Nouriel Roubini's Global EconoMonitor

Sovereign Wealth Funds: Tallying the Losses (Again)

Norway’s fund had the worst quarter ever in Q3 –  the assets under management fell 7.7% in the quarter – in its basket of currencies (lots of details in the Norges Bank Investment management report). Returns in USD are much lower given Norway’s heavy exposure to European markets (around 55-60%). The dollar’s surge reduced the value of their Euro and pound assets. With assets under management of about $359 billion at the end of Q3, Norway’s assets were practically identical to levels of September 2007, despite receiving about $74 billion in new capital the fund over that period.

Further losses in October took the fund to $311 billion, meaning that its assets have fallen to levels last seen in March or April 2007. Ouch! Exchange rate losses likely account for most of this decline.

Norway of course is not alone in reporting losses.   2008 may have marked a peak in new capital received by sovereign wealth funds – if we exclude the one-off large transfer to the CIC last year – but it will also likely mark record investment losses. Unprecedented transfers from the oil boom in Q1-Q3 of 2008 failed to offset major investment losses of the equity and alternative asset-focused SWFs. (this draws on the results from joint work with Brad Setser, who has a great summary of the outlook for sovereign wealth funds). Losses over the last year may be as great as 20-30% of August 2007 holdings assuming index-based returns and no major asset allocation shifts or rebalancing. The Alaska Permanent fund reported 10% losses in Q3 – it now manages $13b less than it did a year ago as paper losses and dividend payments to Alaska eroded its value. So too has Alberta’s fund, even as its revenues have fallen significantly, so much for the new royalties.

Public and private pension funds face similar losses, particularly as they often received the same advice as sovereign funds did. New Jersey’s pension fund, which partnered with SWFs to take stakes in Citi and Merrill has lost $23 billion so far this year including $8 billion in October, meaning its current assets are now less than half their future liabilities. In an environment where state fiscal positions will be ever more stretched and where they were already deferring pension funds given the long-term nature of their liabilities, this is one more blow to retirement savings. CALPERS already faced significant losses on property holdings.

Rather than being just a litany, this experience raises key questions about optimal investment strategies for institutions and countries that are now managing large, if somewhat smaller pools of capital. Where does one go for returns? So what is a fund or rather country to do? Much depends on the level of development of the country and the time horizon. In the short-term, perhaps invest more at home (maintain investment at home) or be ready to be asked to do so. But it does pose a critical question for these long-term investors. How should one invest for the long-term to take advantage of windfall proceeds that may not all be absorbed immediately? Clearly asset allocations will be under review. But getting high returns over the long-term is difficult which is a challenge for those charged with managing large pools of capital.

But those funds that did follow the dominant asset allocation model sold by financial advisors in recent years, have suffered losses and with inflows slowing and domestic constituents calling out for a fiscal boost, funds may privilege liquidity. However, from the perspective of countries seeking to support long-term growth and development and diversify revenue streams, it does raise the question about the best asset allocation for the long-term. While on a long-term basis, equities have outperformed bonds, there have been long stretches of time where they did not.

It also means that countries like Libya, Saudi Arabia, and maybe even China, may have some of the highest returns on their portfolios in 2008 as bonds dominate. Libya for one has yet to make major purchases, significant interest in Italian banks and utilities aside. At the moment Libya’s fund has less than 10% of its $50b+ fund in equities and a recent report suggests that most of its assets are in conservative assets and make up as much as half of the  $80 billion in foreign assets of Libya’s central banks. Algeria was even more conservative than Libya – and its $140b in central bank reserves are in traditional reserve assets.

Norway’s fund – by virtue of being the largest, most transparent fund – is, as always, a case in point. Norway’s relatively modest returns in 2003-7 when funds like ADIA were making major profits show how asset allocation matters. Norway’s 60% fixed income allocation meant it limited equity gains in boom times, as most of its 2005-2007 inflows went towards fixed income. And in 2008, most of the inflows went towards equities.

Norway’s shift towards equities meant that they started allocating large flows of funds to equities near the top of the market, a trend which has continued as prices fell. So it may have mediated its losses. However, it seems likely that Norway’s allocation of equities fell below the 53% of strategic allocation in October given the major losses equities sustained in this period.

Performance of Norway’s fund has frequently been a political issue in Norway. Most problematically for the NBIM, the fund had a negative excess return of 1.84%, meaning that their performance under-performed Norway’s target benchmark for four out of the last five  quarters (Q1 was the exception).  So attention may be drawn to investment management practices, risk management and past performance.

