Thursday, May 22, 2008

No More Salami

The CDO Era is over. According to SIFMA, global CDO issuance in the first quarter of 2008 came to a mere $11.7 billion, down 94% from the same time last year.

(Note: The y-axis legend should read $ Billion) Data: SIFMA

While the sudden death of structured finance may go unlamented by most, you can be certain it will be sorely missed by the hundreds of thousands of newly bereaved bankers and brokers who depended on it.

The making of salami out of hoggish assets involved serious money. During 2006 and 2007 a combined $1 trillion of new CDOs were issued globally, generating tens of billions in underwriting fees alone. When everything else is added up, from sales commissions and secondary trading to the creation of piggy-back products like CDS and SIVs, the total revenue was many times over. Compare this with equity IPOs, which raised a total of $712 billion in 2006-07 (World Federation of Exchanges data).

Clearly, structured finance was the most profitable product coming out of the great salami factories in Wall Street and the City. With the production lines now idle, there are no more financial sandwiches made; and thus, no need for bread, tomatoes, or condiments - and no need for all those deli counter employees, either.

So, what's next on the menu? After all, the financial industry is nothing if not quick in manufacturing new products out of the same pig. I believe this time it will take longer, however. We have killed too many piglets to make salami and the next litter is not yet on the horizon. The sow is not even trying her new lipstick on...

29 comments:

Mane The Mean said...

Wow!

I assume there will be some lay-offs coming soon. Or, was it so that a few brokers pocketed all the money? So that the remaining business could support the financial deli-counter staff?

Cottonbloggin said...

Hell,
Let me see if I have this right....
Money is created in 2 ways. One way is to print it. The other is thru the Fractional Reserve Banking system.
The quantity of Money grows exponentially in the Fractional reserve system. Any graph depicting this begins to show diminishing returns near the top.
In reality, we hit the diminishing returns part of the graph years ago. But. The economy demanded continued growth. Therefore, banks needed to find new ways to create money. Since they had no control of the printing presses, and since they couldn't change the reserve rate, they did the next most logical thing, and changed the way they did business (salami) to extract the last of the available capital.
They also changed the regulations to make it easier to get a loan, increasing their customer base, and thereby increasing the money supply, keeping the economy afloat.
This then bit them in the ass (see US mortgage crisis)
Then, in order to continue their Ponzi scheme (i defy anyone to tell me how fractional reserve banking is different) they had to find outside sources of capital (see foreign investor bailout & Fed Window).
Eventually the system must collapse, and the people at the top know this. How do they protect themselves? By investing their money in commodities which, at the VERY least, will maintain their value (see inflation in global commodities)
If that's true, then how do the little guys (me & you) protect ourselves?
Thai will be happy to hear me say that the solution is stochastically self similar (fractal)
If the big boys are finding value in commodities (especially commodities necessary for survival), then shouldn't our focus be directed towards similar ends, albeit on a much smaller scale.
I teach English in CZ, and all my students laugh at me when I tell them the best investment a person can make right now is growing vegetables at home, and attaching some sort of renewable energy source to their home (for example, my point is that VALUE is more important than MONEY)
The way I see it, if I can exchange all my worthless monetary assets (money=debt), for the same tangible products I spend my money on (energy/food/shelter) then I've maximized my potential in a future which looks much different than todays.
But, I'm surely wrong, since they're the one's laughing, because I'm just a lowly English teacher, and they work at the bank...

Cottonbloggin said...

sorry if that was difficult to read. I should have put spaces between my paragraphs

yoyomo said...

The Oil Drum has a link to a CNBC interview with Robert Hirsch (of the EIA Hirsch Report) predicting $12-15/G gas not too far off and rationing. Looks like TSHF all at once, it's going to be one bumpy ride.

Hellasious said...

A two-pronged approach is now needed to resolve the commodity bubble:

1. Do a Paul Volcker, i.e. squeeze monetary supply.

and AT THE SAME TIME,

2. Reduce physical demand.

Both must be done at the same time, otherwise the imbalances will remain.

Yoski said...

If bankers have to get a real job times are indeed hard.

Anonymous said...

Hellasious:

Squeezing money supply while "reducing physical demand" means decreasing money supply while massively increasing investment demand.

Contradiction, si or no?

Allocation. Allocation. Allocation.

Allocate existing money into projects that either cut costs or generate new value.

Look at the homeowner's P & L statement. Where's the potential for cost cutting, or value (production) increasing?

