ES -- DX/CL -- isee -- cboe put/call -- specialist/public short ratio -- trinq -- trin -- aaii bull ratio -- abx -- cmbx -- cdx -- vxo p&f -- SPX volatility curve -- VIX:VXO skew -- commodity screen -- cot -- conference board

Friday, March 28, 2008


chinese property crash

from jeff matthews:

If we here at NotMakingThisUp ran the joint, the story would have been the entire front page, under a banner headline on par with the Apollo Moon Landing, Dewey Defeats Truman, and Hillary Dodges Bullets in Bosnia.

How the Journal’s front-page editors missed breaking the greatest new story of 2008 is beyond us. Maybe Rupert Murdoch doesn’t want to upset his friends in China, what with the Olympics coming and Tibet trying to escape Chinese suppression and all.

In any event, we urge you to stop reading this and head straight to the Journal’s web site. Read the article carefully and then print it out for your files.

Yesterday's article will be “Exhibit 1” in what will become, we suspect, a very fat file on the impending Chinese Real Estate Implosion.

more evidence that the chinese central bank has finally been successful in its campaign against years of domestic inflation spurred by its dollar-peg monetary policy -- and a potentially massive deflationary bust is underway in china.

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more on rate resets

earlier this month i relayed the comments of larry sumners on rate resets, which have often been cited as evidence that foreclosures are nowhere near peaking at this point.

yves smith with more today following some very optimistic comments by bloomberg's dave barry.

The American CoreLogic databases as of March 2007 contained 38 million mortgages. Their extraordinarily detailed analysis of 8.4 million ARMS originated between 2004 and 2006 showed only 9.1 % with initial interest rates of 8.5% or higher (note that the paper claims an average of 8.64%)

There were more mortgages at 2% and below (1,1 million) than above 8.5% (770 thousand). Without throwing in the intermediate levels, it's obvious that the weighted average is well below 8.64% (the level in the New Century pool, which gave Berry the notion that there wouldn't be much reset shock). Similarly, a March 2007 (admittedly now dated) paper by Chris Cagan deemed ARMs with initial rates of 6.5% or higher as not-very-vulnerable to reset shock.

ARMs with low introductory rates were never intended to reset; the assumption was that the would refinance. And recent pools are running at unheard-of rates before reset, with monthly default rates of 3.5%, which equates to a 34.8% cumulative default rate over three years. Thus the performance of later subprimes is horrendous independent of the issue of resets.

Finally, while Libor was a popular index for setting the reset rate, it's far from the only benchmark. Others include the 11th District Cost of Funds rate, the Prime rate, the Monthly Treasury Average rate, the Constant Maturity Treasury rate. And some of these have not been affected by the Fed's cuts[.]

Note that while prime has fallen, its level is not much below what it was in 2005 and 2006, which were the heaviest years for origination of dubious subprimes (while the 2007 vintage is worse in terms of quality, the volume issues was lower than in the two preceding years)[.]

smith here does not even have to mention the fact of negative amortization to significantly wane barry's hopes. i'm afraid this remains as big a problem as ever, though somewhat diminished by reduced LIBOR and prime rates.

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trade rules

a good set from globetrader, linked by dr. steenbarger. examining my 3/14 UYG position this way:

i entered too early, very arguably, by jumping on the bear stearns bailout -- and did so for capitulative sentiment reasons rather than technical action. dangerous and very probably unwarranted. but now, being in the position, this is the picture.

You go short a test of a lower high in a downtrend

moreover, there can be little question in the longer timeframe that UYG is in a downtrend. as such, the fail at 35.5 to breach the high of 37 from february 27 could have been a sell.

this i am treating instead as a special case in consideration of the capitulative bottom of january 22/23, which was retested (successfully, imo) in mid-march. this is not a trend trade as globetrader would define it; instead, it is a bottom call. the rule on consolidation trading is appropriate, with the directions reversed.

Markets go from equilibrium to equilibrium. Usually the range covered in a trend phase stays constant within limits. If you know the contract you trade, you know when it has reached an extreme of a move. (such as january 22/23 -- gm) ... That does not mean you blindly take a counter trend trade, but if you see Resistance not taken out and say a Double [Bottom] forms (such as mid-march -- gm) or even better price is unable to retest the former [Low], then you go [long] with a Stop [below] the [lows] in case the trend resumes.

that low is 25.

Sellers are in control as long as the market is making Lower Highs

back to the short-term picture -- the powerful positive rebound ran 10.5 points off the low at 25. when price failed to swing to a higher high (marked 'LH', lower high) one could have sold in the 33s.

a normal retracement would be 33% to 66% back, or the window from 32 to 28.5. a move below 28.5 would indicate a possible retest of 25, so a sell stop should be placed at 28.5. this could easily happen on a gap fill to 27, retest of 25 or fail to new daily lows.

for QLD, a similar picture can be drawn, with the expected retracement window from 70.3 to 66.1, below whcih should be a sell stop. again, a lower high sell on this timeframe came late wednesday around 73 -- particularly in light of a momentum divergence.

in summary, sellers are in control on the short-term picture, driving what has been to date a normal consolidation. it remains to be seen if my bottom call stands up -- if it will, this consolidation will hopefully stay normal and provoke gains next week.


Thursday, March 27, 2008


the longer-term picture

bespoke highlighted an interesting article above the fold in yesterday's wall street journal -- with its own insightful spin.

We took the 10-year total return performance of the S&P 500 back to 1900 (non-inflation adjusted) and charted the results below. When the line is highlighted in red, 10-year returns were lower than they are now. As shown, periods where returns were lower occurred in 1914, 1921, 1932, 1938, 1974 and 1977. We also highlight years where returns peaked -- 1929, 1959, 1992 and 2000. While the returns could easily get worse, periods that have been this bad have not lasted longer than 4 years (1937-1941) before they've started to get better.

four years is a long time -- and it is perhaps better contextualized by this post from angry bear.

Today's WSJ article gave the impression that the lost decade should be setting the stage for a period of superior returns as the market returns to the mean. But this chart implies that the market still has a lot of downside as the market PE has only fallen to about its long term average and still has a tendency to fall to below 10.

these earnings ratio compression journeys typically run something on the order of 15 years (give or take a few, of course). if the current one can be said to have begun in 1998, we're already about ten years in. of course, we're also coming off the most exorbitantly-overvalued market peak in the series, and remain near a p/e of 15 with a probable destination in the area of 7.

on the former chart, i'd note that ten years ago was 1998 -- and the dates of the high and low return points are at least as informative by subtracting ten years as they are themselves. this measure of total return is likely to get worse going forward simply because the market raced higher in a colossal blowoff into march 2000. note that the current reading is still +60% for the period, compared with trough returns on the order of 0% to (-40%). not only is four years a long time, but there's plenty of room for downside to reach minimum returns that have considerable precedent.

on the latter (adn more important) chart, if earnings growth continues in the range of 10% a year -- not a given by any means -- that would raise underlying earnings by nearly 50% in four years. that would lower p/e from 15 to about 10. the implication would still be a haircut in price of some 30%. and frankly the notion of persistent 10% earnings growth seems a bit farfetched given the state of the financial system.

therefore, i would suggest that the likely course of aggregate stock prices is significantly lower in real terms.

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continuing record short interest

from bespoke.

On the NYSE, the mid-month short interest report hit a level of 4.15%, which is record high. On the S&P 500, short interest is even higher. As of mid March, 5.4% of the float of S&P 500 listed companies were sold short. This represents an increase of 53% over the last year!


Wednesday, March 26, 2008


why john mccain is an unfortunate candidate for president

i like john mccain. he is a flawed person, but as politicians go it's hard to ask for much. i personally think he has a serious issue with confusing his post-traumatic stress with the needs and aims of the nation, and this leads him to be quite possibly the most militarist and imperialist of many militaristic and imperialistic senators. but again, with american politicians, it's hard to ask for much. he has completely humiliated himself in his drive for power -- but again, consider the field. it was easy to respect his ploy with the mccain 14 over the attempted annulment of the filibuster even if it amounted to a personal power grab that came to nothing, as it at least showed a healthy capacity to alienate one's own party base.

there is, however, another problem. with the united states having embarked this year on what promises to be an epic economic journey, john mccain by his own admission doesn't know fuck-all about economics. and that -- as we've seen with george w. bush -- leaves one at the mercy of the ideology and stupidity of one's advisors.

