Wednesday, October 24, 2007
As The Numbers Get Real
The size of the writedown increased after Merrill conducted ``additional analysis'' of its holdings of so-called collateralized debt obligations, or CDOs, many linked to subprime home loans, O'Neal said in the statement.What really unnerves me is that they are still talking about subprime. There will be more overall losses in risk-layered Alt-A than subprime. Nonetheless, their analysis is likely to have recognized significant advance losses in CDOs, and this will cause everyone to turn a questioning eye on the other big players. It is likely that the details of Merrill Lynch's analysis escaped some other major players.
``We expect market conditions for subprime mortgage-related assets to continue to be uncertain and we are working to resolve the remaining impact from our positions,'' he said.
In other international news, the most significant is that Australia's inflation is way up and their CB is expected to raise rates to compensate. The worries about Japan just do not diminish, and that's for good reasons. Canada is beginning to feel the effects of the strong loonie as higher retail prices are tending to push shoppers across the border into the USA.
In recent days, European funds have been tending to invest more in US equities. On the face of it, this looks odd, because they are investing in a devalued currency that is likely to continue to devalue - but what of growth? In reality, the Eurozone has problems of its own relating to sustainable growth. France, of course, is in the middle of strikes and negotiations with its unions. But Germany has problems of its own in its internal economy. Real wages in Germany have been shifting down for some time, and transport strikes in Germany are just one symptom of that. The housing bubble in Europe, with the exception of a few countries, is somewhat worse than in the US. Ratios of household debt in the UK are actually higher than in the US, Ireland is seeing housing prices stagnate and fall, Spain is giving way, and the booming Italian infrastructure businesses are likely to take a hit from less building. The US probably still has one of the stronger consumption bases in the world. About thirty percent of the US population are financial conservatives, and as asset prices drop they will turn and step in. In a few CA markets, that was close to occurring already. The multinational corporations listed on US exchanges that can profit from global growth and can profit from currency fluctuations now look relatively better. Inflation has hit Europe too, and it isn't clear how strong the growth pattern there will really be.
Paulson is headed to India. I have been watching Indian bank and financial strategies with some concern, because it looks to me like some of the big interests there are intent on getting into other currencies. This hints to me that inflation worries are rising. India's moves to increase reserve requirements may have caused banks there to worry about inflation-related currency swings and caused the movement to invest in other currencies as a reserve. Growth in India, a shortage of qualified workers and wage inflation have now reached the point at which India has started an outsourcing movement of its own, which is vital for continued world growth.
In the US, fixed mortgage rates are now about where I calculate that they should be, provided the underwriting is pretty decent. Many of the larger banks are now beginning to really tighten mortgage underwriting by requiring higher downpayments for areas in declining markets, so we can all confidently expect at least a year more of credit-induced housing declines. That's on top of the demand/supply imbalance. One of the symptoms of the credit restructuring is that 1 year ARM rates are rising in the riskier areas to compensate for the higher expected defaults. They haven't moved to where they should be in every area, but they are getting there.
The Chinese government is locked into an absolutely epic battle against speculation. It is trying everything, including forcing downpayment increases in areas with speculation booms (which produced an RE collapse in Shenzen), and in some regions, banning students from investing on the stock market. It is not clear whether they will win the battle, but if they don't, sooner or later there will be a collapse and a flight of capital. They have a lot to gain by continuing their struggle.
On balance, I would say that the trend in international markets is shifting toward capital preservation. Such a change is likely to push capital into the Old Guard countries such as the Commonwealth countries, the European countries and the US. It is not a good sign for emerging markets under these circumstances. The problem with high growth in countries that have undemocratic systems is that it tends to pool money in a small percentage of the population who then shift to desiring safety of their own money more than growth. Thus high growth increases unfavorable trends for the general populations in such countries. Relative inflation of commodities combined with lower real wages produces a diverging trend of wealth distribution and causes capital to move into safety in other countries, short-circuiting internal growth, which then produces less external investment, which accentuates the trend and causes more capital flight.
Worldwide commodity inflation trends cannot continue as is. Either this pattern will correct of itself or it will cause global political instability. If a few billion people cannot afford to buy food and fuel, we have a severe problem. The monks of Burma died because the people of Burma were aghast at the government passing through fuel costs, and the people were so upset because they literally need that money to buy food. We are so close to the conditions prevailing in the 1920s that it is frightening. The great probability is that a more flexible global investment system will allow a slow and painful correction. If it doesn't, the danger of war is great.
What most political commenters miss is that the growth of radical Islamic movements in China (yes, in China) and the Islamic block is related more to high inflation and declining living standards for the average person on the ground than to any religious precepts. Yes, hatred of Israel and violent interpretations of the Koran serve as the nucleus for these trends, but any cultural nucleus at all would do. The same cultural processes are fueling hostility among the Chinese population toward Japan around the nucleus of Manchuria and WWII injuries. The peasant and urban workers of India, China, Indonesia and Burma are suffering extremely - and what worries me about Iran is less its nuclear weapons than the truly brutal measures it is undertaking to suppress its trade union movement.
I guess ya really gotta live in one of these cities with concentric red and white rings around them to feel the burn...
I laugh at radical Islam filling the void left from the Chicomm purges of Christianity and the like. They got rid of the cats and are overrun my rats. The Chicomms have nowhere near the subtle tools necessary to control speculation. Their banking system is far too primative. In Geopolitical terms they thought they would buy out Tiawan and the US rather than fight but it may be that what they've imported in exchange will be their downfall.
If you look at the history of Italy under Mussolini, you see how internal pressures combined with a narcissist as a dictator caused Italy to embark on a self-destructive venture. I think what I have written is the best possible justification (with real historic credibility) for preventing Iran from becoming a nuclear power. A country that is so self-destructive should not have nukes, because it is very likely to use them and certain to threaten to use them.
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