"The Market - Nearing a Sea Change?"
Sydney M. Williams
More than anything the markets need a strong dose of confidence. The problems in Europe are incalculable, not because they are incapable of being resolved, but because everything in finance and the capital markets are constantly in motion. A snapshot of any bank’s balance sheet is meaningless when markets are moving as quickly as they are. For the past eighteen months the ECB and the IMF have been trying to buy time, time that should have allowed banks to improve their balance sheets. That Greece will have to renege on its loans seems a given. What is unknown is to what extent the loans held by European and U.S. banks have been written down.
In 2008, the United States faced not just a liquidity problem, but a solvency crisis as well. Bear Stearns had been saved from bankruptcy in a last minute deal with J.P. Morgan. A few months later Lehman did go bankrupt. Congress, at the urging of Treasury Secretary Henry Paulson, created the Troubled Asset Relief Program (TARP.) AIG would have gone bankrupt had the government not stepped in; the same fate would have been Merrill Lynch’s had not Bank America, with government urging, come to the rescue. Equity investments were made by TARP in dozens of banks and financial institutions. General Motors and Chrysler were restructured, screwing the bondholders, but saving the companies and thousands of jobs.
Regardless, everyone, including Republicans, has back-pedaled from any association with TARP. Yet, Douglas Elliott of the left-leaning Brookings Institute said: “The TARP is probably the most effective (my emphasis) large-scale government program that the public has decided was a bad idea.” A year ago, Bloomberg estimated that $309 billion in TARP funds invested in banks and insurance companies had returned $25.2 billion, or 8.2%. Most importantly what TARP did was inject confidence into frightened markets.
We can all Monday-morning quarterback and criticize specifics of the federal government’s dealings in the fall of 2008; nevertheless, the worst of that fear in September-October 2008 was dissipated in a matter of weeks. The TED spread, which had been running around 50 basis points in July of that year, spiked to 480 basis points in early October. By year-end 2008, the TED spread had declined to 131 basis points. The yield on Three-month Treasury Bills, which had had a negative yield at the worst of the crisis, was returning 11 basis points by year-end. The spread between Investment Grade Corporates and the 10-Year Treasury declined from 419 basis points to 411 basis points between September 30 and December 31. The stock market continued to decline in early March of 2009, but the High Yield market began recovering in December of 2008. The Bloomberg-FINRA Index had the yield on High Yield bonds peaking over 25% in late November 2008. A month later, the yield had declined to 17.4%.
Fear again grips investors. Each crisis is unique. The current one centers on Europe, their sovereign debt crisis, the question of bond ownership and what the impact of this crisis will be on their economies and ours. The situation begs analysis, because the seventeen nations that share a common currency have no common fiscal authority. The ECB can raise or lower rates, but there is no central treasury authority that can effect tax policy.
Because the future is unknowable, we can only speculate as to what the outcome might be. But most people are nervous and fear the worst; ergo the money pouring into Treasuries, with returns that do not match inflation.
As I wrote at the start of this piece, more than anything, the markets and the economy need a strong dose of confidence. Consumers have been reducing their leverage and there is no reason to believe they will not continue to do so. The federal government has increased its debt enormously in the wake of the financial crisis, but the problem is not debt; the problem is growth, or the lack thereof. Economic growth is dependent on the private sector. Fundamentally, the corporate sector (ex the banks, which are too difficult for me to determine; though I suspect they are in better shape than three years ago) is in good shape. They have adequate liquid resources, but have been reluctant to invest because of unknowns surrounding tax policy and regulatory concerns, especially those relevant to healthcare. Of course, therein lie the opportunities for improving confidence.
Bill Gross, in his “Investment Outlook” suggests that the United States requires “enhanced safety nets of benefits for the unemployed” until the economy recovers and job growth flourishes. He also urges protectionism, in recommending “buy American.” He argues that since China and Brazil do it, “why not us?”
No one wants to see people suffer. There is already too much suffering here and abroad. Welfare is a reflection of a compassionate nation. It is also a bi-product of wealth. While a small number of people have accumulated vast amounts of wealth over the past few years, the vast majority has made little progress. That fact, in combination with high levels of existing debt and an economy negatively impacted by deleveraging, limits our options. Fiscal and monetary policies should have one goal – generate economic growth, for that is the only way to put people back to work and to raise needed federal revenues. Our nation must rebuild its wealth.