We should also convene a meeting of the nation’s top mortgage lenders. Working together, they should pledge to provide maximum support and help to their cash-strapped, but credit worthy customers. They should pledge to do everything possible to keep families in their homes and businesses growing. Recall that immediately after September 11, 2001 General Motors stepped in to provide 0 percent financing as part of keeping the economy growing. We need a similar response by the mortgage lenders. They’ve been asking the government to help them out. I’m now calling upon them to help their customers, and their nation out. It’s time to help American families.

someone in mccain's camp may think that american automakers were actually driven by something like charity to offer zero-percent financing -- but they also, more clearly and unforgivably, don't understand the first thing about the engine of securitization which made cheap money possible for everything from cheap car loans to cheap credit cards to cheap (and tricky) mortgages. as it happens, that same engine is at the source of the mortgage bubble and bust -- and it isn't coming back in anything like the form that made it possible for the credit arms of desperate carmakers in a society of declining real wages to securitize low-interest car loans to credulous investors of what were once perceived to be safe asset-backed securities.

a question, given that: how likely is it that mccain's camp has any idea at all about what must be done to help the situation?

if you didn't answer "not very", the consider this further quotation:

"I have always been committed to the principle that it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers,” he said. “Government assistance to the banking system should be based solely on preventing systemic risk that would endanger the entire financial system and the economy."

to be sure, i completely agree.

but to say that now, when the banking system is in fact rife with systemic risk that endangers the entire financial system and the economy -- has in fact already sunk the economy into an increasingly obvious recession -- is to betray the fact that mccain and his advisors are allowing ideology to drive their pronouncement precisely because they are so out of touch and out of their depth with the real events of this credit crisis.

at some other point in american history, mccain would've made a respectable candidate. under the current circumstances, however, i have a very difficult time taking him seriously.

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a lexis-nexis search shows that ony the l.a. times picked up on mccain's turd of an idea, and only in passing--not even bothering to reflect on the absurdity of the notion. perhaps mccain was secretly trying to push the mortgage lending bloc squarely into the lap of the demos come election time? i can't imagine what other explanation would account for his handlers letting him say something like this to an audience, other than that...or the possibility that nobody would notice (which, clearly, seems to have happened). as with his iran/al qaeda gaffes, he's providing a wealth of evidence that he's too out of touch to be considered a serious candidate anymore.

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from Perrone:

GM, I gotta say, I continue to love your stuff.

"the form that made it possible for the credit arms of desperate carmakers in a society of declining real wages to securitize low-interest car loans to credulous investors of what were once perceived to be safe asset-backed securities."

nutshell, babe. the real problem is, and always has been, that regular folks aren't getting paid enough money. they ought to be, given their contributions to gains in productivity, but they don't, and ain't. that's why the few that _do_ make (more than) enough money have to keep inventing new ways to rip them off -- read, "creative credit" which then drives "creative investment vehicles." till they inevitably drive off the cliff, but then who pays? yep, not the ones who made the money.

so when does it get fixed? when regular folks start getting paid more money. that's at the heart of everything.

hey, when will you start doing some more writing on the Cubbies? I miss that.

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the reassertion of the mahdi army

with financial markets being what they've been, i've not blogged about iraq in a long time.

when the surge was first being enacted and testified to by general david petraeus before congress, i said this:

that petraeus would fabricate most anything he needed to make the administration case for perpetuating the imperial occupation and (they hope) slow pacification of iraq and its vital energy resources -- all the more valuable in the advancing age of peak oil -- is hardly a revolutionary concept, the undue reverence of jingoistic and economically illiterate americans notwithstanding. moreover, he is certainly in a position to make uncontested and unverifiable statements about conditions on the ground in iraq. it should be well understood that the administration has purged military leadership repeatedly to get the yes-men they want in place, with names like shinseki and abizaid finding even slight dissent impolitic and career-ending. petraeus was never in any danger of being candid before congress; at best, he might rise to the level of 'plausible'.

and when iraq started to fall off the national radar screen -- in part because of growing financial pressures here at home -- i suggested

iraq is and will remain a cauldron of regional if not global disaster for many years, and american forces will remain overwhelmed with their task there.

beginning this week, we may see my assertions -- and those of many spartanist pundits, not to mention the capacity of the armed forces of the united states in iraq -- tested. for the placidity of the mahdi army, the devout and militant shia faction led by moktada al-sadr, first declared last august in conjunction with the surge and extended just last month, now looks to be over. civil disobedience is now the rule.

al-sadr went to war in april 2004, stepping into this portrait of a thankful but frustrated iraq, one which had already seen abu ghraib and the stunning and awful incompetency of the bush administration come to light, to give voice to the discontents of many mainstream iraqi shia. following the pivotal and tragic bombing of the golden mosque of samarra, the mahdi became the primary threat to american forces in iraq as well as the sunni population, as well as the de facto enforcers of the rule of law in many shia communities. many people in the united states want to believe, i'm sure, that he was somehow defeated by american force of arms, but that seems to bear little or no relation to reality.

observing the terrible statistics, one can draw one's own conclusion -- i won't pretend to posess special knowledge, but neither do i think one needs much to see what is going on. what most republicans desperately wish to see as the success of the bush administration's 2007 escalation in iraq is more likely the product of al-sadr's period of rest. the same pattern is evident in iraqi civilian deaths and iraqi police force deaths -- no material reduction during the surge buildup and peak levels, but a drastic reduction upon al-sadr's initiation of a truce. if this week marks the end of that truce, i would guess the "success of the surge" is also at an end.

the administration has not ceased to beat the drum for war with iran, and will almost certainly use aggressive action on the part of al-sadr to accuse iran of perpetrating hostilities regardless of any evidence of lack thereof.

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i think that any honest appraisal of the 'success' of the surge has to also include the role of u.s. forces in the rapidy and effectiveness of the ethnic cleansing of neighborhoods (as reported by folks in iraq such as patrick cockburn). and, although they also contributed to the lower death rates from september to january, they have a more long-term effect (and problem): the disentigration of baghdad into walled, armed enclaves. it doesn't take much to envision how baghdad might go the way of beirut from about 1975-1990; 15 years of street-by-street sectarian warfare this time with u.s. soldiers in the crossfire...

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the psychology of position sizing

enjoy. better advice with better justification rarely to be found.


Tuesday, March 25, 2008


questions arise about jpmorgan chase

yves smith passes on the devastating analysis of institutional risk analytics regarding jpm -- could it really be that the fed drove bear to jpm at a very low price as much to shore up jpm as to save bear?

To us, even at $10 per share, the JPM buyout stinks to high heaven because of the conflicted role played by the Fed of New York. Does anyone believe that the Fed would force Lehman Brothers or Goldman Sachs into such a fire sale? Indeed, it looks to us like the Fed of New York and BSC both got rolled by JPM CEO Jamie Dimon and his merry banksters. But the JPM crowd won't be laughing much longer.

The same forces that pushed BSC into insolvency are working on JPM and the other money centers as you read these lines, but JPM first and foremost. Just look at the range of valuations included in JPM's disclosure to Canadian officials regarding price estimates for illiquid structured assets and you can see why JPM's Dimon has been so upbeat in recent months.

To understand the grim outlook for JPM, start the analysis with derivatives. Because of its huge market share in all manner of OTC derivatives, JPM represents a "super sample" of overall OTC market risk. In terms of total size vs the bank's balance sheet, JPM's derivatives book is more than 7 standard deviations above the large bank peer group.

Because of this huge OTC derivatives book, the $1.6 trillion asset bank can tolerate just a 15bp realized loss across its aggregate derivatives position before losing the equivalent of its regulatory Risk Based Capital (RBC). And much like the GSEs, JPM's positions are too big to hedge - despite what Mr. Dimon may say to the contrary about laying off his bank's risk. And note that we have not even mentioned subprime assets yet.

Look at the balance sheet of JPM's three main subsidiary banks and the mounting stress from loans losses is apparent. At the end of 2007, JPM aggregated 97bp of gross loan charge offs, 1.25 SDs above peer, and produced a Loss Given Default of 85%, likewise well above peer. The Exposure at Default calculated by the IRA Bank Monitor using data from the FDIC was 202%, more than 2 SDs above peer.

At the end of 2007, JPM's Tier One Risk Based Capital held by its subsidiary banks was just $88.1 billion, a tiny foundation for the bank's vast trading operations. The Economic Capital ("EC") simulation in The IRA Bank Monitor generates an EC benchmark of $422 billion for JPM or a ratio of EC to Tier One RBC of 4.79:1, suggesting that JPM needs almost five times current capital levels to fully support its economic risks.

