Banks fear rout on risky US bonds

Terrific.

Credit markets across the world were braced for trouble last night after Merrill Lynch abandoned efforts to save two Bear Stearns hedge funds, forcing the sale of $850m (£426m) of sub-prime mortgage bonds and other assets for debt repayment.

“Junk bonds” re-entering finance lexicon is hardly a good omen.

The actual sub-prime market is worth around USD2tr, next to which this USD850m abandonment pales, which is more worrying still. In an age when debt is bought and sold like any other financial instrument, and who knows how much of the derivatives market is based upon hedging those instruments, the fall-out from this – if the structural problem in the sub-prime mortgages sector eats its way into the financial markets trading upon those mortgages – will be phenomenal. My recent post discussing housing slumps vs. housing crashes mostly goes out the window: this will be a crash.

At the moment, it may not. Bear Stearns has been doing this for the week. It has already off-loaded better assets, in a bid to avoid exactly this. To the extent that it satisfied Goldman Sachs and Bank of America already, and possibly also JP Morgan, it succeeded. Merrill Lynch is the fourth lender in line, and is the first to seize assets and try to dump them. So it could just be these funds, having raised USD1.5bn, made very bad bets, including sub-prime mortgage instruments, which have lost a tonne of value.

Or, it could be that loads of hedge funds have been doing mostly the same thing, and this will widen the exposure to junky assets considerably. From the Independent:

The number of sub-prime borrowers – Americans given high-priced home loans, despite being deemed a poor credit risk – who have got into arrears or had their homes repossessed has spiked to a record level, and the effects of rising defaults are rippling through the financial system.

The mortgages have been parcelled together with other investments into products called collateralised debt obligations (CDOs), which are sold on piece-by-piece to other investors. Their sheer complexity is such that their value is usually calculated using mathematical models rather than open-market prices.

Demand for new CDOs backed by sub-prime mortgages has already dried up. If the price existing assets fetch in an auction proves disappointing, hundreds of banks, hedge funds and other investors could discover they are sitting on losses they did not realise. Hank Paulson, US Treasury secretary, warned yesterday that there would continue to be “after-shocks”, but insisted they would be contained and would not damage the overall economy.

If he’s wrong (or hedging himself, to stabilise confidence, and is found out) the pressure extends back down to the mortgage lenders themselves and that will hit the sub-prime housing market (defined by me as houses bought with sub-prime mortgages), making it more likely to fall over. I wonder what Greenspan’s odds of a recession are now?

This will at least bring some of the heretofore very non-public activities of hedge funds out into a little more light. Collateralised Debt Obligations, for example, could do with a little more scrutiny, and the Securities and Exchange Commission has been given a heads-up already about people playing silly-buggers with these debts. Essentially the loans may be bad, but bonds have been created based partly on these loans, and investment banks want to save the bonds: so they’ll pay high prices for the bad loans. Merrill Lynch’s move is an example of an investment giving up on trying to save the bonds, and trying to offload the CDOs – essentially a packaged bundle of low risks and high risks, losses and gains.

If you read this and it seems like nothing is linearly straightforward or calculable, you’ve hit upon exactly the problem. CDOs don’t even have an ordinary market price. And hedge funds, playing for big hedge fund money, appear to be very heavily exposed. Fortune was writing concerns about this back in March.

It’s too confusing for me right at bed-time.

Always low variable-rate mortages. Always.

Just catching news that Wal-Mart is expanding its banking and financial services.

Over the next year, the company said, it will introduce a prepaid debit card, intended for low-income shoppers, and install money centers — which offer check cashing, bill paying and money order services — in 1,000 stores, up from 225 now.

The move is seen as a precursor to wider offerings, like home equity loans and mortgages, which could turn Wal-Mart into a significant force in the banking world. Jane Thompson, the president of Wal-Mart financial services, called the prepaid cards and money centers “foundational products” that the retailer would build upon.

