Close to $500b of debt purchased over the last 18 months, and not a cent of subprime …
China’s reserve managers – the State Administration of Foreign Exchange – recently reported that they have exactly zero exposure to US subprime mortgages.
“”China’s official forex reserves don’t include [the US subprime securities],” Wei Benhua, deputy director of the State Administration of Foreign Exchange, said on the sidelines of a financial industry meeting in Beijing”
Unlike many, SAFE apparently didn’t buy instruments with embedded risks that they did not understand, and in the process contribute to the dispersion of credit risk …
To be honest, though, I am more than a little surprised.
Not by the fact that SAFE’s exposure to subprime is small – or even the now near-certainty that the recent fall in dollar interest rates increased the market value of China’s portfolio by more than enough to offset any credit related losses.
China’s real exposure is to currency risk, not credit risk.
But by the fact that SAFE somehow managed to invest close to $500b – I kid not – in global markets over the last 18 months without buying a cent of subprime. An awful lot of that $500b was invested in dollar-denominated debt. SAFE put a lot of that money to work in the US markets precisely at that point in time when mortgage-backed security insiders believed the the US market was generating some real toxic debt.
Yet SAFE steered clear of all of it.
Here is a bit of math. Since the end of 2005, China has added $515b to its reserves. My calculations suggest that if you net out valuation gains, the real increase – the money China actually had to invest – was more like $480b. That is still pretty close to $500b. And even if you net out China’s investment in Blackstone from the $480b, China still had around $475 to invest in debt markets. At least $350b of that likely flowed into various US dollar denominated debt – though we will need to wait until next spring for confirmation in the US survey data.
During calendar 2006 “private” Chinese investors – overwhelmingly the state banks, often playing with money borrowed through fx swaps from the central bank – bought $109b of debt, and $107b of long-term debt. If all the Chinese state commercial banks disclosed subprime exposure (the BoC has the most foreign assets, and the most disclosed subprime exposure) was bought during this period (and there is good reason to think the banks purchases of foreign debt tailed off in the first bit of 2007), about 10% of their total debt purchases were subprime.
Apply the same ratio to the PBoC’s purchase of debt over the last 18 months and you would get $47b of subprime exposure. That is clearly too high. But I would have guessed that at least 1 or 2% of China’s purchases over the past 18 months — a period when China was showing a bit more risk appetite in the past — might have been in various MBS and CDOS with some subprime exposure. That would work out to between $5-10b in purchases, and between 0.5 and 1% of China’s total dollar portfolio.
Not much, but still more than zero.
If I had to guess now, I would guess that SAFE simply wasn’t buying any CDOs – they were considered too illiquid for its reserve portfolio – and that rule, combined with a desire for high-rated paper, helped it steer entirely clear of subprime.
Either that or there was a tacit division of labor with the state banks. The state banks got a fair amount of fx to play with through the swaps market from the central bank, though we don’t yet know how much. And perhaps the idea was that they would pioneer investment strategies that might later be adopted by SAFE.
Both thoughts are pure speculation on my part though.
But China’s “zero subprime exposure” disclosure does raises a lot of questions.
The US data shows that China has bought — $50b or so of Treasuries, $84b of Agencies and $54b of corporate bonds over the past 18 months.
That $187b total should be compared with the $475b in valuation-adjusted reserve growth if you think the $107b in debt purchased by the state banks and other “private” investors was purchased through Hong Kong, and compared to $580b if you think the state banks purchases are showing up in the US data along with SAFE’s purchases.
Either way, there is a huge gap between recorded Chinese purchases and any reasonable estimate of inflows into the dollar market …
If it didn’t go into subprime, where did it go? Are China’s purchases of Treasuries and Agencies way, way higher than the TIC data suggests?
What kind of corporate debt did China buy during this period? I have assumed that China bought a lot of private MBS (see this post). That is just an assumption – though one that seemed well supported by anecdotal evidence floating around the internet and the markets.
But perhaps all Chinese MBS purchases were done by the banks?
Or perhaps market chit-chat – including the talk that the New York Time’s Keith Bradsher picked up when he reported large Chinese MBS purchases – doesn’t clearly distinguish between MBS with an Agency guarantee (Agencies in the US data) and MBS that lack an agency guarantee, which count as corporate debt in the US data.
The last US survey leaves no doubt that China was been a huge buyer of “Agency” MBS from mid 2005 to mid-2006, and there is no reason to think that has changed over the past year.
If talk about Chinese purchases of MBS effectively referred to MBS with an Agency guarantee, that would help to reconcile the anecdotes suggesting China has been a big player in the MBS market with the exposure China has disclosed – though I guess it is possible that SAFE bought a lot of “private” MBS without buying any subprime debt.
Maybe now that SAFE is showing a bit more openness it might be willing to disclose how many private MBS – that is MBS that are NOT guaranteed by the Agencies – it has in its portfolio. That would clear up a lot of mysteries. The US data is too out of date to be much help.
That would clear up a lot of mysteries.
Trying to figure out China’s holdings of US housing debt has turned into something of an obsession of mine.
No Responses to “Close to $500b of debt purchased over the last 18 months, and not a cent of subprime …”
Sorry Brad, again,
But as I’ve been the last coomenter of several of your posts, I feel myself a bit sorry (I was trying to collaborate!).
Anyway, and this time is very on topic, Spanish news and papers are saying once and again that they are out of USA’s subprime thing. Not problem anywhere!
But the Economist in their special subprime paper, is talking about several investiments banks in Spain with losses, but they don’t are cited in news.
And I remember the articles of The Economist talking about Spanish companies making M&As and buying foreign enterprises with a very high degree of leverage and debt. Mostly debt, and that means CP debth, and the news is no exposure to sub_prime debth.
We are in Murdoch news times, nothing else.
From 60 Minutes last week.
US Government Immorality Will Lead to Bankruptcy
“THE US DEBT IS LIKE A GROWING CANCER”
Nice to see Michael Mandel in this blog with his own name in your previous post.
Let’s fight Murdoch!
Well there’s this:
“Bank of China has $10 billion US subprime exposure
News Digest, 23 August 2007
Bank of China said today that it has almost $10 billion of securities backed by US subprime mortgages, according to the Financial Times. The amount is higher than other banks in Asia. Bank of China, however, says the debt is mostly rated triple A and actual losses are considered small. Industrial and Commecial Bank of China reportedly has $1.23 billion of exposure to US mortgage-backed securities.”
