Sunday, May 31, 2009
Wednesday, May 27, 2009
"Here in my hand is a list of 205 communists in the blogosphere and the mainstream media."
Well – no actually – but I have a long list of people who – on the record – supported the confiscation of Washington Mutual.
Washington Mutual was given to JP Morgan who did not need to honour all of WaMu’s debts. Debt holders – who would normally have expected to recover most or all of their investment were wiped out.
After this – and until very recently – no ma
The confiscation of Washington Mutual thus forced the entire system onto the government guarantee tit. The cost to taxpayers is thus potentially enormous.
Now at the time the confiscation looked
However if JPM was telling the truth – and Sheila Bair had a decent basis for believing them – then this was not arbitrary confiscation – though it was confiscation without appeal. It would be costly for the system – and it might have been
Alas the facts have a neat way of outing the incompetence of Sheila Bair. JPMorgan is now confessing that almost all of the charges taken when Washington Mutual was confiscated will be reversed through their P&L.
Sheila Bair – a Republican appointee no less – confiscated without compensation and without right of appeal valuable private property. I have argued repeatedly that she should resign – but now my basic thesis is proven her position is totally untenable.
A huge number of people supported her at the time. These are people who supported the confiscation of private property without appeal. Usually such people are called communists. The alternative explanation is that these people are
Actually I know a lot of these people and they are not dopes. [Using McCarthyist logic therefore they must be communists.]
But they are not Communists either. Instead they were dopes on this occasion. Panics – be them financial or political do that. They turn thinking – even iconoclastic people like high profile bloggers – into dopes.
Now Washington Mutual was in fact very easy to add up. It was obviously solvent if you ran the numbers properly – but people find it quite difficult to run the numbers on banks. This applies to senior government officials too. And that explains why financial crises happen. People thought there was no risk in financial assets that were obviously risky during 2005 and 2006 and even into 2007. Thereafter they thought that financial assets that were most likely safe were (near) worthless. Government officials seemingly arbitrarily confiscating assets into the height of the crisis
After the confiscation of WaMu we needed not only to
The irrational fear in markets was not unlike the irrational fear that other manias (eg Joe McCarthy) engendered. That doesn’t make the fear less real or less destructive.
I thought at the time that Sheila Bair’s resignation would heal that wound– and would be the single best thing that the government could do to ease the financial crisis. Her resignation would break the nexus between fear in the market and the fear of seemingly arbitrary confiscation by government officials.
That nexus is broken now through repeated and consistent subsidy at huge potential cost to the taxpayers. The government – through repeated capital in
It would have been cheaper for Sheila Bair
However – the immediate and pressing need for Sheila Bair to resign as a matter of policy has past. The market is no longer outright afraid of arbitrary government confiscation of financial assets though they might have some fear about government intervening in
But whilst the time for Sheila Bair’s resignation as a matter of national priority is past, the time for her resignation for proven incompetence has
Tuesday, May 26, 2009
Monday, May 25, 2009
Monday, May 18, 2009
Economics may be a “science” but it lacks controlled experiments. Especially in macroeconomics you can’t repeat an experiment with one variable changed and see how the single variable changes the outcome. Economists have lots of statistical tools to deal with this – but those make the discipline either incomprehensible or diabolically boring. [Apologies to all those who taught me econometrics.]
But every now and again people throw up a controlled experiment – two situations that are very similar and differ markedly only in one ma
What I want to do here is give a stylised version of Japanese and Korean economic history and how it pertains to the banking crisis both countries had. My knowledge of this however comes the way much of my stuff comes – from the history of the banks backwards. So I am sure to offend people with deep understandings of the political/economic history and I welcome someone telling me I am
First however I need a stylised history of
Before Perry Japan was almost autarkic. There was a relatively weak central government and about 300 “han” – being relatively strong feudally controlled districts. The emperor did not effectively speak for
The view of the new oligarchs was that
Ok – that is your 143 word history of
Financing Japanese expansionism - and that financial system until today
Financing Japanese expansionism - and that financial system until today
Firstly it is simply not possible to expand heavy industrialisation of the type required by an early 20th Century military-industrial state without massive internal savings. Those steel mills had to be funded. And so they set up the infrastructure to do it.
Central to this was a pattern of “educating” (the cynical might say brainwashing) young girls into believing that their life would be happy if they had considerable savings in the form of cash balances at the bank (or post office). Japanese wives often save very hard – and are often insistent on it. The people I know who have married Japanese women confirm this expectation survives to this day.
