Today’s links: Washington tries to step up
Lance on Jan 18 2008 at 3:08 am | Filed under: Domestic Politics, Economics, Investing, Lance's Page, regulation
(cross posted at Risk and Return)
Ben Bernanke gives Congress and the President the green light to take steps to stimulate the economy along with a warning:
Fortunately, the Fed has some ideas on what they should–and shouldn’t–do. Bernanke’s remarks came with a warning that any fiscal bailout “could prove quite counterproductive” if it’s not done in a timely manner or if it’s not temporary.
Brian Wingfield goes inside the fed chiefs mind:
Translation: Get to work immediately and spread out the costs over time. The price tag? Bernanke says a $100 billion package would have a “significant” impact on the economy.
Here he explains why he is dubious:
“It’s very difficult to engineer a well-timed fiscal stimulus,” says Vincent Reinhart, a former Federal Reserve economist, now a scholar with the American Enterprise Institute. The 2000 recession was resolved by a “happy accident” of circumstances, he says. President Bush ran for office on a proposal to cut taxes, which helped the economy just as it was slowing. At the same time, the Fed took an expansionary view of monetary policy, cutting interest rates to spark growth (fueling a housing boom, which is at the core of the current downturn).
It might be difficult to time such an economic rescue correctly this time around. “You’re just not sure when you start the process where you’ll end up when legislation’s involved,” says Reinhart.
I have made my own concerns known. Read them, my guess is it is pretty much the gist of what Bernanke is driving at, and probably he is managing his public perception more than expecting it to make any large difference. Either way, I don’t expect it to have any meaningful positive effect on longer term investment results. Douglas Elmendorf is skeptical as well:
One circumstance in which fiscal stimulus is an appropriate complement to monetary stimulus is when achieving full employment with higher interest rates is better than achieving full employment with lower interest rates. In particular, further cuts in short-term U.S. interest rates heighten the risk of investors deciding to flee U.S. assets. The result would be further turmoil in financial markets and a large and quick drop in the value of the dollar, which would be disruptive to the U.S. economy and foreign economies and might slow economic growth further. Moreover, any decline in the dollar puts upward pressure on inflation (beyond any inflationary pressure from the level of employment) because higher prices for imported goods act as a negative supply shock.
However, he does cite some potential positives.
Meanwhile housing starts were even worse than expected, and expectations were pretty bad to begin with:
Home construction plunged in December, tumbling to its lowest point in 16 years, while a sign of future groundbreakings also dropped sharply.
Housing starts decreased 14% to a seasonally adjusted 1.006 million annual rate, after falling 7.9% in November to 1.173 million, the Commerce Department said Thursday. Originally, Commerce reported November starts 3.7% lower at 1.187 million.
The big decline surprised Wall Street. The median forecast of economists surveyed by Dow Jones Newswires was a 5.0% drop to a 1.130 million annual rate. The level of 1.006 million was the lowest since 996,000 in May 1991.
Commercial property is not looking immune either:
The credit crunch that roared through the residential real-estate market is starting to bite commercial projects, too.
Yesterday, Ian Bruce Eichner, the developer of a twin-tower casino resort in the heart of Las Vegas, defaulted on a $760 million loan from Deutsche Bank AG after he failed to get refinancing. The default on the loan supporting the $3 billion Cosmopolitan Resort Casino is a signal of trouble for Mr. Eichner, who gained notice during an earlier real-estate downturn in the early 1990s when he lost several projects in New York City.
Merrill Lynch also did worse than the already awful expectations. My emphasis:
The company recorded a net loss of $9.83 billion, or $12.01 a share, compared with year-earlier net income of $2.3 billion, or $2.41 a share. Write-down expectations were running as high as $15 billion. The company recorded $7.9 billion in mortgage-related write-downs in the third quarter.
Net revenue was negative $8.19 billion because of the write-downs.
The mean per-share loss estimate of analysts polled by Thomson Financial was $4.93 on revenue of $399 million.
Twelve dollars in losses a share!
In addition people are wondering about this whole “de-coupling” thesis (also here.)That is the idea that emerging markets and other countries overseas can avoid a downturn if the US slides into a recession. I admit to being skeptical as well, though I suspect they will only slow down, and while they will be volatile, they will not decline as much as US markets will if things get really ugly.
(ed.- haven’t you already said they were ugly?)
Uglier than people have thought, but I am no longer so lonely and markets have discounted the possibility of recession, not it actually happening. That is a key distinction people have missed. I regularly hear that markets have a recession “in the price.” That is why they have gone lower. If so, then why do prices keep going lower when more bad news hits? Markets discount the probability of something. Shares have declined as investors have felt that probability rising, as it becomes more obvious that profits will decline they will go lower still. If things get worse, it will get a lot uglier in the markets. An actual recession is not in the price.
In fact, the prices in my mind still imply earnings growth over the long term which are unreasonable for the broader indices.
Of course, a good question is, are bonds the answer? I don’t think so, and Doug Kass is downright bearish (H/T:Abnormal Returns.)
The bond market is in a bubble that is reminiscent of (and quite possibly as extreme as) other bubbles during previous eras.
From my perch, the only issue is the timing of this trade.
Surprisingly, today’s 3.68% yield on the 10-year U.S. note is lower than the yield during the recession of 2001. This low yield appears to be artificially affected by a number of temporary and backward-looking factors.
His rationale for this shows the uncertainties surrounding this asset class, though I am not sure now is the time to sell. Let us just say we have deemphasized bonds as a defensive measure and concentrated on other techniques. Bonds have been a drag on our portfolios since November, and so far this year. So we are pretty happy with that choice. The other ways of dealing with this have been far more effective. I expect that will remain true.
What about the risk from insurers of debt I have mentioned before? It is looking grim for them as well. Calculated Risk looks at the latest PR from AMBAC:
Translation: You thought 14% was a steep yield for MBIA to pay on the surplus notes (See: “How many other AAA rated companies are raising money at 14%?”). With this possible downgrade, we might not be able to raise capital even at 20%!
Also note, from Merrill this morning, the $3.1B credit valuation adjustments related to hedges with financial guarantors (ACA financial). There is no party in counterparty. (thanks to BR!)
I did notice that little tidbit on Merrill, which goes to the biggest known risk that hasn’t really hit yet, all those insurers, including investors behind credit default swaps, who may not be able to pay up! What is the level of counterparty risk?
Funny you should ask, because the ratings agencies say they don’t know (my emphasis below)and probably will not know:
The complexity of the global financial system and the imbalance of information available to market participants means the ability to track risk has declined “probably forever”, Moody’s Investors Service said . “It is extremely unlikely that in today’s markets we will ever know on a timely basis where every risk lies,” analysts at the ratings agency, led by chief international economist Pierre Cailleteau, wrote in a report.
Read the whole thing.
Various links from Abnormal Returns:
Tech spending does fall in a recession. (Silicon Alley Insider)
You think?
News you should (already) know. A study finds that “..clowns are universally disliked by children.” (Scientific American)
You think?
A new primer on behavioral economics. (Odd Numbers):
From a new blog by M.I.T. economist Dan Ariely tied to his new book Predictably Irrational. I read and would highly recommend the book if you’re looking for case after case of the failure of rational man.
Definitely going on my blogroll.
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