Kansas City Fed President Esther George Wants To Raise Interest Rates!!!!!
This morning I woke up to see one of the more trending aspects of my portfolio in the proverbial sea of red. Not that I am a bond bull or bear I found this not so surprising to see. Kansas City Fed President Esther George wants to raise interest rates. Isn’t it obvious? How can the minimum wage go to $15 per hour in some cities and not pass along all these costs? Does any really look at the prices in the grocery store? I do…my wife does not. I get sticker shock when I see the grocery bills. In my book “The Bible of Compounding Money”, I quoted Paul Singer, the principle of Elliott Associates L.P.
Paul Singer, the principle of Elliott Associates L.P., started in 1977 with $1.3 million from proverbial friends and family investors. Today Singer’s firm has more than $16 billion in assets under management. Elliott’s principal investment strategy is buying distressed debt cheaply and selling it at a profit or suing for full payment. It is clear that he has seen many different financial cycles and is a world class money manager.
Before the crisis of 2007 he presented his concerns and fears to numerous world finance ministers—that a systemic financial collapse could occur from securitizations of mortgage obligations and collateralized debt obligations. This warning fell on deaf ears. Singer recently gave a speech called “The Shape of the Next Crisis”. In this speech he stated “There are a number of elements that are in play, some of which are novel, completely new in virtually the human landscape”. He stated:
The thing that scares me most is significant inflation,
which could destroy our society.
Excerpts of the speech;
Let’s talk about financial institutions and the financial system. The major message that I want to give you (and I’ve invited challenge on both parts of my thesis here and I’ve never had anybody challenge it): The major financial institutions in the US and around the globe are utterly opaque; and the next financial crisis will happen faster, more suddenly.
We cannot (I have 110 investment professionals), and I surmise that you cannot, understand the financial condition of any bank, major financial institution. You can’t see the actual size of the balance sheet. You have no idea what that derivatives section means…it’s 10 to 100 times the size of the actual balance sheet.
So when people say, “Well, it used to be 40x leveraged,” (some of them were 90x leveraged) “but now they’re 15 to 20 times leveraged.” Well that’s just great. Except you go to the derivatives and see numbers in the trillions and trillions and trillions and there is no clue, you have no clue, no understanding, of what that is actually composed of. Is that composed of trades that are basically unwound where all you have is counterparty risk? Is that composed of actual hedges of upper tranches the way we would have in an admitted hedge fund?
So you are looking at balance sheets without any real understanding of how the balance sheets and the companies would perform in the event of a crisis. Which of these trades or trillions of dollars of trades, which in normal times oscillate like this [very small motion] and that’s why they’re so big, would in really bad times start going like this [large motion]. And if you actually have capital of only half a percent, or one percent or five percent of your actual footings, not just unwound trades that happen to still be on balance sheet, but actual footings, you’re in trouble.
The kind of thing that wound up the financial system three years ago is expected to be different in form than the kind of things that would unwind the financial system the next time. But I’m going to argue that the next time will be faster. If you think back to ’07 and ’08, it was episodic. It wasn’t just suddenly that in the second or third week in September that Lehman goes under and that’s the crisis and the whole world collapsed. No, there were several episodes leading up to that.
After that, what kept the entire financial system from coming to a grinding halt was quite simple. It wasn’t that all of the other firms were in much better shape than Lehman. It’s very simple; it’s that governments, here and in Europe, underwrote the entire system. Ben Bernanke, of whom I’m not a fan… at all, has been quoted as saying that in the absence of the government guarantee and underwriting, 12 of the 13 biggest banks in the world would have gone out of business following Lehman. Whether it’s 12/13, or 13/13, or 6 or 8 of 13, is completely imponderable, but the point is actually well-taken. In the absence of that guarantee there would have been a cascading collapse because of the opacity.
There are people in this room that are on trading desks or manage trading operations at investment banks. You know for a fact that you knew nothing about the financial condition of your five biggest counterparties. And so your relationships and your willingness to trade with those counterparties were dependent on rumor or credit spreads widening or not widening. And that’s a very terrible place for the financial system to be in.
So take the opacity, take the fact that you can’t really understand the financial condition, and take the fact that the leverage hasn’t really been rung out. And what you realize is that the lessons of ’08 will actually result in a much quicker process, a process that I would describe as a “black hole” if and when there is the next financial crisis.
The next financial crisis obviously can only happen if, believably, the governments either cut loose the major financial institutions—believably and credibly unwound the guarantee—or even more difficult and scary, if the government guarantees were not enough. And that’s one of the next elements in the shape of the next crisis. As you know, risk has migrated upward; it’s migrated from lenders and borrowers really to governments. It’s gone on the balance sheet of the US, the ECB (the various countries of Europe, particularly Germany, France, etc.). That the credit of Europe, the credit of America, is being called into question in the starkest way is part of what will shape the next crisis.
But before I get to that part, and explain how I think that impacts, I want to come back to the trader and trading part of this. The lesson of ’08, which is indelibly stamped upon every hedge fund forehead and trading desk head, is: Move your assets first, stop trading first, sell the paper first, and ask questions later. Those that moved from Lehman days or weeks before the end were happy. Those that sat there thinking that they were protected in prime brokerage accounts or protected in some other ways, or that firms like Lehman wouldn’t be allowed to go under were stuck in the company (of course Lehman is still in bankruptcy) with claims trading at 20-something cents on the dollar, depending on where you are in the capital structure.
Paul Singer, one of the best and smartest investors in the world, is most terrified by the one thing that every leading economist says will never happen: High Inflation!
If you looking for a way to overcome the potential threat of inflation lets speak. I have been trading since 1994 and have various ideas in order to protect your net worth….
As well as I do one on one mentoring on improving trading.
Thank you Andrew