George Cole: WSJ 2/1/2000:" Long Economic Boom in Danger? "
February 1, 2000ÿ
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Why the Long Boom? It Owes
ÿÿÿÿÿÿÿÿÿÿÿÿÿ A Big Debt to Capital Markets
ÿÿÿÿÿÿÿÿÿÿÿÿÿ By JACOB M. SCHLESINGERÿ
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Staff Reporter of THE WALL STREET JOURNAL
ÿÿÿÿÿÿÿÿÿÿÿÿÿ WASHINGTON -- As the U.S. economy enters record
ÿÿÿÿÿÿÿÿÿÿÿÿÿ territory Tuesday -- beginning its 107th month of
ÿÿÿÿÿÿÿÿÿÿÿÿÿ uninterrupted expansion -- expect to hear a lot about
ÿÿÿÿÿÿÿÿÿÿÿÿÿ the usual heroes: new technologies (the microchip, the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Web); U.S. Federal Reserve Chairman Alan
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Greenspan; dumb luck.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ But with all due respect, it is time to give credit where
ÿÿÿÿÿÿÿÿÿÿÿÿÿ credit is due -- to something much harder to
ÿÿÿÿÿÿÿÿÿÿÿÿÿ appreciate than PCs and people. Thank the capital
ÿÿÿÿÿÿÿÿÿÿÿÿÿ markets.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Among all the factors bolstering America's economic
ÿÿÿÿÿÿÿÿÿÿÿÿÿ performance over the past nine years, a less-heralded
ÿÿÿÿÿÿÿÿÿÿÿÿÿ but equally crucial force has been the evolution in the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ way money flows from those who have it to those
ÿÿÿÿÿÿÿÿÿÿÿÿÿ who want it. This new economy, where financial risk
ÿÿÿÿÿÿÿÿÿÿÿÿÿ is swapped, shared and spread through manifold
ÿÿÿÿÿÿÿÿÿÿÿÿÿ channels, has more zip -- witness the explosion in
ÿÿÿÿÿÿÿÿÿÿÿÿÿ technology start-ups -- and it enjoys new protection
ÿÿÿÿÿÿÿÿÿÿÿÿÿ against the painful attacks that periodically afflicted
ÿÿÿÿÿÿÿÿÿÿÿÿÿ the old one.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Over the past decade, "we've developed a much more
ÿÿÿÿÿÿÿÿÿÿÿÿÿ stable financial system -- based almost entirely on
ÿÿÿÿÿÿÿÿÿÿÿÿÿ markets rather than banks," says Robert Hall, the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Stanford University economist who heads the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ committee of scholars who officially date business
ÿÿÿÿÿÿÿÿÿÿÿÿÿ cycles. That, he says, "turns out to be a much better
ÿÿÿÿÿÿÿÿÿÿÿÿÿ way to run things."
ÿÿÿÿÿÿÿÿÿÿÿÿÿ A Haunting Vulnerability
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Yet the same capital markets that have fed the boom
ÿÿÿÿÿÿÿÿÿÿÿÿÿ may also be planting the seeds of the next bust. For all
ÿÿÿÿÿÿÿÿÿÿÿÿÿ their advantages, derivatives and the other financial
ÿÿÿÿÿÿÿÿÿÿÿÿÿ tools of the new economy have injected
ÿÿÿÿÿÿÿÿÿÿÿÿÿ unprecedented leverage and complexity into the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ system -- elements that could transform a minor
ÿÿÿÿÿÿÿÿÿÿÿÿÿ economic dip into a calamity. That's why the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ stock-market jitters of late haunt celebrations of the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ record economic boom, raising fears that a mere
ÿÿÿÿÿÿÿÿÿÿÿÿÿ correction could spiral into something far worse.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ "Every time you solve one problem, you create a few
ÿÿÿÿÿÿÿÿÿÿÿÿÿ new ones," says Gary Gorton, a derivatives expert at
ÿÿÿÿÿÿÿÿÿÿÿÿÿ the University of Pennsylvania's Wharton School, who
ÿÿÿÿÿÿÿÿÿÿÿÿÿ warns of "new vulnerabilities in the system."
