Would it Be Cheaper to Just Start from Scratch?

We've had some amazing developments over the weekend with a $300 billion plus bailout of Citibank in addition to the billions it already receives in direct equity investments in addition to lending from the Fed window. In addition, the government today is going to purchase another $500 billion in mortgage related securities. Including the nationalization of Fannie/Freddie as well as the other various acronyms of programs we've got another few trillion added on to the tap in what looks like a purchase and spending plan that's going to end somewhere between $5 and $7 trillion not including any fiscal stimulus that may be planned.

Additionally, we still have not had government regulators impose or require any kind of real visibility on the exposure to derivatives at these institutions which makes many of these companies very vulnerable to runs on their debt and equity securities--often in tandem. Why not require transparency? Is it an issue that the potential liability is so large that regulators fear transparency might induce further panic? Perhaps it would.

Meanwhile, it almost seems as the bailouts, guarantees, and equity infusions never end. We've had a lot of debate on the original TARP as well as giving poor Hank Paulson's underlings dramatic grillings in Congress but what about a debate on the virtues of an alternative. Specifically, letting the market for assets in these various bubble asset classes actually clear. Doing nothing but guaranteeing deposits, various money markets, CDs etc as opposed to trying to guarantee trillions in secured and unsecured debt and equity that underpin these inflated assets with no real end in sight. It's called "catching the falling knife approach". I suppose if you can print unlimited currency, your chances of doing so are better.

The obvious peril here of such an alternative is the forced liquidation of all of our major financial institutions including Citibank, JP Morgan, Wells Fargo, Goldman, Morgan, and Bank of America and letting asset prices in real estate and other areas actually clear. No question the forced clearing process would cause asset prices to over correct. But doesn't that over correction always beget a process of recreating market viability? Didn't it do so in the S&L prices with investors and speculators and homeowners coming in finally to get the market going again. Those first investors got some great bargains but they have as of yet for this crisis not appeared.

One could argue the market intervention now prevents players on the sidelines now in private equity and elsewhere from entering the market due to artificial transactions taking place. Why enter now when it's highly probable that government support will end at some point in the future and better terms can be dictated then. Without that over correction process, you prevent the natural clearing process for assets taking place that we have seen in the resolution of every other bubble for the last 200 years.

We would have to start from scratch with new banks entering the market over time to fill the huge gap left by these exits. No question, the result of that would be fairly catastrophic with secured and unsecured lenders to these institutions wiped out and the credit markets frozen for several quarters if not a lot longer. Of course even with the government intervention now credit markets are pretty much frozen anyway.

We've had quite a few banks forming lately to get access to the governments "free money" so we seem to have an ample supply of folks ready to step in to become bankers. It might even mean foreign banks (the ones who survived the collapse of their American counter parties) would take a more active role in our economy. That would mean big hits to national pride until American institutions could stand on their feet again but maybe we need a good swift kick in the ass right now?

Right now though it seems like the ex-Goldman bankers that run Treasury can't imagine a world without these institutions and have not even considered the proposition of letting the market clear for real estate and other assets and let these institutions exit or thrive upon their own merit. Rules everyone else seems to have to live by.

This would mean a even more drastic and quick drop in consumer spending, a number that needs to go down anyway as well as big drops in the equity markets which have already dropped by approximately 50%. This kind of shock would likely put unemployment up in to double digits past 10%. Real estate prices would drop another 30-50% in some markets and interest rates to finance mortgages would be much higher (8% or higher) without the government backstop.

Right now, lenders to the "chosen banks" in effect have a guarantee on their debt. A far better deal than they probably imagined when they lent the banks money. But it has huge costs to the dollar as we print money out of thin air to support these failed institutions and our financial system and if the current approach continues, the only survivors to this crisis might be the banks and the people that lent to them with surrounding industries destroyed by the heavy burden this crisis will toll going forward. What good is a bunch of banks if long term American viability is put at risk and we have a broken currency? Those kinds of problems are much harder to fix.

At the same time, the most striking thing about the Citibank deal is other banks may need the exact same type of program and in the end, it may not be enough. These balance sheets are so complicated it's not clear where these problems end or how insolvent these institutions really are. I don't think even the managers of these companies have any idea. We could spend several trillion dollars and it still may not solve the underlying problems in these financial institutions. With global central banks heading for zero and potential scenarios for quantitative easing this sure helps its chances though. Although still the ECB has cut anywhere near where the Fed has and policy worldwide is still not coordinated well at all.

It also appears the Fed in cahoots with Treasury is starting to actually just print money to finance some of these programs. There are severe limits to how much of this can be done and eventually it will ruin our ability to finance our way out of problems. This particular outcome would have a truly devastating impact on our economy and our longer term growth rate. Japan left it's deflationary spiral with public debt 300% to GDP and no real growth. One could argue they still are not out of this crisis with their own money rates still near zero. We've criticized their poor policy response and congratulated ourselves on handling our own version of the crisis with alacrity but in some ways it feels we may be heading to the same place perhaps with an even more despondent ending place.

With US government debt in 2007 at 65% of GDP and total debt at 350% of GDP counting consumers debt and mortgages does it not appear like we will be moving all of this debt over to the government ledger with a similar burden just like Japan. Would it not be more prudent to write this off rather than foisting it on the US taxpayer and let those who lent imprudently take the hit?

Was the real error in the Japanese policy response not letting these banks with overvalued assets fail? Taking their pain quickly, then using bailout money instead to help the economy recover afterword? Are we simply putting off the inevitable rather than facing it thereby transforming the US economy into a walking corpse?

The pitfalls of printing Weimar money aside, at some point a huge fiscal stimulus may become so expensive to finance due to higher interest rates, it would in effect become counter productive. This is very similar to the situation we were in during the 80s/90s. It the cost of financing debt were to spiral back to interest rates even during the 90s, the spending may crowd out so much private investment it may actually shrink growth by having the government spend more. Also, there is financing risk in terms of the government borrowing money cheaply now, but when it comes time to roll it over in 2 years, the markets have adjusted and we have to pay much higher interest rates to refinance. Much like people with ARMs today- the US government is falling into the same trap of easy money now, and not being able to pay later.

We could also experience a short term boost from fiscal stimulus (looks to be about a $700 billion plan to start us off but I think the may go as high as twice that) but in several years when the debt rolls over, the interest expense could rise so sharply it could whiplash us into another recession.

On the positive side, it definitely appears that the Treasury is "working ahead of the curve" for the first time I have ever seen. These programs are huge, dramatic and are getting ahead of problems rather than just reacting to them. It may work but there is also the potential that you may get the same kind of disaster scenario of a financial system collapse but with added problems of the collapse of the dollar and huge bubbles in other sectors in the future.

Already we have seen the dollar start to fall and gold start to rise relatively substantially. These are all symptoms of the potential for problems down the road. If the dollar starts to weaken further, it may set off a spiral of events that materially limit the government's ability to finance its own operations. This would lead to debt issuance in Euros or Yen and a significant constraint on our ability to borrow as well as a big rise in rates.

There are other implications as well with the complete nationalization of mortgage debt. I am not sure I love the idea that the government control the mortgage market. A lot of these policy choices are not only high risk, they are also very difficult to undo.

One also wonders if we are simply spreading the pain out over a long period of time rather than taking it all at once, and creating longer term issues in currency risk and our ability to finance our debt. I'd almost rather have 6 months of housing prices collapse, -10% in retail sales, and other deflation while assets get repriced without risking our currency and financial future.

So what is better...letting these very complicated institutions go and letting the cards fall where they may or the current program of shifting risk onto the government balance sheet. In either scenario we would guarantee things like money market funds and deposits but all the secured and unsecured debt would have to be handled the old fashioned way by the private markets.

Either way its a huge gamble and the future direction of the country will be impacted by this choice. To be honest I don't know which path is better and I don't know that I am going to flesh the answer out here on this blog.

