How to identify potentially threatening asset price bubbles?

In a globalized world, with few barriers to capital flows, investors around the world can bid up prices for stocks, bonds and real estate in local markets from New York to Shanghai.  

Central banks have fueled these purchases with record low interest rates and by entering the bond market as major buyers themselves  

Largely as a result, global financial assets (including only stocks and bonds) are worth $280 trillion and amount to about 330% of global GDP, up from $12 trillion and just 110% in 1980.

Traditionally, economists have looked for trouble in the economy to cause trouble in the markets.  

They see no cause for concern when loose financial policy is inflating prices in the markets, as long as consumer prices remain quiet.  

Even conservatives who worry about easy money "blowing bubbles" still look mainly for economic threats to the financial markets, rather than the threat that overgrown markets pose to the economy.   

But financial markets are now so large, that the tail wags the dog.

A market downturn can easily trigger the next big economic downturn.

Summary:

The general rule is that strong growth is most likely to continue if consumer prices are rising slowly, or even if they are falling as the result of good deflation, driven by strengthening supply network.

In today's globalized economy, in which cross-border competition tends to suppress prices for consumer goods but drive them up for financial assets, watching consumer prices is not enough.  

Increasingly, recessions follow instability in the financial market.  

To understand how inflation is likely to impact economic growth,  keep an eye on stock and house prices too.

Housing bubbles and Stock bubbles fueled by borrowings

Be alert when prices are rising at a pace faster than underlying economic growth for an extended period, particularly for housing.  

• Home prices typically rise by about 5% a year.  
• This pace speeds up to between 10% and 12% in the two years before a period of financial distress.
• Once prices for stocks or housing rise sharply above their long-term trend, a subsequent drop in prices of 15% or more signals that the economy is due to face significant pain.  

In general, housing bubbles were much less common than stock bubbles but were much more likely to be followed by a recession.  The downturn is much more severe if borrowing fuels the bubble.  

• When a recession follows a bubble that is not fueled by debt, 5 years later the economy will be 1% to 1.5% smaller than it would have been if the bubble had never occurred.
• If the investors borrow heavily to buy stock, the economy 5 years later will be 4% smaller.
• If they borrow to purchase housing, the economy will be as much as 9% smaller.

Growing threat of Asset bubbles

Globalization

Rising global competition and the emergence of independent central banks have helped countries contain consumer prices.  But globalization is pushing asset prices in the opposite direction.

In a world with few barriers to the flow of capital, foreigners are often the main buyers of stocks, bonds and real estate in markets from New York to Seoul, making prices for these assets less stable, and an increasingly telling signal of a coming economic crash.

Debt-fueled property booms and recessions

Many postwar economic "miracles," ranging from Italy and Japan in the 1950s to Latin America and Southeast Asia later, first took off because of strong fundamentals (like strong investment and low inflation) but were sustained by rapidly rising debts and ended with a bursting property bubble.

In recent decades, recessions have been more likely to originate in debt-fueled property booms, for the simple reason that there has been an explosion in mortgage finance.  Since the boom in modern finance began in the late nineteenth century, mortgage lending has grown much faster than other lending to households and private companies, which helps explain why economic booms and busts "seem to be increasingly shaped by the dynamics of mortgage credit."

The growing threat posed by asset bubbles

Before World War II, there were 78 recessions - including only 19 that followed a bubble in stocks or housing.  

After the war, there were 88 recessions, the vast majority of which, 62, followed a stock or housing bubble.

For the last 3 decades, every major economic shock has been preceded by a bubble in housing, stocks or both, including 

• Japan's meltdown in 1990, 
• the Asian financial crisis of 1997 - 1998, 
• the dot-com crash of 2000-2001, and, of course, 
• the global financial crisis of 2008.  

Asset price crashes can trigger bad consumer price deflation

Often, a crash in prices of houses or stocks will depress the economy, by making people feel suddenly less wealthy.  Thus shaken, they spend less, resulting in lower demand and a fall in consumer prices.  In other words, asset price crashes can trigger bouts of bad consumer price deflation.  

