Tuesday, November 04, 2008

Credit strangling

So Election Day is finally here. To Macro Man, the key issue is not the identity of the new President, which seems to be a foregone conclusion, but rather the composition of the Senate. If the Democrats gain a filibuster-proof 60 senators, that will transform the US government into a British parliamentary-style "ruling party does whatever it wants" one-party system. Given that most US politicians from both sides of the political aisle seem to possess a singular ability to vote for a vested, rather than the national, interest, Macro Man would prefer to see an outcome that retains some element of checks and balances.

Regardless, as observed yesterday, winning today's election could end up being something of a poisoned chalice. Certainly the state of the economy both domestically and internationally is in a dreadful state, and seems almost certain to get quite a bit worse before it gets better. Yesterday's US was singularly awful, continuing a virtually unbroken skein of disappointing activity figures across the world.

Yesterday's ISM was a shocker, with the headline and many of the components registering their lowest readings in more than a quarter century. Particularly disturbing was the export component, which absolutely fell off the edge of a cliff. Net exports have contributed fully two-thirds of overall US economic growth over the past two years; while some of this clearly represents a lower import bill due to weak domestic demand, but some is also a result of relatively buoyant foreign demand for US goods. No longer.
The RBA certainly seems concerned, as they cut rates by a greater-than-expected 75 bps overnight, despite the recent fiscal easing and exchange rate decline. The concern is that financial market distress is feeding through into the real economy, a trend that is evident just about everywhere in the world.

Certainly lending standards have tightened very dramatically, which is no doubt a reason for the cratering of global activity data. Yesterday's Fed Senior Loan Officer Survey makes for grim reading. The proportion of loan officers who are tightening lending standards has risen to an all time high. While financial Calvinists might say "amen to that", there is a difference between a prudent tightening of lending standards and a wholesale strangling of credit in the economy. This is also known as the difference between a recession and a depression. With banks desperately (and, to date, futilely) trying to delever and reduce the size of their balance sheet, there is a real risk of the latter scenario.
The consumer, obviously, is also under the cosh; financial institutions justifiably have little interest in extending loans at non-onerous terms.
Again, however, it is important to ensure that quality borrowers still have access to credit at an appropriate price (and no, Macro Man isn't just saying that because he needs to roll over his mortgage.) A number of UK institutions have already announced that they aren't going to pass through the entirety of any MPC rate cuts, and indeed have increase their base-rate tracker spreads.

So when the Bank cuts rates on Thursday, in all likelihood the effective borrowing rate to the consumer will not have changed, but the banks' spread will have improved. This, in turn, provides the context through which institutions can attempt to earn their way out of this mess even as they try and discard non=performing assets.

And that is why the BOE and, almost certainly, the ECB will be cutting rates in two days.


Anonymous said...

“The difficulty lies not so much in developing new ideas as in escaping from old ones.” John Maynard Keynes quotes

Be Warned...

Anonymous said...


most G7 short end yield curves are now priced for policy rates going up within a year from now. Looks like the IR markets do not believe in a Japan style sustained deflationary period (in contrast to the commodity markets)
Is there a good trade in there?

Macro Man said...

I think there is a trade....whether it is good, I am not sure. The volatility around the trades are likely to be substantial.

prophets said...

MM, any thoughts on how the bond market will absorb 800 B in US treasuries given the economic downturn facing China and lower oil price for the petrostates?

will the long end of the curve finally move up?

Anonymous said...

The US will default on it's debt before the new home boy is out of office.

Anonymous said...

Bond market outlook.

MM,I have been trading Gov. bonds for 15 years and I never felt as puzzled as I am now about where 10 year yields are going. It seems very obvious that Gov. bonds yields should go higher because huge supply, lower tax revenues less petrodollars to be invested.

Real yields have moved higher but nominal yields still very low ... so what happens next? maybe inflation will fall so fast in the next 6 months that real yield will go up without nominal yields having to move much ... remeber Japan, nominal yields still < 1.50% in 10y while debt/GDP ratio exploded at the same level as Italy.

As far as supply is concerned, Gov. supply will more than double next year, in US,UK and most of Euroland but corporate supply has almost stopped ... and as long as it remains the case the net supply of duration to the market does not increase much ...

Anonymous said...

you'd think if one had been trading bonds for 15 years, wouldn't have to hide behind 'anonymous'...
us dollar was down 2 points today getting gold +35 and silver +75, does this all change in middle of tonite when election results are known, or on thurrsday ecb/boc rate cuts

Anonymous said...

oops, forgot my name last post, can do anonymous and type your name like below...
over here in america macro man blog got some good press(briefing dot com) so that's how i found it, great blog thus far!!

walter said...

MM: the effective borrowing rate to the consumer will not have changed, but the banks' spread will have improved. This, in turn, provides the context through which institutions can attempt to earn their way out of this mess

EARN? their way out of this mess?

Didn't you mean to say that central banks will subsidize the banks out of this mess?

Any moron, even a banker, can borrow at politically determined low rates and then lend at market rates that properly reflect true risk.

