Capitalism 2.0

Is Your Money Safe in the Bank?

randolfe — Thu, 09 Oct 2008 13:58:35 -0700

The Federal Deposit Insurance Corporation (FDIC) states there are currently 117 "troubled banks" on its watch list. The FDIC is supposedly prepared to insure the deposits (up to the FDIC limit) for those banks, should they fail. But, Washington Mutual and Wachovia -- two of the largest bank failures in history -- weren't even on the FDIC's list before they collapsed.

That begs the question, how accurately is the FDIC tracking potential bank failures. And, more importantly to each of us: how safe is your money if the FDIC is terribly wrong?

A report on CNBC today enumerated the bank failure estimates of some notable banking research firms, most of which have been in business for many decades and are well regarded as experts within the banking industry. Those firms found:

RBC Capital: 300 likely bank failures over the next 3 years. Nearly three times more than the FDIC currently expects.
Bauer Financial: 426 potential bank failures, or banks needing assistance to avoid failure.
Weiss Research: 1,479 banks plus 159 thrifts, with total assets exceeding $3.2T.

The Weiss report, which is by far the most troubling, estimates over 1,500 potential failures. That is 1-in-9 of every bank in the US. It also represents 41 times the assets the FDIC currently has available to insure deposits, which again is based on their, much smaller, 117-banks number.

So the big question is: can the FDIC come up with $3,200,000,000,000 to cover insured bank deposits should the worst case scenario play out?

The FDIC is "backed by the full faith and credit of the United States of America". I actually take some comfort in that. Not as much as I used to, but I highly doubt the US will go out of business anytime soon. However, anything is possible given current events. Another, related question arises if one was to worry that the FDIC might not make good dollar-for-dollar on full coverage of insured deposits: what about US Treasuries? Hopefully everyone agrees that if US Treasuries were to "break the buck", we're all (as in everyone, worldwide) in for one terrifying ride.

More likely, the FDIC will cover everything. But at what cost? How many trillions can we print? Already, the printing press is losing its leverage, and deflation is taking hold regardless of helicopter-Ben's generosity. Even if the FDIC returns all those trillions to the depositors, that doesn't mean depositors will spend them. Rather, if such a terrible failure of the banks were to occur, I posit that you and I would take our FDIC-insured dollars with the ink still wet and stick them under our mattresses. I know I'm keeping much more cash in reserve than ever before in my life right now.

That is _exactly_ what happened in the Depression. Liquidity couldn't be printed, bought, or borrowed. The only escape is fundamental growth.

Worried about Inflation, Stagflation or Hyperinflation? You shouldn't be.

randolfe — Mon, 06 Oct 2008 17:36:25 -0700

For at least 3-4 years now there has been a lot of fretting and hand wringing over the fears of inflation and its uglier siblings. Certainly, consumer inflation has been growing fairly steadily since the late 1980s. But with this Great Deleveraging that's now occurring globally, are we really right to worry about inflation, stagflation or hyperinflation?

First, some defintions:

Inflation: The percentage change in the price level, usually referring to increasing prices. "Price level" itself can be applied to various measures, most commonly to a basket or bundle of goods and services.

Inflation is generally spoken about as part of the Quantity Theory of Money. It is through this theory's equations that people usually tie monetary policy to inflation.

Deflation, Disinflation: The opposite of inflation. The Great Depression was a deflationary cycle. Recessions are also deflationary.

Stagflation: A situation in which economic stagnation or even contraction occur simultaneously with inflation. Stagflation is particularly interesting because it is theoretically impossible under classical, Keynesian economics. But, of course, it happened twice in the US, leading to new theories and significant advancement of macroeconomic thought. Stagflationary cycles have been broken by the central bank intentionally causing a recession, and thus deflation. This was the famous action of former Federal Reserve Chairman Paul Volker.

Hyperinflation: An inflationary cycle which compounds out of control until currency is effectively debased to zero value. Most definitions of hyperinflation describe it as an order of magnitude increase in inflation per year, or 1% per day. Hyperinflations are relatively rare, and happen primarily as a function of a country's central bank printing money in order to service foreign debts. Hyperinflation has not occurred (for more than a brief moment as it began) within a country in the modern era so long as that country maintained a credible military force or was credibly protected by a country with such a military force. These countries choose to default instead of willingly destroying their own population and inciting an internal revolution. Famous hyperinflations, such as within pre-war Germany, were broken when the Germans militarized and broke war reparation agreements requiring them to repay crushing foreign debts. More modern hyperinflations have been broken by IMF action (ie, foreign intervention), or by various forms of practical default.

The Case for Inflation

Plenty of internet resources exist describing inflation. Suffices to say that we have been in a long-run period of general price inflation. However, it is important to note that perceptions of inflation by average people are often overstated. They usually do not recognize product-cycle-deflation. Items such as consumer electronics, computers, and automobiles are exceptionally deflationary, though most people perceive them as steady-state or inflationary. However, the value of those items rises as a function of technological innovation while the costs to produce them falls as a function of improved production techniques, all while prices tend to remain constant, fall, or rise more slowly than general price inflation.

