Turbulence and Trends

A trend is a trend is a trend.

But the question is, will it bend?

Will it alter its course

through some unforeseen force

and come to a premature end?

Sir Alec Cairncross

I’ve had a lot of meetings this week, and very little time to reflect on fast moving events.  This entry may be light on cites and hyperlinks as I’m in a bit of a rush today.  It will also lack much in the way of perspective or insight as I find it impossible to distance myself just now from the swirling turbulence around me.

Here in Britain, several banks were offered partial nationalisation as an alternative to private recapitalisation.  Strangely, this seems to have encouraged them to more strenuous efforts to recapitalise.  The plan is now being held up as a model as it seems to force managements to confront their undercapitalisation as a problem that they can solve to their advantage or that will be solved for them to their heavy personal cost.

Iceland collapsed.  It was more of a hedge fund than a country, with it’s 200,000 population supporting a massive leveraged position in financial markets via risk loving bankers and financiers.  There were approximately 200,000 British depositors in accounts offered by Icelandic banks.  Local authorities (municipalities) and charities were also big investors, exposed for more than £700 million.  As a result, the government has frozen Icelandic-owned assets in the United Kingdom – using terrorism legislation, naturally – to provide the basis for a partial recovery of the losses likely to be incurred.  This is causing more stress between the two island nations than they have known since the Cod Wars of the 1980s.  Also causing tension is a rumour that Russia might bailout Iceland with $4.5 billion of credit, leading to speculation that the Russians may be eying the vacant airbase formerly used by Americans.  This is problematic as Iceland is a member of NATO, and so has spurred efforts toward finding European alternatives.

Europe continues to call for collaboration while each country unilaterally defines and acts on its self-interest.  That is the way it should be, and I approve heartily.  I would rather not have the European Union making hasty decisions or holding such concentrated powers that it can force a uniform resolution across all member states.  Either the EU builds consensus for action in the common interest, or it remains impotent.  Either is preferable to too much concentration of power in Brussels.

In an attempt to shut just one stable door in a barn full of bolting horses, the Treasury has laid legislation before Parliament to reform the treatment of UK bank insolvencies and deposit insurance arrangements.  Roughly described, the Financial Services Authority will decide if a bank is bust, the Bank of England will be responsible for overseeing its resolution and ensuring financial stability of the system, and the Treasury will oversee a new deposit insurance scheme that no one can currently describe but will make permanent the rise in protection to £50,000 per depositor.  Despite the massive failure of Lehman, and the huge losses incurred by investors and hedge fund prime brokerage clients in London, the legislation is completely silent on the insolvencies of investment banks and broker-dealers and other institutions of systemic importance to financial markets.  My fear is that the failure to address the systemic issues as a whole will be a vulnerability exploited by US banks and authorities as they try to undermine London as a financial centre, gaming the fragile global markets.

There is still a touching confidence among many in the City that the US authorities will provide the “leadership” to reinforce collapsing markets.  As John Plender of the Financial Times quipped, “Gaul votes for Rome to take the strain.”  This seems to me to display a total incomprehension of the way US authorities operate to externalise pain and loss to the greatest extent possible in times of crisis.  Gaul, after all, was an occupied state that was militarily and economically exploited to Rome’s advantage for centuries before Rome’s collapse.  Saving Gaul was never a high priority once Rome was threatened.

Elsewhere in the world, bureaucrats continue to show up at the office in the morning and check to make sure all boxes are ticked, all forms are correctly ordered, and all initiatives in progress continue their stately way forward unimpeded by global chaos.  I find this comforting, although much of their efforts will ultimately prove futile and failed.

Finally, an optimistic note.  I was reminded yesterday that the vast bulk of “wealth” created during the Greenspan/Bernanke bubble years accrued to the very top percentiles of population – with many in the OECD middle class and lower class either stagnating or getting poorer as they mired themselves in unsustainable debt.  While opportunity and employment grew strongly in emerging countries, there too the elites gained disproportionately as income inequalities surged.  The crash of global financial markets therefore will have disproportionate effect on the elites, impoverishing them to a far greater extent, although it will be felt throughout society as employment, pensions, investments and public services contract.