Remember the question from the movie “Marathon Man”? “Is it SAFE, yet?” Who knows. If we can’t get the truth from the US Gov’t, why should we expect the truth from the Chinese gov’t or SAFE?
I know for a fact that China is investing large amounts of money directly into residential US real estate. They are skipping the collateral and buying direct. Better way to guard against inflation if the US decides to repudiate all debt.
Here you go, here is where the ChinoDollars are going:
McMansions Turn ‘McApartments,’ Stirring Ire
“Some of the new homes, neighbors and town leaders say, are being used as boardinghouses for several families or unrelated people. Some are college students. Others appear to be immigrants.”
It only takes 1000 McMansions to make a billion. More if you use lesser real estate. No wonder the home builders are smarting of the Chinese start turning down US real estate investing.
” division of labor ” makes sense.
The swaps are effectively a deployment of reserves. If the state banks are moving out the risk curve to sub-prime mortgages, partly funded by swaps from PBoC, it makes sense for PBoC to let them do it but not to double up itself on that type of risk.
Like you I have no idea what China’s true exposure is to subprime assets nor would I be surprised if we later discovered that it was much higher than reported. This isn’t necessarily because they are dishonest or incompetent, although they might be both, but rather because they may be looking in the wrong places. I remember that during the Mexican crisis in 1995 Lehman Brothers at first reported that they had a very manageable Mexican exposure, but later it turned out their real exposure was so great that rumors had it that the firm nearly went under.
The problem was that they had looked for Mexican exposure only on the Latin American trading desk, then managed by Con Egan, who was much to savvy to allow himself to get wiped out by the Mexican crisis. But the bigger exposure, it turned out unexpectedly, was on the repo desk, where it had been seen as an extremely profitable business but was poorly understood and poorly managed.
It may be that there is a lot more exposure than at first reported but we have been looking only in the obvious places, and not figured out yet where else the exposure might lie. One thing that we should also be thinking about as a consequence of the subprime mess is the impact of the crisis on volatility. I am pretty sure that Chinese institutions have been big buyers of structured notes because my many PKU and Tsinghua students who now work on trading desks have been telling me for years that selling structured notes was the most profitable business for foreign banks in China (indeed one French bank in China makes nearly all of its money selling structured notes and derivatives).
This matters because most buyers of structured notes are looking for yield enhancement, and in structured products that almost always means imbedding short option positions in the notes. Buyers of these products are always short volatility. That means that if the volatility of the asset to which the note is indexed rises, the value of the note MUST fall if correctly marked to market. With vol rising on nearly all financial assets, it would be astonishing if none of the notes held by Chinese institutions were affected. I guess it would also be surprising if they were correctly marked. We will have to just wait and see.
Why no subprime losses? Perhaps the explanation is quite simple: the Chinese Government does a better job than Wall Street at keeping their managers focused on the job.
“Zheng Xiaoyu, former director of China’s State Food and Drug Administration (SFDA), was executed on Tuesday morning with the approval of the Supreme People’s Court.”
Pour encourager les autres.
The original report seemed to quote one official on the sideline. Don’t know how seriously you want to take it.
Then again everyone has their own definition of subprime. Does Alt-A count? What about prime jumbo? Or ABS that contains some subprime? And last but not the least, SAFE’s #1 priority has always been liquidity (it is not an investment house). Neither subprimes nor structured products are liquid so they should have been ruled out a priori for SAFE.
Do you know how leveraged these Chinese structured securities investors are? Shouldn’t that matter when considering the mark to market issue? An insurer, e.g., may not lose much after all even if holding the same securities that hedge funds collapsed on (though may have missed opportunities of making even more).
Do you know if China follows the same practice as Japan, in that the Japanese do not count as reserves any asset with a maturity of ten years or longer? If a ten-year maturity – or a similar limit – applies to China, it would help explain the disappearance of reserves that you have pointed to. Your comments, please.
Maybe the Chinese follow the same practice as CITI. If so, only a crisis will reveal what they are really holding.
re: “keeping their managers focused on the job”
also a very effective way of taking out those who know and encouraging everyone else to shut up.
“…China is growing increasingly worried about the possibility of… further damage to its international profile heading into 2008, when Beijing is to be the host to the Summer Olympics…” http://www.nytimes.com/2007/09/05/business/05counter.html?_r=1&ref=business&oref=slogin
and shouldn’t be too much of a stretch to believe that these tactics:
“…Indonesian officials accuse China of pushing shoddy products and inferior standards on poor countries that have no choice but to depend on it for cheap goods, aid and investment. They say that China, in closed-door meetings, has refused to share basic information, attempted to horse-trade by insisting on discussing disparate issues as part of a single negotiation and all but threatened retaliatory trade actions. The Chinese respond that their products have been the victim of unfair trade actions. In the Philippines in July, a state-owned Chinese company threatened to sue for defamation after the Philippine government released a public warning saying a popular brand of candy was contaminated with formaldehyde…” http://www.washingtonpost.com/wp-dyn/content/article/2007/09/04/AR2007090402284.html?hpid=topnews
extend to other ‘partners’
“Investment banks are creating dedicated teams in London, Hong Kong and Japan to advise sovereign wealth funds and cash in on the growing wave of activity from government investment companies…” http://www.ft.com/cms/s/0/71613db6-5970-11dc-aef5-0000779fd2ac.html
“…This is a matter of trust. Big banks do not trust each other for a loan, so they demand a high interest rate of each other… Each of the big banks fears one of its peers is sitting on a huge loss…” http://www.ft.com/cms/s/0/e7daf0ba-5b49-11dc-8c32-0000779fd2ac.html
another question may be how this feeds through to precious metals and commodity prices, with china presumably being a large player in those markets, and how global cash raising affects china’s asset bubbles as western investors take profits.
“Yet SAFE steered clear of all of it.
Applying Occam’s razor: they are simply lying.