Inflation is synonymous with a high-return global economy. It has become more pronounced and recognized as rolling asset bubbles have plagued the global economy.

The Case for Stagflation

Stagflation occurs as some prices, usually prices of inelastic goods such as food and energy, rise rapidly during a period of economic slowing. Other prices may continue to fall, however, increasingly disposable income falls as people shift spending to essential items for which the price is rising. Stagflations occur due to some economic shock, such as a war or supply disruption. Many have made the case that describes our current global situation, particularly in the US. This case has merit, and I see as the second most likely outcome of the current situation. It may also be that stagflation occurs as a transition into a more deflationary environment.

The Case for Hyperinflation

Hyperinflation is the least likely conclusion for the US, and for most western economies, in my opinion. Even were a hyperinflation to ignite within the US, it is more likely we would either intentionally or naturally quickly break into a Great Depression-style deflation, probably as a result of either overt or effective default on our foreign debts. Most who are calling for a hyperinflation in the US point solely to the "printing of money" as causing inevitable currency debasement. That is flawed reasoning of linear extrapolation. As Japan noted during their deflationary cycle, even cutting the interest rate to zero, and making the real rate negative (meaning one pays to store their cash in the bank instead of earning interest on it) did not result in a hyperinflationary debasement of their currency. Instead they became trapped in a liquidity-trap, as situation in which the central bank lost its ability to affect aggregate demand. I believe, for reasons outlined later, that this is (somewhat surprisingly, perhaps) where the US is headed.

The Case for Deflation

Financia Capital produced a reasonable analysis and essay making a case for deflation in their document MarketWatch Postscript: A Case for Deflation (PDF), June 2007. Other notable works can easily be found by way of a Google search on the subject.

I'll leave their analysis to carry the weight of the deflation scenario argument and just bring out some basics here:

Many products are strongly deflationary, as mentioned earlier. Computers are an easily describable example.
Stiff price increases in commodities is a function of global demand more than monetary policy. During a period of slowing global economic growth, commodity prices subside.
Pursuit of high-returns coupled with easy-money monetary policy has resulted in rolling asset bubbles.
When the rolling bubble(s) encounter an end-game scenario, the popping of those bubbles is strictly deflationary. I argue that real assets (as in real estate) represent the end-game scenario. The amount of leverage generated and global capital deployed to inflate the global real estate bubble is so massive that no other asset class exists to adequately absorb the accrued inflation. Therefore, as it pops, strict deflation must occur.
Attempting to "inflate our way out of" the current scenario will result in a liquidity trap, further complicating deflation. The system of credit is delevering, which necessarily implies, deflating. That is, less credit will be available after the correction than before because capital is being levered much less.
Less credit impacts the consumer sector of the US by decreasing aggregate demand, causing deflation.
Investors will no longer seek high-returns instead preferring optimal risk-adjusted returns. This will cause investment, which fuels credit, to be attracted to less risky, lower growth endeavors. Lower growth adds to deflation.

Please feel free to add your comments, debate, criticize, and discuss.

Inflate, Deflate or Default

randolfe — Thu, 02 Oct 2008 08:30:02 -0700

Craig Jones has written what I think is an excellent article on seekingalpha.com which I strongly encourage you to read:

Inflate, Deflate or Default

He starts off describing how some fifteen years ago he came to the well-studied, theoretically grounded conclusion:

I came to the simplistic conclusion that we, as a country, had but three choices for righting our hopelessly listing fiscal super-tanker; Inflate, Deflate or Default.

However, that didn't happen. Instead something very different occurred. Now he reasons that we're finally back to a fundamental point where his original thesis is valid.

Read for yourself, and read the comments (one of which you'll recognize), and let me know what you think. In my opinion, Craig cleanly summarizes the conversations, arguments and reasoning many of us have been having over the past many years on macro subjects. I'm just no[t] so sure he will be any more right this time around.

No Honor Among Thieves

randolfe — Wed, 01 Oct 2008 09:05:47 -0700

In the past few days I've seen, heard and read interviews with various CEOs and industry advocates from the worlds of the home builders, realty agencies and mortgage brokers/lenders. Three years ago you would have thought these groups constituted one giant, happy family. All of them denying the existence or even the possibility of a bubble. All of them congratulating themselves on achieving historically high home "ownership" levels. All of them urging potential buyers to "buy buy buy". Buy as much as you can, as fast as you can, as often as you can was the mantra.

Enter the Great Deleveraging, a historic credit crunch, and home prices dropping faster than ever in American history: and the once happy family are stepping all over each other to point fingers and defer blame.

Most recently, I heard an interview on the radio with Margaret Kelly, CEO of Re/MAX. She was overtly laying the entire blame for the irresponsible borrowing and home buying of the past few years at the feet of the mortgage brokers and loan originators. She stated, essentially, that:

The realtors had no culpability.
The realtors' hands were tied because they have a "responsibility" only to get the best deal for their clients.
Realtors were warning lenders all along that the real estate market would slow down and probably begin declining.
Lenders need more regulations (though realtors need less).