I guess I wonder though, has Paulson even contemplated a scenario where Goldman and Citibank fail? Has the government thought about the trade off for a "Tabula Rasa" or clean slate? What would the cost to stabilize the system compared to the trillions we are spending now? Would there be aspects where we might be better off? Is Hank Paulson even considering this as an alternative? Wasn't the big mistake Japan made that it didn't allow banks to fail and assets to clear? Didn't we say that was the one thing we were not going to do yet that's precisely what Treasury has arranged? Isn't this "tough medicine" the weak response we chastised Japan for?

Would picking up the pieces after a collapse be wiser than trying to spend a bunch of money now to prevent one? Are we preventing a Japanese crisis of our own or are we just postponing it? Instead of lambasting Paulson and Bernake how about a hearing in Congress to debate the merits of what a more hands off policy would look like.

Lots of hearing in Congress about how bad Paulson's idea is, but in fairness nobody has discussed the alternative. Didn't we attribute the Japanese solution to excessive "pride" by the Japanese in their unwillingness to admit failure? I suppose we are too advanced a society to ever succumb to pride like they did.

Or is it "Pride Always Goeth Before A Fall". Right now I don't have all the facts but in my gut it feels an awful lot like the latter to me.

Chart of the Week

Chart of the week time!

Monetary/Fiscal Strategy to Avoid a Depression

• A $400 billion plan for power transmission lines, new energy technology deployments and energy infrastructure. Most people expect some kind of stimulus of about 3% which assuming GDP is at 14.4 trillion would be about 432 billion. We need to get rid of capacity in dealerships, production and product lines. New technologies are important because if we get rid of legacy costs these industries are competitive on the global stage and can lead an export boom for the United States. This is important because it not only is stimulative but it also has implications for our current account deficit. This deficit is a critical problem and we need to fix this shortfall for the long term viability for this country.
• $250 billion in infrastructure for roads, bridges an telecommunications infrastructure.
• We need a $50 billion plan for the auto makers contingent on major restructuring and cars based on new fuel technologies. What is major restructuring? It means getting rid of employees getting paid for now work or getting retirement payments when they are able to work. We need new exporting businesses to start forming in all sorts of manufacturing businesses. Forget making chips in Taiwan, we need to be making this stuff here. When the dollar starts to fall again, our competitiveness will increase.
• That $700 billion in loans and spending, some of it over multiple years however we need it to offset the $10 trillion (and more) in assets that is disappearing elsewhere. It's a large increase in debt but its really just shifting debt from the private sector the the public one. Before all is said and done, we may need to do quite a bit more but $700 in spending is a start.
  
• For long term energy sustainability (related to current account deficit) we need to have rebates for purchases of fuel efficient cars as well as large taxes for inefficient SUVs. Isn't that interfering with the market? Sure it is but we already regulate fuel economy standards and our auto industry can't survive having standards so much lower than the rest of the world. Now that the car makers are in a jam, now is the time to fix this.
  
• We need to issue as much debt as possible right now 10-30 year debt moving duration way up. In a year, this rate of borrowing could be 8% or higher. The Treasury Secretary needs to refinance the "national mortgage" now while we can. The US treasury is basically using an option arm to finance our debt and we need to finance to a 20 year fixed pronto.
  
• The spreads going on in agency debt is silly and wastes the tax payer money. Everyone on the planet knows the US guarantees this debt just like treasuries yet we pay huge spreads which in fact makes mortgage costs higher. You might as well just turn this into treasuries because that's what they are and the cost of financing would be a lot lower. Paying huge spreads on Fannie Mae debt is silly and a waste of money when it's a nationalized entity.
• Temporary aid to states to prevent state tax increases. State budgets have gone way out of control with some growing spending 40% in just a few years but they need time to gradually bring this spending down. Over time, just like personal spending, states and localities have been over spending and consuming. This gravy train is over but we need a short term cushion to make these transition a little less painful and bloody.
• We need to revisit our regulatory policy. No question that the free markets are an ideal. However, it does not work in periods of fear and greed. In those periods a free hand needs a steadying hand. While everyone loves to make money lax underwriting in mortgages and removing leverage limits and unregulated CDO exposure caused a lot of problems. This problems were compounded by overlapping an in some cases over regulation in already existing areas of banking. These overlaps often exacerbated risk and caused behavior that made these problems far worse then if there had been no regulation at all.
• The ECB and Bank of England need to move their rates down with the Fed immediately. All countries with large cushions of cash reserves need to engage in fiscal spending to boost domestic consumption to offset lost exports. This will also help the consuming nations by creating markets for them to sell to.
  
• From the US standpoint, spending on consumption is not the answer. Any consumption going forward needs to address long term imbalances in the current account balance. Instead of consuming - we need to expand exports and our own domestic production especially in energy (traditional and alternative).
  

Fast Food Genome

Amazing stuff in rapid full genome dna sequencing in an hour in the way. This ability could allow some major progress in how we diagnose things like cancer and how we do targeted treatments specific to your particular genome. Could drastically improve survival rates for cancer and other illness. More here.

The approach, called single-molecule real-time sequencing, has the potential to decipher a person's entire genome in about 15 minutes, said Stephen Turner, founder and chief technology officer of Pacific Biosciences Inc. in Menlo Park, California. Turner helped write a description of the new technique, called SMRT, appearing online today in the journal Science.

Faster, more accurate methods of analyzing the DNA of humans and other organisms will lead to a better understanding of how normal organs and tissues develop, and how they go awry in conditions such as diabetes and Alzheimer's disease. The SMRT approach may allow scientists to speed-read the genome within five years, Turner said.

``If you can sequence a human genome for less than $1,000 in a matter of minutes, that will revolutionize health care'' said Hugh Martin, chief executive officer of Pacific Biosciences. Fast, cheap results would make it possible to look for the complex series of genetic mutations that are involved in many diseases, he said.

Obama Bonds on the Way?

So all this talk of big spending programs and bailouts has got our favorite creditors, namely Japan and China talking about the US issuing debt in Yen or Euros. First of all a couple of reactions:

• It's only fair to know that in terms of government debt to GDP Japan is at about 200%, while Germany and the US are in the 65% or so range last year. While this number is going to be going up, it's going to be a while before we touch Japan. Real business in the US also have relatively low levels of debt. Most of the big increases in debt are by US consumers and banks/non bank financial companies (that's what got us up to 350% of GDP total where 150% is a more historical level for the US) .
  
• Lots of talk about a US Government default and the cost of protecting against it skyrocketing. As long as we denominate all our debt there is almost zero chance of that happening. However, per this article if we started denominated the debt in bonds you would see our ability to create money endlessly finally constrained.
  
• The Fed is drastically expanding money supply. In a fiat money system which we have, money is really just debt. When the Fed increases the money base in a marginal reserve system it creates loans which are then deposited in exchange for some asset then deposited and loaned again. However the velocity of money has dropped dramatically and this is just not taking place.
  
• There was a projection today by FBR that the financials need another 1 to 1.5 trillion in equity (common stock) to become healthy again. No purchasing of debt--just a straight equity purchase. At this point, I'd rather see 300 billion in infrastructure such as power transmission lines and fuel efficient vehicles first. Let's get some money into the real economy right away. Something that's an investment in our future that is worth borrowing for.
  
• Every major G-7 country is going to be spending huge amounts of money to solve this problem. The US has 350% of -total- debt to gdp with government only 60% of that. If it goes to 250% total debt to GDP with all of that being government debt what are the implications? It's just shifting money from Peter to Paul and Paul has a better rate with Japan. Does it actually have an implication to our balance of payments and the credit worthiness of our currency if the aggregate number actually declines? I don't think so as long as economic activity resumes at some point.
• I've got a bit more to say on the topic but Hank Paulson is speaking at 2 and I need to finish converting the last of my dollars into Gold Krugerands in case I need to bribe some border guards. (just kidding--sorta).
• UPDATE: Interesting note. Paulson stepped out around 2 PM EST and within an hour or so the markets were down 450 points or pretty much back to levels not seen 1997. the guy is a "walking time machine".
  

My net on it is with the dollar rising daily and the Treasury issuing debt for free these days, the call for Yen Obama bonds is premature. However, as we privatize more and more of this private debt to the taxpayer the risk for this rises. It's going to be easy to see--just watch the 10 year bond and the spread between the US 10 year and the German 10 year.