Having saved at a bank (and for that matter also purchased life insurance from an insurance company loosely associated with the bank) the financial institutions had plenty of lendable funds.
The financial institutions by-and-large did not lend these funds to the household sector. Indeed lending to the household sector was mostly discouraged and was the business of very seedy loan sharks. To this day
Japanese banks instead lent to tied industry – particularly heavy industry. It was steel mills, the companies that built power plants, the big machine tool makers. Many of the companies exist today and include Fu
Now steel is a commodity which has wild swings in its price. Maybe not as ordinarily wild as the last five years – but still very large swings. And these steel mills were highly indebted to their tied banks. Which meant that they could go bust.
And as expected the Japanese authorities had a solution – which is they deliberately cartelized the steel industry and used the cartel (and import restrictions) to raise prices to a level sufficient to ensure the heavy industry in question could service its debt.
The formula was thus (a) encourage huge levels of saving hence (b) allow for large debt funded heavy industrial growth. To ensure it works financially (c) allow enough government intervention to ensure everyone’s solvency.
When the Americans occupied
Like many post WW2 agendas that agenda was dumped in the Cold War. The owners of the Zaibatsu were separated from their assets and some cross shareholdings were unwound – but the institution survived – and the Zaibatsu (now renamed Keiretsu) remained the central organising structure of
The point is that it was the similar structure before and after the war – and it allowed massive industrialisation twice – admittedly the second time for peaceful purposes.
Now the system began to break down. Firstly by 1985 steel was not the important industry that it had been in 1950 or 1920. Indeed almost everywhere you looked heavy industry became less important relative to other industrialisation. By the 1980s pretty well everywhere in the world tended to look on such heavy industries as “dinosaurs”. This was a problem for Japanese banks because they had lent huge sums to these industries guaranteed by the willingness of the State to allow cartelisation. You can’t successfully cartelise a collapsed industry.
Still the state was resourceful. Originally (believe it or not) they opposed the formation of Sony – because they did not know how to cartelize a transistor industry. Fifteen years later the
UK Prime Minister French Prime Minister President would refer to his Japanese counterpart as “that transistor salesman” and he was not using hyperbole. Still the companies coming out of new
The banks however still had plenty of Yen, and they lent it where they were next most willing – to landholders. The lending was legion and legendary – with golf clubs being the most famous example of excess. [At one stage the listed exchange for golf club memberships had twice the market capitalisation of the entire Australian stock exchange.]
Another place of excessive lending was to people consolidating (or leveraging up) the property portfolios of department stores. Think what Bill Ackman plans to do to Target being done to the entire country – and at very high starting valuations.
Meanwhile the industrial companies became zombies. I have attached 20 year balance sheets for a few of them here and here. These companies had huge debts backed by dinosaur industry structures. They looked like they would never repay their debts – but because they were so intertwined with the banks the banks never shut them down. As long as interest rates stayed near zero the banks did not need to collect their money back from them. As long as they made token payments they could be deemed to be current. There was not even a cash drain at the banks at low rates. The rapid improvement in the zombie-industrial balance sheets in the past five years was the massive boom in heavy industrial commodities (eg steel, parts for power stations etc). Even the zombies could come alive again… only to return to living dead status again quite rapidly with this recession.
Anyway – an aside here. Real
Most of the banks had plenty of lendable funds and a willingness to lend them. They did not have the customers – and the biggest, oldest and most venerable of Japanese companies were zombies. So were the golf courses, department stores and other levered land holders. I get really rather annoyed when people talk of zombie banks in
Note how this crisis ended.
1). The bank made lots of bad loans – firstly to heavy industrial companies and secondly to real estate related companies (golf courses, department stores etc).
2). The loans could not be repaid.
3). The system was never short of funding because the Japanese housewives (the legendary Mrs Watanabe) saved and saved and saved – and the banks were thus awash with deposit funding.
4). The savings of Mrs Watanabe went on – indeed continued to grow – with zero rates.
5). Zero rates and vast excess funding at the banks made it unnecessary for the banks to call the property holders and (especially) the industrial giants to account for their borrowings. Everything was
6). Employment in the industrial giants of
7). The economy stagnated – but without collapse of any of the ma
Now lets look at
And the Chaebol suffered the same fate (slow irrelevance of heavy industry) as the Japanese heavy companies except they were called to account and many of them failed.
