The Coming Muni Bonds Default Crisis…and the Monoline Downgrade Saga…
The latest saga in the credit market relates to the nexus between monolines, borrowing by state and local governments (the muni bonds market) and the related troubles in the tender option bonds (TOB) and auction-rate securities (ARS) markets.
A few issues are clear now: the monolines don’t deserve their AAA and are unable to raise enough capital to maintain such a rating. Moreover, an unavoidable downgrade of these monolines would lead to several side effects: loss of AAA status for the muni bonds insured by the monolines; inability of monolines to generate new business in the muni space as such borrowers expect AAA rating and could not get it from firms that don’t have an AAA rating themselves; a massive writedown – about $150 billion – of the mortgage related securities (RMBS, CDOs, etc.) that had been “insured” by the monolines.
Let us then analyze in more detail the consequences of the above observations for: the future of the monolines; the losses that a downgrade of the monolines would imply for financial firms and investors; and the market for state and local (muni) financing.
The conventional wisdom is that state and local government rarely default; thus, there is a viable business for monolines that insure only state and local government. We will argue in this article that such conventional wisdom – behind the current plans to split the monolines’ business in a “good” muni insurance component and a “bad” structured finance insurance component – may be wrong…
Of all the problems described above currently state regulators care more about the effect of a downgrade on the ability of state and local governments to borrow at reasonable rates, especially now that we are entering a painful recession. While federal financial authorities are also worried about the effects of a monoline downgrade on the balance sheet of banks, investment banks, money market funds and other investors that bought the toxic structured finance products insured by the monolines. Additional losses of the order $150 billion for these insured structured products would be a severe shock to the capital and balance sheet of financial institutions.
Politicians in Congress, in New York state and in other states now care more about the risk that state and local financing would face in the presence of monoline downgrades. They are right to be worried. First, we are entering a recession that will lead to large fiscal deficits at the state and local levels that will need to be financed. Second, the risk of a downgrade of the monolines – together with the greater risk aversion and less ability to lend of financial institutions – has now led to a massive disruption of the TOB and ARS markets: for safe institutions such as the Port Authority of New York and New Jersey having to borrow at 20% rather than the 4% of the previous month is intolerable and economically not rational.
The conventional wisdom is that the muni side of the monoline insurance business was and is still sound while trouble started only when the monolines decided to enter into the insurance of toxic structured finance products. So, the policy solution that is being increasingly considered is to split monolines into two parts: one holding the “sound” business of insuring muni bonds; the second holding the insurance of the toxic stuff.
Let us assume for the moment that the muni business is “sound” (I will later in this paper challenge this conventional wisdom).Then, the effect of splitting the monolines into two parts is similar to the Super-SIV rescue plan for the SIVs: i.e. if you put the “good” assets in one new bucket and allocate most of the existing capital of the firm to the good bucket then the losses for the other “bad” assets bucket – the one containing the bad apples – become even more severe.
So, in principle we can think of rescuing the good muni business of the monolines; but then the losses on the insurance of the structured products would be even bigger as you put all the “bad” apples into one bucket an provide that bucket with little or no capital. So saving the muni financing business – a worthy policy goal in general and an even more worthy one in a recession – may require accepting massive losses on the structured finance products insured by the monolines, thus ensuring the massive writedowns on these assets that would then follow. And since we need to worry about the systemic effects of such writedowns by splitting the monolines we solve one problem but we exacerbate the other one.
It is true that even without spittling the monolines it would be mission impossible to avoid the writedown of the toxic assets that were insured by the monolines. So the logic of the “split the monolines” solution is to acknowledge that the losses on structured finance junk are unavoidable; thus it is better to concentrate on sheltering and saving the muni part of that business to prevent the “rotten” apples from having contagious effects on the “good” muni apples. That still leaves open the question of how to avoid the systemic effects that another $150 billion of writedowns implies for the financial system; but faced with two bad options – rescuing the muni part of the insurance business & accepting massive losses on the toxic business; or allowing a monoline downgrade that will lead to massive losses on both the muni and the toxic business – the former option looks more sensible and desirable even if it leaves totally open and unresolved the other systemic problem.
But let us reconsider next whether the muni business of the monolines is as sound as the conventional wisdom makes it. The usual argument for the soundness of the muni insurance business of monolines is that state and local governments rarely default and thus the actual default risk for such governments is lower than the one implied by their formal credit rating. State and local government with different levels of debt relative to their revenues and different levels of fiscal balances receive different ratings from credit rating agencies. Thus, the borrowing costs for a single A rated local government are very different from those of a AAA rated government.
This is where monoline insurance of muni bonds enters in the picture. By buying insurance from the monolines state and local government can borrow at AAA rating spreads even if their underlying creditworthiness is much lower, say A. How is that insurance beneficial for both the buyers and sellers of insurance? If this insurance market was truly actuarially fair a local government should be indifferent between issuing a bond with a AAA rating that was obtained only after insurance is bought and instead issuing a bond at a spread reflecting its lower actual rating – say A – but without the cost of insurance. The reason for this indifference is simple: fairly priced insurance would imply an insurance premium paid by the borrower that – in expected terms – is equivalent to the difference in the spread between, say, a A rated bond and a AAA rated bond. So, a borrower should be indifferent between buying such insurance or not buying it.
So why do municipalities prefer buying insurance? The reason is that if they can convince insurers that their actual risk of default is lower than the one reflected by their formal rating the premium paid on the insurance is lower than the differential in spreads between a lower rated bond and a higher rated bond. And the argument that state and local government make is that their actual default rates are usually lower than the ones suggested by their ratings: after all, the argument is made, when a state/local government is in trouble it is more likely that it will raise revenues or cut spending rather than default on its bonds. Since the monoline insurers bought this argument made by governments the insur
ance premium that the borrowers pay is lower than the differential in spreads between a lower rated borrowers and an AAA borrower. And as long as default rates remain low for such state and local governments both the borrowers/buyers of insurance and the sellers of insurance (monolines) gain: the borrowers/buyers of insurance gain since the cost of borrowing at AAA with the insurance cost added to it are lower than the costs of borrowing with a lower rating; the sellers of insurance gain since – if default rates remain lower than what is implied by the rating differential – the cash flow on insurance premia will remain much larger than what is paid out in the rare cases of default.
This is also the reason why folks like Warren Buffet want to buy the part of the monolines business that is muni insurance and the reason why some private equity firms or other investors want to enter into the business of muni insurance. For the last 20 years insuring muni bonds has been a cash cow for such insurers with little paid out as muni defaults have been extremely rare. It is like providing life insurance to folks who never die; or provide fire insurance to organisms living underwater with no fire risk.
But is it true that muni bonds are that safe because once state or local governments are under financial stress tightening the belt – in the form of spending cuts and/or raising revenues – is almost always preferred to the option of defaulting on their debts?
The relative safety of muni bonds is based on the relatively low rates of default on their bonds in the last quarter of a century. But there are several reasons to worry that default rates by state and local governments may sharply increase during the coming US recession.
First of all, the previous two US recessions – in 1990-91 and 2001 – were relatively shallow – lasting only 8 months – and did not affect as severely the finances of municipalities. The current US recession is highly likely – for reasons we discussed in the past – to be much more severe than the previous two in terms of its length – at least four quarters and possibly six – and its depth. Thus, the experience of low default rates for local governments in the last two recessions may not be an appropriate guide for the current recession. Such default rates may sharply increase if the current recession is more severe than the previous two.
Second, state and local governments rely heavily on three sources of revenues: fees paid by real estate developers; property taxes; and sales taxes. All three sources of revenue are now under severe stress and will sharply fall further during a recession. The biggest housing bust in US history has already led to a fall in housing starts of over 45% and expectations that housing starts will have to fall another 20% to 30% before they bottom out. This fall in new construction activity is a significant drag on the revenues that state and local government get from real estate developers. And that drag will get even worse once – as it is happening now – we have a bust of commercial real estate on top of the bust of residential real estate.
Moreover, the sharp and continued fall in home prices will lead to a significant reduction in the revenues from property taxes that local governments get. In many cities the fall in home values has already led local governments to reduce property taxes as the value of homes has been now assessed downwards. In other localities homeowners are up in arms requesting reductions in their property taxes as the value of their homes is sharply falling. You can expect a significant fall in such property tax revenues as nationally home prices will fall by at least 20% – and possibly as high as 30% – relative to peak.
On top of these revenue losses one has to add the loss of revenues that an economic downturn will imply for revenues from sales taxes. In California alone – where the housing bubble and bust is particularly severe – such sales tax revenues have already fallen by over 10%. So, an economy-wide recession will lead to a sharp worsening of the fiscal conditions of state and local governments: revenues will sharply fall while the ability to cut spending during a recession may be limited by the need to provide counter-cyclical spending for households negatively affected by such a recession.
Third, an economy-wide recession will have much more severe effects on the fiscal conditions of state and local governments in regions where the housing boom and the home prices bubble were particularly large. For example, while the US economy may have entered a recession only in December of 2007 studies suggest that Florida has already been in a recession since the middle of 2007. This means that aggregate nation-wide measures of the size of the recession are less important than local conditions in assessing how severe the stress on state and local government finances will be. In regions and counties and cities where the housing bubble was the biggest the ongoing housing bust will also be the most severe. So a locality that had a housing boom for a few years but is now experiencing a massive housing bust, where home prices are now falling by 30 to 40% and where massive numbers of foreclosures are occurring will very likely experience significant financial stress and will be more likely to default on its muni bonds. Local fiscal conditions and stress – rather than national ones alone – will determine how many local governments will default on their bonds.
Fourth, many state and local governments will have very large fiscal financing needs in the next couple of years. These financing needs come from two sources: one is the need to rollover – or reissue – the existing outstanding muni bonds that are coming to maturity; the second is the need to issue – on net – new bonds if there is an increase in the fiscal deficit of such a locality. The credit conditions for state and local governments will not significantly improve if – as likely – the monoline problems, the TOB and ARS market problems persist and the credit rating of muni bonds is reduced in a recession; then the cost of financing the rollover of existing maturing debt and the cost of issuing of new debt will significantly increase making it more likely that some seriously distressed local governments will prefer to default on their bonds.
The four factors discussed above suggest that the conventional wisdom that state and local governments rarely default will be seriously tested during the current economic recession. And if the current recession will end up – as likely – being more than the previous two investors and markets will be shocked to discover that their presumption that default rates on muni bonds are always low will be proven to be wrong. But if the default rates on state and local government were – as argued here – likely to soar in a recession the consequences – in terms of losses for financial institutions and investors – would be massive. Certainly financial markets have not priced so far the risk of a significant increase in default rates on muni bonds. But then they had not priced either the risk of subprime mortgages’ defaults or the risk of a sharp increase in corporate defaults.
Thus, the risk of a historical regime break – with a sharp increase in default rates on muni bonds – should not be underestimated. If that were to happen the current delusion that the only problems of monoline insurers are in their insurance of structured finance products and that insuring muni bonds is a profitable cash cow could soon be dashed. Then the ensuing systemic effects of a rise in muni bond default rates would be an order of magnitude larger than those of an already large writedown of the toxic structured products currently insured by the monolines.
So, in conclusion, caveat emptor: muni bonds may be much more risky and subject to default than the current conventional wisdom makes them. A serious US recession may r
eveal what has not occurred for a quarter of a century: a sharp increase in default rates by state and local governments.
152 Responses to “The Coming Muni Bonds Default Crisis…and the Monoline Downgrade Saga…”
artichoke • February 15th, 2008 at 6:04 pm
RichH sorry I could not make it today to your get-together, which was a great idea. I am in the NYC suburbs (Westchester) so I could show up with some more advance warning. Hope a good time was had by all!
Dave P • February 15th, 2008 at 6:11 pm
LIABILITY NO LONGER EXISTS Lawyer-Governor of New York proposes to save the monolines by dividing their assets and liabilities — more specifically, the worthless assets and liabilities from the valuable assets. Whew! The syntax is challenging there. This is patently illegal, but that is no longer relevant in this society when the PC ends justify any means. This would set a great new precedent for us all by making it legal to separate ourselves from our liabilities, place them into a separate entity and then let it go broke. Totally Kool. What a Brave New World we have entered. Dave
DAve P • February 15th, 2008 at 6:27 pm
Local government around the nation have been spending like drunken sailors, expanding budgets, adding new employees and issuing new debt for non essentials like sports facilities, and adding much new capital equipment, all of which require higher higher annual budgets. Now they are caught in the classic debt trap with rapidly shrinking tax revenues. Saying that there aren’t likely to be any defaults is like saying home prices will rise forever. There will be numerous defaults, rising interest rates and without reliable insurance, new issues become next to impossible. Its already happening. But. . . . the denies keep on denying untill its too late and the whole financial heap comes a-tumblin’ down. Nouriel’s predictions are modest in my view. Things are a whole lot worse.
KJ Foehr • February 15th, 2008 at 6:37 pm
Octavio Richetta wrote on 2008-02-15 17:28:52 (in the previous thread) “Business, Obama-Style http://www.businessweek.com/magazine/content/08_08/b4072034342177.htm?chan=magazine+channel_news I was pleasantly surprised by this article! Seems to me Obama is a much better choice than either Clinton or McCain. Smart, well-balanced guy.” He his definitely very smart, with a vision and wisdom seldom seen in politics, IMO. I have read both his books and heard him speak many times. Therefore, I feel I know him better than any other candidate for president in my life. He does seem truly committed to improving the lives of poor people. And, apparently, he is not beholden to any special interest groups other than unions. But that is the potential problem. Don’t get me wrong, I am supporting him and have done volunteer work for his campaign, but his degree of liberalness even worries me a little. He reportedly has the most liberal voting record in the Senate, so I fear a return to the failed programs of the Great Society. And I do worry that business will suffer because of higher taxes and greater regulation. But I am not a laissez faire devotee; I am willing to sacrifice some GDP growth, for improvements in society, infrastructure, and the environment. However, I feel/hope his desire for consensus, inclusion, and respect for opposing views will lead him to more moderate decisions and programs initiatives. Further, I believe his intelligence will lead him to better ideas than old style welfare and other social programs that do not provide sufficient incentives for work, personal responsibility, and giving back to the country. I think he really believes that people should not merely take from their government, but should give back to the country as well – a la “Ask not what your country can do for you…” His opponents will say he is weak on defense and the war on terrorism, but I believe he will be strong when the need is there. He will be stronger than Jimmy Carter, and wiser than any president since perhaps Kennedy. Therefore, he will know when force is truly needed, and he will not squander American blood and treasure unnecessarily. And he will bolster our image in the world. He will keep our friends close and our enemies closer. This, IMO, is a much wiser way to conduct the foreign policy of the USA. Had we done that after 9/11, instead of going off half-cocked, proving to the world that we were strong and would not take the attack laying down, I think we could have killed bin Laden in Afghanistan before the end of 2002. And we would have saved 4000 American lives, countless other lives, and 100s of billions of dollars. If we had just taken our time, kept our powder dry a few months, and reacted wisely using the CIA and special forces instead of a military invasion, we might have avoided much of the mess we have in Afghanistan, Iraq, and most disturbingly, in Pakistan now. We need a wise president who is personally strong, not just a swaggering poser. One who is not afraid to talk with our enemies to settle differences without war, but strong enough to fight them when necessary. I think Obama is personally strong and not afraid to fight, and that the USA will be strong, not weak, under his leadership.
KJ Foehr • February 15th, 2008 at 6:56 pm
@ Giraf “Hey KJF, are you a fellow Canadian? In one of your recent posts about Coach Ben and QB Hal, you mentioned 4 downs! We only have 4 downs in the Great White North.” No, but I have great admiration for Canada, and would consider moving there if it was warmer. I really like B.C., but it is even too cold there for my weak constitution. I live part-time in Illinois and part-time in Maryland. I play tennis, not football, but I thought there were 4 downs in American football. Maybe I should to watch a game sometime to see…
Guest • February 15th, 2008 at 7:41 pm
“David Walker Resigns as U.S. Comptroller General” Some have integrity; not all or most, but some. PeterJB
Yankee • February 15th, 2008 at 7:42 pm
Rich – I am in CT and would make it to an RGE-fest if there is proper advance planning
KJ Foehr • February 15th, 2008 at 8:20 pm
PeterJB wrote on 2008-02-15 19:41:12 “David Walker Resigns as U.S. Comptroller General” Wow, that is a surprise. I worked for GAO under the previous CG, Charles Bowsher. I don’t have any personal knowledge of Walker, but he struck me as independent, innovative, and dedicated to real improvement in the government. I was surprised by his outspokenness, which had previously been frowned upon by Congress. And I suspect that is what caused him to quit: Congress was probably pressuring him to stop speaking out publicly about the dangers of the government debt. (That was the big problem with that agency. It is supposed to be independent, but you could never completely escape the political influences from Congress. It was not always a problem, but it was not unusual either to have many months of work squashed without ever seeing the light of day (publication) because the findings were not welcome on the Hill.) It is ironic that Walker’s warnings may soon be proven to have been prescient. P.s. I wish he would have waited to resign until after the new president was inaugurated.
Jason B • February 15th, 2008 at 8:29 pm
The loss of investor appetite for mini bonds could not come at a worse time. Municipal infrastructure around the country that was built during the WPA of the 1930′s and the post war boom is at the end of its lifespan. The American Water Works Association is calling this the Dawn of the Replacement Era, http://www.win-water.org/reports/infrastructure.pdf as so much will need to be dug up and replaced in the next 30 years. This is financed by municipal bonds. Lets hope investors regain their appetite soon.
Octavio Richetta • February 15th, 2008 at 8:32 pm
“Written by DAve P on 2008-02-15 18:27:28 Great post! Professor says: It is true that even without splitting the monolines it would be mission impossible to avoid the writedown of the toxic assets that were insured by the monolines. So the logic of the “split the monolines” solution is to acknowledge that the losses on structured finance junk are unavoidable; thus it is better to concentrate on sheltering and saving the muni part of that business to prevent the “rotten” apples from having contagious effects on the “good” muni apples. That still leaves open the question of how to avoid the systemic effects that another $150 billion of writedowns implies for the financial system; but faced with two bad options – rescuing the muni part of the insurance business & accepting massive losses on the toxic business; or allowing a monoline downgrade that will lead to massive losses on both the muni and the toxic business – the former option looks more sensible and desirable even if it leaves totally open and unresolved the other systemic problem. There is some faulty logic going on here. The fact that the monoliners may end up defaulting on the non-muni policies even if they are not broken up, does not mean that the holders of the non-muni insurance are going to seat there quietly as they are made part of the “bad” bisuness, i.e., a business with neither capital nor revenues, only huge liabilities. The rules of the game for the insured are being changed after the fact. That won’t work. I smell breach of contract here. Lawyers will step in big time. The only way out would be some sort of public bailout but I don’t see that being worked out in the middle of an election year. And the bailout should probably be the other way around: The Federal Government guarantees the municipal business (defaults will come) and the monoliners keep the non-muni business raising private capital for that.
artichoke • February 15th, 2008 at 8:40 pm
@Octavio: I think it would be politically difficult to sell the idea of forcing taxpayers to pay more to bail out munis, improving protection for the banks who hold the non-muni part. Not to say it won’t happen though.
Octavio Richetta • February 15th, 2008 at 8:40 pm
Krugman getting gloomier by the post. Check the trend in the posts for the last three days… http://krugman.blogs.nytimes.com/2008/02/15/the-consumer-is-always-right/
Gloomy • February 15th, 2008 at 8:52 pm
Dr. Roubini Just the usual crystal clear analysis from a truly great mind. Thanks for keeping us so far ahead of the crowd.