While Norway may not be facing fiscal deficts like major fuel exporters among emerging markets, many of whom assumed a price of $50 a barrel+ for budget purposes, its windfall has also fostered expansion in the good times. Its non-oil deficit has been rising in recent years in absolute terms along with the value of the fund. Norway’s fiscal rule allows it to increase spending up to 4% of the fund’s assets. 4% of 300 billion is a lot. And now may be the time Norway needs to spend some of its savings.

On a relatively unrelated note –  Norway is taking larger stakes in companies. As I noted some months ago, Norway raised the size of the maximum stake to 10% of a given corporation, up from the previous 5% limit. NBIM now notes that its largest ownership interests were close to 6%. However the average size of stake still remains small – under 1%.

For some countries, spending more at home might actually be the best way to increase their long-term growth and diversify revenues. Though there is a concern about the ability of some countries to absorb funds. For those with long-term liabilities, it may be hard to climb out of the hole they are now in, but more investment in real assets including infrastructure in the US and elsewhere might be a good place to start.

But clearly the heyday of debt-financed investment is over for now if not forever. However, they are cushioned by the fact that their lower use of leverage means they are less likely to have been forced into firesales on margin calls. Yet with demands for more liquidity at home (and possibly from the IMF), the flows to liquid assets could remain considerable. And among competing national actors, sovereign wealth funds might be last on the list to get any new capital.  The UAE for one is now putting more funds towards cash strapped Dubai property developers and it and other governments may need to offset the temporary withdrawal of private investment to continue with key projects. This is widely seen in the region as the next step in the implicit bailout of Dubai by Abu Dhabi. It is noticeable that it is federation level institutions that are the prime vehicles. The KIA already withdrew some of its global deposits to fund a domestic equity stabilization fund.

Yet, even as funds privilege liquidity to enable domestic investment –   we could see more activity at opposite ends of the investment spectrum, as governments seek to promote economic stabilization and growth. Strategic partnerships might only become more important and it may be investors like Abu Dhabi’s Mubadala who take direct stakes and invest in sectors and companies that promote domestic economic development. Mubadala has announced a series of new deals in recent months – with GE, with Oman (see more on SWF investment in energy here). One way or the other, these funds may be used for domestic investment and promoting domestic growth, just sooner than some may have thought. But they will have to shy away from high debt levels

And this means that those in recipient countries might have a whole other set of issues

64 Responses to “Sovereign Wealth Funds: Tallying the Losses (Again)”

GuestNovember 26th, 2008 at 1:11 pm

Obama Emulates FDR’s Kennedy Pick With Rubin Clan in ‘Henhouse’Nov. 26 (Bloomberg) — In turning to Clinton administration veterans for his economic team, President-elect Barack Obama is banking that people who had a role in the current financial crisis will be best able to fix it.Timothy Geithner, Obama’s choice for Treasury secretary, was involved in the decision to let Lehman Brothers Holdings Inc. go bankrupt, which exacerbated a global credit-market freeze. Lawrence Summers, his pick for White House economic adviser, ran the Treasury when Congress repealed the Glass- Steagall Act, breaking down walls between commercial and investment banking.Presidents have always sought experienced hands, even if those hands aren’t always clean. The most extreme example might be Franklin D. Roosevelt’s selection of stock speculator Joseph P. Kennedy as the first chairman of the Securities and Exchange Commission.“Kennedy may have been the fox in the henhouse, but he knew where the holes in the henhouse were,” said John Steele Gordon, an economic historian. “You certainly need people with experience in a situation like this, people who know what the hell they are doing.”Obama, 47, acknowledged as much yesterday in naming Peter Orszag, a member of President Bill Clinton’s National Economic Council, as the next budget director.“Peter doesn’t need a map to know where the bodies are buried,” he said. “We are going to hit the ground running.” “The Daily Princetonian”: Peter Orszag ’91 has been named director of the Office of Management and Budget (OMB) in the Obama administration, President-elect Barack Obama announced Tuesday.Orszag, who resigned as director of the Congressional Budget Office (CBO) on the same day, will be a key member of the president-elect’s economic team, advising the president on a variety of issues including federal spending programs and managing the federal budget. His job, Obama said at a press conference, will be to eliminate “those programs we don’t need and insisting that those we do need operate in a cost-effective way…The Orszag family has three brothers: J. Michael ’89, Peter ’91 and Jonathan ’95. Their father, Steven GS ’66, was the F.E. Hamrick Professor of Engineering at Princeton until 1998, when he joined the Yale faculty.Jonathan also worked at Clinton’s NEC from 1997 to 1999, is now a senior managing director at Compass Lexecon, an economic consulting firm in Washington, D.C. He said in an interview that Peter is a good fit for the job…Orszag’s mother Reba, the president of Cambridge Hydrodynamics, a research and consulting firm in Princeton, said in an interview that Orszag has always shown an interest in public finance. “I think he just always had a concern for … what taxes supported,” she said. Reba Orszag was also former president of the Center for Jewish Life board of directors. advisors to Congress warn the cost of U.S.-led war on terror could exceed $2 trillion over the next 10 years. Much of that funding comes from money borrowed overseas, and the non-partisan Congressional Budget Office says it would be best to start paying for the war now and not let the debt grow. From Washington, VOA’s Margaret Besheer has more.The Congressional Budget Office says the wars in Iraq, Afghanistan and other war on terror-related expenses have reached more than $600 billion since September 2001.More than $450 billion of that has been spent on the U.S.-led war in Iraq. President Bush has now asked for an additional $160 billion for Iraq for fiscal 2008.

