Tuesday, September 30, 2008

Tenor Madness

Regular readers will know that Macro Man is a bit of a music aficionado. While he sadly possesses no musical ability (other than possibly as a lyricist), he nevertheless finds it useful on occasion to draw on musical analogies to distill market insights.

He often selects the iPod music for his commute on the basis of his mood or the prevailing market environment. Given the stressful conditions of the past few weeks, he's been listening to an exclusive diet of 1950's and 60's post-bop jazz. After all, The Clash and Run-DMC, linked above, are a bit shouty for the current environment. And if he wants to hear someone moan about the miseries of life, he doesn't need the Smiths- he'll just call up one of his brokers.

In any event, Macro Man's been listening to a lot of Sonny Rollins this month. While Saxophone Colussus is his favourite Rollins record, Tenor Madness isn't too far behind. The latter seems particularly apt for the current state of finance, as fixed income and money markets are caught in the throes of a bit of tenor madness.

With the end of the quarter and the three month date about to rollover into the new year, the dash for cash has generated substantial distortions, despite the recent central bank dollar swap announcements. First quote of the day for overnight dollars was 13.5%, and yesterday's ICAP 3 month quote was 4.375%. The last time 3 month LIBOR was that high, Fed funds were 4.25%. The ruptures in the market can be seen in the chart below, which shows the 2-10 US government yield curve and the 2-30 US swap curve. Unsurprisingly, they are normally very highly correlated. However, recent front-end stress have driven a very significant wedge between government and swap curves.
Quarter-end also brings about the usual mechanistic rebalancing flows from pension funds and other long-term real money investors. It appears that such flows are already going through in Europe, helping to generate a vicious intraday bounce in stocks. Well, it's either that or the news of another Benelux bailout or an Irish government bank guarantee.

Or perhaps the market has decided that news which apparently ushered in a new Great Depression last night is actually pretty meaningless this morning. Macro Man and the chap next to him, both of whom are short stocks, have just been left shaking their heads this morning.

With respect to the TARP's failure to pass Congress, Macro Man touched on the political aspect of it last night (at least with respect to his opinion of the politicians involved), and doesn't intend to go there again.

After an evening's thought, however, it struck him that last night's vote was a Fort Sumter-esque shot in a modern class war. Macro Man has long thought the the negative aspects of globalization would eventually manifest themselves; however, he suspected that the primary mechanism would be protectionism. While there's nothing to say that that still won't be the case, he nevertheless views last night's failed vote through the prism of Joe Sixpack desiring to claw back some living standard away from modern plutocrats.

If the rationale for the TARP's failure could be distilled in one chart, it would be the one below, which shows a surge in corporate profits (at the apparent expense of wages) as a share of national income. It is the divergent fortunes of these two series that has fueled Main Street anger and turned "no" voting Congressmen into class warriors.
Of course, laying the blame for the current state of the world exclusively at the foot of Wall Street is badly misplaced. The US savings rate has been steadily declining since long before the invention of CDOs, SIVs, and subprime. It will have to rise, particularly as society ages. A large part of the rationale for government intervention in the current crisis is to ensure that this occurs in a gradual, orderly fashion, rather than abruptly via the wholesale withdrawal of credit throughout the economy.
Last weekend, Macro Man exhumed some laid-back tunes from his university days in a further effort to remain chilled. The lyrics from one song in particular are remarkably pertinent to the current situation, despite having been written forty years ago:

The percentage you're paying is too high priced
While you're living beyond all your means
And the man in the suit has just bought a new car
From the profit he's made on your dreams
But today you just read that the man was shot dead
By a gun that didn't make any noise
But it wasn't the bullet that laid him to rest was
The low spark of high-heeled boys

Month-end flows and poor liquidity have thus far enabled equity markets to defy the Low Spark; however, thanks to tenor madness Macro Man continues to expect the High Heeled Boys to win out in the end.


Sean Maher said...

Nice chart, the squeeze on real household incomes is the real issue and one I've discussed many times on my finance blog www.deadcatsbouncing.com; interestingly, there are parallels to the 1920's when consumer spending power simply couldn't support the productivity gains in industry, precipitating the Crash; it wasn't the New Deal but the rise of union power and collective bargaining during the war years that set the scene for the 50's and 60's US consumer boom. Labour's share of the cake will have to rise, possibly at the cost of rising protectionism. China better have a Plan B too...

