The Merger Binge and the Economy

We wondered what Microsoft was up to when it started issuing long-term debt last year, something that it had never done all the rest of the time it has been a public company. 

This money was not going to go to expand operations.  It already had tons of cash to do that!

The best bet was that Microsoft was going to go acquiring…but, what.

Now we have a partial view…Microsoft…and Steve Ballmer…is buying Skype!  The estimated cost?  More than $8 billion.

What about all the other money Microsoft raised in the bond market?  My best guess is that we will see more acquisitions in the future!

But, Microsoft is not alone in this.  Hertz is going after Dollar Thrifty and outbidding Avis.  Southwest Airlines acquired AirTran Holdings to get into the Atlanta airport, the world’s busiest. 

And the beat goes on.

AT&T is intent on acquiring T-Mobile for around $39 billion; Johnson & Johnson has a $21.5 billion deal in the works for Synthes; Duke Energy plans to merge with Progress energy, the deal totaling a little less than $14 billion; and there is the bid for NYSE Euronext for more than $11 billion.

I have been arguing for at least a year now that much of the cash being built up at many large corporations was going to contribute to a major acquisition binge…worldwide. 

And, this binge would include companies from more and more nations.  The Chinese are looking to put $200 billion into corporate acquisitions globally.

Roger Altman, Chairman of Evercore Partners, Inc., argues that the deal making will be at an all time high in 2011, surpassing the $4 trillion record total that was achieved in 2007. (http://www.bloomberg.com/news/2011-05-06/altman-sees-dealmaking-recovery-surpassing-record-4-trillion-of-2007-boom.html)

Some analysts argue that the growing stability of the economy is contributing to this.  Others attribute this movement to the strength in the stock market. 

Whereas these support the cumulative rise in the amount of M & A activity taking place, I still believe that this record-breaking rise in acquisition activity is being subsidized by the monetary policy of the Federal Reserve System. 

The first to benefit from this subsidy are those companies that came through the Great Recession with little or no debt on their balance sheets. 

The second group to benefit have been those that have been able to use leveraged loans and junk bond issues to refinance billions of dollars of debt borrowed during the credit inflation of the past decade or so. 

These companies are now buying other companies and strategically positioning themselves for the future.  And, in a real sense, the big are getting bigger…and more complex.  Industry is following the banks on this as the larger firms are getting greater market share and expanded market space. 

And, in my experience, there is only one way to really make acquisitions work.  The acquirers, after the deal is made, must become the biggest “bastards” in the world.  That is, the acquirers must become ruthless in rationalizing their purchase…otherwise…the acquisition just won’t pay off.

The effect on the economy?  In the longer-run…good…very good!  In the short run…continued pain.  Jobs must be cut, un-economic facilities must be disposed of, and, in general, spending must be reduced. 

“In AT&T’s pending deal for T-Mobile USA, the companies estimate cost savings of $40 billion over time, including expected layoffs, starting from the third year after the merger is completed.” (http://professional.wsj.com/article/SB10001424052748704810504576305363524537424.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj)

But, this gets into another point I have been trying to make for the past two to three years.  During this time I have argued that about one-in-four to one-in-five people of working age are under-employed.  Forget the unemployment rate as it is measured…there are a lot of individuals that have either left the labor market or are not fully employed but would like to be.  And, this has been a growing problem over the past half-century. 

The merger and acquisition binge is not going to help this situation…one bit!

David Brooks in his New York Times column this morning emphasis this problem. (http://www.nytimes.com/2011/05/10/opinion/10brooks.html?_r=1&hp)  Brooks reports that 80 percent of “all men in their prime working ages are not getting up and going to work…there are probably more idle men now than at any time since the Great Depression and this time the problem is mostly structural, not cyclical.”

And, the primary factor that distinguishes the unemployed?  Not sufficient educational training.  “According to the Bureau of Labor Statistics, 35 percent of those without a high school degree are out of the labor force.”  Not unemployed…but, “out of the labor force”!  And, while this number goes down the more education one has, there is still a close correlation between the number of individuals “out of the labor force” and the amount of education that an individual has.   

And, as the mergers and acquisitions take place, the trend will just worsen.  For too long a time, when unemployment arose, we have tried to put people back into the jobs they had formerly held, even though those jobs became less and less economically justified.  The expectation was that the government would stimulate the economy and people would get their old jobs back.

