The Bear' View
It is always interesting to be familiar with the views that are different from your own. What is the guarantee that you are correct? Excerpts from an interview with David Tice (Prudent Bear) from the Street.com:
It's been more than 10 years since Dallas-based investment manager David Tice launched this mutual fund to hoard gold, short the market and prepare ordinary investors for the coming economic Armageddon (BEARX).
"That's really irrelevant," Tice says of the landmark. "It's just a number." Does the market's seemingly inexorable rise shake his conviction that it's going to collapse? "It's been quite a rally," he acknowledged. "But it doesn't dissuade us in our opinion. We've never been more confident."
The Dow, he predicts, will fall "at least 50%" from these levels, and he says the market is only months away from beginning a sharp decline. "I think this is a topping pattern," he says. (my emphasis)
"We think it's probably three to six months away from a significant decline." He calls the latest rally "a crack-up boom. At the tail end of credit excess it just gets crazier and crazier. It sucks people in, and it's an extremely dangerous scenario."
In all, Tice argues that the rally of the past four years is masking a long-term bear market that began in 2000 and won't end for at least another five years.
The reason? In short, Tice argues that the bull market is simply massive asset inflation caused by reckless lending and easy money. Sooner or later, he says, it will have to be worked out of the system. (my emphasis)
"Our philosophy is that this has been asset inflation, created by rampant, excess credit." He argues the global money supply has grown by 18% a year for the past four years (no wonder asset prices are booming).
"We believe in the Austrian school of economics," says Tice, referring to the late-19th-century economic theory developed by Austrian economists who emphasized usefulness to the consumer in determining the value of a product.
"If you create credit faster than GDP, you will get inflation. This has to be wrung out of the system. It's only a matter of time."
Crazy? Maybe. But anyone who looks at long-term charts must realize how utterly extraordinary, and unprecedented, the past dozen years have been. Stock market valuations, house prices, household debt, U.S. trade deficits -- they're all tied together, and they've all gone berserk.
It took the Dow Jones Industrial Average nearly 100 years to put on its first 5,000 points --- and just three to put on the second. Yes, there is plenty to make you nervous, and there are a lot of really good fund managers out there who are watching the latest boom with white knuckles and a large bottle of antacid. Tice is not alone.
He believes the canary in the coal mine will probably be the dollar. He expects the greenback to tank as international investors start to lose faith in the U.S. credit bubble. He also predicts the Federal Reserve will respond by jacking up interest rates to protect the dollar from complete collapse. That, of course, would bring the credit market to a grinding halt. We'll see.
The reason? Tice isn't just betting against the stock market overall. He's also short individual stocks, including selected homebuilders, financials and consumer discretionary stocks. Some bets, particularly in the homebuilding sector, have obviously done well recently.
Prudent Bear has also invested about 18% of its portfolio in companies mining precious metals, including gold, silver and uranium. And the prices for those have been skyrocketing. "Gold is the one asset that is not someone else's liability," Tice argues. "Gold is an asset that you can carry around in your pocket, and it's of value."
Bears of all stripes believe gold will prove a "safe haven" if and when the economic reckoning arrives. The reality is that it has proven an exceptional investment over the past five years even while they wait. Part of Tice's analysis, after all, has already proven correct. Easy money has driven up the price of all assets, including precious metals. Meanwhile, America's crazy trade deficit has been slowly undermining confidence in the dollar as the world's reserve currency.
And as the greenback has slid, alternatives, including gold, have risen.
None of this has led to a dramatic market collapse yet. Tice notes that everyone in has a vested interest in keeping the game going as long as possible. "There are no enemies of asset inflation," he says. "Washington likes it. Wall Street likes it. Consumers like it." But as the sun shines on the markets around the world, he still believes storm clouds are on their way. "I am as confident as ever that we are going to be right," Tice says, though he concedes: "Things are playing out more slowly than we thought."
Friday, August 24, 2007
Another Perspective on the Tools the Central Banks Have
The following from Bloomberg gives another perspective on the tools that the central banks have at their disposal.
As global credit markets petrify, central banks are playing ``Whac-A-Mole'' with the hammer of overnight funds to bash down short-term interest rates. At least the ridiculous claims that the subprime crisis is confined to the U.S. mortgage market have subsided.
The Federal Reserve and the European Central Bank are trapped between the devil of inflation and the deep blue sea of the global money markets. The waves that carry billions of dollars and euros between financial institutions every day have been becalmed by concern about, well, take your pick from a laundry list of worries, all of which signal fear ousting greed.
If there's one takeaway from recent events, it's the reminder that the potency of global capital can leave central banks powerless. Bank of America Corp.'s $2 billion investment in Countrywide Financial Corp., the biggest U.S. mortgage lender, may have done more to stabilize financial markets than the hundreds of billions of dollars of short-term funds supplied by the Fed and the ECB.
The ensuing dilemma is simple to enunciate, much harder to resolve. Bow to pressure at next month's policy meetings, with the Fed cutting and the ECB holding fire, and central banks risk accusations of bailing out bad lenders. Keep U.S. rates on hold and raise euro rates, and they will be charged with fiddling while securities burn.
The Fed is under the most pressure to prioritize the needs of borrowers and lenders. Rates in the futures market show traders now see just a 21 percent chance that the key rate will be left at 5.25 percent by the time the Fed's next policy meeting ends on Sept. 18, down from 92 percent a month ago.
After a slow start in responding to the surge in money- market rates earlier this month as banks hoarding capital stopped lending to each other, the U.S. central bank has shown some nifty footwork in trying to dodge the rate-cut bullet.
It started by reducing the cost of emergency funds at its discount window. That borrowing source, though, has provided a weekly average of just $52 million this year when seasonal credit to small institutions in agriculture or tourism is excluded. The most it has been tapped for in the past five years is just $785 million, though almost $12 billion was drawn down following the Sept. 11 terrorist attacks.
So on Aug. 22, the four largest U.S. banks stepped up, with Citigroup Inc., Bank of America, JPMorgan Chase & Co. and Wachovia Corp. each taking $500 million of funds at 5.75 percent, well above the 4 percent rate that the overnight Fed funds rate closed at that day.
The implied message to the smaller finance houses is that there shouldn't be any stigma attached to borrowing at the penalty rate if you need to.
You can imagine the telephone conversation with the Fed that inspired such munificence; not dissimilar from the 1998 chat that brought about the rescue of Long-Term Capital Management LP. A cynic might also wonder whether Bank of America's $2 billion vote of confidence in the U.S. mortgage market by buying preferred stock in Countrywide was similarly Fed-inspired.
