Book Review: The Sellout Out

Just finished "The Sellout" By Charles Gasparino. He is the the tall guy who dropped the f-bomb on CNBC. He also wrote "King of the Club" about Dick Grasso which was good.

Although this book seemed to get some bad reviews by the financial media, I thought it was like a 500 page version of "Liar's Poker" by Michael Lewis. The books starts on Wall Street in the 1980 with Solomon Brothers and Credit Suisse. Although the book is basically a story of the excessive build up of leverage by the I-Banks from 1980-2007, there are separate stories revolving around Larry Fink(CEO of Blackrock), Lewis Ranieri(the co-inventor of the mortgage back security), Dick Fuld (ex-CEO of Lehman Brothers), Jamie Dimon (CEO of JPMorgan), and Jimmy Caynes (ex-CEO of Bear Sterns). Gasparino seems to have weird inside knowledge about all of these characters (from their sexual habits to Caynes pot-smoking in his office at BS).

In the end, the book tells a decent story about the lead up the the subprime crisis, and the major players that got us here. I believe he is one of the only good investigative journalist left (certainly at CNBC, but in general, in the entire financial media). Its a big book, so give yourself a few weeks to read this one.

The End of the Rating Agencies

Up until now, the rating agencies have been able to avoid the current crisis unscathed. Their reputations have not been tarnished, even though they are one of the main causes of the crisis to begin with (imagine all of the institutional investors that could not have been able to buy the credit derivatives without the AAA rating ....)

Although this link really proves nothing, after reading "Fooling Some of the People All of the Time", I am willing to believe anything this guys says. In fact, the fact he is shorting these stocks probably means I should wake up tomorrow and start selling also.

Regardless, its worth listening to the whole 8 minutes, especially to hear his response about Lehman Brother at the end:

Book Review: Bailout Nation

Just finished up "Bailout Nation" by Barry Ritholz. As you may know, Ritholz is famous for his blog "The Big Picture", and its why he got the book deal in the first place.

Although I am not a huge fan of this blog (I am more into the shock-and-awe blogs such as NakedCapitalism and ZeroHedge), this book has a lot of useful information. Barry Ritholz was able to explain a lot of the current problems the US, and the world, are experiencing in layman's terms.

The books begins with him talking about the history of US bailouts. Starting from Lockheed Martin in 1979 and going through the S&L crisis to Long Term Capital Managment in the summer of 1998. With each bailout, he ties in the whole moral hazard theme and attempts to explain how each of these bailouts is directly responsible for where we are today.

Two interesting topics he touches on that I have seen no other commentary are:

1) "The mad scramble for yeild" - an enormous amount of money run on behalf of large foundations, endowments, pension funds, and chartiable trusts. These institutions are constrained by some basic money managment principles. Foremost, amount these is the payout requirement -- the minimum distribution of money that these organizations must pay out each year. Basically, trust and foundations must spend or give away 5% of the average market value of their assets. Failing to do so would lead to heavy penalties (2% of assets).

Greenspan's ultralow rates caused "tremendous angst and consternation" among fixed-income managers because the coul not generate the needed returns when the FED had driven the FF rates so low. There, they ended up in AAA tranches of CDOs/CLOs, etc...we all know how that episode ended.

2) The Commodity Futures Modernization Act of 2000 (sponsored by Phil Gramm).
This piece of legislation allowed derivatives such as Credit Default Swaps to become an enormous, unregulated shadow insurance industry. Removing derivatives from any and all regulation created a situation in which AIGFP could become a giant hedgefund hidden inside of a legitimate, respected insurance company.

The whole books was great, including the ending where Ritholz makes a list of everyone he holds responsible, in their order of responsibility.

A Week Late, but worth watching

The Supreme Court Decides to Stay Crystler Deal

Gross Is A Pessimist

Bill Gross's Monthly outlook for June was pretty interesting. It seems to be prediction:

1. higher taxes
2. a decrease in the US standard of living
3. higher yields on everything because no one will buy our treasuries or, hyperinflation because the buyer of last resort will be the FED, via quantitative easing
4. less rich people overall because of its harder to be rich and also a lot of rich people are no longer rich
   

From PIMCO

I remember as a child my parents telling me, perhaps resentfully, that only a doctor, airline pilot, or a car dealer could afford to join a country club. My how things have changed. Now, as I write this overlooking the 16th hole on the Vintage Club near Palm Springs, the only golfers who shank seven irons into the lake are real estate developers, investment bankers, or heads of investment management companies. The rich are different, not only in the manner intoned by F. Scott Fitzgerald, but also in who they are and what they do for a living. Whether some or all of them are filthy is a judgment for society and history to make. Of one thing you can be sure however: over the next several decades, the ability to make a fortune by using other people’s money will be a lot harder. Deleveraging, reregulation, increased taxation, and compensation limits will allow only the most skillful – or the shadiest – into the Balzac or Forbes 400.

Readers who are interested in such things as the Forbes annual list of hoity-toities will have noticed that more and more of them are global, not U.S. citizens. The U.S., in other words, is not producing as much wealth in proportion to the rest of the world. Its fortune-producing capabilities seem to be declining, which might suggest that its relative standard of living is doing so as well. If so, the implications are serious, not just for Donald Trump but for wage earners and ordinary citizens, as reflected in their income levels and unemployment rates. Stockholders, 401(k) investors, and yes, bond managers will be affected too. Last week’s furor over the possibility of an eventual downgrade of America’s AAA rating demonstrates that only too clearly. On the night of May 20, Standard & Poor’s announced a downgrade watch for the United Kingdom and since the U.S. and U.K. are Siamese-connected, financially-levered twins, the implications were obvious: the U.S. might be next. In the space of 48 hours, the dollar declined 2%, and U.S. stocks and long-term bonds were down by similar amounts. Such a trifecta rarely occurs but in retrospect it all made sense: a downgrade would cast a negative light on the world’s reserve currency, and since stocks and bonds are only present values of a forward stream of dollar-denominated receipts, they went down as well.

