Wealth International, Limited

Finance Digest for Week of March 12, 2007

Note:  This week’s Offshore News Digest may be found here.


Forbes uncovers 946 billionaires in their search this year.

It has been a busy year for Forbes’s team of fortune hunters. Strong equity markets combined with rising real estate values and commodity prices pushed up fortunes from Mumbai to Madrid. Forbes pinned down a record 946 billionaires. There were 178 newcomers, including 19 Russians, 14 Indians, 13 Chinese and 10 Spaniards, as well as the first billionaires from Cyprus, Oman, Romania and Serbia.

Ingenuity, not industry, is the common characteristic. These folks made money in everything from media and real estate to coffee, dumplings and ethanol. Two-thirds of last year’s billionaires are richer. Only 17% are poorer, including 32 who fell below the billion-dollar mark. The billionaires’ combined net worth climbed by $900 billion to $3.5 trillion, or an average of $3.6 billion each. The average billionaire is 62 years old, two years younger than in 2005. This year’s new billionaires are seven years younger than that. Of list members’ fortunes, 60% made theirs from scratch.

Within the ranks are simmering rivalries. Microsoft founder Bill Gates, the world’s richest man for 13 years, and his pal Warren Buffett, who holds the #2 spot despite enormous charitable donations, are quickly losing ground to Mexico’s most-monied man, Carlos Slim Helú. Helú’s net worth is up an astonishing $19 billion this year, and is now just $7 billion shy of Gates and $3 billion less than Buffett. In Europe, Russia’s mostly young, self-made tycoons are catching up to Germany’s often-aging heirs and heiresses. Russia now has 53 billionaires (2 shy of Germany’s total), but they are worth an aggregate of $282 billion ($37 billion more than Germany’s richest). In Asia, India has 36, worth a combined $191 billion, followed by Japan with 24, worth a combined $64 billion. India’s rich are also marching toward the top of our rankings. Brothers Mukesh and Anil Ambani, who split up their family’s conglomerate in 2005, join Lakshmi Mittal, who heads the world’s biggest steel company, Arcelor Mittal, among the world’s 20 wealthiest. India now has three in the upper echelons, second only to the U.S.

But even in such a prosperous year, 44 people dropped off the list for various reasons. All our numbers are based on a snapshot of balance sheets taken on February 9, the day we locked in stock prices and exchange rates. Between February 9 and March 2 the world’s stock markets, as measured by the Morgan Stanley All Country World Local Index, fell by 3.7%. Some fortunes, e.g., those based on private accumulations of real estate, did not feel a blip. But some suffered severe damage. One big loser was a Spaniard, Enrique Banuelos, whose fortune fell 30% in four days.

Are there billionaires we do not know about? Surely, yes. For instance, we did not uncover Ireland’s Denis O’Brien, who pocketed $800 million in a junk bond offering, until 13 days after the 2/9 cutoff date, so he is not reflected in the rankings.

Link here.

Two decades of wealth.

Since 1987 Forbes has scoured the globe tracking the fortunes of the world’s wealthiest people, and uncovering new faces. In those 20 years we have watched fortunes rise and fall – from the steady climb and staying power of Bill Gates to the precipitous decline of Yoshiaki Tsutsumi. Tsutumi was the world’s richest person in our inaugural year, but the Japanese land baron fell off the list this year. More than a catalog of individual wealth, the global rich list reflects the changing nature of the world economy. Since it began, old world power players like Japan and Germany, along with the billionaires who dominate their businesses, have given way to the latest global hotshots such as booming China, India and Russia. New fortunes are also emerging in developing markets like Kazakhstan, Ukraine and Romania. Here are highlights from the past two decades.

Link here.

A quick billion-odd hedgefund bucks.

At 9:30 a.m. on February 9, five little-known financial executives and a posse of their children and colleagues crowded onto the balcony of the New York Stock Exchange to ring the opening bell. Their company, Fortress Investment Group (NYSE: FIG), which manages 4 hedge funds, 14 private equity funds and 2 real estate vehicles, went public at $18.50. The shares commenced trading at $35. By end of day – coincidentally the same day Forbes locked in stock prices and exchange rates for our 2007 billionaires list – the five men were worth a combined $10.7 billion and very publicly outed as billionaires.

In the next seven days at least 90 stories ran in newspapers, wires and Web sites about the Fortress Five. Wesley Edens, 45, Robert Kauffman, 43, and Randal Nardone, 51, former BlackRock (NYSE: BLK) co-workers, founded Fortress in 1998. They were joined four years later by former Goldman Sachs partners Peter Briger, 43, and Michael Novogratz, 42. In five years they had built funds under management from $1.2 billion to $29.9 billion. Since 2005 they have taken home a collective $650 million in fees.

Fortress declined to speak to Forbes, citing a quiet period and desire for privacy. They had better get used to the publicity.

Link here.


Japanese and U.S. high financial mucky-mucks try to stem damage.

Countless words have been written about the heavy handed tactics of Japan’s Ministry of Finance (MoF) in manipulating the value of the Japanese yen, the Japanese bond market, and squeezing short sellers in the Nikkei-225 futures market. Manipulation of markets through the use of jawboning, re-jigging of inflation statistics, and outright intervention is a time honored tradition at the MoF. The MoF is a political, economic, and intellectual force without parallel, and with a greater concentration of power than any branch of government amongst the major industrialized democracies. In Japan, there is no institution with more power, and it has a borrowing ceiling for foreign exchange intervention of up to ¥140 trillion ($1.2 trillion) for the upcoming fiscal year.

So if U.S. Treasury chief Henry Paulson was looking for a quick fix to rescue the Dow Jones Industrials from crashing below the psychological 12,000-level, his visit to Tokyo’s Financial Warlords on March 6th, was perfectly timed. The U.S. dollar was plummeting towards ¥115.25 when Paulson arrived at MoF headquarters in Tokyo. “Yen carry” traders had borrowed an estimated ¥40 to ¥70 trillion ($350-600 billion) and channeled much of the funds into commodities and stocks around the globe. But the “yen carry” trades were going sour, when the yen suddenly zoomed 5% higher.

U.S. stocks lost $837 billion of value in the 5-day period ended March 2nd, amid a worldwide rout that began in Hong Kong. The sudden unwinding of the “yen carry” trade had whacked $1.5 trillion of value from global stock markets, threatening the global economy. The infamous “yen carry"”trade stopped generating rewards, soon after the G-7 central bankers warned on February 10th, that speculators could get burned by one-way bets against the yen. Then, under heavy pressure from angry European finance ministers who are fed up with Tokyo’s 6-year “cheap yen” policy, the Bank of Japan hiked its overnight loan rate to 0.50%, its highest level in 10-years, to stop the slide in the Japanese yen against the euro and U.S. dollar.

While the BoJ’s rate hike put a floor under the yen, it was not enough to push the low yielding currency higher. What did lift the yen sharply higher, and ignited the global stock market shake-out, were meltdowns in share prices of U.S. sub-prime mortgage lenders, and fears the weakening US housing sector could topple the U.S. economy. Former Fed chief “Easy” Al Greenspan put the odds of a U.S. recession at 1:3.

Carry traders were losing an estimated $10 to $12 billion on over-extended short yen positions, and it was looking very bleak for the global stock markets until the US dollar suddenly found support at 115-yen and the euro bottomed at 150-yen. Did the BoJ intervene in the currency markets on March 6th, at the request of Paulson, to stop the surge in the yen? Did the BoJ and the U.S. Treasury intervene to support the Japanese and U.S. stock markets last week?

The nuts and bolts of the “yen carry” trade.

Before examining the latest Japanese MoF and U.S. Treasury intervention tactics, it is important to understand how the yen carry trade works. It is simple to understand, and it is not just hedge funds and international bankers who engage in the trade. Many brokerage firms offer margin loans at near 1% in Japanese yen, which are reinvested by their clients to buy stocks around the world.

The yen carry trade is primarily a simple game of interest rate arbitrage. Step 1: Borrow yen at 0.5% and convert the yen into US$9,000. Step 2: With $9,000 from Japan and $1,000 of your own money, invest $10,000 in U.S. Treasury notes at 5.00%. Step 3: Collect $500 in interest from the U.S. Treasury, and pay $45 to the Japanese lender. Step 4: Pocket the $455 difference as a profit, for a rate of return of 45.5% on your original $1,000. Step 5: Sell the U.S. Treasury note, and convert the U.S. dollars back into Japanese yen to pay off your loan.

Step 5 is the tricky part, because if the yen were to suddenly surge by 5% against the U.S. dollar, the principal amount of the yen loan would also climb 5% from $9,000 to $9,450, which would wipe out the $455 profit from the interest rate spread. It would be nice to buy yen futures as a hedge against a climbing currency. The problem is that yen futures trade at a hefty premium to the cash market price. Locking into a yen futures contract at say a 4.5% premium to the cash price would wipe out the profit from the interest rate differential between the two currencies. So carry traders must take on currency risk to play the game, which can go very wrong if the yen suddenly shoots higher. And that is what happened earlier this month,, until Paulson huddled with Tokyo Financial Warlords on March 6th.

On February 10th, G-7 central bankers had warned traders against the practice of borrowing vast amounts in low-yield currencies such as the yen and Swiss franc to reinvest for a profit elsewhere. “We want the markets to be aware of the risks of one-way bets, in particular on the foreign exchange market. One-way bets in the present circumstances would not be appropriate. We want the markets to be aware of the risks they contain,” said European Central Bank chief Jean “Tricky” Trichet. Japanese Finance Minister Koji Omi was singing from the same song book. “This means that G-7 countries think that markets, particularly foreign exchange markets, should recognize the risk of moving in one direction too heavily. I think we have come to the appropriate conclusion,” he said. When the chief of the powerful Japanese ministry of finance speaks, currency traders listen but do not always obey.

