Monday, May 31, 2010

China Bites Into Commodities Reserves


China appears to be eating into some of its commodities reserves, a potentially worrying near-term trend for commodities producers and investors, analysts said.

The phenomenon could help explain why imports from China in markets such as refined copper, iron ore and lead have declined in the last few months. It also could be a factor behind the recent drop in prices for those commodities.

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The Dow Jones-UBS Commodity Index last week dropped to its lowest level since July, before recouping some of its losses. The index is down 9.9% this year.

In April, China posted a significant drop in imports for some commodities, leaving many analysts wondering whether China's appetite for commodities has abated.

That might be the case. And demand could falter if China further tightens monetary policies to slow growth, particularly in heated property markets.

But several analysts who through field visits and data mining try to gauge China's actual demand lately have concluded that domestic demand still is strong. In fact, they surmise, commodity imports are declining at least partly because the country and its industrial companies are tapping reserves, possibly because they expect prices to fall further.

Longer term, the Chinese government and industrial companies there are likely to return to the market when reserves are running down or prices get low enough, the analysts said.
[abreast] Color China Photos/Zuma Press

Some are concerned that manufacturers are responding to fewer orders from customers, preferring to use the materials they already have rather than add to their commodities stocks. Others said Chinese commodities users are being savvy, waiting for market prices to decline further before stepping up buying. Above, a worker walks on the steel pipes at an iron and steel factory in Huaibei in central China's Anhui province.

Short term, a move to tap reserves is a potentially bearish signal for investors in these commodities, as China's reserves are deep. Analysts at Deutsche Bank said the third quarter may see "considerable pressure" for prices on commodities such as copper and nickel.

Barclays Capital metals analyst Natalya Naqvi wrote last week that China's decline in lead imports may "reflect some running down of domestic stocks." She estimated that China has been eating into its lead stockpiles since March.

China consumes about 40% of the world's lead, which is used primarily in making auto batteries. Since mid-April, prices for lead plunged as much as 26%, compared with an 11% decline in the Dow Jones-UBS Commodity Index.

Still, her note said "macroeconomic data and auto sales in particular have been strong," and that Barclays expects China to turn into a net importer of lead again "towards the end of the year," giving prices room to rise. Aluminum and zinc probably also showed a drawdown in stocks recently, Barclays concluded.

China imported record levels of copper in 2009. In April, the International Copper Study Group cited "the potential release" of inventories in China as one of the biggest risks copper prices face this year. That month, China's refined copper imports declined 2.7% from a year earlier, according to the country's General Administration of Customs. "They had imported much more than they could use last year, so they may be" tapping inventories this year, said Ana Rebelo, chief statistician of the group.

After a field trip to China in mid-May, analysts at Macquarie Securities said some end users of steel, such as auto makers and home-appliance producers, are "choosing to eat into their own inventory, rather than continue to purchase" on the open market.

It is a typical "buyers' strike" when prices are falling, the analysts wrote. "Why buy steel today when it'll be cheaper tomorrow?"

Confidence that prices may fall further could be behind the Chinese reluctance to buy. Since late April, the benchmark hot-rolled flat steel price has fallen as much as 10%, to $600 a metric ton in China, according to the Steel Business Briefing, a firm that tracks steel data. Prices for iron ore, a key component of steel, dropped 23% in that period.

The Macquarie analysts concluded that underlying demand for cars and refrigerators in China remains robust and that manufacturers soon will stop draining their own stockpiles and return to the market.

"While we expect further weakness in the near term, we didn't hear anything that fundamentally changes our view on China steel," they wrote. "We expect conditions to turn around fairly rapidly." Macquarie estimated China's steel inventory peaked in January, and has since dropped about 15%.

Lower steel prices eventually will result in production cuts at mills and help balance the market, they said. The bank estimated steel demand will recover in the fourth quarter.

China still appears to be an avid buyer in some markets, particularly coal and crude oil. In April, China reported that its crude-oil imports jumped 31%, to 5.2 million barrels a day.

Paul Ting, president of Paul Ting Energy Vision, an oil-consultancy firm, estimated Chinese oil demand expanded 13% during the first four months, suggesting there was a small build in oil inventories.

Write to Carolyn Cui at

Friday, May 28, 2010

Personal Income and Outlays for April 2010

Released on 5/28/2010 8:30:00 AM For Apr, 2010

PriorConsensusConsensus RangeActual
Personal Income - M/M change0.3 %0.5 %0.3 % to 0.6 %0.4 %
Personal Income - Yr/Yr change3.0 %

2.5 %
Consumer Spending - M/M change0.6 %0.2 %-0.1 % to 0.5 %0.0 %
Consumer Spending - Yr/Yr change2.9 %

4.6 %
Core PCE price index - M/M change0.1 %0.1 %0.0 % to 0.1 %0.1 %
Consumers are getting healthier-at least financially-as income gains continue. But the consumer paused growth in spending in April after strong gains the prior two months. Personal income posted a solid 0.4 percent increase for April, matching the gain the month before. The April figure came in slightly lower than the market forecast for a 0.5 percent boost. Importantly, the latest increase is in what really counts as the wages & salaries component advanced 0.4 percent after rising 0.3 percent in March.

But spending growth hit a speed bump in April. Overall, personal consumption was flat, following a 0.6 percent rise the prior month and 0.5 percent in February. The April number fell short of analysts' projection for a 0.2 percent increase. April was weakened by a drop in nondurables and was mostly price related.

Inflation is still almost nonexistent. The headline PCE price index was unchanged in April-easing from up 0.1 percent in March. The core rate also was soft, gaining only 0.1 percent and matching both March and the consensus forecast.

Year on year, personal income growth for April came in at 2.5 percent, slipping from 2.8 percent in March. Year-ago headline PCE inflation was unchanged at 2.0 percent. Year-ago core PCE inflation edged down to 1.2 percent from 1.3 percent in March..

The good news is that consumers are finding more greenbacks in their wallets and this should support additional spending and the recovery. April's PCEs number was mildly disappointing but not so much in light of how strong the prior to months were. The consumer on average is now pulling its weight in the recovery. And the Fed likes the inflation news.

On the news, equity futures were little changed.

Market Consensus Before Announcement
Personal income strengthened in March, gaining 0.3 percent, following a 0.1 percent rise the prior month. The heavily-weighted wages & salaries component increased 0.2 percent in March after edging up 0.1 percent in February. However, the highlight of the report was that personal spending outpaced income with PCEs posting a 0.6 percent boost in March, following a 0.5 percent jump the month before. The headline PCE price index firmed to up 0.1 percent after no change in February. The core rate also edged up 0.1 percent in March after no change the month before. Looking ahead, personal income in April should be boosted at least by the wages & salaries component as aggregate weekly earnings jumped 0.9 percent for the month, according to the jobs report. PCEs should be moderately healthy as retail sales excluding autos rose 0.4 percent. But the auto component is a question as unit new motor vehicle sales declined but the auto component in retail sales gained-likely a price effect. PCE inflation should be subdued as the April CPI fell 0.1 percent and the core CPI was flat.
Personal income is the dollar value of income received from all sources by individuals. Personal outlays include consumer purchases of durable and nondurable goods, and services.  Why Investors Care
[Chart] Changes in taxes or social security cost of living adjustments can cause some sharp variations in monthly disposable income growth. However, on the whole, monthly changes in disposable income fluctuate less than monthly changes in personal consumption expenditures.
Data Source: Haver Analytics
[Chart] Monthly changes in personal consumption expenditures are usually skewed by large changes in spending on durable goods. Spending on nondurable goods and services tend to be less volatile from one month to the next.
Data Source: Haver Analytics

