Peas and Bonds

That pea being Black Eyed Pea member “Will.i.am.”. He repeated an oddity that keeps cropping up:

“If America really wants to make a difference, it should stop importing China’s products and pay back its debt“

Now the former is a personal choice, the latter is… well, it makes no sense.

America issues debt in the form of treasury bonds and China along with any other individual or institution on the planet can buy them. Perhaps too much paper is issued but given the low yields on current treasuries its obvious there’s plenty of demand to be a creditor.

The US dollar has depreciated against the Renminbi in recent years, moreso than the bonds yield. Effectively the Chinese government is subsidising the US but at no cost to the US government or taxpayer.

Restricting access to US debt would currently benefit China, not hinder it.

The Flat World Is Coming Unstuck

Excellent blog post by Brad Setser here:

Borders still matter; “the world isn’t as flat as it used to be”

Plenty of cut and pasting from other blogs but it paints the overall picture. The so-called globalised barrier-free economy is still somewhat illusionary.

Guido is One Sharp Cookie

Blogging is a heck of a meritocracy. My oft-forgotten, hardly-up-to-date little blog got a mention at Guido Fawkes thanks to the post about Newsnight. Thanks Guido!

The Irrelevance of Northern Rock

The UK has added circa £111bn of assets and £110bn of debt to its balance sheet. A back of the envelope calculation would suggest that, even with a major housing recession, the British taxpayer will only have to cough up a small fraction of the amount the press suggest.

A 40% real-term drop in house prices and an exceptional default rate on mortgages of 10% would mean a loss of only £4.5bn, £75 per person.

The British taxpayer spends £4bn per annum on the World Bank, £10bn is given in net subsidy to the European Union, the proposed ID card scheme will cost £6bn just to set up and £20bn has been wasted on the NHS computer operations in the last few years. There is so much fat on the lumbering beast that is the British government that at this point a few more pounds is just a little more blubber.

By far the greatest economic worry for Britain is the public sector pension obligation. Amounting to £1,000bn these future payments have quadrupled over the past 10 years. While future social security and pension funding is at the forefront of all facets of the US government economic policy there is no talk in the UK of the, proportionally, far larger debt. It makes the targeting of Northern Rock for political wrath so puzzling.

How Safe is your Bank (pre-Bear Stearns implosion)

The ever brilliant FT Alphaville Markets Live posted a Credit Suisse note earlier with credit default swap numbers for the UK banks:

UK bank CDS are fairly flat with A&L at 375bps, Barclays 163bps, B&B 425bps, HBOS 245bps, HSBC 145bps, Lloyds TSB 133bps, RBS 205bps, and Standard Chartered 143bps. It is interesting to note that HBOS CDS is now similar to levels where A&L and B&B were trading just a few weeks ago. Credit market commentators continues to cite confusion around the decision to issue non-equity tier 1 (particularly given they are already close to maximum headroom on the innovative).

For those who think the above is gobbledegook: A “CDS” Is a Credit Default Swap – a complex mechanism that insurances against a company defaulting. The “bps” is simply basis points (1/100th of 1%) – the cost of insuring the debt of that institution. The higher the bps the more risk the financial markets think there is in holding that banks’ paper.

Here’s my own chart of the above data (click for full size picture):

Note: many foreign banks operating in the UK are considered a far higher risk than Bradford & Bingley, including the Icelandic and Indian options.

Newsnight: time for more despair!

The BBC’s flagship televisual news programme gets it wrong yet again when it comes to compiling a simple markets round up.

The FTSE-100 actually finished down 0.80 points on Valentines day 2008, not 80 points.

This follows a debacle in late November of not one but two cock-ups on consecutive nights. Radio 4 made the same faux pas while Newsnight editor Peter Barron admitted the mistake had been a repeat of earlier events.

For international readers: this is what a $7bn per annum state-funded broadcaster gets you!

Egg on Citi’s face

Citigroup’s withdrawal of 161,000 Egg branded credit cards has enraged much of middle England. The anger isn’t so much over the taking away of credit but rather calling the customers ‘risky’. Many of these customers don’t see themselves as a risk and have taken Egg’s pronouncement personally. Egg’s wording makes sense from their commercial viewpoint. Egg are considering the risk and reward balancing act they face not the absolute risk of default. An example:

1. Ms Perfect pays off her credit card bill in full every month. She believes there is no risk of her defaulting and is aware the creditor is making no money from their business together. Ms Perfect is retired on a comfortable but below average income.

