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Financial Skeptic Bulletin, October 2008
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October
The Fed wasted 425 basis points of cuts in the Federal Funds target rate
since August 2007 trying to fight a liquidity crunch.
And the US recession is only just beginning.
... ... ...
If the liquidity crisis coincides with or is merely the reflection of an
underlying fundamental insolvency crisis, recapitalisation of systemically important
highly leveraged institutions (HLIs) by the tax payer is called for.
... ... ...
In the US, the UK and the rest of the EU, the financial sector is undergoing
both a fundamental solvency crisis (reflecting past reckless lending, investment
and funding decisions) and a liquidity crisis. The liquidity crisis is, I would
argue, more than just the reflection of an insolvency crisis.
After all, (fear of) insolvency is neither necessary
nor sufficient for illiquidity. Indeed, in the current phase
of the crisis, when the authorities in some countries (Ireland is the most extreme
example) have guaranteed most of or even all of the liabilities of the banking
system, we can find ourselves in the interesting
situation that banks are fundamentally insolvent but nevertheless liquid.
Should in 2009 Roubini be considered as a bullish signal ? ;-) Right now
he still probably on mark: he see economy contracting and another 12 months of recession.
Much more painful 2009 then 2008. He expects earnings to decline which represent
downside risks. S&P500 can drop to 720 or even 600. the latter might not materialize.
Q4 is going to be ugly.
by CalculatedRisk From San Francisco
Fed President Dr. Janet Yellen:
The Mortgage Meltdown, Financial Markets, and the Economy. Excerpt on the
economic outlook:
[R]ecent data on the economy have been deeply worrisome. Data released this
morning reveal that the economy contracted slightly in the third quarter.
For the fourth quarter, it appears likely that the economy is contracting
significantly. Mainly for this reason, inflationary risks have
diminished greatly.
...
For consumers, the credit crunch is one of several negative factors accounting
for the decline in spending in recent months. Consumer credit is costlier
and harder to get: loan rates are up, loan terms are tougher, and increasing
numbers of borrowers are being turned away entirely. This explains, in part,
the exceptional weakness we have seen in auto sales. In
addition, of course, employment has now declined for nine months
in a row, and personal income, in inflation-adjusted terms, is
virtually unchanged in extending credit to customers and other counterparties.
Nonresidential construction also is headed lower largely
because of the financial crisis; the market for commercial mortgage-backed
securities, a mainstay for financing large projects, has all but dried up.
...
Until recently, weakness in domestic final demand was offset by a major
boost from exporting goods and services to our trading partners. Unfortunately,
economic growth in the rest of the world has slowed noticeably. ... As a
result, exports will not provide as much of an impetus to growth as they
did earlier in the year.
emphasis added
"It appears likely that the economy is contracting significantly".
Strong words from a Fed president. Q4 is going to be ugly.Comments
steelhead writes:
From Jesse's Cafe Americain "30 October 2008
Even in a "Market Meltdown" and a "Once-In-A-Lifetime Financial Panic...."
...the Other People's Money (OPM) managers can still find time to paint the
tape into the end of month.
When this coat dries, they *might* try to slip on one more layer of paint before
the weekend, but if we break to the downside we would look for a complete retrace
of this rally to retest the lows.
Why? Because it is based solely on speculation, market manipulation and esperimentation
by the Fed and Treasury. It is not based on anything organic to the economy,
neither reform nor restructuring.
Wall Street corruption is one of the biggest impediments to an economic recovery.
It has become an inefficient obstacle to capital allocation, price discovery,
and real economic growth.
The US financial system represents a general systemic risk to the rest of the
world because of the manipulation of the US dollar as reserve currency to serve
the short term secular interests of a small but powerful financial elite."
Absolutely correct.
steelhead | 10.30.08 - 5:00 pm |
#
===
Neuromancer writes:
Yes. Leverage is credit. De-leveraging is removing the credit.
Look, when a bank lends out at 40:1, as many German banks did, this means
for every dollar of actual capital held by the bank (reserve deposits or whatever)
they lend 40. They do this because the feel the risk is low and that they can
make more money. Once banks relaize that this is pretty silly, they start taking
back those 40:1 ratios down to 10:1. That loss of extended credit, hereby a
factor of 4, is a quick and massive loss of credit in the system.
The fed then prints to cover that delveraging (effectively leveraging up
the system) by putting in real reserves that can actually be used to realize
real losses AND so that banks can still lend at (at least) 10:1. Without the
fed, most big banks would simply have gone under and then. Well then, you have
a Depression. The wave of business collpase would have been staggering.
In fact, it still may happen. The US has dumped $130b into AIG and it STILL
may go under. The derivitce exposure to AIG must be staggering.
Neuromancer | 10.30.08 - 6:11 pm |
#
Inflation is the only real problem in fiat money regime...
Notwithstanding, I think Greg is raising a very valid point. Allowing the overall
deflation in the U.S. in the 1930s and Japan in the 1990s was one quite fixable
policy error. But perhaps modern macroeconomists have deluded ourselves into
thinking that if this policy error had not been made, the whole episodes could
have been avoided. How bad would the Great Depression have been if the price
level had not fallen? Not as bad as it was, I'm convinced, but maybe still pretty
bad.I still like
Brad DeLong's
perspective on all this:
Is 2008 Our 1929? No. It is not. The most important reason it is not
is that Bernanke and Paulson are both focused like laser beams on not making
the same mistakes as were made in 1929....
They want to make their own, original, mistakes..
Comments
Whose Afraid Of Deflation?
In my last post, William Gross said this:
"They must also take another bold step: outright purchases of commercial
paper. They should also cut interest rates to 1%, because we are experiencing
asset deflation, and the threat of headline inflation is long past."
Via Greg Mankiw, who wasn't convinced, came the following:
"In a previous post, I expressed surprise
that yields on inflation-indexed Treasury notes are rising.
Readers have emailed me a variety of hypotheses, the most common of which
is deflation. As one smart economist put it:
Here's one possible answer -- the credit crunch has precipitated a massive
expansion of money demand -- a scramble for cash. Despite its best efforts,
the Fed has not matched this with a sufficient expansion of money supply.
As simple IS-LM would predict, this surge in money demand has raised real
interest rates (indicating that monetary policy is perhaps still too tight).
Rising real rates on inflation-indexed bonds and falling rates on nominal
bonds also tell us that markets expect this surge in money demand to result
in near-zero inflation or even deflation in the years ahead. It's starting
to look more and more like 1990s Japan, though hopefully for not as long."
From Michael A. Fletcher's story today in the Washington Post:
"The confluence of trends has some economists worried that the country
could be headed for a debilitating cycle of deflation: a period in which
weak consumer demand, falling prices and tight credit ignite a downward
spiral of still weaker demand and still lower prices. Under this scenario,
as some businesses are strangled, joblessness increases, feeding the cycle.
"It was just a few months ago that everyone was obsessed with inflation.
Now it's deflation," said Bill Gross, co-chief investment officer at Pimco,
an investment management company. "I think it's a possibility."
And:
"Some economists note that a period of price adjustments does not necessarily
signal the start of a deflationary spiral.
"Deflation is not the problem we should be worrying about," said Adam
Lerrick, an economist at Carnegie Mellon University. "A drop in the level
of prices for some goods must be distinguished from a continuous fall of
prices. Oil is down to $90 from $140, but does anyone expect it will be
$55 a year from now and $35 in 2010?"
Analysts said that a few months of price declines should not be a problem
for the economy.
But if prices continue to fall across the board for a prolonged period,
the declines will weigh heavily on businesses and consumers, particularly
those juggling a lot of debt, which must be paid back even as money is harder
to come by.
"For a few quarters, I say bring it on, but not for too much longer,"
Gross said of deflation. "Capitalism depends on mild inflation. Unless we
get it, the dynamics of capitalism sort of move in reverse."
But then, there's this:
"In the United States, policymakers have been much quicker to respond
to deflationary threats. Five years ago, as inflation approached 1 percent,
spawning deflation concerns, Alan Greenspan, then the Federal Reserve chairman,
cut the Fed's benchmark lending rate to 1 percent and the threat was never
realized. It is an outcome that gives assurance to some economists.
"As long as governments print money and run deficits, you cannot
have deflation," Lerrick said."
So, in the end, doesn't that mean inflation is the only real problem?
Posted by:
Don the libertarian Democrat at October 29, 2008 08:32 AM
===
Of course, doing so is a huge mistake that just pushes the real crash out
further.
If we don't have massive deflation soon, we're going to have continued stagflation:
wages falling behind inflation in real cost of living (using Roosevelt's,
not Reagan's, CPI). In fact, we've had that for 20 years now. The real cause
behind falling house prices isn't just the subprime bubble and crash- it's
that housing is now unobtanium for a large percentage of the US population
when you take away con games like the subprime mortgage market.
Food & fuel are also now quite problematic- you can't afford to live 5 miles
out in the country and have an inner-city minimum wage job, there's no way
to get to work. Food prices are increasing fast enough that we're seeing
charity organizations, last resort for the poor, running out of food in
the food banks.