Gloomy • February 15th, 2008 at 9:15 pm
Pushing on a string… Current 1 Month Prior 15-Year Mortgage 5.24 4.95 30-Year Mortgage 5.81 5.45
Gloomy • February 15th, 2008 at 9:18 pm
Sorry, bad format, trying again Pushing on a string… Current 15 year mortage rate=5.24 (4.95 one month ago) Current 30 year mortgage rate= 5.81 (5.45 one month ago)
Guest • February 15th, 2008 at 10:07 pm
@ Octavio Richetta on 2008-02-15 20:32:51 ”The only way out would be some sort of public bailout but I don’t see that being worked out in the middle of an election year.” The technical solution to the current global economic turmoil commencing initially with the USA – the heart of the problem – realistically speaking, is easily possible and relatively simple, albeit to those who would comprise a team of technical and intellectual experienced folk, of integrity which would hold an Authoritative Mandate from the Representative of the Public. There is the need for pain, much pain: this pain would involve huge losses for individuals and corporates; for Banks and financial entities; bankruptcies, write-offs, write-downs, dismissals, promotions, unemployment, imprisonment, misery, sadness, suicide, divorce and much unpleasantness both sad, depressing and disheartening; etc., etc., et cetera. But it must be done if man is to rise to meet his destiny; if it isn’t done, then men will be impacted by a destiny where far more pain will be inflicted; far more hardship will be experienced. The Public Purse that is to say, a future payments will be needed to be committed on even the unborn – by the Public; such is the extent of sacrifice – in order for a Nation that is, the rebuild, reconstruction, the reform and regeneration of those necessary energies and stimulants that evolve and evoke men of civilization. The enemy is the private agenda of influence; the wealthy; the political and the opportunistic ferment of fundamentalism and zealotry. Fear and favour will rule the day and fair effort will be under-mined; treachery, cowardice and theft, lies and deceit; betrayal will lord over any honest attempt to apply the solution which will favour the peoples of this Nation; for the Nation and its peoples.. T Therefore, Rome must, a priori, burn. I believe David Walker (among others of his ilk) prepares for this day… He knows that “leadership” does not exist in place today that is worthy of meeting our destiny. PeterJB
PTM • February 15th, 2008 at 10:19 pm
Like you I am very worried about our state of affairs. Perhaps the problem is simply too many political cronies giving a free pass to corporations and a new politico will fill the bureaucracies with more competent and dedicated appointees. Regardless, I feel the problem is much deeper. The problem stems from years former legislative staff writing laws on behalf of their new corporate employers and submitting these bills back to their former congressmen for subsequent voting and passage in the congress. The problem in other words is structural as opposed to political. So rather than worry about Obama’s spending, have you considered Rom Paul fiscal policies? His 1st priority is to cut spending drastically. The only sane solution to the problem at hand. He is the only presidential candidate who says the government’s role is to allow its citizens the personal freedom to seek virtue. An amazing statement of self-confidence. The ability to seek virtue, as you do, in helping our fellow man, un-encumbered by fiat bureaucratic rules. The ability to seek virtue in doing the best we can to create a better society without all of this government engender madness we have to live through day-to-day. Who’s Ron Paul? He is the guy the corporate news has black listed and does not have a chance to win the republican nomination for president. But this is not about probabilities. It’s about doing the right thing. It’s about making republicans re-think their basic principles ask themselves if they really want to follow the big government, deceptive government practices we have today or do we want to return to a small is beautiful type of government. Once that decision is made then you can choose between the two presidential candidates. ptm
NewstraderFX • February 15th, 2008 at 10:27 pm
Warren Buffett wants to buy INTO the Muni bond insurance business. ‘Nuff said.
JMa • February 15th, 2008 at 10:39 pm
“Pushing on a string… Current 15 year mortage rate=5.24 (4.95 one month ago) Current 30 year mortgage rate= 5.81 (5.45 one month ago)” @ Gloomy and all, thoughts on this being the trend in terms of rates continuing up if not moving up rapidly as a result of the crisis ? I mentioned at the end of the prior thread, a trend line had been broken technically indicating 30 yr rates were to move up. I have been pressing my poor sister who has sold her home to wait, wait, wait. However, she will not be paying 100% cash for the new house, so I just do not want to be involved in getting her in trouble with a MUCH higher mortgage rate later. shoot… Professor, it goes without saying at this point. Your coverage of this is like a surfer riding a wave with sunglasses on drinking a pina colada cruising along with ease. You are out in front and all over it. Thanks. When I lived in New York, a friend of mine used to carry $40 in his pocket at all times as mug money in case something happened. If things get REALLY bad following the potential implosion of the world as we know it. This may not be a bad idea regardless of where you are and just be ready to say here you go and this never happened. Especially when you hear stories about the 5 women shot and killed during a robbery at a shopping mall in Chicago where one of the poor women decided to try and be a hero (or she just did not want to get robbed?) and call 911. Apparently, it was at that point that the guy heard the 911 operator and decided to actually kill them all. He had just had them tied up and was likely not going to kill them… Sorry for the dark story – it is unfortunately part of our reality that is likely to get dramatically worse.
Norka West • February 15th, 2008 at 11:01 pm
If munis are truly desperate for bond insurance on their new and existing bonds, can’t they arrange a policy with Berkshire? View it as an umbrella policy after you have auto, homeowners, and fire insurance.
Guest • February 15th, 2008 at 11:09 pm
It’s about making republicans re-think their basic principles ask themselves if they really want to follow the big government, deceptive government practices we have today or do we want to return to a small is beautiful type of government Republican principles? This crop of republicans has none. Not that the democrats are not complicit to some degree, but they have trashed the treasury, the middle class, U.S. standing in the world and the Constitution. They deserve extinction for it.
Guest • February 15th, 2008 at 11:22 pm
There has been much talk on this blog about the failure of de-coupling. While it’s possible that could happen, I believe that any conclusions are far too early at this stage. Investment themes in the USA suffer from far too much short-term vision … investment myopia. Case in point. Take a look at the price of industrial metals such as copper ($COPPER on http://www.stockcharts.com). Does this price look like it’s going down? Sure doesn’t to me. If pricing for copper holds at these levels, then it sure argues for continued solid demand for industrial metals (and copper is not the only metal that is showing recent price recovery). The possibility that Asian industry is still rolling along just can’t be ignored. Just because the USA is facing the doldrums, and deflation in some major asset classes, does not mean that the whole world is dead in the water. At least not yet. I wonder if too many investors have panicked and sold overseas stocks (esp. Asian stocks) too soon. PeteCA
GSM • February 16th, 2008 at 2:34 am
It is abundantly clear that many local and state entities are entering crisis, are already there already or about to. The 3 mains sources of their revenues- RE developers fees , the residents fees and financial investments- are all simultaneously under enormous pressure. In fact they are imploding. Their receipts must be collapsing and balance sheets flowing with red ink. To avoid default , these entities will begin to action the curtailment of services- police, health, education, utilities and infrastructure, education, medical, social services, legal etc- perhaps even some outright cancellations. Just to remain viable. This is how real living standards decline visibly, in a very big and in your face way. Locally, at your doorstep. It gets worse. A quick look at the probability of any of the 3 main revenue streams for these entities shows that they are not likely to improve anytime soon. Therefore the cuts they make will take on the look of permanence in nature, at least until the revenue/expense equation reaches an equilibrium that would allow new expansion of services, whenever that may be. US lifestyles will change significantly now. In a very negative way I’m afraid.
GSM • February 16th, 2008 at 3:15 am
@KJF, I have just reviewed what I can find of Obama’s economic plan and like all the candidates he is clueless. So rather than portraying him as some savior, perhaps it’s best to say that he may be the best of a very clueless bunch. Which will turn out to be a crying shame. Because the last thing the US needs to see right now is a marshmallow version of the financial disaster now arriving. TPTB are busy dressing up this pig and Obama is doing the same. The US populace needs to wake up. Or, be woken up. With, dare I say it, the (awful) TRUTH about their dire economic condition and more importantly- how it came to be. The old tired methods and textbook responses (MORE AND MORE DEBT) of the past will prove lightweight powder-puff punches against this destructive monster of a financial crisis unfolding before our eyes. Obama’s plans are more of the same, just some components weighted differently. Nothing special and in fact, your purporting it is anything more is disingenuous. Which I feel speaks to the complete lack of basic economic intelligence in the US. If the next US President only provides what the sheeple can understand, he will punch FAR below what is needed to save this once great country from its impending economic catastrophe.
GSM • February 16th, 2008 at 3:24 am
Warren Buffett wants to buy INTO the Muni bond insurance business. ‘Nuff said. Written by NewstraderFX on 2008-02-15 22:27:41 …….. and boy will he charge for that. Buffet’s plan is to be the only one left standing. And , do you think he will do that business at the same cosy prices the existing monolines do? So NewstraderFX, when you see your local taxes go through the roof , at least you know where a good portion of those bucks are headed. Buy Berkshire Hathaway as a hedge?
GSM • February 16th, 2008 at 3:50 am
@PeterCA, I believe that the commodity sphere is reflecting the bid of capital headed for safer havens other than the debased dollar. If that is so, and continued dollar debasement is ahead(which there is no doubt that it is), this trend will continue regardless of physical demand for the commodity. This textbook assumption being tested :Slowing growth=slowing demand=lower commodity prices. But, what if distrust in the dollar is now becoming so profound and widespread that commodity price declines are viewed as opportunities to diversify out of dollars? With 2.5 bill people to feed water and generally provide for, China and India may view it that way now that they have money to throw around. And if they do, what of other players in the markets for commodities? Might they feel crowded out in this struggle, forced to bid up also? This is the other side of the balance sheet debacle facing all US households today. Mountains of debt with imploding assets/collateral, combined with escalating costs for life’s necessities- all in an environment of stagnant or declining real wages/salaries. The trend towards debt serfdom has been clear, starting with the 2 income family, HELOC’s, speculation on housing, 401Kraids, CC indebtedness etc. All now to the dead end off technical bankruptcy and financial collapse. And for what? Certainly not self enrichment. In the face of concerted , sanctioned and overwhelming Govt, corporate and media brainwashing, the US household embraced debt as it’s officially approved savoir. Only now to find that those installments, payments, fees, taxes, and most all their earnings have been confiscated for the enrichment of either Emerging countries or elites locally. They didn’t stand a chance.
Guest • February 16th, 2008 at 4:56 am
why not this enterprise namely RGEmonitor take over the role of rating agencies formally since, as demonstrated by last 16 months time that their analytical capabiltiess are far better and accurate then those socalled rating agencies
London Banker • February 16th, 2008 at 4:57 am
Great post, Professor. Am I the only one here old enough to remember Citibank’s Walter Wriston justifying excess lending to the third world with the observation, “Sovereign nations don’t go bankrupt”? That conventional wisdom led to the huge implosion of credit in the 1980s and the near bankruptcy of Citibank and many other big banks. Municipalities can and will default when their tax bases are eroded by crashing property values, distressed retail and widening unemployment. Nobody will be immune from the steepening yield curve as recession begins to bite harder on the corporates and consumers in the American debt deflation to come. It is worth noting that it was because municipal and state budgets were constrained in the Great Depression that Marriner Eccles proposed to FDR that federal deficit spending should be used for infrastructure to counteract widespread unemployment and lay a foundation for growth. His views were not adopted as policy until 1934, after much damage had been done. It’s hard to know whether the US could use the same mechanism if the credit crisis goes global. Many current US creditors will regard the US as the exporter of deflation and recession, especially as the dollar devalues, and will prefer to invest in more prudent and disciplined markets.
Octavio Richetta • February 16th, 2008 at 6:22 am
Written by JMa on 2008-02-15 22:39:48 Tell your sister to be patient. Lower prices and lower rates are coming (give it about a years). Unless she is 100% certain about her cash flow situation (i.e., she can easily meet mortgage payments even if loosing her job), buying a house is risky business. Even with 20% down you are picking up some very significant leverage. You must meet monthly payments/expenses, otherwise we all know only too well what will happen: house gets taken away and if you are one of the unlucky ones to have some equity in the house you will loose some money too. Let me tell you a short story. I have this Argentinean friend (used car salesman – not a joke) whom I met when I used to consult here (I now live in Argentina -used to teach in the US before the random college shootings started). He sold his house in Argentina for USD 70K and moved the family to Miami in 2000, wife and two kids; with the money, bought an USD 110K apartment with over 50% down; mortgage monthly payments were well within is means. By 2005 the apartment had doubled in price, he refinanced and got out of the deal USD 70K to open up a restaurant (against my advice). Due to the increase in RE prices, he still had over USD 100K equity in the apartment but his monthly payments doubled. He gets divorced, restaurant goes under. Wife kept the apartment but has no skills, speaks no English, gets a job as a Janitor. Under my advice (I told her it was the time to sell), she sold the apartment in early 2006 for USD 210K and got 90K equity out of the deal. Lady was still grieving lost husband so she insists at the very least she should have an apartment. I told her she did not have have the income required to buy a USD 200K apartment; That a divorce moves people in their situation (lower middle class) close poverty . That she should rent and keep the savings as things in Florida were starting to get bad but would get even worse. Lady doesn’t take the free advice, buys a USD 200K apartment with 30% down and a NINJA ARM despite the fact that my friend, her ex-husband, was already missing alimony/child support payments and her monthly income was under USD 2000! You can guess the rest of the story. She lost the apartment along with the USD 60K down payment in late 2007. Now, broke ex-husband, who was kicked out by his girlfriend when the money ran out, is selling used cars in Florida part time (besides RE, I can’t think of a worse business to be in in Florida right now) and moved back with her into a $1500 rental apartment. They tell me lower rents cannot be found for a decent place . This I doubt. IMO, they have become “Americanized” and like many people in the US are not willing to “bite the bullet”/undertake some hard “belt tightening”.
Guest • February 16th, 2008 at 6:23 am
http://online.wsj.com/article_print/SB120308290353671507.html Bond Insurer Seeks to Split Itself, Roiling Some Banks By LIAM PLEVEN, KAREN RICHARDSON and CARRICK MOLLENKAMP February 16, 2008; Page A1 Wall Street Journal The beginning of a messy endgame to the bond-insurance crisis may be underway, and the industry that emerges could look very different from the one that bet big on subprime mortgages. On Friday, FGIC Corp., holding company for the nation’s third-largest bond insurer, told the New York State Insurance Department that in effect it wants to split up the business. The idea would be to create a new company to insure safe municipal bonds and for the existing one to keep responsibility for riskier debt securities already insured, such as those tied to the housing market. The move may help regulators protect investors who have municipal bonds insured by the firm. But it could also force banks who are large holders of the other securities to take significant losses. Some banks that have been talking with FGIC in recent weeks to bolster the firm were taken aback by the announcement and could yet try to block it, say Wall Street executives. Either way, the move is a further sign that the industry could retreat from insuring some of the complex financial instruments that fueled the recent housing boom. If the market settles down, that would be good news for local governments that have been dragged into the subprime-mortgage mess. They would like to see competition among financially solid bond insurers, so that the cost of insuring their municipal bonds remains low. ”Certain aspects of the business model almost certainly will not look the same at the end of the year,” said New York State Insurance Superintendent Eric Dinallo, who has been consulting with the bond insurers about new regulations that will cover what risks they can assume. Already, MBIA Inc., the largest bond insurer in the country, has been forced to raise more than $2.5 billion in capital in an attempt to preserve its triple-A credit rating. Ambac Financial Group Inc., the second-largest, has also been talking with banks about a possible rescue plan. Additional pressure came from New York Gov. Eliot Spitzer, who told Congress on Thursday that bond insurers have three to five days to find a solution to their problems before regulators could step in. Lawyers for insurers and banks are expected to work through the U.S. holiday weekend. Bond insurers have been around for decades, but little noticed by the public. They built their business by promising to repay interest and principal on bonds issued by municipalities if the municipalities defaulted. The insurance made the borrowing cheaper. Now, the insurers have become a linchpin of the financial system, backing more than $2 trillion worth of securities. Riskier Business The industry plunged deeper into riskier business lines in recent years, including insurance for securities backed by subprime mortgages. The downturn in the mortgage market has exposed them to potentially sizeable losses. That has, in turn, called into question whether they can maintain the triple-A ratings that are critical to their business, and has forced some to go looking for more money. Holders of the debt securities — ranging from banks to ordinary investors — also have a lot at stake because the value of the securities hinges in part on the rating of the insurer. That’s one reason regulators have been trying to rally banks to help rescue the insurers. FGIC has already lost its top-notch triple-A rating from all three major ratings firms. Moody’s Investors Service on Thursday cut FGIC’s triple-A financial-strength rating by six notches to A3, with a warning that it could be cut to the lowest investment-grade level of Baa if FGIC’s strategic and capital plans had “an unfavorable outcome.” Mr. Dinallo told Congress on Thursday that the department would consider letting bond insurers split themselves in two, effectively giving his imprimatur to the idea. On Friday morning, FGIC’s general counsel, Ed Turi, notified Mr. Dinallo’s department of its intent “to begin the process” of creating a new bond insurance company in New York. That would require the department to issue a license. If it gets a license, the new insurer will support public bonds previously insured by FGIC and seek new municipal-bond business, the company said. Mortgage insurer PMI Group Inc. owns a 42% stake in New York-based FGIC, while private-equity firms Blackstone Group Inc. and Cypress Group each hold 23%. FGIC insured about $315 billion in debt as of Sept. 30, including about $31 billion backed by mortgages. FGIC’s move caught at least some of the banks in the group that have been negotiating with it by surprise, according to a person familiar with the situation. Banks that own securities insured by FGIC face the risk of write-downs if FGIC is downgraded further, because the value of securities it insures could fall further. Incentive for Infusion FGIC’s move could serve as an incentive to get the banks to step up to the plate on a cash infusion for the company. In the past, regulators have said dividing the insurers is a last resort and urged the banks to put in fresh capital. Calyon, the investment-bank arm of Credit Argicole SA, is leading the bank group. A Calyon spokeswoman declined to comment. The full bank group has had only tentative discussions with FGIC. One question that has dogged the group is whether the principal negotiating partner should be FGIC, its shareholders or regulators. The banks learned of the split-up plan Friday by seeing it reported on CNBC, this person said, calling it a “bizarre situation.” All of the banks have hired legal counsel and are prepared to go to court. The person familiar with the situation said FGIC’s move could result in “instant litigation.” FGIC didn’t respond to queries about the banks’ reaction to Friday’s announcement. One plan the parties are discussing involves commuting, or effectively tearing up, the insurance contracts the banks entered into with FGIC, according to another person familiar with the matter. In exchange, FGIC would pay the banks some amount to offset the drop in value of those securities, or give them equity stakes in the new municipal-bond insurance company. Some observers questioned whether the breakup plan would be fair to all FGIC policy holders. It would probably help municipal governments, because the entity insuring their debt would be healthier, while hurting those who mainly relied on FGIC to insure riskier securities. Also unclear is how the ratings services would treat the two insurers after a split. ”You’re trying to unscramble the egg,” said William Schwitter, chairman of the leveraged-finance practice at law firm Paul Hastings. “When you take a balance sheet that is supporting a variety of obligations and try to split it in two, it’s difficult.” Mr. Schwitter, who isn’t involved in the FGIC negotiations, noted that many investors who bought bonds supported by FGIC insurance probably had no idea the company could be split later. However, if a breakup is endorsed by the New York Department of insurance, that could limit the legal liability. One other wild card: If FGIC splits into two, it could throw into turmoil potentially billions of dollars of bets that banks, hedge funds a
nd other investors have made on whether FGIC would default on its own debt. If FGIC is split, it isn’t clear how those “credit default swaps” would be valued, since one half of the new company would have a higher risk of default than the other.
Anonymous • February 16th, 2008 at 6:23 am
“So why do municipalities prefer buying insurance? The reason is that if they can convince insurers that their actual risk of default is lower than the one reflected by their formal rating the premium paid on the insurance is lower than the differential in spreads between a lower rated bond and a higher rated bond” My impression is that municipalities do not primarily purchase insurance to arbitrage infromation asymetries (regarding the municipalities’ credit), but to boraden the base of potential investors to include those that seek or are required to invest solely in AAA paper. Could you comment?
rightofcentre • February 16th, 2008 at 8:05 am
@GSM In “democracies” like those we believe exist in the anglo saxon world there are more net recipients of government largesse than there are contributors to pay for the largesse. Under these circumstances, those that receive will continue to vote for those who offer and it’s never going to change. Most people believe that the government provides services. In reality the government provides nothing. They use money stolen from the productive taxpayer and borrowed from the taxpayers’ children and grandchildrens’ future. It wouldn’t be so bad if they did it efficiently but huge amounts are wasted in the provision and administration of services. Happens in the U.S., U.K., Australia, Canada. Probably happens in every “democracy”. How is it ever going to change? The great unwashed are never going to vote for someone who openly plans to take all the freebies away.
