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Monthly Archives: October 2010

Microlending: India’s subprime chaos

I posted a piece about two years ago warning about the danger of a microfinance bubble in the developing world.  Now the Indian version of US subprime crisis came into fruition.

WSJ reports that the microlending fueled by high-yield hungry investment banks and private equity firms has caused an upheaval in India.

The microlending movement that was supposed to help lift millions of people in India out of poverty has in recent weeks fallen into chaos.

Urged on by local government officials and politicians, thousands of borrowers have simply stopped paying lenders, even though they have the money. The government has begun ratcheting up restrictions, fearing that borrowers are being buried by usurious interest rates. In some cases, officials have even arrested lending agents for allegedly harassing borrowers.

…the unfettered expansion was leading to poor lending practices, multiple loans to the same borrowers, and fears of widespread repayment problems.

Housing price correction to what year

What year have housing prices corrected to?  By cities.

(click to enlarge; Source: Calculated Risk)

World economy in 2030 update

An updated forecast of the world economy in two decades from the model by A. Maddison.

(click to enlarge; details here)

For another forecast by Bob Fogel, click here.

Abby Cohen on market outlook

Ms. Cohen thinks the Fed will initially purchase $500 billion Treasury securities, a rather gradual approach.

With the Fed’s money printing…

She also thinks the market is currently undervalued.  The fair value of S&P 500 should be around 1275.

Something is happening in China

There appears to be some heated debate going on within the Chinese Communist Party (CCP) regarding the future direction of China’s political reform.

CCP censorship recently ordered Internet sites and news organizations to delete all references to a recent rare interview of Premier Wen Jiabao by CNN. In that Sept. 23 interview (shown below), Mr. Wen said that “the people’s wishes for and needs for democracy and freedom are irresistible.”

According to yesterday’s New York Times, China’s main Communist Party newspaper, People’s Daily, bluntly rejected calls for speedier political reform, publishing a front-page commentary that said any changes in China’s political system should not emulate Western democracies, but “consolidate the party’s leadership so that the party commands the overall situation.”

A cheer for Premier Wen – near the end of the interview, Wen mentioned one of his most-read book is “The Theory of Moral Sentiments” by Adam Smith.   WOW!

Oliver Hart is in town…

Oliver Hart is currently at CBS giving a series of talk on firm theory.  Professor Hart, now teaching at Harvard, is widely considered to be  a future Nobel prize winner in the field of theory of firm, after the seminal contributions of Ronald Coase and Oliver Williamson.

For a list of his talks, click here.

Buffet found his successor

WSJ reports Warren Buffet just named his successor:

Berkshire named Todd Combs, manager of a small hedge fund from Connecticut, to oversee a portion of Berkshire's roughly $100 billion investment portfolio. The surprise appointment will be a challenge for Mr. Combs, 39 years old, whose fund recently had only about $400 million in assets and primarily invested in the shares of financial-services companies.

The succession plan at Berkshire is among the most high-profile in modern American corporate history. Mr. Buffett, who turned 80 in August, has said he will likely split his job in two—into separate CEO and investing functions—and adds that he has no current plans to step down. Mr. Combs is "not going to take over the whole investment function as long as I'm around," Mr. Buffett said in an interview. "I have this dual position as CEO and CIO and I will remain in that."

Mr. Combs will join a company that has fewer than two dozen employees in its corporate office, but owns over 70 businesses that collectively had more than 257,000 employees at the end of 2009. 

The surprise announcement came after two candidates—including Chinese-American hedge fund manager Li Lu, and another individual Mr. Buffett was interested in—took themselves out of the running for the job, Mr. Buffett said. The emergence of Mr. Li as a contender was the subject of a July page-one article in The Wall Street Journal.

The reaction of these two candidates underlines some of the challenges for Berkshire in filling the shoes of one of the most famous investors in history. Talented investment managers can receive pay totaling billions of dollars over a career. Filling Mr. Buffett's shoes won't likely lead to that kind of eye-popping pay, says Mr. Buffett, who earns $100,000 in salary as CEO of Berkshire, though he's been enriched through his holding of Berkshire shares.

"You'll make a lot of money in this job but you won't make billions," Mr. Buffett says.

Mr. Buffett says Mr. Li "decided he would prefer to be where he was. In effect he didn't want the job. I think he made a lot of money doing what he is doing and he has a very good position in life." Mr. Li has developed a close relationship with Charles Munger, Berkshire's 86-year old vice chairman, and manages a large portion of Mr. Munger's family's money that isn't in Berkshire.

Mr. Li said, "I've decided to stay where I am." He declined to elaborate further.

Mr. Comb's fund, Greenwich, Conn.-based Castle Point Capital, was launched in 2005 with seed money from private-equity firm Stone Point Capital. Mr. Combs' fund focuses on stock investing—both buying and selling "short," or betting on price declines. Castle Point has earned cumulative returns of about 34% since the fund launched, according to an investor who read a letter sent by Mr. Combs to clients explaining he was closing his firm to join Berkshire. Over the same period, the S&P 500 index fell 5.1%.



