Syzygeist

Unofficial Poll

Okay, you decide whether the following story is an indicator of the outcome of the 2008 Presidential race:

In Providence Rhode Island on Monday I asked a room of 60 CEOs - many of them in the media and telecom business - whether they believed the outcome of this presidential election would matter. We had been talking about the nature of global and macro uncertainty. These days provoke a lot of worry about how bad things might get. So how should good corporate leaders react? After all, the Dow had been down almost 580 points before recovering a couple of hundred points higher. And this on top of an 877-point decline last week.

Show of hands? Yes. The outcome of this election matters. Unanimous.

Then I asked for another show of hands - without suggesting support for one candidate or another. 

How many in the room thought McCain/Palin would win? 

Not a single hand raised. This caused a ripple of bemused or perhaps nervous laughter.

Then someone called out, "How many are going to vote for McCain?" and the questioner himself raised his hand, looking around for support.  About a fifth of those in the room raised their hands, several of them tentatively.

Is this an official poll? No. A focus group? Well, perhaps, if you wanted to focus on CEO opinion in the media. (Do we think such a distinguished crowd would tip toward Democrats? I would think - hmm, not necessarily at that level of the enterprise.)

I realized that I was not prepared for the outcome of my impromptu poll. This unanimous result fell into the category of "the unthinkable," which had been one of the discussion topics. With so many unthinkable things happening in the world (Freddie and Fannie taken over, Bear Stearns gone, Lehman gone, WaMu gone, Merrill absorbed, AIG saved), what others might business leaders need to take into account in their planning?

Their answers included terrorism on US soil, capital shortages, and internal strife in the US economy akin to that of the 1930s, when people pulled up stakes en masse and left California, to cite one example.

But closer at hand?

A landslide victory for Obama. That's what the "poll" said.

Rome is Burning

With conflagration in markets, global credit frozen, open dysfunction in Congress, unemployment rising and fear driving most asset prices lower, I am moved to speak up (after a long silence) by the fact that Congress now wants – as part of the bill they haven’t passed - to increase FDIC insurance coverage from $100,000 to $250,000 for retail depositors, an apparent attempt to allay panic and curry favor. (My 28-year-old daughter, a WaMu customer who doubts her deposits are really safe despite the takeover by JP Morgan, said last night she intends to withdraw her funds today and open a new account at JP Chase. This may be a bullish sign for Chase in the long run, but it’s also a small piece of a larger bank run. Expect more to come.)
Congress’ move to increase insurance is understandable, reflecting their desire to “Do something now!” to make the general public feel better about the credit crisis and its potential (impending?) impact on their bank accounts.  If people wonder, “Hey, what have they done for me lately?” this might give some comfort.
But does it reflect an appropriate grip on reality and a sense of priorities? The FDIC at the end of the second quarter increased the number of problem banks on its watch list from 90 to 117. Others have predicted that over the next few years as many as 400 banks with assets of over $300 billion will fail. Against these potential losses the FDIC has only $45.2 billion in its insurance fund now against total insured deposits of $4.5 trillion.*
Making an adjustment in FDIC insurance to reflect inflation since 1980 seems to ignore the underfunding problem by multiplying it by 2.5. Is this comforting?
Everyone seems to be grappling with different pieces of the problem. Yesterday we drove to West Virginia for a meeting hosted by the Arlington Institute in which Dr. David Martin, chairman of M-CAM and a fellow at the University of Virginia, held forth in a 2-hour disquisition on the state of the markets and the near term future.  Life ain’t gonna be like it used to be, according to Dr. Martin, who foresees:

-A 30 percent decline in the value of the dollar by December.

-Moves by China to stop purchasing US debt and shift its support toward the Euro. Martin also sees China as the only economy in history that can – and he believes will -  turn inward to build its economy because it has attracted the capital and technology to do it.