The banks are not EARNING anything.

Macro Man said...

Anon @4.09, it's the 550 billion dollar question. Do you price bonds based on a bone-crushing, deflationary recession....or on a wall of supply the likes of which we've never seen? I really do not know.

Walter, is the appropriate response answer to past policy errors to commit another one?

The list of villains in this piece is too numerous to name each one. Banks? Sure. The Greenspan Fed? Of course. Foreign central banks? Absolutely- it was their price insensitive Treasury buying that crowded out the private sector and encouraged the availability of uber-cheap credit. The US government (both parties), for encouraging the orgy of subprime lending and not properly regulating it? You bet.

But how about Mr. and Mrs. Joe Sixpack, who started speculating on property (and, in many cases, committed fraud in doing so)? And who have routinely spent above their means for the better part of a decade or two? Ultimately, if the US consumer had spent within his means, the current account deficit would have been smaller or nonexistent, and foreign Cbs would not have been able to depress the Treasury yields as they did.

Hey, I am 37 years old and have been reasonably successful in my career. But I've never purchased a new car from a lot- always used. I own one television- and that was bought a dozen years ago. In the winter I have to fight with my wife to turn up the thermostat- from 60F to 65F. How many Americans of lesser means can say the same? Listen, say what you want about the banks...at least a few of them have gone bust.

Meanwhile, Ford/GM/Chrysler all still limp along (receiving government handouts, by the way!)...and they are considerably worse at their jobs than US banks were at theirs.

Sadly, the new president will be singularly unable to impact the one thing that America most desperately needs: education. The education to become more competitive globally, to eat less, and to spend within their means.

As a US citizen and taxpayer, I can only hope that that particular lesson is learned by the time all fo this is said and done.

Anonymous said...

MacroMan, there's a very simple check/balance called the 2010 election. Both parties will be straining to the maximum because of the chance to control redistricting.

At the moment, we need clarity of government. We need an unobstructed railroad track. That is because, assuming Roubini is correct, it will be raining privies by the time Obama and the new Congress take office.

If the GOP has 40-42 seats, it's very likely that the damage will be very long term.

Oh, by the way... the Taliban has just taken over the Swat Valley in Pakistan.

Charles of MercuryRising

walter said...

MM: agree about the need for better education -- especially living within our means. How do artificially low central bank rates accomplish this? If anything, the lower borrowing costs (if they were passed along to consumers) would delay the day of reckoning.

Govt subsidies to banks with bad management doesn't help either -- it delays needed reforms. How much better off would Detroit (and the UAW) be if Uncle Sam hadn't bailed out Chrysler? They would have been forced to reconcile their production with actual market demand (quantity and quality). The taxpayers got lucky (we got our money back), but its hard to argue the same for the US automakers. Short term, they got to fight another day -- but nothing was actually fixed. They same problems that kept GM/Ford/Chrysler from sucess in the 1970s are still holding them back today. Lots jobs, lost economic activity, lost market share -- how can that be labeled a "win"? Its not even a tie...

Banks (and consumers) would be better off if they were forced to work out the problems in the bank business model. Sooner or later they are going to have to anyway -- its only a question of how much money the taxpayer will lose while we are delaying the inevitable

Macro Man said...

Charles, I'd consider that protectionist measures (Smoot-Hawley 2009, anyone?)and windfall taxes, both of which are more likely in a filibuster-proof Democratic Congress,are likely to be quite damaging in the long term and could use checks and balances.

A quick perusal of the soon-to-be President's platform promises tax cuts for "hardworking" Americans. Gee, I work pretty damned hard, does that mean I get one, too?

Promising to cut both spending and taxes into a recession may resonate well, but what actually happens as revenues and unemployment levels simultaneously plummet may well be different. I for one would prefer to retain checks and balances once reality bites.

What does the Taliban have to do with anything?

walter said...

BTW -- I am not sure how one could run the numbers, but my gut tells me that Uncle Sam did **NOT** come out ahead with the Chrysler bailout.

Yes, the nominal amount lent was paid back with whatever interest.

But the lost market share, lost economic activity for the last 30 some odd years -- that resulted in a lower earnings (either labor or shareholders) and lower tax revenue for Uncle Sam. If GM were in Toyota's position today, which it used to be, what would it be paying in wages and taxes to US citizens?

Hard to run that scenario objectively -- but I am not sure the Chrysler investment was actually a success.

I am very sure TARP is already a failure. AIG has reportedly blown through most of its bailout money already ( the expanded $130 billion, not the original $85 billion) and may need even more.

With "success" like that, who needs failures?

Macro Man said...

Walter, I don't think you understand my viewpoint here: at this point, without these measures, EVERY bank goes under, and it is Great Depression marque II.

The investment banking model is being re-worked- GS and MS have filed to become holding companies, and recipients of the Federal capital injections will not be able to play the leverage game as in times past.

This is not a question of credit becoming available at an appropriate price; it is an issue of credit becoming unobtainable at any price.

