Unmasking Greenspan Vol. XXIII....

SCHADENFREUDE! I can´t wait to see his new book (already at a 34% discount) to become a major flop. This guy is the most overrated person in the financial history. But this will change very soon. The timing couldn't have been much worse. For more "Greenspan Watch" i recommend Tim´s blog The Mess That Greenspan Made .

Tut mir leid, aber ich kann meine Schadenfreude nicht wirklich unterdrücken. Ich kann es nicht erwarten zu sehen wie das neues Buch ( bereits jetzt mit einem Abschlag von 34% zu erhalten) von "Easy Al" in den Regalen verstaubt oder aber zumindest in alle Einzelteile zerlegt wird. Das Timing hätte schlechter nicht sein können. Der wohl am meisten überschätze Notenbänker aller Zeiten (wird sich sicher in Rekordgeschwindigkeit ändern). Mehr über die Entzauberung von Greenspan findet Ihr regelmäßig auf The Mess That Greenspan Made

Taken from Bush, Bernanke and a bad bailout / Fleckenstein
Of course, as the mortgage-for-anyone-with-a-pulse party was in full bloom, Greenspan was busy cheerleading. In a speech April 8, 2005, Greenspan extolled the virtues of sublending:

"With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. . . . As we reflect in the evolution of consumer credit in the United States, we must conclude that innovation and structural change in the financial-services industry have been critical in providing expanded access to credit for the vast majority of consumers, including those of limited means. . . . This fact underscores the importance of our roles as policymakers, researchers, bankers and consumer advocates in fostering constructive innovation that is both responsive to market demand and beneficial to consumers."

Naturally, it was not until after the debacle unfolded that Greenspan warned banks about imprudent lending standards.

> Another example of how the times have changed is the fact that the book from Hyman Minsky is only available within within 4 to 6 weeks. If you want to buy it now you have to buy a used one and pay at least $167,85 / 34% premium....... ;-)

> Ein praktisches Beispiel das zeigt wie sehr sich die Zeiten geändert haben ist die Tatsache das für das Buch von Hyman Minsky zur Zeit Lieferfristen von 4-6 Wochen in Kauf genommen werden müssen. Wenn man es sofort kaufen möchte muß man auf ein gebrauchtes Exemplar zurückgreifen und mindestens $167,85 / 34% Aufschlag zahlen..... ;-)

> The NYT is reporting in "Greenspan Blogs? Not for Long!" that Greenspan has shut down his blog to promote his new book after only one post....

> Passend dazu berichtet die NYT in "Greenspan Blogs? Not for Long! " das Greenspan seinen Blog zur Promotion seines Buches nach nur einem Post eingestampft hat ......

Ponzificating / economist

please make sure you read also this from pimco on ponzi/minsky http://tinyurl.com/2u64xe

wer möchte sollte sich diese von pimco zu dem thema durchlesen http://tinyurl.com/2u64xe

Is the financial system a confidence trick?

CHARLES PONZI was a likeable man. That helped him persuade American investors in 1920 that he could deliver returns of 50% in just 45 days by exploiting a loophole in the pricing of international postal coupons. In a way, he was advertising an early version of an arbitrage fund.

In reality, the loophole could not be practically exploited. So Ponzi exploited his customers instead. He could deliver returns only by taking money from new investors to give to his early backers. But although he died in poverty, the Italian immigrant achieved immortality of a sort: fraudulent moneymaking operations are often known as Ponzi schemes.

In the world of finance, describing something as a Ponzi scheme is a standard form of abuse. This insult has been bandied around a lot of late. Financial-sector profits have grown far faster than GDP over the past 25 years; everyone has become richer by lending money to everyone else. Household debt is running at about 100% of GDP in America and higher still in Britain. Credit derivatives are soaring in value and payment-in-kind notes (which pay interest with more debt, rather than cash) are in vogue. Last month Tim Lee, a strategist at pi Economics, described the whole financial system as “the equivalent of a gigantic Ponzi scheme.”

In one sense, of course, he is right. Many elements of the system are Ponzi-like in that they depend on confidence—they would collapse if all investors demanded their stakes back—or they rely on new backers to keep them going. Pay-as-you-go pension systems, for example, depend on there being enough workers to fund promises made to retired employees.

The health of the commercial banking system depends on the assumption that, at any time, most depositors will keep their money in the bank. That allows banks to borrow short and lend long; earning higher rates on loans to business. When depositors panic and start to withdraw their money, the result is usually an economic catastrophe.

Ponzi's original scheme was fraudulent from the start. But even if he had found some exploitable anomaly in the financial system, his rationale was flawed. Because he offered such a high rate of return over such a short period, claims on the “Bank of Ponzi” would quickly have reached ridiculous levels.

So perhaps there are good and bad Ponzi schemes. Good schemes will do more than funnel money from latecomers to early takers, allowing the foremost to prosper at the expense of the hindmost. And they will not allow claims to increase too fast. That was the big mistake of John Law, the pioneer of paper money in early 18th-century France. Law's system eventually collapsed, but he did have the insight that the creation of credit might increase trade, and thus general welfare.