Ok, so he is probably right, our standard of living is going to have to decrease, and it should. If you look at any chart with years on the x-axis and private debt (aka the US consumer) on the y-axis, you will see why. People in the US have finally enter the new reality: if you make 30K a year you can't own a flat-screen tv, a humer, a 2-car garage, have 4 kids, and go on two vacations a year. Ok, maybe I am exaggerating, but there are [were] a lot of people in the US that thought like this two years ago. I think we can all agree now the rise in the standard of living we have seen since 1982 till 1999 when the dot-com boom crashed was attributed to spending money we didn't have. Now all of these people can get a nice wiff of reality that their house is foreclosed on, their credit lines are cut off, (oh wait, Obama is making sure these evil credit card companies do not punish people who spent too much... thank god!) and oh no, gas prices are up 20% in the past few weeks and they can't drive 2 hours to work everyday in their GM SUV and still have money left over. I feel bad for these people (not really), but the US needs to change.

I see a lot of articles about the coming metamorphsis of the US. There was a good one in the economist this week actually, title "Trading Down":

Americans are trading down. If they still have jobs (as 91% of the workforce do), they are worried about losing them. Their homes are no longer cash machines and their investments are in a ditch. Household net worth fell by a staggering $11.2 trillion last year. The rich are cancelling orders for yachts. Working Americans are forgoing even small luxuries. Lindt & Sprüngli, a maker of exquisite chocolate truffles, is closing 50 of its 80 stores in America. Hershey’s, a maker of less chocolatey chocolate, is doing rather well. Limited Brands, which owns Victoria’s Secret, is not.

Americans are rediscovering thrift. Retail sales fell by 11% from their peak in late 2007 to April 2009. Personal consumption has fallen 2.5% since last summer. The Boston Consulting Group (BCG), a consultancy, finds that nearly three-quarters of Americans plan to curb their spending over the next year.

Trading down is not difficult. Instead of, say, blowing $4.50 on a Strawberries and Crème Venti Frappuccino from Starbucks, Americans are popping into Dunkin’ Donuts for a basic cuppa Joe at a buck or so. Instead of shopping at Neiman Marcus (a posh department store known colloquially as “Needless Mark-up”), they are driving to the out-of-town Wal-Mart superstore or shopping online for bargains at Amazon (see chart 2). A recent Pew poll found that 21% of Americans planned to grow their own vegetables, 16% had held a garage sale or sold things online and 10% had either taken in a friend or relative or moved in with one. Pundits are coining phrases such as “austerity chic” and “luxury shame”.

Four-fifths of Americans told the BCG they would defer big purchases that can wait. The most obvious example is a car. After a home, this is the most expensive object a typical family buys. New cars are nice, but old ones can last a long time, as any third-world taxi-driver knows. So Americans are keeping their old wheels on the road. Repair shops are bustling. Desperate dealers are offering interest-free finance. Hyundai, a maker of unflashy cars, has lifted its share of the American market by saying: buy a car from us, and if you lose your job we’ll buy it back.

If there is one really great thing about this US, we are very dynamic. It is one of the reason our economy is [was] was great, and its one of the reason why important economist are predicting we will be one of the first countries to leave recession (that and we were one of the first to enter it).

Sorry about the rant ... Back to Bill Gross

The current annual deficit of $1.5 trillion does not even address the “pig in the python,” baby boomer, demographic squeeze on resources that looms straight ahead. Private think tanks such as The Blackstone Group and even studies by government agencies, such as the Congressional Budget Office, promise that Federal spending for Social Security, Medicare, and Medicaid will collectively increase by 6% of GDP over the next 20 years, leading to even larger deficits unless taxes are increased proportionately. Collectively these three programs represent an approximate $40 trillion liability that will have to be paid. If not, you can add that present value figure to the current $10 trillion deficit and reach a 300% of GDP figure – a number that resembles Latin American economies such as Argentina and Brazil over the past century.

The obvious solution to both dollar weakness and higher yields is to move quickly towards a more balanced budget once a sustained recovery is assured, but don’t count on the former or the latter. It is probable that trillion-dollar deficits are here to stay because any recovery is likely to reflect “new normal” GDP growth rates of 1%-2% not 3%+ as we used to have. Staying rich in this future world will require strategies that reflect this altered vision of global economic growth and delevered financial markets. Bond investors should therefore confine maturities to the front end of yield curves where continuing low yields and downside price protection is more probable. Holders of dollars should diversify their own baskets before central banks and sovereign wealth funds ultimately do the same. All investors should expect considerably lower rates of return than what they grew accustomed to only a few years ago. Staying rich in the “new normal” may not require investors to resemble Balzac as much as Will Rogers, who opined in the early 30s that he wasn’t as much concerned about the return on his money as the return of his money.

Ten years from now I would image if I have the time to re-read this article (and hopefully I will not even have the time at that point) that roughly half of this will turn out to be true. Yes, the US standard of living will go down. Yes, the interest rates are going to go up. I have serious doubts of entertaining hyperinflation at this point because:

A) If the US is going to have to print its way out of this problem, it seems as though they are going to have to do it under Obama's first term. Obama is not the God everyone thinks he is, he is just a normal man trying to be re-elected, and I know one thing is for sure, hyperinflation is not going to be good for the campaign trail.

B) Everyone talks about the FED's quantitative easing and the hyperinflation its going to cause the road so matter-of-factly, but the real fact of the matter is no one knows what the hell is going on. Yes, the FED is creating money, to the tune of $300-$400 billion out of thin air, and using this money to buy assets right now. Inflation expectations remain "tied down", and with the deflationary spiral out there right now (watch out for the crash of CMBS coming up in the coming months), I can't see "it" being raised anytime soon (besides increases due to relatively small fluctuations in fuel costs). If inflation does start to take off, then there are new ways (which have not been used in the past) in which the FED can control inflation (besides conventional monetary policy and raising interest rates) like:

a) paying higher interest on bank reserves
b) Congress could give the FED power to issue its own debt (aka f-bills)

Those are just two of the options I thought sounded pretty good when I read about them a few months ago. There are certainly other ideas. Regardless, the point is, I doubt we will see hyperinflation.

Weaker dollar: no shit Bill, we are issuing 1.5 trillion t-bills this year, its the law of supply and demand.

My bet is that the green revolution will play out to be another dot-com boom-and-bust scenario. I am sure when (its more a question of if, not when) it does take place, a majority of the start-ups will be in the US (assuming Obama's protectionist I-hate-rich people-but-now-I-am-one bullshit doesn't pan out), and just like in the dotcom boom, we will pay off a bunch of this deficit with the capital gains tax receipts.

That is it for now. Time will tell who is right. Hopefully its neither Obama or Gross!

