From Mortgages to a Morass

This weekend Financial Times carried a picture of people queued to withdraw cash from Northern Rock. Several articles discussed the run on the bank. This morning, The Wall Street Journal reports that "British government will guarantee all existing deposits at troubled bank Northern Rock PLC, U.K. Chancellor of the Exchequer Alistair Darling."

Diffusion of Financial Crisis among Economic Neighbors

In the last several months, as the credit crisis has rippled from the U.S. to Europe and back, I'm reminder of other historical examples:

Princes, abbots, bishops, even the Holy Roman Emperor debased the subsidiary coinage used in daily transactions (but not gold and silver coin of large denominations) by raising the denomination of existing monies, substituting baser for good metal, or reducing its weight, in order to extract more seignorage in the absence of effective tax systems and capital markets--this to prepare for the Thirty Years' War, which broke out in 1618. Debasement was limited at first to one's own territory. It was then found that one could do better by taking bad coins across the border of neighboring principalities and exchanging them for good with ignorant common people, bringing back the good coins and debasing them again. The territorial unit on which the original injury had been inflicted would debase its own coins in defense and turn to other neighbors to make good its losses and build its war chest. More and more mints were established. Debasement accelerated in hyper-fashion until a halt was called after the subsidiary coins became practically worthless, and children played with them in the street, much as recounted in Leo Tolstoy's short story, "Ivan the Fool."

Charles P. Kindleberger, Manias, Panics, and Crashes: A History of Financial Crisis, 4th edition, p. 121, John Wiley and Sons, Inc., New York (2000)

The Unraveling in Small Turns

Hal Weitzman reports from New York:

Countrywide, the beleaguered mortgage group, prompted an early plunge in stocks by saying it would have to draw on $11.5bn of credit and an official reports showed new homebuilding dropped to a 10-year low while building permits were at an 11-year low in July.

. . . “While Fed officials are proceeding as if the calamity has yet to occur, it would appear that some in the market believe the calamity is simply yet to be fully appreciated,” said analysts at Interactive Brokers.

. . . Nerves were not soothed by the Federal Reserve pumping more liquidity into the system on Thursday morning. The New York Fed announced an overnight repurchase agreement worth $12bn and a 14-day repurchase worth $5bn, while signalling that it expected to make similar repurchases on a more regular basis over the coming days.

. . . An hour before the opening bell, the Commerce Department released a gloomy report on US housing starts, showing that construction of new homes last month dropped to its lowest level in 10 years. The figures underlined the woes that have beset the homebuilding and mortgage sectors in recent weeks.

Lender of Last Resort

As of late last week, central banks in the EU, the US, Japan and Canada have begun claiming their mantle as a lender of last resort, pumping lubricating liquidity into financial markets (at least some $120B of it) to put a break on an impending credit crunch. The coming weeks will reveal more. (John Authers speaks about it here. He calls it "very dangerous times" and speaks of a potential "melt-down" and hopes that this injection of liquidity can push back the tide of "bad news.")

California Property Tax Laws, Time to Catch Up

With the collapse of the sub-prime mortgage back securities, and the reverberations in other other mortgage back securities, it might be time to sell and buy homes. However, as the prices continue to be high, developing an understanding of California tax laws might be necessary. Some resources follow:

1. California Board of Equalization
2. California Counties (Counties have detailed property tax break downs and much more.)
3. County Assessors
4. Clerks to the Board of Supervisors
5. Recorder Clerks' Offices
6. County Treasurers and Tax Collectors

Property taxes can be a huge burden when houses are traded at higher and higher prices. Of course property tax collectors like that.

Germany and Economic Independence

US Under Secretary of the Treasury Stuart Levey's Don Quixotic efforts test German economic and financial independence. The threats are becoming somewhat childish, Ralf Beste, Christoph Pauly and Christian Reiermann of Spiegel Online report:

German financial institutions feel the United States government has been engaging in "downright blackmail," according to one banker. Anti-terror officials from the US Treasury are constantly showing up to demand they cut their traditionally good relations with Iran. The underlying threat from the men from Washington is that they wouldn't want to support terrorism, would they?

Don Quixotic efforts do not end in the offices of the Treasury but have been taken up by the US Congress at 408 to 6. It makes one wonder what rationality and reason is guiding US Middle-East policy. It is almost embarrassing to watch all this: Changing the law to protect against its original wisdom.

Fair Disclosures on the Web

Jonathan Schwartz, the chief executive officer of Sun Microsystems Inc., explains how Sun intends to publish its FY'07 financial results on Monday, July 30. (Note his comments about the use of web for fair disclosure.)

