Can Governments and Central Banks Prevent More Credit Writedowns?


“TK 421, why aren’t you at your post?”

“What?” we replied to one of our analysts this morning.

“He’s the only Storm Trooper named in the Star Wars movie. I bought a card board cut out of him pointing his laser rifle at you. It was on sale the Science Works exhibit. I’ve put him behind your desk to remind you that you’re under the gun.”

True enough. It’s not just your editor under the gun, though. What’s at stake this week is whether attempts by governments and central banks to prevent more credit writedowns have succeeded. If they have, it could prevent the further transmission of the credit crisis from the financial sector to the real economy. And for investors, it could kick off a Great Releveraging.

Are we changing our tune, then, about what to expect from markets? Not one bit. But the question now is timing. The collapse of 2008 was so severe because of the sudden reduction in leverage in the financial sector. As assets fell in value, the most highly leveraged firms (or lenders who raised money by selling debt) went out of business.

This kicked off a chain reaction in which other market players were forced to sell assets and preserve capital. Banks preserve capital by not lending. This is how the credit crisis “jumped” from the financial sector the medium and small businesses (those not big enough or politically connected enough to qualify for government bailouts). And from businesses the deleveraging crisis went straight to households, who began saving more and cutting back spending.

And now it comes full circle. When households cut back, it eats into corporate profits and bank profits. Households with members who’ve been fired get behind on bills. Securitised credit card receivables, car loans, and mortgages – a large chunk of bank assets – start to go pear shaped. And banks face more credit writedowns, accelerating the cycle.

This is the cycle the Feds and global monetary authorities set out to short circuit this time last year. Their main objective: increase asset prices to stabilise bank balance sheets and prevent the spread of the credit crisis. How did they do it? TALF, TARP, CAP, the suspension of mark-to-market accounting rules, and the maintenance of low interest rates (in the States especially).

All these clearly did support asset prices, and especially allowed banks to post a quarter two of quarter over quarter earnings growth. This has created the appearance of stability. But what has not improved one bit is the quality of those bank assets purchased with borrowed money. There will be more writedowns to come. But when?

We should entertain the possibility that the Feds can support asset prices for some time. Take Australian housing for example. This week the Federal government announced that it would chuck another $8 billion in taxpayer money to purchase residential mortgage-backed securities (RMBS). Treasurer Wayne Swan says he’s doing it to support “the home lending market.”

We’d say he’s doing it to keep money flowing into the housing sector so builders stay busy, banks stay profitable, and house prices stay high. Remember, this subsidy to non-bank lenders in the RMBS market is there because other investors won’t fund these lenders. And why would they when the government is happy to put your money on the line.

The government says the securities are collateralised by high-quality residential real estate. But that’s what pretty much anyone who was hawking this kind of debt said in the U.S. for the three years of peak mortgage issuance. This is how real estate – traditionally a local industry where prices vary from place to place – becomes a national market – through the nationalisation of the mortgage bubble. A national mortgage bubble can inflate house prices across the board-making the entire country vulnerable to higher interest rates and/or a credit crisis.

Here you see the public sector adding debt while the private sector scales back. Also, in Australia, there is still widespread public belief that house prices only ever go up. That means the government can support lending because borrowers are still borrowing. This just makes the inevitable house price correction much more devastating. The borrowers with the smallest margin for error are going to be hurt the most.

Here’s something else to think about: what happens when the stimulus spending dries up? Treasury Secretary Ken Henry says that the economy could lose another 100,000 jobs and that the withdrawal of stimulus spending will shave 1.5% off Australian GDP in 2010. This is another way of saying the peak effect of the stimulus (in terms of supporting both consumer demand and employment) was in middle two quarters of the year.

So how will Aussie consumers and businesses behave when the stimulus is withdrawn? Did the Rudd government give the economy just enough free money smack to keep its credit high going? Or will the comedown be just around the corner around Christmas? If they’re cautious, Australians will put away their wallets and cut up the credit cards and reduce spending growth to match income growth. The retail sector and retail stocks will be hit hard.