ÿÿÿÿÿÿÿÿÿÿÿÿÿ What's unnerving is that no one knows which forces
ÿÿÿÿÿÿÿÿÿÿÿÿÿ in this new financial world -- the stabilizing or the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ destabilizing -- will dominate. This grand experiment,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ conducted during a long period of tranquility, has yet
ÿÿÿÿÿÿÿÿÿÿÿÿÿ to be fully stress-tested.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ The signals from the biggest test to date -- when
ÿÿÿÿÿÿÿÿÿÿÿÿÿ problems in Asia and then Russia precipitated a crisis
ÿÿÿÿÿÿÿÿÿÿÿÿÿ in U.S. credit markets in the fall of 1998 -- are mixed.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ It is telling that the crisis was worsened by the bad
ÿÿÿÿÿÿÿÿÿÿÿÿÿ bets of financial whizzes and Nobel Prize-winning
ÿÿÿÿÿÿÿÿÿÿÿÿÿ economists at the Long-Term Capital Management
ÿÿÿÿÿÿÿÿÿÿÿÿÿ hedge fund -- a group of investors who, in theory,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ should have better understood the risks they were
ÿÿÿÿÿÿÿÿÿÿÿÿÿ taking. Yet a few months after President Clinton
ÿÿÿÿÿÿÿÿÿÿÿÿÿ declared "the worst financial crisis in half a century,"
ÿÿÿÿÿÿÿÿÿÿÿÿÿ market conditions had returned to normal with no
ÿÿÿÿÿÿÿÿÿÿÿÿÿ signs of lasting damage.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Indeed, America's capital markets appear to be
ÿÿÿÿÿÿÿÿÿÿÿÿÿ evolving into resilient animals. Traditional banking
ÿÿÿÿÿÿÿÿÿÿÿÿÿ has faded in importance, and savings-and-loans much
ÿÿÿÿÿÿÿÿÿÿÿÿÿ more so. Instead, even Americans of modest means
ÿÿÿÿÿÿÿÿÿÿÿÿÿ can enjoy the benefits of 401(k)s and home-equity
ÿÿÿÿÿÿÿÿÿÿÿÿÿ loans, while more sophisticated players use
ÿÿÿÿÿÿÿÿÿÿÿÿÿ derivatives, asset-backed securities, initial public
ÿÿÿÿÿÿÿÿÿÿÿÿÿ offerings and venture-capital funds to raise money and
ÿÿÿÿÿÿÿÿÿÿÿÿÿ to hedge their financial risks.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Technology is as much a
ÿÿÿÿÿÿÿÿÿÿÿÿÿ benefactor as a beneficiary
ÿÿÿÿÿÿÿÿÿÿÿÿÿ of the 1990s financial
ÿÿÿÿÿÿÿÿÿÿÿÿÿ revolution: The plunging
ÿÿÿÿÿÿÿÿÿÿÿÿÿ cost of computing power
ÿÿÿÿÿÿÿÿÿÿÿÿÿ has made it possible -- and
ÿÿÿÿÿÿÿÿÿÿÿÿÿ profitable -- to conduct
ÿÿÿÿÿÿÿÿÿÿÿÿÿ the countless calculations
ÿÿÿÿÿÿÿÿÿÿÿÿÿ that underlie new financial
ÿÿÿÿÿÿÿÿÿÿÿÿÿ products. Among the most
ÿÿÿÿÿÿÿÿÿÿÿÿÿ important of these tools
ÿÿÿÿÿÿÿÿÿÿÿÿÿ are derivatives -- contracts
ÿÿÿÿÿÿÿÿÿÿÿÿÿ that allow an investor to
ÿÿÿÿÿÿÿÿÿÿÿÿÿ buy protection from, or to gamble on, changes in the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ prices of stocks, bonds, currencies or just about
ÿÿÿÿÿÿÿÿÿÿÿÿÿ anything else. The "notional," or face, value of all
ÿÿÿÿÿÿÿÿÿÿÿÿÿ derivatives contracts outstanding at the middle of last
ÿÿÿÿÿÿÿÿÿÿÿÿÿ year was $92 trillion, according to Swaps Monitor, an
ÿÿÿÿÿÿÿÿÿÿÿÿÿ industry newsletter. That was nearly quadruple the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ $24.6 trillion outstanding at the end of 1992.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ For global companies, such instruments have become
ÿÿÿÿÿÿÿÿÿÿÿÿÿ essential for the smooth running of their operations.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Merck & Co., for instance, does about half its
ÿÿÿÿÿÿÿÿÿÿÿÿÿ business overseas, so the dollar's surge in the 1980s
ÿÿÿÿÿÿÿÿÿÿÿÿÿ "really put a crimp in the performance of the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ company" as the dollar value of foreign revenue fell,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ recalls Chief Financial Officer Judy Lewent. In
ÿÿÿÿÿÿÿÿÿÿÿÿÿ response, the New Jersey-based pharmaceutical
ÿÿÿÿÿÿÿÿÿÿÿÿÿ company was repeatedly forced into sudden cutbacks
ÿÿÿÿÿÿÿÿÿÿÿÿÿ in planned research and development spending and
ÿÿÿÿÿÿÿÿÿÿÿÿÿ capital investments.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Beginning in 1989, Merck started hedging against
ÿÿÿÿÿÿÿÿÿÿÿÿÿ foreign-exchange movements, a practice honed
ÿÿÿÿÿÿÿÿÿÿÿÿÿ throughout the decade. Thus, even as the dollar surged
ÿÿÿÿÿÿÿÿÿÿÿÿÿ against the euro last year, Ms. Lewent says, "we were
ÿÿÿÿÿÿÿÿÿÿÿÿÿ able to go through the year and continue our budget
ÿÿÿÿÿÿÿÿÿÿÿÿÿ commitments to our operating people."
