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Friday, July 18, 2008
regulatory short squeeze to foster dilution
todd harrison at minyanville passes on the overview of what has likely transpired on wall street in the last week.
So far banks have miraculously come through on their end of things. Wells Fargo (WFC) and JPMorgan (JPM) reported better than expected beaten down earnings. Things must be getting better just as the companies need capital.
What a coincidence.
But if you look at how the banks “beat” their earnings the coincidence becomes clear. WFC took the unprecedented step of extending charge-off acknowledgment from 120 days to 160 days. This allowed the bank to move less capital to loan loss reserves and report better than expected horrible earnings. And JPM was even more aggressive. It actually lowered its loan loss reserves quarter to quarter.
The list of financial companies where shorting regulations are being enforced/enhanced is precisely the banks and dealers (and FNM/Freddie Mac (FRE)) that have access to the Fed's balance sheet (dealers through the PDCF and FNM/FRE through the recently-allowed access to the discount window). So we can speculate on the nature of the ''coincidence'': Perhaps the Fed is getting worried about the value of all that collateral these dealers have posted to the Fed balance sheet and must boost the capital of these companies to protect that value.
And now on cue FRE, a $5 billion market capitalization company wants/needs to issue $10 billion in new stock? Doesn’t that sound a little crazy? Well get ready for others to do the same because the banking system needs capital desperately and the government is there to help.
But help at the expense of who?
i don't like conspiracy theories, but the truth is that a massive short squeeze on the financials is incredibly convenient for banks whose funding options have shuttered and who have been forced to sell good assets to cover losses. it was sparked with very well placed and timed government regulatory assistance. moreover, building strength in financial shares indicate that the big houses very likely knew help was coming -- trading desk profits for the i-banks this quarter were doubtlessly helped. it all hangs together with such cynical beauty that i find it hard to dismiss the possibility. very hard.
reading forward, then, what would we expect? as much near-term firepower as possible directed into financial share prices, with the eventual aim later this year of common stock offerings on the part of everyone who can manage to recapitalize in this fashion. it won't be enough, i suspect, but it will be a step toward the light for some banks.
Financial companies are desperate for capital but their stock prices are so low that any issuance would be dilution death for the companies. The government is desperately trying to keep the financial system together. Add that up and you get the possibility of a great manipulation.(and into options expiration -- gm) If just some how these earnings were really good the match would be lit on the kindling.
How would the government engineer a rally in financial stocks so that these companies can sell stock to raise capital at a reasonable or at least palatable dilution level?
It might go something like this. Since financial stocks are in such trouble they have heavy short interest; this is natural and well known and can be used to their advantage. A clever “berry” might think to introduce confusing rules that raise the cost of borrowing short stock and temporarily confuse shorts into covering and not shorting more. And this is precisely what the SEC did.
It seems innocuous to most folks, but it put stock loan desks and dealers in complete disarray. New short sellers could find no stock to borrow and many existing short sellers were forced to cover as the technical rules forced allocation of loans at much higher costs.
For example, the rebate rate on Fannie Mae (FNM) the day before the SEC announcement was 1%; the day after it was -5%. Many who were short the stock were forced to cover, thus driving the stock price up.
But this alone would only drive stock prices up so much. The clever berry needs a catalyst, one that would force panic buying into now truncated supply.
It just so happened that the new SEC rules came conveniently the day before many of these financial companies were to report earnings.
So far banks have miraculously come through on their end of things. Wells Fargo (WFC) and JPMorgan (JPM) reported better than expected beaten down earnings. Things must be getting better just as the companies need capital.
What a coincidence.
But if you look at how the banks “beat” their earnings the coincidence becomes clear. WFC took the unprecedented step of extending charge-off acknowledgment from 120 days to 160 days. This allowed the bank to move less capital to loan loss reserves and report better than expected horrible earnings. And JPM was even more aggressive. It actually lowered its loan loss reserves quarter to quarter.
The list of financial companies where shorting regulations are being enforced/enhanced is precisely the banks and dealers (and FNM/Freddie Mac (FRE)) that have access to the Fed's balance sheet (dealers through the PDCF and FNM/FRE through the recently-allowed access to the discount window). So we can speculate on the nature of the ''coincidence'': Perhaps the Fed is getting worried about the value of all that collateral these dealers have posted to the Fed balance sheet and must boost the capital of these companies to protect that value.
And now on cue FRE, a $5 billion market capitalization company wants/needs to issue $10 billion in new stock? Doesn’t that sound a little crazy? Well get ready for others to do the same because the banking system needs capital desperately and the government is there to help.
But help at the expense of who?
i don't like conspiracy theories, but the truth is that a massive short squeeze on the financials is incredibly convenient for banks whose funding options have shuttered and who have been forced to sell good assets to cover losses. it was sparked with very well placed and timed government regulatory assistance. moreover, building strength in financial shares indicate that the big houses very likely knew help was coming -- trading desk profits for the i-banks this quarter were doubtlessly helped. it all hangs together with such cynical beauty that i find it hard to dismiss the possibility. very hard.
reading forward, then, what would we expect? as much near-term firepower as possible directed into financial share prices, with the eventual aim later this year of common stock offerings on the part of everyone who can manage to recapitalize in this fashion. it won't be enough, i suspect, but it will be a step toward the light for some banks.
Labels: markets, politics, trading
closed oil short -- considering went long
trade the tape not the narrative. participation on the last leg down in DJUSEN gave an upside divergence -- issues over 10dma, 20d hi-lo, volatility envelopes, mcclellan all pointing to possible upside.
i'm experimenting with price targeting using point and figure charting. we'll see where this gets me, if anywhere...
the DJUSEN broke under resistance at 680 and is now at the 645-650 congestion level. a run back to 680 would not be surprising in light of bettering internals. that would push DIG from the current 90 level to about 99. failure might mean 615 or even 590.
also adding to QLD longs into this morning's weakness following the google miss with NDX @ 1820 with upside to 1860-1870. looks to be considerable headroom remaining in participation.
i'd further think SSO an add around s&p 1240 if it gets back there, with an upside target of 1280 or so.
IYF looks a good bet to 75, perhaps 79 from today's 70 -- meaning UYG to 24 or 27 from today's 20. the high-speed plummet here leaves lots of room for improvement, even though UYG is bouncing from 14 and already 40% off that level.
UPDATE: added DIG around 91.40.
i'm experimenting with price targeting using point and figure charting. we'll see where this gets me, if anywhere...
the DJUSEN broke under resistance at 680 and is now at the 645-650 congestion level. a run back to 680 would not be surprising in light of bettering internals. that would push DIG from the current 90 level to about 99. failure might mean 615 or even 590.
also adding to QLD longs into this morning's weakness following the google miss with NDX @ 1820 with upside to 1860-1870. looks to be considerable headroom remaining in participation.
i'd further think SSO an add around s&p 1240 if it gets back there, with an upside target of 1280 or so.
IYF looks a good bet to 75, perhaps 79 from today's 70 -- meaning UYG to 24 or 27 from today's 20. the high-speed plummet here leaves lots of room for improvement, even though UYG is bouncing from 14 and already 40% off that level.
UPDATE: added DIG around 91.40.
Labels: trading
Thursday, July 17, 2008
oil down $17 in three days
tim sykes passes on an article from 1440 wall street regarding the widom of legendary macro trader paul tudor jones.
august oil futures were crushed again today, and have fallen from a peak of $146.65 back to $129.29 as of this writing. to be sure, i can't say if the bubble has broken -- i just have to follow my analysis day by day. but signs are encouraging in my opinion. in a healthy bull there's simply no way oil trades down through iranian missile tests in the gulf; in retrospect i think many will think of that as a watershed moment. the mechanics of how oil prices are discovered, which propelled prices higher in a leveraging of the market, are likely to work in reverse as speculative credit gets harder to come by -- particularly once aggressive participants have taken, say, a 12% bath in four days and face margin calls. bulls will also face rapidly deteriorating demand fundamentals, which should manifest as persistent upside surprises in inventories.
we'll have to wait and see, of course -- bulls will likely be stubborn and probably not give up the entrenched supply pessimism of peak oil quickly, given that the dynamic is basically true if playing out on a different scale and timeframe from what they believe -- but for now, DUG @ 27 looks to have been a very good entry. there's certainly a chance for a bull stand here, though, with oil sitting on resistance at $130 and DUG right up against resistance at $36-37.