Detlef Guertler • February 16th, 2008 at 8:21 am
London Banker on 2008-02-16 04:57:46 Am I the only one here old enough to remember Citibank’s Walter Wriston justifying excess lending to the third world with the observation, “Sovereign nations don’t go bankrupt”? I just finished school at that time, sorry, but I saw a lot of people from Argentina coming to Europe after their country collapsed in 2002, and I still have some Argentinian bonds buried somewhere in my securities account. Argentina is still standing, but my bonds will never be paid back. Like Argentina, Phoenix or Tampa Bay needn’t disappear if they can’t pay their debts. But one question: A lot of these so-called Muni-bonds were not issued by towns or municipalities but by other local or regional entities – hospitals, port authorities, educational services etc. I suppose it’s much easier to send a hospital into default than a town, and hospitals indeed can disappear. And even if the port will stay, that needn’t be true for the port authority. Does anyone know how much of the munibonds are real municipal bonds, and how much belong to other local entities?
oy vey • February 16th, 2008 at 8:52 am
DAVID WALKER ON YOU TUBE http://www.youtube.com/watch?v=I-16u9x3tfE http://www.youtube.com/watch?v=OS2fI2p9iVs
Guest • February 16th, 2008 at 8:55 am
Enough of these negative comments about the munis. They are a heck of a lot sounder than the CDOs. And that’s why what I think is happening is: the banks are driving Spitzer to impose a fast settlement that forces some subsidy from the muni side to the CDO side of the monolines’ liabilities. Otherwise, the munis will see the monolines failing as their credit ratings are cut and they’ll simply flee to Buffett. And the CDOs will die a fast death. Repeat: this process is being driven by the banks so that the munis don’t escape from them.
Guest • February 16th, 2008 at 9:12 am
Detlef: “But one question: A lot of these so-called Muni-bonds were not issued by towns or municipalities but by other local or regional entities – hospitals, port authorities, educational services etc.” That is exactly the problem. What has happened is that in some states, such as my own state of California, an enormous number of muni bonds were issued to fund all sorts of service projects, including schools, water projects, health care etc. To fiscal conservatives (a rare breed at the time), this appeared to be madness. But it was just another symptom of a system that was heavily overloaded with cheap credit. Where was the realization that one day state budgets might shrink? Nowhere to be found. These projects are now completely out of balance with the economic reality of these overspending states. As far as I can see, the ONLY solution they’ve got is Warren Buffet’s proposal. Buffet has got the system backed into a corner, and he may be the only one laughing at the present time. If Mr Buffet does buy in to muni insurance, I suspect he will be a smart shopper. He would be foolish to just consider all US states as equal in terms of risk. Some states will probably pay much higher insurance rates. In the mean time .. few people are commenting on the impending implosion in the CDS market. As Buffet swoops in to scoop up the profitable side of the monolines business, the financial scraps and toxic waste will be unclaimed – and likely to go bust. That means a whole lot of toxic CDO’s will become uninsured (officially) when the monolines go bankrupt. That will cause a series of losses to ripple through the CDS system. All this looks inevitable to me, at this stage. All the other talk about “rescues” is just political window dressing. It’s meaningless. PeteCA
Guest • February 16th, 2008 at 9:23 am
Can the munis somehow extract their prepaid insurance from the monolines, before the banks grab a piece of it? From CR blog: ” Ziggurat | 02.15.08 – 10:52 pm: The key thing is the unearned premium reserve. This is money collected from munis and ‘earned out’ or amortized over the remaining life of the bonds. The unearned premium is largely from munis, who prepay for insurance. The unearned premium is calculated bond by bond, so it is possible to ‘unscramble’ this asset. For FGIC it is $1.4 billion. …”
Guest • February 16th, 2008 at 9:28 am
GFM I agree, and have no doubt, that the current explosion in commodity prices (esp. grains & precious metals) is being driven substantially by speculation. There are a lot of hedge funds that desperately need to make profits – the “hot money” has to go somewhere. So these flows in liquidity are now driving a new relentless force in inflation. Incidentally, the current commodity explosion does seem to fit quite well with the “crack up boom” phase that is advocated by Austrian economists. Rising food costs are hurting households. And not only in the USA. There will be growing civil unrest and political violence in third world countries as food prices are forced upwards. One good example: Kenya. While the overt problem in Kenya is power sharing between the Kikuyu and Luo tribes, there is also a deeper problem. Basic food costs have roughly doubled in Kenya over the last year or so. I think we will see a growing problem of hunger become a destabilizing force in the world – as the central banks turn towards cheap liquidity (as opposed to conservative banking policies). That being said, I am still wondering about the industrial metals. We’ll have to see what the real demand-supply curve is for copper, aluminum, tin and lead. Their prices are doing better than the pessimists expected. But I am keeping an open mind about the slowdowns in China, SE Asia, and India – a slowdown is not the same as an outright recession. “Dr Copper” says that these economies are not as dead as some people think they are. [However, I do NOT believe the argument that continued strength in industrial metal prices shows that a US recovery is imminent]. PeteCA
Guest • February 16th, 2008 at 9:32 am
AP article on David Walker http://news.yahoo.com/s/afp/usgovernmentcongressquit
Guest • February 16th, 2008 at 9:42 am
Nouriel what are single-A rated muni bonds trading at these days, 98 cents on the dollar? (That’s just a guess.) AAA RMBS are trading around 65 cents on the dollar (ABX index at markit.com ) And you’re writing an article about how bad the munis are? Please don’t ignore Mr. Market’s assessment of the relative safety of these two.
Guest • February 16th, 2008 at 9:50 am
Anybody notice something … David Walker (US Comptroller) has quit. Ron Paul (US Congressman) is effectively sidelined, and out of the US presidential race. These two people are amongst the very few leaders in the US political system who have been trying to tell the truth … about the facade that is going on with the American economy. They are both out of the system. Ron Paul may still be a Congressman – but his influence is severely curbed. What does that tell you about the American system being able to “fix itself”, as opposed to experiencing the illness of a long-term deflation – or economic collapse? PeteCA
oy vey • February 16th, 2008 at 10:06 am
@PeteCA Welcome to Rome. from the AP article…. There were “striking similarities” between America’s current situation and the factors that brought down Rome, he had said. These included “declining moral values and political civility at home, an over-confident and over-extended military in foreign lands and fiscal irresponsibility by the central government.”
Octavio Richetta • February 16th, 2008 at 10:08 am
And the party goes on?…. Just got this email: Sovereign Bank: Home Equity Specials for a Limited Time Our lowest rates in the past twelve months Dear Octavio, From now until March 14, 2008, Sovereign Bank is offering exceptional rates on a FlexLockSM Home Equity Line of Credit or a Home Equity Loan. Whether you’re planning some exciting home improvements or facing unexpected expenses, a FlexLock Line of Credit or a Home Equity Loan is the answer. So before you use the cash in your savings, checking, or other investments, consider the advantages of using your home equity instead. Our FlexLock Home Equity Line of Credit is now available at a variable rate as low as 4.99% APR* – our lowest rate in the past 12 months. Borrow up to 90% Loan-To-Value (LTV) Fixed rate options available with terms up to 15 years Interest you pay may be tax deductible+ Click here to learn more about our line of credit offer. On home equity loans, we just lowered our rates. With fixed monthly payments, you know exactly what you owe and when. Plus, there are no closing costs and the interest you pay may be tax deductible.+ Allow interest to build on your money left in savings Keep more cash on hand for everyday expenses Click here to learn more about our home equity loan offer. Remember, these offers expire March 14, 2008 so apply now to take advantage of these special savings. To speak directly with a loan specialist call 1-877-4-SOV-LOAN (877-476-8562). Offer valid in CT, MA, NH, NJ, PA, RI. Terms and Conditions apply * To get the APRs shown, you must apply between January 12 and March 14, 2008. You must also have or must open a Sovereign Premier, Business Owner Premier or Sovereign Partnership Checking account, or Premier Money Market Savings account, and use automatic payment from the qualifying account. The APRs assume that your total mortgage loans, including your home equity line of credit and/or loan, do not exceed 90% of the appraised value of your 1-4 family owner-occupied home. Property insurance is required. Flood insurance may be required. Rates and other terms accurate as of January 31, 2008, and are subject to change thereafter. Offer ends March 14, 2008. Applications subject to approval. Variable rates are subject to change and may vary monthly based on the latest U.S. Prime Rate as published in the Money Rates section of The Wall Street Journal as of the first business day of the month, plus a margin of -1.01% for lines of $100,000 and above (currently 4.99% APR), a margin of -.76% for lines of $50,000-$99,999 (currently 5.24% APR), a margin of -.26% for lines of $25,000-$49,999 (currently 5.74% APR) or a margin of -.01% for lines of $10,000-$24,999 (currently 5.99% APR). Maximum APR is 18%. Minimum APR is 1.99%. Other rates and terms apply to investment properties and loan-to-value ratios up to 95%. There is a $220 termination fee if you close the line within 30 months. There is a $50 annual fee that is waived if you have a Sovereign Premier, Business Owner Premier or Sovereign Partnership Checking account. There is a $50 fixed rate lock fee for each lock-in request, which is waived through May 2008. The fixed rate lock APR is determined based on loan amount, term, and other factors at the time lock-in is requested, and applies only to the portion of your line that has been locked in at a fixed rate. Fixed rate locks are subject to the terms and conditions explained in your loan documents, and must be repaid over a fixed term in substantially equal monthly payments of principal and interest. If your home is on the market for sale at the time of application, you are not eligible for this offer. May not be combined with any other home equity offers. +Consult your tax advisor for details.
sam • February 16th, 2008 at 10:08 am
I personally ecpect George to bomb IRAN before he leaves the Presidency. That will get our minf off the economy.
Octavio Richetta • February 16th, 2008 at 10:15 am
From the post above, which raises exactly the issues I have been talking about. Can’t believe it! The banks learnt about the splitting plan on TV! IMO, Mr. Danillo is just one mediocre bureaucrat!… Calyon, the investment-bank arm of Credit Argicole SA, is leading the bank group. A Calyon spokeswoman declined to comment. The full bank group has had only tentative discussions with FGIC. One question that has dogged the group is whether the principal negotiating partner should be FGIC, its shareholders or regulators. The banks learned of the split-up plan Friday by seeing it reported on CNBC, this person said, calling it a “bizarre situation.” All of the banks have hired legal counsel and are prepared to go to court. The person familiar with the situation said FGIC’s move could result in “instant litigation.” FGIC didn’t respond to queries about the banks’ reaction to Friday’s announcement. One plan the parties are discussing involves commuting, or effectively tearing up, the insurance contracts the banks entered into with FGIC, according to another person familiar with the matter. In exchange, FGIC would pay the banks some amount to offset the drop in value of those securities, or give them equity stakes in the new municipal-bond insurance company. Some observers questioned whether the breakup plan would be fair to all FGIC policy holders. It would probably help municipal governments, because the entity insuring their debt would be healthier, while hurting those who mainly relied on FGIC to insure riskier securities. Also unclear is how the ratings services would treat the two insurers after a split. ”You’re trying to unscramble the egg,” said William Schwitter, chairman of the leveraged-finance practice at law firm Paul Hastings. “When you take a balance sheet that is supporting a variety of obligations and try to split it in two, it’s difficult.”
Octavio Richetta • February 16th, 2008 at 10:28 am
Written by Detlef Guertler on 2008-02-16 08:21:20 You are right on with Argentina. The guy I speak about in a previous post is one of those that entered the US under the visa waiver program and now flood Florida. Argentina thinks they fooled everyone by defaulting on their debt but they are yet to pay the price. They now face huge infrastructure investment (e.g., power plants) and I am still wondering who is going to be the fool that is going to lend them the money. Not stupid Chavez, he spends so much that he ran out of $$$ already. The thing that has saved the government is that they get FOREX USDs by levying heavy export taxes on grains and beef. Needless to say, producers are not very happy about the situation. If we eventually get the commodity deflation the professor predicts, you better look down below Argentina!
Guest • February 16th, 2008 at 10:37 am
Pete Peterson interview from 5 years ago. incredible, looking back how clear he was on the economy. http://www.nytimes.com/2008/02/15/business/15pete.html?pagewanted=1&ref=business
Guest • February 16th, 2008 at 10:50 am
The above video is incredible… gets better at the 20 minute mark
Gloomy • February 16th, 2008 at 10:56 am
”As I noted on CNBC Tuesday, these firms have become financial terrorists, holding the muni bond business as their hostage. They know what happens to bank robbers and bad guys once they let the hostages go — they get riddled with bullets. If it wasn’t for this end of their business, no one care on whit about these guys — they are just another hedgie that blew up.” http://bigpicture.typepad.com/
Octavio Richetta • February 16th, 2008 at 11:20 am
Abelson aat his best. IMO, a must read… http://online.barrons.com/article/SB120312002274772861.html?mod=9_0031_b_this_weeks_magazine_columns&page=sp Jabberwocky THE BEST THING ABOUT LAST WEEK IS that hell didn’t freeze over. … For it was one of those rare times when we were given a chance to observe in living color those we have chosen to guide this great democracy — the envy of the world — in action, dealing with an extraordinary multitude of thorny woes pressing in on their increasingly stressed constituencies. And it provided the epitome of exhilaration to see the zest and efficiency with which those worthies uncomplainingly bent to the formidable task of dispatching a stunning array of disparate and urgent concerns, ranging from the daunting danger of espionage to the gathering threat that the vaunted American dream of a house, fully equipped with three-car garage, an energy-saving refrigerator, a couple of kids and white picket fence, is fast morphing into a mass nightmare. Virtually the only lapse into the edgy partisanship that has so bedeviled the Congress cropped up during the hearing into whether Roger Clemens sought a better earned run average through sedulously lifting weights and eating Wheaties, as he claimed, or through chemistry, as his ex-personal trainer and a self-acclaimed dispenser of steroids, Brian McNamee, contended. (Roger is famously known as the Rocket, presumably for the extreme velocity of his pitches, but, perhaps, more fittingly, for the “high” he experiences when his adrenaline — or something — is running full-blast.) The essence of the tiff was that the Republicans, as avid baseball fans, felt it was sheer sacrilege to even suggest a proven 20-game winner, as Mr. Clemens certainly has been, could possibly do anything unseemly (and we agree that deliberately dusting off batters with killer fastballs doesn’t count). The Dems, for their part, were in a frenzy of disappointment when they discovered that what Roger was dispensing so generously to them in his goodwill tour of Capitol Hill prior to the hearings was his autograph, not his signature on a check. The inevitable cranky spoilsports beefed that the lawmakers shouldn’t be wasting their valuable time in trivial pursuit of whether an athlete juiced up his performance with a banned substance. That’s patently unfair. We’re talking the Great American Pastime, and all by itself that elevated designation eloquently bespeaks the importance of baseball to the well-being of the Republic. Besides, having a celebratory player up to the Hill even to chat about the weather is a surefire way to draw a standing-room-only crowd and a whir of TV cameras. Roger and Brian weren’t the only duo to get featured treatment by the solons. The Ben and Hank show (starring Ben Bernanke, the Fed’s No. 1, and Henry Paulson, secretary of the Treasury) also earned top billing, although, admittedly, their testimony was hardly as riveting as that of Roger and Brian, perhaps because it wasn’t quite as forthright (and we say that knowing that either Roger or Brian is a forthright fibber). Mr. Bernanke’s comments in particular brought to mind Harry Truman’s lament about needing a one-armed economist who wouldn’t neuter his advice with “one-hand this and the other-hand that” (Harry seems to pop up in this space with some frequency of late, as an antidote, we suppose, to all that guff spewed so promiscuously into the air we must breathe in an election year). We fully sympathize with Ben, who, at the end of the day, answers to a higher authority (in this case, Mr. Bush, who, remember, gave him the job) whose economic refrain, is that “fundamentally” everything’s fine, but, not to worry, it’ll soon get better. So Ben has to walk a fine line between telling it as the president says it is and telling as it is. The result often boils down to a discreet form of jabberwocky. Parsing his testimony before the usual slack-jawed congressional audience, we concluded that he doesn’t have that hang-dog demeanor for nothing: In truth, he’s worried stiff about the economy falling into a black hole (it’s already got one foot and part of another in it), while murmuring vague reassurances about protecting the populace from “downside risks.” He does his loyal best to hew to the administration’s line that growth will slow but not disappear, and — let’s hear the trumpets and drum roll; not too loud, please — recovery will come bounding back in the second half. At the same time, he hints at another healthy slice off interest rates next month. As to Hank, why Mr. Paulson, like the good second banana he is, solemnly echoed me, too, except he claims not to believe the economy will slow as much as Ben frets, and professes a bit more optimism about the second half. Conceivably, Hank is a tad subdued by the fact that most of his efforts to provide a lift for one part or another of the ailing economy have come up snake eyes or had slightly less impact than that of a flea on a hippo. Think back, just by way of illustration, to the much heralded Master Liquidity Enchancement Conduit. With a name like that, the scheme, designed to provide aid and comfort to banks whose feckless practices might come home to roost, we felt was destined to be a dud. And it fully met our expectations. Nor is Hank’s latest concoction, dubbed Project Lifeline, likely to break his losing streak. Supposed to provide succor for homeowners at the end of their rope and facing foreclosure, it proposes that folks who are at least 90 days delinquent on their mortgages get a month’s reprieve in order to cajole the lender into giving them a better deal before they’re tossed out of hearth and home. Sounds to us more like a brief stay of execution than a lifeline. But, rest assured, Hank will keep trying, Ben will keep cutting, Congress will keep fuming and fussing — and the economy will keep sinking. INCREASINGLY, THE CREDIT CRISIS resembles the dread red tide that spreads relentlessly and fouls coastal ocean waters with a toxin that impairs or kills just about everything that swims or floats or crawls in them. Increasingly, too, Mr. Bernanke, cheered on by a vast, hoarse chorus on the Street, in D.C. and places far and near, resembles King Canute exhorting the tide to roll back. The latest casualty of the virulent and spreading credit collapse is, as you may have heard, the auction-rate securities market. That’s another of those fairly obscure contrivances, custom-made by Wall Street to satisfy the ravenous hunger among large repositories of capital, ranging from student-loan organizations to the Port Authority of New York and New Jersey, in every part of the good old U.S.A. Like most of the new-fangled contraptions designed to enrich Wall Street (and, after all these years, we’re still fruitlessly searching for the customers’ yachts), the auction-rate securities market was built on fantasy — specifically, the idea that borrowers could raise long-term money, while paying the lower costs of borrowing short. And the magic that would enable them to perform that neat trick was to turn over the obligation via an auction, at intervals varying from a week to over a month. The market was supposed to be extremely liquid, so the borrower would be able to sell whenever it chose to. And so it was. Should an auction fail, the borrower’s interest rate on the loan shot up, typically quite dramatically, sometimes quadrupling or more. But the possibility of that happening was not worth talking or
even thinking about. As last week’s brutal headlines made clear, the auction-rate-securities market was, as advertised, highly liquid — until suddenly it wasn’t. And also, as advertised, the penalty clause on those borrowings, mandating quantum leaps in interest rates, was the rare exception, almost never invoked — until, out of nowhere, it became the rule. We find it still bemusing that Mr. Bernanke and his cohorts, with the strident urgings of untold legions of professional kibitzers in and out of government and on Wall Street, are so devoted to slashing interest rates — inflation and the dollar be damned — in a kind of robotic effort to inject life into the failing economy. Again, as we’ve said many a time and oft, it most evidently isn’t the cost of credit that’s the problem, but its availability, or lack of it. That’s why the industrial-strength reductions of rates by the Fed have proved so unavailing and why further major cuts are odds on to be just as unrewarding. And we’re constrained to repeat also that only righting our horribly askew accounts, both with the rest of the world and ourselves, will lay the groundwork for a solid and extended recovery. Investors still are suffering from the illusion that the Fed’s snake oil will cure what ails the economy and furnish the sustenance for a new bull market. All we can say is — dream on.