The reason is the different banking structure.
The result is that the Korean banks – unlike their Japanese counterparts – were short funds. Endless funding at zero interest rates was simply not possible. Given that the banks eventually collapsed – with many becoming government property and with the government winding up as the largest shareholder in almost all banks. This was a spectacular crash – as opposed to a slow-burn malaise. Chaebol failed. In some instances their founders were imprisoned. The strongest Chaebol is the one most associated with new industries (Samsung). It survived and prospered – but others did not.
It is my contention that the main difference between the Korean and Japanese crashes (and
The recovery was also sharp because the systemic failure meant that businesses that shouldn’t have failed (because they were profitable worthwhile businesses) got into deep distress. Real companies died not because they deserved to die but because the system in crisis killed them. There was a case for bailing out those companies – and the rapid recovery told you this was something systematic – not business specific. The massive upward movement in the stock market at the end of the crisis was the secondary proof that good businesses were killed. It was also probably the best investment opportunity globally in the last twenty years.
The economic decline in
Policy question: how do you ensure the creative destruction without putting the good bits of the real economy to the sword?
Investment question: what bits of the
For discussion. And thanks for bearing with a long post.
Thursday, May 14, 2009
Tuesday, May 12, 2009
The blog however owes a thank you to the (now suffering) people of Latvia. Before I mentioned their forthcoming problems I had about 50 readers. A post about the price of prostitutes got me my first 1000 reader day and my first mention in the main stream media (the Estonian business press).
For those that are new the argument was as follows:
- Latvia and to a lesser extent Estonia and Lithuania had a massive and unsustainable current account deficit. That means they bought more from the rest of the world than they sold (just like America buys far more from China et al than they sell). The current account deficits (relative to GDP) was however much bigger in Latvia.
- In a floating exchange rate regime this would usually be remedied by the currency falling dramatically, increasing the competitiveness of exports (and increasing the price of imports). The market provides a solution. With America this can't happen because the Chinese fix their currency against the US dollar. In the Baltic States the currency is fixed against the Euro.
- Normally to fix the exchange rate a central banker needs to buy the currency that is tending weaker. They buy it and remove it from circulation. In so doing the reduce the money supply in the weaker currency causing interest rates to rise and a mild monetary deflation (increasing the competitiveness of local industry versus foreign competition) and hence over time remedying the current account deficit.
- Unfortunately this monetary deflation causes a recession in the country with the naturally weaker currency. Ultimately that makes fixed rates unpopular in countries with chronic relative economic under-performance – because the populace doesn't like more or less continuous mild recessions. Some countries dealt with this through periodic competitive devaluations (Spain, Italy). Other just gave up on fixed exchange rates (UK). Generally the world has tended towards permanently fixed exchanges (Europe inside the Eurozone) or floating exchange rates (eg Australia).
- Now there is one exception to the idea that the country with a fixed exchange rate and a lack of competitiveness has a sort-of-perpetual monetary squeeze and low-level recession. And that is if somebody cheaply finances your current account deficit ad-infinitum. Then you can have the nice strong currency and spend it and not have any domestic price pressure. Unfortunately you also wind up owing your foreign benefactors just way too much money.
- The party has to end. And it can end quite sharply when the foreign benefactor becomes less willing to lend to you.
But in Latvia the situation was (at least) three times as unsustainable as the US. And ultmately Latvia has less credibility in repaying those loans than say the US.
When it ended in America we got a big recession.
In Latvia it ended when the Swedish banks providing the funding (Swedbank and SEB) themselves got into trouble. Latvia is experiencing something more akin to a depression. Latvian GDP has now dropped almost 20% - about the same proportionate drop as America in the Great Depression. And it is going to get worse still. This is really truly ugly – and the street riots I predicted in the original post have unfortunately happened in all the Baltic States. The governments (and the people can feed themselves) because of foreign aid – mostly through IMF packages funded by the Scandinavian governments.
Well what has all this got to do with the price of hookers?
At least partly for effect I noted that one of the most important (perhaps the most important) export industries in Latvia has been tourism. And it is not any type of tourism – it has traditionally been sex tourism. Latvians are beautiful Scandinavian people (if you like that Northern European look). They also have a more Scandinavian sexual morality and they were relatively poor. This meant that Ryanair put on discount flights and filled them with salivating Irish and English lads. Swill beer on the Friday flight over. Party all weekend, soil the plane on the way home. You could not walk around Riga as a single English guy and not be thought of as a Ryanair sex tourist.