Commodities have been the worst-performing asset class behind stocks, bonds and real estate for the past 200 years, but Wall Street doesn’t highlight that long history when selling commodity index instruments today. Instead, it shows a chart of the bull market of the past 12 years to rationalize why some pensioner should be long cattle futures in the derivatives markets as part of a basket.
I am sure they were using similar logic about tulips three centuries ago. Oil is a huge mania, and it’s going to end badly. We’ve seen it play out hundreds of times over the centuries, and this is no different. It’s just the nature of a rip-roaring bull market. Fundamentals might be good for the first third or first 50 or 60 percent of a move, but the last third of a great bull market is typically a blow-off, whereas the mania runs wild and prices go parabolic.
august oil futures were crushed again today, and have fallen from a peak of $146.65 back to $129.29 as of this writing. to be sure, i can't say if the bubble has broken -- i just have to follow my analysis day by day. but signs are encouraging in my opinion. in a healthy bull there's simply no way oil trades down through iranian missile tests in the gulf; in retrospect i think many will think of that as a watershed moment. the mechanics of how oil prices are discovered, which propelled prices higher in a leveraging of the market, are likely to work in reverse as speculative credit gets harder to come by -- particularly once aggressive participants have taken, say, a 12% bath in four days and face margin calls. bulls will also face rapidly deteriorating demand fundamentals, which should manifest as persistent upside surprises in inventories.
we'll have to wait and see, of course -- bulls will likely be stubborn and probably not give up the entrenched supply pessimism of peak oil quickly, given that the dynamic is basically true if playing out on a different scale and timeframe from what they believe -- but for now, DUG @ 27 looks to have been a very good entry. there's certainly a chance for a bull stand here, though, with oil sitting on resistance at $130 and DUG right up against resistance at $36-37.
Labels: energy, markets, trading
charles schwab bank
like a great many people, i use a discount broker to trade. and like a great many discount brokers, mine -- schwab -- sweeps my cash balances into an FDIC-insured deposit account on which they pay nearly no interest. it serves the brokerage very well, as it is far more profitable for them to use their clients' idle cash to make loans than it is to run the money market fund that used to hold all that cash.
but the loan business has clearly grown hazardous since 2003, which is when schwab followed the lead of merrill lynch and many others in establishing their bank. and being a san francisco-based establishment -- officially reno, nevada, for the bank -- i've been suspicious of what exactly schwab might be holding with the cash they borrow from me.
let me say first that i am not a bank analyst. this is amateur sleuthing, and i welcome criticism.
using the regulatory FFIEC thrift financial report (TFR) data provided quarterly by schwab bank (technically a thrift, FDIC cert# 57450), one can see their past due and nonaccruing loans, and further calculate their texas ratio. this is an exercize i've indulged in with other banks through the FDIC call reports. for example, in the 1q2008 i estimated the texas ratio of national city to be about 71% (in desperate need of capital) -- and the same for marshall & ilsley of around 33% (with a guess at 2q following a scary conference call being 40%, bad and getting worse fast).
schwab bank, however, i found to be reporting just $23mm in troubled loans over nearly $900mm in tangible equity (that is, total equity less intangible assets) in 1q2008 -- a texas ratio around 3%. they carried virtually no REO.
this is a bank with nearly $16bn in assets. just $23mm in past due and nonaccruing loans into the worst housing cycle since the depression? for a california bank? something smells.
it took a bit of digging, but this paper from the chicago fed -- "who holds the toxic waste?" -- hints rather obliquely at where the body is buried.
as of 4q2005, schwab bank was one of the most deeply involved FDIC members in the country in collateralized mortgage obligations on an absolutel level, not to mention as a percentage of assets and of capital. their 4q2005 TFR showed that, of the $3.7bn in securities shown on schedule RC-B, fully $2.0bn -- in relation to $6.8bn in total assets and $540mm in tangible equity -- was private label CMOs, the difference being GSE instruments.
and this has if anything deepened in the time since the fed report was authored, per the FFIEC call report -- in 3q2007, of schwab's $13bn in assets, $8bn were MBS (inclusive of CMOs). of these, $2.8bn was held GSE instruments while $3.5bn was private-label and $1.5bn were 'other domestic debt securities' (which could be corporates or other flavors of securitized debt). that would be 445% of tangible equity ($787mm) in private-label MBS/CMOs alone -- headed into what has been an unmitigated disaster for mortgage-backed instruments of all kinds. there is no general valuation allowance set against the portfolio at all; this continued to hold true in 1q2008.
it has been discussed ad nauseum in the financial blogs how wall street is assiduously avoiding even realistic marks (much less marking to market) on the vast majority of asset-backed securities (most particularly those that are not backed by subprime mortgages). but as prime mortgage performance deficiency accelerates, this can not hold. these securities will find a mark at some point. and even if schwab bank's portfolio is of the highest caliber of private-label CMOs, those marks will be extremely damaging to capital. markit's ABS AAA-HE index for the second half of 2007 is indicating such instruments to be valued at less than 50 cents on the dollar. even if we presume that the ABX index is overwrought (as it may be), it would take only 80 cents on the dollar of schwab's portfolio to eradicate the bank's equity stake.
the position of merrill's banks is similar, though of course they aren't standalone publicly traded entities. but one has only to go back a few months to remember the reaction when merrill first revealed its huge CMO exposure through its banking units.
the fed's working paper from that long-ago era of naivete known as 2006 all but dismissed the loss of principal as a risk -- it was concerned far more with prepayment risk in a rising interest rate environment to banks with high levels of CMO exposure. that concern has faded, obviously, for the moment.
to be sure, it is possible that schwab has so effectively hedged their default risk that they are not experiencing significant difficulty. but that certainly hasn't been the case for the much-scrutinized merrill, which as an investment bank makes hedging its business. and an examination of schwab's 9/30/7 TFR schedule RC-L shows no credit derivatives whatsoever. (though it does show $2.6bn in undrawn HELOCs.) merrill's bank, in contraposition, was the beneficiary of about $8bn in credit default swaps in that period.
it's quite odd that schwab bank is reporting such minimal past due and nonaccrual on its whole mortgage portfolio -- the 1q2008 report further shows that the bank claims not to have foreclosed on anyone in the quarter, which is difficult to imagine in this environment. schwab publicly attributes the fact to "ongoing financial discipline", which strikes me as a bit too thick a layer of self-serving corporatespeak to be true. but the potentially unhedged exposure to CMOs is what should really drive nervousness surrounding this bank, in my (admittedly amateur) opinion. i'll be more careful not to leave cash balances over the FDIC insurance limit uninvested in schwab's brokerage accounts, instead channeling unused funds into treasury-backed money market shares.
one should further note, however, that the broader firm charles schwab & co., of which the bank is a subsidiary, would probably shoulder the implosion and writeoffs on a $4-5bn subsidiary CDO portfolio without existential threat.
but the loan business has clearly grown hazardous since 2003, which is when schwab followed the lead of merrill lynch and many others in establishing their bank. and being a san francisco-based establishment -- officially reno, nevada, for the bank -- i've been suspicious of what exactly schwab might be holding with the cash they borrow from me.
let me say first that i am not a bank analyst. this is amateur sleuthing, and i welcome criticism.
using the regulatory FFIEC thrift financial report (TFR) data provided quarterly by schwab bank (technically a thrift, FDIC cert# 57450), one can see their past due and nonaccruing loans, and further calculate their texas ratio. this is an exercize i've indulged in with other banks through the FDIC call reports. for example, in the 1q2008 i estimated the texas ratio of national city to be about 71% (in desperate need of capital) -- and the same for marshall & ilsley of around 33% (with a guess at 2q following a scary conference call being 40%, bad and getting worse fast).
schwab bank, however, i found to be reporting just $23mm in troubled loans over nearly $900mm in tangible equity (that is, total equity less intangible assets) in 1q2008 -- a texas ratio around 3%. they carried virtually no REO.
this is a bank with nearly $16bn in assets. just $23mm in past due and nonaccruing loans into the worst housing cycle since the depression? for a california bank? something smells.
it took a bit of digging, but this paper from the chicago fed -- "who holds the toxic waste?" -- hints rather obliquely at where the body is buried.
