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Wednesday, August 29, 2007


here's a fun chart

from dealbreaker:


there are all sorts of problems with making these comparisons. are there similarities to 1987? yes -- but there are similarities between 1987 and any liquidity squeeze, and they don't all involve a 23% down day. much as with my awesome china/nasdaq chart, there are a lot of things that can go differently too.

of course, sometimes this shit is informative. i saw several nikkei-nasdaq charts in 1999 and, sure enough, the bubble popped. (so will china's.) i do think that markets are fractal and patterns within the markets echo. but one must conceive of limits in the utility of such simple comparisons. this is a good example. first chart -- scary! so similar! second chart -- best used to demonstrate that different events are in fact different.



credit market insights

minyanville ran an excellent perspective piece on the credit markets yesterday -- here and here.

Through the conduits’ convoluted structures, banks were able to "lend" huge amounts off-balance sheet and collect fees on no-capital-required lines of credit. No one - and I mean no one - ever expected these conduits to move from off-balance sheet back on-balance sheet and I don't think the market yet understands the earnings, capital and liquidity impact of this migration. If you figure you need anywhere from 6-8% capital per dollar of loans, then a move of $1.0 trln from off-balance sheet to on requires $60-80 bln in additional equity capital. I don't know about you, but I don't see this kind of free capital sitting around.

... [T]he last consumer led recession was around 1990. Since then, the SEC has placed enormous pressure on the banks to minimize their loan loss reserves. The SEC hates earnings management and the loan loss provision has historically been a key way for banks to "save for a rainy day." I don't think the market yet appreciates the fact that banks are currently provisioned for the top of the market. (And, in fact, up until recently, most major banks reported net provision reductions over the last several quarters.) As credit continues to deteriorate, the earnings/capital hits will be enormous as provisions need to reflect higher and higher delinquency and loss rates. And, experience suggests, that when the banking regulators finally do begin to act (as they did in New England during the late 1980’s), the pendulum will push banks to over-reserve at what will ultimately be the bottom of the credit cycle.

read: regardless of what the market does, the fiscal/economic disaster in financials relating to asset-backed commerical paper is probably still in its early stages, and will likely hit the banks very hard. though its noted that the discount window is probably slowing the panic for now, there are very real limitations to what the fed can accept as collateral even at the discount window. the ability of banks to remonetize the shitty mortgage-backed securities and cdo's in this manner is limited -- particularly as much of it is on its way to being rerated, and the fed will not accept 'impaired' collateral. again, it comes back to the loans.

the bellweather may be state street.

The news on State Street, however, is very troubling. State Street has no retail franchise to draw deposits from if it needs to fund liquidity line draws. If the chatter on State Street is true, State Street's ability to fund through the interbank market may be the first real tell in the US as to how big a liquidity problem we have."


Finally, no one is talking about it yet, but I think the market will soon begin to realize that the credit card lenders have in essence become the consumer lenders of last resort. As consumers have been shut out of the mortgage and home equity world, the last available credit is plastic. One statistic that I have found very troubling is the degree to which credit card balance growth is running ahead of retail sales growth - a key sign that the consumer is stretched. In normal times, you would expect aggregate credit card balance growth to run about in line with GDP and retail sales growth. This year it is running almost 2.5 times that. Clearly consumers are using their cards for far more than purchases. And my guess is that for many Americans their credit cards have become the latest, but potentially last, source of financing available.

Because of the oversized credit card balance growth, however, I think the market is missing what is really happening within card issuer portfolios – particularly loss and delinquency data. Today, no one seems to be very concerned about the increases in reported losses and delinquencies. However, when you start to normalize these statistics for the enormous balance growth we’ve seen, the increases in both are quite dramatic.

To put this all together, take Target’s (TGT) latest financial results and you can see the numbers for real. First, credit card balance growth was up 14% year-on-year - almost 1.5 times Target sales growth of 9.5%. Second, thanks to this balance growth, reported year-on-year delinquency ratios are up only a little bit (60+ days delinquencies of 3.5% versus 3.4% a year ago), but the dollars of delinquent accounts are up almost 18% - to $242 mln from $205 mln – and, as an aside, “late fees and other revenue” are up more than 36% year-on-year.

Digging even deeper, you come away with more unanswered questions. First, annualized net write-offs for the quarter were up 17% - 5.4% of loans versus 4.6% during the year ago quarter. But behind that, masked by 14% balance growth, there is a 32% increase in the dollars charged off. Further, and to me more troubling, Target dropped its loan loss allowance from 8.3% of loans at the end of July 2006 ($501 mln) to 7.4% at the end of July 2007 ($509 mln). Had Target kept its provision at 8.3% of loans, the incremental cost would have been over $64 mln or almost 40% of the pre-tax quarterly earnings of Target’s credit card business. Alternatively, had Target kept its provision at the same 1.8 times net charge-offs as last year (an 8.3% allowance on 4.6% in net write-offs), the required ending provision would have been over 9.7% of loans - at an incremental cost to the company of almost $144 mln – all but eliminating earnings from the credit card operation for the quarter. Put simply, when measured in dollars (rather than percentages of balances) Target’s nearly flat year-on-year loan loss allowance does not synch with the increase in loan balances, delinquencies, charge-offs, and late fees.

And while I have used Target as an example, I don’t think Target is alone. As we have seen already in other parts of the credit markets, many banks and finance companies are managing their businesses as if today’s increases in credit deterioration are merely a “blip”, rather than the beginning of a broader, potentially more serious, decline. From where I sit, it looks like it is only going to get worse, and “it’s already in the cards.”

the trouble is already expanding into credit cards as overstretched consumers, now deprived of mortgage equity withdrawal, fail out. this is a confirmation of the consumer slowdown that some have claimed to be underway and many others have tried to dismiss using what amounts to old, backward-looking information about the economy. the equity markets have been pulling back from retail and consumer discretionary. that's important, imo.

Tuesday, August 28, 2007


the china bubble chart

i've commented before on the massive credit-driven bubble taking place in chinese a shares. i've even wondered if it's time to short it before (since which time it has risen another 40%+). when it ends is anyone's guess, but this now looks a lot like the blowoff phase seen in the nasdaq in early 2000.

i'm just saying -- fxi is optionable. if the credit crunch proves to be a global deflationary force (and it should), buying out of the money puts beneath this thing is an idea to consider. it could collapse horrendously.

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august consumer confidence

the absolute level of confidence backed off in the first confidence report that incorporated the credit crunch.

august 2007 130.3 88.2 (-42.1)
july 2007 138.3 94.4 (-43.9)
june 2007 129.9 88.8 (-41.1)
may 2007 136.1 90.1 (-46.0)
april 2007 133.5 88.2 (-45.3)
march 2007 138.5 87.9 (-50.6)
february 2007 137.1 93.8 (-43.3)
january 2007 133.9 94.4 (-39.5)
december 2006 130.5 96.3 (-34.2)
november 2006 125.4 91.9 (-33.5)
october 2006 125.1 91.9 (-33.2)
september 2006 128.3 91.0 (-37.3)
august 2006 123.9 84.4 (-39.5)
june 2006 132.2 87.5 (-44.7)
may 2006 134.1 85.1 (-49.0)
april 2006 136.2 92.3 (-43.9)
march 2006 133.3 90.3 (-43.0)
february 2006 130.3 84.2 (-46.1)
january 2006 128.8 92.1 (-36.7)
december 2005 120.7 92.6 (-28.1)
november 2005 113.2 88.4 (-24.8)
october 2005 107.8 70.1 (-37.7)
september 2005 110.4 72.3 (-38.1)
august 2005 123.8 93.3 (-30.5)
july 2005 119.3 93.2 (-26.1)
june 2005 120.8 96.4 (-24.4)
may 2005 117.8 93.4 (-24.4)
april 2005 113.8 86.7 (-27.1)
march 2005 117.0 93.7 (-23.3)
february 2005 116.8 96.1 (-20.7)
january 2005 112.1 100.4 (-11.7)
december 2004 105.7 100.7 (-5.0)
november 2004 90.2 96.3 6.1
october 2004 92.2 94.0 1.8
september 2004 97.7 95.3 (-2.4)
august 2004 100.7 97.3 (-3.4)
july 2004 105.3 106.4 1.1
june 2004 100.8 105.9 5.1
may 2004 90.5 94.8 4.3
april 2004 90.4 94.8 4.4
march 2004 84.4 91.3 6.9
february 2004 83.3 91.9 8.6
january 2004 79.4 107.8 28.4
december 2003 74.3 103.3 29.0
november 2003 81.0 100.1 19.1
october 2003 67.0 91.5 24.5
september 2003 59.7 88.5 28.8
august 2003 62.0 94.9 32.9
july 2003 63.0 86.3 23.3
june 2003 64.2 96.4 32.2
may 2003 67.3 94.5 27.2
april 2003 75.2 84.8 9.6
march 2003 61.4 61.4 0.0
february 2003 63.5 65.7 2.2
january 2003 75.3 81.1 5.8
december 2002 69.6 88.1 18.5
november 2002 78.3 89.3 11.0
october 2002 77.2 81.1 3.9
september 2002 88.5 97.2 8.7
august 2002 93.1 95.5 2.4
july 2002 99.4 96.1 (-3.3)
june 2002 104.9 107.2 2.3
may 2002 111.2 109.7 (-1.5)
april 2002 106.8 109.6 2.8
march 2002 111.5 110.2 (-1.3)
february 2002 96.4 94.0 (-2.4)
january 2002 98.1 97.6 (-0.5)
december 2001 97.8 92.4 (-5.4)
november 2001 96.2 77.3 (-18.9)
october 2001 93.5 n/a n/a
september 2001 125.4 78.1 (-47.3)
august 2001 125.0 79.2 (-45.8)
july 2001 151.3 92.9 (-58.4)

