Ishrc � Discussion Threads

[simon gordon] 10/1/2008 09:55

'Sterling could be the final nail in the Prime Minister's coffin by Matthew Lynn

Gordon Brown must have found the New Year predictions troublesome reading. Just about every City economist is predicting the British economy will be heading into squally weather during 2008. And yet most failed to mention what may well be the biggest threat to the Prime Minister's tattered reputation for economic competence: sterling.

Just as most people carry on making the same mistakes, although in different guises, so in reality most economies carry on stumbling into the same old crises. For Britain, economic trouble has always manifested itself in the currency markets. If it happens again – and there are solid reasons for thinking that it might – then the British economic weather could be about to turn very stormy indeed.

In fact, it might well be sterling that finishes Brown off. For the last 15 years, ever since the pound was slung out of the European exchange rate mechanism, sterling has been among the world's best performing currencies. It remained rock steady against the euro for the first decade of that currency's life. And it has steadily appreciated against the dollar, rising all the way from $1.40 back in 1992 up to around $2.00. Last year, it touched $2.11, and managed a sustained run above $2 – something the pound hasn't achieved since the early 1980s, when it was helped by very high interest rates and the arrival of North Sea oil.

Contrary to what many economists argue, a gradually strengthening currency has been one of the factors behind the strength of the British economy over the past decade. It has kept inflation in check, allowing the Bank of England to keep interest rates lower than they otherwise would have been. It keeps prices of all the stuff Britain imports constantly falling, fuelling a consumer boom. And it allows the country to finance massive trade and budget deficits and consumer borrowing, paid for by borrowing abroad. A strong currency allowed the whole country to look like it was becoming a lot more prosperous.

Most of the City expects the Bank to steadily reduce interest rates this year as the economy slows down. If everything stays as it is, it probably will. Yet if there is a significant slide in sterling, that will become a lot trickier. If the pound dropped to (say) $1.70 – hardly a shocking rate by historical standards – everything Britain imports would become a lot more expensive. Inflation, already a worry, would be a real threat.

In those circumstances, the script which sees the Bank steadily lowering rates through 2008 to stave off a recession would have to be torn up. Instead, the Bank might be forced to raise rates to control inflation and maintain the value of sterling. That would inevitably hit the economy and the housing market hard, probably pushing it into a full-blown slump.

Worse, it would make the trade and budget deficits harder to finance. According to the Debt Management Office, 32% of gilts are now held by foreign investors (a total of £144bn ($285.2bn, e192.6bn)). That compares with 17% at the start of 2000. In effect, all those "diversity officers" and "sustainable energy advisers" who have swelled the government payrolls are actually having their large salaries paid by fund managers in Frankfurt or New York.

So long as they were getting generous interest rates and making money on the currency, they were happy to do that: gilts pay 6%-plus, and you usually make another 5%-plus on the currency every year, meaning British government debt has provided handsome returns for the past decade. But if foreign fund managers start losing 10% a year on the currency, and keep reading forecasts that they will lose more, will they want to keep on lending Brown money? Don't count on it. As for replacing that £144bn with domestic borrowing, forget it. The British have long since given up saving. The money isn't there.

In reality, sterling doesn't need to crash to create real trouble. A slow, gradual depreciation would be enough – and that already looks to have started. Sterling has already weakened significantly against the euro. A pound now buys only 1.34 euros, compared with 1.5 early last year. It is starting to slide against the dollar, dipping below $2, even though that currency has been weakening on world markets as well.

The potential is there for a full-blown attack. The currency markets always need a target, mainly because you can only invest in one currency by selling another one. For the last two years, traders have been selling dollars, but with the American trade deficit now falling sharply, that trend looks played out.

The pound could well be next. It has huge trade and budget deficits. It has a rocky housing market and a government that looks more unstable by the minute. If you want to start selling pounds, you certainly won't be short of reasons to justify it. Indeed, Britain could well face a vicious circle, where a soggy currency weakens the economy and the government, providing more reasons for the markets to sell sterling.

With a strong currency, Britain could just about navigate what looks set to be a tough year. With a weakening currency, it faces a real crunch. The end of political eras, both Labour and Conservative, are usually sealed by trouble for the pound. New Labour may end up joining its predecessors after all.'

[simon gordon] 03/1/2008 19:34

Excellent article from the FT on the Banking crisis:

'Japan offers a salutary tale in banking crises
By Gillian Tett

Published: January 1 2008

A decade ago, Tadashi Nakamae, a prominent Japanese economist, was fretting about a credit crunch: a property bubble had burst in Japan, leaving local banks engulfed in bad loans and prompting a financial crisis.

Ten years later, Mr Nakamae feels an unexpected sense of déjà vu. For as 2008 gets under way, bad loans are yet again undermining major banks, partly due to falling property prices. But this time, the epicentre of the shock is on the other side of the Pacific, in America. "Japan's banking crisis in the 1990s might prove an important lesson for America's subprime woes," Mr Nakamae concludes.

The parallel might have seemed almost unthinkable just a few months ago. After all, Japan's 1990s banking crisis has gone down as one of the worst in history, generating a staggering $700bn of credit losses. And since then, Wall Street financiers have generally assumed that their own financial system was greatly superior to that in Japan (or almost anywhere else in the world). Indeed, confidence in American finance was so high that in recent years Washington officials have regularly travelled to Tokyo to "tell the Japanese what to do with their banks," admits one former US Treasury official.