as of 4q2005, schwab bank was one of the most deeply involved FDIC members in the country in collateralized mortgage obligations on an absolutel level, not to mention as a percentage of assets and of capital. their 4q2005 TFR showed that, of the $3.7bn in securities shown on schedule RC-B, fully $2.0bn -- in relation to $6.8bn in total assets and $540mm in tangible equity -- was private label CMOs, the difference being GSE instruments.and this has if anything deepened in the time since the fed report was authored, per the FFIEC call report -- in 3q2007, of schwab's $13bn in assets, $8bn were MBS (inclusive of CMOs). of these, $2.8bn was held GSE instruments while $3.5bn was private-label and $1.5bn were 'other domestic debt securities' (which could be corporates or other flavors of securitized debt). that would be 445% of tangible equity ($787mm) in private-label MBS/CMOs alone -- headed into what has been an unmitigated disaster for mortgage-backed instruments of all kinds. there is no general valuation allowance set against the portfolio at all; this continued to hold true in 1q2008.
it has been discussed ad nauseum in the financial blogs how wall street is assiduously avoiding even realistic marks (much less marking to market) on the vast majority of asset-backed securities (most particularly those that are not backed by subprime mortgages). but as prime mortgage performance deficiency accelerates, this can not hold. these securities will find a mark at some point. and even if schwab bank's portfolio is of the highest caliber of private-label CMOs, those marks will be extremely damaging to capital. markit's ABS AAA-HE index for the second half of 2007 is indicating such instruments to be valued at less than 50 cents on the dollar. even if we presume that the ABX index is overwrought (as it may be), it would take only 80 cents on the dollar of schwab's portfolio to eradicate the bank's equity stake.
the position of merrill's banks is similar, though of course they aren't standalone publicly traded entities. but one has only to go back a few months to remember the reaction when merrill first revealed its huge CMO exposure through its banking units.
the fed's working paper from that long-ago era of naivete known as 2006 all but dismissed the loss of principal as a risk -- it was concerned far more with prepayment risk in a rising interest rate environment to banks with high levels of CMO exposure. that concern has faded, obviously, for the moment.
to be sure, it is possible that schwab has so effectively hedged their default risk that they are not experiencing significant difficulty. but that certainly hasn't been the case for the much-scrutinized merrill, which as an investment bank makes hedging its business. and an examination of schwab's 9/30/7 TFR schedule RC-L shows no credit derivatives whatsoever. (though it does show $2.6bn in undrawn HELOCs.) merrill's bank, in contraposition, was the beneficiary of about $8bn in credit default swaps in that period.
it's quite odd that schwab bank is reporting such minimal past due and nonaccrual on its whole mortgage portfolio -- the 1q2008 report further shows that the bank claims not to have foreclosed on anyone in the quarter, which is difficult to imagine in this environment. schwab publicly attributes the fact to "ongoing financial discipline", which strikes me as a bit too thick a layer of self-serving corporatespeak to be true. but the potentially unhedged exposure to CMOs is what should really drive nervousness surrounding this bank, in my (admittedly amateur) opinion. i'll be more careful not to leave cash balances over the FDIC insurance limit uninvested in schwab's brokerage accounts, instead channeling unused funds into treasury-backed money market shares.
one should further note, however, that the broader firm charles schwab & co., of which the bank is a subsidiary, would probably shoulder the implosion and writeoffs on a $4-5bn subsidiary CDO portfolio without existential threat.
Labels: economics, markets, trading
Wednesday, July 16, 2008
how does it feel?
kevin depew on the blissful ignorance of popular culture as depression sets in. it is going as unacknowledged today as it did then -- but depew rightly notes that The Fear is accumulating like water behind an earthen dam which will later break.
as fascinating as one can find the boggling mechanics of this credit bust, the social dynamic is even more engrossing. watching as policymakers -- who, i am convinced, are deeply aware of their role in perpetrating the disaster, at least of refusing to take the steps that could have mitigated it -- flail against shortsellers is a mesmerizing statement of political desperation. watching the slow dawning of the extent of the troubles on blithe mainstream americans, heretofore completely ignorant of how exactly they got a mortgage, is fascinating. being able to look back at months and years of propagation from the cult of official optimism -- does anyone remember when this was all "contained"? -- and see it for the self-serving and dissembling fraud it was is fascinating. i sometimes feel as though i'm having an out-of-body experience that has lasted months -- a remote observer, maybe a voyeur of a system laid bare, rubbernecking at a terrible highway crash that i can't seem to drive past.
but that can't last, can it? after decades of moving toward a regrettable extreme of individuation, i imagine that we will soon rediscover just how much 'of a whole' we truly are. few and little will be left untouched. i'm sure my family will be no exception.
as fascinating as one can find the boggling mechanics of this credit bust, the social dynamic is even more engrossing. watching as policymakers -- who, i am convinced, are deeply aware of their role in perpetrating the disaster, at least of refusing to take the steps that could have mitigated it -- flail against shortsellers is a mesmerizing statement of political desperation. watching the slow dawning of the extent of the troubles on blithe mainstream americans, heretofore completely ignorant of how exactly they got a mortgage, is fascinating. being able to look back at months and years of propagation from the cult of official optimism -- does anyone remember when this was all "contained"? -- and see it for the self-serving and dissembling fraud it was is fascinating. i sometimes feel as though i'm having an out-of-body experience that has lasted months -- a remote observer, maybe a voyeur of a system laid bare, rubbernecking at a terrible highway crash that i can't seem to drive past.
but that can't last, can it? after decades of moving toward a regrettable extreme of individuation, i imagine that we will soon rediscover just how much 'of a whole' we truly are. few and little will be left untouched. i'm sure my family will be no exception.
Labels: culture
another step toward 1931?
headline inflation surged in june, per bloomberg.
it is essential to note that these effects are largely a product of commodity price increases -- and they are decidedly not inflation per se, that is the expansion of the supply of money. northern trust's paul kasriel demonstrates that bank credit is crashing as it hasn't since the depression. costs are not passing through to consumers as measured by core rates, and that is exemplified best by kasriel's chart 20. profit margins in american business are being annihiliated by the inversion of input costs and output revenues -- fewer and fewer are making any money -- just as their ability to finance themselves through a bad spell has totally evaporated.
when such a condition arrives in the aftermath of a debt boom, the consequences are bankrupting. when it arrives in the aftermath of the greatest debt boom in the history of this nation, the consequences are potentially catastrophic. corporate bankruptcies have only just begun. only the cash-rich weather this kind of thing well.
consider this in light of the banks, who have thusfar largely suffered as a result of loan malperformance in the residential and residential construction space -- and this has been enough for some. only recently have they begun to see deterioration in credit cards and auto loans. now plaster these same institutions with expanding corporate failures and defaults.
many nonfinancial companies, it has been noted, have been drawing down credit facilities in recent months in an effort to stockpile cash. this created a burst of m3 expansion that many casual observers confused for federal reserve printing, as those drawn funds found their way into broad money market aggregates. but the net effect has been to further weaken the credit position of the banks. should such debt-heavy corporations as drew down those lines in anticipation of their cancellation start to fail, creating yet another wave of losses for american finance, the ramifications will be felt internationally.
the federal reserve under ben bernanke is now stuck with respect to interest rates. deeply negative real rates -- the difference between trailing headline CPI and fed funds is over (-3%) -- have proven completely ineffective in generating credit expansion because banks are capitally incapacitated and becoming moreso as housing falls further into the post-securitization abyss. what they have likely facilitated, however, is a massive binge of speculation and runaway inflation and hoarding in dollar-peg economies in the third world. both are contributing to the massive rise in raw material input costs. low policy rates are not helping american business -- they are now destroying it.
what low policy rates are also doing, however, is minimizing the cost of funding for american banks and keeping them minimally liquid via positive carry -- that is, the fed is playing directly to its banking constituency, at the expense of american manufacturing and services industries. if they reverse course, it would likely be a 1931 moment in the face of now-collapsing money supply.
damned if they do, damned if they don't.
the federal reserve has been concentrating on the 'full employment' aspect of its mandate -- but if the oil bubble does not break proximately, i don't know what alternative the fed will have but to follow the ECB and hike rates to quash speculation and kill third world demand for the sake of 'price stability'. certainly raising margin requirements in commodities markets would be welcome. moreover, any thoughts about guaranteeing the debt instruments of fannie mae and freddie mac must be backburnered -- as accrued interest noted, united states treasury debt sold off on credit quality concerns for the first time since the 1970s. did anyone even know that one could buy a credit default swap on the united states before the FNM/FRE bailout talk started? the price of one has suddenly risen elevenfold. merrill lynch can credibly talk about the government of the united states facing a "financing crisis within months".