Now we are going through a transition in which those “old jobs” are no longer there. 

And, the monetary stimulation coming from the Federal Reserve System is now resulting in a continued reduction in the less productive jobs through the merger and acquisition banquet going on and is doing very little toward helping these people get back into the work force.

This is consistent with the argument that I have continuously made in these posts that the credit inflation created by the monetary and fiscal policy of the United States government over the past fifty years has done a very good job in splitting the labor force into two segments, the less educated and the more educated, and the society into a much more highly skewed income distribution than earlier.

The acquirers have the cash, they can still borrow at ridiculously low interest rates, and these conditions are expected to stay in place for “an extended period.”  Continue to watch all the M&A activity taking place.  I think this will be a time to remember.

Federal Reserve QE2 Watch: Part 6

The Federal Reserve continues to pursue its Quantitative Easing 2 exercise.  Over the four-week period ending May 4, 2011, the Federal Reserve purchased $84 billion of U. S. Treasury securities.  About $18 billion of the acquisitions went to offset mortgage-backed securities and Federal Agency issues running off.

Since September 1, 2010, the Fed has purchased $656 billion in Treasuries, with $208 billion to offset mortgage-backed and Agency issues maturing.

Mr. Bernanke indicated at the start that the Fed would increase its holdings of the Treasury securities by $600 billion outright and then purchase about $300 billion more Treasury issues to cover the run-off of Agencies and MBS securities. 

In recent weeks, Mr. Bernanke has stated that the Fed will continue QE2 through the end of June.  It seems as if they are right on target 

Reserve balances at the Federal Reserve totaled $1,473 billion on May 4, 2011 up from $1,019 billion on December 29, 2010 and $1,011 billion on September 1, 2010. 

Excess Reserves at commercial banks (from the Fed’s H.3 release) averaged $1,433 for the two weeks ending May 4, 2011 relatively close to the Reserve Balance total. In December 2010 excess reserves averaged $1,007 billion and in August 2010 excess reserves averaged $1,020 billion. 

Cash assets at commercial banks (from the Fed’s H.8 release) averaged about $1,565 billion for the month of April 2011 while the banks averaged $1,043 for the month of December 2010 and $1,185 for the month of August 2010.

Thus, for the commercial banking system, all measures of vault cash and bank deposits at the Federal Reserve and excess reserves are closing aligned. 

The basic result of QE2, therefore, is that the Fed has injected a little more than $450 billion in excess liquidity into the banking system since the beginning of September 2010, most of the injection coming since 2011 began. 

The net effect of this liquidity on the commercial banking system?

The volume of Loans and Leases on the books of commercial banks have declined by about $132 billion from the beginning of September 2010 through the end of April 2011, and have declined by about $78 billion from the beginning of 2011 to the present. 

The volume of Loans and Leases at commercial banks appeared to remain relatively constant throughout the month of April.

This trajectory seemed to be similar for both the largest 25 domestically chartered commercial banks in the United States and the rest of the domestically chartered commercial banks.

Of the cash assets at commercial banks in the United States, Foreign-Related Institutions held about 50 percent of the $1,565 billion cash assets in the banking system in April.  (For my comments on this see http://seekingalpha.com/article/265481-large-foreign-related-banks-now-hold-77.) 

So,

The Federal Reserve’s QE2 efforts have not stopped the decline in bank lending, and,

About one-half of the excess reserves the Fed has injected into the banking system have gone to foreign-related banking offices.

Good job!

Looking at the money stock measures, the growth in the M1 and M2 money stock continue to rise. 

The year-over-year rate of growth of the M2 measure of the money stock has risen from 3.5 percent in December 2010 to 4.6 percent in March 2011 and 5.1 percent in April.

The year-over-year rate of growth of the M1 measure of the money stock has risen from 8.4 percent in December 2010 to 10.4 percent in March 2011 and 16.6 percent in April. 

How is this growth happening if bank loans are decreasing?

Well, economic units are still getting out of assets that are earning very little interest and are not counted in the two measures of the money stock and placing the assets in accounts or cash that can be spent when needed which are included in these measures of the money stock.  In several previous posts I have taken this as a negative sign, a sign that people want to keep their assets ready for spending because they are without jobs or without sufficient income or see other assets being underwater.  They are keeping assets in transaction accounts so that they can spend the money when needed. 

