. the Financiers
Kenneth Rogoff

In his August 31 address to the world’s most influential annual monetary policy conference in Jackson Hole, Wyoming, United States Federal Reserve Chairman Ben Bernanke coolly explained why the Fed is determined to resist pressure to stabilize swooning equity and housing prices. Bernanke’s principled position – echoed by European Central Bank head Jean Claude Trichet and Bank of England head Mervyn King – has set off a storm in markets, accustomed to the attentive pampering lavished on them by Bernanke’s predecessor, Alan Greenspan.

This is certainly high-stakes poker, with huge sums hanging in the balance in the $170 trillion global financial market. Investors, who viewed Greenspan as a warm security blanket, now lavish him with fat six-figure speaking fees. But who is right, Bernanke or Greenspan? Central bankers or markets?

A bit of intellectual history is helpful in putting today’s debate in context. Bernanke, who took over at the Fed in 2006, launched his policy career in 1999 with a brilliant paper presented to the same Jackson Hole conference. As an academic, Bernanke argued that central banks should be wary of second-guessing massive global securities markets. They should ignore fluctuations in equity and housing prices, unless there is clear and compelling evidence of dangerous feedback into output and inflation.

Greenspan listened patiently and quietly to Bernanke’s logic. But Greenspan’s memoirs, to be published later this month, will no doubt strongly defend his famous decisions to bail out financial markets with sharp interest rate cuts in 1987, 1998, and 2001, arguing that the world might have fallen apart otherwise.

On the surface, Bernanke’s view seems intellectually unassailable. Central bankers cannot explain equity or housing prices and their movements any better than investors can. And Bernanke knows as well as anyone that none of the vast academic literature suggests a large role for asset prices in setting monetary policy, except in the face of extraordinary shocks that influence output and inflation, such as the Great Depression of the 1930’s.

In short, no central banker can be the Oracle of Delphi. Indeed, many academic economists believe that central bankers could perfectly well be replaced with a computer programmed to implement a simple rule that adjusts interest rates mechanically in response to output and inflation.

But, while Bernanke’s view is theoretically rigorous, reality is not. One problem is that academic models assume that central banks actually know what output and inflation are in real time. In fact, central banks typically only have very fuzzy measures. Just a month ago, for example, the US statistical authorities significantly downgraded their estimate of national output for 2004!

The problem is worse in most other countries. Brazil, for example, uses visits to doctors to measure health-sector output, regardless of what happens to the patient. China’s statistical agency is still mired in communist input-output accounting.

Even inflation can be very hard to measure precisely. What can price stability possibly mean in an era when new goods and services are constantly being introduced, and at a faster rate than ever before? US statisticians have tried to “fix” the consumer price index to account for new products, but many experts believe that measured US inflation is still at least one percentage point too high, and the margin of error can be more volatile than conventional CPI inflation itself.

So, while monetary policy can in theory be automated, as computer programmers say, “garbage in, garbage out.” Stock and housing prices may be volatile, but the data are much cleaner and timelier than anything available for output and inflation. This is why central bankers must think about the information embedded in asset prices.

In fact, this summer’s asset price correction reinforced a view many of us already had that the US economy was slowing, led by sagging productivity and a deteriorating housing market. I foresee a series of interest rate cuts by the Fed, which should not be viewed as a concession to asset markets, but rather as recognition that the real economy needs help.

In a sense, a central bank’s relationship with asset markets is like that of a man who claims he is going to the ballet to make himself happy, not to make his wife happy. But then he sheepishly adds that if his wife is not happy, he cannot be happy. Perhaps Bernanke will soon come to feel the same way, now that his honeymoon as Fed chairman is over.


Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University, and was formerly chief economist at the IMF.
Source: Project Syndicate, September 2007
 
Drill's Must Read
Brian Wesbury is a top US inflation hawk
::::::::::::::::::::::::::::

Unnecessary Rate Cut...On Its Way? To view this article, Click Here
Brian S. Wesbury - Chief Economist / First Trust Advisors
Robert Stein, CFA - Senior Economist
Date: 9/10/2007

Unnecessary Rate Cut…On Its Way?

Our view is that any Fed rate cut would be a mistake. Nonetheless, a weaker-than-expected August jobs report, pressure from politicians, panicky comments from former Fed officials, and howls of protest from Wall Street, have pushed the Fed into a corner. As a result, the probability of a rate cut, at or before the next FOMC meeting on 9/18, is above 50%. And we believe that if the Fed does cut rates it will do so by a total of 50 basis points before the end of 2007.