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Friday, August 24, 2007


foreign central bank selling of treasuries

brad setser channels russ winter to divine that foreign central banks have become fairly aggressive sellers of treasuries.

Using the end of week data, the Fed’s custodial holdings of Treasuries fell by $44.2b from August 1 to August 23. That’s big. Most of the fall came in the past two weeks.

Custodial holdings of Agencies rose by $12.6b – offsetting some of the fall in Treasury holdings. But overall central bank custodial holdings still fell significantly – by close to $30b. That hasn’t happened for a while.

And, obviously, central banks reduced Treasury holdings didn’t exactly imply reduced demand for Treasuries. Treasury yields fell (and prices rose). The ten year yield fell from 4.8% or so to 4.6%; T-bill yields went from around 5% to around 4% with a little detour down to 3% on Monday.

That, on the surface, seems like a refutation of the argument that central bank demand has played a key role in keeping Treasury yields down over the past few years.

So what is happening?

Well, there obviously has been a bit of a liquidity crisis, as investors lost confidence in a lot of CDOs -- and financial firms that borrowed in the money market to purchase CDOs. The total stock of outstanding commercial paper fell by about $200b over the past two weeks – and a lot of money that wasn’t reinvested as commercial paper matured seems to have flowed into the Treasury market.

Foreign central banks, judging from the Fed’s data, helped meet that demand.

disaster? probably not -- foreign banks financing emerging-market capital outflows, thinks setser, in a period of risk aversion. but the data might be useful in the future.

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Thursday, August 23, 2007


bill gross advocates the bailout

i certainly think one is coming, and pimco's main man seems to agree.

The ultimate solution, it seems to me, must not emanate from the bowels of Fed headquarters on Constitution Avenue, but from the West Wing of 1600 Pennsylvania Avenue. Fiscal, not monetary policy should be the preferred remedy, one scaling Rooseveltian proportions emblematic of the RFC, or perhaps to be more current, the RTC in the early 1990s when the government absorbed the bad debts of the failing savings and loan industry. Why is it possible to rescue corrupt S&L buccaneers in the early 1990s and provide guidance to levered Wall Street investment bankers during the 1998 LTCM crisis, yet throw 2,000,000 homeowners to the wolves in 2007? If we can bail out Chrysler, why can’t we support the American homeowner? The time has come to acknowledge that there are precedents aplenty in the long and even recent history of American policy making. This rescue, which admittedly might bail out speculators who deserve much worse, would support millions of hard working Americans whose recent hours have become ones of frantic desperation. And for those who would still have them eat some Wall Street cake as opposed to Midwest meat & potatoes (The Wall Street Journal editorial page suggested they should get darn good and used to renting once again) look at it this way: your stocks and risk-oriented levered investments will spring to life like the wild flowers in Death Valley after a flash flood. And if you’re a Republican office holder, you’d win a new constituency of voters – “almost homeless homeowners” – for generations to come. Get with it Mr. President and Mr. Treasury Secretary. This is your moment to one-up Barney Frank and the Democrats. Reestablish not the RFC or the RTC, but create an RMC – Reconstruction Mortgage Corporation. If not, make some modifications in the existing FHA program, long discarded as ineffective. Write some checks, bail ‘em out, prevent a destructive housing deflation that Ben Bernanke is unable to do. After all “W”, you’re “the Decider,” aren’t you?

the problem, however:

While market analysts can guesstimate how many Waldos might actually show their face over the next few years – 100 to 200 billion dollars worth is a reasonable estimate – no one really knows where they are hidden.

it's probably a lot more than $200bn. realtytrac was saying before the credit crunch that 1.8mm foreclosures with probable bank losses of something like $160bn were likely this year. but these losses will continue for several years forward. with a normalization of credit standards and massive supply piling onto the market, home prices must correct significantly -- and if that takes place in nominal terms, refinancing homeowners with 3- and 5-year arms are going to be upside-down in their mortgagtes and pinched by rate resets as their terms come up in 2008, 2009 and 2010. many of those mortgage holders, who were put into their loans by the same fraudulent practices that 2/28 subprime borrowers were, are going to be defaulting and requiring bailout.

a bailout that would keep these people in their homes is going to require something far more ambitious that $200bn -- so ambitious, in fact, that it will likely threaten the stability of the dollar and be no better/different than pursuing the problem by the monetary policy tools that gross would eschew.

that doesn't make it any less likely -- it's a politically perfect idea, and almost has to happen. but it will not be consequence-free. indeed, i sincerely doubt it will mitigate the ultimate damage at all and it may even compound it severely by putting the treasury market to flight.

UPDATE: perhaps unsurprisingly, gross' fund is deeply invested in the securities that he is essentially advocating a bailout of. whether he's right or wrong, he's definitely self-interested.

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hey gm -- I actually found your economic writing through your Cub blogging. I'm a Card fan but I've really enjoyed your baseball mind, and you were right on about Rich Hill, who I wanted to trade for from way back. anyway, I came across this today as I was jumping around -- it's a year or two old. lucid and pretty prescient, it seems to me -- I'd like to get your thoughts.

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hey perrone -- thanks for the kind words.

on the article, i think that's a good general summation. as i see it, there are two likely paths (and variations in between) that the dollar can take.

one is a crash. this should not be discounted. chinese and japanese central banks and petrodollar recyclers have little desire, i suspect, to precipitate such a thing -- but their intentions may not be the determinant in a very complex system. now that the world is finding that much american mortgage debt is toxic and even broadly fraudulent, these (sole and few) sources of deficit funding may diversify away from the dollar for their own good, if not sell it outright. so great is our need for deficit finance (especially with the military in the field) that even this seemingly mild step could precipitate a run on the dollar. this would be very inflationary, disastrous to credit and (because we are a credit economy) a truly terrible event.

the other is a long, slow decline punctuated by much jawboning and periodic crises as standards of living correct toward the global mean -- similar to the fall of the british pound. this sort of muddling through seems most probable, and built on the back of bumpy but continuing longer-term economic dynamism in the far east and eastern europe.

there is a third possibility -- a long-term continuing financing of the united states by the developing world, built on the back of deep markets and a strong military. this is much the system rome rode for its imperial period. but in a globalized world where china and india are building consumerist middle classes and capital is free to move there -- and a world where the awkward limitations of american military power are being exposed -- i doubt this is likely.

and there is a fourth -- deflationary depression. japan since 1990 is a good case study for how asset price deflation can become a general deflation regardless of monetary policy measures. few -- especially bernanke -- seem to conceive that printing money is not the same as building confidence, and credit is confidence first and foremost. they dismiss japan as the consequence of 'policy mistakes'. i don't think it was. i think it simply proved policy has limitations.

this last is the most dismissed possibility and maybe because of that the most dangerous. and i have to admit i don't see it as likely.

you may have noticed that i just covered every base. :) honestly, in a system this complex, the unintended and the unknowable are likely to dominate. there's a good case for and against each of these paths. the one thing that seems assured to me is the mean reversion of the american standard of living, based as it has been over the last 20 years largely on increasing debt and leverage beyond prudent limits.

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i have to say, though, that IF the government really does begin a monstrous debt-financed bailout of the housing collapse i cannot see forestalling a run on the dollar. on top of iraq, boomer retirement/prescription drug benefits and ridiculously low tax collections (as a percentage of spending)... who would take seriously the idea that profligate americans and their venal politicians are going to actually pay that back?

and indeed, that may be the plan -- as the article points out, inflation has been the favored political expedient of history when trying to escape onerous national debt.

but what the government of the united states may not realize yet is the extent to which they have already forfeited control of its own monetary policy by pursuing such a reckless fiscal policy (publicly and privately). foreign central banks now effectively control longer american interest rates, and may not be sensitive to the need for a slow and controlled unwinding.