But how to tell when a scheme has gone too far? Hyman Minsky, an American economist, distinguished three kinds of borrowers. Hedged debtors can safely meet all debt payments from their cashflows. Speculative borrowers can meet current interest payments from cashflows but need to “roll over” their debt in order to pay back the principal. And Ponzi borrowers can pay neither interest nor principal from cashflows but rely on rising asset prices to keep going.

The American housing market seems to be suffering from the unravelling of a Ponzi-type system. Subprime loans were offered on generous terms that, implicitly or explicitly, depended on rising house prices. The banks that made these loans bundled them up and sold them in the credit markets to investors, eager for high yields. This was supposed to make the financial system more secure by dispersing risk more widely.

But look what is happening now. The buyers of these loans are asking the original mortgage-writers to buy them back. But these homelenders do not have the money to do so. The confidence that sustained their balance sheets has evaporated, leaving many in dire trouble.
Might the problem be more widespread than housing? The latest stockmarket wobbles suggest investors are asking themselves the same question. Financial-sector debt has risen from virtually zero 50 years ago to 100% of American GDP today, and Europe's financial corporations have helped to accelerate the money supply.

thanks to http://www.itulip.com/

George Magnus, a strategist at UBS, has just written a research note entitled “Have we arrived at a Minsky moment?” His big worry is of a contraction in credit supply. As lending standards tighten, consumer demand could suffer, possibly prompting a recession in the United States. No one knows when the credit cycle will end, he says.

But the pyramid is beginning to look a bit top-heavy.

The Plankton Theory Meets Minsky / pimco on ponzi schemes

well done! it looks like the principle of economics havn´t changed over time despite lots of innovation. this is a long but very good read!

fundamentals matter....maybe a bit delayed due to financial innovation or "intervention"......

mal wieder extrem gutes von pimco. gut zu wissen das die grundsätze der wirtschaft doch nicht wie oft suggeriert durch innovationen ausser kraft gesetzt sind. es lohnt sich das lange posting durchzulesen.

fakten zählen....evtl. heutzutage ein bisschen verzögert dank der finanzinnovationen und einiger "interventionen".....

Watching the on-going meltdown in the sub-prime mortgage market, which is triggering a sharp tightening of underwriting standards to these dicey credits, I was reminded of prescient writings by two serious thinkers: Bill Gross and Hyman Minsky. Both narratives go back a long ways, with something that Bill wrote in August 19801 – 27 years ago! – particularly poignant:

“The Plankton Theory, like life itself, begins and ends in the ocean. Plankton, of course, are almost microscopic organisms that serve as food for higher life forms. Without plankton almost every fish and mammal in the sea could not survive, since most species depend upon other fish for their existence and plankton are the initial building blocks of the entire process. Logic would suggest, therefore, that in attempting to forecast the well being of the Great White Whale, Jaws, or even Jaws II, that one of the factors to consider would be the status and future outlook of the plankton. That, in one hundred words or less, is the Plankton Theory.

Now, what possible significance could this have for the investment world? Plenty. Take for example, the area of real estate, especially that of single family housing. We’re all familiar with the rapid escalation of home prices over the last 10 years. For most Americans, their homes have been the best and in many cases the only investment that they have made in their entire lives. Some have gone so far as to invest in several homes and have endured ‘negative carry’ on the cash flow in anticipation of leveraged capital gains a few years down the road. But where does it stop? Can housing continue to increase at twice the Consumer Price Index for the next 10 years?

One way to measure might be via the Plankton Theory. In the case of real estate, the plankton would be the first-time buyer (perhaps a young married couple) with a desire to own their own home but with very little capital to carry it off. When the time comes that they can’t pull it off – either through an inability to come up with a down payment, or to service the monthly mortgage – then the ‘plankton’ would disappear and the rapid escalation in housing prices would ease as well. For, unless the current homeowner has someone to sell his house to, he’ll be unable to afford the house with the view or that extra bedroom, and the process would continue into the echelons of Beverly Hills and Shaker Heights. In the end, the entire market would wither on the investment vine and home prices would stop increasing at the same rapid rate. So to gauge the health of the housing market, look first at the plankton. ”

Bill’s call was a good one, as displayed in Chart 1: home price appreciation tumbled in the first half of the 1980s, as the homeownership rate fell: the Plankton Theory at work! Draconian Fed tightening at the beginning of the 1980s had something to do with it, too, of course, as the Plankton were priced out of the market by high interest rates, independent of the availability – or underwriting standards – for home mortgage loans.

But the theory held: it’s the first-time buyer, stretching to buy, that is the life’s blood of vibrant property markets. ....