This EC produces a "Stressed" result for JPM under IRA's Counterparty Risk Rating and a RAROC of just 0.22%. Similar measure for all US banks are contained in The IRA Compendium of Bank Risk.

While JPM currently boasts the highest Tier One leverage ratio of the top three US banks by assets, in EC terms it appears to be the clear outlier in the marketplace with the highest levels of economic risk vs. capital of any large bank in the US -- with one exception: Commerce Bancorp. The relatively large MBS holdings of CBH push its ratio of EC to Tier One RBC over 8:1 in the IRA Bank Monitor simulation.

Why do we take such a dim view of JPM and the US banking sector generally? First, because the US real estate market is not yet even close to the bottom. Second, the commercial real estate and corporate credit sectors are being dragged down by the same deflationary forces that are causing the US economy to slow dramatically. When you consider that US real estate markets and bank loan losses are unlikely to bottom before this time next year, you begin to understand our bearish outlook.

JPM has been lucky so far because its risk book is heavily weighted toward commercial rather than consumer risk, unlike our beleaguered friends at Citigroup. But like last week's debacle involving BSC, the fast deteriorating situation at C could provide a catalyst that takes JPM down a couple of notches in the next few months.

We hear in the risk channel that the internal situation at C is going from bad to worse as veteran Citi bankers are in near-mutiny against the new, two-headed management team imposed by regulators. Meanwhile, former CEO Chuck Prince, who is a consultant to C, is leading the discussions with regulators on behalf of the bank and is, in effect, acting as shadow chief executive of C. One insider predicts that the C annual meeting in several weeks time will be "very messy" and notes that acting Chairman Robert Rubin is nowhere to be seen.

Keep in mind that C, JPM and many other large banks are still trying to get their arms around the full dimension of the risks facing their institutions, this even as bank loan default rates remain well-below long-term averages. All of the subsidiary banks of C, for example, reported 127bp of charge offs in 2007, a full 2 SDs above peer but well below 1991 loan loss levels.

Click here to see a loan default series for Citibank NA going back to 1989. Notice how low bank loan charge offs were in the 2006-2007 period compared with previous recessions. Of note, the ratio of EC to Tier One RBC for C at the end of 2007 was 3.46:1, significantly better than JPM, but still suggesting that C really needs more than 3x current capital to address its economic risks.

folks, we really need the federal government to step into the banks wholesale -- and very soon. the fed is already (as paul volcker noted) going far beyond its mandate to fill the vacuum being left by the bush adminstration and congress -- for example, the new york fed as part of the jpm-bsc deal is preemptively relieving bsc of $30bn in illiquid assets by creating a fed-sponsored SIV (more at interfluidity). it is therefore essentially buying bad assets, much less taking them as collateral. but it simply hasn't the capacity, much less the mandate, to attack the mortgage complex on the scale that is required.

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chinese and commodity bubbles have popped -- deflation taking hold

in the past year i've remarked on the excessive-liquidity-fueled asset bubble taking place in china.

it's now over. shares are down some 40% from the peak and still collapsing. the economist included a story on chinese shares in this week's briefing on the financial crisis. by the analysis of china economic review, there might be considerable downside remaining.

earlier in february i mentioned that it might be time to evacuate commodities. this is less certain -- wheat subsequently jumped over its february reversal to put in a manic double-top at 1300. it too has subsequently dived over 20% in just a week. commodities broadly have backed off over 10% in the last month. this is not clear -- there could be a rebound and late-stage blowoff as dumb money floods in through ETFs.

but recent action is indicative of massive leverage coming off the underlying securities as large speculators unwind borrowed positions.

the dollar has jumped in the last week but remains entrenched in a steep downtrend. if however it should catch a bid here and break out, in combination with continued deleveraging in commodities and chinese shares, as well as t-bill yields around 1%, the danger of an accelerating and self-feeding debt deflation cycle will no longer be a danger -- it will be a reality. there's already some serious discussion of a liquidity trap.

at the source of deflation, of course, is the housing market. paul mcculley in his latest missive calls such a deflationary spiral an immediate certainty unless government quickly steps into the breach to support housing and the banks that are mired in it. today's release from case-shiller -- a record 2.4% drop in january alone, down 10.7% YoY and 12.2% from peak in may 2006 -- certainly reinforces the idea that house price declines are accelerating. (prices in chicago fell 2.2% in january, 6.6% YoY and 7.2% from the peak in september 2006.) so does the continuing increase in REO. (chicago has become a national leader in foreclosed property.)

his favored measure is a forced writedown of mortgage principal balances -- one can describe buying a house with no money down as the cheap purchase of both a call option with maintenance cost (ie, the mortgage payment) and a free put option. if the house price appreciates, one can maintain the call option as it goes into the money by making mortgage payments. if the house price falls below the outstanding mortgage balance, however -- into a negative equity position -- the call option becomes worthless and the put option goes into the money. one can exercise the put by going to foreclosure. when house prices are falling steeply with little hope of a near-term rebound, then, it is quite sensible to quit the mortgage and lose the house -- particularly if you don't prize your credit rating.

by writing down the value of the mortgage so as to give the owner/option-holder positive equity, one keeps the put option from going into the money and incentivizes the maintenance of the call. the writedowns would be extremely painful for the investors, but as recovery in foreclosure is normally something like 50 cents on the dollar, many mortgage lenders would seem incentivized to write down loan balances.

mcculley presupposes much in this, and ignores the fact that tranched MBSs have high-quality asset holders who would be hurt by such a plan even as lower-quality asset holders would benefit. in other words, there will be resistance to any plan to write down mortgage balances. and he further does note the ethical problem of rewarding the dumbasses and conmen who took out these mortgages.

problems aside -- mcculley is fully aware that if millions of these put options go into the money, there is likely no avoiding the most powerful episode of debt-deflation in the united states since the great depression as we make the reverse minsky journey. there must be a large policy response.

none of that, however, is going to prevent house prices from restoring something like their traditional relationship to incomes and rents in the next few years. mcculley is simply describing a way that losses resulting from much lower prices can be nationalized.

Q: You don't see the housing market naturally hitting a place that will attract cash buyers, like California GOs?

A: Not nearby, if you will. Because you know that California GOs are money good; it's a pretty straightforward calculation to make. But with the property market, you don't have a terminal value known as par. So you're catching a falling knife. Unlike a bond that's going to mature at par, the falling knife in the property market doesn't have a maturity date on it. So you only get to that point, conceptually, when you get price-to-rent ratios down sufficiently that somebody could buy the house and rent it out and have positive carry. With me there? That would work only when I could buy a house for a carrying cost of 1300 bucks a month and rent it out at 2100 bucks a month. That's not the case in America now. It's all negative carry on property relative to what you can rent for. That would conceptually be your floor, but that is so far away from here that the economy would have to go through absolute hell to reach that point. Remember, if you're thinking, "Maybe I want to buy a property here," your second line of thought is probably: "Well, if 10% of the people have in-the-money puts now because they have negative equity, and they're exercising, the very exercise of those puts is going to drive prices down, so you will have another 10% of the people whose puts will go into the money.

Q: That deflationary spiral again.

A: It makes no sense to try to get in front of it, if you know that it's a self-feeding process on the way down. The key issue is that so much of the marginal lending in the last years of the boom was done with no skin in the game. It smells to high heavens and I'm sure that Mr. Bernanke didn't like having to say the words, but the only way that you can stop the process is, effectively, to write down the principal to the point that the guy's put is no longer in the money and his call is actually marginally back in the money. ...

mcculley goes on to note that, even after the government buys mortgages at a 25% discount from investors, the taxpayer is still at risk from further declines in housing. but it would be the taxpayers, and not the banks -- thereby at least relieving the pressure on the financial sector and avoiding the necessity of a wholescale deflationary meltdown.

there's no guarantees, of course -- if such a bailout were to precipitate a run on the dollar, rather than prevent one, the fed would be compelled as in 1931 to raise interest rates at the worst possible time. but i have to imagine mcculley is essentially correct as to what must be done to lessen the risks.

unfortunately, the bush administration is instead inclined to whistle past the graveyard. more from econbrowser on their abdication of responsibility in an election year. if this turns out ot be their final position and deflation accelerates into november, the administration may well solidify the claims of those who would call their tenure the worst presidency in the history of the united states.

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Would that not amount to a defaulting on debt held by China and Petroleum producing countries? Where would that lead?

