After the Fed, ECB,, Bank of England, and other central banks took unprecedented measures over the last month to restore liquidity and recapitalize banks, Nouriel Roubini sounded slightly less gloomy. He had deemed that the authorities has avoided a systemic financial meltdown, but a nasty, protracted recession was in the offing.
It appears that Roubini has reversed himself with his latest remarks He now says systemic risks are increasing due to hedge fund margin calls, redemptions, and liquidations, and the authorities may be forced to close financial markets. Note that this is not a new line of thought. During the turmoil of the last month, particularly the week of October 6, some professional investors were quietly discussing the possibility of short-term market closures.
From Bloomberg (hat tip readers Dwight, Saboor):
Hundreds of hedge funds will fail and policy makers may need to shut financial markets for a week or more as the crisis forces investors to dump assets, New York University Professor Nouriel Roubini said.
“We’ve reached a situation of sheer panic,” Roubini, who predicted the financial crisis in 2006, told a conference of hedge-fund managers in London today. “There will be massive dumping of assets” and “hundreds of hedge funds are going to go bust,” he said….
“Systemic risk has become bigger and bigger,” Roubini said at the Hedge 2008 conference. “We’re seeing the beginning of a run on a big chunk of the hedge funds,” and “don’t be surprised if policy makers need to close down markets for a week or two in coming days,” he said…..
Italian Prime Minister Silvio Berlusconi roiled international markets on Oct. 10, first saying world leaders were discussing shutting down global financial exchanges, and then saying he didn’t mean it.
“In a fairly Darwinian manner, many hedge funds will simply disappear,” Roman said, speaking at the same event as Roubini…
“Things are getting very ugly also in the emerging markets,” Roubini said. “The usual saying is when the U.S. sneezes, the rest of the world catches a cold. Unfortunately, this time around the U.S. is not just sneezing, it has a severe case of chronic and persistent pneumonia. It’s becoming a mess in emerging markets.”
Developing nations’ borrowing costs jumped to the highest in six years today as Belarus joined Hungary, Ukraine and Pakistan in seeking a bailout from the International Monetary Fund to help weather frozen money markets and a slump in commodities. Argentina risks defaulting for the second time this decade.
“There are about a dozen emerging markets that are now in severe financial trouble,” Roubini said. “Even a small country can have a systemic effect on the global economy,” he added. “There is not going to be enough IMF money to support them.”
Roubini, a former senior adviser to the U.S. Treasury Department, earlier this month said that the world’s biggest economy will suffer its worst recession in 40 years.
“This is the worst financial crisis in the U.S., Europe and now emerging markets that we’ve seen in a long time,” Roubini said. “Things will get much worse before they get better. I fear the worst is ahead of us.”
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Who is the masterful teacher of how to handle a market meltdown?
Pakistan?! Of course not – you scoff – but you wouldn’t believe it from the actions and words of our economic leaders and top economists.
Their stock-market falls like crazy so Pakistan bans short-selling. Monkey-see, monkey-do: the FSA of UK and SEC of US ban short-selling. Widely recognised as an idiot move. Tampering with market mechanisms can only cause more damage. Anyway – it did not work for Pakistan either. So next they shut the market. Stocks can’t go down if people can’t trade – brilliant?
Er. No. Angry investors stone the stock exchange – and when it does open it crashes maniacally.
Monkey see – monkey do. Why not close the markets in Western countries?
BECAUSE IT IS THE STUPIDEST IDEA IN 300 YEARS OF CAPITALISM.
It is one thing having a huge credit crisis – it will blow over in 5, 10 or 15 years. But, it is another thing to destroy trust in free markets! That will take 20, 30 or 50 years to restore. This must not be allowed to happen!
Oh really, can I take my ball and go home? Please tell the cheerleading financial networks to give us the facts! For that matter please tell all of media to give us the facts.
