September 15, 2008 Headline: "A Race for Cash at A.I.G. as Ratings Are Downgraded"

http://www.nytimes.com/2008/09/16/business/16aig.html?pagewanted=1&_r=1

This can't be coincidence, right?

Absolutely agree. Except that, for what we care, inflation might not even arrive.

Japan has been using all monetary policies available including monetary easing since the early 90's. It's public debt balloned in the past 15 years.

And yet, even after the economy started picking up around 2005, there were no signs of inflation. Even with the world ecomony growing steadily.

One of the causes might have been that much of the new credit created during the lead years of the L shaped recession went to rot fast, due to a bad economic environment and poor risk assesment (of course due to political pressures to increase credit during the deflationary downturn)

Sounds familiar?

maybe you won't have to wait a year. In Korea, plastic surgeons and dentists already offer two by one. Good for breasts implants, I guess but harder to see the savings in a molar extraction

Kev--

Thanks for breaking it down, as always, especially for those of us like myself who are a few slices short of a loaf.

Question: "when we are barely a third of the way through a deflationary debt unwind"

Intuitively, this registers with me, however, I am wondering where you come up with "barely a 1/3".

Best,

Spicoli

yes, hard to just get a discussion re the staying possibility of deflation with anyone here in austin, i imagine it's most the same everywhere else too

nice article, thanks!

Re: Representative Paul Kanjorski's comments

Hmmm.... That's a bit unnerving, isn't it?

Histories not yet written? Never to be heard of again?

As Butch said to Sundance, just before jumping off a cliff ....


Anyway, let me get this straight. Some "guys" were capable of pulling $5.5 TRILLION in 3 hours; for comparison, M1 is running about $1.5T. So "these guys" could move 4 times the US supply of what Main Street calls money at a whim.

And know that by doing it they were going to crash the whole world economy and cause vast amounts of suffering. Famines, riots, wars - but "they" would come out ahead, so do it. Capital must be allocated for maximum return, after all.

So, assuming this tale is true: I want Obama to cancel the Global War On Terror, and begin the Global War On Plutocrats. I'm sorry to play into the Minyan Theme of Societal Acrimony, but people who can decide to destroy society as we know it to increase already incomprehensible wealth have declared war on me, and my family, and all Minyans and their families, already. They deserve death, and I don't mean that metaphorically.

The Kanjorski clip...very interesting. I guess the gag order is off.

Also, note that at 4:28, he said:

"we probably have to spend 3-4 trillion dollars of taxpayers' money to buy these bad assets..."

So I guess that's the "official" government estimate?

Who or more likely what was capable of "electronically" wiping out the money market funds?? I think Obama would like to know so as to speak with them?

Has Kevin ever considered that we may have deflation in things that we want but inflation in things that we need - both at the same time? Particularly as there are other people in the world (not so dependent on the banking system) who have the capacity to sustain demand for basic goods.

I am sure the "bean counters" are very curious as to who could cause that magnitude of "deflatulence".

I suspect Obama has their names. But they might not take his calls. I'm thinking Saudi princes and Russian oligarchs, for starters.

how long before the prices drop to the level I can buy one!

"those people". You know "THOSE PEOPLE"!!! Why do you think Paulson was looking over his shoulder, and was all sweaty!? "Those poeple" are everywhere!

Dean-
In your first post above, I at first thought you were reserving judgment on the veracity of this tale...
Is the following declaration of war on plutocrats, acrimonious or not, still in an if/then frame of mind, or does it just make too much sense given the TARP mobilization we witnessed early last fall?
I mean, to my eye, Rep. Paul Kanjorski definitely appears to believe what he says in the video...
If true, then I'd like to know how such an event begins - was it a coordinated plan? Or are the plutocrats watching each other out of fear of being too late to reach the exit from a burning building?
Hey, didn't Toddo report hearing rumors of financial terror around that time?
I'm intrigued and bordering on truly alarmed.
Matt

I have. The problem is that in a consumption-based services economy there are truly so very few things we need relative to the amount of good and services produced that we want that the deflation in things we want ultimately swamps any material inflation in things we "need." It is a function of the massive inflation by the Fed over a span when consumer preferences were supportive of accepting more credit, taking on more debt, that everyone seems to assume credit demand is an ongoing certainty. We have already seen how quickly demand evaporates during this deflationary debt unwind. We will now see how quickly items in the "need' column get transferred to the "don't necessarily need" column. Yes, Healthcare, Education, some things seem to be above reproach. But ask your local dentist, plastic surgeon, chiroporacter, podiatrist, nutritionist, optometrist and college endowment investment committee member a year from now about wants versus needs and I suspect their list too will have changed dramatically.