Wednesday, May 26, 2010

Nano cool

A new way of stopping machines overheating is being developed

NANO-THIS. Nano-that. Nano-the-other. The idea that making things so small you measure their dimensions in nanometres (as billionths of a metre are dubbed by the scientific-measurement system) will unlock advantages denied to larger objects has been around for well over a decade. Long enough, in other words, for sceptics to wonder when something useful will actually come of it. It looks possible, though, that something useful is indeed about to happen. The evidence suggests that adding a sprinkle of nanoparticles to water can improve its thermal conductivity, and thus its ability to remove heat from something that it is in contact with, by as much as 60%. In a world where the cost of coolth is a significant economic drain (industrial cooling consumes 7% of the electricity generated within the European Union) that offers a worthwhile gain. It would, for instance, allow the huge computer-filled warehouses that drive the Internet to fit in more servers per square metre of floor space.

Nanofluid cooling, as the phenomenon is known, was discovered almost two decades ago, but is only now coming out of the laboratory. According to Mamoun Muhammed of Sweden’s Royal Institute of Technology, one of the field’s leading researchers, three problems have stood in its way.

The first was stopping the particles sticking together and thus ceasing to be nano. That has been overcome by adding emulsifying agents such as cetrimonium bromide (originally developed as an antiseptic) to the mix.

The second problem is which particles to use. At the moment oxides of metals such as zinc and copper seem to be the favourites, but tiny tubes made of carbon are also being explored. This, in turn, raises the question of how the phenomenon actually works. It is not simply a matter of the added ingredient (6-8% of the total volume seems to be the optimum mix) being a good conductor in its own right, though this helps. Nanofluids are better conductors than the sum of their parts. That suggests the particles are changing the structure of the water itself in ways that improve its conductivity. Water, despite its protean appearance, has a lot of internal structure, particularly when it is cool. The molecules are organised, albeit more loosely, in ways that resemble the material’s solid form, ice. Nanoparticles inevitably alter this arrangement, and that may make the mix better able to transmit heat. If the changes involved were understood, picking the right size and composition of nanoparticle would be less a matter of guesswork.

The biggest problem about moving from laboratory to industry, though, is the question of scale. As the quantities increase, the way the constituents mix and react alters significantly. That makes it hard to predict from small-scale experiments what will happen in a commercial setting.

If these problems can be overcome, though, a bright future beckons, and some of the nanohype that has been swirling around might actually get translated into a useful product.

Stocks Can Fall Further


AFTER OPENING SIGNIFICANTLY lower Tuesday, the Standard & Poor's 500 stock index spent the rest of the day climbing back out of that hole. Followers of candlestick charting saw a very clear and very large pattern called a "hammer" and it is supposed to mark an interim bottom (see Chart 1).


Given weakness in other technical indicators, I am not so sure.

Hammers are formed by days that open and close near their high with an interim drop and recovery. In candlestick lore, the market is said to be "hammering out a bottom."

A similar event occurred in February as the market pulled out of its January slide but there was a difference. The index was above its key 200-day moving average at that time telling us that the bull market was intact (see Getting Technical, "What are the Moving Averages Saying?" May 24). Today, the index is below that average so I am very skeptical of this being an important upside reversal.

By some measures, Tuesday's market action seemed inevitable. European markets were down as much as 4% by the U.S. open and financial headlines were reporting, in very large typeface, how the Dow Jones Industrial Average was about to lose its grip on 10,000. We could sense the fear building.

On the charts, the market lost a lot of value in a very short time leaving it "oversold." By some measures, 90% of stocks traded domestically were in such an overextended decline and that is often a tip-off that an upside reaction was due. The market does not like it when indicators move to such extremes.

But is this a good buying opportunity? If you are a trader with a short-term bent, perhaps. If you are looking for a good place to jump back into the market for the long haul, this is not it.

There are several reasons. The first is that the stock market does not act exactly the same way each time it forms a specific pattern. While technical analysis is based on the premise that people act in similar ways under similar conditions, the word "similar" is critical. Background conditions are not similar.

Aside from the 200-day average, there is another factor working against the bulls today. Two widely followed market cycles are due to bottom towards the end of the year.

Cycles are merely tendencies for stock prices to ebb and flow with measurable regularity. Most investors are familiar with the seasonal cycle where stocks are strong in the winter and weak in the summer. A more familiar name for it is "sell in May and go away."

A nine-month, or 40-week, cycle is due to bottom towards the end of the year. Nine months is also equivalent to 200 days, so we can see the link to the key moving average mentioned above.

It is not a perfect predictor of stock market lows but it is a good indicator of the bias in the marketplace. The last cycle low was earlier this year so at the end of the January correction, the cycle, and its bias for the market, was just turning up. We cannot say the same today.

Another major cycle scheduled to bottom later this year is the four-year, or Presidential cycle. It has been a very good indicator for major bottoms in the market for decades, catching such bottoms as 2002 and 1974, both the end of vicious bear markets.

Combine the seasonal, nine-month and four-year cycles and we can make a compelling case for market weakness all summer long.

We can now see how the short-term signal given by Tuesday's hammer candle is fighting the tide. If the S&P 500 does continue higher, it faces stiff resistance in the 1130 area. This would represent a 50% recovery of losses since the April peak and it is in the vicinity of the close of May 6 - the day of the "flash crash."

Rather than look for bargains in the stock market now, it would seem that it might be better to use any rebound to lighten up.

BofA, Citi Made 'Repo' Errors

Disclosures Cite Accidental Misclassification of Borrowings; No Material Impact

By MICHAEL RAPOPORTBank of America Corp. and Citigroup Inc. incorrectly hid from investors billions of dollars of their debt, similar to what Lehman Brothers Holdings Inc. did to obscure its level of risk, company documents show.
In recent filings with regulators, the two big banks disclosed that over the past three years, they at times erroneously classified some short-term repurchase agreements, or "repos," as sales when they should have been classified as borrowings. Though the classifications involved billions of dollars, they represented relatively small amounts for the banks.

A bankruptcy-court examiner said Lehman had been doing the same thing to make its balance sheet look better before it filed for bankruptcy in September 2008, using a strategy dubbed "Repo 105" that helped the Wall Street firm move $50 billion in assets off its balance sheet.
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Bank of America and Citigroup say their misclassifications were due to errors—not an attempt to make themselves look less risky, which examiner Anton Valukas said was Lehman's motivation. The disclosures, made after federal securities regulators began asking financial firms about their repo accounting, were included in quarterly filings earlier this month but not highlighted.

The disclosures come amid a series of revelations about how banks obscure their risk-taking before reporting their finances to the public, a practice known in the financial world as "window dressing."

Bank of America and Citigroup were among the banks cited in a page-one Wall Street Journal article on Wednesday detailing how financial firms temporarily shed repo debt at the ends of quarters, when they report their finances to investors. Since the financial crisis began, both banks often have reduced their quarter-end repo debt from their average borrowings for the same quarter. That activity didn't involve misclassifying repo loans as sales.