European central bankers demand a stronger yen. U.S. is opposed to idea.

Aided by the euro’s strength against the yen, Japanese exports to the EU nearly doubled to ¥1.06 trillion in December. But on the flip side, European exports to Japan have waffled between stagnation and deterioration. While Japan is a small market for European exporters, Eurozone finance ministers understand that its exporters will suffer badly in world markets because of cheap competition from Japan in addition to cut-throat competition from China. “I will read again what we just said in Essen, we reaffirm that exchange rates should reflect economic fundamentals,” said Trichet on February 15th. “We believe that the Japanese economy is on a sustainable economic path and that exchange rates should reflect these economic fundamentals.” Earlier on January 31, Bank of France chief Christian Noyer said there was room for the Bank of Japan to raise its interest rates carefully.

So last month, European finance ministers demanded and received an interest rate hike from the BoJ to 0.50%, to stop the slide of the yen. For his part, Paulson was opposed to Europe’s idea of pressuring Japan for a rate hike, and instead was content with Tokyo’s cheap yen policy. On February 14th, Fed Chairman Ben Bernanke aligned himself squarely with Paulson before the Senate Banking Committee. “As best we can tell, the yen’s value is being determined in a free, open, competitive market. There is no evidence of any intervention going on,” he said.

Yet Bernanke’s testimony coincided with an announcement by DaimlerChrysler that it was slashing 13,000 jobs at its North American car plants, bringing the loss of U.S. auto manufacturing jobs to 80,000 over the past 12-months. The disintegration of the U.S. manufacturing base is the price that the U.S. Treasury is willing to pay in return for cheap credit from China, Japan, and South Korea. But European finance ministers were not buying the U.S. Plunge Protection Team’s propaganda and demanded that Japan begin to lift its abnormally low interest rates into alignment with the rest of the world. Four weeks later, the yen carry trade began to unravel, triggering widespread selling of commodities and stocks around the globe by over-extended speculators, banks, and hedge funds.

A brief history of Japanese Ministry of Finance intervention in the yen.

There are many tricks of the trade that the U.S. Treasury’s Plunge Protection Team can learn from Tokyo’s Financial Warlords, who have decades of experience in hand to hand combat with nasty currency speculators and bearish stock market operators. Tokyo’s MoF has acquired $875 billion of foreign currencies through its intervention operations, and has skillfully manhandled the $6.7 trillion Japanese government bond market into a range of just 1.2% to 1.9% for most of the past six years. MoF jawboning is very effective in moving the yen into Tokyo’s desired range, because it has built up a reputation for uncompromising ruthlessness in the markets.

Since March 2004, the BoJ has stayed out of the FX market, the longest period that Tokyo has gone without getting its hands dirty since 1991. But that has not stopped the practice of jawboning and verbal threats to guide the yen, when unruly currency traders get out of line with Tokyo’s target zones. Since March 2004, Japan’s foreign currency reserves have grown by around $50 billion to a record $875 billion, mostly due to the appreciation of the euro against the yen. About 65% of Japan’s FX reserves are in U.S. dollars and 35% in euros, so MoF warlords can enforce a floor under the yen at any point of its choosing, and keep a lid on the “yen carry” trade through massive intervention.

Angry U.S. Democrats are demanding that Tokyo start boosting the yen in the FX market. In October 2006, Japanese FX chief Hiroshi Watanabe put a lid on the U.S. dollar rally near ¥120 and then triggered a slide to as low as ¥114.5 over the next six weeks, after telling reporters in New York, “I see no reason for a further deterioration in the yen given the strength in the Japanese economy.” But yen carry traders regrouped for another rally in the euro and U.S. dollar, and also pushed the yen to its lowest level in 21-years against a basket of currencies representing Japan’s largest trading partners. Japan’s ultra-low interest rates have created enormous bubbles in global stock markets, and have increased the risk of disorderly unwinding of global trade imbalances.

For a second time, Japanese MoF warlords put a lid on the dollar’s rally, this time to ¥122 last month, when the radical inflationist Prime minister, Shinzo Abe finally bowed to the European demand for a stronger yen. The BoJ’s rate hike to 0.50% capped the dollar’s rally at ¥121.50, and then trouble in the U.S. housing sector sent herds of carry traders scrambling for the exits at the same time.

The dollar was dealt the final hammer blow on March 5th, after Japanese trade minister Akira Amari told a Fuji TV program, “I have been thinking that 120-yen/dollar was too cheap in light of Japanese economic power.” By the time Paulson arrived in Tokyo for meeting with MoF chief Omi, the dollar was plunging to ¥115.25, after guru Greenspan give a big ticket audience in Hong Kong his forecast that the U.S. economy faced a 1:3 chance of a recession in 2007. While MoF chief Omi huddled with Paulson, Japanese deputy Finance Minister Hideto Fujii did damage control on March 5th, saying he was “keeping a close eye on moves in the stock and foreign exchange markets.”

Japan and U.S. try to rescue global stock markets.

With all eyes focused on the world’s two most powerful figures in global finance huddled in Tokyo, to stitch a rescue package for the dollar and global stock markets, Japan’s Chief Cabinet Secretary Yasuhisa Shiozaki said, “As share prices have fallen worldwide, our stance is that we are closely watching, while keeping close contact with authorities from other countries,” he said.

But Japan’s near-zero interest rates and severely undervalued currency are at the root cause of financial market bubbles and distortions, says Eisuke Sakakibara, “Mr. Yen”, the former Japanese vice-minister for international finance in 1997-99. Mr. Yen estimates the yen carry trade to be worth ¥40 trillion ($430 billion), “it may be ¥60 trillion or ¥70 trillion, but I do not think it matters now, it’s so large,” he said. Sakakibara said it is “worrying that nobody had any real idea of the scale of the yen carry trade, and traders, hedge funds and asset fund managers operating within it are accustomed to operating only in relatively calm market conditions. All the BoJ can do is to normalize Japanese interest rates at the earliest reasonable opportunity because the excess liquidity situation emanating from the Japanese monetary system needs to be changed as soon as possible.”

It seems like déjà vu all over again. After witnessing a 575-point plunge in the Nikkei-225 index, a 3.3% loss, to 16,642 on March 5th, the powerful MoF warlord, Hiroshi Watanabe was asked for his opinion on the market. “We should be closely monitoring stock markets, but we don’t have any serious concern. In Japan the size of the correction is very big, but I don’t think it will last for very long.” Sure enough, Watanabe’s comments put a floor under the Nikkei-225 on March 5th, similar to his rescue of the Nikkei-225’s rout in January 2006 from the Livedoor fiasco. Japanese traders have complete faith in Watanabe’s ability to put out fires and turn bearish markets around. Within a few days, the U.S. dollar rebounded from a low of ¥115.25 on March 5th to as high as ¥118.50, which triggered a 700-point rebound in the Nikkei-225 index.

U.S. Treasury borrows MoF script on intervention.

With MoF warlords putting a floor under the Nikkei-225 at 16,600, the U.S. Plunge Protection Team (PPT) went into action on March 5 and 6th. Just 12-hours earlier, the share price of Goldman Sachs had plummeted by $5.75 to $190 per share, off 14.7% from its record highs set in February. Shares of New Century Financial, the 2nd-largest U.S. home lender in the sub-prime market had plunged 70% the previous day, after some lenders refused to let it tap credit lines. Goldman Sachs is one of New Century’s lenders, along with Morgan Stanley and Citigroup.

Suddenly, the masters of the universe, with their slick and sophisticated Ponzi schemes requiring ever-larger infusions of cheap money were caught off guard. Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley, which earned a record $24.5 billion in 2006, are exposed to sub-prime junk bonds, equaling 10% to 15% of their firm’s capital. Prices for credit-default swaps linked to their bonds traded at levels that equated to debt ratings of Baa2.

Speaking from Tokyo on March 5th, with the DJIA teetering on the brink of the psychological 12,000 level and Goldman Sachs stock in need of some oxygen, PPT chief commander, Henry Paulson issued a buy signal, “Some of the credit issues are there, but they’re largely contained,” Paulson declared. His comments triggered a powerful 160-point DJIA rally by day’s end. “We believe that the economic fundamentals in the U.S. economy are sound,” said White House spokesman Tony Frattoon February 27, borrowing the script from Tokyo’s Ministry of Finance. Treasury spokeswoman Brooklyn McLaughlin said the President’s Working Group of Financial Markets (PPT) was monitoring the markets. The high-level group is made up of the Federal Reserve chairman, Treasury secretary, chairman of the S.E.C. and chairman of the Commodity Futures Trading Commission.

It is very interesting to note that the Dow Jones Industrial futures market gapped 80-points higher after Paulson’s “don’t worry, be happy” comments in Tokyo, during the first 15-minutes of Asian trading on March 6th, putting a nasty squeeze on short sellers. On the previous day, March 5th, a large buyer entered the market to catch a falling knife, and lifted the DJI futures 140-points off their intra-day low within the second hour of Asian trading, when market conditions are usually thin. By week’s end, Goldman Sachs shares had recovered to $201.

Is there intervention in the stock index futures markets?

Did Japan’s finance ministry and the U.S. Treasury intervene in the stock index futures markets, to prevent panic free-falls, and engineer short squeeze rallies? Only their floor brokers know for sure. But intervention also includes jawboning, painting rosy scenarios, downplaying bad economic news and sub-prime mortgage defaults, and pushing money into the hands of securities dealers through coupon passes.