Chinese Students Laugh At Geithner's Comments

Why do the Chinese save so much?

I do not have much to say on this one, besides the fact that its a question I had never really investigated until I read this blog entry. From Michael Pettis:

Demographic causes

• Declining dependency ratios, especially via decline in the number of young people. From the mid-1970s to roughly the middle of the next decade we know that China’s dependency ratio has contracted sharply. A much larger share of the population is of working age today than thirty years ago. Besides being a great source of rapid growth, I think this fact creates a bias towards savings since I think of working population as a proxy for production and total population as a proxy for consumption. This means that with China’s working population growing so much faster than total population (a process which will be reversed over the next three or four decades) Chinese production has grown much faster than Chinese consumption. The difference, of course, is the savings rate.

Structural causes

• Lack of social safety net. With a risky health care system, no social safety net, and limited ability to borrow, Chinese households have to self-insure. This means they save on average much more than they need on average to cover these costs.
• Rapid growth in wealth. When per capita wealth grows very quickly, it may take a while for people to change their consumption behavior as quickly, so growth in consumption lags growth in wealth. Of course the difference between the two is the rising savings rate.
• The generation of “little emperors.” I have heard not-always-satisfactory arguments that households save a huge amount because of the one-child policy — they are essentially spoiled, the argument goes, and parents will sharply limit their own consumption in order to provide everything for their only child. I am ambivalent about this explanation, but I do think the maturing of the one-child generations may have an impact on future savings. They are much more likely, it seems to me, to spend money on themselves, although this argument may be a little too glib.
• Lack of consumer credit. Without easy availability of consumer credit, households who want to borrow to purchase big-ticket items have little choice but to save today for a future purchases.

Policy causes

• Low exchange rates. The reasoning and causality are unclear, but there is evidence that countries with artificially low exchange rates tend to have high savings rates, perhaps because low exchange rates reduce real wages.
• Low interest rates. We also have a lot of evidence that low interest rates create higher savings rates in countries like China. This claim generates a lot of confusion, and I am often asked how this can possibly be true when the opposite is true in the West. My guess is that it occurs because of both portfolio effects and income effects. For the former, because Chinese don’t save in the form of stocks, bonds and real state, but rather in the form of bank deposits, declining interest rates do not increase the value of their savings portfolio, but actually reduces it. This is why reducing interest rates causes savings in the West to decline (Westerners feel richer) whereas it causes savings to increase in China (Chinese feel poorer). For the latter effects, with interest income such a large part of total income, low interest rates are similar to low wage rates in their impact on consumption.
• Policies aimed at running trade surpluses. This is generally a catch-all and must be true by definition. A trade surplus occurs when production exceeds consumption, so any policy aimed at growing production faster than consumption is also implicitly aimed at raising the savings share of income.
• Policies aimed at running fiscal surpluses. Of course this contributes by creating government savings.
• Policies aimed at forcing profitability in SOEs via interest rates and other policies. Another catch-all for policies that drive up corporate savings.

I am not sure if there is any over-arching reason for high savings in China, but generally I would argue that policies aimed at generating high levels of investment and at running trade surpluses must also, by definition, cause high levels of savings. In that sense the policies associated with the so-called Asian development model are policies that implicitly or explicitly cause high savings rate. if this is true, as I have written elsewhere, high Asian savings rates my be threatened in the future by rising savings rates in the US, since in the aggregate consumption and production must balance. The US trade deficits required for the success of high-savings policies in China may no longer exist.

Banks Used TARP money to fund lobbyist

As sad as it is, I have to admit that this article did not surprise me. After the botched billion dollar bailouts of AIG, Bank of America, Citigroup, Fannie, Freddie, GMAC, GM, Crystler ..... need I go on.....

Now its turns out these banks allegedly use TARP money to fund lobbyist to prevent regulation in the very same derivatives (mainly Credit Default Swaps) that got us into this mess.

From the NYT:

The nine biggest participants in the derivatives market — including JPMorgan Chase, Goldman Sachs, Citigroup and Bank of America — created a lobbying organization, the CDS Dealers Consortium, on Nov. 13, a month after five of its members accepted federal bailout money.

To oversee the consortium’s push, lobbying records show, the banks hired a longtime Washington power broker who previously helped fend off derivatives regulation: Edward J. Rosen, a partner at the law firm Cleary Gottlieb Steen & Hamilton. A confidential memo Mr. Rosen drafted and shared with the Treasury Department and leaders on Capitol Hill has, politicians and market participants say, played a pivotal role in shaping the debate over derivatives regulation.

...

Mr. Rosen and other bank lobbyists have pushed on Capitol Hill to keep so-called customized swaps from being traded more openly. These are contracts written for the specific needs of a customer, whose one-of-a-kind nature makes them very hard to value or trade. Mr. Rosen has also argued that dealers should be able to trade through venues closely affiliated with banks rather than through more independent platforms like exchanges.

Mr. Rosen’s confidential memo, dated Feb. 10 and obtained by The New York Times, recommended that the biggest participants in the derivatives market should continue to be overseen by the Federal Reserve Board. Critics say the Fed has been an overly friendly regulator, which is why big banks favor it.

Mr. Rosen’s proposal for change was similar to the Treasury Department’s recently announced plan to increase oversight. Treasury officials say that their proposal was arrived at independently and that they sought input from dozens of sources.

Even so, market participants, analysts and members of Congress who have proposed stricter reforms worry that the Treasury proposal does not go far enough to close several important regulatory gaps that allowed derivatives to play such a destructive role in the current financial crisis.

The main reason why the banks even hired this asshole:

But increased transparency of derivatives trades would cut into banks’ profits — hence the banks’ opposition. Customers who trade derivatives would pay less if they knew what the prevailing market prices were.

Blame it on Reganomics

Paul Krugman had an interesting op-ed piece today in the NYT blaming the Regan-era deregulations for the problems we are facing today. I have never really been impressed by anything Paul Krugman has written (books or op-eds), but this piece does mention some obvious, but yet important trends that began in the early 1980s. From the NYT:

The increase in public debt was, however, dwarfed by the rise in private debt, made possible by financial deregulation. The change in America’s financial rules was Reagan’s biggest legacy. And it’s the gift that keeps on taking.

...

But there was also a longer-term effect. Reagan-era legislative changes essentially ended New Deal restrictions on mortgage lending — restrictions that, in particular, limited the ability of families to buy homes without putting a significant amount of money down.

