Friday, August 24, 2007

Minsky Moment

In Time of Tumult,
Obscure Economist
Gains Currency
Mr. Minsky Long Argued
Markets Were Crisis Prone;
His 'Moment' Has Arrived
August 18, 2007; Page A1
The recent market turmoil is rocking investors around the globe. But it is raising the stock of one person: a little-known economist whose views have suddenly become very popular.

Hyman Minsky, who died more than a decade ago, spent much of his career advancing the idea that financial systems are inherently susceptible to bouts of speculation that, if they last long enough, end in crises. At a time when many economists were coming to believe in the efficiency of markets, Mr. Minsky was considered somewhat of a radical for his stress on their tendency toward excess and upheaval.


Hyman Minsky
"The Financial Instability Hypothesis" by Hyman P. Minsky, May 1992
"The Plankton Theory Meets Minsky" by Paul McCulley, March 2007
"Capitalism's Beast of Burden" by Paul McCulley, January 2001
Today, his views are reverberating from New York to Hong Kong as economists and traders try to understand what's happening in the markets. The Levy Economics Institute of Bard College, where Mr. Minsky worked for the last six years of his life, is planning to reprint two books by the economist -- one on John Maynard Keynes, the other on unstable economies. The latter book was being offered on the Internet for thousands of dollars.

Christopher Wood, a widely read Hong Kong-based analyst for CLSA Group, told his clients that recent cash injections by central banks designed "to prevent, or at least delay, a 'Minsky moment,' is evidence of market failure."

Indeed, the Minsky moment has become a fashionable catch phrase on Wall Street. It refers to the time when over-indebted investors are forced to sell even their solid investments to make good on their loans, sparking sharp declines in financial markets and demand for cash that can force central bankers to lend a hand.

Mr. Minsky, who died in 1996 at the age of 77, was a tall man with unruly hair who wore unpressed suits. He approached the world as "one big research tank," says Diana Minsky, his daughter, an art history professor at Bard. "Economics was an integrated part of his life. It wasn't isolated. There wasn't a sense that work was something he did at the office."

She recalls how, on a trip to a village in Italy to meet friends, Mr. Minsky ended up interviewing workers at a glove maker to understand how small-scale capitalism worked in the local economy.

Although he was born in Chicago, Mr. Minsky didn't have many fans in the "Chicago School" of economists, who believed that markets were efficient. A follower of the economist John Maynard Keynes, he died just before a decade of financial crises in Asia, Russia, tech stocks, corporate credit and now mortgage debt, began to lend credence to his ideas.

Following those periods of tumult, more investors turned to the investment classic "Manias, Panics, and Crashes: A History of Financial Crises," by Charles Kindleberger, a professor at the Massachusetts Institute of Technology who leaned heavily on Mr. Minsky's work.

Mr. Kindleberger showed that financial crises unfolded the way that Mr. Minsky said they would. Though a loyal follower, Mr. Kindleberger described Mr. Minsky as "a man with a reputation among monetary theorists for being particularly pessimistic, even lugubrious, in his emphasis on the fragility of the monetary system and its propensity to disaster."

At its core, the Minsky view was straightforward: When times are good, investors take on risk; the longer times stay good, the more risk they take on, until they've taken on too much. Eventually, they reach a point where the cash generated by their assets no longer is sufficient to pay off the mountains of debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. "This is likely to lead to a collapse of asset values," Mr. Minsky wrote.

When investors are forced to sell even their less-speculative positions to make good on their loans, markets spiral lower and create a severe demand for cash. At that point, the Minsky moment has arrived.

"We are in the midst of a Minsky moment, bordering on a Minsky meltdown," says Paul McCulley, an economist and fund manager at Pacific Investment Management Co., the world's largest bond-fund manager, in an email exchange.

The housing market is a case in point, says Investment Technology Group Inc. economist Robert Barbera, who first met Mr. Minsky in the late 1980s. When home buyers were expected to have a down payment of 10% or 20% to qualify for a mortgage, and to provide income documentation that showed they'd be able to make payments, there was minimal risk. But as home prices rose, and speculators entered the market, lenders relaxed their guard and began offering loans with no money down and little or no documentation.

Once home prices stalled and, in many of the more-speculative markets, fell, there was a big problem.

"If you're lending to home buyers with 20% down and house prices fall by 2%, so what?" Mr. Barbera says. If most of a lender's portfolio is tied up in loans to buyers who "don't put anything down and house prices fall by 2%, you're bankrupt," he says.

Several money managers are laying claim to spotting the Minsky moment first. "I featured him about 18 months ago," says Jeremy Grantham, chairman of GMO LLC, which manages $150 billion in assets. He pointed to a note in early 2006 when he wrote that investors had become too comfortable that financial markets were safe, and consequently were taking on too much risk, just as Mr. Minsky predicted. "Guinea pigs of the world unite. We have nothing to lose but our shirts," he concluded.