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strategizing the bounce

via herb greenberg and minyanville, some insight into the potential consequences of the credit crunch from the options market.

"There is a huge dichotomy in the marketplace. On one hand, the market in general is being bid back up while government officials try to reassure investors as to the soundness of the financial system. Some of the same officials that originally didn't see a problem. On the other, investors are paying prices in options on bank stocks and other financials that indicate bankruptcy. We can't have both. This is not a "wall of worry". I have never seen option prices this high in big captitalization financial companies. Take what you want from that. Either the stock market in general is going to correct massively, or the buyers of this protection are really making a mistake."

i don't think we can know which, but i must admit the general sense that the credit crunch is easing (which is very easy to feel in equity markets media right now) seems in such contraposition to the ongoing facts (the credit markets remain in lockdown) that i remain highly leery of the recent bounce. it feels utterly stage managed.

look at the s&p intraday.

virtually all the gains of the last four days have come at the open -- from the futures market indications or orders executed within minutes of the bell. within the day itself, prices have been sideways or down. in my recollection, big bullish days see buying throughout, just as big bearish days see selling throughout. (this needs more research.)

what has happened thusfar in the equity indexes remains well within the parameters of a normal bounce in an ongoing correction, staying (so far) under the ceiling of the 21-day moving average of the close.

but what is happening in the credit markets is potentially a huge disaster that will very likely take many months to resolve. calling it "over" at this point seems an act of sheer denial to me. bank of america essentially bailing out and initiating a takeover of countrywide is decidedly not good news, but it is being treated as such. four majors in a coordinated destigmatisation of the discount window is not good news either, but is also being spun as such. many people are actually talking about m&a like it's going to come back, like there isn't a huge pile of pier loans choking the system for the foreseeable future. david callaway get it right on both counts, i fear.

what to do, then? fade the rally -- i went short(er) at yesterday's open in anticipation of a retest of the lows, at the very least.

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Wednesday, August 22, 2007


credit crunch fallout hitting housing very hard

before the credit market seizure of the last month, calculated risk opined that housing starts would have to fall to levels nearing 1.1mm.

but that was before the loan market died. now, no less than bank of america is forecasting starts to collapse to 700k.

As mortgage lenders tighten underwriting standards and home prices fall, Bank of America analysts estimated that 40% of home buyers who got a mortgage in 2006 probably wouldn't qualify for a home loan now.

That dwindling mortgage availability means that more home purchases will be cancelled as buyers fail to get the loan they need to pay for their new house. Such disruptions could strain home builder's access to liquidity and borrowing, the analysts warned.

"Our market checks point to a recent spike in cancellations as lenders pull loan commitments and buyers fail to qualify," Bank of America analyst Daniel Oppenheim and his colleagues wrote in a note to clients on Tuesday. "Lower cash flow will strain liquidity, particularly for high leverage builders."

Lack of mortgage availability will mean demand for new homes could fall 35% in 2007, the analysts said. That's bigger than the 20% drop they were predicting earlier this year when subprime problems emerged.

New-home sales could fall as low as 700,000 a year, down from 1.283 million in 2005, they said, noting that traffic at real estate agents is down sharply in August.

toll brothers' latest report did nothing to counteract that perception. it is probably facing cancellation rates in excess of 30% as people who preemptively put large downpayments on new homes are finding they cannot get a mortgage and have to forfeit the capital.

"Through our third-quarter-end [July 31st, pre-turmoil], our buyers generally were able to obtain both conforming and jumbo loans (loans over $417,000).

Nevertheless, tightening credit standards will likely shrink the pool of potential home buyers: Mortgage market liquidity issues and higher borrowing rates may impede some customers from closing, while others may find it more difficult to sell their existing homes."

Translation: "Look out below!"

cr further analyzed the plight of the homebuilders.

The optimum strategy for each individual builder is to keep building - it's the only way they can sell the land and pay their debt. But in the aggregate this is a losing strategy for the industry - a kind of Nash equilibrium.

Toll Brothers is essentially saying they would be OK if everyone else stopped building. That is what everyone else is saying too.

This leads to what is happening in San Diego - record REO sales swamping the market in San Diego, and the builders still breaking ground!

So as you say ... bring on the BKs.

housing prices are supposed to be sticky things that gradually decline over the course of several years. but the combined wave of supply and near-total collapse of demand in residential housing we are now seeing is likely to be without precedent in terms of the dislocations and pressures it generates. bankruptcy for some major builders seems unavoidable.

in chicagoland according to, inventory is up some 15% yoy, with 75th percentile prices having come down 3.2% yoy (ie, about $16,000 on a $500,000 home). my anecdotal experience in looking at realtor listings is that this understates the developing pricing aggression. housingtracker's chicagoland reo index (at 150) indicates that significantly more properties are in foreclosure than were in april -- just four months ago. i'd expect these negative trends to accelerate significantly now, with the mortgage-backed securities market having cracked.

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Tuesday, August 21, 2007


commercial paper shortfalls mean asset sales going forward?

the flight into t-bills was marked by further inability to get commerical paper sold yesterday. ft alphaville channels bnp paribas:

The commercial paper market take up remains very poor particularly for ABCP. According to Dealogic, $41bn of European CP were due to mature yesterday, but they had been replaced by only $15bn of new notes. Within ABCP, $22.6bn matured and only $4.6bn were refinanced, implying a ratio of 20 per cent. In normal market conditions the two figures should be roughly the same. The danger is that this could cause further forced sellers.

more on further forced sellers -- this is one of the most dire-sounding articles i've yet read.

The $1.1 trillion market for commercial paper used to buy assets from mortgages to car loans has seized up just as more than half of that amount comes due in the next 90 days, according to the Federal Reserve. Unless they find new buyers, hundreds of hedge funds and home-loan companies will be forced to sell $75 billion of debt, according to Zurich-based UBS AG, Europe's largest bank.

Those sales would drive down prices in a market where investors have already lost $44 billion, based on Merrill Lynch & Co.'s broadest index of floating-rate securities backed by home- equity loans. That may hurt the 38.4 million individual and institutional investors in money market funds, the biggest owners of commercial paper.

``We're dumping all this collateral into the market and it becomes a death spiral for the assets,'' said Brian McManus, head of collateralized debt obligation research at Charlotte, North Carolina-based Wachovia Corp., the fourth-biggest U.S. bank by assets. CDOs contain pools of mortgage securities that have been repackaged and sliced into pieces.

The credit crunch, sparked by the highest level of defaults on subprime mortgages in a decade, is ``getting uglier and uglier,'' said Christopher Low, chief economist in New York for FTN Financial, the capital markets unit of Memphis, Tennessee- based First Horizon National Corp. ``This has moved beyond temporary. It's gotten beyond bailing out some hedge fund and into the broad economy.''

Investors are refusing to buy short-term debt backed by any mortgage that isn't guaranteed by government-chartered companies such as Fannie Mae and Freddie Mac, Aladdin's Marshman said.

``The unwind will not be denied,'' said Marshman. ``Whether it takes place overnight or over the course of several months, these assets have to be placed in different hands.''

Wall Street is in a ``financial panic'' and won't fund any mortgage bonds, even AAA rated bonds backed by prime home loans, said Garrett Thornburg, chief executive officer of Thornburg, which makes loans of more than $417,000 to people with good credit. The mortgages are known as jumbo loans because they exceed the limit on what Freddie Mac and Fannie Mae can purchase.

Even the Fed's decision to cut the discount rate that it charges banks failed to revive demand. The rate for overnight borrowing in the asset-backed commercial paper market soared 0.39 percentage points to that price on Aug. 17, the biggest rise since the Sept. 11 terrorist attacks. Overnight yields fell 2 basis points to 6.01 percent today, while 30-day paper widened 9 basis points to 6.09 percent. A basis point is 0.01 percentage point.

``There's still a huge problem in the credit markets,'' Thornburg said in an interview. The market ``is unwinding because no one wants to own A1/P1 asset-backed commercial paper.''

Thornburg is using lines of credit for financing even though only 58 of its 38,000 mortgages are 60 days or more in arrears.

