Slouching Towards Wall Street… Notes for the Week Ending Friday, 5 August 2011
We increasingly hear that “the world is awash with liquidity.”
The Wall Street Journal (6 August, “Finding A Prescription For The US’s Money Trap”) says this week’s most “significant event” (italics in original) is “Bank of New York Mellon’s move to charge big corporate customers a fee for putting money on deposit.” The Fed’s dollar destruction has not reversed the slide in the economy — someone get Bernanke on the phone — and the trillions handed to the banks are not poised to re-enter the economy any time soon. Now it seems everyone wants out, and there’s nowhere left to flee.
When the TARP first hit the fan the banks were excoriated for their failure to lend to the private sector businesses that create jobs — so went the meme. Now — two QE’s and a debt ceiling kerfuffle later — media pundits blame the lack of growth on a shortage of demand. Businesses do not want to borrow money and invest in growth, goes the new meme, because they fear the economy has further to fall. The economy, says the Journal, has entered a Liquidity Trap, “a rare condition which appeared during the Great Depression and was thought to have been wiped out.”
Like Treasury Secretary Geithner, we are not an economist. We say this by way of disclaimer before commenting on Keynesian economics. Wikipedia defines Liquidity Trap as a condition where “monetary policy is unable to stimulate an economy, either through lowering interest rates or increasing the money supply.” This occurs “when expectations of adverse events… make persons with liquid assets unwilling to invest.” Among such events the article mentions insufficient aggregate demand, and war.
Economics is a study of human expectations, and what is described here is a situation where deliberate policy moves fail to have their intended effect because unusual expectations counteract the normal response to the Keynesian liquidity dump. Economists will not tell you, but the expectations on which their assumptions rest are not the expectations of actual people faced with underwater mortgages, long term unemployment, or having no health insurance. Rather, they are the economists’ expectations of what people ought to expect, given a set of conditions in the economy. Let’s assume we have an expectation.
We disagree in one fundamental point with the Journal’s quite trenchant analysis which makes the point that, eschewing even the safety of Treasurys, companies are engaging in “a run to the bank” in a frenzy to get into the one investment we are prohibited from making in our 401(K): Cash.
We actually took our retirement funds completely out of the stock and bond funds in which they were invested and moved them to cash a few weeks ago — a lucky move if ever there was one. Imagine the incredulity of the agent for a major brokerage firm when we said we wanted to shift out of the S&P 500 fund and the Large Cap fund — both of which were up 30% in the last year — and go to cash. “But these funds have done so well!” she protested. “Why do you want to get out of them?” It was utterly lost on her that we should want to liquidate them precisely because they were up 30% in the last twelve months. Having finally convinced our agent of our right to make this switch — though her tone made it clear she questioned our sanity — we told her we wished to hold the entire account in cash. “Cash?” she asked. “What do you mean?”
“You know,” we replied, “like in a safe deposit box.” Cash — a plain vanilla demand deposit account — is, it turns out, not an available option. The best proxy was a money market fund which, so the literature assures us, invests in “high grade obligations” of trustworthy entities, including major corporations’ commercial paper, and obligations of the US government and of government agencies. In view of the market declines since we made that shift, we are extremely lucky to have made the move when we did. In view of where that money now resides, we sleep better at night, but only relatively.
We wonder how long it will be when not only major corporations with their $50 billion slugs of semolians, but even Mr. & Mrs. Lunchbucket will be hit with a custodial fee for making cash deposits. Most banks already charge account fees — they just don’t advertise them so blatantly. The Journal says the companies comprising the S&P 500 “collectively have $963 billion in cash,” which they do not want to invest because they fear the economy will continue to weaken. Thus, poised on the brink of an economic black hole, we find ourselves as a nation hoarding cash, though against what eventuality none can say.