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in the first analysis, anon, i'd think deflation would be a net positive to dollar-asset holders overseas. dollars will get scarce and the dollar should strengthen in currency markets -- effectively increasing the payout to dollar holders.

but if the response to avert deflation results in a run on the dollar, then yes -- a dollar collapse is a soft default.

there's an open debate as to what forex losses mean to foreign central banks, or whether such losses would cause them to guide policy. there's a presumption -- larry sumners called it the financial balance of terror -- that once losses or even volatility start exceeding certain thresholds, the balance is broken and large dollar holdlers will refuse to support american deficits and the dollar through continued vendor financing. but i don't know if anyone knows that that is true.

but if we get to that point, it means an inability for americans to import goods (including oil) and a very tangible decline in our standard of living.

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Yes but what about the position of writing down debt principle? The credit crisis is claiming victims as far away as australia already. What happens if this not only becomes even more prevalent, but USG sanctioned as well?

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right, i see your point now anon -- most FCBs hold agency debt, and i don't think that's in any jeopardy of writedowns -- indeed, fannie and freddie will be nationalized before that happens, imo, with USG eating the losses.

but foreign banks and private parties, like domestic investors in private-label MBS, would be taking the brunt of writedowns. the question is whether one can convince them that it is in their interests to do so -- that they actually will improve their recovery of capital. as it is, in many cases they have an illiquid security that may ultimately recover very little of its par value.

as mcculley says, there are no good choices now -- it's all about trying to find the least painful path to clearing prices. i expect, as you may as well, that there will be significant investor resistance to the idea of writedowns because 1) some don't recognize the depth of the problems facing their holdings, and 2) some high-quality MBS that are in good shape stand to be hurt by writedowns. this is why government intermediation would be necessary.

does it mean further asset-price deflation? yes -- this is debt liquidation by de facto default. but it may actually stem an even more severe wave of deflation that would do even more damage to investors.

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Monday, March 24, 2008


a new resolution trust corporation -- and a warning from japan


The only tool left may be for the Fed to help facilitate a Resolution Trust Corp.-type agency that would buy bonds backed by home loans, said Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co. While purchasing some of the $6 trillion mortgage securities outstanding would take problem debt off the balance sheets of banks and alleviate the cause of the credit crunch, it would put taxpayers at risk.

``An RTC-type structure is interesting, and it may not be that much of a burden on taxpayers in the long run,'' said Barr Segal, a managing director at Los Angeles-based TCW Group Inc. who helps oversee $80 billion in fixed-income assets. The government should purchase the mortgages and reissue ``debt that's backed by the U.S. government and there you go, you've unclogged the drain,'' he said.

``Something like that would be very helpful, but the Fed was not designed to and shouldn't assume a huge amount of risk on behalf of taxpayers,'' said Alan Blinder, a Princeton University professor and former vice chairman of the central bank. ``That should come out of the elected parts of the government, which means the administration and Congress.''

President George W. Bush and Treasury Secretary Henry Paulson have resisted calls urging the use of government funds or guarantees to stem a record amount of mortgage foreclosures, the root of the financial crisis, preferring that the markets resolve the trouble. Bush said March 15 he wanted to avoid ``bad policy decisions'' that would do more harm than good.

... For Pimco's Gross that's not enough. ``If Washington gets off its high `moral hazard' horse and moves to support housing prices, investors will return in a rush,'' he wrote in a note to investors published Feb. 26. Gross, who runs the $122 billion Total Return Fund from Newport Beach, California, didn't return calls seeking additional comment.

An RTC-like entity may not be ``the best idea, but maybe it's the idea that gets us through this,'' said New York Life's Girard. ``The likelihood of it happening has certainly increased.''

... ``In a sense they've done that already with Bear Stearns,'' Michael Materasso, senior portfolio manager and co-chairman of the fixed-income policy committee at Franklin Templeton Investments, said of the government taking on the risk of owning mortgage securities. ``This was not just a temporary situation. The process has begun, the question is how far can it go?''

it's been pointed out that gross is talking his book, and he surely stands to benefit from government support for the mortgage-securities market. but no less a personage than paul volcker sees the high likelihood of such a move. so does economist brad delong, who notes that this is now a stage 3 financial crisis and that the alternatives are a depression, a big inflation, or a massive public intervention.

gross, however, either does not understand the mechanics of house prices (very doubtful) or is being disingenuous when he claims that the government can "support housing prices" by buying packaged loans even in a massive public intervention (whereas is might do so in a large inflation, by debasing the currency and allowing a big fall in real prices to occur as nominal prices are essentially static). what the government can do by such an act is help deleverage the money center banks, investment banks and hedge funds that are holding these illiquid, loss-making securities, recapitalizing them by buying their troubled assets as artificially inflated prices. importantly, the same holds for fannie mae and freddie mac, which increasingly appear fit for nationalization in total.

Faced with losses this large, some analysts have suggested that more capital is clearly on the menu. And not just a small amount, like an extra $2 billion — we’re talking gobs of it. The Wall Street Journal reported earlier this month that Friedman, Billings, Ramsey & Co. analyst Paul Miller had estimated that Freddie requires $38 billion of capital, while Fannie would need $41 billion.

While those numbers may represent an extreme, both GSEs earlier this week said they would “begin a process to raise significant capital,” as part of an agreement between OFHEO and Adminstration officials. Freddie Mac has already gone on record saying that it won’t dilute existing shareholders by issuing more common stock.

for gross to be correct, not only the banks but the whole shadow banking system would then have to use their newfound capital strength to... dive right back into the huge leverage and widespread fraud that characterized the mortgage market in recent years! that is exceedingly unlikely to happen, in my view.

recapitalized banks are very likely instead to follow the mode of past bubble-burstings (a precedent set very clear to japanese technocrats if not americans) and find ways to allocate capital to economic sectors that have been the best and safest -- not the worst and most troubled -- recent performers. ken fisher may have read that ahead of most everyone, if it comes to pass, calling for heady performance among mega-caps with large cash balances, international exposure and very high levels of creditworthiness.

moreover, gross papers over a more fundamental concern with a large-scale government bailout of housing -- that of turning a national deleveraging crisis into a vastly worse global currency crisis. in delong's terms, this would be a massive public intervention unintentionally precipitating one of the other two options. this is what japan's finance minister means when he says:

Mr Watanabe warned unless swift and appropriate action was taken by world leaders, the financial market turmoil could lead to a severe dollar crisis.

He said the world’s huge excess liquidity has started flowing out of the US. If that flow were to be extended, it could lead to unprecedented problems.

“One thing is to fix the hole in the bathtub,” he said. “[But] we must recognise that the current crisis is not as straightforward as past dollar crises.”

... The minister said that while the US credit turmoil was structurally similar to Japan’s at the time of its bad debt crisis, there was an important difference in that risk in Japan was contained in the banking sector. In the US, it had been dispersed widely into other areas of the financial industry. So “it is not clear how big the hole [in the US] is because the fire has spread to products other than securitised products”.

the even more important difference that goes unremarked upon here is that japan's policy responses to the lost decade were backed by a very high domestic savings base -- unlike the united states, japan did not have to borrow internationally to finance bailouts. the government of the united states is already nearly $10tn in hock, with half that amount owed internationally. while this is not outrageous as a percentage of american gdp, it is a very large figure in terms of global assets. a massive new flood of treasuries could provoke an international dollar/treasury repudiuation and force a dollar crash as the much-feared carry trade unwinds. indeed, recent severe weakness in the dollar reinforces the minister's remarks. citigroup has very ominously warned of worse to come from that direction as yen deleveraging continues apace, and it's hard to calculate what the impact of a massive flood of new government debt into already-strained international debt markets would have on the currency.

it is paramount to realize that japan's central bank is one of the largest holders of treasury debt in the world. yves smith notes that the minister's highly unusual statements amount to a demand that the united states use the treasury to bail out wall street banking.

The Japanese comment is effectively a statement that significant actors in the US financial sector are bankrupt and will need to be recapitalized. Again, that is a shocking diagnosis to make in a public forum. Wantanabe says that the US banking system will need to get new equity from the government. The delay in recapitalizing Japanese banks (it was hard to win over the public) is considered within Japan the biggest reason for the length of their economic crisis

The Japanese are as nicely as they possibly can telling the US that we are in a terrible mess and we need to get on top of it ASAP. This is a blunt warning. I am sure the significance of the Japanese attempt at tough love will be lost.

japan apparently still fears far more for the death of american consumption than for the value of its central bank holdings. so probably do others. but private buying of american securities has entirely gone, brad setser notes, and smaller central banks are slowly giving up on the united states in favor of investment closer to home.