Matthew,

I don't have enough information to judge whether or not this tale is true. Perhaps Rep. Kanjorski extrapolated $550B in a short period of time (18 minutes?) to $5.5T in 3 hours. The worldwide value of all mutual funds is $26B per the infallible Wikipedia, so this implies that 20% of the world's mutual funds are in the hands of "those guys". It's a little hard to believe that a group small enough to act in concert with secrecy could also control 20% of the world's mutual funds.

But, if such a group exists, and is willing to bring everything down for their own gain, they have declared war on us all. Is it "acrimony" to recognize that someone is trying to bankrupt us all and fight back?

John,

I found one for $2.99 on Ebay.

More to the point, the "have nots" find that their education, health care, and so on, is optional. The backlash against the single mother of 8+6=14 may be just the beginning, as new groups are identified who are unworthy and left out of the social welfare net. Not this year - but watch out if the political pendulum swings towards the "mad at the world" branch of the right.

In a deflationary period, not all prices will fall. The demand for goods, generally speaking, is falling, creating inventory surpluses and thus, falling prices. Prices for things you "need" may fall as well, if there is a large surplus. Chaos changes all of the dynamics, and a deflationary spiral will create chaos in the markets like we have not seen.

"Is it "acrimony" to recognize that someone is trying to bankrupt us all and fight back?"

Oh, heck no!

I'm just trying to gauge how plausible this claim might be and I sensed you might be willing to conjecture further. We don't have much to go on at this point, but the source can hardly be written off as crackpot. I'm building a reserve of acrimonious outrage to unleash if it is revealed that Rep. Kanjorski's version even approximates what happened that day.

Your response struck me as serious-minded and not out of proportion to the stakes involved. We gotta talk frankly here, I think.

Matthew,

It is at least plausible that the description "run on the bank" may be apt - no coordination, just an awareness that things were going south and an urge to get your money out before the mutual funds ran out of funds to mutual with.

let Lehman fail, now shut-up we'll drive.
Sept 15th...who held the swaps. Nice payday.
Prolly just tin-foil stuff...where is my Reynolds cap?

OK we know where the money was coming from, but where was it going? Must have been to somewhere deemed safer than money markets. Treasuries? Other currencies? Where? I don't recall sensing disruptions in markets other than perhaps treasuries that would account for such massive short term flows. Did it all go into treasuries? Did the move in treasuries that day suggest flows of this magnitude? I don't get it (not unusual in my case).

Agreed.

I will dump cell phone, Cable T.V., Internet before food and gas and mortgage.

I already dumped the health club membership and yearly trip to Vegas.

I refinanced, but from a 25 year fixed to a 15 year fixed, matched my 5.125% and am paying down principle. I'm not going to refinance to get more cash to spend in a bad economy like I keep hearing economists say that is why people are refinancing.

I'm surprised how many are smoking the hookah saying that this is the rally that will take us back to DOW 12,000 despite the unemployment, bankruptcies, foreclosures, and the pork spending bill versus a bill with meaningful tax cuts and infrastructure spending.

CNBC was pointing to the rise in used car prices as a sign of economic recovery. Um...wouldn't a rise in prices mean a rise in demand; meaning that people are NOT going to buy new, and are replacing the car going to the junk yard with something cheap? Deflation, no?

While I agree with Kevin's basic premise for the time being - that deflation is the overwhelming force at work in the global economy - the same could be said, to a much greater degree, in early 1933. When FDR took office, prices (down 30% in 4 years) and unemployment (25%) had gone MUCH further into big D Deflation territory than anything we have seen thus far (and yes I'll admit we're at best enjoying the halftime show right now). The banking system was effectively shut down. The entire globe was trapped by the grandmother of all deflations.