There’s one other big question for investors heading into the end of the year. We know the government can support some sectors more effectively than others. Big ticket items like housing and cars can be subsidised with tax rebates or, in the case of housing, with a fresh injection of credit to support politically connected non-bank lenders in the RMBS market.

But you have to reckon the economy boosting effects of supporting the housing market are limited. The main beneficiaries are the banks and the builders. Granted, if you’re a politician, those are two important constituencies to keep happy. But what about the rest of the economy?

The basic question is how much of it will stand on its own two feet once you remove the stimulus. The stimulus, the FHOG, the government backing of the RMBS market…these are all attempts to revive an economic growth model that’s dependent on asset inflation and credit bubbles. That’s the model that led to the bubble that led to the bust.

Papering offer the holes blasted in bank balance sheets by the credit crisis seems to have worked in terms of restoring confidence. Call it a successful psychological operation by the government spin doctors and their buddies in the media and banking. The whole purpose of the operation was to appear to recapitalise banks to healthy levels. But really it was to prevent the banks from having to take further credit writedowns, which itself feeds the process of forced asset sales, declining asset prices, and more household deleveraging.

One immediate risk to watch for is Australia’s resource export industry. Export volumes are down year. But for the largest export categories, last year’s contract prices are still in effect. Looking forward, 2010 could see lower export volumes AND lower prices for bulk commodities like iron ore and coal (especially if Chinese inventory restocking is complete). This would make the current valuations on resource earnings look pretty generous. You’ll read more this week on which sectors are going to thrive and fail in this Great Releveraging.

Back to gold and the dollar and the new world currency order. A simple question: what was all the fuss about last week with a new reserve currency anyway? Here is an answer. If OPEC demands payment for oil in something other than U.S. dollars, then people who buy oil (and who doesn’t?) have to stockpile the other currencies in which oil is priced and traded. That would be pretty tough on America.

To support its oil appetite, the U.S. would have to buy the currencies in which oil is priced. It couldn’t use good old greenbacks. How do you buy foreign currencies?

Well, you can sell your assets (gold, real estate, stocks) and use the money to pay for oil. This is what Australia does. Or you can borrow in a foreign currency (did anyone say future Chinese bond market?) It’s also possible you can use earnings on your foreign-owned assets – provided those assets generate enough money to support your oil habit.

These are all options within the free market system. The main point is that all other things being equal, you have to sell something to pay for something. This is why the foundation for economic health is always wealth production, not consumption. Production creates the goods that facilitate the trade that creates the profits to increase purchasing power for the things you don’t produce.

But outside the free market system, you could opt for just taking the oil by force. By that we meant that should the U.S. be put in the position of having to pay for oil with new borrowings or asset sales, it might take the geopolitical path of least resistance and resort to a good old fashioned overt resource war. The declining Empire will strike back with its principal remaining asset, its military.

Likely candidates for an oil war? Not Iran. It’s too far away. There are too many U.S. troops in Iraq and Afghanistan that would become targets. And the effect of a Middle East war would be too destabilising on oil prices. But Venezuela, on the other hand, is much closer to home.

Granted, comrade Obama is a peace maker. He was a won a price for it. Peace be upon him. And it would not seem like he’s not likely to attack his good friend Comrade Chavez.

But if the current president flounders in the fiscal morass he finds himself in, he’ll be a one term savior. Some pundits are already calling him “America’s Gorbachev.” He’s the man who will preside over the swift fall from grace of a Superpower.

There will be no second coming (term). And that leaves room for a challenge from a more hawkish member of his own party (Hillary Clinton) or a populist Republican with a handy doctrine of liberty within the hemisphere (let’s call it the Palin Doctrine). If Obama is America’s Gorbachev, who is America’s Putin? That’s what Glenn Reynolds at is asking.

Naturally all of this is pure speculation. But our main point is that the oil game is not just a currency game. It’s a power game. And it’s silly to think the U.S. would relinquish its control over the oil market so easily. There will be a fight.

