Month: October 2008

Categories
Uncategorized

The debt black-hole

I read a report recently that suggested the US credit derivatives market is worth at least 50 trillion with CDS’s making up the majority. These are estimates obviously but the bottom line is a figure so large that it could collapse a country never mind a bank. Admittedly that figure is believed to be the total amount of credit derivatives swaps outstanding in the US.
Because of the good old US belief in minimally regulated market freedom a reasonable sounding mechanism to transfer risk became the spring board for a range of financially engineered derivatives which multiplied both the number of parties involved and the net effect of any individual default. CDS’s require low capital backing so they’re risk that appears “cheap” to play with and potentially very lucrative. On the way up, this creates liquidity. However, the multiplying affect is probably 10 or more as the commercial loan market in the US is supposed to be worth around 5 trillion dollars.
So one bank fails and, simplistically, brings down another 10 financial services companies with it. As banks of differing sizes tend to buy credit from banks up the food-chain, Credit is almost like a commodity that can be manufactured and productised into other packages suitable for smaller financial services companies with different capitalisation, risk profile, timeframes etc. Therefore, it’s possible that a large failure, causes a catastrophe for a few smaller banks. If their problems are resolved, the effects are felt by even smaller banks etc. It’s a ripple effect that we can’t insulate ourselves from, even with an unlimited governmental guarantee.
This won’t “balance out” as they say due to the multiplying affect and the scale. There’s simply more risk-based derivatives out there than assets to protect. Even more so when you consider those assets are inflated. We already know European banks have participated in this market so even if no Irish bank has partaken in the CDS market directly, it is reducing and will further reduce the ability of Irish banks to get credit. It could also devalue their other foreign investments. No bank is an island 🙂
I think the size of this black hole of risk is what’s terrifying world governments into producing these massive bail out packages. As it’s cheaper to nationalise or recapitalise one bank than it is 10. Better to protect defaults at source than wait for the meltdown.
Essentially, this is the goal of the 700 Billion dollar bailout package that was passed recently in US Congress. Purchase the debt that’s in default or most likely to become “toxic” ASAP before the “ripple effect”. Now consider, the multiplier effect and you have 7 trillion of associated CDS’s sitting out there. Some has possibly been triggered already due to the events at Lehman Brothers. Although there are differences of opinion regarding exposure, the multiplier factor and the Net effect. Also, it’s worth remembering that you actually have to be able to get the money from the CDS counter-party. They could simply refuse to pay.
How to mitigate the risk of this happening again? Bubble-expert Yale professor Robert Shiller makes a few suggestions which are discussed over the at the freakonomis website. These focus on improving the information available between institutions and public so risk profile is less opaque. He also proposes the solution of creating derivatives on city-level real estate prices. I don’t like this solution as by his own admission markets are subject to mass delusion regarding prices going onwards and upwards. The ability to short these markets may limit control, but with leverage it IMO provides another mechanism for ordinary joe (popular guy recently) to see one of his life’s major investments exploited by profit-hungry hedgers. Reducing leverage capacities of both banks and individuals is an excellent idea. It’s tough love and many commentators suggest it damages liquidity but that’s arguably adopting a catastrophist attitude towards tighter regulation. What good is all that liquidity if it’s going to be channelled into trading timebomb credit derivatives? What’s wrong with telling someone who can’t afford to buy a house that they can’t have it? The only reason they wanted to buy was because of the mass delusion of the ever-ascending property ladder. If sub-prime buyers had been encouraged to wait it out the prices wouldn’t have overheated.
Or to use another(‘s) metaphor we could do worse than remember the world of John Maynard Keynes:

“A general bonfire is so great a necessity that unless we can make of it an orderly and good-tempered affair in which no serious injustice is done to anyone, it will, when it comes at last, grow into a conflagration that may destroy much else as well.”

Categories
politics

The Good Fianna Failer

Pardon the headline, he was with Fianna Fail but upon realising his goodness and moral standing he had the good sense to resign. Wicklow TD Joe Behan who has resigned from the party following the recent abolishment of the automatic entitlement to a medical card for the over 70s. The Greens (read ingratiating taxation apologists) are currently on the Right Hook suggesting that this seemed a reasonable way to reform an abused scheme. Who was doing the abusing? Well, both FF and the Greens are suggesting it was the doctors who used it as “easy money” with ever higher expenses being claimed so it obvously made sense to penalise the elderly. It’s like locking up homeowners when their houses are burgled. It’s tackling the wrong side of the problem.
The Greens are also saying the scheme has “now been shown to be unfair” and so needs a rethink. Do any of them own a friggin calculator? What kind of a lame-brained load of toss of an excuse is that? The unfairness of this scheme was obvious when it was announced yet the cabinet saw fit to vote for it. So FF hate the middle classes and the Greens just hate people, those pesky polluting organisms. As I pointed out in my last post there will be less people to worry about with fuel price increases and the withdrawal of tens of thousands of medical cards. If only this scheme could be implemented worldwide? Think of the reduction of carbon emissions!
If you can put up with 70 years of crap governance then a medical card is a small benefit and should be considered an automatic right. The “rich” don’t need to use a medical card as they have private health care in their old age. Michael O’ Leary pointed this out in his usual entertaining sytle on NewsTalk earlier today. Their health care costs rise however, I wonder why that is. Perhaps the problem is actually that age leads to a deterioration of health. Wow, I think I’m on to something here. We need to abolish old age instead.
I hope Noel Dempsey takes note (still clueless) who blathered on about the medical card reform targetting “the rich”. Do FF not know that their property developer and builder friends are the real rich as opposed to the embattled middle and upper middle classes they screwed over so comprehensively at the last budget.
As I’m listening the Minister for Hardship, Brian Lenihan, is now talking about “taking decisions for the good of the country. For the good of the country could they suspend ludicrous infrastructure projects like the Metro in Dublin? What economic growth will be produced by this? It’s only required because of a complete failure to implement decentralisation over a 15+ year period. How about a further tax increase for those earning over 250k/year? Just a percent but there are many such high earners and they can arguably afford it. Unless they fell for the same Ponzi-scheme property scam as the rest of us…
How about any incentive for creating jobs, like personal tax relief for shareholder/directors of companies which create new high-skills jobs in IT, biochem, pharma, financial services etc. I’ll suggest it again: remove employers PRSI. It’s a disincentive to hire. Apart from the R&D tax relief increase the budget was a tale of woe for industry, retail and most PAYE employees. Quite an achievement really.

