John Mauldin writes convincingly that the Fed is trying to preempt the negative consequences of the housing collapse. However, the players in the market are behaving as if a bail out had occurred. In order for the message to be correctly heard, other signals need to be forthcoming. The problem is that asset markets are not responding to the crisis appropriately. Prices should be down, but they are up … the illusion continues.
Are lower rates going to reduce the chance of recession. Not really. The people that will benefit are those least exposed to the sub-prime problem; those higher up the income ladder. And it won’t encourage a change in behaviour of them either. In fact we will continue to do our supermarket shopping …
Hugh Moore of Guerite Advisors writes:
“Consumer spending accounts for two-thirds of the U.S. economy. Total Household Debt is particularly important in supporting the growth of consumer spending. This indicator includes mortgage debt due to the important role that Home Equity Withdrawal (HEW) has played in sustaining the growth in consumption since the beginning of the decade.
“As shown in the graph below, each time the year-over-year increase in Total Household Debt has dropped more than 40% below its recent peak, a recession (or in the case of 1967, a mini-recession) has occurred. The mid-1980’s slowdown touched this level, but did not exceed it. The current -38.9% level is approaching this boundary and, based on recent credit tightening by financial institutions, is likely to drop significantly below the -40% level.
The European Central Bank left interest rates unchanged at 4% on 7 September, but it is not clear that they will not be increased to 4.25% soon.
The ECB is reacting to the increase in perceived risk in financial markets, catalysed by the sub-prime meltdown. At the same time as the hold on rates increase, the ECB provided another €42 billion to the banking system, whose liquidity has dried up as banks continue to be reluctant to lend to each other, without knowing the scale of losses in the lending markets.
Unfortunately, it will be some months before the scale and scope of the liquidity crisis might be known, and this will make interest rate decisions more difficult. However, I think it unlikely that they will be brought down this year.
This linked article, How We Got into the Subprime Lending Mess (published by my alma mater Wharton), describes the background to the changes in the mortgage industry that contributed to the dislocation between stated risk/return profiles and reality of the loans. The comments following are insightful too.
Oh dear …
Well, it wasn’t as if it wasn’t expected. Futures were pricing a 100% chance of a drop of 0.25% and a 50% chance of a drop of 0.5%. But I still think it was a dangerous mistake. Inflation is pulling at the rein and the speculative dynamic of stock markets continues to undermine fiduciary responsibility and sensible personal wealth management. (For more on these concerns, please see August GRI Equity Review here.)
The first sign that the rate cut wasn’t appropriate was the bounce in the stock markets. After the decision was announced all three major US indexes were up more than 1%.. The Dow Jones industrial average was up 1.37% at 13,587.54, the S&P 500 Index was up 1.87% at 1,504.29, and the Nasdaq was up 1.60% at 2,622.95. As of this writing markets are still open, and up.
There will be a speculative rush for a few weeks until the reality that interest rates are not the problem sinks in. Perhaps on a positive note, they could be increased again if inflation accelerates too soon.
The most unnerving conclusion, however, is that the Fed is not able to give the tough love the markets need, or, even worse, emotions and personal interests got in the way of the decision.
The lower rate will encourage another bout of gorging on debt and further extension of an unsustainable mountain of credit. Consumer behaviour needs encouragement to change, to become more practical. The sooner the better.
(And here’s another discussion of the Fed’s Irresponsible Move published in BusinessWeek.)
As we expected, there appear to be more money than deals in clean-tech.
New Energy Finance reports: 2006 was another record year for Venture Capital and Private Equity investment in the clean energy sector, with $18.1 billion invested in companies and projects. This represented a 67% increase on 2005 ($10.8 billion), and beat New Energy Finance’s original forecast. However, this rapid growth in VC & PE investment only tells half the story: a significant amount of money ($2 billion) resides in funds and has yet to be invested. During 2006 clean energy VCs invested only 73% of the total money available to them – a symptom of a competitive market where demand for deals is outweighing supply, thereby driving up company valuations.
Cleaning Up 2007: Growth in VC/PE Investment in Clean Energy Technologies, Companies & Projects by NEF
Since Autumn 2006 attention to the sector rose as various reports came out: The Stern Report, various IPCC reports, the movie The Inconvenient Truth and so on. Private equity managers all rushed to get in on the game because they saw it as an easy way to raise money and thought that the fundamental economic drivers had suddenly changed. As is always the case with too much money chasing too few deals it is likely that many over paid. It is also likely that few had expertise or an understanding of the emerging economic dynamics of the enlightened consumer. Money will be lost.
The good result however is that more attention is being paid to this area, especially aspects like alternative energy.
The better managers are those that can also look beyond clean tech and make the connection with the growing LOHAS consumer profile as well.
The ninth annual survey of the Dow Jones Sustainability Indexes is available.
