The Risk Of A Total Systemic Meltdown Is Now As High As Ever.
The Us And Global Financial Crisis Is Becoming Much More Severe In Spite Of The Treasury Rescue Plan.
By Nouriel Roubini | 29 September 2008
It is obvious that the current financial crisis is becoming more severe in spite of the Treasury rescue plan (or maybe because of it, as this plan it totally flawed). The severe strains in financial markets (money markets, credit markets, stock markets, CDS and derivative markets) are becoming more severe rather than less severe in spite of the nuclear option (after the Fannie and Freddie $200 billion bazooka bailout failed to restore confidence) of a $700 billion package. Interbank spreads are widening (TED spread, swap spreads, Libo-OIS spread) and are at levels never seen before; credit spreads (such as junk bond yield spreads relative to Treasuries) are widening to new peaks; short-term Treasury yields are going back to near zero levels as the flight to safety mushrooms; CDS spreads for financial institutions are rising to extreme levels (Morgan Stanley was at 1200 last week) as the ban on shorting of financial stock has moved the pressures on financial firms to the CDS market; and stock markets around the world have reacted very negatively to this rescue package. (US market are down about 3% this morning at their opening.)
Let me explain now in more detail why we are now back to the risk of a total systemic financial meltdown.
It is no surprise as financial institutions in the US and around advanced economies are going bust: in the US the latest victims were WaMu (the largest US S&L) and today Wachovia (the sixth largest US bank); in the UK after Northern Rock and the acquisition of HBOS by Lloyds TSB you now have the bust and rescue of B&B; in Belgium you had Fortis going bust and being rescued over the weekend; in Germany HRE, a major financial institution is also near bust and in need of a government rescue. So this is not just a US financial crisis; it is a global financial crisis hitting institutions in the US, UK, Eurozone and other advanced economies (Iceland, Australia, New Zealand, Canada etc.).
And the strains in financial markets— especially short term interbank markets— are becoming more severe in spite of the Fed and other central banks having literally injected about $300 billion of liquidity in the financial system last week alone including massive liquidity lending to Morgan and Goldman. In a solvency crisis and credit crisis that goes well beyond illiquidity no one is lending to counterparties as no one trusts any counterparty (even the safest ones) and everyone is hoarding the liquidity that is injected by central banks. And since this liquidity goes only to banks and major broker dealers the rest of the shadow banking system has no access to this liquidity as the normal credit transmission mechanisms are blocked.
After the bust of Bear and Lehman and the merger of Merrill with BofA I suggested that Morgan Stanley and Goldman Sachs should also merge with a large financial institution that has a large base of insured deposits so as to avoid a run on their overnite liabilities. Instead Morgan and Goldman went for the cosmetic approach of converting into bank holding companies as a way to get further liquidity support— and regulation as banks— of the Fed and as a way to acquire safe deposits. But neither institution can create in a short time a franchise of branches and neither one has the time and resources to acquire smaller banks. And the injection of $8bn of Japanese capital into Morgan and $5bn of capital from Buffett into Goldman are but drops in the ocean as both institutions need much more capital.
Thus, the gambit of converting into a 'bank', while not being a bank has not worked and the runs against them has accelerated in the last week. Morgan’s CDS spread went through the roof on Friday to over 1200 and the firm has already lost over a third of its hedge funds clients together with their highly profitable prime brokering business (this is really a kiss of death for Morgan); and the coming roll-off of the interbank lines to Morgan would seal its collapse. Even Goldman Sachs is under severe stress losing business, losing money, experiencing a severe widening of its CDS spreads and at risk of losing most of its value, as most of its lines of business (including trading) are now losing money.
Both institutions are highly recommended to stop dithering and playing for time as delay will be destructive. They should merge now with a large foreign financial institution as no US institution is sound enough and large enough to be a sound merger partner. If Mack and Blankfein don’t want to end up like Fuld they should do today a Thain and merge as fast as they can with some other large commercial bank. Maybe Mitsubishi and a bunch of Japanese life insurers can take over Morgan; in Europe Barclays has its share of capital trouble and has just swallowed part of Lehman; while most other UK banks are too weak to take over Goldman.
The only institution sound enough to swallow Goldman may be HSBC. Or maybe Nomura in Japan should make a bid for Goldman. Either way Mack and Blankfein should sell their firm at a major discount to the current 'price' before they end up like Bear and be offered in a few weeks a couple of bucks a share for their faltering operation. And the Fed and Treasury should tell them to hurry up as they are both much bigger than Bear or Lehman and their collapse would have severe systemic effects.
When investors don’t trust even venerable institutions such as Morgan Stanley and Goldman Sachs any more you know that the financial crisis is as severe as ever and the fear of collapse of counterparties does not spare anyone. When a nuclear option of a monster $700 billion rescue plan is not even able to rally stock markets (as they are all in free fall today) you know this is a global crisis of confidence in the financial system. We were literally a hair's breadth from total meltdown of the system on Wednesday (and Thursday morning) two weeks ago when the $85bn bailout of AIG led to a 5% fall in US stock markets (instead of a rally).
Then the US authorities went for the nuclear option of the $700 billion plan, together with bans on short sales, a guarantee of money market funds and an injection of over $300 billion in the financial system, as a way to stave off the meltdown. Now the prospect of this plan passing (although there is some lingering deal risk as the votes in the House are not certain)— as well as the other massive policy actions taken, e.g., to stop short selling "speculation" and support interbank markets and money market funds— is not sufficient to make the markets rally, as there is a generalized loss of confidence in financial markets and in financial institutions that no policy action seems able to stem.
The next step of this panic could become the mother of all bank runs, i.e., a run on the trillion dollar plus of the cross border short-term interbank liabilities of the US banking and financial system as foreign banks are starting to worry about the safety of their liquid exposures to US financial institutions. A 'silent' cross border bank run has already begun, as foreign banks have become increasingly worried about the solvency of US banks and have started to reduce their exposure. And if this run accelerates— as it may— a total meltdown of the US financial system could occur.
We are thus now in a generalized panic mode and back to the risk of a systemic meltdown of the entire international financial system. And both US and foreign policy authorities seem to be clueless about what needs to be done next. Maybe they should start with a coordinated 100 bps reduction in policy rates in all of the major economies in the world to show that they are starting seriously to recognize and address this rapidly worsening financial crisis. [[That last would be worse than useless; the problem is not the cost of money, but the probability of the return of money. And no one doubts that the CBs are fully engaged with trying to forestall this looming catastrophe.: normxxx]]
Normxxx
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Tuesday, September 30, 2008
Australia Faces Worse Crisis
Australia Faces Worse Crisis Than America
By Ambrose Evans-Pritchard, Telegraph, UK | 30 September 2008
The world's financial storm has swept through Australia and New Zealand this week amid mounting signs of contagion across the Pacific region. Financial shares were pummelled in Sydney on Tuesday after investor flight forced National Australia Bank (NAB) to slash a £400m bond sale by two thirds. The retreat comes days after the Melbourne lender shocked the markets by announcing a 90% write-down on its £550m holdings of US mortgage debt, an admission that its AAA-rated securities are virtually worthless.
In New Zealand, Guardian Trust said it was suspending withdrawals from its mortgage fund owing to "liquidity difficulties in the market". Hanover Finance— the country' third biggest operator— last week froze repayments to investors. The company said its "industry model has collapsed" as the housing market goes into a nose dive. Some 23 finance companies have gone bankrupt in New Zealand over the last year.
It is now clear that the Antipodes are tipping into a serious downturn. Australia's NAB business confidence index fell to its lowest level in seventeen years in June. New Zealand's central bank began to cut interest rates last week on fears that the economy may have contracted in the second quarter, and is now entering recession. Housing starts slumped 20% in June to the lowest since 1986.
Gabriel Stein, from Lombard Street Research, said Australia could prove vulnerable once the global commodity cycle turns down. It has racked up a current account deficit of 6.2% of GDP despite enjoying a coal, wheat, and metals boom, effectively spending its resources bonanza in advance. Household debt has reached 177% of GDP, almost a world record.
"It is amazing that in the midst of the biggest commodity boom ever seen they have still been unable to get a current account surplus. They have been living beyond their means for 10 years. What worries me is that productivity growth has been very low: they have coasting after their reforms in the 1990s," he said. Australia's Reserve Bank has had to grapple with vast inflows of Asian capital, especially Japanese money fleeing near zero rates at home. Short of imposing currency controls, it would have been almost impossible to stop the inflows.
"The easy money went straight into real estate," said Hans Redeker, currency chief at BNP Paribas. "Australia will now have to generate 4% of GDP to meet payments to foreign holders of its assets," he said. This is twice as high as the burden faced by the US. Both the Australian and New Zealand dollars have fallen hard in recent days and now appear to be breaking down through key technical support against major currencies, including the US dollar. "The Aussie is going down, big time," said Mr Redeker.
The picture is darkening across the Pacific Rim. The Bank of Japan's deputy governor, Kiyohiko Nishimura, said its economy may now be falling into a "technical recession". Household income dropped 2.1% in June compared to a year earlier and manufacturers are the gloomiest since the deflation crunch in 2003. The decision by National Australia Bank to make drastic provisions on its US mortgage debt could have ramifications in the US itself. It opted for a 100% write-off on a clutch of "senior strips" of collateralized debt obligations (CDO) worth £450m— even though they were all rated AAA. No US bank has admitted to such fearsome loss rates.