But the human condition is inherently given to the Mae West Doctrine that if a little of something is good, more is better, and way too much is just about right. ....
Minsky, who passed away in 1996, was the father of the Financial Instability Hypothesis, providing a framework for distinguishing between stabilizing and destabilizing capitalist debt structures. He first articulated the Hypothesis in 1974, and summarized it beautifully in his own hand in 1992:

“Three distinct income-debt relations for economic units, which are labeled as hedge, speculative, and Ponzi finance, can be identified. how would you label this...? / wie würded ihr das bezeichnen...? :-)

Hedge financing units are those which can fulfill all of their contractual payment obligations by their cash flows: the greater the weight of equity financing in the liability structure, the greater the likelihood that the unit is a hedge financing unit.

Speculative finance units are units that can meet their payment commitments on ‘income account’ on their liabilities, even as they cannot repay the principal out of income cash flows. Such units need to ‘roll over’ their liabilities – issue new debt to meet commitments on maturing debt.

For Ponzi units, the cash flows from operations are not sufficient to fill either the repayment of principal or the interest on outstanding debts by their cash flows from operations. Such units can sell assets or borrow. Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stocks lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes. (another ponzi scheme........)

It can be shown that if hedge financing dominates, then the economy may well be an equilibrium-seeking and containing system. In contrast, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation-amplifying system.

..... The second theorem of the financial instability hypothesis is that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.

In particular, over a protracted period of good times, capitalist economies tend to move to a financial structure in which there is a large weight to units engaged in speculative and Ponzi finance. Furthermore, if an economy is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make positions by selling out positions. This is likely to lead to a collapse of asset values.” (just look at new century....)

Clearly, the explosion of exotic mortgages – sub-prime; interest only; pay-option, with negative amortization, et al – in recent years, as shown in Chart 2, have been textbook examples of Minsky’s speculative and Ponzi units.

And as Bill Gross explained long ago, such mortgages have been the food of the Plankton, the first-time homeowner, driving the homeownership rate to record highs, as displayed back in Chart 1, while also fueling accelerating home price appreciation. But as Minsky had forewarned, eventually this game must come to an end, as Ponzi borrowers are forced to “make positions by selling out of positions,” frequently by stopping (or not even beginning!) monthly mortgage payments, the prelude to eventually default or dropping off the keys on the lenders’ doorstep.

That is happening. And true to form, Ponzi lenders are now recognizing their sins of irrational exuberance, repenting and promising to sin no more.....

And in this cycle, it’s not just the first-time homebuyer – God bless him and her! – that is trapped, but also the speculative Ponzi long: borrowers who weren’t covering a natural short – remember, you are born short a roof over your head, and must cover, either by renting or buying – but rather betting on a bigger fool to take them out (“make book”, in Minsky’s words). Thus, the supply of plankton is twice drained.

Which means that the bigger fish in the domestic and global economic sea are going to be living on leaner diets. It also means that any given level of central-bank enforced short-term policy rates will become ever more restrictive with the passage of time. That is nowhere more the case than in the United States, where mortgage originators’ orgy of Ponzi finance stifled the Fed’s ability to temper irrational exuberance in housing with hikes in the Fed funds rate.

More specifically, as long as lenders made loans available on virtually non-existent terms, the price didn’t really matter all that much to borrowers; after all, housing prices were going up so fast that a point or two either way on the mortgage rate didn’t really matter. The availability of credit trumped the price of credit. Such is always the case in manias.
It is also the case that once a speculative bubble bursts, reduced availability of credit will dominate the price of credit, even if markets and policy makers cut the price. The supply side of Ponzi credit is what matters, not the interest elasticity of demand.

Bottom Line
The ongoing meltdown in the sub-prime mortgage market would not matter, except for those directly involved, except that it marks the unraveling of Ponzi finance units that, on the margin, were the plankton of the bubbling property sea of recent years. As the bubble was forming, riding on first-time homebuyers with first-time access to credit on un-creditworthy terms, and first-time speculators riding the same with visions of bigger first-time fools to take them out, all looked well. But as Minsky warned, stability is ultimately destabilizing, as those who require perpetual asset price appreciation to make book are forced to sell to make book. Such is reality presently in the U.S. residential property market, which has flipped from a sellers’ market on the wings of buyers with exotic mortgages to a buyers’ market of only the creditworthy.


This state of affairs need not produce a U.S. recession. But it does unambiguously render any given stance of Fed policy more restrictive: a tightening of credit supply based on underwriting terms means that any given policy rate will elicit reduced effective demand for credit. And that’s the stuff of seriously easier monetary policy to come. Just as mortgage demand seemed inelastic to rising short rates when availability was riding relaxed terms, so too will demand seem inelastic to falling short rates when availability faces the headwind of restrictive terms.

It may be a while before the Fed accepts and recognizes this, waiting for these Minsky style debt-deflation dynamics to become evident in broader measures of the economy’s health, notably job creation. But make no mistake: A Minsky Meltdown in the most important asset in most Americans’ asset portfolio is not a minor matter. Bill Gross’ Plankton Theory ain’t just a theory, but a reality.

Once the Fed begins easing, it will be a long journey down for short rates.