Tuesday, March 04, 2008

Financial Race to the Bottom?

Writing today, Mike Shedlock notes upcoming prime interest rate cuts by various central banks. Of particular interest is the why of cutting rates. Canada cut because their exports to the US are falling and US exports are a large part of their income. The Eurozone is considering a cut because of the same pressures, with many European employers now threatening to layoff people and move jobs outside the Eurozone. Even Japan, with an interest rate of 0.5% is threatening to cut... to what, zero? Why? Because economic growth is slowing in Japan and Japan exports lots of products to the US.

This raises the question of whether the various economic powers of the world are now prepared to race to the bottom in an effort to support their own economies at the expense of everyone else's economy? It certainly is starting to look that way at this time. But what happens during massive contractions? Certainly not building new infrastructure or large scale capital spending on new and unproven technologies.

Thus, it appears that we are adding another positive feedback loop to the existing ones working against mankind right now. The others are natural cycles altered by man - resource depletion, climate change, topsoil erosion, water table depletion, overpopulation, etc. This new one is a man-made system (economics) again altered by man himself with simple greed and corruption, destroying trust in the underlying financial system at precisely the moment in history when the financial system is most needed to counter the other positive feedback loops.

Monday, March 03, 2008

Financial House of Cards Continues to Tumble

1. Margin calls started in mid-February against Thornburg Mortgage. Now it appears that Thornburg Mortgage is about to miss the next series of margin calls as their collateral continues to rapidly decline in value.

UPDATE 3/4/08: Thornburg in default; fails to meet margin calls.

2. The Bank of Montreal has missed margin calls as well. As a result Bank of Montreal's trust funds were downgraded to junk status.

3. Focus Capital, a large US hedge fund, is rapidly dumping assets to raise cash to meet collateral requirements or will face margin calls. UPDATE 3/5/08: Focus Capital collapses against margin calls.

4. Peloton Funds in Britain was wiped out over the weekend as margin calls were made against loans they had taken out. But the collateral had fallen in value. Unable to meet collateral requirements they had to sell assets to come up with the cash. With no buyers in the market, they were forced into firesale mode ultimately liquidating the entire fund for pennies on the dollar. Anyone invested in that fund lost everything that was invested.

5. What is happening right now is that the largest banks lack capital themselves. As a consequence they are starting to squeeze anyone who has an upside down loan, starting with businesses first. The banks need capital, either cash or hard assets. These funds all took out positions based on expectations of further growth at the same time the economy was beginning to slow and now is starting to actually contract. Everyone globally is short cash but the banks are in the best position to squeeze others. However, even the banks are facing trouble. The FDIC is apparently expecting 100-200 bank failures in the next 24 months. This compares to zero failures from 2005-2007.

6. The cash problem is also affecting the bond markets where muni bond sales have collapsed almost completely. Consequently cities and states are being forced to cut services.

Sacramento is cutting their entire workforce 10%. Vallejo, CA is on the verge of bankruptcy. El Dorado county, CA is cutting budget.

The entire state of Arizona is in trouble. (Warning! PDF!)
Quoting from the PDF:
Total January General Fund revenue collections were $849.3 million, or (16.1)% below January of last year. This amount was $(226.2) million below the forecast based on the June enacted state budget.

For the first 7 months of FY 2008, General Fund collections are down (3.5)% when compared to last year, and are $(619.2) million less than the enacted forecast. When factoring in Urban Revenue Sharing, year-to-date collections are (5.1)% below last year.

The January decrease represents the largest percentage year over year decline since April 2002. The dramatic drop in January revenues was across the board in all 3 main revenue categories:

* Sales tax collections were down (7.5)% compared to January 2007, and were $(71.9) million short of the monthly forecast. This is the largest percentage year over year decrease since at least FY 1991.
* Individual income tax collections were down (11.9)%, which was $(98.7) million below forecast.
* Corporate income tax collections were (138.9)% below last year, and $(35.7) million below the forecast.

7. Last month, William Poole, the President of the Federal Reserve Bank of St. Louis, wrote about the problems of "moral hazard" that are showing up right now.

This is all part of the problem that Bernanke is trying to address. The Fed providing liquidity is not helping because liquidity is not the problem. The core problem is that the financial institutions themselves don't even trust each other right now. Bernanke has to solve that problem. How does he solve that? I don't know and it's going to be hard but if he doesn't the entire banking system comes down. Meanwhile, as the Fed does provide more liquidity this causes worsening inflation and further collapses in the dollar. In January 2007, it tool $1.39 to buy 1.00 Euros. Today it takes $1.52 to buy 1.00 Euros. The dollar is collapsing in value globally at a 10% annual rate because we are holding interest rates too low. Meanwhile this is still not helping the banks or other financial institutions because liquidity is not the problem - moral hazard is.

If I were a betting man, I'd be betting on a really bad recession right now. And things could even get worse than that. Why is this important? Because the horsemen of the apocalypse are still riding our direction. Peak oil is not taking a break. Global grain reserves are about to reach the lowest level since 1947. Climate change is accelerating. And now our economic system is coming apart right when we need social and economic stability to confront multiple global problems. If you can't see where this is going, then you shouldn't be reading this blog.