The only problem is that the ridiculous exchange rate made the hookers very expensive.
Ryanair canceled the Shannon/Riga flight (and the Irish lads now go to Prague). The London Riga flights are less full. There are plenty of complaints on the web about over-priced bars and rip-offs in Riga. The oldest and one of the most dependable of professions was – due the ridiculous exchange rate situation – just priced out of existence.
Still markets are correcting in the end. Now that there is a Great Depression in Latvia there is price deflation. Lots of it.
The faster the deflation happens the faster Latvia will again become competitive. [Hint to the IMF – just float the currency and deal with the consequences of the new exchange rate rather than try to defend the old rate.]
Anyway the problem is that most industries have contractual arrangements which fix prices. Wages are very hard to flex downwards. Rents are fixed over sustained periods and the like. All of this means that people go bust rather than reduce prices – simply because prices are sticky.
Well – most prices. The contractual terms of prostitution are short (an hour, a night) and entry to the industry is unconstrained. That means that the prices are very flexible. Extraordinarily flexible.
The price – looking at websites I will not link for decency's sake – has fallen by at least two thirds in the past year – and the advertised price (for a non-English speaking young woman) is LVL30 – or less than 60 US dollars. I am sure the rip-offs are still there – but anecdotal evidence suggests the hookers no longer cost too much.
The first question is how far do other prices have to fall – and how bad will it get in Latvia before it improves.
I did say this was ultimately about geopolitics. The Baltic States all have sizable Russian Minorities. Russia under Putin is very concerned about the state in which those minorities live – and has been prepared to take military action to protect what it perceives as the interest of the Russian people. [Read Georgia/South Ossetia.]
Now I am not going to opine on the validity of the Russian claims. Tensions run very high on all sides.
I will note the Russian-Estonian relation riots in Estonia in particular have been lethal in the past (see the story of the Bronze Soldier).
And I will leave you with a somber note. In Latvia the hookers did cost too much. They don't any more – but most things still do – and there is no easy fix. However what is a classic text-book macroeconomic problem fast risks becoming a geopolitical one. And whilst there are big difficulties bailing out the Baltic economies one of them is not the size of the check you will need to write. These places are small and the checks disappear in a US or even European Budget.
And there are big difficulties allowing the Baltics to drown in their economic problems. Geopolitically a bailout looks like the cheap option.
Gaius Marius of the (usually lower case) “decline and fall” blog left the following comment on my 77 Bank note.
But American banks are not awash in funding – and given the profligacy (especially historic) of the American consumer – not to mention tax cut funded Iraq wars and the like – the US financial system is almost always going to be an importer of spondulicks. That might change in twenty five years – but it is not changing now.i think this is really the big question, isn't it? were not
japanese banks in more or less exactly this position in 1991-2, but with corporate rather than consumer credits sucking up all available lending capacity?
western banks are collecting fat spreads right now, but the true long-term test for the system won't be in loan supply -- it's in loan demand. if banks can't make sufficient new loans to replace the fat ones rolling off their books, earning power will diminish over time even as asset prices continue to deteriorate.
as i understand it,
japan ended up with massive excess funds in banks because (beginning in 1996) the private sector started to repay loans (ie, aggregate loan demand went negative), to the tune during the early 2000s of 5% GDP. but in 1989, the japanese nonfinancial corporate sector was increasing its bank debt at a rate of in excess 12% of GDP (and issuing debt on the order of 5% GDP in capital markets to boot). that massive 17%-of-GDP swing in private credit took ten years to effect. aggregate private sector loan repayment seemed to have ended in 2005, but has probably resumed in this crisis.
to prevent a crash in monetary aggregates, the government borrowed out these excess deposits, which at 77 bank shows up as a massive investment portfolio in JGBs.
for what it's worth, i think a more appropriate comparison would be to the 77 bank of 1991. i have a sneaking suspicion that 77 bank was then also a mirror image of the current 77 bank, but i'd love to be disabused of that notion.
The comment is reflected in several emails I have received. It seems several people had the same idea - though maybe less well articulated than Gaius.