GuestNovember 26th, 2008 at 1:28 pm

Ah, yes. Joseph Kennedy. How easy it is for the insiders to make money because of their superior ability and wisdom, to gain crucial appointments because they “know where the bodies are buried,” who “know what they hell they are doing.” How lucky they: how lucky we.Joseph Kennedy? His name was one of those on the list of men who were notified in advance of the coming October 1929 crash in the stock market. On February 6, the Federal Reserve issued an advisory to its member banks to liquidate their holdings in the stock market, says G. Edward Griffin in his description of “The Great Duck Dinner” as he takes a “Second Look at the Federal Reserve,”Paul Warburg gave the same advice in the annual report to the stockholders of his International Acceptance Bank, the advice reprinted in the “Commercial and Financial Chronicle” on March 9, 1929.Warburg as a partner with Kuhn, Loeb & Co. maintained a list of preferred customers, as did J.P. Morgan Co. “It was customary to give these men advance notice on important stock issues and an opportunity to purchase them at two to fifteen points below their price to the public,” said Griffin. “That was one of the means by which investment bankers maintained influence over the affairs of the world.” How wise.“John D. Rockefeller, J.P. Morgan, Joseph P. Kennedy, Bernard Baruch, Henry Morganthau, Douglas Dillion – the biographies of all the Wall Street giants at that time boast that these men were “wise” enough to get out of the stock market just before the Crash. And it is true. Virtually all of the inner club was rescued. There is no record of any member of the interlocking directorate between the Federal Reserve, the major New York banks, and their prime customers having been caught by surprise. Wisdom, apparently, was greatly affected by whose list one was on.”

GuestNovember 26th, 2008 at 1:16 pm

@Payam – I posted the Gold ETF info in the other thread – I have a question for you; if you had to choose, which author would you prefer to read, Stiglitz, Nash or Krugman?

Alessandro - 26th, 2008 at 2:24 pm

Folks, remember rule number one of the internet: “Do not feed the troll”.

Alessandro - 26th, 2008 at 6:07 pm

I myself deleted a couple of half posts already written. But there are too many more interesting things in life 😉

Wolf in the WildsNovember 26th, 2008 at 7:15 pm

🙂 I totally agree. Not responding anymore to the person who constantly speaks without evidence or proof.

PeterJBNovember 26th, 2008 at 2:26 pm

Pray tell:Wisdom? Wherefore art Thou?”Citigroup’s big problems, beggars in Zegna suits, trade wars on the horizon, Philadelphia Fed report beset by weakness, record injections of liquidity, jobs slashed on wall street, a bevy of financial indicators to ponder just how much we have fallen, market losses trim size of overall economy Citigroup’s problems are double AIG’s, which has the taxpayers and investors on the hook for $170.4 billion. We see AIG’s problems at over $500 billion so that means Citigroup could be offside $1 trillion. Citi is loaded with the same garbage AIG has. That means both AIG and Citigroup are insolvent, and you will get to pay to bail out both of them. CEO Pandit is an idiot and worse so is Citi’s management.” it be clear: When our divine and most high elite “leadership” find their edifices crumbling, nay rotted, suddenly, the struggle becomes a fight, then a brawl; with no holds barred and where the umpire is paid for.From the above post: “Virtually all of the inner club was rescued.” Good point but predictable.Wisdom, is not innate to the US Dollar, but corruptive influences are.A message to you all; the Heretics will also be spared…but, by their own hand ;-)>Ho hum

