Economy in a nutshell
by adam.onionomics on Mar 13, 2009
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This is a presentation I did, but never got to deliver. The audience was a group of credit managers and I think they were all running for cover causing the event organizer to cancel the event. Now, ...
This is a presentation I did, but never got to deliver. The audience was a group of credit managers and I think they were all running for cover causing the event organizer to cancel the event. Now, I provide it free to you.
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- Think about what happens if you have hundreds of glasses and you fill each one up a little at a time.
- Now think of risk as water and the glasses as hedge funds, sovergein funds, your 401K, banks.
Some risk evaporates - loans are payed-offs, swaps and derivatives are novated
- But eventually every glass is almost full and there are no more glasses left.
- As more risk gets poured into each glass, at some point it is going to overflow and that is what happened.
- There was too much risk being poured into glasses around the world and at some point it overflowed
- and firms like AIG, who wrote insurance against risk, couldn’t sip it out of the cups fast enough.
- In order to be able to walk around with a glass of water without spilling it, you need some empty space for air or “tangible equity”
- That is what we are doing now, figuring out where to pour risk water in order to keep these glasses from spilling - although many, many have
- real = adj. for inflation
- At this point, there is a new announcement every week.
- Many are designed to plug holes in demand - stimulus (American Recovery and Reinvestment Act)
- Other are designed to prop-up asset prices - the original goal of TARP and now TALF and the mortgage relief orders
- but what we need most is to....
- The January U.S. personal savings rate hit 5%, according to the BEA. That’s up from 3.9% savings rate last month and 0.1% a year ago. We’re now at levels last seen in the U.S. in 1993.
- Although this somes good and prudent, it is not a good thing for our economy today. We had an economy that was driven by consumer spending and we need a little to get going again
- Over the weekend, Obama did the Bush thing - \"What I don’t think people should do is suddenly stuff money in their mattresses and pull back completely from spending,\" Obama told The New York Time
- The headline derivative is called a Credit Default Swap (CDS)
- An entity would buy a CDS to insure against a loss on a bond or the default of a counter-party
- Since AIG was at the nexus of many of these transactions, if we didn’t “bailout” AIG, there would have been failure everywhere.
- I mean everywhere - Spain, London, France, here.
- Much of the money being put into AIG is going to satisfy collateral obligations to their counter-parties - the world’s financial institutions
- re-pricing and re-evaluating the cost of risk > if risk was priced right in the first place we probably wouldn’t have gotten into this mess
> mis-priced risk led to artificially low and funky mortgage structures (ARMs, balloons) the creation of SIVs and an explosion of mortgage backed securities
> if risk was properly priced, this wouldn’t have happened and asset prices wouldn’t have inflated
- we have to get to a level were the fundamental rates of return are calculated using proper cost of capital
- once we do that, and have available projects, the economy will rebound
- China continued to buy U.S. debt amid a 27 percent increase in its holdings of foreign currencies in 2008. JP Morgan Chase predicted in a Feb. 6 report that China will keep buying Treasuries “not only for the near-term stability of the global financial system, but also because there is no viable and liquid alternative market in which to invest China’s massive and still growing reserves.”
- consumption again
- and some other asset price bubble
> because the world has a history of asset bubbles
> the same thing that causes bubbles, also causes innovation and growth
> you just want to make sure when it pops, there is something left over
- potentially inflation - although Bernake thinks this is less of a problem (but the commodity prices (sans oil) are preparing for it
- and national debt. If we do this right, there is a shot we wil have a return on our bailout investment.
- google is a case in point (crushed the cost of getting ads in front of you and the margins of those that did it another way)
- Things like webex do cut down on travel and boost productivity
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- debtor/creditor negotiations (on both sides)
- “story” liquidations and distressed M&A
- I advise companies through board positions as well