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Monday, November 24, 2008

Bail, Bail, Bail!

China's on "Stimulus Two" (focused on raising the population's ability to consume), the Fed is basically flooding the world with dollars, plus bailing out Citi (preferred stock to Treasury in exchange), even Canada may launch into deficit spending next year.

This is the result of a nearly global lending/borrowing bubble. Abu Dhabi is taking over Tamweel and Amlak (ME mortgage lenders) as their RE bubble bursts. It's hard to find a corner of the world which was not affected by the bubble, and even the relatively fiscally conservative countries (like Canada) are being hit hard as the bubble bursts. Most of the ME countries are pumping money into their own stock markets and/or banks, but the big realty companies are all being hit hard everywhere. Property values are falling all over Europe, in Japan, in China, India, Russia, the US, the UK, Ireland, even Canada.

China's new proposals seem to be focusing on consumption and social unrest:
But it said that the items being studied include raising the threshold for the payment of income tax, boosting housing subsidies and offering other direct subsidies to people with low income levels.

The state planner also plans to set up long-term subsidising mechanism for low-income group and rise salary in large scale to increase resident's income.
That is key, because you can't have wealth flowing into economies that don't sustain consumption.

The real hope of stemming the deflationary surge is that energy and commodity prices will drop enough to boost the spending power of consumers worldwide. The key to that is to make sure that consumers in the developed economies get the benefit of cheaper energy, and that consumers in the less-developed countries get the benefit of cheaper food.

Secondarily, governments should try to redress their public/private balances. In China, the government really should do more to help their poorer citizens - it's an irony, but the "Communist" country has very little in the way of social services compared to the "capitalist" developed countries. In countries like the US and much of Europe, the government sector has grown too large and needs to be rolled back.

The reason we are seeing this coordinated bust is less credit than about the global energy/commodity run up earlier in 2008, which broke millions of supply chains. However, global credit extensions had moved up so much over the last couple of years that of course that breaks credit chains. The next big whack is to European banks, and it's gonna be a heck of a ride.

The September BIS statistical supplement had some pretty intimidating numbers. (Remember, from a banking POV loans are assets and deposits are liabilities.) Table 1 (see page 7) gives you external (international) bank positions. In December, 2005 the total assets were USD 23.9 trillion. In March, 2008, total assets were USD 40.36 trillion. That's an increase of over 16 trillion USD in less than 3 years. Of course it's busting. When you get long chains of international lending, effectively you are increasing the world money supply.

And the bust will be fun. If you go to page 103, you will see Table 19 which lists OTC derivatives. Note that the market value outstanding of credit swaps went from 243 billion in December, 2005 to 2 trillion in December, 2007. The notational value (really amount covered) increased during the same period from 13.9 trillion to 57.9 trillion.

The proverbial man from Mars would look at this and guess that institutions largely substituted purchasing such contracts for the old fashioned practice of trying to figure out whether one was lending to a borrower who was able to repay, i.e. risk assessment and building loan loss reserves. In theory, one is outsourcing the risk assessment to the investment banker bozo who is writing the contract because he or she will charge you according to the risk he or she perceives. In practice, if enough investment bankers are bozos, one is swimming naked with absolutely no protection, because when you show up with the bill you find out that there is a run on the investment bank, and it turns out that investment banks are not FDIC members.

I guess I'm in favor of bailing and balancing, at least as long as the government takes interests in the institutions being bailed out. What's really happening is that the governments are stepping in to cover the shortfalls that the investment bankers can't; an ex post facto FDIC insurance program for IB Bozos is needed, but to cover the cost it's necessary to take something in return for the government guarantees/funds.

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