ÿÿÿÿÿÿÿÿÿÿÿÿÿ The list of risks that derivatives allow companies to
ÿÿÿÿÿÿÿÿÿÿÿÿÿ insure themselves against keeps growing. Wichita,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Kan., energy company Koch Industries Inc. set up a
ÿÿÿÿÿÿÿÿÿÿÿÿÿ weather derivatives group about two years ago and
ÿÿÿÿÿÿÿÿÿÿÿÿÿ soon after started offering "temperature" hedges to
ÿÿÿÿÿÿÿÿÿÿÿÿÿ other energy providers. When a New England winter
ÿÿÿÿÿÿÿÿÿÿÿÿÿ is warmer than normal, participating utilities there can
ÿÿÿÿÿÿÿÿÿÿÿÿÿ receive a payout from Koch to ensure a steady
ÿÿÿÿÿÿÿÿÿÿÿÿÿ revenue stream. If the winter is colder than average,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ the firms pay Koch some of the windfall. Last
ÿÿÿÿÿÿÿÿÿÿÿÿÿ summer, Koch started offering derivatives based on
ÿÿÿÿÿÿÿÿÿÿÿÿÿ heat and rainfall that let amusement parks protect
ÿÿÿÿÿÿÿÿÿÿÿÿÿ against weather-related drops in business. This winter,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ it is peddling snowfall derivatives to ski resorts
ÿÿÿÿÿÿÿÿÿÿÿÿÿ worried about light accumulation.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Another important element of the financial revolution
ÿÿÿÿÿÿÿÿÿÿÿÿÿ has been the spread of asset-backed securities --
ÿÿÿÿÿÿÿÿÿÿÿÿÿ securities that banks and other lenders issue backed by
ÿÿÿÿÿÿÿÿÿÿÿÿÿ their own loan portfolios. In the third quarter of last
ÿÿÿÿÿÿÿÿÿÿÿÿÿ year, the total value of mortgage and other
ÿÿÿÿÿÿÿÿÿÿÿÿÿ asset-backed securities outstanding in the U.S. stood
ÿÿÿÿÿÿÿÿÿÿÿÿÿ at $2.96 trillion, according to the Bond Market
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Association trade group. That's up from $374.5
ÿÿÿÿÿÿÿÿÿÿÿÿÿ billion in 1985. The market was once dominated by
ÿÿÿÿÿÿÿÿÿÿÿÿÿ home mortgages, but has expanded to include
ÿÿÿÿÿÿÿÿÿÿÿÿÿ commercial mortgages, loans to business, credit cards
ÿÿÿÿÿÿÿÿÿÿÿÿÿ and auto loans.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Before asset-backed securities, or securitization, the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ heavy risk of lending used to land solely on the bank
ÿÿÿÿÿÿÿÿÿÿÿÿÿ making the loan. But when banks turn around and sell
ÿÿÿÿÿÿÿÿÿÿÿÿÿ their loans as securities, countless investors around
ÿÿÿÿÿÿÿÿÿÿÿÿÿ the world each take on a small portion of that risk.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ When oil prices plunged in the mid-1980s, many
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Texas drillers went bust, dragging a good number of
ÿÿÿÿÿÿÿÿÿÿÿÿÿ local creditors with them. "The lights went out at the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ local banks," says Jeffery Gunther, a researcher at the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ U.S. Federal Reserve Bank of Dallas. As a result,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ other businesses and households with no ties to the oil
ÿÿÿÿÿÿÿÿÿÿÿÿÿ industry "had a hard time getting credit."