Yes, you're absolutely right that deflation is not to be feared, that the
FED can control the deflationary rate. Yes you're right that deflation is
not a reasonable forecast because of this. But we're coming very close to
the point of the lack of deflation causing a civil war, it's already to
the point where a lack of deflation is causing suicide. Is that what you
really want?
Posted by: Ted Seeber
at October 29, 2008 09:20 AM
Money worries rob workers of sleep, study shows
Nine of 10 American workers are losing sleep over financial worries, according
to a survey released Monday by a company that helps workers deal with wellness
issues.
Thirty percent of respondents reported worrying about the cost of living
while 29 percent cited credit-card debt.
Keeping up with the rising cost of living and credit card debt were top concerns
preventing people from falling asleep, according to the results from ComPsych
Corporation, which surveyed employees of companies it serves. Thirty percent
of respondents reported worrying about the cost of living while 29 percent cited
credit-card debt.
naked capitalism
This informative discussion that sheds further light on the stresses created
by credit default swap settlements comes in the current issue of the Institutional
Risk Analytics weekly, "In
the Fog of Volatility, the Notional Becomes Payable":
Another example of the ongoing discontinuity in the markets comes in the
linkage between the unwind of credit default swap ("CDS") positions written
regarding Lehman Brothers, Fannie Mae and Freddie Mac, and dollar LIBOR
rates in Europe.
The auction process begun by DTCC, by which holders of CDS on bankrupt Lehman
Brothers settled in cash via the DTCC's facility, caused many tongues to
wag as to the "net" amount providers of protection must pay to holders of
CDS. Several members of the media called last week to ask if Don Donahue,
CEO of DTCC, was speaking truth when he said that the net payments on Lehman
contracts processed by the DTCC's warehouse were a mere $6 billion or so.
Of course Don Donahue is providing the straight skinny on the flow of transactions
which have actually participated in the DTCC auction. But consider that
other than holders of CDX and some holders of single name CDS not offended
by the prospect of cash settlement, there remain
a large number of total holders of CDS for Lehman who do not wish to take
cash settlement and indeed are expecting to receive the underlying bonds.
Now the apparent non-event from the Lehman CDS auction is a source of media
frustration. Wasn't there supposed to be a breakdown in the CDS markets,
a dramatic failure event a la Lehman Brothers? But the merchants of doom
should take heart.
The bad effect of the CDS market comes not merely from when there is market
dysfunction and an individual counterparty fails. That happens often enough,
but the prime broker-dealers clean up the mess quietly so as not to roil
the markets. Remember, the dealer already owns the counterparty's collateral
through the credit agreement, so there is no point forcing the issue with
a messy and noisy bankruptcy. Right? This is why the media rarely hears
of fails in CDS.
No, as with the repatriation of the Structured Investment Vehicles onto
the balance sheets of C and other money center banks, the true significance
of CDS comes when the markets function smoothly, as after a default event
like Lehman. The trigger event putting a single
name CDS contract in the money results in a liquidity-raising event for
the seller of protection, who must fund the purchase of the debt at par
less recovery value - whether or not the other party actually owns the debt!
This process of funding the CDS is reportedly a factor behind the high rates
of dollar LIBOR in London and illustrates how cash settlement derivatives
actually multiply risk without limit. Through the wonders of cash settlement,
the derivative-happy squirrels at the Fed, BIS and ISDA created a liquidity-sucking
monster in OTC derivatives that multiplies risk many times, for example,
above the amount of underlying debt of Lehman Brothers. But remember two
things:
- a) In some single-name CDS contracts, the buyer of protection must
deliver to get paid; and
- b) in those contracts, where the buyer fails to deliver, the provider
of protection can walk away.
We hear that there are more than a few EU banks which wrote CDS on Lehman
over the past several years, CDS which were written at relatively tight
spreads. These banks did not participate in
the DTCC auction and instead have chosen to take delivery on the Lehman
debt, forcing them to fund a nearly 100% payout on the collateral. A certain
German Landesbank, for example, took delivery on $1 billion in Lehman bonds
that are now worth $30 million, and had to fund same. Does this example
perhaps suggest a reason why the bid side of dollar LIBOR in London has
been so strong?
As one veteran CDS trader told The IRA on Friday, "It's
not that people can't fund, it is that people have got to fund these CDS
positions. These banks don't have access to sufficient liquidity internally
to fund, so they hit the London markets... The Fed and the
other central banks must start to deal with the huge overhang of currently
hidden funding needs from the CDS and other derivatives." Another market
observer suggests this is precisely why the Fed and other central banks
have been furiously putting reciprocal currently swap lines in place.
Then there is the situation with Fannie and Freddie paper, which is currently
trading 200-300 over the curve despite the Paulson quasi-nationalization
this past August. Some of the very same EU banks that are getting killed
on Lehman paper are also taking delivery of GSE paper on CDS positions.
In this case, the payout on the CDS is small since the GSE debt is money
good, at least in nominal terms, thus the net recovery value is high.
But the huge overhang of paper in the markets
is making the in theory "AAA" rated GSEs trade like poor quality corporates.
In both cases, the normal operation of the OTC
derivatives markets is creating a cash position that must be funded in the
real world and is thus distorting these benchmark cash markets such as LIBOR.
This distortion is magnified by the dearth of liquidity due to the breakdown
in the rules regarding valuation and price. So far, the Fed and other central
banks have addressed the on-balance sheet liquidity needs of global banks.
But as retail and corporate default rates rise, funding the trillions of
dollars in notional off-balance sheet speculative positions in CDS, which
become very real and require funding when a default occurs, could prolong
the economic crisis and siphon resources away from the real economy.:
Comments
Moon of Alabama
While not driven by my recommendation to
declare
all Credit Default Swaps null and void the general idea seem to get a bit
of traction.
At The Agonist Sean-Paul Kelly
asks:
It seems to me that one of the most significant problems we face right
now (and going into the future) is CDSs. What would happen if the Federal
Government simply said: "they are all dead trades. if you sold protection
you are off the hook, if you bought it, too bad"?
He points to a NYT
piece which includes this:
Janet Tavakoli, a finance industry consultant who is president of Tavakoli
Structured Finance, said the stock market’s gyrations are a result of a
severe lack of confidence in the very officials who are charged with cleaning
up the nation’s mess.
...
She also suggests that financial regulators impose a form of martial
law, allowing them to rewrite derivatives contracts that bind counterparties
to terms they may not even comprehend.
Chua Soon Hook who runs a profitable billion dollar fund for Asia Genesis
Asset Management
explained on Bloomberg TV how CDS are now used to raid leveraged companies
and even countries.
Hedge funds and banks load up with cheap credit insurance via CDS for debt
of a company or country. They then short that companies stock. With that, the
stock value of the company sinks, the default likelihood of that company increases
and the value of the CDS bought goes up. This gives the fund money to buy more
credit insurance which, as other market participants watch the increasing default
spreads, will again increase the default risk of the company and the value of
the bought insurance and the value of the short.
Credit insurance can be written, bought and sold in unlimited number. A company's
$1 billion total debt can be insured a 100 times and more. Even if the likelihood
of a debt default increases only a tiny a bit, a big CDS position in a thinly
traded market may dou very profitable deal. Chua
suggests to immediately make the writing of any new CDS worldwide illegal.
A scheme similar to the above now gets some
interest
from New York State and federal prosecutors:
Prosecutors are looking at whether traders
manipulated the largely unregulated market for credit-default swaps to drive
down the price of financial shares over the last year, people briefed on
the investigation said.
In an unregulated over-the-counter market there are no rules and manipulation
will be very hard to prove.
It seems to me that a similar raid tactic is now
used to profit from problems in some countries:
The cost of insuring Russian bonds against bankruptcy rocketed to extreme
levels yesterday. Spreads on credit default swaps (CDS) reached 1,123, higher
than Iceland's debt before it sought a rescue from the International Monetary
Fund.
Russia has over $500 billion in foreign reserves. The high CDS spread is
by all means totally out of whack with reality. But with a rumor here and there,
I am sure it can be driven up even more and some holders of some CDS will profit
a lot from that.
Like Chua I believe that these CDS make the crisis
we are in much worse and create a lot of unnecessary damage in the real economy.
If a company has to pay higher interests because of CDS bets against it, jobs
get lost.
The markets that should reflect the real economy get out of whack because
of unregulated instruments like CDS. The false sentiment
they generated then influences the real economy. This is an example of Soros'
reflexivity.
So here again the steps to get rid of these:
At the same time:
- all financial exchanges and markets of the world close for a week
- CDS are declared null and void and new CDS creation is forbidden until
new regulation is in place
- the publicly dealt financial entities have seven days to figure out
and publicly restate the value of their liabilities and assets excluding
all CDS
- a onetime windfall tax will be created that socializes overt advantages
some entities will have from this
- the proceed of that tax shall be used to prop up the capital of the
big losers in a program comparable to the
Comments (22)
I think not: freedom of the press... But to follow talking head is probably
the worst investing strategy imaginable...