In such a short column we cannot deal with every argument being made for a rate cut, so we will deal with just three.

1) – Some say the Fed is just too tight, while others have gone as far as comparing today to the late 1920s – when the Fed ignored signs of deflation and tightened monetary policy anyway, causing the Great Depression.

These concerns are over-the-top hyperbole. Between 1926 and 1929, the Consumer Price Index was declining by an average of 1.1% per year. Gold prices were fixed, but silver prices plummeted. In other words, there were clear signs of deflation in the late 1920s, but the Fed lifted the federal funds rate to 6% anyway, making its biggest mistake ever.

Today is different. Gold and silver prices have surged in the past six years and are pressing higher, consumer prices are climbing in the 2% to 3% range, and the dollar is weak.

The real (or inflation-adjusted) federal funds rate is low relative to any historical pre-recession period regardless of what inflation rate one uses to calculate the real funds rate – the CPI, the “core” CPI, the PCE deflator, or the “core” PCE deflator. Any similarity between today and the Depression are figments of an overactive imagination.

2) – Some argue that during the past 50 years, every time the US housing market has contracted like it has in the past year it translated into an economy-wide recession.

This idea that housing slumps trigger recessions is a confusion between cause and correlation. Every recession since 1913 (the year the Fed was created) has been accompanied by tight money. And because housing is a big-ticket, interest-rate-sensitive, industry, it has almost always reacted early to tight money. It falls first, before the economy as a whole. But this does not mean housing caused the recession. Tight money did.

Both short-term and long-term interest rates, even rates on jumbo mortgage loans (yes, they are still available), are lower today than they were in the late 1990s – when things were so good many called it a bubble (a false boom).

Today’s problems were created because interest rates were artificially low between 2001 and 2004, not because rates are currently too high. The Fed is not tight, its just less loose.

3) – Finally, the credit market is seizing up, and the Fed must cut rates to make it work again.

But loans are available to credit worthy borrowers, corporate profits are still sky-high and the world is awash in liquidity. Risk spreads have widened but remain well within historical ranges. Credit problems are only visible in the highly-leveraged, asset-backed marketplace – a market that was not pricing risk correctly and got itself into trouble because it expected interest rates to stay at absurdly low levels forever.

The bottom-line is that if the Fed eases, it will do so when it is not tight. It will reverse course at the lowest real federal funds rate for any reversal since the mid-1970s. This is dangerous because it will “lock-in” the inflationary pressures it already created. That is what $700 gold, $76 oil and a $1.38/euro exchange rate are saying. An aggressive Fed easing will push commodity prices even higher and the dollar lower.

Most fearful is that leading voices in the political and financial world are so willing to think that Fed policy can save the world. The probability of tax hikes, massive government involvement in the healthcare system and rising regulation against “global warming” are real threats to prosperity. No matter how much money the Fed prints, it can’t offset damage from too much government interference. It’s not a repeat of the Depression we should fear; it’s a repeat of the 1970s.
 
The Malaysian miracle
By Joseph Stiglitz
[2001 Nobel Prize in economics]
September 13, 2007

http://commentisfree.guardian.co.uk/joseph_stiglitz/2007/09/the_malaysian_miracle.html

August 31 marked the 50th anniversary of Malaysia's Merdeka: independence after more than 400 years of colonialism. Malaysia's peaceful, non-violent struggle may not have received the attention that Mahatma Gandhi's did in India, but what Malaysia has accomplished since then is impressive - and has much to teach the world, both about economics, and about how to construct a vibrant multiracial, multi-ethnic, multicultural society.

The numbers themselves say a lot. At independence, Malaysia was one of the poorest countries in the world. Though reliable data are hard to come by, its GDP (in purchasing power parity terms) was comparable to that of Haiti, Honduras, and Egypt, and some 5% below that of Ghana. Today, Malaysia's income is 7.8 times that of Ghana, more than five times that of Honduras, and more than 2.5 times that of Egypt. In the global growth league tables, Malaysia is in the top tier, along with China, Taiwan, South Korea, and Thailand.

Moreover, the benefits of the growth have been shared. Hard-core poverty is set to be eliminated by 2010, with the overall poverty rate falling to 2.8%. Malaysia has succeeded in markedly reducing the income divides that separated various ethnic groups, not by bringing the top down, but by bringing the bottom up.