More information about the report, as well as selected downloads about each industry leader and regional rankings, are available at http://www.sustainability-indexes.com.
Anatole Galetsky presents GaveKal’s perspective in Here Comes the Whale that Northern Rock is the large problem that needs bailing out in order to pass through the financial liquidity imbalance that has accrued during the past few years.
… on past experience, the long-awaited appearance of the whale – Continental Illinois, Chrysler, Brazil, Drexel Burnham, Kidder Peabody, Mexico, LTCM/Russia, Enron/MCI/Argentina – would announce the beginning of the end of the liquidity crunch. …
… because we started thinking in the middle of 2006 that our whale was overdue for an appearance, but it never quite turned up. In February we finally realised what species of a fish we were looking out for – a mortgage lender, with a specialty in high-risk loans – but still the damn creature refused to show. But this weekend, a whale finally surfaced, though somewhere totally unexpected. Until last week, almost nobody in the markets had heard of Northern Rock PLC. And even on Friday – when Britain’s fifth-biggest mortgage lender was officially “rescued” by the Bank of England in its first lender-of-last-resort operation for 34 years – most people in the markets saw this event as “a little local difficulty” compared with the mess in the US sub-prime market or German state banks.
Time will tell how history views these events and and Northern Rock’s place in history, but other “whales” where well known and media savvy before the crisis, this one was not. It can be said, however, that Northern Rock is contributing to the evidence that a rebalancing of the price of liquidity is taking place.
The FT describes how Norway’s sovereign fund management sets the standard. Government Pension Fund-Global, part of Norges Bank, was set up by the Norwegian government in 1990 and manages about €235 billion. It has worked with authorities in Kazakhstan, East Timor, Bolivia, the Faroe Islands and several African countries among others.
“We make no strategic investments,” said Martin Skancke, director-general of the fund at the Ministry of Finance. “We invest in individual companies and sec tors. We are invested in between 3,000 and 4,000 companies in 40 countries and average ownership of a company is below 1 per cent. We do not feel that this distorts markets.”
Investment decisions are either made by individuals at the fund with specific investment mandates or are contracted out to external asset managers. At the end of 2006, 22 per cent of the fund was managed by 50 external managers with 80 different mandates.
Transparency is paramount. The ministry receives advice on the investment guidelines from the Central Bank of Norway. Consultants are also employed to help with this work as well as to judge performance and the management of costs.
Ethical Guidelines for the Government Pension Fund – Global Norwegian Ministry of Finance
Principles for Corporate Governance and the Protection of Financial Assets
A comprehensive review of the characteristics of the world’s main financial centres by The Economist (EIU): Magnets for money. While the impact of technology on transformations of financial centres in recent decades is analysed, there could have been a more critical review of the outlook for the decentralisation of financial services through ICT.
A new report claims that excessive executive compensation in the US is taking a staggering economic and social toll on American society, threatening leadership in the business, government, and nonprofit sectors and creating instability in the economy. The report gives a good summary of the gross disparity between top earners and average earners and disparages the arguments justifying the excesses.
According to Executive Excess 2007, the fourteenth annual survey of executive compensation from the Institute of Policy Studies and United for a Fair Economy, the figures stand in stark contrast: the CEO of a large company pulls down an average $10.8 million per year in salary and bonuses (excluding perks and some stock options, whose value can run to many millions more. But the average wage is only $29,544 (only about 160% of the poverty level for a family of four). Despite an increase this year to $5.85 per hour, the real value of the minimum wage has declined 7% over the past decade and real wages have risen little over the same period. During this time, executive pay has soared by 450%. The stark comparison even raises the illegitimacy of capitalism and democracy because the socio-economic profile is so feudal. You have to ask what these “leaders” stand for when they are so intent on grabbing more from so many who have relatively little.
The report appropriately debunks the rationalisations for excessive compensation: Excessive compensation is not necessary to attract talent. In fact it may do the reverse by attracting machiavellian individuals out for themselves rather than their employer. Executive Excess 2007 makes the case that it actually erodes good leadership by giving the highest rewards to those who ignore long-term stability in favor of short-term market gains. Employee relations may also suffer, leading to negative impacts on company performance. Enlightened analysis has shown for a long time that money does not make happiness, in fact often the reverse once average needs have been met. And high CEO pay does not correlate with outstanding performance either. The great illustration today is Angelo Mozilo of Countrywide Financial, “the sixth highest paid CEO in 2006…with $42.9 million. In July 2007, the company’s sub-prime mortgage woes drove its foreclosure rates to the highest level in more than five years and contributed to a global liquidity crisis.”
The report makes some proposals for change:
- Eliminate tax subsidies for excessive CEO pay.
- End preferential tax treatment of private investment company executive income.
- Cap tax-free “deferred” executive pay.
- Eliminate the tax reporting loophole on CEO stock options.
- Link government procurement to executive pay.
Download report here. See Social Funds’ review here.