This movement to assets the economic units can transact with is seen in the increase in the holdings of currency, which has gone from a year-over-year rate of expansion of 6.3 percent in December 2010 to 7.7 percent increase in March 2011 and an 8.2 percent rise in April.

The year-over-year rate of growth of demand deposits has risen from 15.7 percent in December 2010 to 20.9 percent in March to 21.8 percent in April. 

Non-M1 portions of the M2 money stock have hardly increased within this time frame.

So, the Federal Reserve continues to push on a string.  The commercial banks aren’t lending.  Economic units aren’t borrowing.  And these latter economic units continue to move their assets from longer-term, less liquid assets to shorter-term, transaction-type assets. 

The evidence here still indicates that the banking system is not fully engaged in economic recovery and the efforts of the Federal Reserve system have accomplished little more than spur on the “carry” trade in international financial and commodity markets.  And, it also indicates that consumers and small businesses, in aggregate, continue to keep their assets where they can spend them through a period when they cannot meet current spending needs with their incomes and cash flows being weak.    

Time For Policymakers To Change Economic Models--Got That Portugal?

 Government policymakers just don’t seem to get it!

The economic philosophy governments have been using as the foundation of their budget and monetary policy since World War II isn’t working.  Governments need to change direction.

Most governments in the developed world need to do a “turnaround.”  But, turnarounds are only successful when the organizational model is changed.  Often this change requires a new management team.

For the past fifty or so years, the governmental leadership in most countries in the developed world have assumed, basically, the same economic philosophy.  And, as in the American case, both political parties have assumed the same fundamental economic model. 

This economic model got us to where we are, and, as in the case of most turnaround situations, the old model must be re-placed before the turnaround can be achieved. 

The financial markets understand this!

The governments involved don’t seem to get it…yet!

We have several “case studies” going at this time.  These “case studies” are called Ireland; Greece: and Portugal. 

Of course, the initial response of these governments when financial markets began to become skeptical of their performance was…the market behavior was driven by speculators…it is not our fault.

The next response was the attempt to bail out these countries.  And, what does a bailout achieve?  A bailout “buys” time with the assumption that given time these governments will be able to get through this period of turmoil. 

Not once do we hear of the possibility that these governments might be operating with a philosophy of government that doesn’t work!

And, the financial markets don’t respond positively to these efforts.  The leaders of these governments shrug their shoulders, get a puzzled look on their faces, and ask why the financial markets continue to punish them and their people.

Portugal cuts a deal with the European Union and…”Portugal was forced to pay a higher interest rate to raise  1.12bn in short-term debt on Wednesday, shortly after announcing a  78bn bail-out agreement.” (http://www.ft.com/cms/s/0/1cb74060-7642-11e0-b4f7-00144feabdc0.html#axzz1LTb4L5XR)

The financial markets seem to be saying…”Nothing has changed!”

Portugal, you still are living off the same model.  You have not really altered anything!

And, this dance has been going on since the beginning of 2010.  Yet, no one seems to think that they need to do anything differently.

Is Spain next?

That, of course, is the question that everyone is asking.  And, some analysts are saying that Spain has gotten the message.

The question is…has Spain really gotten the message?

If not, then, who is next?

As I wrote yesterday and the day before…some things have changed.  The world is in a period of transition.  The next fifty years is going to be remarkably unlike the past fifty years. 

Assumptions are going to have to change.  Leaders are going to have to adopt new models and new philosophies.  And, as we are seeing, the transition is not going to be easy.

The ultimate question relates to the United States…when, along the chain of dominoes, is its turn?

A major problem of the transition will be the speed at which it can occur. 

When a company gets into serious problems, a turnaround specialist can be brought in to change the operating model of the company, enforce discipline, and execute the new plan.  The new leader has substantial authority to make these changes.   

The owners, the shareholders, give the turnaround specialist the authority to make the changes needed.  And, the changes are imposed, not on the owners, but on the employees of the company.  

In democratic governments, executing such a turnaround is not as feasible because the people that do the voting are the people that will bear the brunt of the changes.   It is hard for people to vote in favor of their own pain. 

So, the transition will not be over until it is over.  The future of the governments in the developed world will probably be very much like the last sixteen months have been.  Band aids in order to keep things afloat…but a failure to really get to the heart of the problem.  We will continue to try and “muddle through.”  