Last summer, when the market first took a swoon, the news media filled its air
time and pages with the comments of financial analysts who said that people
should hold their stock and that in fact the depressed prices made it a good
time to buy. In fact, I dug up this
BTP post which refers to BBC radio telling its listeners about the bargain
basement stock prices that should encourage buying. That was back when the S&P
was more than 50 percent higher than it is today.As I pointed out at the
time, a buy and hold strategy is not always best. It makes sense to look at
fundamentals, most obviously the price to earnings ratio. When the ratio is
very high, then there is a risk of large losses and less hope for a large sustained
gain.
The media should have presented analysts making this obvious point. They
rarely did. If the public took the investment advice that they receive through
the media seriously, they have lost a huge amount of money in the last year
as a result.
--Dean Baker
Oct. 27 (Bloomberg)The bundling of consumer loans
and home mortgages into packages of securities -- a process known as securitization
-- was the biggest U.S. export business of the 21st century.
More than $27 trillion of these securities have been sold since 2001, according
to the
Securities Industry Financial Markets Association, an industry trade group.
That's almost twice last year's U.S. gross domestic product of $13.8 trillion.
The growth over the past decade was made possible by overseas banks, which
saw the profits U.S. financial institutions were making and coveted the made-in-America
technology, much as consumers around the world craved other emblems of American
ingenuity from Coca-Cola to Hollywood movies. Wall Street obliged, with disastrous
results: two-thirds of a trillion dollars in bank losses, about 40 percent of
them outside the U.S.
``Securitization was based on the premise that a fool was born every minute,''
Joseph Stiglitz, a professor of economics at Columbia University in New
York, told a congressional committee on Oct. 21. ``Globalization meant that
there was a global landscape on which they could search for those fools -- and
they found them everywhere.''
Eager Adopters
European banks, in particular, were eager adopters. Securitizations in Europe
increased almost sixfold between 2000 and 2007, from 78 billion euros ($98 billion)
to 453 billion euros, according to the
European Securitization Forum, a trade organization.
Three Icelandic banks borrowed enough to buy $228 billion of assets, most
of them securitizations, turning the country's financial system into a hedge
fund. All three banks have been nationalized by the government, leading Prime
Minister
Geir Haarde to advise citizens to switch from finance to fishing.
In Germany, one bank, Landesbank Sachsen Girozentrale, bought $26 billion
worth of subprime-backed investments, putting the state of Saxony on the hook
for $4.1 billion.
In Japan,
Mizuho Financial Group Inc., the nation's third- largest bank, acquired
an entire structured-finance team, which proceeded to lose $6 billion issuing
mortgage-backed securities.
Shadow Banking
The damage reaches all the way to Australia, where the town council of Wingecarribee,
a municipality outside Sydney with a population of 42,000, bought $20 million
of securities from
Lehman Brothers Holdings Inc. Now, Lehman is in bankruptcy, the town council
is in court and the securities are worth about 15 cents on the dollar.
Securitization is a shadow banking system that funds most of the world's
credit cards, car purchases, leveraged buyouts and, for a while, subprime mortgages.
The system, which pools loans and slices up the
risk of default, made borrowing cheaper for everyone, creating a debt culture
that put credit cards in wallets from Seoul to Sao Paolo and enabled people
to buy luxury cars and homes. It also pumped out record profits
for banks, accounting for as much as one-fifth of their revenue over the last
decade.
Beginning about three years ago, investment banks revved the system's engine
to boost earnings. They raised revenue by funding more subprime mortgages and
cut costs by relying increasingly on the $4.2 trillion sitting in U.S. money-market
funds. As it turned out, those decisions would prove fatal.
Powerful Technology
``It's a powerful technology that has been driven beyond the speed limit,''
said
Juan Ocampo, a former consultant at New York-based advisory firm
McKinsey & Co. who wrote a 1988 book popularizing structured finance. ``For
the last five years, instead of going 65 mph, they've been gunning it to 140
mph, 150 mph.''
Before the invention of securitization, banks loaned money, received payments
and profited from the difference between what the borrower paid and the bank's
funding cost.
During the mid-1980s, mortgage-bond traders at Salomon Brothers devised a
method of lending without using capital, a technique at the heart of securitization.
It works by taking anything that has regular payments -- mortgages, car loans,
aircraft leases, music royalties -- and channeling
the money to a trust that pays bondholders principal and interest.
Off-Balance-Sheet
The word ``securitization'' implies safety. Investors with less appetite
for risk buy higher-rated securities and get paid first at lower interest rates.
Those with a bigger appetite get paid later and receive more interest.
Securitization's biggest innovation was off-balance-sheet accounting. If
a bank couldn't sell a bond or didn't want to, the asset could be sold to a
trust within a so-called special- purpose entity, incorporated in a place such
as the Cayman Islands or Dublin, and shifted off the books. Lending expanded,
and banks still booked profits.
With this new technology, a bank could originate $100 million in loans, sell
off some to investors, transfer the rest to a special-purpose entity and not
have to hold any capital. The profit could be as much as 1.25 percentage points
of the amount loaned, or $1.25 million for every $100 million issued.
``The banks could turn a low return-on-equity business into one that doesn't
use any equity, which was the motivation for this,'' said
Brad Hintz, a Sanford C. Bernstein & Co. analyst and former chief financial
officer at Lehman. ``It becomes almost like a fee business because it requires
no capital.''
Capture the Prize
Like most new products, securitization found a market at home before going
abroad. Bankers at Salomon and First Boston Inc. raced from bank to bank to
convince issuers it was the wave of the future.
William Haley remembers a 10 a.m. meeting in 1987 at Imperial Thrift & Loan
Association in Glendale, California. As Haley, at the time a 33-year-old Salomon
banker, and his team walked into the conference room to make a pitch, the First
Boston team was walking out.
``We exchanged some knowing looks and then tried to beat the pants off them,''
said Haley, who now works at RBS Greenwich Capital Markets Inc., a firm specializing
in mortgage-backed securities that is owned by
Royal Bank of Scotland Group Plc. ``There was a fierce desire to capture
the prize.''
First Boston
First Boston, housed in the same New York office tower as McKinsey, was first
out of the gate in March 1985 with a $192 million computer-lease securitization
for Sperry Corp., a predecessor of Unisys Corp. The bank then oversaw a series
of auto-loan securitizations, including a $4 billion issue by
General Motors Acceptance Corp. in October 1986, the biggest corporate debt
issue at the time.
Haley's project was a $50 million deal for Banc One Corp. called Certificates
for Amortizing Revolving Debts, or CARDs. It was the first credit-card securitization
and a blueprint for the $358 billion of such securities now outstanding. The
transaction also gave the banks a way to securitize their own assets and get
them off their balance sheets, which allowed the money to be lent all over again.
The strategy was detailed in Ocampo's 282-page book ``Securitization of Credit:
Inside the New Technology of Finance,'' which he co-wrote with McKinsey consultant
James Rosenthal. Ocampo, who received an MBA from Harvard after graduating
from the Massachusetts Institute of Technology, and Rosenthal, a Harvard Law
School graduate, argued that banks could be more profitable if they used securitization.
McKinsey Book
The authors examined six of the first asset-backed transactions and gave
readers a step-by-step guide for how to repeat them. They said that banks that
didn't embrace the new technology would be at a disadvantage, and they predicted
it would become the dominant form of financing.
``The McKinsey book helped with credibility with issuers,'' said Haley. ``It
wasn't that easy in the beginning. Conferences now have thousands of people,
but I remember once in Beverly Hills, I gave a speech and there were maybe 25
people in the audience. They were furiously taking notes, however.''
The new technology was spread around the world by the people who worked on
the First Boston and Salomon teams. Salomon's group was led by Patricia Jehle,
who later founded Bear Stearns's asset-backed unit. Another member, Michael
Hutchins, started the first team at a European bank when he went to Zurich-based
UBS AG in 1996. A third,
Michael Normile, moved to
Merrill Lynch & Co., where he ran its securities business, then switched
to London-based
HSBC Holdings Plc in 2004. Haley built similar teams at Lehman, Chase Manhattan
Bank and Amsterdam-based
ABN Amro Bank NV.
Hard Sell
First Boston's team included
Walid Chammah, 54, who went on to head debt and equity capital markets at
Morgan Stanley and is now co-president of that firm.
Joseph Donovan, the banker responsible for the GMAC relationship, went to
Smith Barney in 1995, to Prudential Securities in 1998 and two years later took
over the asset-backed group at Credit Suisse First Boston after Zurich-based
Credit Suisse bought First Boston.
Donovan remembers traveling to Europe for First Boston in the early 1990s,
trying to convince
Volkswagen AG in Wolfsburg, Germany, and Renault SA outside Paris of the
benefits of securitization. It was a hard sell. Europeans, he said, didn't take
out auto loans.
``We tried over and over,'' Donovan recalled. ``We were trying to get more
issuers, and there weren't any.''
50-Year Pedigree
By the time Donovan went to work for Credit Suisse in 2000, European attitudes
had changed. Home-mortgage securitizations were especially appealing, he said,
because European banks didn't need a ``50-year pedigree to compete.''