Not that the U.S. could maintain the reserve currency status quo by force. But sooner or later someone at the policy level in America is going to realise that once the reserve currency status is lost, the country loses a huge strategic and competitive advantage. Its standard of living, already in major decline, would face a major body blow.

Just how American policy makers plan on maintaining that advantage is yet to be seen. Of course maybe they don’t plan on it at all. The Empire could be so narcissistic and full of false confidence that few people fail to see the inevitable chain of events the country faces. You’ll just get more spending and more chest-thumping and more fiddling. Or more war.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.


  1. There is no absence of great minds in the US. The Obama to Gorbachev comparison is evidence of that. There is an absence of an ability to politically bring forward and retain economically sustainable public policy. This is because lesser minds can be more effective using the simple and age old methods of racketeers. They target the weak links, political funding, abuse of leverage, and abuse of the world’s reserve currency and global financial institutions as a strategic policy to annex and clip the ticket of assets you only nominally own under title of your bodgey leverage and currency.

    Corruption at the Federal Reserve is endemic, there is little to separate the follies of Arthur Burns and Greenspan. Even Volcker presided over Latin American debt crisis and ticked off on solving the US big bank insolvencies by using high spreads to tax the US economy into the bailout. This as well as sitting idly by while Reagan whooped up the US public debt to spend on the military assets to attack the Soviets cut off any ability to generate the capital to restructure the rust belt economies. Let us hope that Ron Paul’s audit brings about the demise of the Fed but we should also be aware that extreme consequences and behaviour are as likely there as they were under Gorbachev’s perestroika.

    I hope all those that seek peace applauded Galbraith’s sacking from the UN. If there is a truth commission on the former Yugoslavia, he and Holbrooke will be central characters and stand to be condemned. They were at it again in Afghanistan using the cheap penny tunes standards from US blue blood & democrat playbook. This is the first time since the Grenada invasion folly that the US has effectively had its wings clipped in mid action by its now nominal Eurocrat allies.

    I don’t believe in the possibility of controlled releverage. There is too much in the toxic asset portfolio sitting on bodgey balance sheets. The US consumer credit bust tells you that those that you rely on in your theory to borrow and spend aren’t getting the liquidity. It is being given to merchant bankers and hedge funds who are buying up the rest of the world following the Paulson/Summers/Clinton playbook and seeking to profit from the upside down “strong dollar policy”. But it won’t happen …. another play on the Volcker plan to bail out the insolvent banks but this time using the US exchange rate instead of spreads will collapse because of the awesome weight of the US economy itself, this time as a lead anchor.

    And the bailout debt, now it has been remeasured up to 12 trillion as the oxymoron of “going forward”, and that is only on existing trajectories and in the main excludes the now certain need to bail out the US states on the back of revenue collapses. And any attempt at releveraging US domestic consumers requires more juice again. So we are almost as releveraged as we are going to get without lighting the BBQ.

  2. Of course the USA being the largest manufacturer in the world by a SIGNIFICANT margin is conveniently forgotten when everyone is looking for reaons for the demise of the USA.

    How about running another extreme and unlikely scenario.

    The USA refuses to import anything or pay for anything not in USD.

    The american economy would be hurt – but it can easily be self sustainable.

    What would happen to china (and australia) and the rest of the world if the USA REALLY decided to play hardball ?

  3. Begins with the Word of God. Hardball? lol. :)

  4. Prozak, the physical and human assets of the US are not going to suddenly disappear, yet despite this, people are predicting massive change in the US, politically and financially. Ask yourself, does the world want (or need) a powerful America? Are the bankers of America loyal citizens who would never move country? Is America winning its various wars? Are America’s health, industrial, financial and education systems undergoing the necessary reforms?

  5. hey prózak, reading this digital rag the Daily Reckoning for over six months on a regular basis. These are my first comments.

    I heard that Warren Buffet said, ‘if you don’t understand it don’t invest in it.’ makes sense to me.

    I’ve studied money for over twenty years. I have yet to reach an answer to satisfy the vault.

