Are We Measuring the Wrong Money Supply … Again?

Posted on June 12, 2012

Back in 2008 we wrote that the U. S. was facing a serious credit squeeze in part because we had failed to take into account some important structural changes in the credit markets: i.e. the rapid growth and subsequent collapse of the Shadow Banking system. Since then the Fed and the Treasury have spent enormous resources addressing the impact of that collapse through the purchase of assets from financial institutions, the nationalization of Fannie and Freddie and numerous other actions to prop up the housing market in hopes of repairing shrunken balance sheets throughout the economy.

We may be suffering from a different, but equally portentous, issue today arising from another misreading of what the term money really means. In response to our recent article on Fed tightening since the fall of 2011, John Lounsbury, Managing Editor of, made a very astute observation:

You do not mention it in your article but is it possible that the Fed has not been taking a sufficiently global view and has insufficiently reacted to a recessing Europe and a rapidly slowing Asia? India just dropped to a GDP growth rate below anything seen during the Great Financial Crisis. The manufacturing numbers in China have been flirting with contraction for several months. If the Fed reacts to these factors after they have gained a solid foothold, doesn’t that likely increase the magnitude of the yo-yo swings?

The U.S. dollar is without question the world’s reserve currency and the current problems of the Euro have only served to cement that position. Given the global demand for $100 bills, in many parts of the globe the dollar is not only the reserve currency, but the defacto physical currency as well. Yet we continue to look at money as a national, or in the case of the Euro, regional … read the rest

We’re Seven Months into the Great Mess. What’s Going to Happen Next?

Posted on April 14, 2009

Seven months ago (Monday September 15, 2008) we learned of the failure of Lehman Brothers and soon thereafter the sale of Merrill Lynch and the bailout of AIG.  These events were the culmination of a series of market shocks that had started with the demise of the sub-prime loan market, had accelerated with the collapse of the leveraged loan market starting in August 2007 and had included the takeover of Bear Stearns in March 2008.  But September 15, 2008 is the current era’s equivalent of 1929’s Black Monday.

Since September we have witnessed dramatic governmental actions designed to prevent the current crisis from descending into a downward spiral reminiscent of the 1930s.  For the moment, the stock market seems to be giving these actions (as well as our charismatic new President) a vote of confidence.  We’re also hearing from some of our clients that their operations improved in March and that they are more optimistic about their businesses looking toward the summer.  Another “green shoot” is the middle market M&A market, where I spend much of my time.  The M&A market has definitely improved since the first of the year and indications are that it will remain reasonably strong for a while, at least for profitable companies in favored industries such as government contracting, IT services and health care.

So what is the economic scorecard to date and what can we expect to see going forward?

1)    The World economy is in the midst of the first major global recession of the postwar era.  Global trade has been collapsed for many of the major exporters, particularly China, Japan and Germany.


While there have been some recent hints that the rate of decline is slowing (the second derivative of negative growth) or even bouncing a little, world trade is still an area of significant concern.  … read the rest

We’re Fighting the Wrong War

Posted on February 28, 2009

“Generals are always fighting the last war.” Certainly this was true in Vietnam for many years. More recently we tried to refight Desert Storm in Iraq, without understanding that we were headed for another Vietnam.

But what about the economists? Are they subject to the same failings? Most certainly the answer is yes. We have now spent the last year fighting the Great Depression, when the current problem results from a very different cause. True the Great Depression followed the pricking of a stock market bubble, much like the worldwide equity bubble we experienced from 2002-2007. Yet there is one factor in the current market that is materially different from the conditions of the late 1920’s that precipitated the Great Depression of the 1930’s.

You have likely seen the chart below from Ned Davis Research sketching the history of leverage in the United States economy.


Leverage (Total Debt/GDP) peaked in the 1930s at ~2.6 x Gross Domestic Product. Leverage in the current economy peaked at 3.6 times GDP in 2007-2008. So what’s the difference? The difference is that there is no indication that, in the aggregate, the boom of the late 1920’s was caused by a massive leveraging of the economy. From 1923 through 1930, leverage ranged from 150% to 170% percent of GDP. On the other hand, in the current era from Q3 1998 to Q2 2008, a period similar in many ways to the boom times of the 1920s, leverage increase from ~2.6x to almost 3.6x. The massive spike in leverage to GDP from ~1.6x in 1930 to ~2.6x in 1934-36 resulted not from a credit bubble, but from the rapid decline of incomes and output while debt remained relatively constant.

The current down cycle is being driven by a phenomenon different from the forces that led to the Great Depression, i.e. … read the rest

Categories: Banks, Economics

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In For a Penny, In for a Pound

Posted on November 10, 2008

AIG announced today a deal with the Federal Reserve that will have the effect of increasing the Fed’s bailout financing to AIG from $85 Billion to in excess of $167 Billion (and most likely counting).  Any seasoned distressed company investor knows that the first new money put into any failing company is likely to be lost unless the investor is prepared to follow the initial investment with a lot more (sometimes referred to as “good money after bad”).  More than one wag has described this phenomenon as “the second mouse gets the cheese”.

The other big economic news of the day revolved around the proposed bailout of General Motors.  Clearly something is likely to happen here with three million jobs at stake and a lot of political power in play with the United Auto Workers.  Given the inevitable, wouldn’t it make more sense if the money comes in as part of a pre-packaged Chaper 11 which cleans up the company’s balance sheet before the money comes in?

I’ve never seen a successful turnaround that keeps the old, failed management on board to steer the sinking ship.  Perhaps it would make more sense to put together an ownership group that includes some Japanese auto manufacturing skill as well as some of the best business  minds in America.  Toyota, Honda, et. al. clearly know something about running a successful auto plant and they are not afraid of investing in the United States.  And Steve Jobs seems pretty successful at creating a consumer products company.  Let’s harness the best we’ve got to create real change in this vital industry, not subsidize the failures of the past.

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Categories: Bailouts, Bankruptcy, Business Turnarounds

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Did a Declining Money Supply Cause the Crash

Posted on October 15, 2008

While most economists and the Fed discount the control of monetary growth as a tool for managing the economy, money does matter. Monetary growth in excess of growth in the economy’s productive capacity contributes to inflation. Similarly a sharp decline in the money supply would likely lead to economic contraction and ultimately to deflation, as was experienced during the 1930’s.

In my world, mergers and acquisitions and corporate finance, we witnessed a unique phenomenon during the 2005-2007 period as many new sources of financing became available to support the rapidly growing Private Equity community. Loans were syndicated at a furious pace and specialized finance entities, many supported by hedge funds, aggressively provided capital with a speed and at risk levels not seen with traditional bank lenders. Second lien and tranche B paper became the norm.

Much of this paper was ultimately securitized through issuance of collateralized loan obligations and similar instruments. Some have estimated that this resulted in an increase in credit availability of at least 25% above levels that would have been possible if the market had been restricted to traditional sources such as banks and asset based lenders. The net impact was a dramatic decrease in the cost of capital, with loan spreads contracting by several hundred basis points and a sharp relaxation of underwriting standards. Lenders routinely provided senior debt at five times cash flow to companies and deals that would have only supported two and a half to three times cash flow a few years earlier.

As a result purchase multiples increased dramatically and companies that might have been worth six times cash flow earlier in the decade were suddenly worth eight times cash flow or even more. The worm has now turned and deal loans, if available at all, are being underwritten at more traditional levels and more traditional … read the rest

Categories: Economics

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