``You don't need a whole equity-research department and relationships with
CEOs and CFOs,'' Donovan said. ``You basically needed good computers and distribution.
You can always buy a Fannie, Freddie or Ginnie Mae pool. You just go online
and buy it. You can't buy a Ford Motor Credit deal, because you have to know
people.''
CSFB went from third in underwriting structured finance in 2000, behind Lehman
and Salomon Smith Barney, to first in 2001, when it issued $96.3 billion in
securities. Its market share increased 50 percent to 12.7 percent. The bank
fell to fourth place in 2005, although its volume soared to $144.5 billion.
Exporting Debt
As securitization caught on, borrowing increased.
U.S. consumer debt tripled in the two decades after 1988 to $2.6 trillion,
according to the Federal Reserve. Foreign banks used the new technology to expand
lending, seeking borrowers on their home turf.
``One of the things the United States exported overseas was a debt
culture,'' Haley said.
While consumers were snapping up credit cards,
Stephen Partridge-Hicks at Citibank in London were figuring out a way to
sell the new bonds. Their solution: Alpha Finance Corp., the first off-balance-sheet
structured investment vehicle, or SIV.
Alpha was created in 1988 as a way for Citibank, and later
Citigroup Inc., to vertically integrate its business like an oil company.
The raw material was found in a loan, refined into a security, then sold to
a SIV at a profit.
Citigroup, formed in a merger of Citicorp and Travelers Group Inc., which
owned asset-backed pioneer Salomon, also got a new product to sell: capital
notes that boast returns of more than 20 percent a year. Owners of these notes
receive all the excess return when borrowers pay their bills on time, though
they are the last to be paid when times get hard.
Citi SIVs
In the beginning, SIVs were small and cautiouial paper and medium-term notes.
The SIV could hold only debt rated A- or higher and didn't take any currency
or interest-rate risk, according to a 1993 Fitch Ratings report.
Alpha was followed by a slew of SIVs with names such as Beta Corp. and Five
Finance. By 2007, Citigroup's SIVs had $90 billion of assets, equal to the stock
market value of
PepsiCo Inc., making up about one-fourth of the entire SIV industry.
In 2003, the bank was sued by creditors of Enron Corp. for its role in setting
up entities that enabled the Houston-based company to move assets off the balance
sheet for Chief Executive Officer
Jeffrey Skilling. Citigroup paid $1.66 billion
in March to settle the lawsuit. Skilling, a former McKinsey consultant, was
convicted of accounting fraud and is serving a 24-year prison sentence.
Mismatched Funding
Starting around 2005, securitization began to
rely more on short-term money-market funds for financing. This
was especially true for securities made by pooling other bonds, known as collateralized
debt obligations, or CDOs. Investors were loath to buy long-term debt of issuers
that didn't have a track record, so new issuers sold asset-backed commercial
paper that matured in less than a year. While money markets are the cheapest
way to finance, they can also be the most dangerous for borrowers because they
can mature as soon as the next day.
``What happened in 2005 was that because of subprime and some other changes,
commercial paper and asset-backed securities offered a bigger spread than anything
that had ever been in the market before,'' said
Deborah Cunningham, chief investment officer of Federated Investors in Pittsburgh,
who oversees $235 billion in commercial paper. ``It was hundreds of basis points,
as opposed to 10 or 20 basis points before.''
SIVs, banks and CDOs sold trillions of dollars of asset- backed commercial
paper between 2005 and 2007 in maturities ranging from nine months to overnight.
In the U.S., the amount outstanding marched higher almost every week beginning
in April 2005, peaking at $1.2 trillion for the week ending Aug. 8, 2007.
Huge Appetite
Once money-market funds began to be tapped for
financing, Ocampo said, ``it created a huge appetite for high-yield assets,
far more than could be originated on a sound basis.''
To accommodate the demand, banks funded more subprime mortgages, with an
average life of seven years, replacing car loans with an average life of three
years and credit-card bonds paid off within 18 months.
Among conservative lenders, that rang an alarm: Bankers are taught to avoid
such mismatched funding, in which a lender has to pay back money before the
borrower has to pay the principal.
``Most of the terrible things happening now are because of the presence of
money-market assets, taking what used to be long-term funding and making it
short-term,''
Bruce Bent, 71, who started the first money-market fund in 1970, said in
an interview in July.
Reserve Funds
Bent, chairman of New York-based Reserve Funds, said he didn't buy any asset-backed
commercial paper until 2007, when the market froze in the wake of the collapse
of the Bear Stearns hedge funds. That's when his
Reserve Primary Fund began buying castoffs of asset-backed commercial paper
at cut-rate prices from other funds.
Yet asset-backed securities weren't Bent's undoing. His fund also owned $785
million in Lehman debt, bought before the firm filed for bankruptcy Sept. 15.
In the two days following the bankruptcy, Reserve clients asked to pull about
$40 billion from the $62.5 billion fund, and its net asset value fell to 97
cents. It was the first time that a money fund ``broke the buck,'' or fell below
$1, in 14 years. The fund is now being liquidated, and Bent hasn't given an
interview since.
Reserve Primary Fund's implosion, and the subsequent seizing up of two Commonfund
portfolios used by universities and endowments to hold cash, triggered a panic
in U.S. money markets, cutting off this form of credit to industrial companies
and banks. No one could be sure whether the banks held securitizations that
had dropped in value, making them insolvent. That set off a series of bank takeovers
and bailouts around the world, including a $64 billion capital injection by
the U.K. government into that nation's financial institutions and 400 billion
euros in loan guarantees pledged by Germany.
Absolute Disaster
``We've created an absolute disaster,'' said Nouriel Roubini, a New York
University professor of economics, who predicted the failure of investment banks
in a paper he wrote in February titled ``Twelve Steps to Financial Disaster.''
``The reputation of the United States as a financial
center and a leader has been tarnished significantly.''
Also tarnished, if not blackened, is the securitization business itself.
Sales of European asset-backed securities, including bonds for car loans and
credit cards, fell by 40 percent to 12.7 billion euros in the second quarter,
and CDO sales fell by two-thirds to 10 billion euros. In the U.S., mortgage
bonds issued by entities not affiliated with the government plummeted to $10.8
billion in the first half of the year, one-twentieth of the $241 billion sold
in the same period in 2007.
Cioffi, Bosh
The authors of the 1988 McKinsey handbook on securitization have moved on.
Rosenthal, who declined to be interviewed, became a managing director at Lehman
and is now in charge of information technology at Morgan Stanley. Ocampo received
a patent for risk-controlled investing and founded an institutional fund-management
firm, Trajectory Asset Management. The firm doesn't have any structured-finance
obligations.
Bear Stearns's Cioffi, 52, was indicted on charges
of misleading investors by assuring them that his hedge funds were healthy when
he knew they weren't. Cioffi, who now works out of his home in Tenafly, New
Jersey, has pleaded not guilty. He declined to comment.
The Bank of New York's Bosh lost his job when his company was merged with
Mellon Corp. in June 2007. He's still looking for work.
``You try to do the right thing,'' Bosh said in an interview this month.
``And this is what happens.''
(TOMORROW: A Lehman-Assisted Bank Overdose in Germany.)
The next leg of subprime crisis might be not Alt-A loans...
As the world faces up to the risk of emerging market failure, banks’ current
exposure - as estimated by the Bank of International Settlements (BIS) - is
perhaps worth reiterating.
According to Ambrose Evans-Pritchard of
the Telegraph, the BIS states that Western European
banks hold almost all the exposure to the emerging markets:
They account for three-quarters of the total $4.7 trillion
£2.96 trillion) in cross-border bank loans to Eastern Europe, Latin America
and emerging Asia extended during the global credit boom – a sum that
vastly exceeds the scale of both the US sub-prime and Alt-A debacles.
He quotes Morgan Stanley’s currency guru Stephen Jen as saying
an emerging market crash is a vastly underestimated
risk, which threatens to become “the second epicentre of the global financial
crisis”.
The big emerging markets banking players are
to be found in Austria, Switzerland, Sweden, UK and Spain, with exposure ranging
from 50 per cent of GDP (Austria) to 23 per cent (Spain).
Conversely America’s exposure is just small wafer of that at 4 per cent.
Meanwhile, among those European institutions already signalling distress
on their emerging market exposure:
- Austria’s Raiffeisenbank which saw its Russian subsidiary post a 74
per cent fall in Q3 net profit fell on Oct 15th
- Swedbank which today became the first major Swedish bank to bolster
its finances with a fully underwritten $1.56 bn rights issue
- Polish lender Pekao, owned by Italy’s Unicredit, which continues to
see its stock dramatically slump (see chart):
Hat tip to
Barry
Ritholtz (comments to his article
The Big Picture SPX Earnings & Multiples are well worth reading). If we
assume eight times earning and $50 per share we will have estimate of ~400-500 for
S&P 500. That's really presuppose Japanese type of recession. I hope this is not
true...
Oct 25, 2008 | WSJ
"The financial system is undergoing a sea change
that is forcing a global sell-down of assets.