``That's just crazy,'' he said. ``If it's backed by subprime, all right. If it's backed by junk, get out. But if it's backed by high-quality receivables from Macy's or triple As from us, that market should be functioning and that market has stopped functioning.''

the rumor has been that merrill lynch is potentially a victim of all this. speculation has been that one of the investment banking majors is close to chapter 11. and merrill is said to be holding five times equity in commerical paper, a significant slice of which may be of questionable value.

in any case, brad setser links to this blog, noting that most major banks were using commercial paper "to finance what look like mini-credit hedge funds".



update on vix commerical contracts open

a week later, the net commerical position in the vix had gotten yet longer. through august 14, the position was +12,682 (52439 long against 39757 short). current report here -- next update should be out friday august 24, reflecting today's positions, which are post-expiration and likely to be quite different.

the lag is frustrating, but clearly the non-commerical shorts were squeezed very hard this week and should have been compelled to reduce. if they haven't, i'd call that a contrarian indication of more volatility ahead.

marc faber also notes that an intermediate low may be in, but....

Faber is also “not surprised”, he says, by the strong rally from the August 16 intraday low, “because investors are still conditioned to buy the dips and not to sell into strength”. The fear of ‘missing the next advance’ is negative for the market, from what Faber calls his “contrarian point of view”.

His “best guess” is that we have seen an intermediate low, but that the S&P500 - which, as of last week’s close, was still down 100 points from its July 2007 high - “will have great difficulty reaching a new yearly high”.

A glance back at the last 17 months of the S&P500 shows “very strong overhead resistance” between 1500 and 1540, says Faber. “Therefore, I would use additional strength as a selling opportunity.” “It is also my view that, in time, the recent August low and the March 2007 low at 1363 will be taken out on the downside.”



preconditions of a housing turnaround

this is very tentative -- but some housing skeptics are finding at least mildly less critical things to say.

first robert shiller -- seeing signs of strength in some areas, but not bullish.

then calculated risk.

Right now it appears housing is about to take another significant downturn.

But someday housing will bottom.

And I'm starting to see the first signs - not of a bottom - but that it might be worth looking ahead to the bottom. Blasphemy to some, I'm sure.

... To repeat: I expect housing to be crushed in the coming months. But it might be time to start looking ahead to the bottom in residential investment.

very far indeed from optimism, cr is looking for an existing homes price bottom in 2010-12, which comports pretty well with what i've seen elsewhere. but a bottom for the builders in terms of residential investment may come as soon as 2008.



a return to ordinary central banking

according to barron's.

Under Alan Greenspan, the former Fed chairman, the primary solution to financial crises, from the October 1987 stock market crash to the 1998 Long Term Capital Markets hedge-fund blowup to the bursting of the tech-telecom bubble in 2000, was to slash the fed funds rate. That provided cheap money to the deserving and the feckless alike, and gave rise to the notion of the so-called Greenspan Put -- an insurance policy for speculators when markets went bad.

But Friday's action of lowering the discount rate a half percentage point, to 5¾% from 6¼%, adheres to the first principles of central banking going back to Walter Bagehot -- lend freely in a crisis, albeit at a penalty rate to ensure these borrowings aren't abused. The Fed's target for the fed-funds rate remains unchanged at 5¼%.

In that, the Bernanke Fed returns to the practices under Paul A. Volcker, Greenspan's predecessor and arguably the most effective chairman in the Fed's history.

greenspan's legacy may well be that he was the ideologue who so stupidly believed in the rationality of market operators that he ended up complicit in and even instigating the greatest debt bubble of modern times -- and quite possibly, as a result, the genesis of a painful depression.

bernanke has, thusfar, been a different player. lee adler has tracked the tight policy of the fed this year, as it has actually withdrawn money supply over the last year and injected no new money supply for more than a day or two during this crisis. eventually, i suspect, government will be compelled to bail out big banking -- the balance sheet damage to the sector as a result of the mortgage-backed securities problem is more than considerable. but the consequences of the bailout itself may yet be a dagger in the american financial system.


Monday, August 20, 2007


a continuing crisis

equity markets bounced thursday and friday, stabilized today on low volume -- but the crisis is probably not over.

via interest rate roundup, t-bill yields are still crashing, only faster: "Bloomberg just ran a headline saying this is the biggest one-day plunge since the stock market crashed in October 1987." the ^irx dropped 67 basis points to 2.95% just today, indicating an ongoing wholesale flight into the very safest treasury instruments.

some context might be provided by the 1998 chart of the 13-week. rate of change bottomed along with the nasdaq. but it might be noted that this nosedive dwarfs the 1998 move in speed, with a 10-bar rate of change less than half of what we're seeing right now. see also 2h2001. but the strange part is that this huge move is coming without the announcement of a fed funds rate cut.

lee adler, who follows fed policy actions regarding the monetary base:

So far in this crisis, the Fed has NOT injected one cent of liquidity into the system except for that two day bulge on Thursday and Friday August 9-10, which they completely removed by Monday and Tuesday 8/13-14. The Fed remains tight in terms of the SOMA, and making matters worse, foreign central banks are dumping Treasuries to raise cash for injection into their own system in order to try and fix the extreme dollar squeeze in European credit markets. Last week they reduced their custodial holdings at the Fed by a record $17 billion. They actually sold $22 billion of Treasuries, but apparently the Asian central banks are still propping the GSE market as they bought $5 billion in Agencies.

We’ll just have to see if the world’s central banks have the firepower to stop a worldwide credit crunch and liquidity squeeze when some major players are essentially insolvent because dey ain’t no assets backing those ASSet backed securities. Rather than taking decisive action, it looks to me like the Fed is frozen in place like a deer staring into the headlights of an 80 mile per hour downhill runaway tractor trailer, while the ECB is fighting its crisis the only way it can, by selling Treasuries and injecting the cash into their system.

The fact is that the Fed remains shockingly tight in terms of the monetary base, which they have maintained at ZERO growth for the past 8 months, and LESS THAN ZERO in the past week when the sheet was hitting the fan. Sure that can all change next week, but you wouldn’t know it from the actions they took on Friday.

At this point, the cut at the discount window looks like nothing more than throwing a bone to a starving dog. Big freaking deal. Watch what they do, not what they say. It seems to me that they either don’t yet have a handle on the magnitude of the crisis, or they think that smoke and mirrors will fool everyone into thinking that happy days are here again and that the credit markets will “unfreeze” as a result. But so far, they haven’t “done” anything.

the spike in the t-bill would seem to indicate that the markets concur with adler. but it should also be noted that such spikes usually correlate well with market bottoms. the bottom may very well be in, at least for a while, in equities.

the dollar has stabilized near 115 yen, off the low of 112, but backed well off the june high of 124. the dollar/yen is back to a level last seen consistently in 2q2005.


Friday, August 17, 2007


continuing commercial paper problems

problems in commercial paper are apparently continuing in spite of the fed's discount window rate cut and rollover policy change.

Top-rated asset-backed commercial paper maturing Aug. 20 yielded 5.99 percent, up 39 basis points since yesterday and the most since a 45 basis point increase on Sept. 20 in the wake of the terrorist attacks in New York City and Washington.

The Fed is trying to encourage banks to buy commercial paper by allowing institutions to borrow for 30 days rather than overnight and making it renewable at the borrower's option, according to Drew Matus, an analyst at Lehman Brothers Holdings Inc. in New York.

The Fed's action ``may help add confidence that action will be taken when it's necessary, but further action is needed to actually offset the credit contraction we have had,'' Ashish Shah, global head of credit strategy at Lehman Brothers Holdings Inc. said in interview from New York. ``No one actually wants to tap the Fed window. So while this is good, it doesn't actually add any liquidity into the system. It's more of a confidence booster.''

credit markets appear to be holding out for more than what the fed did today. a nice bounce for equities today, but next week will have more to tell. countrywide could well be one of those who approach the discount window.

also, lee adler has been following the fed's actions in open markets this week:

So the discount rate “cut” keeps the discount window .75% above the current market. Big freaking deal, huh? At this morning’s repo auction the Fed did another drain, this time in the amount of $6 billion as they allowed $12 billion to expire, while adding only $6 billion in weekend repos. The stop out rate was 5.35%. Does that sound like a rate cut to you? Because they removed last Friday’s big pump job on Monday, the 5 day net dropped to a drain of $32 billion. Does that sound like liquefaction to you? It sure doesn’t to me.

