Relevant and even prescient commentary on news, politics and the economy.

Household leverage: US vs. UK

Households in the US and the UK are members of the “most levered club”. But put their balance sheets side-by-side, and the outlook for the US economy looks a little brighter than that for the UK. Why? Both are dropping debt burden, but a qualitative analysis suggests that the UK household leverage (probably) should be falling at a more accelerated pace.

The chart illustrates leverage in the US and UK, or household debt (loans) as a percentage of disposable income (DPI) through Q3 2009 and Q2 2009, respectively (the UK releases Q3 Economic Accounts at the end of December). By Q2 2009, UK and US households dropped leverage rather coincidentally, -4.8% and -4.4%, respectively. However, the debt bubble was bigger in the UK than in the US, peaking at 160% of DPI compared to 131% in the US. Why isn’t leverage falling more quickly? Spending.

To be fair, UK Q3 statistics may paint a very different picture. However, that is unlikely, given that real retail sales continue to grow, 3.2% at an annualized rate in the three months ending in October.

Oh, it all makes sense now: UK retail sales remained firm in 2009, and real home values hit a (probably local rather than global) cyclical low much earlier than in the US.

This is an ominous sign for the UK economy. Households are kicking the can down the road: de-leveraging – paying down debt by dropping consumption and saving a relatively higher share of income – is inevitable.


Sit back and relax: the US and China, this is gonna take awhile

China exported its way to a $2 trillion dollar fortress of F/X reserves ($USD mostly), while the US borrowed its way into a hole deep enough to spark a vast global recession. Who’s to blame?

Given the symbiotic relationship in the chart above, it’s hard to blame any one individual, group, or even country. But blame we do. Martin Wolf, at the Financial Times, wrote an interesting article about the need for a “co-operative adjustment” of global current account deficits and surpluses. He argues the following:

China’s exchange rate regime and structural policies are, indeed, of concern to the world. So, too, are the policies of other significant powers. What would happen if the deficit countries did slash spending relative to incomes while their trading partners were determined to sustain their own excess of output over incomes and export the difference? Answer: a depression. What would happen if deficit countries sustained domestic demand with massive and open-ended fiscal deficits? Answer: a wave of fiscal crises.

It sounds so imminent: re-balance now, or else. Sure the tides of portfolio flows must change; structural current account imbalances are now proven to cause economic catastrophe, as illustrated by the 2-yr case study of late. But it’s not going to happen over night. It takes a long time for re-balancing of any kind to fully pass through. Just look at Japan in the 1990’s.

Data note: you can download Japan Flow of Funds data here, and US Flow of Funds data here.

The chart above illustrates the debt bubbles in the US financial crisis and in 1990’s Japan. In Japan, the households didn’t accumulate as much debt relative to the non-financial business sector; however, both sectors dropped leverage. And notice, that it took about a decade for households and firms to do so.

What’s overly obvious is that the Chinese will not be bullied into revaluing the yuan just because the US says so. And also evident is that there is a (very lengthy) de-leveraging process underway in key economies. By default, the debt-reducing developed world will force the Chinese to focus policy more inward (domestic demand) and less outward (export demand), as US consumers drop debt levels. But sit back and relax, it’s gonna be a while.

Rebecca Wilder

Capitalism deserves a better defense, or Reasons to Short the Old Firm, Pre-BK

Ken Houghton’s Loyal Reader directed my attention to this WSJ blog entry, commenting on, and attempting to provide cover for, the management and actions of The Old Firm.

I’m sympathetic to the general argument—Ace Greenberg’s naming of Jimmy Cayne to succeed him was incredibly bad judgment that had real consequences, but not malice aforethought—but the WSJ’s attempt to defend upper management rather goes off the rails.*

Let’s look at some of the analytical parts of the article:

Investment banks were certainly imprudent in leveraging themselves 33 to 1; but they also announced it publicly in their quarterly statements.

“Certainly imprudent” is having unprotected sex with someone who clearly has open genital and/or oral herpes sores. 33x is larger even than the Cox-allowed 30x leverage (which was imprudent in the first place). “Thirty times leverage; it’s not just imprudent, it’s the law.”

UPDATE: My Loyal Reader e-mails:

Cohan writes that only at the end of a quarter was Bear around 40:1 and most of the rest of the time it was at 50 or 55:1….JPMorgan Chase at the time of the takeover calculated that out of $300 billion Bear Stearns counted as assets, $220 billion could be considered “toxic”.

So even Moore’s 33:1 is known to be optimistic. And having more than 73% of your “assets” rated as “toxic” isn’t prudent management: it’s doubling-down while hitting on 17.

We all know that the Prudent Investor definition has been redefined beyond reality, but it’s difficult to believe anyone would consider BSC’s practices to compile with reasonable Standards and Practices.

Shareholders, in turn, never complained as long as the banks were making money in 2006 and 2007. It was only when the music stopped and the economy turned bad that shareholders started to blame the banks for shifty dealings.

And it was only when Madoff admitted there were no more assets that “shareholders” complained. Are we supposed to take some affirmative defense from this, or is Heidi Moore just clueless? (You can chose “and” if you want.)

Meanwhile, regulators are said to still be curious about what caused the “bear raids” that took down Bear Stearns and Lehman and threatened Morgan Stanley and Goldman Sachs.

They’re welcome to be curious, but the minute Alan Schwartz went on CNBC and said, “We think we’re solvent” is the minute anyone with any brains and capital went massively short Bear. And they were late to the party, since anyone in the market with any brains and knowledge of MBS ramifications—think the guy at Solly who called Michael Lewis and said “Buy potatoes” as Chernobyl was happening—knew exactly who was going to be Most Likely to Pay Off if you bought (again, common knowledge) some proverbially-undervalued far OOTM put options.

In fairness, Cohan appears to believe this is a smoking gun. But we’ve heard those rumours since before the bankruptcy, and Bear Stearns is not Iceland. If Cohan’s correct in his assertion on Stewart’s show that the people who bought all those OOTM put options were hedge funds that had previously used BSC for their Clearing Agent, then they voted with their feet in the face of reality.

And the rest of the market isn’t dumb. They could see who was buying, and what their previous relationship with Bear had been. And they would see Alan Schwartz and realise this is not the man who is going to make it between the Scylla and Charybdis. And they would take that—along with things such as Goldman’s immediate affirmation when the rumours starting about Lehmann and Bear that Lehmann would continue to be a respected competitor and trading partner—and be able to add.

As the Beatles said, “One and one and one is three/Got to go short Bear cause he’s so hard to see.”

But the WSJ wants you to think that going even beyond Christopher “I never saw a regulation I planned to enforce” Cox’s SEC-permitted leverage ratios is not a violation of the law, and that hedge funds who see incompetence and near-bankruptcy do not act on that information.

The coolest thing about the Stewart/Cohan interview was when Cohan said “creative destruction” and Stewart immediately came back with Schumpeter by name. Maybe this is why Heidi Moore’s piece opens by calling Stewart “our nation’s foremost financial commentator.” (Take that, Paul Krugman!) But the attempts to argue that The Old Firm was substantively different from a Ponzi scheme are going to need a better case made than she does.

Capitalism deserves a better defense.

*They specifically miss connecting the dots on where there was clear fraud committed by management—and I suspect Cohan did as well, since no one who talks about the book seems to mention it. UPDATE: I’m now told he did deal with it, but sloughed it off. So expect Yves or Barry or Felix (blogroll update candidate, btw) or Paul (maybe even Mish, who has the mindset for the job)—someone who pays a lot more day-to-day attention to the market than I can right now—to jump on this one in the near future.