All of this is evidence that the Fed will keep pulling new tricks to avoid cutting its key overnight target rate of 5.25 percent, either before or at its Sept. 18 gathering -- and will rally U.S. financial institutions to its cause, marshaling the forces of capital by reminding them that their interests in maintaining market order are 100 percent aligned.
The Fed doesn't want to be bullied into changing course; it must also be acutely aware that a policy response would stoke concern the situation is even worse than it appears -- not to mention guaranteeing that Chairman Bernanke would be known as ``Helicopter Ben'' for the rest of his career.
The ECB has a more immediate problem, though its solution is likely to be different. Although President Jean-Claude Trichet repeatedly says ``we never pre-commit'' to rate changes, he has boxed himself into a corner by presaging each of the eight increases in the current tightening cycle with the words ``strong vigilance,'' a phrase he repeated earlier this month.
Expectations are justifiably high that its key one-week rate of 4 percent will increase when policy makers next meet on Sept. 6. And the ECB, sired as it was by Germany's Bundesbank, will be even more reluctant than the Fed to be perceived as pandering to the interests of the market rather than serving the needs of the economy.
The trouble is, money-market rates are already punitively high, with the cost of borrowing euros for three months climbing to 4.78 percent today, the most expensive since May 2001 and up from just 4.23 percent a month ago.
The central bank has tried to steer that rate lower, holding a special auction of 40 billion euros ($54 billion) of 91-day funds yesterday. It also said ``the position of the governing council on its monetary policy stance was expressed by its president,'' a signal that its policy course won't be diverted.
So the ECB's likely path is to enforce a higher one-week benchmark rate next month while continuing to feed the money markets with longer-dated funds.
The modern rules for central banking are still being crafted and honed. There's no guarantee that their evolution will keep pace with the turbocharged rate of change in financial markets where the prospect of fabulous riches motivates insane levels of creativity and entrepreneurship.
The recent turbulence suggests one big change may be needed. Ignoring house values and the stock market when setting monetary policy looks increasingly unsustainable when they play such a vital role in determining the economic outlook. So when central bankers hold the equivalent of their annual picnic at Jackson Hole, Wyoming, at the end of the month, the topic of asset prices should be high on the agenda.
The following from Bloomberg gives another perspective on the tools that the central banks have at their disposal.
As global credit markets petrify, central banks are playing ``Whac-A-Mole'' with the hammer of overnight funds to bash down short-term interest rates. At least the ridiculous claims that the subprime crisis is confined to the U.S. mortgage market have subsided.
The Federal Reserve and the European Central Bank are trapped between the devil of inflation and the deep blue sea of the global money markets. The waves that carry billions of dollars and euros between financial institutions every day have been becalmed by concern about, well, take your pick from a laundry list of worries, all of which signal fear ousting greed.
If there's one takeaway from recent events, it's the reminder that the potency of global capital can leave central banks powerless. Bank of America Corp.'s $2 billion investment in Countrywide Financial Corp., the biggest U.S. mortgage lender, may have done more to stabilize financial markets than the hundreds of billions of dollars of short-term funds supplied by the Fed and the ECB.
The ensuing dilemma is simple to enunciate, much harder to resolve. Bow to pressure at next month's policy meetings, with the Fed cutting and the ECB holding fire, and central banks risk accusations of bailing out bad lenders. Keep U.S. rates on hold and raise euro rates, and they will be charged with fiddling while securities burn.
The Fed is under the most pressure to prioritize the needs of borrowers and lenders. Rates in the futures market show traders now see just a 21 percent chance that the key rate will be left at 5.25 percent by the time the Fed's next policy meeting ends on Sept. 18, down from 92 percent a month ago.
After a slow start in responding to the surge in money- market rates earlier this month as banks hoarding capital stopped lending to each other, the U.S. central bank has shown some nifty footwork in trying to dodge the rate-cut bullet.
It started by reducing the cost of emergency funds at its discount window. That borrowing source, though, has provided a weekly average of just $52 million this year when seasonal credit to small institutions in agriculture or tourism is excluded. The most it has been tapped for in the past five years is just $785 million, though almost $12 billion was drawn down following the Sept. 11 terrorist attacks.
So on Aug. 22, the four largest U.S. banks stepped up, with Citigroup Inc., Bank of America, JPMorgan Chase & Co. and Wachovia Corp. each taking $500 million of funds at 5.75 percent, well above the 4 percent rate that the overnight Fed funds rate closed at that day.
The implied message to the smaller finance houses is that there shouldn't be any stigma attached to borrowing at the penalty rate if you need to.
You can imagine the telephone conversation with the Fed that inspired such munificence; not dissimilar from the 1998 chat that brought about the rescue of Long-Term Capital Management LP. A cynic might also wonder whether Bank of America's $2 billion vote of confidence in the U.S. mortgage market by buying preferred stock in Countrywide was similarly Fed-inspired.
All of this is evidence that the Fed will keep pulling new tricks to avoid cutting its key overnight target rate of 5.25 percent, either before or at its Sept. 18 gathering -- and will rally U.S. financial institutions to its cause, marshaling the forces of capital by reminding them that their interests in maintaining market order are 100 percent aligned.
The Fed doesn't want to be bullied into changing course; it must also be acutely aware that a policy response would stoke concern the situation is even worse than it appears -- not to mention guaranteeing that Chairman Bernanke would be known as ``Helicopter Ben'' for the rest of his career.
The ECB has a more immediate problem, though its solution is likely to be different. Although President Jean-Claude Trichet repeatedly says ``we never pre-commit'' to rate changes, he has boxed himself into a corner by presaging each of the eight increases in the current tightening cycle with the words ``strong vigilance,'' a phrase he repeated earlier this month.
Expectations are justifiably high that its key one-week rate of 4 percent will increase when policy makers next meet on Sept. 6. And the ECB, sired as it was by Germany's Bundesbank, will be even more reluctant than the Fed to be perceived as pandering to the interests of the market rather than serving the needs of the economy.
The trouble is, money-market rates are already punitively high, with the cost of borrowing euros for three months climbing to 4.78 percent today, the most expensive since May 2001 and up from just 4.23 percent a month ago.
The central bank has tried to steer that rate lower, holding a special auction of 40 billion euros ($54 billion) of 91-day funds yesterday. It also said ``the position of the governing council on its monetary policy stance was expressed by its president,'' a signal that its policy course won't be diverted.
So the ECB's likely path is to enforce a higher one-week benchmark rate next month while continuing to feed the money markets with longer-dated funds.
The modern rules for central banking are still being crafted and honed. There's no guarantee that their evolution will keep pace with the turbocharged rate of change in financial markets where the prospect of fabulous riches motivates insane levels of creativity and entrepreneurship.