Even over the last four days, when the stock market was melting down and the credit markets were in crisis, the Fed only added a net of $4 billion. There’s just nothing to see here. At least not yet. All in all, the Fed’s action this morning seems like a mean, stupid, and futile gesture, worthy of Animal House for its humor and theatrical impact. And aside from the Fed’s draining in the face of catastrophe, there was even more bad news from the Foreign Central Banks (details later in the report).

that news from the foreign central banks? russ winter:

This week marks an historic liquidation of foreign central bank (FCB) held US securities. The total tossed overboard was $17 billion, which also brings the three week total sold to $22.0 billion. This was likely necessitated by the need for US Dollars particularly as European banks were squeezed by insolvency issues ( I refuse to use the term “liquidity”). That’s what reserves are for in theory, emergencies and not just subsidizes for Americans. If you are looking for a causa proxima to market swoons of late, look no further. Old Maid Card issuers in the US are heavily reliant on this opiate.

this would help to explain some of the declines in the dollar against other currencies, as dollar-denominated securities were sold for dollars and the dollars sold for home currencies. moreover, it was already beginning in may.

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the worst case scenario

from ft. it's worth noting that bernanke's rate cut has sparked a run on the dollar against both the euro and the yen that amounts to a continuation of previous weakness after a short-term rally -- a similar pattern to what we saw in march. it's quite possible that the lag effects of the end of quantitative easing are hitting us now.

Central banks are likely to attempt to ratify current inflated asset values by inflating prices and incomes to avoid a deflationary economic collapse. Unfortunately, sharp reductions in interest rates in the US, UK and the euro area will lead to a rapid unwinding of the global carry trade, perversely threatening to worsen problems in the credit markets.

The solution would have to involve massive unsterilised intervention by the Japanese authorities, which would have the effect of inflating Japanese prices to a level consistent with the current yen exchange rate, thereby alleviating huge upward pressure on the yen as the carry trade unwinds.

Combined with a similar inflation in the US this "solution" would require roughly a doubling of the Japanese price level, destroying the real value of Japanese savings.

If the losses are to manifest purely in real terms - via inflation - then they must occur mostly where the savings have been, which is certainly not in the US.

If the Japanese authorities baulk at the prospect of such a huge inflation, then global deflationary collapse will be inevitable once the credit bubble bursts.

part of that inflation will probably involve a government-backed bailout.

i personally doubt the japanese monetary authorities will balk at some very radical inflationary policies (ie, throwing money from helicopters) if america desires them to be implemented. but even if they do, the path is frought with uncertainty and the prospect for unintended consequences.

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it's the loans

an april article with relevance for coming years.

To bring us back to where we started, a great many Alt-A and Prime borrowers will lose their homes because they will be hopelessly underwater when they need to refinance 3 to 5 years from now. If they had borrowed with conventional mortgages as they did in the past, they would not be facing this mortgage reset timebomb, and they would simply ride out the Sub-Prime debacle just as many homeowners made it through the declines of the early 90’s. However, it is different this time. This time, the loans they have taken out are going to ruin them. It’s not the borrowers, it’s the loans.

this does something to explain why the "subprime problem" is NOT a subprime problem -- it is a mortgage problem, regardless of borrower quality, and it is going to be very severe and last several years.

the fed cut interest rates by an emergency 50 bp this morning as it dawned on them that the bounce instigated yesterday afternoon had not carried through to asian and european markets. the futures spiked -- after all, this is what "consequence-free" capitalists had been dying for all week -- but the bounce in the equity market does nothing whatsoever to fix the basic trouble underlying the liquidity crisis: the insolvency crisis.

until or unless the american government starts taking all the hundreds of billions of levered mortgage-backed securities and their derivative cdo's off the balance sheets of banks, investment houses, insurers and pension funds -- not to mention foreign central banks -- and converts it into treasury debt, the problem remains as intractable as it ever was. these institutions are sitting on immense amounts of bad debt -- something like $450bn in mortgage-backed assets without a market between american and european banks alone, for which there is now nearly no market.

and is even that a solution? what if the government issued $450bn in new treasury debt to bail out the banks, all of it backed by essentially nothing? would that not destroy the dollar? would that not finally compel treasury holders to sell as indiscriminately as they bought? is a bailout of such scope even possible without inflicting even greater economic damage than it would remedy? the savings and loan bailout of 1989 amounted to $157bn. anything that would begin to help would dwarf all precedent -- and we're talking only about relieving the pressure of these unsold securities on originating bank balance sheets. it would not even begin to address all the paper that has already been moved off to pension funds, insurance and reinsurance, banks, the commercial paper market.... the rmbs market is estimated at $6.5tn (that's trillion, not billion). when the san francisco examiner suggests that a trillion-dollar bailout would be target, i think they frankly underestimate the cost considerably. debt forgiveness on this scale has the potential of sending the united states into a weimar scenario -- where the issuance of government debt and currency cannot add to the money supply because every new issuance is counteracted by an even bigger drop in the value of the currency.

as this disaster plays itself out, prudent observers should pay attention to the dollar. what is going on -- deleveraging, defaulting, tightening -- amounts to a contraction of the money supply and a slowing of the velocity of money. it should be getting harder to find money. these forces are deflationary. the dollar should strengthen as it becomes rarer.

but it likely won't. capital flight -- if it truly takes hold -- would result in people selling american debt and dollars for their home currencies (yen, euro). the issuance of bailout debt (or even just the anticipation of as much) would worsen the situation. if that cycle gets to a point where further cash injections can't offset currency devaluation, we could see the kind of problems that make for interesting history books.

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Thursday, August 16, 2007


long-term p/e

a great piece of value investing in today's ny times.

Their classic 1934 textbook, “Security Analysis,” became the bible for what is now known as value investing. Warren E. Buffett took Mr. Graham’s course at Columbia Business School in the 1950s and, after working briefly for Mr. Graham’s investment firm, set out on his own to put the theories into practice. Mr. Buffett’s billions are just one part of the professors’ giant legacy.

Yet somehow, one of their big ideas about how to analyze stock prices has been almost entirely forgotten. The idea essentially reminds investors to focus on long-term trends and not to get caught up in the moment. Unfortunately, when you apply it to today’s stock market, you get even more nervous about what’s going on.

Most Wall Street analysts, of course, say there is nothing to be worried about, at least not beyond the mortgage market. In an effort to calm investors after the recent volatility, analysts have been arguing that stocks are not very expensive right now. The basis for this argument is the standard measure of the market: the price-to-earnings ratio.

It sounds like just the sort of thing the professors would have loved. In its most common form, the ratio is equal to a company’s stock price divided by its earnings per share over the last 12 months. You can skip the math, though, and simply remember that a P/E ratio tells you how much a stock costs relative to a company’s performance. The higher the ratio, the more expensive the stock is — and the stronger the argument that it won’t do very well going forward.

Right now, the stocks in the Standard & Poor’s 500-stock index have an average P/E ratio of about 16.5, which by historical standards is quite normal. Since World War II, the average P/E ratio has been 16.1. During the bubbles of the 1920s and the 1990s, on the other hand, the ratio shot above 40. The core of Wall Street’s reassuring message, then, is that even if the mortgage mess leads to a full-blown credit squeeze, the damage will not last long because stocks don’t have far to fall.

To Mr. Graham and Mr. Dodd, the P/E ratio was indeed a crucial measure, but they would have had a problem with the way that the number is calculated today. Besides advising investors to focus on the past, the two men also cautioned against putting too much emphasis on the recent past. They realized that a few months, or even a year, of financial information could be deeply misleading. It could say more about what the economy happened to be doing at any one moment than about a company’s long-term prospects.

So they argued that P/E ratios should not be based on only one year’s worth of earnings. It is much better, they wrote in “Security Analysis,” to look at profits for “not less than five years, preferably seven or ten years.”

This advice has been largely lost to history. For one thing, collecting a decade’s worth of earnings data can be time consuming. It also seems a little strange to look so far into the past when your goal is to predict future returns.

But at least two economists have remembered the advice. For years, John Y. Campbell and Robert J. Shiller have been calculating long-term P/E ratios. When they were invited to a make a presentation to Alan Greenspan in 1996, they used the statistic to argue that stocks were badly overvalued. A few days later, Mr. Greenspan touched off a brief worldwide sell-off by wondering aloud whether “irrational exuberance” was infecting the markets. In 2000, not long before the market began its real swoon, Mr. Shiller published a book that used Mr. Greenspan’s phrase as its title.

Today, the Graham-Dodd approach produces a very different picture from the one that Wall Street has been offering. Based on average profits over the last 10 years, the P/E ratio has been hovering around 27 recently. That’s higher than it has been at any other point over the last 130 years, save the great bubbles of the 1920s and the 1990s. The stock run-up of the 1990s was so big, in other words, that the market may still not have fully worked it off.

graham and dodd is in my library as it is millions of others. but i (perhaps amazingly) never read shiller's now-classic book. maybe i should. it has certainly been a basic thesis of mine that the secular bear that began in 2000 has several years left to run, and that the credit explosion of the last five years is but an intermediate stage on the path to a final, deleveraged, lower bottom -- where ten-year-trailing price-to-earnings will approach levels seen in 1982 and stock investing will be completely out of vogue for ordinary people (most of whom will consider it wildly risky or a surefire money-loser).