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Ambrose Evans-Pritchard, Telegraph, UK | 30 September 2008
The world's financial storm has swept through Australia and New Zealand this week amid mounting signs of contagion across the Pacific region. Financial shares were pummelled in Sydney on Tuesday after investor flight forced National Australia Bank (NAB) to slash a £400m bond sale by two thirds. The retreat comes days after the Melbourne lender shocked the markets by announcing a 90% write-down on its £550m holdings of US mortgage debt, an admission that its AAA-rated securities are virtually worthless.
In New Zealand, Guardian Trust said it was suspending withdrawals from its mortgage fund owing to "liquidity difficulties in the market". Hanover Finance— the country' third biggest operator— last week froze repayments to investors. The company said its "industry model has collapsed" as the housing market goes into a nose dive. Some 23 finance companies have gone bankrupt in New Zealand over the last year.
It is now clear that the Antipodes are tipping into a serious downturn. Australia's NAB business confidence index fell to its lowest level in seventeen years in June. New Zealand's central bank began to cut interest rates last week on fears that the economy may have contracted in the second quarter, and is now entering recession. Housing starts slumped 20% in June to the lowest since 1986.
Gabriel Stein, from Lombard Street Research, said Australia could prove vulnerable once the global commodity cycle turns down. It has racked up a current account deficit of 6.2% of GDP despite enjoying a coal, wheat, and metals boom, effectively spending its resources bonanza in advance. Household debt has reached 177% of GDP, almost a world record.
"It is amazing that in the midst of the biggest commodity boom ever seen they have still been unable to get a current account surplus. They have been living beyond their means for 10 years. What worries me is that productivity growth has been very low: they have coasting after their reforms in the 1990s," he said. Australia's Reserve Bank has had to grapple with vast inflows of Asian capital, especially Japanese money fleeing near zero rates at home. Short of imposing currency controls, it would have been almost impossible to stop the inflows.
"The easy money went straight into real estate," said Hans Redeker, currency chief at BNP Paribas. "Australia will now have to generate 4% of GDP to meet payments to foreign holders of its assets," he said. This is twice as high as the burden faced by the US. Both the Australian and New Zealand dollars have fallen hard in recent days and now appear to be breaking down through key technical support against major currencies, including the US dollar. "The Aussie is going down, big time," said Mr Redeker.
The picture is darkening across the Pacific Rim. The Bank of Japan's deputy governor, Kiyohiko Nishimura, said its economy may now be falling into a "technical recession". Household income dropped 2.1% in June compared to a year earlier and manufacturers are the gloomiest since the deflation crunch in 2003. The decision by National Australia Bank to make drastic provisions on its US mortgage debt could have ramifications in the US itself. It opted for a 100% write-off on a clutch of "senior strips" of collateralized debt obligations (CDO) worth £450m— even though they were all rated AAA. No US bank has admitted to such fearsome loss rates.
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Banking Crash Hits Europe
Banking Crash Hits Europe As ECB Loses Traction
By Ambrose Evans-Pritchard | 30 September 2008
The global credit crisis has slammed into Europe with stunning violence over the last two days, triggering five major bank rescues and a near total shut-down of the region's credit markets. The Dutch-Belgian bank Fortis, Britain's Bradford and Bingley, and Iceland's Glitnir, were all partially or fully nationalized after failing to roll-over debts in the short-term money markets, while the French state pledged support for the Franco-Belgian lender Dexia after the share price collapsed on reports of a capital shortage. "The European financial sector is on trial: we have to support our banks." said French President Nicolas Sarkozy. He has reportedly ordered the state investment arm Caisse Des Depots to shore up Dexia, even though the bank is based in Belgium.
Germany's Hypo Real Estate, a commercial property lender, was rescued with a €35bn lifeline from a consortium of local banks. The lender has $560bn in liabilities, almost as much as Lehman Brothers. Hypo Real's share price crashed 74pc, setting off a masse exodus from financial stocks in Frankfurt. Commerzbank fell 23% and Aareal Bank was off 43%. Anglo Irish Bank was down 44% in Dublin on wholesale funding fears.
Europe's credit markets have come close to seizing up as three-month Euribor jumped to a record 5.22% and OIS spreads rocketed to 113 basis points. "The interbank market has collapsed," said Hans Redeker, currency chief at BNP Paribas. "We're now seeing a domino effect as the credit multiplier goes into reverse and forces banks to cut back lending to clients," he said. Mr Redeker said the latest alarming twist is a move by banks to deposit €28bn in funds at the European Central Bank in a panic flight to safety. This has jammed the mechanism used by the authorities to shore up the financial system in a crisis.
"The ECB is no longer able to inject liquidity because the money is just coming back to them again. This is extremely serious. If monetary policy is no longer working, there is a risk that the whole system will blow up in days," he said. The euro plunged on Monday as the wave of bank failures hit the newswires, dropping 2% to $1.43 against the dollar. It recovered slightly as the US Federal Reserve flooded the markets with $630bn of dollar funding with fellow central banks in the biggest liquidity blitz in history.
Analysts say German finance minister Peer Steinbrueck may have spoken too soon when he crowed last week that the US would lose its status as a superpower as a result of this crisis. He told Der Spiegel yesterday that we are "all staring into the abyss". Germany— over-leveraged to Asian demand for machine tools, and Mid-East and Russian demand for luxury cars— is perhaps in equally deep trouble, though of a different kind. The combined crises at both Fortis and Dexia have sent tremors through Belgium, which is already traumatized by political civil war between the Flemings and Walloons. Fortis is Belgium's biggest private employer.
It is unclear whether the country has the resources to bail out two banks with liabilities that dwarf the economy if the crisis deepens, although a joint intervention by The Netherlands and Luxembourg to rescue Fortis has helped Belgium share the risk. Together the three states put €11.2bn to buy Fortis stock. This tripartite model is unlikely to work so well in others parts of Europe, since Benelux already operates as a closely linked team. The EU lacks a single treasury to take charge in a fast-moving crisis, leaving a patchwork of regulators and conflicting agendas.
Carsten Brzenski, chief economist at ING in Brussels, said the global crisis was now engulfing Europe with devastating speed. "We are at imminent risk of a credit crunch. Key markets are not functioning properly. The Europeans thought the sub-prime crisis was just American rubbish that the US should clean up itself, but now they are finding out that it is their rubbish too," he said.
Data from the IMF shows that European banks hold 75% as much exposure to toxic US housing debt as US banks themselves. Moreover they have mounting bad debts from the British, Spanish, French, Dutch, Scandinavian, and East European housing markets, where property bubbles reached even more extreme levels than in the US. The interest spread between Italian 10-year bonds and German Bunds have ballooned to 92 basis points, the highest since the launch of the euro. Bond traders warn that the spreads are starting to reflect a serious risk of EMU break-up and could spiral out of control in a self-feeding effect.
As the eurozone slides into recession, the ECB is coming under intense criticism for keeping monetary policy too tight. The decision to raise rates into the teeth of the crisis in July has been slammed as overkill by the political leaders in France, Spain, and Italy. Mr Sarkozy has called an emergency meeting of the EU's big five powers next week to fashion a response to the crisis. Half of the ECB's shadow council have called for a rate cut this week, insisting that the German-led bloc of ECB governors have overstated the inflation risk caused by the oil spike earlier this year.
Jacques Cailloux, Europe economist at RBS, said the hawks had won a Pyrrhic victory by imposing their hardline monetary edicts on Europe. "They have won a battle but lost the war. The July decision will hardly go down in history books as a great policy decision," he said.
Financial Crisis: Ireland’s Banks Are Rescued
Ireland Has Launched A Full-Scale Rescue Of Its Financial System, Issuing A State Guarantee Worth €400bn (£316bn) To Cover The Key Liabilities Of Its Biggest Banks And Mortgage Lenders.
By Ambrose Evans-Pritchard | 30 September 2008
Irish package for banks may prove one Guinness too many for the EU Commission. It is the most dramatic and comprehensive bank bail-out in Europe since the Scandinavian rescues of the early 1990s and may serve as a model for Britain and other countries that so far have been muddling through from one mishap to another with a mish-mash of ad hoc policies. The state guarantee exceeds 200% of Irish GDP, marking a new phase in the escalation of the crisis.
The move came as Standard & Poor's cut Iceland's sovereign credit rating from AA— to A+ following its nationalisation of Glitnir Bank. It is a warning that the cascade of bank bail-outs on both sides of the Atlantic could start to undermine the credit-worthiness of Western states. S&P warned that the tiny Nordic island is now saddled with liabilities that dwarf its economy.
The euro suffered the sharpest drop since the launch of the currency, dropping almost 3% at one stage to $1.40 against the dollar in a day of high drama across Europe. Belgium, France, and Luxembourg stepped in to rescue Dexia, the world's biggest lender to local authorities. The trio agreed to inject €6.4bn in fresh capital after the share priced crashed on Monday. Dexia's top management stepped down.
"We must have total confidence in the safety of the French banking system: there is absolutely no reason to panic," said Christian Noyer, head of the Banque de France. "The credit crisis is working its way up the food chain," said Chris Whalen, head of Institutional Risk Analytics. "Now states that sponsored the idiocy of the credit bubble are being challenged themselves. Unfortunately this could lead to global debt deflation. We are seeing a shrinkage of bank capital and this will cause a depression unless we stop it," he said.
The Irish measures amounts to a state rescue of Allied Irish Bank, Bank of Ireland, Anglo Irish Bank, Irish Life and Permanent, and Irish Nationwide, which all suffered a frightening share slide on Monday. "We can't bail out a particular bank: that wouldn't be right," said Brian Lenihan, the Irish finance minister. "What we have decided to do is give a general guarantee that the banks can lend in security and safety", he said. RBC Capital Markets said it was unclear whether wholesale support for Irish banks is legal under EU state aid rules.