Borrowing Gap

A look at the overall net short-term borrowing of large banks in the repo market as well as the net short-term borrowings of the three banks.
Repos are short-term loans that allow banks to take bigger risks on securities trades; classifying the transactions as sales instead of borrowings allows a firm to take assets off its balance sheet and thus reduces its reported leverage, or assets as a multiple of equity capital.

Federal securities rules bar financial firms from intentionally masking debt to deceive investors. There is no indication that Bank of America or Citigroup misclassified their repos intentionally or that the Securities and Exchange Commission will take any action against them. An SEC spokesman declined to comment.

The amounts Bank of America and Citigroup cite are relatively small. The misclassifications had tiny impacts on the banks' reported leverage, and none at all on their earnings or shareholder equity. The banks didn't restate any financial statements.

Bank of America said the misclassified transactions in certain quarters over the past three years—ranging from $573 million to as much as $10.7 billion—"represented substantially less than 1% of our total assets" and had no material impact on its balance sheet, earnings or borrowing ratios.

Citigroup said the misclassified transactions—of $5.7 billion as of the end of 2009, and as much as $9.2 billion over the past three years—involved "a very limited number of our business units" that "used this type of transaction in very small amounts." It also said its errors were immaterial to its financial statements. "At no point in time was the impact of these sales transactions large enough to have a noticeable impact on our published leverage ratios."

By comparison, both banks have more than $2 trillion in assets.

The SEC had asked big banks in March for more information about their repo accounting in the wake of the Lehman bankruptcy report. That inquiry hasn't found any widespread inappropriate practices, SEC chief accountant James Kroeker told a congressional subcommittee last week.

But Mr. Kroeker said the SEC has asked several companies to provide more disclosure about their repo accounting in their securities filings. Bank of America and Citigroup indicated they had found their errors on their own initiative.

More broadly, the SEC is now considering stricter disclosure and a clearer rationale from firms about quarter-end borrowing activities. The agency may extend these rules to all companies, not just banks. The potential new rules, disclosed by SEC Chairman Mary Schapiro at a congressional hearing last month, came two weeks after the Journal's initial article about banks' debt-masking activity.

Separately, Bank of New York Mellon Corp. said in a securities filing that it had found some small errors in its repo accounting over the past three years. The bank said it didn't use Repo 105 transactions.

The errors have been corrected, and none of them were material to the bank's financial statements, the bank said in the filing. A Bank of New York Mellon spokesman declined to comment further.
Write to Michael Rapoport at

Monday, May 24, 2010

Euro Resumes Slide


LONDON—The euro fell Monday after the Spanish government came to the rescue of a small savings bank over the weekend, refocusing market attention on the risks associated with euro-zone lenders.

The euro was down at $1.2371 from $1.2583 late on Friday in New York, according to EBS. The single currency was also down at ¥112.11 from ¥112.80. The dollar was up at ¥90.14 from ¥89.64 and at 1.1570 Swiss francs from 1.1480 francs. The pound was down at $1.4439 compared with $1.4445.

However, as the failed bank, CajaSur, represents only 0.6% of Spanish banking assets, the impact on investment flows should be minimal, analysts said.

If anything, global sentiment has been helped by positive talks between the U.S. and China, which lowers the risk of a trade war, and by news that Germany plans to launch an austerity program next year.

Good news on deficits came from the U.K. as well, as the new U.K. government started to unveil its proposals for more than £6 billion of spending cuts. The volatility in market sentiment was illustrated by the performance of the Australian dollar, which initially came under heavy selling pressure as investors pulled out of risky markets, but then rebounded to trade back up over $0.83 where it had begun.

The failure of CajaSur hurt market sentiment at first given the ongoing concerns about the euro-zone banking system. But, as strategists at BNP Paribas said, it is too small an event "to interrupt the move back into risk appetite" which was apparent at the end of last week.

Concern about euro-zone banks was compounded by a report that some major U.S. banks remain at risk from a credit downgrade, a move that would seriously increase their funding costs.

On the plus side, deficit fears diminished a little as Germany appeared set to lead by example with its plans for austerity measures next year.

The speed with which the new U.K. government under Prime Minister David Cameron is unveiling its deficit reduction plans is also providing some cheer for financial markets. There had been fears that the cuts would be watered down because of the coalition government that Cameron was forced to form with the Liberal Democrats.

Another factor helping to keep market sentiment from deteriorating too much is the unusually cordial talks being held between U.S. Treasury Secretary Timothy Geithner and his Chinese counterparts in Beijing.

The talks have increased speculation of an imminent revaluation of the Chinese yuan as well as reduced the risks of a trade war.

In China, the Shanghai Composite Index posted a strong 3.5% gain but sentiment in European stock markets at the opening was very mixed.

Write to Nicholas Hastings at

Friday, May 21, 2010



  在很多讨论中,就此回溯到一个社会心理学假说——“维特效应”(Werther Effect),即自杀模仿现象:两百年前,歌德的《少年维特之烦恼》发表后,欧洲发生模仿维特自杀的风潮,为此好几个国家将《少年维特之烦恼》列为禁书。社会心理学家菲利普斯通过对1947年到1968年之间美国自杀事件的统计发现,每次轰动性自杀新闻报道后的两个月内,自杀的平均人数比平时多了58个;而在媒体报道了玛丽莲梦露的自杀新闻之后,那一年全世界的自杀率增长了10%。

Still in a spin - Impact from Greece, Portugal, and Spain

A rescue by the European Union and the IMF has given Greece some breathing space. But much more may need to be done to avert eventual default

Apr 15th 2010 | From The Economist print edition

TWO months ago the governments of the euro zone agreed in principle to offer emergency loans to Greece. A near-panic in the bond markets has now forced them to spell out the terms of support for their stricken colleague, should it be needed. If push comes to shove, the other 15 euro-zone countries are willing to provide Greece with up to €30 billion ($41 billion) of three-year fixed- and variable-rate loans in the first 12 months of any support programme. The announcement was made by Olli Rehn, the European Union’s economics commissioner, and Jean-Claude Juncker, chairman of the Eurogroup of finance ministers, after a telephone conference of the Eurogroup on April 11th.
The chief obstacle in previous negotiations had been the interest rate to be charged for the rescue loans. Germany had insisted on “market rates”—ie, with no element of subsidy. That made little sense: if a backstop were provided only on such terms, what would be the point of it? Eventually a formula was found that both met Greece’s needs and satisfied the Germans. The interest rate for emergency aid will be 3.5 percentage points above the benchmark “risk-free” rates for euro loans. That works out at around 5% for a fixed-rate loan, which is less than markets were asking of Greece before the deal was struck but still steep. Portugal and Ireland, the next-riskiest borrowers in the euro area, pay less than half as much for three-year money. Germany pays a mere 1.3%.
The IMF is expected to chip in €15 billion, at interest rates that are likely to be a little kinder to the Greeks. The resulting package of €45 billion would be enough to finance Greece’s budget deficit for the rest of this year as well as repay its maturing debts. Yet Greece is likely to need far more support than this as it struggles to put right its public finances.