• This is what happened in Japan, where the real estate and stock crash of 1990 led to the long fall in both asset and consumer prices. 
• It also happened in the US, where the stock crash of 1929 was followed by consumer price deflation in the early years of the Great Depression.

Definition of a Stock Bubble

Definition of a stock bubble


A bubble occurs in a stock when:

1.  Implausible assumptions are applied to justify its present price using normal valuation (e.g.  DCF) models.

2.  There are people buying at these prices ignoring these implausible assumptions.


Based on this defintition, Tesla is a bubble while Apple and Microsoft are not at current prices.  

Humbling Lessons from Parties Past by Burton G. Malkiel

HUMBLING LESSONS FROM PARTIES PAST
By BURTON G. MALKIEL

•The ‘Elec-tronic” boom of 60s, the Nifty 50s boom of 70s, the Biotech boom of 80s and the Technology Bubble of 90s.

•

•BENJAMIN GRAHAM, co-author of "Security Analysis," the 1934 bible of value investing, long ago put his finger on the most dangerous words in an investor's vocabulary: "This time is different."

•

•Pricing in the stock market today suggests that things really are different.

•Growth stocks,  especially those associated with the information revolution, have soared to dizzying heights  while the stocks of companies associated with the older economy have tended to languish.

•

•Well over half the stocks on the New York Stock Exchange and Nasdaq are selling at lower prices today than they did on Jan. 1, 1999.

•

•It is not unusual today for new Internet issues to begin trading at substantial multiples of their offering prices.

•And after the initial public offerings, day traders rapidly exchange Internet shares as if they were Pokémon cards for adults.

•

•As we enter the new millennium, how can we account for the unusual structure of stock prices?

•Does history provide any clues to sensible strategies for today's investors?

•

•To be sure, we are living through an information revolution that is at least as important as the Industrial Revolution of the late 19th century.

•And much of the current performance in the stock market can be traced to the optimism associated with "new economy" companies - those that stand to benefit most from the Internet.

•

•The information revolution will profoundly change the way we learn, shop and communicate.

•But the rules of valuation have not changed.

•Stocks are only worth the present value of the cash flows they are able to generate for the benefit of their shareholders.

•

•It is well to remember that investments in transforming technologies have not always rewarded investors.

•Electric power companies, railroads, airlines and television and radio manufacturers transformed our country, but most of the early investors lost their shirts.

•Similarly, many early automakers ended up as road kill, even if the future of that industry was brilliant.

•

•Warren E. Buffett, chief executive of Berkshire Hathaway and a disciple of Graham, has sensibly pointed out that the key to investing is not how much an industry will change society, but rather the nature of a company's competitive advantage, "and above all the durability of that advantage."

•

•Yet the Internet must rely for its success on razor-thin margins, and it will continue to be characterized by ease of entry.

•

•A drug company can develop a new medication and be given a 17-year patent that can be exploited to produce above-average profits.

•No such sustainable advantage will adhere to the dot-com universe of companies.

•

•Moreover, the "old economy" companies may not be nearly as geriatric as is commonly supposed.

•We still need trucks to transport the goods of e-commerce, as well as steel to build the trucks, gasoline to make them run and warehouses to store the goods.

•

•Precedents of recent decades offer many valuable lessons to today's investors.

•Consider the "tronics boom" of 1960-61, a so-called new era in which the stocks of electronics companies making products like transistors and optical scanners soared.

•

•It was called the tronics boom because stock offerings often included some garbled version of the word "electronics" in their titles, just as "'dot-com" adorns the names of today's favorites.

•

•More new issues were offered than at any previous time in history.

•But the tronics boom came down to earth in 1962, and many of the stocks quickly lost 90 percent of their value.

•

•Another parallel to today's market was seen in the 1970's, when just 50 large-capitalization growth stocks, known as the Nifty 50, drew almost all the attention of individual and institutional investors.

•They were called "one decision" stocks because the only decision necessary was whether to buy; like family heirlooms, they were never to be sold.