they're absolutely right to point out that not only is this as bad as previous financial crises, but that it might be worse than the most notorious one of the last thirty years because of foreign financing dependence. (UPDATE: and, as a corollary, a near-zero consumer savings rate.) the dollar has been conveniently neglected for a long time, but its turn has come to be protected on some level.
that said, i think the oil bubble is breaking as margined speculators are feeling the credit pinch and fearing anything like a significant fall. that would probably allow the fed to stay on a neutral course with policy rates. one has merely to hope that george w. bush doesn't attempt to remove all doubt that he is the least competent executive in the history of the united states. this is a very important caveat, as -- following up on months of preparing the battlefield -- the idiot-in-chief is apparently 'amber-lighting' plans for the american-mideastern proxy state to instigate what may well end up being a regional war. short oil stocks -- but keep a stop-loss order in the system beneath them.
even with amenable oil, however, there are other, more inexorable forces afoot in the currency sphere. per michael pettis, pressure is increasing in china for the appreciation of the yuan to accelerate. this would have the great intermediate-term benefit of moderating chinese inflation and cutting speculative inflows to the country, even though the transition could be disruptive. it is also the long term policy goal of the chinese government as they move to a free floating currency from a dollar peg, which will likely allow the yuan to become the de facto reserve currency of the far east (with all the implied benefits). as demonstrated by private research i've had the pleasure of reading, many highlight the potential cost to china -- particularly forex losses on its massive dollar-debt holdings -- but ignore the manifold benefits. a stronger yuan would reduce the cost of oil for china in local terms, and this benefit alone given the rate of oil consumption in china would all but offset all the forex losses. its export sector would be hampered on the lowest end, but china is already in the process of moving its manufacturing capacity up the scale of finished goods into more complicated products (such as cars and semiconductors) where there are simply no viable competitors in the world on quantity and price. the net cost to china of revaluation is widely overestimated in the united states -- largely out of wishful thinking, i suspect.
again, the hope is that a fall in oil prices thanks to demand destruction and clipped speculation would forestall the pressure to appreciate the yuan, at least out beyond the six months that merrill is speculating above. but for the united states, increasingly rapid yuan revaluation would almost certainly mean the end of the debt supercycle and vendor finance -- and would shift the current credit contraction into a much higher gear, as it would effectively remove from the field the primary creditor of both the american government and the GSEs. the kind of collapse that would come in america following a sudden yuan appreciation would be a life-changing event for all americans. it is going to happen in the not-so-distant future -- but i think we should universally hope that it doesn't this year or next.
``Inflation has galloped,'' Michael Feroli, an economist at JPMorgan Chase & Co. in New York, said before the report. ``It puts the Fed in a really tricky position. I don't see how they can change rates this year.''
Consumer prices were forecast to rise 0.7 percent, according to the median forecast of 79 economists in a Bloomberg News survey. Estimates ranged from gains of 0.2 percent to 1.1 percent. Costs excluding food and energy were forecast to rise 0.2 percent, the survey showed.
Prices increased 5 percent in the 12 months to June, the most since May 1991. They were forecast to climb 4.5 percent from a year earlier, according to the survey median.
... Wholesale prices rose 1.8 percent in June, the most in seven months, the Labor Department reported yesterday. From a year ago, prices climbed 9.2 percent, the biggest surge since 1981.
it is essential to note that these effects are largely a product of commodity price increases -- and they are decidedly not inflation per se, that is the expansion of the supply of money. northern trust's paul kasriel demonstrates that bank credit is crashing as it hasn't since the depression. costs are not passing through to consumers as measured by core rates, and that is exemplified best by kasriel's chart 20. profit margins in american business are being annihiliated by the inversion of input costs and output revenues -- fewer and fewer are making any money -- just as their ability to finance themselves through a bad spell has totally evaporated.when such a condition arrives in the aftermath of a debt boom, the consequences are bankrupting. when it arrives in the aftermath of the greatest debt boom in the history of this nation, the consequences are potentially catastrophic. corporate bankruptcies have only just begun. only the cash-rich weather this kind of thing well.
consider this in light of the banks, who have thusfar largely suffered as a result of loan malperformance in the residential and residential construction space -- and this has been enough for some. only recently have they begun to see deterioration in credit cards and auto loans. now plaster these same institutions with expanding corporate failures and defaults.
many nonfinancial companies, it has been noted, have been drawing down credit facilities in recent months in an effort to stockpile cash. this created a burst of m3 expansion that many casual observers confused for federal reserve printing, as those drawn funds found their way into broad money market aggregates. but the net effect has been to further weaken the credit position of the banks. should such debt-heavy corporations as drew down those lines in anticipation of their cancellation start to fail, creating yet another wave of losses for american finance, the ramifications will be felt internationally.
the federal reserve under ben bernanke is now stuck with respect to interest rates. deeply negative real rates -- the difference between trailing headline CPI and fed funds is over (-3%) -- have proven completely ineffective in generating credit expansion because banks are capitally incapacitated and becoming moreso as housing falls further into the post-securitization abyss. what they have likely facilitated, however, is a massive binge of speculation and runaway inflation and hoarding in dollar-peg economies in the third world. both are contributing to the massive rise in raw material input costs. low policy rates are not helping american business -- they are now destroying it.
what low policy rates are also doing, however, is minimizing the cost of funding for american banks and keeping them minimally liquid via positive carry -- that is, the fed is playing directly to its banking constituency, at the expense of american manufacturing and services industries. if they reverse course, it would likely be a 1931 moment in the face of now-collapsing money supply.
damned if they do, damned if they don't.
the federal reserve has been concentrating on the 'full employment' aspect of its mandate -- but if the oil bubble does not break proximately, i don't know what alternative the fed will have but to follow the ECB and hike rates to quash speculation and kill third world demand for the sake of 'price stability'. certainly raising margin requirements in commodities markets would be welcome. moreover, any thoughts about guaranteeing the debt instruments of fannie mae and freddie mac must be backburnered -- as accrued interest noted, united states treasury debt sold off on credit quality concerns for the first time since the 1970s. did anyone even know that one could buy a credit default swap on the united states before the FNM/FRE bailout talk started? the price of one has suddenly risen elevenfold. merrill lynch can credibly talk about the government of the united states facing a "financing crisis within months".
The country depends on Asian, Russian and Middle Eastern investors to fund much of its $700bn (£350bn) current account deficit, leaving it far more vulnerable to a collapse of confidence than Japan in the early 1990s after the Nikkei bubble burst. Britain and other Anglo-Saxon deficit states could face a similar retreat by foreign investors.
"Japan was able to cut its interest rates to zero," said Alex Patelis, Merrill's head of international economics.
"It would be very difficult for the US to do this. Foreigners will not be willing to supply the capital. Nobody knows where the limit lies."
they're absolutely right to point out that not only is this as bad as previous financial crises, but that it might be worse than the most notorious one of the last thirty years because of foreign financing dependence. (UPDATE: and, as a corollary, a near-zero consumer savings rate.) the dollar has been conveniently neglected for a long time, but its turn has come to be protected on some level.
that said, i think the oil bubble is breaking as margined speculators are feeling the credit pinch and fearing anything like a significant fall. that would probably allow the fed to stay on a neutral course with policy rates. one has merely to hope that george w. bush doesn't attempt to remove all doubt that he is the least competent executive in the history of the united states. this is a very important caveat, as -- following up on months of preparing the battlefield -- the idiot-in-chief is apparently 'amber-lighting' plans for the american-mideastern proxy state to instigate what may well end up being a regional war. short oil stocks -- but keep a stop-loss order in the system beneath them.
even with amenable oil, however, there are other, more inexorable forces afoot in the currency sphere. per michael pettis, pressure is increasing in china for the appreciation of the yuan to accelerate. this would have the great intermediate-term benefit of moderating chinese inflation and cutting speculative inflows to the country, even though the transition could be disruptive. it is also the long term policy goal of the chinese government as they move to a free floating currency from a dollar peg, which will likely allow the yuan to become the de facto reserve currency of the far east (with all the implied benefits). as demonstrated by private research i've had the pleasure of reading, many highlight the potential cost to china -- particularly forex losses on its massive dollar-debt holdings -- but ignore the manifold benefits. a stronger yuan would reduce the cost of oil for china in local terms, and this benefit alone given the rate of oil consumption in china would all but offset all the forex losses. its export sector would be hampered on the lowest end, but china is already in the process of moving its manufacturing capacity up the scale of finished goods into more complicated products (such as cars and semiconductors) where there are simply no viable competitors in the world on quantity and price. the net cost to china of revaluation is widely overestimated in the united states -- largely out of wishful thinking, i suspect.
again, the hope is that a fall in oil prices thanks to demand destruction and clipped speculation would forestall the pressure to appreciate the yuan, at least out beyond the six months that merrill is speculating above. but for the united states, increasingly rapid yuan revaluation would almost certainly mean the end of the debt supercycle and vendor finance -- and would shift the current credit contraction into a much higher gear, as it would effectively remove from the field the primary creditor of both the american government and the GSEs. the kind of collapse that would come in america following a sudden yuan appreciation would be a life-changing event for all americans. it is going to happen in the not-so-distant future -- but i think we should universally hope that it doesn't this year or next.