Stiglitz: Fed’s QE2 won’t work

Joe Stiglitz explains why the Fed’s easier monetary policy won’t work (source: WSJ):

The Federal Reserve, having done so much to create the problems in which the economy is now mired, having mistakenly thought that even after the housing bubble burst the problems were contained, and having underestimated the severity of the problem, now wants to make a contribution to preventing the economy from sinking into a Japanese-style malaise. How? As Chairman Ben Bernanke announced last week, through large-scale purchases of U.S. Treasurys—called quantitative easing, or QE.

The Fed is right to be worried.

If high unemployment continues, America faces the risk of losing human capital as the skills of the unemployed erode. It will then become increasingly difficult to bring the unemployment rate down to anywhere near the levels that prevailed in the mid- and late 1990s, and the higher unemployment rate and lower output will make the current pessimistic budget projections of the Congressional Budget Office and the Office of Management and Budget look rosy.

The problem is that, with interest rates already near zero, there is little the Fed can do to restart the economy—and doing the wrong thing can do considerable damage. In 2001, (then) record-low interest rates didn’t reignite investment in plant and equipment. They did, however, replace the tech bubble with an even more dangerous housing bubble. We are now dealing with the legacy of that bubble, with excess capacity in real estate and excess leverage in households.

Today, the Fed is paying too little attention to the transmission between the interest rates paid by government and the terms and availability of credit to small and medium-sized enterprises (SMEs). Large businesses are flush with cash, and small changes in interest rates—short-term or long—will affect them little. A banker rightly asks if such a business comes asking for money, “What’s wrong with it?”

But it is SMEs that are the source of job creation in most economies, including the U.S. Many of these enterprises are starved for cash. They can’t borrow money at the interest rate that big banks, big firms or government can. They borrow from banks, and many of the smaller local and community banks on which they depend are in dire straits—more than 800 are on the FDIC’s watch list.

Yet even if the banks were willing and able to lend, lending to SMEs is typically collateral-based, and the value of the most common form of collateral, real estate, has fallen 30% to 40%. No wonder then that credit availability is so constrained. But QE in the form of buying U.S. Treasurys is not likely to affect this much. It will have some effect in lowering mortgage rates, and lower mortgage rates will put a little more money into people’s pockets. Higher real-estate prices may also allow some SMEs to borrow more. But these effects, though positive, are likely to be small—so small as to make a barely perceptible difference in America’s persistent unemployment.

There is another channel through which easing will have some positive effects: Equity prices are likely to rise. But for all the reasons just given, this is unlikely to have much effect on investment. Nor will most Americans, burdened with debt and diminished retirement accounts, likely embark on much of a spending spree. Nor should they. Doing so would only delay the deleveraging that is necessary if we are to have sustainable growth going forward.

There is another downside risk: QE may not even succeed in lowering interest rates, or lowering them very much. Given the magnitude of excess capacity, there is little risk of inflation today. But if the inflation hawks come to believe that the risk of future inflation is real, then they’ll believe that short-term interest rates will rise. This will mean that long-term interest rates, even now, may actually rise, in spite of the massive Fed intervention, because long-term interest rates are based on expectations of future short-term interest rates.

QE poses a third risk: The bursting of the bond market bubble that the Fed is seeking to develop—the sequel to the tech and housing bubbles—will clearly have adverse effects on the economy, as we should have learned by now.

The advocates of QE point to another channel through which it will strengthen the economy: Lower interest rates may also lead to a weaker dollar, and the weaker dollar to more exports. Competitive devaluation engineered through low interest rates has become the preferred form of beggar-thy-neighbor policies in the 21st century. But this policy only works if other countries don’t respond. They will and have, through every instrument at their disposal. They too can lower interest rates. They can impose capital controls, taxes and bank regulations, and they can intervene directly in their exchange rate.

Under the gold standard, there was supposed to be an automatic adjustment mechanism, as a country with a trade surplus would see an inflow of gold and an increase in prices, leading to an automatic real appreciation of its currency. It never worked as smoothly as it was supposed to, but in the modern economy with fiat money, the adjustment processes can be short-circuited even more easily. China, for instance, has sufficient control of its banking system and economy that it can simultaneously maintain a stable exchange rate that generates a surplus and prevents inflation.

Such policies may come with a price, but the price may be less than the alternative: the bankruptcies and unemployment that would follow from disruptive currency appreciation as the U.S. lets forth a flood of liquidity. That money is supposed to reignite the American economy but instead goes around the world looking for economies that actually seem to be functioning well and wreaking havoc there.

The upside of QE is limited. The money simply won’t go to where it’s needed, and the wealth effects are too small. The downside is a risk of global volatility, a currency war, and a global financial market that is increasingly fragmented and distorted. If the U.S. wins the battle of competitive devaluation, it may prove to be a pyrrhic victory, as our gains come at the expense of others—including those to whom we hope to export.