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Today, however, if a major Texas borrower goes bust,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ "that property is just a $1,000 commercial
ÿÿÿÿÿÿÿÿÿÿÿÿÿ mortgage-backed security bond in some portfolio
ÿÿÿÿÿÿÿÿÿÿÿÿÿ manager's portfolio in Boston, and the rest of his
ÿÿÿÿÿÿÿÿÿÿÿÿÿ portfolio is fine," says Reilly Tierney, a research
ÿÿÿÿÿÿÿÿÿÿÿÿÿ analyst specializing in asset-backed securities for
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Fox-Pitt, Kelton Inc. in New York. "The risk is shared
ÿÿÿÿÿÿÿÿÿÿÿÿÿ among so many more risk-takers that people don't
ÿÿÿÿÿÿÿÿÿÿÿÿÿ stop lending."
ÿÿÿÿÿÿÿÿÿÿÿÿÿ The expansion of capital markets by such methods
ÿÿÿÿÿÿÿÿÿÿÿÿÿ means that the U.S. now has more of what Mr.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Greenspan calls "spare tires" in its financial system,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ with money available from many different types of
ÿÿÿÿÿÿÿÿÿÿÿÿÿ lenders and investors. That lowers the odds that any
ÿÿÿÿÿÿÿÿÿÿÿÿÿ one pothole -- a banking crisis, for example -- will
ÿÿÿÿÿÿÿÿÿÿÿÿÿ bring the economy to a screeching halt.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ When a real-estate bust forced U.S. banks to curtail
ÿÿÿÿÿÿÿÿÿÿÿÿÿ lending in 1990, "the then recently developed
ÿÿÿÿÿÿÿÿÿÿÿÿÿ mortgage-backed securities market kept residential
ÿÿÿÿÿÿÿÿÿÿÿÿÿ mortgage credit flowing, which in prior years would
ÿÿÿÿÿÿÿÿÿÿÿÿÿ have contracted sharply," the Fed Chairman noted in a
ÿÿÿÿÿÿÿÿÿÿÿÿÿ recent speech. "Without the capital-market backing,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ the mild recession of 1991 could have been far more
ÿÿÿÿÿÿÿÿÿÿÿÿÿ severe." Since then, those recession-damping markets
ÿÿÿÿÿÿÿÿÿÿÿÿÿ have grown even bigger and more sophisticated.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Many economists argue that the more evolved
ÿÿÿÿÿÿÿÿÿÿÿÿÿ financial markets are also better at nurturing new
ÿÿÿÿÿÿÿÿÿÿÿÿÿ companies with good ideas. Clubby bankers, who are
ÿÿÿÿÿÿÿÿÿÿÿÿÿ more likely to support large, established companies
ÿÿÿÿÿÿÿÿÿÿÿÿÿ than struggling start-ups, have less control over
ÿÿÿÿÿÿÿÿÿÿÿÿÿ capital. Venture capitalists, eager to find the next
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Netscape, have more.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Investments by venture-capital funds reached $28.6
ÿÿÿÿÿÿÿÿÿÿÿÿÿ billion in the first nine months of 1999, compared
ÿÿÿÿÿÿÿÿÿÿÿÿÿ with $5.8 billion for all of 1995, according to Boston
ÿÿÿÿÿÿÿÿÿÿÿÿÿ research firm Venture Economics. Such investments
ÿÿÿÿÿÿÿÿÿÿÿÿÿ have fueled the rise of purveyors and users of untested
ÿÿÿÿÿÿÿÿÿÿÿÿÿ technologies, such as Amazon.com. Venture capital
ÿÿÿÿÿÿÿÿÿÿÿÿÿ and initial public offerings have also helped keep
ÿÿÿÿÿÿÿÿÿÿÿÿÿ various product markets competitive by providing
ÿÿÿÿÿÿÿÿÿÿÿÿÿ quick funding for new rivals to domineering giants.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Hot IPOs last year bolstered bids by VA Linux
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Systems Inc. and one of its distributors, Red Hat Inc.,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ to chip away at Microsoft Corp.'s operating-system
