Debt Revulsion

The Real Great Depression.. strong echos

Could the current crisis be more like the Panic of 1873 than the depression in 1929?
Great article by Scott Reynolds Nelson a historian of the 19th century.
Some of the parallels with the current crisis are eye-opening.
Some highlights;
The problems had emerged around 1870, starting in Europe. In the Austro-Hungarian Empire, formed in 1867, in the states unified by Prussia into the German empire, and in France, the emperors supported a flowering of new lending institutions that issued mortgages for municipal and residential construction, especially in the capitals of Vienna, Berlin, and Paris. Mortgages were easier to obtain than before, and a building boom commenced. Land values seemed to climb and climb; borrowers ravenously assumed more and more credit, using unbuilt or half-built houses as collateral. The most marvelous spots for sightseers in the three cities today are the magisterial buildings erected in the so-called founder period.
Rapid mortgage growth... so what killed it?
Wheat exporters from Russia and Central Europe faced a new international competitor who drastically undersold them. The 19th-century version of containers manufactured in China and bound for Wal-Mart consisted of produce from farmers in the American Midwest.
So the growth plans of Europe were undermined by a new economic superpower. The interesting part is the flow through to bank lending;
As continental banks tumbled, British banks held back their capital, unsure of which institutions were most involved in the mortgage crisis. The cost to borrow money from another bank — the interbank lending rate — reached impossibly high rates.
The collapse of many companies dependent on debt rocketed (those with reserves did well - Carnegie and Rockefeller especially), unemployment in the US grew to 25%. The similarities between the current crisis and the Depression are strong - with a bank crisis spreading rapidly to the high street. Let's hope some of the other fall-out (protectionism, alienation of immigrant communities) does not follow.

James Montier's "Road to Revulsion"

Clearing out the inbox I came across an interesting post by John Mauldin on the road to revulsion. The principle argument is that the bursting of the debt bubble is not a Taleb "Black Swan" but all too inevitable given the progress of the bubble.
The progress has the following stages

  1. Displacement - The birth of a boom 
  2. Credit creation - The nurturing of a bubble 
  3. Euphoria 
  4. Critical stage/Financial distress 
  5. Revulsion 

Most interesting is the comment on the final two phases:

Critical stage/Financial distress 
The critical stage is often characterised by insiders cashing out, and is rapidly followed by financial distress, in which the excess leverage that has been built up during the boom becomes a major problem. Fraud also often emerges during this stage of the bubble's life.

Madoff anyone? Remember that this was posted in June this year.

And finally revulsion;
Revulsion 
This is the final stage of a bubble's life cycle. Investors are so scarred by the events in which they participated that they can no longer bring themselves to participate in the market at all.
Could the UK and US consumer really have this attitude to debt? When (or if) the banks finally capitulate and lend freely will the populace want to borrow?

Britain’s debt ‘disturbing’

Dominique Strauss-Kahn, head of the International Monetary Fund, calls Britain’s level of public debt ‘disturbing’.

From Credit Action - some of these disturbing numbers.

Average household debt in the UK is ~ £9,633 (excluding mortgages).
This figure increases to £21,952 if the average is based on the number of households who actually have some form of unsecured loan.Average household debt in the UK is ~ £59,630 (including mortgages). 

Average owed by every UK adult is ~ £30,398 (including mortgages).

Average outstanding mortgage for the 11.7m households who currently have mortgages now stands at ~ £103,903.
Britain's interest repayments on personal debt have soared to £95.9bn in the last 12months. 
The average interest paid by each household on their total debt is approximately £3,930 each year.
Apparently the only way out of this mess is to encourage people to borrow more - by providing liquidity to the banks and slashing interest rates.

Maybe it's time to take away the drink from the drunk.

London Banker - "Deflation has become inevitable"

Sitting on the fence between inflation and deflation and trying to work out which way massive monetisation of bad debt will push us has been a preoccupation of mine for about a year.

"London Banker" has made his call - link.

I’m now coming down on the side of deflation for a very simple reason: there is no longer any incentive to save or invest, and so debt and investment cannot increase much beyond current bloated levels.
Interesting hitorical perpective
In Lombard Street, Bagehot’s seminal tome on fractional reserve central banking, Bagehot advises any central bank facing a simultaneous credit crisis and currency crisis to raise interest rates. By raising rates they will ensure that foreign creditors remain incentivised to maintain the general level of credit available while the central bank resolves the local liquidity crisis through liquidation of failed banks and temporary liquidity support of stressed banks.
I'm going to pick up Bagehot's book and look for clues as to what happens when governments do exactly the opposite..

"This is a large crisis"

Sandy Chen of Panmure's note continues
"In fact, if you've got a moment, it's a twelve-storey crisis with a magnificent entrance hall, carpeting throughout, 24-hour portage, and an enormous sign on the roof, saying 'this is a large crisis'"... quoting Blackadder.
The amusement is short lived.
"We think the mutually reinforcing combination of deflation and deleveraging will lead to a deadly spiral of falling prices, bad debts, credit contraction and bankruptcies that will take years to play out. Banks' shareholders will bear the brunt of the pain; big Keynesian bailouts will only deepen and prolong this crisis, in our view.

"We believe that the sheer pace and scale of central bank rate cuts worldwide points to a global concern about deflation. This concern is valid: underneath the torrent of micro and macro newsflow, the havoc that can be wreaked by the mutually reinforcing combination of deflation and deleveraging looms.

"In the current environment, we expect banks [to continue] tightening their lending criteria even further, and borrowers paying down their debts first 
and thinking about consumption and investment later. Expected result: stagnant top lines and falling asset prices.

"As prices fall further, we expect more loan covenants will be breached, leading to more bankruptcies and more forced selling, putting more cash flows (both individual and corporate) under pressure. The expected result is further deleveraging and deflation, and further economic contraction.

"Against this, there seems to be an almost worldwide consensus that the Keynesian fiscal and monetary policies being implemented (including moves towards quantitative easing) are good and necessary things, on the view that a lot of cash (read: sovereign debt) will stop this downward spiral.

"We disagree. Bailouts could both deepen and prolong the crisis, by sending conflicting signals to consumers, savers and investors. Thus, instead of a recovery for the UK economy (and its banks) in 2009, we expect the opposite: further economic contraction and a further rise in bad debts and bankruptcies.
"We have pushed through further forecast downgrades for all our UK banks (including HSBC and Standard Chartered), and we have cut most of our price targets again. We maintain our sell recommendations on all the UK banks except for Lloyds-HBOS, which we have downgraded to hold on our top-down view."

My stake in the ground, my first post, is that I'm pretty much aligned with this note. As the war rages between Deflation and High (Hyper?) inflation and Governments globally attempt to reinflate the bubble my conclusion is that they will only drag out and delay the inevitable.