Octavio Richetta • February 16th, 2008 at 11:30 am
A “rare” one by Gene Epstein in support of a gold standard. http://online.barrons.com/article/SB120312013624372883.html?mod=9_0031_b_this_weeks_magazine_columns Greenspan Was Right: The Case for Gold, Part I By GENE EPSTEIN ”UNDER THE GOLD STANDARD,” observed Alan Greenspan in a 1966 essay, “a free banking system stands as the protector of an economy’s stability and balanced growth.” As you probably heard, a serious bout of instability caused by major imbalances currently plagues the U.S. economy. So a free banking system under the gold standard must be just what the economy needs, if Greenspan had it right. In that same essay, the future Fed chairman saw another key advantage to a gold standard. While taxing and borrowing against future taxes were the conventional ways government raised revenue, the abandonment of gold permitted a third way: “chronic deficit spending” effectively financed by the “unlimited expansion of credit.” A gold standard would end that abuse. But adoption of gold is not exactly high on the world’s agenda. Accordingly, this first installment in my two-part case for gold began with Alan Greenspan’s oft-cited essay (called “Gold and Economic Freedom”) for a strategic reason. Atlantic.com blogger Megan McCardle was wrong to call the gold standard a “terrible idea.” But she was obviously right to point out that “so few economists [are] willing to raise their voices in support of” any version of a gold standard. It might therefore help to remind readers that the most respected Federal Reserve chairman ever raised his voice in just this way as a seasoned economist of 40, in an essay that was brief but mainly focused on the right arguments. Also, Alan Greenspan’s 2007 memoir, The Age of Turbulence, adds to the case for gold, while incidentally helping to suggest why “so few economists” are gold advocates. The long-standing alternative to gold is, after all, the central banking system, in whose service more than a few economists have found tangible career benefits. That may help explain why The Age of Turbulence never mentions the main point that Greenspan himself made in “Gold and Economic Freedom”: that gold would protect the economy from the instability of business cycles. In fact, nowhere does he mention the essay itself. We can only conjecture about the omission in a book that is supposed to chronicle his intellectual development, and which otherwise mentions gold. I conjecture that he found the argument an affront to his career as a central banker. Indeed, the same essay he buries down the memory hole aggressively indicts the Federal Reserve for playing a destabilizing role. We can regard the 1966 essay as representing his most recent thought to date on this point, since nothing else is available. The Age of Turbulence does make an additional point in favor of gold not mentioned in that original essay: that a gold standard would prevent price inflation. In the most disturbing, and valuable, section of this book, Greenspan sees an end to the era of tame price increases, beginning around 2030. He points out, first, that the benign “disinflationary pressures” from economies like that of China will have played out by then. And at the same time, inflationary pressures could be intensified by the fiscal “tsunami” brought on by retiring baby boomers. He affirms that gold would check price inflation, referring to the “gold standard’s inherent price stability.” So why not support gold for this important reason? It turns out that, while the Greenspan of 1966 objected to chronic deficits financed by “an unlimited expansion of credit,” the Greenspan of 2007 now accepts that very thing. “I have long since acquiesced in the fact that the gold standard does not readily accommodate the widely accepted …view of the appropriate functions of government,” he candidly admits — namely, the “propensity of Congress to create benefits for constituents without specifying the means by which they are to be funded.” But to accept the government’s power “to create benefits…without specifying the means by which they are to be funded” is effectively to endorse the government’s right to finance its operations, not just through taxing and borrowing, but through the unilateral creation of money and credit. On this point, gold advocate George Reisman observes: “When the government need not obtain its funds from the people, but instead can supply the people with funds, it can no longer easily be viewed as deriving its powers and rights from the people.” So let us repeat Alan Greenspan’s three main arguments for gold. A gold standard will protect the economy from 1) the business cycles that have long burdened it and 2) the rapid price inflation that Greenspan sees as a future plague. It also will 3) prevent the government from raising funds through the unilateral expansion of money and credit that Greenspan used to regard as a plague on our freedom. …
Octavio Richetta • February 16th, 2008 at 11:42 am
According to Santoli the stock market is just fine where it is. I strongly disagree! http://online.barrons.com/article/SB120312005443772673.html?mod=9_0031_b_this_weeks_magazine_main Role Reversal IN THE USUAL SCHEME OF THINGS, the bond market is the conscientious firstborn, focused on the important things — inflation and the repayment of principal. The stock market is the feckless kid brother — distractible, impulsive, minding his older sibling only when forced. The credit markets, as we know too well, began grappling with the dragons of subprime-mortgage risk, buyout-loan excesses and all the over-engineered securities tied to them a year ago. At the time, most stock investors thought “monoline” was the train that takes you from the hotel to the Magic Kingdom, rather than a kind of financial insurer, and the typical equity trader was still busy hunting for the next LBO target. Now there is fresh panic over a part of the debt market that stock traders would no sooner worry about than they would about who produces the dial tone for their phone. The market for auction-rate securities — usually low-risk instruments from creditworthy issuers, whose rates are reset every few days or weeks — threw a rod and seized up. The Port Authority of New York and New Jersey, whose revenues are as reliable as the traffic on its George Washington Bridge, saw its debt costs surge to 20%. Hundreds of auctions “failed,” as bidder’s balked and capital-constrained underwriters refused to buy in. And while the stock market balked briefly, it was up for the week, is more than 5% above its January low and is off a modest (compared to credit-market losses) 13% from its all-time peak. This has led to an increasingly popular idea that stocks are whistling past the graveyard and need to decline a whole lot more to fully take account of the financial carnage. Maybe it’s not so simple. One largely unrecognized aspect of this debt crisis is — for lack of a better term — the bureaucratic nature of much of the flight from credit risk. Bristol-Myers Squibb (BMY) recently booked a $275 million loss in its cash-management account from losses in this area, which of course led every big-company treasurer to promise the CEO no such thing — safe or not — would be bought. Then the brokers, in a regulatory-capital pinch due to their mark-to-market write downs, won’t take up the slack, in part because they fear that the monoline insurers will lose the triple-A ratings that virtually nobody believes they deserve. Huge categories of bond buyers can, by mandate, only own paper of a certain rating, and the banks’ carrying values for insured securities are tied in part to the ratings. The market, meanwhile, is pricing things without asking Moody’s what they’re worth. This doesn’t mean the credit distress is all about accounting and regulatory semantics. No, there was a credit bubble, in which risk was massively under priced and an insane amount of leverage was piled on insufficient or unreliable cash flows. But there comes a point when the formalities of valuing this and rating that diverge from reasonable economic reality based on cash flows. Parts of the bond market have gotten there when solid issuers are charged usurious rates. This is not unusual. When bubbles burst, the guilty and innocent are punished. Stocks, though, were not the locus of the insanity that infected markets this time. Sure, credit is crucial in regulating the blood-flow of capital into stocks, and the credit bubble helped inflate some earnings streams that stocks capitalized at too-generous multiples. But stock values themselves never got nutty, so the return to some semblance of sanity in credit-land doesn’t imply there has to be quite the same level of pain in stocks as we’ve seen in pockets of the debt market. …
Octavio Richetta • February 16th, 2008 at 12:00 pm
IMO, TAN’s version of the trading week is a lot closer to reality than Santoli’s la-la land exercise. Short interest at its lowest since 2000 and falling. It looks like the credit crunch is hurting the shorties. IMO, this is great news if you are short… http://online.barrons.com/article/SB120311959176072735.html?mod=9_0031_b_this_weeks_magazine_market_week Just How Bearish Are the Bears? By KOPIN TAN Vital Signs PITY THE BULLS! THEY’VE HAVE had a tough time since the stock market peaked Oct. 9. The economic outlook is bleak, consumer sentiment bleaker, and mounting losses have seen even old allies — Wall Street lenders that bankroll expansion — turn tight-fisted and testy. Just look at what bulls had to suffer last week: UBS (ticker: UBS) reported a $13.7 billion write-down and warned of more to come. Consolidated Edison (ED) warned of households falling behind on their electric bills, and a 12% rise in delinquencies. Even Blue Nile (NILE) had bad news near Valentine’s Day — a day invented to stoke male guilt and boost jewelry sales — when it trimmed its 2008 forecast. The service-industry slowdown hasn’t spared even Playboy Enterprises (PLA), that trusty provider of service journalism, which reported drooping newsstand sales and sagging television revenue. Cheaper prices have attracted bargain hunters, and mildly good news has now begun to surprise — as did data last week showing a minuscule uptick in January retail sales. But rallies keep running out of steam and for all the mileage on its odometer, the zigzagging Standard & Poor’s 500 index remains mired not far above its January low. The major benchmarks ended the week higher, although gains were reduced by the two-day pullback that shaved 204 points off the Dow Jones Industrial Average. For the week, the Dow added 166, or 1.4%, to 12,348. It has bounced 6.1% off its Jan. 22 low but is 12.8% off its Oct. 9 peak. The S&P 500 gained 19, or 1.4% to 1350, and has climbed in three of the past four weeks. Technology stocks underperformed again, with the Nasdaq Composite Index adding 17, or 0.7%, to 2322, while the Russell 2000 Index of small stocks rose 3, or 0.4%, to 702. Crude oil made its biggest weekly gain in nearly three months, climbing 4.1% to $95.50. With benchmark interest rates already slashed to 3%, even the promise of more rate cuts — which the Federal Reserve held out last week — no longer stirred the crowd like it used to. Besides, “the issue today isn’t so much the cost of credit, but the availability of credit,” says Kevin Kruszenski, director of trading at KeyBanc Capital Markets. Anxious newspaper headlines — along with persistent worries about credit-rating downgrades — give the impression that stock investors remain extremely bearish, but are they? “Contrary to popular belief, short interest is low and decreasing, not high and rising,” notes Goldman Sachs strategist David Kostin. In fact, the S&P 500 short interest ratio is near the 10-year low reached in 2000. All 10 S&P sectors recently have short-interest ratios below their one-year average, and bearish bets have eased to a one-year low in four sectors: consumer staples, health care, telecom services and utilities Even financials, the focus of market worry, have seen “reduced hedging” recently, says Goldman’s option strategist John Marshall, as the ratio of bearish puts to bullish calls relaxes to its lowest level since March. As the Fed cuts interest rates, the ranks of bulls-or at least opportunists-jockeying for a much-anticipated bounce and recovery have continued to swell. Three weeks after stocks’ Jan. 22 low, a hopeful consensus grows rather quickly — perhaps too quickly — that the market may have already seen its worst. Friday’s plummeting Michigan consumer confidence index, at levels last seen in the early 1990s, showed consumers turning increasingly bearish. Lenders certainly aren’t yet bullish. “While we remain constructive on stocks long-term,” says Michael Darda, chief economist of MKM Partners, “the recent aggressive widening in swap spreads, and the renewed weakness in the commercial paper market, are a significant setback that may signal more near-term equity market weakness to come.” LIKE CDO, SIV AND RMBS, the latest casualty of the credit crunch has achieved enough sudden notoriety to be identified by acronym alone. The demise of the market for “auction rate securities,” or ARS, grabbed headlines because it pushed up to 20% from 4.2% the weekly interest rate the Port Authority of New York and New Jersey must pay on a big tranche of debt. But the pain was felt by equity investors — and many a Barron’s reader — who watched their closed-end funds slide. Auction Rate Securities are bonds issued by municipalities, student-loan companies, hospitals and other entities. The interest rates on these reset every seven, 28 or 35 days through bank-managed auctions. Back when the world was happy and liquid, eager lenders proffering low rates helped swell ARS to a $330 billion market. These days, however, wary bidders are fleeing complex securities bearing acronyms, and the dearth of takers-and banks’ reluctance to step up and make markets-have sent rates soaring. LIKE CDO, SIV AND RMBS, the latest casualty of the credit crunch has achieved enough sudden notoriety to be identified by acronym alone. The demise of the market for “auction rate securities,” or ARS, grabbed headlines because it pushed up to 20% from 4.2% the weekly interest rate the Port Authority of New York and New Jersey must pay on a big tranche of debt. But the pain was felt by equity investors — and many a Barron’s reader — who watched their closed-end funds slide. …Closed-end funds looking to improve returns by using leverage have sold ARS, and their leverage costs have jumped correspondingly. Mariana Bush, a closed-end fund analyst with Wachovia Securities, estimates that auction rate preferred securities issued by closed-end funds add up to about $64 billion. Nearly $14 billion of these were issued by closed-end equity funds. Unlike the problem with subprime mortgages, what paralyzes the ARS market is a crisis of confidence, and not a crisis of asset quality, since many of these bonds are issued by highly-rated municipalities. A return of lender chutzpah, or the arrival of new investors, can quickly bring rates back to more normal levels. But if debt-market nerves persist or worsen, ARS resetting to higher interest rates could begin cutting into a fund’s income and threaten its dividend, spreading the collateral damage further and wider. …
Prof. Taplin • February 16th, 2008 at 12:06 pm
Dr Roubini-The January retail figures rise, which spurred a rally on Wednesday were due entirely to food and energy inflation. How will continuing cuts in interest rates help this situation? http://jtaplin.wordpress.com/2008/02/16/inflation-does-matter/
KJ Foehr • February 16th, 2008 at 1:53 pm
Octavio Richetta wrote on 2008-02-16 12:00:17 “IMO, TAN’s version of the trading week is a lot closer to reality than Santoli’s la-la land exercise. Short interest at its lowest since 2000 and falling. It looks like the credit crunch is hurting the shorties. IMO, this is great news if you are short…” I am nearly 100% short the market, so this would be good news for me. But it is not consistent with the current high level of bearish sentiment. So I wonder, do the short interest numbers include short ETFs? There have been reports that cash flows have increased into these short funds such as SKF and SRS, therefore, unless these cash flows are included, short interest may not be a good indicator now. Because these ETFs, especially the 200% short funds, require less cash investment / actual short selling due to the use of swaps for leverage, it is likely that there is significantly more real short interest in the total market than is indicated by the direct short interest in individual equities. Sentiment Journal: Falling Volatility Fails to Ease Investor Fears Frederic Ruffy, Optionetics.com February 15, 2008 Excerpt … The high levels of bearishness reflected in the sentiment surveys, the withdrawals from stock mutual funds, and the low readings from the ISEE all confirm that bearish sentiment remain high and is probably still rising. In this environment, the stock market can continue to struggle because money is moving out of the market, which is a negative from a liquidity standpoint. However, when the sentiment indicators reach extremes, as they have in recent weeks, there is a good chance that some investors have overreacted. That, in turn, can lead to sudden rallies that are fueled by aggressive short covering. Such extreme levels of negativity can also form the basis for important turning points and major market bottoms for the equity market. … http://www.optionetics.com/market/articles/19036
artichoke • February 16th, 2008 at 3:16 pm
I don’t get it. The Auction Rate Security is like a floating rate note isn’t it, just a long-term loan with the rate regularly marked to market. The “market” in this case is an auction rather than say a rate from an exchange traded security. But why wouldn’t the auction settle at whatever the borrower could have gotten for a new short-term loan elsewhere? I understand the problem is that a guarantee is required, and this would be a big problem because many of the insurance contracts in these markets are now known to be bogus. (I suspected the same long ago, but only dimly in the sense I didn’t quite “get” how these things made sense.) But I don’t see why insurance is required in this market. To put it in terms of derivatives, an option to enter into an ATM swap (using the market rates prevailing at that future time), one month in the future, has a market value of zero. It’s a fair game. There’s nothing of value to insure! Furthermore, sellers of these ARS pay slightly above market. So if insurance is required, it would seem to me that the buyer needs the insurance to keep the seller from prepaying (or refinancing cheaper) the whole thing. I just can’t see why the rate would balloon on a still-good borrower like the Port Authority. The bidders in the auction can buy the cash flow stream, lay it off in the market, and make a small spread. There’s no reason for them to make a 15% spread and competition among them should make that impossible.
artichoke • February 16th, 2008 at 3:22 pm
Sorry, ATM is an abbreviation for at-the-money.
Giraf • February 16th, 2008 at 4:05 pm
@artichoke on 2008-02-16 15:16:22 I’ve only read a document for Goldman’s ARS products. At a reset auction, as a holder, you get a number of choices. To hold at any reset rate, to hold at a minimum reset rate, to sell, etc. If the auction fails, the holders are locked in until the next auction date, getting a rate tied to something like Libor. I understand other issuers may have much more penal (to the issuer) renewal rates on auction failures. PANY looks like one of those and should fire its financial managers and agents for their foolishness in doing such a deal. From the GS document, I also learned that the ARS are primarily a vehicle for the retail investor. My thoughts were the same as yours. These are pretty good issuers and you’d think that there would be a good spread to be earned between cost of funds and the rate on the ARS. Yesterday, I read in the WSJ that institutional and hedge funds were being attracted by “the blood in the water” that PANY’s 20% dilemma attracted. Another thing that was interesting in the GS document was that holders are restricted to whom they can sell their securities at times other than the regular auction date. I forget the exact wording but it implied that holders could only sell to GS or other members of the issuing group. I don’t know if this rule applies to issues launched by other firms. Hope this helps.
Guest • February 16th, 2008 at 4:13 pm
@ Roubini ”So, in conclusion, caveat emptor: “ Says it all really but I wonder if this ‘bottom-line’ fundamental Maxim of the free capitalistic system in play justifies or equates to “Moral Hazard” as is the practice? Does ‘caveat emptor’ permit, allow, er expect the regulators, the lenders (banks) and the policy makers to become one with the borrowers, investors, players; does it justify the whole charade from the offices of the elite through Wall Street into Congress and the White House and then into the bastion of the Federal Reserve, the private central bank? Does ‘caveat emptor’ suggest that when the financial industry falters into self-imposed losses leading to the possible need of protection from its creditors that the peoples savings, taxation, work effort energies must, a priori, be granted and leveraged into the future, that is to say, be granted in absentia, from the yet unborne; is this the meaning of ‘caveat emptor’? Or, is it that ‘Moral Hazard’ is the expected and accepted behavioral standard of the upper classes known in modern terminology as the ‘elite’; that is, those of the financial industries and all that hangs off them? From Hellasious and as I had previously posted along the same contextual threading: ”In recent years, we have also become aware of shifting social attitudes: debt is no longer viewed as a “moral” obligation, a binding social contract between consenting parties, but as an adversarial relationship between borrower and lender. Therefore, as conservative businesspeople we must also account for a higher probability that borrowers will walk away from their debts, if it suits them.” Get that: “adversarial relationship”. - my emphasis (of a previous post in these pages) being that some of the grassroots were actually becoming smarter; or wiser to the vagaries of the elite classes. This brings the point that now both ‘caveat emptor’ and ‘Moral Hazard’ applies upward as well. Or, in other words, it is not just the elite that prey on the grassroots, but now the grassroots are hunting the elites. From my own experiences of recent years I see a frenzy from the elites or from their representative commercial services offered by the shareholders ‘out-of’ the financial industries: These frenzies include: 1. Highly complex skimming through algorithmic billing – particularly in telcom, internet and utility services as the norm 2. Huge increase in some government services – rate increases sometime of up to 100% 3. Increases in local government real-estate taxations and service (expected to soon blow-out) 4. Imposed unsolicited top secret “third-party-content-provider” services concealed by government sanctioned “interpretation-of-law”. 5. “Goods and Services Taxes” (GST) 6. “Value Added Taxes” (VAT), etc., et cetera. It has become most obvious that the bernaysian spin of sophist finance industry origins known as ‘innovative excellence’ is naught but toxic ‘cdostereotypical’ packaged mediocrity – at best – but and where in reality the offerings of the day are seen with eyes in risk that now understand “caveat emptor” and which needs – a priori – to be responded to in terms of “Moral Hazard”. Voila, ici, the playing field is becoming somewhat level albeit, your mileage will vary! From the 95 year old lady who is being thrown out of, into the street, of her retirement home after 40 years because the financial model doesn’t work any more – by the church (Hah!) to all those being threatened with legal recourse, incarceration and worse for having the effrontery to question their local council, their ISP, their telephone provider, their electricity company, etc., etc., I advise to do as I do… take me to court – throw me into the street – sue me and whatever because one penny more that cannot be validated and justified, you will get not! Cash is KING! Does “caveat emptor” permit the sale of government infrastructures that have been paid through taxation receivables to financial industry? And, when those of the financial industry suffer losses, does “caveat emptor’ mean that the taxpayer needs to pay those of the financial industry – the full cost of their losses? Is this what “caveat emptor” means? It appears so! PeterJB
Giraf • February 16th, 2008 at 5:06 pm
@Jma A couple of days ago you posted a comment about the Long Term Treasury yield breaking out to the upside. I have a chart you’d find interesting. Send me an e-mail with an e-mail address for yourself. G.