Ok, you can stop laughing and/or grimacing now. I wonder if Leslie Appleton Young, David Lereah, and Lawrence Yun would agree with Ms Kelly, given they were continuously banging the drum of no-bubble, never-a-bubble, buy-buy-buy. In Yun's case, he inexplicably still is banging on that drum.

But it doesn't stop there. In past days I've heard the CEOs of Toll Brothers and KB Homes blaming both realtors and lenders for the current situation. And of course, the mortgage brokers association has been busy laying the blame at the feet of the banks and Wall Street in general.

I raise all this because

This was as predictable as the bubble popping itself.
This is entertaining as a source of Schadenfreude.
Most importantly, it presents an opportunity for geniune, honest, ethical professionals in the real estate industry to stand up, be contrarian leaders, and drive for a serious purging of the riff raff and scoundrels from your ranks.

I do agree with all of these folks in one regard: you all need more regulation. I really dislike unecessary regulations. In your case, you've earned regulation.

No Treasury Bailout ... For Good?

randolfe — Mon, 29 Sep 2008 13:35:21 -0700

The US House of Representatives today defeated the Paulson Bailout Bill. Leaving the politics of this aside, what are the real economic and financial consequences? Are we really now doomed to Great Depression 2.0? Or is this the beginning of the healing process?

Some things to consider:

Free market fundamentalism is likely to fail as bad as, or worse than, wreckless interventionism. Hopefully we learned those lessons in the Great Depression 1.0. Laissez-faire economic policy is arguably just as bad as command socialistic economic policy.
Failure of this plan alone is not sufficient to ensure a Great Depression 2.0.
The DOW is not the economy. I, for one, am tired of the media running around acting like the DOW is a proxy for the health of the economy.
Calling the bailout plan a "rescue plan" won't change anything other than what the talking heads on television spew. They've lost that battle anyway, my 70 year old mom in Ohio calls it a "bailout". Therefore, it is a "bailout" to Main Street. Get over it, media and Wall Street apologists.
And most of all -- for anyone in the real estate industry: look out below! You thought home prices were coming down before? You ain' seen nothing yet. (By the way, I just saw a new construction home we looked at earlier this year, which had then been marked down from $1.55mm to $1.395mm, and was advertising $1.098mm a couple months ago...$699K. And it's _still_ overpriced. If you're the guy next door who paid $1.6mm for your nearly identical unit in 2007, what do you do now? That home won't retrace that price in your lifetime.)

No Treasury Bailout ... For Now

randolfe — Fri, 26 Sep 2008 06:45:29 -0700

Now that House Republicans have thrown the Paulson bailout plan into total disarray, and Washington Mutual marks the largest bank failure in US History, and global credit markets are basically offline -- should we brace for Great Depression 2.0?

While I can't say 'no' with any authority, I tend to think not. Certainly bank failures and the mother of all credit crunches does no good for the economy. And by economy I mean both Wall Street and Main Street. But just because this particular $700bn (really estimated to be more on the order of closer to $2,000bn all told) bailout of primarily Wall Street investment bankers and their compatriots has stalled does't automatically spell the end of capital markets as we know them.

A few points:

I think there still will be a deal. Realpolitik trumps all when it comes to D.C. All it takes a bit more pain, fear and panic to break even the most ideological opponents of the Paulson bailout plan.
I think the Paulson bailout plan sucks. I outlined a lot of reasoning around that on another site until they saw fit to delete most of my comments, apparently because they might scare away naive prospective homebuyers. (I'll retrace those comments if any discussion arises here.)
I think the Republican alternative plan sucks (but not as bad as Paulson's). Insurance is a good idea. More deregulation is a bad idea. Tax cuts are a great idea, but not practical right now and everyone but ideologues realizes that.
Capital markets are more resilient than anyone seems to be giving them credit for.
Speaking of "credit", it is increasingly obvious that "dumb money" is mostly counted with the stock market and related derivatives, and "smart money" is mostly counted with the bond & treasury markets.
Ron Paul is an idiot. For all his good ideas "abolishing the Federal Reserve" is the stupidest idea I've heard in all this. I know he's been saying it for years. So, he's been an idiot for years, just no one took it seriously before. You cannot abolish the US Central Bank. You cannot disarm US nuclear weapons either. Both are necessary simply because other countries have them. Until Paul can magically dissolve all central banks world wide, I'm not listening. While he's at it, please make all the nuclear weapons disappear.
Many of the otherwise credible "rogue blog economists" like Mish, etc. who have contributed so much to this debate the past 5 years need to quit listening to Paul and supporting him so openly. Now is a time where credibility is gold. Who you ally with and support determines your credibility.

Think. Read. Discuss. Then think some more. Now is not the time to panic. It is the time for concern and determination. Not despair.

Some form of bailout package will be passed anyway. It just might not be the Paulson Bailout Plan. It could be better, it could easily be worse, but Congress will pass something. Don't bet they'll just go home.

--Randy H