PeterJBNovember 26th, 2008 at 3:00 pm

Woolworth into administration* Robert Peston* 26 Nov 08, 05:07 PMI have learned that Woolworth, one of the UK’s best known and oldest store groups, will tonight file to go into administration under UK insolvency procedures.WoolworthsThe board will meet at 6pm to take the formal decision.Deloitte will be appointed as administrators to the store chain and also to Entertainment UK, which supplies books and DVDs to supermarket groups.Ho hum

kilgoresNovember 26th, 2008 at 4:21 pm

By the way, the original Woolworth stores began in the States, and migrate to the U.K. They’ve ceased to operate under that moniker here, but have carried on under the Woolworth name in the U.K. and elsewhere.SWK

PeteCANovember 26th, 2008 at 9:25 pm

Pretty interesting – because Woolworth’s tends to cater to lower-income customers. If they can’t make a go of it, it points to serious reductions in consumer spending in the UK.PeteCA

kilgoresNovember 27th, 2008 at 12:45 pm

Pete:I agree. I think the effects are first felt at the bottom, and trickle up the socio-economic ladder.Incidentally, there was a good piece on the Newshour on PBS last night about the impact of the downturn — or as it is referred to in the UK, the “credit crisis” –on small business owners in London. I think it’s going to get really bad, shockingly so, starting in the first quarter of the New Year.SWK

GuestNovember 26th, 2008 at 3:15 pm

This is interesting – it seems that the Auto Sector has become the lightening rod for the outrage felt by the US public about the bailouts and Obama is tapping into that – The autos want a bridge loan while Obama insider Rubin’s company (CITI) got a bailout in the hundreds of billions with the full blessing of Obama’s Treasury Sec Geithner. I guess Obama must believe that the American public is that easily manipulated.Obama Chides Auto Makers in Fresh Blow

WASHINGTON — The federal government sent Detroit packing last week, saying the Big Three auto makers had to establish their financial viability before any bailout, but it moved quickly over the weekend to give Citigroup Inc. $20 billion and promised as much as $275 billion more.On Monday, President-elect Barack Obama offered his own rebuke of the auto makers’ stuck-in-the-mud approach to restructuring.”Taxpayers can’t be expected to pony up more money for an auto industry that has been resistant to change,” Mr. Obama said at a news conference in Chicago. “And I was surprised that they did not have a better-thought-out proposal when they arrived in Congress….I think that the auto industry needs to present us with some clarity in terms of the dollar figures that they’re talking about.”

GuestNovember 27th, 2008 at 9:33 am

What’s ironic is that the Big 3 themselves turned a blind eye to the democrats and funded the republicans election efforts vs. wall street was very generous to Obama and the democrats. But ironicaly Obama and the democrats owe their political dominance to states like Michigan an Ohio big union states. The question is will they turn their backs on their biggest political supporters to spite the big 3 brass?

MarkNovember 26th, 2008 at 3:34 pm

Actually wishing to comment on the blog at hand, I believe it to present more than a key point:In an environment where state fiscal positions will be ever more stretched and where they were already deferring pension funds given the long-term nature of their liabilities, this is one more blow to retirement savings. CALPERS already faced significant losses on property holdings.Rather than being just a litany, this experience raises key questions about optimal investment strategies for institutions and countries that are now managing large, if somewhat smaller pools of capital. Where does one go for returns? So what is a fund or rather country to do? Much depends on the level of development of the country and the time horizon. In the short-term, perhaps invest more at home (maintain investment at home) or be ready to be asked to do so. But it does pose a critical question for these long-term investors. How should one invest for the long-term to take advantage of windfall proceeds that may not all be absorbed immediately? Clearly asset allocations will be under review. But getting high returns over the long-term is difficult which is a challenge for those charged with managing large pools of capital.Money has consolidated like never before. All these aggregators are duking it out for returns. As the number of players diminish the fight for returns on investment become much more visible. The fallen increasingly leave larger ripples. No more is it a matter of someone off in some distance being affected, no, such failures now affect nearly everyone!It’ll be last man standing. And in the end we’ll see that all our eggs will be in one basket, just as it’s exposed that the basket is crumbling and the eggs are all rotten.