Labels: china, economics, energy, food, housing, iran, israel, markets, politics, trading
hi gm, great post. i've always said china would not pull any plugs before the olympics. i think they will be quick about it afterwards though. hope i'm wrong.
love your comments on bush - please check out my simple blog. (see my short sections "about the blog" and "about me.") i'd be honored. also, got your blog listed as one of my faves. thanks and best regards - - darkcloud
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love your comments on bush - please check out my simple blog. (see my short sections "about the blog" and "about me.") i'd be honored. also, got your blog listed as one of my faves. thanks and best regards - - darkcloud
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Tuesday, July 15, 2008
understand how desperate leadership is
if you had any question in your mind about the powerlessness of officialdom in the face of this credit unwind, put it to rest. this is an act of panicked animals lashing out.
if we're going to see a crash...
... it's going to be today.
but time is probably better spent preparing for what to buy in the aftermath of a turnaround.
UPDATE: the answer is QLD and UYG, which i bought this morning as markets recovered from their early swoon. could easily be madness, but improving participation in the last two weeks in combination with implied volatility at upside outlier levels makes me game for a trade. maintaining positions in DUG and short FXI.
but time is probably better spent preparing for what to buy in the aftermath of a turnaround.
UPDATE: the answer is QLD and UYG, which i bought this morning as markets recovered from their early swoon. could easily be madness, but improving participation in the last two weeks in combination with implied volatility at upside outlier levels makes me game for a trade. maintaining positions in DUG and short FXI.
Labels: trading
Monday, July 14, 2008
bank credit, monetary aggregates now contracting
indymac fails
following intense rumors and its move for help, indymac failed on friday and reopened today under the management of the FDIC. it is now the biggest american bank failure since continental illinois in 1984.
much web comment. calculated risk on coming bank failures and the moral hazard of FDIC deposit insurance. note that the new york times is reporting analyst opinion that as many as 150 banks could fail in the next year.
much web comment. calculated risk on coming bank failures and the moral hazard of FDIC deposit insurance. note that the new york times is reporting analyst opinion that as many as 150 banks could fail in the next year.
Friday, July 11, 2008
closed out shorts
thanks to improving upside participation going back to june 27 in the s&p 500 and july 1 in the NDX, i cut and run on QID and SKF this afternoon once prices started to move north in earnest, at neither the highs nor the lows of the day.
of note, one element the implied volatility divergence i look at (a MACD on the index measures) reached oversold levels a few days ago, and the other element (spread between index measures and an intermediate-term moving average) will or will be very close today unless index implied volatility (finally jumpy after weeks of trepidation) crashes out the rest of the day. an average true range/cross correlation study is split -- the average ATR for an s&p stock is now some 12% over the 21-day average, an oversold signal, but other studies of correlation indicate a lower low is out there.
another view of index implied volatility -- the volatility curve, measuring the spread between the cash VIX and its 3- and 6-month forward futures -- jumped into oversold territory. same is true of the VIX:VXN ratio.
however, it's far from unanimous -- isee put/call sentiment data, for instance, isn't demonstrating the kind of negativity that usually marks intermediate bottoms.
i haven't the courage of conviction such that i went long. to be honest, i feel another downside stab is entirely possible next week -- possibly even something fearsome. notably, we haven't got the 90% upside day that often marks the beginning of tradable rallies to break a string of 90% down days. (the exception is in the IYF/SKF basket, which did have such a day on july 8 -- its first since may 1.) but an oversold bounce looks increasingly likely to me, and so i'm out to protect gains. it's okay to leave some money on the table, if that's what i'm doing.
QID gains from 6/3 amounted to about 16%. SKF gains from 4/22 came to a rude 59%.
i remain short the oil and gas complex via DUG, and hold a token short of FXI.
of note, one element the implied volatility divergence i look at (a MACD on the index measures) reached oversold levels a few days ago, and the other element (spread between index measures and an intermediate-term moving average) will or will be very close today unless index implied volatility (finally jumpy after weeks of trepidation) crashes out the rest of the day. an average true range/cross correlation study is split -- the average ATR for an s&p stock is now some 12% over the 21-day average, an oversold signal, but other studies of correlation indicate a lower low is out there.
another view of index implied volatility -- the volatility curve, measuring the spread between the cash VIX and its 3- and 6-month forward futures -- jumped into oversold territory. same is true of the VIX:VXN ratio.
however, it's far from unanimous -- isee put/call sentiment data, for instance, isn't demonstrating the kind of negativity that usually marks intermediate bottoms.
i haven't the courage of conviction such that i went long. to be honest, i feel another downside stab is entirely possible next week -- possibly even something fearsome. notably, we haven't got the 90% upside day that often marks the beginning of tradable rallies to break a string of 90% down days. (the exception is in the IYF/SKF basket, which did have such a day on july 8 -- its first since may 1.) but an oversold bounce looks increasingly likely to me, and so i'm out to protect gains. it's okay to leave some money on the table, if that's what i'm doing.
QID gains from 6/3 amounted to about 16%. SKF gains from 4/22 came to a rude 59%.
i remain short the oil and gas complex via DUG, and hold a token short of FXI.
Labels: trading
moving to a new form of mortgage finance
minyan peter assesses the future prospects for the american mortgage finance market.
this is an eminently reasonable line of thought. but its consequences are disturbing.
i often say that FNM/FRE will be nationalized, but what is nationalization? in this case, as minyan peter suggests, it probably does not entail moving the GSEs onto the government balance sheet. they are too large, their funding requirements too onerous for a government already deeply in debt, for that to be the first option.
moving to a covered bond format in the distant future seems very possible, but what are its near term ramifications? this is private finance, and the covered bond market in europe has been shuttered for a year. capital is currently too threatened to step into a quagmire of highly questionable valuations and bottomless house price forecasts. so the chances of a workable covered bond market in the near term seem very remote to me -- and if one is attempted, i would expect the flow of capital to mortgage markets to be severely restricted.
while this is sensible capitalism, government is highly unlikely to allow the scenario to unfold so disruptively without massive intervention. rather than putting FNM/FRE into runoff, then, and making that transition, i would expect the former -- a capital injection to prop up government's favorite housing policy tools. given the movement in equity prices, that injection is likely to come sooner rather than later -- again, as minyan peter suggested, before monday's open. this will allow congress to seek a more permanent solution while continuing to allow FNM/FRE to support the mortgage market in which it is now at least 80% of the activity.
plenty of discussion on the web. calculated risk notes that an outright debt guarantee is a potentially friendly solution as, despite the balance sheet size, the imbalance of assets to liabilities is (at this stage, anyway) not overwhelming. i suspect the markets would treat it with much suspicion, however -- see john jansen -- and it would in any case represent another example of government going to the credit well and thereby forcing private credit need to thirst. he doesn't see the point of conservatorship, which is the initial direction of the white house per the new york times (via yves smith). mish considers the mess too big to bail. paul kedrosky and david merkel weigh in as well, with merkel making the important point that the federal reserve is essentially powerless here due to the immense size of the GSEs, which dwarf the central bank, and the dire nonexistent likelihood that the fed would print enough currency to expand itself to relevant size.
merkel, moreover, looking to the intermediate term:
minyan peter writes that FHA and FHLB will step into the gap, but merkel notes that they won't be big enough to fill it completely. mortgage markets are likely to see a decrease in the capacity to make mortgages here barring radical congressional action to expand federal borrowing to bolster FHLB. even then, would private banking expand to make the mortgages? the implication is more gas on the housing bonfire.
UPDATE: to underscore market aversion to a government takeover of FNM/FRE, per john jansen today saw treasury securites crumble on the possibility of a GSE debt guarantee by the treasury. in parallel, credit default swaps on the united states treasury (yep) surged to a record high. given these signals, it's that much more likely that instead the GSEs are infused with capital at some point.
