Tuesday 29 December 2009

Don't believe the hype - About the reality hiding being some of the economic data...

A lot of the economic data being released is being propped up or gently massaged to look good.

If you look at my favourite links I invite you to have a look at the Shadow Stats:


I came accross a very interesting read in another blog about new home sales and I invite you to have a look at it:


You cannot rely on the recent new home sales data as a positive sign of improvements in the housing market in general and the economy in particular. Tax credits have inflated the results of new home sales. It is the same case with new cars sales. The reality is that the US car industry still has too much capacity for a demand which will be weaker as soon as tax credits will be withdrawn.

From the above article published on the blog www.nakedcapitalism.com you can read the following statement from a contact of the blogger based in Texas relating to what might be happening behind the data relating to new home sales and the picture is not nice at all to say the least if it is true.

"When I went to the bankruptcy / foreclosure auctions here a few weeks ago I found out that the whole thing is a charade. Bank of America (for instance) auctions off houses that have gone into foreclosure for the amount owed plus any carrying costs which usually makes the auction price higher than what was owed. A pre-bid was submitted by Bank of America Home Loan Servicing (the rename for Countrywide) in the exact amount of the auction minimum (mortgage owed plus carrying costs). No one else bids so the house is “sold” by Bank of America to Bank of America Home Loan Servicing. In essence, the property is simply transferred from one division to another so that clear title is established. But this is counted as an existing home sale which artificially inflates existing home sales numbers. This is what was happening for most of the 102 BAC mortgages and the 130 Wells Fargo mortgages. For the house I “rent” where the original mortgage was with Countrywide (and then transferred to B of A when B of A bought the property) this is simply a process for getting the house off of B of A’s books and back on Countrywide’s books (now BAC Home Loan Servicing). As I said, it is all charade or smoke-and-mirrors or a shell game.

Later Bank of America Home Loan Servicing will contact a realtor who will eventually put the house on the market for sale. Let’s say that the auction price was $200,000 but the house is now worth only $150,000. Of course when this house is sold by the realtor it is again counted as an existing home sale."

As well as treating new home sales data with caution, you also need to treat cautiously data relating to unemployment levels.

The big question for 2010 will be around liquidity withdrawals from governments and its impact on current market valuations.

Tuesday 22 December 2009

The heart of America and the need for a defibrillator

David Goldman in his blog is right about the recovery. Until small businesses thrive again, it will not happen. What is so severe in the current recession is how profound they have been impacted this time around.

Small business (firms employing 500 workers or fewer) accounted for 64% of net new job creation for the past 15 years according to a small independent government agency called SBA (Small Business Administration).

According to an article in The Economist, cities with small firms have done better in creating jobs for the last 20 years.

In this recession, it has been very ugly for the small businesses of America. The small businesses employing less than 50 employees have accounted for 45% of the job losses!

The heart of America is failing and the Obama administration need to find a proper defibrillator soon to help them out in this downturn.

With activity picking up for some, small firms are being savaged by the credit crunch. They cannot get credit. Credit card debt and home-equity credit have been reduced drastically by the banks and seriously impaired by negative equity.

In conjunction to the lack of credit, small businesses cannot rely on regional banks because these small banks are getting crushed by their difficulties with the commercial property bust.

The Economist in its December 12th issue highlights the current situation:
"Nearly 40% of outstanding small-business loans exposure are held by banks with the greature exposure to commercial-property risk. In 1993, the figure was only 11%. As commercial property losses grow, banks will be forced to curtail lending."

Yes, this time around it is worse than during the Savings and Loans crisis which led to the demise of 450 banks.

Since the beginning of the year, a massive number of these regional banks have gone bust:


List of individual banks which have failed since 2000:


Another 7 banks went down just on the 18th of December.

Lending for the small businesses of America is the key battle for the recovery.

Let's hope the US administration will find the right defibrillator this time around to jump start the heart of American economy.

On a final note, I wish you all a Merry Christmas!

Thursday 17 December 2009

Blue pill or Red Pill?

Morpheus: This is your last chance. After this, there is no turning back. You take the blue pill - the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill - you stay in Wonderland and I show you how deep the rabbit-hole goes.

The Matrix movie - 1999

There we are year end coming fast and everyone is expecting the recovery in 2010, following the surge in the many green shots seen in the economy.

Too many people have taken the blue pill.

The facts unfortunately doesn't support the idea of a strong recovery.

In my last post Greece Sovereign CDS was trading around 230 bps for 5year. Another downgrade from S&P came along and there we are with Credit-default swaps linked to Greek debt rising another 30 basis points to 260, according to CMA DataVision, the highest since March.