These restrictions were put in place in the 1930s by political leaders who had just experienced a terrible financial crisis, and were trying to prevent another. But by 1980 the memory of the Depression had faded. Government, declared Reagan, is the problem, not the solution; the magic of the marketplace must be set free. And so the precautionary rules were scrapped.

Together with looser lending standards for other kinds of consumer credit, this led to a radical change in American behavior.

We weren’t always a nation of big debts and low savings: in the 1970s Americans saved almost 10 percent of their income, slightly more than in the 1960s. It was only after the Reagan deregulation that thrift gradually disappeared from the American way of life, culminating in the near-zero savings rate that prevailed on the eve of the great crisis. Household debt was only 60 percent of income when Reagan took office, about the same as it was during the Kennedy administration. By 2007 it was up to 119 percent.

One of the reasons I dislike Krugman's editorials is for some reason, (and I havn't figure this out yet) he is a HUGE cheerleader of big government. There is no doubt in my mind, in the US, government IS the problem, and its NEVER the solution. The word "solution" can never be put into the same sentence as Harry Reid, Nancy Pelosi, or Barak Obama. We certainly have a lot of problems in this country, but partisan politics and trillion dollar deficits are not going to make them go away.

I think I may be underestimating Krugman's wealth. Very few smart people in the US that are mildy rich and successful (or aspire to be) would support this administration!

IMF Paper On the Bernanke's Monstrous Balance Sheet

IMF on Fed Balance Sheet

Publish at Scribd or explore others: Non-fiction money usa

Mariner Kemper - We Do Not Need More Regulation

Roubini to CNBC - Yellow Weeds

Interview With Charles Munger (Buffetts VP at Berkshire)

Legal Matters With Munger

Publish at Scribd or explore others: School Work Other Books Non-fiction money world

As we look at the current situation, how much of the responsibility would you lay at the feet of the accounting profession?

Munger: I would argue that a majority of the horrors we face would not have happened if the accounting profession developed and enforced better accounting. They are way too liberal in providing the kind of accounting the financial promot-ers want. They’ve sold out, and they do not even realize that they’ve sold out.

Would you give an example of a particular accounting practice you find problematic?

Munger: Take derivative trading with mark-to-market accounting, which degenerates into mark-to-model. Two firms make a big derivative trade and the accountants on both sides show a large profit from the same trade.
And they can’t both be right. But both of them are fol-lowing the rules.
Yes, and nobody is even bothered by the folly. It violates the most elemental principles of common sense. And the reasons they do it are: (1) there’s a demand for it from the financial promoters, (2) fixing the system is hard work, and (3) they are afraid that a sensible fix might create new responsibilities that cause new litigation risks for accountants.

Can we fix the accounting profession?

Munger: Accounting is a big subject and there are huge forces in play. The entire momentum of existing thinking and existing custom is in a direction that allows these terrible follies to happen, and the terrible follies have terrible consequences. The economic crisis that we’re in now is, in its triggering circumstances, worse than anything that’s ever happened.

Ron Paul's HR 1207 - A Great Idea

Ron Paul is the man:

US to regulate OTC derivatives

This is long overdue. Of course the big banks are going to lobby against these measures, because any type of regulation/clearing house for OTC derivatives (especially credit derivatives) is going to severely cut into their future profits (bid-ask spreads will drop drop 100s of bps): From the WSJ:

Under a proposed raft of reforms, regulators could be given authority to force many standard over-the-counter derivatives to be traded on regulated exchanges and electronic-trading platforms. That would make it easier to see prices and make markets more transparent.

Firms with large derivative exposures or that trade more-complex derivatives would be subject to new reporting requirements. The proposal also calls for all standardized derivatives to go through clearinghouses that will guarantee trades and help cushion the impact of a collapse of a large financial institution.

The regulatory overhauls are in response to growing concerns of outsize risk and leverage among derivatives that trade directly between pairs of firms. Much trading in this market, estimated to total hundreds of trillions of dollars, now happens privately, and contracts are typically negotiated over the phone.

I suspect that if CDOs/CLOs/CMOs and CDSs move to a clearing house or electronic exchange, it will be considerably more difficult for the banks to apply mark-to-model on these assets. As their balance sheets become more transparent (no more Tier 3 assets), the public will regain there confidence.

The move, the latest step to tighten federal regulation of finance, is designed to address markets such as those for credit-default swaps, which many say exacerbated the financial crisis. Any such moves would require congressional approval.

"Reporting those positions will address the primary concerns of the market, about who is trading what derivatives," said Joel Telpner, a derivatives lawyer at Mayer Brown in New York.

Also Wednesday, Mr. Geithner said the Treasury would soon release a separate plan to simplify which agencies oversee financial markets, a move that could bring sweeping change to the alphabet-soup of regulatory bodies.

"I think the president believes we need to have a much more simplified, consolidated oversight structure," Mr. Geithner told the Independent Community Bankers of America trade group.

The plan to move some trades onto exchanges and electronic trading platforms could reduce profits for investment banks, which currently take fees for facilitating the trades.

The long term solution to credit default swaps may be the holder of the derivative has to have a position in the underlying asset. This will take most of the speculators out of the game, and although that will probably negatively affect liquidity, it will prevent speculators from taking down companies (equity prices are highly correlated with CDS rates).

Proposals for new financial regulations ... good stuff

Credit Suisse is forced to the back of the line

I do not really have an opinion on this article, besides the fact that it probably sets a bad precedent for future foreclosures down the road. To make a long story short, it appears CS was found guilty of predatory lending, in regards to the Yellowstone Club Ski resort, which is now in foreclosure. Their punishment is there they are going to have to step behind others lenders (they are now a subordinate debt holder behind the DIP financing) waiting to get their money (CS lent 370 million). From Rueters:

Credit Suisse Group AG (CSGN.VX), which lent $375 million to the exclusive Yellowstone Club ski and golf community before the club's bankruptcy, will have to step behind other creditors, after a judge ruled the loan "predatory".

"The only plausible explanation for Credit Suisse's actions is that it was simply driven by the fees it was extracting from the loans it was selling, and letting the chips fall where they may," wrote U.S. Bankruptcy Judge Ralph Kirscher in a preliminary ruling entered on Tuesday.