Part of the country's success in reducing poverty reflects strong job creation (pdf). While unemployment is a problem in most of the world, Malaysia has been importing labour. In the 50 years since independence, 7.24 million jobs have been created, an increase of 261%, which would be equivalent to the creation of 105 million jobs in the United States.

There were many reasons not to have expected Malaysia to be a success. Just as Malaysia was gaining its independence, the Nobel prize winning economist Gunnar Myrdal wrote an influential book called Asian Drama, in which he predicted a bleak future for the region.

Malaysia is rich in natural resources. But, with few exceptions, such countries are afflicted with the so-called "natural resource curse": countries with an abundance of resources not only do not do as well as expected, but actually do worse than countries without such benefits. While natural resource wealth should make it easier to create a more equalitarian society, countries with more resources, on average, are marked by greater inequality.

Moreover, Malaysia's multiracial, multicultural society made it more vulnerable to civil strife, which has occurred in many other resource-rich countries, as one group tried to seize the wealth for itself. In many cases, minorities work hard to garner the fruits of this wealth for themselves, at the expense of the majority - Bolivia, one of the many rich countries with poor people, comes to mind.

At independence, Malaysia also faced a communist insurgency. The "hearts and minds" of those in the countryside had to be won, and that meant bringing economic benefits and minimising "collateral" damage to innocent civilians - an important lesson for the Bush administration in Iraq, if it would only listen to someone outside its closed circle.

And Malaysia had a third strike against it: for all the talk of the "white man's burden", the European powers did little to improve living standards in the countries they ruled. The dramatic decline in India's share of global GDP under Britain's rule, as Britain passed trade laws designed to benefit its textile producers at the expense of those in its colony, is the most visible example.

The colonial powers' divide-and-rule tactics enabled small populations in Europe to rule large numbers outside of Europe, pillaging natural resources while investing little in the physical, human capital, and social capital necessary for an economically successful, democratic self-governing society. It has taken many of the former colonies decades to overcome this legacy.

How, then, does an economist account for Malaysia's success? Economically, Malaysia learned from its neighbours. Too many of the ex-colonies, rejecting their colonial heritage, turned to Russia and communism. Malaysia wisely took an alternative course, looking instead to the highly successful countries of east Asia. It invested in education and technology, pushed a high savings rate, enacted a strong and effective affirmative action programme, and adopted sound macroeconomic policies.

Malaysia also recognised that success required an active role for government. It eschewed ideology, following or rejecting outsiders' advice on a pragmatic basis. Most tellingly, during the financial crisis of 1997, it did not adopt IMF policies - and as a result had the shortest and shallowest downturn of any of the afflicted countries. When it re-emerged, it was not burdened with debt and bankrupt firms like so many of its neighbours.

This success was, of course, not only a matter of economics: had Malaysia followed the policies recommended by the IMF, it would have torn apart the social fabric created over the preceding four decades.

Malaysia's success thus should be studied both by those looking for economic prosperity and those seeking to understand how our world can live together, not just with toleration, but also with respect, sharing their common humanity and working together to achieve common goals.

In cooperation with Project Syndicate, 2007.
 
The Banker Looks Back
By JAMES GRANT
Wall Street Journal / September 18, 2007

At one point during his long interview on "60 Minutes" Sunday evening, Alan Greenspan could be seen autographing dollar bills for his smiling fans. Meanwhile, off camera, unautographed greenbacks continue to depreciate against a variety of metals and foreign currencies. A century ago the pound sterling anticipated the dollar's role today as the pre-eminent global monetary brand. But the pound was exchangeable into gold at the bearer's demand. Not since 1971 has the dollar been collateralized by gold or exchangeable at the U.S. Treasury into anything except nickels, dimes and quarters.

Sooner or later, the dollar will lose its luster and finally its value, as paper currencies always do. Striving to understand why people trusted it in the first place, historians will naturally reach for the memoirs of the foremost central banker of his day. But Mr. Greenspan's "The Age of Turbulence" will leave them just as confused as they ever were.

The first reports of the book's contents trumpeted Mr. Greenspan's criticism of the current administration's spending habits and his (approving) sense that the Iraq war had something to do with crude oil. But the real news in "The Age of Turbulence" is what it reveals about the greenbacks to which Mr. Greenspan affixed his celebrity signature and the ways in which the currency has been managed and, especially, mismanaged.