When one looks at the three principal sectors of the economy – consumer, private business and government – the only one that has the means to invest and to hire is the private sector. A bold, radical redesign of the corporate tax code, with permanent, not temporary, changes would go a long way toward restoring confidence. Removing the tax consequences of repatriating money held offshore would encourage investment back home. Stimulus does not necessarily mean that government must control the spending; government can simply make it easier for the private sector to invest.
But private capital is not considered as compassionate as government, for it demands a return on investment, whereas government’s motives are deemed to be more benevolent. Nevertheless, the unintended consequences of government’s actions can produce pain, as the last two years have demonstrated. With the private sector in charge, pain may well come faster, but so will recovery. The consumer knows the answer is deleveraging, and that is what he has been doing over the past two or three years. He has made headway, but still has a ways to go. An abundance of capital and very low interest rates may be marginally important, but the consumer realizes his first priority is to reorganize his balance sheet, not to take on additional debt.
The most obvious way out of the economic morass is to focus on exports and, in that regard, it is a good thing that the President is sending the three trade bills to the Senate. But it is a bad sign that China bashing persists with Senators Chuck Schumer (D-NY) and Lindsay Graham (R-SC) urging passage of the Currency Exchange Rate Oversight Reform Act. The bill is based on the premise that China has not allowed its currency to appreciate adequately, despite the Yuan having risen 30% against the Dollar over the past six years. China is our second largest trading partner and our third largest export market. It is the second largest economy in the world. Even recognizing that countries like China, Brazil and Russia are mercantilist and so therefore they have an edge in terms of pricing, does it really make sense to pick a fight with China? Besides being our third largest export market, they are also our largest creditor. The returns they receive on their Treasury investments to date are not offsetting the decline of their currency versus the Dollar. Do we really want to chase them away from our markets? Is not that Schumer-Graham bill reminiscent of that great trade blunder of 1930, the Smoot-Hawley Tariff? Protectionism has a populist appeal, making it attractive during times of economic turmoil, but once started, trade wars are hard to stop.
The answer to the question in the title depends greatly on policy action taken by the President and Congress over the next several weeks. It is possible they can restore confidence, but it will take a seismic shift in both words and action – not, in my opinion, a high probability, but, also, not impossible.
Thought of the Day
“The Market – Nearing a Sea Change?”
October 4, 2011More than anything the markets need a strong dose of confidence. The problems in Europe are incalculable, not because they are incapable of being resolved, but because everything in finance and the capital markets are constantly in motion. A snapshot of any bank’s balance sheet is meaningless when markets are moving as quickly as they are. For the past eighteen months the ECB and the IMF have been trying to buy time, time that should have allowed banks to improve their balance sheets. That Greece will have to renege on its loans seems a given. What is unknown is to what extent the loans held by European and U.S. banks have been written down.
In 2008, the United States faced not just a liquidity problem, but a solvency crisis as well. Bear Stearns had been saved from bankruptcy in a last minute deal with J.P. Morgan. A few months later Lehman did go bankrupt. Congress, at the urging of Treasury Secretary Henry Paulson, created the Troubled Asset Relief Program (TARP.) AIG would have gone bankrupt had the government not stepped in; the same fate would have been Merrill Lynch’s had not Bank America, with government urging, come to the rescue. Equity investments were made by TARP in dozens of banks and financial institutions. General Motors and Chrysler were restructured, screwing the bondholders, but saving the companies and thousands of jobs.
Regardless, everyone, including Republicans, has back-pedaled from any association with TARP. Yet, Douglas Elliott of the left-leaning Brookings Institute said: “The TARP is probably the most effective (my emphasis) large-scale government program that the public has decided was a bad idea.” A year ago, Bloomberg estimated that $309 billion in TARP funds invested in banks and insurance companies had returned $25.2 billion, or 8.2%. Most importantly what TARP did was inject confidence into frightened markets.
We can all Monday-morning quarterback and criticize specifics of the federal government’s dealings in the fall of 2008; nevertheless, the worst of that fear in September-October 2008 was dissipated in a matter of weeks. The TED spread, which had been running around 50 basis points in July of that year, spiked to 480 basis points in early October. By year-end 2008, the TED spread had declined to 131 basis points. The yield on Three-month Treasury Bills, which had had a negative yield at the worst of the crisis, was returning 11 basis points by year-end. The spread between Investment Grade Corporates and the 10-Year Treasury declined from 419 basis points to 411 basis points between September 30 and December 31. The stock market continued to decline in early March of 2009, but the High Yield market began recovering in December of 2008. The Bloomberg-FINRA Index had the yield on High Yield bonds peaking over 25% in late November 2008. A month later, the yield had declined to 17.4%.