ÿÿÿÿÿÿÿÿÿÿÿÿÿ monopoly.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Still, while the broader, deeper capital markets of
ÿÿÿÿÿÿÿÿÿÿÿÿÿ recent years shift and spread risk, they don't eliminate
ÿÿÿÿÿÿÿÿÿÿÿÿÿ it. And indeed, in some areas, they seem to be creating
ÿÿÿÿÿÿÿÿÿÿÿÿÿ new dangers.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ For one, while the new instruments allow some
ÿÿÿÿÿÿÿÿÿÿÿÿÿ players to reduce their risk, they have also multiplied
ÿÿÿÿÿÿÿÿÿÿÿÿÿ the opportunities for others to gamble. Derivatives
ÿÿÿÿÿÿÿÿÿÿÿÿÿ often are a zero-sum game: For every global company
ÿÿÿÿÿÿÿÿÿÿÿÿÿ hedging against currency movements and every
ÿÿÿÿÿÿÿÿÿÿÿÿÿ amusement park hedging against light snow, there
ÿÿÿÿÿÿÿÿÿÿÿÿÿ typically is someone willing to bet on the opposite
ÿÿÿÿÿÿÿÿÿÿÿÿÿ outcome.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ And many of these bets are highly leveraged, meaning
ÿÿÿÿÿÿÿÿÿÿÿÿÿ the amounts invested represent only a small fraction
ÿÿÿÿÿÿÿÿÿÿÿÿÿ of the potential loss on the investment. When hedging
ÿÿÿÿÿÿÿÿÿÿÿÿÿ against adverse changes in interest rates, or a drop in
ÿÿÿÿÿÿÿÿÿÿÿÿÿ the value of the Standard & Poor's 500-stock index,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ an investor often doesn't put down upfront anything
ÿÿÿÿÿÿÿÿÿÿÿÿÿ close to the full value of what is being hedged. That
ÿÿÿÿÿÿÿÿÿÿÿÿÿ makes such transactions potentially far more
ÿÿÿÿÿÿÿÿÿÿÿÿÿ calamitous for investors than deals fully paid-for: A
ÿÿÿÿÿÿÿÿÿÿÿÿÿ wrong bet can mean having to cough up many times
ÿÿÿÿÿÿÿÿÿÿÿÿÿ more than the initial investment.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ An Alarming Spread
ÿÿÿÿÿÿÿÿÿÿÿÿÿ The expansion of stock ownership -- to nearly 50% of
ÿÿÿÿÿÿÿÿÿÿÿÿÿ American households in 1998 from 32% in 1989 --
ÿÿÿÿÿÿÿÿÿÿÿÿÿ through the spread of 401(k)s and mutual funds, as
ÿÿÿÿÿÿÿÿÿÿÿÿÿ well as direct investment, has yielded annual
ÿÿÿÿÿÿÿÿÿÿÿÿÿ double-digit returns for the masses, but also has
ÿÿÿÿÿÿÿÿÿÿÿÿÿ exposed more people to risk.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ High risk is one reason why IPOs have traditionally
ÿÿÿÿÿÿÿÿÿÿÿÿÿ been the preserve of institutional investors and
ÿÿÿÿÿÿÿÿÿÿÿÿÿ wealthy individuals. No more. Last spring, for
ÿÿÿÿÿÿÿÿÿÿÿÿÿ example, Friedman, Billings, Ramsey Group Inc., of
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Arlington, Va., launched a drive to "put the public
ÿÿÿÿÿÿÿÿÿÿÿÿÿ back in initial public offerings" with an online
ÿÿÿÿÿÿÿÿÿÿÿÿÿ investment bank that allows the little guys -- people
ÿÿÿÿÿÿÿÿÿÿÿÿÿ making as little as $50,000 a year -- to buy into some
ÿÿÿÿÿÿÿÿÿÿÿÿÿ of the start-ups the firm underwrites.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Fbr.com (www.fbr.com) estimates that such
ÿÿÿÿÿÿÿÿÿÿÿÿÿ "mid-networth individuals" snapped up 20% of the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ 3.3 million shares in the IPO of NetCreations, a New
ÿÿÿÿÿÿÿÿÿÿÿÿÿ York e-mail marketer that went public in November.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ (Fbr officials say they screen potential investors and
ÿÿÿÿÿÿÿÿÿÿÿÿÿ reject bids from those who seem inappropriate for the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ IPO, based on net worth, investment experience and
ÿÿÿÿÿÿÿÿÿÿÿÿÿ investment goals.)