It was Mr. McCulley at Pacific Investment, though, who coined the phrase "Minsky moment" during the Russian debt crisis in 1998.

Laurence Meyer, who served on the faculty with Mr. Minsky at Washington University in St. Louis, was a Federal Reserve Governor during those turbulent times. Mr. Meyer says that when he was an academic, Mr. Minsky's work didn't interest him very much, but that changed when he went into the real world. He says he grew to appreciate it even more when he was at the Fed watching financial crises unfold.

"Had Minsky been there, he probably would have been calling me and alerting me along the ride. And that would have been a good thing," Mr. Meyer says. "Every year that goes by, I appreciate him more. I hear myself sometimes and I think, oh my gosh, I sound like Hy Minsky."

Steven Fazzari, an economics professor at Washington University, says that Mr. Minsky would have supported the Federal Reserve's recent move to provide cash and cut the rate it charges banks on loans from its discount window to try to avert a financial crisis that could spill over to the economy. But he would probably be worried, too, that the moves might be bailing out investors who would all too soon be speculating again.

Having seen recent events unfold in the way his friend and former colleague predicted, Mr. Fazzari says, "I hope he's someplace saying, 'Aha, I told you so!'"

Monday, August 20, 2007

Treasury yields fall more than after 9/11 attacks.

Treasury Bill Yields Fall Most Since 1987 on Money Fund Demand
By Deborah Finestone and Elizabeth Stanton

Aug. 20 (Bloomberg) -- Yields on U.S. Treasury bills fell the most in two decades on demand for the safest securities amid concern over a widening credit crunch.

Bill yields have fallen five straight days as money market funds dumped asset-backed commercial paper in favor of the shortest-maturity government debt. Three-month yields dropped the most since the stock market crash of 1987 and more than in the wake of the Sept. 11, 2001, terror attacks in the U.S, as funds shunned assets that may be linked to a weakening mortgage market.

``The market is totally, absolutely, completely in fear mode,'' said John Jansen, who sells Treasuries at CastleOak Securities LP in New York. ``People are afraid that lots and lots of mortgage paper and mortgage paper derivatives of all sorts is completely opaque and they can't price it.''

The three-month Treasury bill yield fell 0.82 percentage point to 2.94 percent as of 2:54 p.m. in New York. It's the most since Oct. 20, 1987, when the yield fell 85 basis points, or 0.85 percentage point, on the day the stock market crashed, and eclipses the drop of 39 basis points on Sept. 13, 2001, the day the Treasury market reopened after the attacks. The yield has fallen from 4.69 percent on Aug. 13. The bills yielded about 7 percent in mid-October 1987, and 3.2 percent in the days before the September 2001 attacks.

``The psychotic atmosphere that's gripped the markets recently is still in place,'' said Tony Crescenzi, chief bond market strategist for New York-based Miller Tabak & Co. ``This is quite evident in the way the T-bill market is acting.''

`Get into Treasuries'

The flight to government debt helped the U.S. Treasury sell $21 billion in three-month bills today at a high discount rate of 2.85 percent, the lowest since 2.8 percent on May 16, 2005.

Investors fled even money market funds, considered among the safest instruments, on concern that the funds, which hold $2.5 trillion, have invested in risky collateralized debt obligations backed by subprime mortgage loans.

``We had clients asking to be pulled out of money market funds and wanting to get into Treasuries,'' said Henley Smith, fixed-income manager in New York at Castleton Partners, which oversees about $150 million in bonds. ``People are buying T-bills because you know exactly what's in it.''

The Federal Reserve Bank of New York said in a statement it won't re-invest the $5 billion of Treasury bill holdings maturing on Aug. 23 through its System Open Market Account to give it ``greater flexibility'' to manage reserves. It is the first time the Fed redeemed the Treasury bills since the 2001 terrorist attacks. Crescenzi said the move shows the Fed expects banks to borrow that much at the Fed's discount window.

Job Cuts

Treasuries headed higher earlier after SunTrust Banks Inc., the seventh-largest U.S. bank, said it expects to eliminate 2,400 jobs by the end of next year as part of a plan to cut costs. That may signal the credit crunch in the U.S. will cost jobs and may slow the economy.

The yield on the benchmark two-year note fell 11 basis points to 4.08 percent. The price of the 4 5/8 percent security due in July 2009 rose about 6/32, or $1.88 per $1,000 face amount, to 101.

