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

Tuesday, September 30, 2008


that didn't take long

less than five weeks after sarah palin was pulled from a well-earned obscurity to the big lights -- this actually was written by a columnist for the national review online?

It was fun while it lasted.

Palin’s recent interviews with Charles Gibson, Sean Hannity, and now Katie Couric have all revealed an attractive, earnest, confident candidate. Who Is Clearly Out Of Her League.

and this?

That Russia answer with Couric. Oy. ... I’m not where my friend Kathleen Parker is — wanting her to step aside to spend more time with her family and Alaska — but that’s not a crazy suggestion. She's right to say that something’s gotta change.

... When I watch these interviews, I see a woman who looks like she’s stayed up all night studying and is trying to remember the jurisprudential chronology of privacy vis-a-vis reproduction, the war on terror, and public figures (add 12 more things, described in the most complicated way possible, to the list to be more accurate). She looks like a woman who’s been cramming talking points and great Matt Scully lines and Mark Salter-McCain war stories and Steve Schmidt marching orders into her head since that first plane ride from Alaska.

though at least this latter, in the best recent republican tradition, blithely dismisses the need for comprehension and proposes that the candidate be "freed" to... make a fool of herself without having crammed talking points? it isn't clear.

If Sarah Palin is John McCain’s secret weapon, let her go, whoever is holding her back. And, frankly, if it turns out that the “authentic” Palin of rallies and the Republican convention is just good speech delivery in a woman with some good spirit, I want to know that sooner rather than later. (Mitt’s still available. Someone in Washington who can actually run a business and knows something about the economy will come in handy once the federal government owns the U.S. banking system.) But if the Palin we know and love and have projected our hopes for sanity in American politics is the real Sarah Palin — then come out from the shadows, woman. You’re the one who is going to win this election. Be yourself. Otherwise, what’s the point?

at least there's recognition here that palin is a pretty but empty vessel into which republican voters desperate for good news have poured a lot of projection and imagination. that investment explains much of the ridiculous behavior of grassroots republicans in the immediate aftermath of her selection. she's been parchment on which the party has tried to write some "political bullshit about narratives". and she's gradually being exposed as what she is, at least to those who still think about their politics.

when such a virulent publication as NRO is on damage control even before the first (and only) vice-presidential debate, then it's obvious that sarah palin should fall on her sword for the good of the party, even if it is probably too late -- in light of an unfolding financial disaster acting as the cherry atop the eight most incompetent years of executive stewardship in the 230-odd year history of the nation, preserving the electorate from its own stupidity -- to save the republican ticket from the landslide defeat now brewing. she clearly should never have been selected and stands as a timeless indictment of john mccain's judgement.

i spoke today with another thoguhtful dyed-in-the-wool conservative -- one who more closely affiliates himself with the republican party than i do -- who simply isn't voting republican this year. it's his hope that the wilderness will break the stranglehold of neoconservative, jacobin, fascist, utterly ungrounded and deeply unrealistic politics which now renders the party unfit to govern. that's my hope too.


good one, gm. liked the article links to the second half start of america's most moronic president. (when bush got a second term, i literally was depressed, saying aloud "we won't survive 4 more years of this man." well, here we are, eh?)

clinton and reagan both had opposing-party congressional majority in one or both houses of congress for 6 of their 8 years in office - resulting in negotiation and compromise for legislation and executive signature.

bush the stupid had same-party majority congress in both houses from 2001-2006. for the first time in recent history, the republicans (with neoconservatives) dominantly ruled our executive and legislative branches. and there was inadequate bipartisanship, compromise, and negotiation.

imho, these 6 years of 2001-2006 contain many of the foundations of our damage today. in the tone of mass disenchantment with the repubs/neos - with all due respect - what do you think?

and isn't the damage too big to fix, at least without some major pains and adjustments, somewhere?

"there are few like us - and few like us." - stephen decatur

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a failure of mimesis

michael scherer writing for time.

wsj's alan murray discusses how the self-interest of the house republicans has shattered what little public confidence was left in government.

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central banks crowding out interbank lending

via barry ritholtz -- the record quote for LIBOR is all but fiction, however high, as no one is lending to anyone. the rate is an irrelevant. central banks are the lender of first, last and only resort.

"The money markets have completely broken down, with no trading taking place at all. There is no market any more. Central banks are the only providers of cash to the market, no-one else is lending.''

-Christoph Rieger, a fixed- income strategist, Dresdner Kleinwort.

the commercial paper market is seizing up as well as money is getting scarce -- see china's withdrawal of short-term funding from american banks -- and this is extremely bad news if it lasts for any length of time.

The CP market not functioning is a big deal. What is surprising is that it is continuing not to function. The big buyers of CP are money market funds (corporate treasurers are also major players). The backstop to the money market funds last week should have taken care of this problem. Clearly it hasn't.

in the cited london times article from friday:

Industrial and commercial companies outside the financial sector have been caught out by the sudden drying-up of investor appetite for commercial paper (CP), the standard way for large companies to borrow for a few days to a few months.

this adds stress to the banks as corporations draw on backup facilities to make up for the CP they can't sell.

in short -- central bank liquidity -- which has gone well beyond enormous -- is becoming a problem, as was noted in the ft last week and relayed by naked capitalism.

It looks like central banks are worried that the only thing keeping banks up now is the fragile commercial paper market, which banks have been desperately tapping in the past few days as a source of overnight funding.

Liquidity is being thrown at the system, but it’s just making things worse.

By pumping in more money central banks aren’t addressing the fundamental concerns of the banks at all. Going cold turkey is a very unpleasant thing, but the solution isn’t more drugs, even if they alleviate short term pain.

In assuming they can rely on central bank money market operations - which will be expanded (as is the case) when the going gets tough - banks are naturally avoiding lending to each other.

solvency has become a monster problem in light of the lehman and washington mutual collapses, each of which surprisingly revealed that there was not capital enough in liquidation to pay out even senior bondholders. the revelation, in combination with access to central bank lines, has killed both interbank lending and private recapitalization of banks. instead, central bank lending is crowding out all other forms of financing for banks. and this may get even worse as the fed moves to pay interest on reserves, as noted by a reader of yves smith:

This is one of the things I have heard being discussed, although I can see the law of unintended consequences coming into play here: if anything, the way I see it, it makes matters worse, as banks with excess reserves are less likely to lend them if they can earn interest at the Fed.

so extensive has fed lending become that the fed itself, though rightfully nervous of taking on credit risk by lending so much to so many banks against suspect collateral, is becoming illiquid. more from brad setser:

Right now, the US is relying a bit too heavily on the Fed to keep this crisis from spiraling truly out of control. That avoids hard political choices –notably hard choices about how best to recapitalize the financial system — but it also creates some long-term risks for the Fed.

the paulson TARP was, in some sense, perhaps designed to relieve the fed from this role. its failure at the hands of john mccain and house republicans in a belated attempt at populist vote-grabbing has thrown that plan into question for the time being. without such a program, it's questionable how banks could be weaned from the central bank teat -- and further how the inevitable bank failures would not compromise the fed's balance sheet.

funding concerns are particularly acute today, the quarter-end. there will probably be some relief tomorrow, but pressure continues to ramp up in the most important markets in the world.

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Monday, September 29, 2008


black monday: house fails to pass paulson plan

republicans voted against en masse, with about 2/3 voting against -- which of course helped to split the democratic vote, of which 1/3 voted against. dow down 600 and falling at this writing.

now we may see some real fear.

UPDATE: house leadership on both sides currently threatening members voting no to switch over before the vote closes -- it's got 207 and needs 218 to pass, and they're holding voting open past time. but which congressman would dare to be the deciding switchover that gets splahsed onto every editorial page in the world tomorrow?

UPDATE: the vote is closed. it will not pass. nasdaq 100 off (-8%); IYF off over (-10%); dow off 600 and has been as much as 700. bennet sedacca has a primer on what to expect.

UPDATE: macro man:

Clearly there are more voters on Main Street than Wall Street, and we all know that the first job of a Congressman in October is to make sure that he is a Congressman in January.

So the question now low do equities have to go, and how many banks have to fail, before Main Street decides that bailing out Wall Street might not be such a bad idea, after all?

Barring a volte-face from the House, we may be about to find out....

