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Regular readers know that besides ETF portfolios and trading strategies I prefer to focus on big picture economic and investment articles. Below are four articles I found worth reading for this week, along with a brief summary of each and excerpts:
John Hussman’s Weekly Market Comment for this week is titled We’re Speaking Japanese Without Knowing It. The Japanese we speak? Propping up Zombie banks:
At a speech at the Princeton Club last week, economist Carmen Reinhart reiterated that by propping up unhealthy banks, the U.S. is unwittingly committing the same mistakes as the Japanese did in their decade-long stagnation, saying, “These are not zombie loans. They’re just non-performing. We’re speaking Japanese without knowing it.”
Later, he notes his primary thesis, and I think much of the reason why he tends to have a tempered view of the equity rally the past few months:
Historically and across countries, according to the IMF, 86% of systemic banking crises have ultimately required government restructuring plans that included closing, nationalizing and merging banks. Yet the policy response of the U.S. has been akin to putting a band-aid on an untreated infection. Worse, not only has the underlying infection been overlooked, but thanks to the easing of FASB mark-to-market rules early this year, we have at least temporarily stopped reporting on the status of that infection.
After the bubble burst in Japan in 1990, Japanese banks were not compelled to properly disclose their losses either. The predictable result is that the problems resurfaced later, but worse, because they had not been addressed.
This sort of “regulatory forbearance” – setting aside requirements for large loan loss reserves and timely loss disclosure – was helpful during the Latin American debt crisis of the 1980’s, but largely because it allowed time for negotiations with countries to restructure debt, first by rescheduling payments, and then ultimately through debt-equity swaps, exit bonds, and other major debt restructuring under the Brady Plan.
Forbearance only works, however, if you’re buying time to do something to restructure debt. Instead, we’ve celebrated bailouts and the easing of reporting requirements as if they are a substitute for restructuring. In my view, this is a mistake that will haunt us….
….The simple answer is that we have not solved the mortgage mess. We have temporarily buried it under a pile of public money, bailing out bank bondholders at public expense. As I’ve noted before, the best time to panic, in the financial markets, is before everyone else does. Similarly, the best time to consider responses to credit strains is before they surface. My sincere hope is that if, and I believe when, financial trouble resurfaces, we will be wise enough as a nation to prevent policy makers like Geithner and Bernanke from making the same bailout mistakes twice, protecting irresponsible lenders, and further burdening the nation with debt in the process.
With regard to the banking system, we still have no mechanism by which large undercapitalized banks would be able to absorb large losses with their own balance sheets, in lieu of going into receivership or default. The problem is that there is too much on the balance sheets in the form of debt, and not enough in terms of equity. Citigroup, with about $2 trillion in assets, continues to fund about $600 billion of that through debt to its own bondholders. Customers would never be at risk of loss in the event that Citigroup was to “fail.” The bondholders would. But we have chosen to defend the bondholders. A cushion on the balance sheet that can’t be touched is no cushion at all.
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Good article from John Mauldin on the “fourth turning” discussed by Neil Howe, author of The Fourth Turning, a widely successful and popular book that discusses how the Anglo-Saxon world has a pattern of four repeating generational types.
Mohamed El-Erian of PIMCO warns us that the return of the old ways of thinking threatens recovery:
We are at the point of maximum confusion in the multi-year transition of the global economy, markets and policymaking. We have left the global growth regime that was driven primarily by debt-financed consumption in the US, but we have not as yet reached a position of more balanced, albeit anaemic, growth. Those who lack a robust anchoring framework, be they investors or policymakers, risk being misled and backtracking to outdated ways of thinking.
The signs of inappropriate reversion are multiplying. Confusing temporary factors for sustainable ones, a growing number of analysts have extended the ongoing stimulus/inventory bounce to a V-like recovery next year and beyond. The momentum for meaningful financial reform is stalling in spite of clear evidence that financial activities have far outpaced the regulatory infrastructure. And some banks are returning to the bad habits that almost destroyed them…
…These considerations serve to accentuate the inconsistency between market valuations and the reality facing companies and economies. Today’s markets – be they industrial country equities or corporate bonds – have priced in vigorous growth for 2010. Valuations assume companies will be able robustly to grow earnings through higher revenues, not renewed reliance on the cost reductions that have propelled earnings in the past six months. For that, they are depending on what is likely to prove to be an elusive high-growth scenario for 2010.
The longer it takes for investors and the policy consensus to shift to the appropriate analytical framework – one that factors in levels rather than just rates of change – the greater the risk of disappointment in 2010.