Even when this is complete, there is likely to be greater restraint when
it comes to the use of borrowed money to juice returns.
... consensus estimates peg 2009 aggregate operating
earnings for companies in the Standard & Poor's 500-stock index
at about $94 a share,
according to Thomson Reuters. That figure assumes earnings growth both this
year and next.
If those estimates panned out, the S&P on Friday would have traded at what looks
like a bargain multiple of about 9.3 times forward earnings.
... it is well above trough
valuations of about eight times
seen during the depths of the 1970s bear market, according to data from UBS.
And the economic outlook, along with the unwinding of the credit bubble, means
it is unlikely that earnings will increase this year or next.
The better question is how far they will fall.
... Barry Ritholtz, director of research at Fusion IQ, for example, says he
reckons that 2009 earnings could drop to about $50 a share.
In that case, even a multiple of 14 times
would bring the S&P to about 750 -- nearly 15% below current levels."
[Oct 26, 2008]
Fire !
by Clay Bennett, Chattanooga Times Free press
Hat tip to Barry Ritholtz. Is that what they mean by the 'FIRE Economy'?
You can probably assign particular Fed and Gov characters to four firemen poring
water into the bank while all the streets around them are on fire.
Very wise words from Doug Noland:
Only today is it readily apparent what a mess the global pricing system had
become. Think in terms of a net Trillion plus U.S. dollars inflating the world
each year, of which a large part was recycled through Chinese and Asian purchases
of U.S. securities (inflating domestic Credit systems and demand in the process).
Think in terms of rapidly inflating economies with several billion consumers
(Brazil, Russia, India, and China). Think in terms of the surge of inflation
that forced thoughtful policymakers in economies such as Australia, New Zealand
and elsewhere to significantly tighten monetary policy. Rising rates, however,
only enticed more disruptive speculative finance flowing loosely from (low-yielding)
Credit systems including the U.S., Japan, and Switzerland. Speculation could
have been as simple as shorting a low-yielding security anyplace to finance
a higher-returning asset anywhere. Or, why not structure a complex leveraged
derivative transaction that, say, borrowed in a cheap currency (i.e. yen or
swissy), played the upside of rising emerging equities markets, and at the same
time had triggers to hedge underlying currency and/or market exposure. And the
counterparty exposure for a lot hedges could be wrapped up in collateralized
debt obligations (CDOs).
And later on he gives the money quote.
The notion that derivatives can be a reliable hedge has proven a fallacy.
One thing was missing in the cartoon; the bucket
brigade of homeowners ignoring their houses and pouring their "water" into the
source of the firemen's liquidity.
Posted by: AGG | Oct 25, 2008 7:21:31 PM
Amid the credit market strains and hedge funds' deleveraging, economists are
still adjusting their forecasts downward -- just last week, economists at both JPMorgan
Chase & Co. and Citigroup Inc. lowered their U.S. estimate for fourth-quarter GDP
to a drop of about 4 percent. According to JPMorgan's Lee, "valuations, in our view,
will not define the bottom, but rather an abatement of risk aversion." So, with
the economy and the markets in uncharted territory, waiting for the dire headlines
to end and gauging investors' sentiment is in some ways more helpful than looking
at historical charts and technical factors like price-to-earnings ratios.
Even if stocks have seen their lowest levels, an upturn is not necessarily around
the corner.
"When will that occur and what will spur it? Good economic news should, but
who knows when that will happen," Detrick said. The Dow's recent range of about
8,200 to 8,600 prices in "a major recession, the biggest recession since the
'30s. Hopefully it's wrong and this is a tremendous buying opportunity, but
no one knows."
Economists are not optimistic about data this week on new home sales, durable
goods orders, third-quarter gross domestic product, personal spending and income,
and consumer confidence. All these reports are anticipated to show continued
weakness -- GDP in particular, which is expected to come in negative.
Investors are also worried that this week's earnings reports from companies
such as Kellogg Co., Kraft Foods Inc., Procter & Gamble Co., Visa Inc. and Colgate
Palmolive Co. will reveal signs of an even weaker-than-expected consumer.
The Federal Reserve is expected to lower interest rates by at least a half-point
to 1 percent this week. But the rate reduction is already priced into the market
and unlikely to calm its restlessness.
One reason: The credit markets remain incredibly constricted, even in anticipation
of another rate cut. Bank-to-bank lending rates are down from their highs earlier
this month, but are still lofty by historical standards, suggesting that banks
continue to hoard cash instead of lend.
This is a troubling sign for companies that rely on banks and the credit
markets for borrowing. Demand has all but dried up for bonds issued by companies
with less-than-ideal credit ratings -- a huge problem that has yet to be fully
felt by the real economy.
"Every week credit markets remain dysfunctional is doing unknown damage to
the macro economy," JPMorgan stock analyst Thomas J. Lee wrote in a research
note Friday.
Another reason the market is likely headed for more turbulence is the enormous
amount of deleveraging going on. When investors like hedge funds deleverage,
it means they are getting out of debt and risky assets and building up their
cash levels.
Some of the recent deleveraging is due to risk aversion, but some of it isn't
even within the funds' control -- investors are asking for their money back,
so the funds have to cash out other assets. Often, these assets are typical
safe-haven investments like big-name industrial stocks and commodities, because
they're the only things that can be sold in the current environment.
"Sectors that traditionally and intuitively should be defensive are really
getting punished," Knepp said.
Knepp used the S&P 500's utilities group as an example; this should be a
strong sector right now, but it's down about 35 percent year-to-date. Another
favorite asset during times of crisis -- gold -- has fallen 20 percent since
the beginning of October.
Reuters
The U.S. Federal Reserve is widely expected to
announce a 50 basis-point cut in overnight rates on Wednesday that would take
them to 1 percent, the lowest level since June 2004, with some expecting an
even deeper reduction to 0.75 percent.
Advance third-quarter U.S. economic growth data due on Thursday is expected
to show a 0.5 percent contraction in gross domestic product after 2.8 percent
growth the previous quarter.
"Increasingly, the signs point to a deep and synchronized global recession,"
JPMorgan economist Bruce Kasman said.
Moon of Alabama
Four days ago we
mentioned
the possibility of a U.S. default. Via naked capitalism we now
learn that some folks in Taiwan take such talk seriously:
Regulators in Taiwan ordered insurers to limit their holdings of Freddie,
Fannie, and Ginnie Mae paper. The stated reason was that they could not
assess the credit risk and could not rely on published ratings. The explicit
repudiation of rating agency ratings seems to be the first move of this
type. and may be the beginning of a trend.
This statement either shows considerable ignorance or is an early warning
of worries about the creditworthiness of the US government.
...
What calls this action into question, however, is that inclusion of Ginnie
Mae on the list. Ginnies are full faith and credit obligations of the US
government. If you are worried about the payment risk on Ginnies, then you
are worried about the creditworthiness of the US government, period.
On Wednesday Roubini gave a talk at a London hedge fund show (video
45 min,
report.) He is getting gloomier again. The major points:
- the worst is still ahead of us
- we are again on the border of a systemic financial meltdown
- 2/3 of global GDP (countries) is in recession
- IMF may soon be out of money (see remark below)
- a panic is the stock market is possible
- expect stock market closures for several days
- politicians are out of possible policy responses
- we will have 2 years of recession
- followed by Japan like stagnation
- the crisis has geopolitical and social-political consequences (Roubini
explicitly mentions China's possible
demand
of Taiwan)
The IMF has $100 to $250 billion it can lend to countries in need. This is
now too little. As the NYT
reports today, there are talks of 'western officials' to somehow enable
the IMF to lend up to $1 trillion to emerging market countries (Brazil, South
Africa, Turkey.) The piece does not say where that money would come from.
The Fed has now acknowledge a loss of $2.6 billion on the $29 billion of
loans it took over in the Bear Stearns bailout. Those losses will grow. AIG
got a $123 billion loan line from the Fed in its bailout. $90.3 billion of these
have now been used by AIG to pay off bad bets on Credit Default Swaps. AIG will
need more money.
As Roubini says politicians are running out of policy options. The only policy
response that I can think of would make a real difference is to
declare
all credit default swaps null and void.
A finance professional from Shanghai was on Bloomberg TV yesterday and came
close to that:
Chua Says New Credit-Default Swaps Should Be Banned. He believes that CDS
are now used to manipulate (short) some currencies and stock markets and threaten
to bankrupt whole countries making the situation even worse than it already
is. He may well be right.
With concern of U.S. solvency now being official, some CDS issuers and speculators
may think about this and try a trick or two against the U.S. If Soros
could break the Bank
of England, could some savvy rich folks from Asia or the Gulf try a similar
trick on a different country?
The Taiwanese regulators seem to think so.
It is hard to recall a grislier day in the financial markets. We’ve experienced
nastier economic shocks. We’ve seen bigger share market falls. We’ve witnessed
uglier profit warnings. We’ve heard doomier pronouncements. But never quite
so many squeezed into so few hours.
The GDP numbers were horrific. The British economy is shrinking at a far greater
than predicted speed. The pound is collapsing at an astonishing rate, plumbing
$1.55 at one point yesterday. Shares slid to new five-year lows.