•

•In the early part of that decade, price-to-earnings multiples of Nifty 50 stocks like I.B.M., Polaroid and Hewlett Packard rose to 65 or more while the overall market's multiple was 17.

•

•The Nifty 50 craze ended like all others; investors eventually made a second decision -- to sell -- and some premier growth stocks fell from favor for the next 20 years.

•

•The biotechnology boom of the early 1980's was an almost perfect replica of the microelectronics boom of the 1960's.

•Hungry investors gobbled up new issues to get into the industry on the ground floor.

•

•P/E ratios gave way to price-to-sales ratios, then to ratios of potential sales for products that were only a glint in some scientist's eye.

•Stock prices surged.

•

•Again, as sanity returned to the market and more realistic estimates of potential profits were made, many biotechnology companies lost almost all of their value by the early 1990's.

•

•The lessons here are clear. Occasionally, groups of stocks associated with new technologies get caught in a speculative bubble, and it appears that the sky is the limit.

•But in each case, the laws of financial gravity prevail and market prices eventually correct.

•

•The same is likely to be true of the dazzling stocks in today's market.

•Few of the Internet darlings will ever justify their current valuations, and many investors will find their expectations unfulfilled.

•

•Even supposedly conservative index-fund investors may be surprised to know that very significant shares of their portfolios are invested in information technology companies whose P/E and price-to-sales ratios vastly exceed even the sky-high multiples reached during those past periods of market speculation.

•

•At the very least, investors might well start the year by examining their portfolios, to see if their asset allocations are appropriate for their stage in life and their tolerance for risk.

•

•Burton G. Malkiel is an economics professor at Princeton University and the author of “A Random Walk Down Wall Street" (W.W. Norton).

•

•http://www.alphashares.com/OpEd_Humbling_Lessons.pdf

•

Warren Buffett on Bubbles and Excess Leverage

http://youtu.be/X37cv_Q0jnY

Will emerging markets be 2011’s great bubble?

INVESTING
Will emerging markets be 2011’s great bubble?

SUJATA RAO
LONDON— Reuters
Published Friday, Dec. 17, 2010 10:01AM EST
Last updated Wednesday, Dec. 22, 2010 5:50PM EST


Emerging markets, the consensus trade for 2011, look set for further heavy inflows of investment dollars, raising questions over how much more new money they can comfortably absorb without igniting an asset bubble.

Most fund managers at a recent Reuters summit picked emerging markets as a top bet for next year, citing double-digit returns, underpinned by rising incomes and fast economic growth.

Equity portfolio flows to emerging markets are set to reach $186-billion (U.S.) this year, and, while they are seen falling a touch to $143-billion next year, according to the Institute for International Finance (IIF), they will still be more than double the $62-billion annual average seen between 2005 and 2009.

Yet, some are starting to ask if investors are getting carried away. Not only do unbridled portfolio flows risk inflating sector valuations into bubble territory, but the flows may be based on unrealistic expectations of long-term returns.

“The bigger bubble risk is the investor expectation of EM, there’s such euphoria,” said Mark Donovan, chief executive officer of Robeco, which manages €146-billion ($194.3-billion). “I’m always wary of these herd moves into certain asset classes, generally they are not well-timed.”

SWEET SPOT HIDES BITTER TRUTH

Mr. Donovan does not question the underlying emerging markets growth story. But he and some others believe new investors may be ignoring potential problems, within and outside the sector.

Emerging markets have been in a sweet spot this past year or two as liquidity unleashed by Western central banks has pumped up the market, fuelling double-digit returns.

A Reuters poll forecasts emerging returns will far outstrip U.S. and UK equity gains in 2011. Excess liquidity, however, is fuelling inflation in developing economies, potentially leading to overheating. Higher U.S. Treasury yields could also become a headwind.

“My central scenario is that in 2011 emerging markets will be okay. Given where valuations are you will still get a positive absolute return,” said John-Paul Smith, chief emerging markets strategist at Deutsche Bank in London.