Anonymous said...

Thanks for bringing Sonny Rollins to mind. I too am a fan and will pull out his tunes for some personal musical therapy. Things look tough, but won't innovation and the need for all of us around the globe to feed and clothe our families ultimately put this Humpty Dumpty together again? Perhaps I misunderstood your high-heeled boys winning in the end reference, but that seemed a gloomy prognostication. What gives?

dblwyo said...

Traffic at Santa Monica Pier:

Led off by tenor sax no less.
Granted the socionomic vector of your thesis consider an alternative outcome is a highly stratified society with declining mobility and increasingly rigid social controls.
Before somebody takes that too far I'd suggest however that we're in a major structural shift.

As it happens if you map out the waves of innovation, e.g. coal & steel to cars, gasoline & electricity they come in 20-30 year waves. Right now we're in a hiatus with the next one some years off.

Such shifts bring about sociopolitical strains and new demands. The differences in the two alternatives lie in our adaptabilities and resiliences.

pej said...

I love your "why the package failed" graph!!!

Macro Man said...

@Anon, to me the victory of the high heeled boys means the acceptance of the bear market, and perhaps a cathartic down move. The sooner this happens, the sooner one can start be constructive on , for example, equities. From my perch, they still look expensive, so I am short.

dblwyo, wouldn't the Internet revolution qualify? I mean, we are now in an era of instant information, where regrettably any jackass with a computer (e.g., me) can broadcast himself to the world. By providing an effective means of communication, the Internet provides a channel for discontent (as well all sort of other diversions that a Victorian would say contributes to the moral degradation of modern society.)

dblwyo said...

MM - yeah, in a way. Wasn't trying to list them all. Post the US Civil War there were 3 1/2 major ones (preceeded by the 1rst in England). Rough cut (& one has to remember that invention to innovation to adoption is itself a long cyclic process,e.g. post WW2 was based on 1930s research WW2 investment and so on). Rough cuts:
1. Coal & Steel => Mass Markets (1870-1900)
2. Chemicals, Electricity, Gasoline
3. Electronics/Computers, Materials (Plastics), Pharmaceuticals, Transportation: 1950-1970
3.5 Distributed Computing

Internet was built on a whole bunch of stuff and compared to where we set out (speaking as a founding member of IBM's original e-Business task forces) we've never touched the B2B side.

Notice that as each reached maturity there was a tendency for saturation and financial frenzy, leading to speculative collapse.

BtW - just for fun I think the next one is about ten years from starting, will be based on Systems Biology, Computronics and artifical materials engineering. The paradigm shift is the application to multiple fields of systems thinking and complexity (cf. E.O. Wilson, "Consilience")

normal being said...


In the Schumpeter-Kondratiev model the internet revolution is supposed to be wave 5. You can easily argue for other ways of counting, but there can be no doubt that breakthroughs like the steam engine or the PC don't happen every year.

In many countries the explosion in internet access is still ongoing and raises productivity. But in the US every toddler seems to have a PC already. There are no gains (in productivity) to be had from more internet and more computers, just as in 1893 building even more railway didn't make sense any more.

So for another 90ies-style productivity growth another technological breakthrough is needed (and yes, it will be either artificial materials or self-regulating "bionic" systems, whichever comes first).
Will it take 20 years? No. The first wave took 60 years more or less (after the steam engine, canals and mechanical loom but before the Bessemer process there was not much else), 1893 to 1929 was a timespan of 36 years.
I think, that there is every reason to assume progress is accelerating. At least, if we don't blow it.

The obvious usage for artificial materials is in the energy sector, including Craig Venter's crude-producing-bacteria.
The first application for self-regenerating, intelligent systems will be in the field of financial regulation. If it works there, we will probably have to take on climate regulation/ bio engineering.

normal being said...

Sorry, geo engineering, not bio.

mikarsky said...

dblwyo: great point raised. just think of what's going on at all fronts: new energy, nanotech, internet, general culture shift. take it all together and the possibilities will be endless. it's called exponential innovation. you have to break an egg to make an omelet. well, seems like a lot of eggs!!

dblwyo said...

Normal - fair enough. You might find some of the talks on TED, which are now online accessible, to be interesting and well worth your time.