Credit Suisse lent the money to the club without requesting audited financial statements from Yellowstone Club, among other "curious" decisions, said the judge. The firm received fees of $7.5 million.

"We are disappointed in this ruling and disagree with the court's findings," said Credit Suisse spokesman Duncan King. "We are weighing our options at this time." King declined to comment further.

Credit Suisse has a lien of $232 million, which is now subordinated to the debtor-in-possession financing provided by CrossHarbor Capital Partners LLC, as well as the payment of administrative fees, costs of the bankruptcy and the claims of unsecured creditors.

"The only equitable remedy to compensate for Credit Suisse's overreaching and predatory lending practices in this instance is to subordinate Credit Suisse's first lien position to that of CrossHarbor's super-priority debtor-in-possession financing and to subordinate such lien to that of the allowed claims of unsecured creditors," wrote Judge Kirscher.

Here come the lawsuits

It appears the 60 million dollar Goldman settlement in Massachusetts has the potential to create a windfall of lawsuits by states against the large banks. I causally read this article a few days ago, but didn't really think about the implications of what had taken place. Bruce Krasting had an interesting post on the article:

This means next to nothing for Goldman Sachs. However, a very dangerous precedent has been set. In the critical years 2005-2007 Goldman was ranked 15th in the League Tables for sub prime and Alt-A origination/securitization. Goldman’s management must be pleased as punch with that poor showing today. Those that ranked high on that list are no doubt consulting with their attorneys. 

If Goldman gets its hand slapped for $60mm over 714 mortgages what does this mean for Countrywide Financial? They were very big in Boston. Merrill Lynch was at the top of those securitization tables. That is what got Stan O’Neal fired. If the settlement in Boston is representative of what will be forthcoming then Bank of America is going to be facing a very big number. And that is just Massachusetts. The AGs in the all of the other states, especially Florida, Nevada, Arizona and California must be licking their chops at this news.

This is lining up badly for the banks. The States are broke. They will see this as a source of revenue. Politicians will also like it. They will be able to claim that they are helping their constituents. Word on this will spread quickly from borrower to borrower. Every one of them will be looking for a break.

The settlement makes an important distinction between first and second mortgages. The rights of the second mortgages are clearly subordinated in the deal. This is how a bankruptcy court would treat the two classes of debt. This provides a clue on how these ‘seconds’ will be treated in the future. 

One of the largest sources of these second mortgages is the Mortgage Insurance Industry. They provide a guaranty of payment on the first loss of 20%. This product competed with the second mortgage industry. It created the same result for the borrower, the ability to buy a home with no money down. Precisely what Goldman is paying up for. In this case what quacks, walks and swims like a duck is likely to be treated like a duck.

Fannie Mae and Freddie Mac hold tens of billions of these insured or ‘enhanced’ mortgages. FHFA recently reported that the Agencies collectively held or guaranteed 30.2 million mortgages. Of that amount 16%, or 4.8 million are identified as “Non Prime”. Put differently, the Agencies hold 6,000 times more non-prime mortgages then Goldman originated in Boston.

The Great Government Momentum Trade

"Its a crazy, positive momentum based on zero fundamental improvement, zero fundamental improvement" - M. Whitney

Another Reason Why I am glad I am not French

They think cows are good long term investments. On second thought, maybe they are onto something here. From the NYT:

For Pierre Marguerit, 60, cows make a safe, secure investment, allowing for long-term growth from a renewable resource. The cow contracts are hardly new, but go back to Richard the Lionheart; the French word for livestock, “cheptel,” is the root for “capital.”

These are not exactly cash cows. But investment in Mr. Marguerit’s Holsteins will bring a 4 to 5 percent return a year after taxes, he said, based on “natural growth” — the sale of their offspring. That compares to an interest rate now of 0.75 percent on the basic French bank account.

Last year, his business went up by 40 percent, and so far this year, it has “practically doubled ,” said Mr. Marguerit, the managing director of Élevage et Patrimoine, a cattle investment firm in this part of eastern France, near the Alps, and president of Gestel, which works with farmers and investors.

The supposed 4% to 5% percent sounds great (especially after taxes, its more like 10%, and in socialist France, maybe even higher) until another mad cow disease comes along. In the US this trade may be even more attractive though because of our agricultural subsidies.

“People have saved money and don’t want to waste it,” he said. “Stocks have fallen a lot, and people see it. We need somewhere to put our money for a long-term investment, something more stable.”

At the moment, there are about 37,000 cows under contract in France at some 880 farms, according to theFrench Association for Investment in Cattle. But the potential market is huge, Mr. Marguerit insists, perhaps as many as one million head in France and six million in Europe as a whole.

A typical couple will buy 10 to 20 dairy cows for about $1,700 each and can decide to sell the offspring each year or keep them as additional “capital.”

“At this difficult time, it’s a much better investment than real estate and much more tangible than the stock market,” Mr. Marguerit said. He then proceeded to praise the new interest “in natural, organic and lasting things” among the French, who have always romanticized the countryside and imagined themselves shrewd peasants at heart. “This is part of the patrimony,” he said.

In the steep financial crash, “we’re having a moment of realization — we’re landing hard and people are asking real questions.” Diversify into cows? Why not?

Interesting Article On Company Balance Sheets

There was an interesting article I found in last weeks Economist talking about company balance sheets.  One of the interesting points it mentioned was how highly leveraged many smaller companies are in the United States, while the largest list firms have very little debt:

Yet the data reveal a striking oddity: the largest listed firms have disproportionately little debt compared with both smaller listed peers (see bottom chart) and private firms. Of America’s ten biggest non-financial firms, no fewer than six, including Microsoft and ExxonMobil, reported net cash positions at the end of 2008. Different accounting conventions make comparisons inexact, but non-financial firms in the S&P 500 index of listed American companies appear to account for only about a third of national corporate net debt, despite contributing a majority of profits. In Europe, with its tradition of bank financing, firms have always been keener on debt, but although overall corporate gearing has risen to “unprecedented” levels, according to the European Central Bank, listed firms have actually steadily cut theirs since 2000.

To grasp why big listed firms are different requires a bit of theory and some history. In theory, chief financial officers spend idle moments admiring charts of the idealised firm’s optimal capital structure. From this they are meant to conclude that debt is only moderately attractive. Since interest payments are tax deductible, but dividends are not, some borrowing makes a balance-sheet more efficient. Too much, though, makes a firm too risky, raising its overall cost of capital. It is a fine trade-off, which at most should add 10-20% to a firm’s overall value.

