It's spreading

[peterbirks]

Has anyone else noticed the similarities between the outbreak of Foot and Mouth disease in the UK and the global fall-out from the US subprime loan meltdown?

Just as the government relaxes movement restrictions of cattle, up pops the disease in Dorking, 10 miles outside the original exclusion zone. Just as Bernanke says that the subprime loans problem is contained, BNP Paribas says that it won't buy some funds because at the moment it can't sell them. Yes, it's the famed liquidity crunch. The ECB panics and pumps as much into the economy as it did in the immediate aftermath of 9/11 (an indication of how seriously the pwers-that-be are taking things) — €95bn. The markets see what the ECB has done and promptly assume that things must be much worse than they had previously thought.

Ah well, try to look on the bright side. A problem with the booming UK housing market has been the limitless supply of easy credit. The government tries to stem consumer demand by raising interest rates. But now, the problem solves itself, because the supply has been cut off. That doesn't mean interest rates will fall, because there is the other side of the equation. If people won't lend, and there are still people who want to borrow (albeit, fewer of them), then the "price" of borrowing goes up. It's all very well the BoE setting base rates at 5.75%, but there's a real market of lenders and borrowers out there. Compare it to the Zimbabwe situation, where they tried to curb inflation by not printing notes. Net result? Inflation continued and liquidity dried up because there wasn't enough cash to "oil" the economy.

The same thing can happen with interest rates. Set them too low in a credit-crunch market and all that happens is that trade dries up. So you have to inject more cash into the markets (passim, the ECB and Fed yesterday, the JCB today). All of that makes things quite exciting for the macroeconomist, but a first-impression interpretation from Birks Towers would be that you can forget any easy loans for the next 18 months. That pushes through to the "real" economy, bringing down house inflation in the UK and general inflation elsewhere. That eases upward pressure on interest rates for the "curb inflation and borrowing" reason. But it doesn't ease the upward pressure from the very unusual "encourage supply" reason. You (the Central Bank) can get round this by supplying it yourself, in the short term, but eventually the markets have to get back into gear. If they don't, you have a very hard landing indeed.

FTSE down another 140 today? I wouldn't be surprised.

PJ

Comments

[(Anonymous)]

So how can the individual profit from the current turmoil? Time to go into loan-sharking?

matt

Loan sharking

[(Anonymous)]

Too late, already started ((Ed. and finished)) in Cornwall according to the media

Keith S

[(Anonymous)]

Hi,

when you say the government put say 90 billion into the econonmy; what exactly do you mean, where does it go to?

cheers

fiscally naive

[peterbirks.livejournal.com]

See for example:

http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article2233274.ece

The European Central Bank said today that it lent a further €61 billion (£41.3 billion) to the banking system as world equity markets continued to plunge amid mounting tension in the credit markets.

The move, which takes the form of a series of 3-day loans which will be repaid on Monday, comes on top of the Bank's move yesterday to inject €95 billion in an unprecedented emergency action by the Frankfurt-based central bank for the eurozone. The money went to 49 banks.

The latest injection from the ECB brings to almost £125 billion the amount central bankers have pumped into the system in the past 24 hours. Requests from banks for a further €49 billion of loans have been left unsatisfied.

Elsewhere the US Federal Reserve put in $24 billion (£12 billion), the Bank of Japan injected the equivalent of £4.1 billion, and the Reserve Bank of Australia pumped A$4.95 billion (£2.1 billion) overnight.

[(Anonymous)]

Interesting and thanks, but I'm compelled to ask in the scheme of things how much can be achieved with a 3 day loan? Might it really, (realistically) say, stave off a global recession?

fiscally naive

[peterbirks.livejournal.com]

How much does a three-day loan help? Not a lot.

It's the "we're here to help" sign that is meant to make the difference.

But, eventually, the banks have to be willing to lend money. The problem for the past few years (as I have written at length, many times) is that banks stopped being banks and started being brokers. They lent money at 7% and then securitised it at 6%. Now that they can't securitise anything, they don't want to lend "off their own back". The old days of just lending the money that depositors keep on account are long gone (and, besides, that falls into the trap of lending long and borrowing short). It's been the classic "moral hazard" (in insurance terms, when you insure something to such a degree that you actually want it to happen) gone mad.

Eventually, you have to hope that the rather painful readjustment to "retaining some of the risk yourself" will result in more responsible lending. And one man's "credit crunch" is another man's "but this is how everything used to be in the 1950s". Put at a personal level, how many people in the UK could function as most people did in the 1950s, borrowing nothing (because no-one would lend you money apart from loan sharks) and only having their wages at the end of the week to spend? For this reason, "credit crunch" - something that would have been a minor irritation in the 1950s, is a first world disaster in the 2000s. On the plus side, we might start seeing fewer ads in the afternoon inviting poor people to consolidate their debts into "one, easy-repayment, loan".

It seems to me that there are two ways out of this abyss. One is the hard way. Return suddenly to a much less credit-oriented society. This ain't gonna happen. Not because it's economically impossible, but because it's politically unacceptable. When something negatively affects too many people, it doesn't happen.