Possible cost-cutting measures:

Energy. Substitute solar for fossil. Eliminate the commute.
Labor hours. Eliminate the commute. Spend the time reading technical or history books.
Food. Learn how to manage a garden or an orchard or a greenhouse
Education. Distance learning

Possible revenue-increasing measures:

Household-scale production. self-publishing, on-line store, home-office (get share of corporate cost-avoidance), retro-fit prev-generation machines (fossil-to-solar-electric conversions, PCs to peer-to-peer local wireless network controllers)
Neighborhood-scale production. power co-ops (solar, wind, hydro), food production co-ops (greenhouses, aquaculture, CSAs, wireless networks), satellite shared-offices in re-purposed shopping or school facilities

You get the drift. The point is that we need the slosh to be re-directed, not destroyed. The only problem with the (oversized) money supply is that it's not backed by profit streams - right now some major chunks of the money supply are backed by loss streams. Just need to change the location of the investment and re-center it upon profit streams.

How do you get profit? You cut costs or you increase revenue. What organizational type controls the majority of costs and revenue in any economy? The household. It's the linch-pin around which most most investment and GDP revolves.

Focus on re-directing household investment. That's where the action is.

OuterBeltway

Anonymous said...

One more point:

Fractional reserve banking has been wildly successful. The wealth of the U.S. has increased dramatically over the past century, and a good bit of that has been because money is readily available.

Ready money is good. The challenge of so-called "fiat money" is to grow the money supply at the same rate as the value of the assets it's backing. Money is to a country like stock is to a company. If the company is producing profits (generating value) the stock goes up; if it goes up enough the company does a stock split (prints more "money"). In the context of increasing value, "splits" are a good thing, right?

The problem with our money supply is that there's more money than underlying value ("splits" increased much faster than "value"). Why? Because we spent the money on McMansions and big-screen TVs, which - here's the key - don't produce any value. They don't call them "money pits" for nothing.

I hope we don't waste too much time condemning a great tool - fractional reserve banking - because most of that time will be spent denying its obvious benefits while misunderstanding its problems.

Understand the problem: it's what the money is used for (allocation), not the existence of the money that is causing our troubles.

In this context, the term "allocation" stands for "the ability to imagine and then implement the tools necessary to operate the world as it is now, not as it used to be".

Adaption = Smart allocation = Healthy economy.

OuterBeltway

Edwardo said...

So I take it by your last sentence that you believe the fictitious paper game will, in time, be reconstituted?

I am of the mind that Peak resources are, as you observed, e a "game changer" such that the old paper game as we just knew is finished for good.

Anonymous said...

Eduardo:

Peak resources are indeed a game-changer.

Money as a representation of value, as an exchange agent, is here to stay. I do believe that, resource shortfall or not.

I also believe that the stock of "value" will increase over time. I think that humans have vastly more productivity in them than has been presented to date. Ideas and knowledge are very, very potent, and the human race is not even ten steps out of the starting blocks in a marathon race on this dimension. Yes, value will increase - exponentially.

We are going through a resource-policy change process, not an "end of resources" process. Matter is neither created nor destroyed - it just changes form. Once policy aligns with resource availability constraints, all will be OK again. It will just take a massive loss of biological stock or a massive growing-up, or both, to accomplish it. I say it blithely, but this reality is what has made my last few years of unfolding realization so psychologically painful.

Keeping it light and abstract, our society is at the point when one set of resource-utilization habits doesn't work any more, and we haven't identified nor widely adopted the set of habits that will work.

So, will the "paper money" process be replaced? Nope. Then what's the consequence of the massive mis-allocation I keep harping upon? People that are ignorant will get fleeced again, and the smart but greedy types will triumph again. The biosphere will continue to get hammered. This process will continue so long as people think it's a good idea to let others "take care of them" in the political and economic sense.

That, I think, is the habit that'll be hardest to break. The process of waking up and taking responsibility is really, really hard work.

OuterBeltway

Anonymous said...

"my point is that VALUE is more important than MONEY"

Point well taken. Your students are fortunate to have a teacher with such heretical insight.

jkiss said...

It seems to me that the real point is that investors will not be providing funds for home purchase, it will have to come from the banks, and they're broke. With a contraction in available credit (to all, businesses and individuals both) would be buyers will have to bid for funds, driving up long term rates.

Marcus said...

Financial companies will have a big redesign in revenue production, likely causing massive layoffs in the field?

Good, we need the engineers and mathematicians back in the productive sector.