Here is the piece below and the full article here:

While it remains unlikely that the US government will default on its debt, a weaker dollar would ease the burden of payment on existing debt.

In the past few months, the US dollar has strengthened against other major currencies, with the notable exception of the yen, even as the country has been at the epicenter of the deepening financial crisis. That dollar strength is not expected to last.

"There is no wonder the dollar will weaken," said Eisuke Sakakibara, Japan's former top currency official and now a professor at Waseda University. "The dollar now looks strong for a technical reason. The money the US financial firms had invested in the world is being repatriated into the homeland, causing dollar-buying. But once this conversion into the dollars is done, the currency will head south," Sakakibara said at a forum in Tokyo on Sunday.

Faced with the unprecedented growth of the US budget deficit and the prospect of an increasingly weaker dollar compared with the yen reducing the value of Treasury debt held by Japan, economists in Tokyo are calling for the administration of president-elect Barack Obama to issue US Treasuries denominated in yen and other currencies. The issuance of foreign currency-denominated US Treasures would reduce the perceived risk of holding the debt.

The idea of issuing foreign currency-denominated US Treasures is not new. The Jimmy Carter administration, buffeted by the two oil crises of the 1970s, sold "Carter bonds", denominated in German marks and Swiss francs, in 1978 to attract foreign investors into Treasuries.

"The US will be forced to issue foreign currency-denominated US Treasures in its hour of need," said Mizuno. "The US cannot finance its deficit by itself. The US financial system cannot survive without foreign investors. We will see 'Obama Bonds' in the future."

With the US owing increasing amounts to foreign nations, the confidence in US Treasuries continues to be shaken, said Masaaki Kanno, chief economist at JPMorgan Securities Japan Co in Tokyo, said. "This will push up long-term yields, and the dollar will be sold," said Kanno, speaking at the forum in Tokyo on Sunday.

"Financial Markets Have Turned the Corner" Hank Paulson

As we noted in the blog yesterday Hank Paulson pronounced that the U.S. financial system had "turned the corner" as he announced he would not be pulling down the Tarp or going to Congress for any new infrastructure stimulus. Well, today the credit markets turned the corner and it was Hank in "supersized" hummer burning the fuel formerly known as American wealth at 8 miles to the gallon. It remains to be seen if it was a hit and run or not.

If he fits to pattern of being responsive rather than preemptive I'd bet he pulls down the 2nd tranche some time this week but it will be too late to be effective as it could have been. The key here is to actually move ahead of it. Pull the money down and deploy it before it's needed. Hit the market with a lot more than it expects--it's expensive but it's the only way to solve the problem and it's a lot less expensive than the current strategy. Equity markets can be mispriced for long 2-3 periods but credit markets don't lie--problems there translate into reality pretty quickly.

Until the credit markets come back it isn't wise to tread back into risk based assets. See Bloomberg commentary on credit markets below:

Credit markets from commercial mortgages to junk bonds fell to record lows as concerns grew that the slowing economy would overwhelm government efforts to stem the worst financial crisis since the Great Depression.

The average yield on high-yield, high-risk debt rose beyond 20 percent for the first time in two decades. Top-rated securities backed by subprime and commercial mortgages fell and loan prices declined as U.S. automakers lobbied Congress for government aid to stave off bankruptcy.

Yields rose relative to benchmark rates after economic data showed the recession is deepening and the heads of the largest U.S. carmakers warned they may fail without government funds. Treasury Secretary Henry Paulson said he probably won't spend the second half of a $700 billion rescue package on troubled assets, sparking concern that prices may decline even further.

``Everything is under a tremendous amount of pressure,'' said Jamie Jackson, who oversees government and agency debt trading at Minneapolis-based RiverSource Investments, which manages $90 billion.

Prices of leveraged loans and high-yield bonds fell as General Motors Corp., Ford Motor Co. and Chrysler LLC renewed pleas today for government aid to prevent their failure in what GM Chief Executive Officer Rick Wagoner said would be a ``catastrophic collapse'' for the economy.

The price of the Markit LCDX index linked to U.S. leveraged loans, which falls as sentiment worsens, dropped 2 1/2 percentage points to a mid-price of 79.75 percent of face value, after earlier falling to a record low of 79.5, according to Goldman Sachs Group Inc.

Economic Effects

``It's not just the Big Three,'' said Randy Schwimmer, managing director and head of capital markets for New York-based Churchill Financial Group LLC, referring to GM, Ford and Chrysler. ``The impact it would have on suppliers, manufacturers and the potential rise in unemployment is adding to the negative tone.''

The average yield on high-yield, high-risk debt rose to 20.14 percent yesterday, from 19.74 percent on Nov. 17, the previous record, according to Merrill Lynch & Co.'s U.S. High Yield Master II index. The level rose today to 20.73 percent, the highest since Merrill began collecting overall yield data in January 1986.

``Prices are in a virtual freefall,'' said Martin Fridson, chief executive officer of money management firm Fridson Investment Advisors in New York.

Depression-Level Defaults?

``Either the market is right and expecting a default rate considerably higher than it was in the Great Depression, or we have such profound dislocations and selling pressures going on that it really is creating extraordinary fundamental value.''

Commercial-mortgage securities are also plunging following reports yesterday that two borrowers with $334 million of loans bundled into bonds were about to default.

The cost of credit-default swaps on AAA rated bonds rose 161.8 basis points to 714 basis points based on the latest Markit CMBX index contracts, according to administrator Markit Group Ltd.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.

Yields on the safest types of AAA rated commercial-mortgage bonds rose 77 basis points to a record 1,195 basis points more than benchmark swap rates, after jumping a record 264 basis points yesterday, according to Bank of America data. A basis point is 0.01 percentage point.

More here.

Mark Cuban / SEC Email Exchange

Without commenting on whether Mark Cuban is guilty I will say he gave a fantastic speech a few years ago at the Austin Entrepreneur of the Year Awards. Just an amazing, high energy guy with great vision and obviously good timing (maybe too good in some cases I dunno).

However, the exchange with some SEC staff which may or may not be related to the investigation (according to the SEC unrelated) is pretty shocking. Abuse of power is one of the worst sins, and this kind of exchange was pretty disgusting. Amazing stuff. Some excerpts below on emails from Norris to Mark Cuban:

Norris on Cuban’s alleged slander of President Bush:

“Tell me why you want to inspire hat[r]ed of President Bush?”

***
“Trying to present yourself as ‘agnostic’ when it comes to this trash doesn’t absolve you from blame. You are promoting a point of view that is radical and irresponsible. Because of you, and others like you, refuse to be discriminating, people who hate this country and hate this President have the opportunity to disseminate the worst kinds of lies.”

On comparing Cuban to others:

Your actions place you in a category of people such as Sean Penn, Michael Moore and Jane Fonda.

***

What you are promoting, and likely profiting from, is akin to someone during WW II disseminating through mass communication a story that Franklin Roosevelt arranged Pearl Harbor and secretly funded Hitler’s invasion of France.

***

When this dialogue is over, you will fade into the background and become just another one of the many people who harm our nation through greed or hatred or apathy or, simply, lack of judgment.

On his disappearing love for the Dallas Mavericks:

“Yesterday, I hoped the Mavericks would win the NBA Championship. Today, I won’t be following the team, but I will be hoping they exit in the first round.” [Norris got his wish.]

***

Next time one of them asks me “Daddy, do we like the Mavericks?”, I will say: “No, honey, we don’t. We hate the Mavericks because the man who owns the team helps very bad people who hate America and hate President Bush. We love the Lakers.”

On SEC Chairman Christopher Cox:

I assume Mr. Cox would view your involvement with “Loose Change” much as I do.

***

I’m sure [Cox] is a Laker fan.

On teaching his own children:

Now, you will have to excuse me. I need to tell the children why we won’t be turning on the Mavericks games anymore….

***

…[Y]ou will be an object lesson. I will direct the attention of my children and say: “That’s Mark Cuban. He owns the Mavericks. I don’t respect him because he helps people who hurt our country and hate President Bush….I don’t think Mark Cuban is an evil man. He just doesn’t care enough about truth to do what is right.”