The world economy no longer looks remotely immune to Europe’s and America’s
woes. Shares in emerging markets, the regions supposed to soften the economic
agony in the West, are down by 15 per cent on the week.
Even the most cautious officials have been rocked by the forces threatening
the world’s financial institutions. “This is . . . possibly the largest financial
crisis of its kind in human history,” says Charlie Bean, the Deputy Governor
of the Bank of England, not a man prone to hyperbole.
The gloom has spread far beyond the world of banking and financial services.
Sony, Air France-KLM, Samsung, Microsoft, Daimler, Fiat and Renault are among
the groups to have sounded warning notes in the past 48 hours.
The cost of insuring against blue-chip companies defaulting on their bonds ballooned
to a record high. The premiums paid on these insurance policies - credit default
swaps – are regarded by many officials as the best measure of stress in financial
markets, more important even than the wholesale interbank lending rates
Yet the news is not all bad: inflationary pressures are abating fast. Even
so, this hides more bad news. The broken financial system will weaken the transmission
from monetary easing to the economy. This will make the coming slowdown last
a long time. Even though decisive action has saved the financial system from
its recent heart attack, the patient remains enfeebled.
"The role of government regulators leading up to the current financial crisis
was the subject of yesterday's gathering of the
House Committee on Oversight and Government Reform and, just in case you're
a real glutton for
punishment, our government has made the entire transcript available in
.pdf form - all 201 pages of it. Your tax dollars at work..."
The key replies from the former Fed chairman were that he "found a flaw" in
his ideology regarding how markets work, that he was "partially wrong" about
derivatives, and that he “made a mistake” in trusting industries and individuals
to self-regulate.
But, without a doubt, the big news was the fall
from grace.
To wit, this opening exchange:
Henry Waxman: You were perhaps the leading proponent of deregulation of
our financial markets, certainly you were the most influential voice for
dergulation. You have been a staunch advocate for letting markets regulate
themselves. Let me give you a few of your past statements:
-
In 1994, you testified at a Congressional hearing on regulation of financial
derivatives. You said there was nothing involved with federal regulations
that make it superior to market regulations.
-
In 1997, you said there was no need for government regulation of "off-exchange"
transactions.
-
In 2002, when the collapse of Enron led to the renewd Congressional
efforts to regulate derivatives, you wrote the Senate, "We do not believe
a public policy case exists to justify government intervention"
-
And earlier this year, you wrote in the Financial Times, bank loan officers,
in my experience, know far more about the risks and working of their
counterparties than do bank regulators.
And my question for you is simple: Were you wrong?
Alan Greenspan:
Partially. Let's separate these problems into their component parts. I took
a very strong position on the issue of derivatives and the efficacy of what
they were doing for the economy as a whole...
Waxman: So,
you don't think you were wrong in not wanting to regulate derivatives?
Greenspan:
Well, it depends which derivatives we're talking about. Credit default swaps
have serious problems associated with them...
Waxman: Let
me interrupt you because we do have a limited amount of time.
...
Waxman: Dr.
Greenspan, Paul Krugman the Princeton Professor or Economics who just won
a Nobel Prize wrote a column in 2006 as the subprime mortgage crisis started
to emerge. He said,
"If anyone is to blame for the current situation, it is Mr. Greenspan who
poo-pooed warnings about an emerging bubble and did nothing to crack
down on irresponsible lending".
He obviously believes that you deserve some of the blame for our current
conditions. Do you have any personal responsibility for these financial
crises.
Greenspan:
Let me give you a little history, chairman. There's been a considerable
amount of discussion about my views on the subprime market in the year 2000.
And indeed, one of our most distinguished governors at the time, Governor
Gramlich, who regrettably is deceased but who was unquestionably one of
the best governors I've had to deal with, came to my office and said he
was having difficulty with the problem of what turned out to be a fairly
major problem in predatory lending...
Waxman: He
urged you to move with the powers that you had as chairman of the Fed as
both the Treasury Department and HUD suggested that you put in place regulations
that would curb these emerging abuses in subprime lending, but you didn't
listen to the Treasury Department or Mr. Gramlich.
Do you think that was a mistake on your part?
Greenspan:
Well, I question the facts of that. He and I had a conversation. I said
to him I have my doubts whether that would be successful. But to understand
the process by which decisions are made at the Fed it's important to understand...
Waxman: Dr.
Greenspan, I'm going to interrupt you. The question I have for you is...
You had an ideology ... You had the authority to prevent the lending practices
that led to the subprime mortgage crisis, you were advised to do so by many
others, and now our whole economy is paying the price. Do you feel that
your ideology pushed you to make decisions that you wished you had not made.
Greenspan:
Well, remember what an ideology is. It's a conceptual framwork for the way
people deal with reality. Everyone has one. To exist, you need an ideology.
The question is whether it is accurate or not. And what I'm saying to you
is that I found a flaw - I don't know how significant or permanent it is
- but I've been very distressed by that fact. But if I may, can I just answer
the previous question?
Waxman: You
found a flaw in the reality...
Greenspan:
I found a flaw in the model that I perceived is the critical functioning
structure that defines how the world works.
Waxman: In
other words you found that your view of the world, your ideology, was not
right. It was not working.
Greenspan:
That's precisely the reason I was shocked because I was going for forty
years or more with very considerable evidence that it was working exceptionally
well.
But, just let me finish if I may...
Waxman: Well,
the problem is that time is already expired.
Is he in too early ? Is he is trying to catch a falling knife ?
As one reader commented: "Remember the Hysenberg uncertainty principle? When you
start basing your actions on observation, the thing being observed changes behavior.
Barry, I think you are log rolling off Niagara Falls. Try to be more careful and
prudent. A lot of people trust you for advice and leadership. Don't get carried
away."
The Big Picture
We put some more money to work this morning into the mess -- another 5% -- while
I was somewhere over North Carolina, on the way to Tampa. we are now down to
55% cash, from a peak of 80%.As I noted on
October 10, we "scale in over time, in 10% increments, and recognize
that the bottoming process can take several months to several quarters to complete.
Hence, slowly buying in is the key."
I would expect that another whoosh down will lead us to put another 5-10%
to work. I was disappointed to see we didn't get the 1000 point down capitulation.
That's probably to pat, and widely expected/hoped for.
Comment
We have an entire industry of traders, money managers, institutional investors,
etc. who are trained to buy anytime the market drops big. They are all looking
for a “capitulation” event, with a spike of fear, because historically it has
been profitable to do so. Now what we see is that any time the market opens
down big, everybody gets excited and jumps in to buy.
As long as this occurs, we’ll never truly see
the selling climax that they’re looking for. The bottom won’t
be in until all these traders jump in, and then get smoked when the market falls
by another 20% or more. It happened during the depression. It will happen again.
The bottom won’t be in until NONE of these clowns wants to jump in and buy equities.
That will be the final capitulation.
===
No, Barry is not insane for scaling in slow and
easy. Recessions end, even bad ones. Stocks almost always bottom before the
recession ends.
There are some massive amounts of equity dumping going on that are not, IMO,
based on either the seller's opinion of company fundamentals, the seller's view
of the stock technicals, or even the seller's fear of additional market losses.
Rather, the selling reflects the sellers need
to raise cash. There is plenty of the other kind of selling,
too, of course, but I think there is also a large temporary component to the
selling.
===
We should have another down leg in here to new lows, but, if we are truly
in a bear market (my view), it will be less dynamic that the spike low at Dow
7880. The liquidation on that decline will be from individual investors who
were shocked at the recent selloff but didn't act.
In bull markets individual investors and institutions are the sellers in
spikes because they lack conviction. In bear markets they hold until new lows
finally discourage them. The bottom should be a "W" not a "V"
After that, a rally for a few months and then we start down again for a deeper
leg
===
What's going to ignite this recovery?
We haven't even gotten into all the job losses. Keep the powder dry
friends...this ones got a long way to go. It aint
your average Bear Boo-boo....
===
This is how capitulation works in real time.
- BR was right for 2 years so now he thinks by scaling in for 2 years
eventually he will be right.
- When he is all in and wrong for another 2 years THEN an epiphany.
The other option is to trade it away, then gain insight.
Capitulation only occurs when you have been wrong
for a long, long time. Quote for today
"Cash will continue to outperform until stocks are no longer fashionable."
And boy will that take a long time. One reluctant
convert at a time.
===
Cash is a position. It is NOT a Mega Bear or a Perma bull. When someone disagrees
with you it is not name calling. Do a Google search for stock investing rules.
You will find:
- Never take a big loss
- Dead cats don't bounce
- Wait until the move begins
- The trend is your friend
- Manage risk
- Be patient
- Do not throw good money after bad
This is Investing 101 stuff, if you do not have any capital when the real
trend becomes clear what then?
I do not know what that trend is going to be, and yes maybe it will be up.
love you all
===
For those of you looking for the bottom:
Yes, there were some people that made money during the 30s. It wasn't by looking
for a bottom. It was by looking at those boring things like fundamentals.