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Stock investors are borrowing at record levels, too.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Margin debt -- loans issued by brokers to clients to
ÿÿÿÿÿÿÿÿÿÿÿÿÿ buy stock -- hit a record $228.5 billion last year,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ nearly doubling from 1998. At a congressional
ÿÿÿÿÿÿÿÿÿÿÿÿÿ hearing last week, Mr. Greenspan said the Fed was
ÿÿÿÿÿÿÿÿÿÿÿÿÿ growing worried about the recent jump in leverage
ÿÿÿÿÿÿÿÿÿÿÿÿÿ fueling the stock market. "We're doing a good deal of
ÿÿÿÿÿÿÿÿÿÿÿÿÿ thinking about the whole process," he said.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ The ever-increasing complexity of choices makes it
ÿÿÿÿÿÿÿÿÿÿÿÿÿ hard for even the most sophisticated investors to
ÿÿÿÿÿÿÿÿÿÿÿÿÿ understand what they are buying. Consider the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ derivatives debacles of '90s: Orange County, Calif.;
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Procter & Gamble; Barings PLC, among other
ÿÿÿÿÿÿÿÿÿÿÿÿÿ victims. Orange County and P&G accused their
ÿÿÿÿÿÿÿÿÿÿÿÿÿ bankers, Merrill Lynch & Co. and Bankers Trust New
ÿÿÿÿÿÿÿÿÿÿÿÿÿ York Corp., respectively, of misleading them about
ÿÿÿÿÿÿÿÿÿÿÿÿÿ the amount of risk involved in their complicated
ÿÿÿÿÿÿÿÿÿÿÿÿÿ investments. Orange County Treasurer Robert Citron
ÿÿÿÿÿÿÿÿÿÿÿÿÿ and 28-year-old Barings trader Nicholas Leeson were
ÿÿÿÿÿÿÿÿÿÿÿÿÿ lured by the prospect of ultrahigh returns, and were
ÿÿÿÿÿÿÿÿÿÿÿÿÿ able to hide from overseers the perils of their
ÿÿÿÿÿÿÿÿÿÿÿÿÿ strategies.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Just last week, the Bank for International Settlements,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ the Switzerland-based consortium of the world's
ÿÿÿÿÿÿÿÿÿÿÿÿÿ major central banks, issued a report fretting that banks
ÿÿÿÿÿÿÿÿÿÿÿÿÿ were once again letting standards slip in lending to
ÿÿÿÿÿÿÿÿÿÿÿÿÿ hedge funds, after a brief period of tightening
ÿÿÿÿÿÿÿÿÿÿÿÿÿ following the Long-Term Capital Management fiasco.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ "Many banks remain keen to trade" with hedge funds,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ the report said. "Business levels could increase again
ÿÿÿÿÿÿÿÿÿÿÿÿÿ without appropriate changes in risk management."
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Herd Mentality
ÿÿÿÿÿÿÿÿÿÿÿÿÿ The growing role of market-based financing means
ÿÿÿÿÿÿÿÿÿÿÿÿÿ large sectors of the economy now are susceptible to
ÿÿÿÿÿÿÿÿÿÿÿÿÿ mass mood swings. That's what happened with
ÿÿÿÿÿÿÿÿÿÿÿÿÿ emerging markets in 1997 and 1998, when shaky
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Russia was showered with funds during the bull
ÿÿÿÿÿÿÿÿÿÿÿÿÿ market, and even stable economies such as Mexico
ÿÿÿÿÿÿÿÿÿÿÿÿÿ got trampled on during the retreat.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ The breadth of the markets makes it harder for
ÿÿÿÿÿÿÿÿÿÿÿÿÿ regulators and leading financiers to contain the
ÿÿÿÿÿÿÿÿÿÿÿÿÿ damage. Robert Rubin, a former Goldman, Sachs &
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Co. co-chairman, a former Treasury secretary and
ÿÿÿÿÿÿÿÿÿÿÿÿÿ currently an executive at Citigroup Inc., recalls a
ÿÿÿÿÿÿÿÿÿÿÿÿÿ crucial step in limiting the fallout from the Asia
ÿÿÿÿÿÿÿÿÿÿÿÿÿ crisis: phoning a handful of top bankers on Christmas
ÿÿÿÿÿÿÿÿÿÿÿÿÿ Eve and persuading them to roll over outstanding
ÿÿÿÿÿÿÿÿÿÿÿÿÿ loans to South Korea.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ That agreement prevented Seoul from defaulting, an
ÿÿÿÿÿÿÿÿÿÿÿÿÿ event that Mr. Rubin believes could have triggered a
ÿÿÿÿÿÿÿÿÿÿÿÿÿ world financial crash. The agreement was made
ÿÿÿÿÿÿÿÿÿÿÿÿÿ possible by the fact that South Korea still depended
ÿÿÿÿÿÿÿÿÿÿÿÿÿ largely on a relatively small number of banks --
ÿÿÿÿÿÿÿÿÿÿÿÿÿ something that is becoming less and less common as
ÿÿÿÿÿÿÿÿÿÿÿÿÿ capital markets become more dominant.