“The usual saying is when the U.S. sneezes, the rest of the world catches a cold. Unfortunately, this time around the U.S. is not just sneezing, it has a severe case of chronic and persistent pneumonia.”
Pneumonia isn’t directly contagious, per say.
The cold virus is something that can certainly be contagious and sometimes it turns into pneumonia.
However, it does not mean a patient with pneumonia is any more or less likely to pass the actual pneumonia around, than say, someone that simply sneezes.
(sorry, all…that’s my snark for the day)
If they close the stock markets for a week, won’t it scare people even more? Who is going to give us a fireside chat? Bush? The market seems to drop every time Bernanke and Paulson open their mouth.
Roubini is probably correct that hedge funds are going to continue to be pressured, at least those that have leveraged the wrong way.
I think, though, that unlike a couple years ago, we don’t need anyone – particularly not someone who “called the past two years correctly” – making bold downside predictions. The excesses have been shaken fairly well, there’s probably some shaking left to do, but no need to push the patient over the cliff at this point.
So maybe, I’d say, Roubini could go off to an undisclosed location and have a conference with Bush and Paulson, and leave Bernanke back on 9 to 5 duty with instructions to maintain a steady policy and tweak as necessary to shake off speculators making runs at policy, for the next month.
Then allow the next President to hold a pre-inauguration conference, a la Clinton.
I see Roubini didn’t like being out of the spotlight over the last couple of days, so he said something to spike the attention levels back up. Poor guy was probably going through withdrawal.
Roubini might not be wrong. A dislocation in the bond markets, even treasuries and longs could happen. I have also been hearing persistent rumors about the COMEX jawboning those wishing to take delivery into cash instead. Here are some interesting tid bits from Jesse’s Cafe American…
‘Delivery failures plague Treasury market
Total hit a record $2.29 trillion as of Oct. 1
By Dan Jamieson
October 19, 2008
The credit crisis is causing a growing number of delivery failures with Treasury securities.
The latest data from the Federal Reserve Bank of New York showed that cumulative failures hit a record $2.29 trillion as of Oct. 1. The federal settlement period is T+1 (trade date plus one day).’
and…
‘Naked short selling and float and reserve plays are causing a record ‘failures to deliver’ in the US Treasuries markets. Some of this may be a ‘kiting’ scheme in which the sellers are playing an aribtrage against the slight fees and penalties versus returns on price distortions and extremes in volatility.
Or it might be a case of selling and using the same thing so many times as collateral that you don’t really know what is your actual condition, solvent or insolvent. We can think of several (roughly nine) derivative and instrument laden banks that are utterly insolvent if forced to deliver their net obligations.
The Fed cannot even regulate its own products among its own dealer circles. What could possibly possess anyone to believe that they can do this with any other product in a larger, less exclusive market?
There are system breakdowns that have caused signficant spikes in failures, such as the widespread technical failures following the distruptions caused by 911.
But we are not aware of any massive computer system failures and shutdowns at this time. This may be a case of when the going gets tough, the frat boys bend the rules until they break, and then line up for a slap on the wrist from dad’s business associates.
Is this because of the failures of Lehman and Bear Stearns and AIG? Hard to believe but we have an open mind. Transparency builds confidence more effectively than rhetoric and empty promises.
Who are the responsible parties? Let’s have a list of the prime offenders of this market. We might *not* be surprised at who is failing to deliver what they sell. It might be an indication that they are in trouble. Oops, perhaps that is why we can’t have it.
We suspect the Fed is turning a ‘blind eye’ to this activity. But more transparency would be helpful to alleviate that concern.
And do not be surprised when other things that you think that you are buying or think you own fail to show up.
There are some who see an approaching ‘fail to deliver’ spike at the COMEX and they may be right. There were some who believed that LTCM was short 400 tons of gold at the time of its failure, and that several central banks stepped in to depress price and increase supply to alleviate the potential shock on counterparties.
Replay in progress? It could get interesting if it is.