Central banks from 16 Asian nations may invest more of their $1 trillion of foreign reserves in the region's debt as Federal Reserve interest-rate cuts reduce returns on U.S. assets.

``This is something that most of us, that are not yet investing in, will be looking at,'' Bangko Sentral ng Pilipinas Governor Amando Tetangco said in a March 23 interview in Jakarta. There can be ``some kind of shift'' to Asian sovereign bonds, Central Bank of Sri Lanka Governor Ajith Nivard Cabraal said in a separate interview on March 22, after a weekend meeting of policy makers from the region.

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Thursday, March 20, 2008


it's officially a recession

per the high priests at ECRI.

the analysis at fitch, via housing wire: the credit crunch is not only not over -- it's accelerating.

the immediate bout of illiquidity and panic may or may not be over, but the intermediate-term picture is actually getting bleaker by the moment.

prepare yourself. once bank failures start, the great unwind is likely to accelerate, opening the possibility of some truly ghastly consequences.

What commentators totally miss is how incredibly fragile consumption really is. With mortgage lenders going bust by the day and the household sector hit by a barrage of depressing headlines it is entirely possible that further retrenchment in the obscenely high borrowing requirement will yet generate a economic slump which no-one will predict… This is the big domino that is yet to fall.

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global bank panic is over

how's that for duplicity?

as i wrote yesterday, i continue to believe that the second wave is coming.

as it manifests, smaller banks and particularly heavily-exposed midsized regional players will face a new set of threats emerging not from defaults in the residential and consumer lending aspects of their balance sheet -- elements which are in fact unusually small this go-round -- but the commerical real estate (CRE) and commerical and development (C&D) aspects, which are unusually large. i would not be surprised to see american regional banks at the epicenter of the next down leg in the financials as the realization of the nascent CRE bust becomes unavoidable on wall street and fuels fears of a deeper recession -- or worse.

but i also think dick bove of punk ziegel may be right. the last two days have seen (see here and here) dramatic spread tightening and a return of risk appetite in credit markets. it is beginning to be reflected in the credit default swap market in the form of contracting spreads. THAT IS IMPORTANT, if it continues, and bove is further saying that the investment banks have increasingly been able to find clearing prices in problem assets. that may be the critical sign that these banks, which have been in a nine-month hell of illiquidity, are starting to move beyond the "collateral crunch" having secured deep and radical intervention from the federal reserve.

this could be all wrong, to be sure. there could easily be a rapid return of risk aversion. but news like this in conjunction with the possibility that the market is indicating a relatively durable bottom is in place makes going long financials a much better risk-reward opportunity than at any point in the recent past. financials outperformed on tuesday and wednesday both, and are leading higher today as well, and strong curve flattening is underway again this morning.

part of me wants to wait for a gap fill in the IYF to 78.28 to get longer still in financials. but another part is not at all sure the index is coming back in the short term.

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Wednesday, March 19, 2008


eight centuries of financial crises


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global bank panic is not over

via ft -- rumor will continue to circulate in financials for months. and there still appear to be heightened tensions in the global financial system.

but even well beyond that, the bust in commerical real estate is apparently just getting started.

[T]he Architecture Billings Index (ABI) tumbled almost nine points in February. As a leading economic indicator of construction activity, the ABI shows an approximate nine to twelve month lag time between architecture billings and construction spending. The American Institute of Architects (AIA) reported the February ABI rating fell to 41.8, its lowest level since October 2001, and down dramatically from the 50.7 mark in January.

as it manifests, smaller banks and particularly heavily-exposed midsized regional players will face a new set of threats emerging not from defaults in the residential and consumer lending aspects of their balance sheet -- elements which are in fact unusually small this go-round -- but the commerical real estate (CRE) and commerical and development (C&D) aspects, which are unusually large. i would not be surprised to see american regional banks at the epicenter of the next down leg in the financials as the realization of the nascent CRE bust becomes unavoidable on wall street and fuels fears of a deeper recession -- or worse, given continued weakness in residential housing. ambrose evans-pritchard is a dramatist, but he is not wrong to point out the possible.

America is not facing "recession-as-usual". It is in the grip of a property crash. House prices have fallen by 10 per cent so far; Goldman Sachs fears they may fall by 30 per cent in the end. The sub-prime mortgage industry has already disintegrated. Some 241 lenders have gone bust, or shut their doors.

The crisis has since spread to prime mortgages. Fannie Mae and Freddie Mac - the fortress agencies that guarantee 60 per cent of America's $11 trillion mortgage market - began to crumble last week. Even bodies standing at the top of the credit system are no longer deemed safe. As Barclays Capital put it, this was a "tsunami event".

Or in the words of City veteran David Buik at Cantor Fitzgerald: "No one in living memory has ever seen a banking crisis like this. I am older than God, and the outlook has never looked as bleak."

Any smug assumption that this will remain a local American affair may soon be confounded. The IMF has abruptly changed its tune. "Obviously the financial market crisis is now more serious and more global than a week ago," it said on Monday.

Property booms will soon be deflating across the Anglo-Saxon world and the eurozone's Club Med belt. Japan is already on the brink of recession. Debt levels are higher now in most rich countries than they were in 1929. The levels of financial leverage are greater.

As the Bank for International Settlements wrote last year, we are more vulnerable to a 1930s dénouement than people realise - should the authorities botch the response.

UPDATE: the lack of confidence in american banking is reflected here in something called the yen basis swap.

The last time the swap moved in this fashion was back in the 1990s, when concerns about the Japanese banks prompted the so-called “Japan premium.”

Now the situation appears reversed. Counterparty concerns about the US banks may have prompted funds to start unwinding their trades. Now it’s starting to look like a stampede to get out, with no bid on the swap.

What potential for damage does the emergence of an “America premium” have? Significant we’re told.

According to those with skin in this particular financial game, the recent dramatic move suggests significant potential losses. Anecdotally, one fund is said to have kissed goodbye to about a year’s profit getting out of this trade.

t-bills today finished yielding 0.59% -- near a post-war record low. it's utter and complete panic everywhere, and that is a truly massive amount of frightened cash sitting in t-bills earning deeply negative real rates.

UPDATE: yves smith with citigroup's call -- the Great Unwind has begun.

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welcome to the reality of things

from andrew sullivan, with respect to this.

I am immensely grateful that McCain is the nominee, because he is a far bigger man than many in the "conservative" movement today. To read the Corner today was to be reminded that some are immune to the grace and hope and civility that Reagan summoned at his best; the anger and bitterness is so palpably fueled by fear and racism it really does mark a moment of revelation to me.

i don't personally fall into any easy political catagory, and i suspect most intelligent and independently-directed people don't. and i admit to being baffled at the inability of many otherwise smart devotees to see what is at the core of the 21st-century republican party. fear, and the hatred fear spawns, accounts for the better part of the republican platform.

and yet sullivan professes to be shocked. has he ever really watched fox news? has he ever really listened?

there is nothing particularly conservative about fear. no conservative political party has to make its name on and formulate its policy around fear. so why is the republican party so very prone to do so?

the answer, i suspect, lies in political expediency more than anything. fear is the cheapest path to power, particularly in a woefully demotic society, particularly when your economic ideology has the unfortunate reputation of enabling the exploitation of the masses. and true to form, the constant appeal to the basest instincts of its constituency has with too much success denigrated and animalized that constituency exactly as it was hoped.

william buckley died recently, and i have to admit that i felt genuinely sorry for him in recent years. he watched helplessly as the conservative movement he formulated and gave life to out of the fractured and scattered shards of post-war opposition seemed to sink once again into the disingenuous crackpottery, stone-blind ideology, neofascism and naked powermongering that most of his soul must have convulsed at the sight of. the second bush administration particularly has seemed almost a perfect insult to buckley and his kind, the almost farcical perversion and corruption of everything he once worked for.

some people who would label themselves conservative (including myself) have already fled the republican party. i sincerely hope that many more will, because the grand old party now represents the most clear and present danger to the health of our republic.

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Bravo! Here! Here! Harumph! Harumph!

Seriously, very well-put and it couldn't have been said better. Election 2000 angered me. Election 2004 imposed a mild depression on me, as I stated to anyone and everyone: "I don't think we will survive four more years of this idiot." Right now, I think I'm looking pretty good on my forecast. We shall see, eh?

Regards, gm. Cheers and fears!

