Leverage in a Global Economy

Posted by T.W. Hanson - Apr 2nd, 2008 at 20:04

 earth

The New York Times devoted an entire section of today’s paper to living in a leveraged world.  The potential problems of this reality are small compared to global climate change, but they are much larger than the current U.S. housing crisis.

This is a must read for vicenarians interested in how money, markets and the global economy functions.

Leveraged Planet

Exxon Vs. Venezuela, Round 2

Posted by T.W. Hanson - Mar 18th, 2008 at 20:03

oil platform

So you are the world’s largest company and operate oil wells around the globe. You wake up one morning, and you are told that your $5 billion investment is no longer yours. Apparently, Venezuela has decided to take away your oil assets in their region. Fortunately for you, the financial wherewithals of the two parties are about equal. They have a military, but I hear Blackwater is available for hire.

Step 1: Sue them everywhere in the world.

In January, Exxon won rulings from courts in London and elsewhere freezing Venezuelan assets around the globe.

Step 2: Wait for a reaction.

Since that ruling, Venezuela has responded by threatening to cut off oil supplies to the West and moved troops to the Colombian border, one of America’s best friends. They also continued to fight Exxon’s legal claims in court.

Today, a London court ruled in Venezuela’s favor. The assets were unfrozen and Hugo Chavez acheived a clear victory.

Step 3: Keep the legal challenge going and look up Blackwater’s phone number.

A Market Bubble Collapses: The Slow Motion Train Wreck Version

Posted by T.W. Hanson - Mar 16th, 2008 at 20:03

train wreck

Vicenarians don’t have much practical experience with the troughs in the business cycle. There was the savings and loan crisis in the late 80s and early 90s, but many of us were learning how to read during those years. The Internet/.com bubble collapse of 2000 is our primary frame of reference for distressful economic times. This crisis is appears very different. Although characteristics like increased unemployment seem to reappear each cycle, there are rarely perfect parallels from one downturn to another. One of the macro differences is the speed. The rate at which this credit markets are contracting is much slower than the rapid implosion of the Internet companies in 2000.

Unlike in 2000, today’s irrationally overvalued assets are homes and properties.  Prices for these assets are sticky.  Most are unique and take weeks, months or years to sell.  One result of this is that the securities tied to the value of these properties have fallen at a similarly and painfully slow pace.  Write downs of assets on bank balance sheets haven’t occurred all at one but have been stretched from quarter to quarter to quarter.  This is forecast by some to continue for quarters to come.

bubbleDuring the Internet bubble, company values were wiped out overnight.  Equity values disappeared, companies shut down, people and families felt pain and the economy took a hit.  However, it was over in a relatively short period of time.

The industry this is hitting the hardest is slowing down the bleeding even more.  The financial institutions provide and source the capital for all other industries.  Each day they are operating in a weakened state, other businesses and individuals aren’t getting the financings or financing terms that a fully functioning free market would provide.

When will the market recover and economic expansion resume?  When the financial sector reaches a catharsis resulting from both the final write down and the replenishment of tangible assets on their balance sheets.  Don’t hold your breath.

Bear Stearns

Posted by T.W. Hanson - Mar 15th, 2008 at 11:03


bank run

This is exactly what is happening.

Confused Crisscrossing Markets

Posted by T.W. Hanson - Mar 12th, 2008 at 21:03

 directions

Since the current financial trouble started in the summer of 2007, stock, credit, currency and commodity markets have moved severely.  Interesting is the lack of coordination.  The past 48 hours are a good illustration of this phenomenon.  Equity markets found the $200 billion in lending from the Fed to be fabulous news while the bonds of some of the very same equities didn’t really move.  Traders in the currency markets were convinced early today that the Fed action would fail in its purpose, and pummeled the dollar.  It took the equity market until the end of the day to react in a seemingly similar fashion.  What is the cause of this confusion?

Analytics and quantitative models have lost the faith of the market.  Tools used to value everything from the value of a mortgage to probabilities of corporate defaults are coming scrutiny.   The equations, machines and historical correlations that have typically governed market behavior broke down over the summer.  The variations of models used to value everything from bonds to mortgages to credit default swaps are more disjoint, leaving traders with less uniform valuation techniques.  Think of a heard of buffalo all losing their sight while barreling across the Serengeti.  One example was the lack was the lack of any consolidation of opinions on what the quantitative impact of the Fed’s $200 billion infusion will be.

Without the unifying models and historical correlations, specialization in training on Wall Street becomes another force decoupling the markets.  As my former superiors in investment banking liked to say, “The days of the generalist are over.”  Foreign exchange, corporate credit and equity people work on separate floors; it is even rare to see them at the same social functions.  With all of the current turmoil, each of these worlds is interpreting data differently.  For example, credit analysis often focuses on the past performance of a company while equity markets usually value securities based on future cash flows.  The equity world is much more likely to forgive big write downs and look to the future while credit investors have their attentions squarely on the trauma of the past half year.  We have seen more than a handful of days in 2008 where equities have traded higher while bond spreads have increased, truly irreconcilable moves in “efficient markets.”

What this will bring in the weeks ahead is volatility.  Until it is somewhat clear in what direction the economy is moving or at least what the general effect of Fed policy will be, the markets will continue to move in confounding directions.  Rumors will continue to fly, which have already almost brought down institutions like Bear Stearns.

Tomorrow, we get to see how the markets will interpret retail sales numbers.  Consumer spending makes up over 2/3 of the economy.  The number isn’t likely to be pretty, but how much of that is already priced in to the market?  Wait, how much of that is priced into which market?

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