Might I also recommend Chandler and his disciples body of work. As he pointed out very early the rise of mass production and distribution was a bigger change in socionomic organization than at any previous time in history. In other words a Baltimore merchant of 1830 would have been perfectly at home in the Medici's Florence while by 1880 he was out of business.

In the US we responded with the massive social engineering of the Progressives. What now ?

Beyond Chanlder's early works (best summary worldwide is "Big Business and the Wealth of Nations") his studies of electronics and pharmaceuticals are well worth any investor's time. IMHO of course :) !

gramps said...

MM: sorry to drag you back to yesterday's post -- but I guess I didn't elaborate in my comments enough - I was asked last week to keep my comments shorter :)

I agree 100% that there is a crisis of confidence -- that is the problem, but stealing from future generations (via massive odious debt) to bail out bad bankers does nothing to instill confidence.

When any of us humble peons of the market lose money, we are expected to pay up.

When we get a margin call, we had better meet it. Your broker would laugh at you if you tried to argue the market price is wrong and reflects undue panic.

But when the losers of Wall Street fail to practice Risk Management 101, and THEY get a margin call -- suddenly we are told the sky will fall if they don't get a tax payer bailout.

There is nothing "confidence building" about do what I say, not what I do.

Lehman (and AIG and Bear and ...) deserved to fail. They were run by smart guys, but they got greedy and over levered. And the same thing happened to them that would happen to us if we got greedy and stupid.

"Do what we say, not what we do" is not a way to restore confidence -- quite the contrary.

Stealing from future generations to bail out your crony friends is a great way to destroy all confidence.

gramps said...

BTW -- your chart on US personal savings rate basically supports my comments from yesterday (too bad commenters cannot attach graphs!)

The economy isn't "growing" when we take on all sorts of debt-- we are just going deeper into debt and that's it.

The mortgage problem happened because home prices increased by a lot more than incomes, making Joe Sixpack unable to service his mortgage.

He tried to make ends meet by going deeper into debt and/or using a relaxed underwriting standard (less than 20% down, no doc, etc)... but that doesnt solve the problem long term.

We need REAL growth, not debt induced bogus growth.

The disasterous bailout package that Paulson tried to jam down everyone's throats did NOTHING to address a single problem, other than to allow unqualified bank CEOs to hold on to their jobs.

Yes, if you lever your investment bank 30x after seeing LTCM fail at 20x leverage -- you really should look for an alternate career path.

Any **taxpayer** bailout package needs to help society as a whole, not just CEOs.

Homeowners (renters?) need to get sufficient income with which to pay a mortgage -- either home prices have to fall further and/or incomes have to go up... Paulson's dumb plan addressed neither

Banks need to be recapitalized -- which requires investors to have confidence that we will get a reasonable return on our investment. I need a CEO selected by merit (not politics) to run my investment prudently. That isn't happening.

Henry Paulson grinning on TV and basically yelling "The fix is on!" will never restore anyone's confidence.

Macro Man said...

So if an entrepreneur borrows money to start a new business, is that real growth or not?

The collapse of credit means that that sort of 'animal spirit of capitalism' cannot occur.

It also means that companies who access credit markets to finance their inventory cannot do so.

"Credit" is not all about overconsumption and/or stealing from future generations. It's also about the continuation of economic activity.

As an aside, there's a decent chance that the government could actually make a profit buying distressed assets below intrinsic value.

Oh, and if AIG were left to its own devices to die....the global economy seizes up- no air travel, for example, as they ensure much of the industry.

gramps said...

MM: if an entrepreneur fails, is that real growth?

I assume that is not a serious question?

Its far from obvious that there was an entrepreneur here -- between banks and non-bank banks, everyone and their cousin was offering mortgages.

It all sounds a lot like the Asian crisis a decade or so ago when a beef processor decided to build a DRAM manufacturing plant... as I recall, that nonsense ended quite badly. The world only needed so many DRAM chips.

Turns out the US (and Europe) only need so many houses. Excess housing, built to satisfy speculators not buyers or renters, is not growth-- even though GDP and other statistics mis-reported it as such.

BTW - when Asian markets collapsed, the US made a really big stink that Asian governments should NOT bail out crony banks- we even insisted that existing shareholders be wiped out when taxpayer support was given. We insisted that moral hazzard be reduced by wiping out the existing shareholders AND giving taxpayers a big part of the (new) upside). And lastly, the US absolutely insisted that Asian countries needed to bring their government spending under control.

