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Monthly Archives: December 2010

20% of outstanding mortages set to default

Value investing conference hosted at Darden Business School of UVA.

Some nice big-picture views of the current economy.  Pay attention to the interesting analysis on housing market – among the 56 million US residential mortgages, it’s estimated that 20% of them, or 11 million, will eventually default. Housing price is set to decline by another 5% at least; if without government support, probably by 10%.

Can ECB prevent an European contagion

So far, ECB has been using the wrong tools to fix a very urgent crisis.  Bailout and debt monetization won’t solve the problem.  Either way, it puts too much pressure on Euro.

(click on the graph to play the video; Source: FT)

John Cochrane at U. of Chicago thinks the right approach is to have a bailout with precondition of debt restruction.

If European governments want to bail out their banks, let them do so directly and openly—not via the subterfuge of country bailouts. Then they should face the music: How is it that two years after the great financial crisis, European banks make so-called systemically dangerous sovereign bets, earn nice yields, and then get bailed out again and again?

European bank regulators should announce that sovereign debt is not risk-free, and that their banks need capital against sovereign loans, or they need to buy insurance (credit default swaps) against sovereign exposure. Will taking this step hurt bank profits? Well, yes. Sorry. That game, at taxpayer expense, is over.


The big culprit in all of this is short-term debt. There would be no crises if governments had issued long-term debt to match long-term plans to repay that debt. If investors become gloomy about long-term debt, bond prices go down temporarily—but that’s it. A crisis happens when there is bad news and governments need to borrow new money to pay off old debts. Only in this way do guesses about a government’s solvency many years in the future translate to a crisis today.

There are two lessons from this insight. First, given that the Europeans will not let governments default, they must insist on long-term financing of government debt. Debt and deficit limits will not be enough. Second, the way to handle a refinancing crisis is with a big forced swap of maturing short-term debt for long-term debt. This is what “default” or “restructuring” really means, and it is not the end of the world.

Andy Xie on China’s inflation outlook

Interview of Andy Xie, former Morgan Stanley Chief China economist.

Pay attention to his view that raising interest rate will have limited effect on containing inflation because it may prick the housing bubble. This is especially true when considering local governments’ huge stake in keeping housing and land prices high.

I expect Chinese government will resort more to raising bank reserves and administrative measures to contain inflation.

Three other things are also likely to happen:
1) Chinese government may distort official inflation numbers, i.e., more human smoothing.
2) Accelerate Yuan’s appreciation, which I think is most likely. In fact, Qing Wang of Morgan Stanley expects the RMB to appreciate from currently 6.64 to 6.2 by Dec. 2011. Marty Feldstein, in my earlier post, echoed the similar view.
3) tighter capital control to prevent inflow of hot money.

More broader picture is that the super easy monetary policy by the Fed is propping asset bubbles everywhere in the world, especially in the fast growing emerging economies (carry trade factor). Besides China, Brazil also faces grim inflation outlook, and Brazilian interest rate is already above 10% and expected to rise further.

Commodity prices are already high and fast rising. But given the debasement of paper currency across board, and the grim inflation outlook in emerging markets, it’s reasonable to believe commodities are set to rise further.

Higher volatility is ahead of us; expect to see more booms and busts; and China is facing another real challenge.

Chanos on the building boom in China

Interview of Jim Chanos, who is one of the biggest short sellers on China’s real estate developers.

Fed’s inflated control

WSJ has a nice short piece questioning Fed's chairman's overconfidence.

Three things listed as the main limits for the Fed to raise interest rate when needed:
1) higher interest rate will hurt housing sector's recovery;

2) higher interest rate will make banking sector more vulnerable, as banks hold $2.4 trillion residential mortgage and $1 trillion mortgage backed securities;
3) slow recovery in labor market

Ben Bernanke would like to add something, beyond death and taxes, to life's short list of certainties: the ability of the Federal Reserve to quash inflation.

Speaking on "60 Minutes" on Sunday, the Fed's chairman declared he was "100%" confident the central bank could control an inflationary surge: "We could raise interest rates in 15 minutes if we have to. So there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time."

If only it were that easy. While the Fed has managed over the past few decades to keep inflation in check, in the future, its ability to choke off inflation through interest-rate rises could be constrained by fear of destabilizing still-weak property and banking sectors.

Any swift rise in interest rates, for example, could hit home prices again, in turn pressuring banks, which held about $2.4 trillion in residential mortgage debt at the end of the third quarter and more than $1 trillion in mortgage-backed securities. Also, stubbornly high unemployment could reduce the Fed's appetite to squeeze the economy.

Of course, Mr. Bernanke may speak with such conviction because he is certain any looming inflation won't be the sort the Fed cares about. While the Fed's $600 billion bond-buying program is spurring price rises in agricultural commodities, metals and energy, these aren't generally counted in the Fed's measure of "core" inflation. Core inflation would take time to emerge. And it should come from a strengthening economy, which would in theory be able to absorb higher rates.

It depends on your definition of inflation. But Mr. Bernanke, who infamously declared in a May 2007 speech that problems in the housing market would be "limited" to the subprime sector, should know better than to give blanket assurances.

Bernanke ’60 Minutes’ Interview

Ben Bernanke’s second interview ever.

He declares, “we are not printing money”, because money supply is not moving. (I laugh…)

Mr. Bernanke called the inflation fears “way overstated” and said he had 100% confidence he could act quickly enough to keep prices in check. “We’ve been very, very clear that we will not allow inflation to rise above 2% or less,” he said. “We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time.”

I am troubled by his 100% over-confidence. Yes , the Fed could raise interest rate in 15 minutes, but will the Fed raise interest rate when the inflation passed 2% yet unemployment rate remained very high still?

This video interview will become an evidence of the Fed’s overconfidence in a few years time.

Hatzius: Fed won’t raise rates in 2 years

Interview of Goldman Sachs’ chief economist. His view is that inflation is less of a worry, and the Fed won’t raise rates in 2011, not even in 2012.

China to build more affordable housing

In another effort to diffuse housing bubble, China has set an aggressive 2011 construction target of 10 million subsidized, affordable housing units for local governments, 72 percent higher than this year's 5.8 million units, with an emphasis on public rentals for lower income families.


(graph courtesy of US Global Investors)