Wednesday, February 20, 2013

Time to Go Short: Here Come Those Experts Again

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (, 2009)

            The February 2, 2013, edition of The Economist presented a rousing endorsement for Scandinavian living. ("Cecil Rhodes once said that 'to be born an Englishman is to win first prize in the lottery of life.' Today the same could be said about being born Nordic.") The front cover ("The Next Supermodel: Why the World Should Look to the Nordic Countries") followed by an editorial and a 14-page supplement, cited the authority of 37 experts. Nowhere did the esteemed magazine mention three of the largest housing bubbles in the world. This does not serve the Economist's constituent short sellers. More fundamentally, it betrays the establishment's blank slate of lessons learned from the past decade.

            The destructive quality of irredeemable credit, understood by some before the U.S. mortgage crash, obvious to more in its wake, was crystallized in the too-low, centrally controlled, interest rates that flushed a bacillus of fake money and credit, even though it was mathematically impossible for overzealous borrowers to produce cash in quantities sufficient to meet loan payments.

            Nowhere does The Economist suggest Scandinavian countries are similarly hobbled despite the tell-tale data (published in every issue of The Economist). "The Next Supermodel" is being celebrated, at least partially, as a consequence of medicated interest rates.

            A pinnacle of indiscretion, so we thought, was achieved in late-2006, when U.S. consumer debt peaked at 160% of GDP. Crosscurrents exist in the methodology for this calculation, so direct comparisons, by simple alignment of ratios, is difficult. As prelude, it is the conclusion here that Scandinavian consumer borrowing is past the point of no return.

            Toronto Globe and Mail, November 1, 2012: "Household debt in Sweden now stands at 173 per cent of disposable income, following a steady climb from just 90 per cent in the mid-1990s, according to the Riksbank, Sweden's central bank.... That's well above the level reached in the United States prior to that country's housing crash." (As to the unlearned lesson by the fashionably educated: "[T]he escalation of household debt has gone hand in hand with house prices, which have increased threefold since 1995 as mortgage rates plunged from 10 percent to 4 percent.") From the San Francisco Federal Reserve, quoted in the Herald Tribune, June 25, 2012: Norway's "household debt to disposable income...ratio [is] north of 200 %..." Bloomberg, February 6, 2013: "Household debt [in Denmark] is about [300 per cent of] disposable income..." Finland is a laggard, depending on the source, at around 100% household debt to disposable income.

            The Economist could follow its Scandinavian advert with a cover story on another praiseworthy economy: Canada. It might celebrate the departure of Canada's central banker, Mark Carney, who is escaping to Britain, where he will head the Bank of England. In the Supermodel spirit, it could commend Canada's banking system, voted the world's soundest by the World Economic Forum for the past five years. To adorn Canada with such laurels, The Economist would avoid mentioning the consumer debt to disposable income ratio, which has risen from 137% in 2007 to 165% in 2013. This is from Moody's, in its January 28, 2013, Special Comment: "Key Drivers of Canadian Bank Rating Actions." Moody's cut Canadian bank ratings. For a larger discussion on Canada, see "Exit, Pursued By Bear."

            Those who are featured in round two of The Big Short will achieve their success not only by identifying "what?" but also "when?" The crux of the Canadian mortgage investigation is the CMHC (Canadian Mortgage and Housing Corporation). It bears some similarities to Fannie Mae and Freddie Mac, especially in the lack of interest it receives, just as Fannie and Freddie were universally acclaimed by experts in 2006, even though the CMHC is bumping up against its $600 billion mortgage-insurance limit. (To compare to the United States, multiply by nine. This would be $5.4 trillion of mortgage insurance in the U.S.) A large proportion of bank mortgage lending is insured by the CMHC. A close reading of the insurance documentation is necessary to understand the banks' exposure to poorly written loans. Also of note is financial-service company exposure to ballooning consumer credit.

            It is an open question whether the CMHC limit will be boosted. It has been in the past, at $150 billion intervals. There is no question though, that the bust is on. The CMHC has already been forced to tighten mortgage terms of the mortgages it insures.

            A second lesson learned since the Internet crash is the need to attract greater quantities of credit to sustain a bubble. Such intrusions of tighter standards by the CMHC in a market with few qualified buyers (Canadian home ownership is 70%; the U.S. peaked at 66%) will hasten the reckoning.

            Is Canadian housing in a bubble? A recent and indicative news story on CTV (Canadian Television Network): "Experts Predict B.C. [British Columbia] Real Estate Bubble Will Remain Intact." A series of experts parade across the screen with such comments as "sky-high real estate prices are here to stay."

            Housing sales in British Columbia have slowed to zip. Alas, the experts always find some pawns. This, from the Vancouver Real Estate Anecdote website, posted February 3, 2013: "I just opened an account with National Bank to trade [Bulletin Board] stocks....I know its super risky, but I need the money to buy a condo."

            Requiescat in Pace. 