"This may be one Guinness too many for the EU Commission. The action may affect trade between EU member states and raise the ire of other governments," it said. The EU Competition watchdog said it was in "urgent" consultations with Dublin. The Irish banks have been bleeding money as the property bust sets off a chain of defaults. House prices have fallen for eighteen months, and are now down 13% from their peak. Construction reached 21% of gross domestic product at the height of the bubble.
Under EMU membership the Irish authorities have been unable to cut interest rates to cushion the hard-landing. The European Central Bank raised rates in July to 4.25%. With Euribor now at record levels, the borrowing cost for Irish homeowners on floating rates (55% of the total) has risen by 1.5 percentage points since the credit crunch began. Ireland is now the first eurozone state in official recession. Unemployment has risen from 5% to 6.1% since January.
Moritz Kraemer, head of European sovereign ratings at S&P, said there is no immediate threat to Ireland's AAA rating. The country has tiny national debt (25% of GDP) and may not have to commit state funds for the rescue plan to restore confidence. "If it all goes terrible wrong in the property market, there could be significant losses for the treasury given the size of the Irish banking system. This could hit the sovereign rating," he said. It is another matter for Iceland where the three biggest banks have ammassed liabilities equal to 800% of the country's GDP in a breackneck expansion across Europe.
S&P said the Glitnir nationalisation had alone cost 5.9% of GDP, but the taxpayer burden could reach well beyond that figure. "The Icelandic banks are super-sized compared to the Icelandic budget. If there is a systemic crisis it could be very hard for the authorities to stop it. Moreover, the banks have used aggressive leverage, so their funding base is volatile," he said.
The euro suffered the sharpest drop since the launch of the currency, dropping almost 3% at one stage to $1.40 against the dollar in a day of high drama across Europe. Mr Whalen who advises the Icelandic authorities, said the country would muddle through. "Iceland has an open economy, so it has been easy for the hedge funds to come in and rape the currency. But the country is really like a giant private equity fund. Its banks buy real things so its liabilities are matched by assets. I am not really worried," he said.
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Ambrose Evans-Pritchard | 30 September 2008
The global credit crisis has slammed into Europe with stunning violence over the last two days, triggering five major bank rescues and a near total shut-down of the region's credit markets. The Dutch-Belgian bank Fortis, Britain's Bradford and Bingley, and Iceland's Glitnir, were all partially or fully nationalized after failing to roll-over debts in the short-term money markets, while the French state pledged support for the Franco-Belgian lender Dexia after the share price collapsed on reports of a capital shortage. "The European financial sector is on trial: we have to support our banks." said French President Nicolas Sarkozy. He has reportedly ordered the state investment arm Caisse Des Depots to shore up Dexia, even though the bank is based in Belgium.
Germany's Hypo Real Estate, a commercial property lender, was rescued with a €35bn lifeline from a consortium of local banks. The lender has $560bn in liabilities, almost as much as Lehman Brothers. Hypo Real's share price crashed 74pc, setting off a masse exodus from financial stocks in Frankfurt. Commerzbank fell 23% and Aareal Bank was off 43%. Anglo Irish Bank was down 44% in Dublin on wholesale funding fears.
Europe's credit markets have come close to seizing up as three-month Euribor jumped to a record 5.22% and OIS spreads rocketed to 113 basis points. "The interbank market has collapsed," said Hans Redeker, currency chief at BNP Paribas. "We're now seeing a domino effect as the credit multiplier goes into reverse and forces banks to cut back lending to clients," he said. Mr Redeker said the latest alarming twist is a move by banks to deposit €28bn in funds at the European Central Bank in a panic flight to safety. This has jammed the mechanism used by the authorities to shore up the financial system in a crisis.
"The ECB is no longer able to inject liquidity because the money is just coming back to them again. This is extremely serious. If monetary policy is no longer working, there is a risk that the whole system will blow up in days," he said. The euro plunged on Monday as the wave of bank failures hit the newswires, dropping 2% to $1.43 against the dollar. It recovered slightly as the US Federal Reserve flooded the markets with $630bn of dollar funding with fellow central banks in the biggest liquidity blitz in history.
Analysts say German finance minister Peer Steinbrueck may have spoken too soon when he crowed last week that the US would lose its status as a superpower as a result of this crisis. He told Der Spiegel yesterday that we are "all staring into the abyss". Germany— over-leveraged to Asian demand for machine tools, and Mid-East and Russian demand for luxury cars— is perhaps in equally deep trouble, though of a different kind. The combined crises at both Fortis and Dexia have sent tremors through Belgium, which is already traumatized by political civil war between the Flemings and Walloons. Fortis is Belgium's biggest private employer.
It is unclear whether the country has the resources to bail out two banks with liabilities that dwarf the economy if the crisis deepens, although a joint intervention by The Netherlands and Luxembourg to rescue Fortis has helped Belgium share the risk. Together the three states put €11.2bn to buy Fortis stock. This tripartite model is unlikely to work so well in others parts of Europe, since Benelux already operates as a closely linked team. The EU lacks a single treasury to take charge in a fast-moving crisis, leaving a patchwork of regulators and conflicting agendas.
Carsten Brzenski, chief economist at ING in Brussels, said the global crisis was now engulfing Europe with devastating speed. "We are at imminent risk of a credit crunch. Key markets are not functioning properly. The Europeans thought the sub-prime crisis was just American rubbish that the US should clean up itself, but now they are finding out that it is their rubbish too," he said.
Data from the IMF shows that European banks hold 75% as much exposure to toxic US housing debt as US banks themselves. Moreover they have mounting bad debts from the British, Spanish, French, Dutch, Scandinavian, and East European housing markets, where property bubbles reached even more extreme levels than in the US. The interest spread between Italian 10-year bonds and German Bunds have ballooned to 92 basis points, the highest since the launch of the euro. Bond traders warn that the spreads are starting to reflect a serious risk of EMU break-up and could spiral out of control in a self-feeding effect.
As the eurozone slides into recession, the ECB is coming under intense criticism for keeping monetary policy too tight. The decision to raise rates into the teeth of the crisis in July has been slammed as overkill by the political leaders in France, Spain, and Italy. Mr Sarkozy has called an emergency meeting of the EU's big five powers next week to fashion a response to the crisis. Half of the ECB's shadow council have called for a rate cut this week, insisting that the German-led bloc of ECB governors have overstated the inflation risk caused by the oil spike earlier this year.
Jacques Cailloux, Europe economist at RBS, said the hawks had won a Pyrrhic victory by imposing their hardline monetary edicts on Europe. "They have won a battle but lost the war. The July decision will hardly go down in history books as a great policy decision," he said.
Financial Crisis: Ireland’s Banks Are Rescued
Ireland Has Launched A Full-Scale Rescue Of Its Financial System, Issuing A State Guarantee Worth €400bn (£316bn) To Cover The Key Liabilities Of Its Biggest Banks And Mortgage Lenders.
By Ambrose Evans-Pritchard | 30 September 2008
Irish package for banks may prove one Guinness too many for the EU Commission. It is the most dramatic and comprehensive bank bail-out in Europe since the Scandinavian rescues of the early 1990s and may serve as a model for Britain and other countries that so far have been muddling through from one mishap to another with a mish-mash of ad hoc policies. The state guarantee exceeds 200% of Irish GDP, marking a new phase in the escalation of the crisis.
The move came as Standard & Poor's cut Iceland's sovereign credit rating from AA— to A+ following its nationalisation of Glitnir Bank. It is a warning that the cascade of bank bail-outs on both sides of the Atlantic could start to undermine the credit-worthiness of Western states. S&P warned that the tiny Nordic island is now saddled with liabilities that dwarf its economy.
The euro suffered the sharpest drop since the launch of the currency, dropping almost 3% at one stage to $1.40 against the dollar in a day of high drama across Europe. Belgium, France, and Luxembourg stepped in to rescue Dexia, the world's biggest lender to local authorities. The trio agreed to inject €6.4bn in fresh capital after the share priced crashed on Monday. Dexia's top management stepped down.
"We must have total confidence in the safety of the French banking system: there is absolutely no reason to panic," said Christian Noyer, head of the Banque de France. "The credit crisis is working its way up the food chain," said Chris Whalen, head of Institutional Risk Analytics. "Now states that sponsored the idiocy of the credit bubble are being challenged themselves. Unfortunately this could lead to global debt deflation. We are seeing a shrinkage of bank capital and this will cause a depression unless we stop it," he said.
The Irish measures amounts to a state rescue of Allied Irish Bank, Bank of Ireland, Anglo Irish Bank, Irish Life and Permanent, and Irish Nationwide, which all suffered a frightening share slide on Monday. "We can't bail out a particular bank: that wouldn't be right," said Brian Lenihan, the Irish finance minister. "What we have decided to do is give a general guarantee that the banks can lend in security and safety", he said. RBC Capital Markets said it was unclear whether wholesale support for Irish banks is legal under EU state aid rules.
"This may be one Guinness too many for the EU Commission. The action may affect trade between EU member states and raise the ire of other governments," it said. The EU Competition watchdog said it was in "urgent" consultations with Dublin. The Irish banks have been bleeding money as the property bust sets off a chain of defaults. House prices have fallen for eighteen months, and are now down 13% from their peak. Construction reached 21% of gross domestic product at the height of the bubble.
