The New Paradigm: The Calculus of Derivatives
First Posted by S. Caroline Schroder on InterimCEO.com on February 13, 2008 at 4:29pm
More than half a decade late, but the new paradigm in world economics is finally here. The market’s up 4.4%, the market’s down 4.4%; retail sales fall through the floor, retail sales rise on prices through the floor. It sounds like the Greenspan story of another era, but the ending of this story will be never be the same. Fractures have formed over decades in the financial structure of the country. Slippage is not just mere recession or stagflation, but fundamental global shifts in world economic and national financial power which sets a new world paradigm. Beyond the rise of China, beyond the rise of the Euro, we have in the past six months seen a flow of US financial power and determination offshore. Where the U.S. economy lands, or plateaus, is largely to be determined beyond our shores in Singapore, Saudi, China and Euroland. This is a first for the U.S. Its ultimate effect cannot be measured, nor can it be ignored. As Oystein Noreng, the Norwegian economist, has pointed out, the barrel of oil is de facto denominated in Euros and may be soon in fact; imports and exports trend thus too. Now our debt at the highest levels, the CDO/subprime debt, is getting sold in the form of cash infusions to banks from Singapore and Saudi, Abu Dhabi and Kuwait. We stand on the precipice of a national recession unlike any other. This is not business as usual. This is no ordinary cycle.
CDO to cov lite, the bankers drank the Kool Aid ® from the Greenspan punch bowl with irrational exuberance and everyone partied, from the traders to the sub prime house buyers, but this is an old, old rave and not an ordinary 20th century hangover. Certainly debt recently took off and fed the overhang of cash which fueled the private equity surge, spreading derivatives from here to Germany and China. The overhang of debt finally became oversteep on the backs of the subprime house buyer, and from Merrill to Citi, Morgan Stanley to WaMu, the bankers have reaped the losses as consumer paper wealth disintegrated into ash. However, this is not just a punchbowl of the past 2 years, the past 5 years, or even the past decade. Greenspan was already late to the party with his warning in December 1996. This dates back to the rise in consumer and corporate debt in the 1980’s. New paradigms were forecast even then as everyone was to own a house, build a life on credit and corporations were to take on new life through debt through LBO and at the gun point of Boone Pickens’ green mail. This story has a long history.
When the CDO’s will have passed on, we will still have a nation layered up with debt, from the consumer with credit cards all the way up to the layers of debt added to corporate balance sheets amidst the private equity party. This is not just a dose of Omega 3 fish oil; this is the Little Prince’s elephant which the boa swallows and does not digest. The lump will still be there: With food prices shooting up 35%, oil still over $90, and thousands already laid off in banking, mortgage banking and real estate alone, and inevitable curbs on consumption of everything that builds, fits, restores and fills a house or condo, it’s not over for the consumer and the economy until the last trickle down…
And even then, in a world where a Halliburton, on its billions of dollars of U.S. government contracts, moves its headquarters to Dubai, oil is denominated in Euros and countries outside our usual galaxy of the old NATO allies, countries of ambivalent regard for the U.S., hold key pieces of our financial structure, can anyone tell what will happen next? At the drop of the market or the quarterly numbers, U.S. companies no longer feel a need for the mutual loyalty of company and employee measured in decades or even a year, and cut backs, suspension of benefits and salary and wage give-and-take, and mass de-layering can occur overnight. We have seen it in the oil industry, we have seen it in the power industry; it can move down street and around the block and through the neighborhood of any region and any sector, fast. Does anyone remember the industrial north on the back of escalating oil prices in 1980, the oil industry in 1984 and 1987, power and technology in 2002, agriculture in year after year for the family farm? Does anyone remember waves of people tossing keys to the banks in the 1980’s, subdivisions emptying? You may not, if it was not your region, but people in Texas, Ohio, Michigan and out in the farm towns everywhere remember. These things go in waves, disturbingly. There are a lot of sectors implicated in this coming wave. We would never want to be negative thinkers, but there’s an awful lot of risk just about now. There’s a new paradigm at last; but perhaps we did not calculate on derivatives making it this global vision thing.
© Copyright 2008. Sigrid Caroline Schroder. All Rights Reserved.
What, Me Worry? We’re in the Hands of the Street.
Posted by S. Caroline Schroder on February 26, 2009 at 8:30am
Yes, I worry, but not about too much regulation. We should not worry excessively about the re-regulation of the financial services industry or the markets. They have quite enough continuing influence. The financial services industry is secure enough with Tim Geithner in there fighting for it, just as he blocked severe restrictions on executive compensation, government replacement of the bank executives, and government dictation of proper usage of bailout money. We have more to worry about an America without a domestic car and truck industry in a dangerous world. We have more to worry about being unable to produce our own textiles, rolled steel, flat steel and industrial and agricultural equipment than we have to even worry about energy reserves. We have more to worry about a nation swimming in debt, desperately short of cash flow. No, the worry is no longer regulation but whether the banks will be nationalized and what will happen if they are not. Just as Maureen Dowd reports continued bank partying just this past week in a cross-country boondoggle orgy of luxe excess, lessons have not been learned. The imperial Street sinks at the threat of stress tests and cringes at compensation caps. Would we be likely to see 3500 on the Dow were serious regulation to be proposed? Yes. No, the greatest worry is that we will have to nationalize the banks and significant sectors of industry to break the cycle and return industry to sane management, prudent risk taking and a culture of ethics and responsibility.