KJ Foehr • February 16th, 2008 at 5:07 pm
@GSM on 2008-02-16 03:15:38 I respect your opinion, but I would like to respond to a few points you made. You wrote, “I have just reviewed what I can find of Obama’s economic plan and like all the candidates he is clueless. So rather than portraying him as some savior, perhaps it’s best to say that he may be the best of a very clueless bunch.” I did not write specifically about his economic plan. In fact I said I was worried that he might return to failed transfer of wealth social programs like those of Johnson’s Great Society. Specifically, I think implementing a universal health care system is obviously unaffordable now and will remain so for the foreseeable future. Therefore, I believe Obama will be forced to postpone this plan given the realities of the current economy. But as you point out, does Hillary or McCain have a better grasp of economic issues? I think not. Therefore, I will trust the candidate I believe is the most intelligent and has the best judgement to deal with the economic situation we will face in the coming years. If they are all clueless, then I want the one who is best able and willing to learn. You wrote, “The US populace needs to wake up. Or, be woken up. … The old tired methods and textbook responses (MORE AND MORE DEBT) of the past will prove lightweight powder-puff punches against this destructive monster of a financial crisis unfolding before our eyes.” The people are awakening now. Reality is waking them, not the words of politicians. Ross Perot couldn’t do it, Dave Walker and others couldn’t either. It is only now, when Americans are feeling it in their pocketbooks that they are waking up and asking what is going on? I don’t think it is useful to blame the current crop of candidates for not speaking the “truth” when no one really knows yet what is going to happen with the economy. The best we can do know is select the best person to handle the crisis, to bring us out of whatever we face, just as FDR did in the Great Depression. I blame overly unfettered capitalism for this crisis, exacerbated by disrespect of the Federal government that caused the administration to purposefully “break” the Federal treasury. IMO, they felt that overspending and running up the national debt was a way to undermine the Federal government, and to prevent it from spending on social programs. In the process, they transferred as much money from the public coffers and the pockets of future generations to the pockets of the wealthy, leaving behind a government that is insolvent. Government is the problem, they say, so why not destroy it? Further, if the economy is as bad as many of us on this blog think, then I believe it will take a return to a social market economy like FDR’s New Deal to begin the process of digging ourselves out of this tremendous hole. And who is better able to do that than a progressive Democrat like Obama? Just as FDR ascended when the Great Depression occurred, perhaps Obama is appearing on the scene now to take us through this new crisis. You wrote, “Obama’s plans are more of the same, just some components weighted differently. Nothing special and in fact, your purporting it is anything more is disingenuous.” I really don’t feel I was disingenuous. I did not praise or purport anything about his specific economic plan. I discount most of what all three candidates plan to do because I believe their plans will be waylaid by the realities of this economy. The plans don’t matter now; what matters is having the intelligence, wisdom, vision, and judgement to handle whatever comes in the future. And I feel strongly that no matter what the future brings, Obama is the person best able to make the wisest decisions for the American people. I want the best person, not the best plan. I believe he is and will be an extraordinary leader.
David Bach • February 16th, 2008 at 6:23 pm
Re: The Coming Muni Bonds Default Crisis…and the Monoline Downgrade Saga… While the economic argument here makes total sense, it seems to me that the political consequences for a municipality defaulting on its bonds in the next few years – especially a large one (like New York) – would be immensely problematic for that municipality, and it hard for me to imagine a large municipality not going to ANY extreme that they needed to to avoid such a situation. During the 1930s depression, some large municipalities defaulted, but generally, painful bailout packages instituted by municipal leadership kept their bonds secure even when underlying economics didn’t support that. Thoughts?
Octavio Richetta • February 16th, 2008 at 6:27 pm
A great one from Mauldin. It addresses a lot of the issues that have been discussed here this past week: http://www.investorsinsight.com/thoughts.aspx
artichoke • February 16th, 2008 at 7:21 pm
Hm, wonder if the “auction failure” on the PANYNJ bonds was an act of collaboration among the banks, so they could receive 20% for a few weeks. Otherwise I still don’t see how the auction could fail utterly. Banks are still writing mortgages, why wouldn’t they do a 30-day loan to the Port Authority? The alternative is they really think the Port Authority isn’t credit worthy. This still doesn’t make any sense to me. Black swan …
artichoke • February 16th, 2008 at 7:39 pm
And in fact the Port Authority is a hell of a lot more credit worthy than they are!
artichoke • February 16th, 2008 at 8:07 pm
Well if the banks are brain-dead, the hedgies aren’t … http://online.wsj.com/article/SB120308876297871615.html?mod=fpa_whatsnews I guess they don’t get it either 
Guest • February 16th, 2008 at 8:17 pm
@PeterJB “…I wonder if this ‘bottom-line’ fundamental Maxim of the free capitalistic system (caveat emptor) in play justifies or equates to “Moral Hazard” as is the practice?” Caveat emptor quia ignorare non debuit quod jus alienum emit (Let the buyer beware because he should not be ignorant of the property he is buying) is the Maxim of a banana republic financial system. America’s contract society is based on the English Common Law system that agreements are made between honorable people where neither party need fear the other with whom he is dealing, i.e. the fine print. If the buyer is not satisfied, it is understood that the seller will do everything necessary to rectify that dissatisfaction. Western civilization was built on moral agreements. It would be destroyed by “caveat emptor”.
a student • February 16th, 2008 at 9:36 pm
i am not an american but who did that walker guy work for wasn’t it this agency mr spitzer is refering to? From the gov. of new york: …Not only did the Bush administration do nothing to protect consumers, it embarked on an aggressive and unprecedented campaign to prevent states from protecting their residents from the very problems to which the federal government was turning a blind eye. Let me explain: The administration accomplished this feat through an obscure federal agency called the Office of the Comptroller of the Currency (OCC). The OCC has been in existence since the Civil War. Its mission is to ensure the fiscal soundness of national banks. For 140 years, the OCC examined the books of national banks to make sure they were balanced, an important but uncontroversial function. But a few years ago, for the first time in its history, the OCC was used as a tool against consumers. In 2003, during the height of the predatory lending crisis, the OCC invoked a clause from the 1863 National Bank Act to issue formal opinions preempting all state predatory lending laws, thereby rendering them inoperative. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks. The federal government’s actions were so egregious and so unprecedented that all 50 state attorneys general, and all 50 state banking superintendents, actively fought the new rules. http://www.washingtonpost.com/wp-dyn/content/article/2008/02/13/AR2008021302783.html
Guest • February 16th, 2008 at 10:52 pm
Student David Walker was head of the GAO. That’s a very responsible position, in charge of audits across the US Gov’t. PeteCA
Guest • February 16th, 2008 at 11:18 pm
@GMC “The trend towards debt serfdom has been clear, starting with the 2 income family…to the dead end of technical bankruptcy and financial collapse…” Inflation is a domino game. One thing hits against another, then another. In the end, it’s the sum of all the dominoes hitting the consumer that can bring the economy down. When the domino of $3.00 diesel fuel pushes against the trucker he pushes a domino against the peach grower/shipper who pushes a domino against the peach processor who pushes a domino against the grocer who pushes a domino against the consumer, who, by this January, was paying nearly 13% more for food and energy than last January (see link to Prof. Jon Taplin’s “Inflation Does Matter”). The machinery of alternate inflations and deflations is an alternation that hits everybody except the dealers in money who profit on balance either way. The businessman, whether retailer or manufacturer, is hurt on balance, and all wage earners and savers, the vast majority of the population, suffer excessively. It is fatally wrong that the creation and destruction of the US dollar should be left in the hands of a private banking cartel of shareholders who own the Federal Reserve System. The US government keeps stable measures of weight and length in view of commutative justice in buying and selling. Why has it abdicated its Constitutional duty to see that its money issue is a stable measure of value? Says Taplin: “On Wednesday morning the Commerce Department announced a rise in January retail sales. Traders on the stock market, signalling that we might not be in a recession after all, bid the Dow up almost 200 points. But…the sales rise was entirely due to the rising cost of food and energy. All other aspects of normal retail activity were falling sharply. Its easy to confuse ‘a growing economy’ with inflation.” John Williams’ shadowstats showed consumer inflation touching 12% at the end of December.
GSM • February 16th, 2008 at 11:19 pm
The US could do much worse than to pay heed to what David Walker has been saying for years. 6 months ago I saw a 60 mins piece where you could have sworn he was a NR blog commentor. This guy has command of all the US Govt books (excluding the black one)- he is an accountant. His measage is clear, the US is stone broke and he can’t work out why anyone wants the US dollar.
Guest • February 17th, 2008 at 12:24 am
Does this have anything to do with David Walker’s leavetaking? January 20, 2008, 12:14 pm David Walker Points to a Recession Celebrities, from Paris Hilton to Jessica Alba, are filing into Park City, but so, too, are high-ranking government officials. U.S. Comptroller General David Walker, at the festival with the world premiere documentary “I.O.U.S.A.,” a non-partisan account of America’s rising national debt, spoke at a post-screening Q&A about the looming economic downturn. A scene from “I.O.U.S.A.” “There’s better than a 50% chance we’ll be in a recession,” he said, pointing to what he characterizes as America’s current unsustainable fiscal policy of “butter, guns, and tax cuts.” Directed by Patrick Creadon (”Wordplay”), “I.O.U.S.A.” argues that America is suffering from a “fiscal cancer,” (in Mr. Walker’s words,) with potentially “catastrophic consequences.” Other interviewees such as Warren Buffet, the Concord Coalition’s Robert Bixby, and former U.S. Treasury Secretaries Robert Rubin and Paul O’Neill joined Mr. Walker in decrying the dangers of America’s over-spending and lack of revenue. “When you can’t service your debt, you’re finished,” said Mr. O’Neill, who also claimed that the Bush Administration fired him for his sobering views about budget deficits. While the national debt may not be among the foremost issues of this year’s presidential candidates, Mr. Walker and the film’s executive producer, Addison Wiggin (co-author of “Empire of Debt”) want to change that with the release of the film –- still to be determined — in 2008. “We’re hopeful that this will be an issue in the general election,” said Mr. Walker. “The electorate needs to hold the [candidates] accountable. That’s been the purpose of the film.” –Anthony Kaufman Permalink | Trackback URL: http://blogs.wsj.com/filmfest/2008/01/20/david-walker-points-to-a-recession/trackback/
GSM • February 17th, 2008 at 1:34 am
“It is fatally wrong that the creation and destruction of the US dollar should be left in the hands of a private banking cartel of shareholders who own the Federal Reserve System.” Written by Guest on 2008-02-16 23:18:53 This get’s to the heart of it. Because that creation and destruction is with the worlds reserve currency- in effect the Fed is holding the entire world to ransom with its hell bent debasement of the US dollar. This is the transmission mechanism for inflation worldwide. Confidence in the dollar is the very first defense against inflation and then hyperinflation. The Fed/US Govt has effectively destroyed that defense. The massive deflationary forces brought on by the official Cold War ending have worked their way through the world economy. They have now given way to a massive consumption/development phase in world development. The US predicament will now cause that to reset for sure- but it will not shut down that trend. Which means that while demand for some commodities may falter for a time, it will re-assert itself and that spells inflation disaster when beholden to a debased reserve currency. You ask; “Why has it abdicated its Constitutional duty to see that its money issue is a stable measure of value? “ Yes indeed, and why now? I have 2 trains of thought on this. The first: They simply have lost it. (They= The US Banksters and Industrial elites). The speed with which the house of cards collapsed has blindsided them, setting off a chain of paper, credit and debt related catastrophes that have spiraled up so fast they have essentially lost control. They (the Banksters or Pigmen) had it all so sweet, the money train was a rollin’- until J6p and Jose threw a spanner in their works . Now they are scrambling and quite possibly resigned to the fact that all is pretty much lost so damage control is fully in order. Part of that is the “socialize the losses” plays and the “not on my watch” mentality. Shift Armageddon into the future, let’s go see Africa. When Bush and Paulsen leave office, Ben will be holding the baby. The second: Its been a setup. Big forces are at work behind the Fed playing the really BIG game now. Who benefits?. One , I think, major outcome of all this will be move by all the Anglo/Western-type economies at least to rally round the US, if for no other reason than to save their own economic skins. The US leads the way out of the mess. “Leads”. Since the overt cold war’s demise (it still continues covertly) the world has been a very disparate place. When the Iron Curtain fell many nations spun off into increasingly independent orbits. The US tumbled from its esteemed mantle. Leaving the US giant more and more bereft of its former influence and control. The “war on terror” and Iraq failed to claw back the leadership the US has lost. That does not sit well at all with many powerful and influential families/people I am certain. Its quite probable these 2 trains are in fact one. The point is that major forces are indeed afoot throughout this I have no doubt. I have little or no hope that the “balance of power” so called, will change. I have my tin foil hat firmly in place. Therefore self protection in these shark infested waters is my top priority.
Guest • February 17th, 2008 at 2:55 am
February 16, 2008 (LPAC)–The world’s top banks may have to write off as much as $203 billion in new losses on top of the $152 billion in writedowns already taken, Swiss banking giant UBS said in an analyst’s report. The bank said the banks may have to write off as much as another $120 billion on their CDO holdings, another $50 billion for losses in SIVs, $18 billion for mortgage-related securities and $15 billion for LBO loans. “Risks are increasing and spreading and the liquidity situation is still far away from normal,” the report said. On Feb. 14, UBS revealed it had additional $26.6 billion exposure to American mortgages, on top of the $27.6 billion in exposure to such paper it had already admitted, plus a $2.9 billion exposure to monoline insurers. The bank took a $13.7 billion writedown in the final quarter of 2007, after a $4.4 billion writedown in the third quarter, giving it a net loss of $4 billion for the year.
Alessandro • February 17th, 2008 at 3:21 am
Giraf: “@Jma A couple of days ago you posted a comment about the Long Term Treasury yield breaking out to the upside. I have a chart you’d find interesting. Send me an e-mail with an e-mail address for yourself.” I’m intrigued by the long term yield as well (not from an investing point of of view, thou) and if you don’t mind I’d like to see your charts as well. You have my email already. TIA.
London Banker • February 17th, 2008 at 4:29 am
A week or so ago I posited that “cash” on corporate balance sheets might not be “cash” at all if it were invested in money market funds and other instruments which were impaired by subprime and other credit contagion. If true, corporates could be a lot more exposed to liquidity crisis blowback than their balance sheets suggest. That appears to be the case, and it may be exacerbated by the problems in the auction rate securities markets. Companies’ cash-like holdings pose risks As corporate losses mount from investments that until recently seemed as safe as cash, shareholders are in a pickle: They don’t know the severity of the problem or which companies are affected. So far, Bristol-Myers Squibb Co., US Airways Group Inc., Qwest Communications and others have disclosed multimillion-dollar losses on a common type of higher-yielding bonds marketed as short-term and low-risk. Such descriptions for these investments, known as auction-rate securities, were at best wishful thinking in the era of easy credit that helped fuel the housing boom. But as credit tightens on Wall Street and around the globe, it has become extremely difficult for companies and wealthy individuals to sell these securities, which are backed by mortgages, student loans and municipal bonds. ”The problem is quite widespread,” said Lance Pan, director of investment research at Capital Advisors Group Inc. in Newton, Mass. “There will be more confessions to be made by large corporate investors.” This could get ugly fast.
Octavio Richetta • February 17th, 2008 at 5:27 am
The Blackstone touch? Did you realize in one of the articles above that Blackstone is one of the owners of FGIC? http://www.blackstone.com/private_equity/portfolio.asp?Order=ByPortfolioCompany&ll=f&ul=g Recessions/slowdowns and excessive leverage don’t mix well. I would expect Blackstone companies to have more than a fair share of the bankruptcies that are coming. Shall we say they have the black touch? Look at their acquisitions by deal size: http://www.blackstone.com/private_equity/portfolio.asp?Order=ByTransactionSize Take, for example, their purchase of Nalco a company I am familiar with from my chemical Engineering days. The purchase price of 4.2 billion was financed with 3.2 billion in debt and 1 billion in equity: 76& debt!. http://www.blackstone.com/news/press_releases%5C09-04-03.pdf Look at the Hilton one. It gets worse! The Merger, the repayment of certain Hilton indebtedness and the payment of transaction expenses has been financed with $20.6 billion of mortgage and mezzanine debt financing (the “Secured Debt”) incurred by subsidiaries of Hilton and approximately $5.7 billion of equity invested by investment funds affiliated with The Blackstone Group. http://www.blackstone.com/news/press_releases%5C10-24-2007.pdf As a last example, consider Blackstone purchase of Sam Zell’s Equity Office Properties Trus which being a REIT is already highly leveraged. They bought at the peak for 36 billion including 16 billion in debt! http://globaleconomicanalysis.blogspot.com/2007/07/vital-lesson-from-blackstone.html Lots of pain coming for old man Peterson whom, may I add, is not as “nice” as the NYT article implies: http://zzpat.tripod.com/cvb/jan_2007/the_concord_coalition.html http://www.prospect.org/cs/articles?articleId=12436
London Banker • February 17th, 2008 at 6:05 am
@ Octavio Your analysis of Blackstone reminds me that most investors went bust in the Great Depression buying on the way down. They think they are buying “value” as the prices become depressed, but find that the “value” keeps disappearing. If they borrow to buy, the dynamic accelerates even more. It looks like Blackstone is an accelerator of the coming collapse, leveraging to buy leveraged depressed assets that are no where near hitting bottom.
London Banker • February 17th, 2008 at 9:08 am
Economic Indicators Continued by Shadow Government Statistics. The Department of Commerce (DOC) has decided to discontinue its economic indicators service economicindicators.gov (effective March 1st) “due to budgetary constraints.” Shadow Government Statistics is pleased to announce that it will provide — at no charge to the public — a continuation of the basic link service heretofore provided by the DOC’s Economics and Statistics Administration. The existing government service provides links to the Web pages and recent releases of the Bureau of Economic Analysis and the U.S. Census Bureau. We eventually plan to extend the service to other government or quasi-government reporting agencies, including the Bureau of Labor Statistics, the U.S. Treasury and the Federal Reserve, as well as to provide links to other major economic data providers. We plan for the new service to be operational by Wednesday, February 20, 2008.
