Paul Volcker on the Financial Crisis

Cognitive Dissonance

Cognitive dissonance is a psychological state that describes the uncomfortable feeling when a person begins to understand that something the person believes to be true is, in fact, not true.

Is this a trigger effect for the change in expectations? It appears to be what's happening at the moment in the Irish market (evidenced by Prime Time last night).

Four mega-dangers international financial markets face

Article by Dennis J Snower

Four dangers

The first danger we have witnessed since August 2007: The subprime mortgage crisis gave rise to a liquidity crisis in the international banking system, due to uncertainty about who holds the losses. This is leading to reduced lending to firms and households. But that is not the end of the story, because the reduced lending will lead to reduced consumption and investment. With a lag, reduced sales of goods and services will reduce stock market valuations. And, with another lag, the lower stock market prices will – in the absence of any favourable fortuitous events – intensify the banks’ liquidity crisis.

The second danger lies in the dynamics of U.S. house prices. As more and more U.S. households find themselves unable to repay their mortgages, foreclosures are on the rise, more houses are put on the market, the price of houses falls further – with further lags – this leads to more foreclosures and declines in housing wealth. This dynamic process plays itself out only gradually, as households face progressively more stringent credit conditions and house sales gradually lead to lower house prices.

The third danger results from the interaction between wealth, spending and employment. As U.S. households’ wealth – in the housing market and the stock market – falls, their consumption is beginning to fall and will continue to do so, again with a lag. This decline in consumption is leading to a decline in profits, of which more is on the way, which in turn will lead to a decline in investment. The combined decline in consumption and investment spending will eventually lead to a decline in employment, as firms begin to recognise that their labour is insufficiently utilised. The decline in employment, in turn, means a drop in labour income, which, with a lag, leads to a further drop in consumption.

And that leaves the fourth (and possibly the nastiest) of the dangers, one that concerns the latitude for monetary policy intervention. As the Fed reduces interest rates to combat the crisis, the dollar is falling. This is leading to higher import prices and oil prices in the United States, putting upward pressure on inflation. The greater this inflationary pressure – which is currently in excess of 4 percent – the more difficult it will be for the Fed to reduce interest rates in the future, without running a serious risk of inflaming inflationary expectations and starting a wage-price spiral. U.S. firms and households will gradually recognise this dilemma and the bleak prospect of little future interest rate relief will further dampen consumption and investment spending.

The Live Register

The graphs below show the number of people on the live register. We are currently at a level similar to 1999.Expectations are for another significant change this month. The majority of these jobs would appear to be from the construction industry and you can see the changes in the graphs as construction levels rose in the late 90's to present day, unemployment decreased.

Note: no adjustments have been made for population increases or an increase in foreign labour.

The latest update on the Live Register is due on Friday.

The graph below is from 2006 to 2008. To try your own go here.



This graph below is from 1998 to 2008.



The 90's.



The 80's.

Nobel Thoughts - Joseph Stiglitz

An excellent discussion on CNBC with Joseph Stiglitz.

The clip is 11 minutes long but gives an excellent description of the US through a discussion on savings, investment and consumption.

HERE COMES THE ALT-A CRISIS

This short piece provides an interesting & scary comparison between the sub-prime & Alt-A levels of lending and default. The information has been obtained from the New York Fed and is pretty easy to follow.

The basics are that there is more lending in the Alt-A market for higher amounts a lot of which is for non owner-occupied housing. The lending ratio is up around the 90% mark and defaults are already at 14% which is similar to that of the sub-prime area last year.The credit rating difference between these two isn't that great. The majority of these loan applicants were based on stated income or "liar loans". And, finally, the majority of mortgage resets on the Alt-A's are set to kick in over the next two years.

There are strong comparisons that can be made between America & Ireland.
We also had 100% lending (and more).
Lax lending standards.
The "rent a room" to supplement/increase the mortgage.
Interest only loans; when people finally see the real level of repayments they have to make what will happen?
Negative equity is beginning to kick in for those who have purchased in recent times on a high loan to value rate.

In America, it's easier to file for bankruptcy, hand back the keys and walk away. It's not so easy in Ireland, but that's not to say it won't happen.
What about construction workers who can't afford their mortgages due to lack of work. What's to stop them from picking up tools, moving to Oz where there's a demand for their labour and leaving their Irish mortgage troubles behind them?

Super-Senior Debt : Greed & Avarice

An interesting article on super-senior debt.

First, a brief note of explanation. The concept of super-senior debt was essentially invented by creative bankers about four years ago to refer to the chunk of debt that sits at the very top of the capital structure of a collateralised debt obligation. It is the bit that gets paid off first, before other investors, if the CDO ever defaults. In theory, it makes this debt super-safe; indeed, so secure that rating agencies have been happy to give super-senior CDO debt a AAA tag, irrespective of what lay inside the CDO.