MorbidNovember 27th, 2008 at 6:31 am

Let The Big Guns Duke It OutIt’s like I said before:1. Save, save, save. Don’t buy anything you don’t really need.2. Pull all your money out of the market and go on with your life. The whole market is rigged, corrupt and immoral at this point. Support your local economies.PS Do you see the insanity that the governor of Michigan is recommending in the WSJ 24-11-2008 issue? That car loans and car buying incentives be provided by the Feds because the car industry cannot make money unless 15 million cars are sold annually. Is this a workable business model? Did she not hear that the American consumer is shopped-out, under so much debt they can’t see straight? What a economic model we follow – it is a Ponzi scheme that has reached the end of its run.

MarkNovember 27th, 2008 at 10:55 am

Yeah, what part of unsustainable don’t they get? I have a better idea, why not put everyone to work digging ditches, and then have them fill them in again! The end result will be similar in that we’ll be burning up energy doing nothing; except, with digging ditches at least we won’t be producing a bunch of toxic crap!

GuestNovember 26th, 2008 at 6:28 pm

Good article, Rachel.I’ve been both stunned and appalled by the poor investment decisions taken by Singapore’s sovereign wealth funds (Temasek Holdings and Government Investment Corporation). Instead of adopting conservative investment mandates, they behaved more like speculative hedge funds; buying into dud companies and investment banks when there was already ample evidence of impending disaster for these entities.Unfortunately, these Einsteins ended up losing billions of dollars of tax payers’ savings and became sovereign loss funds in the process.Temasek recently announced their senior managers had “volunteered” to take pay cuts of between 15-25%. The government should have made them involuntarily disemployed instead. So far, Singaporeans have heard nothing about what actions GIC will take to hold people accountable. If these people at Temasek and GIC want to earn the big bucks, then the buck must stop with them when they mess up.Temasek and GIC need to review their risk management policies and investment mandates before they lose another swag of billions of other people’s money with their very poor judgement.

RachelNovember 30th, 2008 at 4:24 pm

Thanks for the comments – yes we are starting to see more political ripples from SWF losses. However, while GIC has become somewhat more accountable, at least to the outside world, it still refuses to disclose its assets under management.However, the one saving grace is that funds like GIC actually used less leverage, meaning that they may not have faced margin calls.But losses are becoming very unpopular in countries like China and maybe even in the Gulf.One of the problems for some SWFs is that they started patting themselves on the back a bit too soon – ie GIC did liquidate many of its bets on MBS, unfortunately they plowed it back into UBS.

GuestDecember 3rd, 2008 at 11:15 pm

Not only did GIC plow money back into UBS, they ponied up money for Citigroup as well. And sister SLF (sovereign loss fund), Temasek, compounded a problem with their Merrill Lynch investment by injecting even more cash during ML’s capital raising.Then there was Temasek’s silly investment in ABC Learning Centres. Why buy into an over-leveraged company with cooked books? And more critically, why throw more good money after bad even after news of ABC’s cooked books emerged?As I noted earlier, pay cuts weren’t sufficient for these Einsteins. Summary dismissal would have been more appropriate for losing such large swags of tax payers’ money.Temasek’s March 2008 annual report was rosy. Let’s see if the next report highlights their dumb errors. And I wonder if they mark their assets to market.

Shootin' Non-Live Stuff is FunNovember 26th, 2008 at 9:24 pm

For all of you deflationists; the price of my Wal-Mart full metal jacketed .45 ACP ammo has been rock solid for the last 18 months, but this week it went up from $29.88/100 to $31.97/100; that’s a 7% price hike.There does not seem to be a justification for this inflationary price hike. Commodity prices are down. Shipping costs are down. No pay hikes at Wal-Mart, etc. So WTF?Gun sales are hot; maybe ammo manufactures are being opportunistic? But my guess is that this is showing how paper-prices of commodities in general are diverging from their physical prices.As you know physical price starts with a pa, pa, “p” and that rhymes with a ta, ta, “t” and that stands for trouble right here in River City!

