Browsing the archives for the Warehouses tag.

Virtual Fixed Assets

Economic Reality, Virtual Reality
According to the US Bureau of Economic Activity, the real US economy (i.e. non-public sector) spends just over $1 Trillion / year on non-structural fixed assets.
This number excludes the cost of buildings, warehouses and factories but includes all household, farm, business, and non-profit organization spending on fixed assets.  A precise definition is found here.
Roughly half of that amount ($537 Billion in 2011) is on information processing equipment and slightly over half of that amount ($279 B) is software.
Spending on transportation equipment (trucks, cars, ships) was $232 B and industrial equipment (engines, lathes, robots, …) $178 B. Furniture and other types of equipment (e.g. agricultural, mining, oil rigs, …) was $194 B.
Within the $537 B on information processing equipment, is spending on computers ($79 B ) and network equipment ($77 B).  The 3rd largest sub-category after software is medical equipment at $72 B.
So the largest single spending area for fixed assets is for software which is a virtual asset! Henry Ford must be spinning in his grave!
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Anatomy of The Financial Crisis

Financial Crisis

Originally published October 9, 2008 in Facebook.

Subprime Loans

The US subprime mortgage market was approximately $400 B. Nearly half of these loans were enhanced by so-called piggyback loans to help borrowers pay for the equity portion of the first mortgage. It was common for a first mortgage to cover 80% of home value (underwritten by Freddie Mac) and instead of the 20% buyer equity, the piggyback loan (usually from the same bank) would cover the difference – i.e. a second mortgage but with virtually no lien on the property.

Since the first morgage was secured by Feddie Mac, it was easy for the originating bank to sell it to other institutions, so the bank only needed to fund the piggyback portion of the loan. And since, those banks operated with 10x leverage ratios, they only had deposits & equity to cover 1/10 of those bad loans. 1/10 x 20% x $400 B = $8 B. Trouble indeed as the estimate for defaults on those mortgages has esclated from approx 20% to 40%.

Bank of England


The first mortgages in turn were purchased by large lenders who pooled loans of varioius quality which were sold to investment banks who in turn issued preference tranches on each pool. Top tranches would be paid out first, lower tranches would be paid out later, thereby artificially creating different instruments with different levels of credit grade. Since major banks operate with a leverage ratio of appoximately 6:1, the securitized MBS must have had a book value of approx 6 x $400 B x 80% = $2 Trillion.

Bank of England

At the start of the crisis in 2007 as defaults mounted on the mortgages, the market for the MBS securities started to dry up. As shown in the chart above the estimated total impact of impaired MBS securities is $160 B.  The immediate problem facing banks was the rapid increase in their funding requirements when they could not securitise or otherwise distribute their loan warehouses. Banks began to hoard liquidity to meet actual and potential increases in these funding requirements, causing interbank rates to spike during August and September 2007.

Structured Credit

Towards the end of 2007, banks began announcing substantial losses on their own holdings of structured credit products. That $2 Trillion of market value was starting to unwind. Current estimates (see below) show that the structured credit market losses are in the vacinity of $400 B (so far).

Bank of England

Counterparty Risk

An element of counterparty credit risk began to influence interbank lending decisions. Some banks could not gain unsecured funding, amplifying their financing difficulties. As the end of the year approached, banks sought to increase their liquid asset positions, in part to strengthen the appearance of their reported balance sheets. This was a major contributing factor to the rise in London interbank offered rates (Libor) internationally in early December. This was alleviated to some extent by co-ordinated central bank action on 12 December 2007 causing money market conditions to improve during January 2008.

In February and March 2008, however, money markets tightened again as banks reported significant additional write-downs on ABS and the prospect of losses on exposures insured by monolines increased. Central banks provided a second round of co-ordinated liquidity provision on 11 March 2008.

However, by Aug/Sept 2008 not just the originating bad lenders have gone under, but also the major investment banks and large US lenders that created the MBS mess have failed (or been forced to merge). This has extended the counterparty risk substantially to international banks and the dominos continue to fall.

Bank Failures

We are now seeing bank failures in UK, Germany, Holland, and Iceland. These will in turn extend the imprint of counterparty risk and cause even more bank hoarding. Banks hoard by declining to deal with other banks and by raising credit costs to businesses and consumers. The impact on business is growing with each passing week. Already 20% of all US car dealers are facing bankruptcy as they cannot finance their inventory due to tighter credit imposed by their banks and a drop-off in spending by consumers who can’t afford to pay the rising interest on their mortages.

Substantial interest rate cuts will be necessary to improve bank margins (making it easier for them to hoard cash) but don’t expect to see any of it in your personal credit card, car loans, or mortgages and certainly not in your business lines of credit, lease rates, etc.

Coupled with over $1 Trillion so far in bailouts in the USA and UK to guarantee the bad loans and ensure bank creditworthiness, we can expect serious degredation in the buying power of cash. Only by devaluing the purchasing power of the dollar can the central banks suck excess liquidity out and devalue the bad loans at the heart of it all.

So don’t be surprised when everything costs a lot more this time next year.

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