Given Wal-Mart’s penchant for squeezing costs out of every business it enters — from oil changes to prescription drugs — the move is expected to jolt the financial services business.

The introduction of such services represents an end-run around the federal government, which last year denied Wal-Mart a charter to open a bank amid fears that it would crush smaller financial institutions.

Previously, Wal-Mart had its plans for banking blocked. These plans, on the other hand, don’t require that Wal-Mart have a banking license. It will use 3rd party providers for the financial services that do, while the other services (cheque-cashing, pre-paid cards) are targeting account-less customers. Does this count as predatory? We shall see.

I say if GM can run a financial game, preying on poor pensioners in the UK in the process, everyone should be allowed to. The effects on smaller lenders and other financial institutions ought to be interesting, if Wal-Mart’s achievements in big-box retail are anything to go by.

I knew that someday soon we’d all sail to the moon/On the high tide of technology

The Wall Street Journal discusses the latest labour report by the OECD.

“Millions are benefiting from globalization, but at the same time there’s a feeling something’s wrong with the process,” says OECD Secretary General José Angel Gurría. That is creating political resistance to further moves to free up international trade and investment, he says, particularly in the U.S. and France.

A growing number of economists are expressing concern about the number of losers from globalization. Despite strong economic growth, these economists note, many workers in developed countries are struggling to find well-paid work amid a combination of cheap imports, the relocation of factories and offices to low-wage countries, and changing technology.

“The conventional wisdom was that all boats would be lifted by the rising tide. That was overly optimistic,” says David Audretsch, director of the Max Planck Institute for Economics in Germany.

In fact, as the WSJ points out,

The Employment Outlook concludes that “the expansion of trade is a potentially important source of vulnerability for workers.”

Globalization has probably contributed to slow wage growth in the U.S. and Europe in recent years, the report finds, and is also partly to blame for rising income inequality. Since the mid-1990s, the incomes of the highest-paid have grown at a faster rate than those of the lowest paid in 19 out of 21 countries surveyed, OECD figures show.

But trade isn’t the main culprit, the OECD claims: The spread of computer technology – even harder to reverse than imports from China – is the chief cause of the widening gap between the incomes of low-skilled and high-skilled workers, it argues.

I relate this – with no self-consciousness whatsoever about self-aggrandisement – to my post yesterday about student debt vs. the investment in higher education being worth it. Currently I would say this is moreso than ever. The structure of the modern economy is not going to benefit you if the Global Economy is something that happens to you.

Related to this evening’s posts about peak oil, I take a different long-term view. Learn how to farm, hunt and shoot. I’m a pessimist – at least when it comes to human nature in times of crises…

Forbes also has a look at the report, discussing some of the apparent recommendations for ’selling’ globalisation, and forestalling a backlash:

“One specific thing: don’t trap people in the jobs they’re in,” said Paul Swaim, one of the authors of the OECD report. “You have to have policies that support high level mobility so that workers can move between different sectors. Some countries have a lot of policies to protect existing jobs, but that’s not a good idea.”

Rather than defend jobs that have become uncompetitive, governments should instead make sure companies give advanced notice and severance pay when redundancies are made. Regulators should also make sure that companies let their relative wages adjust to the changing market conditions.

As for benefits bestowed on individuals who are in between employment, the OECD suggests that should be coupled with a system that actively assists people in their job hunt. “That doesn’t involve retraining a high proportion of people,” said Swaim. “It means connecting them with job openings, and helping them to search effectively for new jobs.”

One idea which the OECD praises, and which is being seriously looked at by the European Union, is that of “flexicurity,” a portmanteau of flexibility and security based on the idea of making hiring and firing easy, while providing benefits and insurance for the unemployed.

Founded in Denmark, the method has pulled unemployment down to 1% there, while giving the country one of the world’s highest levels of employee turnover.

Flexicurity sounds like a very nice concept – not unlike the basic principles of IR in social-welfarist economies. We invite other economies to join us.

