did the Laissez-faire free market create the perfect storm not seen
since the great depression? fear of lending, fear of borrowing, the
only instances we have experienced both in modern times are the Great
Depression and Japa

http://suddendebt.blogspot.com/

there was no government intervention here, the groups of sellers,
buyers and lenders were all rational people operating in a free
market, so what happened, and why does it always happen in the above
scenario?
please see site for graphs.

WEDNESDAY, FEBRUARY 6, 2008
Won't Lend, Won't Borrow, No Time For Sorrow

The Era of Debt is coming to an end (for now, anyway...).

The Fed's latest Senior Loan Officer Opinion Survey (January 2008, pdf
document) vividly demonstrates that a one-two punch is being delivered
to credit expansion: lenders are furiously tightening lending
standards and borrowers don't want to borrow. The following charts are
from the above survey and tell the story succintly.

First, residential mortgage lending:

Net Percentage of Respondents Tightening Standards
For Residential Mortgage Loans

Net Percentage of Respondents Reporting Stronger Demand
For Residential Mortgage Loans

Next, commercial real estate credit.

Net Percentage of Respondents Tightening Standards
For Commercial Real Estate Loans

Net Percentage of Respondents Reporting Stronger Demand
For Commercial Real Estate Loans

Consumer loans...

Net Percentage of Respondents Reporting Increased Willingness
To Make Consumer Installment Loans

Net Percentage of Respondents Reporting Stronger Demand
For Consumer Loans

The picture is the same for corporate and industrial loans, albeit
slightly less "crunchy" so far.

Net Percentage of Respondents Tightening Standards
For C&I Loans

Net Percentage of Respondents Reporting Stronger Demand
For C&I Loans

The Borrow-Spend-Grow economic model was never in the best of health,
to begin with; the charts now officially proclaim it clinically dead.
It is time for the attending physicians and the relatives to realize
that they won't revive their patient by increasing the dose of the
same medicine. Better to pull the plug and focus on the "maternity
ward", instead. That's where the new economy will come from.

It's no time to wallow in sorrow about the dearly departed asset
inflation economy. Let's move on: Save-Invest-Sustain.

POSTED BY HELLASIOUS AT WEDNESDAY, FEBRUARY 06, 2008 18 COMMENTS
LINKS TO THIS POST

TUESDAY, FEBRUARY 5, 2008
The Fear Factor (2)

Continuing a bit from yesterday's post on The Fear Factor (i.e. risk
aversion), I calculated corporate credit spreads for AAA and BAA bonds
vs. the 10 year Treasury. I then divided these spreads with the yield
of 10 year Treasurys, to obtain a ratio of the spread as a percentage
of the Treasury's current yield.

This gives us a sense for the "effective" credit spread, i.e. how much
upside in income a potential investor gives up by choosing a
government bond instead of a corporate bond. It's one thing to give up
an extra 100 basis points when rates are 10%% and another when they are
5%% - the effect is double in the second case. The results are charted
below (click to enlarge).

Data: St. Louis Fed

The ratios have shot up faster than ever before and are nearing all-
time highs; investors are spurning higher yields and instead seek the
safety of Treasury bonds. Return of principal is taking priority over
return on principal.

In addition, AAA and AA corporate bonds have become endangered species
over the years, as debt replaced equity in balance sheets and overall
credit quality deteriorated (how many AAA or AA corporate names can
you think of?). Markit's CDX Investment Grade credit default swap
index for North America is made up 53%% with bonds rated BAA, 42%% rated
A and just 5%% rated higher. This makes BAA bonds a better benchmark
for "real economy" credit spreads.

Intra-corporate credit spreads between BAA and AAA bonds vs. Treasurys
have also shot up sharply (chart below, BAA yield minus AAA yield,
divided by 10 year Treasury yield).

Another sign of risk aversion is the sharp rise in credit spreads for
higher-risk corporate loans used for LBOs and such leveraged takeover
activity. Spreads for Markit's LCDX index have jumped from 310 bp to
460 bp in less than one month.

Chart: Markit

Now, there are two ways to interpret the charts: if you are a
contrarian, you could say that risk aversion is overdone and will soon
recede, resulting in all manner of rallies in financial markets. Or...
not.

Personally, I think risk aversion is the new paradigm and will
persist. Readers of this blog sporadically report hearing their
friends "confessing" they are lowering debt; an article in today's NY
Times comes to confirm this:

...But now the freewheeling days of credit and risk may have run their
course -- at least for a while and perhaps much longer -- as a period of
involuntary thrift unfolds in many households. With the number of jobs
shrinking, housing prices falling and debt levels swelling, the same
nation that pioneered the no-money-down mortgage suddenly confronts an
unfamiliar imperative: more Americans must live within their means...