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the double 90s

i noted in closing yesterday that the market put in what is by my estimate the second 90% upside day in six sessions. others have picked up on the fact too, notably at quantifiable edges and traders narrative. first the latter:

David Aronson, a professor of finance at Baruch College looked at instances in the market (from 1942 to present) when we have these double 90-90 days. His time frame for the second is much wider than what we just witnessed - 3 months. But the results are intriguing nonetheless.

After the special circumstance of a double 90-90 day, the following 60 (trading) days have historically provided a return of +22% [annualized] instead of a paltry 4.5% annualized otherwise. It is more remarkable when you consider that that return comes with the assumption that you enter the market on the close, after a double 9-to-1 signal was triggered and without adding any dividends!

then the former:

Also of note is the fact that breadth was extremely positive today. Upside volume swamped downside by more than 9:1. Last week we just missed a 90% upside day, posting 89%. While it doesn’t quite fit the criteria, I did a study in November on my old blog looking at 2 90% upside volume days within a 5-day period. Results were extremely bullish, although that instance did not work out well.

the results of that study:

Two 90% up days in a five day period (this also triggered today 11/28/07): 5 past occurrences: 11/29/71, 8/20/82, 8/2/84, 1/5/87, 8/31/07 - buy on close of 2nd 90% day

  • t+10 - 100% profitable, 4.8% avg gain, worst drawdown=2.33% (8/31/07 trade)
  • t+20 - 100% profitable, 7.5% avg gain, worst drawdown=2.33%
  • t+40 - 100% profitable, 10.6% avg gain, worst drawdown=2.33%
  • t+60 - 80% profitable, 10.2% avg gain, worst drawdown = 4.55% (losing trade was 3.1% loss from 8/31/07 to 11/27/07 which now is just a 0.3% loss at day 61)
  • t+90 - 100% profitable (4 trades complete), 15.4% avg gain, worst drawdown = 4.55%

these studies are not related to the big-spike-and-nonconfirm pattern of new lows i set out earlier, but they do indicate the relatively high probability of a three-month-plus rally of sigificant size.

UPDATE: jeff saut caught it too.




by which i mean the aftermath of the most radical episode of central banking since and perhaps including the great depression.

charlie rose last night interviewed saint paul volcker, former fed chairman and quite probably the most universally respected american central banker of the 20th century. the journal has excerpts, and video will soon be available. volcker of course hasn't sought to be a saint, but his de facto canonization is particularly evident these days.

some points:

Rose: Somebody said to me that we entered a period in which they were worshiping mathematical models … And mathematical models had no business sense.

Volcker: The market was being run by mathematicians that didn’t know financial markets. And you keep hearing, you know, god, that event should only happen once every hundred years, according to my model. But those every hundred years events are coming along every two or three years, which should raise some questions.

i would argue that this is an important manifestation of the long-run trend toward scientism. financial markets are far from the only place where humans subscribing to the empirical tradition of david hume have lost sight of the limitations of modeling drawn on simplistic linearities. what fits for climate change also fits here:

it seems to me that the irreducible complexity of the system will always defy meaningful analysis, despite what adherents of scientism and the cult of techne might like to believe. our models -- such as they are, being hopelessly reductive -- are constructed essentially by backtesting some broad ideas and adjusting parameters to fit the data we have collected on the recent past -- itself a sample size too small to be significant -- and in any case without anything that an appropriately honest scientist would call a well-understood mechanism.

under such circumstances, any prediction our integrated assessment models of the global environment eject on a hundred-year scale then is little better than a coin flip -- for the same reasons that mathematical models backtested to fit the stock market invariably lose money. the reality is itself unpredictable -- the actual open system is both complex and chaotic. observation of past behavior yields no mechanism by which long-term future performance can be even hinted at.

so why should these predictions be treated seriously?

indeed they shouldn't be, at least not too seriously. in adopting scientific method, one must be sensitive to the philosophical limitations of the method -- and the boundary lays at the edge of complexity, whereafter what seem to be broadly identical inputs to a system yield widely different outcomes.

this is an irreversible verdict against quantitative trading, in my opinion, and indeed on the very sort of historical and mechanistic contextualizing that i use to inform my own trading. it also does much to explain the general ineffectiveness of economics and psychology in making useful predictions. at best, one might hope to ascertain probabilities with a significant factor of error, often larger than the magnitude of the prediction itself.

Rose: Has [the economy] bottomed out, or have we seen the worst?

Volcker: Look. The basic economy is not irretrievably damaged in any way, shape, or form. We had to go through an adjustment, which is tough. It’s happening much quicker. You’d rather have it happen gradually. But I’m optimistic that, okay, we’ve got to get the consumption down, we got to get spending in line with our capacity to produce. I think that’s going on. And that process is going to take a while. If we can stabilize the financial market, we ought to come out of this. Then we’ve got a lot of work to do about what we do with the regulatory system, the supervisory system, what the role of the Federal Reserve is, what the role of the Treasury and the government is, because this is a different financial market.

we may rally here -- fashioning a rope ladder higher from the very noose of historical expectation -- but there will be more fallout from the mean reversion of indebtedness and consumer spending. volcker seems to believe that the reversion will be a long process, and i tend to agree.

Volcker: We’ve seen the Federal Reserve take more extreme measures in some respects than any that have been taken in the past to deal with a financial crisis, which raises some real questions about not only for the Federal Reserve and its authorities, but for the structure of the financial system… The Federal Reserve is designed to lend to banks. And the banks were considered to be at the center of the financial system, and lend liquidity, provide cash in return for good assets, when a bank got in trouble. Now they found in this case, where some of the investment houses were in trouble, and prototypically Bear Stearns … it’s lightly regulated by the SEC or some other, but not for the same reasons. They haven’t got the concern over the stability of those things….We’re going to lend to them and protect them, shouldn’t they be regulated?

Rose: Is it a wise precedent?

Volcker: Whether it’s wise or not depended upon how severe this crisis was and their judgment about the threat of demise of Bear Stearns. That’s a judgment they had to make and an understandable judgment. There is no question about it.

Rose: Could we have risked the failure of Bear Stearns?

Volcker: Well who knows? It would take a lot of courage.

The Federal Reserve … has not, in the past, been conceived as a place where you put in bad assets, possibly bad assets. Lending institutions take risks. I’m not suggesting the assets are terrible, but they have collateral. But that is a new departure. And at some point, the government ought to — in my view, the government ought to be taking responsibility for that kind of action, not the Federal Reserve, which is an independent agency designed to provide an ample supply of liquidity to the economy but not too much, protect against inflation, not to protect particular sectors of the economy from bad loans.

Rose: So the Federal Reserve should not be doing that, in your judgment. It’s not because it shouldn’t be done, it’s the role of the federal government.

Volcker: Absolutely. In this situation, they stepped in and nobody else was there to do it…They stepped into a vacuum, and I think quite appropriately, it’s a judgment they had to make. But is this what you want for the longstanding regulatory support system? My answer is no.

volcker is pointing up the need for fiscal remediation, a view that is coming to be widely held in financial circles. the federal reserve is not designed to forgive bad debts, but some government construction could be -- along the lines of the resolution trust corporation (or RTC). an mentioned at across the curve today, one of the drivers of a continuing large curve flattening move is...

... a Wall Street Journal back pages story that the administration would be willing to hold talks with Congressional Democrats about a coordinated Federal response to the crisis. The translation is that they will soon spend taxpayer money to fix the mess.

moreover, a move by GSE regulator OFHEO to release fannie mae and freddie mac from capital constraints put in place when the books of the GSEs turned up sour a few years back. this is another step toward making the GSEs part of the reliquifaction of the mortgage-backed securities market -- but also more heavily levered and volatile than ever. in time, one suspects, these institutions which back 60% of the american mortgage market will be openly nationalized, becoming part of volcker's preferred legislative resolution to the housing bust.

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Tuesday, March 18, 2008


lose confidence because it's the right thing to do

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fed cuts 75 bps to 2.25%

1.15pm -- now for the reaction -- first stab was lower from s&p 1310. it's less than the fed fund futures, which called for a full point.

1.24pm -- a recovery to 1310 -- pushing and shoving! the day high remains 1316. post-cut low around 1305.

