Monday, May 14, 2007

What will catalyze the "meltdown"?

Let's face it. fuBarrio has wasted a lot of time musing about potential melt-downs and scary outcomes for the financial markets in this blog. The executive summary of this entry in case you don't want to dig through the details of my still muddled mind is that I'm predicting a bankin crisis in the US -- beyond what we've already seen in the subprime lenders.

Uruguay and Argentina had a pretty brutal crisis here about 5 years ago that they are just shaking off. However, there are no shortage of people here with some pretty scary stories. While it's true that the people who were bein paid in dollars made out like bandits, those unfortunate souls would were being paid in pesos and borrowing in dollars made out like "bagholders"

The title of this blog entry "may" be overstating the case for a meltdown, but I believe a meltdown is imminent. So what does "imminent" mean? Well...this is a developin thesis so I'm still looking for feedback to help develop this theory from the two readers of this blog...but, as I start to lay out my arguments in a somewhat incoherent fashion (especially at first) maybe you can get an idea of what i mean by "imminent".

Here's the crux.

The US econ transforming into a service economy. While this sounds well and good, I believe it has gotten ahead of itself. Pushing bits has become the only way to make money in the US it seems. At first it was the technologists....and after that crashed the "bits" financial credits and debits represented by "bits" on a computer.....the new fangled version of pushing paper.


Lots of reasons, I guess....and i'm sure i don't know them all....but i think numero uno is costs of doing anything else in the North America. I had the opprotunity to look at the costs associated with opening up a new semiconductor fabrication facility in the valley in 2003/2004

Even with a desperate landlord and a built out fab selling for pennies on the dollar in the wake of the tech-wreck, all the "other" costs couldn't be reconciled against just boxing up the entire thing and sending it overseas. Now, don't get me wrong, moving, reinstalling and requalifying used semi fab equipment overseas ...even for a small fab, is a 7 or 8 figure expense....but the "hidden costs" of doing mfg business in the states is crushing.

Regulatory hurdles to new facilities/beauracratic red tape
Attorney costs -- any long term relationship/contract with any vendor/partner/distributor/supplier becomes something for attorneys to pine over for weeks at 450/hr.
Taxes -- these come in a 101 flavors for the small business
Compliance -- this is a big bugaboo...Sarbanes Oxley hits not just big companies, but little companies with hopes of being big, or hopin to be bought by someone big.

So, it was hard to open a plant making refrigerators in America's heartland the last 10 years. So, rather than just sit around and starve we got creative about ways to feed our families.

Those with "education" and didn't want to pull down big bucks fixing toilets or swinging hammers often found themselves in some part of either the "Real Estate Industrial Complex" (REIC) or something broadly defined as "Financial Services"

The result of this (coupled with criminally loose monetary policy) has been an explosion in the REIC and financial services include in my definition for the REIC

builders & construction
title companies
mortgage brokers
IB's repackagin mortgage products
RE Agents
etc, etc, etc, etc.

And for the "financial services industry"

commodity trading
hedge funcs
PE funds
derivatives traders
etc, etc, etc, etc.

Now that the REIC is contracting massively, it is putting additional pressure on a financial services industry that is already leveraged to the hilt (in my opinion).

What we are seeing now is banks (and other assorted bagholders) who still have yet to "come clean" on the depth of the mess. In one of the most disturbin revelations to come out of this, I read a few months ago (have yet to independently confirm) that many banks are booking negative amortization loans' unpaid balance increases as income in the current period. This is eerily reminescent of almost every other "accident waiting to happen" in recent memory of my adult life.

In summary...."income" being booked that had nothin whatsoever to do with "cash flow".

Those banks and financial institutions unfortunate enough to be holding a large amount of residential real estate returned to them by borrowers unable to pay will eventually be forced to unload their holdings at "any cost" to remain liquid.

So again, in summary....I need to study this issue more thoroughly, but I'm predicting a banking crisis of sufficient magnitude to hit the mainstream press....and not just in the subprime lenders as previously born out.

you'll see them first (probably) in smaller, less capitalized, regional banks in areas hit by heavy fraud...and then if it gets big enough this whole mess could people to look under the rocks at fannie mae.....and that's where you wind up with "too big to fail" issues. when something is "too big to fail" typically, the US taxpayer ends up footing the bill while a host of clowns sail into the sunset already set for life. This is a key covenant of "privatizing benefits" while "socializing risks".

The exact reactions of the Fed, the US govt, and our trading partners are a little difficult to gauge right now....We could see something like the old Real Estate Trust Co. (RTC) reformed and that is why i really don't have any "new" plays to try in this market other than *possibly* shorting the banking index with long term puts (this b.s. could carry on for years before it's brought to the light of day) and an inflation hedge offsetting your puts in case the printing presses try to paper over this mess.

for now, in the housing fund, i'll sit in depreciating dollars and txm.v

ciao for now,


j.p. in ohio said...

This thought occured to me as I was out walking my dog...

Let's just assume for the sake of argument that every country was to eliminate fiat money and move to a gold standard.

In this case it seems that two things would happen:

1) The world economy would eventually "top out"- which is to say, there's only a finite quantity of gold in the earth, so once it's all been mined out, then how would any economic EXPANSION be achieved?

2) Economic activity becomes a zero-sum game. If I have one more ounce of gold, everyone else has one less. In this case it would be possible, theoretically, for one person/group/company/government to monopolize the money supply, the effects of which I'm sure you can imagine.

I can see the flaws in the alternative (i.e., the way things work now) and it definitely doesn't point to a rosy future, but it seems like the gold standard has even bigger potential problems.

Is there something I should be considering that I'm not?

FuBarrio said...

j.p. glad to see that you are out walking....walking your dog....and thinking about things.

thank you for the comment.

i'm a bit pressed for time and even if i wasn't i wouldn't have a perfect answer for you.

i guess the long and short of it is that anything that people are trying to use as a medium of exchange and a STORE OF WEALTH and could be problematic if it could be easily expanded at a rate that is greater than the actual expansion of goods and services.

right now, it's arguable that there is any real expansion at all in the US, and yet most people put the expansion of money and credit at either just over 10 percent or high single digits.

so, if you are schmuck trying to hold something to ensure that your work today (and yesterday) can be used in exchange for something of value tomorrow you are being "secretly" taxed....not just by the govt who spends, but the fed who prints (out of thin air) and taxes the govt (with interest) for the right to borrow the money they could have just printed themselves.

i still can't completely wrap my head around the perverseness of it all....

now if we stopped growing the money supply but kept growing goods and services would life really grind to a halt???

or, conversely, would people keep expanding their offerings of goods and services (at a faster rate than money supply) and thus the value of money goes up over able to buy more things cuz there is less money chasing more goods?

and, if there was more goods to money over time, you could just store your money safely and earn a benefit for not spending now....this seems a lot cleaner than chasing "interest" in the face of an expanding money supply.

of course these are very early thoughts i'm throwing out and i'm sure some minimally trained economist will chime in and tell me why it would NEVER work. it would result in a DEPRESSION and that INFLATION is the only managable monetary policy worth discussing.

of course, all that said....if we just abolished "central planning" perhaps the market would find the proper rates quick enough as to have a market response that would self correct things like runaway inflation and negative savings rates without needing to go to a gold/oil/conche shell standard

good question.


j.p in ohio said...

Thanks for giving my question some attention. Sorry to keep pestering you.

Perhaps Chuck Stull could provide some insight...

FuBarrio said...

no problem...i enjoy the question. next time i see chuck i'll ask him....and then undoubtedly i'll have a few beers in me and i'll talk over the top of his answer without giving him the chance to get a word in edgewise :)