In Dr. Martin’s view of the world, the US brand of consumer and finance capitalism is finished. We went too far believing in currency and consumerism and now have sold ourselves out into insurmountable debt, and transferred key technology to China that has effectively hollowed out our competitive capacities. Increasing the insurance the government says it will pay for lost deposits does not alter the underlying reality – a deficit-driven government struggling to pump liquidity into failing markets and boost confidence when the US economy itself has lost its competitive edge, and its official paper is under threat.
Are bank deposits safe – and is an insurance increase the answer? I listened this week to a former Wall Street insider rejoice in having sold his entire Morgan Stanley stock portfolio before the share price dropped below $42 (it’s was trading at $23 on September 30th), and explain why a mix of 80 percent Treasuries and the balance in JP Morgan and Bank of America stock makes sense to him as a defensive portfolio with real upside. This reflects an underlying belief  - common in the US - that our currency will continue to dominate, the world will always be willing to buy our debt, and we will always have a few banks that really are too big to fail.
This former Wall Street executive would not have been encouraged by Dr. Martin’s arguments. Martin says US Treasuries are in deep trouble – not a safe haven as widely believed – in part because China faces a stark choice – either to build its internal economy as fast as possible now to meet the needs of 170 to 230 million perpetually single males coming of age, or to continue to buy more US Treasuries to help the US economy recover (and keep our consumer society liquefied).
Martin believes the Chinese will take care of their own and leave the US economy in the lurch, which would mean, among other things, many more bank failures.
Is the answer to increase deposit insurance? Or is there a bigger picture to consider? Martin believes that Chinese moving “off the dollar” will mean trouble for Singapore, Malaysia and heighten tensions in a region rife with Muslims who have no affection for the US. To hear him telling it, increasing deposit insurance for the FDIC at a time like this amounts to fiddling while Rome burns. 

-Eric Best

_{*See Roger Cass’s most current report No More BRICS in the Wall- When the Gods of the Market Tumbled at http://bestpartners.cc/pdfs/partners/roger_cass/3Q2008.pdf}

The "Attack Iran?" Scenario

The page 1 photo in today's New York Times, showing the proximate profiles of Russia's Vladimir Putin and Iran's Mahmoud Ahmadinejad, is a bit chilling for what it may portend. They mutually declared that "any use of force" in the Caspian Sea region is unacceptable, which is reasonable enough, but consider the following context: Intelligence sources we rely on note growing evidence that "Ahmadinejad is making a grave miscalculation about the Bush administration's willingness to act militarily in its final year in office." These sources suggest that the recent Israeli bombing of nuclear facilities in Syria  "is indicative that the US/Israel are preparing for a military showdown with Iran in the coming months."
The NYT photo showing Putin and the Iranian president shoulder-to-shoulder may symbolize how a military exchange in the region might escalate beyond expected boundaries. Secretary of State Condaleeza Rice, who has favored diplomatic measures to deal with Iran, is now leaning toward Vice President Cheney, who with his Middle East adviser David Wurmser has been contemplating strategies to provoke a military showdown with Iran. War plans actually carried out are riddled with perverse unintended consequences, history shows. It is hard to come up with an exhaustive list of possibilities in this case, although $180-a-barrel oil is readily suggested in some analysis, with a global recession soon to follow, and maybe cells of terrorists released to do their damnedest.
Suffice to say that anyone who is not seriously thinking through the "Iran attacked" scenario is probably unprepared for what could well develop before the end of 2008.