On Religion:

Someone once told me that I should not criticize people on the left side of the political spectrum because “Jesus was a lefty.” My response was that Jesus . . . valued truth and that is what distinguishes him from the left in America today. Moreover, Jesus is God; people on the left only think they are.

On Cuban’s temper:

I don’t want to “piss you off” any more, because that will only entrench you further in your defense of what I think is a socially irresponsible decision. The danger is elevated with you because you’re a hothead–but that’s part of your charm.

On being busy at the SEC:
I would love to continue this communication. Unfortunately, I have a responsibility to protect investors from fraud and I need to turn to that obligation.

Good Auto Piece by Mitt Romney in NY Times

Good piece by Mitt Romney---the best part is the first paragraph. I wish he had gone into more detail on specific recommendations (I guess it's tricky) but it's still something I agree with:

IF General Motors, Ford and Chrysler get the bailout that their chief executives asked for yesterday, you can kiss the American automotive industry goodbye. It won’t go overnight, but its demise will be virtually guaranteed.

Without that bailout, Detroit will need to drastically restructure itself. With it, the automakers will stay the course — the suicidal course of declining market shares, insurmountable labor and retiree burdens, technology atrophy, product inferiority and never-ending job losses. Detroit needs a turnaround, not a check.

More here.

Al Qaeda Talking Smack

Wow. You want the US to start to disengage in Pakistan and Afghanistan so you call the new President a house negro? Obama campaigned on making the campaign here a focus of his Presidency, I hope we find this dumb ass in particular. Pakistan and Afghanistan are starting to work together, and if we downscale out of Iraq we'll have the resources to do what is needed in this region of the world. I'd love to see something effective being done here:

n a message purportedly from Ayman al-Zawahiri, the al-Qaeda deputy called Mr Obama a "house slave" - a demeaning term implying he served white people.

Mr Obama's plan to bolster the US military presence in Afghanistan would fail, Zawahiri said.

And his election did not mean that US policy towards the Muslim world had changed, he added.

The audio message, which ran with photographic stills and some video footage, appeared on militant websites.

Zawahiri, an Egyptian by birth, is often referred to as Osama Bin Laden's right-hand man and the chief ideologue of al-Qaeda.

'Same as always'

In the 11-minute message he warned Mr Obama of failure if he followed Bush administration policies in the Middle East and Afghanistan.

His poll win did not mean that America should be perceived differently, he said.

"America has put on a new face, but its heart full of hate, mind drowning in greed, and spirit which spreads evil, murder, repression and despotism continue to be the same as always," he said.

The US was the same as ever, he said, so "we must continue to harm it in order for it to come to its senses".

Zawahiri also criticised Mr Obama - whose father is Muslim - for abandoning his Islamic roots.

"You were born to a Muslim father, but you chose to stand with the enemies of Muslims," he said.

Mr Obama was not an "honourable black American" like Malcolm X, he said, but an "abeed al-beit" - a word that translates as house slave but was rendered "house negro" in the message's English subtitles.

The audio was accompanied by footage of a speech by Malcolm X in which he distinguished between "field negroes" who hated their white masters and "house negroes" who, he said, were loyal to them.

On Sunday, in his first television interview since his 4 November election win, Mr Obama reiterated his commitment to shift more US troops to war-torn Afghanistan.

Stamping out al-Qaeda "once and for all" was a top priority, he said, and capturing or killing Osama Bin Laden was "critical" to US security

Morning Musings

Just a few quick thoughts this AM:

• The world continues to be round (or pointed or something). Recent books announcing the world is flat look less and less relevant by the day. Not only is the US still able to borrow at ridiculously low rates, others in the emerging markets continue to risk default. The dollar continues in an uptrend although it is down today. The dollar is still king. If we didn't have a flight to quality I think it would be substantially lower due to a ridiculous and absurd trade deficit.
  
• The CPI numbers out this morning were pretty ugly. The 1% drop was the largest drop in history but Trichet (ECB) is still worried about inflation. Because of some contract expiration Friday AM would be a great time to do a big rate cut. From a market intervention standpoint that's when you get the biggest bang for your buck.
  
• I am surprised oil is still this high--it's having trouble getting down below 50.
  
• Waiting until February/March for some big fiscal packages is a huge economic mistake. From a macro standpoint the delay causes all sorts of unintended consequences and in many ways pushes the economic crisis out. You need a package this week that's of sufficient size that it leaves reasonable doubt that there may not need to be one with the new administration. I'd lay odds we are not going to get that. That leaves actions by the Fed and others as the only real backstop and the Fed is out of bullets.
  
• The GOP is kidding itself if it thinks there is not going to be some kind of auto bailout. One or more will be running out of cash any month now and the economy is so unusually bad it can't be allowed to fail. I wish I had a way to short Cerberus. By the way, it's unlikely we will ever get the money back unless it's done in conjunction with a pre packaged bankruptcy.
  
• Lots of rumors on a big Russian devaluation and 20% of the world's currency reserves being drained trying to defend the ruble. Medvedev is coming out with a big softening in tone towards the United States. A combination of oil dropping and Bush leaving office is changing the political calculus there. Plus they might need a loan again at this rate.
• Although there is almost no evidence to support this--I would not be surprised to see a surprise rate cut from the ECB perhaps in unison with other central banks. Again, Friday morning would be a good time.
  
• Deflation is much more formidable enemy then inflation and it needs to be fought even harder. People are gonna think of the inflationary days of yesteryear and see them as the good old days.
• Housing starts were abysmally low this AM. They are finally starting to come down. What I don't get is why these guys were building houses a year ago. Only recently are these guys slowing production of new houses and cutting capacity. Too bad they didn't do this last January and a lot of price depreciation might have been avoided. Better late than never.
  

Auto Testimony Today

A couple more reactions on the auto bailout and the testimony by the big 3 today:

• In contrast to the TARP hearings, I have been impressed with the line of questioning by the Senators except for maybe Dodd. Maybe it's because I am not as close to the auto industry and know a bit less about what's going on but some of these questions seemed tough, logical, and at least somewhat well thought out. So with that qualifier, I thought these guys did a great job.
• The cash burn rates in the last quarter and even in the last year were staggering. I think it's a safe assumption that one or more of these companies is going to run out of cash well before the inauguration. I don't have a belief that you are going to see a rebound until at least Q3 in terms of auto sales activity. At there present burn rates they roughly had a few months before I am sure they will burn through some covenents and the debt will get called. If Cerberus has not written this to a negative number because of liability issues, let alone zero I think that's agressive. Given how bad those cash burn numbers are, I'd be surprised if something isn't done in some form even though supposedly there are not enough votes.
  
• The Senators made the point how after the Clinton administration, the auto makers abandoned fuel economy standards and started cranking out SUVs with much lower fuel economy standards than their competitors and fought Congress tooth and nail to do so.
• Cerberus made the "generous" offer that it would forfeit any gains from the bailout to its shares. That one gave me a chuckle...you've got to be kidding me. If these guys don't take a major loss on that deal I am gonna be an upset little camper. If I were valuing it as a private equity deal I'd put it somewhere south of zero given the labor liability issues.
  
• The testimony illustrated that the foreign car companies are over 7 years ahead of US car companies in terms of fuel technology. I wish we would could look on this as an opportunity to consolidate this industry into a technology leader. There is no reason we couldn't create an industry powerhouse here if we got rid of legacy issues and deployed new technologies.
  
• Please please no tax rebates for people buying cars and homes. We don't want to encourage consumption at this point...we need to start living within our means.
  
• Nardelli at Chrysler seems like he's done a bit more on cost cutting. It's probably reasonable to assume he misses Home Depot at this point. That said its interesting that it just hasn't been enough. No matter what he did at Home Depot, my view of the guy he's a fairly tough customer. I know an execution oriented manager when I see one but he looks relatively beaten here. There is probably something interesting to be learned from him coming from a totally different industry and the roadblocks he ran into. I'd grab the guy in a private room and find out how to really reform this.
  