The U.S. PPT gave frazzled U.S. investors a chance to catch their breath as the DJIA rebounded 226 points last week, after a 736-point plunge from its February 20th record high. But it has been almost four years since the Dow Industrials or the S&P 500 fell 10% from a high, which is an exceptionally long period without such a pullback. Not even Tokyo’s financial warlords have been able to put together such as winning streak!

Was the 416-point plunge in the DJIA and sharp declines in other global stock markets the beginning of a bear market, or just a nasty correction in the a longer term bull market?

Link here.


Goldman Sachs, Merrill Lynch and Morgan Stanley, which earned a record $24.5 billion in 2006, suddenly have become so speculative that their own traders are valuing the three biggest securities firms as barely more creditworthy than junk bonds. Prices for credit-default swaps linked to the bonds of the New York investment banks recently traded at levels that equate to debt ratings of Baa2, according to Moody’s Investors Service. That is five levels below the actual Aa3 rating on the three investment banks’ senior unsecured notes and two steps above non-investment grade, or junk.

Traders of credit derivatives are more alarmed than stock and bond investors that a slowdown in housing and the global equity market rout have hurt the firms. Merrill since 2005 has financed two mortgage lenders that subsequently failed and bought a third, First Franklin Financial Corp., for $1.3 billion. “These guys have made a lot of money securitizing mortgages over the years in a mortgage boom time,” said Richard Hofmann, an analyst at bond research firm CreditSights Inc. in New York. “The question now is what is the exposure to credit risk and what are the potential revenue headwinds if they are not able to keep that securitization machine humming along.”

Credit-default swaps on the debt of Goldman, the world’s biggest securities firm, have risen to $32,775 per $10 million in bonds, up from $21,500 at the start of the year, according to prices compiled by London-based CMA Datavision. The price touched $35,000 on February 28. Spokespersons for Goldman, Lehman, Merrill and Morgan Stanley declined to comment.

Morgan Stanley and Goldman were among the top five traders of credit-default swaps in 2005, a group that represented 86% of the market, according to a September Fitch Ratings report. Lehman, Merrill and Bear Stearns were among the top 12. The contracts were conceived by Wall Street to protect bondholders against default and pay the buyer face value in exchange for the underlying securities should the company fail to adhere to debt agreements. An increase in price indicates a decline in the perception of creditworthiness.

Link here.


Caroline Baum has another great article out entitled “As Housing Goes Bust, Lenders Become Predators?” She writes:

Congress is gearing up for hearings on predatory lending, the latest chapter in its long history of barn-door-closings on already-departed horses. Delinquency rates on these risky home loans are rising, subprime lenders are going belly up at an alarming rate, criminal probes of some lenders are under way (the trial lawyers must be salivating at the prospect of a whole new class of class-action suits), and front-page stories are proliferating almost as fast as you can get a no-money-down, no-questions- asked mortgage.

Last week, federal financial regulators, including the Federal Reserve, Office of the Controller of the Currency and the Federal Deposit Insurance Corp., proposed a series of guidelines “to address certain risks and emerging issues related to subprime mortgage lending practices, specifically, particular adjustable-rate mortgage (ARM) lending products.”

Congressional committee chairmen have already invoked the idea of “predatory lending” to create interest in planned hearings. In an opening statement at a Feb. 7 hearing, Dodd said “that predatory and irresponsible lending practices are creating a crisis for millions of American homeowners.”

“We’ve created an unproductive asset,” says Joe Carson, director of global economic research at AllianceBernstein. “A house doesn’t produce income. ... We created as much debt in housing in the last six years as we did in the prior 50.” ... After the late 1990s stock market bubble, the economy recovered with a combination of interest-rate relief and income growth, he says. That rate relief was the cause of the current housing bubble, former Fed Chairman Alan Greenspan’s claim about the Berlin Wall coming down notwithstanding. How can the cause also be the cure?

By the time Congress or the Fed gets around to doing something, the time to do it is already long over. Subprime lenders are dropping like flies, bankruptcies are soaring, flippers have stopped flipping, and credit lending standards have tightened dramatically in the aftermath of one housing disaster after another. Now that the market has imposed its solution – dramatically tightened credit lending standards in the wake of bankruptcies, foreclosures, defaults, and REOs – Dudley Do-Right (as played by Congress) is leading the charge to save Nell Fenwick from Snidely Whiplash. Sorry Dudley (aka Congress/Fed), Nell Fenwick has already lost the deed to her ranch.

Congress and the Fed are acting trillions of dollars too late in credit lending and four years too late in time to save dear Nell and tens of thousands of folks just like her. This was entirely predictable right down to the Avalanche of Lawsuits, the congressional hearings, and the final finger pointing. Those hearings are nothing but demagoguery and a complete waste of time. Not only has the market already imposed its solution but all the finger pointing will be in the wrong direction.

The roots of this problem are numerous attempts by Congress and this administration to promote the “ownership society”, the creation of GSEs, hundreds of pieces of congressional legislation supposedly to make housing more affordable all of which had the exact opposite effect, and to top it all off the Greenspan Fed came along slashing interest rates to 1% in a misguided attempt to prevent deflation in the U.S. In short it is not “predatory and irresponsible lending practices”, but Congress and the Fed fostering an environment that not only allowed but actually encouraged this to happen.

Unfortunately the demagogue’s fingers will be pointing every which way except at Congress and the Fed. Ultimately legislation will be enacted to prevent this from happening again. That legislation is sure to do nothing to solve the existing problem , but rather it will be written in a manner that will cause some other different problem down the road. The key point in Baum’s article, however, is not predatory lending, congressional demagoguery, or all lawsuits coming down the pike. It is Joe Carson’s “unproductive asset” observation.

Austrian economists would call this malinvestment. For all this artificial boom, we did not create any productive capacity, we did not even improve infrastructure. All we did was pile on debt. That debt will not be inflated away, wages will simply not rise fast enough, and jobs will become harder to find in the upcoming recession. That debt will be deflated away via bankruptcies. The process has started and it has a long, long way to go before it is over.

Instead of spending money on productive assets we are actually selling assets to foreigners to finance our reckless spending habits. We have also wasted what will eventually amount to trillions of dollars to blowing up Iraq, and since no one else is willing to say this, I will: Every life lost in Iraq was wasted as well, every single one of them.

Compare and contrast how we have been wasting dollars to what China and India are doing with their dollars. Yes, China has built tons of overcapacity, but unlike us they at least have capacity, and unlike us China and India have massively improved infrastructure while we have allowed ours to go to waste.

The market is in the process of repricing those malinvestments right now. That is why subprime lenders are blowing up, home prices are falling, defaults and foreclosures are rising, and credit lending is imploding. In attempting to prevent deflation the Fed has essentially guaranteed it. Congress played right along giving the banks and credit card companies exactly what they wanted: A bankruptcy reform act written to make people debt slaves forever. This fostered risky credit card lending in the belief that those loans will be paid back. They will not.

Instead of taking a hit in 2002, Greenspan and Bernanke made matters worse by creating the mother of all housing bubbles. Instead of allowing people to go bankrupt, we passed laws making it harder, and those laws have already started to backfire. Instead of stopping subprime lending earlier, institutions repeatedly dropped lending standards to meet growth requirements. Instead of taking writeoffs now, lenders are refusing to admit mistakes hoping on a wing and a prayer that these bad home loans will cure themselves. Those loans will not be paid off either. We are following in the footsteps of Japan except that our consumer debt loads will make it worse. The Fed has learned nothing every step of the way.

Link here.

The Easy Society

Things are starting to get a bit rough for “The Easy Society”. Florida Today is reporting, “5,600 Brevard Residents Are on the Brink of Losing Their Homes” due to “A wave of home mortgage foreclosures” that are “sweeping across Brevard County – signaling a disastrous end to the local housing boom for those who could lose their homes ... Many of the cases stem from homebuyers – both residents and investors – getting sucked into risky loans, with limited options to refinance or sell because of the recent decline in local property values ...”

Within the article: “‘There are a variety of factors here,’ said Steve Srein, founder of People’s First Financial Services of Melbourne. ‘The first thing is people are not changing their lifestyles to pay for the loans they took on their homes. We’ve adapted to what I call ‘The Easy Society’, in that we made it easy for people to get into houses with submarginal credit. Since they had submarginal credit, that puts them in the subprime category, ripe for a product like the exotic mortgage or the junk loan, or optional adjustable-rate mortgage.’

“‘The problem today is that the people were pushed into loans they really couldn’t afford,’ Srein said. ‘The real estate people and the mortgage brokers are saying the borrowers knew what they were doing. But, really, it’s the optional (adjustable-rate mortgages) that are the big culprit behind the whole problem’ ...”

A tsunami of subprime defaults is about ready to sweep The Easy Society right out of their houses. Fed Governor Susan Bies says, “Subprime Defaults Are ‘Beginning of Wave’”: “The nation’s banks are just beginning to feel the pain of defaults on risky mortgages they made at low introductory rates when housing prices were soaring, U.S. Federal Reserve Governor Susan Bies said.” The Fed is also four years and trillions of dollars too late on those lending guidelines. I talked about that in “Malinvestments, Predatory Lending, and Demagogues” [above], and it is likely that I will be writing on that theme again soon.

So the Fed is “watching for contagion.” Exactly what can the Fed do about it when it hits? That will not be Bies’s problem, as she is cleverly leaving her post at the end of March, as Forbes reported back in February in “Fed Gov. Bies Quits”: “Two days after a group of major U.S. banks asked regulators to reconsider proposals for regulating bank risk, the Federal Reserve governor heading their implementation resigned. ... Bies leaves five years into an appointment that was not slated to end until 2012. In a resignation letter address to President Bush, Bies ... offered no reason as to her departure.”