I see no reason why we can't take our own medicine. We aren't going to restore anyone's confidence by refusing to live by our own rules

Macro Man said...

Judging by the relative economic performances and wealth creation of Asia and the US since 1997, it seems quite clear that the Asian medicine was far, far superior to that recommended by the US, IMF, et al.

gramps said...

MM: As an aside, there's a decent chance that the government could actually make a profit buying distressed assets below intrinsic value.

That is absurd. The banks are already undercapitalized and they are already able to sell their assets at firesale prices -- you are basically arguing that the bailout is unnecessary (which I agree with). The only way the bailout would help under capitalized banks is if the Treasury deliberately overpays for assets. Underpaying would cause even more banks to fail

And BTW -- credit is by definition the shifting of consumption over time... by definition, you are stealing from future generations.

If you pay the debt back in your lifetime, then you are borrowing from yourself... Let's be honest here: between perenial budget deficits, two wars, and USD50 trillion unfunded entitlements -- there is absolutely zero possibility this bailout is going to be paid for by the current generation. You cannot get water from a stone.

OK -- I promise not to further bury this blog with my comments :)

Andy said...

How do the Irish propose to backstop 250% of GDP?

Macro Man said...

It is not absurd. It doesn't matter how often you say it, it doesn't necessarily make it true.

The default rates implicit in market prices for these securities are, in many cases, well above even the most pessemistic projections for house prices and unemployment. Thus, if they are held to maturity, it is entirely reasonable to conjecture that they can return a profit. The divergence between market pricing and intrinsic value represents the liquidity premium of these assets. If every asset on every balance sheet in the world were marked at the price it would fetch if everyone sold at the same time...guess what? We'd all be insolvent.

Moreover, you appear to fail to realize that the implosion of credit markets affects everyone...including those legitimate enterprises that wish to borrow because the apparent cost of capital is lower than the expected return on investment. When capital is unavailable at any price, there is a problem.

And at the moment, capital is virtually unavailable at any price.

Macro Man said...

Andy...with lots of Guinness.

gramps said...

MM: I will grant you that **IF** you buy the assets at current "firesale" prices, then you might (or might not) get a profit. But that assumption is absurd.

(1) The banks can already sell at firesale prices (eg MER), but mostly they are refusing to do so. If they did, incompetent CEOs would have to admit they are failures
(2) If the taxpayer manages to buy at firesale prices -- it means the banks have to do a lot more write downs, and they are already under capitalized
(3) Analyst projections? I am sorry, but I just can't take Wall Street analyst projections seriously anymore. These guys are far worse than the weatherman. They might get lucky and be right, but given their track record a prudent investor would have to bet against

(4) The U.S. government does not generate profits. OK, they got lucky with Chrysler -- but that investment involved taking a big equity position that gave the taxpayer lots of upside. In every other instance, the US government has lost money

And more than a few people have argued that the Chrysler bailout was actually a failure... by allowing Detroit to continue along "status quo", rather than facing up to changing realities in the car market -- the bailout actually saved Chrysler short term and doomed it long term.

Banks also need to face reality. The Greenspan put is over and done. Any monkey can get over-levered in a bull market (and EVERY monkey did). Banks cannot get a sustainable competitive advantage by doing something that is the antithesis of unique

Anonymous said...

gramps, might I suggest that you create your own blog?

So a beef processor in Asia expanded into DRAM production...what does this say about the expansion of a potato processor in the US into the same market? (I am neither long nor short MU.)

Anonymous said...

MM, I don't understand why you're straining to cast this as Main st vs
Wall St, class struggle issue etc. Politicians are saying similar
things (Main St is "angry" about "bailing out fat cats").

I don't know if you read the proposed legislation but I feel that it
was a very sub-optimal, hastily crafted bill which had some very loose
language about what the treasury could/could-not do and some
completely un-enforceable stuff that looked like it was thrown in to
hoodwink appropriate constituencies (the equity warrant and the
clawback in case of a loss was a joke, so was the oversight language).