But within a few short months, by July of 1933, Industrial production was up 57% (no that's not a misprint), the economy was growing steadily and, believe it or not, within a year INFLATION had returned (albeit in a benign fashion). From 1933-1937 we enjoyed one of the strongest expansions on record - only to have the Fed get nervous about inflation, jack up reserve requirements and throw the whole economy back into the hellpit of the 1938 recession - which it took lend lease and WW2 to get us out of.

But back to the turnaround of 1933. How did FDR do it? Simple. He backed each and every bank that reopened with FDIC insurance. And he devalued the dollar by nearly 70%. That kind of money printing buys you a lot of reflation.

Part 1 has effecitvely been done - albeit in a haphazard and awkward fashion. Now, while it won't be as easy as it was for FDR (who had the gold standard to toss under the proverbial bus) Part 2 has been specifically threatened by Bernanke in various papers and books. According to Uncle Ben no self-respecting central bank with a fiat system and printing press should ever have to willingly suffer deflation. Now from what I've seen he is more than willing to put his academic theories to work. Add to that the fact that Congress has neither the power under current law nor the politcal will to veto Federal Reserve and you have enough potential unintended consequences to keep any reader of economic history up all night.

So go ahead and invest for deflation (and please keep the great articles on that subject coming, Kevin!). And make sure to adjust your lifestyle (retire debt, build savings) if you haven't already (if your'e reading this here in Minyanville I'm sure you did it years ago).

But don't be so foolish as to turn your back on The Federal Reserve and write inflation off as a problem so far in the future that it's not even worth planning for.

In my humble opinion, any investment plan for 2009 that does not allow for both inflation and deflation is as fiscally irresponsible and historically unaware as the US Congress (and that's saying something).

Minyan Jim

The NYT article is available in the NYT archives at:

http://www.nytimes.com/2008/09/16/business/16aig.html?scp=1&sq=A+Race+for+Cash+at+A.I.G.+as+Ratings+Are+Downgraded&st=nyt

Correct link:

http://www.nytimes.com/2008/09/16/business/16aig.html?scp=1&sq=A+Race+for+Cash+at+A.I.G.+as+Ratings+Are+Downgraded&st=nyt

Great comments, well said, Jim. It is not an all-or-nothing thing. True. Maybe think of the flow of a basketball game. Even in cases where the home team is more talented and has a decided edge, the flow of the game is typically not one way. The home team may jump out to a 10 point lead, but the visiting team goes on a mini-run and closes the gap. This may happen 4,5 times or more throughout the game. Moving to economics, and if the home team is deflation, then what is happening now is that every time the visiting team (inflation) scores a point there are people in the gym throwing their hands up and saying the visiting team is surely going to win, regardless of the score. The underlying trend is deflationary. The Fed - as the embodiment, literally, of inflation - is working over time to try and reverse the course of deflation. But the debt unwind is too much. There will be periods of time, as you point out, when the Fed will be successful. But when the final horn sounds, the home team will prevail.

This is really just a guess. And more than a guess, probably wishful thinking.

Kevin, there were scores of books/theses writtne prior to this meltdown, about the coming major social/financial impacts of the huge demographic shifts to occur as the boomers reached retirement age.
It is my current thesis that these effects, occuring in parallel with the macro events we continue to see unfold, take us from the perfect storm, to the "once-in-1000 years" storm.
Just a few very quick thoughts:
- boomers have lost most of the suggested $15T wealth (?)
- boomers who lost their jobs, will have the hardest time finding new work, or certainly equivalent pay work
- boomers will not ever return to any risk asset ( stocks, etc. ); they cannot, they must hold on to whatever is left, they do not have time ot recoup losses
- boomers woud have downsized in any event; they will now downsize on steroids

I'd be interested in a future article taking this idea into account, and overlay its effect onto the deflation argument ( which I fully agree with, by the way- so few authors understand the borrowing side of the reflation argument ).

I've always maintained that when Dog Walking becomes a viable career option, you know you're going down the tubes. Our status as a service economy is particularly scary, because every wave of layoffs guarantees more layoffs. Take Apple, AT&T, BBY, and Google and wipe them off the map: Does it matter? Unless they start making edible iPods, probably not. How many items in the Home Depot can I live without? Just about every one of them.