• The UAW also testified and these guys are desperately trying to get this money. They see a bankruptcy coming and realize they will lose quite a few golden gooses.
• I was least impressed with Wagoner from GM. It's the company that's probably got the most bloat and this guy had steadfastly refused to consider resigning. I remember when one car company came to Columbia shipped in a car to have it assembled inside the business school and nobody even showed for the presentation. The vibe this guy gave off is just one of the reasons why.
• There was an insightful discussion of "natural run rate" in terms of the # of autos consumed in the United States without the fake credit bubble. Is it 14, 11, or something even lower?
  
• Paul Morrisey from UMD should have talked more. I loved what he said and wish we saw more of it. He pretty much pointed out that given the natural rate is much lower than what it is now.
• Menendez--this Democrat was fantastic.
  
• The key question for me is what's the delta between the negotiated Union concessions vs what would happen in a prepackaged bankruptcy with a Federal bankruptcy. Would the delta be large enough to warrant the risk? What about the dealer costs (too many dealers for the amount of cars sold)? Are the labor restrictions and buyouts so large at this point? My gut would be a prepackaged bankruptcy with a Federal backstop as the only real way to get rid of the legacy costs but hopefully someone will do the math there.

Market Musings for Today

• In the Great Depression, the stock market began the crash in October of 1929, and it bottomed in April of 1932. The government has a more flexible monetary policy and social transfer payments that should minimize the risk of something that protracted, deep and long. We are technically in about month 13 by my count.
  
• That said, the attitude by Pauslon to hold off on calling down the 2nd tranche of the Tarp is foolish. This guy absolutely refuses to stay ahead of the curve. It's really easy to 2nd guess from the side lines but reactionary policy has not been working well, maybe try something new Hank? Waiting until you need it, almost guarantees the money will arrive too late and be wasted when it finally is deployed. Additionally, I know a lot of money managers that want to wait to see how/where it's deployed before they deploy their own capital. They know it's coming--better for them to wait until January or February then play it there. This means they essentially wait in cash which delays any kind of restoration of proper functioning in the debt markets. Something political is going on here and I think it has to do with the new terms any new deployment require.
  
• There is very little virtue to not staying ahead of a very steep curve like this. Psychology is the most important thing here and confidence needs to be restored with an abundance of stimulus. Paulson sitting on his ass for 3 months is going to make this recession far more protracted and the amount the US spent is far less than what others in Europe have spent as a % of GDP. The more we spend earlier, the less we spend later. One argument for waiting is it preserves a little bit of dry powder but that presumes we are not going to be drawing down a whole lot more cash anyway which I think is a false one. Additionally, it gives time for monetary stimulus to work. Frankly, it makes more sense to hit this from every end possible to make it as shallow and short as possible.
  
• The Auto bailout. It's going to happen in some form. Refusing to take part now means it goes to the next Congress. The only thing I like about it is the Democrats are going to be much harder on the Auto makers then the GOP will be. Primarily this is because the Democrats are more worried about the environment than that saving what is now a much smaller part of the labor force. One of those ironic twits since the Auto unions support the Democrats, not the GOP. Sometimes people don't realize the winds have changed until its too late.
  
• Yahoo. I think this finally opens the door for a Microsoft acquisition. At this point, the barbarians might have the gate opened from the inside. The price is gonna be 15-17 which is a far cry from $31. If Yahoo ends up trying to sell itself in pieces (other than some of its foreign subs) I think that's going to be a disaster. Search is the whole caboodle here other then Asian subs and the rest is kinda uninteresting.
  

Nice New App From Google

Via Ihacker below:

The search-by-voice iPhone app we heard about on Friday may not have shown up as planned, but it is now available from the iTunes App Store. The iTunes page itself doesn't show the app as updated, but download and sync it anyway, and you'll notice a shiny new Google Mobile on your iPhone complete with voice-recognition. I've just started playing with it, but my initial one-word review: Amazing!

This application lets you hold your Iphone to your ear and ask any question. i.e. Where is the closest gas station or what is a Y chromosome? Hotness.

Mortgage Bailout On the Way

Lots of economists most people are viewed as conservative are coming out with some aggressive plans to bailout people that are under water. It's a distasteful topic to anyone who refrained from buying real estate in the last 5 years based on a view it was over valued and is now being asked to pay increased taxes to finance those who did. Here is a proposal by Marty Feldstein in a WSJ piece here:

The key to preventing further defaults and foreclosures among current negative-equity homeowners is to shift those mortgages into loans with full recourse, allowing the creditor to take other property or a fraction of wages. But the offer of a low-interest-rate loan is not enough to induce a homeowner with substantial negative equity to forego the opportunity to default and escape the existing debt. Substituting a full-recourse loan requires the inducement of a substantial write-down in the outstanding loan balance. Creditors have an incentive to accept some write-down in exchange for the much greater security of a full-recourse loan. The government can bridge the gap between the maximum write-down that the creditor would accept and the minimum write-down that the homeowner requires to give up his current right to walk away from his debt.

Here is an example of how that might work. Consider a homeowner with a $240,000 mortgage and a home that is worth only $200,000. The $40,000 gap between the mortgage and the appraised value could be divided with the government taking one-third, the creditor taking two-thirds, and the homeowner agreeing that the remaining $200,000 loan would have full recourse. The creditor would give up about $27,000 of potentially uncollectible debt but would avoid the extra loss of value that comes with selling a foreclosed property, and would achieve a much more secure loan. The homeowner would get to keep his house and would eliminate all of the excess debt.

With 12 million negative-equity homes and an average negative equity gap of $40,000, the total cost to the taxpayers of taking one-third of the losses would be no more than $156 billion. Alternative proposals to help negative-equity homeowners do not convert their mortgage debt to full-recourse loans and would not succeed in stopping the downward spiral of house prices.

A few reactions to Marty's piece and the problem in general:

• There is going to be some kind of bailout bill by Q1 of next year. If you have folks like Feldestein proposing hand outs this aggressive, it's a pretty good signal we are headed for the mother of all housing bailouts once the new Congress is in session.
  
• Marty points out how US mortgage loans are non recourse to income and assets which is a unique feature of our markets (we've talked about this before and compared it to the Danish model). A lot of people want bankruptcy judges to be able to alter mortgage loans in personal bankruptcy. In my view non recourse goes hand in hand with exemption from adjustment by bankruptcy judges. In an ideal world I'd like to see both types of loans exist. I don't think there is any harm in what Feldstein proposes in terms of making home loans recourse but I don't think its going to make that much of a benefit either. If people can pay their mortgage and stay in their home, they are going to be inclined to wait it out and hope for appreciation down the line. I think he fundamentally misreads the psychology here. If people have some kind of interest only balloon mortgage with impossible math, making the loan recourse isn't going to make a difference anyway and they are probably already searching for their next home.
  
• Government intervention to try and stabilize housing prices is like catching a falling knife and a waste of taxpayer money. Housing prices are too high, they need to come down. In real estate markets when prices have been cut, people start to buy again. I think prices have another 25% in some of the more inflated California markets.
• Don't shoot me but the best way to get rid of excess housing supply is to halt this clamp down on immigration. Migrants workers are a big part of production in agriculture and other industries and each family is one less home on the market. Losing 800,000 immigrant workers to a clamp down has a big impact, it also is a part of the reason food prices in the US went up so much in the last year. Immigration, as long as the new immigrants learn English, is a vital part of our nation's strength.
  
• Free credit drove up prices, any no matter how good your judgement was --you probably overpaid if you bought a house in the last 5 years in markets like California and Florida. In that sense, everyone was a victim. The only ones who are not victims are those who put 0% down and flipped or are now negotiating big principal reductions on homes that were well beyond there means. That's going to leave a legacy for a while in mortgage policy and regulation and it should.
  