A more self-knowing memoirist might have titled this book "The Age of Credulity." The great public drama of Mr. Greenspan's life is, of course, the work he performed as chairman of the Federal Reserve from 1987 to 2006. That work, in all but name, was price fixing. It consisted (and, under his successor, Ben S. Bernanke, still consists) of setting an interest rate and shoving it down the throat of the world's largest economy. It is a mighty strange work for a "libertarian Republican," as the Maestro styles himself here, let alone a former worshipful member of the inner circle of the radical individualist Ayn Rand. "It did not go without notice," the author writes of his swearing-in as chairman of the President's Council of Economic Advisers in 1974, "that Ayn Rand stood beside me as I took the oath of office in the presence of President Ford in the Oval Office."

The fantastic irony of Mr. Greenspan's career path -- from gold-standard libertarian to federal interest-rate fixer -- seems hardly to have registered on Mr. Greenspan himself. The closest he comes to acknowledging it is his description of how the Fed looked to him from the outside. It was, he writes, a "black box." Having watched his mentor, Arthur Burns, struggle with the chairmanship, Mr. Greenspan notes, "it did not seem like a job I felt equipped to do; setting interest rates for an entire economy seemed to involve so much more than I knew." A deeper kind of libertarian might have added: "Maybe nobody can know enough to set interest rates for an entire economy."

So Mr. Greenspan, a consulting economist of no special attainments (on the eve of the 1974 stock-market collapse, he was quoted in the New York Times saying "it is rare that you can be as unqualifiedly bullish as you can now"), agreed to perform the impossible. Succeeding Paul A. Volcker, he became America's monetary central-planner-in-all-but-name. Mr. Greenspan ruled the roost in 74 fiscal quarters, of which recession darkened only five.

Under his direction, the Fed became a kind of first responder to the scene of financial and economic distress. It soothed taut nerves following the 1987 stock-market break, nourished a crisis-ridden banking system with cheap money in 1990-92, helped to lead the Clinton administration's rescue of the Mexican economy in 1994-95 and engineered the so-called soft landing of the U.S. economy, also in 1995. It famously trimmed its interest rate three times during the Long-Term Capital Management crisis of 1998, succeeding so well in one artfully timed intervention that the stock market, in the final hour of a single session, leapt by 7%. And the market kept right on leaping, all the way to the Nasdaq's own Mount Everest in March 2000. One of those rare recessions followed, after which came the campaign to scotch what Mr. Greenspan was pleased to call "deflation." To fend off the peril of low and lower everyday prices, the Fed pressed its interest rate all the way down to 1% in 2003 and kept it there until mid-2004. Now it was house prices that went into orbit. They were just beginning to return to Earth when Mr. Greenspan retired from public life.

Readers who got one of the fancy new teaser-rate mortgages in 2003 or 2004, and who have lived to rue the day, are unlikely to find much nourishment in Mr. Greenspan's discussion of the theory of financial bubbles or in his self-exculpating account of the Fed's role in financing them with artificially low interest rates. Nobody can identify a bubble as it is inflating, Mr. Greenspan has long insisted -- though, as you will not read in these pages, Mr. Greenspan was so certain that he detected a stock-market bubble in 1994 that he tried to prick it by pushing interest rates up. Strangely, the author's bubble-sensor failed him later in the decade. He did, in 1997, utter the innocuous phrase "irrational exuberance," but that was as far as he went in attacking sky-high equity valuations.

Mr. Greenspan now writes that the enlightened central banker will let speculation take its course. Following the inevitable blow-up, he will clean up the mess with low interest rates and lots of freshly printed dollar bills -- thereby gassing up a new bubble.

Only one of the troubles with this prescription is that it requires an enlightened central banker to carry it out. Nowhere in this book does Mr. Greenspan own up to his role of underestimating the severity of the credit troubles of 1990, or of cheering on the tech-stock frenzy in 1998-2000, or of dangling the most beguiling teaser rate of all during the mortgage frolics of 2004 -- i.e., that 1% federal-funds rate. In February 2004, only months before the Fed started to raise its rate, in a speech titled "Understanding Household Debt Obligations," Mr. Greenspan demonstrated next to no understanding. His advice to American homeowners was not that they lock in a fixed-rate mortgage while the locking was good, but rather that they consider an adjustable-rate model. He who set the rates got it backward.