UPDATE: barry ritholtz:


s&p now down (-8%) and still falling 30 minutes from the close. dow down 720 points and falling. todd harrison forecast an equity "dislocation" sometime in 2008; he was right. this is it.

UPDATE: the tally:

for the record, the dow finished off 777 points, or (-6.98%). at least that's as of now -- i imagine they're still clearing trades.

black monday, indeed.

one of the immortal headlines to come out of this, sure to pass into myth, is marketwatch's rex nutting -- house to wall street: drop dead.

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i am stunned, ccd.

some people will characterize this as a victory for the people, and it's certainly a deeply flawed plan. but as a victory it may seen quite pyrrhic in a few months' time.

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hi gm. quite a party, eh? feels kinda like the giants beat the patriots in the super bowl again! what an upset.

it remains to be seen, but i'll trust the markets to do the right thing over the government anyday, pal.

like my old man said: things gotta way of workin' out.

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i've no doubt the sun will keep rising and setting, dc! :) it'll work out. one way or another.

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fed to pay interest on reserve deposits

across the curve cites the jpmorgan chase outlook.

This change would greatly increase the ability of the Fed to expand the size of its existing liquidity facilities. Under current procedures, any time the Fed has provided market liquidity by injecting reserves into the banking system — be it through the TAF, PDCF, discount window lending, lending to AIG, or other forms of Fed lending — the increase in reserves has had to be ’sterilized’ by selling Treasuries, conducting reverse repos, or, more recently, through the novel route of having the Treasury overfund itself to increase its account at the Fed. Those means of sterilization threatened to run up against certain balance sheet constraints: the Fed now has less than $250 billion of Treasuries that it hasn’t lent out through the TSLF and TOP, and the Treasury’s overfunding could eventually bump up against the debt ceiling.

With interest on reserves, the Fed would not have to sterilize injections of reserves into the banking system. Normally, reserve injections need to be sterilized to prevent the fed funds rate from undershooting the FOMC’s funds rate target. With interest on reserves, wherever the Fed sets the rate on its deposit facility would effectively set a floor under the funds rate: anytime the effective funds rate would be below the deposit rate, banks would have an incentive to deposit excess reserves with the Fed. Excess reserves would be ’sterilized’ by banks depositing them with the Fed.

One proposed operating procedure using interest on reserves, called the floor system or the Goodfriend system, would have the Fed set the deposit rate at the FOMC funds target rate and then inject massive amounts of reserves into the banking system — possibly by increasing TAF or similar facilities — and allowing the excess reserves to be deposited with the Fed at the target rate. Following such an operation, the Fed’s balance sheet would contain more risky assets and — on the liability side — more deposits (the monetary base would be roughly unchanged); the private sector’s balance sheet would contain less risky assets and more safe assets in the form of deposits with the Fed. The effect on the private sector balance sheet from the TARP is similar, though in that plan Treasury debt takes the place of Fed deposits.

expect then to see significant expansion of the fed's balance sheet.

in conjunction with the expansion of the last two weeks, this becomes a major turning point in the history of american monetary policy. in reaction to a precipitate debt-deflationary unwind, the united states government is regretfully -- in what is to my mind and that of minyanville's mr. practical misguided defense of asset prices -- embarking on an inflationary path that may well lead to significant destruction of the purchasing power of the dollar. to be sure, these first halting steps are not tantamount to a hyperinflation; but they may be taken as a compass upon which to infer the government's future direction. the adjustment in our wealth and standard of living will, if government succeeds, be transmitted to us not in lost savings and income but in the diminishment of the real value of those savings and income streams.

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institutional risk analyst: bailout won't work

today was a pressure date, and government has only a tentative handshake with a house vote today and senate vote wednesday. with a push from a wave of monster global bank failures, markets are off 3%+ and running this morning.

the institutional risk analyst can run pretty warm on politics at times, which is enough to cast a shadow on credibility in spite of the fact that they are probably the best single independent analytical source regarding the banking crisis. i for one am happy to hear them in this missive step away from political persuasion and back to analytical persuasion. but the results are not cheering.

So let us try to describe in financial terms why we believe that the legislation currently being finalized in Washington will be ineffective in achieving the stated goal of restoring liquidity to financial institutions and thereby make it possible for banks to begin to expand their balance sheets and lending books, both of which are currently contracting at an alarming and accelerating rate. In a soon to be published article by Alex Pollock and John Makin, both of American Enterprise Institute, "The RTC or the RFC: Taxpayers as Involuntary Equity Investors," the two respected financial observers write:

"A better model for a fair solution to the incipient solvency problem is the Reconstruction Finance Corporation, or RFC, of the 1930s. This was one of the most powerful and effective of the agencies created to cope with the greatest U.S. financial crisis ever. When financial losses have been so great as to run through bank capital, when waiting and hoping have not succeeded, when uncertainty is extreme and risk premia therefore elevated, what the firms involved need is not more debt, but more equity capital."

Pollock and Makin point out that simply buying bad assets from banks does not solve the most basic problem, naming restoring confidence in one another among financial institutions by ending questions regarding solvency.

... It is important for all Americans to understand that this financial crisis began more than a year ago with the collapse of liquidity in many types of mortgage assets, but the battle is quickly shifting to concerns about capital and solvency. The Federal Reserve System, Federal Home Loan Banks and the Treasury have already advanced huge amounts of liquidity in the form of debt to financial institutions in an attempt to help them stabilize their funding sources and slowly begin to re-liquefy. ... But unfortunately neither these existing sources of funding nor the proposal to provide even more debt-financed support gets to the core issue that is undermining in the financial system, namely worries about solvency.

... The difference between the current, RTC type model and the 1930s RFC model can be summarized succinctly: The bailout proposal now before Congress does not deal sufficiently with the issue of solvency and ensures that the US banking system will continue to deflate and de-lever, meaning that less and less credit will be available to the private economy and the recession is likely to be far longer and deeper. The present situation in the US economy is not nearly as bad as the 1930s, but if Ben Bernanke and Hank Paulson don't soon refocus their attention from liquidity to solvency of depository institutions, the US economy could end up in a situation that is much worse that the 1930s given the huge inflation of asset values seen over the past decade. This situation is soluable and can be quickly repaired, but only if we make capital and the leverage it can support work for us, not aganst us as is now the case.

With the RFC model, on the other hand, by quickly moving to inject capital into solvent banks, we can actually reverse the process of deleveraging and deflation that is currently grinding the global banking system -- and the world economy -- into the ground. By using new leverage and private capital, we can not only re-liquefy the banking system but also decrease the length and severity of the now present recession.

the whole article is must reading -- even moreso the stunning appended interview with robert arvanitis -- and some of it runs contra to bert ely's assumptions of systemic solvency. this is one of the first times that i have heard any mainstream analysis that admits the truth about american leverage -- if let to run, the delevering can bring on a disaster not as bad as the 1930s but in fact much worse. this is possible because -- as previously seen -- there is far more debt in the system as a function of income than in 1929. wolfgang munchau in today's FT (via yves smith) alludes to the ghastly size of american finance and the need for the system to shrink quite a lot before government can intervene with a hope of success, that is, without sparking a dollar disaster. to some extent, using the great depression as the yardstick by which all other crises can be measured is a failure of imagination.

this too did not escape the IRA:

Of note, in the WaMu resolution, equity and bond holders of the parent holding company were effectively wiped out - a significant landmark for bank investors that probably kills the private market for bank equity for the foreseeable future. Significantly, the advances from the FHLBs and the covered bonds issued by WaMu's bank subsidiary were conveyed through the receivership and assumed by JPM.

in other words, private capital raising is right out for the duration. government and government-brokered-and-backstopped deals are now the only game in town.

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I've been saying the system is insolvent for years. So? Who will listen to me?

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one of the things i find most frustrating and intriguing about this crisis is the ease with which is was foreseeable, ia.

i'm just one guy in a maelstrom. but i knew enough to sell all my bank stocks and my parents' bank stocks in 2006. i knew enough to sell my city condominium in late 2005 and start renting.

if i knew these things, clearly many, many people up the chain knew what was likely in the blind. and it would seem that most of them blundered right into it.

who listened? no one. now, i don't think anyone should listen to me particularly -- but i'd wager every single i-bank chief had more than one person who pointed out to them what now seems obvious. inertia won the day anyway.

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citi consumes wachovia; bank failures go global

sheila bair presided while hank paulson held the shotgun. for the record, it "didn't fail" -- but of course it did.