Once we hit bottom of this downturn, some years hence in all probability, we may experience a democratisation of wealth and opportunity like none seen since the end of World War II when education reforms and unionisation laid the groundwork for the rise of the American and OECD middle classes.  Those who have lost economic and political power during the boom years, are likely to organise and retake authority within economic and political systems during the bust years.  This could provide reorientation of economic progress toward more equitable, sustainable and democratic outcomes in coming generations.  I hope so, it’s the only bright spot of the week.

26 Responses to "Turbulence and Trends"

  1. Mark   October 10, 2008 at 5:36 am

    LB, it’s people like you who keep me from utterly giving up on the prospects that humankind has any chance.Your commenting on power concentration is dead on. If there’s anything we are to learn by this monstrosity of a mess is that centralization doesn’t work, that diversity is the ONLY way forward (nature wouldn’t have it any other way). The notion of diversity calms me, but bothers others in that they always seem to seek some sort of monolithic solution for _all_. People scream for a “Plan B;” I say that we need a “Plan D,” “D” as in Deconstructing the existing before we are to go forward. Nature perfects the simple…

    • Mark   October 10, 2008 at 5:38 am

      Oh yeah- FIRST! OK, finally got THAT out of the way :-)

      • London Banker   October 10, 2008 at 5:53 am

        “Single point of failure” versus “distributed open networks” – it’s an old, old choice – like Microsoft versus Linux. Authority always prefers concentrated power and wealth, as it makes it easier to control and police. The interests of the people, however, are better served by decentralised authority and equitable distribution of wealth and opportunity.

        • Guest   October 10, 2008 at 11:42 am

          Sounds closer to communism than socialism. The end point of communism is supposedly the withering of the state … a kind of anarchism which would presuppose some kind of socialism. Doesn’t sound so bad.But unfortunately without organized political opposition to the current order, I see more oligarchy and violence than equality and peace. Many of the current trends are decidedly fascist, from the top and the bottom of US and European societies. The next period will be difficult in all likelihood.

  2. Anonymous   October 10, 2008 at 6:29 am

    I have the feeling that there is and for sure will be much more pain felt in other parts of the world than in the US. And I would not even be surprised if the US came out of the crisis in an even stronger global position that they have now.I really wonder how much of this is according to a blueprint, and how much is just collateral damage. There are so many hints that inidcate that the crisis was anticipated long time ago by the US administration, and there has been surprisingly little action during the last two years to prevent the crisis.So my question is: Can we rule out that we are in right the middle of a financial war?

    • London Banker   October 10, 2008 at 6:51 am

      I agree that there is a plan to export deflation and then take advantage of catastrophic declines in commodity prices and exchange rates to exert US economic hegemony again. I just don’t believe it’s going to work this time.Without going into detail, I’ve spent part of the week with emerging market central bankers. They are forging a head on cooperative, collaborative strategies that are largely independent of the USA and Wall Street. Their plans are innovative, conscientious, and likely to be of long term strategic benefit to their peoples and their economies.The USA might think that it got away with exporting inflation and now is getting away with exporting deflation. They might be surprised that the plan doesn’t result in their reaping the profits and commodity dominance they expect.

      • Guest   October 10, 2008 at 11:49 am

        Any sense about the decline of BWII? There isn’t a way for emerging economies to gain independence without breaking out of the dollar zone. The recent moves by Argentina and Brazil, though partial, may be a sign of things to come. The end of BWII would mean US inflation on top of the inflation that we expect soon after deleveraging from the attempt to cheapen dollar denominated debt.Whitey

        • London Banker   October 10, 2008 at 11:57 am

          BWII will be decided in Moscow, Beijing and Riyadh. When the time is right, there will be a coup against the dollar that will overturn dollar hegemony for good.The Arab Gulf exports 80 percent of its oil to Asia and imports 80 percent of its goods from Europe. The dollar is an artifact that is too expensive to maintain, but with so many US troops and ships in the Gulf, now would be an impolitic time to overthrow the dollar. More likely they will wait until the US is forced to withdraw from Afghanistan and Iraq, just as Eastern Europe waited until the Soviets were forced to withdraw in shame from Afghanistan two decades ago.In the meanwhile there are treaties being signed, infrastructure being built, currencies being realigned, and regional consolidation across Asia toward a more collaborative future.

