Here Come the Waves of Credit Defaults, Deleveraging, and Recession

Its called an economic contraction. The US is in a serious recession, much more serious than the headlines will allow because of the significant understatement of inflation in the chain deflator, worse even than the CPI. The government and financial sector is acting with reckless disregard for the welfare of the country by silencing all the alarms one used to be able to rely upon to protect themselves and make sound personal and business decisions.

Credit Card ABS Locking Up: Report
By: PAUL JACKSON
August 5, 2008
HousingWire.com

Here it comes: the spillover from subprime mortgages that many secondary market participants had hoped not to see looks increasingly as if it may finally be coming home to roost. A published report Tuesday morning noted that the credit card ABS market is locking up, as investors pull back from the sector and more borrowers begin to default on their consumer credit debt.

The Wall Street Journal, citing data from JP Morgan Securities, said that issuance of credit card ABS fell to $4.4 billion during July, off from $5.26 billion in June and less than half of the $10.1 billion issued in March. A report by JP Morgan structured finance analysts said that deal flow has “slowed considerably” — and, adding insult to injury in the latest xBS market to falter, those deals that are coming to market are taking longer to do so.

Adding to investor fears in the credit card sector was an August 1 report by Citigroup Inc. with the Securities and Exchange Commission that saw the fourth-largest credit card issuer post a $176 million loss in credit card securitization activity during the second quarter.

Overall U.S. ABS issuance slowed to a crawl, totaling just $8.6 billion in July according to industry trade publication Asset Backed Alert; so far this year, ABS issuance has totaled just $123.5 billion.

Last year at this time, total U.S. ABS issuance was $465.8 billion. Forty-two percent of U.S. ABS issuance this year has been in the form of credit card debt, the largest percentage of ABS (which also includes auto financing, student loans, and the like).

July’s abysmal ABS issuance total was the worst since December 2007, and the second worst in more than 9 years; and it’s led more than a few market participants to wonder what’s next in a capital market that has been reeling from the effects of the mortgage crisis for more than a year now.

“One has to wonder if the subprime thing wasn’t just an underwater event out in the ocean and now the tsunami waves are rolling in, one after another,” said one of HW’s sources, an MBS/ABS analyst, via email on Tuesday morning.

When the Going Gets Weird, the Weird Turn Pro

We just don't have the words.

Morgan Stanley to Advise U.S. Department of the Treasury Regarding Fannie Mae and Freddie Mac


NEW YORK -- (Business Wire) --

Morgan Stanley (NYSE: MS) confirmed today that it has been

retained by the United States Department of the Treasury to provide

capital markets advice to support the Treasury's responsibilities

associated with its new authorities regarding Fannie Mae and Freddie

Mac. As part of that assignment, Morgan Stanley will support the

Treasury's work to promote market stability and the availability of

mortgage credit.


Morgan Stanley Chairman and Chief Executive Officer John J. Mack

said, "Morgan Stanley is honored to have been asked to serve as

financial advisor to the U.S. Treasury as it evaluates various

alternatives for Fannie Mae and Freddie Mac. We are pleased to be able

to offer our services to the government and look forward to working

with Secretary Paulson and his team as they work to restore stability

to the global capital markets and confidence in the U.S. housing

market." Morgan Stanley will accept no fees for this assignment and will

receive only $95,000 from the Government toward its expenses.

($95,000 for expenses? That's a lot of Taittinger at The Palm and VIP lapdances at Camelot. Or are we talking something a little more Spitzeresque? We'll take that job in a Manhattan minute for free. It would put a certain 'edge' to our blog. Think about it Hank. - Jesse)

The Message of the Markets

Today's market action looked like a major Wall Street insiders push to break the traders/funds who were playing the long oil-long metals - short dollar-short financials cross trades. They were leaning awfully hard on them.

Just as an update we took down our short oil - long gold cross trade the past couple days. We wanted to be in a stronger cash position to be a able to move quickly in case some things unfold as we expect they might.