That seems like a good move. I would not want to stick around for this tsunami, either. Most of those in The Easy Society will not even know what hit them. They will be blaming predatory lenders, hurricanes, insurance companies, and anyone and everyone but the primary culprit (the Greenspan/Bernanke Fed). I suspect that is the real reason (at least one of them) for Bies’s resignation.

To be fair, Forbes also reported: “In her last position, she was spearheading efforts to revise and implement the international capital standards for banks developed in 1988. Although banks and regulators agreed the old standards were outdated and overly simplistic, updating them has been a contentious issue for years. ... Bies had recently voiced frustration at the slow progress. ... On Wednesday, four major U.S. banks submitted a letter to the Federal Reserve and urged it to move away from certain Basel II proposals. JPMorgan Chase, Washington Mutual, Wachovia, and Citigroup complained that the new rules would require U.S. banks to hold more minimum capital and would give foreign banks an advantage.”

If Bies is resigning because she refuses to go along with tightening minimum capital requirements, then perhaps she should be applauded. For now, she is not saying. Once she is gone, I hope she will disclose her reasons. It will also be interesting to see if she stops chirping the economy is strong with Paulson, and starts singing the recession blues with Greenspan. Regardless of what tune she will be singing, The Easy Society is in for very harsh times.

Link here.


With last Friday’s relatively benign jobs report coming in close to the consensus forecast and with the stock market comfortably above the previous Monday’s low, most on Wall Street are breathing a sigh of relief. The popular position is that last week’s turmoil was simply a speed bump on the road to greater prosperity, and that a recession and a bear market are low probability events. I beg to differ.

Despite the rebound, the technical and psychological damage to the stock market is major, and the odds that the carnage is over are slim. A more likely scenario is that the bear market rally that began for U.S. stocks in October of 2002 has ended, and a new leg down in this long-term bear market has begun. As for the likelihood of recession, not only does it seem to be highly probable, but it is more of an outright certainty. With the construction industry shedding 62,000 jobs last month, it is clear that housing is already in recession. The major question when will the overall recession begin? The second half of this year or early 2008?

The current train wreck unfolding in the sub-prime lending sector provides a good preview as to what will happen to the entire credit-financed bubble economy when the funding dries up. Contrary to the self-serving rhetoric of Wall Street and housing industry shills, the entire mortgage sector is not insulated from sub-prime. Beneath the surface lie similar problems in Alt-A and prime loans, where borrowers also relied on adjustable rate mortgages to purchase over-priced homes that they could not otherwise afford.

With the sub-prime market drying up, most first-time home buyers will be unable to buy. Without those “starter-home” buyers, the trade-up buyers will be unable to sell their existing homes, and hence unable to trade up. This brings down the entire house of cards. Home prices must collapse, affecting all homeowners, regardless of their credit ratings.

How can anyone ignore the announcement by Freddie Mac that they would no longer buy loans where there is a “high likelihood” that borrowers cannot meet their monthly payments and which are “highly vulnerable to foreclosure.” Talk about closing the barn door after the horse! This is tantamount to an admission that Freddie Mac formerly bought loans knowing full well that they would likely end in default! When asked on CNBC why the agency had waited so long to impose tougher standards, the head of Freddie Mac explained that when home prices were rising, Freddie Mac did not think it wise to prevent sub-prime borrowers from profiting from the boom. In other words, since people were making piles of money by making bad bets on real estate prices, Freddie Mac did not want to turn down the action. So even though they knew speculative buyers were lying about their incomes and assets in order to purchase houses they could not afford, Freddie Mac did not want to rain on everyone’s parade. So instead of acting responsibly, they simply kept the party going, held their noses, and bought the loans anyway!

Since 70% plus of the U.S. economy is based on consumer spending, how can we possibly avoid a recession if the credit well funding much of it runs dry? Since home equity has been the principal asset collateralizing that credit, how can consumers keep borrowing and spending when housing prices fall? I heard one commentator on CNBC claim that the U.S. economy was in great shape except for housing. That is like a doctor telling a patient that he is in great health, except for the javelin sticking out of his chest. If housing is going down, there is no way on earth the entire economy does not get caught in its undertow.

Link here.


Ben Bernanke’s call for Fannie Mae and Freddie Mac, the government sponsored enterprises dedicated to housing lending, to reduce their outstanding assets below the current $1.4 trillion is a classic political statement. It will have no effect in practice, except to insulate Bernanke somewhat from criticism once Freddie and Fannie are subject to a gigantic taxpayer bailout. However, as the mortgage financing business gets deeper and deeper into difficulties, one begins to wonder whether a mortgage finance disaster could spread economically far beyond housing?

Home mortgage debt was $10.7 trillion in 2006, of which Fannie and Freddie had guaranteed $3.4 trillion and owned directly an additional $400 billion. Since the value of U.S. housing is approximately $22 trillion, if housing debt was one gigantic home mortgage there would be no problem. There would be plenty of room for price declines before the mega-loan was in real trouble. Unfortunately, the quality of home mortgages varies enormously, and the amount of collateral available is also varied, with zero or 5% down-payments having become increasingly common in recent years. Roughly $1.4 trillion of mortgages of sub-prime and another $1.6 trillion of mortgages are endangered if interest rates were to rise sharply. The fate of these two pools will be sharply different. Last August I suggested that house prices were likely to decline by 15% nationwide, with declines averaging 30% on the two coasts where the run-up had been most excessive. That looked excessively bearish when I wrote it, but is currently looking increasingly prescient, and probably about right.

In that case, loan losses on sub-prime mortgages will be very extensive. Some sub-prime loans are in fact second mortgages, others are on new property or property that is in other respects wildly overpriced. With a 15-30% price drop and no equity cover in the first place, losses on second mortgages may well be total. Even losses on sub-prime first mortgages may easily run 30-40%, when repossession and sale costs are factored in, with an overall default rate on these sub-prime mortgages of perhaps 75%. Thus a loss rate of 60% of the sub-prime mortgage pool would appear reasonable, far worse than pundits are currently projecting, to give a capital loss of $840 billion.

Losses on negative amortization and zero-principal mortgages to non-sub-prime borrowers, on the other hand, will not be so severe. Interest rates are far too low in real terms, and are thus bound to rise either in the short term or, more likely, in the long term. However, the overall excess interest costs born by these borrowers is unlikely to exceed 3-4% per annum, unless inflation really takes off, in which case house prices will, after a lag, follow it. Thus not all these mortgages will default, maybe only 1/3, and of the defaulters the losses will be limited, maybe 25% of principal. That gives losses on this mortgage pool of 8.3% of loans outstanding, or $140 billion. Just under $1 trillion in losses between the two categories, not counting whatever defaults may occur on prime mortgages.

However, there is a snag here: Fannie and Freddie. With $3.8 trillion of the $10.7 trillion of home mortgages, they should suffer $350 billion of losses. Since they have an upper mortgage amount limit of $417,000, they will have fewer loans on the coasts than average, and fewer loans against grossly overpriced McMansions than average. They may also have fewer sub-prime loans than average, though they have been active in negative amortization rubbish. Thus their losses may be lower than average, perhaps “only” $250 billion. But Fannie and Freddie’s combined capital is only $79 billion. That means they are almost certain to default, and to require bailout by the long-suffering U.S. taxpayer.

The next question is what effect this will have on the U.S. economy. A wealth loss of $1 trillion on mortgage debt is far from a negligible amount, but does not represent a huge hit compared with the fluctuations of a stock market that is currently worth $18 trillion or so. Even adding in a $3.3 trillion value loss on a $22 trillion housing stock, that is still only equivalent in itself to a 25% stock market downturn, painful but by no means cataclysmic. However, the housing decline will not be an isolated event.

One problem that may make the downturn worse is that housing supply during the bubble has been poorly matched to demand. 39% of properties were bought as investments or second homes in 2005. You can bet that many of those purchasers do not realize the ghastly cash flow reality of rental property ownership, and so will drown financially and default on their loans when the repair bills arrive and the credit-worthy tenants do not.

New construction was heavily concentrated at the upper end of the market, where wealthy speculators used non-repeating bonuses to make down payments on more house than they needed. The real estate industry trumpets growing population as a rationale for house price spirals and heavy construction, but the reality is that the baby boomers are close to retirement and will soon begin scaling down, while the 12 million illegal immigrants cannot afford McMansions, except to the extent of mass squatting in empty, unsaleable ones. This is not a problem we have seen in past housing booms. Market signals this time around were especially distorted by excessively loose money and the speculative atmosphere that prevailed in the housing market in 2003-05.

Finally, Fannie and Freddie may have only $79 billion in capital, but they have guaranteed $3.8 trillion in mortgage loans, nearly 30% of U.S. GDP. If they have to be bailed out, the uncertainty while Congress is adding Christmas tree ornaments to the bailout bill is likely to be seriously disruptive to the U.S. capital markets in general. Some mortgage backed securities holders may come to wish they had invested in the sound economy and fiscal policies of Ecuador rather than in the profligate U.S. housing sector!

Thus the housing malaise, in house prices, national wealth, loan losses and market disruption, is likely to be gigantic, and will inevitably spread into the rest of the economy. In particular it will itself cause sufficient despair in U.S. securities markets to accentuate a stock market downturn that is in any case inevitable, given the current overvaluation of the market and the rapidly deteriorating state of corporate balance sheets. Between the two, housing and stocks, the decline in U.S. net worth is likely to be both steeper and deeper than any we have seen since the 1930s.

Having run a printing-press money policy for the last decade the Fed will have no easy way to get the economy out of the mess. Indeed, it may be forced to deepen the mire. It is one thing to tolerate inflation at the 8-10% level in the interests of sorting out an unexpected but major U.S. downturn, it is quite another to run the risk of hyperinflation as the Fed will do if it attempts to reflate housing and stock market bubbles before the excesses in the economy have been worked out. Still, unlike in 1929, the voting public will not be able to blame Wall Street much, although doubtless it will be tempted to do so. This will truly have been a Main Street Crash.