Stand and Deliver: Significant Fails in the US Treasury Market – 10 Oct 2008
Delivery failures plague Treasury market
Total hit a record $2.29 trillion as of Oct. 1
By Dan Jamieson
October 19, 2008
The credit crisis is causing a growing number of delivery failures with Treasury securities.
The latest data from the Federal Reserve Bank of New York showed that cumulative failures hit a record $2.29 trillion as of Oct. 1. The federal settlement period is T+1 (trade date plus one day).
The outstanding U.S. public debt is $10.3 trillion.
“Current [fail] levels are at historic levels,” said Rob Toomey, managing director of the Securities Industry and Financial Markets Association’s funding and government and agency securities divisions. “There’s been significant flight to quality” with the market turmoil, he said.
With the strong demand for Treasury securities, “some of the entities that bought Treasuries are not making them available in the [repurchase] market, which is the traditional way to get them,” Mr. Toomey said.
Unlike some past bouts with high failure rates that involved particular bond issues, the current high fails involve all types of maturities, he said. (Such as in the 2001-2003 market crash – Jesse)
This month, New York- and Washington-based SIFMA came out with a set of best practices to reduce failed deliveries.
This year, the New York Fed revised its own Treasury market trading guidelines. Its guidelines, originally released last year, warned that short-sellers “should make deliveries in good faith.” (And all good boys and girls should remain pure until they are married – Jesse)
LACK OF LIQUIDITY
Chronic failures can increase illiquidity problems in the market and expose market participants to losses in the event of counterparty insolvency, according to the New York Fed.
“There is a question about there being some impact on liquidity if [delivery failures] last for a long period,” Mr. Toomey said.
Many retail investors also own Treasury securities, either directly or indirectly. The Treasury market is also an important fixed-income benchmark, so any liquidity problems can affect all participants.
In extreme cases, chronic fails could cause participants to limit their trading in secondary markets, the New York Fed said.
“Who wants to buy what they’re not going to get?” said Susanne Trimbath, a market researcher with STP Advisory Services LLC of Santa Monica, Calif. In a September research paper, she estimated that based on failure rates in 2007 and 2008, the cost to investors from failed deliveries is about $7 billion annually. (Pays for the facials – Jesse)
The cost arises because sellers don’t have access to their money. In addition, the federal government loses $42 million a year in lost revenue, and the states miss out on an additional $270 million in revenue due to excessive claims of tax-exempt income on state-tax-free Treasury securities, Ms. Trimbath said.
She and researchers at the New York Fed said that some delivery failures are intentional. (We’re shocked, shocked! – Jesse)
As with naked shorting of stocks, naked shorting of Treasuries “allows you to avoid the borrowing costs,” Ms. Trimbath said.
“There can be circumstances in a low-rate environment where it’s cheaper to fail” than deliver, Mr. Toomey said. Such an environment also reduces incentives to act as a lender of securities, he said.
A 2005 study by the New York Fed confirmed that episodes of persistent settlement fails are often related to market participants’ lack of incentive to avoid failing. (Thanks for the kind of knowledge that most mothers, teachers, and adults over the age of 25 could have told us for free, propeller heads – Jesse)
“We’ve got to get the [Securities and Exchange Commission], the Fed and SIFMA in there to force” Treasury traders to deliver securities, Ms. Trimbath said. (That ought not to be hard. We hear the Fed has people on premise every day with most of the probable perpetrators – Jesse)
The Department of the Treasury has a buy-in rule for the cash markets, but the repurchase markets rely on contracts, Mr. Toomey said. Currently there are no penalties for failures, and regulators to date have not required disclosure whether the dealer or the client fails to deliver. (Self regulation at its finest. Sounds like the honor system my neighbor uses to sell tomatoes in the summer from a box in her front yard. Except for the most part the people here in our neighborhood are not greedy, self-centered, shameless, hedonistic shits – Jesse)
By industry convention, fails are generally allowed to roll over until they are eventually closed out, Ms. Trimbath said.