    I’ve noticed that most people that blog on this site are professionals in multiple fields. Most of you appear to be investors plus something else…. like the investor who just happens to be the sheriff. lol. :( The unbiased analyst who just happens to work for ……. and the guy who stands up in the board room and yells this is illegal! :)! who is he? he’s been working here since we founded this place. i gotta love it.

    So, prozak i was just musing on the term: hardball. A marble perhaps? What do you intend to do with this?

    Having said that it’s nice to meet all of you. I’ve learned from you 4that I thank you. I don’t plan on writing here all that much. maybe in another six months. who knows…

  6. “Granted, comrade Obama is a peace maker”

    “Comrade” key term.

  7. Interesting analysis, but to pick up on Prozak a bit, what happens if China and OPEC don’t realize that the US is essentially willing to fight recession with recession? If anything, shouldn’t China be studying the antebellum Japanese foreign policy for actions based on energy needs? Though oil is fungible and a global commodity, the US is actually a very minor player in global energy trade – huge regionally (Canada and Mexico, and to a small extent Venezuela).

    Finally, the US can and will continue to exercise monopsony power in many other ways. How will Europe do so with Russia for its energy? What happens to Ukraine and Poland – seeing how they also get to control the pipelines?

    Interested Conservative
    October 13, 2009
  8. Oh yeah–we see a “major body blow” as a possibility. The “competitive advantage” chips will fall where they may. We may even have to tough it out for–years? decades? a generation?

    Further along we’ll know more about it…

    Sweet Bye & Bye
    October 13, 2009
  9. Reasonable suppositions and questions all. Nearly. The big question is not “if Obama is America’s Gorbachev, who will be America’s Putin?” It is: If Obama is America’s Gorbachev, who will be the world’s Reagan?” He warned of a “thousand years of darkness.” Europe is gone. The United States is failing. China?

    Someone needs to take the United States to the wood shed before it’s too late.

  10. prozak:

    I think the problem with the idea of the USA as self-sustaining is that it is a consumer/importer economy (currently) and that without trade most economies will suffer hugely.

    If the US refuses to play nice, this will adversely affect trade. People will start requesting more USD for everything that they sell, and the USD will lose its value. If the US decides to print more money, it will lose even more value. And so on.

    The US does not currently have the manufacturing structure and capability to suddenly build all of the items that it imports. It would take many years for it to rebuild itself into a self-sustaining country, and whilst doing so it would have to forego other industries – like the finance industry for instance. Sure it could produce a lot of corn, but what about lithium batteries for its electric cars? What about oil for its non-electric cars?

    I agree that the military thing is an issue, however a country without sufficient international trade is a country that will suffer immensely. Protectionism seems like a good idea at the start but certainly ends badly.

  11. And to add one last thing – the American consumer will not like a shift from importer/consumer to self-sustaining producer. That is a huge lifestyle and behavioural shift. And it is not one that would get voted for, particularly not by people that have experienced the ‘good times’.

    But…in 10 years or so, they may be forced that direction regardless.

  12. Pete, (et al)
    of course there are issues with what I suggested. And it would never come to pass. Just as there are issues with all the anti-american spin we get.

    My point really was that everyone is running all the anti-american scenarios but no one seems to be looking the other way.

    If the world turned and it was every country for themselves, I know who I would have my money on.

    Where is this great China if the USA and Europe decide on protectionism? They are DOA. It would hurt the USA and Europe but it would destroy China (economically and politically) Anyone who thinks otherwise is truly kidding themselves.

  13. Absolutely right, prozak, if push came to shove militarily, it’s a no-brainer that the US is still miles head – but the balance there is changing also, and a sweet-point is approaching where the US might find itself eclipsed in certain types of conflict. In some ways the US has been very successful in Iraq and Afghanistan – they’re still there, for example, but it has exposed many of the US’ limitations. Time is short, and there are no guarantees that they can pull off all-out domination over the Middle East.

    Economically the US has a few soft spots too, as we know. So in the event of a worldwide conflict (military + economic), the outcome is not black and white. I love hypotheticals.