Cracks in the masonry

An earlier analysis by The Economist (“Safety not”, March 27th) suggested that Greece would need at least €75 billion of official aid. We based this figure on several assumptions: that Greece would need five years to stabilise its ratio of debt to GDP; that it could take the pain of a brutal fiscal retrenchment; that private investors would still be willing to refinance existing debts, at an interest rate of 6%, if a rescue fund covered the country’s new borrowing; and that the economy would start to grow again in 2013.
An updated set of projections is set out in table 1. We have made two changes so the analysis is a bit rosier. We now assume that Greece cuts its budget deficit, as a share of GDP, by four percentage points this year, as planned, so it has less to do later. We also assume that the interest charged on all maturing and new borrowing is 5%, in line with the cost of the aid offered by Greece’s euro-zone partners. With those changes, we reckon Greece would need to cut its primary budget deficit (ie, excluding interest costs) by 12 percentage points to cap its debt burden—a slightly less fierce adjustment than in our first simulation. On that basis Greece will run up an extra €67 billion of debt by 2014, by which time its debt will stabilise at a scary 149% of GDP. That sum is less than our previous estimate, but still half as much again as the amount on offer.
Some will see this scenario as too pessimistic. It is far gloomier, for instance, than that envisaged in the EU retrenchment programme, which assumes that Greece will get its deficit below 3% of GDP in three years and that the economy can continue to grow as it does so. However, even with a more benign assumption about growth, Greece’s debts would still be very large. For instance, suppose that any losses in nominal GDP during recession are quickly recovered. Debt would still then stabilise at 142% of GDP.
It will be hard for Greece to make such savage cuts in its budget and emerge from recession at the same time. Furthermore, prices and wages will have to fall if Greece is to regain the cost competitiveness needed for sustained economic growth. That will drag down nominal GDP in the short term, and make budget cuts more difficult to carry out.
Our analysis may even be too optimistic. If economic growth does not return, deficit reduction proves too painful or interest rates are much higher than we assume, the debt ratio is likely to spiral upwards until default becomes all but inevitable. Even if that is avoided, Greece’s rescuers may have to shoulder more of the financing burden than we have estimated, should private investors reduce their exposure to Greece.
They have plenty of reasons to do so. On April 9th, two days before the euro-zone rescue package was announced, Greek government bonds were downgraded by Fitch, a credit-rating agency, to BBB-, just a notch above junk status. As Greece’s debt mountain grows, investors are increasingly likely to shun its bonds in favour of those of other, more creditworthy, euro-zone countries. Though IMF cash is welcome, private investors know that the fund is first in the queue when money has to be paid back. A euro-zone rescue party may also demand priority.
The bolder sort of investor may reckon that the high yields on offer are ample reward for the risk that Greece may be unable to repay all it has borrowed. But some will be more cautious. And others may judge that an interest rate big enough to compensate for the risk of default would only add to the pressure on Greece, making default more likely. Mohamed El-Erian, the head of PIMCO, the world’s biggest bond fund, said on April 12th that his firm was steering clear of new Greek bonds. “Based on what we know right now, we would not be a buyer,” he told Reuters television. Asian central banks that want to balance their dollar holdings with euros may choose to park their cash in France or Germany and save themselves any worries about Greece and its politics.
The signs are not encouraging. An issue of Greek six-month and one-year bills on April 13th was hailed as a sign of robust private demand because the auction, which raised €1.6 billion, was heavily oversubscribed. The interest rate that investors demanded told a different story. Greece had to pay 4.55% to borrow for six months, just two days after the Eurogroup had all but promised to refinance Greece for the next year and at a time when central-bank interest rates are a paltry 1%. A day later yields on ten-year Greek bonds rose to 7%, 3.9 percentage points more than those on comparable German Bunds.
Greece’s euro-zone partners could find themselves with a large and open-ended commitment to roll over the country’s existing debts and to provide cash to cover its budget deficits. The rescue package announced this week may over time evolve into a rolling series of soft loans, at ever-lower interest rates and increasing maturity, designed to prop up Greece and keep default at bay. Such loans—in effect, grants—would amount to a kind of fiscal drip-feed. That could spur a political backlash, and perhaps legal challenges, in the countries supplying the funds.

