*michael parekh on IT*

ON RISKS OF A DOLLAR CARRY TRADE

SLIP-SLIDING AWAY

Barron's this weekend has a piece that may make one's head hurt at first reading, but is important enough to read twice.  Appropriately titled "Money for nothing and bucks for free", the piece makes the following point:

"The dollar could become the main funding source for the carry trade. To review, the carry trade consists of borrowing cheaply to invest in something with a higher return. ("Carry" in this instance refers to the cost of holding or "carrying" an inventory, be it a commodity or a security, which mainly consists of financing charges.)

The preferred way to fund the carry trade had been to borrow in yen, where the cost is near zero. Those yen could be converted into anything with a higher yield, such as U.S. mortgage-backed securities, to garner the spread.

The key risk -- aside from the loss of value of the asset being bought, as with any purchase on margin -- was that the cost of the liability would increase. That would happen with a rise in the yen in this case. And, not coincidentally, the yen rose in tandem with the dollar as carry traders had to unwind their positions during the crisis.

Now, with the Fed pinning the federal funds rate near zero and market rates -- such as the Libor, the London interbank offered rate, a money-market benchmark -- returning to their pre-Lehman collapse relationships versus the Fed's target, borrowing in dollars to fund carry trades looks tempting.

Remember, one of the big risks of a cross-border carry trade is if exchange rates bite you. But what's the risk of borrowing dollars at less than 1% if the U.S. currency's trend is down? Then you're effectively paid to borrow."

Why is this something to potentially worry about?  Well, it puts the Fed in a bit of a difficult position:

"America...still has a substantial current-account deficit that has to be financed with capital inflows. Outflows, as to finance dollar carry trades, would increase the need to attract capital inflows, which would put added downward pressure on the greenback.

Pomboy posits this could potentially lead to the return of such contrivances as the interest-equalization tax, a levy introduced in the 1960s to deter such outflows of capital.

Stanching the free flow of capital would be 21st century equivalent of the infamous Smoot-Hawley tariff, which importantly contributed to the contraction of global trade in the Great Depression..."

In choosing between the lesser of two evils, they may opt to allow the dollar to fall rather than impose draconian measures to curb dollar selling or deflating the economy to defend the exchange rate, the traditional medicine.

Then the response of other countries will be key. Do they permit an appreciation of their currencies, which would hurt their export competitiveness? Or do they follow the dollar's decline?

So far, equity markets have viewed the dollar's slide benignly. Stock investors haven't looked beyond the positive impact of exchange-rate moves on earnings of the Standard & Poor's 500.

But as the world sees a lower dollar as a one-way bet, it will be hard to stop."

Good point to keep in mind, especially for financial worry-warts.

* Image source.

ON A HISTORIC SILK ROAD SPOT

CHANGING TIMES

One of the most memorable places I've had the opportunity to visit over the years is the ancient town of "Kashgar in the western-most regions of China.  As this New York Times article earlier this week explains:

A thousand years ago, the northern and southern branches of the Silk Road converged at this oasis town near the western edge of the Taklamakan Desert.
Traders from Delhi and Samarkand, wearied by frigid treks through the world’s most daunting mountain ranges, unloaded their pack horses here and sold saffron and lutes along the city’s cramped streets.
Chinese traders, their camels laden with silk and porcelain, did the same.
The traders are now joined by tourists exploring the donkey-cart alleys and mud-and-straw buildings once window-shopped, then sacked, by Tamerlane and Genghis Khan.

Now, Kashgar is about to be sacked again."

The piece goes on to explain how this historic town is likely to be changed forever as the central government in Beijing moves forward with it's plans to make the town's residents "earthquake proof" by essentially razing the many parts of Kashgar that make it so special for visitors and those interested in preserving history.

"Over the next few years, city officials say, they will demolish at least 85 percent of this warren of picturesque, if run-down homes and shops. Many of its 13,000 families, Muslims from a Turkic ethnic group called the Uighurs (pronounced WEE-gurs), will be moved.

In its place will rise a new Old City, a mix of midrise apartments, plazas, alleys widened into avenues and reproductions of ancient Islamic architecture “to preserve the Uighur culture,” Kashgar’s vice mayor, Xu Jianrong, said in a phone interview.

Demolition is deemed an urgent necessity because an earthquake could strike at any time, collapsing centuries-old buildings and killing thousands. “The entire Kashgar area is in a special area in danger of earthquakes,” Mr. Xu said."