AfANovember 27th, 2008 at 1:29 am

In a deflation, not everything needs to go down in price. Similarly, during an inflationary period, not every single item needs to go up in price. It is about the general tendency. In fact, if ALL prices moves up and down in sync there would be no “real” inflation or deflation perceived.NB. When I say all prices, that include the price of finished products, commodities, services, labor, debt, assets …

Shootin' Non-Live Stuff is FunNovember 27th, 2008 at 7:24 am

I thought the anecdotal example with the ammo was apropos because its retail price withstood the inflationary pressure that we have seen everywhere else for the last 18 months. Now that commodity prices should be decreasing, ammo starts its climb with all the other products in the store. But as you say it’s just one item in a milieu of price points and pricing crosscurrents.As an aside, I don’t enjoy shooting live things for sport even under the excuse that I will eat it. But, I am preparing for a day I may have to shoot another person to save myself from grave bodily harm or even death.I don’t like thinking about such an event, but I do enjoy the skill training and the paradoxical relaxing effect of discharging a large caliber weapon. If the event were to happen, it would not be fun. Rather it would be extremely stressful. I may be shot. I will have to navigate the legal system under the assumption of guilt. The experience would change me for life in terms of nightmares, sense of distrust, and general level of paranoid thoughts. But I would be alive or tried my best to stay alive.

GuestNovember 27th, 2008 at 9:42 am

Food has barely gone down in price and unfortanately with the excessive labor deflation we’ve had the past 10 years and efficiencies in retailing there isn’t much room for prices to come down without causing serious wage deflation which there is little room for. There are so many monoplolies and mega companies in collusion like insurance companies that price reduction aren’t adequate per losses of jobs. Like do you think your gas and electric bill will come down? Or how about your cable bill? The things that people struggle to pay for like utilities cable bill and food aren’t coming down to affordable levels. Even if people had no mortgage payment they would struggle to survive so the housing deflation is good but not adequate.

GuestNovember 27th, 2008 at 9:00 pm

Ive been reading articles about gun sales surging. One would assume ammunition would do the same. Plus, there are many worries over Obama’s gun-control tendencies and movements to implement micro stamping and other bogus technologies in order to make ammo too expensive. Buy more while you still can.

AfANovember 27th, 2008 at 1:48 am

Even this applies more to the previous post by Roubini, I believe I found the way, or perspective, from which we, or at least I, should read or listen to what he is saying. We all agree that the analytical and predictive skills of Professor is what makes him outstanding among his peers.We should read any of his posts as such: a speculation or forecast and not policy recommendation, even when he says they are. Case at hand, compare those two posts:The Deadly Dirty D-Words: “Deflation”, “Debt Deflation” and “Defaults”. And How Central Banks Will Have to Resort to “Crazy” Policies as We Have Reached Such Bermuda Triangle of a “Liquidity Trap”AndDesperate Measures by Desperate Policy Makers in Desperate Times: the Fed Moves to Radically Unorthodox Policies as Economy Is in Free Fall and Stag-Deflation DeepensIt took less than a week before what he saw was coming start becoming truth. The same thing happened with the Dodd Frank plan (remember that one?) and Paulson’s Plan. From now on, I will not argue against him about any of his policy recommendations, because I will view them as speculations from his part – even if he doesn’t intend them as such.Thank you Professor for the Edge.

MRNovember 27th, 2008 at 6:07 am

Countdown Continues years 3.54 today…and falling.

Jason BNovember 27th, 2008 at 8:47 am

Who is going to buy treasuries at these yeilds, as the Fed debases the dollar? How is the US going to finance itself next year.Its hopeless. Game over. Leap2020 was right.

PeteCANovember 27th, 2008 at 9:58 am

Jason BSome quick comments for you.You’ll notice that the Fed effectively nationalized the US mortgage industry this past week. That’s a radical step for them (and expensive). But why did they do it? Well … clearly the Fed is looking ahead and realizing that they must flood the global credit markets with new US bonds (and UST’s) this next year. This is necessary to pay off the enormous US deficit in FY w2009. This will cause the value of US debt to plunge – and yields to soar. Normally such a move would dramatically penalize the mortgage industry – rates on mortgages would also soar. But this is not what the US Government wants. They don’t need a further major plunge in the US housing market (on top of the exisiting plunge). And that’s what woould happen if mortgage rates soared to bouble digits. So what the Fed has moved to do – is to effectively set the mortgage rates directly themselves. These rates will be at much lower levels than the free market would set in 2009 and 2010.Recent Fed actions, plus statements by Obama, point to an expected collapse in US bond prices, and a situation of raging inflation within the USA in the next 12-24 months.PeteCA