“But some of the outsize returns forecasts are probably way too high ... I’m concerned that if people become too optimistic we could see a bubble-type situation developing. When the bubble bursts, it has horrible repercussions for the real economy.”

EMERGING MARKETS ARE ... STILL EMERGING

One worry, Mr. Smith says, is that the inflows risk encouraging emerging policymakers’ hubris, removing the pressure for reform.

Some doomsayers note big capital inflow peaks often precede crises. This may be especially true of emerging markets which remains a relatively small, illiquid asset class: the market capitalization of the 37-country MSCI emerging index, is less than a third of the U.S. S&P 500.

That means a large-scale cash influx can quickly inflate asset prices to unsustainable levels, risking a repeat of the familiar boom-bust emerging market cycles.

RBC estimates that a 1 per cent re-allocation of global equity and debt holdings will send $500-billion into emerging markets – more than 10 per cent of the MSCI emerging market cap.

NOT YET A BUBBLE

At present, emerging valuations are not in bubble territory – they trade at a discount to developed markets at around 11.5 times forward earnings.

Valuations are still below 2007 peaks and well off levels during the dot-com bubble in the late 1990s when some stocks were trading at 60-80 times forward earnings. And the volume of securities available for investment is growing.

The MSCI EM’s market capitalisation has grown by around 10 per cent a year in the past decade and emerging markets’ share of the world index has tripled to 14 per cent. The emerging debt universe too has doubled to around $6-trillion over the past five years, JPMorgan says.

Still, with investors piling in, too much cash could in coming years end up chasing too little market cap.

Global equity fund allocations to emerging markets now stand at 16 per cent of assets under management – in dollar terms that is $1.5-trillion, Barclays Capital said, noting bond allocations are at 7.2 per cent. Both are close to pre-crisis highs.

“(Positioning) has reached levels at which investors rightly question the sustainability of the EM flows story going into 2011,” Barclays analysts said in a note.

SIGNS OF NERVOUSNESS

There are signs of wariness. Many investors say that instead of increasing outright EM longs, they prefer multinationals such as Unilever that have exposure to emerging markets.

Another tactic has been to hedge EM exposure via Australian bonds, which are seen making big gains in case of a hard landing in China – a scenario feared by many.

Michael Power, global strategist at Investec Asset Management, says 2011 may well shape up to be the year in which investors learn not to be unequivocally bullish on the sector.

“People are looking at EM as a cake and saying ‘I want a slice,’ without looking at the ingredients of that cake. So some countries that are not born equal are being swept along in the trade along with the deserving ones,” he said.

“When bubbles burst, there is a fallout and the deserving emerging markets will be considered guilty by association.”

Why do bubbles sometimes last so long?

Bubbles are fueled by speculators who are willing to pay even greater prices for already overvalued assets sold to them by the speculators who bought them in the preceding round.

Each financial bubble in history has been different, but they all involve a mix of fundamental business and psychological forces.  In the beginning stages, an attractive return on a stock or commodity drives prices higher and higher.  People make questionable investments with the assumption that they will be able to sell later at a higher price to a "greater fool."  Unrealistic investor expectations take hold and become self-fulfilling until the bubble "pops" and prices fall back to a more reasonable underlying value.

Why do bubbles sometimes last so long?   One reason is that nobody likes to be a "party pooper" and people ARE getting rich.  In addition, there is nothing inherently illegal about profiting during a bubble.  The only problem is getting out BEFORE the collapse.  Whoever owns the overpriced asset when the bubble pops is the loser, just as the last person standing in a game of musical chairs.

17th century in Holland:  Tulip Bulbs bubble (1630s)
1995 - 2001:  Technology Stocks bubble
2007:   U.S Housing Crisis bubble

Investing in bubbles can be quite profitable if you can get out before the bubble bursts.  However, many people who did not get out before the 'pop' saw their market crashed and their wealth value evaporated.

Bubbles are not caused by fraudulent activity.  However, swindles and accounting fraud often come to light just after bubbles pop.  Nobody is looking and few care while the good times roll.  Highly leveraged frauds often run out of cash and collapse when bubbles pop.