However, with America's subprime saga now entering its seventh month, this latest crunch has turned far uglier than initially thought. Consequently, while Japan is not the only historical parallel for the current woes – banking crises have actually been fairly common in the past century – the events in Tokyo offer a useful prism for analysing events. In particular, they raise a crucial question: will Washington and Wall Street prove better at dealing with their banking shock than Tokyo? Or is the west now destined to face years of financial pain – as Japan did a decade ago?

By any standards, the challenges dogging western policymakers are huge. In some respects – as US officials are keen to point out – America's situation looks much better than that which prevailed in Japan in the 1990s. Most notably, the US is not haunted by deflation, as Japan was a decade ago. What unites both sagas, however, is that both have been triggered by a tangible credit shock – rather than, for instance, a loss of market confidence of the type that triggered the 1987 stock market crash. At the root of both tales, in other words, are bad loans.

Moreover, the potential scale of US bad loans offers a further similarity with Japan. When so-called subprime borrowers (the term for households with bad credit history) started to default on mortgages almost a year ago, the US Federal Reserve initially suggested this could create credit losses of $50bn. However, default rates continue to rise – and property prices are now falling at a rate not seen since the second world war, according to Robert Shiller, an economics professor at Yale University.

As a result investment banks such as Goldman Sachs now expect subprime losses to reach $200bn to $400bn, as around 2m households default. But the rub is that subprime is no longer the only issue: there are signs that defaults are rising on other forms of consumer debt, such as credit cards and commercial property loans. Many bankers now anticipate the final tally of bad loans could be $400bn to $800bn, excluding corporate debt.

The good news – at least for US policymakers – is that American banks are not shouldering the burden alone. A decade of frenetic financial innovation has enabled bankers to turn loans into bonds and derivatives and sell them to institutions all over the world, including non-bank bodies such as asset managers. The bad news is that precisely because of the scattering of these bad subprime loans, the shock has spread around the world. In recent weeks, for example, it has emerged that governments in places as diverse as Norway, Australia and Florida face investment losses.

Moreover, even though the losses have been sliced and diced, they are so vast in scale that the "hit" to individual banks is still proving very painful, particularly on Wall Street. If credit losses did eventually rise to $600bn, for example, this might represent as much as one-third of the core (tier one) banking capital for US and European banks – and much more for some banks, since the losses are not evenly spread. Thus, just as the cost of writing off bad loans left some Japanese banks running short of capital a decade ago, a similar pattern is threatening to emerge in parts of the western banking world.

But there is a second, potentially more pernicious analogy with Japan: a loss of investor faith. In normal circumstances, loss of confidence gets little attention from modern investment bankers since sentiment is not something that can be factored into a computer model. However, since banks abandoned the ancient practice of holding an ounce of gold (or another tangible asset) to back each bank note, finance has relied on faith. Because modern banks never have enough cash to repay depositors if these all demand their funds back, they rely on the fact that depositors will not ask for their money back – as long as they believe it is there.


However, when faith crumbles, the consequences are brutal. The last time the world witnessed this on a significant scale was in Japan, when three local institutions suddenly collapsed in the autumn of 1997. Until then it had been assumed that Japanese banks would never collapse, due to the use of the so-called convoy system, a practice where strong banks supported the weak, under government pressure. But in the 1997 this faith in the convoy system collapsed, causing the money markets to freeze up as investors and depositors fled.

A decade later, something similar has occurred in parts of the western financial world. This time, however, confidence has been shattered in a field of banking known as structured finance – an arena where bankers have repackaged credit risk in recent years at a frenetic pace, creating new products such as collateralised debt obligations (CDOs) and shadowy investment entities such as structured investment vehicles (SIVs).

As this field rapidly expanded, many observers quietly wondered whether it was becoming dangerously opaque. But just as investors in Japanese banks before 1997 used to pin their faith on the convoy system – and closed their eyes to the fact that Japanese banks were not transparent – so 21st-century investors continued to buy complex structured products despite quiet misgivings. A key reason was that investors placed huge faith on judgments from credit rating agencies. If a product was labelled AAA, for example, it was considered extremely safe.

Further, the message from many regulators and policy officials in recent years was that structured finance had made the system more resilient to shocks because credit risk was less concentrated at individual banks. "It has been like an article of faith that innovation and risk dispersal was a good thing," says one senior European central banker. "Almost everyone believed it."

This faith in 21st century financial innovation has since evaporated. The events of last year showed with brutal clarity that risk dispersal does not always prevent financial shocks, but may fuel contagion instead. Innovation has not shielded the banks from losses, as regulators had hoped: instead, as entities such as SIVs have collapsed, banks have been forced to take more than $60bn of assets back onto their balance sheets, undermining their capital resources.

Meanwhile, confidence in the rating agencies has also crumbled. Having failed to foresee subprime losses, the agencies have been forced to downgrade thousands of securities – including triple-A rated instruments. "Not since the high-quality batch of railroad and utility bonds of the late 1920s faltered during the Great Depression have so many high-quality ratings been unable to stand the test of time," says Jack Malvey, senior analyst at Lehman Brothers.

That has delivered a huge psychological shock to investors, particularly to risk-averse bodies such as local authorities, money market funds and pension groups, which typically buy "safe" AAA products. Many such investors have fled the market, halting purchases of numerous structured finance products or asset-backed commercial paper.

In turn that has made it increasingly difficult for banks to raise funding and contributed to a wider money market freeze. "The key problem is a loss of trust," explains the treasurer of one of the world's largest investment banks. "I have never seen this before . ;. . except in Japan."