Besides subprime bonds, there are plenty of other “AAA” financial securities to be purchased in Ginnie Mae, Fannie Mae, Freddie Mac, and US Treasury bonds. The pass through MBS bonds from the GSE’s have the implicit guarantee of the US federal government. General Electic, IBM, and Exxon Corporations also issue “AAA” bonds with GE’s finance division alone issuing hundreds of billions in bonds. So I think it is perfectly possible that the Chinese PBoC could have avoided any subprime exposure. On a footnote, the Bank of China’s holding of subprime bonds consist of mostly “AA” rated tranches, not the lower BBB. The Chinese aren’t high risk hedge fund speculators.
Liquidity crunch only a symptom
Banks worldwide now reportedly face risk exposure of US$891 billion in asset-backed commercial paper facilities (ABCP) due to callable bank credit agreements with borrowers designed to ensure ABCP investors are paid back when the short-term debt matures, even if banks cannot sell new ABCP on behalf of the issuing companies to roll over the matured debt because the market views the assets behind the paper as of uncertain market value.
This signifies that the crisis is no longer one of liquidity, but of deteriorating creditworthiness systemwide that restoring liquidity alone cannot cure. The liquidity crunch is a symptom, not the disease. The disease is a decade of permissive tolerance for credit abuse in which the banks, regulators and rating agencies were willing accomplices.
“The pass through MBS bonds from the GSE’s have the implicit guarantee of the US federal government. ”
They do not. It has been explicitly stated that the US federal government does not guarantee the debt of the GSEs.
So please please, if the GSEs were to default and the Chinese were lo and behold large possessors of their bonds, please please spare us posts about the U.S. government reneging on its obligations. It has not; it is simply you and others who have failed to listen.
Fannie Mae, Freddie Mac are too big to fail since they guarantee over 30% of mortgages in the United States. Also the GSE’s have a direct line of credit from the US Treasury that even “AAA” rated General Electric and Exxon don’t have.
Written by Michael Pettis on 2007-09-04 22:54:01
Not clear why one needs to be short options in order to lose money from exposure to sub-prime assets.
Moreover, if a CDO leverages up to finance sub-prime assets, the equity holder is effectively long an option – the risk is that its value crashes to 0 when sub-prime assets default.
David Chiang says: “The Chinese aren’t high risk hedge fund speculators.”
The Chinese invested $3,000,000,000 into Blackstone, a high risk hedge fund, and are already down over $500,000,000. I’d call that high risk speculation.
David Chiang says: “Fannie Mae, Freddie Mac are too big to fail”
Two years ago there was a lot of chatter about the possibility of Freddie failing. After having seen Hong Kong and Japanese real estate prices fall 50% (although Hong Kong has since recovered), is any entity really too big to fail? David, do you have any facts to back up your assertions? What, in your mind, constitutes failure?
“…The Chinese economy is itself something of a c*s*no. The potential payoff is enormous, but you can still lose your shirt. The banking system is rickety. Corruption is rife. The stock market is immature and volatile… Then there is the political risk. With a government that rules by force rather than consent, China is like any other authoritarian system: brittle and subject to the risk of sudden upheaval…” http://www.globeinvestor.com/servlet/story/RTGAM.20070905.wibasia05/GIStory/
“Fannie Mae, Freddie Mac are too big to fail since they guarantee over 30% of mortgages in the United States. Also the GSE’s have a direct line of credit from the US Treasury that even “AAA” rated General Electric and Exxon don’t have. ”
If you, or anyone else, think they are too big to fail, then buy their debt by all means. But again, if they do default and the U.S. government doesn’t come to the rescue (besides the very limited line of credit that it is legally obligated to give), then just don’t bellyache how the U.S. government reneged on its commitments. It wouldn’t have. It would be you who made an error in judgment. There is no guarantee.
Blackstone may be one of their safer bets.
Then as everyone agrees the real confidence and trust problem is China, why is everyone igoring china’s own subprime which, apparently, makes US subprime look safe.
While I personally disagee with China’s government stock purchase, Blackstone is a private equity fund, not a CDO hedge fund. Blackstone takes public companies, private with its investor capital. Private companies are not subject to the short term, quarterly shareholder pressures that discourages long term investment by US Corporations. The strategic investment into Blackstone probably also provides the Chinese PBoC with financial insight and important political connections in the Washington beltway to acquire more equity in U.S. and foreign corporations.
Fannie Mae, Freddie Mac are too big to fail. Two decades ago, in the first case of too big to fail scenario, Continental Illinois Bank based in Chicago received a FDIC bailout. All deposits, even above $100,000 were guaranteed by the federal government. The repercussions from a Fannie Mae collapse are far more serious than the failure of a regional bank.
a on 2007-09-05 08:20:42 – but perhaps china’s safest bet.
in this part of north america, the newer, bigger casino caters to the chinese.
“The repercussions from a Fannie Mae collapse are far more serious than the failure of a regional bank. ”
Of course they are. If you or anyone else want to buy Fannie debt with that in mind, you are more than welcome. But if Fannie does default and the U.S. government does not rescue it, then you would have made an error in judgment, for which you should pay. There is no guarantee.
“…”The Fed is like a snail crawling along a razor’s edge. One false move and it gets bisected.”…” http://www.washingtonpost.com/wp-dyn/content/article/2007/09/04/AR2007090402178.html
and china’s pig gets…
there is no guarantee. but there is also a strong expectation that the GSE are too big (and too important to both the US housing market and to host of governments that matter to the uS) to fail.
Mr. Pettis — very, very interesting.
AP Simkin — I don’t know. Foreign central banks hold very few US treasuries with a maturity of over ten years, but i simply don’t know if china has a rule prohibiting holding longer-term assets. Note tho that their willingness to buy AGENCY MBS suggests some willingness to take interest rate risk (and prepayment risk)
HZ — Wei used to be China’s executive director at the IMF, if memory serves. He is also the dep. director of SAFE. If he didn’t want this to be in the press, if wouldn’t be. I believe that he is reporting what SAFE wants to have reported.
David Chiang, in the 1980s a panoply of S&Ls went under, and the FSLIC could do nothing to save them. Nothing, including the planet earth, is too big to fail. As far as Blackstone is concerned, the Chinese banking system is probably more transparent.
Steve Schwartzman and his lifestyle tell me all I need to know about Blackstone. That company is a business oligarch’s multi-level marketing scam, and you know what happens to those investors who got in late and are low on the downline. When the music stops, and they ain’t got no chairs, Schwartzman will still get to keep his throne.