1963:  Salad Oil Scandal
2001:  Enron
2002:  WorldCom


Comment:  
Is the economy in a bubble?  Is the present market a bubble?  A definite not.  However, some individual stocks had been speculated up to bubble proportions and some had already popped.  Individual stock bubbles are a lot  more common than whole market bubble.

Selling Hysteria

For the most part, it is in short-term trades that prices are driven by emotion.  Mid-term and long-term investments are usually influenced more by the fundamentals.

Bubbles burst in the wake of hysteria, while plummeting prices usually end in panic.

You can see panic in falling prices when you see them collapsing straight down day after day for extended periods.  Historically, long periods of selling have ended in "selling climaxes" when everyone finally panics and dumps to get out of the market at any price no matter what the fundamental reality might be.

Large price declines across the board should attract your attention.  A good rule of thumb is to sell during times of market hysteria and buy during times of panic.  

Always remember to buy low and sell high.  It sounds so simple, but it is extremely difficult.  Just keep this dictum in mind always - especially when your emotions are getting the best of you.

Ref:
Jim Rogers
A Gift to My Children

Has the bubble finally burst for capitalism? What may lie ahead?

The Sunday Times
April 12, 2009

Has the bubble finally burst for capitalism?

Global capitalism has been rescued from the brink of collapse by huge state bailouts.

Newsnight’s economics editor looks at what may lie ahead

Paul Mason

Hyman Minsky was an economics professor at Washington University, St Louis, who died in 1996. He was ignored by the political establishment and treated as crazy. Once you understand his theory, you can see why. He warned: “The normal functioning of our economy leads to financial trauma and crises, inflation, currency depreciations, unemployment and poverty in the middle of what could be virtually universal affluence – in short . . . financially complex capitalism is inherently flawed.”

Minsky showed that speculative bubbles, and the financial collapses that follow them, are an integral part of modern capitalism. That is, they are not the result of accidents or poor decision-making, but a fundamental and recurrent feature of economic life once you deregulate the financial system.

He pointed out that, given sustained economic growth, there was a tendency for the finance system to move from a situation where everything is under control, to a speculative situation, which is precarious.

Minsky’s proposed solution to financial crisis was state intervention on two fronts:
the government should run a big budget deficit and
the central bank should pump money into the economy.

It will be noted, despite Minsky’s pariah status in economics, that his remedy is exactly what has been adopted – in America, Britain, the eurozone and much of the developed world. The problem is, it has not so far worked. Trillions of dollars of ready money, tax cuts and state spending were shovelled into the world economy to stop the credit crunch producing another Great Depression. Yet all these trillions are up against a collapse in the real economy.

Fortunately, Minsky had spent his time musing on a more permanent solution: the socialisation of the banking system. This he conceived not as an anticapitalist measure, but as the only possible form of a high-consumption, stable capitalism in the future. Minsky argued: “As socialisation of the towering heights is fully compatible with a large, growing and prosperous private sector, this high-consumption synthesis might well be conducive to greater freedom for entrepreneurial ability and daring than is our present structure.”

Minsky never spelled out the details of how it might be done. But there is no need to do so now. Stumbling through the underground passageways of Downing Street on the morning of October 8, 2008, I saw it happen. Tetchy and bleary-eyed, fuelled by stale coffee and take-away food, British civil servants had designed and executed it in the space of 48 hours. Within 10 days, much of the western world’s banking system had been stabilised by massive injections of state credit and state capital.

The state takeover of large parts of the banking sector was seen – like the tax cuts and liquidity injections – as a way of speeding the return to the “normality” of the past decade. It is also clear, on the basis of conversations with senior UK policymakers, that the consensus by the time of the Washington G20 summit last November was that the recession would be a blur, a sharp V-shape, over by mid 2009.

In reality, the world is facing a much more strategic problem: its growth model is in crisis, and the banking business model is in crisis.