The second way is a gradual reigning in of credit, with central banks taking on the role of providing liquidity when required. I don't think we have much to worry about in the realm of "easy lending" for a few years, but we might well have a structural problem of "no liquidity". The (difficult) technique will be to gradually shave more and more off the the top of the credit tree (i.e., the riskiest part). Unfortunately, the madness of the past few years (and we still don't know where all the risk has gone) will make this seem painful. It's of little compensation to be told "you think that this is bad? You should see the alternative". And one reason for this is that people have been living a decade of a golden age. Simple regression to the mean makes what is in fact better than average, seem awful.

PJ

Holy shit! That was a Golden Age?

[real-aardvark.livejournal.com]

I think more people need to take an A-Level in History. Seriously. It's easy these days: you only need to get a 'C' to be rated the same as me, according to official statistics from the current newspaper of record, the Telegraph.

(And, just as a diversion, that same paper stated that "40% of school children at the age of eleven fail to meet average standards in the core subjects of reading, writing, and arithmetic." I leave commentary on this truly wise statement to those who give a fuck about British education, or can understand what an arithmetic or even geometric average might mean.)

Basically, you are absolutely correct. Something like your "second way" is going to happen. Unfortunately, this does not depend upon regression to the mean: if only. It will happen (and this is purely an ill-informed personal opinion) because financial markets have got too smart for their own good.

Were I to give a shit, which I don't, I would be very, very worried about the unravelling of CDOs and like derivatives. As far as I can see, these are not traceable, let alone transparent.

I'm guessing at a short-term market collapse whilst things get sorted out. I'd call 20% or so off the FTSE 250, followed by a partial recovery.

And, incidentally, what is the difference between "regression to the mean" and "falling off a cliff?"

Jesus Christ, man. Re-learn some maths.

PS Dollar at £0.47 between now and the end of the year. Want to take a £10 bet?

Re: Holy shit! That was a Golden Age?

[peterbirks.livejournal.com]

0.47? What kind of a bet is that? $2.127 to the pound is probably a 2-to-1 on shot. It might even make that in the next upwards move, which could start on Monday.

$2.20 would be an interesting bet, and one that I might go for.

But if I did, I suspect that it would have a potential gain of a bit more than a tenner.


And be careful talking to poker players of regression to the mean. It's a topic very close to all of our hearts and is probably a phrase that poker players understand properly, as opposed to most political commentators and not a few proprietary traders, who think it means that, if you get 100 heads in a row, then tails MUST come up next time (see "buying distressed financial products at 'bargain' prices", part six).

PJ

Re: Holy shit! That was a Golden Age?

[real-aardvark.livejournal.com]

I just happen to like the number 47. I like nasturstiums, too, but I wouldn't bet on them. Nice to know that you have a calculator on hand.

I'm on "buying distressed financial products at 'bargain' prices", part eight, and working backwards. I believe that this is called "contrarian." I have no use or time for either political commentators or proprietary traders, who are all, in their own little way, selling themselves, and therefore worthless.

I'd be very interested in your views on the poker angle of regression to the mean. Clearly (unless the poker player in question is chum for the sharks) this is not related to the hilarious "law of averages." I'm assuming that it has something to do with the rather more interesting ebbs and flows on the various forms of the game (on-line or otherwise), for example your ongoing musings on No-Limit.

I look forward to more insights on this.

Meanwhile, you're quite right. $2.12 is pretty much guaranteed, at least for a half-hour during frenzied trading. Whether it's justified in the bigger picture or not is a different question. So here's another bet for you (the same tenner, evens):

The pound/dollar rate to be 1:2.20 for 24 hours between now and the end of October.

Personally, I think this one's a crush. But there you go.

Re: Holy shit! That was a Golden Age?

[peterbirks.livejournal.com]

What, you want me to back the 2.20, or you want to back the 2.20?

As for the poker angle on regression to the mean, the most famous error in online poker relating to this is the so-called "cash-out curse". People noticed that they tended to get worse results shortly after cashing out. Reams of statistical proof was supplied.

It was then pointed out that people tended to cash out after they had had a good run. Therefore, if they just performed "as expected", they would tend to have worse results after cashing out. Nothing to do with conspiracy by the poker sites. Simply a case of regression to the mean.

PJ

Re: Holy shit! That was a Golden Age?

[real-aardvark.livejournal.com]

Oh, is that all it was? How tedious.

I would have thought that, having suggested $2.12 (or whatever it was), that it would be fairly obvious that I'm prepared to extend the range to $2.20. All the rest was just trying to define what "$2.20" means. We seem to be more or less in agreement on the probabilities here, so I'll try again, and sweeten the bet. (It's only a tenner, after all.)

Some time between now and October 31st, and for twenty four consecutive hours on either the London or the New York Forex, a pound will buy you $2.22. I expect the pound to buy more. (And it doesn't make any sense to me, but then I've been religiously avoiding the City for twenty five years precisely because of this sort of autistic, irrational crap.)

Me: $2.22 and up. You: who knows?

Want to put a tenner on it?

Re: Holy shit! That was a Golden Age?

[peterbirks.livejournal.com]

OK, I'll back against you Pete, for fun. If it reaches 2.20 for 24 consecutive hours, then you win.

But your conclusion was far from obvious. Just because you think it will go to 2.12, that is no reason for me to conclude that you think it will go as far as 2.20. I had agreed with your 2.12, and had posited 2.20. You might have thought. "It might hit 2.12, but 2.20? No way!".

PJ