“the GSE are too big (and too important to both the US housing market and to host of governments that matter to the uS) to fail.”
“Fail” is a vague word. Actually, if worse does come to worse, I would expect the government not to pick up the tab on any defaulted GSE bonds, but to restructure them so they can continue their role in the housing market.
I am pretty sure that Freddie or Fannie are indeed too big to fail.
(1) I don’t see how they can default without every effort being made to recover as much from the individual mortgage debtors first, including foreclosure. As we are seeing, the US has neither the moral or political courage to go through with this.
(2) Almost all central banks round the world hold GSE debt. Assuming that the GSEs cannot selectively default to particular holders like China, default would upset a lot of friendly countries.
So SAFE avoided subprime, but that still counts as a non-denial denial to me. They could have Alt-A exposure, which may not turn out to be of much more quality at the end of the day. As could the Bank of China. The only denial that would have impressed me would be something like, “With regard to US mortgage securities, we only carry those that are issued by Fannie, Freddie, or Ginnie,” or something to that effect.
RE: Fannie and Freddie being too big to fail: If we were to do what we did in 1989-90 for the thrifts, we guarantee Fannie’s and Freddie’s bonds, wipe out the shareholders, and start over. That would be the way to take care of this while retaining at least some deterrent for moral hazard. Of course that is still giving a big bailout to investors like PIMCO but I am not sure we want to put the Fannie guarantees in doubt; they are the flip side to deposit insurance, or have become that way. On the other hand: if Fannie and Freddie held to their standards of what makes a conforming loan, the great bulk of the bonds they issued, should have good underlying assets. Their due diligence is what underpins the secondary mortgage market.
I’m surprised that everyone is surprised that the PBC has no-subprime exposure. The PBC has been extremely conservative about investing currency reserves. Going from treasuries and GSE’s to anything else would have been accompanied with a lot of noise. The investment in Blackstone was accompanied by a lot of noise and thinking out loud and it is still something of an experiment.
BOC and ICBC are commercial banks and are different.
Also, I don’t think that authoritarian governments == brittle government.
black swan: Assets for a private equity are in the billions. The most any human being can spend on luxury is in the tens of millions. The thing about finance is that there is so much money flowing around, that if you capture a very small slice of it, you can live with scary amounts of personal excess.
my general sense is that SAFE was becoming a bit less conservative over the past year or so (while remaining very conservative relative to most private sector investors), and was buying a significant quantity of “private mbs” over this period. would you agree with that characterization?
agree that blackstone = something of an experiment, and more generally think the CIC’s approach and strategy is still a work in progress.
Twofish said: “Assets for a private equity are in the billions. The most any human being can spend on luxury is in the tens of millions. The thing about finance is that there is so much money flowing around, that if you capture a very small slice of it, you can live with scary amounts of personal excess.”
When I see someone running an empire and living like a Dennis Kozlowski, I see a house of cards. Do you think Schartzman is the only player skimming massive profits from Blackstone? Many of these people are vultures that rip the meat of a company’s carcas and leave little more than bones held together with highly leveraged debt. These guys are financial engineers that create little more than mega-wealth for a select few. The pension plans that end up buying IPOs from companies like Blackstone, are buying little more than looted, leveraged structures. Time will tell, but I believe we are revisiting the latest manifestation of the junk bond era. Before the private equity company, the Carlyle Group, turned Dunkin Doughnuts around, it was an unofficially gov’t subsidized arms merchant. Doesn’t papa Bush work there?
Written by Michael Pettis on 2007-09-04 22:54:01
Buyers of structured products are typically long embedded options – not short.
Although the exact composition of China’s foreign reserves is a state secret, I concur that the China PBoC has been generally very conservative with its bond investments. US Treasury bonds, Ginnie Mae bonds, GSE Agency Bonds, and “AAA” rated Corporate Bonds from the Fortune 500 are part of the mix. For instance, with top rated General Electric, GE Finance is its largest company division contributing over half of corporate profits and issuing over $200 billion in “AAA” rated debt securities in the past year. I’m sure the China PBoC owns a good chunk of GE Finance debt. With an estimated 70% of reserves in US Dollar assets, China PBoC overexposure risk is in dollar assets, not credit risk in MBS bonds.
“Almost all central banks round the world hold GSE debt. ”
Is that really true? Perhaps I am misremembering (or remembering fantasy), but I think several years back the BCE pointedly asked the Fed whether the full faith of the U.S. government was behind the GSE debt. When the Fed didn’t reply “yes”, the BCE dumped whatever GSE debt it had.
If I am misremembering I’d appreciate knowing. Brad, does the BCE have any agency debt ?
BCE = ECB en anglais?
I haven’t to be honest looked at their reserve portfolio.
but I am sure that the ECB knows that the fed would never state that Agency debt is backed by the full faith of the US government. that would make agencies treasuries ..
i agree with sunlight: in bad states of the world, though, it is likely that the agency bonds would be kept whole and the agencies capital would be wiped out …
are you joking china’s whole banking and capital market is sub prime do not worry about a 50 -100bn loss worry about a 2-3trn loss
Well, I respectfully disagree with sunlight. The thrifts were American, and bailing them out was paying American tax payer dollars to other Americans. Redistribution from America’s poor to America’s rich is a time-honored tradition. It’s a horse of a diffirent color with the GSEs. There are a lot of those GSE bonds in foreign hands, and a bailout would be, to some extent, having America’s poor paying off the rich in other countries. I don’t think that will fly. It is in the American interest to renege. It’s that simple.
anyone closer to knowing what’s up with Barclays?
“…”in price, is knowledge.” There’s knowledge buried in the price that Barclays is being charged in the money markets. We just don’t know what that knowledge is yet.” http://www.bloomberg.com/apps/news?pid=20601039&sid=a8uEKKBYY7As&refer=home
re: “don’t think that authoritarian governments == brittle government” – any that come to mind eventually fell hard.
a on 2007-09-05 12:11:24 – as pointed out earlier, what may be different now is that many more tax-payers may be NR foreigners, whether with the help of subprime credit or not, and assume most have to pay taxes.
PE/hedge fund privacy has to be a requirement if they want to attract and retain secretive, wealthy, foreign clients.