A Problem With Large Government Deficits

 When one discusses large government deficits the discussion generally centers on either the ability of the government to finance those deficits in financial markets or the need to “monetize” the debt, thereby creating the possibility of substantial future inflation.

There is another problem that doesn’t get as much attention yet is very, very important for the running of the government.  It is a problem the United States government is now facing. 

If a government (or anyone for that matter) is running a large deficit in its financial budget then the very existence of such an excessive budget restricts the government in what else it might be able to do.  That is, the government’s flexibility in taking on new expenditures is severly limited. 

The United States government is facing this problem in several areas at this very moment.  Let’s review a couple of them.

The United States government is facing tremendous competition from China in international trade and finance.  The United States is very limited in its ability at this time to respond to the initiatives that the Chinese are making in the world…politically and economically. 

“Flush with capital from its enormous trade surpluses and armed with the world’s largest foreign exchange reserves, China has begun spreading its newfound riches to every corner of the world—whether copper mines in Africa, iron ore facilities in Australia or even a gas shale project in the heart of Texas.”  This comes from the article “As China Invests, U. S. Could Lose,” in the New York Times. (http://www.nytimes.com/2011/05/04/business/global/04yuan.html?ref=business)

A “study, commissioned by the Asia Society in New York and the Woodrow Wilson Center for International Scholars in Washington, forecasts that over the next decade China could invest as much as $2 trillion in overseas companies, plants or property…”

The United States government and United States business does not have that much “dry ammunition” to combat such an investment program.  And, as U. S. government policy continues to underwrite a weak dollar, the ability to take on such an investment program internationally continues to fade into the background.  But, other BRIC nations pose such a challenge as well.

Yet, the United States cannot afford to be un-competitive in this area.

Also this morning we read about the plight of United States regulatory agencies: “US Regulators Face Budget Pinch as Mandates Widen.”  (http://dealbook.nytimes.com/2011/05/03/u-s-regulators-face-budget-pinch-as-mandates-widen/?ref=business)  In effect, as Congress has given banking and financial regulators more to do, due to the recent financial crisis, the regulators find that they are finding less and less money to carry out the new charge they have been given. 

Many of us may not be upset with this situation, still it points to the fact that with the large budget deficits forecast into the future, the United States government just cannot commit to fund certain programs people have wanted to see become more aggressive. 

One final situation that has recently occurred.  This has to do with the situation in Libya.  Many have argued that the United States cannot take on more military roles in the world because it just cannot pump up the expenditures on the budget to meet such responsibilities.  Consequently, since it favors military actions in selected spots, such as the one in Libya, it cannot fully participate in the exercise and must get others, like NATO, to carry the burden of the effort.

The question then becomes, “Is this budget constraint keeping the American government from doing things in other areas it believes it should be involved in?”  Like in Yemen or Syria?

The problem is that one can’t do everything…even if that “one” is the richest and most powerful nation in the world and oversees the reserve currency of the world.  And, this is the problem with lots of debt.  It allows “one” to live beyond ones means for a while…but then there is always the possibility that “one” will need to do more…and can’t.

It is an issue of management and discipline.  One cannot constantly push debt limits to the extreme and then expect to be able to go further into debt should the occasion arise at some time in the future. 

Boy, this idea seems “old fashioned”!

But, this is exactly what the United States government has been doing…and it has been doing it for an “extended period”…it has been doing it since the 1960s.  This is the foundation of the credit inflation we have been experiencing for the last fifty years.

And this is the foundation of the decline in the value of the United States dollar for the past fifty years and for the terrible balance of trade situation the United States finds itself in which has led to the surplus of dollars in the hands of the Chinese and others. 

I know…if the value of the dollar declines, the trade deficit should get smaller.  I tried to respond to this issue earlier.  See my post “Does a Decline in the US Dollar’s Value Reduce the Balance of Payments Deficit”: http://seekingalpha.com/article/265072-does-a-decline-in-the-u-s-dollar-s-value-reduce-the-balance-of-payments-deficit. 

The value of the dollar continues to decline because those in international financial markets don’t observe the “management and discipline” in the Unites States government that is necessary to change what goes on relative to the budget of the United States government. 