In the real world, however, many managers burnt their textbooks long ago and steadily increased their firms’ leverage, taking only the occasional breather in tricky economic patches such as the 1970s and early 1990s. This partly reflects their pay, which is often based on measures (such as earnings per share) that are flattered by higher gearing, giving them an incentive to take on more debt than is justified by mere tax planning. More demanding owners and abnormally low interest rates also led firms to take on more risk.

Also interesting but yet still important is how the article talks about how financial deregulation, and the large number of new innovative products that came along with it allowed many of these companies to stay afloat:

Financial deregulation, too, has played a big role, notes Jeffrey Palma, a strategist at UBS. A series of new debt products enabled even the leakiest corporate balance-sheet structures to stay afloat—for a while. In the 1980s junk bonds opened up credit markets for lower profile firms. In the most recent boom, companies bought by private-equity outfits, the corporate equivalent of subprime borrowers, packaged their debt into collateralised loan obligations, a form of structured credit that is now as toxic as it is hard to explain. The rash of leveraged buy-outs may account for as much as half of the rise in American corporate net debt since 2002.

Lo and behold their prediction of the future was: companies will be more risk-adverse and avoid carrying as much debt:

All this is likely to change the debate on corporate leverage in two ways. First, the gung-ho and largely erroneous assumption that higher debt means higher risk-adjusted returns will be replaced with a more measured assessment of the limited boost to tax efficiency that leverage can provide. One banker in London suggests that for the next few years, managers will be prepared to take on more debt only to the point where they are sure that they can refinance it if another crisis should strike. That suggests that quoted firms could further reduce their net debt from today’s level of about 50% of their book equity.

Second, the psychological scars will run deep for the private firms that bear a disproportionate burden of overall corporate debt. Many face bankruptcy, with the destruction of value that entails. Financial regulators, too, are far less likely to tolerate the sort of capital-market fads that allowed private companies to overload on debt at the top of the economic cycle and infect the banking system as they did so. It used to be that equity, as well as lunch, was for wimps. Not any more.

Bernanke Is A Douche Bag

He reminds me of a parrot reading that monitor ....

The Confidence Game

Back in the early 1900, the renown economist Irving Fisher lost the equivalent of 10o million USD in the crash of 1929. He is also famous for his theory of debt deflation. Almost 100 years later, is there anything we can learn for Fisher? Steve Keen thinks so:

Fisher’s confidence led him to hang on to his margin-financed stocks (worth over $100 million in 2000-dollar terms). Despite his confidence, the stock market continued its plunge from its peak of 31.3 in July 1929 to the nadir of 4.77 in May of 1932, while unemployment rose from zero to 25 percent. Fisher was wiped out financially, and left to ponder how he could have got the behaviour of the market, and the economy, so badly wrong.

Three years later, he reached the conclusion that he had been misled by two core elements of the neoclassical theory he had helped build: the beliefs that the economy was always in equilibrium, and that the debt commitments borrowers had entered into to purchase financial assets were based on correct forecasts of future economic prospects.

On equilibrium, he reasoned, even if it were true that the economy tended towards equilibrium, random events alone would ensure that all economic variables were either above or below their equilibrium levels. Therefore economic theory had to be about disequilibrium rather than equilibrium:

“Theoretically there may be— in fact, at most times there must be—  over- or under-production, over- or under-consumption, over- or under spending, over- or under-saving, over- or under-investment, and over or under everything else. It is as absurd to assume that, for any long period of time, the variables in the economic organization, or any part of them, will “ stay put,”  in perfect equilibrium, as to assume that the Atlantic Ocean can ever be without a wave.” (Fisher 1933)

This realisation in turn put paid to any notion that today’s debt commitments were based on an accurate prediction of tomorrow’s economic outcomes. Instead, he identified over-indebtedness as one of the two key causes of Great Depression:

“two dominant factors [are ...] over-indebtedness to start with and deflation following soon after… these two economic maladies, the debt disease and the price-level disease, are, in the great booms and depressions, more important causes than all others put together.

Thus over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money. That is, over-indebtedness may lend importance to over-investment or to over-speculation.

The same is true as to over-confidence. I fancy that over-confidence seldom does any great harm except when, as, and if, it beguiles its victims into debt.” (Fisher 1933)

One would hope that economic theory had learnt from the Great Depression, and in particular from Fisher’s insights. Unfortunately, economics was eager to unlearn these lessons, because the very phenomenon of a Depression was anathema to a profession that had always sought to eulogise the market economy, rather than to understand it. Equilibrium came back again in the guise of the “Neoclassical-Keynesian synthesis” in the 1950s. By the 1990s, all vestiges of Keynes had been thrown away–and nothing of Fisher had been even assimilated in the first place (skerricks of his thought are percolating through now though: see The Economist for a pretty good overview of Fisher).

Today, macroeconomic models like TRYM (the TReasurY Macroeconomic model that is used to prepare the Australian Federal Budget) presume that the economy tends towards a “long run equilibrium”. The apparent dynamics such models display are simply the convergence of the model from an initial starting point to the assumed long run equilibrium.

For example, the figure below shows the TRYM model’s predictions for unemployment from March 1995 till March 2010 (Figure 10: Dynamic Adjustment towards Steady State - Unemployment; Modelling Section, Macroeconomic Analysis Branch, Commonwealth Treasury, The Macroeconomics Of The Trym Model Of The Australian Economy,  Commonwealth of Australia 1996). The model “predicted” that unemployment would fall from around 9 percent in 1995 to just below 7 percent in 2010, simply on the basis that unemployment was assumed to converge to an a long run equilibrium rate of 7 percent over time (the actual level fell well below this, and the  assumed equilibrium unemployment rate–the “NAIRU”–was therefore later reduced to 5.25 percent).

Virtually everyone knows Keynes’s quip that “in the long run we are all dead”. Yet very few realise that Keynes’s target was precisely this approach to economic modelling–of assuming that the economy would simply tend to return to equilibrium after any disturbance:

“ But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.”   (Keynes, 1923)

Hobbled by this naive belief in equilibrium, the economics profession was as unprepared for today’s crisis as it had been for the Great Depression. Now that the crisis is well and truly with us, all conventional “neoclassical” economists can offer is the hope that the crisis can be overcome by a good, strong dose of confidence.