Under EMU membership the Irish authorities have been unable to cut interest rates to cushion the hard-landing. The European Central Bank raised rates in July to 4.25%. With Euribor now at record levels, the borrowing cost for Irish homeowners on floating rates (55% of the total) has risen by 1.5 percentage points since the credit crunch began. Ireland is now the first eurozone state in official recession. Unemployment has risen from 5% to 6.1% since January.
Moritz Kraemer, head of European sovereign ratings at S&P, said there is no immediate threat to Ireland's AAA rating. The country has tiny national debt (25% of GDP) and may not have to commit state funds for the rescue plan to restore confidence. "If it all goes terrible wrong in the property market, there could be significant losses for the treasury given the size of the Irish banking system. This could hit the sovereign rating," he said. It is another matter for Iceland where the three biggest banks have ammassed liabilities equal to 800% of the country's GDP in a breackneck expansion across Europe.
S&P said the Glitnir nationalisation had alone cost 5.9% of GDP, but the taxpayer burden could reach well beyond that figure. "The Icelandic banks are super-sized compared to the Icelandic budget. If there is a systemic crisis it could be very hard for the authorities to stop it. Moreover, the banks have used aggressive leverage, so their funding base is volatile," he said.
The euro suffered the sharpest drop since the launch of the currency, dropping almost 3% at one stage to $1.40 against the dollar in a day of high drama across Europe. Mr Whalen who advises the Icelandic authorities, said the country would muddle through. "Iceland has an open economy, so it has been easy for the hedge funds to come in and rape the currency. But the country is really like a giant private equity fund. Its banks buy real things so its liabilities are matched by assets. I am not really worried," he said.
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
A Brief Guide To Fixing Finance
A Brief Guide To Fixing Finance:
Know What Went Wrong Before Beginning To Fix Anything
Click here for a link to complete article:
By Martin Neil Baily and Robert E. Litan, The Brookings Institution | 27 September 2008
There has been a "domino-like" character to the financial crisis that is now readily apparent to all:
These events, individually and in combination, have led to the bear stock market, whose downward slide accelerated Monday, September 15 through mid day Thursday the 18, after Lehman Brothers filed for bankruptcy and the Federal Reserve lent AIG $85 billion to keep it afloat— although the market quickly recovered at the end of the week after the Administration’s massive mortgage securities rescue initiative was announced.
So far, the financial turmoil on Wall Street has had a surprisingly modest impact on Main Street. Despite the crisis and the surge in commodity prices, the non-financial sector of the economy has continued to grow, spurred in significant part by a large growth in exports (fueled, in turn, by a steep decline in the dollar). Whether this pattern will continue— and specifically whether consumer spending will hold up in the face of the recent nerve-racking financial events and the steady climb in the unemployment rate (now over 6 percent)— is one of the large uncertainties confronting us all.
Likewise, in retrospect it is now relatively easy to see that much of this financial carnage, and thus any subsequent economic damage, could have been avoided:
Recognizing what went wrong is important in assessing what needs to be changed in the future. We do not plan to get into the blame game, nor is it productive for policy makers to do so (though we expect a certain amount of this during an election campaign). Instead, it is vital that those charged with fixing this mess draw on what is now widely known and agreed upon so as to develop appropriate reforms that would dramatically lower the risks and consequences of future such financial crises, without chilling the financial innovation for which America’s highly entrepreneurial financial sector has long been known. That is the approach we will follow in this project, and in the broad suggestions outlined next.
M O R E. . .
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Know What Went Wrong Before Beginning To Fix Anything
Click here for a link to complete article:
By Martin Neil Baily and Robert E. Litan, The Brookings Institution | 27 September 2008
There has been a "domino-like" character to the financial crisis that is now readily apparent to all:
- the bubble in home prices, fueled by the ready availability of credit, resulted in an underestimate of the risks of residential real estate;
- the peaking of residential home prices in 2006, combined with lax lending standards were followed by a very high rate of delinquencies on subprime mortgages in 2007 and a rising rate of delinquencies on prime mortgages;
- losses thereafter on the complex "Collateralized Debt Obligations" (CDOs) that were backed by these mortgages;
- increased liabilities by the many financial institutions (banks, investment banks, insurance companies, and hedge funds) that issued "credit default swaps" contracts (CDS) that insured the CDOs;
- losses suffered by financial institutions that held CDOs and/or that issued CDS’s;
- cutbacks in credit extended by highly leveraged lenders that suffered these losses.
These events, individually and in combination, have led to the bear stock market, whose downward slide accelerated Monday, September 15 through mid day Thursday the 18, after Lehman Brothers filed for bankruptcy and the Federal Reserve lent AIG $85 billion to keep it afloat— although the market quickly recovered at the end of the week after the Administration’s massive mortgage securities rescue initiative was announced.
So far, the financial turmoil on Wall Street has had a surprisingly modest impact on Main Street. Despite the crisis and the surge in commodity prices, the non-financial sector of the economy has continued to grow, spurred in significant part by a large growth in exports (fueled, in turn, by a steep decline in the dollar). Whether this pattern will continue— and specifically whether consumer spending will hold up in the face of the recent nerve-racking financial events and the steady climb in the unemployment rate (now over 6 percent)— is one of the large uncertainties confronting us all.
Likewise, in retrospect it is now relatively easy to see that much of this financial carnage, and thus any subsequent economic damage, could have been avoided:
- Had policy makers reined in the increasingly irresponsible subprime mortgage lending practices that were apparent earlier this decade— the proliferation of "no-doc" loans, often taken out with little or no equity from subprime borrowers, and frequently on adjustable terms with seductively attractive initial "teaser" interest rates, all on the widely held assumption that home prices would continue to rise— it is likely that this crisis would been largely, if not entirely, avoided. When there is a significant probability that an asset market is in a speculative bubble, it is time to tighten lending standards, not loosen them.
- Had Federal policymakers in both the Congress and the Administration not pressed so hard on "affordable housing goals" that encouraged lenders to extend and borrowers to take out loans that could not be reasonably serviced unless home prices continued to rise, and which Fannie and Freddie began to buy in large volumes in the last several years, Fannie and Freddie may have escaped the fate that has befallen them.
- Had the credit rating agencies whose stamps of approval were key to the sale of CDOs and other complex securities that later suffered losses been more transparent in how their ratings were provided and in the limited nature of the data on which they were made, it is likely that these securities would have been much more difficult to sell, and thus in turn, that subprime mortgages would not have been so easily originated.
- Had regulators done a better job monitoring the risk exposures of commercial banks, especially through their creation of off-balance entities known as "Structured Investment Vehicles" (SIVs), the market for CDOs would not have been so deep (the same is true for the state insurance regulators who oversaw the "monoline" insurers that insured CDOs and AIG, the nation’s largest insurer, that issued them).
- Had policy makers not permitted investment banks to vastly increase their leverage so that they were far more exposed to failure when they suffered losses from their various investments, the previously independent investment banks may have been able to avoid their forced alliances with commercial banks (or, in the case, of Lehman, failure).
- And had financial institutions followed their own internal risk management guidelines, then it is possible that the current crisis would not be so deep and that the face of both of the commercial and investment banking industries would now not be so radically changed.
Recognizing what went wrong is important in assessing what needs to be changed in the future. We do not plan to get into the blame game, nor is it productive for policy makers to do so (though we expect a certain amount of this during an election campaign). Instead, it is vital that those charged with fixing this mess draw on what is now widely known and agreed upon so as to develop appropriate reforms that would dramatically lower the risks and consequences of future such financial crises, without chilling the financial innovation for which America’s highly entrepreneurial financial sector has long been known. That is the approach we will follow in this project, and in the broad suggestions outlined next.
M O R E. . .
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Hussman Votes No!
Hussman Votes No! You Can't Rescue The Financial System If You Can't Read A Balance Sheet.
Click here for a link to complete article:
By John P. Hussman, Ph.D. | 30 September 2008
This is a bad idea.
However the final legislation is written, the Troubled Assets Relief Program (TARP) being rushed through Congress will evidently be built around its single worst provision, which is that the Treasury will have authority to purchase distressed mortgage securities from U.S. financials. As I noted last week in An Open Letter To Congress Regarding the Current Financial Crisis, the sequence of bankruptcies that we've observed among U.S. financials has been almost exactly in order of their gross leverage (the ratio of total assets to shareholder equity). The reason for that is:
1) as the assets of a financial company lose value, the losses reduce the asset side of the balance sheet, but also reduce shareholder equity on the liability side;
2) as the cushion of shareholder equity becomes thinner, customers begin to make withdrawals;
3) in order to satisfy customer withdrawals, the financial company is forced to liquidate assets at distressed prices, prompting a further reduction in shareholder equity;
4) go back to 1) and continue the vicious cycle until shareholder equity goes negative and the company becomes insolvent.
Let's return to the basic balance sheet of a typical financial company before the writedowns:
Now let's write down the questionable assets— not all the way to zero, but to $2:
This shortfall of protection on the liability side of the balance sheet is what causes a run on the institution, because once shareholder equity is gone, the only way to get at the debt to bondholders is for the company to declare bankruptcy. The concern has been that continuing bankruptcies would throw the whole financial system into disarray, especially for investment banks having lots of counterparty relationships with other institutions. But the reality is that for nearly all of these institutions, the cushion of debt to bondholders has always been more than sufficient to protect customers from losses even in the event of bankruptcy.