Fear again grips investors. Each crisis is unique. The current one centers on Europe, their sovereign debt crisis, the question of bond ownership and what the impact of this crisis will be on their economies and ours. The situation begs analysis, because the seventeen nations that share a common currency have no common fiscal authority. The ECB can raise or lower rates, but there is no central treasury authority that can effect tax policy.
Because the future is unknowable, we can only speculate as to what the outcome might be. But most people are nervous and fear the worst; ergo the money pouring into Treasuries, with returns that do not match inflation.
As I wrote at the start of this piece, more than anything, the markets and the economy need a strong dose of confidence. Consumers have been reducing their leverage and there is no reason to believe they will not continue to do so. The federal government has increased its debt enormously in the wake of the financial crisis, but the problem is not debt; the problem is growth, or the lack thereof. Economic growth is dependent on the private sector. Fundamentally, the corporate sector (ex the banks, which are too difficult for me to determine; though I suspect they are in better shape than three years ago) is in good shape. They have adequate liquid resources, but have been reluctant to invest because of unknowns surrounding tax policy and regulatory concerns, especially those relevant to healthcare. Of course, therein lie the opportunities for improving confidence.
Bill Gross, in his “Investment Outlook” suggests that the United States requires “enhanced safety nets of benefits for the unemployed” until the economy recovers and job growth flourishes. He also urges protectionism, in recommending “buy American.” He argues that since China and Brazil do it, “why not us?”
No one wants to see people suffer. There is already too much suffering here and abroad. Welfare is a reflection of a compassionate nation. It is also a bi-product of wealth. While a small number of people have accumulated vast amounts of wealth over the past few years, the vast majority has made little progress. That fact, in combination with high levels of existing debt and an economy negatively impacted by deleveraging, limits our options. Fiscal and monetary policies should have one goal – generate economic growth, for that is the only way to put people back to work and to raise needed federal revenues. Our nation must rebuild its wealth.
When one looks at the three principal sectors of the economy – consumer, private business and government – the only one that has the means to invest and to hire is the private sector. A bold, radical redesign of the corporate tax code, with permanent, not temporary, changes would go a long way toward restoring confidence. Removing the tax consequences of repatriating money held offshore would encourage investment back home. Stimulus does not necessarily mean that government must control the spending; government can simply make it easier for the private sector to invest.
But private capital is not considered as compassionate as government, for it demands a return on investment, whereas government’s motives are deemed to be more benevolent. Nevertheless, the unintended consequences of government’s actions can produce pain, as the last two years have demonstrated. With the private sector in charge, pain may well come faster, but so will recovery. The consumer knows the answer is deleveraging, and that is what he has been doing over the past two or three years. He has made headway, but still has a ways to go. An abundance of capital and very low interest rates may be marginally important, but the consumer realizes his first priority is to reorganize his balance sheet, not to take on additional debt.
The most obvious way out of the economic morass is to focus on exports and, in that regard, it is a good thing that the President is sending the three trade bills to the Senate. But it is a bad sign that China bashing persists with Senators Chuck Schumer (D-NY) and Lindsay Graham (R-SC) urging passage of the Currency Exchange Rate Oversight Reform Act. The bill is based on the premise that China has not allowed its currency to appreciate adequately, despite the Yuan having risen 30% against the Dollar over the past six years. China is our second largest trading partner and our third largest export market. It is the second largest economy in the world. Even recognizing that countries like China, Brazil and Russia are mercantilist and so therefore they have an edge in terms of pricing, does it really make sense to pick a fight with China? Besides being our third largest export market, they are also our largest creditor. The returns they receive on their Treasury investments to date are not offsetting the decline of their currency versus the Dollar. Do we really want to chase them away from our markets? Is not that Schumer-Graham bill reminiscent of that great trade blunder of 1930, the Smoot-Hawley Tariff? Protectionism has a populist appeal, making it attractive during times of economic turmoil, but once started, trade wars are hard to stop.
The answer to the question in the title depends greatly on policy action taken by the President and Congress over the next several weeks. It is possible they can restore confidence, but it will take a seismic shift in both words and action – not, in my opinion, a high probability, but, also, not impossible.
Labels: TOTD
posted by Thought of the Day @ 6:48 AM
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