In fairness to the banks (we can not believe we are actually saying this) they have to pay the FDIC about 0.10% on their deposit base to cover the cost of insurance. Even former FDIC head Sheila Bair said it makes sense that the banks are imposing fees for large deposits, since they can not do anything with the cash in today’s economy. We can just imagine the rush to the exits when CFOs of the Fortune top 25 companies remove tens of billions of dollars from bank accounts and stuff it into safe deposit boxes. There’s a movie plot here, though whether a tragedy or a farce, we can not say.
Economic theory presents various approaches to breaking the liquidity trap, all of which bear risk. The theory reportedly favored by Harvard economist Kenneth Rogoff, is “for the Fed to convince everyone it’s going to create more inflation.” If inflation rises, but interest rates remain low, real interest rates go negative, which will theoretically stimulate borrowing and spending.
We’re not sure what legerdemain would permit the Fed to create a convincing illusion that it intends to raise rates — nor how Bernanke & Co. might contain “a sustained burst of moderate inflation, say, 4% to 6% for several years.” Inflation targeting is a tricky business. Ask Alexandre Tombini, Brazil’s central banker, who has now “re-set” the nation’s inflation policy. Ambiguous recent statements hint that Brazil may extend its inflation target into 2013 — they already put it off from 2011 to 2012. Brazil’s “target range” is 2.5% — 6.5% inflation, with the 4.5% midpoint being the bull’s eye. When inflation recently hit 6.51% on a rolling twelve-month basis, the government insisted the target range was still in play — finance minister Guido Mantega says Brazil is experiencing “high and controlled” inflation.
As to the Liquidity Trap, we think the term is misapplied because the definition rests on fear of non-monetary factors that may counteract the government’s monetary policy. What we are experiencing today is a tsunami of cash that was purposely created by the government. This can hardly be called an exogenous factor.
When the internet bubble burst, there was the Flight To Quality. When the housing bubble burst, there was the Flight To Safety. Now no one wants quality — you can not get a bid on the bluest blue chip stock. No one wants safety — companies are turning down Treasurys in favor of demand deposits. Now even the institutions designed to warehouse cash do not want it. Where will we next take Flight when the cash bubble bursts?
Perhaps we should ask the nation’s leading economist. Speaking of Expectations, Mr. Bernanke, putting all these trillions of dollars into the marketplace, what did you expect?
You may recall a university study some years ago that arrived at the amazing conclusion that drinking beer makes members of the opposite sex look more attractive. Along those lines, Trader’s Magazine Online (15 July, “Study Vindicates Aggressive Trading On Buys”) quotes a recent report by Credit Suisse that finds “aggressive trading on buy orders is often justified if the stock has positive momentum.” This is a highfalutin’ way of saying that, when stocks are trading higher, they often trade higher.
Why has Credit Suisse dusted off this notion, itself a fundamental of the professional trader’s toolkit? It is clearly a bid for new business. Credit Suisse “looked at alpha generated in the five days after a trade as well as at the added costs of executing an order aggressively. It found that buy orders have a fast decaying alpha.” The conclusion? Traders must “be more aggressive in order to capture returns.” Plain English: you need to give us more commission business.
We are used to Wall Street glomming academic studies to justify ramming new product down the throats of the retail investor, but we don’t often see ivory tower-type minds turn their attention to devising new ways to separate professional traders from their cash. Clearly, the world is awash in cash, and it’s hurting everyone.
By now you have surely heard the giggling testimony of Doris Talamantes who, because she had “a small purse,” secreted a hard drive in her bra the day “king of the bonds” Jeffrey Gundlach departed his former employer, hedge fund TCW. The fund, a division of Societe Generale, maintains that Gundlach stole client information, saying the drive contains TCW’s entire database of mortgage-backed securities. TCW alleges Gundlach’s new firm, DoubleLine Capital, was launched using their purloined information.
Talamantes says she stuffed the hard drive into her bra when “all hell broke loose” on the trading floor after Gundlach’s termination. Outside the building, Talamantes says she gave the hard drive to a fellow employee — now DoubleLine’s chief risk officer. “He said ‘I love you’ and gave me a hug,” Talamantes testified.
