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Five Things You Need to Know: Can We Say This is No Longer "Well Contained" Yet?; What Is Contagion?; What Does Contagion Look Like?; Financial Crisis Explained by Inexplicable "Herding Behavior"; 23 Million?


What you need to know (and what it means)!


Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Can We Say This Is No Longer "Well Contained" Yet?

What do the following companies have in common: Owens Corning (OC), Burlington Northern Santa Fe (BNI), DuPont (DD), Furniture Brands (FBN) and Office Depot (ODP)?

  • Unfortunately, they are companies that make and sell something that is used to build, furnish, design, sell, live in, be carried into, or out of, or in some cases simply very near, a house.
  • So can we say the housing slump is no longer "well contained" yet?
  • Railroads, chemical producers and insurance companies are among a long list of companies blaming the housing slump for their earnings troubles, according to Bloomberg in a summary article today .
  • Burlington Northern Santa Fe, the second-biggest U.S. railroad, said lower shipments of housing products and lumber reduced second-quarter earnings, Bloomberg noted.
  • DuPont blamed slumping demand for kitchen and bathroom countertops for its profit drop.
  • And Furniture Brands International, the maker of the Broyhill and Thomasville brands, said back in April that it would cut 330 jobs and close three North Carolina plants, Bloomberg reported.
  • Even Office Depot (Office Depot, not Home Depot) is not immune.
  • North American retail president, Chuck Ross, last week said "the impact of this housing slump has adversely affected a broad range of small businesses and resulted in a reduction in our customers' overall spending patterns.''

2. What Is Contagion?

Everyone knows what it means to be "well contained" but what about that thing which the "well contained" container contains in the first place... you know, contagion? What is contagion anyway?

  • Surprisingly enough, or perhaps not surprising at all, the World Bank actually has a formal answer.
  • According to the World Bank, "contagion is the cross-country transmission of shocks or the general cross-country spillover effects."
  • "Contagion can take place both during "good" times and "bad" times," the World Bank explained.
  • When does it occur?
  • "Contagion occurs when cross-country correlations increase during "crisis times" relative to correlations during "tranquil times," the World Bank added.

3. What Does Contagion Look Like?

Ok, great. So financial contagion has a formal definition. How about giving us a hypothetical example?

  • Well, suppose a U.S. hedge fund or two blew up due to leveraged investments in a financial instrument that was riskier than they thought.
  • And, hypothetically speaking, of course, suppose those investments, though based on assets here in the U.S., were actually quite popular among hedge funds all over the world.
  • And, just for argument's sake, suppose a "revaluation" of that entire asset class occurred because other investors in those instruments suddenly perceived the risk profile of the investments differently.
  • As a result, suppose hedge funds based in other countries began to blow up because of the revaluations.
  • And then just stop and think, and remember this is purely hypothetical, what might happen if those blowups began to cause investors in other funds to inquire begin demanding to withdraw their investments.
  • Why, this might cause fund managers to become increasingly risk averse to protect against redemptions (just thinking out loud here).
  • But we're just getting started. What if the initial blowups by the two American funds were related to investments whose credit worthiness relied on lending practices that were not as selective as they should have been, and recognizing this, lenders in entirely other areas - such as banks providing money for leveraged buyouts and corporate buybacks - began to review their lending practices and create higher standards for borrowers?
  • Well, as the World Bank explains, this may create "shocks to other countries" or "cross-country correlation, beyond any fundamental link among the countries and beyond common shocks."

4. Financial Crisis Explained by Inexplicable "Herding Behavior"

Hmmm, cross-country correlation, beyond any fundamental link among the countries and beyond common shocks? That sounds familiar, wonder why?

  • Ah yes. As the World Bank notes, this definition is usually referred to as "excess co-movement, commonly explained by herding behavior."
  • So in other words, financial contagion is explained by herding behavior.
  • And what explains herding behavior?

5. 23 Million?

Yesterday we noted a weird statistic from China's Vice Premier Wu Yi that we picked up from a Reuters story that ran the Washington Post:

That's from the article, "China tells Paulson it's poor and poses no threat." Now 23 million sounds like a lot, to be sure. But here in the U.S., with a population that is barely a quarter of China's, Census stats show 37 million Americans living in poverty. So what gives? Minyan Bryan, who is currently living in China, provided some interesting color commentary on what is most certainly a mis-characterization of China's true poverty rate by the Vice Premier.

Kevin -

Anybody who has studied Mandarin can tell you that translating numbers is a little tricky. Although I'm not an authority and I was not there, I'll bet 10 lbs. of pork that Wu said 230 million Chinese were living in poverty…. And that's poverty as defined by Chinese standards… my neighbors who have brick odd-houses and use coal for indoor heating are living above the poverty line.

One day I'll tell you about the words for "buy" and "sell". I bet you cannot distinguish between them at all.

- Minyan Bryan

No positions in stocks mentioned.

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