Link here.


“House prices to recover next year,” said The Times of London on 17 November, 1989. Real estate in the United Kingdom had risen three times over on average during the previous 10 years. National prices rose 40% in the last 18 months alone! But now, suddenly, house prices had stopped rising. When would the good times kick off again?

The Bank of England did all it could, slashing UK interest rates by one-third. Mortgage lenders put on a brave face too, easing their E-Z lending terms further still. And the gentlemen of the press were only too willing to talk up the market. No wonder, then, that “recovery [was] forecast for house prices in market awash with loan funds,” as The Times reported in January 1990. But not even broad money supply growing by 18% annually could stop the rot. By July 1990, “the bottom of the current house price cycle may have passed,” the paper went on. Come the fall of that year, however, The Times had to repeat itself again. “House prices bottom out ... the long slide in house prices could be nearing its end,” it said. National prices continued to slide regardless.

By September 1991, real house prices stood 25% down from the peak. “House-price surge is on the way,” said The Times, “but wait for it.” No fooling! The following month The Times finally admitted that “Fall in house prices dashes market hopes.”

Why so glum, and who was to blame? The mortgage lenders looked guilty. But they were now suffering record late payment rates. At least one major bank looked set to go under. Mortgages more than 6 months in arrears accounted for 3.5% of all loans outstanding at the start of 1992. Cue The Times to report that “record repossessions are keeping down house prices” – even though the mortgage lenders themselves had long since stopped repossessing when they could possibly help it. America’s mortgage lenders may well try the same remedy in 2007.

U.S. foreclosures rose 42% in 2006 according to RealtyTrac.com, to 1.2 million nationally. But throwing young families out on the street rarely makes for good PR. And during a genuine real-estate slump, it only adds to the downward pressure on home prices. ForeclosureDeals.com picks up the story: “If a homeowner can’t make his or her monthly mortgage payments ... he or she is usually in forced into the position of defaulting on the mortgage, and then the lender must foreclose on the home. After repossession, the lender is the new owner ... Whatever name the properties have, they all have one thing in common – the new owners want to sell them as quickly as possible, often even if that means selling the repo homes at a price well below their full market value.” Selling an asset below market value might bring a quick sale. But it also pulls aggregate prices down further. The lesson for U.S. mortgage lenders could not be clearer.

Ahead of the UK’s last house-price crash, nine out of every 10 late-paying mortgages more than 12 months in arrears were taken into repossession. By the bottom of the slump, however, the mortgage lenders slashed that kill rate beneath 1-in-5. Fast forward to March 2007, and “it’s true that [US] foreclosures could have a negative impact on the housing market if they continue to increase at this rate,” said James Saccacio, CEO of RealtyTrac, recently. “However, most local markets have been able to re-absorb foreclosure homes without seeing any major damage to the local economy.”

As long as that is true, the collapse of America’s subprime lenders may indeed be “contained” as Ben Bernanke would have us believe. But the subprime lenders, trapped in a classic “prisoner’s dilemma”, know the dangers posed by forced real estate sales. In the “prisoner’s dilemma”, two players can either help or betray each other. The optimum choice is always to turn state’s evidence and get early release – assuming, of course, that the other felon plays it straight and does not betray you! Similarly, for each individual mortgage lender, the need to cover their ass will mean recovering their assets. But for the industry as a whole, it would be better off leaving late-paying home-owners right where they are. Foreclosing and selling en masse will only push real-estate prices lower, faster.

Either way, a lot of companies and households now look set to go bankrupt. Expect to find zombies wandering both Wall Street and Main Street, carrying debts they cannot repay lent by finance companies that cannot afford to call in their loans.

“Boom days gone forever as house prices still fall,” said The Times of London in June 1992, three years after the top. But taking that as a contrarian signal and buying back in would have cost you money for another four years.

Link here.


You have probably read this before: Even when housing prices slump, they do not fall all that much, at least compared to stocks and other risky investments. I have passed on this bit of “wisdom” myself. It is not a totally ridiculous thing to say. Even in the big California bust of the mid-1990s, prices in the L.A.-Orange County metro area fell only 20% peak to trough in the region’s worst five years. We are not talking Nasdaq bust here, but, well, there is a bit more to it than that. ...

Below is a chart I made from data in a 2005 FDIC report. It shows the worst peak-to-trough five-year nominal performance for housing prices in several markets. The blue cities are in California, the green ones are in New England. In red, dropping by as much as 40%, are “oil patch” towns, which cracked in the late 1980s right along with oil prices.

It is easy enough to dismiss the evidence from the oil patch, if you want to. Prices there were forced down by an unusual, and very local, economic shock. The economies of L.A. and Boston are better diversified. Then again, if the oil boom-and-bust of the 1980s was an anomaly, what should we call the easy-credit-driven housing inflation of the early 2000s? Liar loans, interest-onlys, option ARMs, and aggressive subprime lending have changed the rules. History would not seem to be a very reliable guide right now.

One reason real estate prices tend to be less volatile than stocks is what housing economist Karl Case calls “downward stickiness”. When prices fall, many people just decide to stay in their houses rather than cut their price low enough to make an easy sale. But that also means there is a lot human pain behind a housing decline of “just” 10%. People get stuck in their houses, and that can change their lives.

Link here.


Over the last decade the commodity markets have changed to the point that to some they may be unrecognizable. Since 1848, the open outcry and hand signal method of trading on commodity exchange floors was the only way to go. Enter electronic trading in the early 1990s, and soon the old auction method looked as if it were about to die any minute. Add the Internet and easier access to these markets by individuals, and it was bye-bye trading floor, hello computer screen.

We all know that did not happen, and I personally believe it will not happen. But we cannot deny that the electronic era is here to stay. Today’s trading methods are not your grandfather’s, and neither are today’s markets. The markets we see actively trading today may not be the only ones we will see trading five years down the road. We may see alternative energy commodities such as ethanol take off from their infancy. We may see markets like corn and sugar explode because of ethanol demand. We may see new contracts for such things as water. We have seen commodity exchange seat prices jump, and we have seen the world scramble for resources. The explosion in commodities and natural resources over the last few years has been remarkable. As a nearly 20-year veteran of these markets, I have never seen anything like it.

There are certain commodities that are staples of trading and most all investors should know these sectors and be very comfortable with them. One of them, of course, is gold. Back when I started trading, the COMEX was the top exchange in New York. The badge was green in color, and it took a lot of “green” to get one. At the time, a seat on the COMEX also was the most expensive seat on the New York exchanges, of which there were really four: the Coffee Sugar and Cocoa Exchange (CSCE), the New York Mercantile Exchange (NYMEX), the New York Cotton Exchange (NYCTN), and the Commodities Exchange (COMEX).

Chicago markets like the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME) were viewed as being on an even higher plane, and most Chicago traders considered the New York markets to be second-class citizens. Now much of that has changed. But as I arrived on the scene, a pivotal shift was happening: As the NYMEX began to grow in stature, the COMEX became a bit more tarnished.

The Hunt brothers’ silver debacle, after their attempt to corner the world silver market in early 1980, drove many investors away from the metals, and some never returned. Today, however, the metals have come full circle, and silver, which for most of my career traded in the $5 to $7 range, is now busting out to new highs. For many years, gold was simply a hedge against inflation, but today the shiny yellow metal is being sought as a flight to a quality instrument and also for its uses in jewelry on a large scale. The new gold exchange-traded funds also have helped to drive the price of gold higher, as these new instruments are backed by physical gold. E-gold is another phenomenon that is not just fantasy anymore.

The metals markets can be very volatile, and one strategy for capitalizing on the long-term rise in gold is to use options, specifically, long-dated gold options that may seem very far out of the money. For example, as I write this, gold is trading in the low $600s but had been over $700 an ounce. It is quite possible that gold could surge to $1,000 an ounce. So to play this right now (with gold at $623), we would add the $950 call options. They would be considered quite far out of the money (above the current spot price). But all that could change if gold rallies to new highs. Meanwhile, by buying gold options, I cannot lose any more than I initially invested. It is one of the safest ways to invest in gold.

On to silver ... For years the silver market has languished in a narrow range with little momentum and not much of a bright future. Not anymore. This often maligned metal is up a whopping 60% since the beginning of 2005, and so far 2006 is looking good, too. There are many ways to play silver, as with gold: silver bars, ingots, coins, jewelry, certificates, stocks, futures, and options. All have advantages and disadvantages, but the one we want to add to our portfolio is silver options.

Silver closed at its highest level in more than 22 years recently on hopeful expectations that the S.E.C. would soon approve a silver-backed exchange-traded fund. This silver ETF is similar to the gold futures-based funds, streetTracks Gold and IShares Comex Gold Trust. According to reports, investors hold more than 14 million ounces of gold in the ETFs – significant because it is equivalent to about a fourth of worldwide supplies in 2006. In 2006, the launch of the silver ETF drove silver prices up several cents, and seemingly out-of-the-money options were tripling and quadrupling in price. In less than a two-month period, our positions were returning unheard-of 400% profits and more.

Link here (scroll down to piece by Kevin Kerr).


In the popular 1984 film, The Terminator, current California governor and former actor Arnold Schwarzenegger plays a cyborg sent back in time to eliminate the mother of future leader John Connor before he could be born. Single-minded and highly developed, the robotic killer relentlessly pursues his intended prey throughout the movie, despite strong resistance from the hero’s supporters, although the good guys eventually win out in the end.