          • Guest   October 10, 2008 at 2:20 pm

            Thanks for this LB. I agree that there is a military dimension to this question.I also expect there to be more pressure on BWII because some countries will have to break away due to food price inflation and the political instability that it causes. So in this respect, Moscow, Beijing, and Riyadh will find it increasingly expensive to maintain BWII and may not be able to set the timetable at their pleasure.Given the speed of recent developments, BWII could collapse in the short to medium term. Then a new round of pain will begin in the US.But what will happen to the Euro in that case? I’m relatively more optimistic about the EU, UK excepted, because they have less debt and better production than the US. It seems that Europe will have to integrate more with Asia and perhaps Africa to insure growth.Whitey

          • Guest   October 11, 2008 at 8:31 am

            I came across this 2005 article by Roubini on Bretton Woods II Will the Bretton Woods 2 Regime Unravel Soon?The Risk of a Hard Landing in 2005-2006You comment that there will be a coup agains the dollar – do you see merit in the Debt Super Cycle perspective? AN INFLECTION POINT IN THE DEBT SUPERCYCLE

  3. PeterJB   October 10, 2008 at 6:30 am

    “This could provide reorientation of economic progress toward more equitable, sustainable and democratic outcomes in coming generations. I hope so, it’s the only bright spot of the week.”@ LBBet on it; for that is the natural function of revolution and this is what we are currently experiencing; the key phrase is:”Once we hit bottom of this downturn, some years hence in all probability”We have to hit bottom.Me? I am totally optimistic and looking forward to a most interesting and delightful future for mankind; a future which will make the last 50 years or so, appear as Hell.I am happy that you use the term ‘turbulence’; most appropriate.;-)>

  4. PeterJB   October 10, 2008 at 6:40 am

    “According to the most recent data, released June 30, 2008 by the Office of the Comptroller of the Currency, the three largest American bank holding companies, JP Morgan Chase, Bank of America and Citicorp, had current outstanding derivatives contracts, totaling $179.4 trillion dollars. The three banks combined have total assets of just under $5.6 trillion!As of Dec. 31, 2007, according to the Bank for International Settlements, the total over-the-counter and exchange-traded derivatives totaled more than $675 trillion. However, these “authoritative” figures are, according to Executive Intelligence Review analyst John Hoefle, grossly understated. The true figures, Hoefle estimated, are well-above a quadrillion dollars. “@ http://larouchepac.com/news/2008/10/09/derivatives-hyperinflationary-bomb-crushing-international-fi.htmlH'mmm, why don’t I disagree with Mr. LaRouche here?Ho hum

    • London Banker   October 10, 2008 at 6:55 am

      Gross positions are misleading. Net derivative positions are what measure market exposure, taking account of offsetting long and short positions in correlated derivatives. The real risk in the huge derivatives exposure is from credit risk, which is both highly concentrated (as you suggest) and which results in unforeseen and difficult to manage market exposures as hedged positions default.This crisis will become much more intense as hedge funds begin to fail in significant numbers, as hedge funds often took out of the money positions in derivatives for upfront premia to gain access to more cash to leverage. When these dominoes topple, it will lead to very unpredictable impacts at the dealer banks.

      • Guest   October 11, 2008 at 4:39 pm

        Numerous articles have linked last weeks market declines to forced selling from both an increase in margin requirements on hedge funs and demands created by the Lehman CDS auction.You speak of hedge funds beginning to fail in significant numbers due to leverage. Apart from that there is talk of huge redemptions from hedge funds, redemptions from mutual funds and even from money markets. Add to that the implications of the Lehman auction on the remainder of the CDS market estimated at $50T. Related concerns include Lehman’s secured but uninsured creditors such as JPM at $23B or even the possibility of defaults related to the $400Bn in obligations resulting from the Lehman auction.My concern is that instead of asking which inning we are in (baseball analogy); the question should now be which sport are we in. The Tour de France comes to mind, which begs the question; which of the 21 stages are we in?