Thanks Brad….BCE had me wondering! You may be right that the ECB did cut back on agencies a few years ago, but they may have gone back in since the agencies were subjected to caps and more oversight, and no other central banks that I know stopped investing in them anyway.
The same question arises regarding wiping out their capital. Can this be legally done without getting as much as possible out of the mortgage borrowers first?
“…Because so many German institutions have been caught holding the sub-prime baby, the country’s banking system has been brought into disrepute. For a such a proud nation, it has come as a shock to discover that so many reputable domestic institutions have been made to look foolish. These events might take place in third-world countries but surely not in Germany?..” http://www.financialnews-us.com/?page=uscomment&contentid=2348656472
“U.S. financial investor J.C. Flowers is keen to expand its presence in German state-backed banks by buying the 38% stake in WestLB held by the German state of North Rhine-Westphalia…” http://www.reuters.com/article/ousiv/idUSL039170320070903?pageNumber=1
sure — GSE capital can be wiped out if there is a gap between their assets (loans. mbs) and liabilities (debt). if the equity is wiped out and assets do not cover liabilities, the USG picks up the bill.
re: “It is in the American interest to renege” –
well, not if you need someone to buy your debt to finance an ongoing deficit. the price of reneging is that you cannot borrow — and often for some time.
in any case, talk about a nuclear option — the big holders of agencies right now are China and Russia, both of whom have real nukes. clearly they bought agencies knowing the risks, but it would be a major int. issue.
I’d be impressed too if PBoC eschewed the chase for yield and stuck to high quality, high liquidity. Reserves are held to be liquid in bad times, when confidence is poor, so they did their jobs well if they invested as they say they did.
What is scary is that many central banks probably fell for the sales patter of chasing yield and are probably going to regret it if the liquidity squeeze tightens up and their reserves become important to credibility again.
Spain got away with losing all the swapped gold it had in Drexel because the markets bounced back and Spain was growing strongly in the 1990s.
Central banks that have swapped out their gold reserves and invested in tainted securities could find themselves very badly compromised if the liquidity squeeze is followed by recession.
Marx may have been prophetic when he predicted, “Capitalists will sell us the rope we hang them with.” And that rope may be the dodgy over-engineered toxic dross of financial innovation. Meanwhile China and Russia and other far-sighted central banks sit on the highest quality assets and strengthening currencies as the capitalists writhe and stumble.
The quote is by Lenin, not Marx. My bad.
re: “the highest quality assets” – backed by the capitalists
I don’t think you are taking my GSE point seriously enough Brad! If their loans default, then the security of the loans – the houses – belongs to the lender. So no foreclosures, no equity wipeout. You cannot simply tell the stockholders that their holding has gone without allowing them to pursue every legal means of recovering the value of the assets of their business first.
It does not sound unlikely to me that PBoC would avoid sub-prime exposure. I was surprised to hear that they bought MBS directly, let alone through some structured pig in a poke. Before that, the only central bank I knew that bought MBS was ambivalent about continuing, because of the costs of risk management etc. A better question might be why any principal (as opposed to agent) investor would buy an investment that they did not understand.
Brad – Needs your attention and insight
Black swan: Do you think Schartzman is the only player skimming massive profits from Blackstone?
No Blackstone probably has a few hundred employees. But one of the cool things about Wall Street is that there is so much money flowing around that you can afford to be honest. The amount the Schartzman makes is known to the people that invest in Blackstone and it’s a miniscule amount of money compared to the amounts he is managing.
[q]Many of these people are vultures that rip the meat of a company’s carcas and leave little more than bones held together with highly leveraged debt.[/q]
I think a better metaphor is a mosquito sucking blood out of a giant elephant. The amounts of money that flow through the financial industry are so huge, that you take a very, very small fraction of it, and that turns out
to let you live out whatever material wants you have.
[q]These guys are financial engineers that create little more than mega-wealth for a select few[/q]
Do you have a mortgage on your house? The 15 or 30-year mortgage is one of the most complex derivative instruments on the planet. The fact that you have pay principal over time and refinance is due to a huge amount of financial engineering. Do you have money in a bank? Do you have a car loan? Do you have any credit cards? Do you use an ATM? Each of these products has a huge amount of technology behind them and when it all works, the result is so magical, that most people have no idea the difficulty involved in getting all the pieces to work together.
If Fannie and Freddie default that means that there is a massive amount of mortgage default in the United States, and at that point we are very close to a “guns and gold” economy.
re: “don’t think that authoritarian governments == brittle government” – any that come to mind eventually fell hard.
Singapore. Also, the Soviet Union seemed to fall suddenly but that was after about thirty years of economic stagnation.
re: “don’t think that authoritarian governments == brittle government” – any that come to mind eventually fell hard.
Singapore. Also, the Soviet Union seemed to fall suddenly but that was after about thirty years of economic stagnation.
(“Yet SAFE steered clear of all of it.
Applying Occam’s razor: they are simply lying. )
The trouble then is that you start going in circles. I believe the situation is bad. How do you know the situation is bad if you don’t have evidence. Well I don’t know, but it is bad.
Getting to Brad’s point. SAFE has gotten less conservative, but you still have to be want to role the dice somewhat before you get to sub-prime mortgages.
2fish is getting more and more cynical everyday:
“Do you have a mortgage on your house? The 15 or 30-year mortgage is one of the most complex derivative instruments on the planet. The fact that you have pay principal over time and refinance is due to a huge amount of financial engineering.”
In USA, mortgages might be very complex, but in EU the ARM are very easy to understand, and as far as interest rates don’t play like yo-yos (like Dow-Jones lately), they are very easy to understand to anyone who finished the compulsory school.
The bank shows you the amount of money to be paid every month and, the amounts if rates go up or down in 1% levels. And all that with no refinancing fees, nor amortization fees, etc.
We could be in a different planet, but to reference ordinary lending with interest rates, with financial engineering, seems a bit out of tone.