SCRUTINY
She said that scrutiny by the SEC and the Fed, and widespread investigations into short-selling practices, are driving the industry to rein in questionable practices with Treasuries. (Apparently with ‘great success,’ Borat, given the record number of fails – Jesse)
Mr. Toomey said that one of SIFMA’s best-practices suggestions is to require that extra margin be provided by the party that is underwater due to a failed delivery. (Wrist slap by fines is a real deterrent – Jesse)’…snip
http://jessescrossroadscafe.blogspot.com/2008/10/buyers-of-treasuries-cannot-take.html
Oh my goodness, HUNDREDS of hedge funds could go bust?
That many disappeared in 2007. No one noticed.
memo to us —
http://www.youtube.com/watch?v=dMuKRbJa3O8
my little secret is that I have been trading off of NR and Bill Gross for the last year. I have been seeing them as predictive of market moves. But I have no short positions right now, and he is saying they may close the markets in coming days – oh my god. That is seriously bearish. Probably time for an out of the money put on the market [which is a seriously crowded trade].
How would it help to close markets for a week? Won’t happen.
The seemingly inevitable election of Obama could spark a honeymoon bear rally, forestalling any alleged need for a market closing.
Traditionally, right after a US election, the newly elected (or re-elected) president enjoys a post-election bump in approval ratings. This is true even in the case of close-fought elections like 1960 Kennedy-Nixon or 1948 Truman-Dewey (although Bush-Kerry 2004 was apparently an exception). Psychologically, people have a tendency to close ranks and buy into a collective decision, at least for a honeymoon period.
Here is a list of New York Stock Exchange special closings since 1885. Note July 31 – November 27 1914 (for the outbreak of World War I), several one-day closings in November 1929 (to deal with heavy-volume paperwork, supposedly), and March 6 – 14 1933 (national banking holiday), and September 11 – 14 2001. Nothing for Pearl Harbor, but they did delay the start of trading on January 24 1925 for a solar eclipse.
The question is is shutting down capital markets the answer to the crisis. What happens when markets are closed? An accumulation of nerves and panic to a point where rationality is completely overwhelmed. In turn, this might lead to the point where the minute the markets are opened, the accumulated panic would force a sell-off that overwhelms systems already burdened by the quantity of trade.
Close the markets and you risk “realizing the greatest fears of the investor” that the value of whatever investment they are holding is nil or close to nil. Marked to market and trading in such times are not the culprits, the correction of past excesses is the main event.
We may even see a curious situation where trading is halted, no money is technically lost on the exchanges but hedge funds close down anyway, because, investors (particularly those with large stakes) are pulling out $ as fast as is humanly possible. When you see queues of ordinary people ( read, non-millionaires) outside their banks and financial institutions requesting to close investment accounts and enquiring about company pension schemes/funds, that’s when the crap has hit the fan, ‘cos the masses are usually the last ones to hear the bad news.
Mr. Roubini’s volatility (cautiously optimistic to massively pessimistic) is matched by the VIX which hit another record high intraday today.
This uncertainty/fear measure shows that no one has a feel for which way is up nor do they have a feel for the magnitude of “hedge fund failures”.
One thing to keep in mind: many of these “failures” are now technical in nature caused by the downdraft of forced selling.
Sure, the fundamentals of the economy are weak, but $0.60 is *way* to low for Term Loan A bank debt to be trading at, and that is where it has arrived at over the last few weeks.
Reality will set in, and “closing the markets” will not get us there.
Mr. Roubini has been truly on point throughout and leading up to the crisis, so I hesitate to publicly disagree with him like this.
However, this seems to me to be a product of the panic and the crowd he was hanging out with in London…I hope.
What is the math behind this prediction? Let’s say, 1/3 hedge fund investors pulled their money out in October/November. Anyone experts out there have any insights? Would this amount be enough to close the markets?