If you want _something/anything_ *today*, we'll likely get something
really bad (like from last weekend) and we'll still be carrying
zombies of near-dead ex-IBs on our backs a decade later like Japan.
Was it the worst legislation ever? Probably not. Did it need to be
as good as it could be? Most definitely yes, considering the
importance and the scrutiny it was going to get.

I live/work in Silicon Valley. At least in my vicinity, I know
several people who hold similar views. I wouldn't necessarily
classify them as Joe Sixpacks. I doubt if they feel a part of any
class struggle as it is commonly understood. They're most definitely
not angry over Wall St. "fat cats" making a ton of dough or even over
tech jobs getting shipped to Bangalore.

Anonymous said...

MM- V useful post, provoking very interesting exchanges in the comments. I known each day that I will learn and be entertained. Thanks. Gramps-- from my perspective you are spot on. MM-- what odds would you assign to the S&P at, say, 900 by end of Oct? Any thoughts on the VIX?

Robert said...

My thinking is that it is time to bypass the banks and have the government buy CP directly.

If the CP market is what is frozen, it seems very circuitous for the government to buy $700 worth of CDS in hopes that the money flows into CP. Go into the CP market directly. That way we know there is no billionaire tax on the money so allocated.

MW said...

Re: Main St. vs. Wall St. --- I think there are two problems:
1) Main St. doesn't recognize the importance of financial intermediation to the real economy 2) it's seen as a bail-out of Wall St. fat cats.

There is a failure on the part of Congress to communicate 1) to their constituents.

dblwyo said...

MM - for some of your readers for whom the "economic consequences of the credit markets" seems to be something of a mystery (if you'll forgive the ob - a puzzling phenomenon for people who make their livings but we all tend to take our inherited ecologies for granted) we might remember the full title of the General Theory is "Employment, Interest and Money". And that it was preceded by a "Tract on Monetary Reform" while the heavier and more difficult section of his Essays was about credit and exchange markets. In much of which he was initially the student of Robertson and Pigou.

Anonymous said...

Macro Man,

Visit the Macro Blog and find out about real compensation for American workers.



Anonymous said...


Think some of the systemic changes that many are blindly groping for could be heralded with the proper accounting of intangibles (R&D, IT, IP) and wider quantification of the knowledge economy. Its not often that I'll argue for the underestimation of econ stats, suffice to say that the hank in the suit may try to negotiate with the high heeled boys if he can think clearly and quickly enough. Remain bearish, but lightened up a little in the throes last night, the other side of the tunnel promises to be interesting (http://www.youtube.com/watch?v=rK7xkNGKVP0).

As to social mobilisation would point out that social inequality has different dynamics and levels between the Anglo-Saxon and continental economies (Wyplosz had an interesting commentary in todays FT), and would be very surprised if anything really manifested in the US.

Signing off with some ipod imagery, cheers, JL

Anonymous said...

Link was clipped. Try this one:



Macro Man said...

Johan, two observations:

a) while I'd concur that hourly wages are an imperfect measure, the overall compensation figures also include stuff like dividends, interest payments, etc. that are not strictly wages. My chart shows a more complete picture of the relative gains of wages to the rest of the economy.

b) Moreover, the real data hides the growing income inequality in the US, a trend amply demonstrated in the Fed's triennial survey of consumer finances. Real income growth has not been evenly distributed- it's been concentrated primarily primarily at the top, particularly this decade.

And that, anon @ 4.53, is one of the reasons that I've interpreted the vote as a class struggle. Another is a browsing of the comments section of stories in places like The Times or the Washington Post. There are a lot of "screw the rich effers" type comments, which anecdotally the Congresspeople must be hearing from their constiuents.

I'd concur that the bill was suboptimal (or at least insufficient), but as a signalling device I believe it sent the wrong message to say "we're going to take action X to try and fix this problem" and then to fail to accomplish action X at the first hurdle.

Now, you might say that markets haven't exactly carried on today as if it's the end of the world as we'd know it, and you'd be right. However, I don't think it's a case of markets downplaying the impact of the credit crisis and lack of remedy so much as bargain-hunting and quarter end rebalancing.

As noted on many occasions, equities still look pricy to me relative to the macro environment and fundamentals; having never re-entered a max size short after the other week, I'll happily be selling into a sentiment-driven squeeze.

Robert said...

Re: Class struggle.
Exactly correct. The relative prosperity and economic security (whatever that is) of folks like me has been won on the backs of the lower 60% of the income scale. These folks have been decimated by outsourcing and (illegal) insourcing.