The recent turbulence suggests one big change may be needed. Ignoring house values and the stock market when setting monetary policy looks increasingly unsustainable when they play such a vital role in determining the economic outlook. So when central bankers hold the equivalent of their annual picnic at Jackson Hole, Wyoming, at the end of the month, the topic of asset prices should be high on the agenda.
Thursday, August 23, 2007
Problems the Fed Faces - 20th-Century Tools in a 21st-Century Market
The excerpts below from an article in the WSJ is very interesting because it discusses the problems the tools the Fed has that were created to handle an early 20th-century economy in an early 21st-centurn environment. If you don't have a subscription to the online WSJ, try page A2 of Thursday's edition.
Think, for a moment, of bearded, bookish Ben Bernanke as the chief mechanic looking under the hood of the U.S. economy.
His problem: He's got tools designed for an early-20th-century Model T Ford to fix a 21st-century computer-controlled hybrid.
The Federal Reserve was created in 1913 and equipped to prevent and respond to banking panics. When banks need cash and can't sell their assets or borrow against them because markets are panicked, the Fed lends freely to banks with good collateral.
But the Fed chairman's challenge is that bank finances aren't today's primary problem. Banks are flush but are reluctant to lend at a time when everyone else with money is also uneasy about lending. Nonetheless, Mr. Bernanke and his monetary mechanics are stuck using 1913-era tools designed for a bank-centric financial system to repair a 2007-era market-centric financial system.
The excerpts below from an article in the WSJ is very interesting because it discusses the problems the tools the Fed has that were created to handle an early 20th-century economy in an early 21st-centurn environment. If you don't have a subscription to the online WSJ, try page A2 of Thursday's edition.
Think, for a moment, of bearded, bookish Ben Bernanke as the chief mechanic looking under the hood of the U.S. economy.
His problem: He's got tools designed for an early-20th-century Model T Ford to fix a 21st-century computer-controlled hybrid.
The Federal Reserve was created in 1913 and equipped to prevent and respond to banking panics. When banks need cash and can't sell their assets or borrow against them because markets are panicked, the Fed lends freely to banks with good collateral.
But the Fed chairman's challenge is that bank finances aren't today's primary problem. Banks are flush but are reluctant to lend at a time when everyone else with money is also uneasy about lending. Nonetheless, Mr. Bernanke and his monetary mechanics are stuck using 1913-era tools designed for a bank-centric financial system to repair a 2007-era market-centric financial system.
Chronicles of the Credit Crunch #3 - Perspectives on the History and Where it is Going
The following articles give different perspectives on the credit crunch and the ultimate outcome. The "game" of the credit crunch is now in progress, the question is where it will end up.
This article from UK's Independent gives a perspective from outside the US:
The debt market is what makes the financial world go round, providing credit for governments and companies to invest and individuals to buy houses, start up businesses and fund their education. The market has become more complex as investment banks dreamt up new investment products based on these loans, which investors lapped up in search of high returns.
After years of relaxed lending, the market has suddenly seized up, triggered by rising defaults by "sub-prime" US mortgage borrowers. As these defaults mounted, institutions rethought their attitude to risk and suddenly became scared of losing money. Banks became unwilling to lend to each other for fear of not getting their money back. The panic has spread to shares, and there are fears that the panic could spread from financial markets to hit the wider economy. . . . .
A recent article Reuters is interesting. Below is the conclusion, which should act as a good teaser.
If -- and I think it will happen -- the interrelationship between asset securitizers and leveraged investors, be they sophisticated hedge funds or some benighted European bank, is put on a permanently more conservative footing, many asset prices will have to fall.
The damage done to the economy by the bad loans already made and by the credit drought we face until the new model emerges will be very significant.
The following articles give different perspectives on the credit crunch and the ultimate outcome. The "game" of the credit crunch is now in progress, the question is where it will end up.
This article from UK's Independent gives a perspective from outside the US:
The debt market is what makes the financial world go round, providing credit for governments and companies to invest and individuals to buy houses, start up businesses and fund their education. The market has become more complex as investment banks dreamt up new investment products based on these loans, which investors lapped up in search of high returns.
After years of relaxed lending, the market has suddenly seized up, triggered by rising defaults by "sub-prime" US mortgage borrowers. As these defaults mounted, institutions rethought their attitude to risk and suddenly became scared of losing money. Banks became unwilling to lend to each other for fear of not getting their money back. The panic has spread to shares, and there are fears that the panic could spread from financial markets to hit the wider economy. . . . .
A recent article Reuters is interesting. Below is the conclusion, which should act as a good teaser.
If -- and I think it will happen -- the interrelationship between asset securitizers and leveraged investors, be they sophisticated hedge funds or some benighted European bank, is put on a permanently more conservative footing, many asset prices will have to fall.
The damage done to the economy by the bad loans already made and by the credit drought we face until the new model emerges will be very significant.
Wednesday, August 22, 2007
Central Banks Still Injecting Funds
Excerpts below from an article in the WSJ indicates that the central banks (ECB, the Fed, BOJ, etc.) are still injecting funds into the credit markets. But the amount is much lower than the massive amounts pumped into the markets almost two weeks ago.
The Federal Reserve injected $3.75 billion, following the $3.5 billion it put into markets Monday. The European Central Bank allotted €275 billion ($371 billion) in one-week funds, which is €46 billion more than it estimated banks need for routine business. And the Bank of Japan put 800 billion yen ($6.96 billion) into its market, following an infusion of one trillion yen Monday.
Meanwhile, Russia's central bank hurried to buoy the weakening ruble and keep money rates stable. In a rare move, Russia's central bank sold around $4.5 billion on the market yesterday to help support the ruble, traders said. It also injected 87.8 billion rubles ($3.4 billion) into the market through two one-day securities repurchase agreements.
Japan's finance minister, Koji Omi, said he had spoken by telephone with U.S. Treasury Secretary Henry Paulson as they work together closely to monitor the recent financial-market turmoil.
Among major central banks, the Bank of England has stood out for its reluctance to pump extra funds into markets. The use of the standing facility typically goes unnoticed by the broader markets. But the short-term debt market is in such disarray that even the slightest hint of more trouble could roil markets.
"The London money markets are still very tight," said David Page, U.K. economist at Investec. "The [Bank of England's] lack of intervention, especially compared with other central banks, has been to the detriment of the London market."
The euro commercial-paper market has also slowed significantly in recent days. Short-term debt investors, who typically buy the corporate IOUs without concern, have been unwilling to risk that the paper might not be renewed or paid down.
The worst hit is the asset-backed commercial-paper market, where affiliates of banks or money managers sell short-term debt to pay off investors and buy assets such as mortgage-backed securities.