Billionaire pitches supersonic business jets at Paris Air Show

Meanwhile:

Bass is bankrolling an effort to build the world’s first supersonic private business jet. He was at the Paris Air Show this week, pitching his project, known as Aerion, to aircraft manufacturers and potential customers.

“With this plane, you can have breakfast in New York, fly to London, stay for four hours, and fly back to New York for dinner,” said Bass, who makes do with a Falcon jet that flies below the speed of sound – too slow to make it to that Manhattan dinner.

Even with a minimum price of $80 million, Bass said, his needle-nose jet had drawn keen interest, which said something about the “Can-you-top-this?” exuberance of the market for private aircraft.

I saw this literally upon the finishing of the Futureshock documentary, which closed with discussion that peak oil, and the fact that oil (particularly the cheap stuff) is running out, and there won’t be any more – but ordinary citizens aren’t aware of it. Despite the catastrophic economic consequences of entering real peak oil (by which I mean the acknowledged state in which we wake up every day with less oil to use than the day before), governments clearly are not acting, and probably will not act in time.

Then of course, I see this. A billionaire at the Paris Air Show, shopping supersonic jets for other billionaires. At any point in the following timeline:

• Peak oil hits. Oil supplies decline permanently. Oil prices escalate dramatically.
• Costs of production follow suit. Wage demands follow that, sending inflation up dramatically.
• Central banks (and, indeed, governments), irrespective of the state of their economy, increase interest rates in order to cope.
• Economies dry up, particularly (i) economies dependent upon oil, trade or both, (ii) economies expanding on cheap credit (the UK and Europe, the US, Australia, et al).
• Transport is priced out of the hands of most households, food and household necessities begin to be rationed along with oil.

you may stop and marvel that we ever carried on like this. Air Shows, of all things.

Among the interesting points in the documentary was near-casual mention that, although we’ve seen oil shocks before, as devastating as those were, they were temporary. This is permanent. As many allusions as we can make to the Great Depression, it too was temporary. Moreover, it was based on decimation of the public’s confidence in stocks and lending. This will be an actual decimation of the value of those things.

Business, meanwhile, continues to do, at the top, exactly what consumers do at the bottom (what is this, if not the elite equivalent of driving one-per-car on the highway to and from work?) – exactly the opposite of what we should be doing right now.

During the next decade, Teal projects, manufacturers will turn out 12,000 business jets, worth a cumulative $173.2 billion. While analysts expect a temporary plateau in sales after 2009, few predict a recurrence of the boom-and-bust cycle that used to haunt the market.

In part, that has to do with the increasingly global nature of wealth. The United States used to be the dominant market for these jets, making the industry hostage to the U.S. economy.

Future Shock: End of the Oil Age

I forgot! Courtesy of The Oil Drum, a documentary from RTÉ One (in Ireland) concerning Peak Oil.

In Future Shock: End of the Oil Age, RTÉ’s Chief Economic Correspondent George Lee brings us to the heart of one of the biggest challenges that Ireland faces in the future – life after Peak Oil.

Peak Oil refers to a point in time when, with remaining reserves beginning to diminish, world oil production will reach its maximum point. The crossing of this simple threshold will be one of the biggest events in modern history: every day that passes after Peak Oil, there will be less oil available. The ensuing and inevitable rise in oil prices will be only the first of the continuing shocks for Ireland and the developed world.

The link to the documentary is on the page. It’s about bang-on 60 minutes. Watch it for Peak Oil, watch it for the accents. Watch it to hear someone else point out that we won’t long survive burning up our pre-history as we go.

I’m still in it, so to speak. The voice-over guy is terribly dramatic, for my tastes, but it’s working out as a pretty good and generalisable intro to peak oil the circumstance.

USD28.5bn from Big Oil: Good. USD7.5bn to Big Coal: Bad

News today that the (US) Senate Finance Committee has cooked up a USD28.5bn love-letter for coal and renewable resources. Most of this comes from taxes demanded, and concession withheld, from the oil industry.