Wednesday, August 15, 2007


what is the potential scope?

recent market events have been labeled "the subprime crisis" in spite of the fact that mortgage securites backed from the alt-a and jumbo prime universe are also participating in accelerated default rates and leveraged buyout bridge-cum-pier loans are a key element. but if the crisis involves more than subprime, how much more is it? and what can one expect.

the difficult answer from nouriel roubini:

[W]e have no idea of what the subprime and other mortgage losses will be: $50 billion, $100 billion, $200 billion? They could be as large as $500 billion if the US enters in a recession and we have a systemic banking and financial crisis. The uncertainty about these losses depends on the fact that we have no idea of how deep and protracted the housing recession will be and how much will home prices will fall. If home prices were to fall – as my research suggests as likely – more than 10% in the next year or so, the subprime carnage will massively expand to near prime mortgages and prime mortgages. There is already plenty of evidence that the delinquencies are not limited to subprime mortgages as a number of near prime and prime lenders are now bankrupt or in trouble (AHM, Countrywide just to cite two examples). The worse the housing recession will be the worse these now uncertain losses.

as roubini goes on to explain, the incredible complexity and opacity of the derivatives market and the private unregulated funds that trade in them make the consequences of this crunch unforeseeable. but what is truly fearsome is the leverage that the financial engineering of recent years has built into the system.

[T]oday any wealthy individual can take $1 million and go to a prime broker and leverage this amount three times; then the resulting $4 million ($1 equity and $3 debt) can be invested in a fund of funds that will in turn leverage these $4 millions three or four times and invest them in a hedge fund; then the hedge fund will take these funds and leverage them three or four times and buy some very junior tranche of a CDO that is itself levered nine or ten times. At the end of this credit chain, the initial $1 million of equity becomes a $100 million investment out of which $99 million is debt (leverage) and only $1 million is equity. So we got an overall leverage ratio of 100 to 1. Then, even a small 1% fall in the price of the final investment (CDO) wipes out the initial capital and creates a chain of margin calls that unravel this debt house of cards. This unraveling of a Minskian Ponzi credit scheme is exactly what is happening right now in financial markets.

i can't say exactly where this ends. the market sold off hard into the close again today, meaning the bottom probably isn't here yet. things are hysterical enough that merrill proposed bankruptcy for countrywide, the largest mortgage lender in the country.

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learn the lessons of rome

as noted in the financial times and justin raimondo, the comptroller general of the united states shares some views with me.

Transforming government and aligning it with modern needs is even more urgent because of our nation’s large and growing fiscal imbalance. Simply stated, America is on a path toward an explosion of debt. And that indebtedness threatens our country’s, our children’s, and our grandchildren’s futures. With the looming retirement of the baby boomers, spiraling health care costs, plummeting savings rates, and increasing reliance on foreign lenders, we face unprecedented fiscal risks.

Long-range simulations from my agency are chilling. If we continue as we have, policy makers will eventually have to raise taxes dramatically and/or slash government services the American people depend on and take for granted. Just pick a program—student loans, the interstate highway system, national parks, federal law enforcement, and even our armed forces.

... America is a great nation, probably the greatest in history. But if we want to keep America great, we have to recognize reality and make needed changes. As I mentioned earlier, there are striking similarities between America’s current situation and that of another great power from the past: Rome. The Roman Empire lasted 1,000 years, but only about half that time as a republic. The Roman Republic fell for many reasons, but three reasons are worth remembering: declining moral values and political civility at home, an overconfident and overextended military in foreign lands, and fiscal irresponsibility by the central government. Sound familiar? In my view, it’s time to learn from history and take steps to ensure the American Republic is the first to stand the test of time.

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rate cuts may actually be difficult to justify going forward

it's commonly presumed -- particularly lately -- that the federal reserve can "fix" the mess of the markets by cutting the fed funds rate. and they certainly can reduce the rate anytime they want, making money cheaper to borrow.

but there are a number of difficulties with such a simple scenario. one is the insolvency problem -- slightly cheaper financing is not the end-all for enterprises and people facing more debts than assets. banks may not be compelled to mark their damaged illiquid assets -- japanese banks held assets above their market value for years in the aftermath of their asset price collapse in 1994 -- but finding further leverage will be very difficult.

another is that the fed's mandate is not ot save markets but to provide price stability. in practice, with a burgeoning fiat currency, this means keeping a cap on the inflation statistics manufactured by the government for public consumption.

that's about to get more difficult, as two major negative cpi months roll out of the backward 12-month window. the fed's justification for rate cuts being inflation fighting and not money supply or liquidity concerns, this will make it very difficult for the fed to cut -- and indeed, from their current tightening bias, may even pressure them to raise rates.

this is exactly the opposite of what the fed funds futures are telegraphing, and disappointment could take the form of selling pressure as economic conditions weaken.

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Tuesday, August 14, 2007


difficulties in commerical paper

via calculated risk, it's beginning to look like the credit crunch has made mortgage-backed securities so illiquid that asset-backed commerical paper -- the stuff of money market funds -- may break down.

Coventree Inc., the Canadian finance company that went public in November, failed to sell asset-backed commercial paper to replace maturing debt because of the credit crunch caused by U.S. subprime mortgage losses.

The shares tumbled 35 percent after the company extended maturities on C$250 million ($238 million) of commercial paper and sought emergency funding for another C$700 million of debt. Toronto-based Coventree's units have about C$16 billion of asset- backed commercial paper outstanding.

``Problems that initially seemed isolated to a few U.S. subprime mortgage lenders have led to broader concerns relating to debt capital markets generally,'' including the Canadian asset- backed commercial paper market, Coventree said in a statement today.

... ``There's so much CP out there, and if one part of the market locks up, it tends to be contagious,'' said Brian Yelvington, a strategist at CreditSights Inc. in New York.

In the U.S., asset-backed commercial paper comprises about $1.15 trillion of the $2.16 trillion in commercial paper outstanding. The debt is backed by mortgages, bonds, credit card and trade receivables as well as car loans.

In the U.S., extendible notes constitute about $172.5 billion in debt outstanding, according to Moody's Investors Service. About $60 billion is backed by mortgages securities, according to New York-based Bears Stearns.

Coventree's announcement heightened worries that rising defaults on subprime loans are infecting securities across the credit markets. DBRS, a Toronto-based ratings company, said today it received notice from ``a number of'' Canadian issuers that had sought backup financing.

``It's not just Coventree,'' said Huston Loke, group managing director of Global Structured Finance at DBRS. ``We're still in the process of going through notices. When it becomes more clear, we'll have more to say.''

``If a manager is extending due to the inability to issue new CP, there is little incentive for the traditionally low-risk tolerant CP purchasers to take risk on new paper from that issuer,'' Yelvington said. ``The risk-reward usually is not high enough.''

there is risk here. some money market funds may be considerably exposed. from barron's this week:

Nevertheless, the lack of transparency for the new esoteric instruments, such as collateralized debt obligations and collateralized loan obligations, has exacerbated the current nervousness because nobody knows what they're worth, he also notes.

In that, it appears some of the problem lies with asset-backed commercial paper "conduits" and so-called structured investment vehicles. These ABCP conduits and SIVs are used to fund the purchase of assets such as trade receivables, auto loans, credit cards, whole mortgage loans, as well as securities such as corporate debt, residential mortgage-backed securities and CDOs, according to a Bear Stearns report.

The ABCP conduits and the SIVs then are able to issue high-grade commercial paper to finance these assets, which are less the prime quality. ABCP now comprises over half the $2 trillion-plus commercial paper market, up from 20% in 1998, according to MacroMavens' Stephanie Pomboy. And, money market funds own 27% of all CP outstanding, she also notes.

According to the Bear report, some $38 billion-$43 billion RMBS and CDOs could be liquidated from ABCP conduits. Got that? In other words, a load of these assets is backing ABCP and may have to be sold into a less than receptive market.

even more here from ft alphaville.

nobody close to this sector expects to see a quick solution soon. Commercial paper interest rates have not yet fallen, irrespective of central banks’ actions. In New York on Friday, they closed at their highest level for six years.

There is deep uncertain­ty about what the central banks will do next – making ABCP players even more reluctant to start issuing and trading again. “Nobody is going to handle commercial paper if they think the Fed could be about to cut rates or do something else completely unexpected overnight,” explains one.