Our debts, your problem

Yet the alternative to a bail-out—default—is too grisly to contemplate, not least because of the dire consequences for Europe’s banking system. Banks in Greece hold €38.4 billion-worth of the government’s bonds, according to Deutsche Bank. This amounts to almost 8% of their total assets. A big write-down in the value of those bonds would leave the banks crippled. But around 70% of Greek government bonds, €213 billion-worth, are held abroad, mainly elsewhere in Europe.
There are no solid figures on how much of this is held by banks but it is possible to make rough guesses. The Bank for International Settlements (BIS) provides figures for foreign banks’ lending to the Greek government, Greek banks and the private sector combined. Furthermore, according to analysts at the Royal Bank of Scotland, banks bought a bit less than half of the Greek bonds sold between 2005 and 2009. Based on these figures, table 2 contains our estimates of which countries’ banks own Greek public debt.
The “low” figure is calculated using the weight of each country’s total exposure to Greece in the BIS figures. For instance, French banks account for a quarter of all foreign-bank loans to Greece. If we assume that half (ie, €106 billion) of the €213 billion of Greek government bonds owned outside Greece are held by banks, and that French banks have a quarter of that, their share is €27 billion. On the low estimate, euro-zone banks own €62 billion of Greek government bonds.
The true exposure is probably a bit higher, perhaps €70 billion. It is more likely that holdings within the euro area are weighted more towards commercial banks than pension and insurance funds, because banks are able to use Greek government bonds as collateral for cash loans from the European Central Bank (ECB). The “high” estimate assumes public debt accounts for all the foreign banks’ lending to Greek entities in BIS data. This is surely an overstatement, but the exposure of German banks, for instance, is likely to be much closer to our high estimate, €30 billion, than the low one. As Laurent Fransolet of Barclays Capital points out, Hypo Real Estate, a state-owned German bank, has already reported an €8 billion exposure to Greek sovereign bonds.
Given the pain that a Greek default would inflict on the euro area’s banks, it is perhaps not surprising that the currency club’s governments have rushed to announce firmer details of a bail-out. A default that would reduce Greece’s debt burden to, say, 60% of GDP would cut the value of its bonds by half. Because banks are still fragile, euro-zone governments would probably have to cover their losses, at a cost of at least €31 billion (ie, half of €62 billion). A €30 billion loan that gives Greece a chance to right its public finances looks good value compared with a €31 billion loss for bailing out banks should Greece fail. Euro-area governments are thus ready to lend money to Greece so that it can repay euro-area investors, many of them banks that are backed by the same governments. In effect, they are offering to bail themselves out.
There are other good reasons to try to postpone any reckoning. The world economy will, with luck, be stronger in a few years. A rescue package buys time, and not just for Greece. There is a risk that contagion could affect Ireland, Italy, Portugal or Spain, the other euro-area countries with some mixture of big budget deficits, poor growth prospects and high debts.
Of these, Portugal and Spain have most in common with Greece, because of their reliance on foreigners’ savings. Italy draws more from domestic resources to finance its debt and deficits. It has a worryingly large debt burden, around 120% of GDP, but is closer to a primary budget balance than the others. Perversely the sheer size of its debt is a strength. Italy’s bond market is the third largest in the world and is thus very liquid. Ireland is also less reliant on foreign savers and has a better record of deficit-cutting than most countries. And as one of the euro zone’s more flexible economies, its medium-term growth prospects seem less dire.
Were Portugal and Spain to get into the same sort of trouble as Greece, the resulting problem might be too big even for the deep pockets of Germany, France and the IMF. So Europe has a direct interest in making sure trouble does not spread to Iberia. Foreign banks’ exposure to Greece, Portugal and Spain combined comes to €1.2 trillion. European banks have lent most of this. German banks alone account for almost a fifth of the total (see chart 3).
Spain is a much bigger worry than Portugal, because it has a much bigger economy. Its public finances are not in as poor shape as Greece’s, thanks to good fiscal discipline during its boom years. Spain’s debt burden is half that of Greece: last year government debt was 54% of GDP. Even so, its debts are rising too quickly for comfort. The European Commission expects the budget deficit will be 10% of GDP this year. A bigger fear is that Spain will not recover from recession with any vigour because, like Greece, it is hampered by high wage costs and a rigid economic structure.
Optimists point out that the problem of cost competitiveness is exaggerated. Even during its long consumer boom, Spanish exporters maintained their share of world markets, unlike their French and Italian rivals. Yet Spain’s export sector is too small to spur a recovery and the high cost of laying off permanent workers in dying industries means it is hard to shift resources to exporting firms. The rapid expansion of temporary work contracts since the 1990s has given the Spanish economy more flexibility. But this came at a cost. Firms have little incentive to train the young temps whom they will soon lay off, and that has contributed to Spain’s dismal record of productivity growth.
The trouble engulfing Greece ought to startle Spain’s policymakers out of a dangerous complacency. The euro-zone rescue package for Greece, to which the Spanish would contribute, buys Spain time to secure bond investors’ trust. The government has said it will press for reforms to the country’s complex system of wage agreements. These are urgently needed to ensure that pay responds to changes in business conditions. The gap between the two tiers (permanent and temporary workers) in Spain’s job market needs to be tackled, to boost productivity and speed up the flow of workers to rising industries. Regulations should be dismantled to make it easier for firms to challenge stodgy incumbents, particularly in services.
The offer of support for Greece is worthwhile if it gives the country a chance of getting its house in order and if other members of the euro area make the most of the chance to carry out growth-enhancing reforms. Yet there is a risk that the rescue is treated as an opportunity to relax.
A further danger is that measures to help Greece now may complicate matters in the years ahead. The head of the ECB, Jean-Claude Trichet, confirmed on April 8th that the central bank would continue to take bonds rated BBB- or above as collateral for its cash loans to commercial banks. Although low-rated private asset-backed bonds will be subject to bigger discounts after this year, government bonds will not. So banks will be able to get ECB cash in exchange for Greek government bonds as easily as for Bunds.
This change in policy was surely designed to send a signal. If Greek bonds are good enough for collateral at the ECB, they ought to be good enough for private investors, too, whatever the (mostly American) rating agencies say. The trouble is, the policy only encourages a greater concentration of Greek bond holdings among European banks. That will increase the vulnerability of Europe’s financial system to concerns about a Greek sovereign default.

The default option

Is such a thing imaginable? Conventional wisdom has it that sovereign defaults are always messy and painful. In fact the lesson of such defaults over the past decade or more is that this is not necessarily so. More than a dozen emerging economies have restructured their sovereign debt in the past decade without huge losses of output and without paying enormous penalties in exclusion from capital markets or higher spreads. With a few exceptions (notably Argentina) the process has been much quicker than in earlier sovereign restructurings, and governments and creditors have managed to work together. Governments sometimes negotiated a restructuring with creditors before formally missing a payment of interest or principal—a process known, in the jargon, as “pre-emptive” restructuring. Legal innovations to encourage creditors to take part in restructurings and make it harder for holdouts to litigate have helped.
In 2003 Uruguay restructured all its domestic and external debt, exchanging old bonds at par and at the same coupon rate for new ones but stretching maturity dates by five years. The country returned to capital markets a month later. The “haircut”, or loss to bondholders, was small (13.3%, in net present value), as were the amounts restructured ($5.4 billion), but it showed that orderly sovereign workouts are possible. Countries such as Jamaica and Belize have had orderly restructurings recently.
Greece is different because it has much more debt outstanding and because bondholders may face a more severe haircut—although with sufficient fiscal consolidation a more modest restructuring could be feasible. Sovereign-debt lawyers say that in some ways a restructuring of Greek debt would be easier than many people think. But other things would be new and harder, especially the complexity caused by credit-default swaps, which have not yet played a big role in any sovereign-debt restructurings. It is uncertain, for instance, whether a pre-emptive restructuring would trigger the default clause in credit-default swaps. But Lee Buchheit, a leading sovereign-debt lawyer, says that the biggest risk in most debt-restructuring cases is governments that try to put off the inevitable. “By far the greater risk is pathological procrastination by the debtor in the face of an obviously untenable financial situation,” he argues, in which a country pursues frantic and ruinously expensive emergency financing in the lead-up to an eventual restructuring.
Would a defaulting country have to leave the euro? No. It is perhaps natural to conflate default with devaluation because they often occur together. But a euro member has no currency to devalue. Nor is there a means to force a defaulter out, since membership is meant to be for keeps. A new currency would have to be invented from scratch, a logistical nightmare. All contracts—for bonds, bank deposits, wages and so forth—would have to be switched to the new currency. The changeover to the euro was planned in detail and in co-operation. The reverse operation would be nothing like as orderly. A country that had lost the faith of investors in its public finances would find it hard to reconstruct a sound monetary system. Default by a member would be a body blow to the euro’s standing. But it need not spell the end of the currency.

Thursday, May 20, 2010

four basic assumptions of ordinary least square

four basic assumptions CIIN

normality,  independence and  constant variance (heterogeneous) of the errors,
and the independent variable being measured without error

John Rawlings applied regression analysis, page 48

Stocks' Swoon Stokes Correction Talk


The stock market's recent swoon, fueled by worries about the fallout from Europe's credit crisis, has pushed major indexes back within reach of a 10% correction.

The Dow Jones Transportation Average, the sister measure to the industrial average, as well as the Nasdaq Composite and the Russell 2000, fell below the traditional 10% threshold during the day, though bounced back before the close.

All ended down 9% or more from their highs reached this spring. All three market measures previously entered correction territory on May 7 after the "flash crash" of the previous day.

The S&P 500 is now down 8.4% from its closing high. Of all the major indexes, the Dow Jones Industrial Average is furthest from entering a correction. The Dow ended Wednesday down 66.58 points at 10444.37—6.8% off its high.

That the Dow transports index is heading lower, sooner, is a concerning sign to some traders who traditionally look at the transports as a leading indicator. They argue that waning demand to move goods usually means that spending is down, which is likely to translate into lower profits for product makers in the industrial average.

Ten-percent market declines have been common in previous bull markets to shake out speculative excess. But they have been notably absent during the current bull run, which began in March 2009.

That absence has heightened some traders' jitters about the current retreat, while optimists have latched on to a scenario only slightly less distasteful, that the market may be "correcting" this time by going through a prolonged malaise in lieu of completing an actual 10% leg down.