Citigroup will absorb as much as $42 billion of losses on Wachovia's $312 billion pool of loans, the Federal Deposit Insurance Corp. said today in a statement. The FDIC will take on losses beyond that amount in exchange for $12 billion in preferred stock and warrants.

``For Wachovia's customers, today's action will ensure seamless continuity of service from their bank and full protection for all of their deposits,'' FDIC Chairman Sheila C. Bair said in the statement. ``There will be no interruption in services and bank customers should expect business as usual.''

in global news -- belgian banking giant fortis was nationalized by a consortium of low country governments, large german mortgage bank hypo was rescued from failure by the german government, and english bank bradford and bingley followed northern rock into the arms of the british government. iceland further nationalized its third-largest bank, and continental lender dexia will attempt to raise capital.

``The precarious global environment means the weakest links in Europe are now falling,'' said Mamoun Tazi, an analyst at MF Global Securities Ltd. in London. ``If banks continue not to lend to each other we'll see more failures.''

good morning!

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The dramatic statements by Wachovia about Citigroup.
Such details of the deal were unlikely to have waited!
all this... Personally, I do not like it

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Friday, September 26, 2008


inflationary policy response and fed illiquidity

david merkel highlights the new deviation from earlier policy, which highlights both the severity of the ongoing delevering and the inflationary will of the fed.

We may have finally hit the panic phase of monetary policy, where the Fed increases the monetary base dramatically. They are pumping the “high-powered” money into loans:

  • $20 billion for Primary credit
  • $80 billion for Primary dealer and other broker-dealer credit
  • $70 billion for Asset-backed commercial paper money market mutual fund liquidity facility
  • $40 billion for Other credit extensions
  • $80 billion for Other Federal Reserve assets
  • $20 billion netting out other entries

Making it an increase of roughly $270 billion from last week’s average to Wednesday’s daily balance. Astounding.

In general, the increases are not being pumped into the banks, but into specialized programs to add liquidity to the lending markets. Now, I’ve written about this before, but it bears repeating. What happens if the Fed takes losses on lending programs. It reduces the seniorage profits that they pay to the Treasury, which means the Treasury has to tax or borrow that much more. The Fed isn’t magic; it’s a quasi-extension of the US Government in a fiat currency environment. It’s balance sheet is tied to the US Treasury.

Yves Smith at Naked Capitalism is correct. The US is no longer a AAA credit, particularly if you measure in terms of future purchasing power of US dollars.

london banker has noted in response to brad setser's highlighting of the same points:

I’ve been speculating all week that the pressure being used on the Congress to pass the Paulson Plan is the threat of Fed illiquidity. As of two weeks ago, the Fed had lent out more than $600 billion of its $800 billion balance sheet Treasuries against crap MBS collateral.

The Paulson Plan would have allowed the banks to unwind the repos putting the Treasuries back in the Fed, get cash for the crap MBS, and get more Treasuries from the issues financing the $700+ billion funding of the Plan. As a bonus, the Paulson mark-to-maturity price becomes the implicit Level 3 price for capitalisation of all the firms and banks in the system, giving them some breathing room to stay in business. Everyone wins except the poor American taxpayer.

The Fed is very close to being illiquid. That is the fear factor we are seeing at work, and the reason no one will discuss why the bailout is needed - only emphasise the urgency.

click banker's link to jim jubak. somewhere down the road, the united states is risking its credit rating. jubak cites concern about the ratings agencies downgrading the united states; but what to worry about is pre-emptive action from the central banks of china, japan, russia and some petrostates.

open foreign bank accounts and place significant savings there before the united states prohibits americans from moving money out of the country.

"The next emergency measure will be that Americans are not allowed to buy foreign currency and transfer money overseas, and the next measure will be not permitting Americans to buy gold and so on and so forth…. It creates even more uncertainty in the market place when you continually change the rules," Faber said.

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from Perrone: hey, GM. why Swiss Francs and not Yen? loved your Andromeda Strain riff, btw. for me, Bernanke is that spectacled lady scientist with epilepsy -- tremendously learned, talented, on the verge of heroic success, but in the end unable to overcome the sinister, debilitating forces within and without.

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From Perrone: Bush is Bailey Boy!

you know, a literary analogy came to me. remember that scene towards the end of "A Good Man is Hard to Find," when a petrified Bailey Boy chirps out, "hush! everybody shut up and let me handle this!" then, "listen! we're in a terrible predicament! nobody realizes what this is," as the gunmen come over to lead him into the woods. that's Bush at the Thursday White House meeting. McCain's his wife, Paulson is grandma. but who's the Misfit? that's the distorted world economy, the undertaker that won't be cheated -- not in the end.

ah, it's no real pleasure in life.

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hi perrone -- you've got it -- i think the important part is to find a way into one of the carry trade funding currencies. yen seems acceptable to me as well, but i would prefer CHF for two subsidiary reasons:

the yen is subject to heavy intervention, japanese exports are a serious matter to the government and the government is further something more than an american "ally" in my view. this is also a country with an outstanding government debt of 170% of GDP.

switzerland, on the other hand, is primary a banking center whose continued economic welfare depends primarily on currency stability. they are backed 40% by gold and remainder by very prudential swiss government bonds.

it's a matter of preference on some level. but i am of the opinion that CHF is safer.

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monday is the deadline

White House press secretary Dana Perino later said: "We don't have any reason to believe that we can't get it done by Monday."

it would be best if the credit market were not disappointed on this count, as warren buffett says.

“We are looking over a precipice in terms of the economic condition of the country for the next few years,” Buffett said during an interview on the Fox Business Channel. “If Congress doesn't help us on this, heaven help us.”

"The only thing that counts in the economic world today is the U.S. Congress,” Buffett said. “They hold the fate of the U.S. economy for the next few years in their hands. And I think they'll do the right thing. I have great confidence — I mean, when they recognize what the problem is, they will do the right thing. They won't do the perfect thing. Nobody can do the perfect thing.

“Later on we'll let the historians decide who to blame. I could go around saying I told you so on this or that. But it doesn't make a difference.”

buffett is certainly talking his book, and should be read with that in mind. but i'm encouraged to hear him talk in this fashion. it increases the likelihood that house republicans will concede to a deal by monday.

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house prices and household formation

david altig takes a different look at house prices into the future, using an economic correlation to household formation. the conclusion is unfortunately broadly the same as implied by a return to price-to-income valuation.

If the ratio for the post-2000 period is to return to its historical value, house prices would drop 21 percent from second-quarter 2008 levels.

this dovetails nicely with jpmorgan chase's estimation of house price losses going forward may look like -- per calculated risk, revealed in the presentation that went along with hoovering up wamu.

JPMorgan presented three scenarios: a base case (with national prices falling 25% peak to trough), a deeper recession (28% decline), and a severe recession (37% decline).

Currently the Case-Shiller futures are predicting a 33% decline peak-to-trough, Goldman is forecasting 27%, and Lehman was forecasting 32%.

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morgan stanley cash flight

they are trying through reorganization to get some cheap funding through deposits. but it just isn't that easy until they can outmaneuver others to hoover up deposits like jpmorgan chase did last night.

in the meantime -- cash flight from the prime brokerage will test their solvency.

Morgan Stanley lost close to a third of assets in its prime brokerage last week, amounting to hundreds of billions of dollars, as hedge funds fled after the collapse of Lehman Brothers and moved to rival banks.

The losses, confirmed by several people familiar with the business, will deal a big blow to Morgan Stanley as its prime brokerage is one of its most profitable and successful businesses.

... Many of the world’s biggest hedge funds moved their assets to commercial banks regarded as safer last week, as they and their investors worried that Morgan Stanley could follow Lehman into trouble.

a lot of those accounts will not be back. it's a lot safer to house with JPM or BAC at this point, regardless of who bails what.

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here comes wachovia

so soon?

Wachovia cash bonds have dropped by 20 points today. The CDS is trading with points up front and the last quote I heard is 33/37.

One corporate bond salesperson opined that Golden West Financial,which Wachovia acquired, looks very much like WAMU.

Separately, a commenter on another post at the blog noted that Morgan Stanley CDS is trading points up front. I do not have a quote.

This can not continue. The system is eating its young.

an immediate consequence of the washington mutual bond wipeout. there will be no prisoners now short of massive government intervention to prevent bank failures.