“A VORACIOUS APPETITE for economic growth lies at the heart of the boom that has now gone bust,” wrote Morgan Stanley economist Stephen Roach on the eve of the meltdown. It is worth reiterating just how spectacular that growth has been, and how spectacularly uneven. In 2007 global GDP growth was 5% – well above its historic trend – for the fourth year in a row. Growth in the developing world averaged 8%; and in Asia it was 10%. Across the G7 countries it was 2.6% – slightly below the average for the 1990s. Roach summed up the problem: “An income-short US economy rejected a slower pace of domestic demand. It turned, instead, to an asset-and debt-financed growth binge . . . For the developing world, rapid growth was a powerful antidote to a legacy of wrenching poverty. And the hyper-growth that was realised in regions like developing Asia became the end that justified all means – including . . . inflation, pollution, environmental degradation, widening income disparities, and periodic asset bubbles. The world’s body politic wanted – and still wants – growth at all costs.”

He concluded: “This crisis is a strong signal that these strategies are not sustainable.” But if the old growth model has reached a dead end, what can follow it?

There are three rational options for the developed world. The first is to revive the high-debt / low-wage model under more controlled conditions; the second is to abandon high growth as an objective altogether; the third is to find a radically different basis for high growth, with a return to higher wages, redistribution and a highly regulated finance system.

The first course of action is implicit in the approach agreed last November at the Washington G20 summit. In the summit communiqué, globalised markets and free trade are treated as hallowed principles, as is the national basis of regulation. Regulation would be more coordinated, there would be more information sharing, governments would commit to do better next time – but the only concrete measures to reregulate the system remained disputed. Even within the EU there was strong resistance to a single banking regulator, as London, Frankfurt and Milan vied with each other to become global banking centres on the basis of different regulatory systems.

The second solution embraces the end of a high-growth, high-consumption economy: if it can’t be driven by wages, debt or public spending, then it can’t exist. And if it can’t exist in the West, then Asia’s model of high exports and high savings does not work either. In previous eras, any proposal to revert to a low-growth economy would have been regarded as barbarism and regression. Yet there is a strong sentiment among the antiglobalisation and green movements in favour of this solution. And it has found echoes in mass consciousness as the world has come to understand the dangers of global warming. The problem is that it is only an option for the developed world: every slum-dweller and roadside migrant labourer I have ever met south of the equator had electricity and a flush toilet high on their wish list, which will need high growth for at least another couple of decades – possibly half a century.

As for the third option – a high-growth economy that transcends the limitations of both Keynesian and neoliberal models– it was Minsky who spelled out how it could be achieved: nationalise the banking and insurance system; place strict limits on speculative finance; change the tax structure to decrease inequality so that the bottom half of the income scale benefits from growth, and growth itself sustains consumer demand rather than debt. Finally, limit the power of huge companies so that you create permanently benign conditions for entrepreneurs.

This, it should be stressed, was Minsky’s prescription to rescue capitalism, not to destroy it, though the outcome would seem highly “anticapitalist” to anybody who defines capitalism as being essentially about free markets.

Surreally, as this book goes to press, large parts of the Western financial system are either semi-nationalised or on life-support with taxpayers’ money. New laws to limit speculation are being formulated. A blunt form of the Minsky solution has been improvised as a crisis measure, but it leaves many questions unanswered.

It is uncharted territory for the bankers, but actually we have long experience of what happens when companies cannot make money, form a monopoly through mergers and acquisitions, and are essential to the functioning of the rest of business. They are called utilities. Many believe banking is now about to become just like a utility: heavily regulated, low-profit, orientated by law to achieve a social aim rather thana financial one. This prospect has already got some in the banking industry so depressed that they are predicting the mass departure of the teams engaged in the high-risk parts of the banking business into the hedge-fund and consultancy businesses.

With low-profit, utility-style commercial banking, the question then arises: if banks are being asked to meet social objectives, like avoiding home repossessions or continued lending to small businesses, and are already supported by vast quantities of state finance, would it not be more efficient for the state to own key parts of the banking sector? One senior figure in the industry told me: “Once they become low-profit utilities, I don’t really care whether they stay in the private sector or are nationalised – they’re just doing the same thing.”