Octavio Richetta • February 17th, 2008 at 9:58 am
From Mr. Fisher’s opinion, one could easily infer that the professor and a most of the poster in this blog are just a bunch of gloomy clowns. His argument goes as follows: Worrywarts thought the word was gonna end in 98 and it didn’t. Thus, they are also wrong now and the party will go on, if not in the US, somewhere else…. Wow! I am impressed by the depth of his analysis!:-) http://www.forbes.com/columnists/forbes/2008/0225/108.html (free regitration required. Posted here for convenience) Financial Columnists 1998 Redux Ken Fisher 02.25.08, 12:00 AM ET The worrywarts seek a parallel to today’s market and think they see it in 1930: credit crunch, rising unemployment, financial institutions in trouble. So we must be in for a ferocious bear market. I seek a parallel and find it only ten years ago. And that makes me bullish. Early 1998 saw financial crises eerily similar to today’s and a lot of hand-wringing about institutions collapsing and setting off a domino chain of other collapses. But guess what? The S&P 500 was up 28% that year. Early January 1998 saw stocks implode on news of the late-stage aftermath of the so-called Asian Contagion. Currencies and then debt markets started disintegrating in Asia, and that should supposedly have brought the world economy down. The parallel today is the American subprime contagion. Back then the dollar was strong, U.S. stocks led foreign, and technology led on the upside and the downside. Now it is a weak dollar, foreign stocks lead and emerging markets dominate instead of tech. This year January started rough. So what? Despite folklore, history shows January market movements foretell nothing about the rest of the year. In early 1997 this column started saying that all you needed to beat the S&P 500 was to own any half of its very largest stocks. That worked for 30 months. My definition of large was a stock whose market capitalization was greater than the weighted average of the index. (This sounds convoluted, but it’s mathematically simple: Take every market cap, square it, sum the results and then divide that sum by the combined market cap of all the stocks.) Then, the weighted average market cap of the 500 stocks was $55 billion, and 30 stocks topped that, ranging from General Electric (nyse: GE – news – people ) down to Bell South. In 1998 these 30 stocks climbed an average 39%. Nowadays my hunting ground is the whole world, where there are 24,000 stocks to choose from. The weighted average market cap of the MSCI World Index is $81 billion. In one of the stranger coincidences in finance there happen to be 81 companies whose market caps exceed that $81 billion figure. This is where you should concentrate your money. After all, we just started the final leg of a seven- or eight-year bull market (beginning in late 2002), and final legs of bull markets are dominated by big stocks. In 1997 credit spreads had started widening as everyone feared Asia’s finances and its low-quality debt. The result was that the biggest, safest firms were disproportionately allocated credit and lower-quality borrowers were cut off. We’re seeing a replay now. Last summer junk borrowers were squeezed out of the market, especially the commercial paper market. General Electric and ExxonMobil (nyse: XOM – news – people ) can borrow all they want. With big stocks continuing strong and weak ones getting squeezed we could see a bifurcated market in 2008. Don’t be surprised if the biggest stocks do well while indexes of small stocks like the Russell 2000 do badly. This contrast will drive technical analysts nuts because they are trained to hate markets where there are more decliners than gainers. Ignore the technical analysts. Here are five huge, good stocks. France’s Sanofi-Aventis (nyse: SNY – news – people ) (40, SNY ) is a leader in drugs to treat ailments including cancer and diabetes and those involving the heart and the nervous system. No single drug makes or breaks it, and sales have been roughly in proportion to global gross domestic product. Quality growth at 12 times 2008 earnings is tough to beat. With 50 million customers, 55% of its market and effective Japanese protectionism behind it, NTT Docomo (16, DCM )also licenses its wireless technology outside Japan. The stock has lagged for years; it now sells at 1.6 times annual revenue and 14 times likely earnings for the fiscal year ending March 2008. Chevron (nyse: CVX – news – people ) (84, CVX )operates in all segments of the oil business and all across the world. The market isn’t expecting much from this $197 billion megacap, since it is priced at only 90% of revenue and nine times trailing earnings. You can expect a lot, including a 2.7% dividend yield. Soda-and-snack vendor PepsiCo (nyse: PEP – news – people ) (68, PEP )will survive a weakening economy. Alternatively, it will do well in a strengthening economy. Great brand names like Frito-Lay and Gatorade, with stable growth at marketlike valuations, make Pepsi easy even for the fearful. IBM (107, IBM )doesn’t grow much, because the competition is endless. But this is one of the world’s highest-quality companies, with very stable earnings that the market doesn’t think very much of. It costs 12 times expected 2008 earnings and 1.6 times sales. Money manager Ken Fisher’s latest book is The Only Three Questions That Count (John Wiley, 2007). Visit his homepage at http://www.forbes.com/fisher. Subscribe to Forbes and Save. Click Here.
Guest • February 17th, 2008 at 10:30 am
DAVID WALKER THE CHIEF COMPTROLLER FOR THE GAO RESIGNED (fired) for his speaking out on the horrible mess we are in. watch the vidoes. Very enlightening http://news.yahoo.com/s/afp/usgovernmentcongressquit http://www.youtube.com/watch?v=I-16u9×3tfE http://www.youtube.com/watch?v=OS2fI2p9iVs Posted by sam · February 17th, 2008 at 4:14 pm http://en.wikipedia.org/wiki/David_M._Walker_%28U.S._Comptroller_General%29 Walker has compared the present-day United States with the Roman Empire in its decline, saying the U.S. government is “on a ‘burning platform’ of unsustainable policies and practices with fiscal deficits, chronic healthcare underfunding, immigration and overseas military commitments threatening a crisis if action is not taken soon.[2] [3] [4] Walker has actively taken a public stance against the accumulation of massive federal budget deficits and public debt. He has participated in community lectures through an effort organized by the Concord Coalition, in a set of public appearances known as the “Fiscal Wake-Up Tour.” This has consisted of a series of trips acros the country, along with Robert Bixby, director of the Concord Coalition, in which a group of speakers make presentations in various communities regarding the size and impact of the US National Debt. This has been chronicled in the 2008 film, I.O.U.S.A..
Gloomy • February 17th, 2008 at 10:35 am
Northern Rock to Be Nationalized By U.K. Government (Update2) By Loveday Morris Feb. 17 (Bloomberg) — Northern Rock Plc, the U.K. bank bailed out by the Bank of England, will be nationalized after efforts to sell the struggling bank to a private company failed, a person familiar with the matter said. http://www.bloomberg.com/apps/news?pid=20601087&sid=ak7ihPj0e160&refer=home
Guest • February 17th, 2008 at 10:35 am
Northern Rock to Be Nationalized By U.K. Government (Update2) By Loveday Morris Feb. 17 (Bloomberg) — Northern Rock Plc, the U.K. bank bailed out by the Bank of England, will be nationalized after efforts to sell the struggling bank to a private company failed, a person familiar with the matter said. http://www.bloomberg.com/apps/news?pid=20601087&sid=ak7ihPj0e160&refer=home
cold in my car • February 17th, 2008 at 10:37 am
well gosh darn. AN LBO is happening that will be oversubscibed. all is good, we can all rest now. http://www.marketwatch.com/news/story/hsbc-raise-42-bln-debt/story.aspx?guid=%7BB1B0C302%2D3FE8%2D490E%2DB17E%2D1CC30CF964ED%7D&siteid=yahoomy
Gloomy • February 17th, 2008 at 10:55 am
I thought this was a nice “State of the Mess” summary This week provided further confirmation of ongoing momentous Credit market developments. From today’s article by the Financial Times’ Michael Mackenzie: The auction-rate securities market, a $330bn slice of the municipal bond sector, could disappear if the credit squeeze remains entrenched, analysts warn. ‘The auction-rate securities market is unwinding and most of the market will enter a failed state,’ said Alex Roever, fixed-income strategist at JPMorgan. ‘The lack of confidence is the contributing factor and there is a risk this type of structure will go away.’ Like the asset-backed commercial paper market that was popular with structured investment vehicles until last summer, auction-rate securities, a form of rolling short-term funding for long-term municipal commitments, have become fashionable in recent years. “Auction-rate securities” has joined the beleaguered ranks of “subprime,” “asset-backed commercial paper,” “SIVs,” and the “monolines” – financial structures that flourished during the prolonged Credit Bubble but no longer pass market muster in today’s Post-Bubble Risk Revulsion Backdrop. This week’s “unwinding” of the “auction-rate” market and the blowing out of Credit spreads should be seen as an escalation of the ongoing unwind of “Contemporary finance” and its many avenues of Risk Intermediation. On numerous fronts, the markets and economy confront a Highly Problematic Breakdown in “Wall Street Alchemy” – the disintegration of key processes that had for some time transformed ever-increasing quantities of risky loans into perceived safe and liquid debt instruments that enjoyed insatiable demand in the marketplace. In the case of the “auction-rate securities,” it was a clever restyling of long-term and generally illiquid municipal debt (as well as student loans and other borrowings) into perceived liquid securities that could be easily sold at regularly recurring auctions (every one to a few weeks). With scores of flush corporate treasury departments and wealthy clients (managing huge Credit Bubble-induced cash-flows) keen to earn extra (after-tax) yield on “cash equivalents,” the Wall Street firms had been diligent in ensuring (making markets for clients, when necessary) a highly liquid and enticing marketplace. Now, with the onset of Risk Revulsion and Acute Financial Sector Balance Sheet Pressures, investors are running for cover and Wall Street firms are shunning the use of their own capital to support this and other markets. Market liquidity has evaporated, confidence has been shattered, and we are witnessing yet another “run” on a previously popular risk market/asset class. The music has stopped for another game of musical chairs. This week saw heightened systemic stress stampede toward the epicenter of the U.S. Credit system. It certainly didn’t help that insurance behemoth AIG Group reported an almost $5bn writedown of its Credit default swap portfolio or that international securities dealer behemoth UBS reported massive losses on its U.S. Credit positions. Confidence was further shaken by huge losses reported by mortgage insurers, as well the twists and turns of the “monoline” bust turned apparent bailout. In the markets, various indices of investment grade Credits widened sharply to record levels. The key “dollar swap” (interest-rate derivative hedging) market saw spreads widen sharply. Agency spreads also widened significantly. Benchmark Fannie Mae MBS spreads widened a remarkable 20 bps against 10-year Treasuries, while agency debt spreads widened a noteworthy 12.5 basis points to 69.5 bps (high since November). The Breakdown of Wall Street Alchemy is now pushing the Credit Market Dislocation uncomfortably close to the core of our monetary system. I’ll return to financial aspects of this crisis, but I definitely feel the economic ramifications of the unfolding Credit Crisis are receiving short shrift in the media. This week saw parts of the municipal debt market grind to a virtual halt and the corporate debt market take another significant blow. Investment grade debt issuance has now slowed markedly after beginning the year at near record pace. At this point, the junk, CDO, ABS, “private-label” MBS, muni, and even investment grade debt markets are all somewhere between impaired, dislocated and completely dysfunctional. There is no mystery behind the recent string of abysmal economic reports. The preliminary reading on February University of Michigan Consumer Confidence dropped 8.8 points to the lowest level since the 1992 recession. The Economic Conditions index sank and the Economic Outlook index plunged, while one-year Inflation Expectations rose from 3.4% to 3.7%. The Economic Outlook has sunk a remarkable 22 points since July. Falling national home prices are clearly wearing on confidence. This week, Dataquick reported that home sales throughout much of California have collapsed to more than 20-year lows, while home price declines accelerate. This is a huge unfolding issue/debacle for the MBS, agency, mortgage insurance, CDO, and Credit derivatives markets, not to mention the U.S. banking system and real economy. Countrywide Financial reported delinquencies on its $1.5 TN mortgage servicing portfolio had jumped to 7.47%, up from the year ago 4.32%. The New York “Empire” Manufacturing index sank to the lowest levels since April 2003. The economy is now faltering badly and there is every reason to expect the downturn to gather pace – negative real interest rates compliments of the Fed and stimulus package compliments of the federal government notwithstanding. While fourth quarter data is not yet available, one can look to the first nine months of 2007 to gain important perspective. Despite the dislocation in the subprime mortgage market, Non-Financial Debt Growth accelerated from Q2’s 7.2% to Q3’s 8.9% (from the Fed’s Z.1 report). And while Household Debt Growth had slowed to a 6.9% pace, Business Borrowings accelerated to a blistering 11.9% annualized rate in the third quarter. This was the strongest corporate debt growth since the tech/telecom boom in the late nineties. Importantly, total (financial and non-financial) Corporate Debt expanded at an 11.1% rate during the first three quarters of 2007, followed by 9.3% growth in State & Local government borrowings. And while residential mortgage debt was slowing meaningfully, Commercial Mortgage Debt was expanding at an almost 13% rate. Total (financial and non-financial) Credit expanded a seasonally-adjusted and annualized record $5.0 TN during the third quarter – as nominal GDP expanded at a 6% pace. While many trumpeted the “resiliency” of the U.S. economy in the face of mortgage and housing woes – more adept analysis would have focused on the massive Credit creation that had come to be required to sustain the Bubble Economy. Importantly, the faltering subprime market initially instigated only greater excesses throughout commercial real estate, municipal finance, M&A finance, and corporate lending more generally. The Credit Bubble was sustained at the great cost of heightened instability and weakened structures – especially throughout leveraged lending, state & local finance, and investment-grade corporate borrowings. Keep in mind that through the third quarter CDO issuance was actually running ahead of 2006’s record pace. Until the fourth quarter, record Credit growth continued to fuel the finance-driven economy. This is all now coming home to roost. Today, with bursting bubbles in corporate and municipal finance joining the mortgage bust, the U.S. Bubble economy has quickly fallen desperately short of sufficient Credit and liquidity. And the greater the Credit market dislocation and broad-based tightness of Credit, the bleaker become econ
omic prospects and the more intense the Revulsion to Wall Street’s Credit instruments. The days of free-flowing cheap finance for home buyers, state and local governments, LBO firms, commercial real estate speculators, college students, risky auto buyers, and high-risk Credit card holders are over – and they will not be returning for some time to come. When I have previously underestimated the “resiliency” of the U.S. Credit Bubble and economy, it was in each instance a failure to appreciate the capability of Wall Street finance to expand to ever greater degrees of Bubble excess. Today, with “contemporary finance” mired in a historic collapse, I am confident that the Credit system is today only in a position to surprise on the downside. It is this framework that shapes my view of a rapidly escalating Credit crisis feeding an arduous economic adjustment period. And while it could undoubtedly prod a highly speculative stock market, there is no resolution to the “monoline” dilemma that would meaningfully influence the trajectory of the unfolding Credit and economic bust. As we’ve been saying for awhile now, confidence in Wall Street finance has been irreparably shattered. Trust has been broken in “AAA” ratings, “mark-to-model,” CDO structures, myriad risk models, Credit insurance, counter-party risk, and various instruments and vehicles for intermediating risk in the markets. Moreover, old fashioned lending will not come close to sufficing the demands of a highly imbalanced Bubble economy, especially with bankers nervous and retrenching. Again, we’re witnessing nothing less than the Breakdown of Wall Street Alchemy – one that took a turn for the worst this week. In a disconcerting development, recent market developments seem to confirm that the leveraged speculating community and the GSEs are poised as the next shoes to drop – the next Dominoes in an Escalating Contagion. Along with the “monolines” and mortgage insurers, the “Credit default swap market” and GSE mortgage Risk Intermediation were at the epicenter of the most egregious Systemic Risk Distortions and Accumulations. They are now quickly moving to the forefront of Current Acute Fragilities. Simplifying highly complex circumstances, the various risk models that empowered the greatest leveraging of risk in the history of finance no longer function as expected – or as required to maintain highly leveraged exposures to a multitude of escalating risks. And it was all just only a matter of time. The overriding flaw was to ignore that a runaway Bubble in market-based finance ensured that various market and Credit risks all coalesced into One Massive, Unmanageable, Highly Correlated, Unhedgable, Undiversifiable Association of Interrelated Systemic Risks. http://www.nakedcapitalism.com/2008/02/breakdown-of-wall-street-alchemy.html
littleann • February 17th, 2008 at 10:59 am
Anyone care to comment on the recent report of IMF gold sale and how that will affect gold price short term- seems bearish and many here own various forms. How would you interpret this news? a big boy game to drive the price down to allow CBs to scoop it up. Math calculations indicate they have the potential to dump over 3000 metric tons (over $100 billion at present prices)Does anyone know the present size of the gold bullion market as defined by gold etfs etc. Much appreciated.
Guest • February 17th, 2008 at 11:33 am
@Octavio: “The worrywarts seek a parallel to today’s market and think they see it in 1930… So we must be in for a ferocious bear market. I seek a parallel and find it only ten years ago. And that makes me bullish.” (Ken Fisher quote) Alan Abelson seeks a quick anodyne for the USA’s economic ills and finds none: “And, make no mistake and don’t be conned by that familiar touts’ siren song: This time it won’t be any different…. “There’s not a scintilla of doubt that the mortgage mess and all the horrors odiously oozing from it – the massive seizing up of the credit markets, the consumer-wealth defect, the dangerously listing economy and the fearsome bouts of vertigo afflicting equities – will trigger a furious fusillade of regulation aimed at Wall Street as the devil’s architect of those phantasmagoric structures that suckered so many people out of house and home and precious dollars…”(“End of an Era” 2008-02-13 22:09:45) Does anyone get the feeling a lot of Goldilocks’ touts are bouncing their columns off Nouriel Roubini’s Blog?
a student • February 17th, 2008 at 12:01 pm
Comptroller Dugan Responds to Governor Spitzer WASHINGTON — Comptroller of the Currency John C. Dugan issued the following statement today, responding to comments from New York Governor Eliot Spitzer: Almost everyone who has paid attention to the subprime lending crisis has concluded that OCC-regulated national banks were not the problem. Instead, the worst abuses came from loans originated by state-licensed mortgage brokers and lenders that are exclusively the responsibility of state regulators. However, comments from today assert that the OCC and national bank preemption have prevented the states from taking action against predatory or abusive lenders. That’s just plain wrong. The OCC extensively regulates the activities of national banks, including mortgage lending. The OCC established strong protections against predatory lending practices years ago, and has applied those standards through examinations of every national bank. As a result, predatory mortgage lenders have avoided national banks like the plague. The abuses consumers have complained about most — such as loan flipping and equity stripping — are not tolerated in the national banking system. And the looser lending practices of the subprime market simply have not gravitated to national banks: They originated just 10% of subprime loans in 2006, when underwriting standards were weakest, and delinquency rates on those loans are well below the national average. Nothing the OCC has done has prevented the states from regulating and preventing abuses among the lenders that they license – lenders that are the source of most of today’s problems. The states have ample authority – as well as clear responsibility – to set standards for these lenders and enforce them. It defies logic to argue that preemption was an impediment. National banks are bound to obey the strict standards enforced by the OCC everywhere they operate – even in states that had far less rigorous standards. The states should have applied equally rigorous standards to the non-bank lenders that were responsible for the bulk of the problems. http://www.occ.treas.gov/ftp/release/2008-16.htm i get more confused trying to understand — who are the regulators ?
London Banker • February 17th, 2008 at 12:04 pm
Regarding the Northern Rock nationalisation, I think the Bank of England is way ahead of the curve in recognising what is to come as inevitable, and in taking early steps to mitigate the social harm likely to result. They have been deeply involved in Northern Rock since last summer, and know its problems and options pretty well by now. They also know the state of play throughout the rest of the banks, and so know how a failed private sector solution would impact the rest of the sector, or how a liquidation of Northern Rock assets would affect the values of other participants’ portfolios. Nationalisation can be the most efficient and market oriented option when the private sector is so full of distortion that it only offers inefficient, market failure options. In the case of Northern Rock, the business model which it operated under (borrow short, lend long, lie about your accounting) will not become sustainable again for decades – when mankind has forgotten the lessons it is about to learn all over again. Under the circumstances, nationalising Northern Rock may well be the best means of supporting market confidence in the banking sector, realising the value of Northern Rock’s existing portfolio of assets, and liquidating the bank in a controlled manner that does not adversely affect other financial intermediaries. The Bank of England is looking out for the health of its flock by taking Northern Rock out of the pasture and into the abottoir. Other managers and shareholders will take note, and that promises a better result long term for the whole sector.
Gloomy • February 17th, 2008 at 12:10 pm
If you put a frog into a pot of boiling water, it will jump out. If you put it in a pot of cool water and slowly raise the temperature to boiling, it will remain in the pot and get cooked alive. Thus, Mr. Fisher.