"The market has been more volatile lately, but if you really look at it, it's back where it was in February," said technician Roger Volz, of BGC Partners. "That kind of sideways move may be the consolidation we're all looking for, a time correction instead of a price correction."

Bank stocks on Wednesday bucked the downward trend as some traders bet the financial regulation making its way through Washington may not be as harsh on financial companies as previously thought.

Corporate bond prices fell for a fourth straight day, pushing borrowing costs higher. The price of protecting against a default by an investment-grade corporate borrower rose 3%, according to the Markit CDX index.

Trading-Firm Breakdowns Accompanied Market Chaos


As the stock market spiraled out of control two weeks ago, two major firms that handle trades for retail brokerages suffered trading breakdowns.

One, the big Chicago hedge-fund firm Citadel Investment Group, stopped taking orders for a number of securities, according to an internal email and people familiar with the matter. Shortly after the market plunged, Citadel asked clients, including discount brokers such as E*Trade Financial Corp. and TD Ameritrade Holding Corp., to route orders elsewhere.

Citadel's technical glitch, as well as woes at another firm that trades for retail brokers, Knight Capital Group Inc., show how some everyday investors unknowingly were caught up in the market maelstrom.

Citadel Execution Services, the hedge-fund outfit's arm that makes markets, is one of the biggest players in executing trades for retail customers, from day traders to mom-and-pop online investors, executing and routing half a billion shares a day, according to its website. Citadel also ranks second among firms that provide liquidity on the Nasdaq Stock Market, the Nasdaq website says.

While it remains unclear what effect Citadel's problems had on the market, its move is emerging as another example of a tripped wire in the market machinery on May 6.

Knight was handling so many orders that one of its computers "just blew up," according to a person familiar with the matter. The breakdown led to a slight delay in handling orders and affected less than 1% of the firm's orders, the person said.

The Dow Jones Industrial Average fell almost 1000 points within minutes that afternoon, before rebounding.

Market participants, exchange officials and regulators trying to piece together the day's events have so far identified a number of possible contributors, including heavy selling of futures contracts, a withdrawal of high-frequency traders and conflicting practices on different exchanges.

The problems at Citadel and Knight may reveal another piece to the puzzle. Their breakdowns could have strained a market already overloaded by an explosion of trading volume, possibly causing disorder to spread, interviews with market participants and exchange officials suggest.

Discount brokers said several trading venues they use experienced problems during the turmoil but that they didn't disrupt clients' ability to trade. "There were a number of different destinations that we had to reroute" orders away from, said TD Ameritrade spokeswoman Kim Hillyer.

"There were strains in the system," said Greg Framke, E*Trade's chief information officer. "If there were issues, we were dealing with them."

At about 2:45 p.m., Citadel encountered problems with its order book that handles exchange-traded funds listed on NYSE Arca, the electronic exchange of NYSE Euronext Inc., according to a Citadel email to customers reviewed by The Wall Street Journal. Exchange-traded funds, or ETFs, are securities that trade on exchanges that represent a basket of stocks, for example tied to a sector or index.

At 2:57 p.m., Citadel sent the following email to clients: "We are currently experiencing Equity system issues. We are advising clients to please route away."

About a half-hour later, Citadel started taking some order flow back from clients who were experiencing trouble at other trading venues, according to a person familiar with the matter. The next morning, Citadel sent an email notifying clients its systems "are operating normally."

Under an agreement known as "payment for order flow," Citadel pays clients such as E*Trade and TD Ameritrade a tiny fee for shares routed its way. In the first quarter, it paid TD Ameritrade less than 0.15 cent a share on average, according to TD Ameritrade's SEC filings. For trades in which customers didn't specify a routing destination, Citadel handled more than a third of orders for NYSE-listed stocks for TD Ameritrade and E*Trade in the first quarter. Citadel owns about 27% of E*Trade's shares.

Other firms, including Citigroup Inc. and Knight Capital, also pay for order flow from retail brokers. The firms make money by taking the other side of the trade and flipping for a profit. For instance, if a customer of E*Trade submits an order to buy a stock for $10, a market maker could purchase the stock elsewhere in the market for $9.90 and sell it to the investor for a 10-cent profit.

The problems at Citadel also highlight the disproportionate impact the May 6 turmoil had on ETFs. Nearly 70% of trades that were cancelled following the plunge were in ETFs, according to a May 18 report on the events by the Securities and Exchange Commission and the Commodity Futures Trading Commission.

"ETFs as a class were affected more than any other category of securities," the report said.

Democratic Rift Stalls Financial Overhaul

Senators Reject Call for a Final Vote on Bill, as Some Dissenters Press for Further Consideration of Restrictions on Banks

WASHINGTON—A handful of Democrats joined with Republicans to block a bid by the Senate Democratic leadership to end more than three weeks of debate on sweeping legislation overhauling regulation of U.S. financial markets.

The 57-42 roll call fell short of the 60 votes needed to close off debate and hold a vote on the bill itself.

The surprise failure was a setback for Senate Majority Leader Harry Reid, who orchestrated the showdown in hopes of clearing the floor for other high-priority bills, including legislation funding military operations in Iraq and Afghanistan.
"We have to put this thing to rest," Mr. Reid said.

For weeks, Mr. Reid has tussled with Republican leaders over the bill, including one high-profile fight over whether debate should even begin on the White House-backed initiative.

Now he is struggling with the demands of some liberal Democrats pushing proposals to impose new restrictions on bank activities, beyond those already included in the 1,500-page bill.

The legislation is designed to close the regulatory gaps and end the speculative trading practices that lawmakers say contributed to the collapse of U.S. financial markets two years ago.

Two Democrats, Sens. Russell Feingold of Wisconsin and Maria Cantwell of Washington, joined with 39 Republicans to vote against the motion to close off debate. Two Republicans, Maine Sens. Susan Collins and Olympia Snowe, joined 55 Democrats in support of the motion. Sen. Arlen Specter, who lost the Democratic primary Tuesday in his home state of Pennsylvania, didn't vote.

At the last minute, Mr. Reid also voted against shutting off debate. That was a procedural quirk meant to preserve his right to keep the issue alive. Only senators who vote "no" on a matter are permitted to later ask that it be reconsidered.

Ms. Cantwell said she wanted to toughen provisions in the bill that would restrict trading by banks in derivatives, complex financial instruments often used to hedge risk. Many lawmakers argue that bad speculative bets by banks on derivatives exacerbated the financial crisis in 2008, and that therefore the sector needs closer regulation.

Mr. Feingold said he wanted to reimpose Depression-era rules that would bar traditional banks from affiliating with investment firms, among other things.

"We need to eliminate the risk posed to our economy by 'too big to fail' financial firms and to reinstate the protective firewalls between Main Street banks and Wall Street firms," said Mr. Feingold, who is up for re-election this year. "Ending debate on the bill is finishing before the job is done."

Mr. Feingold also wants the bill to include additional restrictions, notably on the size and complexity of U.S. banks. Efforts to include specific amendments to address the issue either failed or didn't get a vote.

A second vote will take place Thursday, as Mr. Reid vowed to "continue working on this" bill.
Journal Community

Mr. Reid later blamed Republicans for standing in the way of the bill, saying they "want to do the bidding of the big bank executives ... they want to let Wall Street off the hook."