In my view, the United States government does not have to do much to gain the confidence of world financial markets.  The first thing the government must do is accept the goal of maintaining the value of the United States dollar in foreign exchange markets as its primary economic objective.  (I have discussed this in a post to my Instablog, “What is Needed to Reduce the Federal Deficit”: http://seekingalpha.com/author/john-m-mason/instablog.)

This would allow two things to happen.  First, the United States government could get away from its current primary goal, the Keynesian goal of achieving full employment, which it cannot accomplish anyway. (See my post from yesterday: http://seekingalpha.com/article/267307-the-new-way-of-conducting-business.)  The exchange rate goal incorporates an inflation goal within it.

Second, the government needs to focus on “good” long-term management and discipline in its budgetary practices.   Good, long-term management pays off.  My recent example of this is the efforts led by Treasury Secretary Robert Rubin in the latter part of the 1990s to balance the United States budget.  International financial markets saw this effort; believed that President Clinton and others within his administration supported the effort; and the value of the US dollar began to climb in foreign exchange markets even before a balanced budget was achieved. 

The important thing to note is that the economy also got stronger during this time so that the government achieved not only a greater balance in the budget and a rising value of the US dollar, but it also saw the US economy continue to grow.  International financial markets approved of the “management and discipline” that it believed it saw in the United States government.  Plus, this effort created some room for the Bush 43 administration to add additional “unexpected” expenditures to the budget ,as they were needed, such as the “war on terrorism.

The "New Way" of Business

 I have been talking with a lot of people recently about the changes that are taking place in the United States and elsewhere.  More and more people are discussing the possibility that the world is changing in a way that only happens every once every eighty years or so.  These people are saying that whatever comes out in the 2010s and 2020s will be incredibly different than what was there before 2000.  In essence, the sixties are dead!

They seem to be saying that what came out of the 1940s and 1950s was “different” from what existed in the 1920s.

An interesting case-in-point is the recent demise of Osama bin Laden.  Although the general response to this action has been that this was an important occurrence, there is also the undertone that the “times have changed”; maybe the world has moved on and the significance of this event lies more in the past than the future.

In this the “protestors” and the “street” in the Middle East have become more important than the purveyors of a closed fundamentalist group that promotes jihad and the return to a model of society that is more from the Middle Ages than from the 21^st century. 

To these people seeking broader rights, the passing of bin Laden is just a footnote to the real battle.  To these people the cell phones and the social networks represent the path to freedom and self-respect.  Osama bin Laden was legacy, coming from the age of the television where he saw and rejected the creeping intrusion of Western culture into his image of what the Middle East should be. 

Where Osama bin Laden saw the end of the “old way”, the young people now protesting in the streets see the “new way” of opportunity and greater self-determination.

The “old way” was movies, newspapers, and television.  The “new way” is instantaneous photographs, videos, tweets and texts. 

Maybe this is the way we need to look at business and finance.  That is, the “new way” which is the time after 2000, and the “old way” which live in a time before 2000. 

The “old way” is the time of General Motors, United States Steel, and General Electric.  The “new way” is the time of Microsoft, Google, and Facebook.

The “old way” is the production line; the “new way” is the instantaneous trading of stocks and the presence of an immense amount of information at our fingertips.

Exciting to me is the headline “Rejecting Wall Street, Graduates Turn to Entrepreneurship,” found in the morning New York Times (http://dealbook.nytimes.com/2011/05/02/rejecting-wall-street-graduates-turn-to-entrepreneurship/?ref=business)

This article discusses the rapid increase in new companies started by students at Harvard and at the Wharton School, UPENN.  The article states “Graduates (of Harvard) from the class of 2010 started 30 to 40 businesses last year, a 50 percent increase from the previous year.”     

And, I have directly experienced some of the effort and energy of these students the article talks about through the angel networks and venture networks in which I participate.

The ideas for the new companies generally come from the students themselves.  They see something missing in the markets they work within.  For example, in the New York Times article, one of the young entrepreneurs discussed got his idea “after trying to find diapers for his son during a family trip to Rio de Janeiro…  Struck by the lack of high-quality baby care goods (the young entrepreneur) saw an opportunity in Brazil’s fast-growing markets, where more than three million babies are born every year…” His grades suffered this year as he often traveled from Cambridge, MA to Brazil to develop his new business. 