To be sure, some euro commercial paper is being sold, albeit for much shorter maturity dates than usual. A normal duration date for the short-term debt is one to three months. But much of the debt that traded Monday had much shorter maturities and was increasingly expensive for the debt sellers to issue.
In the euro zone, the ECB's second-consecutive surplus weekly infusion shows euro-zone banks remain unusually hungry for cash. Still, it is less than the extra €73.5 billion the bank injected during its weekly refinancing operation last week. The bank said it is trying to mop up some of those excess funds.
Excerpts below from an article in the WSJ indicates that the central banks (ECB, the Fed, BOJ, etc.) are still injecting funds into the credit markets. But the amount is much lower than the massive amounts pumped into the markets almost two weeks ago.
The Federal Reserve injected $3.75 billion, following the $3.5 billion it put into markets Monday. The European Central Bank allotted €275 billion ($371 billion) in one-week funds, which is €46 billion more than it estimated banks need for routine business. And the Bank of Japan put 800 billion yen ($6.96 billion) into its market, following an infusion of one trillion yen Monday.
Meanwhile, Russia's central bank hurried to buoy the weakening ruble and keep money rates stable. In a rare move, Russia's central bank sold around $4.5 billion on the market yesterday to help support the ruble, traders said. It also injected 87.8 billion rubles ($3.4 billion) into the market through two one-day securities repurchase agreements.
Japan's finance minister, Koji Omi, said he had spoken by telephone with U.S. Treasury Secretary Henry Paulson as they work together closely to monitor the recent financial-market turmoil.
Among major central banks, the Bank of England has stood out for its reluctance to pump extra funds into markets. The use of the standing facility typically goes unnoticed by the broader markets. But the short-term debt market is in such disarray that even the slightest hint of more trouble could roil markets.
"The London money markets are still very tight," said David Page, U.K. economist at Investec. "The [Bank of England's] lack of intervention, especially compared with other central banks, has been to the detriment of the London market."
The euro commercial-paper market has also slowed significantly in recent days. Short-term debt investors, who typically buy the corporate IOUs without concern, have been unwilling to risk that the paper might not be renewed or paid down.
The worst hit is the asset-backed commercial-paper market, where affiliates of banks or money managers sell short-term debt to pay off investors and buy assets such as mortgage-backed securities.
To be sure, some euro commercial paper is being sold, albeit for much shorter maturity dates than usual. A normal duration date for the short-term debt is one to three months. But much of the debt that traded Monday had much shorter maturities and was increasingly expensive for the debt sellers to issue.
In the euro zone, the ECB's second-consecutive surplus weekly infusion shows euro-zone banks remain unusually hungry for cash. Still, it is less than the extra €73.5 billion the bank injected during its weekly refinancing operation last week. The bank said it is trying to mop up some of those excess funds.
Troubles with S&Ls as Well
The excerpt below from an article in the WSJ indicates that there are problems with S&Ls in terms of delinquency. This is somewhat disconcerting because S&Ls play in the prime/jumbo portion of the sandbox.
Troubled assets -- loans that were 90 days or more past due or had been repossessed -- at federally regulated savings-and-loan associations in the second quarter rose 49% from a year earlier to the highest level in 14 years, according to the Office of Thrift Supervision.
The agency also said that the number of "problem thrifts," or companies rated poorly by regulatory standards, had risen to 10, up from four in the second quarter of 2006.
Still, officials said that while the 836 regulated thrifts continue to feel stress from housing and liquidity markets, their overall health remains strong, based on earnings and capital.
The thrifts make one of every four mortgages, specializing in prime or jumbo loans. Stress in their loan portfolios suggests that more types of loans -- not just subprime mortgages -- are under pressure.
The thrift industry had $14.2 billion in troubled loans, up from $9.5 billion a year earlier, officials said. That is the highest sum since 1993, though as a percentage of total assets it is only the highest since 1997.
The excerpt below from an article in the WSJ indicates that there are problems with S&Ls in terms of delinquency. This is somewhat disconcerting because S&Ls play in the prime/jumbo portion of the sandbox.
Troubled assets -- loans that were 90 days or more past due or had been repossessed -- at federally regulated savings-and-loan associations in the second quarter rose 49% from a year earlier to the highest level in 14 years, according to the Office of Thrift Supervision.
The agency also said that the number of "problem thrifts," or companies rated poorly by regulatory standards, had risen to 10, up from four in the second quarter of 2006.
Still, officials said that while the 836 regulated thrifts continue to feel stress from housing and liquidity markets, their overall health remains strong, based on earnings and capital.
The thrifts make one of every four mortgages, specializing in prime or jumbo loans. Stress in their loan portfolios suggests that more types of loans -- not just subprime mortgages -- are under pressure.
The thrift industry had $14.2 billion in troubled loans, up from $9.5 billion a year earlier, officials said. That is the highest sum since 1993, though as a percentage of total assets it is only the highest since 1997.
More on the Chronicles of the Credit Crunch
Below are a series of articles in the WSJ, that if you have the time, will give some insight into the history of the credit crunch of early August, how this crunch looks compared to 1987 and 1998, and whether or not the Fed efforts are working. By the way, if you do not have a subscription the WSJ online, these articles on the front page of the WSJ on Monday and Tuesday. Go to the library, these articles are a 30 minute read.
A bried history of the credit crunch
Some lessons from 1987 and 1998
Are all the Fed efforts working?
Below are a series of articles in the WSJ, that if you have the time, will give some insight into the history of the credit crunch of early August, how this crunch looks compared to 1987 and 1998, and whether or not the Fed efforts are working. By the way, if you do not have a subscription the WSJ online, these articles on the front page of the WSJ on Monday and Tuesday. Go to the library, these articles are a 30 minute read.
A bried history of the credit crunch
Some lessons from 1987 and 1998
Are all the Fed efforts working?
The Chronicles of the Credit Crunch (almost sounds like an advertisement for cereal)
Below are excerpts are from a Market Watch article that gives an abbreviated history of the credit crunch of early August.
Let's review the series of seemingly inconsistent events . . . . during what was supposed to be a quiet stretch on the summer deck.
At the beginning of the summer, when "collateralized debt obligations" and "subprime mortgages" were first introduced into the mainstream vernacular, Treasury Secretary Hank Paulson was quick to assure us that the problems were "contained."
To be fair, Mr. Paulson wasn't alone. In fact, he was in very good company. San Francisco Fed President Janet Yellen, Federal Reserve Chairman Ben Bernanke, Dallas Fed President Richard Fisher and Federal Reserve Governor Fredric Mishkin were unanimous in their assuring voices that we had nothing to fear but fear itself.
Fast forward a few months. That's when things really started getting strange.