You know, like is there a market for the product
the company makes?
For the next few years, the only buyer of market
goods in quantities to increase a corporation's profit will be the government.
The people are tapped out. It's depressing but it it's the real
deal. There is no there, there.
We are going back to a low VIX and dividends
as the main investment attraction. Yeah, it's boring but that's
the way things are when liquidity is gone.
===
Those of you that who are so convinced we are going much lower with no rally
in between whatsoever, would you be so kind as to explain,in simple terms, the
basis for your calls?
---------------------
1. Apart for financials, I think earnings have barely
started to come down.
2. I think people are still focusing on dividends
when dividends will be cut as the economy weakens and eps drop.
3. So if you cut future eps, multiples still too high.
4. Too much money sloshing around still. Too many investors salivating
with every market drop.
5. True. Markets don't fall in a straight line to the trough. They do bounce
around, but I've been in the business long enough to know myself.
When I'm invested I spend too much time looking
at my stock prices and not enough time doing my research. For the last 5 years,
I've been doing my research and I know which prices stocks have to hit for me
to pick them up. Now I'm working on the next 5 years.
Also, I know that I have trouble selling the sutff once it bounces up so
I'm better waiting for the bottom. Then it falls again and I want to wait for
the next leg up. Nope don't want to play that game.
Finally, I have a life. If I'm playing the trading game to catch every bounce
from every bottom, it can't focus on anything else. And because I have a life,
I tend to miss the bounce backs because I'm not necessarily on the trigger when
it's time to sell.
There are many ways to make money and rule number
1 is to know yourself.
===
Thank you Dan !
I appreciate your
arguments, and I really don't disagree with any of them very much.
Mine is a trading call (when the easier thing to do would have been
to stay mostly in cash).
But I love comments like yours -- healthy debate makes us all
better trader/investors.
As to catman -- what we get paid to do isn't greed, its to be
opportunistic. Its not greedy when you go to work and get paid --
my job description includes making money for clients when opportunities
arise.
As to "the egotism of being right" -- thats more about preventing
anonymous trolls (not you) from besmirching a professional reputation.
I have no patience for those haters, and I happily delete and ban
the same asshat posters again and again.
===
Yields for BAA-rated paper/bonds are high right now because demand
for them is low. In Q1 1930, Baa paper waterfall'ed from a yield
of 6% to nearly 13% Q2 1932. Yields for BAA-rated paper/bonds are
high right now because demand for them is low.
Note that Moody has A and AA and AAA rated corporate bonds, which
did NOT drop as much as the BAA.....This
is a telling sign that the bond markets do NOT believe that the
debt of these corporations are collectable per whatever period they
sell for.
These are bond yields, on not the
best rated, but still investment grade corporate bonds. It is the
guys closer to the margin. Its not the worst of the worst, but given
the fact many corporations don't have stellar ratings these days,
you find there are quite a lot of them at or near the margin. Notice
also the speed of this collapse. It happened within
DAYS compared with the 30's MONTHS. The GDP collapse this implies
will be much the same.
We're getting a different rhyme this time round from 1929.
In '29 the crash in oct/nov wasn't due
to the bonds leading the way. But the April 30 bear
market taking away 86% of the DOW WAS led by this paper.
One more reason I fear the chances
of a "rally" are gonna be interesting
Posted by: brion | Oct 24, 2008 6:16:22 PM
====
Scott F. -
Its the economy, silly. Earnings
flat-out SUCK. The Alt-A and option ARMs haven't
begun re-setting in earnest. We have Birth/Death model catastrophically
tilting the unemployment numbers. We have massive demographic (Boomers)
that has been socking away the lion share of their income into the
market and they are about to begin withdraws, in earnest.
We have banks hoarding capital. We have a FED that has lost control
of the one thing they actually control. We have credit card debt
that is higher than many countries GDP.
We are at a point where each dollar of new debt has a Net
negative effect to the GDP.
We have hedge funds blowing up. The alphabet soup the FED has
created is not working. Auto makers are a hair away from total implosion.
The consumer is close to saying no mas, if they haven't already
(see closing and consolidation in retail land).
I have more... shall we go on?
[Oct 24, 2008] Kotok Says Hedge Funds "Definitely" Causing
Pushdown in Markets
Oct. 24 (Bloomberg) -- David Kotok, chief investment officer at Cumberland
Advisors Inc., talks with Bloomberg's Tom Keene and Ken Prewitt about his outlook
for the U.S. economy and financial markets, Federal Reserve monetary policy
and his recent research.
Listen/Download
Another symptom of equity-market distress. And the
New York Times also provides an interesting discussion of the behavioral
implications of corporate officers borrowing against their holdings:
When executives own big stakes in the companies they run, investors can
rest a little more easily at night, knowing those managers have the shareholders’
best interests at heart.
Except when maybe they don’t....
Already this month, there have been about $1 billion in sales by company
insiders dumping stock to meet margin calls, as lenders’ demands for the
stock sales are known. According to Equilar, an executive compensation research
firm in Redwood Shores, Calif., executives at three dozen companies have
disclosed such sales since October....
Under Securities and Exchange Commission rules, executives are typically
required to disclose insider sales within two days of making them and indicate
why they were sold, including as a result of a margin call. But experts
say there are no rules requiring that the public be told ahead of time that
an executive has pledged stock in a margin loan or how the borrowed money
is being used. It might be a loan to buy more shares of the company’s stock
— which would indicate a vote of confidence in the shares. Or it might be
a loan to buy some other company’s stock or something else altogether —
possibly a sign that the executive thinks there are better places to invest.
“The disclosure rule is vague,” said Ben Silverman, director of research
at InsiderScore, which tracks the buying and selling of company insiders.
Over the last 25 years or so, investors have come to take on faith the need
for executives to own significant amounts of company stock, as a way to
make sure the interests of the people running a company are aligned with
those of the shareholders. But the ability to use the shares as collateral
for a loan may change that dynamic, said Charles M. Elson, a corporate governance
expert at the University of Delaware.
“It may be at certain levels de-aligning,” he said. Although individual
circumstances may not require public disclosure of an executive’s decision
to pledge the stock, Mr. Elson said, he argues that the boards of directors
should be told.
Paul Hodgson, a senior analyst at the Corporate Library, a governance research
group, says it is too easy for investors to be misled when executives are
not holding the stock outright. “The disclosure is a problem,” Mr. Hodgson
said. Most investors will look at the executives’ holdings in the proxy
statement, he said, and say, “ ‘They own a lot of stock — they are really
committed.’
Comment
And when commercial paper markets also dry up, as has been the case in the
current credit crisis, not only SMEs (Small
and medium enterprises --NNB)
may run short of working capital. Large enterprises,
which typically fund themselves through the commercial paper market, are also
likely to find themselves off their notional output supply curves because credit
is simply not available at any price.
... ... ...
It is likely that, with commodity prices falling globally (relatively and
absolutely in most currencies), and with demand getting hammered, especially
from the consumer demand side and increasingly from the fixed investment side
also, inflation will be dropping sharply globally.
Where the working capital channel of monetary and credit transmission via
the supply side are important, however, effective
supply failures may, in the short run, reduce or even reverse the domestic inflationary
effect of the credit crunch.
Monetary policy makers should, in my view, ’see through’ this reduction in
domestic disinflationary pressures caused by effective supply (constrained by
credit availability) being below notional supply (what supply would be if credit
markets were not subject to rationing but functioned normally).
It is the task of credit policy (and banking sector solvency restoring or
solvency-boosting measures by the fiscal authorities) to eliminate the gap between
effective supply and notional supply.
[Oct 23, 2008] Bianco Calls Fed Liquidity Efforts
'Hyper-Inflationary': Video
Posted by Barry Ritholtz on Thursday, October 23, 2008 | 02:30 AM
Jim Bianco, president of Bianco Research LLC, talks about the Federal Reserve's
move to provide up to $540 billion in loans to help relieve pressure on money-market
mutual funds, credit market conditions and the outlook for the U.S. economy
and stock market.
click for video
00:00 Fed move to buy money fund commercial paper
01:59 Commercial paper market; "shortage" of loans
04:36 U.S. credit markets, Fed liquidity efforts
06:59 Outlook for housing, mortgage markets
07:54 Potential second stimulus a "short-term fix"
09:27 Fannie and Freddie loan, mortgage rules
11:08 Bank lending practices, housing market
13:10 Fed liquidity efforts: impact on inflation
16:01 Outlook for U.S. dollar, stocks: strategy
Running time 19:47
Sources:
Bianco Calls Fed Liquidity Efforts `Hyper-Inflationary'
Bloomberg, October 21, 2008 13:30 EDT
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aloQWaKlGBNE
[Oct 23, 2008]
Monetary despotism
By Hossein Askari and Noureddine Krichene
Asia
Times
$700 billion Troubled Assets Relief Plan (TARP) of US Treasury Secretary
Henry Paulson and Federal Reserve chairman Ben Bernanke. If recent bailouts
and liquidity injection are added together, the price tag could easily amount
to 70% of US gross domestic product in 2008.