The company was one of the top three winners of Harvard’s annual Business Plan Contest, which added to other capital the founders, raised for the new business.  The “fund-raising effort, which valued the company at $5.6 million, included several well-known venture capitalists…”

And, these schools are contributing to this movement by starting other initiatives on campus to encourage interested students in new ventures and to encourage them to talk with one another and bounce ideas around.  They also have money and space where “entrepreneurs-in-residence” can get started.

I see this kind of entrepreneurial activity going on all over the place.  It is exciting, energizing, and cause for hope.  It is the new world based on information technology, not the old world based on physical capital.  And, in my mind, its future dominance is unstoppable.

We are transitioning to this new period in our history.  And, transitions cause pain.  Let’s look at three areas, the current business structure, financial structure, and work force.

In terms of the current business structure, shifts have been taking place for several decades now.  The emphasis on manufacturing and the capacity utilization of industry is receding.  Capacity utilization of US manufacturing, which was over 90 percent in the 1960s has been declining constantly through the late twentieth century and now hovers below 80 percent as the economy now recovers. 

Physical output is going to continue to decline as a proportion of what the US economy does.  Ideas are going to come from all over the place.  As observed above, more and more people are going to find “missing markets” and attempt to fill them in.  Much of this activity will be information based.  The evolution into this new structure will take time and this is one of the reasons why the economy is not picking up that quickly: a restructuring is taking place and people are not being hired back into the jobs they lost in the Great Recession. 

This gets us to the work force.  There is a very powerful article in the Economist this week, (the April 30 issue) titled “Decline of the Working Man.”  The sub-title is “Why ever fewer low-skilled American men have jobs.”  The big culprit?  Education.  The less education you have the less likely you are to be fully employed and this is consistent with the restructuring going on in American industry. And note, the article is about American men…American women have learned this lesson and are way ahead of men in this area.

But, this means that the old Keynesian idea that when there is unemployment, fiscal stimulus can just put people back to work in their old jobs, is not really valid: especially if you want to help the “low-skilled” find meaningful, long-term employment.

And finance?  More and more financial capital is coming from angel finance networks, private equity, and hedge funds…the shadow banking industry.  This is the kind of finance that the young entrepreneurs need.  And they are getting it.  It is not coming, nor will it come, from the commercial banks, especially the smaller ones, who have come to rely more and more on residential real estate loans and commercial real estate loans…not on business loans. 

Yesterday, the Chrysler Group posted its first quarterly profit since 2006.  To me, as with the other news reported above, this should be just a footnote.  This is news about the “old way.”  We need to focus on the “new way” and like some of the other revolutions taking place, the “new way” in business is found in non-traditional places.  But, that is what information technology allows us. 

Sovereign Recovery Swaps? What Are They?

 Sovereign recovery swaps are “bets on how much money will be retrieved in a default.”  The first trades took place last year.  (See “Default risks spark interest in recovery swaps trading,” http://www.ft.com/cms/s/0/0ab272c8-702e-11e0-bea7-00144feabdc0.html#axzz1KivknddC.)

Why did sovereign recovery swaps arise?

They arose as “European policymakers have moved to curb trading of credit default swaps, the established way to hedge against the risk of a debt restructuring.” 

These new tools are gaining more publicity as the eurozone moves back into a crisis mode concerning the sovereign debt of their troubled constituents.  This is especially coming to the fore as Greece struggles over its failure to achieve fiscal targets set to combat earlier financial market unease. 

Greek debt reached euro-era high interest rates yesterday…as did the interest cost of Ireland and Portugal debt. 

Calls are increasing for a restructure of the debt of Greece.

So, financial market participants want a way to protect themselves against unfavorable movements in debt prices…given the wisdom of “policymakers” to curb trading in other instruments that might do the same thing.

With recovery swaps, an investor can bet on the level of “haircut” that might take place on any restructuring. 

A credit default swap might have a fixed recovery rate in the case of a restructuring.  If the recovery rate is lower than this fixed rate, the investor makes up the shortfall through the purchase of the recovery swap. 

Of course, there are risks associated with these tools: the “credit event” that triggers the contract must be due to a failure of the nation to meet obligations…it must be an “official” default.

The point I want to emphasize, however, is how quickly financial markets respond to fill a need when restrictions or potential restrictions are devised to restrict or constrain other means of achieving the same objective. 

Policymakers just don’t get it! 