• If we are going to do some kind of bailout I liked a version more along the lines of what Barney Frank proposed which has home owners give up a % of future home appreciation in exchange for loan modification. This can be accomplished another way with ideas for a "Balloon Payment" that represents the principal reduction which would be applied in the future. These plans can be structured to stretch out mortgage terms, and reduce payments but adjust the appreciation so that when it does return the home owners give something up. I think that's a little more palatable to those who exercised a bit more restraint in their real estate purchases. People who benefit from these programs have to at least appear to be paying some kind of cost. Higher taxes for health care is one thing, but so you can bailout those who spent beyond their means on homes and lots of crap goods from China? Not thanks.
• As I type this, Barney Frank is crucifying Hank Paulson for not using the Tarp to stop foreclosures. Uh, Hank you might want to bring up the fact that you nationalized Fannie and Freddie and the government now owns the majority of mortgages. That's a lot more than the TARP could ever do and adds 2-3 trillion of debt to the US balance sheet.
  

Auto Maker Tango in Congress this Week

Above is the latest and greatest propaganda from the US auto makers. Hey if you guys are doing so well, how come only the US Auto makers need help? Oh and a lot of those retirees are not even 55 yet? Why do they get to keep their pensions when millions of Americans have lost their jobs and pensions and are actually willing to work? Why should those Americans bail them out?

A couple things are sort of interesting about the turn of events in the Auto industry. First of all, I find myself find that I agree with Nancy Pelosi and her arguments that the industry should be forced to restructure to receive bailout money. The argument by Bush is to just release money out of the earlier loans but eliminate the fuel economy requirements associated with the loans.

Are we back to that again? Every time fuel prices go down are we just going to bail these guys out so they can make more high margin SUVs. This argument by some that it's market interference to ask the makers to reform ignore the fact that it's already a heavy regulated industry. The lobbying in Congress for lax fuel economy standards that were well below the rest of the world have left our auto industry vulnerable. Congressmen out of Michigan have been fighting fuel economy standards that are often substantially lower those in Japan and Europe putting us at a competitive disadvantage and making fuel shocks much harder on our economy.

The second interesting element is the blackmail that's occurring with the unions and management saying no reform is needed and if they don't get money they will go bankrupt. Obviously even a casual study of the industry makes that argument unflattering to your intelligence. But the interesting part is it pits Obama and Pelosi vs the unions which contributed quite a bit to the campaign. However Pelosi and Obama are singing the same toon that big reforms will be required. They are 100% correct and need the cooperation of the GOP to get something done before January.

For the GOP they have to wonder if getting something now with a compromise is better than waiting until January where they will have very limited ability to stop anything.

Fuel economy isn't just an economic security issue, it's a national security issue, and this is an opportunity to bring needed reform to this industry which in the long run will be good for the auto makers, good for the unions and good for the country.

Full piece in Bloomberg here:

U.S. automobile manufacturers need to reorganize to ensure their viability, House Speaker Nancy Pelosi said, as the head of the United Auto Workers called for government aid before President-elect Barack Obama takes office.

The Democrats plan for help ``will provide immediate, targeted assistance to allow the carmakers, together with affected unions, time to develop a plan to assure the long-term viability of the industry,'' Pelosi said.

Under legislation being drafted by Democrats, automakers would receive $25 billion in loans out of a $700 billion financial-rescue package approved earlier this year. President George W. Bush's administration opposes using the plan's funds for carmakers and Republican legislators have voiced opposition.

A GM collapse alone would cost the government as much as $200 billion for costs associated with unemployment insurance and other programs after millions of auto-related job losses, according to a forecast from IHS Global Insight Inc. in Lexington, Massachusetts.

A survey by Peter D. Hart Research Associates that was commissioned by GM found 55 percent of Americans support government loans for the auto industry. Thirty percent of those surveyed on Nov. 11 and 12 opposed loans. The poll of 804 adults had a margin of error of 3.5 percentage points.

Interesting Middle East Setup

This has the potential to be a bit of a game changer in the middle east. Essentially Obama is rumored to be backing the Saudi peace plan which Olmert has recently moved towards along with a few other Israeli leaders. Essentially, this plan would theoretically bring peace with Syria as well as normalized relations which the Gulf States and Saudi Arabia.

The real question for Israel is if they were to go along with this--would it truly bring peace with the main extremist groups such as Hamas, Hezbollah and Iran. If Israel, Syria and the Arab world made peace would this not make it difficult to Iran to carry on with aggressive acts towards Israel? I would think given the ramifications in terms of isolation, lack of investment and integration with the world economy the costs would be a bit too high.

The intriguing thing could be a new vision of the middle east with a democratic government in Iraq, combined with some scaling down of open hostilities between Hamas, Hezbollah and Israel. Concerns about Iran's nuclear program would not be so dire an we might see this region start to grow with the huge cash reserves accumulated by the gulf states. This combined with an Obama Presidencies efforts to combat religious extremism which I believe he will be able to do effectively make me a bit more optimistic.

On the purely selfish side, peace in the middle east would allow me to satisfy some long standing desires to check out the archeological sites in some of the most interesting parts of the world. Syria, Iraq and Iran are all historical goldmines with some of the oldest cultures in written history. It would also take off a huge amount of geopolitical risk.

I have quite a few skeptical freinds who don't believe peace is possible on both sides but I think if Israel got guarantees that 1) Hostilies from Hamas and Hezbollah would stop, normalized relations with Saudi Arabia, UAE, all the Gulf States, and the rest of the Arab world 2) Veto on right of return 3) Jerusalem as city shared by all the world's relegions with capitals for both Israel and Palestine 4) Return to 1967 borders with land for land swaps in areas where that's currently impractical.

Full article via the Times:

Obama intends to throw his support behind a 2002 Saudi peace initiative endorsed by the Arab League and backed by Tzipi Livni, the Israeli foreign minister and leader of the ruling Kadima party.

The proposal gives Israel an effective veto on the return of Arab refugees expelled in 1948 while requiring it to restore the Golan Heights to Syria and allow the Palestinians to establish a state capital in east Jerusalem.

On a visit to the Middle East last July, the president-elect said privately it would be “crazy” for Israel to refuse a deal that could “give them peace with the Muslim world”, according to a senior Obama adviser.

The Arab peace plan received a boost last week when President Shimon Peres, a Nobel peace laureate and leading Israeli dove, commended the initiative at a Saudi-sponsored United Nations conference in New York.

Peres was loudly applauded for telling King Abdullah of Saudi Arabia, who was behind the original initiative: “I wish that your voice will become the prevailing voice of the whole region, of all people.”

A bipartisan group of senior foreign policy advisers urged Obama to give the Arab plan top priority immediately after his election victory. They included Lee Hamilton, the former co-chairman of the Iraq Study Group, and Zbigniew Brzezinski, a Democrat former national security adviser. Brzezinski will give an address tomorrow at Chatham House, the international relations think tank, in London.

Brent Scowcroft, a Republican former national security adviser, joined in the appeal. He said last week that the Middle East was the most troublesome area in the world and that an early start to the Palestinian peace process was “a way to psychologically change the mood of the region”.

Advisers believe the diplomatic climate favours a deal as Arab League countries are under pressure from radical Islamic movements and a potentially nuclear Iran. Polls show that Palestinians and Israelis are in a mood to compromise.

The advisers have told Obama he should lose no time in pursuing the policy in the first six to 12 months in office while he enjoys maximum goodwill.

Political Tactics

The smart move for the GOP now is to spend cash now to revive the economy ASAP by compromising with the Democrats to get a bipartisan approach to the economy. Specifically:

1) They should draw down the second tranche of the TARP with provisions for exits
2) Get an auto bailout done but requiring reforms, elimination of equity, reduction of pensions (everyone else in the country has hits to their pensions), and new labor contract reforms.
3) An economic stimulus program that extends unemployment benefits, food stamps and infrastructure in energy (power lines especially to allow for transmission of solar, wind, nuclear to end user demand).

In the end we have seen about $10 -$15 trillion of debt that I don't understand in our economy. A portion of that has to be written off and a portion needs to be replaced. Whether we like it or not--this is going to cost trillions to fix...

If the GOP insists on being obstructionist rather than compromising, when the new Congress comes in January their solutions are going to be a lore more polarizing. Do the right thing for the country and get something done.

Piece here via Yahoo news:

President-elect Barack Obama said the U.S. government will do ``whatever it takes'' to revive the economy, and that means ``we shouldn't worry about the deficit next year or even the year after.''