Fortunately, the Tokyo tale shows that such psychological shocks never last forever. A decade after investors' faith in Japanese banks was so rudely shattered, these institutions are once again trusted: they can raise funding relatively cheaply and investors are willing to hold their shares.

Yet this recovery took many years, largely because the Japanese government spent years denying the scale of the problem. "The biggest lesson from Japan's past is that bankers' stubborn refusal to recognise bad debts and authorities' secretive attitude amplifies the problem in the long run," says Mr Nakamae.


So the question that haunts credit markets now is whether they will be able to regain this all-important investor faith any faster than their Japanese counterparts did. Western policymakers insist that the answer is "Yes". They have already taken some dramatic measures: last month, for example, the European Central Bank and four other central banks injected more than $400bn-worth of short-term liquidity into the markets to persuade banks to continue lending money. "In some respects, what the ECB is doing now is similar to what the Bank of Japan did a decade ago," says Hiroshi Nakaso, a senior official at the Bank of Japan. "Back then banks lost faith in each other as counterparties, but they still had faith in the central bank so the central bank became like a central counterparty."

However, as Japanese officials such as Mr Nakaso also point out, such injections can only ever offer a breathing space – not a cure. "What is needed now is not cash but wiping out widespread mistrust," explains Daisuke Kotegawa, a senior official at the Ministry of Finance.

In practical terms, the experience of Japan suggests that at least three steps need to occur to recreate trust: investors need to believe that financial institutions have revealed their losses; banks need fresh capital; and, crucially, investors need to know that the peak in credit losses is past.

On the first point considerable progress is already being made, and faster than in Japan. "The major banks this time round are being much quicker to reveal losses," says Mr Nakaso. "I think that partly reflects accounting differences." The current credit crisis is the first that has ever occurred in a system partly run according to "mark to market" accounting rules. As a result, Wall Street banks and other financial institutions have written off some $100bn of losses in a matter of months, not years.

"I do think this crisis will work its way through quicker," says Timothy Ryan, vice-chairman of financial institutions and governments at JPMorgan, and formerly a senior US regulator. "Banks are bringing the problem assets back on the balance sheet ... and writing down positions and adding reserves."

However, progress is not uniform. In Washington, some politicians still seem tempted to delay the day of reckoning: the US government recently unveiled measures, for example, to help subprime borrowers. And while Wall Street banks may now be writing off losses, institutions in other jurisdictions are taking longer to reveal theirs. Worse, many structured finance instruments are so complex that it is hard even for the experts to measure the losses.

"This time it is a lot more complex than earlier [banking crises]," admits Mr Ryan. "Former US bank regulators like me feel a bit responsible because we used risk-adjusted capital rules to push riskier assets off balance sheet – but we never expected that it would lead to the creations of things such as the SIVs and complex leveraged CDOs ... This was financial engineering that went too far."

On the second necessary step to rebuild trust – capital injections – evidence is also mixed. Japan only managed to rebuild its banking system when the government agreed to pour in billions of dollars in funds. And observers such as Mr Nakamae think it is inevitable that taxpayer money will be used in the current crisis. Governments, however, seem very wary of this. "I don't think there is any appetite in Europe or America among the regulators or government to do what the Japanese did in terms of using public funds to support the banks," says Mr Ryan.

Nevertheless, as Mr Nakaso says, "another difference this time round [compared to Japan] is that there are new sources of capital."

Some of this comes from private equity. Last month Warburg Pincus, a buyout fund, provided $1bn of finance to MBIA, a troubled monoline insurance group. But the most controversial new source of capital is sovereign wealth funds. Citigroup, Morgan Stanley, Merrill Lynch and UBS, for example, have received around $25bn of capital injections from Asian and Gulf funds – and more Wall Street groups are expected to follow suit this year. "The banks are getting public funds – but just not from our government," quips one senior US banker.

But it is the third issue – namely evidence that credit losses have peaked – which could prove most difficult to resolve. Some bankers hope that the worst of the credit crunch could be over by the middle of this year. After all, they point out, the markets are already braced for a huge chunk of subprime losses. And in some important respects, the macroeconomic fundamentals look far better than in Japan. America is not beset by economic decline; on the contrary, the US has just enjoyed several years of strong growth and its policymakers are fretting about inflation.

What is vexing investors – and could derail any early end to the credit crunch – is the prospect of a recession. One of the most remarkable details about the western credit crisis so far is that it has hitherto only really affected consumer debt, such as mortgages. In the corporate world, by contrast, default rates have been extraordinarily low.

However, if a recession occurs, corporate defaults could rise sharply. Citigroup forecasts a sharp rise in the rate of defaults among sub-investment grade companies this year, projecting that if there is no recession the default rate will rise from 1.3 per cent to 5.5 per cent, meaning that five out of every hundred high leveraged companies will fail to repay their debts. If a recession were to occur it expects a far higher default rate.

"If Round One of the credit crunch was about the impact on money markets and bank finance, Round Two looks set to be about the impact on the economy and [corporate] defaults," it said.

While mainstream US and European companies have not borrowed heavily in recent years, private equity groups have loaded huge debt burdens onto entities they have acquired. This does not give them much margin for error – meaning that if growth slows, they could struggle to repay their debts.

That in turn could create several hundreds of billions worth of corporate bad loans, which would hit the weakened banks just as they are overcoming their subprime woes. "America would be hit by a financial crisis should an increasing number of bought-out firms drop into the red and creditors refuse to roll over the loans," says Mr Nakamae.