What the financial system has needed most has been for Congress to streamline the bankruptcy process for investment banks, so that in the event of failure, the "good bank" (assets and liabilities, ex the debt to bondholders) could be cut away quickly and liquidated to an acquirer, leaving the proceeds as a residual for the bondholders. Indeed, that's exactly how it works for regulated banks. What investors overlooked in last week's panic was that we actually saw the largest bank failure in history— Washington Mutual— with absolutely no losses to customers or the U.S. government, precisely because the good bank was seamlessly cut away and sold to J.P. Morgan, wiping out shareholder equity, preferred equity, and subordinated debt, with partial repayment to the bondholders.
Snap— just like that! Now, let's go back to the previous balance sheet. The Treasury plan seeks to buy up those questionable assets and thereby protect the institution against failure. Problem is, suppose the Treasury buys those questionable assets at their going value of $2. Here's the result:
Does this transaction protect the institution against failure? No! If you buy the bad assets off the balance sheet at their market value, nothing changes on the liability side! You may have improved the "quality" of the balance sheet, but you've provided no additional capital. At best, you've allowed the bank to liquidate its assets more easily to meet continuing customer withdrawals in the vicious cycle described above.
The only way that buying the questionable assets will increase capital on the liability side of the balance sheet is if the Treasury overpays for them.
A better approach would be for the government to provide capital directly, in the form of a "super-bond," in an amount no greater than the debt to bondholders. The "super-bond" would be subordinate to customer liabilities, so it could be counted as capital for the purpose of capital requirements, and would be seen by customers as a legitimate cushion of protection. However, in the event of bankruptcy, it would have a senior claim in front of both stockholders and even senior bondholders. Do that, and you've actually got a mechanism to protect the financial system while at the same time protecting customers and taxpayers. Ideally, the super-bond accrues a relatively high rate of interest so that financials have an incentive to shift to private financing as soon as possible, but you would also defer the interest until the bank meets a minimal level of profitability to make sure that the financing doesn't strain the institution's liquidity.
But then, Congress didn't do this because nobody thinks in terms of balance sheets. So after a nice pop to maybe 1300 or even 1400 on the S&P 500, we can expect all hell to break loose again.
As a side note, a lot has been made of Warren Buffett's investment in the senior preferred stock of Goldman Sachs. But it's notable that Buffett invested in Goldman only upon the conversion of Goldman to a bank holding company, which puts it under a different regulatory structure that gives it access to the Fed window. Goldman's balance sheet has $40 billion of shareholder equity that would have to be drilled through before getting at the preferred. [[Moreover, WB's preferred is 'senior' to all of GS's other preferred: normxxx]]. Evidently, Buffett believes that Goldman's asset mix is diversified enough, and light enough in mortgage assets, that Goldman won't take a major haircut on its entire (largely hedged) portfolio of assets.
Buffett's investment may reflect confidence in Goldman, particularly with a government backstop on whatever questionable assets it does own, but if anything, it suggests that the government should have gone the same route— namely, provide capital in return for a financially viable security that is senior to common shareholder equity, have it accrue a relatively high rate of interest, and allow it to be repaid early (Buffett's preferred is callable by Goldman) as soon as the financial institution can secure cheaper financing.
Instead, the government is taking on financially non-viable securities and warrants on common equity, while failing to improve the capital position of these financial companies at all (unless it overpays). Taxpayers will not make money here.
As Congressman Scott Garrett noted to taxpayers on Sunday, "This morning we should be very much alarmed. Obviously, Washington is not listening to your wishes. Those who used to work for Goldman Sachs will support this deal. Those who have blocked reform in the past will support this deal. I will not support this deal." I [John Hussman] couldn't agree more. This is not a good deal, because it will waste taxpayer money without addressing the fundamental solvency problems.
Market Climate
As of last week, the Market Climate for stocks remained characterized by unfavorable valuations and unfavorable market action. At present, however, there's not a lot to stand in the way of a violent short squeeze, particularly in financials, on the prospect of hundreds of billions in helicopter money for Wall Street. The Fund remains well hedged against substantial downside risk, but we did establish a modest "anti-hedge" on market weakness last week: an out-of-the-money index call option position amounting to about 1% of assets, not to create a significant positive exposure, but to soften our hedge in the event of a hyperactive relief rally.
This is not a long position for us, and certainly not a "buy signal." It's just risk-management to provide for the contingency that investors could shift to a risk-taking preference for a while. If broad improvement in market action confirms that sort of shift, we'll allow that call exposure to go "in-the-money," which would provide the Strategic Growth Fund with a modest positive exposure to market fluctuations. Poor internal market action on any relief rally would encourage us to clip off that call option exposure or raise our strike prices to capture any intrinsic value that accrues.
In bonds, the Market Climate last week was characterized by relatively neutral yield levels and modestly unfavorable yield pressures. If the legislation is passed, as appears likely, Treasury prices may be pressured lower on expectations of expanded supply, combined with potential aversion of foreign investors to hold a currency that is increasingly backed by junk. If you take a U.S. dollar out of your wallet, you'll see "Federal Reserve Note" written prominently along the top. Witness how the U.S. currency is now backed. The Treasury plan will make the situation no better.
For our part, the Strategic Total Return Fund is primarily invested in short-dated Treasury securities with little sensitivity to interest rate fluctuations. The Fund also holds about 30% of assets in a mix of foreign currencies, precious metals shares, and utility stocks.
M O R E. . .
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Click here for a link to complete article:
By John P. Hussman, Ph.D. | 30 September 2008
This is a bad idea.
However the final legislation is written, the Troubled Assets Relief Program (TARP) being rushed through Congress will evidently be built around its single worst provision, which is that the Treasury will have authority to purchase distressed mortgage securities from U.S. financials. As I noted last week in An Open Letter To Congress Regarding the Current Financial Crisis, the sequence of bankruptcies that we've observed among U.S. financials has been almost exactly in order of their gross leverage (the ratio of total assets to shareholder equity). The reason for that is:
1) as the assets of a financial company lose value, the losses reduce the asset side of the balance sheet, but also reduce shareholder equity on the liability side;
2) as the cushion of shareholder equity becomes thinner, customers begin to make withdrawals;
3) in order to satisfy customer withdrawals, the financial company is forced to liquidate assets at distressed prices, prompting a further reduction in shareholder equity;
4) go back to 1) and continue the vicious cycle until shareholder equity goes negative and the company becomes insolvent.
Let's return to the basic balance sheet of a typical financial company before the writedowns:
Good Assets: $95
Questionable Assets: $5
TOTAL ASSETS: $100
Liabilities To Customers: $80
Debt to Bondholders: $17
Shareholder Equity: $3
TOTAL LIABILITIES AND SHAREHOLDER EQUITY: $100
Now let's write down the questionable assets— not all the way to zero, but to $2:
Good Assets: $95
Questionable Assets: $2
TOTAL ASSETS: $97
Liabilities To Customers: $80
Debt to Bondholders: $17
Shareholder Equity: $0
TOTAL LIABILITIES AND SHAREHOLDER EQUITY: $97
This shortfall of protection on the liability side of the balance sheet is what causes a run on the institution, because once shareholder equity is gone, the only way to get at the debt to bondholders is for the company to declare bankruptcy. The concern has been that continuing bankruptcies would throw the whole financial system into disarray, especially for investment banks having lots of counterparty relationships with other institutions. But the reality is that for nearly all of these institutions, the cushion of debt to bondholders has always been more than sufficient to protect customers from losses even in the event of bankruptcy.
What the financial system has needed most has been for Congress to streamline the bankruptcy process for investment banks, so that in the event of failure, the "good bank" (assets and liabilities, ex the debt to bondholders) could be cut away quickly and liquidated to an acquirer, leaving the proceeds as a residual for the bondholders. Indeed, that's exactly how it works for regulated banks. What investors overlooked in last week's panic was that we actually saw the largest bank failure in history— Washington Mutual— with absolutely no losses to customers or the U.S. government, precisely because the good bank was seamlessly cut away and sold to J.P. Morgan, wiping out shareholder equity, preferred equity, and subordinated debt, with partial repayment to the bondholders.
Snap— just like that! Now, let's go back to the previous balance sheet. The Treasury plan seeks to buy up those questionable assets and thereby protect the institution against failure. Problem is, suppose the Treasury buys those questionable assets at their going value of $2. Here's the result:
Good Assets: $95
Cash Proceeds from Sale of Questionable Assets to Treasury: $2
TOTAL ASSETS: $97
Liabilities To Customers: $80
Debt to Bondholders: $17
Shareholder Equity: $0
TOTAL LIABILITIES AND SHAREHOLDER EQUITY: $97
Does this transaction protect the institution against failure? No! If you buy the bad assets off the balance sheet at their market value, nothing changes on the liability side! You may have improved the "quality" of the balance sheet, but you've provided no additional capital. At best, you've allowed the bank to liquidate its assets more easily to meet continuing customer withdrawals in the vicious cycle described above.
The only way that buying the questionable assets will increase capital on the liability side of the balance sheet is if the Treasury overpays for them.
A better approach would be for the government to provide capital directly, in the form of a "super-bond," in an amount no greater than the debt to bondholders. The "super-bond" would be subordinate to customer liabilities, so it could be counted as capital for the purpose of capital requirements, and would be seen by customers as a legitimate cushion of protection. However, in the event of bankruptcy, it would have a senior claim in front of both stockholders and even senior bondholders. Do that, and you've actually got a mechanism to protect the financial system while at the same time protecting customers and taxpayers. Ideally, the super-bond accrues a relatively high rate of interest so that financials have an incentive to shift to private financing as soon as possible, but you would also defer the interest until the bank meets a minimal level of profitability to make sure that the financing doesn't strain the institution's liquidity.