In the short term, ``the most important thing is that we avoid a deepening recession,'' Obama said in an interview broadcast last evening on CBS News's ``60 Minutes.''

Obama, who yesterday resigned his Illinois Senate seat, effective today, said the government needs to provide assistance to the automobile industry. Such aid -- in the form of a ``bridge loan,'' he suggested -- must be provided on condition that management, labor, suppliers and lenders come up with a plan to make the industry ``sustainable,'' he said.

``For the auto industry to completely collapse would be a disaster in this kind of environment -- not just for individual families but the repercussions across the economy would be dire,'' Obama said. If that were to happen now, he said, ``you could see the spigot completely shut off so that it would not potentially permit GM to get back on its feet.''

A Flock of Canaries

Lots of "the world is ending" we need to change slides from VC firms these days. I don't buy into theories that the problem is about particular VC strategies or modus operendi although firms often operate very differently. I boil it down to--too much capital chasing too few quality deals. I don't think it's a lot of this personalized advice or anecdotes about particular firms being over rated or funding their "buddies" too much.

The credit bubble inflated a lot of markets, the venture market was anything but an exception. By 2005 I was pretty surprised to see so many firms still alive and kicking--mostly because LPs still had large allocations available to alternative assets and the work is so fun that nobody wants to leave.

This is the 2nd crisis to hit the industry in 10 years this crisis should have a more pronounced effect given the lack of new commitments to alternative asset classes by institutions.

TheFunded - Canarie

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The View Ahead

• I had a positive comment on Paulson today in terms of adjusting the TARP plan but I have one big negative one. He sent some pretty big signals that he was in wait and see mode. ---You mean as opposed to when you have been proactive Mr. Paulson? His ability to inspire confidence is about the same as his boss. Today he made it pretty clear that he wanted to "let the markets work" instead of trying to get ahead of the curve. He is purely a reactionary guy and is always playing defense it seems. I would kill to have Jamie Dimon or someone like that in there.
  
• My best guess is there is about $10 trillion in debt running around that seem to be a phantom of the credit bubble. Essentially what seems to be happening worldwide is debt is moving from private hands to public hands. While this is a horrible problem, it is somewhat mitigated by the fact that this is happening worldwide. So while the American develeraging process is taking place, huge debt ramp ups in Europe, Russia, and Asia based on real estate, consumer debt and so forth are still going on at the same tine. So while government debt levels will go up here quite a bit, they will be going up everywhere.
  
• A lot of people right now are trying to find the natural bottom in equities so they can buy the bottom but this economic environment is so poor that strategy is unlikely to work well. Perhaps it's 800 which has been my guess for a long time ( altho things have been so bad I'm thinking 700 might be a better number) on the S&P or it may be some other number. However, remember the sequence when this started. First the credit markets froze (in August or before of 2007) then all the debt traders were wondering for about 3 months why the equity market had not crashed as well. In fact, the equity markets went from August to a very substantial rally in October to a new high.
  
• What are the implications of that? Does it not stands to reason then that the credit markets are going to need to recover first. This means lending needs to resume, commercial paper needs to start moving again and people need to be able to buy cars, homes etc at a new "natural rate". The natural rate is some new equilibrium that is unencumbered by historically high leverage ratios.
  
• Assuming the Fed keeps the money supply growing, and there are large fiscal infrastructure programs my "guess" on timing of an economic stabilization would be mid 2009. That would imply an equity recovery some time in Q1 of 2009. But you don't even need to time it -- just watch the debt markets. Don't bother with risk based assets until then. Logically they shouldn't come back until that occurs.
• On the plus side, we are likely to see some big government interventions in terms of more from Asia, more from the US Congress and Europe. No current excuse for the ECB and BOE to have their rates so high in a deflationary environment which has been ongoing for a long time now.
• The leading candidate for Sec of State is Bill Richardson. I really don't want Richardson to get State--that guy is sans spine.

Paulson Bait and Switch?

Paulson is out today announcing that the Treasury bailout will not be used to buy bad debt and create a market as originally planned and pitched to Congress and people are very upset. Lots of indignant folks about "bait and switch" and other issues with his performance and securing the bailout.

The fact is the plan to buy debt was a bad idea because 1) it's an inefficient use of capital and did nothing to restore capital to the banks 2) It was too small to induce any liquidity. Pretty much the case outline in this post here with an excerpt below:

Advocates claim it would create a market where currently there is none but I think the number at 700 billion is too small to do that.

Albert Einstein once said "Things should be as simple as possible, but no simpler". 700 billion is too small to create a market, but it's not too small to put equity into the banks to recapitalize them. Eventually the stakes can be sold off and in fact we could put a 10 year deadline for privatizing the stake to allay conservative fears of government control of our banking system.

I really don't like Paulsons plan and I don't think he has got a wise approach to this but I also know there are people a lot smarter than me working on this and here is hoping I am incorrect and this plan will work wonderfully. It feels a lot to me as though the GOP didn't want to have government ownership of banks during a transition period so the tried and true method of private equity issuance to solve the problem has not been used.

Better to use equity to wipe these guys out, put cash into the balance sheet, close the bad banks quickly, roll them into stronger institutions and where necessary put preferred equity into those that can't be solved any other way.

Basically the plan that he has implemented is far better than what he originally proposed which would have failed. I for one am glad he changed it and would rather see him alter and adapt his plan rather than execute on a plan that would have done nothing to solve the problem.

So while I've been critical of Paulson, I think he deserves credit here. Looking back with 20/20 hindsight my biggest issue has been some of the panic he induced in the markets to get the bill through Congress. Perhaps he couldn't get the bill done without screaming fire in the croweded theater but the economic damage that was created because of that call essentially froze economic activity and as of yet, it has not come back.

Here is a link to the WSJ piece on the current brouhaha.

P.S. It looks like we are going to need another $750 billion to $1 trillion in equity along witha $300 billion fiscal stimulus bill that will probaly be followed by another $150 billion. Essentially, we are replacing all the bad private debt with public debt.

Putin Devalues Ruble

We've talked about the impact of declining commodities on Russia and the problems there are becoming severe. This is a pretty excellent case that large reserves do not immunize a currency from speculative attacks. In Russia's case, people are imputing that large significant deficits will begin with oil at its current price or potentially even falling further. Cash is exiting the currency as Russians and foreigners alike put their money in western (mostly US) banks. Their stock markets are routinely closed and capital flight is accelerating.

Putin wants respect for his country and is threatening to use the military to get it, but the country needs to start producing goods and services and that means a big change in it's domestic investment policy. Full article here and excerpt below:

The cost of protecting against a default by Russia soared after the central bank increased the ruble's trading band and lifted its benchmark interest rate to stem record capital outflows.

Credit-default swaps on Russian government bonds jumped to 7.87 percent of the amount insured from 6.14 percent yesterday, according to CMA Datavision prices. The yield on its 30-year dollar bonds increased to 10.77 percent from 9.1 percent, according to Bloomberg prices.

The central bank's widening of its ruble target against a basket of dollars and euros by 1 percent yesterday ``achieved nothing'' and cost almost $7 billion of the nation's foreign- currency reserves, according to analysts at Renaissance Capital. Russia joins Hungary, Iceland and Pakistan among a handful of central banks raising interest rates to stem currency losses, as the rest of the world cuts the benchmarks to spur lending.

``The current pressures have largely been provoked by the central bank itself, whose recent clumsy steps in the currency market triggered a new speculative attack on the ruble,'' analysts led by Alexei Moisseev at Renaissance in Moscow said in a report today.

Russia has drained more than 20 percent of its currency reserves, the world's third largest, to stem a 15 percent slide in the ruble against the dollar since the start of August as investors withdrew about $147 billion, according to BNP Paribas SA data to Nov. 10.

Fitch Ratings and Standard & Poor's said they may downgrade the nation's debt because the slide in reserves. The total at $484.7 billion remains more than double the combined international reserves of the eurozone

Another excerpt from the WSJ here with a little more juice:

So far, the Kremlin's $200 billion bailout package hasn't arrested the slide in Russia's financial markets and economy. With confidence in the economy waning, a large part of the Kremlin's aid money has been used to buy dollars, fueling record capital outflows, according to bankers.