Indeed, the "nightmare" scenario outlined by some economists is a vicious cycle where a credit crunch tips the economy into recession later this year, creating more losses. This would worsen the credit problem and prolong the pain for years.

For the moment, most policymakers think such a gloomy forecast remains relatively unlikely. After all, the US economy has remained fairly resilient. And though corporate earnings are slowing, they are falling from a high base – a factor keeping equity prices relatively high. "There's almost a strange divergence between the acute nervosa experienced in the credit markets, and the minor state of anxiety evidenced in other capital market sectors," observes Lehman's Mr Malvey.

From the Japanese experience, though, one can draw two key lessons: it is much easier to destroy trust in a financial system than to rebuild it, and crises have a nasty habit of being more painful than financiers or governments initially admit.

The longer the US credit squeeze lasts, the greater the danger that it will hurt the "real" economy – and thus harder it will be to restore investor confidence. Governments and bankers will need to be very wise – and lucky – if they are to bring a complete end to the credit crunch in 2008; or, at least, much wiser and luckier than they were a decade ago in Japan.'

[insipiens] 03/1/2008 00:04

"Commodities come back to earth. Gold falters as the dollar rises from its deathbed. The US current account deficit drops below 4pc of GDP, helped by sliding oil prices. Crude finds support around $62. Peak oil is postponed, but not peak food. The global Left steps up its war on 'Dethanol'."

"Gold finds support at to its 200-day moving average in the low $700s. The long-term bull market lives on. It is a replay of the mid-1970s: a mini sell-off within a commodity super cycle."

"Thankfully, sterling can -- and does -- plummet to healthier levels, perhaps $1.72 by the end of the year. The Bank of England can -- and does - cut rates to 3pc or lower to prevent implosion. Spain and Ireland do not enjoy either luxury inside EMU. They burn."

quite right - been buying AIGP and done quite nicely so far.

[simon gordon] 02/1/2008 17:09

By Ambrose at the Telegraph:

'Relief comes. A reflation rally ignites Wall Street and global bourses late this year, but first we do penance for leveraged excess.

The bears take all in early 2008 as the insolvency crunch tightens its vice on the real economy. The downturn spreads through the Anglo-Saxon world and the euro-zone.

The Baltic and Balkan bubbles pop, exposing the folly of foreign currency mortgages across the region. The Swiss franc rockets as Europe's carry trade unwinds. A version of the East Asia 1998 crisis sweeps half the ex-Communist bloc.

Japan slides into recession, not helped by an 18pc surge in the yen against the euro. The Japanese bring their money home, cutting off a key source of liquidity for New Zealand, Australia, South Africa, and Turkey. Hedge funds hammer trade deficit countries. The MSCI emerging market index drops a third.

Hopes that China can step into the breach are dashed as credit tightening and yuan appreciation crush margins, leading to an abrupt Sino-slowdown. The World Bank's new methods reveal that China's GDP is 40pc smaller than we thought, relegating it to sixth place again behind Britain and France. The decoupling doctrine quietly disappears from the pundit's lexicon.

Commodities come back to earth. Gold falters as the dollar rises from its deathbed. The US current account deficit drops below 4pc of GDP, helped by sliding oil prices. Crude finds support around $62. Peak oil is postponed, but not peak food. The global Left steps up its war on 'Dethanol'.

Gold finds support at to its 200-day moving average in the low $700s. The long-term bull market lives on. It is a replay of the mid-1970s: a mini sell-off within a commodity super cycle.

The US Federal Reserve, the Bank of England, and the European Central Bank slash rates much further and faster than almost anybody now expects. It is enough to postpone the day of global reckoning for another cycle -- even if the effect is achieved by inter-generational theft, stealing prosperity from the future.

As it becomes clear that the central banks -- reflecting the collective will of our instant-gratification democracies -- shrink from inflicting the pain required to redress the vast imbalances in the global system, gold speaks its rebuke. Call options above $1000 pay off.

The monetary blitz prepares the ground for a torrid bull market, with spectacular gains for the stocks of banks and bond insurers beaten to a pulp by the credit crunch.

But first we see capitulation. The bail-out comes too late to avert a hard landing. Lingering oil and food inflation hobbles monetary policy through the first crucial weeks of this year. By the time it is clear that this inflation as a false alarm, even more damage has already been done. This may be a comfort for Calvinists offended that capitalism should so blithely dodge the consequences of Greenspan's moral surrender.

Debt deflation and falling house prices bleed Anglo-Saxon households for months. The losses from mortgages, commercial property, home equity loans, credit card debt, and all the tentacles of structured credit, mount to a $1 trillion before it is over, entailing a $4 trillion contraction in lending.

Banks plead for relief from the Basel II rules on capital ratios, and find a sympathetic ear from Gordon Brown.

The British miracle is exposed by the harsher lighting of 2008 as a double sham of debt and rampant public spending. A budget deficit of 3pc of GDP at cycle-top forces Brown to tighten fiscal policy into the slump. He opts for taxes. With household debt running at a world-beating 101pc of GDP, we face a slow grinding purge as in post-bubble Japan. Labour makes a move to ditch the prime minister as a crippling liability before the year is out.

Thankfully, sterling can -- and does -- plummet to healthier levels, perhaps $1.72 by the end of the year. The Bank of England can -- and does - cut rates to 3pc or lower to prevent implosion. Spain and Ireland do not enjoy either luxury inside EMU. They burn.