Everyone is expecting Greece to do the right thing, cutting on spending and reducing their abyssmal budget deficit before it is too late. Will a Greek socialist government be as aggressive as the Irish in tackling their issues?
The answer is definitely no.

Standard Bank has definitely turned negative on both Ireland and Greece:


As per my previous post, there is a probability that Greece could at some point exit the Euro.

Prime Minister George Papandreou announced he was taxing greek bankers at the rate of90% of their bonus and a the same time he announced that civil servants making less than 2,000 euros a month would get pay rises above inflation.

How does the Prime Minister of Greece expect to fund the salary of his public servants? By issuing bonds that no one will want?


Get ready for another bumpy ride in 2010...

Also in the news, one of Austria's largest bank (ranked 6th) had to be rescued by the Austrian Government:


Hypo Group Alpe Adria hit the wall. Another one bites the dust.

"Under the terms of the deal, Austria will take over 100 per cent of HGAA and the shareholders surrender their stakes and inject about €1bn ($1.5bn) in capital."

"Meanwhile, Austrian banks could face another €10bn in writedowns over the next two years, Austria’s central bank warned on Monday. Austrian banks have about €200bn of exposure to central and eastern Europe and have written down €15bn since the start of the crisis."

Problems have not been resolved by the governements and the deleveraging is still an ongoing process globally.

Defaults are still rising and unemployment levels are still going up.

(Bloomberg) -- Homeowners with mortgages of more than $1 million are defaulting at almost twice the U.S. rate and some are turning to so-called short sales to unload properties as stock-market losses and pay cuts squeeze wealthy borrowers.


It started with subprime mortgages going sour, then the ALT-As and ARMS, now the prime and jumbo loans are getting hit hard as well.

What we can expect is that the FED will maintain the interest rates low for a long period. We cannot expect them to raise rates in 2010. By maintaining them artificially low, they are trying to ensure banks can offset somehow the tidal wave of defaults and provisions they are facing, ensuring they make some very good profits on the spread banks are borrowing at and lending at.

The recession will really be over when small businesses which are the motor of an economy will start to hire as they did last time we had a valid recovery.

Here is the Red Pill for all of you who want to see how deep is the rabbit-hole we are:

From David Goldman's excellent blog (the link is indicated in this blog as well)

"Structurally, a very large percentage of job losses during recessions reflect creative destruction: big companies who lay off workers in recessions downsize permanently. The jobs are not replaced at the same companies; the old jobs go away forever, and new jobs are created at the grass roots of the economy.

That’s why we have to look to small business for continued job growth, and why the prospects are grimmer than the market seems to believe."


No matter how much liquidity the US administration injects, no matter how Obama would like bank to increase lending (for some who have the capacity to do so...), the recovery is not around the corner but at least a couple of years down the line.

This is the awful truth.

The governments are preventing creative destruction to take place by trying to prop up some dying parts of their economies: GM, some banks, etc.
I mean by creative destruction the emergence of a new economy based on new technology or new industries.

As Joseph Schumpeter mentioned creative destruction hurts a lot in the short term and this goes again governments and short term views for short term political gains.

Volcker, arguably the best president the FED ever had, killed stagflation in the US in the late 70s. Soon we will be entering a new phase of Stagflation and you can expect inflation to start creeping up at some point and commodities prices to reach new highs.

As per a Wikipedia article around Creative Destruction:
"Layoffs of workers with obsolete working skills can be one price of new innovations valued by consumers. Though a continually innovating economy generates new opportunities for workers to participate in more creative and productive enterprises (provided they can acquire the necessary skills), creative destruction can cause severe hardship in the short term, and in the long term for those who cannot acquire the skills and work experience."

Joseph Schumpeter was a visionnary, and probably on of the first takers of the "red pill".

For those of view who would like to extend on Schumpeter's economic views which are very accurate, I recommend reading his book: Capitalism, Socialism and Democracy.

Here is a link to Wikipedia's review on this major book.

So which countries to look for to invest? Follow where innovation is taking place at a fast pace, where education levels are strong and where there are plenty of skilled workers: Asia. India and China will continue to grow strong in 2010, they have the skills and the ressources to navigate these treacherous waters much better than most developped countries.
Canada as well will do well thanks to their natural ressources and their solid financial sector which was not damaged by the financial crisis.

I will conclude this post by a quote from Joseph Schumpeter:

"Capitalism’s Greatest Enemy: The Intellectual
The proper role of a healthily functioning economy is to destroy jobs and put labor to better use elsewhere. Despite this simple truth, layoffs and firings will still always sting, as if the invisible hand of free enterprise has slapped workers in the face. Unsettling by nature, capitalism’s churn gives rise to a labor movement designed to protect workers from job loss. That movement is fed emotionally by displaced workers and others who blame the capitalist system for their troubles, but it is led psychologically by a whole other type of person—the intellectual. Intellectuals—with little to do owing to the success of the capitalist economic system but with an intense desire to be seen as caretakers of society’s general well-being—anoint themselves as leaders of the labor movement. They object to capitalism on moralistic grounds and seek its destruction and replacement by another system—socialism—which places them center stage."