While the story is pure fantasy, some may not realize that in the stock market there are the equivalent of dangerous man-made automatons lurking in every corner. Often technology-based, they are powerful, sophisticated, and difficult to keep under complete control. Yet they are exerting a growing and pervasive influence on prices. Unfortunately, these potential share-price assassins, if they were to be suddenly unleashed all at once, represent a Terminator-like threat to financial markets, especially if conditions are just right.

Like they are now, when the economy is rolling over and share prices have already begun to correct from historically overvalued and overbought extremes. First among the potentially destructive creations are exchange-traded funds, or ETFs, which have become a significant feature of the modern investment landscape. Far too significant, some would say. Recent research from Prudential Equity, for instance, suggests that buying and selling in three small cap ETFs is having a sizeable impact on certain stocks in the Russell 2000 index. By their reckoning, activity in Barclays’ iShares Russell 2000, iShares Russell 2000 Value, and iShares Russell 2000 Growth index funds accounts for 20% to 40% of turnover in some smaller issues. Like index-related arbitrage and other forms of basket-type trading, such activity is not driven by fundamentals in the traditional, Graham-and-Dodd sense, but instead reflects the rapidly expanding role of various technical, arbitrage, thematic, and macro-type investing strategies.

The problem is that while some of this “price insensitive” trading – not based, in other words, on stock-specific information or insight – has been a boon for equity markets in recent years amid gushing liquidity and a mad dash for incremental returns, the negative consequences for prices as credit, economic, and investment cycles turn for the worse could be considerable. Under the circumstances, index-related selling, for example, could transform markets in thinly-traded securities that have been unusually liquid and serene into boggy swamps of illiquidity. This would spur widespread fear and even a sense of panic, along with a substantial increase in volatility, as hordes of investors scramble nervously towards the exits.

The broad use of chart-based, trend-following, and momentum-driven trading and investing strategies is also likely to exacerbate the market’s woes in the face of a sustained downturn. With fear a more powerful motivating force than greed, the herding behavior that such methods naturally encourage will likely create a snowball effect that will be hard for anyone – either those diving in or those bailing out – to resist.

Other modern risk-management methods and tactics will also fan the bearish flames once former long-term bull markets start coming apart at the seams. These include the widespread use of high-powered statistical and computerized models that measure and help manage risk exposure using data derived from recent market behavior. When trading conditions are serene, firms can take on more risk. If prices start swinging wildly, they must cut back on their exposure, which often means selling into a falling market.

In the past, corrections and full-fledged bear markets have been accompanied by significant price gyrations and converging correlations between different products, sectors, and markets. When that happens in an environment like we have now, where there are numerous large institutions with complex and highly-leveraged bets in myriad markets, it creates the potential for a seemingly relentless death spiral where selling leads to increased volatility, begetting further selling.

There is also the unsettling and potentially destabilizing fallout from the growing use of portfolio-based margining and risk management strategies. Aside from the sudden and unwelcome appearance of gaps between expected and actual loss, rising illiquidity in some markets will force many participants to try and sell positions or hedge themselves in others that remain accessible, causing additional markets to quickly buckle under the pressure.

Another potential source of destructive energy will likely stem from capital flows linked to gyrations in foreign exchange markets, a far-reaching reassessment of trade policies in the face of slowing growth around the world, and the unwinding of global financial imbalances that are already at unsustainable extremes. Moreover, during uncertain times, history suggests that investors tend to favor repatriating funds that are invested overseas, regardless of whether the decision makes sense in the long term.

Finally, a dramatic increase in outstanding derivatives exposure, especially in recent years, suggests that violent crosswinds associated with speculation, hedging, and unwinding will wrack the underlying assets. Formerly deep out-of-the-money and structural long-term derivatives positions that were once thought to require little oversight will suddenly demand active risk management, as will exposure taken on in more recent times.

Overall, there are myriad signs that the economic winds are shifting and a bearish darkness is settling over the investment landscape. It is worth remembering, of course, that when the share-price Terminator shows up, he will not just be a character in a movie.

Link here.


The worst mistake I have made in recent years in economic forecasting was to expect the 2000 crash well before it happened. I started warning that a stock market recession was due in 1996. I was still hung up on the 1989 to 1992 recession which had been more serious in London than in New York. Nevertheless, the recession did eventually come, though by 2000 the bears had mostly lost confidence and been converted into belated bulls. I should never have tried to time the downswing at the end of the boom, and I am not about to repeat that mistake. However, there are a number of worrying developments which justify increasing caution. Most of them involve the risks of leverage.

Everyone knows that increasing the leverage is one way in which the financial performance of a stock can be improved without any improvement in the underlying commercial performance, and can be improved still more when the underlying performance itself is improved. The mechanism by which private equity works involves leverage. It is good for the shareholders because profits are higher and good for the management because bonuses, in some form or another, are also higher. It is not so good for the staff because jobs are usually lost. It is good for the economy in the short term, but may not be so good in the longer term.

Private equity seldom takes a long term view – that is for someone else. However, it is the leverage which worries me most, because what proves to be excessive leverage can create a lose-lose situation. The Congressional inquiries after the 1929 crash largely focused on the disaster of over-leverage in circumstances of recession. A company with low leverage is seaworthy in a storm. It is very unlikely to run out of cash, which is the problem which causes businesses to become insolvent. It will have assets which can be sold, or can be borrowed against. The analogy is with a sailing ship. An ship that has a huge spread of sail can travel fast in favorable conditions, but in a great storm she can keel over. A ship which carries light sail does not win the race in favorable weather, but can survive a storm.

The assumption shareholders make when they increase leverage is that there is not going to be an early recession or perhaps that there will be no recession at all. Early in a bull market, this assumption may be a safe one. Later in a bull market it becomes less safe, but investors feel safer because they have become accustomed to good times. Finally the recession comes, probably at the time that the last bear has run for cover.

Now we have a fashion for high leverage – in derivatives, in private equity, and in hedge funds. The global financial system has spread its sails. The momentum is awe-inspiring. There is less transparency than there used to be – investors do not understand derivatives, hedge funds are less transparent than old fashioned investment businesses, and private equity is less transparent than public companies.

Any traditional value investor reads balance sheets with more confidence than he reads profit and loss accounts. The global profit and loss statement looks pretty good, but if the global balance sheet does not scare us it certainly should.

Link here.


The “credit bubble baton” gets passed from the housing market to Wall Street. The raw numbers boggle the mind.

Fourth quarter Credit data have arrived. Despite the deepening housing downturn, the year came to an end with total non-financial debt expanding at a robust 7.9% pace. And while total household borrowings decelerated to a 6.4% rate in Q4, non-financial corporate borrowings surged to a 10.9% growth rate. Financial sector credit market borrowings increased at a 7.2% pace. Federal debt growth was stable at 3.3% during the quarter, with receipts up 11% and expenditures up 5.5% y-o-y. State and local government borrowings accelerated to a 13.5% growth rate, as receipts grew 5.5% and expenditures increased 4.5% y-o-y.

After a prolonged credit bubble, percentage changes do not do justice. Nominal debt growth numbers are more illuminating, in the case of the Q4 “seasonally-adjusted and annualized rates” (SAAR). Total credit market borrowings accelerated from $2.348 trillion in 2002, to $2.725 trillion in 2003, to $3.002 trillion in 2004, to $3.403 trillion in 2005, and to $3.555 trillion for all of 2006. And while household sector borrowings slowed to $838 billion SAAR (from Q3’s $928 billion), non-financial corporate borrowings surged to $605 billion SAAR (from $276 billion). For perspective, households borrowings increased $1.239 trillion during 2005, and non-financial corporate borrowings expanded $245 billion.

U.S. system credit and marketplace liquidity buttressed by accelerating financial sector debt growth.

Last year was an extraordinary year for macro credit analysis. Non-financial debt growth decelerated from 2005’s 9.4% to 7.9%. In nominal dollars, non-financial debt growth slowed to $2.100 trillion from the previous year’s $2.279 trillion. Students of credit theory could have justifiably expected this development to be problematic for inflated asset markets and the U.S. and global bubble economies generally. Importantly, however, total U.S. system credit and marketplace liquidity were buttressed by accelerating financial sector debt growth (from 8.7% to 9.3%). In nominal dollars, financial sector credit market debt growth (which excludes, among others, bank deposit growth) increased from 2005’s $1.040 trillion to a record $1.200 trillion. But this in no way reflected the entirety of financial sector liability expansion.

The ballooning Financial Sphere – financing robust mortgage and corporate credit growth, and at the same time positioning in the securities markets to profit from unfolding Economic Sphere and Fed rate moderation – was a key macro credit theme for 2006. Rapid system credit and liquidity creation way beyond the needs of the real economy fueled rampant financial asset inflation at home and abroad.

Nowhere was this dynamic more conspicuous than within the broker/dealer industry balance sheet. Broker/dealer assets expanded $515 billion SAAR during Q4 2006, or 24.3% annualized. For all of 2006, broker/dealer assets expanded a blistering (responsible?) 28.9% to $2.742 trillion, posting an incredible 2-year gain of $897 billion, or 49%. For perspective, Broker/Dealer Assets expanded $615 billion during 2006, $282 billion in 2005, $232 billion in 2004, $278 billion in 2003, and declined $130 billion during 2002. So 2006 broker/dealer asset growth was double the previous record (2005’s $282 billion) and almost triple 2000’s $220 billion (at the time a record).

In the enigmatic world of contemporary securities finance, there is an entangled interplay between the Wall Street firms, the securities “repo” market, “Funding Corps” (“Funding subsidiaries, nonbank financial holding companies, and custodial accounts for reinvested collateral of securities lending operations”), and the “money” market. The ongoing ballooning of these various securities financing vehicles is nothing short of stunning. While there is definitely a “double-counting” issue between the Fed’s different debt and credit intermediation categories, it is nonetheless worth noting that Open Market Paper (chiefly commercial paper), expanded at a 24% rate during Q4 and 20.8% for the year to $2.216 trillion.