Instead of litigating, maybe SocGen should make a deal. Gundlach could hire SocGen’s other high-profile former employee, Jerome Kerviel, and put him in charge of DoubleLine’s trading desk. Kerviel will need a high paying job when he gets out of prison, as the judge in his rogue trading case ordered him to pay SocGen $7 billion. As for Ms. Talamantes, for the rest of her life she will forever be greeted with the line “is that a hard drive in your pocket, or are you happy to see me?”
Speaking of bras and such, have you heard about the buck rabbit among the bunnies? William Marovitz, the husband of former Playboy CEO Christie Hefner will pay $168,352 to settle insider trading charges. The SEC says he traded Playboy shares in his personal account between 2004 and 2009, even though both his wife and his lawyer told him not to. Marovitz allegedly traded in advance of earnings announcements, and during the failed acquisition talks that ultimately saw his father in law take the company private. Marovitz is a Chicago real estate executive and a former Illinois state senator, of which least said, soonest mended.
The SEC believed they had a clear case, but they accepted Marovitz’ settlement, in which he will pay a fine but not admit wrongdoing. We wonder who is doing the covering-up here? Playboy has gotten in trouble over the years by publishing photos that reveal too much. This must mark the only time they have had a problem over covering something up.
The United States Of AAArgentina?
So went the debate over S&P’s downgrade of US debt from AAA to AA+.
Last week we hosted a conference call with Peter Atwater, CEO of financial consulting firm Financial Insyghts (to request a podcast, please contact sales@hedgeye.com). Atwater spoke about the rating agencies and noted how sensitive they are to timing. The raters, says Atwater, give entities time to get their financial house in order. They do not want to be seen as causing an event. Tell that to the markets this Monday morning… As to the political process in Washington, Biblical fundamentalists must welcome the behavior of our elected officials, as it presents a clear argument against the theory of evolution.
As observers of this self-created crisis, we may have failed to appreciate the historical context that forms the setting for this mad tea party. Opines the Wall Street Journal (2 August, “A Debt Deal The Founders Could Love”) the vitriol, the cravenness, the hypocrisy and the utter lack of regard for the wellbeing of the nation that has attended the artificial debate over a manufactured crisis — all this is of a piece with the blind rage and vituperative invective that has accompanied the legislative process since before the founding of this great nation. We have only lacked for loaded pistols and fisticuffs on the floor of the House of Reprehensibles to take us back to the down and dirty days when they really knew how to make laws. But we disagree with the Journal’s conclusion. We think the Founders recognized human nature as flawed, and recognized the propensity of groups to factionalize within a society. But we believe they hoped that society would evolve, forging ever greater unity as the commonality of our national interest came into sharper focus over the generations. Hope, alas, is not a governance process. Today it’s a wonder the world continues to hold anything denominated in dollars.
Brazilian finance minister Guido Mantega observed this week that the financial crisis of 2008 has not gone away, but has morphed into a global sovereign debt crisis. The obvious corollary to that statement is that the US is leading the way downward. Mantega was interviewed this week by leading Brazilian newspaper O Estado de Sao Paulo and set a new standard for caginess when asked about Brazil’s central bank’s monetary policy. Mantega said he may be the only Brazilian who has not read the minutes of the last meeting of the central bank monetary policy committee, made public this week. “I don’t have to read them,” said Mantega. “The market will read them, and I will read the market.” The reporters persisted, attempting to get Mantega to give central banker Alexandre Tombini a thumbs up or thumbs down. They asked whether there was a risk of mis-timing monetary policy moves and Mantega broke out laughing. After an awkward silence, indicating one of the reporters, Mantega said, “I only laughed because she did. It’s contagious. It’s a form of contagion. There’s a lot of that in economics.” Indeed.
In the current environment it may not be comforting to have a finance minister who finds his own job risible. It is nonetheless worth noting that, unlike our own Treasury secretary, Brazil has an economist in the job. In politics this is called a Trade-Off.