More Risk Ahead?

Another Financial Times' report notes a warning from BIS, Bank for International Settlements:

Interest rates in the world’s leading economies should rise while conditions are good to avert the twin risks of rising inflation and trade imbalances that could destroy the remarkable strength of the world economy, the Bank for International Settlements has warned.

The central banker’s bank, based in Basel, Switzerland, also says that financial innovation may be dangerous, especially the wider distribution of credit risk using asset-backed securities. “More scepticism might be expressed about some of the purported benefits of having new players, new instruments and new business models,” it says in its annual report.

More Euros in Circulation

Financial Times' Ralph Atkins reports from Frankfurt (home of ECB) that there are now more euors in circulation than dollars.

Banknote holdings per person are almost twice as high in the 13-country eurozone as in the US, the study shows, while eurozone citizens typically withdraw 50 per cent more each time they use a cash machine.

Net shipments of euro notes to outside the eurozone are declining, says the report. Only 10-15 per cent of euros in circulation are held abroad. About 60 per cent of US dollars in circulation are held overseas.

One explanation for Europe's cash addiction could be that the use of payment cards is less developed in many eurozone states than in the US. The ECB believes low inflation and interest rates have increased the attraction of holding cash, while euros are available in higher-denomination notes than dollars. Demand for €500 ($674, £337) notes has shown a particular rise.

Excluding notes held abroad, per capita holdings in the US were worth the equivalent of about €870. For the eurozone, the figure was more than €1,600.

People Eat and They Drive

The Economist knows the difference between the headline inflation and core consumer price index, and understands the importance of the former as an inflation indicator:

What the markets blithely ignored was the day's bad news. Headline consumer prices rose by 0.7%, the biggest monthly increase for nearly two years. Unlike core inflation, the headline measure includes fuel costs, which rose sharply, as well as food prices. For bond prices to rise on such a big jump in inflation, markets must be placing a great deal of faith in the core index as the true gauge of price pressures. Is that wise?

The cold-and-hungry index

The lure of core inflation as a barometer is that headline inflation rates tend to be volatile. Last June the annual headline rate in America, pushed up by soaring oil prices, was as high as 4.3%, but by October it had plunged to 1.3%. The rationale for excluding food and fuel is to filter out prices that jump around for temporary reasons, such as the vagaries of the weather or the messy politics of the Middle East. A good core index excludes this noise, leaving only the enduring part of inflation that reflects the weight of spending in the economy.

Money Supply

Despite the recent correction to the falling prices and rising yields of U.S. treasuries, I've been wondering how the Federal Reserve might react in the coming months as the bond market remains jittery. The talk to beat inflation was tough when the new chair took his place. However, if money is tightened to reduce inflation, interest rates will have to rise even more, furthering the slump in the housing market already suffering from the recent subprime melt-down. This course of action will lead to serious unhappiness among those owning property. If the Fed decides on merely talking about beating the inflation while letting money loose, interest rates will remain less volatile and inflation will rise but perhaps at a slower rate than would cause a shock. If I were to bet, I would bet that the Fed will choose the latter coure of action. It is the politically "prudent" course although many who earn wages and have little property to own may suffer more than others.

From an entirely different perspective ...

If they fight inflation too hard, interest rates will go higher, more adjustable rate mortgages will go into default, and fewer people will be able to afford a first home. If they don't fight inflation, adjustable rate mortgages do not need to go up too high. Instead, salaries will eventually go higher with inflation (there's always a delay with salaries) ... but this course of action devalues outstanding debt. In other words, those who have given their money into debt will be earning lower, real interest rates (real interest rate = nominal interest rate minus inflation rate) ...

So, they need to side either with people that owe (mortgages or other debt) and let inflation rise or with those who lend and let interest rates rise.

Bond Sell-off

As 10, 20 and 30 - year treasury prices go down, their yeild goes up, putting upward pressure on interest rates. Thus, reports Krishna Guha of Financial Times:

The spectacular sell-off in the US bond market this week is a macroeconomic event not just a financial market event, with consequences for the rate and composition of US growth and the conduct of monetary policy.

The sharp increase in yields on 10, 20 and 30-year Treasuries will push up mortgage rates and put renewed pressure on a still-weak housing market, with potential spill-over effects on US consumer spending.

In a second FT report, Richard Beales and Joanna Chung, describe how the rise in yeilds relate to expectations:

Investors sold bonds heavily on Thursday following growing concerns over rising interest rates and the sustainability of easy credit conditions.