The big surprise in 2008 is Europe's failure to shake off the crunch. It is a victim of its half-reformed labour markets, just as it was after the US dotcom bust. But this time it lacks the crutch of a weak currency. Worse, the rift in competitiveness between the Latin and Nordic blocs has grown that much wider. Greater Germany can cope with a euro at $1.47, but Club Med is under water.

The deflating housing bubbles in Spain, Ireland, parts of France and Italy, and soon Greece, expose the fault lines of monetary union as 2008 unfolds, and start to render the euro-zone's one-size-fits-all system unworkable. Bond spreads over German bunds edge up as the pressure mounts, then jump sharply higher.

French president Nicolas Sarkozy finds a receptive mood for his Community Preference (a closed-trade bloc), and for his war on the ECB. He threatens to invoke Maastricht Article 104 on exchange policy.

Spain's Zapatero government crashes in March. Italy's Prodi coalition falls apart. Nationalists replace signed-up Europols in charge of all the Club Med powers. The ECB must meet Mr Sarkozy half way, or risk its own institutional destruction.

While Mr Sarkozy reshapes Europe in a dirigiste mould, Hillary Clinton takes the White House, with Democrats in control of both Houses. Will she really unpick NAFTA, halt the DOHA round, lash out at China, and chase the money-changers from the Temple like FDR?

No, but it will be a chillier world for free market capitalism. Karl Marx begins to chuckle beneath the Highgate sod.

Here are few hostages to fortune. If I have to eat my hat for every howler, I will doubtless choke on cloth.'

[insipiens] 20/12/2007 17:35

Conversely one day it will perform. Timing is the question - for me I see the yield being high for the coming year so will steadily accumulate over that period.

Be interesting to see what/how the rebalance affects things re your 70% :0

[simon gordon] 07/12/2007 18:25

Just looked at the sector weighting of the fund, 70% is held in Financials. No wonder it is underperforming!!

[simon gordon] 07/12/2007 16:19

Bearish comments from Christopher Woods at CLSA on the prospects for the UK economy:

'Wood remains firmly bearish on US financials, but says he would be even more bearish now on European financials "where the downturn is going to hit later than in the US, and where the lack of transparency in terms of the problems in the credit markets remains much greater than in America".

Greed & Fear's advice to absolute-return investors remains to bet heavily on both Bank of England and ECB monetary easing next year. It may also pay to be short the euro and sterling against not only the Asian currencies, but also against the US dollar, notes Wood, adding that this is despite the fact he believes the Fed will also be cutting aggressively in 2008.

The British economy, meanwhile, "is a much more straightforward sell than the US economy", because its growth profile is so heavily orientated to finance, housing and subprime-consumer financing. This is why the British economy could quite conceivably turn out to be the biggest loser from the so-called "subprime crisis".'

Sourced from the FT.

----

SLXX now yields close to 6%.

[insipiens] 28/11/2007 10:09

Yes it did drop by the dividend.

[simon gordon] 27/11/2007 15:42

They go xd tomorrow, so they should drop £1.79.

They now yield 5.7% which is 1.1% more than the ten year gilt.

If the economy heads to a recession, or even worse a depression, then UK rates would fall dramatically.

So, if you buy today and hold for a year, you get a 7.1% in yield, plus any capital uplift.

The chances of interest rates rising are, probably, zilch.

The only factor holding back SLXX, is the flight to quality into Government bonds and away from Corporate bonds.

[insipiens] 27/11/2007 15:28

ah, yes. Duh.....


SLXX getting closer to my target of 128. = 5.76% flat yield

Be worrying if they go much lower - that might imply quite a large correction coming in the markets. "No surprise" - I hear you saying.

[simon gordon] 27/11/2007 13:41

Yes, I've put it in the header.

[insipiens] 27/11/2007 13:08

Can't fault your strategy.

No doubt you've seen this site:

[simon gordon] 26/11/2007 16:03

I don't hold any SLXX.

I am sitting 97% in Cash.

I think UK stocks could be in for a torrid time, as our over-leveraged economy comes down to earth, after the Blair boom. We could now be at the start of the Brown bust. If so, equities could fall a long way. In fact we are still in a bear market that began in 2000.

SLXX goes xd tomorrow and if the BoE cut in December then SLXX should bounce.

I don't hold SLXX because I feel the lowest stress in Cash. I am thinking of moving into the Nationwide 6.7% one year bond but I am also thinking that if a stock market crash happens, then many bargains will be available. Cash looks to be the best place to park off!!

[insipiens] 23/11/2007 16:51

yes, agreed.

Personally 2/3 cash right (sipp) now looking to pick up value investments over the coming months. Already started with some uk banks. I tend to go for big caps though.

picking up slxx as it goes lower - got some at 12904 today, also picking up iukd too.

Will you hold any slxx?

[simon gordon] 23/11/2007 16:10

I don't know.

I think the best thing to do is to sit in cash.

It seems a lot of wise heads in the market think equities will fall - including Mervyn King who has called 2008 brilliantly.

I'm personally hoping for a Crash so that I can load up on rock solid Small Caps.

If a big bank takes a mega hit and it's future is at risk, then this could be the trigger for a Crash.

From what I read on the FT's Alphaville, the derviatives market is seizing up further.

[insipiens] 23/11/2007 15:43

and which scenario do you think is most likely?

reckon slxx has some way lower to go yet, sub 128 before year end.