  5. kilgores   October 10, 2008 at 7:22 am

    Thank you, LB. I thoroughly embrace your hope for a democratisation of wealth and opportunity.SWK

  6. Syndrum   October 10, 2008 at 7:37 am

    I wish I could be so optimistic…As asked above, “I really wonder how much of this is according to a blueprint, and how much is just collateral damage.”Its true that the crash will erase a huge chunk of wealth from the wealthy. But it will also further impoverish the poor and the middle class. The banks are consolidating, power will be further concentrated. The question we need to ask is who will have money when we hit bottom? They will be the ones truly benefiting. Despite the rich losing billions, millions will still be left…Further equilibrium or disequilibrium will be up to the new laws and regulations put into place because of the crash. Something gives me the idea that the original blueprint of this engineered feet wasn’t to redistribute the wealth and the power…

  7. Guest   October 10, 2008 at 12:06 pm

    can this issue be solved by giving more authority to Bush, Cheney, Paulson, or Bernanke? Or to the United Nations? It seems that something like that will be the end result of all of this.

    • Guest   October 10, 2008 at 12:36 pm

      Not in Europe it won’t. We’ve seen how that particular script ends, and we lost too many of our families and friends to it to want to repeat the experiment.

      • Syndrum   October 10, 2008 at 1:00 pm

        If Europe cannot produce an adequate consorted response to the current crisis, many will place the blame on the ECB’s limited powers. Further centralized control will be the call of the day.On the other hand, others will deep culpable precisely the restrictions imposed on national economies my the ECB’s monetary choices.Either way we can expect further strife and disagreements as to the future state of the ‘European’ financial system.

        • London Banker   October 10, 2008 at 2:44 pm

          I get tired of Americans dancing on Europe’s grave – prematurely. Europe formed to prevent conflict leading to war, so any instability here raises a fierce determination to collaborate and compromise. We will talk to the Chinese, to the Russians, to the Gulf, to the Iranians, to the Africans and to anyone else we feel is important to resolving the crisis – not just the Americans. We recognise the interests of small nations as well as large ones. We are open to hearing every voice, every plan, every perspective.Yes, our process is slow and messy and lacks authoritative leadership. And I have rarely in my life appreciated that as a quality to celebrate as I do now.

          • Whitey   October 11, 2008 at 8:20 am

            I agree, but I am still concerned about Europe’s position relative to the US and Asia. Unfortunately, I think that many Europeans are naive about the US government’s view of Europe. The US does not always act as Europe’s ally.1) In many respects, the Euro is subordinate to the dollar and some argue that it is a derivative currency to the dollar as far as its international position.2) Most of Europe is still militarily subordinate to the US through NATO.3) There are some European weaknesses vis a vis Asia: http://www.atimes.com/atimes/Global_Economy/JJ11Dj01.htmlWhile some of these points are valid, others seem to be exaggerated or decontextualized.Nevertheless, I still see medium to long term strength in the European position, even if there are some losses in imperial strength or the losses in individual countries such as Britain. Europe has productive capacity, wealth, and educated populations, despite aging demographics. There is a greater tradition of multilateralism in Europe which provides advantages in a more multipolar world.Perhaps we can’t know at this point but I would like to see systematic weighing of prospects for Europe post-financial crisis.