GuestNovember 27th, 2008 at 10:48 am

Came across this article (Oct 13) which speaks to your comment:Bond Market Collapse is Imminent

AfANovember 27th, 2008 at 12:25 pm

Are you saying that the Fed will be the market maker for the mortgage industry; that, on top of their mission to promoting growth and putting inflation in check mainly through the manipulation of the FFR, the Fed will have to manipulate the FMR (Federal Mortgage Rate).But we all know how successful the Fed is in keeping rates on target during turbulent times. Since the current crisis started, the Effective rate was much lower than the Fed’s target. Do they believe they would have more luck influencing mortgage rates than bond rates and other types of repos? And even if they did, chances are demand for and supply of mortgage debt would not follow – Interbank lending was frozen, even though repo rates were driven to low levels. Lenders would always find ways to drive the IRR (and its risk-adjusted version) higher – through higher requirements and fees.

JLCNovember 27th, 2008 at 9:03 pm

If the Fed is buying the majority of the MBS, they can control the rates. Its part of Bernanke’s Deflation paper strategy. The Fed will monetize certain segments of the bond market in order to hold down long term rates while they attempt to re-flate.Will it work? What has worked?

Jason BNovember 27th, 2008 at 11:37 am

Pete -Thanks for your comments. I agree with your assessement of the Fed’s nationalization o fthe mortgage market. My morbid “its hopeless. Game over” statement referred to the dollar. BWII and the dollar as reserve currency. You may remember my “oh sh*t” moment a few weeks ago when I looked at the leading indicators. We are caught between the hammer of our economic depression and the anvil of our failing currency. Hard times are ahead. Chances are very high of the “endgame” of high inflation and dollar crash. Peter Schiff, my favorite bear, predicts hyperinflation, food rationing and rolling blackouts. I cannot refute this possibility.

GuestNovember 27th, 2008 at 12:18 pm

Happy Thanksgiving to All,I sitting here overlooking the beach on the Outer Banks of North Carolina with friends and family. It helps to relax and enjoy life a bit with all the doom and gloom that we will face in the coming months and years. Hope that you all are doing something similar.Anyhow, I’m wondering if anyone might have some forward looking thoughts on the most recent developments with the terrorist attacks in Mumbia, India and the recent ruling by the Iraq government to support the US military’s retention for the next three years? What does that mean for the US economy, stock markets, price of oil and precious metals? Your collective wisdom never ceases to impress me!PKB

AfANovember 27th, 2008 at 12:39 pm

Happy Thanksgiving to you too.I hope you are not the one in charge of preparing the Turkey – that might revive some traumas.OTOH, even though there is nothing forward looking in what I say, the market has – well I think so – a non-linear discounting machine; depending on its “mood”, it doesn’t react to the same news similarly during different times. Then, we have to distinguish between endogenous and exogenous news. The markets would always react to an endogenous news although the reaction horizon may not be predictable; a person who is suspecting having some kind of stealth sickness may either right away to see a doctor, or after a month, a year, or only after symptoms become pronounced. Exogenous news may never be discounted.

PeteCANovember 27th, 2008 at 12:53 pm

PKB: Although the terrorist attack in Mumbai is very upsetting at a personal level (and certainly deserves our concerns), it is unlikely to affect the US markets very much. Indian stock markets may certainly be affected of course (they may be closed), but globally the impact would be much smaller. Same goes for local decisions in Iraq. The US market only reacts to these incidents if they have broad and grave consequences, or if regional stability or economies are affected (e.g. terrorism causing a major rise in Mid-East tensions and a subsquent increase in the price of oil would affect the Market – but the Mumbai incident won’t do that).But we need to remember the families of all the victims at Mumbai, and keep condolences and prayers in our hearts.PeteCA

GuestNovember 27th, 2008 at 1:35 pm

PeteCA – I think you will find that in the coming days this despicable act develops into a regional crisis. For India this attack is at least in the order of magnitude as 7/7 was for the UK. India will almost assuredly lay the blame for this on Pakistan (even if it was of domestic origin). The result could well be that the government of Pakistan, already in economic and political crisis, is brought down. With the current global economic fragility and increasing political tensions between Russia and the West, a regional crisis involving India and Pakistan could well spin out of control.At this juncture the global economy does not have sufficient shock absorbers to withstand such an event. In the coming days I fully expect that India/Pakistan will dominate the news cycle both on the front page and in the financial section.I hope I am wrong.