Guest • February 17th, 2008 at 12:22 pm
@London Banker: The Department of Commerce (DOC) has decided to discontinue its economic indicators service economicindicators.gov (effective March 1st) “due to budgetary constraints.” DOC’s move at this point in time bears out the contention that the nation’s economy is in a lot worse shape than the government implies — listing perhaps toward GSM’s “debt serfdom”. In short, DOC doesn’t dare report on it…all the way down. As John Ruskin put it in 1872, “The essence of lying is in deception, not in words; a lie may be told by silence, by equivocation…and all these kinds of lies are worse and baser by many degrees than a lie plainly worded.” Or, as London Banker put it today: “This could get ugly fast.” Kudos to John Williams and “Shadow Government Statistics” for keeping the public apprised.
cold in Maine • February 17th, 2008 at 12:32 pm
Northern rock press conference http://video.news.sky.com/skynews/video/?&videoSourceID=1305764&flashURL=/feeds/skynews/latest/flash/darling_rock_170208.flv
Anonymous • February 17th, 2008 at 1:07 pm
Spitzer wishing to divide the monolines into two monolines–one good, other very bad is like wishing to split a very leaky boat into two parts. One, watertight and seaworthy, the other, Davy Jones’ locker. Just try that anytime on the high seas when your craft tears out its bottom on a coral reef. Of course it will work, ask any captain worth his salt.
Octavio Richetta • February 17th, 2008 at 1:24 pm
Written by cold in my car on 2008-02-17 10:37:37 Good to notice who is involved: Dubai’s SWFs. If they can’t raise 4.2 billion who can? Like Buffet and Microsoft (who wants to buy Yahoo via Blackstone using debt as part of the deal), these are part of the fortunate few that can borrow at very low rates, low rates which are courtesy of uncle Ben. Also, you say deal will be oversubscribed. That may very well end up being the case but that is not what the article says: The debt syndication is expected to be completed ahead of Feb. 27 when Borse Dubai is expected to close its acquisition of OMX, Hussain said.
Guest • February 17th, 2008 at 1:29 pm
@Anonymous: “Spitzer wishing to divide the monolines into two monolines–one good, other very bad is like wishing to split a very leaky boat into two parts…” It’s hard to sleep on this economic cruise knowing the captain has never steered a ship.
Guest • February 17th, 2008 at 1:40 pm
good read. http://news.yahoo.com/s/ap/20080217/ap_on_bi_ge/the_uneasy_economy_3
Octavio Richetta • February 17th, 2008 at 1:48 pm
A great one by Moegenson. Has the time to short Apollo Group finally arrived? http://www.nytimes.com/2008/02/17/business/17gret.html?ref=business Fair Game The Insiders Are Selling, but Why? By GRETCHEN MORGENSON Published: February 17, 2008
Octavio Richetta • February 17th, 2008 at 1:59 pm
Written by Guest on 2008-02-17 13:40:40 Great article! Send it to Mr. Fisher at Forbes; who, given his “booming business”, may be a bit out of touch with reality. http://www.businessweek.com/magazine/content/04_19/b3882100_mz020.htm
Octavio Richetta • February 17th, 2008 at 2:12 pm
Mal de muchos consuelo de tontos (Two in distress makes sorrow less?): Cheer up! What goes on in the French CEO ranks is even worse than what we have here! In France, the Heads No Longer Roll http://www.nytimes.com/2008/02/17/business/worldbusiness/17france.html?pagewanted=1&adxnnl=1&ref=business&adxnnlx=1203278513-8H7hmP1p3XdiVHFmad2XzQ
Octavio Richetta • February 17th, 2008 at 2:18 pm
another shoe waiting to drop: http://www.nytimes.com/2008/02/17/business/17swap.html?ref=business … In a credit default swap, two parties enter a private contract in which the buyer of protection agrees to pay the seller premiums over a set period of time; the seller pays only if a particular credit crisis occurs, like a default. These instruments can be sold, on either end of the contract, by the insurer or the insured. But during the credit market upheaval in August, 14 percent of trades in these contracts were unconfirmed, meaning one of the parties in the resale transaction was unidentified in trade documents and remained unknown 30 days later. In December, that number stood at 13 percent. Because these trades are unregulated, there is no requirement that all parties to a contract be told when it is sold. As investors who have purchased such swaps try to cash them in, they may have trouble tracking down who is supposed to pay their claims. “This is just a giant insurance industry that is underregulated and not very well reserved for and does not have very good standards as a result,” said Michael A. J. Farrell, chief executive of Annaly Capital Management in New York. “I think unregulated markets that overshadow, in terms of size, the regulated ones are a real question mark.” Because these contracts are sold and resold among financial institutions, an original buyer may not know that a new, potentially weaker entity has taken over the obligation to pay a claim. In late 2005, at the urging of the Federal Reserve Bank of New York, market participants agreed to advise their trading partners in a swap when they assigned contracts to others. But it is unclear how closely participants adhere to this practice. It would be as if homeowners, facing losses after a hurricane, could not identify the insurance companies to pay on their claims. Or, if they could, they discovered that their insurer had transferred the policy to another company that could not cover the claim. …
Octavio Richetta • February 17th, 2008 at 2:28 pm
More from the previous post. Do I smell Goldman Sachs “no subprime losses” may have something to do with this? … Years of a healthy economy and few corporate defaults led many banks to write more credit insurance, finding it a low-risk way to earn income because failures were few. Speculators have also flooded into the credit insurance market recently because these securities make it easier to bet on the health of a company than using corporate bonds. Both factors have resulted in a market of credit swaps that now far exceeds the face value of corporate bonds underlying it. Commercial banks are among the biggest participants — at the end of the third quarter of 2007, the top 25 banks held credit default swaps, both as insurers and insured, worth $14 trillion, the currency office said, up $2 trillion from the previous quarter. JPMorgan Chase, with $7.8 trillion, is the largest player; Citibank and Bank of America are behind it with $3 trillion and $1.6 trillion respectively. But many speculators, particularly hedge funds, have flocked to these instruments to bet on a company failure easily. Before the insurance was developed, such a bet would require selling short a corporation’s bond and going into the market to borrow it to supply to the buyer. The market’s popularity raises the possibility that undercapitalized participants could have trouble paying their obligations. “The theme had been that derivatives are an instrument that helps diversify risk and stabilize risk-taking,” said Henry Kaufman, the economist at Henry Kaufman & Company in New York and an authority on the ways of Wall Street. “My own view of that has always been highly questionable — those instruments also encourage significant risk-taking and looking at risk modestly rather than incisively.” Officials at the International Swaps and Derivatives Association, a trade group, say they are confident that the market will stand up, even under stress. “During the volatility we have seen in the last eight months, credit default swaps continue to trade, unlike other parts of the credit market that have shut down,” said Robert G. Pickel, chief executive of the association. “Even if we have a series of credit events at the same time, we have the processes in place to enable the market to deliver.” Such credit problems have been rare recently. The default rate among high-yield junk bonds fell to 0.9 percent in December, a record low. But financial history is rife with examples of market breakdowns that followed the creation of complex securities. Financial innovation often gets ahead of the mechanics necessary to track trades or regulators’ ability to monitor the market for safety and soundness. The market for default insurance, like the subprime mortgage securities market, is a product of good economic times and has boomed in recent years. In 2000, $900 billion of credit insurance contracts changed hands. Since then, the face value of the contracts outstanding has doubled every year as new contracts have been written. In the first six months of 2007, the figure rose 75 percent; the market now dwarfs the value of United States Treasuries outstanding. Roughly one-third of the credit default swaps provided insurance against a default by a specific corporate debt issuer in 2006, according to the British Bankers’ Association. Around 30 percent of the contracts were written against indexes representing baskets of debt from numerous issuers. But 16 percent were created to protect holders of collateralized debt obligations, complex pools of bonds that have recently experienced problems because of mortgage holdings. There is no exchange where these insurance contracts trade, and their prices are not reported to the public. Because of this, institutions typically value them based on computer models rather than prices set by the market. Neither are the participants overseen by regulators verifying that the parties to the transactions can meet their obligations. The potential for problems in sizing up the financial health of buyers of these securities leads to questions about how these insurance contracts are being valued on banks’ books. A bank that has bought protection to cover its corporate bond exposure thinks it is hedged and therefore does not write off paper losses it may incur on those bond holdings. If the party who sold the insurance cannot pay on its claim in the event of a default, however, the bank’s losses would have to be reflected on its books. Investors are already reeling from the recognition that major banks inaccurately estimated losses from the mortgage debacle. If further write-downs emerge as a result of hedges that did not work, investor confidence could take another dive. To be sure, the $45 trillion in credit default swaps is not an exact reflection of what would be lost or won if all the underlying securities defaulted. That figure is impossible to pinpoint since the amounts that are recovered in default situations vary. But one of the challenges facing participants in the credit default swap market is that the market value amount of the contracts outstanding far exceeds the $5.7 trillion of the corporate bonds whose defaults the swaps were created to protect against. To the uninitiated trying to understand this complex market, its size might initially seem a comfort, as if there were far more insurance covering the bonds than could ever be needed. But because each contract must be settled between buyer and seller if a default occurs, this imbalance can present a problem. Typically, settling the agreements has required the delivery of defaulted bonds if the insurance buyer wants to be fully covered. If the insurance contracts exceed the bonds that are available for delivery, problems arise. For example, when Delphi, the auto parts maker, filed for bankruptcy in October 2005, the credit default swaps on the company’s debt exceeded the value of underlying bonds tenfold. Buyers of credit insurance scrambled to buy the bonds, driving up their price to around 70 cents on the dollar, a startlingly high value for defaulted debt. Market participants worked out an auction system where settlements of Delphi contracts could be made even if the bonds could not be physically delivered. This arrangement was done at just over 36 cents on the dollar; so buyers of protection on Delphi who did not have the bonds received $366.25 for every $1,000 in coverage they had bought. Had they been valuing their Delphi insurance coverage at $1,000 per bond, they would have had to write off that position by $633.75 per $1,000 bond. That is why the valuation of these contracts is of such concern to some participants. As with other securities that trade privately and by appointment, assigning values to credit default swaps is highly subjective. So some on Wall Street wonder how much of the paper gains generated in these instruments by firms and hedge funds last year will turn out to be illusory when they try to cash them in. “The insurance business is very difficult to quantify risk in,” said Mr. Farrell of Annaly Capital Management. “You have to really read the contract to make sure you are covered. That is going to be the test of the market this year. As defaults kick in and as these events unfold, you are going to find out who has managed this well.” And who hasn’t.
Octavio Richetta • February 17th, 2008 at 2:42 pm
For the nth time… 2008 earnings forecasts don’t jibe with reality. What are these WS analysts smoking? http://www.nytimes.com/2008/02/17/business/17fund.html?_r=1&ref=business&oref=login These SV guys are mighty fast! Warming up the engines for the next bubble? Silicon Valley Starts to Turn Its Face to the Sun http://www.nytimes.com/2008/02/17/business/17ping.html?ref=business … Financial opportunity also drives innovators to exploit the solar field. “This is the biggest market Silicon Valley has ever looked at,” says T. J. Rogers, the chief executive of Cypress Semiconductor, which is part-owner of the SunPower Corporation, a maker of solar cells in San Jose, Calif. Mr. Rogers, who is also chairman of SunPower, says the global market for new energy sources will ultimately be larger than the computer chip market. “For entrepreneurs, energy is going to be cool for the next 30 years,” he says. Optimism about creating a “Solar Valley” in the geographic shadow of computing all-stars like Intel, Apple and Google is widespread among some solar evangelists. …
Guest • February 17th, 2008 at 2:47 pm
Hellasious says in “Un Ballo In Maschera”: “I have often remarked that I am on the deflation side of the inflation-deflation debate…” http://suddendebt.blogspot.com/ ”The alphabet soup (CDOs, CLOs, CDSs, SIVs, ABCPs,CRDOs…) seems thick and opaque, but don’t let the jargon confuse you. Here is the crucial point: almost all of these “securities” were unfunded debt, i.e. money equivalents created from thin air. All they did was to generate more and more “buying power” to boost asset prices higher, from houses in the Inland Empire of California to share prices in New York, London and Shanghai. In case it is still unclear: it was margin debt. ”If you are familiar with buying stocks or commodities on margin, you can immediately appreciate what went on, and why all current attempts to avert a wider crisis will fail miserably for as long as the focus is on the symptoms, instead of the underlying illness. Margin debt cannot be “restructured” with falling asset prices. Period. ”Depending on the leverage used, this debt is now worth anything from zero to a deep discount from face value. And that’s where it is trading at, when it trades at all in the secondary market. All those trying to hide the balance sheet reality behind plywood and canvas should be recognized for what they are: Potemkin village builders. ”This artificial money is now being removed, destroyed by dropping asset prices…” A very good read. What I like about Nouriel Roubini and Hellasious is they can take a cauldron of economic soup and boil it down to a bouillon cube. A rare talent. Jon Taplin’s blog says the rise in January retail sales reported by the DOC was entirely due to the rising cost of food and energy with sales +13%. All other aspects of normal retail activity were falling sharply, he says, with clothing and general merchandise sales down at 3%; and furniture, appplicance and electronic sales down to about 2%. (Energy includes sales at gasoline stations and fuel dealers.) http://jtaplin.wordpress.com/2008/02/16/inflation-does-matter/ These figures, IMO, are confirming coming stagdeflation: i.e. stagnated wage/saving/pension income pouring into inflationary priced necesssities and out of discretionary expenditures, pushing down prices of non-necessities. Says Taplin, “Its easy to confuse ‘a growing economy’ with inflation.”
Octavio Richetta • February 17th, 2008 at 3:10 pm
More CR on The Suprime Put http://calculatedrisk.blogspot.com/2008/02/walking-away-or-hiding-away.html
Octavio Richetta • February 17th, 2008 at 4:49 pm
Latest one from Das. Guest Commentary, by Satyajit Das The Credit Crunch – In 2008 The Worst May Keep Getting Worse February 15, 2008 Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall). http://www.prudentbear.com/index.php/GuestCommentaryHome
Anonymous • February 17th, 2008 at 4:50 pm
Let’s see if centrifuging works on monolines. Is it possible to spin out the modest “gems” while garbagings the castings and overburden. Or is it really always been a zero sum game? Garbage in, garbage out. Just like off-balance sheet holdings, eventually losses must be recognized. Since these entities cannot recognize them themselves without BK/insolvency. Where are they going to find anyone on God’s green earth stupid enough to step in for assured losses and no potential gains? Yes, you know already, only the US congress who will JAM increasingly restless taxpayers with the bag and bill. Alchemists are still trying to create gold from lead, but marketplace is wiser now despite the circus barkers and shills.
Octavio Richetta • February 17th, 2008 at 7:04 pm
Ambac is going for it too! Ambac in Talks to Split Itself Up By CARRICK MOLLENKAMP, KAREN RICHARDSON and LIAM PLEVEN February 17, 2008 7:18 p.m. http://online.wsj.com/article/SB120329343557274561.html?mod=hps_us_whats_news The devil will be in the details!
Guest • February 17th, 2008 at 7:11 pm
news from australia and Japan http://www.bloomberg.com/apps/news?pid=20601087&sid=a6qpV4oik9eo&refer=home
Guest • February 17th, 2008 at 7:14 pm
Stagflation Hits Singapore as Inequity Grows http://www.bloomberg.com/apps/news?pid=20601039&sid=aZM2OxYMU7f8&refer=home
Guest • February 17th, 2008 at 7:19 pm
more on australia and new zealand. The us of A’s crap was bought by everybody, it seems. http://www.bloomberg.com/apps/news?pid=20601087&sid=add9V8DfcN0A&refer=home
Guest • February 17th, 2008 at 7:22 pm
this is the whole ambac story if you dont have a subscription. Ambac in Talks to Split Itself Up By CARRICK MOLLENKAMP, KAREN RICHARDSON and LIAM PLEVEN February 17, 2008 7:18 p.m. Ambac Financial Group Inc. is in discussions to effectively split itself up in a move aimed at ensuring that municipal bonds backed by Ambac retain high credit ratings, according to a person familiar with the situation. A deal could fall apart because of the complexities in such a move, this person said. Bond insurers in recent weeks have become ground zero in the global credit crisis because the companies contractually have agreed to stand behind billions of dollars in securities underpinned by U.S. subprime mortgage loans. A halving of Ambac would create one unit that insures municipal debt and one that would cover rapidly diminishing securities tied to the mortgages in a structure that effectively creates a so-called “good bank” and “bad bank.” Bond insurers generate revenue by promising to cover bond payments on debt issued by a range of entities, including local governments. Bond insurers now are under pressure, though, because they also agreed to guarantee payments on mortgage debt or securities to banks, brokers and investors. Ratings companies now are poised to further cut credit ratings on bond insurers because of those guarantees. Ratings downgrades can have chain reactions and lead to increased borrowing costs for municipalities and write-downs for banks that own debt backed by the insurance providers. To avert financial chaos, regulators in New York, including state insurance superintendent Eric Dinallo and Gov. Eliot Spitzer have pressured the companies to find solutions or else face regulatory action. Ambac is one of two bond insurers considering an effective break-up. FGIC Corp. on Friday notified Mr. Dinallo’s office, the New York State Insurance Department, that it is pursuing an effective break-up. But according to people familiar with the situation, FGIC’s plan came as a surprise to a consortium of banks that had been in early discussions to shore up FGIC’s capital. Talks between the two sides be prolonged and litigation may be one outcome. Ambac’s plan is much further along and an announcement could be made this week. But the plan to split Ambac is complex and has required tens of hours in recent days. While a “good bank-bad bank” model has existed for decades, there isn’t a playbook for halving a bond insurer. A number of issues remain to be resolved, said a person familiar with the situation. An Ambac spokesman wasn’t immediately available for comment. Ambac is based in New York and is the second largest U.S. bond insurer behind MBIA Inc. FGIC ranks third. Write to Carrick Mollenkamp at mollenkamp@wsj.com Karen Richardson at richardson@wsj.com and Liam Pleven at pleven@wsj.com
Leo70 • February 17th, 2008 at 9:53 pm
Guest • February 17th, 2008 at 11:32 pm
Movement in ASia Mkts today are amazing…
Guest • February 18th, 2008 at 2:54 am
“HOLY FREAKING FINANCIAL ARMEGEDDON, BATMAN, THAT’S A MIND-BLOWING 4.2 TRILLION DOLLARS OF LOSSES!!! Yes, you read that correctly, that’s trillion with a “T” and this combined total is close to one third of the entire freaking US Gross Domestic Product, which has just been flushed down the toilet in a matter of months!” http://www.theinternationalforecaster.com/item.php?topicId=2&articleid=227 Bob sends a little clearer message than poor, poor Ben’s testimony (speech) last week. As I have said previously, Germany nears returning to the Mark and that now depends on Trichet. When that happens the EU is dead meat. Treaty of Lisbon was approved last year??? And now, Tony Blair for World President? – now I know we are doomed! Never mind, change is good. Ho hum PeterJB
Octavio Richetta • February 18th, 2008 at 4:36 am
Written by Leo70 on 2008-02-17 21:53:48 BlackRock’s closed en funds are not limited to municipals. They have taxable and equity funds as well. The note on ARPS talks about closed end funds in general. Does this mean that there are entities that used to raise money via ARPS that are unrelated to traditional Municipal issuers? In other words, that the ARPS auction dry-out effect goes beyond the municipal market?