1.27pm -- the reaction to the news is always more important than the news itself. in this market, earnings from goldman and lehman which amount to ancient history in this environment provided sufficient impetus to spark a 3% rally. yesterday, bears couldn't manage to push the market under in spite of having virtually every excuse. disaster after unfolding disaster has nevertheless seen the january lows held. this seems to my silly and self-serving eyes to be a market that wants to trade higher. it's really just a matter of giving traders the excuse.

in that context, is it really wise to disappoint the fed funds futures? particularly when you just spent the previous weekend doing the regulatory equivalent of running around screaming for help?

1.32pm -- now lower to 1302, a new post-cut low.

1.37pm -- negative real rates got three-quarters of a point more negative for short-term depositors -- but hte initial reaction in the longer-dated market is rising yields, though just a couple ticks on the ten-year from 3.39% pre-cut to 3.41%.

1.40pm -- the dip continues to 1298.

1.52pm -- the first move is always the false one, the old saw goes. from 1298 a pop up to 1305, but will it stick? finishing on or near the highs on a day that saw the market disappointed by a rate cut could be interpreted as a very strong bullish statement.

1.57pm -- and the market is making it -- or at least trying to make it -- a push to new highs in the s&p at 1316!

2.01pm -- ISEE data is notably still bearish today, with puts outnumbering calls 611 to 453 so far. cynicism in the face of a possible bottom is a good contrarian sign.

2.03pm -- now 1318 and rising, with the nasdaq 100 back to its intraday high at 1737.

2.09pm -- i find i'm trying to openly root my still-wet UYG over 30 from its 28.22 buy point... maybe i should consider selling it....

2.12pm -- yield on the long bond is now diving, down to 4.28% after having been as high as 4.36% today. good for the banks, good for inflation expectation, and therefore good for the fed -- if it holds.

2.16pm -- gold (GLD) is tanking post-cut -- down 1.3% from flat at 1.15pm -- and is coming off $30 from the all-time high. but it is interesting to look at the futures chain -- march 2008 delivery is off $5.10 to $996.30 but farther out in time the contracts are up.

2.39pm -- s&p 1323 and on the march. the NDX is now outperforming, up 3.8% versus the s&p 3.6%, which is a good sign and a continuation of a budding trend since late february. generally, NDX outperformance indicates increasing speculative interest.

2.47pm -- more upward pressure as this trend day comes home. NDX now up 4.1%.

3.02pm -- NDX up 4.4% at 1761.05, s&p up 4.2% at 1330.39, both closing on the highs. that was quite a day!

3.11pm -- my lovely UYG finished at 30.86, up 4.34 or 16.4%. THAT is a nice day.

3.22pm -- so what next? if in fact this is enough panic, i'd suggest s&p 1395 has to be busted. there could be a day or two of backing and filling now to consolidate today's move.

4.13pm -- one follow-on -- that was a 90% upside day, which i make to be the second in six sessions. that should augur for higher prices, at minimum a rally to 1395 and i would suggest very likely beyond. IYF should run to 90.78, a further gain of 9.3% (implying about 18% in UYG), though it will have to break the line of declining highs around 85.50 first. but any rally will continue to be reliant on a return of risk appetite in credit, about which more from across the curve. today's curve flattening by big jumps in the 2-year and 5-year yields is sign of that return.



is this enough panic?

it's the question of the year -- has there been enough rout to reroute the market?

i can't pretend to know. headlines are one thing, but subjectivity dominates. i try to look at more quantitative measures, and here's one.

this is the picture of abject options marketplace terror. take it along with the ISEE data -- in the last 15 days, only once have as many calls been written as puts. that is (pardon a moment of incivility) fucking ridiculous. time-arbitrage in volatility contracts offered huge ~20% spreads yesterday again, for the third time in six months. and try for a moment to find some commentary on the internet or anywhere else which proffers a powerful, sustained rally. there are no bulls, as far as i can tell, and any rally is most often deemed short-covering and a good excuse to sell into strength. and that makes some sense, in fact, as short interest in the s&p has rarely been higher.

all that makes for a powderkeg, in my humble opinion, and one sitting atop a non-confirmation in new lows, which amounts to a lit fuse. at the very least, this is a bad time to open new shorts.

UPDATE: from across the curve -- risk aversion may be breaking in the credit markets. if it continues, this would be utterly critical and fuel for the equity market, the nine-month fall in which has largely been a shadow of a much larger disturbance on the credit side. as noted at accrued interest, bank credit default pricing is what to watch to know if markets think the fed is succeeding -- and they are indeed pulling in.

UPDATE: more on tightening agency spreads from across the curve. very positive stuff if it sticks.



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Sorry, the first was a misfire.

Nice post. I'll not become a bother, but I thought you would emjoy this:

"Beware the parabolic rise"

Cheers! (and fears!)

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bother away, dc! :) and thanks for the link.

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the first hint of optimism for housing

it's not much to get excited about -- there's a long way to go -- but house price declines, busting homebuilders and tightening mortgage credit are starting to have their effect on the market in new homes.

The second graph shows Single family housing starts vs. New Home sales. Single family starts also include homes built directly by owners, in addition to homes built for sale (and some other minor differences).

This graph indicates the difference between single family starts and new home sales has narrowed recently, possibly indicating: 1) that fewer homes are being built by owners, and 2) that single family starts are now low enough to begin to reduce the inventory of new homes for sales.

inventory reduction -- if it starts become evident -- would be indication that prices are falling far enough to begin clearing the market. prices would then very probably continue to decline in an effort to attract more demand to clear backlogged inventory.

to be sure, sales are still falling and inventory is very, very high and still rising -- there's no bottom to call quite yet. as calculated risk noted a couple months ago, lowest lows in starts may come further down -- possibly much further.

but the narrowing of the spread between new home starts and new home sales has been a historical precondition of a bottom in both starts and sales, such as was the case in 1982 and 1991.

and the lowest lows in real house prices followed in those cases at a distance of some 8-12 quarters.

UPDATE: more along these lines from calculated risk. and more. as an aside -- if we are closing in on a bottom in new home starts and sales, what might it mean for the builders?

a thorough look back at historical performance is difficult, but some conclusions might be drawn from the 1991 sales low point.

many homebuilder stocks peaked in 1986 or early 1987 -- coincident with the peak in new starts. and while real home prices bottomed finally in 1994 alongside existing home inventory, the builders had been nourished on increasing sales volumes well before that. as can be seen in their charts, the low points came in late 1990/early 1991 with most stocks having fallen 50-80% from peak.

that sounds very much like the current condition set, where homebuiders have been falling since the 2005 sales peak and are now as a group off by two-thirds with many individual cases being down 80% or more.

to be sure, some will go to zero. but as a group, i've heard sillier ideas than going long what has to be one of the most heavily shorted sectors of the marketplace.

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probably not

i was having a pretty good morning until i saw this on the newsstand. i'm sure i don't need to recapitulate the entire history of the magazine cover indicator, and it's enough to note that it isn't perfect (see the continuation of big picture's chart). but it isn't for nothing that you want to fade the crowd -- and whether editors are leading the sheep or adroitly reading their audience, they are vox populi.

i think it must be highly unlikely that a long-term bottom has been put in around s&p 1270 if this sort of hopeful bottom-fishing is making the cover of a plebiscitarian paper like the chicago sun-times. we might bounce hard here for a month or three or even six -- but past that one has to be looking lower with sentiment like this afoot.

UPDATE: the british press seems to be holding up its end of the bargain much better. here's some extra historical perspective with respect to the new york times. and i'm not sure if it's good or bad that much professional opinion is probably darker than the broadsheet.


Great post. I enjoy your evidence and analysis. I can't say I was feeling pretty good this morning, but I can say I felt worse after reading the post. BUH-HAW!

Seriously, I enjoy your posts greatly, except for your (enviable) periods of nonactivity.

Best Regards,

Dark Cloud (Steve B), STL, MO

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thanks, steve -- much appreciated!

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Monday, March 17, 2008


ready for a ride

9.06am (chicago time) -- markets have been open for half an hour, and nyse volume through 10am is running 38% higher than friday's high-volume session. the VIX opened up at 35.60.

9.10am -- dollar trashing is all the rage, and indeed carry trade unwinding is provoking a panic in the dollar/yen. the pair has backed off a little from the overnight 95.71 to 96.97, but this is still amazing action.

9.13am -- the s&p reached down to 1262.72 this morning, but is trying to hold the january low of 1270. currently 1272.90.

9.21am -- jeff miller with what i hope is an important observation -- there are no bulls. ticker sense demonstrates very high bearish sentiment among bloggers anecdotally, and quantifiable edges notes that it is a mass phenomena as measured by the michigan sentiment index. bill luby elaborates on how rare these conditions really are. problem is that every sentiment measure can always get more dour still.