Think the unthinkable

     For some reason(s?) I decided recently to re-read “Manias, Panics and Crashes – A History of Financial Crises” by Charles Kindleberger and Robert Aliber. It reminded me that most of the financial crises in the last two centuries – and they have been accelerating in frequency in the last two decades – were largely a function of cross-border currency flows, leading to spikes in asset prices, and related nutty behavior which I will affectionately call investor mayhem.
      Rising asset prices attract too many investors, the worst/weakest last, and unsustainable price levels are just that – unsustainable. When they fall, the most foolhardy fall with them, but corollary damage can be high. So the history shows, wherein the Crash of 1987, the Asian financial crisis of 1998 and the bursting of the tech bubble are relevant examples.
     I may have been influenced to seek out the Kindelberger book again after a 20-year hiatus because of general trembling in the system, a condition that Kindleberger and Aliber remind us often presages A Very Bad Thing Happening.  What trembling? Oh, high oil prices, Russian (Putin’s) intransigence, Middle East war developments, massive trade imbalances, the prospect of elections in the US - or perhaps my ongoing work with a bank in Japan, where troubling questions arise from the yen-carry trade (“How long can this go on? When will it end?  How does it end when it does? Who wins and who loses?”) If the Bank of Japan remains trapped in low interest-rate conditions, maybe this just goes on as far as the eye can see, as more investors borrow cheap yen to buy higher return assets elsewhere. But I sort of digress…
I may also be induced into heightened a state of nervousness (or state of heightened nervousness) by the sub-prime loan situation in the US and related press. The stories, and the underlying fact that many assets have been priced on models not markets, so that prices are not well understood, and therefore not known, and so…) makes you wonder if termites might have been eating your vacation home all winter and as the summer crowd arrives, it’s about to all fall down.

     We do not know where we are in the process of “working this out,” so we cannot say what may yet come of it. But nervousness abounds. The collapsing summer house is an imperfect (and perhaps overstated) analogy, but it is reinforced by another contemporary book that is getting some attention among strategists and investment professionals - “The Black Swan,” by Nassim Nicholas Taleb. “Black Swan” is a term for the thing that was thought not to exist (all swans are white) but which appears unexpectedly, as the Thanksgiving Day axe appears to a turkey who has become convinced that life is all about fattening.
      The Black Swan concept is a bit elusive because it really means something that cannot be known in advance. Take for example the Middle East revulsion over all things Dutch in the wake of a political cartoon that suddenly destroyed the revenue of Dutch firms specializing in Middle East retail markets. The cartoon and its aftermath could not have been anticipated and for some was a perfect Black Swan - a sudden development for which they were totally unprepared, largely because they were too highly concentrated in an increasingly volatile environment.
      Taleb, who also wrote “Fooled by Randomness,” is making a case that it is better to prepare for events that are highly improbable but have a huge impact than to participate in the stampede that will necessarily – in a manic, panic, crashing kind of way – lead much of the herd off the cliff. Taleb is also arguing that Black Swans and other asymmetric events provide massive opportunities for anyone who actually imagines them coming, and buys the appropriate options in case they do. We are left then with questions about how to anticipate and prepare for what we do not know and cannot know.
      Here I am reminded of a case where scenarios to contemplate Y2K produced the thought that the Bank of New York would be unable to settle trades. This meant enormous enterprise risk for the likes of Morgan Stanley, for whom I was conducting scenario studies at the time.
     Of course, Y2K came and went, the most outspoken Y2K crisis theorists ended up with some egg on their faces. The Bank of New York trading and settlement system was not a problem. However, on the day after 9/11, a top contingency planning item under discussion in Morgan Stanley’s command central was the fact that BoNY had lost its trading/settlement capability when a Verizon tower went down in the conflagration. Because of its Y2K scenario preparations, Morgan Stanley was unaffected. Thinking through a contingency that did not come to pass was the secret of success in one that did.
     This all comes back now amid thoughts of foreign exchange-driven imbalances, assets and derivatives that are overbought and under-understood, and a general mood of trembling in the system that something is likely to break sometime soon.
      Both Kindleberger/Aliber and Taleb are worth reading in this regard, if only to be reminded that Bad Things Do Happen, and while you cannot predict what they will be, you can prepare. Think the unthinkable. One way to do this is to think through scenarios, using the smartest and most imaginative people you can lay your hands on, to see if you can get close to anticipating, and therefore preparing for, the kind of thing that could happen. This will also force you to explore whether you and your enterprise are smart or courageous enough to buy options, or insurance, when others are pooh-poohing the risk or are simply too invested in the stampede du jour to reconsider the nature of the game they’re actually playing.