From Fisher’s point of view, such a belief is futile. In an economy with an excessive level of debt and low inflation, he argued that confidence was irrelevant–and in fact dangerously misleading, as he knew from painful personal experience. Given over-indebtedness and low levels of inflation, a “chain reaction” would occur in which: 

“(1) Debt liquidation leads to distress selling and to

(2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes

(3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be

(4) A still greater fall in the net worths of business, precipitating bankruptcies and

(5) A like fall in profits, which in a “ capitalistic,”  that is, a private-profit society, leads the concerns which are running at a loss to make

(6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to

(7) Pessimism and loss of confidence, which in turn lead to

(8) Hoardinq and slowing down still more the velocity of circulation.The above eight changes cause

(9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.” (Fisher 1933; The Debt Deflation Theory of Great Depressions)

What will finance look like after the global financial crisis?

Satyajit Das,  author of the Traders, Guns, and Money has made his prediction:

Das seems to be echoing the common themes here: giant trade imbalances (China/USA), deregulation (financial and telecomm), cheap labor from the emerging markets, and low inflation with debt induced consumption:

Recent global prosperity derived from a fortunate confluence of low inflation and low interest rates. In the 1980s, brutally high interest rates and recessions squeezed inflation out of the economy facilitating lower interest rates. Low energy prices, following the first Gulf War, helped keep inflation low and fuelled growth.

The fall of the Berlin Wall in 1989 and the reintegration of the command economies of Eastern Europe, China and India into global trade provided low cost labour helping maintain the supply of cheap goods and services. Emerging economies provided substantial new markets for products and capital driven by the very high levels of savings in these countries.

Deregulation of key industries, such as banking and telecommunications, fostered growth by increasing access to finance and improved essential infrastructure. Adoption of new technologies, such as information technology and the Internet, improved productivity and assisted growth, though the extent is disputed.

Many countries switched from employer or government pension schemes to private retirement saving arrangements underwritten by generous tax incentives. Rapid growth in this pool of investment capital was also a factor in growth.

Governments, irrespective of political persuasion, benefited from the favourable economic environment. The ability of governments and central banks to control and "fine tune" the economy with a judicial mixture of monetary and fiscal policy became an article of accepted faith. Voters were lulled into false confidence by a mixture of rising wealth, improved living standards and stability.

Elegant theories about the "Great Moderation" or "Goldilocks Economy", with the benefit of hindsight, seem to be little more than narrative fallacies where a convincing but meaningless story is shaped to fit unconnected facts and coincidence is confused with causality.

Das is supposedly a derivatives expert, and I find it to be interesting that he is sitting here saying that "financial innovation" is really a misnomer, and that all they really do all day is change a product a bit (usually making it more unstable), and then market it and make fees.

First came the Mortgage-Backed securities, then came the CDO, then came the credit default swap, etc .... I guess he may have a point

"Financial engineering" replaced "real engineering" in many countries. Entire cities (London and New York) and economies (Iceland) become dominated by the rapidly growing financial services industry. In the US, financial services’ share of total corporate profits increased from 10% in the early 1980s to 40% in 2007. The stockmarket value of financial services firms increased from 6% in the early 1980s to 23% in 2007.

The reliance on financial innovation proved disastrous. In A Short History of Financial Euphoria (1994), John Kenneth Galbraith noted that: "Financial operations do not lend themselves to innovation. What is recurrently so described and celebrated is, without exception, a small variation on an established design . . . The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version."

Financially engineered growth extended into international trade flows. Since the 1990s, there has been a substantial build-up of foreign reserves in central banks of emerging markets and developing countries that became the foundation for a trade finance scheme.

Many global currencies were pegged to the dollar at an artificially low rate, like the Chinese Renminbi, to maintain export competitiveness. This created an outflow of dollars (via the trade deficit driven by excess US demand for imports based on an overvalued dollar). Foreign central bankers purchased US debt with dollars to mitigate upward pressure on their domestic currency. The recycled dollars flowed back to the US to finance the spending on imports.

The process relied on the historically unimpeachable credit quality of the USA and large, liquid markets in dollars and dollar investments capable of accommodating the very large investment requirements. This merry-go-round kept US interest rates and cost of capital low encouraging further borrowing to finance consumption and imports to keep the cycle going.

Foreign central banks holding reserves were lending the funds used to purchase goods from the country. The exporting nations never got paid at least until the loan to the buyer (the vendor finance) was paid off. Essentially, growth in global trade was also debt fueled.

And the solution to our problems are: de-leverage and reduce debt overall. Ironically, Obama and Geithner are just fighting de-leveraging with more debt. This is one of the reasons I am pessimistic about the recovery.

The initial phase of the cure is the reduction in debt within the financial system. Some of the debt created during the Ponzi prosperity years will not be repaid. Non-repayment of this debt, in turn, has caused the failure of financial institutions. The process destroys both existing debt and also limits the capacity for further credit creation by financial institutions.

Total losses from the GFC to financial institutions, according the latest estimates, will be in excess of US$ 2 trillion. Banks need additional capital to cover assets that were parked in the "shadow banking system" (the complex of off-balance sheet special purpose vehicles) but are now returning to the mother ship’s balance sheet. The global banking system, in aggregate, is close to technically insolvent.

Commercial sources for recapitalisation are limited as losses mount and the outlook for the financial services industry has deteriorated. Government ownership or de facto nationalisation is the only option to maintain a viable banking system in many countries.

Even after recapitalisation the capital shortfall in the global banking system is likely to be around US$ 1-3 trillion. This equates to a forced contraction in global credit of around 20-30% from existing levels.

The second phase of the cure is the effect on the real economy. The problems of the financial sector have increased the cost and reduced availability of debt to borrowers for legitimate business purposes. The scarcity of capital means that banks must reduce their balance sheets by reducing their stock of loans. Normal financing and loans are now being effectively rationed in global markets.

This forces corporations to reduce leverage by cutting costs, selling assets, reducing investment and raising equity. This also forces consumers to reduce debt by selling assets (where available) and reducing consumption.

"Negative feedback loops" mean reduction in investment and consumption lowers economic activity, placing stresses on corporations and individuals setting off bankruptcies that trigger losses for the financial system that further reduces lending capacity. De-leveraging continues through these iterations until overall levels of debt reach a sustainable level determined by lower asset prices and cash flows available to service the debt.

