Sunday, June 19, 2011

EU Interbank Lending

"The Depression may have started with a stock market crash, but what hit the general economy was a disruption of credit. Credit availability has the ability to build a modern economy. But lack of credit has the ability to destroy a modern economy-- swiftly and absolutely. The inability to stock store shelves, buy spare parts and seed for farms, purchase houses and nearly everything else is what made the Depression so awful for the people of this country. If you do not act boldly and swiftly, we will replay the Depression of the 1930's.. only this time, it will be far, far worse. If you don't do this, you won't have an economy on Monday" Ben Bernanke, September 18th 2008.

What Bernanke was so terrified of was the freezing of the credit markets; the inability of everyday businesses to access the credit needed to continue their daily operations. At the very heart of the credit markets is inter-bank lending, which is where banks loan to each other for short periods of time. This inter-bank lending is measured by a few different measurements; the most widely known of these is the LIBOR (London Inter Bank Offer Rate), which is the interest rate banks are charging to one another. Another one that I don't have a terrific understanding of is the OIS spread. During the crisis of 2008, banks became very nervous about unsecured loans to each other (and to anyone else) because they were afraid they'd be lending to a failing institution. In short, it's a matter of confidence. When there is some sort of scare, the LIBOR rate soars and banks essentially stop lending. There hundreds of measurements of the economy: GDP numbers, the Stock Market performance, Bond markets, inflation reports, unemployment reports, and on and on. By leaps and bounds, the one measurement that has the ability to terrify entire nations and governments more than any other is the interbank lending measurements.

Last Friday the OIS spread, one of the interbank lending measurments, began spiking. Also China's interbank lending measurement, called the SHIBOR, began spiking. Today, an article in the UK's Guardian newspaper shed light on the pulling back of some of Britain's banks from lending to other EU banks: "Senior sources have revealed that leading banks, including Barclays and Standard Chartered, have radically reduced the amount of unsecured lending they are prepared to make available to eurozone banks, raising the prospect of a new credit crunch for the European banking system. Standard Chartered is understood to have withdrawn tens of billions of pounds from the eurozone inter-bank lending market in recent months and cut its overall exposure by two-thirds in the past few weeks as it has become increasingly worried about the finances of other European banks. Barclays has also cut its exposure in recent months as senior managers have become increasingly concerned about developments among banks with large exposures to the troubled European countries Greece, Ireland, Spain, Italy and Portugal"

There are few things scarier than this for us econo-nerds. While this is not on a grand scale as yet, this is how the 2008 Meltdown began in earnest and forced Bernanke to give the above speech to a group of US Congressional leaders as he pleaded with them for the $700 billion TARP bill. 

All of this is coming about because of the mess in Greece. After hours Friday began well enough: there appeared to be an agreement between the ECB, France and Germany on the outline of a new bailout plan. The IMF also agreed to cough up a $12 billion loan to Greece, despite their political mess and resistance to more austerity measures. The agreed upon plan was a victory for the ECB and France, who were against any sort of restructuring.

But today came an article from Der Spiegel which refutes this agreement. "It's no longer on the table". Germany wants private creditors to take a haircut; the French and ECB are worried (especially the ECB, which has vast exposure to Greek debt) that any such forced haircut would be seen as a form of default. Any form of default may have the ability to actually make the ECB itself insolvent. The German public, who are sick of endless bailouts of nations who lost control of their own finances, have handed Chancellor Merkel several defeats in recent small elections. In particular the retirement age of Greek civil servants is 50 years old, whereas in Germany it's 64. This has yet to change, and the Germans are (not unreasonably) upset at having to (again) bail out a nation where this overgenerous retirement plan exists. 