“well, not if you need someone to buy your debt to finance an ongoing deficit. the price of reneging is that you cannot borrow — and often for some time”
I don’t understand the logic of this at all. There is GSE debt, which the U.S. government has made clear is not guaranteed. And there is Treasury debt, backed by the full faith of the U.S. government. Now suppose the GSEs default. On what grounds can investors cry that the U.S. government was supposed to bail them out? Because they supposed it was too big to fail? Isn’t that their own error and their own fault? They have no legal claim, and they don’t have a moral claim, on the U.S. government. All they have is a claim based on their own stupidity. Sure the investors might say they aren’t going to buy Treasuries unless they get bailed out (investors will say anything to get there money back), but in reality it will probably sink in pretty quickly that in fact Treasuries are guaranteed and therefore a good risk.
While depositor in the Cont. Bank were protected up to 100 thousand the shareholders were pretty much wiped out. The government did not make them whole:
The FDIC provided funds to the Continental’s parent holding company – – the Continental Illinois Corporation – – by purchasing newly issued preferred stock to be downstreamed to the bank as equity capital. This served to recapitalize the bank and, by having the bank upstream dividends to its parent, permitted the holding company to pay interest on its debt and to stay out of bankruptcy. The FDIC also purchased $3.5 billion of bad loans from the bank at adjusted book value. The bank was effectively nationalized. The FDIC chose new senior management. The interest of the old shareholders, although not terminated altogether, was greatly reduced. They received a residual claim on the nonperforming loans purchased by the FDIC (FDIC, 1998b). When, after five years, losses from resolving these loans exceeded the amount specified in the financing agreement, the old shareholders’ interests were declared worthless and the change in control was complete. The FDIC slowly reprivatized the bank by periodically selling its shares to the public. The last shares were sold and the bank completely reprivatized in 1991.
Koteil: We could be in a different planet, but to reference ordinary lending with interest rates, with financial engineering, seems a bit out of tone.
“Ordinary lending” is much more extraordinary than most people realize. Behind all of that “ordinary lending” is a pretty huge amount of financial engineering that most people don’t know about. The 30-year fixed-rate home mortgage is an extremely complex instrument to value. The problem with having an ARM is that you run the risk that at sometime in the next thirty years, interest rates will spike and you will go broke. Having a multi-billion bank take these risks rather than small homeowners, seems like a good idea to me.
“…“We have survived so far, 42 years,” he said. “Will we survive for another 42? It depends upon world conditions. It doesn’t depend on us alone.” This sense of vulnerability is Mr. Lee’s answer to all his critics… And although what you see today — the superstructure of a modern city — the base is a very narrow one and could easily disintegrate.” Asked whether, looking back, he felt he might have gone too far in crushing his opponents… he answered: “No, I don’t think so. I never killed them…” http://www.nytimes.com/2007/09/02/world/asia/02singapore.html?_r=1&oref=slogin
Twofish: “The amounts of money that flow through the financial industry are so huge, that you take a very, very small fraction of it, and that turns out
to let you live out whatever material wants you have.”
Gordon Gekko: “Greed is good.”
Comparing a 30-yr mortgage with CLOs,CDOs,SIVs,SIV lites and ABCP is like comparing jay walking with murder. If Bear Stearns, let alone most stockbrokers, can’t figure out derivatives, I doubt Joe Sixpack, who somewhat understands his mortgage, will ever understand why his job has been done away with or why his pension has disappeared.
Chinese Interested in building $30 billion Alaska Gas Pipeline
Sept. 5 (Bloomberg) — A Chinese company is among firms interested in building a natural gas pipeline from Alaska’s North Slope to export fuel to the Pacific Rim, said the U.S. official in charge of Alaska gas projects.
Alaska lawmakers in May approved a plan from Governor Sarah Palin to provide incentives for building a $30 billion pipeline. Neither the state law nor federal legislation enabling the pipeline prohibit bringing gas to the port of Valdez where it could be loaded onto tankers and shipped overseas, Pearce said.
I don’t want to be too pedantic, but buyers of structured notes are mostly SHORT, not Long options. If they were long, yields would be lower, unless there are some investment banks out there paying investors to take options. If so, I’d be eager to become a client.
“Moscow-based Troika Dialog Asset Management, in conjunction with Deutsche Bank, has closed CDO I, the first ever rouble-denominated collateralised debt obligation invested in Russian corporate bonds to be fully placed with investors…” http://www.hedgeweek.com/articles/detail.jsp?content_id=167774
” Unlike straight derivatives whose entire value is dependent on some underlying security, index or rate, structured securities are hybrids, having components of straight debt instruments and derivatives intertwined. Rather than paying a straight fixed or floating coupon, these instruments’ interest payments are tailored to a myriad of possible indices or rates. In addition to the interest payments, the securities’ redemption value and final maturity can also be affected by the derivatives embedded in structured notes. Most structures contain embedded options, GENERALLY SOLD by the investor to the issuer. These options are primarily in the form of caps, floors, or call features. The identification, pricing and analysis of these options give structured notes their complexity. ”
Here is an interesting quote. Please note the mention of Chinese banks and the Chinese Government.
Randall W.Forsyth from Barron’s quote from a hedge-fund operator (it would have been nice for Forsyth to have named the operator):
‘Real money’ (U.S. insurance companies, pension funds, etc.) accounts had stopped purchasing mezzanine tranches of U.S. subprime debt in late 2003 and [Wall Street] needed a mechanism that could enable them to ‘mark up’ these loans, package them opaquely, and EXPORT THE NEWLY PACKAGED RISK TO UNWITTING BUYERS IN ASIA AND CENTRAL EUROPE!!!!
“These CDOs were the only way to get rid of the riskiest tranches of subprime debt. Interestingly enough, these buyers (mainland Chinese banks, the Chinese Government, Taiwanese banks, Korean banks, German banks, French banks, U.K. banks) possess the ‘excess’ pools of liquidity around the globe. These pools are basically derived from two sources: 1) massive trade surpluses with the U.S. in U.S. dollars, 2) petrodollar recyclers. These two pools of excess capital are U.S. dollar-denominated and have had a virtually insatiable demand for U.S. dollar-denominated debt . . . until now.”
State-owned Chinese Banks including the Bank of China with a $10 billion exposure have already disclosed subprime ownership. Until proven otherwise, the China PBoC disclosure that they do not have subprime ownership should be taken at face value. It would be a radical departure from existing monetary policy for the China PBoC to be buying subprime toxic waste. The China PBoC has disclosed ownership of US Treasury bonds and GSE Agency bonds.