Investors' focus is turning to ``the amount of job cuts you're going to have from this fallout,'' said Sean Murphy, a Treasury trader and strategist in New York at RBC Capital Markets, the investment-banking arm of Canada's biggest bank.

Slower Economy

More than half of the 21 primary government security dealers that trade with the Fed now expect the central bank to cut its target interest rate by next month from the current level of 5.25 percent.

``The Fed is going to lower the funds rate, it's a question of when,'' said Thomas Tierney, head of U.S. Treasury trading at Citigroup Global Markets Inc. in New York. ``Credit's gotten tighter, and it's going to slow the economy.''

The Fed on Aug. 17 cut the rate it charges banks for direct loans to banks by 0.5 percentage point to 5.75 percent. It was the first reduction in borrowing costs between scheduled meetings since 2001. The central bank said in a statement that risks to the economy have risen ``appreciably.''

The move failed to revive demand for asset-backed commercial paper in Europe. Solent Capital Partners LLP, a London-based credit-fund manager, is seeking to draw on emergency financing after it couldn't borrow in the commercial-paper markets.

``There is a lot to roll over in the commercial paper market and that has people getting nervous,'' said Ian Lyngen, an interest-rate strategist in Greenwich, Connecticut at primary dealer RBS Greenwich Capital.

Interest-rate futures traders see a 100 percent change the fed will lower its overnight lending rate between banks by its next meeting on Sept. 18. Eighty-six percent of those bets are for rates to drop to 4.75 percent, while the balance is for a cut to 5 percent.

To contact the reporters on this story: Deborah Finestone in New York at ; Elizabeth Stanton in New York at

Sunday, August 19, 2007

Are we there yet?

How close are we to a true market dislocation. One that is severe enough to take out large players in the debt/credit pyramid. As I was watching Cramer's "meltdown"/carefully orchestrated demagoguery at the behest of some big credit players to get the attention of public/government, it became obvious that there was some real money being lost by real players. It is rather amusing that Cramer's antics were so widely ridiculed; yet it had the desired effect. Namely, The Fed cut the discount rate. Though largely symbolic, it shifts the bias of the Fed into "easing" mode. Surely cuts in the Fed Funds rate are nigh. Since the Fed is really a private bank with monopolistic currency printing power that is doing the bidding of the big Wall Street Firms/Political elite, rate cuts are a "sure thing". Despite Mr. Poole saying that only a "calamity" would force a rate cut, Goldman Sachs Alpha Fund is down some 25%. This "Star Fund" represents some big money, now taking big losses, and in the eyes of the Fed, this is a calamity. An acquaintance of mine told me that they are starting to serve free lunches at GS, an obvious attempt to soothe their people about their shrinking bonuses this year (no free lunch). NY real estate runs on bonuses, and thus by extension confidence. If there is a large market correction leading to a few thousand pink slips, this will sink the NY Real Estate market like the Bismarck (another unsinkable ship). We are really at the precipice now. If Bernanke keeps FF rates at 5.25%, the tsunami in the credit markets will roll through and take out many players quickly. If he lowers rates (which I believe he will as well as the EUCB), credit party continues for a while, but dollar/euro will get hurt. Yen carry trade probably finally unwinding and thus yen may be the most undervalued asset in the world.

Sunday, August 12, 2007

Some more problems for "home builders"

Missold loans are blow for US builders
By Doug Cameron in Chicago
Published: August 12 2007 18:42 | Last updated: August 12 2007 18:42
US homebuilders are facing a fresh bout of legal and regulatory challenges to their ability to rebound from sluggish demand and the fallout from the subprime loan crisis.

Some of the largest builders have been hit with class-action suits over their lending practices and at least two companies have been surrounded in recent weeks by speculation that they could be forced to file for bankruptcy protection.

The problems deepened after the market close on Friday when Beazer Homes USA said it would delay filing its second-quarter earnings with the Securities and Exchange Commission amid multiple probes into possible accounting irregularities.

The Atlanta-based group is already the subject of federal and civil actions into alleged misselling of home loans after cut-price offers led to a surge in foreclosures in North Carolina. DR Horton, the largest US builder, revealed last week that it had become the latest target of a class-action suit into its selling policies.

Beazer, the subject of a formal investigation by the SEC, said an internal accounting probe revealed possible problems with the recording of “reserves and other accrued liabilities” related to land-development and building costs, which may have deflated expenses.

The announcement came a week after Beazer’s share price slumped by more than 40 per cent in a single day amid speculation it could be forced to file for Chapter 11 protection. Shares in the seventh-largest US builder by revenues have slid by almost 70 per cent so far this year, weighed by the legal uncertainty and the weak demand which has spread through the sector over the past 18 months. Citadel, the hedge fund manager which has already snapped up some distressed subprime lenders, has since taken a 5.7 per cent stake in the group.