Well Gaius – you can be disproved of the notion. I have uploaded a 20 year balance sheet for 77 Bank here. It is here. The loan to deposit ratio started at 74 percent and wound up at 64 percent – with the mix of the loans moving towards lower margin government loans over time.
Note that relatively quick in this context is a depression level recession lasting a few years - rather than a sustained malaise lasting decades.
Still this difference has profound investing implications - and also some policy implications - and that makes it worth thinking about.
Sunday, May 10, 2009
- The losses as estimated by the JP Morgan and told to regulators when they were manipulating Sheila Bair into confiscating Washington Mutual were lies – indeed were so grotesquely over-estimated as to be absurd criminal lies or
- The losses as estimated by JP Morgan and the regulators in the stress test are grotesque under-estimates – which – in order to be that grotesquely wrong had to involve major misrepresentations of their book by JP Morgan.
Saturday, May 9, 2009
“I don’t think the Republic is going to be brought to its knees if private equity owns banks, personally,” Mr. Flowers said from his Midtown Manhattan office with its expansive views of Central Park. “We invest around the world — Japan, Germany, England, no problem.”
Shinsei racked up profits in its first six years under foreign ownership. The bank gave funds to J.C. Flowers to invest and had no discretion where Flowers placed the money, Flowers said. Neither Shinsei nor Flowers would give the amount.
Friday, May 8, 2009
77 Bank has a very large market share (near 50%) in
Here is its balance sheet:
(click for a more detailed view).
Note that it has USD42.6 billion in deposits. This compares to $35.8 billion for Zions Bancorp – as close to an American equivalent as I can find. [Disclosure - I had been short Zions Bank at various times - but not for the great collapse in its local commercial property market. I lost money. I thought Zions modestly risky - but it wound up very risky.]
77 only has USD26.4 billion in loans though. If you take out the low margin quasi-government loans it probably has only USD20 billion in loans.
This bank seems to be very good at taking deposits – but can’t seem to lend money.
This is typical in regional
So – guess what. It sits there – just sits – with huge yen securities (yields of about 50bps) doing nothing much.
It’s a big bank. It has next to no loan losses because it has no lending.Here is an income statement:
(click for a more detailed view)
Profits were USD87 million on shareholder equity of 3251 million. You don’t need a calculator – that is a lousy return on equity for a bank without credit losses.
You might think that given that they have no profitability and no lending potential they might be returning cash to shareholders. Obviously you are new to
In a world where banks everywhere are short of capital 77 bank is swimming in it. Here is the graph of capital ratios over time:
This bank has an embarrassment of riches – and nothing to do with them.
Welcome to regional
An American Mirror
The title of this post was “An American Mirror”. And so far I have not mentioned
There are also mirror image lands – 77 is our mirror image.
Macroeconomic investing calls
We live in a world with considerable excess (mostly Asian) savings. Banks with access to borrowers made good margins because the borrowers were in short supply. Savers (or banks with access to savers) were willing to fund aggressive Western lenders on low spreads.
77 Bank has been the recipient of those low spreads. It has not been a fun place for shareholders as the sub 3% return on equity attests.
The economics of 77 Bank (and many like it) will change if the world becomes short on savings. There is NO evidence that that is happening now – and so 77 Bank will probably remain a lousy place for shareholders.
The market produces what the market wants
This is an aside really. We live in a world with an excess of savings. This is equivalent to saying that we live in a world with a shortage of (credit) worthy borrowers. So we started lending to unworthy borrowers – what Charlie Munger described as the “unworthy poor [whoever they might be] and the overstretched rich”. We know how that ended.
Unfortunately the financial system cannot make worthy borrowers. It can only lend to them when it can identify them.
This Subprime meltdown heralds the death (for now) of lending to the unworthy. The shortage of the worthy however is as acute as ever – and money for the worthy is still very cheap. [Money for the worthy is now difficult to obtain (at least outside Fannie/Freddie space), but still relatively cheap once obtained.]
The subprime meltdown does not solve 77’s problems.
One year later postscript:
The basic call that the global savings glut was not going away was right. The global glut of savings - which found its way into endless dodgy subprime mortgages and other problem loans - still exists. Chinese people still save to excess. Americans are saving more. The fundamental imbalance that drove the world financial crisis is still there. It is not obvious how that is fixed.
Japanese banks however have found that low margins are particularly dangerous - as there is little profitability to offset losses (even small losses). And Japanese banks are now having losses.