Is this hyperbole? Go ask the Japanese (who, oh by the way, had a helluva lot more savings than Americans) how the last eighteen years have been for them.

Macro Man said...

And in response to the obvious rejoinder, the sort of measures that are being employed in the US and elsewhere were not used in Japan until a decade or more of half-assed attempts to sort things out in a piecemeal, behind-the-curve fashion.

Macro Man said...

AIG is not the TARP- they are a separate issue that frankly should be nationalized and sold off in piecemeal fashion.

Why not let 'em go bust straight away? Hey, why not-unless you want to travel or ship anything, in which case good luck with finding someone to do it for you now that they have no insurance.

walter said...

MM -- no doubt the Japanese were (and are) in a mess for 18 years and counting.

And I agree that 18 years of deflation when you are a net saver (like japan) is very different from what a net debtor (the U.S.) would face. Deflation is a good thing for creditors, its disaster for debtors.

But the fact remains that all the artificially low rates in Japan were simply a catalyst for the Yen carry trade. Reforms didnt happen to corporate Japan; and sensible people did not lend at politically set rates. Even Japanese housewives weren't foolish enough to buy into the BofJ's plans -- they have been big into the carry trade themselves.

Artificially low rates don't help anyone long term; and they only help a very limited number of "insiders" in the short term.

Anonymous said...

The IB model is being reworked because MS and GS have become bank holding companies?

That was nothing but a legal change that allowed them to borrow at Fed rates. Leverage is being unwound at gunpoint like everyone else. They aren't proactively setting up a new business model -- they are just reacting to market events.

And while Bernanke has lowered borrowing rates for banks by 425bp in the last 14 months, most mortgage ARM resets are actually printing HIGHER.

Banks are hoarding taxpayer cash injections, and purely playing the spread between 10yr treasuries and Fed Funds... 100% of the "emergency lending" is being used by banks -- not one penny of it is making its way out to businesses or consumers

walter said...

Sorry - I know AIG isn't officially part of TARP... but Hank Paulson is pulling the strings behind AIG and TARP -- and failing on both accounts.

This guy explains why TARP is failing better than I can

luther said...

MM, if i could answer for charles --

because that move into the valley just cost the US taxpayer another $100B +...

...then again nothin like another war to get the economy movin...and wandering eyes off the economy...

calvino said...

Financial Calvinists? Macro, you are in the skinflint legion yourself, fancy you casting aspersions at your brothers in ARMS. Surprised you did not pay cash for your abode up front. If you are not in the reformed congregation yourself, then I withdraw my credentials.

btw, the BOJ has been hosing all and sundry with dollars. I think there is a clasue in the US constitution about counterfitting currency.

Anonymous said...

Here's a Phototoon to memorialize the moment.

--Charles of MercuryRising

Rich said...

With respect to the mountain of US debt issuance: I'd suggest that you think more broadly about all debt issuance for the year. Mortgage debt is down very sharply, as is corporate debt. The mortgage area is shrinking due to reduced new issues and continuing , though stretched out, amortization of existing paper. Corporates and munis suffer a lack of buyers, but still aren't being issued.

Anonymous said...

Rich (and others):

Why is it that the massive bubble issuance of mtge (and corporate and muni) debt for the last 8-10 years was not inflationary...

...but now you want to argue that the destruction of such debt is deflationary?

You only see what you want to see

Inflation was much higher -- and real rates drastically negative -- during Greenspan's reign of stupidity.

If you don't agree with that statement -- then you cannot claim deflation now

Anonymous said...


Regarding GS and MS becoming bank holding companies, as anon. @ 8:00pm pointed out, I think that, esp. in the case of GS, this is something of a strawman. Yesterday, I beileve, on SA, there was a post noting that MS has been much more aggressive in de-levering than GS. One commentor queried if there was someway GS could "un-do" the bank holding company status. My response to that individual was that I thought (certainly not an expert) that GS, at some point d0own the road, could spin-off the bank holding company, in some fashion, and go back to the current IB model.

Cynic that I am, I'm guessing that GS is just using cheap Fed funds to weather the current shit-storm, and will revert as soon as feasible.


old trader

Anonymous said...

Just wanted to thank you for touching on the issues of the monetary policy transmission mechanism via the bank lending channel (actually Bernanke's area of expertise), I am digging as think there is more here concerning the impact of leverage preventing rate cut pass through.
Hope you did your civic duty!
Cheers, JL

Anonymous said...

MacroMan says, "What does the Taliban have to do with anything?"

War spending, MM. The more war spending, the less budgetary balance, the more the chances of a dollar crash and the market in a spin.

As for the rest, I don't think the likelihood of tariffs is any greater than that of a comeback of buggy whips. Windfall taxes... well, someone has to pay for the $10T hole that Bush has opened in the budget (math by Stiglitz).

I think the Democrats came close enough that they can bribe the remaining 2-3 votes necessary into compliance on the more important things. But already at least one Republican Senator is making non-negotiable demands as though they won the election. That's a recipe for very ugly gridlock at a time when the nation needs action.

--Charles of MercuryRising