Later in the day came this: "European governments weighed withholding half of Greece’s next 12 billion-euro ($17.2 billion) aid payment, seeking to keep the country solvent while maintaining pressure on the government to slash the debt that pitched the euro area into crisis. Euro-area finance ministers may authorize only a 6 billion- euro loan to tide Greece through bond redemptions in July, while further aid hinges on Greek budget cuts, Belgian Finance Minister Didier Reynders said"

In short, this Friday's calming news was blown up even before the markets have opened in Asia. This is not how to calm credit markets. The Eurocrats are like the gang that can't shoot straight. While I don't think it's a serious matter as yet, continued inaction and indecision will weigh on market confidence. As we speak the Greek government is debating a vote of confidence on PM Papandreou's government; the vote is expected next Tuesday nite. Should he fail, the markets will certainly react badly. These politicians are playing hot potato with a hand grenade here and need to come up with a solid and plausible plan for Greece. In the end, I actually believe they'll get a deal done and Greece's indentured servitude will be extended again, but as each day passes I get more scared that their dithering and confusion will blow up in their faces.

Monday, June 13, 2011

June 15th and Greek Pitchforks

There has been a lot of movement in the last week in regards to the situation in Greece-- and much of that movement appears to be backwards. Without listing too many details, it appears that the Germans' attitude towards another bailout is hardening.. it's becoming clear to many in Germany that extending yet more loans to an insolvent nation isn't the answer. Preparations for a Greek default are taking on a new seriousness in EU banking circles. The ECB is refusing to participate in another bailout-- likely because it simply is unable to thanks to the support they've already given to Greek, Portuguese, Irish and Spanish banks and government bonds. June 15th is the critical day: on that day, the Greek Parliament will vote on a series of new budget slashing moves. Among them are the slashing of over 100,000 civil servant jobs, tax hikes, more stringent tax enforcement measures, and reductions in both pay and pensions of state workers. The Germans are demanding that Greece also begin the sale of "state enterprises"-- companies and assets owned by the Greek Government. June 15th also happens to be a day when a general strike is planned. 

But today something a little more ominous is taking shape: a group calling itself the Syntagma Assembly, which has proven itself extremely successful in getting tens of thousands of Greek protestors into Greece's main Syntagma Square, is calling for a massive blockade of the Greek Parliament building on that very same day-- and this is in addition to the union organized general strike. Here's their call: "Last night (June 11th) the popular assembly of Syntagma square announced a call to blockade the Greek parliament ahead of the voting of the so-called Mid-term agreement between the Greek government and the troika (IMF/ECB/EU). The call-out for the blockade below is one of the most important acts we have seen by the Syntagma assembly so far. June 15th is gearing up to become a historical day in Greece, a crucial chance to block off the charge-ahead of neoliberalism here. Don’t be a spectator to this – translate and disseminate the text below; organise a gathering where you are, or come join us at Syntagma. This is the struggle for freedom and for our lives."

It's here that we need to take a hard look at what might happen should the protests attract 100,000 or more angry protestors physically blocking the parliament building. The last protest these people organized attracted about 75,000 people. The Greek Parliament did look at this situation-- and decided that it was time to hire some foreign workers to clean out the existing underground tunnel that leads from the Parliament building to the port of Piraeus:

For weeks I've been saying that a deal would be made, but after the events of this weekend-- especially the ones outlined above-- I'm beginning to think the worst might come this week. Make no mistake-- these are ominous developments. Would YOU want to be a Greek MP and vote for this package with the howling mob blocking the building ? If they vote it down, default and depression will follow within a fortnight.. and there will surely be serious (but in my view not catastrophic) problems with EU stock and bond markets as well as banks, beginning with the ECB, which might actually need to be recapitalized. No matter the outcome, one thing is for sure-- either way, the people of Greece will be the losers.

PS 6/14: It appears that the validity of the underground tunnel story is under serious question at this point. In addition, it appears that the Greek Parliament is only scheduled to begin debate on the 15th, but the vote is not expected until later in the month. Herein lies a good lesson for me about relying on only one media source for information.. a mistake I'll remember. Nonetheless, it appears that a number of Greek PM Papandreau's own party members are abandoning the ship and the vote is far from certain to pass.