What shits me is the kick-back carved out for coal – specifically, ‘clean coal’. I’ve mentioned previously I don’t believe there is such a thing. Don’t believe me? Find an old copy of Vanity Fair.

Or try google. What does that have to do with economics? Little, if anything, it just demonstrates that ‘clean’ is obviously a matter of perspective. In this case, ‘clean coal’ exists when ‘clean’ only applies – loosely – to one end. I’m sure the Appalachian people use a different definition to seeing mountaintops blown away and dumped in the valleys. It makes for rather an Uncommon Treasury.

But back to the story:

“The provisions of this bill constitute the most comprehensive set of incentives for the production of clean, alternative energy ever contemplated by Congress,” Sen. Jeff Bingaman, D-N.M., chairman of the committee’s energy sub-panel said.

Finance Committee Chairman Max Baucus, D-Mont., said that the package was necessary given that gasoline prices are over $3 a gallon, crude is north of $60 a barrel and there is concern over mounting global warming.

I expel my coffee – when was the last time the Chairman of the Finance Committee picked up a newspaper? North of USD60 per barrel? The news is excited that the oil finally went (barely) below USD69 per barrel. That’s rather more than “North”, I should think. I suppose distance is also a matter of perspective. I still cannot find what the Congressional Budget Office had been using as their estimates for the budget figures. There are too many bloody Acts they’ve ‘costed’, but I feel certain it was not USD69 per barrel.

I’ve seen stories about Norway re-doing its numbers last year, but that’s about it. And why wouldn’t it, with the highest gas prices in the world?

And how popular is the bill with the party of goddamn lunatics who think there isn’t a problem?

Although ranking member Chuck Grassley, R-Iowa, whose state will benefit from the biofuels provisions, supported the chairman’s legislation, other Republicans were staunchly opposed to the bill.

“This is the biggest tax and spend bill that we’ve seen…and is bad spending policy and bad tax policy,” said Sen. Jon Kyl, R-Ariz.

Kyl and Sen. Jim Bunning, R-Ky., primarily expressed concern over the $21 billion in additional taxes for big oil companies.

You’ll forgive me if I don’t join them in sympathy for USD10bn-per-quarter profit oil companies. They’re welcome to leave any time they like – as long as the business is profitable, someone will do it.

Back to the story of the prices, it isn’t all that glorious. Prices fell upon news that stocks were unexpectedly high – but they aren’t that high, and neither is production.

“We had an unusual amount of maintenance that had to be done on refineries this year,” said Lynn Westfall, senior vice president and chief economist at San Antonio-based Tesoro Corp., the largest oil refiner in the U.S. West. “A lot of normal maintenance that would have been done last year had to be put off until this year.”

The nation’s refineries haven’t operated above 93.8 percent of capacity since September 2005 after hurricanes Katrina and Rita roared through the Gulf Coast region, causing power outages, flooding and wind damage affecting more than a third of U.S. refining capacity. Refiners delayed maintenance last year because of lingering closures caused by the storms.

I don’t recall any models suggesting cyclones were going away – unless they’re moving oil refining out of the Gulf Coast region altogether, I’d bet this was a characteristic of US oil refinement and supply, now.

”We require imports and we have for about the last 10 years,” Westfall said. “Now every time demand goes up, we have to go into the world market and bid up the price.”

This is US refining of oil. There is also the matter of supply: Nigeria faces strikes, Venezuela is still sorting out ownership, post-takeovers, and the Middle East is, well …politeness forbids one, really.

What worries me is the standard line pushed by Jim Kunstler for a long time now. Oil prices shoot up – we cast about desperately for something else. We call coal ‘clean’, we say nuclear energy is complete safe and cheap, we talk about oil shale and switchgrass, of all things, but the simple fact remains: it doesn’t matter what we find to fuel Happy Motoring – there isn’t enough of it.

And nothing we do will achieve anything more than ever shorter postponement of dealing with that simple fact. Even the economics of trying to beat it, and what happens when we fail, are uninteresting.