Beazer has insisted it does not face a liquidity squeeze, and banks have continued to extend credit, albeit halving the size of its current unsecured line.

Standard Pacific, a California-based builder with exposure to the overheated markets in Phoenix and Florida, was also hit by speculation last week that it could be forced to file for bankruptcy protection. The company said it had reopened talks with banks about easing its lending covenants.

Credit experts said banks were unwilling to push any of the leading builders into liquidation by enforcing the strictest covenants. Banks hope to remain primary lenders when the industry recovers – although this could take well into next year – and are also wary of ending up with a glut of foreclosed home assets at a time when excess inventory is pushing down prices in most parts of the US.

Copyright The Financial Times Limited 2007

Friday, August 10, 2007

Amusing "Educational" Video from EU Central Bank

I don't know if I should laugh or cry. It reminds me of the nuclear power educational videos you see on The Simpsons. Interestingly, no where in the video is the price of real estate mentioned when they talk about the importance of "price stability".

Central Bank Propoganda

Thursday, August 09, 2007

ECB injects more liquidity than after 9/11 attacks.

Central banks’ aggressive moves stun markets
Published: August 9 2007 19:12 | Last updated: August 9 2007 19:12
The European Central Bank stunned markets on Thursday with its aggressive intervention to quash a brewing liquidity crisis in European financial markets.

The ECB move far exceeded in scale and scope the relatively modest steps taken by the Federal Reserve to sustain adequate liquidity in US markets.

After noting a sharp rise in overnight interest rates to 4.7 per cent – far above the target 4 per cent – the ECB put out a statement in the morning saying it stood “ready to assure orderly conditions in the euro money market”.

Within a couple of hours it acted: taking the unprecedented step of offering a pre-announced unlimited tender so that European banks could get as much cash as they wanted.

The last time it stepped in to provide large-scale liquidity in response to market concerns was in the aftermath of the September 11 terrorist attacks. But even then, it did not offer unlimited support.

Equally striking was the amount of money the 49 banks that took up the tender received: €94.8bn ($129bn). This was far above the €69bn banks took on September 12 and the €40bn the next day. By contrast, the Federal Reserve – which also saw overnight rates move up to above 5.75 per cent, compared with its target rate of 5.25 per cent – took less drastic action to support liquidity.

The New York Fed brought forward by a few minutes its normal daily open market operations, injecting a total of $24bn in overnight and 14 day repos during morning trading.

As of midday in the US, the Fed had not made any public statements.

The scale of US intervention – about twice the average for a normal day – is unusual, but does not suggest that the Fed is in full crisis-fighting mode.

It suggests that the Fed believes US markets are still functioning adequately – albeit in need of some additional liquidity support – rather than in danger of completely seizing up.

Martin Barnes, editor of the Bank Credit Analyst, an economic newsletter, said “We have a real role reversal here.”

The liquidity shortfall in Europe that caused the ECB to act was grounded in fears about US subprime mortgage securities held by European investors. Moreover, the Fed has traditionally been much quicker to ride to the rescue when markets encounter difficulties, with European central bankers adopting a more hands-off approach, concerned not to cause “moral hazard.”

This time, though, the ECB moved to inject unlimited liquidity only two days after the Fed retained its focus on inflation at its August policy meeting.

The stand-out nature of the ECB move was partly driven by the way it interacts with financial markets. Unlike the US Fed, it does not inject or withdraw liquidity every day, but instead conducts what it calls “fine-tuning” every now and then to regulate liquidity – and such actions were not scheduled for some time.

Many analysts applauded the ECB for its decisive action. Erik Nielsen, an economist at Goldman Sachs, said “This is outstanding central banking by the ECB and ought to provide a lot of comfort to the market.”

Bruce Kasman, an economist at JPMorgan, said the move sends two signals: first, that the ECB is “ready to provide liquidity to ensure the smooth operation of European money markets” and second, that for now it is happy doing so at its current interest rate.

However, some central bank officials fretted that the ECB move could cause market participants to worry more than they needed to.

“The aggregate liquidity conditions are usual even if there is a bit of turbulence. But there is the risk that banks may not really have needed this amount of liquidity and that the market therefore reads something into this action that they shouldn’t do,” says one ECB official.

Analysts pondered whether the ECB’s step indicated that there were more serious problems in the European financial system that were not yet public.

Meanwhile, the jury is out on whether the Fed is wise to adopt a relatively sanguine approach, keeping its powder dry for use in the event of a true liquidity crisis – or whether it is dangerously behind the curve and could be soon forced into an embarrassing reversal.

Copyright The Financial Times Limited 2007

Sunday, August 05, 2007

Nice Video on Subprime Derivatives