PS 6/15: Well today was not good; at the Greek Parliament building, the crowd was near 100,000, some of them throwing molotov coctails and rocks at police. There was no debate on the new bailout, however-- PM Papandreou instead presented his head on a platter, offering his resignation. At the end of the day, there will be a confidence vote on Sunday. This was because he apparently had lost enough of his own party members' support. If he passes the vote of confidence, he'll try to push thru the next bailout package; the confidence vote will closely mirror the bailout vote. If Papandreou fails, Greek leaders will try and form some sort of coalition government, which are notoriously weak. Should the confidence vote fail, we could have a replay of the May, 2010 near meltdown in Europe. Already today there are signs of interbank lending stress. Other really bad signs were that the EUR sunk badly versus the USD and oil tanked. These were all the same signs the EU economy gave last May when it nearly melted down. 

Saturday, June 4, 2011

The US Dollar: Past and Future

In 1906, the New York Stock Exchange began an ugly slide downwards. By the autumn of 1907, the stock market's value had fallen by over 50%, causing a recession. It was then that a group of investors, financed by loans from banks and trust holding companies, attempted to corner the stock of a company called the United Copper Company. In 1980's, they termed such things "hostile takeover bids". Unfortunately for these investors, their bid to corner United Copper failed miserably, leaving these banks and trusts who loaned this scheme money insolvent, most importantly the gigantic Knickerbocker Trust Company. Their insolvency then spread to other institutions who in their turn had loaned them money. A general panic had begun, now known as the Panic of 1907. Financier J.P Morgan and a few other titans of finance came to the rescue of several large banks. Several other large companies affected by this had what is now known as "shotgun marriages", much like the Bear Stearns - JP Morgan marriage in 2008. Coincidentally, one of the biggest of the 1907 shotgun marriages was between JP Morgan's US Steel Corp and essentially insolvent Tennessee Coal Iron and Railroad Co. JP Morgan himself had plenty of experience in these affairs; during the Panic of 1893, JP Morgan had rescued the US Treasury itself. President Teddy Roosevelt, tiring of these constant panics, pushed through the Aldric-Vreeland Act of 1908, which did nothing but create the National Monetary Commission (1909-1912). Their goal was to create a better banking and currency system that would avoid and better deal with these endless panics. The NMC wrote what is now called the Federal Reserve Act of 1913, which was signed by newly elected US President Woodrow Wilson. At the heart of this new currency system was the idea of "Fractional Reserve Lending". In this type of system, it was seen as important to have a way to provide currency liquidity and so in this system, a bank would be able to loan out ten dollars for every dollar they had in their vault-- Fractional Reserve Lending. The 10-1 rule was the Law of the Land from 1913 to the early 1980s, which along with the Depression's Glass-Steagal Act, provided forty years of relative prosperity. But it is in truth a dangerous system by design: if more than a tenth of your loans went under, your bank was toast. 

Also in this system, all currency would be introduced into the system as debt: your local bank borrows from the Federal Reserve, and then your bank loans it out to businessmen and consumers. It is a top-down system built on debt. In the 1980s, Fed Chairman Alan Greenspan got rid of the core 10-1 rule for big banks, famously saying that these bankers are adults and can be trusted not to be foolish with the money. Big banks then loaned out vast sums of money; the Reagan, Clinton and Bush boom decades were built upon a mountain of debt. Some US financial institutions found themselves leveraged 40-1 loans/cash. People with no documented incomes were given mortgages; my ex-wife among them. This madness resulted in the Lehman Meltdown of 2008. Given the rate at which new dollars are being printed, there is at this junction little doubt that our currency system and the value of the currency itself is in serious doubt. Peter Schiff, a former US Senate candidate and investor who very publicly called the housing bubble and the stock market meltdown years before it happened, has said that a currency crisis is coming within the next couple of years. This is echoed by Canada's Eric Sprott, who runs Canada's largest and most successful investment fund. 

Currently there is only one US politician who consistently and endlessly calls for the repeal of the Federal Reserve Act and the creation of a new currency system.. Texas Rep Ron Paul. I fully believe a new system is in order. But what will replace the Federal Reserve Fractional Lending System ? Many, Paul included, believe that the answer lies in handcuffing the amount of currency in the system to the value of Gold or Silver. Paul also calls for a credit based system instead of the current top-down debt based system. No such system has ever really existed, although gold and silver based currencies have.