9.28am -- as suspected last night, lehman is under terrible pressure. i have to agree with interfluidity, though -- the fed has basically said that no primary dealer will fail in this episode. that may not prevent a run on lehman, but it probably will save the franchise for another day.

9.32am -- market surging up now @ s&p 1278 and rising. could the fed's massive backstop have drawn a line under the equity market?

9.50am -- excellent from yves smith. i read bookstaber and am compelled to agree -- in systems as complex as markets, unintended consequences dominate, particularly in times of crisis. on this view, what the fed is doing by expanding access to its funding is not necessarily relieving the deleveraging so much as pushing its horizon further down the chain. with the TSLF, to save commercial banks, their client investment banks were imperiled. now, to save investment banks, their client hedge funds are being imperiled.

9.56am -- but of course that does mean the investment banks are being saved -- and an important vote of confidence may be coming in from the market. my warily-held shares of UYG (bought friday) have climbed from a low of 24 back to $27.17 -- and the $BKX is flat at 77 after having been as low as $73.22.

10.03am -- more on dollar trashing from yves smith.

Bernanke has assumed that the US can create as much liquidity as it needs to in order to prevent deflation. But he's presupposed that America can act in isolation. Our huge current account deficit means there are limits to how far we can go with the printing press operation, and we seem to be breeching them now.

in effect, the fed is finding itself nearer where it was in 1931 -- faced with a growing probability of havign to raise policy rates in order to prevent some measure of capital flight from foreign investors.

10.48am -- equities back off and the s&p bounces off 1270 exactly -- for the moment. currently 1272.46.

11.08am -- but not for long. back to session lows at 1263. volume now running about 4% higher than friday.

12.43 pm -- new session lows saw the s&p bounce at 1256 -- very near the overnight futures low from martin luther king day of 1255.

1.14pm -- and from those lowest lows a rally, back to 1273 and rising in the last half hour. massive, massive volatility today! a 2% gap down, then a fill of that gap, a plunge to carve out lower lows and push any definition of a january retest, and now a pickup in volume and price pulling the s&p up twenty points. nyse volume now running 13% over friday.

1.48pm -- VXO is trading at 34.86, having been as high as 37.17 today. it's the highest level for the old-formulation volatility index since february/march 2003, one of two times (the other being the bottoming process in 2002) that it stayed elevated for more than a few days. but it can clearly reach quite a bit higher as panic ratchets up before a low is put in.

1.58pm -- there may be some reason for positivity headed into the close with rising bottoms in momentum underlying the indeces. indeed, on a daily scale, there are divergences now with both momentum and MACD. it may not mean much, but with sentiment SO negative it may not take much.

2.17pm -- a good reminder from felix salmon: in the event of broker bankruptcy, you don't own the securities in your brokerage account.

2.35pm -- more on the volatility indexes -- taking a look at the ratio of cash VIX to the futures both 3- and 6-months out, there's clearly an panic jolt underway on the same order of the lows in november and january.

2.40pm -- market is still climbing with the s&p now at 1286 within sight of breakeven on the day, which would be a major and improbable moral victory.

2.50pm -- volume in 11% over friday on the nyse.

2.52pm -- the two-year note yielding 1.37%, with the 90-day bill is yielding 0.99%.

3.06pm -- a pretty strong fade at the close sends the s&p to 1276.57, off 0.9% on the day. a rollercoaster day, likely to be followed by more strangeness tomorrow.


Sunday, March 16, 2008


jpmorgan pays $2/share for bear; fed cuts rates again

if anyone doubted just how desperate things are in the united states financial system, consider this action from a sunday.

the fed and treasury must have pointed a gun across the table at bear stearns' execs, who accepted in principle an emergency sale at $2/share in jpm stock. the fed further agreed to fund bear's worst assets to the tune of $30bn. bear traded at $180 not so long ago, $70 a week ago and $30 even after the worst single day stock price collapse in living memory friday. bear has come full circle since the failure of two of its poorly conceived credit funds went belly up to kick off what many are calling the worst credit disaster since the great depression. more from yves smith.

what's more, to try to put a seal of confidence on the whole sordid affair and diminish the possibility of a massive selloff on monday, the fed put in place an intermeeting discount rate cut of 25 bps, and furthermore announced unprecedented six-month loans (or what will amount to that) to all primary dealers through the discount window -- previously reserved for commercial banks with depositors -- in return for a broad range of collateral. the program is called PDCF for primary dealer credit facility.

it amounts to a statement that the fed will take credit risk on from primary dealers because it won't allow primary dealers to fail -- or at least it hopes it can save them, so long as they keep coming just one at a time. for the record, lehman brothers would probably be next. again yves smith, but interfluidity makes the most important point about the new discounting policy -- had it been in place last week, bear would still be with us; therefore, the prospect of lehman or any other primary dealer now failing would seem remote indeed. as such, it should stay a great many concerns about a counterparty-risk-driven unwind.

at this writing, however, it's not working -- the s&p futures are off 32.70 to 1260.30, nasdaq 100 futures off 37.75 to 1686.75. a huge rumbling from beneath the market is growing louder as the japanese yen is soaring higher, a symptom of the long-dreaded carry trade unwind. the steps taken to relieve the investment bank disaster may seem to traders to be perpetrating a currency collapse of even greater ramifications.

what's more, as smith notes, while precious metals are up commodities in general are trading down -- could it be that traders are finally beginning to fear a deep demand-crushing recession of global reach? or deflation?

if this doesn't stop at this critical juncture, many will view it as final judgment that the american government no longer has any control over events, which are spiralling down with massive inertia.

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Friday, March 14, 2008


the potential for real problems

there's a canard in american political history that herbert hoover did nothing to alleviate the onset of the depression. such was the angle of attack from franklin roosevelt in 1932, and so successful was that campaign that its propaganda became embedded in american mythology.

it's not so, of course -- hoover was a very activist commerce secretary who took an active role in creating the credit excesses of the 1920s, and then an even greater activist stance in forestalling the bust. the new deal was his deal, by and large, carried out in grand scale by roosevelt as the depression wore on.

one can argue about the wisdom of government intervention in the aftermath of the bubble bursting, of course. but the original sin is in the creation of the bubble -- something that can only be done with government at minimum standing aside from its natural regulatory role, and indeed which in this case was facilitated by manipulation of interest rates and the underwriting of massive credit backstops in the form of the GSEs.

many american conservatives are so totally divorced from reality on the issue as to be dangerous. they generally have encouraged all manner of government facilitation of the credit bubble under the bush administration since 2000, but there remains underneath an ideological and utopian desire for non-interference. and now that long-building problems which arose with government complicity are surfacing, the animal desire to flee the problem (and all responsibility for creating it) is also surfacing -- in the form of belated laissez-faire.

moral hazard aside, an honest history of capitalism will reveal that every major crack-up since the tulip mania of the 1620s was addressed with government-taxpayer bailouts on some level. it is part of capitalism to do so -- the losses, once too great, are socialized, and this is the price paid for the long-term benefits of price-driven resource allocation. that this fact isn't part of the ideological mantra of capitalism as defined by the zealots and high priests is as meaningless as the fact that the doctors and philosophers of communism were disappointed by the impurity of their ordained system in practice. and it is very important for in situ leadership to understand that ideological purity is a noose by which they will be hung if they insist.

what has happened in the united states is not good, but it is probably manageable IF government recapitalization of the banking system gets underway. however, the sort of public denial of deep-seated problems at the heart of the system that our executive leadership is apparently willing to forward -- beyond being yet another dimwitted escapade of a kind with that which led them to eschew the "reality-based community" over iraq -- can have massive ramifications if it results even in just a significant delay of action. once a deflationary credit unwind gets underway, it can be extremely difficult to stop. the key will be to support the banks well before that happens, and then to move into the credit markets with a measure of regulatory zeal longer-term to prevent the kind of credit underwriting lapses that characterized 2002-2007.

it seems almost comic that the tragic administration of george w. bush -- unsatisfied with trashing american soft power and cultural advantage, unsatisfied with plunging this nation into a fiscal and military morass in the middle east, unsatisfied with widening and hardening virtually every division in the american political landscape -- would take its infamous conflation of raging incompetence and ideological zeal to the final length of sealing the american economy in a tomb. and yet it might. if the administration draws a line against government recapitalization and tries to defend it, it will actually become what roosevelt once only painted the adminstration of herbert hoover as. and that would have the potential for real problems.

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