Anonymous said...

Sean, I agree that it appears labour's share of the pie will have to rise, but I can't make the leap to the 50s and 60s that you do. During that era, the US was uniquely positioned as the sole remaining industrial power not decimated by the war. Once the rest of the world was back on it's feet 20 years later, it was inevitable that the value of unskilled was going to decline in a global marketplace. So, today's situation simply cannot be compared. What does that leave as the way forward? The protectionist route beckons, but that leads to a smaller pie for all world-wide, and so I hope that road's not taken. The other route is increased socialism - labor's share of the pie is raised in a way that won't appear on MM's chart, namely, by having a greater share of their consumption paid for by the government in one way or another. Two obvious big-ticket items are health care and education expenses. Other costs may be subsidised by "tax credits" that amount to a negative tax rate for lower income groups.

Anonymous said...

Robert Said.....

"My thinking is that it is time to bypass the banks and have the government buy CP directly."

Robert that appears to be a sensible solution. However, TPTB are not focused on CP as they want the public to believe. This bailout it all about a certain list of banks that perform a specific function.

HoosierDaddy said...

Anon 19:36 I wonder if rising energy costs will be a "stealth tariff" on Chinese goods. I have heard more than once that the cost of bringing a box from China to the US has quadrupled. Also the Chinese are not as energy efficient in manufacturing yet (that's not a permanent condition, they just haven't had to be yet). The high value, low cube/weight stuff (electronics) won't come back, but a lot of low value, high weight stuff (steel) will, though much of it will wind up in Latin America and Emerging Europe. It won't be the 1950s but the global wage arbitrage is going to relent a little. Also it seems like China is going to be naturally pushed into greater competition with Japan and Taiwan in high value manufacturing and will aspire to compete with India in outsourcing (much less energy intensive).

Anonymous said...

Dilbert (2002) on the current bailout debate:


Anonymous said...

Well Macro, I haven't been around for a few days, felled by torpor and a feeling of heaviness in the limbs. I do come around the monitors in a mechanistic fashion. I do not make it a habit to discuss deeply cherished music, however, for you, I will except. Wayne Shorter, Juju.

I am still not sure what the hell Steve Winwood meant there, although it sounds very ominous. I just do not associate Stevie Winwood with something as sinister as a low signature muzzle attachment, to weakly stretch the substitute simile as far as it can go. Or perhaps it was something as simple as a badly cobbled pair of heel protectors


that would strike the pavement with the nailhead and cause a spark?

Swedish Cortex said...

Some idiot once said: "The history of all hitherto existing society is the history of class struggle"

A problem like the present mess is pretty much what we make it out to be. By making it a class-against class-issue we will, in effect, disqualify any solution that does not include significant amounts of pain for bankers and shareholders, regardless of the benefit of the general public. Given that the issue is decided by politicians we can forget about the economic and logical merits of any solution -- if it doesn't fly with the uneducated public it simply doesn't fly.

Sean Maher said...

Anon 7.36pm, agree globalisation makes any top down attempt to increase labour's share of productivity growth tricky, but whether by pushing the burden of social costs onto corporates Europe style, or redistributing the tax burden away from low/middle income earners to high earners and business, the political imperative is now to address what Macro Man calls an incipient class war in the US, before a new generation of demagogues like Huey Long re-appear on the scene.

Anonymous said...

If this a class struggle, how come so many democrats and so few republicans voted for the package?

To me, it sounds more like morality than class struggle.


Macro Man said...

Johan, I'd be willing to bet a lot of money that the per capita income in so-called Blue states is higher than it is in Red states.

As for morality, it has no place in politics except when immediately preceded by the letters "i" and "m".

Anonymous said...

It's no small irony to me that the President of one the perennial "Sick men of Europe" (Sarkozy - France) is needling German and U.K. to come up with their own bail-out plan. Certainly the opportunistic Mr. Sarkozy is using his time as rotating EU President to bolster his political chops. That said, and against the current economic backdrop, even Mr. Trichet must have realized he would have appeared like a caricture of himself had he sounded the cauldron on inflation once again.

Treasury and the Fed have been tap dance pretty fast non-stop for the past couple months.

It looks like the dance is just getting started in Europe.