ÿÿÿÿÿÿÿÿÿÿÿÿÿ "You used to be able to organize a relatively small
ÿÿÿÿÿÿÿÿÿÿÿÿÿ number of banks in order to develop some kind of
ÿÿÿÿÿÿÿÿÿÿÿÿÿ temporary relief so the banking system could work
ÿÿÿÿÿÿÿÿÿÿÿÿÿ through its problems," Mr. Rubin says. With banks
ÿÿÿÿÿÿÿÿÿÿÿÿÿ increasingly replaced by millions of bondholders,
ÿÿÿÿÿÿÿÿÿÿÿÿÿ "there's no equivalent way to organize the creditors,"
ÿÿÿÿÿÿÿÿÿÿÿÿÿ he says. "There's no way to organize a standstill that
ÿÿÿÿÿÿÿÿÿÿÿÿÿ might prevent things from cratering."
TA
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To: heinz blasnik who wrote (38661)
ÿÿÿÿ From: George S. Cole
ÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿ Monday, Jan 31, 2000 ÿ9:54 AM ET
ÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿ Reply #ÿ of 38735
ÿÿÿ From Morgan Stanley This Morning.ÿ
ÿÿÿ They see yield curve inversion as primarily technical and NOT signalling a slowdown in the economy or a significant bond rally.
ÿÿÿ Global: Tick Tock
ÿÿÿ Stephen Roach (New York)
ÿÿÿ Turn off the snooze button. The unmistakable sound of the cyclical clock is growing louder. Central
ÿÿÿ banks around the world are awakening from their long slumber. That?s especially the case in a fully
ÿÿÿ employed US economy, which is about to enter a record 107th month of uninterrupted expansion.
ÿÿÿ But it?s also the case elsewhere around the world. The challenge for world financial markets is to find
ÿÿÿ value in an era of monetary tightening. I continue to believe that will prove to be a much tougher task
ÿÿÿ for investors in 2000 than it was in the preceding four years.ÿ
ÿÿÿ The crux of financial market tension is in the United States, heretofore the leader in the global
ÿÿÿ economy. New economy or not, the debate in America is boiling down to the time-honored tradeoff
ÿÿÿ between growth and inflation. And for the first time since 1994, there is now a legitimate case for an
ÿÿÿ inflation scare. Upside surprises to 4Q99 reports on the Employment Cost Index (+1.1%) and the
ÿÿÿ broadly based GDP price index (+2.0%) cannot be taken lightly in this regard. Nor can the flagrant
ÿÿÿ overshoot of US economic growth -- average annualized gains of 5.75% in the final half of 1999, the
ÿÿÿ strongest six-month increase in 15 years. On the heels of such momentum, Dick Berner has raised
ÿÿÿ his US growth forecast for 2000 to 4.3% (from 4.0%), his third such upward revision in four
ÿÿÿ months. This is precisely the cyclical outcome that leaves the Federal Reserve with little choice. There
ÿÿÿ is no traction whatsoever between its sole policy instrument -- the real federal funds rate -- and the
ÿÿÿ real economy. A multi-stage Fed tightening is the only appropriate response.ÿ
ÿÿÿ A similar verdict is evident in Euroland, albeit in a very different context. Compared with classic
ÿÿÿ late-cycle pressures now evident in the US, inflation risks are far more muted in an early-cycle
ÿÿÿ Euroland economy. Even so, Joachim Fels argues that there is now good reason to believe that
ÿÿÿ Euroland price stability is in jeopardy. That?s certainly the message that comes through on several
ÿÿÿ different fronts -- accelerating money-supply growth; the euro?s breach of the
ÿÿÿ psychologically-important parity barrier; signs that headline inflation are about to pierce the 2%
ÿÿÿ threshold; and risks that aggressive wage demands in Germany?s IG Metall union could set in
ÿÿÿ motion a classic wage-price spiral. In the end, credibility is a central bank?s most potent weapon. For
ÿÿÿ the newly constituted ECB, the time to establish credibility is now at hand. This will also take a
ÿÿÿ multi-stage monetary tightening, in our view.ÿ
ÿÿÿ Elsewhere in the world, our economists have reached similar conclusions with respect to central banks