2. Mr Lax doesn’t pay off his bill in full. Indeed, he has a patchy payment history but pays back reasonable sums at a high interest rate and his public sector job provides a steady, high, earned income.

It is Ms Perfect who is the riskier customer.

Mr Lax provides a highly profitable and ongoing income stream. Even if Mr Lax did eventually default on the capital it may be far enough in the future that the risk was worth taking and he has been a profitable client. Ms Perfect has far less chance of defaulting but there is no upside for the credit card company. Breaking even when extending a credit line of £1000s is very little reward for a little too much risk in the current climate [1].

Of course, this is an overly simplistic example, Citi will have used numerous parameters to decide the ‘risk’ of a customer. The decision will be dependent on a strict and highly complex risk/reward calculation. This doesn’t mean Citi will get it right 161,000 times but the large majority of those who feel besmirched by the too ‘risky’ tag will indeed be a bad bet on a risk/reward basis. It isn’t a simple matter of whether the customer will pay off their credit card bill or not.

Perusing financial messageboards this weekend it is no exaggeration to say many Ms Perfects consider the allegation of being ‘risky’ as tantamount to libel. The ‘risk’ label has been taken as a personal affront. For this layman of law it brings up a potentially interesting scenario. If some sharpshooter solicitor opens a class action suit what will Citi do?

Citi could simply admit ‘risk’ to them is the “responsible” lending to Ms Perfect rather than the “irresponsible” lending to Mr Lax. On the flip-side Citi could decide it’s better to offer a settlement without publicly stating they’re happier going after Mr Lax than Ms Perfect which could be a public relations nightmare.

Rock and hard place, its not where I’d want my eggs.

[1] The current climate of an economic slowdown and potential recession, of course. Idle musings could suggest a rather convenient coincidental event at Citi last week. On Wednesday Citi published an investment report pointing out the risk to the balance sheets of two UK banks (RBS and Barclays) in the event of a UK recession. Both banks were downgraded by Citi with the presumption in the report being there’d be a fullscale UK recession. The following day Citi’s most visible UK subsidiary is sending out letters to 7% of customers cutting off credit.

Decoupling the Myth

Monday 21st January 2008 saw big falls in stock prices but rather like February 2007 there is no clear consensus view as to why.

Ambac was the big story, the fear of $2.4 trillion being uninsured and/or unhedged with the monolines saw heavy falls in banking. Yet, the greatest movement was from the miners. The two biggest fallers in the FTSE-100 were the two largest miners, Rio Tinto and BHP Billiton. There was some company specific news: BHP lining up 7 (seven!) banks to tie-up a deal with Rio but other miners also fell sharply. Even Xstrata fell despite concrete talk of Brazilian’s Vale looking to make a bid.

Miners fell so much thanks to the macro sentiment. Japan saw the largest fall from an established market due to fears of an all-out US recession. Of the emerging markets India got the greatest hammering. The idea of “decoupling”, that resource stocks and far-eastern companies would do okay in a US downturn with the Chinese and Indian markets continuing healthy expansion, seems to be on life-support.

While many in the media, especially the left-leaning media (aka BBC/Guardian) have positively lapped up the decoupling hypothesis it has little basis in reality.

Paul Kedrosky makes the point that you could (and I would) argue:

“when it comes to the importance of the U.S. to global GDP, darn little has changed”

http://paul.kedrosky.com/archives/2008/01/21/deflating_the_u.html

The strenghening influence of BRIC countries is, perhaps, a very long-term trend. Yet that hypothetical trend is of no use when the US is still well within its long-term norm of % of world GDP.

We’re all doomed!

“If you expect to be a net saver during the next 5 years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”

Warren Buffett, chairman’s letter to Berkshire Hathaway shareholders, 1997.

The Framing of Political Arguments

The usual terminology of political language is stupid. What is ‘left’ and what is ‘right’? Why should Hitler be ‘right’ and Stalin, his temporary friend, be ‘left’? Who is ‘reactionary’ and who is ‘progressive’? Reaction against an unwise policy is not to be condemned. And progress towards chaos is not to be commended. Nothing should find acceptance just because it is new, radical, and fashionable. ‘Orthodoxy’ is not an evil if the doctrine on which the ‘orthodox’ stand is sound. Who is anti-labor, those who want to lower labor to the Russian level, or those who want for labor the capitalistic standard of the United States? Who is ‘nationalist,’ those who want to bring their nation under the heel of the Nazis, or those who want to preserve its independence?

Ludwig von Mises in  Interventionism, An Economic Analysis (1940).