In short, reality is pushing the banking industry towards a utility-style solution. The result could be some form of “mixed economy” in banking, with a base layer provided by a state-owned lender, large utility banks on top, and then a big gap between this world and a slimmed-down speculative sector.

As the crisis worsens, it is becoming common for pundits to observe that, although capitalism is collapsing, nobody has thought of an alternative. This is not true. The Minsky alternative – a socialised banking system plus wealth redistribution – is, I believe, the ground on which the most radical of the capitalist reregulators will coalesce with social-justice activists. And it may even go mainstream if the only alternative is low growth, decades of debt-imposed stagnation, or another rerun of this crisis a few years down the line.

© Paul Mason 2009 Extracted from Meltdown: The End of the Age of Greed, to be published by Verso on April 27 at £7.99. Available from The Sunday Times Books First at £7.59 (including postage and packaging) on 0845 271 2135 or at timesonline.co.uk/booksfirst

http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article6078127.ece

The ABCs of Screwball Economics

The ABCs of Screwball Economics
By Alyce Lomax April 13, 2009 Comments (2)

We've had TARP (and the return of the TARP), we've had TALF, now we've got the PPIP. Our government's interventions into the economy have come hand in hand with a great propensity for acronyms that are becoming less clever all the time. (I mean, come on, PPIP?)

I've got some great acronyms for what I think these are going to do for our economic situation, but most are not appropriate for our family-friendly site. Here's one that makes it through: SNAFU. Or how about ROFLMAO, if you've got a gallows sense of humor. I still see little possibility that the government's actions are going to help our economic situation in the least.

IPS (It's the price, stupid)

The new PPIP basically fails to admit what more and more people have been arguing, and that is that the major banks like Bank of America (NYSE: BAC), Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC) don't have liquidity problems, but rather solvency problems.

There is toxic garbage on their books (and continued lack of transparency on them). The prevailing idea that it's acceptable to price these assets at fantasy levels sounds absurd to me, but the banks want to price these assets at unrealistic levels, and the recent loosening of mark-to-market rules pretty much tells you what you need to know -- somebody wants the fantasy to continue. (Even worse, some are wondering if the banks are just going to sell the assets to one another, with government help.)

The real marketplace wants to price those toxic assets, as low-down and nasty as those prices may be, and doesn't want to pay artificially inflated prices. (Meanwhile, why would we want the government to subsidize purchase of these assets at artificially high prices anyway?). Suffice it to say, it doesn't follow that prices should be whatever these companies decide they should be and the government should support that.

IDS (It's the debt, stupid)

The government's programs have been geared toward stimulating lending again. But here's the thing that's been driving me crazy for ages: There's a heck of a lot of indebtedness in our system already; it's part of the problem, and that goes for corporations, consumers, and our government itself.

Of course, the government wants to kick up lending again. Our past economic growth was based on an artificial daisy chain fed into by bubbly asset prices, low interest rates, and the inevitable loads and loads of debt being taken on. Of course, this has to correct because if you really think about it, it's been utterly unsustainable, but nobody wants to take the inevitable medicine. The smart consumers and companies that didn't dig themselves into massive debt holes probably don't want to borrow right now. So, who's left?

Consumers were melting the MasterCard (NYSE: MA) and Visa (NYSE: V) cards buying up Coach (NYSE: COH) handbags and Tiffany baubles, or flat-screen TVs or Sirius XM (Nasdaq: SIRI) radios. Unfortunately, we can now gather that a heck of a lot of their spending wasn't based on real income, but rather subsidized by debt or taking equity out of their bubbly priced homes. Now many consumers are busted broke, with slashed credit lines, defaulted loans, and lost jobs. Should they borrow more?

Meanwhile, many corporations loaded up on debt, too. I remember thinking it was weird for companies to take on debt to say, pay dividends or buy back shares (much less to finance their operations). Back then, it made sense to just about everybody, and everybody was doing it. But now? It's pretty clear that many companies weren't concerned about a rainy day coming, a day when it might become difficult for them to service that debt. Well, it's come. Should they borrow more?