Here’s another trade-off. The Obama presidency is finally coming into its own. Like most men who seek power, it is clear that Obama sought the presidency for the mere purpose of attaining it. He came on during the campaign like a lusty lover pursuing his lady. Like many a successful Conquistador, he clearly did not respect us in the morning. He is trying to surf the grand shift to the Right that made itself apparent even in the late stages of World War II. President Eisenhower warned about it explicitly, yet no one paid heed. The illicit love affair that was the military-industrial complex led to the elopement of Washington and Wall Street. While there were abundant reasons why these two should never have been bound in unholy matrimony, everyone present at the nuptials held their peace, notably the guardians of the public trust: the politicians, whose campaigns are financed by Guess Who? — and the media whose business empires are likewise nourished on the corporate teat. This is another form of contagion.
In the wake of the Financial Crisis, both the media and Washington attacked the rating agencies for their failure to protect the markets from the excesses in the asset-backed securities sector. This is known as deflecting the blame — what we call the lookaway. Washington would never admit they had failed by preventing the derivatives markets from being properly regulated. The press would never admit they had failed to question what Wall Street was feeding them. Instead, everyone was happy to blame S&P for destroying the world economy. Now they are in an uproar that S&P is exercising professional prudence and analytical judgment.
Not that we believe in coincidences — and speaking of economic contagion — but we notice that S&P’s announcement followed by mere hours the confirmation that Tim Geithner will remain on board as Treasury Secretary. Geithner had served notice, saying he wished to spend time with his family — perhaps the only departing member of the financial squad to give anything resembling an excuse. The rest, from Larry Summers to Austan Goolsbee, have hotfooted it out the door like so many rats fleeing the sinking ship of state.
Obama has accomplished the only thing he cares about: he has deferred debate on the economy until after the next presidential election, and he has secured the services of the one member of the economic team unafraid to duke it out in the down and dirty world of Washington. Getihner, as we have seen in his numerous appearances on the Hill, takes damned little lying down. President Obama has turned into the Charlie Brown of American politics. We can just hear him muttering haplessly to himself, “Why doesn’t anyone like me?” With Geithner at his side — and with the impassive Bernanke at the Fed — Obama has two pillars to lean upon. Like Italian Olympic hero Dorando Pietri, who won the 1908 Marathon only after being carried across the finish line by race officials, Obama will need all the help he can get. The Treasury
Secretary and the Fed Chairman, both of whom are charged with providing oversight to the nation’s economy, will have to be up to the task of dragging their boss back into the White House.
Speaking of Italy, the Berlusconi government staged police raids in the Milan offices of S&P and Moody’s. It was not clear what they hoped to find, but the message is as subtle as a note saying YOU DIE! wrapped around a brick and thrown through your kitchen window at midnight. And speaking of government intervention, Argentina’s official inflation rate is about 10%. This is challenged by independent economists who reckon it closer to 25%. The government has punished publications who print these projections with fines in the hundreds of thousands of dollars. Responding to S&P’s warnings of a downgrade, the best Treasury could do was to call them stupid, saying they “miscalculated” by some $2 trillion. Is the government going to crack down on McGraw-Hill?
As we go into a Monday that looks most decidedly like The Morning After The Night Before, we offer a new twist on an old joke.
Says S&P, we are going to downgrade US debt. You’re wrong, we say. The US will not default on its obligations.
Says Treasury: S&P’s calculations are off by $2 trillion. You’re wrong, we say. The GAO’s analysis admits of a range of assumptions. Treasury is working with one set of assumptions, S&P is working with a different set that also fit GAO parameters.
Says Treasury: S&P failed to take into account the historic compromise reached last week. You’re wrong, we say. The “compromise” was merely an excuse for all players in this dirty game to defer the blame until after the next general election, some time in 2013 — coincidentally the same time frame that Brazil will be forced to revisit its inflation policy.
Says S&P: it’s our responsibility to issue our opinions without playing favorites. Say we: don’t get us started on your responsibility…
Just a minute, you interject. You say S&P is wrong, and you say the government is wrong? They can’t both be wrong!
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