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the andromeda strain

anyone remember the 1970s? in between the bell-bottoms and the disco, it was a great time for disaster films. one of the best was about a small town of piedmont, new mexico, which inherits from the heavens a small crashed satellite carrying a bizarre and extremely lethal airborne pathogen which is neither viral nor bacterial. institutional science struggles through some drama to find a cure before the killer spreads to population centers. in spite of the altogether human failings of the lead scientists, not to mention the unintended consequences of the mechanics of technological institution, their perseverence and curiosity see them through to a cure -- with the help of the only survivors of the small town outbreak, held in quarantine, a newborn baby and an old drunk.

i was struck today on reading the news that we are living something of an analog of that story.

the killer fell in the form of debt, and the lethal pathogen of deleveraging is now airborne and slaughtering the unwary. contagion is rife -- and the gory deaths of lehman brothers and now washington mutual are sure to spread the disease. why? bondholders -- heretofore held to be the saved -- were annihiliated in both deals. on lehman, read yves smith; on wamu, the financial times -- but the story is the same. there wasn't nearly enough left in the pot to cover even senior debtholders of either company. this is NOT how these companies have represented themselves in financial reporting up until now -- liquidation has revealed that they were not even nearly solvent in a crisis for which many of their assets are simply no bid.

and this does much to explain interbank lending, which is effectively dead at this time. libor quotes notwithstanding -- no one is lending anyone anything at libor. market rates have become a false price signal as liquidity has gone. the magnitude of draws upon central banks has gone far beyond anything intended, and there is effectively no way now to reduce or even threaten to reduce aid to banks without sparking catastrophe.

most importantly, contagion has now spread to the public. wamu was done in not by its asset side -- again, that's a slow motion problem -- but by its liability side. in a replay of northern rock, a depositor run of $17bn this week killed the bank. everyman is now awake to the creeping death, and more bank runs should be expected -- along with exceptional authoritarian pleas for calm.

amidst growing carnage -- much of it still invisible to everyman, hidden as it is in the unseen credit markets -- the equivalent of debilitating mechanical lasers designed for our own protection have arrived right on cue. i am no fan of the paulson plan -- listen to robert shiller or read accrued interest -- but SOMETHING must be done now if anything is ever to be done. tim duy:

The US economy is limping through the second half of the year as the impact of this summer’s stimulus checks fades. The continued weakness, I suspect, will come as a shock to the public, who have now been essentially promised that their problems will be solved with a bailout package they really don’t understand to begin with for the financial sector they view as arrogant aggregators of wealth. But any bailout will only prevent a financial meltdown that threatens to deepen the credit crunch and worsen the ongoing slowdown, not reverse the current weakness. I doubt, however, the general public sees that distinction. And they are not likely to be convinced; this Administration sacrificed its credibility long ago. Instead, the public will see billions channeled into Wall Street as the unemployment rate climbs. And climb it will.

... My hope is that a bailout is coming. But it will not change the path the economy is already on, it will only prevent activity from shifting to a new, less desirable path. I don’t quite see how the billions of dollars plowed into this program will be funneled to households. I see instead it will only cushion the process of deleveraging, and thus minimize the quantity of resources stripped from the economy. This is important and necessary, but will not provide a miracle cure for the economy’s travails....

that has not stopped misguided and ill-informed house republicans -- apparently in a final bid to destroy the republican party once and for all -- from trying to pull the plug on the compromise paulson-dodd plan. again duy:

With the bailout package currently in doubt, however, my worry is that credit markets will collapse Friday morning. Under these circumstances, the Fed would likely be forced into cutting interest rates in an intermeeting move. With Congress nipping at their heels over their handling of the crisis to date, and Republicans undermining the bailout package, monetary policymakers may simply be out of other tricks.

all this with the encouragement of senator john mccain, whose failing white house bid -- sinking under the weight of the obviously incompetent and increasingly exposed sarah palin and tarred by the popular association of republicans with wall street -- is now desperately in need of radical populist action. mccain ostentatiously "suspended" his campaign (har har) to return to washington with the specific intention of railroading the bill, it would seem. idiocy and short-run self-interest run deep in the back benches, and a desperate candidate is levering that into risking the american economy in his bid for power. politico:

Although John McCain hasn’t said whether he supports the bipartisan, bicameral compromise struck earlier in the day Thursday, one of his leading Senate surrogates – Lindsey Graham of South Carolina – said Thursday night that McCain joined House Republicans in opposing that proposal.

... According to one GOP lawmaker, some House Republicans are saying privately that they’d rather “let the markets crash” than sign on to a massive bailout.

“For the sake of the altar of the free market system, do you accept a Great Depression?” the member asked.

it's a final curse from dimwitted and quite mad free market fundamentalists, if it comes to pass, whose drive to deregulate over the last twenty-eight years has been the primary facilitation of this crisis. total collapse is far from certain, but i imagine few if any of the house republicans truly understand either what is taking place or how quickly their impetuousness could spiral out of control.

i still expect something will come from congress -- even if the president has to lock house minority leader john boehner into a wire cage in guantanamo bay to get it done.

so if we are reliving the plot of the andromeda strain, perhaps hank paulson is now desperately trying to escape the lethal force of house republicans run amok in an effort to communicate a (hopeful) cure to the outside world before contagion annihilates the world as we know it.

but in the real world we don't know the outcome of the plot. the white house is pushing buttons and making threats to get a deal done. president bush:

"There are disagreements over aspects of the rescue plan," he said, "but there is no disagreement that something substantial must be done. We are going to get a package passed."

i hope so, mr. president, but in the meantime i'll simply wish i were a newborn baby or an old drunk.

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Thursday, September 25, 2008


house republicans in rebellion

yet another twist on the hill even as washington mutual is seized by the FDIC. i'm watching barney frank and chris dodd excoriating the house republican leadership, which has apparently decided not to participate in the paulson plan legislation. they're calling out the president to bring his party into line, but i'm not sure they're listening to the white house anymore. this potentially jeopardizes the bill.

i can see their position politically. they are facing waterloo in november, potentially the worst republican result since the 1960s, thanks to where the white house has led them. now the administration is a lame duck full of retirees, and they have to face the voters alone. and this same administration is trying to get them to pass one of the most loudly opposed bills in recent memory.

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wamu fails

the biggest bank failure in american history, and an extremely well telegraphed one. no one expected washington mutual to survive. jpmorgan chase (again) is in on the deal, this time buying the deposit base and some other parts for a song from the FDIC.

now comes the question again -- who next? gm, ford and chrysler were all funded by the government this week. morgan stanley and goldman sachs reorganized and bank holding companies, likely at least forestalling their demise. general electric warned today and suspended their planned buyback, but are further from mortality than others.

instead, i'll try wachovia.

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finding a fair price

now that the paulson plan is going to happen, the essential element of the action will move to center stage -- what price?

there are two schools out there now. the first -- among them at least one hedge fund manager whose call i sat in on today -- believe that the default rates and price declines such as we have seen them do not justify the excessive markdowns being applied to mortgage-backed securities in general, which are a consequence of a massive liquidity squeeze. when that squeeze lifts, say advocates, valuations will rise -- and in some cases financial companies that have marked aggressively will be in line for write-ups. evidence that third quarter writedowns will not be bad can be found in the ABX historicals -- prices for MBS have been rising for most of the quarter.

bill gross shares at least some of that logic, as does ben bernanke.

Gross said the government must find the right price between the market value of the assets they are buying and the value they have on paper at the banks holding them.

As an example, Gross said Pimco recently paid 65 cents on the dollar for a pool of mortgage-related assets. He said distressed loans and securities can trade anywhere from 20 cents on the dollar to 80 cents on the dollar, but 65 cents is a good benchmark.

Pimco expects to earn a double-digit return on its money for the 65 cents on the dollar it paid. The trick for the government is to find the right price between 65 cents and 100 cents on the dollars. The closer it gets to 100 cents on the dollar, the better banks will like the deal. But the closer it stays to 65 cents, the better for taxpayers. Gross said government must be careful and find the best compromise price, which means taxpayers will not lose money and may earn a profit.

Gross said 65 cents on the dollar assumes as many as 30 percent of the loans being purchased will end in foreclosure, and for every home that ends in foreclosure the investor gets as little as 40 cents on the dollar.