I've always maintained that when Dog Walking becomes a viable career option, you know you're going down the tubes. Our status as a service economy is particularly scary, because every wave of layoffs guarantees more layoffs. Take Apple, AT&T, BBY, and Google and wipe them off the map: Does it matter? Unless they start making edible iPods, probably not. How many items in the Home Depot can I live without? Just about every one of them.

Exactly right about the service economy. How resourceful are we as a people? In our small town there are empty shops that are screaming for:
1. A shoemaker. Joe, John or Jane Shoemaker.
2. A clothing maker. Leather, weaves, whatever.
3. A toy, clock, furniture, maker....
You get the idea.
That is essentially our ticket, and the government aint selling that.

Hi Kevin,Good comments right back at you. I like the basketball game analogy. But I feel the need to take it one GIANT step further. I would say that the Fed is playing with Shaquille O'Neal on the bench. They haven't put him in yet because there's some eligibility questions they haven't quite worked out with the league yet. Also we, the home team, are out of time outs and there's a special rule that once you're out of timeouts you can no longer make substitutions.

The concern I'm beating to death with this metaphor is that once the Fed brings in Shaq (monetization of debt, printing money on a grand scale to buy things like MBS and long term Treasuries, no longer bothering to borrow to finance these asset purchases, attempting to drive the dollar down another 20 or 30%) the highly talented deflation team will be quickly out-manned and the momentum will turn in a hurry. Without the ability to call a time out the home team may not be able to come up with a defense that can stop Shaq.

I'd guess we are maybe halfway through the game of adjustment and while Shaq has not even taken off his warm up suit, we are already out of deflationary timeouts, and the visiting team coach is already talking to the asst. coach about maybe putting in the big tall guy. And with every point the home team scores they will be more inclined to risk the inevitable trouble with the league brass (Congressional hearings in 2011 when Moody's drops their ratings on US gov't bonds to near junk status). So I'd say, investment wise, that any further deflation pushes the Fed closer to the panic button and justifies their use of it. Since investing requires looking forward I feel the need to hedge a LOT by maintaining positions that will benefit from both outcomes (and even hedging my hedges in the case of put protection on my GLD last week - thanks for the Mr. T reminder!).

So I'd agree with your description of the game so far but counter that while deflation is up big and their shooting has been phenomenal of late, there's a decent chance that once Shaq gets in the game inflation will at least cover the spread and possibly force overtime.

Which is what makes this game so fascinating to watch.

Cheers,

Minyan Jim

Perfect analogy. Everyone thinks once Shaq enters the game, the tide has to turn, doesn't it? I mean, he's Shaq? ( by the way, Shaq is an old, hobbled shell of his former self ).
Everyone, well the inflationista's anyway, think the Fed has the power to just magically reflate, no matter the demand destruction, no matter the over-supply of everything, no matter unemployment numbers, no matter the complete attitudinal shift away from consumption.
If I get the argument straight, personal wealth has been decimated, cash flow is crippled, yet prices go up because the Fed wants them to?
Don't see it.

The money market run happened on September 15, 2008, Monday. See my link for AIG details. The previous weekend, September 13 and 14, 2008, Lehman collapsed, filing bankruptcy the 15th.

When the money market run occurred Lehman had just failed and AIG was going to go too. This is enough to explain the run.

From the NYT on Sunday, September 14th:

http://www.nytimes.com/2008/09/15/business/15lehman.html?_r=1

No conspiracy is needed to explain events.

Upon reflection, I agree. But I still must ask how much concentration of wealth plays into this. Do we have people or families that are "too big to fail" but can choose to "fail", i.e., take all their money out of the system? In other words, the question "Who are these guys" still stands. It may not be a conspiracy, but if the actions of a few can destroy us all that's not good.

Hi Pat,
I agree with you - somewhat. And I have positioned myself to benefit from further deflation through a fairly market neutral position. However the point I'm trying to make is that a sensible investor must also plan for and have some insurance against Shaq (which is the Fed AND Congress IMO).
You write that the inflation argument suggests that the "Fed has the power to just magically reflate"...
That is not my argument.
I would say rather that the Fed has the magical power to DESTROY the value of the dollar and they have the means (the printing press) and the stated willingness to do so.