You could replace "intellectuals" in the quote in today's economy by politicians and you would not be far from what is currently happening in many countries today.

Wednesday 9 December 2009

The importance of being earnest, about the Eurozone in general and the Euro in particular

The Unknown
As we know,
There are known knowns.
There are things we know we know.
We also know
There are known unknowns.
That is to say
We know there are some things
We do not know.
But there are also unknown unknowns,
The ones we don't know
We don't know.

—Donald Rumsfeld, Feb. 12, 2002, Department of Defense news briefing

Another change in perception this week, to follow up on my article about the Dubai mirage. This time, Greece in particular and the Eurozone in general!

On Tuesday, Fitch Ratings Inc. cut Greece's rating to BBB+ with a negative outlook and it unnerved the markets.

Markets once again have a short memory. BBB+ was the rating for Greece before the introduction of the Euro in 1999.


Greece managed to fiddle with its stats to get in the Eurozone and benefited from the cheap funding available to all members of the coveted Euro currency. We all know what happened to Spain, cheap funding generated a massive real estate bubble and when it went tumbling down Spain's employment rates went through the roof (Spain unemployment level will rise to 22% in 2010 and some Spanish regional banks are still sitting on hefty losses). Eastern European citizens also played a dangerous game, borrowing in Euros or CHF. All these "cheap" loans went badly wrong when Eastern European currencies had to be devalued as the GDP in these countries dropped like a stone.

As any form of peg, the Euro, although a safe haven for many, has now become some countries worse nightmare. As Greece cheated it's way it, Greece is now facing great troubles as it cannot cheat its way out by massively devaluing its currency and reduce therefore the debt to GDP percentage which currently stands at 110%.

Greece 5 year CDS (232.19 Bps on the 5 year point, source CMA DataVision) is now trading above Turkey 5 year CDS and the spread of Greek debt versus 10 years German Government bonds (Bund) is trading at level not seen since 1999...

I remember a conversation I had with a trader back in 2005, about the spread between 10 years German Bund and 10 years Italian BTP. At some point the spread between both was around 22 bps. This was abnormally tight and at the time I thought it was a fantastic bet to put on and a very simple one: betting that the spread would go back to where it was before the introduction of the Euro, above 120 bps. It did happen. Now the spread has come back to the 60bps level. I don't think that in the near future it will stay there.

The virtues of joining a single currency doesn't coincide with the vices of some European governments, who issued more debt and ran larger and larger budget deficits. It is a game you cannot play forever unless you can devalue and make your own citizens poorer in the process, which used to be a regular tool used by Italy before joining the Euro.

When I hear Mrs Christine Lagarde saying the following: 'I don't think Greece could go bankrupt,' on RMC radio. I have to disagree.

David Einhorn, who is President of Greenlight Capital, was cited in a recent letter published by John Mauldin' in the excellent "Outside the box" on the 26th of October
Here is an excellent quote relating to Mrs Lagarde foolish statement: "To slightly modify Alexis de Tocqueville: Events can move from the impossible to the inevitable without ever stopping at the probable."

Even France is increasingly at risk. The last time France had a balanced budget was in 1980. Since then, the government has been spending more than it has been collecting and the service of the external debt (payments of the interest only), is not even covered by the receipts coming from the income tax.

As per a Reuter article published today:


She also said that French debt was popular in financial markets but France would continue to take care to ensure that there was not threat to its credibility.

"By comparison to our partners we are very well rated," Lagarde said. "So France's signature is good. The market likes our paper and we are extremely determined to be very careful to the way we issue."

Asked about the potential size of a new loan that President Nicolas Sarkozy is planning to fund investment projects, Lagarde said: "It must be a figure which does not raise questions about the quality of France's debt signature."

It is once again all about maintaining at all cost perception that everything is fine.

Well, things are not fine.

Because of the euro, governments cannot cheat at the moment by devaluing their currency. France had three devaluations in 1983 as a reminder.

Italy used to regularly devalue the Lira before the introduction of the Euro.

Could Greece or Italy leave the Euro?

For those who would like to evaluate the probability of this event, please find enclosed the link to two very good articles:

One written by Nouriel Roubini on the subject in 2005.


The other I recommend reading is the excellent article written by Macro Research House Gavekal on the subject written as well in 2005.