“It’s certainly possible if done right for the Treasury to make money for the tax payer,” Gross said.

goldman sachs is estimating that around $1.2tn of currently distressed mortgages are out there and potential fodder for paulson. as such, the full $700bn would vacuum up a sizeable potion of the distressed mortgages available if that is where efforts are concentrated -- though the plan emerging from congress will disburse just $250bn initially.

To arrive at this conclusion, the economists Jan Hatzius, Andrew Tilton and Kent Michels looked at the percentage of commercial and residential mortgages in foreclosure or delinquency and compared it to the total value if U.S. mortgages. They estimate that approximately 9.16% of $11.3 trillion in residential loans are at risk of not being repaid, and 4.24% of commercial loans are in the same boat.

there is another school of thought, however, part of the logic of which was embraced by paul jackson of housing wire.

Both Fed chief Ben Bernanke and Treasury chief Henry Paulson have sought to sell their plan to Congress by suggesting a dichotomy between current “fire sale” prices and the long-term “fundamental value” of an asset; the argument is that a lack of market transparency and investor fear have driven the prices of whole loans and ABS/MBS/CDO issues to levels that no longer reflect their fundamental value.

The government, they say, will buy these assets at prices greater the current market is assigning them; the idea is that in so doing, balance sheets are freed, institutions are recapitalized, and pricing discovery takes place (which, in turn, is supposed to help the prices of ABS/MBS/CDO issues recover). And thus the lending machine starts anew.

Let me make something clear, outside of the academic debate now being used to sell this bailout: if any of this junk had value, it would be trading right now. And more importantly, the lack of trading activity has little to do with a need for “price discovery,” a term being bandied about inside the Beltway with reckless abandon this week.

There is an ugly truth that Paulson is choosing to keep to himself: most already know what the prices for these sort of assets are. The problem is that there isn’t a financial institution whose balance sheet can handle selling at those prices — at least, not without putting an entire business into the side of a canyon. This is the real reason assets are clogging up balance sheets at inflated values, or put into Level 3. Or the reason that whole loans are marked at a value that in no way reflects the price that loan would receive if it was sold.

Paulson & Co. are telling Congress that the government may break even or profit from this venture, but paying an above-market price for assets valued by the market at junk levels is the pretty much the definition of how to lose money in asset management. And gobs of it, too, far more than the $700 billion figure associated with this plan.

to my mind, there is room for elements of both views. there is certainly a liquidity premium that has driven down the price of any and all asset-backed securities. however, the quality of any individual MBS is largely a function of the loans that support it, the structure of the security and its seniority in receiving payments out of principal and interest. a great many MBS and CDOs of MBS (much less CDOs of CDOs) really are worthless. a great many more are not.

chances are that the government will be presented the worst of the worst and buy it at considerably more than it is marked -- that is part of the point of the program, as defined by bernanke. so taxpayers will be paying something for nothing. while the method gross describes is possible, the reality is that banks and other bailees are going to be loath to sell to the government those securities in which they themselves see significant upside potential -- particularly if those sales mean issuing equity warrants to the government as well.

but there's a bigger danger for both banks and government here, and that is the destination of house prices. as earlier noted, bernanke's fallacy of a hold-to-maturity price as a knowable level is predicated on knowing the destination of house prices in both time and level. he does not know that -- no one does. and most banks' current estimates of the eventual decline are shy of the probability of a full reversion to and indeed overshoot of historical means of price-to-income.

as financial deleveraging continues -- something this measure can do little to abate -- credit standards will continue to be tight throughout the duration of the process. banks are trying to reduce assets, not grow them. bernanke and paulson have a stated intention to get credit flowing again from banks to companies and consumers, but even in the aftermath of a complete delevering and recapitalization (something we are nowhere near, with or without the paulson plan) the return of merely normal credit underwriting standards implies a return to normal price-to-income ratios for housing. if standards are actually tighter than the historical norm, we should fully expect house prices to fall below mean valuation metrics before volume picks up significantly and the unsold housing market inventory overhang begins to clear in earnest.

such levels could easily be another 30% lower from today; a mere return to normality is another 25% down. and that kind of downturn would wipe out a lot of MBS that most banks today blithely believe to be valuable, to say nothing of the junk that will be presented to paulson. and that will beget yet more deleveraging in financial services.

the degree of supposed validity in the idea of making money on overpaying for the worst assets at this point is, in the final analysis, a function of the degree to which one believes that housing prices will remain elevated well above historical relative valuation metrics -- which itself is a function of one's belief that credit can be made once again very, very easy for the average homebuying american.

that ease of credit was predicated not only on the balance sheet expansion of the american financial services industry, but the willingness of foreign creditors to buy private-label asset-backed securities from american investment banks hip deep in the business of securitization. i would wager heartily that neither of those features of the boom are coming back any time soon -- indeed just the opposite appears more likely.

it therefore seems more likely to me that the paulson plan, even in what might be a sincere attempt to find a fair price, is likely to lose a lot of money over time. even bill gross may end up disappointed with his return at 65 cents even on what looks today to be a sensible deal. and that, as much as pure liquidity constraints, explains the difficulty in moving asset-backed securities.

the government losing money would frankly be normal for systemic bailouts -- after all, an average one would cost the united states about $2.3tn. i'm not sure why the program should be presented as a profit center for government.

the problem is instead that the paulson plan seems on this reading unlikely to effect any of its goals by losing just several hundred billion dollars.


paulson plan on

popular dissent means so little, really.

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GM, ford, chrysler loaned $25bn

hidden in the high grass of the paulson plan.


durable goods plummet

with reports like these, there's no doubting a pretty severe recession is already afoot.

August durable goods orders slipped 4.5%, which is worse than the 1.9% decline that was widely expected. Prior month orders were downwardly revised to reflect a 0.8% increase. Excluding transportation, orders were down 3.0%. Economists were expecting a 0.5% decline after the downwardly revised 0.1% increase in the preceding month. Initial jobless claims for the week ending September 20 totaled 493,000, up 32,000 week-over-week. The latest results were worse than the 450,000 claims that were expected.


chinese banks to halt lending to US banks

there is a sea change afoot in the far east. compound these official directions with the publicly expressed fear of a panic and american debt default.

this is not the same as cutting off funding for, sya, treasuries. but given how china and others walked away from the agencies to precipitate their rescue, it has become dangerous to ignore the turning of spigots in china.

Wednesday, September 24, 2008


paulson plan support waning

naked capitalism passes on the reportage of weak and dissipating support on capitol hill for the paulson plan.

House Speaker Nancy Pelosi is telling Democrats that she will not support President Bush's $700 billion bailout of the financial sector unless there is significant Republican support for the controversial plan. ...

Pelosi (D-Calif.) has effectively sent the message that if she is going to jump off a cliff to rescue Wall Street, she wants House Minority Leader John Boehner (R-Ohio) and George W. Bush holding her hands when she leaps. ...

{But] It's hard to find even one Republican ready to publicly pledge his or her vote. Democratic leaders are speculating that GOP leaders can count on no more than 40 votes. A Republican aide said if Pelosi needs a Republican majority to bring it to the floor, she won't be bringing it to the floor.

Perhaps sensing the trouble, Vice President Dick Cheney trekked to Capitol Hill to lobby his fellow Republicans for the plan.

But the meeting brought no public converts. Republicans leaving the hour-and-a-half-long meeting said Cheney was told that the plan lacked the details they needed.

Things don't look much better on the Democratic side, though some members are starting to think about what they might ask for in exchange for the vote. Reid predicted that Democrats will be ready to approve it as long as there is adequate oversight, executive pay limits and accountability.

one of the hazards of lacking effective leadership in the lame-duck white house -- really, who cares about cheney now, so close to the end of a widely loathed administration?

there's a confluence of reasons, but amidst the fray congresspersons must weigh the outpouring of man-in-the-street opposition to what many perceive (rightfully) to be both inordinately geared for the benefit of risk capital and a naked power grab by the imperial presidency. and not a little schadenfreude colors the very righteous anger of main street americans, as evidenced in rep. kaptur's rant. we are very close to the first tuesday in november, and support for a wildly unpopular bill will not be forgotten between then and now.

but it won't go down without the administration's best efforts, and this is why president bush will be addressing the nation this evening. i would count on having the crap scared out of you regardless of what bert ely thinks.

i still think something gets passed -- the contingent liability in doing nothing could be spectacular.

