sábado, 18 de agosto de 2007

Burbujas y Minsky

Leyendo acerca de la explosion y las burbujas inmobiliarias, en un lugar que frecuento, me encontre con esto, que me hizo acordar al procer cuyo nombre ostenta este blog, y un colega de el, Ponzi, de una persona que vive de esto

Minsky Has His Moment

July 29th, 2007 by reality

prechter-fig-1.gifThe Minsky Moment is important because it means the beginning of forced selling. Buying driven by ever-increasing leverage stops, and selling to decrease leverage begins. The deleveraging sellers are there because they must sell.

Last week, the stock market had its first significant bout of selling since the China-driven break in late February. Up to this last week, the buying has been relentless. The chart at left, borrowed from a May piece by Robert Prechter, shows one part of the debt - the credit extended to hedge funds - that has been driving up prices.

NYSE margin debt was a record $378 billion in June, about one-third higher than the previous peak in early 2000.

While there is some modest coverage in the press about the turmoil in the credit markets, it is not getting the coverage it should. As the Minsky Moment passes and the bust begins, it will be important to monitor the state of the credit markets. Fortunately, we have the excellent Markit site showing the yield spreads and the cost of credit default swaps. They lay it out pretty well, although it is not obvious what the various indices are. A brief directory:

  • ABX are the asset-backed indices, meaning the collateral for the credit is physical. Right now only the ABX-HE series exists, although others such as auto loans will be provided in the future. HE means Home Equity, these are second mortgages and lines of credit.
  • CDX covers corporate debt of various kinds - domestic, emerging markets and so forth.
  • CMBX covers securities backed by mortgages on commercial property (i.e. not houses and condos.)
  • LCDX is a tradable index of the cost of credit default swaps on an index of 100 corporate loans (similar to CDX loans).
  • LevX is an index covering the most liquid traded corporate loans in Europe.

It should be clear from browsing these indices that there has been an abrupt change in the pricing of risk. Bulls will say, yes, but high-yield spreads (the difference in interest rates between junk bonds and Treasuries) are still nowhere near the levels they have reached in the past, so it is really no problem. To which my response is, leverage today is far higher than it has ever been in the past. The stock market has been levitating because of debt -

  • traditional margin debt, borrowed money in brokerage accounts. While extreme, leverage here is generally limited to 2:1 by SEC rules so it is comparatively safe.
  • leverage in hedge funds. One of the Bear funds that recently failed was leveraged 15 times. The problem is not so much the average, but the extremes.
  • leveraged purchases of hedge funds, (which is why Barclay’s is now suing Bear Stearns, because they were financing Bear’s customers’ purchases of the Bear hedge funds).
  • so-called private equity, really traditional leveraged buyouts. Problem here is that as rates go up, even though money may be available, the target companies aren’t earning enough to pay the interest.

The reality is that there are lots of folks out there who are leveraged 20:1 and more. It only takes a 5% loss to wipe them out. Let’s recapitulate Minsky’s classifications of borrowers in a bubble:

  • Hedged borrowers, who can meet all debt payments - interest and principal repayment - from their cash flows.
  • Speculative borrowers, who can meet their interest payments, but can only repay principal when the asset is sold.
  • Ponzi borrowers (you remember Chuck), who can’t pay the interest, let alone the original debt, and rely entirely on rising asset prices to allow them continually to refinance their debt.

We know who the Ponzi borrowers are:

  • Anyone borrowing against their property on a teaser rate - a low rate which carries a prepayment penalty - or a negative-amortization loan. Or who simply has bought or held on to property that they do not have the cash flow to carry, but must sell fairly quickly.
  • The leveraged hedge funds - and the idiots (yeah, I know, judgmental) borrowing to invest in them.
  • Many stock traders using margin. We know, for sure, that corporate dividend yields are way below margin rates so the margin borrower is burning money with net carry in his or her account. Maybe they can keep putting more money in. Or maybe not.

These folks are the first to go. They are the first forced sellers. Next up are the speculative buyers. These folks are forced over the side as soon as any kind of economic decline takes hold. While the corporations which have been stuffed with debt by the private equity guys (should really be called private debt) are OK today, these recent deals have been done with extremely thin interest coverage. That is, as soon as the corporation suffers any kind of reversal in a recession, they will not be able to service their debt and will default or restructure. The downward spiral soon follows. The big advantage of equity financing of a corporation is that it is undemanding, sure shareholders like dividends, but the company can withhold them at any time without penalty. (Interesting side note - after the close on Friday, American Home Mortgage announced it wasn’t going to pay its recently declared dividend, I’ve never seen that before).

personal savings.gifTurning to the man in the street, who has met the challenge of flat real income with credit cards and borrowing against property, to say nothing of buying anything and everything with loans and leases rather than cash.

The net outcome has been a negative savings rate, which shows that household expenditure is now exceeding household income. There’s a lot of debate about what is properly considered investment, and therefore saving, not expenditure. Personally I don’t think granite countertops and Sub-Zero appliances are an investment, although technically they are considered to be. I would even argue that when the price of a house exceeds its fair value based on rental income, the excess should be considered consumption rather than investment. It is certainly malinvestment in the Austrian sense.

But any way you cut it, looking at the savings rate or the trade deficit, America consumes more than it makes and is reliant on borrowed savings from other countries to make ends meet. At some point, the carrying costs of that debt make it difficult to service. Joe and Jane Ponzi can no longer refinance or roll over asset gains to meet their carrying expenses. Then the downward spiral begins. Consumption falls, incomes fall. That’s probably where we are.

But nobody cares. Complacency rules. The chart below shows that mutual funds, the largest investors in the stock market, have practically no cash reserves with which to meet redemptions. Yet this week saw the biggest outflow from U.S. stock mutual funds in five years, according to TrimTabs.

It is likely, in my opinion, that the late afternoon selling on Friday was mutual funds meeting redemption requests. If this continues in the short term, look out below. There is no cushion, funds must sell.

In summary, we’re going to have a lot of forced sellers in the major asset markets. Foreclosures, margin calls, redemptions. Be careful out there.

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