One can conceptualize the Government Sponsored Enterprises having a few years back handed the credit bubble baton to the Wall Street firms, with the “money” markets now catering to the ballooning speculator community rather than the mortgage agencies. It is interesting to compare the assets held by Money Market Mutual Funds at the end of the year to those at the conclusion of 2002. Agency/GSE securities have declined from $333 to $131 billion, and Treasuries have dropped from $142 to $83 billion. Meanwhile, security repos have jumped from $273 to $395 billion, and corporate bonds (including Asset Backed Securities) have increased from $228 to $368 billion.

Total mortgage debt (TMD) expanded $1.172 trillion (9.7%) during 2006. This was an enormous expansion, especially considering the rapidly slowing housing markets, though a notable deceleration from 2005’s blockbuster $1.462 trillion (13.7%) growth. For perspective, TMD expanded an average $268 billion annually during the nineties and $888 billion annually during the first half of this decade. For the quarter, home mortgage borrowings slowed to a 6.1% pace, while commercial mortgage debt growth accelerated to a 15.6% rate. For the year, home mortgage borrowings increased 8.8% and commercial 15.6%. Over two years, TMD jumped 25% (home up 24%, commercial up 32%). TMD more than doubled (109%) in seven years. GSE assets were little changed during Q4 and expanded only $35.6 billion during 2006 (1.3%).

Rest of World (RoW) holdings of U.S. financial assets expanded $1.671 trillion SAAR during Q4 and $1.527 trillion for the year – a more than 50% increase from 2005’s $1.041 trillion increase, and compares to 2004’s $1.321 trillion, 2003’s $824 billion, 2002’s $771 billion and 2001’s $658 billion. For both Treasuries and Agencies, RoW purchases accounted for the majority of new issuance, and this has generally been the case now for the past several years (Conundrum?). Foreign Direct Investment was up 11% y-o-y to $2.074 trillion.

Household balance sheets provide invaluable credit bubble insight.

The household balance sheet, as always, provides invaluable credit bubble insight. For Q4, total household assets expanded $1.641 trillion, or 9.8% annualized, to a record $68.920 trillion. This surge in financial wealth was led by a $1.356 trillion (13.3% annualized) increase in financial assets. Mutual fund holdings surged $320 billion (28% annualized) during Q4. This significantly offset the slowdown in the housing inflation “wealth effect”, which fell to $246 billion during the quarter (4.4% annualized). And with household liabilities increasing “only” $266 billion (8.2% annualized), household net worth surged a robust $1.375 trillion (10.1% annualized) during the quarter to a record $55.626 trillion. For the entire year, household assets jumped $4.906 trillion (7.7%), with real estate up $1.464 trillion (6.9%) and financial assets inflating $3.230 trillion (8.3%, with mutual funds up 20.4%). with liabilities increasing $1.074 trillion (8.8%) during 2006, net worth surged $3.832 trillion (7.4%). Household net worth has inflated $15.937 trillion, or 40%, over the past four years.

Fueled by prolonged credit excess, National Income expanded 8.2% during 2006 to $11.698 trillion, the strongest pace of growth since 1988. Total compensation increased 6.4%, the largest gain since 2000’s 7.9%. For comparison, total compensation increased 2.8% in 2001, 2.5% in 2002, 3.8% in 2003, 5.1% in 2004, and 5.7% in 2005.

What to make of it all?

There are key aspects of analysis that the new data helps to confirm. First, in the context of ongoing credit excesses, the 2006 moderation in mortgage credit creation was more than offset by a sharp increase in corporate and financial sector borrowings. Securities finance, in particular, was nothing short of spectacular. Rampant domestic credit growth was sufficiently ample to finance an ongoing economic boom, unprecedented current account deficits, and general “bubble economy” asset inflation. Outflows from massive U.S. current account deficits coupled with heightened speculative outflows were major sources instigating global liquidity excess, flows that were then recycled back to U.S. financial markets where they were “recycled” yet again into unrestrained financial excess.

The problems associated with the U.S. mortgage finance bubble having evolved into corporate debt, securities finance, and global credit bubbles are great. To sustain myriad bubbles will require massive and uninterrupted credit growth. Conditions for such an undertaking were actually quite favorable last year. Wall Street was firing on all cylinders, with the housing slowdown fostering expectations for Goldilocks and an imminent easing of Fed policy.

But 2006 excesses have created a serious dilemma, one not well recognized. Post-bubble sub-prime and general mortgage credit risks pose an increasingly recognized problem on one hand, while heightened bubble excesses in corporate and securities finance are equally risky on the other. Because of heightened inflation risks associated with ongoing domestic and global excesses, and one can envisage a scenario where the Fed remains quite hesitant to provide the easing cycle Wall Street is anxiously positioned for.

Link here (scroll down).


Even though oil prices have come off their recent lows, investors are still ignoring the oil and gas industry. We last wrote to you about cheap gas in January, when crude was trading as low as $50 a barrel. We warned then that the break in higher oil prices probably would not last too much longer. We have since seen crude trading back above $62 a barrel. There have also been reports of $3-a-gallon gas on the West Coast over the past couple of weeks. However, our collective oblivion to one of the world’s most profitable businesses continues.

In January, the P/E ratio of the independent oil and gas industry was 12.6. Major oil companies had an average P/E of only 9.8. (For reference, the average P/E of the S&P 500 is around 20.6). Now, the average independent oil and gas outfit is still trading at about 13 times earnings. The P/E of big oil has even dipped a little to 9.4. Did we all just forget just how much money is in oil?

From 2002 to 2005, the top 10 major public oil companies sold $1.5 trillion worth of crude, according to MSNBC. And they turned more than $125 billion in profits. Just last year, Exxon Mobil grabbed the record for the biggest annual profit by an American company, posting a net income of $39.5 billion. With all of this in mind, three independent oil companies graced these pages six weeks ago. All three of them had price-to-earnings ratios of less than 10, and only one traded above $10 a share. Here is where they stand today.

Keep an eye on these shares as rising oil prices begin to grab headlines ...

Link here.


Opportunities abound for investors in the energy market right now, just looking at what has being set in motion globally. The end of the age of oil will not be a disaster if we are prepared for it as investors and consumers. Acceptance is the first step.

Aside from water, the world is most thirsty for oil. Since the last major oil crisis in the 1980s, there has been tremendous population growth, with no less than one-third of that population beginning to industrialize their economies. China, home to 1.3 billion people, and India, with more than another billion, are both growing fast, and they must have oil. Then add the U.S.’s oil addiction to the mix, with our ever-larger gas guzzlers and our seemingly insatiable desire for bigger and better, whether it is cars, boats, houses, amusement parks, shopping malls, or whatever.

Combine this demand with dwindling global supply, the ongoing threat of terrorist attacks, the fact that there has not been a major oil find in more than 36 years, natural disasters such as 2005’s hurricanes along the Gulf Coast, and continued geopolitical tensions, and do not be surprised if oil reaches $150 a barrel, or more. How can you capitalize on this?

It is always important to have vision, to see beyond the short-term outlook and predict what can and may happen in the future. By using spread trades and options in the energy markets, traders can maximize profit potential while limiting downside risk. (Spread trades are exactly what they sound like. The most common spreads are those between the different trading months, such as December/January spreads or, as we call them, DEC/JAN spreads. Basically, you are simply trying to trade a price differential between the months. There are many different types of spreads but this kind is the most common.)

Oil is the lifeblood that moves things, that keeps the whole world functioning and growing. In the last 100 years we have become very spoiled - we have been used to easily obtained, easily moved, and easily processed petroleum, crude oil, and natural gas. Oil, among other things, spurred the development of the internalcombustion engine, which does the work of a thousand people. Oil essentially constitutes a major workforce throughout the world. This virtually invisible workforce has allowed the world’s population to grow to over 6 billion. Not only that, it has allowed us to plow millions of acres of land, to produce fertilizers, to transport people and goods, even to wage global wars and to set up global communication systems. Our dependence on oil, and energy as we know it, is similar to an addict’s affliction. The world’s craving for oil is just as debilitating.

At this moment the U.S. does not have an energy source that would be as easy to produce and transport as oil. Nuclear power can produce electricity, but the remaining rich uranium ore will last for decades, not for centuries. Renewable energy can probably never cover the current levels of global energy consumption or even U.S. consumption. So what is a practical solution right now?

Recovery from oil addiction is possible, and the long-term, easy-to-reach answer may be in a fuel source that is right under our feet – coal. Coal is cheap and reliable and much cleaner-burning than it use to be. As the world goes through painful withdrawal from oil dependence, coal may help. Clean coal technology (CCT) uses a number of processes to remove unwanted minerals, which makes the coal burn cleaner and more efficiently. Coal has often been stereotyped as a dirty and less desirable product of the energy industry, but not anymore.

Electricity turns our turbines and runs our assembly lines. When we read in bed, turn on the air-conditioning, look at the nighttime skyline, it is there. And we take for granted that it will always be there, every time. But when more and more people, in more and more countries, start making that assumption, you have a situation. Right now, one in every three people does not even have electricity. And already, our electrical grids are overtaxed and electricity demand is higher than it has ever been. What happens when the rest of China and India hop onto the power grid? What happens when the world population hits 7 billion? Or 9 billion, as the U.N. is predicting?

Without billions of dollars invested in new electricity resources right now, imagine brownouts, blackouts, shutdowns, and worse on a scale 10 times greater than anything we are seeing today. This all sounds scary, and does not have to happen if the biggest and most ambitious economies in the world kick in right now with several hundred billion dollars to jump-start a whole new era of electricity investing.