...The shift under way feels to some analysts like a cultural
inflection point, one with huge implications for an economy driven
overwhelmingly by consumer spending.

_______________________________________________

P.S. December real retail sales in the Eurozone dropped 2%% from last
year. Biggest declines occurred in Belgium (-6.9%%), Germany (-6.7%%)
and Spain (-1.8%%). Is it necessary to point out that Germany is the
world's third largest national economy?

Chart: Eurostat

P.P.S. The January ISM Non-Manufacturing Index was just released and
it was downright horrible: 41.9 vs. 54.4 in December. The index tracks
prospects for the service economy, i.e. 90%% of US GDP. As a diffusion
index, readings below 50 signify contraction and vice versa.

The drop was the largest ever since ISM started publishing the index
in 1998.

Data: St. Louis Fed

POSTED BY HELLASIOUS AT TUESDAY, FEBRUARY 05, 2008 6 COMMENTS LINKS
TO THIS POST

MONDAY, FEBRUARY 4, 2008
The Fear Factor

Yields for two year (blue line) and ten year (green line) Treasury
securities have plummeted in recent weeks and today stand at 2.07%% and
3.59%% respectively (see chart below, click to enlarge). These levels
were last visited in 2002, when Fed funds (red line) were already at
1.75%% and on their way to 1%%, a real rate so negative that it
generated the largest, most participated-in capital misallocation in
the history of finance: the US real estate bubble.

Chart: St. Louis Fed

The economy has come full circle: the popping of the housing bubble
brought us back to where we started six years ago. Nothing was really
accomplished in the intervening years, except the creation of another
wealth-devouring black hole. In 2000 it was dotcoms and telecoms,
today it is millions of homes sitting unsold or in various stages of
repossession. And there is no better proof of deflated excess past,
than Microsoft's current $45 billion takeover bid for Yahoo, which in
early 2000 was worth over $160 billion.

So, are we now paving the way for the creation of yet another debt-
financed asset bubble? Is this what today's low interest rates are
predicating? Perhaps, but I don't think so.

For one, I don't see the assets that can be pumped up. Commodity
ownership is so narrowly concentrated that the wealth effect can't be
dispersed into the wider economy. Dubai, Calgary and Perth may be
doing fabulously well, but they are mere droplets in the global
bucket. Higher material prices also feed the goods-inflation monster
at a time when consumers have limited spending power. What higher
commodity prices give to the Arabs, Canadians and Australians they
take away from the Americans, Europeans and Chinese. It's a win-lose
game and as producers and speculators get too greedy, it will end up
lose-lose because income and savings constricted consumers will
necessarily clamp down on their spending.

Instead, I think low interest rates for Treasurys reflect fear,
specifically fear of a deflationary spiral in credit and asset prices.
How else to explain the now negative spread between the yield on 10-
year Treasurys (green line) and CPI inflation (red line, see chart
below) ?

Chart: St. Louis Fed

Negative real 10-year Treasury rates are extremely rare. Perhaps they
are telling us something else about fear, too - or, rather, the same
thing expressed in a different way: that after many years of positive
returns, borrowers now can't put the money to profitable use
generating returns significantly above inflation, so demand for credit
is evaporating. This includes all long-term asset buyers who finance
their purchases with debt, from businesses investing in plant and
equipment or buying back stock, to people buying homes.

Therefore fear, or risk aversion as it is properly called in finance,
comes in two versions: the first one is fear of lending, which results
in tighter credit conditions by banks and other lenders. It comes and
goes with the regular business cycle and, in the greater scheme of
things, is not uncommon. The second one is fear of borrowing and it is
very uncommon; I believe the only instances we have experienced in
modern times are the Great Depression and Japan. If both of them ever
come together, we may get a "perfect storm" where credit expansion
goes to zero, or even turns negative.

It is hard to imagine that a situation would ever arise where lenders
are unwilling to lend and borrowers unwilling to borrow, at the same
time. The main reason is that usually those two classes are separate
and have different interests. They are brought together by
professional intermediaries, i.e. bankers who profit from matching the
two in an appropriate fashion that benefits everyone. Yet...

I won't elaborate further, but I have the sneaking suspicion that the
shadow banking system of originating, securitizing and widely
distributing debt (chop and shop?) has turned those two classes into
one super-class that may very well obey Polonius's maxim: "Neither a
borrower nor a lender be".

_____________________________________
P.S. Breaking news from Reuters:

Bush's $3.1 trillion budget proposal would nearly freeze domestic
spending in fiscal 2009.

This is exactly unwillingness to borrow, writ as large as can be.