  8. Guest   October 11, 2008 at 2:14 am

    Via Don Fishback’s blog – Survivor Bias in action:

    What REALLY HappenedI hope my good friend Larry McMillan doesn’t mind me doing this. He has a terrific advisory service — The Options Strategist. In this morning’s hotline, He had this to say about the goings on yesterday:The selling has reached historic proportions. There literally is a “run on the market,” as investors worldwide are dumping stocks. It seems that the major catalyst for this selling is the fact that the newest large banks primarily J. P. Morgan, Goldman Sachs, and possibly Morgan Stanley as well — have issued massive margin calls to hedge funds and other professional traders who use these banks as prime brokers. These calls were not issued because of market losses, but more because the banks arbitrarily decided that they wanted their customers to use less leverage. Margin rates as low as 15% for broker dealers were raised to 35%; hedge funds who had been used to operating on high leverage were told that they had to bring accounts up to a much larger percentage of equity. In this illiquid environment, where all manor of exotic securities literally have no bids, the only place to raise the cash to meet margin calls was to sell stock. That is what really setthis market over the edge — as the first notice of these calls were issued on October 2nd and 3rd. There was something of a grace period to meet the calls, but funds realized they weren’t going to be able to meet themother than by selling stock. There are rumors that the most massive of the calls are due Monday (October 13th). If so, this market could continue to decline through then.There doesn’t seem to be any reason for this increase in margin. The most benign one is that the banks became overly worried that their prime brokerage customers could cause problems with leverage. A more sinister reason revolves around the fact that the banks issuing the calls will likely wind up the owners of some excellent inventory (relatively illiquid preferreds, bonds, etc., which are being sold at prices well below theoretical value). They are in effect confiscating from their prime brokerage customers.

  9. Guest   October 11, 2008 at 2:12 pm

    LB–Thank you for taking time to keep us posted with your observations, lucid prose, upliftng thoughts etc. Many of us depend strongly on you and the professor and a few others to light the path.You refer to constructive activities of emerging market central bankers. I’m curious to know if you have any information about what the Shanghai Cooperative Organization is doing these days. It seems to me that they will be sitting on the top of the pile when all is said and done and it behooves those of us who will be underneath to know more about what to expect…and even how to behave.

    • London Banker   October 12, 2008 at 4:54 am

      Look to the trendlines. GW Bush has been using his military to forcibly seize commodity rich territories and using propaganda to divide ethnicities and religions. China’s Premier Hu has been quietly going about the world preaching a doctrine of mutual alignment of long term interests. While W wastes US and borrowed wealth on the military and financial sectors, Hu invests in ports, transport, mines, wells, refineries, smelting plants and factories globally in every country with which he signs long term resource development treaties.If Europe does find its future alignment with China, it may be that such economic and socially tolerant alignment serves its longer term interests better than military alignment with the USA.The SCO has made more rapid progress toward common alignment of interests and goals than just about any outside expert expected. Meanwhile NATO and other US-led institutions are under huge stress.These trends don’t have to continue, but I’m not at all sure that we wouldn’t globally be better off if they did.

      • Guest   October 12, 2008 at 10:20 pm

        (I posted the question)…thank you LB for your comments that mirror my own observations, including the last sentence.

  10. Anonymous   October 12, 2008 at 4:33 am

    “As one senior European banker put it to me in private discussion, “There is an all-out war going on between the United States and the EU to define the future face of European banking.”“Knowing that at a certain juncture the pyramid of trillions of dollars of dubious sub-prime and other high risk home mortgage-based securities would come falling down, they apparently determined to spread the so-called ‘toxic waste’ ABS securities as globally as possible, in order to seduce the big global banks of the world, most especially of the EU, into their honey trap.””By agreeing on a strategy of nationalizing what EU finance ministers deem are ‘EU banks too systemically strategic to fail,’ while guaranteeing bank deposits, the largest EU governments, Germany and the UK, in contrast to the US, have opted for what will in the longer run allow European banking giants to withstand the anticipated financial attacks from the likes of Goldman or Citigroup.””A functioning solvent banking and interbank system is far the more strategic issue. The ABS debacle was ‘Made in New York.’ Nonetheless, its effects have to be isolated and viable EU banks defended in the public interest, not just the interest of Paulson’s banking cronies as in the US.”http://www.engdahl.oilgeopolitics.net/Financial_Tsunami/Warfare_Behind_Panic/warfare_behind_panic.html