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ely: bailout not necessary

through yves smith, the IRA interview of banking guru bert ely. this is an eye-opener.

A banking industry expert, Bert Ely, who has a stellar track record in predicting crises and calling false alarms says that the banking industry can handle this mess internally and does not need subsidies.

ely's cobbled quotes:

I have run the numbers looking at the capacity of the industry to pay the tab. Assuming that bank insolvency losses don't get way out of line, which I don't think they will, then the industry can handle it. It's not going to be cheap, but the banks can handle it and clean up their own mess. The losses will feed back through the industry to depositors and borrowers in the form of lower rates on deposits and higher cost of loans....

There is absolutely no need for the Treasury to have the authority, as you suggested, to "inject capital into solvent banks that are temporarily unable to raise new capital." If a bank truly is solvent, it can raise additional capital or sell itself, if its present owners are realistic about what their bank is worth. The reason solvent banks have a problem raising capital, or selling themselves to a stronger bank, is that they set their price too high, as did AIG. ... There is absolutely no need for the taxpayer to subsidize banks so they can stay independent, provided no barriers are erected to prevent new entrants into bank or specific banking markets.

... we need to get ruthless investors inside troubled banks to get these banks and their bad assets cleaned up and/or sold. That is what should have happened at AIG, but unfortunately did not.

... The housing bubble has to be allowed to collapse in order to clear the markets. We have a very necessary correction process underway. But this process creates a lot of pain and loss. I don't like that, but we have to clean up the mess and take the pain in order to get the economy back into balance. In collapsing bubbles you have collapsing companies. Japan tried to muddle through and they had a lost decade. I hope we are not going to do that...

i have read a lot of economist opinion over the last week (and further back), and most have called the bailout necessary, inevitable or both. certainly most systemic banking crises have resulted in government intervention and recapitalization. ely has a fine reputation, but he is also a decidedly libertarian figure -- it would be his natural inclination not to intervene as the market clears.

as i read it the essence of what ely is suggesting is that, while some market entities are insolvent, the system is not. the total losses ought not overwhelm total capital, and in individual institutions where that does occur and no willing buyer can be found there is the FDIC -- which is funded out of bank insurance premia, sure to rise in coming years.

to be sure, however, we are coming out of one of the greatest credit bubbles of all time. the adjustment envisioned by ely -- even if it came off in an orderly fashion, regardless of how workable from an operational standpoint -- would likely result in an economic depression as banks wrote off bad debts, destroyed capital, contracted lending and restored a more sustainable proportionality to the rest of the economy. it is this outcome that the government broadly aims to either slow or (delusionally) avoid entirely with the plans under discussion.

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a different way

martin wolf in the ft:

The simplest way to recapitalise institutions is by forcing them to raise equity and halt dividends. If that did not work, there could be forced conversions of debt into equity. The attraction of debt-equity swaps is that they would create losses for creditors, which are essential for the long-run health of any financial system.

The advantage of these schemes is that they would require not a penny of public money. Their drawback is that they would be disruptive and highly unpopular: banking institutions would have to be valued, whereupon undercapitalised entities would have to adopt one of the ways to improve their capital positions

If, as seems plausible, a scheme that imposes such pain on the financial sector would be rejected out of hand, the next best alternative would be injection of preference shares by the government into decapitalised institutions, on the lines proposed by Charles Calomiris of Columbia University. This would be a bail-out, but one that constrained the behaviour of beneficiaries, not least on payment of dividends. That would make it far better than dropping benefits on the unworthy, via mass purchases of overpriced toxic paper.

What then do I conclude? Yes, there may well be a place for intervention in the market for toxic securities. But this is a costly and ineffective way of meeting today’s deepest challenge. What is needed, still more, is a clear and effective way of deleveraging and recapitalising the financial sector, ideally without using taxpayer funds. If such funds are to be used, they must also be injected in as carefully targeted and controlled a way as possible. Comprehensive action is essential, as Mr Paulson has decided. But let the US take the time to make that comprehensive action right.

this university of chicago roundtable assesses the fundamental problem correctly -- there is too much leverage, and a way must be found to delever and recapitalize -- and in part advocates forced debt-to-equity swap.

the idea is fundamental to restructuring distressed companies, and involves creditors agreeing to write off a portion of the lender's debt in exchange for equity participation. the result is a lessening of the lender's liabilities, raising balance sheet equity, and improvement of cash flow (as debt service is no longer required on the forgiven debt).

though equity is summarily diluted and existing stockholders can realize terrific losses, the serious pain is on the creditor side -- and is part and parcel to an admission by primary market participants that bondholders, not just stockholders, will have to suffer too for the risks they have taken in funding banks.

this is not currently the case -- the paulson plan concept (to call it a plan is to irresponsibly glorify it) is all about making the chinese central bank taxpayers take all the pain instead, leaivng bondholders whole and stockholders perhaps off lightly. the paulson concept seems to be that, by offering the ridiculous prices of 2005 through the magic of government borrowing, both delevering and recapitalization will be abetted.

that will be true, too -- for some, probably goldman sachs and morgan stanley as they now go about finding depositors and delevering its asset book into compliance with bank holding company regulatory leverage. as brad setser pointed out, though, it will be only some. the size of the effort will have to be much larger than $700bn if the government intends to pay top-dollar for bad assets, or it simply won't move enough bad assets to make the difference. for the rest, delevering must continue apace for the foreseeable future.

that said, debt-to-equity conversion would be painful, contracting and deflationary -- which is why the financial community and their captured government proxies are not even mentioning it as a possibility.

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Tuesday, September 23, 2008


credit crisis loss estimates still growing -- part 5

i referred to the average cost of financial system bailouts earlier, implying that america should expect something on the order of a $3tn need, and have also kept tabs on the top estimates for eventual damage. but -- as may make sense as the crisis deepens -- the upside estimates for cost and damage are growing.

yves smith notes a new milestone.

Treasury Secretary Henry Paulson's $700 billion plan to buy devalued assets from financial companies is ``a joke'' because it doesn't go far enough to calm markets, said Kenichi Ohmae, president of Business Breakthrough Inc.

Ohmae, nicknamed ``Mr. Strategy'' during his 23 years as a McKinsey & Co. partner, called for a $5 trillion ``international facility'' to be made available to financial institutions. The system could be modeled on one used by Sweden during its banking crisis in the early 1990s, he said.

now i think we've gotten to realistic estimates of what this could cost. the fact that ohmae notes the need for a coordinated global fundraising across many savings-rich countries implies his recognition that, should the united states try it alone, the consequences for the dollar will be catastrophic -- indeed, the bailout would be worse than the depression it was meant to avoid. even like this, the pressure on the dollar would be considerable.

UPDATE: marc faber concurs.

``The $700 billion is really nothing,'' Faber said in a television interview. ``The treasury is just giving out this figure when the end figure may be $5 trillion.''...

``The decline in home prices of 20 percent is a relatively minor decline so far and it has created so many problems,'' Faber added. ``The US is in much worse shape'' than Japan was when its stock market crash ushered in a decade-long slump in 1990.

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I was a bit disappointed at how vague the summary of Ohmae's $5 trillion "liquidity facility" was.

We already have liquidity facilities (TAF, etc) that keep on growing to match the demand -- don't we need a solvency facility??

Also I wonder if the $5 trillion is really an apples to apples comparison with past loss estimates (such as Roubini's $1-2 trillion)... same list of countries? same types of losses? etc. Roubini long ago estimated much more than $2 trillion in losses when declines in broader asset prices (not just financial system) are considered as well.

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it's the financial system, stupid

from fivethirtyeight -- the american electorate may be dull and slow-witted -- but no one can say on this reading that they have forgotten how to respond to a clubbing over their collective head.

see if you can spot when fannie, freddie, lehman, merrill and AIG failed. LOL!