I don’t know but closing the markets might be due to brokerage houses not having a way to collect enough funds through margin calls to cover failed redemptions and not enough funds held by the house itself, so….they liquidate their share holdings (your shares because they are in street name, the house name, not in your name)to make good on the debt payable. Sure you are insured but how long will it take for an insurance payout. What if litigation involves the Courts adding to the time table with pennies on the dollar of share value returned. Maybe the insurance runs out of funds, then what? Again I really don’t know.
I took advantage of the hedge fund deleveraging to buy some gold. A few dealers continue to sell KRands, Eagles, etc, although the wait period for delivery has grown longer.
I believe gold to be a poor investment but a good safety net.
Anan cites: “There can be circumstances in a low-rate environment where it’s cheaper to fail” than deliver.
This is it. Micro-management of (in this case, artificially low) interest rates is exacerbating risks of systemic failure in the Treasury bond market.
Governments need to let the market set interest rates – and if they don’t like the interest rate they have to pay on their debt- they should run balanced budgets.
If market can not form a price you shut it down. I understand that reckoning that market is not God make some people feel bad but this is not my problem, it is their problem. Should they have spared time instead of spending all of it blessing the liberist ideology and read something about institution, man and history probably today they would have been better of. And me too. But the point, plainly speaking, is that you’d have cashed in lower bags (or whatever you call it… bonuses?)
The situation can be better understood by realizing that people, not just in the U.S. but worldwide, have been living beyond what their productivity can sustain, and that the financial system is catching up with that. To predict what we can expect, just remove credit of all kinds and estimate where we would be with a cash or barter economy.
I expect the bottom will see a reduction in the price of housing and most other such infrastructure by a factor of at least 4 in present dollars — below cost to build, so building will nearly stop for a decade or more.
Personal incomes will drop by about a similar factor, perhaps a little more. Good guess would be by a factor of 5.
However, the costs of most goods and services will not decline that much, because they are still based on costs to produce.
I expect, however, that foreign countries will cease to loan money to the U.S. government, so that most federal spending deficits will go directly into inflation. Expect an inflation rate of least 400%.
Trade will become balanced: No more credit for imports.
The result, after about 5 years, will probably be a standard of living about that of Argentina today. However, the standard of living of Argentina and other countries will have declined even more. Countries that have been loaning money won’t have it to loan, because all such money is fiat currency, with no backing other than the credit of the issuing country.
Ultimately, this is not just about exotic financial instruments. It is about credit-based currencies, and that will become clear in the months ahead.
I’d been seeing the parallels with the 1920s over and over again. I try not to say the “D” word and hope that it’s never like that…but reading yet again wikipedia’s entry on the Great Depression brings up the over use of credit in the markets as prime reasons…but the intense growth of income of the top one percent while the middle classes and workers suffered are other problems paralleling.
I think we’ve avoided the bank failure problems that happened then so it hopefully won’t be as bad but then we’ve got a whole new bag of problems unimaginal then. hedge funds, credit swaps and ridiculous “notational” values. Again ‘credit’ unsustainable.
but above all….the die-off of demand by a shuttered and ignored middle class (workers) is the major problem of next year. If demand continues to fall….the values of the Dow can’t but vaguely rally and then fall again. I was thinking that our friend, an accountant professor and daytrader, predicting a 5000 Dow was being overly extreme….but hell we’re almost there.
read Marriner Eccles at wiki’s Great Depression: wide differences of income between the rich and the middle and then bankruptucy for the many after a financial collapse and a market admidst lowering incomes has only one way to go in a consumer culture: Down.
Only a massive return to Demand side economic principals, away from purely supply-side reactions such as the huge giveaways to the banking entities can turn this around. Probably 2 trillion in govt. projects, job’s programs, to increase income and demand can turn this around and it has to done next year!!
Temporary rally’s will come and go…but with demand continuing to fall?