Some of the motivation here at the highest levels of the Chinese government may be to control and contain some of the separatist efforts in recent years to carve out a more independent identity for the region.  The piece is worth reading in it's entirety.
The place is not very critical in the global scheme of things.  But once visited, it remains etched as a very special place in history.  Here's hoping some of Kashgar is preserved for generations to come.

ON UNSTRESSFUL STRESS TESTS

PASS PASS
One of the best explanations of the recent Bank "Stress Tests" by the U.S. Treasury, comes not from a mainstream new outlet, but a mainstream TV comedy show. 
Specifically, Saturday Night Live hits it out of the park with it's take and analysis of these stress tests.  Check it out here, and see what you think:
Now CNNMoney took a similar approach with it's story on the stress tests titled "Bank Stress Tests:  Everybody gets an A!". 
But somehow SNL's take doesn't make one cry as much.

ON POLITICS OF CAP & TRADE

HORSE TRADING

This New York Times piece asks some timely questions about one of the most popular tools in the government's tool chest to address global warming:

"How did cap and trade, hatched as an academic theory in obscure economic journals half a century ago, become the policy of choice in the debate over how to slow the heating of the planet? And how did it come to eclipse the idea of simply slapping a tax on energy consumption that befouls the public square or leaves the nation hostage to foreign oil producers?"

And goes on to provide a not too surprising answer:

"The answer is not to be found in the study of economics or environmental science, but in the realm where most policy debates are ultimately settled: politics.

Many members of Congress remember the painful political lesson of 1993, when President Bill Clinton proposed a tax on all forms of energy, a plan that went down to defeat and helped take the Democratic majority in Congress down with it a year later.

Cap and trade, by contrast, is almost perfectly designed for the buying and selling of political support through the granting of valuable emissions permits to favor specific industries and even specific Congressional districts. That is precisely what is taking place now in the House Energy and Commerce Committee, which has used such concessions to patch together a Democratic majority to pass a far-reaching bill to regulate carbon emissions through a cap-and-trade plan.

The bill is poised to win committee approval this week, although with virtually no support from Republicans."

Ironic since the whole thing really got going in a Republican administration:

"If there was a single moment when cap and trade crossed the threshold from relatively untested economic concept to prevailing government policy, it came in May 1989 in the West Wing office of C. Boyden Gray, counsel to President George H. W. Bush."

The piece makes for compelling reading on the unintended consequences of some initially far-fetched ideas.  Especially since it looks like it'll be even more of a reality for all of us in not too long.

* Image source.

ON ANECDOTES OF A TRADE WAR

IT'S BEGUN
One of the scariest headlines of the week has nothing to do with unrest in a nuclear Pakistan, rising challenges for the U.S. in Afghanistan, or increasing violence in Iraq.  Instead, it's this story in the Washington Post, titled "Trade Wars launched with ruses, end runs", indicating that the global race to the bottom in a back-door trade war may have begun:

"Is this what the first trade war of the global economic crisis looks like?

Ordered by Congress to "buy American" when spending money from the $787 billion stimulus package, the town of Peru, Ind., stunned its Canadian supplier by rejecting sewage pumps made outside of Toronto. After a Navy official spotted Canadian pipe fittings in a construction project at Camp Pendleton, Calif., they were hauled out of the ground and replaced with American versions. In recent weeks, other Canadian manufacturers doing business with U.S. state and local governments say they have been besieged with requests to sign affidavits pledging that they will only supply materials made in the USA.

Outrage spread in Canada, with the Toronto Star last week bemoaning "a plague of protectionist measures in the U.S." and Canadian companies openly fretting about having to shift jobs to the United States to meet made-in-the-USA requirements. This week, the Canadians fired back. A number of Ontario towns, with a collective population of nearly 500,000, retaliated with measures effectively barring U.S. companies from their municipal contracts -- the first shot in a larger campaign that could shut U.S. companies out of billions of dollars worth of Canadian projects."

The piece goes on to tell tales of unintended consequences unleashed by the politics of government bank bailouts across the world:

"The United States is not alone in throwing up domestic policies assailed by critics as protectionist. Britain and the Netherlands, for instance, are forcing banks receiving taxpayer bailouts to jump-start lending at home at the expense of overseas clients. French President Nicolas Sarkozy initially insisted that his nation's automakers move manufacturing jobs home in exchange for a government bailout, but backed down after outrage surged among his peers in the European Union, of which France is a central member."

These trends seem to be accelerating, at least in an anecdotal form.  It shouldn't be too long before we see the consequences of our best intentions in national and international economic statistics start to pile up.