“I don’t want to be too pedantic, but buyers of structured notes are mostly SHORT, not Long options. If they were long, yields would be lower, unless there are some investment banks out there paying investors to take options. If so, I’d be eager to become a client.”
On structured notes where options are embedded, yields ARE lower. Sometimes the structured note offers to repay only the principal back (so effectively a 0% interest rate), the difference going to pay for the option, a commission for the seller, and the IB for all its hard work.
Written by a on 2007-09-06 06:39:18
Yes. That was my point, although the quote earlier wasn’t a correct illustration.
Seems there are two generic forms of structured product – one where the primary option is bought by the investor (your example) and one where the primary option is sold by the investor (several commenters have pointed this out as THE generic type, which I don’t think is right). Also, I’m not sure that yield enhancement is best linked to option structure per se – its compensation for risk, but is it best described as compensation for option structure?
Perhaps somebody can help out with a better overview of how this breaks out amongst the full range of structured products. But I don’t think its right to suggest that structured products generically create short option risk for the investor (as per your example). That was my only point.
Here’s a July quote from Aisa Times. What “Chinese companies” are they referencing? Are these code words for SAFE?
“China’s State Administration of Foreign Exchange (SAFE), which manages the reserves, does not release figures for the proportion of foreign reserves held, but it is estimated that China holds about 70% of its foreign reserves in dollar assets, including treasury bonds.
Yi Xianrong, a senior economist and finance professor with the Chinese Academy of Social Sciences, a central government think-tank, attributed the previous surge of mortgage-backed securities bought by Chinese companies to inexperience in conducting risk assessments and their miscalculation of the US property market.”
“After seeing how the property prices in China kept soaring, these Chinese companies never thought of the US property market as having problems and they bought a lot of mortgage-backed securities, particularly in the past two years,” Yi told Asia Times Online. “Apart from underestimating the level of risk, the better returns offered by MBS over US Treasury bonds also made the Chinese investors unable to judge the high risk of the US mortgage market.”
“China will delay allowing local investors to buy Hong Kong shares directly until rules have been introduced to limit capital outflows… Easing controls too rapidly may lead to an exodus of funds from the Shanghai and Shenzhen stock markets and increase financial risks. China prevents individuals from investing overseas under restrictions designed to keep its currency, the yuan, stable…” http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aXi.Q8Q4WbZE
Chinese PBoC Central Bank quietly Dumping US Treasury Bonds
A sharp drop in foreign holdings of US Treasury bonds over the last five weeks has raised concerns that China is quietly withdrawing its funds from the United States, leaving the dollar increasingly vulnerable.
Data released by the New York Federal Reserve shows that foreign central banks have cut their stash of US Treasuries by $48bn since late July, with falls of $32bn in the last two weeks alone.
“This comes as a big surprise and it is definitely worrying,” said Hans Redeker, currency chief at BNP Paribas. They don’t seem to be switching into other currencies, so it is possible they are moving into gold instead. Gold is now gaining momentum across all currencies and has broken through resistance at 500 euros,” he said.
While the greenback has been resilient over recent weeks – even regaining something of a ‘safe-haven’ role as banks scrambled to buy the currency to cover dollar debts – most experts believe that America’s $850bn current account deficit will eventually cause the dollar to resume its relentless slide.
“Asia’s assets under management surged to a record high of $9.2 trillion last year… as growth in the region continues to outpace expectations. Institutional Investor’s annual ranking said assets under management at Asia’s 100 biggest money managers leaped by 10.6% in 2006… China posted the biggest gain with a 7% rise… The record held by domestic Asian managers does not include those assets managed by international firms operating in the region. Growth for the international firms, however, surpassed the rise in assets realized by domestic companies. Leading the international list is Barclays Global Investors with $290bn, up 22.5% in 2006. Second place State Street Global Advisors’ assets grew 29.6% to $249bn. AXA Group touted the biggest gain at 44.7%, climbing to sixth place for 2006 with $123.4bn in assets under management, from tenth place the 2005 rankings.” http://www.financialnews-us.com/?contentid=2448682941&page=ushome
“I’ve looked through Ambrose’s work in America, and found nothing he originally reported-not a single disclosure, not all his purported revelations compounded together-credible enough to warrant a single paragraph in a “mainstream” American newspaper…. Perhaps Ambrose is not the worst British correspondent in Washington of his generation… Nonetheless, even when delivered in polished Oxbridge prose, conspiracy theories remain the investigative journalism of fools.” http://www.amazon.ca/Secret-Life-Bill-Clinton/dp/0895264080
“…These days, companies are global in scope, and a lot of international trade happens within those companies. For example, a U.S. manufacturer might have components made in China by its own subsidiaries, import the parts to the U.S., finish the product, and then sell it, perhaps mostly in the U.S. This creates a U.S. trade deficit with China that is internal to the company – in fact, it is on purpose, self-financing and therefore sustainable. Taking account of trade with majority-owned foreign subsidiaries implies that over 40% of the U.S. trade deficit is inside of multinational companies; allowing for less-than-majority ownership takes this figure as high as 65%.
What this means is that at least 40% of the U.S. trade deficit is self-financed internally, implicitly in U.S. dollars. Only the foreign local costs require conversion in the foreign exchange market. And given that the global demand for dollars far exceeds the size of the U.S. economy – in short, because the U.S. economy no longer fits inside the lines on the map – the financing of the rest of the trade deficit has been very easy to do. Indeed, it is estimated that U.S.-owned foreign affiliates generate some $3-4 trillion in sales abroad each year, which means that the U.S.-dollar economy is far larger than what we define as the U.S. economy, a purely geographic concept…”
black swan: Are these code words for SAFE?
Doubt it. Most likely they are talking about the big four commercial banks. There is a lack of professional money managers in China, and SAFE/PBC is likely to get first pick of them.
black swan: Comparing a 30-yr mortgage with CLOs,CDOs,SIVs,SIV lites and ABCP is like comparing jay walking with murder.
No it isn’t. A 30-year mortgage is ***far*** more complex product than CLO’s, CDO’s, SIV’s, SIV lites, and ABCP. What makes a 30-year mortgage difficult to value is that it has an option to refinance, and the formula for when someone chooses to refinance is something that can’t be derived from basic economics. People refinance for all sorts of reasons that can’t easily be put into a simple equation.
black swan: If Bear Stearns, let alone most stockbrokers, can’t figure out derivatives, I doubt Joe Sixpack, who somewhat understands his mortgage, will ever understand why his job has been done away with or why his pension has disappeared.