The US Government will not explicitly guarantee the debt of Fannie and Freddie, but rather will either inject capital (super senior preferred stock subordinated debt a la a Continental Illinois style bailout) or provide a “make-whole” guaranty on the assets of both companies (a la an FDIC/RTC style failing bank resolution). The choice of the former suggests a “going concern” for the GSEs, while the latter suggests an orderly wind-down.
In either case there's considerable historical precedence. And either choice implies that the common stock of both companies is worthless and the preferred stock value is at best uncertain.
If Freddie and Fannie are placed into conservatorship and are wound down (the second choice), I expect that the US mortgage market will move quickly to the covered bond format that is common to the Europe mortgage market. (And for a quicker primer click here.)
I believe that Hank Paulson began laying the public groundwork for this on Tuesday when he stated at the FDIC conference that “…as Treasury seeks to encourage new sources of mortgage funding in the United States, improve underwriting standards and strengthen financial institutions' balance sheets, covered bonds have the potential to serve these purposes and reduce the costs for first-time home buyers, and for existing homeowners to refinance.”
this is an eminently reasonable line of thought. but its consequences are disturbing.
i often say that FNM/FRE will be nationalized, but what is nationalization? in this case, as minyan peter suggests, it probably does not entail moving the GSEs onto the government balance sheet. they are too large, their funding requirements too onerous for a government already deeply in debt, for that to be the first option.
moving to a covered bond format in the distant future seems very possible, but what are its near term ramifications? this is private finance, and the covered bond market in europe has been shuttered for a year. capital is currently too threatened to step into a quagmire of highly questionable valuations and bottomless house price forecasts. so the chances of a workable covered bond market in the near term seem very remote to me -- and if one is attempted, i would expect the flow of capital to mortgage markets to be severely restricted.
while this is sensible capitalism, government is highly unlikely to allow the scenario to unfold so disruptively without massive intervention. rather than putting FNM/FRE into runoff, then, and making that transition, i would expect the former -- a capital injection to prop up government's favorite housing policy tools. given the movement in equity prices, that injection is likely to come sooner rather than later -- again, as minyan peter suggested, before monday's open. this will allow congress to seek a more permanent solution while continuing to allow FNM/FRE to support the mortgage market in which it is now at least 80% of the activity.
plenty of discussion on the web. calculated risk notes that an outright debt guarantee is a potentially friendly solution as, despite the balance sheet size, the imbalance of assets to liabilities is (at this stage, anyway) not overwhelming. i suspect the markets would treat it with much suspicion, however -- see john jansen -- and it would in any case represent another example of government going to the credit well and thereby forcing private credit need to thirst. he doesn't see the point of conservatorship, which is the initial direction of the white house per the new york times (via yves smith). mish considers the mess too big to bail. paul kedrosky and david merkel weigh in as well, with merkel making the important point that the federal reserve is essentially powerless here due to the immense size of the GSEs, which dwarf the central bank, and the dire nonexistent likelihood that the fed would print enough currency to expand itself to relevant size.
merkel, moreover, looking to the intermediate term:
Two notes on the politics here: the Bush Administration wins, and loses. Wins, because they end the dominance of the GSEs in a bigger way than they ever could have imagined. Loses, because they can’t use them to support the mortgage market any more. Can the FHLB pick up the slack without them? I doubt it, at least not fully. The FHA isn’t big enough either.
minyan peter writes that FHA and FHLB will step into the gap, but merkel notes that they won't be big enough to fill it completely. mortgage markets are likely to see a decrease in the capacity to make mortgages here barring radical congressional action to expand federal borrowing to bolster FHLB. even then, would private banking expand to make the mortgages? the implication is more gas on the housing bonfire.
UPDATE: to underscore market aversion to a government takeover of FNM/FRE, per john jansen today saw treasury securites crumble on the possibility of a GSE debt guarantee by the treasury. in parallel, credit default swaps on the united states treasury (yep) surged to a record high. given these signals, it's that much more likely that instead the GSEs are infused with capital at some point.
Labels: economics, housing, markets, politics
Thursday, July 10, 2008
fannie, freddie "insolvent"
says no less a personage than a highly respected former federal reserve bank president.
the way is being prepared for outright nationalization, as john jansen and others have noted, probably along the bear stearns model which all but wiped out equity holders. per calculated risk, it's also above the fold for the wall street journal this morning. the public is being prepared through official mouthpieces, it seems to me.
poole is a longtime GSE critic.
but, though one can argue around the margins, the truth of what he is saying should be plain. the GSEs have been put on the path to a de facto nationalization (whether or not is is euphemized) by its reckless growth and leveraging leading up to the credit crunch. it doesn't matter what its executives say -- they would tell any lie now to avert public criticism and market skepticism.
congress will be forced to bring the GSEs back on balance sheet soon, though quite probably with an intermediate step involving a federal reserve rescue and bridge. that in itself will enable FNM and FRE to become explicit policy tools in the effort to nationalize the american mortgage market, becoming conduits for federal handouts through both availability and pricing. such a change would likely forestall some of the inevitable reversion of home prices to traditional price-to-income valuations and conditions of positive carry for investors -- though it may only exacerbate the inavailability of private credit, as was postulated by hoisington investment management this week.
UPDATE: more important than the GSE equity -- which is again being savaged, with FRE down (-25%) just today! -- is the bonds. GSE debt instruments underpin a lot of the american financial system, and they are being annihiliated this morning. per bloomberg:
those company bonds are on the balance sheets of every significant bank in the west.
Fannie Mae paid a record yield relative to Treasuries on the sale of $3 billion in two-year notes yesterday amid concern the biggest provider of financing for U.S. home loans won't have enough capital to weather the worst housing slump since the Great Depression. The company's credit-default swaps show traders are treating the AAA rated debt as if it were five steps lower. Fannie Mae shares tumbled 13 percent yesterday in New York to the lowest level in almost 14 years.
Chances are increasing that the U.S. may need to bail out Fannie Mae and the smaller Freddie Mac, former St. Louis Federal Reserve President William Poole said in an interview. Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules, he said. The fair value of Fannie Mae's assets fell 66 percent to $12.2 billion, data provided by the Washington-based company show, and may be negative next quarter, Poole said.
``Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer,'' Poole, 71, who left the Fed in March, said in the interview yesterday.
the way is being prepared for outright nationalization, as john jansen and others have noted, probably along the bear stearns model which all but wiped out equity holders. per calculated risk, it's also above the fold for the wall street journal this morning. the public is being prepared through official mouthpieces, it seems to me.
poole is a longtime GSE critic.
While leading the St. Louis Fed, Poole roiled markets in 2003 when he said the government should consider severing its implied backing of Fannie Mae and Freddie Mac and said the companies lack the capital to weather financial market disruptions. In 2006 and 2007 he called for lawmakers to strip Fannie Mae and Freddie Mac of their charters.
but, though one can argue around the margins, the truth of what he is saying should be plain. the GSEs have been put on the path to a de facto nationalization (whether or not is is euphemized) by its reckless growth and leveraging leading up to the credit crunch. it doesn't matter what its executives say -- they would tell any lie now to avert public criticism and market skepticism.
congress will be forced to bring the GSEs back on balance sheet soon, though quite probably with an intermediate step involving a federal reserve rescue and bridge. that in itself will enable FNM and FRE to become explicit policy tools in the effort to nationalize the american mortgage market, becoming conduits for federal handouts through both availability and pricing. such a change would likely forestall some of the inevitable reversion of home prices to traditional price-to-income valuations and conditions of positive carry for investors -- though it may only exacerbate the inavailability of private credit, as was postulated by hoisington investment management this week.
UPDATE: more important than the GSE equity -- which is again being savaged, with FRE down (-25%) just today! -- is the bonds. GSE debt instruments underpin a lot of the american financial system, and they are being annihiliated this morning. per bloomberg:
The companies, created to boost homeownership and promote market stability, own or guarantee about half the $12 trillion in U.S. home loans outstanding. In addition to those obligations, Fannie Mae has $831 billion in company bonds outstanding, while Freddie Mac has $644 billion, according to Bloomberg data.
those company bonds are on the balance sheets of every significant bank in the west.