The Federal Open Market Committee, the Fed's rate-policy panel, announced on August 7 that while "markets were volatile" and "credit conditions tightened for some households and businesses," the economy "seemed likely to expand at a moderate pace in coming quarters, paced by solid growth in unemployment and incomes and a robust global economy." . . . .
Two days after the FOMC meeting, BNP Paribas, France's largest bank, halted withdrawals from three funds because it couldn't fairly value holdings tied to the stateside subprime mess.
IKB Deutsche Bundesbank confirmed that it was holding special meetings to discuss its "financial situation."
The U.K. issued a statement that its subprime crisis might be worse than the one in the U.S.
Those concerns, on the margin, were disconcerting. But as actions speak louder than words, the sequence of events that followed offered a more telling view that strange things were afoot at the Circle-K.
The European Central Bank, in an "unprecedented response to a sudden demand for cash," injected $130 billion into the financial machination.
The U.S., Japan and Australia also stepped up to the plate with piles of dough, upping the ante to more than $300 billion.
Even Canada -- Canada! -- chimed in to "assure financial-market participants that it will provide liquidity to support the stability of the Canadian financial system and the continued functioning of the financial markets."
The next day, Countrywide Financial, the biggest U.S mortgage lender, said it faced "unprecedented disruptions" in the operations. If investors were waiting for another shoe to drop, was that it?
On Aug. 14, as the price action in the financials continued to falter, UBS, Europe's largest bank, professed that "turbulent markets may cut into profits for the rest of the year."
Santander, the large Spanish bank, offered that it had upward of $3 billion of exposure to high-risk loans in the U.S.
Australian mortgage lender Rams Home Loans Group, citing "unprecedented disruptions in credit markets," promptly took a 20% overnight haircut.
The ECB and the U.S. continued to pump liquidity into the marketplace as concerns continued to mount.
David Walker, the U.S. comptroller general, proclaimed that the U.S government was on a "burning platform of unsustainable policies with fiscal deficits, chronic health-care underfunding" and "chilling long-term stimulations" as he mapped the parallels between modern-day society and the fall of the Roman Empire.
These are not my words. They come from a nonpartisan figure in charge of the Government Accountability Office, which is often described as the investigative arm of the U.S. Congress.
"I'm trying to sound an alarm and issue a wakeup call," he said in the midst of his 15-year term, which began during the Clinton administration. "The U.S is on a path toward an explosion of debt."
The next session, as fate would have it, was Redemption Day for funds with a 45-day advance-notice redemption window. As the smartest money on the Street, including Goldman Sachs's mighty Alpha fund, took it on the chin, investors were given a chance to leave the dance.
That dynamic, so it's said, will continue to play out in the coming month as the clock ticks and outgoing mail begins to sail.
The next day, Bill Poole, the (soon-to-be-ex-) president of the St. Louis Fed, amazingly offered that the FOMC wouldn't issue a surprise rate cut absent a "financial calamity."
As Countrywide Credit tapped its entire $11.5 billion credit line, forced liquidations found their way across a spectrum of sectors and the mainstay averages approached a 10% correction from the highs, Mr. Poole seemingly tied a bow across the box the Fed now found itself in.
True to the path of maximum frustration, and amid a 300-point decline in the Dow Jones Industrial Average, the market reversed sharply higher and closed near the flat line, catching late-to-the-game pressers leaning the wrong way. Still, the overnight session was an absolute mess, with global markets getting pummeled and tensions rising into options expiration.
And that's when the FOMC, fully aware that the structural machination of August expiration would worsen volatility, pulled the trigger and cut the discount rate, completely contradicting what it said two weeks prior.
The near-term reaction, after a few tenuous downside tries, was seemingly what the panel wanted: higher prices, albeit mutedly so.
On Monday, we learned that Deutsche Bank borrowed money from the FOMC's 5.75% discount window. While the amount wasn't disclosed, sources say that the move was orchestrated to show support for the Fed as it continued to combat the credit squeeze.
As we powered up for trading yesterday, the chief executive of WestLB, one of Germany's largest banks, warned that "foreigners were increasingly loathe to extend credit to financial institutions in Europe's largest economy, which could spark a crisis."
Those comments followed similarly strained sentiments from German lender SachsenLB, which said it required a credit line of $23.2 billion due to investments affected by the U.S subprime-mortgage crisis, and IKB Deutsche Industriebank, which required a similar bailout.
Germany's finance minister, Peer Steinbrueck, remained optimistic in the face of the news, offering that he saw no signs of the German economy being affected and that he believed "those involved have the situation in hand."
Shortly thereafter, as the U.S market readied for trading, Mr. Paulson, ahead of his closed-door meeting with Fed Chairman Ben Bernanke and Senate Banking Committee Chairman Christopher Dodd, stepped back on stage to assure us that we were enjoying the benefit of a "strong global economy" and a "healthy financial system."
Below are excerpts are from a Market Watch article that gives an abbreviated history of the credit crunch of early August.
Let's review the series of seemingly inconsistent events . . . . during what was supposed to be a quiet stretch on the summer deck.
At the beginning of the summer, when "collateralized debt obligations" and "subprime mortgages" were first introduced into the mainstream vernacular, Treasury Secretary Hank Paulson was quick to assure us that the problems were "contained."
To be fair, Mr. Paulson wasn't alone. In fact, he was in very good company. San Francisco Fed President Janet Yellen, Federal Reserve Chairman Ben Bernanke, Dallas Fed President Richard Fisher and Federal Reserve Governor Fredric Mishkin were unanimous in their assuring voices that we had nothing to fear but fear itself.
Fast forward a few months. That's when things really started getting strange.
The Federal Open Market Committee, the Fed's rate-policy panel, announced on August 7 that while "markets were volatile" and "credit conditions tightened for some households and businesses," the economy "seemed likely to expand at a moderate pace in coming quarters, paced by solid growth in unemployment and incomes and a robust global economy." . . . .
Two days after the FOMC meeting, BNP Paribas, France's largest bank, halted withdrawals from three funds because it couldn't fairly value holdings tied to the stateside subprime mess.
IKB Deutsche Bundesbank confirmed that it was holding special meetings to discuss its "financial situation."
The U.K. issued a statement that its subprime crisis might be worse than the one in the U.S.
Those concerns, on the margin, were disconcerting. But as actions speak louder than words, the sequence of events that followed offered a more telling view that strange things were afoot at the Circle-K.
The European Central Bank, in an "unprecedented response to a sudden demand for cash," injected $130 billion into the financial machination.
The U.S., Japan and Australia also stepped up to the plate with piles of dough, upping the ante to more than $300 billion.
Even Canada -- Canada! -- chimed in to "assure financial-market participants that it will provide liquidity to support the stability of the Canadian financial system and the continued functioning of the financial markets."