But then, Congress didn't do this because nobody thinks in terms of balance sheets. So after a nice pop to maybe 1300 or even 1400 on the S&P 500, we can expect all hell to break loose again.
As a side note, a lot has been made of Warren Buffett's investment in the senior preferred stock of Goldman Sachs. But it's notable that Buffett invested in Goldman only upon the conversion of Goldman to a bank holding company, which puts it under a different regulatory structure that gives it access to the Fed window. Goldman's balance sheet has $40 billion of shareholder equity that would have to be drilled through before getting at the preferred. [[Moreover, WB's preferred is 'senior' to all of GS's other preferred: normxxx]]. Evidently, Buffett believes that Goldman's asset mix is diversified enough, and light enough in mortgage assets, that Goldman won't take a major haircut on its entire (largely hedged) portfolio of assets.
Buffett's investment may reflect confidence in Goldman, particularly with a government backstop on whatever questionable assets it does own, but if anything, it suggests that the government should have gone the same route— namely, provide capital in return for a financially viable security that is senior to common shareholder equity, have it accrue a relatively high rate of interest, and allow it to be repaid early (Buffett's preferred is callable by Goldman) as soon as the financial institution can secure cheaper financing.
Instead, the government is taking on financially non-viable securities and warrants on common equity, while failing to improve the capital position of these financial companies at all (unless it overpays). Taxpayers will not make money here.
As Congressman Scott Garrett noted to taxpayers on Sunday, "This morning we should be very much alarmed. Obviously, Washington is not listening to your wishes. Those who used to work for Goldman Sachs will support this deal. Those who have blocked reform in the past will support this deal. I will not support this deal." I [John Hussman] couldn't agree more. This is not a good deal, because it will waste taxpayer money without addressing the fundamental solvency problems.
Market Climate
As of last week, the Market Climate for stocks remained characterized by unfavorable valuations and unfavorable market action. At present, however, there's not a lot to stand in the way of a violent short squeeze, particularly in financials, on the prospect of hundreds of billions in helicopter money for Wall Street. The Fund remains well hedged against substantial downside risk, but we did establish a modest "anti-hedge" on market weakness last week: an out-of-the-money index call option position amounting to about 1% of assets, not to create a significant positive exposure, but to soften our hedge in the event of a hyperactive relief rally.
This is not a long position for us, and certainly not a "buy signal." It's just risk-management to provide for the contingency that investors could shift to a risk-taking preference for a while. If broad improvement in market action confirms that sort of shift, we'll allow that call exposure to go "in-the-money," which would provide the Strategic Growth Fund with a modest positive exposure to market fluctuations. Poor internal market action on any relief rally would encourage us to clip off that call option exposure or raise our strike prices to capture any intrinsic value that accrues.
In bonds, the Market Climate last week was characterized by relatively neutral yield levels and modestly unfavorable yield pressures. If the legislation is passed, as appears likely, Treasury prices may be pressured lower on expectations of expanded supply, combined with potential aversion of foreign investors to hold a currency that is increasingly backed by junk. If you take a U.S. dollar out of your wallet, you'll see "Federal Reserve Note" written prominently along the top. Witness how the U.S. currency is now backed. The Treasury plan will make the situation no better.
For our part, the Strategic Total Return Fund is primarily invested in short-dated Treasury securities with little sensitivity to interest rate fluctuations. The Fund also holds about 30% of assets in a mix of foreign currencies, precious metals shares, and utility stocks.
M O R E. . .
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Monday, September 29, 2008
Who's Next After Lehman Brothers?
Who's Next After Lehman Brothers Is Fed To The Wolves?
One Can Date The Onset Of The Great Depression From December 1930 With The Collapse Of The New York Bank Of The United States, A Mid-Size Lender To The Jewish Community In New York.
By Ambrose Evans-Pritchard, Telegraph, UK | 16 September 2008
It is often alleged that the '[WASP] Anglo' elites let The New York Bank Of The United States fail from motives of anti-semitic malice. True or not, the consequences were dire for almost everybody. The failure set off a worldwide run on US gold deposits (ie, the dollar), and forced the Federal Reserve to raise interest rates into the slump. Some 4,000 lenders were ultimately driven to the wall.
We will find out soon enough whether the decision to throw Lehman Brothers to the wolves a [couple of weeks ago] was any wiser. Princeton economist Paul Krugman has accused the US Treasury and the Fed of playing "Russian Roulette" with the financial system, warning that the 'shadow' banking system could disintegrate within days. The hunting packs switched instantly to AIG, driving down its shares by 90%. The world's biggest insurer [was] suddenly on the brink of collapse as well. The killer virus is striking deep into a whole new sector of the financial system.
"This is a potentially very dangerous situation," said Professor Tim Congdon from the London School of Economics. "Banking system capital is being wiped out. The risk is that this could lead to a contraction of credit and set off a self-reinforcing downward spiral, leading to the sort of debt-deflation we saw in the 1930s. It is already clear that money growth has ground to a halt over the past three months. We must prevent it from actually contracting. If the Fed and European Central Bank don't cut interest rates soon, it is going to be a problem," he said.
When creditors cut off funding to Bear Stearns in March, the Fed reacted with dramatic speed. It invoked nuclear powers under Article 13 (3) of its charter, allowing it— in "unusual and exigent circumstances"— to take credit liabilities on to its own books for the first time since the Roosevelt era. It was fiercely criticised for rescuing Wall Street from its own folly, but the risk was a meltdown in the vast, untested market for derivatives. Bear Stearns alone had over $13 trillion in contracts, with heavy exposure to the turbo-charged CDS credit swaps that so [belatedly] terrify the New York Fed.
Nobody was ready for a derivatives shock at that time. This time, hopefully, they [would be[[— needless to say, they weren't!: normxxx]]] The Bear Stearns bail-out gave the banks an extra six months to clean up their positions and lower exposure. Hence the orderly unwinding of trades at an emergency session of the International Swaps and Derivatives Association on Sunday afternoon.
With the tail risk of a derivatives Chernobyl out of the way, the Fed and the Treasury at last feel safe enough to strike a blow against moral hazard. The line has to be drawn somewhere. Unlike mortgage giants Fannie Mae and Freddie Mac, broker dealers are not crucial pillars of the US housing market. Lehman is an optimal candidate for ritual sacrifice. While the appearances of free market discipline have been upheld, the reality of the weekend events is a further lurch towards socialism, or state capitalism if you prefer.
The Fed's lending window has been widened, allowing all forms of investment grade paper [[aka, "crap": normxxx]] to be used as collateral in exchange for taxpayer credit. Even equities are now admitted, though under a disguised formula. "With investment banks falling like ninepins, the Fed may have decided that it would be prudent to provide some official underpinning for equity market values and hope to avoid a stockmarket collapse," said Stephen Lewis, chief economist at Insinger de Beaufort. Yet the dangers remain acute, even after the move to shield Merrill Lynch from contagion by orchestrating a shotgun wedding with Bank of America.
The credit crunch is about to bite deeper. The interest rate on Tier 1 debt for typical banks has jumped by 125 basis points since Friday. "This is a violent effect," said Willem Sels, credit strategist at Dresdner Kleinwort. The closely-watched Libor/OIS spread on three-month money in the US has risen to 105 basis points, pointing to a lending crunch over the winter. Europe's iTraxx Crossover index measuring default risk on junk debt has surged to over 600.
"There is a flight to quality. People are hoarding liquidity and this is going to prove very damaging. What concerns me is that the banks refused to take on Lehman's bad assets even at a low valuation, and that tells you they still don't know where the clearing level is for this mortgage debt," he said. As this newspaper has long feared, the world is now faced with both a tightening credit squeeze and a synchronised hard-landing across most of the world economy. The Eurozone and Japan are almost certainly in recession already. Britain will follow soon.
America is plummeting into a second downward leg as the fiscal stimulus package fades and the exports mini-boom stalls. China cut interest rates yesterday following a sharp fall in property prices over the summer. Superficially, one can blame Lehman and its ilk for the excesses that led to this crisis. However, the root cause lies in the actions of governments across the Western world. They held interest rates too low for much of the past two decades, and encouraged the debt burden to explode to unprecedented levels.
This reckless experiment has left our societies acutely vulnerable to a sudden reversal of debt issuance, or "deleveraging" as it is known. The ferocious purge now under way will come at a high human cost. Millions in Britain, Europe, the US, and the rest of the world will lose their jobs over the next two years, through no fault of their own.
Having caused this crisis, it would now be remiss for governments to pursue a policy of strict debt liquidation in the name of capitalist purity. As the bankruptcies mount, the state will have an obligation to step in to preserve social stability. If that means the temporary nationalisation of large chunks of the Western economy, so be it. This is too grave a crisis for ideological preening and free market infantilism. May those calling for debt liquidation "a l'outrance" [["to the utmost" or "to the death": normxxx]] be the first in line to lose their jobs.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
One Can Date The Onset Of The Great Depression From December 1930 With The Collapse Of The New York Bank Of The United States, A Mid-Size Lender To The Jewish Community In New York.
By Ambrose Evans-Pritchard, Telegraph, UK | 16 September 2008
It is often alleged that the '[WASP] Anglo' elites let The New York Bank Of The United States fail from motives of anti-semitic malice. True or not, the consequences were dire for almost everybody. The failure set off a worldwide run on US gold deposits (ie, the dollar), and forced the Federal Reserve to raise interest rates into the slump. Some 4,000 lenders were ultimately driven to the wall.