  14. One small fact that no one seems to notice: in regards to oil, the U.S. could , if push comes to shove, find the political will to start tapping into its vast reserves of oil, natural gas and coal. So far, the U.S. has chosen not to drill off its coasts, not to drill in the huge reserves in Alaska, not to exploit the 2 trillion barrels of shale oil (which at a cost of $50/barrel is profitable now to extract) in Colorada. And we are not even talking about nuclear energy. There are still a plethora of oil wells in Texas and Wyoming that have been capped for years because it has generally been cheaper to import the oil then pump it out of the ground. The U.S. has so far been able to indulge the whims of the Environmentalists and get its oil elsewhere. If things got rough, the U.S. could not only become energy independent, it could actually become an exporter of oil. If the U.S. merely cut back on imports to 30 or 40% of total consumption, that would have a huge effect on the wealth equation and the strength of the dollar.

    The U.S. is vulnerable in the energy sector only because (stupidly) it chooses to be vulnerable. As we saw last Summer when oil was over $100/barrel, the American public can quickly put pressure on for tapping these resources. If the price of oil had not dropped by November 2008, it likely would have been President McCain.

  15. The US would just redirect who it imports from. Central and South American would become our new China. Which is already happening.

  16. the Old Russian Parable of ‘all roads lead to rome’. So that’s how this works. I sit here at the table. The boss hands me a note that says …. Perhaps there is an ORP Corp nobody here has heard of. Hey, anyone heard of the ORP Corp? I do know a fair bit about computer applications. In addition to all the listening done here I’ve the time to play an exceptional amount of games and it wouldn’t be surprising if I were to be seen…. how do you say?… placing 5 gold bars from my pack into such a sector. Just the other day i was at the tracks and a couple of buddies took 3 minutes off a 5 minute track. A killing? :) Personally, I love cross platform applications at any scale. A few people are multi and anywhere you find someone who is a multi you’ll find… multiple ….

    Mum gave me a dictionary for my birthday.

    interest group n (1908) : a group of persons having a common identifying interest that often provides a basis for action.

  17. Dufinishin:
    That is a mighty confusing post. I can’t speak for everyone, but I don’t think I understood a thing you said.

  18. Hi Pete. Even a deer in the headlights is not confused. Mercy? Overwhelmed is probably more accurate. I’m not one to put people to confusion. I’m hoping you’re not either. Nevertheless, as they say…. one never knows. huh?

    I’m learning the basics here. Being a small understaffed organization is a great chanllenge. Reading through all these posts. This person goes here. That person goes there. This is connected to that. This is not. This is. This is referenced over here. That is referenced over there. It’s all connected in an understandable fashion. i hope :( lol. Ever just throw up your arms. This is hopeless!

    How do you handle a public dialogue that contains special references to organizations that are adequately staffed and hold priviledged access to knowledge not easily obtained if at all by lesser businesses?

    Nothing new here.

    I believe an objective that is tailored with a measure of transparency to be superior to one that is not.

    That’s my story and I’m sticking to it!

  19. Difunishin, the cock crows not how, but why, in its obfuscation. Your organisational metaphorics and neologisms left the camp on a combobulated plateau, with the tethered strands of thyme hanging out of the melting pot of whatever the hell you’re on.

    I don’t understand a word of it either.

  20. I think Difunishin is a random word generator. You know, the kind that pumps out phrases often found in spam e-mail messages. Or quite possibly a Nigerian businessman looking to cut you into a $25 million dollar deal.

    He might also be a frumpy old housewife from New Jersey that I met on an internet forum many years ago. I can’t tell. I don’t know what to make of it.

  21. Thanks Dan, If I have the time and it suits me I’ll look up Greg in Japan if he’s near the Yamaha shop and make my way to Sydney and explain it to you in English and Spanish if necessary.

    One sentence. Are you any better? :)

  22. Haha Dan, that is literal gold.

  23. Always good to welcome a new perspective to the site Dufinishin – I mulled over your earlier first post with considerable interest and suspect I’ll learn a considerable deal from you. So once again – Welcome aboard!