Categories
economics

Budgetting for a generation of fear and loathing

Brian Lenihan has committed the political equivalent of armed robbery. Now that the sham of the celtic tiger economy has been exposed. While the budget is to “target all sectors of society” according to today’s Irish Times article, it’s difficult to see what good that will do.
“Radical direct and indirect taxes” mostly affect the middle and upper middle classes. Think of families with 2 working parents earning between 70 and 110k in total. That seems like a lot of money until you realised they’re saddled (or perhaps shafted) with massive debts to buy mediocre accomodation and are possibly in negative equity. The bigger their salaries the greater the debt on their massively overpriced accomodation that this same government encouraged them to buy. Their fuel bills, travel costs and medical bills will now rise.
Their children’s allowance will be cut. Their mortgage relief has been cut. Any to cap it all.. a move of utter stupidity a half percent rise in the high rate of VAT.
I suppose we can console ourselves that by using less fuel and catching pneumonia we’ll be delivering a double benefit to the environment. I miss the principled outspoken PD’s when all I see are these ingratiating tax apologists hanging onto the monster’s coat tails. I’m talking about the greens of course 🙂
As a retailer I can tell you I’m feeling the pinch together with everyone in “trade”. Consumer spending has been moving steadily down the past 2 christmas as rising interest rates and massive house prices reduced the disposable income and hence spending. The sheer pointlessness of raising the high rate of VAT to 21.5 percent. Retailers around the country will have an extra bit of their margins eroded and will have to adjust prices. Has Minister Lenihan noticed the whole country is on sale?
Throw in overpriced childcare and this budget has pulled the trigger of the long gun barrel the middle classes have been looking down since our economy went into free fall. This group are the engine of most retail in Ireland and on their spending many businesses will fall, creating more unemployment, poverty, emigration and all the negative aspects of Irish life for decades. It was well known economist Morgan Kelly who suggested that the boom was so great because successive generations of governments had managed to insulate the Irish people from the effects of a boom for years. Cometh they hour, cometh Lenihan!
The government are suggesting the poor have been protected. What about the friggin middle classes or the “new poor” as I like to call them? I know a few families of modest incomes that are already struggling. Finances are tight and jobs are uncertain. This budget won’t help them or ease their concerns one bit. Instead, it slaps them across the face for bothering to work as opposed to living on benefits.
It seems the super rich (the oligarch class as David McWilliams describes them) will escape relatively unscathed with tax incentives in place and a relatively modest hike in income tax. It would be such a shame to hurt the stud farm industry. I wonder do they escape the 1% levy?
We already some of the world’s highest levels of indirect taxation masking a low-ish direct tax regime. Far from reform we’ve moved farther away with, in reality, nordic levels of personal taxation for inadequate service provision.
Raising taxes across all sectors has been proven time and time again to exacerbate the effects of a recession. While the reckless trading of credit derivatives in the US might have created this crisis, there’s a cogent argument to suggest that raising taxes brought about the recession that together with US bankruptcy laws led to the meltdown in the sub prime market.
The following piece from the Cato Institute makes some valid points about the effect of increasing tax burden during a downturn. By reducing growth and actually causing bankruptcies such measures increase the burden on the exchequer. Raising taxes only bails out the state for poor economic planning. It HAS NEVER and NEVER WILL ameliorate a recession as it reduces the available income for industry, spending etc.
Richard Bruton also made some neat points about this “take away” budget.

“This is a Budget that is all about extra taxes for ordinary families, about extra charges for people, and about cutting capital spending,’’ said Mr Bruton.
“You are looking to make it tougher for people who are struggling to get by,’’ he added.
“There is no sign that you are aware of the pressure on people from fuel bills, the pressure on people who have lost their jobs.”

There are signs he may actually know what he’s doing and it’s a shame that Enda’s shiny suit distracted from what could have been a very capable minister for finance. There’s still time!
It’s difficult to be shocked that a Belvedere-educated, former Trinner-lecturing, barrister (Lenihan) is a bit out of touch with the general electorate. Oh, of course we needed to do this to remain within our EMU parameters. That’s some incentive to the overstretched single parent who’s had their child support for college-going kids slashed. How will they pay the registration fees which just doubled. Equal opportunities indeed.
If the management of a public company had performed so badly they’d be ousted at an A/EGM. Yet the cabinent are congratulating themselves on their principled 10% wage cut. They got reelected by telling the people of the country an economic fairytale that several economists rubbished and which precipitated a crisis in almost the exact way they predicted. There’s a clear attempt at political misdirection where they try to confuse the issue in the public’s mind. The credit crunch hasn’t lowered consumer spending NOR did it lower a few weeks ago. This is a fallacy and any attempt to suggest this budget is entirely the effect of “worldwide economic conditions” is horseshit. George Hook dealt with this very nicely when Miniature Cullen tried this tack on his radio show yesterday evening.
What can we really expect when we don’t have a cabinet member who has any experience of running an SME? If we keep electing these monkeys we SHOULD EXPECT to live on peanuts.