In their efforts to fight “past wars”, policymakers invent new rules or regulations to combat behavior the policymakers deem to be inappropriate or unacceptable.  In doing so, these policymakers just chase the participants in financial markets to move elsewhere or to create new financial innovations.

Two points here:

First, in this electronic age, there is little that regulators can do to establish the “control” that they want because it is so easy for one form of “information” to be transformed into another form;

And, second, once financial innovation is in place, there is no going back to an earlier time.

Policymakers just don’t seem to understand these two points.

Furthermore, another fear that the policymakers have is that these financial innovations can be used for “speculation”. 

For example, when the government of Greece announced its latest budget results, the cost of borrowing immediately went up and the price of credit default swaps and sovereign recovery swaps rose.  Some government officials claimed that unconscionable speculators betting against the government caused these movements. 

This, of course, is the basic visceral response of leaders faced by market movements unfavorable to the direction they are leading their organization.  I don’t know how many chairman I have known or worked for that have claimed that ‘the market just doesn’t understand us” and “speculators are hitting us just when we are down.”

I was less worried the other day when Standard & Poor’s said that the outlook for the debt of the United States was negative than I was about the response of President Obama saying that the bond markets were being impacted by speculators.  Oh, my!

Policymakers must eventually deal with the problems they have created.  Many governments in Europe have been dealing with the problems they have created for many months now, yet have not faced their real issues head-on. 

Policymakers must eventually realize that they cannot resolve these problems by changing the rules and regulations or by trying to buy time with “quick-fix” bandages.  The eurozone has been attempting to “get around” the solution to the problems of its members with short-term “fixes” and have not dealt with the fundamentals of the situation.

Policymakers must eventually understand that in the modern world information spreads and that governments cannot respond to crisis by pointing the finger in another direction, blaming “speculators” or “terrorists” or some other agent that is questioning their leadership.  The governments of the eurozone must ultimately take responsibility for their actions and do something about it.

Keep your eye on markets and market innovations.  Don’t impose your own view on these market changes but dig as deeply as you need to in order to determine what the market is trying to tell you.  The markets may not always be right, but they do contain information we need to consider in making our own decisions.

The news today…there is going to have to be a debt restructuring within the eurozone.  Financial “band-aids”, government bailouts, and new rules and restrictions are not going to do the job.  Will it be Greece…or will it include Ireland?  Will it extend to Portugal…and then to Spain?  And, maybe others will be impacted as well?

The betting is getting hotter!

Large Foreign-Related Banks Now Hold $776 Billion in Cash Assets!

On February 21, 2011, I asked the question, “Why is most of the Fed’s QE2 cash going to foreign-related banking institutions?” (http://seekingalpha.com/article/254004-why-is-most-of-the-fed-s-qe2-cash-going-to-foreign-related-banking-institutions)

At that time, foreign-related banking institutions held $538 billion in cash assets. This was up $177 billion from the end of 2010.

This was so startling because large domestically chartered commercial banks in the United States held only $486 billion in cash assets. Yet, this number was up only $72 billion from the end of last year.

Here we are at the end of April and these same foreign-related banking institutions have increased their cash hoards by another $238 billion to $776 billion.

Note that since the end of 2010, the Federal Reserve has only increased the total cash assets in the banking system by $283 billion so that almost two-thirds of the QE2 money ended up at foreign banks!

The increase since then has been $250 billion of which 95 percent of the Fed’s injections have ended up in foreign banks!

What is going on here?

And what seems to be the major movement on the other side of the balance sheet?

Well, on December 29, 2010, these foreign-related banks had a negative $420 billion in an account called “Net due to related foreign offices.” Since this was a negative it serves basically as an asset. This is the amount owed foreign-related banks in the United States from their foreign offices.

On April 13, 2011, these foreign-related banks had a positive $7 billion in this account, so that the account moved $427 billion from an asset to a liability to these foreign offices.

In other words, it seems as if a bank asset was paid down to the point that the offices of these foreign-related financial institutions now came to “owe” their foreign offices.

What offset this $427 billion movement of funds from America to offshore accounts?

It looks a lot like the $415 billion increase in cash assets.

Is this what QE2 has succeeded in doing? Is QE2 getting transferred directly into foreign-related banking institutions and then getting transferred offshore?

Sure looks like it. The evidence is in the Fed’s own statistics.

No wonder that bank loans in the United States have failed to increase. No wonder the banking industry is not contributing to a stronger economic recovery.