Wednesday, February 13, 2013

Japanese RORO

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (, 2009)

            A translator asked: "In your book, 'open-mouth policy' occurs many times. Would you please elaborate on this term?"
On the same day, February 11, 2013, Akira Amrai, Japan's economic minister, announced: "It will be important to show our mettle and see the Nikkei reach the 13,000 mark by the end of the fiscal year (March 31)... We want to continue taking (new) steps to help stock prices rise." The Nikkei must hop 17% in less than seven weeks to meet the government's injunction.

Comparing and contrasting the Greenspan-Amrai eras is an illustration of institutional collapse.

Federal Reserve Chairman Alan Greenspan was blamed for operating an "open-mouth policy" as the stock market rose. He did not, however, speak often about the stock market, having shut his mouth on that topic in February 1997.

Greenspan had given his "Irrational Exuberance" speech in December 1996. This alluded to the possibility that asset prices might be too high. He was still concerned about asset prices when he testified before the Senate in February 1997. Senator Phil Gramm from Texas disagreed with the chairman: "I think people hear what you are saying and conclude that you believe equities are overvalued. I would guess that equity values are not only not overvalued but may still be undervalued." Greenspan never again discussed bubbles, either in public or, in private (at FOMC meetings) except to deny the Federal Reserve could either identify or pop one. Speculation swept the country. In July of 2001, Gramm put it to the chairman: "If this is the bust, the boom was sure as hell worth it. You agree with that, right?" The craven poltroon's response: "Certainly." Gramm joined UBS as vice chairman when he retired from the Senate.

Greenspan's references to the stock market after February 2007 were generally oblique testimonials, calling upon rising productivity or Wall Street analyst views. His top priority was to assure the carry-trade that risk was on. Yet, he was discreet. He did not say, directly, the Fed's policy was to boost the stock market. That would have been a step beyond - many, many steps beyond - the protocols of central banking. Even though Greenspan was careful, the chairman's critics voiced strong opposition to his "open-mouth policy." There was no mistake he was rooting for stocks. (In his Credit Bubble Bulletin of September 26, 2003, Prudent Bear fund manager Doug Noland wrote: A few weeks ago hedge fund manager extraordinaire Leon Cooperman was on [TV]. His fund is up big this year, and Mr. Cooperman was pleased to explain his very successful bet on the junk bond market. 'The government wanted us to own them,' if I recall his comment accurately.... Our policymakers have made it perfectly clear - to the home owner, to the stock jockey, to the global bond players, to the derivatives trader - that leverage is the way to easy profits. And everyone has been rushing full-throttle to play inflating asset markets...")

A decade or so later, central banks are desperately attempting to prevent an asset crash. Maybe an economic crash too, if they give any thought to such distractions. In 1999, then-Fed chairman Alan Greenspan triggered a final stock-market fling when his Y2K crash-prevention strategy consisted of issuing $50 billion into the banking system. From that point, the Nasdaq more than doubled, then peaked, then crashed.

In 2013, Fed Chairman Ben Bernanke is buying over $100 billion of securities each month (with newly created dollars tapped off a keypad). At a rate of over $1 trillion a year, quite a hike from Greenspan's $50 billion in 1999, he is getting very little for it. Maybe $10 trillion would spur a Nasdaq-like lift, but he is only inflating the world's prices now. Apparently not oblivious to a lack of oomph in his thesis, Simple Ben has added "communications" as a Federal Reserve tool to fulfill its missions. (The Fed has announced 30 or so missions, policies, and deceptions.)

An example of the Fed's explicit communications strategy was offered by William C. Dudley, Federal Reserve President of New York, speaking at City University of New York, on October 1, 2010: "We have tools that can provide additional stimulus at costs that do not appear to be prohibitive.... [P]urchases of long-duration assets [by the New York Fed will] pull down the level of long-term interest rates.... [L]ower long-term rates would support the value of assets, including houses and equities and household net worth."

On January 13, 2011, Chairman Bernanke was interviewed by CNN. A capsule: "He pointed out that since he signaled the Fed would likely unveil QE2 during a speech in Jackson Hole, Wyoming [August 27, 2010 - FJS], that the Russell 2000 of small cap stocks is up 30%, even more than the 15% to 20% rise in blue chip indexes." The Japanese government's price target is simply the next step. Eliot Spitzer hounded Henry Blodgett for such indiscretions less than a decade ago.

The academics who run central banking today probably think Russell 2000 is a classroom in the chemistry department.

So what is an investor to do? Trying to divine whether this is a "risk on" or "risk off" day can be a challenge. One hedge-fund manager sent along his risk-on, risk-off (RORO) approach: "In the spirit of RORO, I simply tell my investors whether I'm risk on or risk off, using the initials to stand in for the words themselves.  So it's either RO, or RO.  My new communications transparency, learned by studying the Fed, has worked wonders with my investor relations."

Bernanke and his fellow fruitcakes have made owning paper assets a worse gamble than Vegas.