ÿÿÿ in the United Kingdom, Canada, Australia, and Sweden. With inflation risks in these countries tipping
ÿÿÿ to the upside, short-term real interest rates seem likely to follow. The questions increasingly boil
ÿÿÿ down to timing and the cumulative magnitude of such actions. Japan remains the notable outlier in all
ÿÿÿ this. Despite a global economy that continues to play to the upside of our own above-consensus
ÿÿÿ growth prognosis, the data flow coming out of Japan still conforms nicely with Robert Feldman?s
ÿÿÿ below-consensus growth prognosis. December?s household surveys were particularly disconcerting
ÿÿÿ in this regard, underscoring the distinct possibility of renewed weakening in Japanese consumer
ÿÿÿ demand in 4Q99. This will make it all the more difficult for the Bank of Japan to move away from its
ÿÿÿ zero-interest-rate policy -- leaving the BOJ increasingly isolated vis a vis the world?s other major
ÿÿÿ central banks. Japan continues to run against the grain of an otherwise synchronous global business
ÿÿÿ cycle.ÿ
ÿÿÿ Many are now arguing that our scenario is now "old news" -- or essentially in the market. Yield
ÿÿÿ curves do appear to have discounted multi-stage monetary tightenings by most central banks, and
ÿÿÿ long-term interest rates have even started to rally in anticipation of the coming slowdown that such a
ÿÿÿ policy response implies. This is all too cute for me. For starters, it is important to remember the
ÿÿÿ outcome of the slowdown bet over the past several years: It has failed miserably, especially in the
ÿÿÿ United States. Second, I concur with David Greenlaw and see no economic or policy significance to
ÿÿÿ the recent inversion at the long end of the US Treasury yield curve; instead, it reflects more of a
ÿÿÿ supply-demand imbalance at the 30-year end of the maturity spectrum rather than a US economy that
ÿÿÿ is about to falter. Indeed, long-term real interest rates (for a 10-year TIPS) have held relatively steady
ÿÿÿ at 4.3% during this inversion, suggesting that the bulk of the rally is coming more from a reduction in
ÿÿÿ inflationary expectations than from a rethinking of economic growth prospects. This is very much at
ÿÿÿ odds with evidence increasingly in support of an inflation scare -- underscoring our view that the
ÿÿÿ yield curve inversion is more technical than fundamental. In my view, barring a spontaneous collapse
ÿÿÿ in equity markets, a sustained rally in global bond markets is unlikely; after all, it?s early in the
ÿÿÿ monetary tightening cycle and global growth is still surging to the upside.ÿ
ÿÿÿ In the end, world stock markets probably hold the trump card for an increasingly wealth-dependent
ÿÿÿ global economy. Just when most timeworn valuation models have been discarded, global equity
ÿÿÿ investors are starting to tremble at the possibility of fighting the Gang of Five -- the Fed, the ECB, the
ÿÿÿ Bank of England, the Bank of Canada, and the Reserve Bank of Australia. In recent years,
ÿÿÿ accommodative central banks have largely abdicated control over their real economies and financial
ÿÿÿ markets. The task now at hand is for them is to regain that control. And equity investors are just
ÿÿÿ starting to figure out what that means: Not only are they faced with the macro tradeoff between
ÿÿÿ volume growth and margin pressures, but they are also staring at much tougher comparisons from
ÿÿÿ elevated bond yields. The hope, of course, is that a spontaneous rally in global bond markets will save
ÿÿÿ the day -- resetting the valuation clock and bringing dip buyers back in with a vengeance. While
ÿÿÿ that?s the way it?s worked out for several years, I fear that another timepiece will shape the ultimate
ÿÿÿ outcome. The cyclical clock is ticking. Don?t roll over and go back to sleep. |