The good news is that the total $16 trillion headed for all the energy markets, including the $10 trillion that will go into electricity, is still only about 1% of the total global GDP. So making the investment is not only very possible, it is nearly certain. The electricity markets are still in their infancy in the commodities world. As with so many other up-and-coming opportunities, you just have to be ready to seize those chances when they come.

Alternative energy is another area investors are focusing on, and one of the biggest is solar power. The rallying cry for quick and easy solutions to our nation’s oil addiction spurred immediate interest in alternative energy, from nuclear to ethanol. Since the 1970s, the solar power industry has come a long way. The industry has made enormous progress in the past 20 years, finding new solutions to the ongoing problems of high costs and massive regulatory barriers. Manufacturing processes have been streamlined and continue to become more cost-efficient with the help of government subsidies, consumer rebates, and tax credits. As oil prices continue to increase, it seems inevitable that a convergence of the cost of conventional and alternative energy costs will occur. Many companies in the solar sector seem to be focused on the development of improved solar efficiency through broadbased applications that can be put to practical, immediate use.

Investors should always keep in mind that every trade has flaws. In the case of solar power, there are several. Although there is so much good news for solar power, there are challenges, too. For example, there is the lack of silicon, which is needed for making solar panels. A silicon shortage has limited the supply of the panels and frustrated potential buyers. Orders take several months to complete, and prices, after years of floundering, have increased by as much as 15%. The winners are those companies that benefit from the lack of silicon, primarily producers of less efficient, yet available, thin-film solar panels [if the silicon shortage situation lasts – see this article]. Other beneficiaries include companies that have emerging technologies, such as plastic solar cells.

Worldwide, the solar market has exploded, growing by 40% annually in just the last five years. Germany and Japan alone use 39% and 30%, respectively, of the global solar panel stockpile. The U.S. uses only 9% of the global solar panel supply, but California is likely to drive that stat much higher as demand grows exponentially in that state and others, too.

Link here (scroll down to piece by Kevin Kerr).
Profiting from global warming hysteria - link


There is a tipping point, a line in the sand, that once crossed allows small caps to become blue chips. The trick is to determine which small caps sit on the brink. Find the penny stocks that rest just beneath this line. Because when they cross, their share price takes off.

I came across the seed for this idea in what is perhaps the best article on finance I have seen in the past four years. Elizabeth Collins at Morningstar.com wrote an insightful piece about her favorite financial ratio – return on invested capital, or ROIC. ROIC measures how much cash a company receives for each invested dollar. This helps discern how well and efficiently a company profits from its invested assets. She points out that more conventional metrics, like return on assets (ROA) or return on equity (ROE), rely too much on net income, a figure that can easily make an unprofitable company look like a cash cow with a little creative accounting.

I agree. Free cash flows are so important. I want to know how much tangible cash is coming through the door. Here is how you calculate a company’s ROIC:

  1. Aftertax income = (operating income) x (1 - tax rate)
  2. Invested capital = total assets - (current liabilities - short-term debt)
  3. ROIC = aftertax income / invested capital

Collins notes, “a company creates value only if its ROIC is higher than its weighted average cost of capital, or WACC. The WACC measures the required return on the company’s debt and equity, and takes into account the risk of the company’s operations and its use of debt. WACCs typically range between 9% and 12% for large-cap companies.”

Companies producing ROICs well above their weighted average cost of capital tend to be secure, cash-producing machines ... companies like Johnson & Johnson (JNJ: NYSE) and PetroChina (PTR: NYSE). In turn, the market typically places a premium on their share price. But there are companies out there that earn just less than their cost of capital. They are companies on the brink. Companies that with a minor adjustment (sales growth, patent approval, etc.) are poised to break through. And when they do, the share price typically responds quite favorably.

Take the Korean blue chip Posco Steel. In 2001, Posco produced a 5% return on invested capital – not so hot for a company with a 10% WACC. But Posco had potential. They were developing technologies that would revolutionize the steel industry. By 2003, they finally broke through, when the ROIC reached 12% (financial record here). And look what happened to the share price.

Double-digit gains do not happen by chance. If you are serious about increasing your odds, search for small-caps with return a on invested capital just below the company’s weighted average cost of capital.

Link here.


Blustery March winds blew through global markets again yesterday. At one point, the Dow was sold off to under 12,000, before recovering. The London stock exchange took a beating too. Investors are “jittery” says the Financial Times, over the subprime crisis in the U.S. European and Asian stock markets suffered their second biggest losses of the year yesterday.

One thing is clear – volatility has returned. That long, lazy, self-assured and complacent period that annoyed us for so long seems to be over. And good riddance. We are literary economists and market voyeurs. We like action ... something to look at ... someone to laugh at. For instance, there is now a restaurant in NYC that now boasts a “luxury pizza” topped with (among other things) crème fraiche, eight ounces of caviar, and four ounces of lobster tail. And the price tag for this edible extravagance? $1,000. We are not sure, but this seems like a bit too much. And a bit too late.

We like a good comedy as well as a good tragedy, something that causes our ribs to heave and someone who gets what he has coming to him. And at last, we seem to be getting one. For months – no years – we have been watching ... waiting ... hoping. “Something has to give,” we kept saying. “When the end comes ...” we warned ominously. “This cannot go on forever,” we wrote so many times we began to wonder if it was true. Well, the end may still be far away. But at least a few more people can see it coming. They have seen prices go up and down sharply. It does not take too much imagination to see them going down decisively.

Which means that the price of insurance is going up. “Banks face rise in cost of default protection,” says the FT. Credit Default Swaps are going up. So is the protection available to the average investor. Yesterday, the VIX volatility index reached its highest level since June of last year.

What is gratifying about this sort of action is that it has genuine heroes and cads – people whom the gods reward for their virtue or destroy for their vices. Take New Century Financial, for example. Teetering on the edge of bankruptcy, we regretted that we could not give it a push. But yesterday, along came Barclay’s bank to do what we could not. The British bank demanded $900 million, and wants it right now.

“All of our exposure to U.S. subprime lending is fully collateralized ...” Barclay’s told the press. “We do not envisage any material losses due to exposure to the sector.” We are not privy to the details, but we can also perfectly well imagine that Barclays is misinformed. All the subprime debt was fully collateralized. That was not the problem. The problem was that the collateral was fraudulent. Encouraged by rising property prices, aided and abetted by appraisers, mortgage brokers, and real estate agents, and enabled by “low document” lending procedures, neither the subprime collateral, the subprime securitized debt, nor the subprime borrowers were worth what they said they were worth. Now, with property prices falling in many parts of the country, it may be impossible to unload the foreclosed houses for anything near to what lenders had expected.

“The reliance on judgment and reason will be pushed aside,” said 80-year-old economist Henry “Dr. Doom” Kaufman in New York. What we found interesting was his use of the future tense, referring to the growing tendency to replace wisdom and experience in the financial markets with sharp calculations. If there is a half a point of yield to be gained by exchanging yen for ringgit, buying emerging market bonds, leveraging with zlotys and hedging with euros, even though the old timers might judge it too risky or too complicated, the mathematicians will find it irresistible.

We fuddy-duddy literary economists are not the ones who have made money in this liquidity bubble. We are not complaining. Our gold rose from a low of $252 in 1999 to around $645 last time we looked. But the real money was made by those who reached for yield, leveraged it up and sold it on. We just learned that Goldman Sachs actually outperformed analysts’ expectations. Yes, the master of the masters of the universe masterfully masterminded a masterstroke. Theirs is a masterpiece of ... well, never mind. The report referred to earnings “in the first quarter”. The quarter ended on February 23, only four days later world markets sold off on panic following a 9% drop in the Shanghai composite index. And what is this? On February 27 Goldman was down 12% from its all-time high of 222.75 made on February 22. Talk about nice timing.

There is something screwy about the whole spectacle. The numbers, for all their pretended precision, never seem to add up. How can you have a “quarter” that ends in the middle of February? How could the whizzes on Wall Street make such errors about the value of their subprime debt?

Still, who says the top is in? Who says America is in decline? Who says the liquidity bubble is over? Who says there is not more money to be made? We literary economists do not presume to know, nor do we pretend to care. But the show is definitely getting more interesting.

The world’s second largest economy looks like a much better bet for investors than its first largest one.

While the rest of the world enjoyed one sunny day after another, poor Japan remained in darkness. Its stocks crashed. Its property crashed. Its consumer prices crashed. This went on for – what? – 14 long years? Nothing seemed to come from Japan but good cars and bad news.

But in 2005, the rising sun began to peek over the horizon. Stocks soared 40%. Consumers and businessmen seemed to recover some of their old bonsai spirit. In 2006, stocks rose again, albeit much less than in 2005. And now the economy is expanding nicely.

But what attracts our attention today is Japan’s property market. Prices are still going down! Japan, and Japan alone, is still bucking the worldwide trend towards higher prices for immoveable objects. Property prices are down 32% since 1997. Last year, the stuff fell another 2.7%. By contrast, U.S. housing rose 102% during the last 10 years. This was modest compared to Ireland, with a 253% increase, and South Africa, where prices jumped 351%.

For a contrarian, what is not to like in Japan? The currency has been going down for years. Speculators are short hundreds of billions of dollars worth yen. Stock indexes are still less than half what they were 17 years ago. And the Japanese economy after a long period of on-again, off-again deflation finally seems to be growing at decent rates.

It is America, Britain, China and the other high-fliers that a contrarian should be wary of. A few years ago we co-wrote a book predicting that the United States would follow Japan into a long, dark slump. We were surely early. But we are still not convinced we were wrong.

Link here.
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