However, the third, most pernicious problem is that it is becoming clear central banks cannot resolve the biggest problem – a lack of clarity about valuations in structured credit markets and the almost complete loss of confidence that is infecting even the biggest and most diversified of conduit-type programmes.

and from the economist:

The trouble is, the banks suspect that even worse problems may be lurking, especially in the asset-backed securities markets where most have invested heavily. This is clear from the performance of the commercial-paper market, another short-term asset class that rarely hits the headlines, where rates suddenly hit six-year highs last week. In recent years, banks have created an abundance of investment funds, known as structured investment vehicles and conduits, which finance themselves through the $2.2 trillion commercial-paper market and invest in asset-backed securities, such as mortgages. Now banks are forcing their counterparties to pay a much higher price to roll the paper over, and it is not clear how quickly central-bank injections of liquidity will ease the squeeze.

The mounting concerns about overnight interbank rates and the commercial-paper market have led many investors to argue that the Fed should cut rates to restore calm. That would follow the script from 1998 when three rate cuts between September and November helped to bring the LTCM crisis to a speedy end.

But the Fed chairman, Ben Bernanke, made clear this month that inflation was more of a concern than disorderly markets. Some fear that even if the Fed did ease monetary policy to restore order, lingering inflation fears would push up long-term rates, compounding America’s mortgage mess.

once again, it's an insolvency crisis of which one of the features is a liquidity crisis. no one knows where the bad debt is concentrated, no one wants to hazard more exposure to it, so no one buys or lends while many try to sell and borrow. but that there is a lot of bad debt -- upon which a lot of leverage is placed -- is a feature that was not present in 1998.

UPDATE: the first money market fund i've ever seen to suspend redemptions. unfortunately, sentinel is a liquidity reserve for futures and commodities traders.

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Monday, August 13, 2007


commercial money long the vix

i used to follow the commerical s&p contract commitment data from the board pretty closely, and i think it does have predictive value. interesting then to see this. the commercials are heavily long volatility at a time when big and small traders have rushed to short it on the presumption that things will shortly head back to normal.

confirmation of complacency seemed to come also from the new ticker sense poll.

i've kept my shorts on, for better or worse.

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they could and should -- but will they?

i mentioned the chinese comments on the dollar last week:

the oft-resorted-to fallback that china would never intentionally depreciate an asset it holds so much of doesn't carry much water with me. i think they'd be more than willing to take a 20-30% haircut for the right policy goals, knowing that the damage in the united states would be massively larger.

brad setser opines further.

The general consensus in the US is that China cannot cut off the US without “shooting itself in the foot."

I disagree. At least in part.

China is already shooting itself in the foot – financially speaking. It loses money every time it buys another dollar bonds. The dollar will depreciate against the RMB some day, leaving China – which finances its purchase of dollars by selling RMB-denominated debt – with large losses.

And, generally speaking, adding to a losing position adds to your ultimate losses.

China would be better off financially if it let the RMB appreciate substantially, stopped financing the US and took large losses now rather than continuing to finance the US, adding to its stock of dollars and adding to the scale of its future losses. A bank that is lending to a failing company reduces its ultimate loss by cutting the company off and taking its lumps now, not by covering ever bigger losses with new loans to avoid “turmoil.” China is in a similar position. The US isn’t a failing company, but China is lending to the US on terms that imply very large financial losses for China.

China’s real problem is that it cannot stop financing the US without shooting its own exporters’ in the foot.

Up until now, China’s exporting interests (perhaps in conjunction with all those who benefit from loose monetary policy) have driven Chinese policy. But the interests of China’s exporters aren’t quite the same as the interests of China writ large.

By the same token, the interest of US firms with operations in China – or US firms that rely on Taiwanese and Hong Kong firms with supply chains that stretch back into China -- aren’t quite the same of the interests of the US as whole. There are parts of the US economy that have benefited from China’s policy of subsidizing US consumption, and US borrowing, but there are also parts that haven’t.

... The possibility that China might cut the US off is remote – barring a confrontation over Taiwan. But it also isn’t totally beyond the realm of possibility that China might someday change a policy that many in China think benefits the US more than it benefits China. That is one reason why the balance of financial terror may not be quite as stable as it now seems. The costs associating with maintaining the status quo – most notably the costs associated with China’s huge dollar position – are growing, not falling.

on balance, it isn't good for them or for us -- the largest thing blockading movement is inertia. how long can that last?

probably quite a while longer, but i just do not and will not know.

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Friday, August 10, 2007


markets today

i think there's potentially more downside here. the low held today, but in tenuous fashion -- poor volume (good for friday, though), nasdaq did not get back to even on the rally, neither did the dow, s&p barely did. not a clear-cut call, though. participation seems to be improving. financials -- the downside leader in this slide -- did not lead down today. very sketchy, and could go either way. june 21 shorts are still open; did close some smaller financial shorts; converted one QID short to SKF.

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a new kind of bank run

floyd norris in the new york times.

A few generations ago, savers responded to financial panics with runs on banks, and even healthy institutions could fail if they could not raise enough cash quickly enough.

For a long time, that all seemed to be safely relegated to the past. But now the runs are back — and this time the targets are not banks but the securities that have replaced them as the prime generators of credit in the new financial system.

“Our current system of levered finance and its related structures may be critically flawed,” said William H. Gross, the chief investment officer of Pimco, a mutual fund company. “Nothing within it allows for the hedging of liquidity risk, and that is the problem at the moment.”

This problem has plagued the United States at regular intervals. The Panic of 1907 was halted only when the banker J. P. Morgan persuaded banks to stand together and halt the string of closings by lending money to threatened institutions. That led to the creation of the Federal Reserve, as Congress recoiled from the notion that the country’s financial health had relied on the wealth and wisdom of one private citizen.

Then the Depression, with a wave of bank failures, led to the establishment of deposit insurance. With that, savers became convinced that they need not worry about the health of their bank, and bank runs vanished.

But a new financial architecture emerged in the last decade — one that relied more on securities and less on banks as intermediaries. With the worth of those securities now being questioned — and no equivalent of deposit insurance — some who financed the securities want their money out, a fact that has created the 21st-century equivalent of a run on a bank.

Left to deal with the run are the institutions that were created to deal with the old system’s problems — notably the central banks like the Federal Reserve and the European Central Bank. But, in contrast to their close involvement with the banking system, these banks have little regulatory oversight of the securities that are in trouble and may not even know who is holding them.

At the heart of the new system was a decision to have loans financed directly by investors, rather than indirectly by bank depositors. Investors, ranging from hedge funds to wealthy individuals, had confidence in the arrangement because most of the securities were blessed as very safe by the bond rating agencies, like Moody’s and Standard & Poor’s.

The highly rated securities pay relatively low interest rates, but until now there were many willing to own them or to lend money to those who did own them. But there is no reason to hold them if there is any question about their safety — just as there was no reason to keep deposits in a bank that was facing a run amid rumors about its safety.

A result has been a freezing up of markets for many securities that, it turns out, were critical to the free flowing of credit. The problem first gained widespread attention when two hedge funds run by the brokerage firm Bear Stearns collapsed and a third Bear Stearns fund had to suspend redemptions as investors sought to get out even though there was no evidence that the fund was in trouble.

“The third Bear Stearns fund announcement was the key,” said Robert Barbera, the chief economist of ITG. “You have to believe that in the hedge fund and mutual fund complexes, there is a decision that is building that says, ‘I want to hold some Treasuries to have a cushion if I see redemptions.’ ”

The basis of the system was a belief that securities backed by bad credit could be very safe — so long as there were other securities that would suffer the first losses that came from defaults in pools of subprime mortgages or of loans to highly leveraged companies.

So far, none of those highly rated securities have failed to make their interest payments on time, but that fact is not enough to make anyone want to buy them. The rating agencies have downgraded some securities, and they are tightening their standards for new ratings.

Early this week, stock market investors around the world tried to reassure themselves that nothing was really wrong, and financial stocks bounced back after suffering sharp declines last week. Analysts argued that profits remained strong, as does world economic growth.

On Tuesday, the Fed declined to lower the federal funds rate, saying that despite financial market volatility and a decline in the housing market, “the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.”

But that comforting outlook did not help the credit markets recover, or persuade anyone to buy the newly questioned securities — at least at anything like the prices people had assumed. No one wants to sell the securities at very low prices — and in many cases they have borrowed heavily against them. So the markets have dried up.

Yesterday, BNP Paribas, a major French bank, said it could no longer value three investment funds that it managed, whose assets had been invested in highly rated securities that were backed by dubious mortgages.

“The complete evaporation of liquidity in certain market segments of the U.S. securitization market,” the French bank said, “has made it impossible to value certain assets fairly, regardless of their quality or credit rating.”