[simon gordon] 23/11/2007 15:37

Sourced from the FT:

Scenario 1: The Fed sticks to its assertion that the risks for inflation and growth are now in balance, does not cut rates any further and the US economy grows past its credit crunch. If this happens, it would be massively bullish for the dollar, massively bearish for gold and potentially bearish for HK and Chinese equities (which are now anticipating more rate cuts). It would also be very bearish for US Treasuries and government bonds around the world. Additionally, we would most likely see a rotation within the stock markets away from commodity producers and deep cyclicals (which have been leading the market higher for years) towards the more traditional "growth" sectors, such as technology, health care, consumer goods, and maybe even Japanese equities.

Scenario 2: The Fed sticks to its guns, does not cut rates, and the US economy really tanks under the weight of the credit crunch. In essence, the US would move into a Japanese-style "deflationary bust". In this scenario, equities around the world, commodities, and the dollar would collapse, while government bonds would go through the roof.

Scenario 3: The Fed ultimately cut rates, but this fails to rejuvenate the system and get growth going again. This would likely mean stagflation. As such, gold and other commodities would do well, while stocks and the US$ would struggle. Excluding bonds, this is increasingly what the market is pricing in today.

Scenario 4: The Fed ultimately cuts rates, and succeeds in reining in the economy. This would be good news for equity markets, commodity markets, and the dollar, but of course, terrible news for bonds.

[simon gordon] 25/9/2007 10:05

The Credit Crisis Could Be Just Beginning
By Jon D. Markman
TheStreet.com
9/21/2007

Satyajit Das is laughing. It appears I have said something very funny, but I have no idea what it was. My only clue is that the laugh sounds somewhat pitying. One of the world's leading experts on credit derivatives (financial instruments that transfer credit risk from one party to another), Das is the author of a 4,200-page reference work on the subject, among a half-dozen other tomes. As a developer and marketer of the exotic instruments himself over the past 30 years, he seemed like the ideal industry insider to help us get to the bottom of the recent debt crunch -- and I expected him to defend and explain the practice. I had started by asking whether the credit crisis was in what Americans would call the "third inning." This was amusing, it seemed, judging from the laughter. So I tried again. "Second inning?" More laughter. "First?" Still too optimistic. Das, who knows as much about global money flows as anyone in the world, stopped chuckling long enough to suggest that we're actually still in the middle of the national anthem before a game destined to go into extra innings. And it won't end well for the global economy.

Das is pretty droll for a math whiz, but his message is dead serious. He thinks we're on the verge of a bear market of epic proportions. The cause: Massive levels of debt underlying the world economic system are about to unwind in a profound and persistent way. He's not sure if it will play out like the 13-year decline of 90% in Japan from 1990 to 2003 that followed the bursting of a credit bubble there, or like the 15-year flat spot in the U.S. market from 1960 to 1975. But either way, he foresees hard times as an optimistic era of too much liquidity, too much leverage and too much financial engineering slowly and inevitably deflates.

Like an ex-mobster turning state's witness, Das has turned his back on his old pals in the derivatives biz to warn anyone who will listen -- mostly banks and hedge funds that pay him consulting fees -- that the jig is up. Rather than joining the crowd that blames the mess on American slobs who took on more mortgage debt than they could afford and have endangered the world by stiffing lenders, he points a finger at three parties: regulators who stood by as U.S. banks developed ingenious but dangerous ways of shifting trillions of dollars of credit risk off their balance sheets and into the hands of unsophisticated foreign investors, hedge and pension fund managers who gorged on high-yield debt instruments they didn't understand and financial engineers who built towers of "securitized" debt with math models that were fundamentally flawed. "Defaulting middle-class U.S. homeowners are blamed, but they are merely a pawn in the game," he says. "Those loans were invented so that hedge funds would have high-yield debt to buy."

Das' view sounds cynical, but it makes sense if you stop thinking about mortgages as a way for people to finance houses and think about them instead as a way for lenders to generate cash flow and to create collateral during an era of a flat interest rate curve. Although subprime U.S. loans seem like small change in the context of the multitrillion-dollar debt market, it turns out that these high-yield instruments were an important part of the machine that Das calls the global "liquidity factory." Just like a small amount of gasoline can power an entire truck given the right combination of spark plugs, pistons and transmission, subprime loans became the fuel that underlies derivative securities that are many, many times their size.

Here's how it worked: In olden days, like 10 years ago, banks wrote and funded their own loans. In the new game, Das points out, banks "originate" loans, "warehouse" them on their balance sheets for a brief time, then "distribute" them to investors by packaging them into derivatives called collateralized debt obligations, or CDOs, and similar instruments. In this scheme, banks don't need to tie up as much capital, so they can put more money out on loan. The more loans that were sold, the more they could use as collateral for more loans, so credit standards were lowered to get more paper out the door -- a task that was accelerated in recent years via fly-by-night brokers that are now accused of predatory lending practices. Buyers of these credit risks in CDO form were insurance companies, pension funds and hedge-fund managers from Bonn to Beijing. Because money was readily available at low interest rates in Japan and the U.S., these managers leveraged up their bets by buying the CDOs with borrowed funds. So if you follow the bouncing ball, borrowed money bought borrowed money. And then because they had the blessing of credit-ratings agencies relying on mathematical models suggesting that they would rarely default, these CDOs were in turn used as collateral to do more borrowing. In this way, Das points out, credit risk moved from banks, where it was regulated and observable, to places where it was less regulated and difficult to identify.