Bush is accused by many of an Imperial Presidency. Imperial Presidency? Obama shows all the signs of catching up with Bush quite nicely fast. As for Bush, the Bush Presidency was a terrorized Presidency after 9/11 and the ensuing market crash. Terror drove all the thinking. Overall, I have seen more imperial presidents of home owners associations.
We should worry more about the Imperial Street where cult analysts have driven other industry hostage to short-term, number crunching, showmanship and market fad. Critical thinking disappeared. The Street, McKinsey and the banks drove the growth mania and bonus and options systems which bent Enron, fed the dotcom tulips, and generated the fraud roll call from Tyco to WorldCom to Global Crossing. As we have seen through three and now four Administrations, every POTUS governs at the mercy of the imperial Street. Every attempt by the Fed to control the problem in the 90’s was met by stunning cascades of the market and ultimately engendered a mythology of ‘new paradigms’ to obscure the fact that Greenspan had been taken hostage. We should have worried more about administration officials rolling out onto the Street and coming to preside over the death of Citibank and regulators revolving out the door to make big money on the Street or in its handmaiden professional firms–or marry the niece and compliance officer of their lauded subject of investigation. The reign of the Imperial Street continues: Obama only had to mention “regulation” and the market dropped so that forces had to emerge to ameliorate the sound of “stress tests.”
True fault lies back in the Clinton administration wherein Rubin and Summers pushed Congress for the repeal of Glass-Steagall and change of the Bank Holding Company Act. Fault for mortgages lies back with Barney Frank and much earlier. Remember evil “red-lining”? Fannie Mae and Freddie Mac were pushed, politicized and ultimately spun loose and pushed OVER Bush administration concerns for systemic risk to the financial system; they were pushed for growth by the Iimperial Street looking for high growth quarterly numbers. Who could not have foreseen disaster? One did not need a Greek chorus. And look who is in control now, Summers and Rubin’s pupil, Geithner, along with Frank.
© 2009 S. Caroline Schroder. All Rights Reserved.
Has Bernanke not yet lost all credibility?
What the government would do or see itself doing is not to be confused with what it might do or what it should do. The crisis is global, the problems systemic from New York to London to Paris to Berlin. The wave has hit Australia, China, India and Japan. At the heart we have financial megaliths like Citi and AIG on the ropes, flatlining to the point of dismantling. This initial first shot is not so much an outlier as a first skirmish. Just as the WPA and the CCC did not solve the Great Depression, so too do we have a system battered and dismembered past the point of good works or opening a pipeline of cash through TARP and random trillions. Fundamental restructuring of management, ethics, discipline and risk aversion will ultimately be necessary. For insight, you might read the Japanese journalist Hiroko Tabuchi’s fascinating comparison of this crisis with the Japanese experience in the 1990’s after its fall from economic grace and new paradigms.
It would not seem that Obama quite “gets it.” Obama doles out mortgage support for the home borrowers who grasped for more than they could own on the backs of those more conservative. Meanwhile Obama’s tax increase for upper income brackets will include reduction of the mortgage interest and charitable deductions. What will this do for housing prices? What will this do for the nonprofits whose endowments have been sacked? Does Obama yet seem to have true understanding of the drivers of this crisis? This “fix” might have worked years ago to suppress formation of a high-end housing bubble and to alter behaviors around appreciated stock and exercise of options. Now it only exacerbates the problems and creates new ones.
The US market has shivered at the phrase “stress test;” it does not like compensation restrictions, management restrictions, re-regulation or scrutiny; but its components have come to the taxpayer tin cup and kitchen sink in hand. This will not pass in 6 months or a year and if staved off by trillions more will only revisit us with new revenge as fundamental behaviors and structures do not change.
© 2009 S. Caroline Schroder. All Rights Reserved.
Are You Surprised?
Did the downturn really catch you off guard? Does the timing and the depth really astound you? Do you cling to expectations of an early turnaround? Can restructuring of US banks really stem the tide, across the globe? Re-regulation, tax cut, stimulus spending: Will they work or is this the new paradigm at last? Have punch bowl economics, the feast of debt and irrationally exuberant credit finally run their course worldwide? How many of you did not:
1. Fret cov-lite lending;
2. Worry over luxury consumer credit spreading the life of the rich and famous — to those who were neither;
3. Wonder where due diligence had gone;
4. Comment on the prevailing corporate sense of entitlement not just to a job and earned income but real wealth, status and power (and that was just the Y Millennials);
5. Disbelieve real estate values;
6. Doubt the wisdom of portfolios of homes, at home and abroad, all endlessly furnished and refinished in granite, theater and rubbed bronze on lenders’ dollars;
7. Speculate on capital market values based on esoteric IP and dreams of IP–and revenue;
8. Anticipate the squeeze when trebling commodity prices would meet the finite stretch of budgets and flush out bad hedges on their way down;
9. Inveigh against hedge fund greed, excess and unregulated opacity heading straight to the cliff;
10. Predict the implosion of China on nonperforming loans, excess capacity, duplicity, cultural machination and manipulation of the Renminbi in a hyper-inflationary environment of unreality? The down won’t reverse without the real new paradigm. Look to Ballmer and Microsoft: economic reset has to be preceded by a cultural reset. Do we have the nerve?