ON THE FOUNDATION OF GREEN SHOOTS

HOPE SPRINGS ETERNAL

Long-time former editor of Barron's, Alan Abelson, has always had a way with words.  This weekend he does it even better than usual, talking about the current  ebullience in the stock markets, in a piece entitled "A Surge in Botanists":

"...not only are things getting worse more slowly, but equally as important in the remarkable revival of euphoria is that investors en masse, taking a leaf from Federal Reserve Chairman Ben Bernanke, have become budding botanists, able to espy green shoots of recovery in virtually every compost pile..."

He then goes on to add,

"PERHAPS THE MOST ELOQUENT expression of how delusional Wall Street has become was its response to Friday's report on what happened to employment -- or, more importantly, unemployment -- in April. Payrolls shriveled by 539,000, less than the 550,000 to 600,000 guesstimates of the seers as well as March's initial tally of 633,000. That was enough for the choristers to start humming Happy Days Are Here Again.

A slightly more careful look suggests rather emphatically that they're not. The unemployment rate extended its doleful rise, hitting 8.9%, the highest level since 1983. The jobless ranks have swollen by 5.7 million since the recession got underway in December 2007, and there are now 13.7 million people out of work.

Moreover, our favorite measure of unemployment -- favorite because we think it a truer gauge -- is the Bureau of Labor Statistics' U-6, which includes the likes of workers laboring part-time because they can't land full-time jobs, rose to a fresh peak of 15.8%. That means 24.7 million people are effectively unemployed. It's a figure that doesn't get too much notice -- maybe it's just too depressing -- but it should.

For that matter, bad as it is, 539,000 doesn't do justice to the severity of the payroll shrinkage. For one thing, it was puffed up by the 72,000 federal census takers signed on by Uncle Sam. And for another, it includes 226,000 supposed jobs, or 60,000 properly adjusted, courtesy of what David Rosenberg calls the Alice-in-Wonderland birth/death model. Ex this pair of extraordinary items, he points out, the headline number would approach 670,000.

In one of his valedictory scribblings (David's leaving Merrill Lynch and returning to the glories of his native Canada and money management), he also notes that private-sector employment sank by 611,000 in April, and did so across a wide swath. "The data," he contends, "just don't square with the conventional wisdom permeating the investment landscape."

And then finishes it off with this bit on another way to look at "green shoots" going forward:

"Looking ahead, David scoffs at the idea that the "jobs data are about to get better because the markets have enjoyed a nice two-month rally." Among the reasons he's skeptical: the still record-low workweek, at 33.2 hours; the 66,000 downward revision to the back data (which, he avers, tends to feed on itself); the 63,000 slide in temp-agency employment; and the high levels of both initial and continuing jobless claims.

All of which, he believes, foreshadow a further 550,000 payroll plunge when the May data roll out early next month.

To David, as to us, the present buoyant mood on the Street is obviously more the result of rose-colored glasses than of green shoots."

One must always try to be an optimist, but not forget to also be a bit of a pragmatist, and not over-shoot on green shoots.

* Image source.

ON A KEY LEHMAN RIDE

PUNCHY TIMES

Reading this article titled "How Lehman Brothers got it's real estate fix", one gets a clearer sense of how companies can be caught up in the thrill of a chase, just like people.  The New York Times piece chronicles the up and down cycle of Lehman's real estate infatuation, lead by 49-year old Mark Walsh:

"Many factors, of course, contributed to Lehman’s demise last fall. Near the end, it carried $25 billion in toxic residential mortgages.

It was wildly overleveraged. And the federal government made the fateful decision not to rescue Lehman from its mistakes. But when real estate overheated in the years before Lehman’s implosion, Mr. Walsh made billions of dollars in loans and equity investments that also ultimately helped bring down the bank."

There are compelling anecdotes that make up the story, including how premier Manhattan buildings like the Chrysler building were bought and sold at ever increasing prices.  The whole piece needs to be read to get the full impact, but here's one that hits home:

"Developers also loved the fact that Mr. Walsh was willing to lend them enormous sums. In 1997, Barry Sternlicht, then the chief executive of Starwood Hotels and Resorts, needed $7 billion to buy ITT.