Adding to the problem is that the questionable securities are widely owned and sometimes have been repackaged to form the basis of other securities. European banks and funds own paper tied to subprime mortgages, and it is not clear who else does, or how investors will react.

Banks that are worried about their own liquidity decided this week to increase their reserves, which they can do by borrowing from other banks. Loans on such rates rose as a result of the added demand. Both the federal funds rate — the rate on loans of reserves between American banks — and the London Interbank Offered Rate leaped sharply yesterday.

The Fed — which conducts monetary policy by focusing on the fed funds rate — was forced to inject money into the system to bring the rate back down to its targeted level. And the E.C.B. lent almost 100 billion euros ($130 billion), to European banks.

If the current panic is just that — unreasoning fear — then such cash infusions may be able to let the new financial system weather the storm. Money can be lent to those owning the dubious securities, obviating the need to sell. As they eventually turn out to be good, the loans can be repaid and all will be happy.

On the other hand, if many of those securities turn out to be as bad as people now fear, some of those loans will not be good, and there may be more financial failures.

Yesterday, stock prices fell in Europe and kept declining in the United States, amid speculation over what other owners of the securities might surface as having problems. But American stock prices remain well above the levels they fell to in February, after a sudden drop in the Chinese stock market, and many stock investors still think all will work out acceptably.

The central banks, while clearly crucial to dealing with the loss of faith in the new financial system, lost influence under that system. Loans could be arranged by nonbanks, not subject to bank regulators, and the regulators were hesitant to impose rules that would not apply to all lenders. The lenders sold securities to finance mortgages that let people borrow at rates that — temporarily — were far lower than the Fed envisioned. That delayed the impact of the Fed’s attempts to raise interest rates in 2005 and 2006.

“That is important because it means the decline in the housing market is likely to continue,” Mr. Barbera said. If the American economy does continue to weaken, the Fed may feel forced to reduce interest rates sooner than it had expected, even if that move threatens to hurt the value of the dollar.

Prices in the futures market for federal funds show that just a few weeks ago investors thought there would be no Fed easing this year. Now they seem to think such a move is highly likely, and some expect it as early as next month.

But the Fed’s influence is limited when lenders are suddenly risk-averse. “The impetus of lowering interest rates may not help, if they don’t let you borrow in the first place,” said Kingman Penniman, the president of KDP Investment Advisors.

The new financial system is not the one the Fed was created to deal with, but it is the one it must try to handle.

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Thursday, August 09, 2007


is the credit crunch finally here?

minyanville says yes.

Sooner or later the market will realize that this is a credit crunch. We have not seen a real credit crunch since 1973. Go back to your history books to witness what a credit crunch does to asset prices. Pure and simple, when the borrowing dries up, there is no "money" to buy assets.

This is a process that is likely to take years to correct. It will not be a pretty process as debt gets destroyed (foreclosures) until enough of these excesses get wiped away to start anew. It was all caused by too-easy credit for too long by a Central bank not willing to let the market itself handle the allocation of capital. It insisted on providing credit cheaply when the market didn't deserve it.

So U.S. consumers have lived beyond their means for too long. They have wasted away their savings and are now in too much debt. Pure and simple.

so does nouriel roubini.

Insolvent and bankrupt households, mortgage lenders, home builders, leveraged hedge funds and asset managers, and non-financial corporations. This is not just a liquidity crisis like in the 1998 LTCM episode. This is rather a liquidity crisis that signals a more fundamental debt, credit and insolvency crisis among many economic agents in the US and global economy. Liquidity runs can be resolved by the liquidity injections of a lender of last resort: in the cases of the liquidity crises of Mexico, Korea, Turkey, Brazil that international lender of last resort was the IMF; but in the insolvency crises of Russia, Argentina, and Ecudaor the provision of the liquidity by the lender of last resort – the IMF – only postponed the inevitable default and made the crisis deeper and uglier. And provision of liquidity during an insolvency crisis causes moral hazard as it creates expectations of investors’ bailout. Thus, while the Fed and the ECB had not option today but to provide massive liquidity in the presence of a most severe liquidity crunch and run, they should not delude themselves that this liquidity injections can resolve the deep insolvency problems of many overstretched borrowers: households, financial institutions, corporates. Insolvency/credit crises lead to financial and economic distress – hard landing of economies – and cannot be resolved with liquidity injections by a lender of last resort. And now the vicious circle of a weakening US economy – with a housing recession getting worse and a fatigued consumer being at the tipping point - and a generalized credit crunch sharply increased the probability that the US economy will experience a hard landing. We are indeed at a "Minsky Moment" and this recent financial turmoil is the beginning of a much more serious and protracted US and global credit crunch. The risks of a systemic crisis are rising: liquidity injections and lender of last resort bail out of insolvent borrowers - however necessary and unavoidable during a liquidity panic- will not work; it will only pospone and exacerbate the eventual and unavoidable insolvencies.

this could be a terrible shock.

bnp paribas shuttered three funds with large holdings of united states mortgage-backed securities exposure because it hasn't been able to get a price on those assets since monday. that is a serious liquidity event in major credit markets, which have apparently gone into something like panic. the investment banking world is really on the precipice now, and i doubt the odds of a true cascading crash -- however remote -- have been higher since 1998, perhaps since 1987. that probably won't happen, of course. but with some very important credit market underpinnings having broken down, it now easily could. hard to say when liquidity will return, but the speculation has been in weeks.

central banks worldwide injected liquidity today in the hopes of alleviating disaster, but as roubini and minyanville note this is a crash protection measure, not a solution. it had previously been noted by lee adler

The Fed has again brought the SOMA to the bottom of the long term 5% growth channel as it leans against the speculative fever that has gripped the credit markets for the past several years. The growth rate has been zero since last Thanksgiving and only 3.25 % over the past year. The Fed’s actions over the past three months are shocking. Why, in the midst of a credit crunch, is the Fed still pushing at the bottom of the channel and threatening to break it? This is the question of the hour.

You have to wonder if the Fed is asleep at the switch or if it really wants to foment a crash. The answer is “no,” of course, but if their aim was to prick the bubble, then it’s likely that they have succeeded. It is not likely that they can now manage the consequences. The act of keeping monetary base growth at zero as the financial system spiraled into the black hole of a deflating credit bubble could go down as one of the Fed’s great blunders ever. Not that pumping would solve the long term problems of the economy, but we are talking here about a possible liquidity crisis with the potential to turn into a crash.

I’ve been saying that only if the gods have gone crazy would the Fed tighten the monetary base here, but historically, we know that they’ve made mistakes before. So, we’ll see. They’ve clearly been leaning against the tide of credit market speculative mania, and after 8 months that lean has finally begun to have an effect. So the question is whether Ben has seen enough and is unnerved enough to start giving the guys some gas again. In that respect, Monday’s rally was counterproductive for those desperately wanting a rate cut. Bernanke may really believe the phony economic data coming out of Washington, or the Wall Street Journal editorial last week that touted “the best economy in the history of the world”. If they really do believe that garbage, then they are not about to loosen the monetary
base to any significant degree.

the indexes are difficult reads now -- these are not measuring very liquid securities and the makeup of each cdo in the index varies -- but the pictures are amazing. subprime has been a problem for months now but...

... this is triple-a asset backed. this was not considered possible a couple months ago by many people.

high-yield corporate credit default swaps.

spreads on investment grade, high yield and emerging markets.

central bank liquidity injections appear to be (at least temporarily) relieving pressure on these measures. but for how long? adler:

After this week, the giant sucking sound from the Treasury will resume until the end of September according to the Treasury Borrowing Advisory Committee (TBAC) report. One ominous sign was that the TBAC had estimated in May that the Treasury would need only $2 billion in new money in the 4 week bill. Instead they are raising $17 billion. Things are not going as well as planned whether in revenue collections, or increased expenditures. I haven’t checked the Treasury statements, but I suspect that the revenue projections are falling short, if the reports from the California and Florida Departments of Revenue are any indication.

The Fed has given itself plenty of room to offset the pressure from the Treasury but so far it hasn’t. If the FCBs don’t step up and the Fed doesn’t pump, after this week’s Treasury paydown the market should begin to feel enormous pressure again.

In another shocker, foreign central banks were net sellers last week, according to the Fed's data on custodial holdings. It put the short term FCB indicator back on the sell side, and left the intermediate indicator in a holding pattern rather than turning up, as expected. At this week’s auctions indirect bidders including FCBs added only $1.6 billion to their holdings. That could be signaling a bare cupboard ahead, but while we are aware of what they do at the Treasury auctions, not all indirect buyers are FCBs, and what the FCB indicator does also depends on what they do in the secondary market, particularly for GSEs. We get that data from the Fed every Thursday evening for settlements through Wednesday.

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