PeteCANovember 27th, 2008 at 1:46 pm

You make a good point. I don’t know how the Indian Gov’t is going to respond to this incident. That really could develop into something bigger. So my comments only apply to the actual incident itself – not to possible larger repercussions.PeteCA

GuestNovember 27th, 2008 at 12:46 pm

The probable outcome of the Mum attack is that an already fragile Pakistan rapidly destabilizes. In the coming days what was a blip on the ticker Wednesday will become a significant burden within a week as all h breaks out in that region.As I had posted here a number of weeks ago all bets are off if there is a world event (physical or political). This I am afraid to say is likely it.

GuestNovember 27th, 2008 at 2:14 pm

The Pakistan ConnectionEvidence is still sketchy, but tensions are already rising between India and its nuclear-armed neighbor.By Ron Moreau and Sudip Mazumdar | Newsweek Web ExclusiveNov 27, 2008 | Updated: 2:25 p.m. ET Nov 27, 2008

GuestNovember 27th, 2008 at 2:34 pm

I hope that this does not lead to a downward spiral to stability, but it has that potential. One thing is for sure is that nothing good can come of this.PKB

KJ FoehrNovember 27th, 2008 at 7:11 pm

Rachel,A few weeks ago Dr. Roubini was talking about the liquidity troubles of countries like Iceland, some eastern European countries and others like Estonia and Latvia I think it was. And I heard similar stories in the main stream media. What happened with them? Are all the problems resolved? Or are they still brewing?Also, a few weeks ago I heard some other stories about possible serious problems with cash flow at year end for many banks. Have those problems been resolved too, or is there still a possibility of such problems?Thanks for your efforts.And many thanks to Nouriel for generously sharing his thoughts with us here.I hope everyone had a wonderful Thanksgiving day.

RachelNovember 29th, 2008 at 8:54 am

Hello KJ,The liquidity problems faced by countries in Central and Eastern Europe and the CIS have not disappeared. In fact Ukraine’s rapid currency depreciation is an example. However the negotiation of rescue packages with the IMF does lessen the short-term balance of payments risk but the next challenge will be making the difficult economic policy changes to reduce the large deficits these countries developed. For these countries though the bigger issue is the fact that many may be headed towards a hard landing. A recent report from the EBRD suggests that many Central and Eastern and Southern European countries will face much slower growth rates in 2009 than in 2008 due to the reduction in global demand and the reversal of capital flows – with growth at half of its high levels this year. Russian GDP growth may slump to 3% from 7% this year and 8% in 2007. That’s a major decline and many of the baltics might actually suffer contractions.

MRNovember 27th, 2008 at 8:59 pm

Pete,So that means that the dollar will not fail and the US debt will decrease ? With only some inflation ?Won´t we see after the deleverage a dollar colapse and hyperinflation at US ?

PeteCANovember 28th, 2008 at 9:22 am

MRPersonally, I wouldn’t be surprised to see BOTH a major drop in US bond prices and a major devaluation of the US currency. I am not yet sure if the US Gov’t will make a surprise announcement and deliberately devalue the US dollar, or if they will allow it to sink due to forces in the currency markets. I don’t believe that they will succeed in offloading all of the (rapidly expanding) US deficit due to increased sales in the bond markets – I just don’t think the buyers exist to take care of that volume of trade in UST’s (i.e. the Gov’t will be forced to monetize).PeteCA

PeterJBNovember 28th, 2008 at 12:10 am

Krugman, the carpetbagger, cheap opportunist, political apologist and the great pretended revealed, er, at last:”Neanderthal” EconomicsDaily Article by Chris Brown | Posted on 11/25/2008″It seems the Austrian economist possesses more truth in his pinky finger than Paul Krugman in his entire Nobel Prize–winning body. What other explanation can there be for Krugman’s consistent policy “solutions” to the current economic crisis, which would actually exacerbate the problem and lead to a deepening and prolonging of a recession? Austrians not only predicted the current financial crisis but can accurately diagnose it and prescribe the proper antidote. Krugman’s recent New York Times article, “Depression Economics Returns,” continues to demonstrate his ignorance of economic truth by presenting even more antidepression policies as solutions. In this article, we will analyze Krugman’s recommendations and provide the Austrian cure, including what government can do to cure the recession.” Krugman knows nothing about economic phenomena.User-Contributed Tags:inflation policy Depression keynesian stimulus Cluelessness krugman Neanderthal Bizarro CharlatanomicsHo hum