We will find out soon enough whether the decision to throw Lehman Brothers to the wolves a [couple of weeks ago] was any wiser. Princeton economist Paul Krugman has accused the US Treasury and the Fed of playing "Russian Roulette" with the financial system, warning that the 'shadow' banking system could disintegrate within days. The hunting packs switched instantly to AIG, driving down its shares by 90%. The world's biggest insurer [was] suddenly on the brink of collapse as well. The killer virus is striking deep into a whole new sector of the financial system.
"This is a potentially very dangerous situation," said Professor Tim Congdon from the London School of Economics. "Banking system capital is being wiped out. The risk is that this could lead to a contraction of credit and set off a self-reinforcing downward spiral, leading to the sort of debt-deflation we saw in the 1930s. It is already clear that money growth has ground to a halt over the past three months. We must prevent it from actually contracting. If the Fed and European Central Bank don't cut interest rates soon, it is going to be a problem," he said.
When creditors cut off funding to Bear Stearns in March, the Fed reacted with dramatic speed. It invoked nuclear powers under Article 13 (3) of its charter, allowing it— in "unusual and exigent circumstances"— to take credit liabilities on to its own books for the first time since the Roosevelt era. It was fiercely criticised for rescuing Wall Street from its own folly, but the risk was a meltdown in the vast, untested market for derivatives. Bear Stearns alone had over $13 trillion in contracts, with heavy exposure to the turbo-charged CDS credit swaps that so [belatedly] terrify the New York Fed.
Nobody was ready for a derivatives shock at that time. This time, hopefully, they [would be[[— needless to say, they weren't!: normxxx]]] The Bear Stearns bail-out gave the banks an extra six months to clean up their positions and lower exposure. Hence the orderly unwinding of trades at an emergency session of the International Swaps and Derivatives Association on Sunday afternoon.
With the tail risk of a derivatives Chernobyl out of the way, the Fed and the Treasury at last feel safe enough to strike a blow against moral hazard. The line has to be drawn somewhere. Unlike mortgage giants Fannie Mae and Freddie Mac, broker dealers are not crucial pillars of the US housing market. Lehman is an optimal candidate for ritual sacrifice. While the appearances of free market discipline have been upheld, the reality of the weekend events is a further lurch towards socialism, or state capitalism if you prefer.
The Fed's lending window has been widened, allowing all forms of investment grade paper [[aka, "crap": normxxx]] to be used as collateral in exchange for taxpayer credit. Even equities are now admitted, though under a disguised formula. "With investment banks falling like ninepins, the Fed may have decided that it would be prudent to provide some official underpinning for equity market values and hope to avoid a stockmarket collapse," said Stephen Lewis, chief economist at Insinger de Beaufort. Yet the dangers remain acute, even after the move to shield Merrill Lynch from contagion by orchestrating a shotgun wedding with Bank of America.
The credit crunch is about to bite deeper. The interest rate on Tier 1 debt for typical banks has jumped by 125 basis points since Friday. "This is a violent effect," said Willem Sels, credit strategist at Dresdner Kleinwort. The closely-watched Libor/OIS spread on three-month money in the US has risen to 105 basis points, pointing to a lending crunch over the winter. Europe's iTraxx Crossover index measuring default risk on junk debt has surged to over 600.
"There is a flight to quality. People are hoarding liquidity and this is going to prove very damaging. What concerns me is that the banks refused to take on Lehman's bad assets even at a low valuation, and that tells you they still don't know where the clearing level is for this mortgage debt," he said. As this newspaper has long feared, the world is now faced with both a tightening credit squeeze and a synchronised hard-landing across most of the world economy. The Eurozone and Japan are almost certainly in recession already. Britain will follow soon.
America is plummeting into a second downward leg as the fiscal stimulus package fades and the exports mini-boom stalls. China cut interest rates yesterday following a sharp fall in property prices over the summer. Superficially, one can blame Lehman and its ilk for the excesses that led to this crisis. However, the root cause lies in the actions of governments across the Western world. They held interest rates too low for much of the past two decades, and encouraged the debt burden to explode to unprecedented levels.
This reckless experiment has left our societies acutely vulnerable to a sudden reversal of debt issuance, or "deleveraging" as it is known. The ferocious purge now under way will come at a high human cost. Millions in Britain, Europe, the US, and the rest of the world will lose their jobs over the next two years, through no fault of their own.
Having caused this crisis, it would now be remiss for governments to pursue a policy of strict debt liquidation in the name of capitalist purity. As the bankruptcies mount, the state will have an obligation to step in to preserve social stability. If that means the temporary nationalisation of large chunks of the Western economy, so be it. This is too grave a crisis for ideological preening and free market infantilism. May those calling for debt liquidation "a l'outrance" [["to the utmost" or "to the death": normxxx]] be the first in line to lose their jobs.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Sunday, September 28, 2008
Lehman's Demise Triggered Cash Crunch Around Globe
Lehman's Demise Triggered Cash Crunch Around Globe
Decision To Let Firm Fail Marked A Turning Point In Crisis
By Carrick Mollenkamp and Mark Whitehouse, UK; Jon Hilsenrath And Ianthe Jeanne Dugan, UK | 29 September 2008
Two weeks ago, Wall Street titans and the government's most powerful economic stewards made a fateful choice: Rather than propping up another failing financial institution, they let 158-year-old Lehman Brothers Holdings Inc. collapse. Now, the consequences of that decision look more dire than almost anyone imagined.
AFP/Getty Images. A policeman tries to calm and direct customers crowding the entrance of a branch of Hong Kong's Bank of East Asia after rumors spread about BEA's exposure to assets linked to failed investment bank Lehman Brothers.
Lehman's bankruptcy filing in the early hours of Monday, Sept. 15, sparked a chain reaction that sent credit markets into disarray. It accelerated the downward spiral of giant U.S. insurer American International Group Inc. and precipitated losses for everyone from Norwegian pensioners to investors in the Reserve Primary Fund, a U.S. money-market mutual fund that was supposed to be as safe as cash. Within days, the chaos enveloped even Wall Street pillars Goldman Sachs Group Inc. and Morgan Stanley. Alarmed U.S. officials rushed to unveil a more systemic solution to the crisis, leading to Sunday's agreement with congressional leaders on a $700 billion financial-markets bailout plan.
The genesis and aftermath of Lehman's downfall illustrate the difficult position policy makers are in as they grapple with a deepening financial crisis. They don't want to be seen as too willing to step in and save financial institutions that got into trouble by taking big risks. But in an age where markets, banks and investors are linked through a web of complex and opaque financial relationships, the pain of letting a large institution go has proved almost overwhelming.
In hindsight, some critics say the systemic crisis that has emerged since the Lehman collapse could have been avoided if the government had stepped in. Before Lehman, federal officials had dealt with a series of financial brushfires in a way designed to keep troubled institutions such as Fannie Mae, Freddie Mac and Bear Stearns Cos. in business. Judging them as too big to fail, officials committed billions of taxpayer dollars to prop them up. Not so Lehman.
"I don't understand why they didn't understand that the markets would be completely spooked by this failure," says Richard Portes, professor of economics at London Business School and president of the Centre for Economic Policy Research. Rather than showing the government's resolve, he says, letting Lehman fail only exacerbated the central problem that has afflicted markets since the financial crisis began more than a year ago: Nobody knows which financial firms will be able to make good on their debts.
To be sure, Lehman's downfall was largely of its own making. The firm bet heavily on investments in overheated real-estate markets, used large amounts of borrowed money to supercharge its returns, then was slower than others to recognize its losses and raise capital when its bets went wrong. The depth of the firm's woes made finding a willing buyer a difficult task, leaving officials with few viable options. Given the limited time and information available, many experts believe government officials made the best choices possible.
Struggle For Capital
As they watched Lehman struggle to raise capital, policy makers— including Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke and New York Fed President Timothy Geithner— mulled the question of whether they could let Lehman fail. On the one hand, they didn't want to come to the rescue because they were concerned about moral hazard, the idea that bailouts encourage irresponsible risk-taking, according to people familiar with the planning. They doubted Lehman had viable buyers and they thought the market and the Fed had had time to prepare to handle the fallout if a big institution collapsed.
Still, some Fed officials were leery of sending signals that the Fed was done working with Wall Street to stop the spreading crisis. Mr. Geithner, for one, had been telling others that the markets were still in for serious trouble. "If you don't do something, the outcome is going to be bad," Mr. Geithner told executives as they gathered to bargain over Lehman's fate at the New York Fed's downtown headquarters on Friday night, Sept. 12, according to a person in the meeting. At one point, officials raised with Wall Street bankers the possibility of a private-sector rescue fund, but the bankers either balked at the idea of bailing out a competitor or didn't have the extra funds needed, people familiar with the situation said.
Prepare The Markets
Over the weekend, as possible buyouts by Bank of America Corp. and U.K. bank Barclays PLC fell through, Fed officials focused on what needed to be done to prepare markets for what would be the largest bankruptcy in U.S. history. Lehman's total assets of more than $630 billion dwarf WorldCom's assets when the telecom company filed for bankruptcy in 2002 with assets of $104 billion. Officials were particularly concerned with two areas: the credit-default-swap market, where players buy and sell insurance against defaults on corporate and other bonds; and the so-called repo market, where Wall Street banks fund their investments by putting up securities as collateral for short-term loans.