“I called up Mark and Goldman Sachs and said, ‘Would you be interested?’ ” he recalls. “Goldman said they were. They came to see us. But we needed to get it done really quickly. Mark said, ‘Yeah, we’ll do it.’ I said, ‘Really? You are going to do it yourselves?’ He said, ‘Yup.’ ”

Mr. Sternlicht says Mr. Walsh brought Mr. Fuld (then Lehman CEO) himself to a meeting at the hotelier’s home to assure him that Lehman would back his acquisition. “Dick Fuld sat there in my living room and said: ‘You have our word. We’ll get this done,’ ” Mr. Sternlicht recalls.
“We paid a $20 million fee. I was never so happy paying a fee.” Mr. Fuld declined to be interviewed for this article."

And then one much later:

"SOON after Lehman’s bankruptcy, a former executive who declined to be identified because he wasn’t authorized to speak publicly about his time at the firm went to Mr. Walsh’s office to talk. But they sat in silence. After two minutes, the executive left. “It became clear that neither one of us was going to say something that the other didn’t already know, or that we were going to actually have a new idea or bring greater clarity to the situation,” he recalls."

That's going to make one heck of an ending scene in the movie. 
Fade to black.

ON EDUCATION IN PAKISTAN

ROOT CAUSES

There is an eye-opening story in the New York Times today on the state of education in Pakistan.  It matters to us for a whole host of reasons, not the least of it being that we may bear some responsibility for it.  First the context:

"...the state has forgotten the children here, the mullahs have not. With public education in a shambles, Pakistan’s poorest families have turned to madrasas, or Islamic schools, that feed and house the children while pushing a more militant brand of Islam than was traditional here.

The concentration of madrasas here in southern Punjab has become an urgent concern in the face of Pakistan’s expanding insurgency. The schools offer almost no instruction beyond the memorizing of the Koran, creating a widening pool of young minds that are sympathetic to militancy.

In an analysis of the profiles of suicide bombers who have struck in Punjab, the Punjab police said more than two-thirds had attended madrasas."

Bear in mind that the word "Madrasa" used in the piece simply means "School" in Arabic.  It's being used incorrectly here to refer to Islamic schools.
That aside, the piece does make some sobering points:

"President Obama said in a news conference last week that he was “gravely concerned” about the situation in Pakistan, not least because the government did not “seem to have the capacity to deliver basic services: schools, health care, rule of law, a judicial system that works for the majority of the people.”

He has asked Congress to more than triple assistance to Pakistan for nonmilitary purposes, including education. Since the Sept. 11 attacks, the United States has given Pakistan a total of $680 million in nonmilitary aid, according to the State Department, far lower than the $1 billion a year for the military.

But education has never been a priority here, and even Pakistan’s current plan to double education spending next year might collapse as have past efforts, which were thwarted by sluggish bureaucracies, unstable governments and a lack of commitment by Pakistan’s governing elite to the poor.

“This is a state that never took education seriously,” said Stephen P. Cohen, a Pakistan expert at the Brookings Institution. “I’m very pessimistic about whether the educational system can or will be reformed...”

"...Literacy in Pakistan has grown from barely 20 percent at independence 61 years ago, and the government recently improved the curriculum and reduced its emphasis on Islam.

Failures in Education

But even today, only about half of Pakistanis can read and write, far below the proportion in countries with similar per-capita income, like Vietnam. One in three school-age Pakistani children does not attend school, and of those who do, a third drop out by fifth grade, according to Unesco. Girls’ enrollment is among the lowest in the world, lagging behind Ethiopia and Yemen.

“Education in Pakistan was left to the dogs,” said Pervez Hoodbhoy, a physics professor at Quaid-e-Azam University in Islamabad who is an outspoken critic of the government’s failure to stand up to spreading Islamic militancy."

"This impoverished expanse of rural southern Punjab, where the Taliban have begun making inroads with the help of local militant groups, has one of the highest concentrations of madrasas in the country.

Of the more than 12,000 madrasas registered in Pakistan, about half are in Punjab. Experts estimate the numbers are higher: when the state tried to count them in 2005, a fifth of the areas in this province refused to register.

Though madrasas make up only about 7 percent of primary schools in Pakistan, their influence is amplified by the inadequacy of public education and the innate religiosity of the countryside, where two-thirds of people live.

The public elementary school for boys in this village is the very picture of the generations of neglect that have left many poor Pakistanis feeling abandoned by their government."

And to the point of our bearing some of the blame:

"The phenomenon began in the 1980s, when General Zia gave madrasas money and land in an American-supported policy to help Islamic fighters against the Soviet forces in Afghanistan."

The whole piece is worth reading in it's entirety, since at the minimum, it illustrates the multi-generational nature of this state of affairs.