If you read my original post on 1933 consider that back then "wealth had been decimated, cash flow was crippled" (to a MUCH greater degree than today) and prices went up. Not because the Fed "wanted them to" but because Roosevelt destroyed the value of the dollar by 70% with one stroke of his pen...
And if you doubt that the Fed has the power to do this today look at a chart of the dollar over the 95 years the Fed has been in operation. They have destroyed the value of our currency to the tune of 96%. Look at a dollar index chart from 2001, the last time the Fed felt "threatened" by deflation. The power of the Fed is written all over those charts.

In my opinion positioning only for deflation at this point in time (a trade that I must admit has earned me a near doubling of my portfolio over the past two years) would be to overlook this history. Gold prices have been pronouncing the power of the Fed to destroy the dollar since Nixon closed the window in 1971. Gold today is anticipating further actions by the Fed.
In my opinion every century notch lower on the SPY gives more cover for Congress and the Fed to take action. Thus the further into deflation we get the more I feel we must prepare for the other side of this equation.

While I wish the Fed would just let our nation experience a deep deflation, write down our debt, go bankrupt on a massive scale and then rebuild our economy from there, everything Ben Bernanke has ever said on record would suggest that he has other plans.

The Fed will try to fix this problem with more debt. They will also print money to "retire" debt.
They could print enough money tomorrow to buy every outstanding MBS from every bank in the world. Ben told congress yesterday he plans to buy as much as a trillion dollars worth of credit card, auto and student loans.
This is only the beginning...
And again, I don't want this to happen and I think it is not at all in our natioal best interest, but I have to invest now with one eye toward the possibility that someday sooner than we think or want Team Deflation (who I am still betting with - though not exclusively so) will be trying to guard against a 7 foot 300 pound monster in the paint.
Cheers,
Jim

Most everyday money market fund owners are too clueless to realize that the sudden bankruptcy of Lehman and the bankruptcy of AIG immediately to follow meant they had to get out of money markets instantly. So, obviously, we are looking at "smart money" here. The warning to get out of money funds had to have been spread somehow. Some sort of (probably) informal network exists.

Notice, too, that the Federal guarantees on money market accounts are $250,000 PER ACCOUNT, not per person or per money market fund. An individual owner of a money market account, say, of $25 Million could, with one phone call to the fund, open a hundred new accounts and spread the money out evenly amongst them thereby getting the federal guarantee for the whole $25 Million. It would only take the time needed to make the data entries.

This last is not certain in my mind; perhaps someone more knowledgeable would comment?

www.portfolio.com/views/blogs/

market-movers/2009/02/11/

kanjorski-and-the-

money-market-funds-the-facts

Remove the inserted line breaks.

Thanks for the link, Dean.
Do you consider it case closed? One of the comments for the portfolio.com piece reads:
"Felix, you're not looking at the right data. If Kanjorski's data is close to the truth it is because the outflow from PRIME money market funds was close to $500 billion. Of course, we've always known that most of this got transferred into Treasury [money market] funds -- that was already clear to anyone who was watching Tbill rates on September 16."
Is that an important point, in your opinion?
I've continued to wonder about Kanjorski's claim, but if it's just plain foolishness given the available data, I'd like to put it out of mind...

Corporate earnings.

With 80% of the S&P 500 composite 4th quarter earnings reports in...

OPERATING EARNINGS are down to $5.79 per share! Down 64% from Q3!!!

You read that correctly...64% SEQUENTIALLY.

Annualize $5.50 per share = $22 per share.

$22 x 15 PE = 330

There is a BLACK SWAN if I ever saw one.

I'll tell you what...all I hear is the following scenarios:

1. BULLISH - The market is in the process of bottoming and it may take a few more months and we are building a base and all will be fine in the second half of 2009 or by the latest mid 2010.

2. BEARISH - we will still head down into the second half of 2009 and will bottom around 680 to 600. Then we MAY be in a position to rally fairly well in 2010.

I DO NOT hear a scenario of UP UP AND AWAY to 1200 on the S&P 500 (for obvious reasons).

And I DO NOT hear the scenario of 2008 looking like a picnic and that sometime in the next 12 months we head WELL BELOW 600 on the S&P 500 and maybe break below 500!

Looking at earnings - I see this last scenario as MUCH more plausible than all the people I highly respect here at Minyanville think as a worst case scenario.