  24. I’ve been hanging around on this site like a bad smell for the best part of a year now Dufinishin – Just thought as a bit of new blood to the site I might try to cash in on the fresh insights you bring and ask your opinion as to how much you reckon slavish obediance to political correctness adds to our mediocre little Oz society? (Consider your response carefully please – We do NOT tolerate abberant views easily in the land of the sinking sun is my experience!!!) Zeig Hail (zat’s Duetches) Mo__it bit (dat’s Rrroskie!)

  25. Señor Ned S, a man with the very heart of God. You are tremendously important to us and your hospitality is of great value to myself. O my goodness Ned good to see you!

    Here in North America over the past nine or tens years hospitality has been all but forgotten. That’s the North America I know.

    If you could picture the weathered, war-ridden face of a Father saying, ‘I don’t know what world you’re from, but I sure as (explicative descriptor) know this world|place!’

    I’ll knock around your Question in my skull. I’ll certainly need to confer with my brother(s) on that. ~Many Colo(u)rs he says. thx:

    With that I’ll close and return to comfortable reading.

    All the Best & Great Work.


  26. Ah, you are of Spanish extraction Dufushin? (As an ignrunt gringo I always find yor long fancy names so hard to recall) – And a while back when one of your mob was still playing standoffish with me after two years during which I reckoned he was a real good bloke (the Pom and the Kiwi he had worked with for MANY years reckoned he had always remained aloof?) – I just told him “Mate, back home they might call you Senor Don “Pedro” but to me you are and will always be a gecko “c” ” [Quite, specifically the chap was and is a Flip.] He didn’t speak to me for 2 days – A throat infection bunging up his voice box perhaps? But after that we got to very good cobbers – Which just brings me back to that original challenge question Duf … What exactly ARE your thoughts on political correctness (as currently exercised in Oz) me ole plonko … What’cha reckon hey?

  27. Dufinishin: actually I think I’m beyond help ;)

  28. Ned, I found myself not having an opinion and not needing one. That’s a good place for someone like me to be. It means that Ned’s opinion is strong enough that my opinion doesn’t matter or isn’t needed. That’s great.

    There’s alot to be written another time. So, I’ll just defer to those more able and qualified to handle all the thoughts and opionions. I realize that most people here are operating with extended or enhanced perception capabilities. If you’re not one of those people reading this it just adds mystery and hopefully a good one due to the everyday efforts of people like Dan & Pete.

    I do say that the EURO failed in it’s central or greater mandate and that brings Oz & America together in a good way having the same miserable parents.

    I still believe the Euro will succeed. It’s not the Euro of five years ago and next to the US dollar the Euro is a champ.

    I’m more interested in looking at all these Yen.

  29. You don’t wriggle out of it that easy Duf – While you are alive ya gotta keep kicking – dem’s da rules! Nice try though!!! :)

    Of course even the crack front line troops are expected to ask for a bit of R&R occassionally – So yeh, enjoy a rest if you can find it within yourself to truly have one …

    Advice noted – Ta!

  30. Dufinishin, master of understatement and humility :) Good thoughts about the Euro – it seems to me that the purpose of the Euro was as a retry of what pretty much everyone had in mind before the second World War – a united Europe (and beyond) … which incidentally existed peacefully for centuries under the Romans. At least it was attempted via economic means and not bloody means this time around. I think from that point of view yes, the Euro won’t be abandoned without a fight.

  31. Dufinishin – Yarrestin! See you over at the other watering hole Dan …

  32. That is the essential question that we must all ask ourselves. ,

  33. Hamlet, act three, scene one – Least that’s what wiki says. There’s a few new voices chiming in I see – Sounds good.

  34. Dufinishin I am not sure if I am near a Yamaha shop but I can find one if you get up this way. I am a big fan of the Yen by the way and the Euro but I must admit I am not that plugged into the Eurozone although I expect there will be a lot of growth potential as the EU expands.


Leave a Reply

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to