MPs grill private equity bosses

This isn’t the first time I’ve mentioned the UK parliament having a go at private equity bosses. Seems they’re not finished, yet.

Not only is the Treasury select committe meeting again today (and Tuesday, July 3), but Graeme Wearden is there, live-blogging (I can’t help it – the idea of live-blogging a Treasury committee hearing is awesome!).

It appears to be a bit Unions v. Equity Bosses early on, with job-slashing-upon-stalking-and-purchase the issue (this was a big element of the aborted stalking of Sainsbury’s, not too long ago).

Taxes paid (i.e. not paid) and what to do about taper relief are of interest to Treasury, as is the combination of secrecy under private equity buy-outs and leveraged buy-outs. Specifically structurally risky debt instruments. Which they bloody-well should be.

Example:

3pm

The unions aren’t having this all their own way. MPs are suggesting the unions are motivated by a desire to fuel the class war.

Not true, says Mr Dromey.

“We have great respect for venture capitalists, who create wealth and jobs”. The tax system is “being exploited by management buy-ins”.

He’s also cited Cadbury’s announcement yesterday of up to 7,800 job cuts, which it said was driven by the private equity threat.

“We’re just sticking up for our members, as you should stick up for your constituents”. Heady stuff from Jack Dromey, who is taking an assertive approach.

It’s a good hearing – Americans will find it a good deal more interesting than Gonzalez’ memory or everyone from Mark McGwire to Petroleum CEOs sitting and pleading the Fifth over and over again.

How to tango on two back feet?

Kevin Rudd is finally running into thicker underbrush. Having dealt with the leaked productivity memo with almost no political sensibility whatsoever (allowing for the fact that the Australian is not all that sympathetic to Labor to begin with – hence the story is big in the Australian, not so much visible elsewhere. How it is in Japan, I don’t know.)

Now he’s moving to kick a CFMEU official out of the party, after video footage of said union boss being abusive and threatening to a workplace manager. This is a shame – I’ve worked with/for the CFMEU, and I quite like the job they do. This guy was clearly an idiot – but then he isn’t the first to lose his head.

Combine these two, and Labor is right back in the world where anyone who feels inclined can write them off as in thrall of the Unions, with no idea how to run the economy. Not a place to be (again). The fact that one could equally put all business owners in the Liberal camp, along with all of their workplace shenanigans, seems unimportant.

Howard, meanwhile, would press the matter, but has his own problems – such as being the only people saying their IR legislation is any good. If you can’t spot the sucker in the room…? So several debates could all find themselves swirling around our workplaces. Neither party seems to be doing the same thing, but we shall still find ourselves called upon to decide whose thing is the best.

Then there’s the either well-timed (for Rudd, who gets more room to duck) or poorly-timed (for Howard, who gets far less room to swing a punch) news that parliamentarians were handing themselves a pay increase. Now, this is the worst behaviour assumed of politicians, and it couldn’t have come at a worse time. Inflation, housing affordability, tax-and-benefits and the value of Liberal policies to Australian households, the bloody ‘battlers’ and high-speed internet access…a lot of this election is going around on welfarist issues, and now the Prime Minister is defending a whopping 6.8% pay increase for politicians (this year – they had 7% last year, also. And one that will put their AUD150 per week in their pocket sooner than the average household gets their far smaller one). This, while he picks up some AUD21,000 extra per year.

The argument is, as always, that government needs to be competitive, or it won’t get talent. It never works (who honestly believe their politicians are talented at anything but lining their own pockets). Moreover the Prime Minster’s salary, the highest, goes to around AUD330,000. I’m sure there are wonderful benefits to being the Prime Minister, but only one person gets to be at a time, and it’s downhill from there. I don’t see that competiting with the real Brain Pies in hedge funds and private equity.

I can’t wait for the next round of newspolls to hit the streets. Whatever keeps talking heads in suits and ties, I suppose.