The volumes are just not there so far to justify this run up in the stock indices. The Fed did not do anything today to justify a 300+ point rally. The spin on financial television is running hard from the 'chief strategists.' Wall Street wants to get the market up and offload more shares to mom and pop to further damage the economy for their own benefit. That's what they do. This is why our economy is sick. It is being run by shills and gamblers for the benefit of 'the house.'

We will be very surprised if the market does not sell off tomorrow, but we have an open mind and will start considering the notion of government intervention which could sustain a prolonged 'reflation rally.' If the Fed and Treasury can get behind this in a meaningful way then all bets are off.

But for now this just looks like the Wall Street wiseguys peeking at the other players cards from their seating vantage points as insiders and limit raising the bets against the prevailing trades on the trend fundamentals. If this is the case, the prior trends should reassert themselves within the week. If not, then we might be in a new ballgame.

We will WAIT for a sign that this is the case, although we did put on a few Sept. Index shorts into the close. There is no point jumping in front of this in case it is something more profound than just the usual Wall Street shenanigans.

More on Fisher and the Theory of the Great Depression

In 2006 a Mr. Alex Grey had posted an insightful comment on one of the financial blogs which we have kept in mind. Here it is in its entirety.

There was definitely a hole in Keynes' theory of the Great Depression. This has thankfully been filled by the article "Fisher, Keynes and the Corridor of Stability" by Robert Dimand (American Journal of Economics and Sociology, Vol. 64, No. 1 (January, 2005), pp. 185-199).

This article is I think the missing link that established that the Keynesian Liquidity Trap that characterised the Great Depression was a result of debt deflation as described by Fisher. This establishes that Friedman and Schwartz's view of the great Depression has the causality reversed - the economic contraction led to the contraction in monetary aggregates, notably M3. The Fed or its the equivalent could do little to avert this.

I think averting the process of debt deflation cannot be accomplished through monetary policy (Bernanke following Friedman believes the opposite). This again points to the contrast between Keynes and Friedman.

Evidence in support of the incorrectness of Friedman's view is seen in the experience of Japan in the 1990s where the government succeeded only in increasing M1 while M3 continued to shrink (see paper by Krugman (1997 on this) and asset prices, notably housing, continued to fall. The reason why monetary policy cannot avert debt deflation is that asset prices are bid up to unrealistically high levels during booms based on the same "animal spirits" that govern investment. When markets turn then so do expectations which cannot easily be reversed and certainly not by monetary policy.

Financial innovation as described by Minsky leads to greater increases in asset prices during booms as it permits greater amounts of borrowed funds to flow into asset markets making asset prices more sensitive to the business cycle. As a result the risks of debt deflation during cyclical downturns increases over time. The reasoning behind this is simple - the ultimate effect of all financial innovation is to increase the level of debt relative to income. At the macro level this entails an increase in the debt to GDP ratio.

Therefore the Great Depression can be viewed as the natural course of the business cycle in economies subject to financial innovation. The full downswing portion of the business cycle can be forestalled by Keynesian counter-cyclical policy however this has to be accompanied by financial regulation. If not, financial innovation risks creating pro-cyclical swings in asset prices that will ultimately swamp Keynesian counter-cyclical policy.

Since 1980 we have witnessed the elimination or substantial reduction in almost all legislation governing the financial sector. This combined with disinflation and financial innovation set in motion a period of sustained increase in private credit relative to GDP. The foregoing suggests that an imminent recession could morph into an economic depression if it triggers debt deflation.

There does seems to be little doubt that Bernanke et al. believe that they can mitigate the process of credit contraction through monetary policy. There is an interesting question about the possible inflationary effects.

It is to be expected that Bernanke et al. have all thought about this, and would seek to mask the short term inflationary effects and the indicators of this very phenomenon described by Alex Grey of a sluggish broader money supply as compared to the narrow measures which are more amenable to monetary policy.

There is it seems a significant wild card which few seem to account for explicitly in the relative values of currencies and their impact on the import prices of economically important commodities.

We will be speaking more about this in the future. One of the slants on this that seems worth considering is the difference between the Japanese economic experience, which so many cite, and the Russian experience, which is qualitatively different and perhaps illuminating of important elements and differences therein.