'mark to maturity'

i happen to be at home today, and watching he testimony of ben bernanke, hank paulson and chris cox before the senate banking committee.

it is a sham. cox is an afterthought, but bernanke and paulson clearly have no idea how they want to use $700bn, much less how they should. financial catastrophe or not, if this is the best they can manage, congress should send them away to clarify the options and recommend an actual plan rather than a fantastic concept.

congress is being asked to risk the currency of the united states on an incredibly complex bailout mechamism. it should at least be given a technical manual to explain the mechanism and how it would hopefully work. bernanke and paulson are giving them side 2 of "metal machine music".

so void of meaning and clarity is much of the testimony that one cannot help but suggest diversion. exemplary is bernanke's testimony that there are "methods" by which he can determine the "hold-to-maturity" value of the mortgage-backed securities it purports to buy out of the banking system. this is a fraud -- it presupposes that he knows with accuracy in both price and time how far house prices will fall. no one knows this, and no one can.

bernanke himself, if he is not caught in a god complex, knows this. so why would he pretend to know?

there is a disingenuity in this line of testimony and others. i deeply suspect it turns out that the paulson plan is to throw money at the banks without direction or specific intention. it sets up as a colossal boondoggle. no one hereafter should reference the resolution trust corp, as usually that reference implies that taxpayers might "make money". they won't here.

but the bigger question is "will it work?" -- and no one knows. but here is context.

the economist cites an IMF working paper regarding past systemic bailouts.

Sooner or later most governments realise the need for a comprehensive solution to the crisis, involving public funds. This can take different forms, from bank recapitalisation to forgiveness of all the underlying debts. In three-quarters of the cases, governments shored up bank capital by, for instance, injecting preferred stock. About 60% of the time, governments set up institutions to manage distressed assets.

The evidence from these attempts is sobering for proponents of an RTC II. Some institutions worked well. In the early 1990s, for instance, Sweden successfully set up an asset-management company to take over and sell the bad loans from its biggest banks. But, in general, the paper argues, such government-owned asset-management firms are ineffective — often because politicians try to push them around.

On average, the study finds that government attempts to stanch systemic banking crises over the past three decades have cost 16% of GDP. That average hides enormous variation, much of which depends on how crises were handled. America’s mess, even if it has already led to the demise of famous Wall Street firms, is far from finished. That is why the international lessons are worth taking seriously. Resolving a financial mess is cheaper, quicker and less painful if governments take a rounded approach. For the moment, the bail-out tacticians are in overdrive. But the strategists’ moment is approaching.

american GDP runs about $14tn. a 16% fraction implies an average bailout cost of $2.3tn. but, as the economist notes, variation is wide -- and the united states today is the most financialized and debt-dependent major economy in world history. moreover, the current incarnation of the paulson plan will bail out banks of foreign origin holding impaired american securities. and as noted above treasury will looks to pay not clearing prices but exceptionally high prices -- perpetuating illiquidity by crowding out any potential private capital transaction. in light of such considerations, if anything, the american bailout should be more expensive than average. and if cost is to be kept to a minimum, it will have to be exceptionally well directed.

brad setser also attacked the problem of bailout size. his point:

Figuring out who owns the debt of US households.... That leaves around $6.5 trillion of outstanding mortgage exposure in the hands of the financial system, give or take. It might be higher because it is possible to create “synthetic exposure” to various kinds of securities....

Willem Buiter thinks that the US Treasury will be buying up assets at roughly 33 cents on the dollar, which would broadly speaking move $2 to $2.1 trillion in face value of debt off the balance sheets of major US financial institutions. ...

I am not though convinced that the banks can afford to sell at 33 cents on the dollar. If these assets were valued at par before the crisis, I think that implies taking an aggregate loss of $1.4 trillion — which seems much higher than the losses that the banks have recognized to date. The hit to the banks balance sheet might be too big. ...

What is the point of all this?

Well, to me it helps to highlight the challenge the Treasury faces. If it pays a high price for various dud assets, it won’t move nearly as much off the banks’ balance sheet — which may leave residual questions about the health of key institutions. On the other hand, if the Treasury pays a low price, it may leave a lot of banks in trouble and in desperate need of new equity.

It also helped me try to think through whether $700b is a lot a money or a little bit of money, relative to the enormous challenges the US now faces supporting a financial sector that is gravely ill. I was reminded just how big the balance sheet of the US financial sector is — and just how much of that balance sheet is tied up in the real estate market.

and of course there are trillions in non-mortgage failed securitizations and pier loans that the paulson plan would be designed to help sop up.

in short, on an examination of both scale and acuity, what congress is being presented cannot be a probable "successful" solution insofaras success means general economic health. it seems clear early on that it was not enough, and represented more of a 'down payment' on a realistic final cost. what it may do is prevent some banking receiverships that would otherwise have been inevitable. chances are, though, that the next treasury secretary will be back to ask for much more money later.

in the final analysis, i think kevin depew has this right.

There is only one thing necessary to understanding what is happening and it is this: no one at U.S. Banks, no one at the Federal Reserve and no one in politics can accept the reality that real estate assets in this country remain oversupplied, overpriced and overleveraged.

It is that simple.

TAF, TSLF, SuperSIV, TARP, none of that matters. No matter what acronym is created to disguise the fact that assets are overpriced, or what government intervention is created to prop up those asset prices, the market will inevitably overpower it. This time is not different. In fact, it is continuing to play out almost exactly as the Great Depression did. The bottom line is that despite the proposed bailout, whatever form it may take, risk in owning stocks has increased, not decreased.

UPDATE: see that high-side bailout estimates are growing into the $5tn range.

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"i deeply suspect it turns out that the paulson plan is to throw money at the banks without direction or specific intention. it sets up as a colossal boondoggle."

Isn't that the definition of government.

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gm, as a former CEO of Goldman Sachs, is it public how much stock Paulsen owns in Goldman Sachs?

Keep up the great work.

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ccd -- paulson was forced to sell his goldman holdings upon taking office. of course that doesn't matter much -- like any pol, it's all about accumulating favors that are cashed in upon leaving office. paulson is making an unimaginable amount of money out of this. he just won't receive it for a few more months.

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Monday, September 22, 2008


dollar down; oil up $25/bbl

unintended consequences! it's pretty clearly a short squeeze in the near month, though -- farther out, the jump is more like $6 to $110 or so.

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the dodd plan

senator chris dodd has made a counterproposal to treasury's bill.

UPDATE: the administration is accepting congressional changes.

UPDATE: cnbc says no deal yet. this could go on a while.

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'a year away from the pecora hearings'

that line from josh rosner on charlie rose.

what were the pecora hearings, you ask?

i commented yesterday that, for all the awful precedents being set and constitutional allocations of power circumvented, this is unlikely to put an end to the delevering. doug noland has more.

[T]his gets right to the heart of the matter – where the analytical rubber meets the road. A massive inflation of government obligations; a major government intrusion into all matters financial and economic; and an unprecedented circumvention of free market forces have been unleashed – but to what end? I believe it is a grave predicament that such a rampage of radical policymaking has been unleashed in order to maintain inflated asset markets and to sustain a Bubble Economy. Normally, such desperate measures would be employed only after a crash and in the midst of a major economic downturn – not in efforts specifically to forestall the unwind. Not only will such measures not work, I believe they will only exacerbate today’s already extreme Global Monetary Disorder. They will definitely worsen the inevitable financial and economic dislocation.

I have over the past several years repeatedly taken issue with the revisionist view that had the Fed recapitalized the banking system after the ’29 stock market crash the Great Depression would have been avoided. Some have suggested that $4bn from the Fed back then would have replenished lost banking system capital and stemmed economic collapse. But I believe passionately that this is deeply flawed and dangerous analysis. An injection of a relatively small $4bn would have mattered little. What might have worked – albeit only temporarily – would have been the creation of many tens of billions of new Credit required to arrest asset and debt market deflation and refuel the Bubble Economy. Importantly, however, at that point only continuous and massive Credit injections would have kept the system from commencing its inevitable lurch into a downward financial and economic spiral.

Importantly, market, asset and economic Bubbles are voracious Credit gluttons. I would argue that the system today continues to operate at grossly inflated – Bubble - levels. The upshot of years of Credit excess are grossly distorted asset prices, household incomes, corporate cash flows and spending, government receipts and expenditures, system investment and economy-wide spending and, especially, imports. So to generally stabilize today’s maladjusted system will, as we are now witnessing, require massive government intervention. Enormous government-supported Credit growth will be necessary this year, next year, and the years after that. To be sure, a protracted and historic cycle of Misdirected Credit Runs Unabated.