The next day, Countrywide Financial, the biggest U.S mortgage lender, said it faced "unprecedented disruptions" in the operations. If investors were waiting for another shoe to drop, was that it?
On Aug. 14, as the price action in the financials continued to falter, UBS, Europe's largest bank, professed that "turbulent markets may cut into profits for the rest of the year."
Santander, the large Spanish bank, offered that it had upward of $3 billion of exposure to high-risk loans in the U.S.
Australian mortgage lender Rams Home Loans Group, citing "unprecedented disruptions in credit markets," promptly took a 20% overnight haircut.
The ECB and the U.S. continued to pump liquidity into the marketplace as concerns continued to mount.
David Walker, the U.S. comptroller general, proclaimed that the U.S government was on a "burning platform of unsustainable policies with fiscal deficits, chronic health-care underfunding" and "chilling long-term stimulations" as he mapped the parallels between modern-day society and the fall of the Roman Empire.
These are not my words. They come from a nonpartisan figure in charge of the Government Accountability Office, which is often described as the investigative arm of the U.S. Congress.
"I'm trying to sound an alarm and issue a wakeup call," he said in the midst of his 15-year term, which began during the Clinton administration. "The U.S is on a path toward an explosion of debt."
The next session, as fate would have it, was Redemption Day for funds with a 45-day advance-notice redemption window. As the smartest money on the Street, including Goldman Sachs's mighty Alpha fund, took it on the chin, investors were given a chance to leave the dance.
That dynamic, so it's said, will continue to play out in the coming month as the clock ticks and outgoing mail begins to sail.
The next day, Bill Poole, the (soon-to-be-ex-) president of the St. Louis Fed, amazingly offered that the FOMC wouldn't issue a surprise rate cut absent a "financial calamity."
As Countrywide Credit tapped its entire $11.5 billion credit line, forced liquidations found their way across a spectrum of sectors and the mainstay averages approached a 10% correction from the highs, Mr. Poole seemingly tied a bow across the box the Fed now found itself in.
True to the path of maximum frustration, and amid a 300-point decline in the Dow Jones Industrial Average, the market reversed sharply higher and closed near the flat line, catching late-to-the-game pressers leaning the wrong way. Still, the overnight session was an absolute mess, with global markets getting pummeled and tensions rising into options expiration.
And that's when the FOMC, fully aware that the structural machination of August expiration would worsen volatility, pulled the trigger and cut the discount rate, completely contradicting what it said two weeks prior.
The near-term reaction, after a few tenuous downside tries, was seemingly what the panel wanted: higher prices, albeit mutedly so.
On Monday, we learned that Deutsche Bank borrowed money from the FOMC's 5.75% discount window. While the amount wasn't disclosed, sources say that the move was orchestrated to show support for the Fed as it continued to combat the credit squeeze.
As we powered up for trading yesterday, the chief executive of WestLB, one of Germany's largest banks, warned that "foreigners were increasingly loathe to extend credit to financial institutions in Europe's largest economy, which could spark a crisis."
Those comments followed similarly strained sentiments from German lender SachsenLB, which said it required a credit line of $23.2 billion due to investments affected by the U.S subprime-mortgage crisis, and IKB Deutsche Industriebank, which required a similar bailout.
Germany's finance minister, Peer Steinbrueck, remained optimistic in the face of the news, offering that he saw no signs of the German economy being affected and that he believed "those involved have the situation in hand."
Shortly thereafter, as the U.S market readied for trading, Mr. Paulson, ahead of his closed-door meeting with Fed Chairman Ben Bernanke and Senate Banking Committee Chairman Christopher Dodd, stepped back on stage to assure us that we were enjoying the benefit of a "strong global economy" and a "healthy financial system."
Monday, August 20, 2007
The Fed Comments on the Wealth Effect of the Housing Boom and its Aftermath
The following from Market Watch discusses a paper released by the Vice Chairman of the Fed concerning the wealth effect of the housing boom and what could happen as a result. Based on the article the paper does not say anything particularly new, but it validates what many have been thinking for some time, namely the increasing wealth effect has juiced consumer spending. Also decreasing asset values has a more sensitive effect on consumer spending then in previous periods.
Rising home prices and innovations in the financial sector are the two biggest factors in the spike in U.S. household debt and the related decline in savings, Federal Reserve Vice Chairman Donald Kohn wrote in a research paper presented Sunday.
In a paper presented to a conference held by the Reserve Bank of Australia, Kohn and a Fed economist wrote that a "wealth effect" caused by rising home prices could boost consumption, leading in turn to an increase in household debt. Expenditures for more expensive homes are another factor behind an increase in debt, wrote Kohn and co-author Karen Dynan, chief of the household and real estate finance section of the Fed's Division of Research and Statistics.
In their paper, Kohn and Dynan noted that the personal savings rate in the U.S. has fallen from an average of 9.1% in the 1980s to an average of 1.7% so far this decade. In the same period, the ratio of total household debt to aggregate personal income has risen from 0.6 to 1.0.
Meanwhile, new financial products have reduced the cost and availability of housing finance, wrote Kohn and Dynan.
"Innovation has opened up greater opportunities for households to enter the housing market and for homeowners to liquefy their housing wealth, thereby helping them smooth consumption of all goods and services," they wrote.
Kohn and Dynan wrote that there are several reasons to be cautious about the impact of rising debt levels on the overall economy, although they noted that increased access to credit should give households the ability to weather shocks.
They said household spending is now probably more sensitive to unexpected movements in asset prices than it used to be. (my emphasis) Kohn and Dynan also wrote that some households are prone to become very highly indebted relative to income and wealth.
They noted that some U.S. households will face "significant financial distress" thanks to ongoing turmoil in the subprime mortgage market and said that regulators should consider additional rules for safe and sound underwriting practices.
Later this year, in an effort to address the fallout from that turmoil, the Fed is expected to propose rules addressing practices like prepayment penalties and evaluating a borrower's ability to repay a loan. Individuals and groups have urged the Fed to ban or limit so-called "no-doc" loans and prepayment penalties, which are the fees charged when a borrower pays off a mortgage early.
The following from Market Watch discusses a paper released by the Vice Chairman of the Fed concerning the wealth effect of the housing boom and what could happen as a result. Based on the article the paper does not say anything particularly new, but it validates what many have been thinking for some time, namely the increasing wealth effect has juiced consumer spending. Also decreasing asset values has a more sensitive effect on consumer spending then in previous periods.
Rising home prices and innovations in the financial sector are the two biggest factors in the spike in U.S. household debt and the related decline in savings, Federal Reserve Vice Chairman Donald Kohn wrote in a research paper presented Sunday.