As I see it, part of the problem with a gold or silver based currency is that the value of these metals (and thus the value of the currency) can be manipulated. In late 1978, the Hunt brothers from Texas began accumulating vast quantities of silver. Between September 1979 and January of 1980, the value of silver went from $11/oz to over $50/oz.. in four months. Sadly for Nelson Bunker Hunt, his attempt to corner the market failed. Shortly thereafter, silver collapsed down back below the original $11/oz. If a couple of Texas billionaires can do this, imagine what a large sized nation or group of nations can do. This could result in complete havoc for any currency based in silver. The US did in fact have a gold standard as late as the 1970's-- but herein lies another problem. US President Richard Nixon and his Fed Chairman began to print US dollars well in excess of the nation's gold reserves to fund the war in Vietnam and the accompanying deficits. As there was no higher authority, there was nobody watching-- or so they thought. The Arab nations noticed. They began to exchange dollars for gold in titanic amounts. On August 15th 1971, Nixon took several steps to combat inflation caused by money printing-- the biggest one being his decision to end the convertibility of Dollars into Gold. The whole premise of tying the currency to a metal in order to prevent overprinting had just come crashing down.

So.. if Schiff and Sprott are correct and there is a currency crisis, what would replace it ? Since this is my blog and I believe I'm the Fountain of All Wisdom, I'm going to take a stab at this. Lets take a look at what we need: 1. There needs to be a viable way to prevent the printing of too many of them. 2. There needs to be a way to introduce currency into the system other than as debt (the top-down model). 3. If you are going to handcuff the currency to something physical, take care to make it something which would be immensely difficult to manipulate.4. Have a means to temporarily inject currency in the case of another panic and/or crash-- it was the lack of currency in the system which really caused the hardships of the Depression, something Bernanke is keenly aware of.

Therefore-- I would establish a National Currency Board, with each state electing a new member every four years, who's job it is to determine the amount of currency needed in the system based on growth (or contraction) of the economy. For example, if the Currency Board determines that the US economy grew by 1.1% in the first quarter, the nation would need to increase the monetary base by the same amount. If it contracts, no additional currency. Secondly, the currency would be introduced into the system by simply mailing checks (or electronic credits now a days) to all of the nation's citizens.. the first bottom-up system ever tried. Banks, stocks and bonds would compete for the investment capital from the citizenry instead of Central Bank lending, thus achieving Paul's dream.Thirdly I would handcuff the value of the currency to a certain value of a whole group of agricultural commodities such as corn, wheat, lumber, oats etc. So under my scenario, twenty dollars would be able to purchase four bushels of corn, two bushels of wheat, five bushels of oats, etc.. with the party expected to cough up the commodity having the choice in which commodity he wishes to pay the presenter. The idea here is to have some sort of constraining influence on the printing of money, but make it so that the commodity is not easily manipulated. Also, if a 7/8ths majority of the Currency Board agrees, a mechanism to loan cash to savings banks (not investment houses) and/or the Federal Government will exist; the limit of these loans will not exceed 1/20th of the nation's GDP. 5. Glass-Steagal will be reinstated.. verbatim.

Will this happen ? Not while the bankers and politicians have the power to prevent it. Only by revolution will we ever have a bottom-up currency system, and I don't see that happening. If Schiff's Day of Reckoning does arrive, the new system will very likely be much the same as the old one, condemning yet more generations to indentured servitude. Wash, Rinse, Repeat.

PS 4pm: In the Greek bailout, one of the major parts of "The Plan" is to ask creditors to voluntarily accept new, longer dated bonds as a way of easing the short term demands on the Greek Treasury. My question is.. if you are holding a credit default swap and were watching this, how comfortable would you be that your CDS was worth anything when it appears Greece deftly scooted around it's obligations without anybody benefitting from the insurance policy they took out against precisely this outcome ? Jamie Dimon will be fielding some interesting phone calls from those he's insuring come monday morn.