Sen. Charles Grassley (R., Iowa) disagreed with Mr. Reid and said the "opposition from Republicans and Democrats" was about ensuring consideration of additional amendments.

Sen. Grassley cited a number of proposals on which he wanted action, including an amendment that would potentially limit the fees imposed on ATM transactions. "It wasn't responsible to shut down this bill at this time," he said.

But Mr. Reid's more immediate problems were on the Democratic side of the aisle. He held the vote open for nearly an hour, and attempted several times to convince Ms. Cantwell to support ending debate and moving forward with the bill.

"They're pretty cranky on the other side," crowed Sen. Bob Corker (R., Tenn.), who voted against the motion to shut off debate. Mr. Corker said there was chaos on the floor, as senators milled in the well and the vote dragged on.

For much of the last 18 months, Mr. Reid has shown canny ability to maintain party unity, especially on White House-backed priorities, such as the economic-stimulus package and legislation overhauling the nation's health-care system.

Now, however, the Democratic leader is navigating a bill deep in an election year as voters show strong displeasure with business as usual in Washington. Indeed, some of the remaining proposals for amending the bill reflect a desire by some senators to get tough on Wall Street.

Sens. Jeff Merkley (D., Ore.) and Carl Levin (D., Mich.) are proposing to bar banks from using their own capital to engage in speculative trades, and prohibit firms from betting against securities packaged and sold to their own clients.

Sen. Sheldon Whitehouse (D., R.I.) proposed to allow individual states to limit the interest rates that nationally chartered banks can charge, an amendment aimed at empowering states to drive down credit-card costs. Late Wednesday, Democratic leaders cleared the way for a vote on the proposal, a nod toward the demands for action. However, the Whitehouse amendment attracted only 35 votes, well short of the 60 votes needed for passage.

Earlier in the day, Senate Banking Chairman Chris Dodd (D., Conn.) backed away from a proposal to dilute provisions of the bill that would crack down on banks' trading of derivatives.

Mr.. Dodd had proposed to delay for two years provisions of the bill that could force banks to spin off their derivative-trading operations. He dropped the idea after it prompted an outcry from both fellow Democrats and the finance industry, which said it would increase uncertainty.

The legislation is designed to combat the root causes of the 2008 financial market collapse. Among other things, the bill would create a new system to manage the failure of a large financial institution and would establish a new consumer-protection agency, which would provide additional oversight of the home mortgage business.

Write to Greg Hitt at and Damian Paletta at

Wednesday, May 19, 2010

The Euro Turns Radioactive

Longer-Term Investors and Companies, Not Just Hedge Funds, Shun the Currency


Some of the world's largest money managers and central banks have become increasingly skeptical of the euro, presenting a threat to the common currency's prospects.

So far during the euro's months-long descent, attention has been focused on hedge-fund selling of European assets but central banks and large managers have a much-larger influence on foreign-exchange markets. Even if they don't dump euro assets, a mere pause in their buying could weigh heavily on the currency.

The euro on Wednesday rose to $1.2385, bouncing from $1.2143, its lowest level against the dollar in four years hit during the day, and from $1.2210 late Tuesday in New York. It was only the second gain in seven days against the dollar for Europe's shared currency, which has slumped nearly 15% against the dollar this year.

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Agence France-Presse/Getty Images

Germany Chancellor Angela Merkel calls for a major overhaul of Europe's fiscal rules Wednesday during a speech in Berlin.

South Korea's central bank, which has about $270 billion in foreign-currency reserves, among the biggest in the world, said this month that the euro zone's sovereign debt problems make the euro, used by 16 nations, less attractive as a reserve currency. Iran's central bank chief this week said that country may rethink its reserves, which the Central Intelligence Agency estimates around $81 billion. And Russia, with $400 billion in foreign-currency reserves, said it shifted its mix of reserves away from the euro last year.

Mutual-fund data show that in recent weeks, European and U.S. investors have shifted out of euro-zone equity funds. Asia's largest bond fund, Kokusai Asset Management's Global Sovereign Fund with $40 billion under management, lowered its euro allocation from 34.4% in March to 29.6% on May 10, according to a company manager. And portfolio managers with huge money pools, such as Allianz SE's Pacific Investment Management Co., or Pimco, and Baring Asset Management, expressed caution on the euro in interviews with The Wall Street Journal.

To be sure, not all money managers are selling euros, and some see the currency's weakness as a buying opportunity. An adviser to China's central bank, the biggest player in currency markets with more than $2 trillion in reserves, said this week it planned to keep diversifying its vast dollar holdings, which has in the past involved buying euros.

Recent euro weakness is a sign that longer-term investors and companies, not just hedge funds, are heading toward the exits. The shift is causing worries that central banks could be next. WSJ's Mark Gongloff discusses.

China, Russia and large emerging-market holders of currency reserves have tried in recent years to shift their mix of holdings in favor of euros, expressing worries about the fiscal health of the U.S. While China's may still diversify, many banks began paring their euro exposure late last year, and the wariness has lately become more apparent.

"The program of diversifying out of dollars has come to a screeching halt," said Collin Crownover, managing director and global head of currency management for State Street Global Advisors. "If the downward progression of the euro continues, then you see outright selling of euro-zone assets, and it snowballs and gets worse."

Money flowed out of Europe at an annualized pace of $50 billion in the first two months of 2010, according to Jens Nordvig, managing director of currency research at Nomura Securities International. That pace has likely increased in recent months, contributing to the euro's recent decline.

That outflow is likely due almost entirely to large investors, partly because hedge funds likely have reached the upper limit of their ability or desire to place bets against the euro, suggests Mr. Nordvig.
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"Somebody new is selling now," he said.

And unlike speculative investors, long-term investors likely won't quickly change their recent behavior even if the euro enjoys a respite.

"It's too early in the evolution of this particular crisis to assume all's well and investors should jump back into places that have burned them in the past few weeks," said Scott Mather, head of global portfolio management at Pimco, the world's largest bond-fund manager.

Many "real money" investors that might be expected to buy the euro on dips in value are staying on the sidelines given Europe's discouraging economic outlook and persistent grumblings in Germany over the cost of bailing out crisis-racked Greece.

"It's making a few people think, 'What am I getting into?' " said Colin Harte, director of fixed-interest and currencies at the London office of Baring, which has more than $47 billion under management. "What if you buy the euro and the Germans vote with their feet and leave" the currency union?

While Mr. Harte would normally buy the euro at its current rate, he says he can't really predict where the euro will go from here. His forecast ranges from $1.10 to $1.34 by year-end.

Central banks, which held a combined total of around $7.5 trillion in reserves at the end of last year, form the backbone of the currency markets. Their slow and steady shifts out of the dollars they generally receive from trade or commodities exports, and into other currencies, play a big role in determining exchange rates.

Reserve managers wouldn't need to sell euros at this point to hit the currency hard. Instead, they would merely need to slow down the pace of euro purchases, and that risk is needling market watchers now.

Central banks "are not as active as they had been," said Adam Reynolds, co-head of currencies and fixed income at Societe Generale in Hong Kong. His firm, like others, processes currency trades on behalf of central banks, sovereign-wealth funds and private investors.
—Katie Martin, Andrew Monahan and Min Zeng contributed to this article.