Unsympathetic said...

Hell,

One thing that I've noticed you never mention is switching to running cars on LNG. Is there an easily noticeable flaw in the thought to spend 2k on a pump for the garage and about 2k to retrofit the fuel system to handle LNG instead of crude? Cost per gallon down under $1 now that oil's headed upwards of $12-$15. Probably LNG will go over $2 given ramping demand for it as a replacement.. but even so, there's lots of it and so little demand it's burned off in flares so bright they're visible from the space station.

City buses are switching to LNG (and propane) but is there a reason the residential market can't handle this? I can't imagine why LNG as a temporary stopgap for the next 20-25 yrs isn't mentioned more regularly.

Hellasious said...

re: LNG

Natural gas is also going to be tight. I don't think too many fields are flaring it any more.

And if we switch cars to run on LNG then it will run out VERY quickly, certainly not in 25-30 years.

The energy balance equation is dynamic, not static.

Anonymous said...


marcus said:

Financial companies will have a big redesign in revenue production, likely causing massive layoffs in the field?
Good, we need the engineers and mathematicians back in the productive sector.

Sorry, financial companies led the charge of corporations offshoring Information Technology to low wage countries. Manufacturers continued to offshoring engineering. So after all the layoffs and offshoring in these fields, and the ensuing job insecurity, Americans have little incentive to invest in these careers.

Just like manufacturing, you can't magically snap your fingers and get that back. It takes years of capital and workforce investment.

Rachael said...

Anonymous wrote in response to my post:

Peak resources are indeed a game-changer.
Money as a representation of value, as an exchange agent, is here to stay. I do believe that, resource shortfall or not.

-I should have been more clear, when I said the old paper game as we knew it is finished for good. I did not mean to suggest that currency, (as opposed to money, since they are by no means necessarily the same), would disappear forever. Rather, I meant specifically that the sort of explosions in paper instruments that really took off earlier this decade, and that are now imploding at record speed, are a thing of the past.

I also believe that the stock of "value" will increase over time. I think that humans have vastly more productivity in them than has been presented to date. Ideas and knowledge are very, very potent, and the human race is not even ten steps out of the starting blocks in a marathon race on this dimension. Yes, value will increase - exponentially.

-I'd like to hear specifics regarding "vastly more productivity" You see, I am of the view that vast productivity is part of, and quite possibly, the problem in a global sense, as we humans are eating our way through the planet's resources with no ability to replace said resources.

We are going through a resource-policy change process, not an "end of resources" process.

-My but that sounds awfully benign and bland in a policy paper sort of way.

Matter is neither created nor destroyed - it just changes form.

-Indeed, and all that oil we've used up has changed form into matter which is of absolutely no use.


Once policy aligns with resource availability constraints, all will be OK again. It will just take a massive loss of biological stock or a massive growing-up, or both, to accomplish it. I say it blithely, but this reality is what has made my last few years of unfolding realization so psychologically painful.

- A massive loss of biological stock? That's quite a euphemistic turn of phrase to describe a potential planet wide human die off.

Keeping it light and abstract, our society is at the point when one set of resource-utilization habits doesn't work any more, and we haven't identified nor widely adopted the set of habits that will work.

So, will the "paper money" process be replaced? Nope. Then what's the consequence of the massive mis-allocation I keep harping upon? People that are ignorant will get fleeced again, and the smart but greedy types will triumph again. The biosphere will continue to get hammered. This process will continue so long as people think it's a good idea to let others "take care of them" in the political and economic sense.

-To the extent that I agree with you, the fleecing you describe was possible when it was of a kinder and gentler variety, but the conditions that allowed it aren't likely to persist.

That, I think, is the habit that'll be hardest to break. The process of waking up and taking responsibility is really, really hard work.

-And pray tell, what, in a practical sense, amounts to "taking responsibility."

Thai said...

Hell, this is incredible. One thing that really stands out fro your charts is the speed and size the CDO market developed. Was there ever any other market in the history of the world that grew so large so fast? Conversely has any market ever shrunk from such heights so fast?

As I don't think uncertainty is ever going to diminish, and bubbles will always be inevitable, is this a taste of the shape and size of global financial bubbles of the future?

We are in for a wild future if it is.

Greenie said...

"A two-pronged approach is now needed to resolve the commodity bubble:

Both must be done at the same time, otherwise the imbalances will remain."

I would argue that it will die on its own.

Greenie said...