The end of the Asian Development Model

Now that the US is finally saving money, is the Asian Development Model of its last leg?

Michael Pettis thinks so:

Although the debate is much less transparent in China today than it was in the US in the early 1930s, I think the latter group – the domestic constituency and provincial leaders – is once again winning the debate, at least for now. It is probably no surprise to regular readers of my blog that I largely disagree with this camp, and the main reason I didn’t want to forecast very low 2009 GDP growth numbers with much confidence is because I doubt the former group will win the debate. As I see it, the massive expansion in credit and investment we are experiencing is simply more of the same set of policies that, especially over the past five years, have pushed China ever deeper into the Asian development model, and to the extent that they are successful they will keep pushing China, which I think of as exemplifying the Asian development model on steroids, in the same direction. Beijing, in other words, is increasing the dosage of steroids. (I think I am mixing metaphors all over the place.)

The reason I think this is a mistaken strategy is because I would argue that the Asian development strategy is dead, and over the next three to five years it will become increasingly evident that 2008 was the year it died. I may be wrong, of course because it is doubtful but not inconceivable that the great consumption party in the US can resume for a few more years. It would not be the first time that what seemed like an unstoppable correction in the trade imbalances was interrupted. To a certain extent we already saw a dress rehearsal for this event in the 1987 crash, around which time the US trade deficit, which had risen to around 3.5% of GDP the year before (a level which seemed unimaginably high at the time), began its inexorable reversion, to the point where the US achieved a small surplus in the early 1990s.

Chinese assumed that the US was an "importer of last resort". They were wrong....

In other words for small countries the need to export is not likely to be a constraint since they can always generate trade surpluses without creating significant global trade distortions. But when large countries, or a large grouping of countries, have policies aimed at generating trade surpluses they run into a very strict constraint – that some country or group of countries must be capable and willing to run large corresponding trade deficits. Without this willingness to run trade deficits, the Asian development model must inevitably run into brutal 19th-Century-style cycles of rapid production growth leading to overinvestment crises.

This is the main vulnerability of the Asian development model – its dependence on an importer of last resort. We don’t often think of this as a weakness because for so long the US was seen as the automatic importer of last resort, so much so that we didn’t even consider it a constraint. But we may have gotten lazy in our thinking. Many people who should know better simply write off US consuming habits as something endemic to American culture, and we just assume it as a universal constant, but in fact US consumption levels, like those of every other country, respond to changes in conditions, and these are about to change.

The US is the shit:

We should never underestimate the immense flexibility of the US and its ability to restructure itself at a pace far faster than most other countries can manage (anyone who grew up in the dismal 1970s will remember the dramatic – and seemingly improbable – US economic transformation of the 1980s), and if the Obama administration is serious about creating conditions for an increase in US savings, it probably wouldn’t be a good idea to bet heavily against success..

Say good by to the US trade deficit:

Those days are almost certainly over. Even without Obama’s desire to create conditions for an increase in US saving rates, US households have to increase their savings and rebuild their balance sheet, which means that we have several years ahead of us of deleveraging and increased savings. It also means we have several years ahead of US consumption growing more slowly than US GDP. I don’t think anyone is expecting much net growth in US GDP for the next three or four years, and so it is not at all implausible that we will see negative growth in US consumption and, as a consequence, a collapse in the US trade deficit, which may even turn into a trade surplus. The pace of this transition will largely depend on US fiscal policies aimed at slowing, but not eliminating, the contraction in demand.

If the US is no longer the importer of last resort, and if no one else can replace the US in that role in the medium term (I stress medium term because in the long term the demographic changes in Europe and Japan – and China for that matter – may well result in rising trade deficits in those countries), then any development model that necessarily results in production growth exceeding consumption growth – high savings development models, in other words – will run into the trade deficit constraint. They must run surpluses to grow, but if no one else runs sufficiently large deficits, they simply cannot run those surpluses.

The Chinese stimulus is prolonging the needed reforms to the Chinese trade surplus model, and also, the spark in new lending is liable to create a large number of non-performing loans (these are never good for economic recovery, just ask Shittybank)

This is why I am worried about recent fiscal and credit policies. It is not just that these policies are slowing down the rate at which China will adapt to the new world of lower US trade deficits. More importantly perhaps is that the only obvious replacement for US demand – domestic Chinese demand – will itself be sharply constrained by current policies, especially credit policies.

Why? Among other things because if the explosion in new lending (loans are up 15% in the first quarter of this year) leads, as it almost certainly will, to a subsequent explosion in non-performing loans, in the next few years just as China is expanding its production and struggling with US reluctance to absorb its rising excess capacity, the resolution of the NPLs will itself constrain Chinese consumption. Resolving future NPLs, in other words, will reduce future domestic consumption growth in China, just as the current resolution in the US of bad loans and shattered household balance sheets must come with reduced US consumption growth.

This is because if China’s banks see an explosion in non-performing loans it will have to pay for that increase in the coming years in one or both of two ways. The central government can recapitalize the banks by giving them money, which they have raised by borrowing or increasing taxes, or the regulators can keep deposit rates very low as a way of subsidizing bank profitability so that they earn their way out of the NPL losses. They did both after the last banking crisis, and will probably do both again.There is a third thing they can do, appropriate the money from SOEs, but I suspect that there won’t be nearly enough to resolve the NPLs – the World Bank estimates that the last banking crisis cost China 55% of GDP.

China could experience its own domestic credit crisis if things do not work out correctly:

Both strategies will represent, ultimately, a large transfer of income from households to banks, and in either case it will also represent a continued drag on consumption growth in the medium term. If the government borrows to bail out the banks, it will divert resources from the real economy and so slow income growth. If it raises taxes, it will reduce disposable income and so reduce household consumption growth. If it keeps interest rates low it will again reduce disposable income (interest income is an important source of income) and so slow consumption growth (in China lower interest rates tend to increase the savings rate).

Since it is unlikely that the US will be in a position in the near future to return to the halcyon days of large trade deficits, and since no other economy can replace the US in the role, turgid consumption growth in China will translate directly into turgid GDP growth for many years. Rising non-performing loans are not a small threat to China’s long-term growth. If the Asian development model is dead, China will need domestic consumption growth more than ever, and this is cannot be the best time for China to try to revive the production-enhancing model in a way that may limit future domestic consumption growth.