In a paper presented to a conference held by the Reserve Bank of Australia, Kohn and a Fed economist wrote that a "wealth effect" caused by rising home prices could boost consumption, leading in turn to an increase in household debt. Expenditures for more expensive homes are another factor behind an increase in debt, wrote Kohn and co-author Karen Dynan, chief of the household and real estate finance section of the Fed's Division of Research and Statistics.
In their paper, Kohn and Dynan noted that the personal savings rate in the U.S. has fallen from an average of 9.1% in the 1980s to an average of 1.7% so far this decade. In the same period, the ratio of total household debt to aggregate personal income has risen from 0.6 to 1.0.
Meanwhile, new financial products have reduced the cost and availability of housing finance, wrote Kohn and Dynan.
"Innovation has opened up greater opportunities for households to enter the housing market and for homeowners to liquefy their housing wealth, thereby helping them smooth consumption of all goods and services," they wrote.
Kohn and Dynan wrote that there are several reasons to be cautious about the impact of rising debt levels on the overall economy, although they noted that increased access to credit should give households the ability to weather shocks.
They said household spending is now probably more sensitive to unexpected movements in asset prices than it used to be. (my emphasis) Kohn and Dynan also wrote that some households are prone to become very highly indebted relative to income and wealth.
They noted that some U.S. households will face "significant financial distress" thanks to ongoing turmoil in the subprime mortgage market and said that regulators should consider additional rules for safe and sound underwriting practices.
Later this year, in an effort to address the fallout from that turmoil, the Fed is expected to propose rules addressing practices like prepayment penalties and evaluating a borrower's ability to repay a loan. Individuals and groups have urged the Fed to ban or limit so-called "no-doc" loans and prepayment penalties, which are the fees charged when a borrower pays off a mortgage early.
Saturday, August 18, 2007
Ever Heard of the Minsky Moment – You May Want to Read About It
The following from the WSJ is an article about Hyman Minsky and his thoughts on the business cycle, speculation, and crisis in the financial markets. Although never popular amongst academics of his time, he is popular with some investors. (Which one is a mark of success?)
The recent market turmoil is rocking investors around the globe. But it is raising the stock of one person: a little-known economist whose views have suddenly become very popular.
Hyman Minsky, who died more than a decade ago, spent much of his career advancing the idea that financial systems are inherently susceptible to bouts of speculation that, if they last long enough, end in crises. At a time when many economists were coming to believe in the efficiency of markets, Mr. Minsky was considered somewhat of a radical for his stress on their tendency toward excess and upheaval.
Today, his views are reverberating from New York to Hong Kong as economists and traders try to understand what's happening in the markets. The Levy Economics Institute of Bard College, where Mr. Minsky worked for the last six years of his life, is planning to reprint two books by the economist -- one on John Maynard Keynes, the other on unstable economies. The latter book was being offered on the Internet for thousands of dollars.
Christopher Wood, a widely read Hong Kong-based analyst for CLSA Group, told his clients that recent cash injections by central banks designed "to prevent, or at least delay, a 'Minsky moment,' is evidence of market failure."
Indeed, the Minsky moment has become a fashionable catch phrase on Wall Street. It refers to the time when over-indebted investors are forced to sell even their solid investments to make good on their loans, sparking sharp declines in financial markets and demand for cash that can force central bankers to lend a hand.
Mr. Minsky, who died in 1996 at the age of 77, was a tall man with unruly hair who wore unpressed suits. He approached the world as "one big research tank," says Diana Minsky, his daughter, an art history professor at Bard. "Economics was an integrated part of his life. It wasn't isolated. There wasn't a sense that work was something he did at the office."
She recalls how, on a trip to a village in Italy to meet friends, Mr. Minsky ended up interviewing workers at a glove maker to understand how small-scale capitalism worked in the local economy.
Although he was born in Chicago, Mr. Minsky didn't have many fans in the "Chicago School" of economists, who believed that markets were efficient. A follower of the economist John Maynard Keynes, he died just before a decade of financial crises in Asia, Russia, tech stocks, corporate credit and now mortgage debt, began to lend credence to his ideas.
Following those periods of tumult, more investors turned to the investment classic "Manias, Panics, and Crashes: A History of Financial Crises," by Charles Kindleberger, a professor at the Massachusetts Institute of Technology who leaned heavily on Mr. Minsky's work.
Mr. Kindleberger showed that financial crises unfolded the way that Mr. Minsky said they would. Though a loyal follower, Mr. Kindleberger described Mr. Minsky as "a man with a reputation among monetary theorists for being particularly pessimistic, even lugubrious, in his emphasis on the fragility of the monetary system and its propensity to disaster."
At its core, the Minsky view was straightforward: When times are good, investors take on risk; the longer times stay good, the more risk they take on, until they've taken on too much. Eventually, they reach a point where the cash generated by their assets no longer is sufficient to pay off the mountains of debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. "This is likely to lead to a collapse of asset values," Mr. Minsky wrote.
When investors are forced to sell even their less-speculative positions to make good on their loans, markets spiral lower and create a severe demand for cash. At that point, the Minsky moment has arrived.
"We are in the midst of a Minsky moment, bordering on a Minsky meltdown," says Paul McCulley, an economist and fund manager at Pacific Investment Management Co., the world's largest bond-fund manager, in an email exchange.
The housing market is a case in point, says Investment Technology Group Inc. economist Robert Barbera, who first met Mr. Minsky in the late 1980s. When home buyers were expected to have a down payment of 10% or 20% to qualify for a mortgage, and to provide income documentation that showed they'd be able to make payments, there was minimal risk. But as home prices rose, and speculators entered the market, lenders relaxed their guard and began offering loans with no money down and little or no documentation.
Once home prices stalled and, in many of the more-speculative markets, fell, there was a big problem.
"If you're lending to home buyers with 20% down and house prices fall by 2%, so what?" Mr. Barbera says. If most of a lender's portfolio is tied up in loans to buyers who "don't put anything down and house prices fall by 2%, you're bankrupt," he says.
Several money managers are laying claim to spotting the Minsky moment first. "I featured him about 18 months ago," says Jeremy Grantham, chairman of GMO LLC, which manages $150 billion in assets. He pointed to a note in early 2006 when he wrote that investors had become too comfortable that financial markets were safe, and consequently were taking on too much risk, just as Mr. Minsky predicted. "Guinea pigs of the world unite. We have nothing to lose but our shirts," he concluded.
It was Mr. McCulley at Pacific Investment, though, who coined the phrase "Minsky moment" during the Russian debt crisis in 1998.