Turning $1 Into $20

The liquidity factory was self-perpetuating and seemingly unstoppable. As assets bought with borrowed money rose in value, players could borrow more money against them, and it thus seemed logical to borrow even more to increase returns. Bankers figured out how to strip money out of existing assets to do so, much as a homeowner might strip equity from his house to buy another house. These triple-borrowed assets were then in turn increasingly used as collateral for commercial paper, the short-term borrowings of banks and corporations, which was purchased by supposedly low-risk money market funds. According to Das' figures, up to 53% of the $2.2 trillion of commercial paper in the U.S. market is now asset-backed, with about 50% of that in mortgages. When you add it all up, according to Das' research, a single dollar of "real" capital supports $20 to $30 of loans. This spiral of borrowing on an increasingly thin base of real assets, writ large and in nearly infinite variety, ultimately created a world in which derivatives outstanding earlier this year stood at $485 trillion -- or eight times total global gross domestic product of $60 trillion. Without a central governmental authority keeping tabs on these cross-border flows and ensuring a standard of record-keeping and quality, investors increasingly didn't know what they were buying or what any given security was really worth.

A Painful Unwinding

Here is where the U.S. mortgage holder shows up again. As subprime loan default rates doubled, in contravention of what the models forecast, the CDOs those mortgages backed began to collapse. Because these instruments were so hard to value, banks and funds started looking at all CDOs and other paper backed by mortgages with suspicion, and refused to accept them as collateral for the sort of short-term borrowing that underpins today's money markets. Through late last month, according to Das, as much as $300 billion in leveraged finance loans had been "orphaned," which means that they can't be sold off or used as collateral. One of the wonders of leverage is that it amplifies losses on the way down just as it amplifies gains on the way up. The more an asset that is bought with borrowed money falls in value, the more you have to sell other stuff to fulfill the loan-to-value covenants. It's a vicious cycle. In this context, banks' objective was to prevent customers from selling their derivates at a discount, because they would then have to mark down the value of all the other assets in the debt chain, leading to the need to make margin calls on customers who are already thin on cash.

Now it may seem hard to believe, but much of the past few years' advance in the stock market was underwritten by CDO-type instruments that go under the heading of "structured finance." I'm talking about private-equity takeovers, leveraged buyouts and corporate stock buybacks -- the works. So the structured finance market is coming undone; not only will those pillars of strength for equities be knocked away, but many recent deals that were predicated on the easy availability of money will likely also go bust, Das says. That is why he considers the current market volatility much more profound than a simple "correction" in prices. He sees it as a gigantic liquidity bubble unwinding -- a process that can take a long, long time.

While you might think that the U.S. Federal Reserve can help prevent disaster by lowering interest rates dramatically, as it did Wednesday, the evidence is not at all clear. The problem, after all, is not the amount of money in the system but the fact that buyers are in the process of rejecting the entire new risk-transfer model and its associated leverage and counterparty risks. Lower rates will not help that. "At best," Das says, "they help smooth the transition."

[simon gordon] 18/9/2007 14:29

Housing market crisis for UK suggests Christopher Wood
By Mark Kleinman

The analyst credited with predicting the collapse of the United States sub-prime mortgage market warned yesterday that the Northern Rock crisis was "just the beginning" of Britain's exposure to the unwinding of the structured credit industry.

Christopher Wood says Mervyn King should 'feel like a schmuck'

Christopher Wood, a managing director at CLSA, the Asia-focused brokerage, told The Daily Telegraph that the British economy was at particularly grave risk from the turmoil in the world's financial markets because of its relative reliance on the City as its growth engine.

"The UK economy is heading for a sharp shock," he said. "It is based on the City of London, the housing market and sub-prime consumer lending. While the UK probably won't suffer on sub-prime to the same extent as the US, a real downturn in Britain's housing market seems to be inevitable."

Mr Wood, who was born in Britain and has earned a following for the punchy commentary in his regular research publication Greed and Fear, warned in 2005 that US mortgage debt was the principal source of risk in the American financial system, making him the first to highlight the dangers of the sub-prime lending sector.

In his latest note, published on Sunday, Mr Wood suggested that Mervyn King, Governor of the Bank of England, should "feel like a schmuck" for the Bank's decision to bail out Northern Rock. He said that Mr King had "massively accentuated moral hazard" by coming to the lender's assistance. "It is amazing that the Bank of England has felt it necessary to come to the rescue of an institution that had been run in such a reckless fashion". Northern Rock's balance sheet, he wrote, "would not disgrace a Thai finance company prior to the Asian Crisis" of 1997.

"Northern Rock was always a candidate to be the first to go under because of its aggressive lending model," said Mr Wood yesterday. "This is just the beginning. I would be amazed if there isn't worse to come in the UK."

He said the global credit crisis would usher in a new era of more stringent financial regulation. "The regulatory backlash will be worse when it is the ordinary person who gets hit," he said.

Mr Wood also attacked the credit rating agencies. "Their model was a recipe for massive conflicts of interest," he said.

[simon gordon] 23/8/2007 20:39

From the Telegraph by Ambrose Evans-Pritchard:

The liquidity crunch is not yet over: the insolvency crunch has hardly begun.

Repercussions will follow for the man on the street

Yes, investors are jumping back into the stock markets, hoping this is just another routine shake-out - much like February 2007, or May 2006 - before the rally resumes. The `buy-on-dips' orthodoxy dies hard.

And yes, speculators have renewed their leveraged bets on the yen and Swiss franc carry trades, borrowing cheap in Tokyo and Zurich to play global assets. The core belief is that nothing has really changed, that the world economy is still in rude good health.