Labels: economics, housing, markets, politics
Wednesday, July 09, 2008
fannie, freddie tagged again
on the heels of a spectacular down day monday and with a big surge in between, GSE shares are being walloped again. FRE is down over (-18%) at this writing to 11.01 and testing its monday lows. FNM is down over (-10%) at 15.85, still above its monday lows around 15.
UPDATE: freddie settled at 10.26, fannie 15.31. across the curve notes:
UPDATE: freddie settled at 10.26, fannie 15.31. across the curve notes:
In my opinion the market’s relentless hounding of Freddie and FNMA stock indicates a collective belief that the fundamental manner in which these companies do business is about to be altered. I am not sure if that is today or tomorrow but the ever efficient market is discounting that possibility as we speak.
It is also interesting that the debt has barely budged. That speaks volumes and in the background we can hear the choir chanting soto voce,”Bear Stearns”. I think that the market expects that the nationalization of the GSE will follow the template of the Bear Stearns takeover. In that case the shareholders were thrown (aggressively) under the bus and debt holders survived. I think that will be the outcome here, too.
I wrote facetiously yesterday that the government takeover legislation of FNMA and Freddie Mac would be the first piece of legislation signed by President Obama in January 2009. It is beginning to look as though that might be the final act of the lamest of lame ducks, George Bush.
short oil with impunity
at the risk of hyperbole -- if, on a day when iran test-fires missiles around its oil-shipping-choked gulf, the price of oil trades down at any point... then it seems clear that the bubble is bursting.
UPDATE: yves smith with a hilarious anecdote that might mark the top.
UPDATE: yves smith with a hilarious anecdote that might mark the top.
deflation at work
mish through minyanville offers a brilliant anecdote of how deflation is undermining wages and (yes) even prices as we speak.
this mechanism is at work in business small and large alike -- witness massive layoffs driving unemployment higher and credit standards tightening, and one can see the chances of a wage-price spiral that would drive an inflationary spiral are simply zero. there may come a desperate time when the government takes a conscious step to debase the dollar through printing -- but it will likely be in response to an incipient deflation taking strong hold of the american credit-based economy.
john mauldin passes on more excellent research from hoisington investment management on why deflation is the next war.
i've been harping in credit availability/contraction as the arbiter of our future path. some others view government fiscal stimulus as a potential offset for private sector trepidation. i've never subscribed to that -- the credit pie is too large, and incremental changes in it will chew through overwhelm even aggressive fiscal stimuli -- but this analysis of how government fiscal stimulus in a deep deficit condition is actually counterproductive is both straightforward and damning.
in other words, the austrian model is trumping the keynesian as private credit collapses -- fiscal stimulus, while providing transient short-term flowthrough to gdp, is forcing interest rates higher and cutting off what would be private financing in the short and intermediate terms. because govnerment did not fill its coffers in the good times -- indeed, quite the opposite -- it will now have to call on resources that would otherwise take part in preventing a deeper credit contraction from materializing.
and this was observed on rebate checks totalling $150bn. what happens when government goes to market seeking financing to expand the FDIC and nationalize FNM and FRE? (for more on what awaits the GSEs, check david merkel's summary of disaster finance.)
the charting in hoisington's paper is positively deathly, showing that both consumer sentiment and the pace of private credit contraction are currently worse than at any point since the great depression. if you can find a way to spin that positively, please comment.
I own a computer business and I used to pay techs $15-20/hr. I now have people willing to work for $8-$10/hr. While the nice guy inside is saying “pay people well” the businessman is saying “market conditions demand paying people what the market will support.”
Recently I have had to offer price discounts to obtain new business. Some contracts I picked up were for around 1/3 of my standard fees. I have cut costs to the point where they can be cut no further if I am to maintain my debt obligations. I am now at the point where my options are to work more hours for less money or “exploit” the labor market. Considering that I am already working 80-90 hour, there was no choice.
I just interviewed a single man nearing retirement age with a young daughter a couple years older than mine. He is not only willing, but trying to hide the fact that he’s DESPERATE to work for $8-10/hr. I might be able to afford to pay him $12/hr today, but with what’s coming over the horizon, wisdom dictates paying him $8 and using the difference to lessen debt obligations as quickly as possible. That would lower my costs for when the available business gets even tighter, leaving me in a stronger position to bid and win, and helping make sure he’ll still have a job in 12+ months.
this mechanism is at work in business small and large alike -- witness massive layoffs driving unemployment higher and credit standards tightening, and one can see the chances of a wage-price spiral that would drive an inflationary spiral are simply zero. there may come a desperate time when the government takes a conscious step to debase the dollar through printing -- but it will likely be in response to an incipient deflation taking strong hold of the american credit-based economy.
john mauldin passes on more excellent research from hoisington investment management on why deflation is the next war.
How is it possible that bonds, which have the ultimate sensitivity to inflation, would decline in yield and rise in price in such an inflationary environment? The short answer is that in the broadest terms, insufficiency of demand has, and will continue, to overwhelm inflationary forces, creating deflation in many categories.
In the second quarter, current dollar gross domestic product totaled an estimated $14.3 trillion, about $572 billion greater than a year ago. Of this gain, $359 billion can be attributed to price increases and $213 to higher real output. There are times, however, when GDP is not the final arbiter of the economy's performance, and this is one. The seemingly large gain in GDP pales in comparison to the loss in wealth, which GDP does not capture. Over the past fiscal year, holdings in the stock market, as measured by the Wilshire 5000 Stock Index, lost more than $2.1 trillion. Simultaneously, the 15.3% contraction in the Case Shiller Home Price Index suggests the wealth loss in value of household residences was a staggering $3.1 trillion. Without including the negative wealth impact for declining prices of automobiles and other durables the total wealth loss was approximately $5.2 trillion. Obviously, the sum of dollars being erased from our economic system has overwhelmed the amount of dollars being increased by inflation by a factor of more than 14 to one. Thus, once again, the bond market had it right--deflation is in ascendancy. Treasury bond yields fell, and they will continue to trend lower, creating an even more profitable environment over the next four quarters for long-term Treasury bond holders.
i've been harping in credit availability/contraction as the arbiter of our future path. some others view government fiscal stimulus as a potential offset for private sector trepidation. i've never subscribed to that -- the credit pie is too large, and incremental changes in it will chew through overwhelm even aggressive fiscal stimuli -- but this analysis of how government fiscal stimulus in a deep deficit condition is actually counterproductive is both straightforward and damning.
Fiscal policy would seem to be undisputedly supportive for the economy with the Treasury's $110 billion in rebate checks and a Federal budget deficit that is approaching a record $500 billion. But that is not the case. The Treasury does not have $500 billion in its checking account to cover the deficit, nor even the lesser amount for the rebates. The Treasury has to raise the funds by selling debt securities to the private sector. Credit availability may be thought of as a pie. When the Federal sector, which is the economy's premier borrower, takes more of that pie, fewer dollars are left for the private sector. Thus, deficit financing crowds out funds that would have gone to private uses. With the exception of the Federal funds rate, in the first half of this year virtually all money and bond yields rose, a clear sign that the deficit usurped funds for the private sector. This has had the impact of slowing, rather than stimulating economic growth.
in other words, the austrian model is trumping the keynesian as private credit collapses -- fiscal stimulus, while providing transient short-term flowthrough to gdp, is forcing interest rates higher and cutting off what would be private financing in the short and intermediate terms. because govnerment did not fill its coffers in the good times -- indeed, quite the opposite -- it will now have to call on resources that would otherwise take part in preventing a deeper credit contraction from materializing.
and this was observed on rebate checks totalling $150bn. what happens when government goes to market seeking financing to expand the FDIC and nationalize FNM and FRE? (for more on what awaits the GSEs, check david merkel's summary of disaster finance.)
the charting in hoisington's paper is positively deathly, showing that both consumer sentiment and the pace of private credit contraction are currently worse than at any point since the great depression. if you can find a way to spin that positively, please comment.
Labels: economics, housing, markets
Monday, July 07, 2008
indymac driven to FDIC; fannie, freddie hammered
trading halted late in the day today on IMB, and news announced after the bell indicates that indymac -- the second-largest mortgage originator in california and seventh-largest the united states in the last few years after ill-fated countrywide -- will stop making new loans and will make at least some of its activities subject to FDIC approval.
looks like the rumors were right. more from calculated risk and housing wire.
but that may not even be the big story today, which is reserved for fannie mae and freddie mac. both saw their equity savaged, off over (-15%) in just today's trading on "news" that both are woefully undercapitalized. more via marketwatch and housing wire. put it down as another waymarker on the road to nationalization.