An only child of divorced parents growing up in New York City in the 1930s, Mr. Greenspan had seemed destined for better things than a career in interest-rate manipulation. He was an exceptional clarinetist, a Morse code enthusiast and the developer of a personal system for scoring baseball games. The boy who would date Barbara Walters, marry NBC's Andrea Mitchell and be knighted by the queen of England was, above all things, lucky. In 1944, a dark spot on the X-ray of his lung made him undraftable. He spent the late war years in the reed section of the Henry Jerome orchestra. Luck still with him, he gravitated to economics, thence to Ayn Rand and thence -- what could Rand have thought? -- to the security of the federal payroll.

Admirers or detractors of Mr. Greenspan's central banking record will turn the pages of the first half of this book -- the story of his life, his loves and his economics -- without once having to stifle a yawn. But few will remain alert while toiling through the public-policy ruminations that pad out the final 200 pages. As Fed chairman, Mr. Greenspan had a habit of inflicting on captive audiences his not always original views on such topics as rural electrification, education in a global economy and the bright promise of technology. Such ponderations are no more scintillating now that he is out of office.

"As Fed chairman," Mr. Greenspan writes, "I was queried by fellow central bankers with large holdings of U.S. dollars about whether dollars were safe investments." The monetary bureaucrats will find no reassurance in these all-too-many pages.

Mr. Grant is the editor of Grant's Interest Rate Observer.
 
The Top Ten Professional Business And Financial Bloggers

By 24/7 Wall St.
Oct 25, 2007

24/7 Wall St. has done a ranking of the Top 25 Financial Blogs for two years in a row. But, this list excluded bloggers who were full-time paid employees of media companies that host and promote their own blogs. So, we decided to look at blogs at the top twenty newspaper websites around the country, major business magazine websites, and large financial websites. Since many of these web properties have several bloggers, we looked at well over 100 blogs.
As we reviewed these, we ruled out bloggers who cover subjects like the home office, business travel, and environmental topics. The goal was to draw from a list of people who write on business, finance, tech, and the economy.
Here is out list of the Top Ten Professional Business and Financial Bloggers, in no special order:

David Gaffen, MarketBeat, The Wall Street Journal. We don't know this for a fact, but MarketBeat must be one of the reasons that readers return to WSJ.com throughout the day. The blog is timely. It covers a wide variety of topics. It has wit. And, Gaffen is liberal with links to smaller blogs. No one following Wall St. should miss this blog.

Eric Savitz, Tech Trader Daily. Barron's. Those interested in technology stocks and industry trends need to check this blog several times a day. Savitz not only has a deep knowledge of the subject, he must get research reports from several hundred tech analysts. No critical piece of analysis gets missed. He also blogs from major industry conferences.

Herb Greenberg, MarketBlog, MarketWatch. Investigative pieces. Sharp looks at earnings. CEO beatings, at least from time-to-time. Almost always takes the other side of conventional wisdom.

Michael Flaherty. DealZone, Reuters. Looks inside the Wall St. deal culture worldwide. Often provocative. Excellent sources. Sometimes a bit nasty, but there's nothing wrong with that.

Zubin Jelveh, Odd Numbers. Portfolio. Covers economics. Good global perspective. Wit. Broad intelligence. He looks at the economics of everything from the last World War to basketball salaries to IRS penalties. Brilliant.

Paul R. La Monica, Media Biz, CNNMoney. Old media. New media. This blog covers all of the major companies in these industries. Google. Comcast. The works. He has a finger on trends that most writers miss. As well-researched as any writing on these topics. Has the eye of securities analyst's.

Bruce Einhorn, Eye On Asia, BusinessWeek. It's hard to get good picture of what is going on in the business community and the big companies in Asia. Part of it is the vastness of the region, and part is the number of cultures. This kind of reporting and analysis is simply not available anywhere else.

Mathew Ingram, Technology Blog. Globe and Mail. This blogger switch hits. He has his own blog and writes for this Canadian newspaper. Unusually keen insights covering the world of online media and technology. Not from America, but we can waive that.

Dana Cimilluca, Deal Journal, The Wall Street Journal. This is about as far as you can get into the big heads on Wall St. without being a shrink. A lot of his blogs actually break news. Particularly strong on deal analysis.

Saul Hansell, Bits, The New York Times. It's very hard to tell when this blogger sleeps. Not much that goes on in the world of technology innovation gets past him. Encyclopedic knowledge of his beat.
 
Top