For those who would like to track sovereign risk in the CDS markets, please use the following useful link:


The CDS market is a good indicator of the perception of risk for both corporate risk as well as sovereign risk.

It is also a very good indicator of possible movements in the equity markets. The equity market took many months to react to the widening of the CDS markets which started in August 2007, following the blow out of the two Bear Stearns Structured Credit Funds, which marked the beginning of the subprime crisis.

We have moved from a financial crisis to an economic crisis and now a sovereign crisis.

To conclude:

Yes, countries can go bankrupt and can go from being very rich to very serious distress. Markets have short memory, and so do Finance ministers...and particularly French ones as well.

Maybe Mrs Lagarde should study the history of Argentina which increased in prosperity and prominence between 1880 and 1929, and emerged as one of the 10 richest countries in the world at the time before completely crumbling down.

In our next episode we will revisit my central theme about perception and facts about the current economic situation.

I will leave you with a final quote from the movie The Matrix from 1999, year of the Euro as an appetizer for my following post

Morpheus: This is your last chance. After this, there is no turning back. You take the blue pill - the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill - you stay in Wonderland and I show you how deep the rabbit-hole goes.

Tuesday 1 December 2009

Dubious Dubai and the issue of perception...

From Wikipedia definition of a "mirage"

"A mirage is a naturally occurring optical phenomenon in which light rays are bent to produce a displaced image of distant objects or the sky. The word comes to English via the French mirage, from the Latin mirare, meaning "to look at, to wonder at". This is the same root as for "mirror" and "to admire"."

Suddenly last week, Markets reacted strongly on news relating to the difficulties arising in Dubai. Sovereign CDS protection on Dubai significantly widen on the news and Credit indices such as Itraxx Main and Banks CDS also took a hit. It took them a while to realised how inflated their perception of Dubai real estate companies creditworthiness was.

It was all about false perception. Similarities can be made on this story that made headlines recently. Perception of the credit worthiness on Dubai World was all about implicit guarantees from the Dubai Government. Investors invested believing in implicit support. Probably the same investors who believed in the sacro-saint AAA rating issued on dodgy CDOs and CLOs as a gauge of credit quality of the underlying pool of assets in the structure. Probably the same investors who believed that a callable LT2 bond will be called on the call date by the issuer, because it has been market practice in the past. How suprised they were when Deutsche Bank, nearly a year ago in December 2008, decided not to redeem some sub debt on the date of the call! Investors trade sub debt based on the date of the call to calculate the price of the bond.

This shows you how short memory is on the market and how perception can affect sound judgement.

I travelled to Dubai in October 2008 and I went to Cityscape 2008 (as per the picture above, all rights reserved). For me it was an eye opener on the real estate bubble in Dubai. As equities market were getting crushed following Hank Paulson's fateful decision of letting Lehman go under with catastrophic consequences (when an orderly wind down could have been managed under FDIC's supervision), 60,000 "Real" Estate professionals were meeting in Dubai to have a look at the pharaonic new projects which were presented in this event. It was history in the making, the top of the bubble.

What's next for Dubai?

From the 1973 movie My Name is Nobody, here is a reminder of a little story told in the movie...
In “My Name is Nobody,” the protagonist, Nobody (played by Terence Hill), tells a famous fable:
"There was this little baby bird that fell from it’s tree in the cold of snow. It starts peeping, “Pa peep! Pa peep!” as it was damn near freezing.
Along comes this cow. She looks down at the little bird and feels sorry for it. She raises her tail and… “splah!”
…She drops a steaming hot cow pie right on top of it.
The little bird starts again… “Pa peep! Pa peep!” Because it’s hungry.
Along comes a mean ole Coyote… It reachs down easy into the cow pie and picks the little bird up. He raises the little bird higher and brushes the dirt off him real nice.
And then… “Gulp!” Swallows the little bird down all in one bite!
My grandfather says there is a moral to the story, but you have to figure it out for yourself…
At the movie’s end, the aging gunfighter, legend Jack Beauregard (played by Henry Fonda) figures out the moral to the story:
Folks that throw dirt on you aren’t always trying to hurt you, and folks that pull you out of a jam aren’t always trying to help you. But the main point is: when you’re up to your nose in shit, keep your mouth shut."

Although Sheikh Mohammed bin Rashid al-Maktoum tried to reassure the market, there was a continued sell-off in the Gulf stock markets today.

It looks like perception has changed, like perception changed for AAA ratings for structured CDOs/CLOs notes previously, and for callable LT2 bonds.

The price for the bail out of Dubai will be costly and prized assets such as Emirates airlines could possibly change ownership and end up in the hands of their powerful saviours Abu Dhabi.
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