Write to Mark Gongloff at, Alex Frangos at and Neil Shah at

Tuesday, May 18, 2010

How the 'Flash Crash' Echoed Black Monday

May 6 Selloff Had Parallels to 1987; Electronic Trading Magnified Selling Pressure This Time


Soon after the Black Monday crash of 1987, exchanges and regulators scrambled to enact new rules to prevent a repeat of the biggest stock market shock in 50 years. Even then, they worried they hadn't done enough.

"I simply cannot give you assurances that we have fixed the system," the chairman of the Securities and Exchange Commission at the time, David Ruder, told the Senate Agriculture Committee in early 1988.

After two decades of rule-changing and technological advancements, those comments seem haunting, especially as investigators of May 6's "flash crash" stumble upon echoes of the Black Monday meltdown.

Technological innovation has been widely touted as having made the market more efficient, and more resilient. Instead, the May 6 drop—while much smaller than the 1987 crash—showed that technology mainly served to speed up trading and magnify the market moves.

On May 6, "The velocity of the volatility was stunning, beyond anything I had ever seen, with the exception of October of 1987, when I was on the trading floor," said Ted Weisberg, president of Seaport Securities in New York.

"There's a strong parallel between the Black Monday crash and the flash crash," said Michael Wong, an analyst at Morningstar who tracks stock exchanges.

On Oct. 19, 1987, the Dow Jones Industrial Average tumbled more than 20%, and the swoon extended into the following day, before a rebound. Floor traders, working by telephone, dominated the action and computer-generated trading was still in its infancy. Dark pools and high-frequency trading were the stuff of science fiction. Trading reached 600 million shares, according to the SEC.

Fast forward to May 6, 2010: The worst part of the lightning descent lasted roughly 10 minutes and the decline hit 9.8% at its worst. Trades, many executed in milliseconds, reached 19 billion shares.

In both cases, troubles first appeared in the stock futures market, which precipitated a decline in the regular "cash" market. The two created a feedback loop, dragging both markets lower.

Perhaps the most concerning parallel was how professionals abandoned the market. In 1987, some human market-makers on the floor of the exchange stopped providing bids for certain stocks.

Two decades later, in a market dominated by technology, high-speed traders who often provide liquidity for the market, just switched off their computers. Other big players, including fast-trading hedge funds, also pulled out of the market, according to traders and exchange officials.

"Go back to the 1987 crash, every major firm pulled out," said Chris Concannon, a senior partner at Virtu Financial LLC, a New York electronic market making firm, which continued trading during the May 6 turmoil. "In every break you find evidence of major firms withdrawing their buying and selling interest from the market."

Ahead of Black Monday, many agreed the market was due for a slide, having staged a 40% run-up earlier that year, part of a bull run that had started in 1982. And in the past 12 months, many market observers watched warily as the Dow staged a 60% rally from its lows of March 2009.

On the morning of Black Monday, futures contracts dropped sharply before the start of regular stock trading on the floor of the New York Stock Exchange. When New York opened, stocks plunged to reflect the lower futures prices.

That led to more futures selling. A relatively new financial product in the 1980s called portfolio insurance, in which investors used futures to hedge against losses in stocks, amplified the downdraft. Heavy selling of futures pushed down stock prices. Investors looking to protect themselves from further losses in stocks in turn sold futures—sparking another wave of stock selling.

While portfolio insurance has long since gone by the wayside, a large number of traders still use futures to hedge against losses. The May 6 selloff appears to have been led by a wave of futures selling. Commodity Futures Trading Commission Chairman Gary Gensler, in congressional testimony a week ago, said trading between futures and stocks became "highly converged" in the May 6 decline. The plunge in futures caused stocks to fall, leading to even more selling of futures.

The link means that in times of stress, these two key parts of the market—stocks and futures—can have a self-reinforcing effect that can turn an average selloff into a crash.

Selling pressure on both days became so intense that any remaining buyers were overwhelmed, creating an "air pocket" in stocks and other securities that led to vertiginous declines.

Many market makers on Black Monday had exhausted their funds, while others were overwhelmed by the volatility. The NYSE later took steps to boost traders' capital.

Some of the key changes in the markets helped magnify the selling pressure on May 6, rather than helping cushion the market.

This time around, many investors rushing to sell unloaded exchange-traded funds, which didn't exist in the 1980s.

Heavy selling of ETFs spread losses to other parts of the stock market. ETFs linked to indexes such as the Russell Midcap index spiraled in value in the selloff; indeed, the value of many ETFs actually fell to pennies. About two-thirds of all securities that had canceled trades on May 6 were ETFs, according to

Yet there is one last parallel between 1987 and 2010. Mr. Ruder, the former NYSE head and currently an emeritus professor at Northwestern University, is now part of the government committee examining the "flash crash."

Saturday, May 15, 2010




             • 断言本轮经济危机已经结束,仍为时尚早。
             • 当代资本主义制度性质未变,但体制转换了,从而使其延续下来。
             • 不改体制,制度难以维持;改了体制,制度将继续保存下来。
             • 国有企业制度和城乡二元体制不搞掉,计划经济还是没有退出历史舞台。
             • 中国不要奢谈自己的体制优势。耽误转型难度会更大。
             • 后危机时代,中国要保持清醒头脑,制度调整不能停止。
             • 终止制度调整没有出路,停止改革没有出路。
  【《财经》记者 马国川】世界经济危机似乎已经远去,一种乐观情绪在中国蔓延。
  在全世界金融和经济一片愁云惨雾中,似乎只有中国经济一枝独秀。国内外一些人士罕见地组成了“合唱队”,声称全球经济危机证明“西方那一套”行不通,只有“中国模式” 才是世界未来发展的模式。
  厉以宁:从那时开始,国家开始对经济进行干预。当时还有一个背景,就是在经历了19世纪和20世纪初期之后,自由市场经济的作用到1929—1933年世界经济危机前夕已经达到了顶点,越过这个顶点, 完全自由市场经济的作用受到普遍的质疑。人们的思想开始发生转变,认为政府干预经济的行为是对自由市场经济运行机制缺陷的一种补充,也是更好地贯彻亚当•斯密经济学理论的必要手段,因为亚当•斯密在论述自由市场经济作用的同时,也分析了社会正义和公平的问题。依赖于政府的调节,不仅不会阻碍自由市场经济目标的实现,反而会使这一目标的实现具有可能性。而社会上有越来越多的人的观念发生了上述变化,也为西方国家对经济的干预提供了合理性。西方国家的政府从这时起相继采取了资本主义制度调整的措施,如干预经济以增加就业,关注民生问题以缓解社会矛盾。到第二次世界大战结束以后,一些西方国家在维持就业、促进经济增长和推行社会福利政策方面采取了比较有力的措施。在第二次世界大战结束后的半个多世纪内,西方国家的经济从总体上说是平稳发展的,GDP逐步增长,人均收入也随之提高。尽管各国的经济增长率有高有低,各国政府的经济政策有所差异,各国资本主义的制度调整进度也有快有慢,但各国社会基本上都能够接受制度调整的现实,制度调整的结果也继续存在,并被一些国家的法律固定下来了,使得资本主义制度依然存在。