Today’s efforts to sustain the Bubble Economy create an untenable situation. Washington is now in the process of spending Trillions to bolster a failed financial structure, while focusing support on troubled mortgages, housing, and household spending. Regrettably, this is a classic case of throwing good ‘money’ after bad. Not yet understood by our policymakers, literally Trillions of new Credit will at some point be necessary to finance an epic restructuring of the U.S. economic system. Our economy will have no choice but to adjust to less household spending, major changes in the pattern of spending (i.e. less “upscale” and services), fewer imports, more exports, and less energy consumption. Moreover, our economy must adjust and adapt to being much less dependent on finance and Credit growth – which will require our “output” to be much more product-based as opposed to “services”-based. We’ll be forced to trade goods for goods.

The current direction of Bubble-sustaining policymaking goes the wrong direction in almost all aspects. At some point, the markets will recognize this Bubble Predicament, setting the stage for a very problematic crisis of confidence for the dollar and our federal debt markets.

i've made this point before, as have many others, but it bears constant repetition:

recapitalizing the banks will not support asset prices by itself. the requirement for that would be for the banks to further take that new capital and head off on another incredibly reckless lending binge -- to mimic the conditions of 2003, 2004, 2005 and 2006 whence those inflated asset prices were created. that is not going to happen -- we aren't going back to no-money-down and zero-interest financing, to teaser rates and negative amortization, to liar loans -- and government efforts to make it happen in real terms will be futile.

the primary question for asset managers is whether the government will instead settle for trying to make it happen in nominal terms -- trying to force-feed these many trillions in credit into the economy in an effort to sustain bloated credit supply. and this is whereupon fears of the spectre of a dollar collapse and hyperinflation arise.

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SKF and the ban

from morningstar.

Investors who already own SKF or SEF can sell the funds at any time because trading has recommenced, and since redemptions are still allowed, there is little risk of selling at a discount. In fact, there may be a good chance of selling at a significant premium sometime before this situation resolves itself.



reeling in goldman and morgan

per mish, they're to become bank holding companies like everybody else.

Kiss the last independent investment banks goodbye. And with this change, it is going to become much harder for Goldman and Morgan Stanley to make (or lose) money given leverage will be reduced to 12 instead of 30-40.

reinstituting the net capital rule but too late. asset sales will have to be considerable.

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Sunday, September 21, 2008


dollar weakness coming?

per yves.

this is intended to be actionable. if the united states experiences a funding crisis, there will be no place in the dollar universe to hide. carry trade currencies like the swiss franc and japanese yen will benefit from risk aversion.

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effect of the end of short sale arbitrage in futures and options

via cafe americain -- one of the potential unintended consequences of the idiotic short-selling ban.

On Friday evening the December S&P futures settled 9 points lower than the S&P 500 index. Fair value is several points higher than the index close. If this discount to fair value persists DURING in the trading day on Monday, I expect we will see the market to start to go into a spiral decline....

as trader mike calls it, financial armageddon is in full effect.

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usurping the power of the purse

as highlighted earlier, congress is about to sign off on spending what will end up trillions of dollars with less than a week's deliberation -- and no real choice in the matter. the fed and treasury have, under the direction of the administration, turned this crisis into a lever by which they are usurping the power of the purse.

this is possible without the complicity of congress, i suspect -- would they really win a constitutional battle of tactics? public pressure for expediency would cow them regardless of the complete validity of their position! -- but such circumvention isn't needed.

instead -- as with the days after september 11 -- they can be terrified into signing away any claim on authority.

read yves smith's objection to the proposed legislation. this is actual text from the bill treasury has forwarded:

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

these are pathetic moments in the decline of the american government by law. if there was any question that the experiment was over, the reaction to the great crisis of 2008 is answering it. this is validation of naomi klein's shock doctrine. if this is passed, there is no rule of law. it's the financial equivalent of the 1933 enabling act.

and the awful final parallel to the disastrous response to september 11? it's unlikely to do any of the things that supposedly justify it. nouriel roubini in the ft noted that the shadow banking system is unraveling.

beyond yves smith's trenchant opposition and joe nocera's times piece, there are many others to note -- david merkel, dean baker, luigi zingales, paul krugman, calculated risk, steve waldman, jck at alea, tim duy

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Friday, September 19, 2008


swiss banking

primer on swiss banking

micheloud & cie

list of swiss banks

a resource

"who caused this mess?" - beautiful, gm.


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details of the RTC/RFC plan are still to be settled in washington. but calculated risk was the first to point this out, to my knowledge, about the plan's current incarnation. he follows up here.

... [B]uying the assets isn't enough. These asset sales will lead to substantial write-downs, and that will reduce the regulatory capital at the banks.

So how do the banks recapitalize?

The hope is that by making the assets transparent, and selling off the toxic waste, that will rebuild confidence with investors. Maybe. But the U.S. Government might also have to help recapitalize the banks to keep them lending (like the Reconstruction Finance Corporation (RFC) did during the Depression). Either way, it appears the current shareholders face massive dilution.

the trillion-dollar pricetag being bandied about (a figure hank paulson implies but won't touch for its psychological volatility) is very likely just the first part of the plan (though the government will theoretically reclaim residual value either by a later sale or holding to maturity). buying off a trillion or more dollars of bad debts would serve mostly to open the gates for a badly-needed and more expensive recapitalization.

as ever, take the government admission of cost and multiply by three or five. this is going to hurt.

as tim duy writes:

Try as policymakers might, they cannot forever ignore the fact that we are not Japan; we do not have excess domestic savings to fund such a program. Eventually that fact will come home to roost. Perhaps it already has, as pressure from the Chinese appears had some role in the Freddie/Fannie bailout. And Americans may have to recognize that the remaining storied investment banks, names that drove American capitalism for generations, may soon be substantially owned by China. Indeed if the Bank of China continues to be a dominant financer of US excess, they have found a way to dominate the US in a way that could never have been achieved militarily. They will have effectively exploited a gaping hole in the international financial architecture opened increasingly wider by US policymakers over the last 28 years. But, US citizens all get cheap flat screen TVs, so who cares?

And China is just one of the nations financing the US. We remain lucky that these counterparties have yet to ask for the restructuring program the US Treasury demanded during the Asian Financial Crisis.

What is the alternative? A tax increase? Tell Americans six weeks before an election that they need to accept a lower standard of living? I don’t see that happening. It won’t happen until the foreign credit is turned off. Otherwise, policymakers will continue to behave as if deficits don’t matter.

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who caused this crisis?

there's a lot of blame to go around, but -- as pointed out by tim duy -- let's not forget this.

As we learn this morning via Julie Satow of the NY Sun, special exemptions from the SEC are in large part responsible for the huge build up in financial sector leverage over the past 4 years -- as well as the massive current unwind

Satow interviews the above quoted former SEC director [Lee Pickard], and he spits out the blunt truth: The current excess leverage now unwinding was the result of a purposeful SEC exemption given to five firms.

You read that right -- the events of the past year are not a mere accident, but are the results of a conscious and willful SEC decision to allow these firms to legally violate existing net capital rules that, in the past 30 years, had limited broker dealers debt-to-net capital ratio to 12-to-1.

Instead, the 2004 exemption -- given only to 5 firms -- allowed them to lever up 30 and even 40 to 1.

Who were the five that received this special exemption? You won't be surprised to learn that they were Goldman, Merrill, Lehman, Bear Stearns, and Morgan Stanley.

As Mr. Pickard points out that "The proof is in the pudding — three of the five broker-dealers have blown up."

here's the SEC statement regarding the alternative net capital requirement for broker-dealers. in short, it was excessive leveraging that helped the investment banks facilitate the credit boom and killed them in the subsequent bust. short selling has nothing whatever to do with it -- the idea is a red herring perpetuated almost singularly by investment banking chiefs who desperately need scapegoats onto which they can deflect blame for the disaster they have created.

so who exactly relieved these broker-dealers of their leverage restrictions and enabled idiot bankers to commit financial suicide -- now at terrible public expense?

the director of the SEC at that time was william donaldson, founder of the erstwhile donaldson, lufkin and jenrette and former nixon undersecretary of state -- and appointee of the george w. bush administration. it is important, however, to see this sort of risk-modeled view of regulatory capital to be pushed initially by the basel ii accords produced by the basel committee. at the time, protest was predictably wrongheaded -- many complained that this would be "another layer of regulation" and somehow a burden to the i-banks. that too, it turns out, was a red herring.

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