UPDATE: i have to agree with accrued interest -- the popular story that some lehman report about fas 140 is responsible for FNM/FRE dumping 15% ishorseshit confusing correlation with causation. no streetwise holder of that stock is compelled in the slightest by such a flimsy analyst reading. something else is afoot, and we may find out only later exactly what.
looks like the rumors were right. more from calculated risk and housing wire.
but that may not even be the big story today, which is reserved for fannie mae and freddie mac. both saw their equity savaged, off over (-15%) in just today's trading on "news" that both are woefully undercapitalized. more via marketwatch and housing wire. put it down as another waymarker on the road to nationalization.
UPDATE: i have to agree with accrued interest -- the popular story that some lehman report about fas 140 is responsible for FNM/FRE dumping 15% is
Labels: economics, housing, markets
credit crisis loss estimates still growing, part 3
previous record was $1.3tn. now make it $1.6tn, thanks to hedge fund titan bridgewater associates.
Labels: economics
the eventual end of vendor financing
brad setser rightly notes that the biggest story of our times continues to be foreign central bank purchasing of united states treasury and agency debt.
skyrocketing reserve growth in asia is what the united states counts on now as much as ever before. private demand for american securities is dead, and so a few central banks are making american economic life possible on anything like current terms. the end of that regime -- what the BCA terms the end of the debt supercycle -- hasn't yet come in force. but it will, with the yuan revaluation already underway diminishing the need of china to support the dollar with vendor financing and reducing third world inflation. indeed, michael pettis notes that officially-regulated newsflow in china is introducing the yuan free-float into the official public debate. and it will thusly remain on radar screens everywhere for some time longer.
setser, yves smith, and tim duy are all concerned -- nouriel roubini is forecasting the end of bretton-woods 2, the regime of emerging market and petrodollar currency pegs.
roubini notes that economic weakness has stayed the hand of BW2 participants, as the measures needed to quell inflation in those economies are stringent. instead, inflation appears to be the chosen path of these countries which will force the relative macro adjustments that appreciating currencies would be, in a free-float system, forcing.
roubini elicited more commentary from yves smith.
the wild card here is the potential effect of an economic crash in china. few can model the consequences but, as yves points out, with the chinese speculative bubble ending it seems to me that virtually all estimates of chinese growth in 2008 and 2009 are too optimistic. what happens if china's adjustment to high oil prices proves to be, as morgan stanley's stephen jen euphemizes, "non-linear"?
This matters. The US had a large external deficit going into the subprime crisis. That means it has a constant need for external financing. Foreigners need to more than just hold their existing claims on the US, they need to add to them. The US responded to the subprime crisis with policies — a fiscal stimulus, monetary easing — designed to support domestic US demand, not to assure ongoing demand for US financial assets. And for a complex set of reasons - ongoing growth in China, energy-intensive growth in the Gulf, limited expansion of supply and perhaps monetary easing in the US — the price of oil has shot up even as the US has slowed. Higher oil prices are likely to push the US trade deficit and the US need for financing up — not down - at least in nominal terms.
So far that hasn’t been a serious problem. Central bank reserve growth has been very strong, most because a couple of big countries are adding to their reserves at an incredible rate. The New York Fed data tells us that a lot of that growth has been channeled into safe US assets. But there are also growing signs that rapid reserve growth is causing some countries — including some big countries — trouble.
skyrocketing reserve growth in asia is what the united states counts on now as much as ever before. private demand for american securities is dead, and so a few central banks are making american economic life possible on anything like current terms. the end of that regime -- what the BCA terms the end of the debt supercycle -- hasn't yet come in force. but it will, with the yuan revaluation already underway diminishing the need of china to support the dollar with vendor financing and reducing third world inflation. indeed, michael pettis notes that officially-regulated newsflow in china is introducing the yuan free-float into the official public debate. and it will thusly remain on radar screens everywhere for some time longer.
setser, yves smith, and tim duy are all concerned -- nouriel roubini is forecasting the end of bretton-woods 2, the regime of emerging market and petrodollar currency pegs.
It is true that BW2 is still alive as the massive ongoing reserve accumulation by BRICs, GCC and other emerging markets suggests. But the rise in inflation that these exchange rate policies are causing may soon lead to its demise: abandoning pegs and/or letting currencies appreciate at a faster rate will be the necessary step to control inflation in such emerging market economies.
roubini notes that economic weakness has stayed the hand of BW2 participants, as the measures needed to quell inflation in those economies are stringent. instead, inflation appears to be the chosen path of these countries which will force the relative macro adjustments that appreciating currencies would be, in a free-float system, forcing.
... [F]ormally BW2 is still alive and well as the reserve accumulation is as aggressive as ever or even more aggressive than in 2006-2007 among many – but not all – members of the BW2 club. But continuing with BW2 is leading now – with certainty – to inflation becoming so unhinged in the BW2 club that the basis of undervalued currencies and export-led growth will be destroyed by the real appreciation that a rise in inflation induces. So the delusion – exposed by the proponents of BW2 – that this regime would last for 20 years or more is rapidly being challenged. Either way, we are now much closer to the end game of BW2.
roubini elicited more commentary from yves smith.
Roubini believes they will let inflation run, and even allow it to become embedded. In the long run, this will achieve similar results to a revaluation (as local goods prices rise in nominal terms, it winds up increasing the price of exports, much as currency appreciation would. However, it would happen more gradually and (implicit in Roubini's argument) it would be hard to point fingers (while a change in the currency regime would clearly be tied to specific authorities).
While Roubini may well be correct, that many countries will follow the path of least resistance, the consequences of this development would be profound. Highly inflationary economies are terrible for financial investment (I recall that the 24 stocks traded on Mexico's Bolsa in 1984 had P/Es of either 2 or 4), indeed, investment of any kind.
Similarly, in the stone ages of my youth, currencies that offered investments with high interest rates were shunned. The assumption was that they were fundamentally unsound and prone to devaluation. The bad image of high inflation economies carried over to moderate inflation ones, the reverse of the yield-chasing carry trade logic of today. Although one robin does not make a spring, India is now apparently having to defend its currency from a fall, the converse of what one would have expected a year ago.
the wild card here is the potential effect of an economic crash in china. few can model the consequences but, as yves points out, with the chinese speculative bubble ending it seems to me that virtually all estimates of chinese growth in 2008 and 2009 are too optimistic. what happens if china's adjustment to high oil prices proves to be, as morgan stanley's stephen jen euphemizes, "non-linear"?
continuing market weakness
good stuff today. first dr. steenbarger, who posted a quadrumvirate on markets over the weekend -- on sentiment, on materials, on technicals not once but twice. his conclusion, broadly -- as oversold as equity markets appear to be, weakness still was building through the end of last week and expanding into previously strong sectors. and it was doing so not in a crisis pattern but in classic bear market fashion -- a slow, grinding decline without appreciable panic and capitulation.
his comments on materials may be especially relevant to holders of DUG, though too late for KOL. demand destruction is on the warpath, and dr. steenbarger rightly (i think) notes that this means worries about inflation are misplaced. throw in mounting evidence for a global shipping slowdown -- reports from UPS, fedex and CMA CGM all add up.
the sentiment picture reminds me rather of january 9. the market then looked deeply oversold and set to rally -- but instead broke and cascaded into january 22/23. i turned bullish too early then.
UPDATE: this weakness-on-top-of-weakness has drawn the attention of rob hanna at quantitative edges as well in two posts -- here illustrating that persistent recent declines really have little parallel since the decade-plus of systemic deleveraging that was at its most powerful in the 1970s; here showing that such persistent selling is (on limited precedent) extremely bearish looking out as far as 20 weeks.
his comments on materials may be especially relevant to holders of DUG, though too late for KOL. demand destruction is on the warpath, and dr. steenbarger rightly (i think) notes that this means worries about inflation are misplaced. throw in mounting evidence for a global shipping slowdown -- reports from UPS, fedex and CMA CGM all add up.
the sentiment picture reminds me rather of january 9. the market then looked deeply oversold and set to rally -- but instead broke and cascaded into january 22/23. i turned bullish too early then.
UPDATE: this weakness-on-top-of-weakness has drawn the attention of rob hanna at quantitative edges as well in two posts -- here illustrating that persistent recent declines really have little parallel since the decade-plus of systemic deleveraging that was at its most powerful in the 1970s; here showing that such persistent selling is (on limited precedent) extremely bearish looking out as far as 20 weeks.
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