IES (It's the economy, stupid)

It's morally reprehensible that the government should expect already overly indebted consumers to keep on borrowing to reinflate our deflating economy. Some of us are concerned that our economy has been an accident waiting to happen, given the fact that consumer spending represents 70% -- the lion's share -- of GDP. The emphasis on services and the financial industry's love for pushing pieces of paper around has put us in a precarious position indeed, as has the emphasis on debtor spending to make our economic world go round.

Meanwhile, it looks like my fears of a zombie apocalypse economy are coming to pass. Throwing good money after bad not only robs taxpayers, but it also robs healthy companies of capital as the zombies are kept alive. Propping up losers means that soon, all we'll have are losers, and an awfully big bill to pay.

BBIAF, with more bad acronyms

There are many arguments emanating from many different schools of thought about what to do. I've always thought that the government should stay out of this so we could have a difficult, but likely shorter lived, correction, clear out the artificial excess, and get to work on moving back to an economy with real innovation and truly healthy businesses -- all the while leaving bubbly fakery behind.

I know many people don't agree with my point of view, but it seems like more and more people from many different economic camps are starting to come around to the idea that the fixes from government intervention from both the previous administration and the current one are simply helping politically connected bankers and doing little to actually fix what ails the real economy. The word "oligarchy" seems to be cropping up an awful lot, in fact.

Let's hope that the next acronym program won't be one that denotes being completely out of luck, but after endless government interventions that don't seem to help and seem more likely to hurt, it's starting to feel like that's our destiny. Let's hope not.


Alyce Lomax does not own shares of any of the companies mentioned. The Fool has a disclosure policy.

http://www.fool.com/investing/general/2009/04/13/the-abcs-of-screwball-economics.aspx

World's burst-bubble economy

Reviving the world's burst-bubble economy seems further away than ever
In the US and in Ireland, governments have been scrambling again to support their banks.

By Ian Campbell, breakingviews.com

Last Updated: 6:25PM GMT 16 Jan 2009


For the economic prospects of these countries, and the world economy, that is troubling. Recession is only just beginning and yet many banks are holed.
Governments are being obliged to pour in more capital, adding to the huge liabilities they now face. This vicious circle augurs poorly for recovery.
It is not that governments should avoid intervening in banks. They are obliged to. To put public money into the banking system is the right thing to do because neither national economies nor the world can afford the collapse of large financial institutions.
Moreover, fresh losses at banks will make them more risk-averse and less inclined to lend into the economy, excerbating the recession. Economic recovery needs credit and the banks need economic recovery.
To restore their financial positions, banks must continue the retreat from high leverage and risk. But the large amounts of public money poured into them do not automatically mean they will be quick to lend more.
At present, neither is in a strong position to help the other. On the contrary, recession and low-growth risk are creating further asset losses for banks - and further recourse to government budgets already under huge strain.
Had Anglo Irish Bank become insolvent, the Irish government, whose fiscal deficit is already heading towards double digits, would have been liable for some 100bn euros in deposits - about half of Ireland's GDP.
The Irish government has guaranteed deposits in all its banks but could not afford to honour that guarantee without issuing debt that would far exceed the country's GDP. It is improbable anyone would want to buy it. Nor can Ireland resort to the money printing press for funding, as the US and UK governments may eventually do. Ireland no longer has its own pounds to print.
The worst afflicted banks are in countries which have experienced property price bubbles, like the US and Ireland. But as recession bites, more loans in more sectors and in more countries may turn bad.
All this makes it likely that governments will be forced to print more money. At present, central banks are buying financial assets but not directly funding governments. Before long, however, they may be forced along that sorry path - the same one traveled in the past from Argentina to Zimbabwe.
It's not yet the time. But monetising bad debt and devaluing paper money may in the end be the only way of reviving the world's burst-bubble economy.



http://www.telegraph.co.uk/finance/breakingviewscom/4272951/Reviving-the-worlds-burst-bubble-economy-seems-further-away-than-ever.html