Redstate

...don't serve quite the same financial function or real-world function that ours do. I'd take your point and state it even more strongly: a large number of small speculators are streaming into the market, and they're going to get skinned. And I don't think the Chinese authorities care one whit about them. I think they care very much, on the other hand, about creating a perception of stability in their stock markets.

But in reality, these markets aren't very deep, and they're probably not very liquid. China has managed (for the last nine years and counting, at any rate) to avoid serious distress in their "real" financial system, mostly through the mechanism of the dollar peg. I don't think the fate of a few dozen million speculators matters to them.

VIX is at about 13.9 as I write this, up nearly 0.40 :-). As I said in my original post, it's good trading weather today.

are speculating and are in because they 'don't want to miss the ride'. Been there, done that, got the scars. As you pointed out, liquidity and market depth are concerns - more reasons why I haven't dipped my toe in. Then again, I also stopped casino gambling over 20 years ago.

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"Enlightened statesmen will not always be at the helm." -- James Madison

Sorry Shaggy, not sure what you're referring to, please enlighten. Thanks.

I think you have written in the past that you work on Wall Street. Don't you perceive that lenders are pushing the credit envelope, racheting up the amount they lend relative to cash flow, while offering low interest rates and loose covenant terms.

I think they are doing this because the hedge fund and CLO investor demand for debt allows the big money center bankslike BofA and Chase who used to be more conservative to write big loans, collect the fees, and limit their risk by sticking the paper with these institutional investors and buying credit default derivatives.

Maybe Lender behavior is rational, but there was a much ballyhooed letter from the head of Carlyle to their deal professionals earlier this year that opined, among other things, that lenders are taking excessive risks, and various articles in the WSJ this year have noted that the flood of big LBO deals has been made possible by easy credit terms.

It seems to me reminiscent of lending practices in the late 1990s that led to big lending losses after the recession, only the excessive credit loosening seems worse now.

I believe credit defaults are at an all time low now, but that can't last for ever and unfortunately it "justifies" a continuation of pushing the envelope now. When defaults do eventually start to spike up, it could shut down the liquidity spigot that has been funding the LBO boom, which has been in signficant part fueling the overall positive economy and stock market for the past year+. Could be a difficult ripple effect.

To the extent you agree (or not) that what's happened with lenders pushing the credit envelope is a debt bubble, it probably won't be as bad as the Nasdaq bubble, which was totally irrational, but loose corporate debt terms are a major driver of the economy right now and if it has a big pull back it could lead to an overall economic contraction.

Since you don't sound like you perceive this the same way, I am interested in your opinion.

I see why I was confused by your original comment. When you said "corporate debt," I thought you meant the daily capital requirements of businesses. But their balance sheets are looking pretty healthy on the whole (and getting more so).

I don't pretend to understand the dynamics of the PE revolution, but I'm the first to admit it's a very big deal.

I won't explicitly disagree with your points because I'm not confident my intuitions (that's all I have) are any better than your information.

I do think a more apt comparison would be to the mid-80s, the original LBO boom, which unlocked a huge amount of untapped potential in the stock prices of businesses (or to see them as Wall Street sees them, of revenue streams).

I believe that public stocks are the new bonds. The largest holders of public equity are tax-free and beneficial institutions that are using their portfolios to fund pension and underwriting liabilities, as well as mutual funds that people use to fund their retirements.

What does that mean? It means that the most important owners of stocks are looking for them to return as close to a consistent 8 to 10 percent as they can get. Stocks are the new bonds.

And corporate managements manage to meet those goals. Now whenever you hedge away earnings volatility, you axiomatically give away upside potential. (That falls right out of modern portfolio theory.)

I believe this opens up the enormous opportunities in PE that we're all seeing. The only way to make a business enterprise return 15% or more is to take it private and manage it aggressively. Of course, since our tax system privileges capital growth rather than income, the only way to realize the higher returns is to eventually sell the equity back to the public. That explains all the observed behaviors.

Honest to goodness, I don't see any reason to be concerned about credit quality at this point. You may be working from different (and better) information than I am, of course! I do think that we've been seeing a serious deterioration of credit quality in China, but that's logical given how many dollars they have to sterilize every quarter. But still, they won't have a recession until we do.

It seems to me that the investment banks have been primary sources of liquidity for PE deals, not the institutions that used to be called "money-center" banks. (If you have information to the contrary, don't keep it a secret!) As far as the derivatives you mention, I think they're far less risky than is commonly supposed. I know about the potential for systemic risk. But I trust the guys at Goldman and Bear Stearns to know what they're getting into, enough to be a big buyer of their stock lately.

As far as Carlyle goes: I have nothing but respect for Lou Gerstner, believe me! But don't you think there's a PR aspect to whatever he allows to leak out to the WSJ? ;-) I'd be more inclined to think those statements were intended more for consumption by Carlyle's competitors than by the rest of us.

And I am sure I do not have better information than you. I just like to follow the economy and obsess about what can go wrong. Any time I see a big surge in one sector, I get worried. Equity and debt investors get paid to do deals, and as the market gets more and more aggressive, the higher they go, but what goes up must come down eventually.

But you may very well be right that things are not that far out on a limb yet. Many people said in prior years that the real estate bubble was out of control and would implode, and while it is now deflating it doesn't appear to be wrecking the economy yet.

We'll see about the LBOs, but at any rate your China story gives me one more thing to enjoy worrying about. Please keep it coming, like I said MSM doesn't connect the dots at all.