In exchange for an increase of interest rate of a few tenths of percent, Joe Sixpack has gotten a financial product that he doesn’t have to worry too much over. In effect he has sold his risks to a bank who then hires armies of people who do worry about these things. If something unexpected happens and the models break, the people who will be losing money are the IB’s that can afford it rather than Joe Sixpack.
Part of the point of the financial service industry is to transfer risk from Joe Sixpack, for whom a $200,000 loss would be a life shattering disaster, to people and institutions for which $200,000 is a rounding error. The 15/30-year mortgage is a good example of that in action.
If Bear Stearns, let alone most stockbrokers, can’t figure out derivatives, I doubt Joe Sixpack, who somewhat understands his mortgage, will ever understand why his job has been done away with or why his pension has disappeared.
Again, I’m surprised that people are surprised that the PBC has been prudent with its reserves. The big reason the PBC *has* reserves in the first place is that the Communist Party saw what happened to Suharto in 1998 and wants to have a buffer in place to cushion against a run like what happened with the Asian crisis. Also having money means that you can tell the IMF and World Bank to go to hell if necessary.
“…The fund will have about $200bn under management, obtained by the issuance of bonds by the finance ministry, through intermediary agencies, to the People’s Bank of China, the central bank, which has the reserves on its books. But a substantial part of those funds will be used to buy the holdings of Central Huijin Investment, an existing holding company under the central bank. Huijin, the vehicle used in recent years to recapitalise and then list offshore three of China’s largest state banks, will become part of the new investment company. The price the new fund will have to pay to subsume the assets of Huijin is just one of many thorny issues that have delayed the establishment of the body. Underlying many of the disputes is institutional friction between the People’s Bank of China and the finance ministry, which have jostled for control over the reserves and their management. Arthur Kroeber of Dragonomics, a consultancy in Beijing, calculates that after buying out Huijin’s assets, which include a number of forthcoming capital injections, the fund will have only about $72bn of new money left to invest. “Even with increased funding, the fund is unlikely to exert a meaningful influence on global markets for some years to come,” Mr Kroeber said. The dominance of Huijin’s assets also means that, for the moment at least, the fund “looks to be more an instrument of China’s industrial policy than a true international investment fund…” http://www.ft.com/cms/s/0/f179ab28-5047-11dc-a6b0-0000779fd2ac.html
“That was my only point.” Then you’re right. There are many many types of structured products. Some embed options (either long or short), some embed correlation pay-offs, etc. There are too many to list, but it’s true that there are often peculiarities in various markets which determine which kind are selling. I don’t know anything about the Chinese market (which is the comment which set this all off), so I can’t say whether there is a tendency in that market to buy a certain type of structured product.
black swan — I quoted the FT alphaville piece on Chinese demand for subprime CDOs a while back as well. the hint that SAFE was buying doesn’t seem to be confirmed.
DC — on the China dumping treasuries story, see macroman (and my comments there). I don’t buy it. the fall in the FRBNY accounts reflects central banks efforts to help finance global deleveraging — something that is most obvious for russsia.
“This creates a U.S. trade deficit with China that is internal to the company – in fact, it is on purpose, self-financing and therefore sustainable. Taking account of trade with majority-owned foreign subsidiaries implies that over 40% of the U.S. trade deficit is inside of multinational companies; allowing for less-than-majority ownership takes this figure as high as 65%.
What this means is that at least 40% of the U.S. trade deficit is self-financed internally, implicitly in U.S. dollars.”
Sorry, but this is wrong. US companies which import components from china (or finished products) but don’t export us made goods to china contribute to the United States deficit and China’s surplus. the surplus of dollars flowing into china from intra-company trade shows up on the PBoC’s balance sheet as reserve growth. the PBoC buys dollars from the foreign company for RMB, providing the company the RMB it needs to pay its chinese suppliers.
It isn’t self financing in a BoP sense.
the World bank Beijing agrees with me on this — see their latest quarterly. unless you can convince me their BoP analysis is off, I would prefer not to have these kinds of references posted here — and certainly not an a thread where they aren’t really relevant. Wait until i post on ipod-economics and then we can discuss the accounting for component trade in the BoP data.
it simply isn’t the case though that this is all self financing. there is a reason why the PBoC’s dollar stash is expanding. if the pboc dropped out of the market, the rmb would rise until flows matched. but that isn’t the case now.
2fish – if China wants, and is able to tell the World Bank to go to hell, why does it continue to accept development aid?
Brad – you’ll have to pursue any arguments and accusations directly with EDC – which you may choose to do if you find them at odds with the world bank. i have no reasons to defend or argue with either. my posting of the information perhaps somewhat inspired by your Ambrose Evans-Pritchard echo, which does nothing to enhance your own credibility. whatever the ‘ipod-economics’ is, i’m not aware of any reason to anticipate or wait for it.
Guest: if China wants, and is able to tell the World Bank to go to hell, why does it continue to accept development aid?
Right now, China doesn’t want to tell the World Bank or the IMF to go to hell, but that’s conditional on what the WB or IMF want China to do.
Also, it will be interesting to see what sort of relationship CIC and Huijin will have. Right now it looks like far from a “done deal” to clarify the interaction between the two. The basic issue is that Huijin is so large, that if CIC were to absorb Huijin outright, that it would be a reverse-takeover and it would turn out that Huijin would run CIC. Since Huijin is under the Ministry of Finance, there might be opposition to that.
There are lots of alternatives. One would be have CIC buy a minority stake in Huijin. Another would be to set up a coordinating board between CIC and Huijin. Or we could set up CIC has a coodinating board and have subsidaries being Huijin and a strategic investment divisions.
All of this is taking so long since the basic question is who is in charge of what, and that won’t be totally resolved before the next Party Congress in October……
I don’t know whether SAFE is lying or not but its a novel concept for investors to avoid investing in securities they don’t understand. Perhaps we should try that in America…
guest — i am not impressed by anonymous challenges to my own credibility. and you will find that i was quoted on reuters to the effect that there is no there there on the story about CBs selling treasuries.