Octavio Richetta • February 18th, 2008 at 4:54 am
PeterJB Written by Guest on 2008-02-18 02:54:56 From your link: This credit default swap situation alone is pure unadulterated lunacy, but we have not even mentioned the interest rate swaps yet. There’s another 600 trillion of notional principal wrapped up in these weapons of mass financial destruction. That’s forty times GDP in notional principal. Who was asleep at the wheel while these puppies multiplied? For every trillion of notional principal, all those who are on the wrong end of these thermonuclear devices by only a 1% differential between fixed and variable rates get to eat 10 billion in losses. When we get double digit inflation due to rampaging risk reassessment from imploding bonds and credit default swaps while the Fed attempts in vain to raise rates to stop hyper-stagflation as it reaches full bloom in its reign of terror, what if the differential between fixed and variable returns for those on the wrong end of these reserve-vaporizers rockets to 10%. That is 100 billion per trillion of notional principal. Whew, we sure hope the big banks who own most of these reserve-destroying financial meat grinders don’t have lopsided trading positions between fixed and variable rate swaps, but given what we’ve seen so far, we hold out little hope for a good conclusion. Can anyone comment on Interest Rate Swaps? It would appear that if long rates keep creeping up due to Benny’s easy hand this may be another shoe to drop. Did someone mention Imelda Marcos shoe collection? http://en.wikipedia.org/wiki/Imelda_Marcos
freezing in my car • February 18th, 2008 at 6:49 am
Bond Insurer Split May Trigger Litigation, Bank of America Says http://www.bloomberg.com/apps/news?pid=20601087&sid=amNxEh5d1lX8&refer=home
Giraf • February 18th, 2008 at 7:03 am
@PeteJB Re: “HOLY FREAKING FINANCIAL ARMEGEDDON, BATMAN, THAT’S A MIND-BLOWING 4.2 TRILLION DOLLARS OF LOSSES!!!” I think the gentlemen are confusing “real” triple A mortgage bonds with the phantom triple A ratings of the junk backed by sub-prime loans. BIG difference!
London Banker • February 18th, 2008 at 7:15 am
The calm before the storm . . . or the flat sea before the tsunami? CDS report: “Horrible” fall-out scenario preoccupies market Credit market participants took a shellshocked pause on Monday, with the spectre of more structured product unwinds hanging heavily over the market. Trade was thin in Europe, but spreads did not recede far from the record wides reached on Friday, when again the talk was that structured products – synthetic CDOs or CPDOs – were being liquidated. “If these things do get unwound en masse, the effect on the market will be horrible,” said credit strategist Barnaby Martin at Merrill Lynch. “Between 1 and 2 trillion dollars of synthetic CDOs have been issued over the last four years. Any unwinding will likely be crammed into a much shorter time period.” A fire-sale is every market participant’s worst nightmare, but even the more orderly process of deleveraging will put pressure on spreads.
London Banker • February 18th, 2008 at 7:52 am
I can’t help but note that the FTSE 100 is up 70 points this afternoon, with bank stocks leading the way. If bank failure – which the Northern Rock nationalisation implies – is so wonderful for the markets, perhaps if all the banks fail we can get to a new all time high on the FTSE! In other news, some weeks ago I predicted that the BHP bid for Rio Tinto and Vale bid for Xstrata were likely illusory – merely fluffing the mining stocks while the smart money exits at the top of the commodities cycle. Among other things, China’s official opposition to both bids made either very dangerous for any bank wanting future business in China. It appears as of today that Vale may walk away from the Xstrata bid and that Rio Tinto is pulling out of BHP’s reach as their share prices diverge. Res ipsa loquitor.
Guest • February 18th, 2008 at 8:05 am
LondonBanker, Dow futures up 40pts.. looks like this leg of th suckers rally has sometime to go… not sure what would eventually wake the bear up again though… mrskeptical
Guest • February 18th, 2008 at 10:14 am
up goes the price of oil http://www.cnn.com/2008/US/02/18/refinery.blast/index.html?eref=rss_topstories
Guest • February 18th, 2008 at 10:24 am
Barron’s interview with Jeremy Grantham, “This Credit Crisis Has a Long Way to Run,” is referenced today in Bill Fleckenstein’s new post. If you think Barron’s questions below are fascinating, then you will agree with interviewer Sandra Ward’s assessment of Grantham’s answers, “Fascinating as always, Jeremy. ” Grantham is Chief Investment Strategist at GMO. http://online.barrons.com/article/SB120251582071855267.html Barron’s: You, along with George Soros, have called this the worst financial crisis we’ve had in the post-war era. Can these bubbles burst if the Fed is easing the way they are? What about places to hide? What should we expect from the market between now and 2010? What exactly will make them more uncomfortable? (Aside) He (Bernanke) was taking his cue from Alan Greenspan, who said we should all be taking out adjustable-rate mortgages. So the Fed’s actions won’t stave off a slowdown? I understand you are most concerned with further fallout in the private-equity arena? Where else does this housing crisis lead us? What about the dollar? What other bets would you take here? What about growth stocks? Isn’t there value there? But how do you define quality these days? What about the deal market, will that provide any lift to stocks? Microsoft’s bid for Yahoo! hasn’t done much for the market. Fascinating as always, Jeremy. Thank you. Fleckensteins says today,” It’s too early to be bullish… If you listen to some prominent market professionals, you might think the worst is over. But the credit/housing bubble is a far bigger mess than the tech-stock bust.” http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/ItsTooEarlyToBeBullish.aspx
JMa • February 18th, 2008 at 10:27 am
“”Short interest at its lowest since 2000 and falling.”” “IMO, this is great news if you are short…” @Octavio – I agree, one would think if all or most are expecting bounce there is not much of a bounce coming… So I wonder, do the short interest numbers include short ETFs? @KJ Foehr The short ETFs have to short somehow ? However, they likely do it via options and or futures so still may not show up in short interest. I can not remember if I read it here or in Barron’s – an idea that the hedgees shorting have been required to take of positions due to credit market losses. Now, that development would no doubt be bearish if it were true. Cash became crowded so cash had to be punished. Too many people get long anything and it has to be punished and now indeed – “cash” is being punished. Silly investors, didn’t you know you needed to diversify your cash. You want a diversification strategy, find assets you have never heard of or rarely hear about and invest in them with some percentage of your portfolio. These bankers have created so much monopoly money all the known asset classes require adjustment apparently including muni bonds and CASH.
Guest • February 18th, 2008 at 11:01 am
DOW futures up 146. Logic no longer matters, does it?
Anonymous • February 18th, 2008 at 12:40 pm
Just a street view of the reach-down by retailers in hopes of inventory reduction and getting cash in hand. CASH IS KING, and about to become even more dear. Lately observed: Sam’s Club offering 18 months interest free on purchase over $300 computers/electronics Disney extra two day stay free with Park Hopper passes AND $50 gas card, for price of three day stay Lowe’s/HD 40% discount OR $10 off 25$ purchase unlimited. local lumber companies offering 1 year interest free and $1000 off purchase over $5000 Craigslist significantly jumping in terms of furniture, tools, building materials, and used durables and vehicles. Spike in volume and 20%+ drop in pricing. Seller revolt in Ebay due to increases in list pricing, coordinated seller strike. Also auction prices are rapidly softening with much higher numbers of goods going unsold. Local builders offering lock-in pricing for buyers so that for two years they receive adjustments should pricing fall further. Upfront rebates of $5000 to assist in downpayments AND choice of household appliances/landscaping to sweeten the deal. Many builders are beginning to finesse their own means of lending to oblige buyers with mortgages unavailable through traditional banks (though not subprime grade). We are on the verge of larger and more competetive fire sales as inventory holders seek to reduce stock and get CASH. Though widely touted as an economy rife with liquidity, REAL CASH is becoming ever more dear and the reach-downs will become more glaring and more beneficial for those who saved their GUNPOWDER.
Guest • February 18th, 2008 at 1:40 pm
@ Guest: DOW futures up 146. Logic no longer matters, does it? You can’t steal, even for the stock market and the bankers, if there’s nothing left to steal. In the late 80s, The New Statesman, writing about insider trading in the British market before it became a criminal offense in 1980, called the ‘City’ “an unpatriotic casino which pays itself obscenely high salaries for dancing on the grave of British industry.” Now its America’s Fed central power that is dancing on the graves of American industry and the American middle class, robbing the producers to bail out non-producing, backfiring banking schemes. Says Jeremy Grantham in Barron’s last week, “Debt in the aggregate does not drive the economy. The economy is driven by education, man-hours worked, capital investment and technology. It is not driven by what I owe you and you owe me.” Greenspan and Bernanke, he says “have taken a hands-off approach for two consecutive great bubbles, first in TMT — telecommunications, media and technology — and second, in housing. A hands-off approach is a polite way of saying they facilitated this. And what is the point of a 125-basis-point rate reduction, other than to provide reinforcement for the people who borrow short and lend long? From bankers who have committed every crime you could possibly accuse a banker of, to hedge funds who borrow short, leverage, and invest long in the stock market — that’s who really benefits from the interest-rate reduction. The economy, broadly defined, does not.” The hard fact is, to have an economy you must have people who are producing. You cannot rebuild an economy by inflating paper. The bankers and international corporations are not sharing their money with America’s economy — in research and development, in small business, in manufacturing, new enterprise, state-of-the-art education, infrastructure… they are putting it in their pockets…. transferring it to other non-producers… off-shoring it to the Cayman Islands… IMHO, we’re in a bear market where traders spin what they picked up last week to resell on the rally this week for more money. The incredible points made by Grantham in “The Credit Crisis Has a Long Way to Run” aren’t opinions, they are substantiated. That’s the way with truth: you can’t argue with it.
Gloomy • February 18th, 2008 at 2:36 pm
Regardless of how things end up with the monolines, it seems to me ratings downgrades will happen soon. Is there any reason for any goverment official, Federal or state, to discourage the rating agencies from downgrading MBIA or AMBAC? Wouldn’t a downgrade help precipitate a split, which is exactly what governments want now?
Octavio Richetta • February 18th, 2008 at 5:42 pm
Written by Anonymous on 2008-02-18 12:40:47 “Cash is King” Great post!
Guest • February 18th, 2008 at 6:51 pm
the way i see.. it’s telling us, people who are still eligible/able for refinancing are starting to feel the pinch and requires extra cash,due to higher expenses so people with good credit rating are cash strapped too, dont they know their home value could depreciate further in the near future maybe they do know but havent much of a choice…. http://www.bloomberg.com/apps/news?pid=20601068&refer=economy&sid=aulAek0aCrKM Bernanke Turns 10-Year Notes Into Losers as Refinancing Surges By Liz Capo McCormick Feb. 19 (Bloomberg) — The more Federal Reserve Chairman Ben S. Bernanke cuts interest rates, the less appealing 10-year Treasuries become to investors like Doug Dachille, chief executive officer of First Principles Capital Management LLC. Consumers taking advantage of lower borrowing costs have pushed the Mortgage Bankers Association’s refinancing index to its highest level since March 2004. Ten-year notes fell 4.83 percent in April 2004 as the extra cash homeowners pocketed from replacing high-rate loans spurred bigger gains in retail sales and consumer confidence than forecast. As then, a drop in rates may help ease the burden of consumers’ monthly payments and contribute to forecasts of a rebound in the economy, diminishing the appeal of government debt. The price of the 10-year note has fallen 3.15 percent since Jan. 23, according to Merrill Lynch & Co. index data, and St. Louis Fed President William Poole said Feb. 11 that “the best bet is that we will not have a recession.”
Anonymous • February 18th, 2008 at 6:59 pm
This just in! Schizophrenic patients are undergoing delicate surgery splitting themselves down the middle. In monoline mimicry, mental illness is being surgically removed from the larger body and institutionalized while the patient undergoes complete recovery. Franken can now join society at large as a perfectly normal contributing member, while Stein has been encapsulated and walled off from his peers. In a related story, pigs were found soaring the skies in an unusually cold day in hell.
Guest • February 18th, 2008 at 8:10 pm
@Guest: “the way i see it (“Bernanke Turns 10-Year Notes Into Losers as Refinancing Surges”),,, it’s telling us, people who are still eligible/able for refinancing are starting to feel the pinch…” I didn’t think it was such a rosy picture, either. It was interesting to me that the article chose the lowest one-day rate of 5.48% for a savings’ comparison, didn’t mention points paid if any, nor did it relate the impact of government programs to help at-risk mortgage holders, if any. This latest refinancing surge, IMO, has several dissimilarities to the June 2003 high. It did say, however, that “the rise in refinancings may be skewed by borrowers submitting multiple applications for loans as bankers tighten lending standards,” according to Joseph Mason, an associate professor of finance at Drexel University in Philadelphia. Nor does Mason “see a housing market recovery right now. People can’t get a mortgage” because “banks are restricting access to credit,” he said. It further notes that “declining property values are also making it harder for a growing number of homeowners to refinance” and that “by year-end as many as 15 million households may owe more on their mortgages than their homes are worth.” “Even so,” it notes “the drop in rates is helping homeowners with subprime adjustable-rate mortgages…” and “will probably reduce scheduled increases through 2010 in subprime borrowers’ payments to 8 percent on average, or $182…” The Big Question: Is the drop in rates good enough to counter falling property values and keep borrowers with no equity from “walking”?
Octavio Richetta • February 18th, 2008 at 8:15 pm
Written by Guest on 2008-02-18 18:51:53 Greenspan’s work? Will Benny be able to follow through? http://www.mises.org/story/1859 There has been a great deal of volatility in long rates with temporary inflation concerns playing a role. http://finance.yahoo.com/q/bc?s=%5ETNX&t=5y&l=off&z=m&q=l&c= http://finance.yahoo.com/q/bc?s=%5ETNX&t=my&l=off&z=m&q=l&c= Regardless of what we ultimately get (either deflation pushing long rates in the 1 % direction or run away inflation pushing long rates up – I don’t see a middle way here), it appears that Greenspan’s conundrum will become a thing of the past.
Octavio Richetta • February 18th, 2008 at 8:34 pm
IMO, CR’s explanation of AG conundrum may be closer to what is really going on and that we will get a very hard recession along with deflation. http://calculatedrisk.blogspot.com/2005/02/greenspans-interest-rate-conundrum.html
Guest • February 19th, 2008 at 2:35 am
Explanation for increase in US futures? Qatar is purchasing shares in Credit Swisse and plans to spend 15 billion over the next year in European and US markets http://www.chron.com/disp/story.mpl/business/5550809.html
Alessandro • February 19th, 2008 at 3:28 am
And Credit Swisse cheerfully welcomes the new investors with $2.85bn worth of unexpected write-down and a fat -10% in stock price: http://www.bloomberg.com/apps/news?pid=20601087&sid=aYUzb_89dhnc&refer=home
Octavio Richetta • February 19th, 2008 at 5:18 am
Written by Guest on 2008-02-19 02:35:24 I am sure most of you have read about BB’s savings glut theory: i.e., Asian and Oil countries piling up savings while us pile up debt. From your post on Qatar, It looks like Goldilocks believe that a plausible solution to the huge debt problem in the US is to just “press reset” as follows: 1. everybody worth their salt (actually most are not worth their salt:-) exercises his/her subprime put as described in previous posts: people walk out on their mortgages, stop making cc/car payments, banks walk out of equity deals, SIVs. etc. i.e., Everybody, people banks, hedge funds, etc. just default on their debts. 2. The “nice and dumb” people with lost of savings (i.e., Asian and Oil country SWFs) replenish capital at the banks so that banks can start lending again to people who now have no debt as they defaulted on it. 3. The party goes on: Commodity/energyalternative energy bubble is next. Yes, you are right; it all sounds so implausible and stupid! Anyone who has been around long enough has seen lots of implausible, stupid things happen… BTW, it was party time is Asia yesterday. It looks like BB’s low rates are working wonders for speculators, at least outside the US. http://finance.yahoo.com/intlindices?e=asia
Little Saver • February 19th, 2008 at 6:25 am
A voice for little savers to listen to: Consider his (Jeremy Grantham’s) “Greenspan Prize”, awarded to economic titans who offer the most boneheaded observations. This is in honour of the revered former Federal Reserve chairman Alan, of course, who once posited that you cannot recognise bubbles before they pop. Other distinguished winners, and targets of Mr Grantham’s withering commentary, include Hank Paulson, the Treasury secretary, for saying last spring that subprime troubles were “contained”, and Ben Bernanke, the Fed chairman, for riffing that inflated housing values merely reflected a strong economy. http://www.ft.com/cms/s/0/dd20b926-de8d-11dc-9de3-0000779fd2ac.html
Octavio Richetta • February 19th, 2008 at 7:09 am
Written by Little Saver on 2008-02-19 06:25:21 Thanks for the great article! BTW: I really welcome responses to my “stupid” devil’s advocate post above: Written by Octavio Richetta on 2008-02-19 05:18:35 Is it really possible to patch-up the US “financial black-hole” using SWFs from Asian countries, Oil countries, Rich arabs, etc.
Medic • February 19th, 2008 at 7:21 am
So I woke up this morning to read that another European bank is taking another large loss and gold is up almost $15 so far. Another stellar day in store for the market. I have written before about Kevin Bacon’s character in Animal House at the end of the movie when he gets trampled by a crowd while yelling “All is well!” – BB and Paulson will have foot prints on them soon…….
Octavio Richetta • February 19th, 2008 at 7:38 am
A hint for reading FT articles. If you click on an FT link and you reach “To continue reading, please subscribe…” Do the following: copy the first two-three lines (article title author date) and paste it into your Google search bar. Most of the times you will get a link to the article (this may not work when the article is too fresh)
Guest • February 19th, 2008 at 7:41 am
Octavio, I really doubt it.. but who really knows!? for sure… Even if banks are re-captitalised, credit contraction will still continue… its a like a negative bubble now… i dont see how, credit can continue to grow in the US of A? mrskeptical
freezin in my car • February 19th, 2008 at 7:57 am
Bond Insurer Split Threatens $580 Billion of Notes http://www.bloomberg.com/apps/news?pid=20601087&sid=aTJGNMihnPOk&refer=home lets start off the week just like every other week, BAD NEWS
Octavio Richetta • February 19th, 2008 at 8:08 am
Written by freezin in my car on 2008-02-19 07:57:28 It does not look like equity investors read the same press: http://finance.yahoo.com/intlindices?e=asia http://finance.yahoo.com/intlindices?e=europe http://finance.yahoo.com/indices?e=futures http://www.bloomberg.com/markets/stocks/futures.html
Hellasious • February 19th, 2008 at 8:19 am
Re: Re-capitalizing banks using SWF money It’s not as if the foreign money was hiding under a mattress and will now come out. It was invested somewhere to begin with, e.g. govt. and agcy. bonds, deposits in banks, shares in hedge and PE funds.. In other words, this is not “new” money. It does make a difference if some of it goes towards buying bank shares, but not as much as one thinks. The only money that REALLY matters to the economy is the “new” money that is created by spending and credit expansion. Shifting existing money around won’t solve anything..
Guest • February 19th, 2008 at 8:52 am
Anyone notice that the 10 year yield is up over 40 bps. in a couple weeks and now todya, oil is trying really, really hard to bust thorough $100. That, of course, must be good news for the economy according to tthe party on wall street this am. Grab your parachutes cause the floor is getting ready to come out from under us all…you have been warned…
Little Saver • February 19th, 2008 at 8:52 am
@Octavio: BTW: I really welcome responses to my “stupid” devil’s advocate post above: Written by Octavio Richetta on 2008-02-19 05:18:35 Is it really possible to patch-up the US “financial black-hole” using SWFs from Asian countries, Oil countries, Rich arabs, etc. Written by Octavio Richetta on 2008-02-19 07:09:34 As long as the decision makers in the SWFs profit from the US consumption frenzy, they will probably try to patch-up any “financial black-hole” that threatens to end their source of milk and honey, I think. But it probably isn’t sustainable in the long run. How long, I don’t know. Reading Nouriel’s blog might give some indications on what the future will bring.
London Banker • February 19th, 2008 at 8:54 am
Minneapolis Fed’s Stern sees slow growth, possible US credit crunch “Many large banks, both here and abroad,” he noted, “have found it desirable to protect balance sheet capacity in the wake of unanticipated asset expansion and material financial losses in some cases as well.” He defined a credit crunch as “as an environment in which quality borrowers find credit either unavailable or available only on very expensive terms”, and said “it is possible that an appreciable tightening of credit conditions will” — as it did in the early 90s — “restrain the economy for a time.” D’oh!
Alessandro • February 19th, 2008 at 9:05 am
@Hellasious The paradigm shift from ‘IOU’ to ‘I own you’. Doesn’t look like the path to Heaven for the US.
Guest • February 19th, 2008 at 9:12 am
LOL oil price is now at 98++ man these bulls r f’kin crazy to think higher oil price reflects a good economy
Guest • February 19th, 2008 at 9:19 am
new thread
alexcanuck • February 19th, 2008 at 9:31 am
New thread