There are wars being fought on multiple fronts - peak debt versus peak oil, peak oil versus global warming. I am on the side that expects peak debt to win all other marginal conflicts.

Anonymous said...

Rachel:

You asked for clarification on some points I made. Your points in italics, my responses in regular font.


-I'd like to hear specifics regarding "vastly more productivity" You see, I am of the view that vast productivity is part of, and quite possibly, the problem in a global sense, as we humans are eating our way through the planet's resources with no ability to replace said resources.

Productivity, in my view, is getting more value from less inputs, or in the economic or environmental sense, cheaper inputs. Suppose we develop a solar cell and associated battery system so effective that it can capture and store enough power during the day to propel your car to and from work tomorrow. That's productivity. Productivity doesn't have to squander resources or damage the environment. Quite the opposite.

We are going through a resource-policy change process, not an "end of resources" process.

-My but that sounds awfully benign and bland in a policy paper sort of way.


It's neither benign nor bland. Humans don't like change, especially fast, wrenching change. The inevitable, and probably sudden upcoming resource policy shift (e.g. off fossil fuels fast) is going to be really rough on everyone. Yes, it is policy, and yes, it will likely be written on paper, but it's not going to be bland.

Matter is neither created nor destroyed - it just changes form.

-Indeed, and all that oil we've used up has changed form into matter which is of absolutely no use.


Right. Worse than useless; it's greenhouse gas.

- A massive loss of biological stock? That's quite a euphemistic turn of phrase to describe a potential planet wide human die off.

That's why I prefaced the remark with this:

"I say it blithely, but this reality is what has made my last few years of unfolding realization so psychologically painful."

-And pray tell, what, in a practical sense, amounts to "taking responsibility."

To me, taking responsibility means transcending our human limitations/tendencies at a velocity way past our comfort zone. Making decisions such as having (much) fewer kids, or consuming less stuff. Prioritizing environmental consequences before immediate comfort, gratification, of social needs.

It means using your head, figuring out what needs to get done, and doing it because it needs to get done, whether or not anyone's "looking". Practical things like figuring out a way to not commute, or riding your bike to work, or not use fertilizer on your yard, or using efficient light bulbs, or insulating your attic, etc.,

You set out some good push-back, Rachel. Now, I've got a question for you. If it's not innovation/productivity increases, or "taking responsibility" that avoids the big crackup, where are you expecting to get the massive change in world-wide human behavior necessary to dodge the bus that's headed our way?

OuterBeltway

Mitchell said...

Meanwhile CDSs have been shooting up.

Anonymous said...

Hell-

To continue your analogy, they will find a new source of revenue - they will make sausages out of beef, or opossum, or roadkill, or start making jerky or gyros.

Jason B

Thai said...

Well said Outerbeltway. And you didn't even push her on the issue of increased life expectancy.

And Hell, FYI, fish rot from their guts first, not their heads-- it took me a little while to verify the truth (having lost count of the number of dead people I have seen over the years, I had my suspicions you were wrong). As another interesting FYI, the proverb seems to have originated in Russia some time in the 1600s. It is an inaccurate metaphor; factually and (I think) figuratively also,

Edwardo said...

You set out some good push-back, Rachel. Now, I've got a question for you. If it's not innovation/productivity increases, or "taking responsibility" that avoids the big crackup, where are you expecting to get the massive change in world-wide human behavior necessary to dodge the bus that's headed our way?

Sorry for the confusion, but it's Edwardo that you are conversing with, but because I was on another computer my wife's handle was used to log on.

In any case, thanks for your thoughtful responses. Here's my answer to your question:

We won't dodge the bus, but if we are lucky, and it will be more luck than anything else, we won't be hit head on, but will suffer a glancing blow that while doing substantial damage won't do us in.

Individuals, and even small groups seem to be quite capable of the sorts of maneuvers you describe under the heading of "taking responsibility, but not whole societies. So, some unspecified portion of humanity will be spared the worst of what is in store, and the rest will not.

Anonymous said...

Hell,

What do you think the next hot product on Wall Street will be and could this potentially be the next 'bubble' asset class??

Anonymous said...

Hell,

What do you think the next hot product on Wall Street will be and could this potentially be the next 'bubble' asset class??

Hellasious said...

The next bubble is already forming and Wall Street is all over it: commodities and related fields (e.g. shipping, fertilizer, etc).

There are already plenty of financialized products in the sector, e.g. shipping futures and swaps - all OTC of course.

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