Be very careful. Interest rates in Europe and Asia are that much higher now, with delayed effects starting to bite hard. Japan's economy has stalled to 0.1pc growth in Q2; the euro-zone has slowed to 0.3pc; and China's refusal to import (by currency manipulation) makes it a drain on world demand. Above all, the credit bubble that perpetuated the rally of the last eighteen months beyond its natural life has definitively burst.

Credit spreads on the iTraxx Crossover (a good barometer of corporate bonds) have ballooned 180 basis points since February. The cost of borrowing for most firms in Europe and North America has jumped from circa 6.5pc to 8.3pc, if they can get it.

Many cannot. Germany's Chamber of Industry told me yesterday that it had been flooded with distress calls from family Mittlestand firms unable to roll over credit lines. In Canada and Australia, junior mining finance has dried up almost entirely.

Global junk bond issuance has been frozen for two months. Fresh sales of collateralized debt obligations – the CDOs of subprime notoriety: a $1 trillion sold last year - have all but stopped. Banks have yet to off-load $300bn of debt from leveraged buy-out deals, forcing them to keep the liabilities on their books. They are all snake-bitten now.

The private equity buy-out premium – which pushed up the price/earnings ratio on the MSCI-600 of "median" stocks to a record high of 20 in May - has vanished. The P/E ratios on the DOW 30 big stocks are much lower – because they are too big even for the big cat predators, KKR and Carlysle – but they are not low, given the late stage of the cycle. In reality, an earnings bubble and ultra-cheap credit have flattered profits.

So no, the world has changed, dramatically. Whether this means a protracted global downturn and a "profits recession" depends on how quickly the central banks choose to respond, and how far they are willing to go.

Ben Bernanke is looking hawkish to me, given the shock of what happened on Monday when yields on 3-month US Treasury notes plunged at the fastest pace ever recorded, a panic flight to safety that no living trader had ever seen before.

Why? Because trust had collapsed to such a degree that players with a lot of cash no longer believed it safe to leave wealth in bank accounts, or the money market funds of brokerage companies - (exposed as they are to short-term commercial paper and subprime CDOs). This did not occur after 9/11, or in the heat of the October 1987 crash. Nor did was there such a banking panic in October 1929. (it hit in August 1931). If you think this is of no importance, or that this will pass swiftly, you have a strong nerve.

"When you have a run on the money markets like this, it is bound to spill over into the real economy," said Albert Edwards, global strategist at Dresdner Kleinwort.

"We already thought there was a 40pc chance of a US recession before all this happened, but the risks are now much higher and don't forget that rates on adjustable mortgages will keep rising until a peak next March, so the maximum pain will be in the second and third quarters of 2008," he said

"There will be large bankruptcies, and liquidity is not going to help because too many people bet the farm at the top of the cycle, and they're now insolvent. A lot more bodies are going to be floating to the surface before this is over," he said.

The belief that Europe would somehow be insulated has been tested over the last two weeks. Two German banks have required bail-outs on subprime bets – Sachsen LB for Eu 17.3bn, IKB for Eu 8.1bn.

Alexander Stuhlmann, boss of WestLB, confessed that the German banking system was in a "not uncritical situation". Jochen Sanio, head of the German regulator BaFin, said a few days earlier that the country faced the worst banking crisis 1931.

Hence the continued actions of the European Central Bank, which has quietly injected 85bn euros in extra liquidity so far this week, almost as much as it did on the first day of emergency stimulus in early August.

"Banks are still thirsty for credit, and the spreads have been amazing. This is not business as usual at all," said Julian Callow, chief Eurozone economist for Barclays Capital and an expert in the arcane field of central bank operations. (He used to work for the Bank of England.)

To clarify: the ECB allotted an extra Eu 45bn extra through a `weekly refi' on Tuesday; and then Eu 40bn in a 3-month offer on Wednesday to stop the short-term commercial paper market seizing up.

What we know is that 146 banks bid for loans on Wednesday, some clearly in such distress that they were willing to pay up to 5pc interest – a full 1pc above the ECB's benchmark rate.

Just like the dotcom bust: when the US sneezes, Europe catches... you know the rest.

In a warped sense, one has to admire the cool way that Americans – who save nothing, in aggregate – tapped into the vast savings pool of thrifty Germans to finance their speculative excesses, and then left the creditors holding a chunk of the subprime losses.

Was it sharp practice, in the same way that foreigners were recruited by Lloyds of London in 1986 and 1987 – before the impending asbestos losses were known – and place like cannon fodder on "spiral syndicates" to absorb crippling losses? (Lloyds denies this occurred).

I am endebted to Randall W.Forsyth from Barron's for this delicious quote from a hedge-fund operator, recounting with disgust what happened this time in a letter to clients.

'Real money' (U.S. insurance companies, pension funds, etc.) accounts had stopped purchasing mezzanine tranches of U.S. subprime debt in late 2003 and [Wall Street] needed a mechanism that could enable them to 'mark up' these loans, package them opaquely, and EXPORT THE NEWLY PACKAGED RISK TO UNWITTING BUYERS IN ASIA AND CENTRAL EUROPE!!!!

"These CDOs were the only way to get rid of the riskiest tranches of subprime debt. Interestingly enough, these buyers (mainland Chinese banks, the Chinese Government, Taiwanese banks, Korean banks, German banks, French banks, U.K. banks) possess the 'excess' pools of liquidity around the globe. These pools are basically derived from two sources: 1) massive trade surpluses with the U.S. in U.S. dollars, 2) petrodollar recyclers. These two pools of excess capital are U.S. dollar-denominated and have had a virtually insatiable demand for U.S. dollar-denominated debt . . . until now.

Shameless.