Laurence Meyer, who served on the faculty with Mr. Minsky at Washington University in St. Louis, was a Federal Reserve Governor during those turbulent times. Mr. Meyer says that when he was an academic, Mr. Minsky's work didn't interest him very much, but that changed when he went into the real world. He says he grew to appreciate it even more when he was at the Fed watching financial crises unfold.
"Had Minsky been there, he probably would have been calling me and alerting me along the ride. And that would have been a good thing," Mr. Meyer says. "Every year that goes by, I appreciate him more. I hear myself sometimes and I think, oh my gosh, I sound like Hy Minsky."
Steven Fazzari, an economics professor at Washington University, says that Mr. Minsky would have supported the Federal Reserve's recent move to provide cash and cut the rate it charges banks on loans from its discount window to try to avert a financial crisis that could spill over to the economy. But he would probably be worried, too, that the moves might be bailing out investors who would all too soon be speculating again.
Having seen recent events unfold in the way his friend and former colleague predicted, Mr. Fazzari says, "I hope he's someplace saying, 'Aha, I told you so!'"
The following from the WSJ is an article about Hyman Minsky and his thoughts on the business cycle, speculation, and crisis in the financial markets. Although never popular amongst academics of his time, he is popular with some investors. (Which one is a mark of success?)
The recent market turmoil is rocking investors around the globe. But it is raising the stock of one person: a little-known economist whose views have suddenly become very popular.
Hyman Minsky, who died more than a decade ago, spent much of his career advancing the idea that financial systems are inherently susceptible to bouts of speculation that, if they last long enough, end in crises. At a time when many economists were coming to believe in the efficiency of markets, Mr. Minsky was considered somewhat of a radical for his stress on their tendency toward excess and upheaval.
Today, his views are reverberating from New York to Hong Kong as economists and traders try to understand what's happening in the markets. The Levy Economics Institute of Bard College, where Mr. Minsky worked for the last six years of his life, is planning to reprint two books by the economist -- one on John Maynard Keynes, the other on unstable economies. The latter book was being offered on the Internet for thousands of dollars.
Christopher Wood, a widely read Hong Kong-based analyst for CLSA Group, told his clients that recent cash injections by central banks designed "to prevent, or at least delay, a 'Minsky moment,' is evidence of market failure."
Indeed, the Minsky moment has become a fashionable catch phrase on Wall Street. It refers to the time when over-indebted investors are forced to sell even their solid investments to make good on their loans, sparking sharp declines in financial markets and demand for cash that can force central bankers to lend a hand.
Mr. Minsky, who died in 1996 at the age of 77, was a tall man with unruly hair who wore unpressed suits. He approached the world as "one big research tank," says Diana Minsky, his daughter, an art history professor at Bard. "Economics was an integrated part of his life. It wasn't isolated. There wasn't a sense that work was something he did at the office."
She recalls how, on a trip to a village in Italy to meet friends, Mr. Minsky ended up interviewing workers at a glove maker to understand how small-scale capitalism worked in the local economy.
Although he was born in Chicago, Mr. Minsky didn't have many fans in the "Chicago School" of economists, who believed that markets were efficient. A follower of the economist John Maynard Keynes, he died just before a decade of financial crises in Asia, Russia, tech stocks, corporate credit and now mortgage debt, began to lend credence to his ideas.
Following those periods of tumult, more investors turned to the investment classic "Manias, Panics, and Crashes: A History of Financial Crises," by Charles Kindleberger, a professor at the Massachusetts Institute of Technology who leaned heavily on Mr. Minsky's work.
Mr. Kindleberger showed that financial crises unfolded the way that Mr. Minsky said they would. Though a loyal follower, Mr. Kindleberger described Mr. Minsky as "a man with a reputation among monetary theorists for being particularly pessimistic, even lugubrious, in his emphasis on the fragility of the monetary system and its propensity to disaster."
At its core, the Minsky view was straightforward: When times are good, investors take on risk; the longer times stay good, the more risk they take on, until they've taken on too much. Eventually, they reach a point where the cash generated by their assets no longer is sufficient to pay off the mountains of debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. "This is likely to lead to a collapse of asset values," Mr. Minsky wrote.
When investors are forced to sell even their less-speculative positions to make good on their loans, markets spiral lower and create a severe demand for cash. At that point, the Minsky moment has arrived.
"We are in the midst of a Minsky moment, bordering on a Minsky meltdown," says Paul McCulley, an economist and fund manager at Pacific Investment Management Co., the world's largest bond-fund manager, in an email exchange.
The housing market is a case in point, says Investment Technology Group Inc. economist Robert Barbera, who first met Mr. Minsky in the late 1980s. When home buyers were expected to have a down payment of 10% or 20% to qualify for a mortgage, and to provide income documentation that showed they'd be able to make payments, there was minimal risk. But as home prices rose, and speculators entered the market, lenders relaxed their guard and began offering loans with no money down and little or no documentation.
Once home prices stalled and, in many of the more-speculative markets, fell, there was a big problem.
"If you're lending to home buyers with 20% down and house prices fall by 2%, so what?" Mr. Barbera says. If most of a lender's portfolio is tied up in loans to buyers who "don't put anything down and house prices fall by 2%, you're bankrupt," he says.
Several money managers are laying claim to spotting the Minsky moment first. "I featured him about 18 months ago," says Jeremy Grantham, chairman of GMO LLC, which manages $150 billion in assets. He pointed to a note in early 2006 when he wrote that investors had become too comfortable that financial markets were safe, and consequently were taking on too much risk, just as Mr. Minsky predicted. "Guinea pigs of the world unite. We have nothing to lose but our shirts," he concluded.
It was Mr. McCulley at Pacific Investment, though, who coined the phrase "Minsky moment" during the Russian debt crisis in 1998.
Laurence Meyer, who served on the faculty with Mr. Minsky at Washington University in St. Louis, was a Federal Reserve Governor during those turbulent times. Mr. Meyer says that when he was an academic, Mr. Minsky's work didn't interest him very much, but that changed when he went into the real world. He says he grew to appreciate it even more when he was at the Fed watching financial crises unfold.
"Had Minsky been there, he probably would have been calling me and alerting me along the ride. And that would have been a good thing," Mr. Meyer says. "Every year that goes by, I appreciate him more. I hear myself sometimes and I think, oh my gosh, I sound like Hy Minsky."
Steven Fazzari, an economics professor at Washington University, says that Mr. Minsky would have supported the Federal Reserve's recent move to provide cash and cut the rate it charges banks on loans from its discount window to try to avert a financial crisis that could spill over to the economy. But he would probably be worried, too, that the moves might be bailing out investors who would all too soon be speculating again.
Having seen recent events unfold in the way his friend and former colleague predicted, Mr. Fazzari says, "I hope he's someplace saying, 'Aha, I told you so!'"
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