Late Monday, Prime Minister Vladimir Putin gathered bankers, finance officials and the heads of law-enforcement agencies to issue a stern warning that Kremlin aid funds were meant for the Russian economy and those caught taking them out of the country would face harsh sanctions.

Late Tuesday, in its fifth increase this year, the central bank raised a series of interest rates, most by one percentage point, in an effort to keep money from flowing out of the country.

Russian leaders have sought to portray the country as relatively isolated from the global turmoil. But over the past month, the financial tremors have spread from Russia's fragile stock market -- now down 68% this year -- to undermine the banking sector and the economy as a whole.

The Kremlin's bailout package is one of the largest in the world relative to the size of the national economy. But it has only partly cushioned the impact as prices for Russia's main exports have plunged. Companies are cutting production, jobs and investment plans, while consumers are pulling back.

Possible Breakthrough in Limb Regeneration

I love technology but this story is flat out amazing. It's also appropriate for veterans day and I can't think of a better way to honor their service then to grow back lost limbs. Full story here and excerpt below:

American military researchers say they have unlocked the secret to regrowing limbs and recreating organs in humans who have sustained major injuries.

Using "nanoscaffolding," the researchers have regrown a man's fingertip and the internal organs of several test subjects.

The technology works by placing a very fine apparatus called a scaffold, which is made of polymer fibres hundreds of times finer than a human hair, in place of a missing limb or damaged organ. The scaffold acts as a guide for cells to grab onto so they can begin to rebuild missing bones and tissue. The tissue grows through tiny holes in the scaffold, in the same way a vine snakes its way up a trellis.

After the body part has regenerated, the scaffold breaks down, is absorbed into the person's body and disappears entirely.

The military plans to announce the breakthrough at the 26th Army Science Conference - which attracts more than 1,600 international military scientists - in Florida next month.

John Parmentola, director of research and laboratory management for the U.S. army, revealed some of the details of the announcement this week to a select group of bloggers and military observers on a conference call.

"There is a case of an individual who, with a model airplane, lost the tip of their finger," Parmentola told the group on the call. "And by the tip I mean the nail, the bone, the actual tip of their finger while they were starting up the airplane.

"That has been completely regrown . . . the nail, the bone, the tissue," he said.

By using nanoscaffolding, the military was able to regrow the man's fingertip, restoring everything he had lost, much like some amphibians can regrow a leg or tail.

BlindReason Now a Bank Holding Company

It is with great pleasure that I announce that I have applied to convert this blog into a "Bank Holding Company" under the Bank Holding Company Act of 1956 under Title 12 of the United States Code.

This was a tough and harrowing decision but with all the vast expenses in accordance with setting up this blog, and what I thought was a clever plan at the time to lever our future site advertising revenue against 20 million dollars in Icelandic bank debt. We've been clicking on our own ads all day but we have not been able to meet even our covenant lite loan requirements so the situation was obviously intense and time sensitive. Oh, plus, I went a little crazy on Itunes the other day and need the extra cash and I paid a little too much for my autographed copy of the Terminator: Sarah Conner Chronicles DVD.

Now I can almost hear some small segment of you out there questioning why your tax dollars are being used to bail us out.

I'm sure you didn't realize that blogging is a risky business, especially in sudden economic downturns and 70 to 1 leverage on your google adsense click through rates. Obviously, you guys just are not clicking on the ads enough and Google needs to put up more interesting ads. Are we to blame that Google cannot pick ads that correctly fit the interests of the readers and it absolutely ruined our financial projections? These guys obviously don't know what they are doing with this whole internet ad thing.

Unfortunately, as of yet we have been unable to contact our loan officer and the phone seems to ring and ring. Is there some sort of financial problem in Iceland? The 1-900 number on the internet application we used to get the loan doesn't seem to be working...

Is it just me, or is it impossible to find a reliable investment banker over the internet anymore? They just seem so hard to get a hold of now.

Without our reformation as a bank holding company the blog is in danger of imminent shutdown and nothing in America can ever fail now so we need your money fast!

To those skeptics out there, don't worry, the money we get will be used to repay our Scandinavian friends which we hear need to get repaid because they securitized our loan with some other prime assets such as Sacramento mortgages and some loan shark debt out of Brooklyn.

This move will also ensure domestic financial stability since we can now use a government facility to take loans off our balance sheet based on revenues that may or may not currently exist and businesses that are speculative at best that you never bloody even knew about by some overpaid investment banker.

In short, us getting your tax dollars is good for jobs and good for America so feel good about it okay?

Slow Going

An action packed few days so posting may be minimal next day or so.

Localized Power Generation

One of the trends we've talked about is power generation become more localized (away from distant plants and closer to the point of consumption).

Here is a story on a license deal for localized nuclear plants coming to market in 5 years. Pretty amazing story and frankly a little sooner than I would have guessed via the Guardian:

Nuclear power plants smaller than a garden shed and able to power 20,000 homes will be on sale within five years, say scientists at Los Alamos, the US government laboratory which developed the first atomic bomb.

The miniature reactors will be factory-sealed, contain no weapons-grade material, have no moving parts and will be nearly impossible to steal because they will be encased in concrete and buried underground.

The US government has licensed the technology to Hyperion, a New Mexico-based company which said last week that it has taken its first firm orders and plans to start mass production within five years. 'Our goal is to generate electricity for 10 cents a watt anywhere in the world,' said John Deal, chief executive of Hyperion. 'They will cost approximately $25m [£13m] each. For a community with 10,000 households, that is a very affordable $250 per home.'

Deal claims to have more than 100 firm orders, largely from the oil and electricity industries, but says the company is also targeting developing countries and isolated communities. 'It's leapfrog technology,' he said.

The company plans to set up three factories to produce 4,000 plants between 2013 and 2023. 'We already have a pipeline for 100 reactors, and we are taking our time to tool up to mass-produce this reactor.'

The first confirmed order came from TES, a Czech infrastructure company specialising in water plants and power plants. 'They ordered six units and optioned a further 12. We are very sure of their capability to purchase,' said Deal. The first one, he said, would be installed in Romania. 'We now have a six-year waiting list. We are in talks with developers in the Cayman Islands, Panama and the Bahamas.'

The reactors, only a few metres in diameter, will be delivered on the back of a lorry to be buried underground. They must be refuelled every 7 to 10 years. Because the reactor is based on a 50-year-old design that has proved safe for students to use, few countries are expected to object to plants on their territory. An application to build the plants will be submitted to the Nuclear Regulatory Commission next year.

'You could never have a Chernobyl-type event - there are no moving parts,' said Deal. 'You would need nation-state resources in order to enrich our uranium. Temperature-wise it's too hot to handle. It would be like stealing a barbecue with your bare hands.'

Other companies are known to be designing micro-reactors. Toshiba has been testing 200KW reactors measuring roughly six metres by two metres. Designed to fuel smaller numbers of homes for longer, they could power a single building for up to 40 years.

Friday Levity

A little levity to end the week...I don't always follow British humor particularly well but this sketch is something I enjoy.

Nice Chart of the Week

Relatively interesting chart on country default risk. Russia jumps out as relatively high on that list which wouldn't be a big surprise other than the have some of the largest dollar reserves on the planet. However, an economy that produces only commodities in a global macro environment that at least for some undefined period has collapsing commodity prices has the potential for Yeltsin part Duex.

Also of interest is Venezuela where Chavez has privatized assets at a stormy pace. These nationaliszations were done at "offer you can't refuse" / "robber baron" prices but now it looks like he overpayed and he hasn't figured out how to pay for it. this economic crisis has some upsides. Every cloud.

European Startups

Fred Wilson has some nice slides on European startups right here.

As far as Silicon Valley startups-- and everyone preparing for a 2001 nuclear winter --I'm not sure things are going to turn out the same way as last time. Old adages like--you don't have to outrun the bear, you just have to outrun your friends are probably still true. But the tumilt now is probably an opportunity to create bigger/better ideas--especially as LPs retrench their capital committments which is already taking place.