ON PROTECTED TEACHERS

HARD RULES

For an eye-opening look at one of the key tenets of our education system, this investigative piece by the LA Times is a must-read.  The title says almost says it all: "Firing tenured teachers can be a costly and tortuous task".  And the news gets worse from there:

"It's remarkably difficult to fire a tenured public school teacher in California, a Times investigation has found. The path can be laborious and labyrinthine, in some cases involving years of investigation, union grievances, administrative appeals, court challenges and re-hearings.
Not only is the process arduous, but some districts are particularly unsuccessful in navigating its complexities. The Los Angeles Unified School District sees the majority of its appealed dismissals overturned, and its administrators are far less likely even to try firing a tenured teacher than those in other districts.
The Times reviewed every case on record in the last 15 years in which a tenured employee was fired by a California school district and formally contested the decision before a review commission: 159 in all (not including about two dozen in which the records were destroyed). The newspaper also examined court and school district records and interviewed scores of people, including principals, teachers, union officials, district administrators, parents and students."

The findings are eye-opening to say the least, as a couple of examples show:

"* Building a case for dismissal is so time-consuming, costly and draining for principals and administrators that many say they don't make the effort except in the most egregious cases. The vast majority of firings stem from blatant misconduct, including sexual abuse, other immoral or illegal behavior, insubordination or repeated violation of rules such as showing up on time.
* Although districts generally press ahead with only the strongest cases, even these get knocked down more than a third of the time by the specially convened review panels, which have the discretion to restore teachers' jobs even when grounds for dismissal are proved.
* Jettisoning a teacher solely because he or she can't teach is rare. In 80% of the dismissals that were upheld, classroom performance was not even a factor."

It's an extraordinary state of affairs, and would never stand in the private sector of course.  Yet, it's as natural in our highly politicized education system, as breathing.

* Image source.

ON CAR BUSINESS AS USUAL

NO CHANGE

At first glance it was a bit startling to see the President of the United States, accompanied by his auto industry task force, holding a press conference to announce that a private sector company, Chrysler, will be imminently filing for Chapter 11 Bankruptcy.  As the New York Times reports:

"Chrysler, the third-largest American auto company, will seek bankruptcy protection and enter an alliance with the Italian automaker Fiat, the White House announced Thursday.

The bankruptcy case, which officials envisioned as a swift, “surgical” process, was filed in United States Bankruptcy Court in New York. It marks the first time a major American car company has tried to restructure under bankruptcy protection since Studebaker in 1933.

“I have every confidence that Chrysler will emerge from this process stronger and more competitive,” President Obama said during a noontime appearance at the White House."

But on further reflection, it shouldn't be surprising that the leader of the free world should be involved in such a way over the restructuring of a private sector company.  As Jenkins Holman Jr. explained in his WSJ op-ed titled "The Truth about Cars and Trucks" yesterday,

"For three decades, the Big Three were able to survive precisely because they skimped on quality and features in the money-losing sedans they were required under Congress's fuel economy rules to build in high-cost UAW factories. In return, Washington compensated them with the hothouse, politically protected opportunity to profit from pickups and SUVs.

Doesn't sound much like what you hear incessantly from your Congressman, about how Detroit's problems are all due to management "incompetence" in deciding to build "gas guzzling" SUVs, does it?"

And despite the current seemingly Herculean efforts by the government, the prognosis isn't much better going forward, as Mr. Holman goes on to explain:

"Yet the muddled, covert bailout continues: Washington's latest fuel-economy rules actually reward manufacturers for increasing the size and weight of some vehicles. The truck tariff remains in place. The fuel-mileage rules continue to protect the UAW monopoly by discouraging the Big Three from shipping small-car production offshore.

In a real bankruptcy, which is the natural fate of companies unable to meet their obligations, Chrysler and GM would be run (or liquidated) for the benefit of their creditors, not their workers. But, here, "pattern bargaining" will remain the law of the Detroit jungle. The UAW will continue to use its unnaturally augmented clout to extract uncompetitive pay and benefits (it can do no other given its internal incentives).

As it has for 40 years, Washington will pitch in with one improvisation after another, disguised as energy policy, trade policy, health-care policy or environmental policy, to stop the rivets from popping off. Politics, especially Democratic electoral politics, will play a more dominant role than ever."

Read the whole piece, and one gets the distinct sense that all this is not just business as usual, but bigger than ever.  Maybe one day, it'll be different.  But not today.