Certainly, Western central banks have not injected this much in real gross domestic
product, that is, in millions of tons of commodities (rice, corn, milk, oil,
vegetables, clothing). If they had done so, their action would have been most
beneficial. They have only created money out of nothing. Some call it legal
robbery, others call legal counterfeiting.
Their action has amounted only to a redistribution
of real GDP and real wealth among two groups: the winners (bankers, debtors)
and the losers (workers, taxpayers, pensioners, creditors). How will this redistribution
take place? The answer is forced inflation.
Bailouts schemes on such a scale have no precedent. They are the outcome of
cheap money policy followed in the past decade and the sophisticated speculation,
call it financial engineering or exotic finance, which developed complex derivatives,
proliferating fictitious credit to gain abnormal returns.
The speculative exponentiation of fictitious assets on the top of each
other has made most banks over leveraged in ratios of 1 to 40. In a credit system
devoid of securitization, the credit multiplier is finite and cannot exceed
six or seven. In a system with securitization, the credit multiplier is theoretically
infinite and in practice could reach 50. Certainly, these giant bailouts have
changed the rules of the game. Speculators, that is asset funds managers, are
now secured by central banks; it is a case of if heads, they win; if tails,
taxpayers loose.
The credit to be bailed out, or, if you will, the capital to be recapitalized,
is not money that has been channeled to agriculture, industry, commerce, or
infrastructure. These sectors rely on long-term capital, financed essentially
through equities, or corporate, government or municipal bonds. All productive
loans are fully performing and have negligible default.
All the bailouts by central banks and governments are purely for replacing losses
of short-term speculative capital that has caused the present financial trauma.
Only speculative capital causes financial instability; such was indeed the cause
of the Great Depression, brought about by default on speculative loans in stock
markets. The bailouts are primarily intended to write off bad debts, so that
borrowers can walk free of their debt obligations and enjoy the wealth they
had acquired earlier on.
Of course, in this new system of free lunch, everyone would like to become a
borrower, as borrowing is the easiest way for acquiring free wealth in form
of houses, cars, stocks, appliances and goods. Bailouts are meant to replenish
liquidity of asset funds (such as hedge funds, equity funds and so forth) so
their skilled managers can keep inventing complex products and earning high
financial profits. Bailouts are also intended to buy intoxicated assets (identified
in the alphabet soup of MBSs, CDSs, CDOs, and so on). Being free money, some
of this money will be used for celebration and retreats in luxurious hotels.
The banking and political establishment would have us believe that these bailouts
are meant to save the banking system and allow the economy to borrow, credit
markets to unfreeze, and economic prosperity to prevail.
Academics, media and politicians have welcomed with applause the recapitalization
of banks. Many have already declared victory, saying the worst is over and the
crisis, thanks to this giant recapitalization, is fully resolved. Markets rebounded
on the first day in a most spectacular way. Of course, and to be expected, the
market then gave up more than its gain in the next two trading days.
However, the biggest surprise was that banks unanimously
rejected recapitalization but were forced to sign on. They wanted the TARP.
This again shows that policy making is in a vacuum of factual data, sound economic
analysis, and only follows political pressure or market hiccups.
Economic uncertainty has never been as high. Has the crisis been correctly tackled
or has it only been made worse? In view of incredibly huge liquidity injection
by major central banks, has money supply become out of control? In view of the
incredibly huge bailouts and recapitalization by governments, how will the fiscal
deficit will be financed? How long will the crisis last? Which sectors and countries
will it affect? What will be its impact on growth and employment? What will
be its fiscal and inflationary cost? Will inflation finally run out of control?
How soon will another, and far bigger, come due once speculation resurges again?
What will be the social consequences among workers?
Western central banks and political leaders, like ostriches, have decided to
ignore these questions and perpetuate their misguided policies.
While precise answers to these crucial questions are not possible, it is quite
irresponsible not to assess the implications of such monumental bailouts. Absent
economic modeling, assessing the macroeconomic consequences of these gigantic
bailouts over the short-and-medium-term can only be based on economic theory,
extrapolation of recent trends, and empirical experience.
Many scenarios of economic and social chaos are possible, with intensity and
duration that cannot easily be predicted. The most
feared scenario would be forcefully maintaining unsustainable and overly expansionary
fiscal and monetary policies that will rapidly erode real savings and investment,
and ignite a runaway inflation and unemployment.
This scenario will be in essence similar to Bernanke's aggressive expansionary
policy since August 2007, which set off speculation in commodities markets,
triggering food riots and sending food and energy prices to levels that finally
disrupted transport sectors, brought world economic growth to a remarkable slowdown
and triggered rising unemployment.
Under this scenario, fiscal deficits will soar to unprecedented levels, public
debt will rise rapidly, real savings and investment will decline, external deficits
will widen, currency will depreciate, real incomes of workers will fall sharply,
and real spending will sharply decline, causing unemployment to increase even
more rapidly.
As under former Fed chairman Alan Greenspan's credit boom, overabundance of
liquidity combined with negative real interest does not help productive sectors;
it only fuels speculation by asset funds, Ponzi financing, and deteriorating
creditworthiness. Speculators will take advantage again of real negative interest
rates and abundant liquidity to re-engage in asset and commodities speculation.
On October 11, the Group of Seven leading industrialized nations stated in a
communique that "Crisis Requires Urgent and Exceptional Action. We agree to:
Take decisive action and use all available tools to support systemically important
financial institutions and prevent their failure. Take all necessary steps to
unfreeze credit and money markets and ensure that banks and other financial
institutions have broad access to liquidity and funding. The actions should
be taken in ways that protect taxpayers and avoid potentially damaging effects
on other countries. We will use macroeconomic policy tools as necessary and
appropriate."
However, in of spite their declaration, Western central banks continue to reject
adamantly the most important tools for stabilizing monetary policy, and only
want to perpetuate, at any cost for the economy, the unsustainable monetary
policy that brought about the present financial and fiscal chaos.
It is not understood why Western central banks insist on a cheap money policy
and on forcing negative real interest rates, despite the disastrous consequences.
Bernanke wants to solve the financial crisis by still reducing the federal funds
rate from its present 1.5%. What did he achieve with previous cuts?
In an environment where many leading banks are overly
leveraged and their assets are impaired, is 1.5% an equilibrium rate for interbank
loans? Although the market mechanism is disrupted, could the equilibrium rate
be 20% or 30% instead of 1.5%?
The only plausible explanation for such negative
real interest rates and massive bailouts is to force speculative losses on taxpayers
and workers. Banks are forced into a loss-making situation under
the threat of nationalization.
The US and the European economies are recognized as the world's most advanced.
Unfortunately, they have in the past decade suffered from central banking despotism.
Greenspan ignored criticism for bailing out hedge funds such as LTCM as well
as warnings regarding housing speculation. Bernanke and Paulson have only been
aggravating financial instability and crippling economic growth.
An economy cannot operate optimally or grow with such immense price distortions
or inflationary price pressure. The G-7 has to have a coordinated approach for
reining in money supply, re-introducing money and credit targets, and totally
freeing interest rates and housing prices. The faster an economy returns to
equilibrium prices, the faster recovery will be. In a context of supply-oriented
and employment-promoting strategy, credit has to be selectively oriented to
productive sectors and much less to speculation. The health of each bank has
to be dealt on a case-by-case basis and over a long span of time.
The credit crunch appeared only in speculative financing.
If recapitalization is used to fuel speculative credit, then it will be too
damaging for economic growth, as seen in the past year. The answer to
the present crisis is how to reduce the speculative component of credit without
reducing the circulating media (that is, protecting deposits) and how
to reallocate credit to non-speculative and growth-generating sectors. These
aspects have not been addressed by Western central banks.
It would appear that the Fed and the European central banks have not learned
the real lessons of the Great Depression. But they had better start soon.
Hossein Askari is professor of international business and
Chart 2.5 Share of corporate debt accounted for by businesses with interest payments greater than profits:
2001 = 30%
2002 = 30%
2007 = 27%
2008 = ?
2009 = ?
"I don't know why she swallowed a fly.."
IMHO, if the ZIRP-linked value of currencies connects the deflationary impacts of depreciation to lower yields, hot money will chase after commodity swaps that are based on nothing but speculation. Hence, we will see inflation increase during this recession and a return visit to stagflation with a nice taste of liquidity trap.
This does go back to the concept that tossing a trillion bucks at a hundred trillion is like sprinkling pennies in front of Buffett and watching him get flattened by a steamroller. While there may be some dancing in the streets today and a huge campaign to turbocharge the amplification of the music, the game of musical chairs and hot potato have yet to be played out.
I suggest re-reading some of The Helicopter Ben Bedtime Stories, of which there are many, and here is one example: "This distinction between inflation that is positive yet too low and deflation is worth exploring for a moment. Although the Federal Reserve does not have an explicit numerical target range for measured inflation, FOMC behavior and rhetoric have suggested to many observers that the Committee does have an implicit preferred range for inflation. Most relevant here, the bottom of that preferred range clearly seems to be a value greater than zero measured inflation, at least 1 percent per year or so."