The Fed had been pushing Wall Street firms for months to set up a new clearinghouse for credit-default swaps. The idea was to provide a more orderly settlement of trades in this opaque, diffuse market with a staggering $55 trillion in notional value, and, among other things, make the market less vulnerable if a major dealer failed. But that hadn't gotten off the ground. As a result, nobody knew exactly which firms had made trades with Lehman and for what amounts.
On Monday, those trades would be stuck in limbo. In a last-ditch effort to ease the problem, New York Fed staff worked with Lehman officials and the firm's major trading partners to figure out which firms were on opposite sides of trades with Lehman and cancel them out. If, for example, two of Lehman's trading partners had made opposite bets on the debt of General Motors Corp., they could cancel their trades with Lehman and face each other directly instead.
The Fed had also seen with the collapse of Bear Stearns how the repo market was prone to severe disruptions when lenders got skittish, a problem that threatened to cut off crucial funding to Wall Street banks. Because repo loans are made for periods of as little as a day, the funding can disappear suddenly— one reason the Fed set up an emergency facility to lend to securities firms in the wake of Bear Stearns's collapse. Fed officials worked furiously through Sunday to expand that facility, allowing banks to put up as collateral for loans a wider range of securities, including stocks.
On Sunday, after the Barclays deal fell through, the group began to "spray foam on the runway"— the term Mr. Geithner used to describe measures to cushion the blow. By that night, Fed officials recognized that their preparations might not cover all contingencies. Still, they expected the turbulence to settle down after a time, with the help of the expanded lending facilities they hurried Sunday to put in place. They also felt that financial institutions and markets had been given enough time to prepare for the shock of a large failure since the crisis consumed Bear Stearns in March.
But Lehman's bankruptcy, filed early Monday morning in federal bankruptcy court— case No. 08-13555— proved far more destabilizing, and spread much further, than many had expected. The bankruptcy immediately wiped out huge investments for Lehman shareholders and bondholders. Among the biggest was Norway's government pension fund, which invests the country's surplus oil revenue. As of the end of 2007, the most recent data available, the fund owned more than $800 million worth of Lehman bonds and stock. Lehman's demise has become a lightning rod for critics who have long questioned the way the government was investing the oil resources. A spokesman said the fund's management is "very concerned and monitoring the situation closely."
The government's decision to let Lehman go marked a turning point in the way investors assess risk. When the Fed stepped in to engineer the takeover of Bear Stearns by J.P. Morgan Chase & Co. in March, Bear's shareholders lost most of their investments, but bondholders came out well. In the financial hierarchy of risk, this wasn't surprising, since bondholders have more contractual rights to get their money back than equity holders. But it created a false impression among investors that the government would step in to rescue bondholders when the next bank ran into trouble. By letting Lehman fail, the government had suddenly disabused the market of that notion.
The reaction was most evident in the massive credit-default-swap market, where the cost of insurance against bond defaults shot up Monday in its largest one-day rise ever. In the U.S., the average cost of five-year insurance on $10 million in debt rose to $194,000 from $152,000 Friday, according to the Markit CDX index. When the cost of default insurance rises, that generates losses for sellers of insurance, such as banks, hedge funds and insurance companies. At the same time, those sellers must put up extra cash as collateral to guarantee they will be able to make good on their obligations. On Monday alone, sellers of insurance had to find some $140 billion to make such margin calls, estimates asset-management firm Bridgewater Associates.
As investors scrambled to get the cash, they were forced to sell whatever they could— a liquidation that hit financial markets around the world.
Cash Calls
The cash calls added to the problems of AIG, which was already teetering toward collapse as it sought to meet more than $14 billion in added collateral payments triggered by a downgrade in its credit rating. AIG was one of the biggest sellers in the default insurance market, with contracts outstanding on more than $400 billion in bonds. To make matters worse, actual trading in the CDS market declined to a trickle as players tried to assess how much of their money was tied up in Lehman. The bankruptcy meant that many hedge funds and banks that were on the profitable side of a trade with Lehman were now out of luck because they couldn't collect their money. Also, clients of Lehman's prime brokerage, which provides lending and trading services to hedge funds, would have to try to retrieve their money or their securities through the courts.
Autonomy Capital Research, a London-based hedge fund that was started in 2003 by former Lehman trader Robert Charles Gibbins, was among the Lehman clients who got caught. When Lehman filed for bankruptcy protection, it froze about $60 million of Autonomy's funds, according to a person close to the situation. That is about 2% of the $2.5 billion Autonomy manages. An official at Autonomy declined to comment.
Spooked that other securities firms could fail, hedge funds rushed to buy default insurance on the firms with which they did business. But sellers were hesitant, prompting something akin to what happens if every homeowner in a neighborhood tries to buy homeowners insurance at exactly the same time. The moves dramatically drove up the cost of insurance on Morgan Stanley and Goldman Sachs debt in what became a dangerous spiral of fear about those firms.
At the same time, hedge funds began pulling their money out of the two firms. Over the next few days, for example, Morgan Stanley would lose about 10% of the assets in its prime-brokerage business. "It was just mayhem," says Thomas Priore, the CEO of New York-based hedge fund Institutional Credit Partners LLC. People were paralyzed by fear of what could erupt.
Amid the uncertainty about how Lehman's bankruptcy would affect other financial institutions, rumors and confusion sparked wild swings in stock prices. On Tuesday, for example, a London-based analyst issued a report saying that Swiss banking giant UBS AG, already hurt by tens of billions of dollars in write-downs, might lose another $4 billion because of its exposure to Lehman. Shares in UBS fell 17% on the day. UBS subsequently said its exposure was no more than $300 million.
Rising concerns about the health of financial institutions quickly spread to the markets on which banks depend to borrow money. At around 7 a.m. Tuesday in New York, the market got its first jolt of how bad the day was going to be: In London, the British Bankers' Association reported a huge rise in the London interbank offered rate, a benchmark that is supposed to reflect banks' borrowing costs. In its sharpest spike ever, overnight dollar Libor had risen to 6.44% from 3.11%. But even at those rates, banks were balking at lending to one another.
Within a few hours, the markets had shifted their focus to the fate of Goldman Sachs and Morgan Stanley, which found themselves fighting to restore investors' flagging confidence. During an earnings presentation in which he answered one after another question about the firm's ability to borrow money, Goldman chief financial officer David Viniar made an admission: "We certainly did not anticipate exactly what happened to Lehman," he said.
Morgan Stanley's stock, meanwhile, plunged 28% in early trading as investors bet that it would be the next after Lehman to fall. At around 4 p.m., the firm decided to report its third-quarter earnings a day early, in the hope that the decent results would halt the stock decline. "I care that it could be contagion," Morgan Stanley chief financial officer Colm Kelleher said in a conference call with analysts. "You've got fear in the market."
Even as Morgan Stanley's call was taking place, the Lehman fallout cropped up in a different corner of finance: so-called money-market funds, widely seen as a safe alternative to bank deposits. Many of the funds had bought IOUs, known as commercial paper, which Lehman issued to borrow money for short periods. Now, though, the paper was worth only 20 cents on the dollar.
At around 5 p.m. New York time, a well-known money-market fund manager called The Reserve said that its main fund, the Reserve Primary Fund, owned Lehman debt with a face value of $785 million. The result, said The Reserve, a strongly conservative fund which had criticized its rivals for taking on too much risk in the commercial-paper market, was that its net asset value had fallen below $1 a share— the first time a money-market fund had "broken the buck" in 14 years. [[And the first time ever for retail clients!: normxxx]]
The trouble in the commercial-paper market presented a particularly serious threat to the broader economy. Companies all over the world depend on commercial paper for short-term borrowings, which they use for everything from paying salaries to buying raw materials. But as jittery money-market funds pulled out, the market all but froze.
On Wednesday, the freeze in lending markets triggered a dramatic turn of events in the U.K. Amid growing concerns about its heavy dependence on markets to fund its business, HBOS PLC, the UK's biggest mortgage lender, saw it share price plummet by 19%. The situation was a red flag for government officials, who suffered embarrassment earlier this year when they were forced to nationalize troubled mortgage lender Northern Rock PLC, which had become the target of the country's first bank run in more than a century.
Moving quickly, the government brokered an emergency sale of HBOS to UK bank Lloyds TSB Group PLC. In a sign of their desperation to make the deal happen, officials went so far as to amend the UK's antitrust rules, which could have prevented the merger. Together, HBOS and Lloyds control nearly a third of the UK mortgage market.
Back in New York, the situation at Morgan Stanley and Goldman Sachs was worsening rapidly. In the middle of the trading day, at about 2 p.m., Morgan Stanley CEO John Mack dispatched an email to employees: "What's happening out here? It's very clear to me— we're in the midst of a market controlled by fear and rumors." By the end of Wednesday, employees at Morgan Stanley and Goldman were shell-shocked. Morgan Stanley's shares had fallen 24% to $21.75 while Goldman, the largest investment bank by market value, fell 14% to $114.50.
By Thursday, Messrs. Paulson and Bernanke decided that the fallout presented too great a threat to the financial system and the economy. In the biggest government intervention in financial markets since the 1930s, they extended federal insurance to some $3.4 trillion in money-market funds and proposed a $700 billion plan to take bad assets off the balance sheets of banks. Three days later, Goldman Sachs and Morgan Stanley applied to the Fed to become commercial banks— a historic move that ended the tradition of lightly regulated Wall Street securities firms that take big risks in the pursuit of equally big returns.
To some, the government's decision to resort to a bailout represents a tacit admission: For all officials' desire to allow markets to punish the risk-taking that engendered the crisis, banks have the upper hand. "Lehman demonstrated that it's much harder than we thought to deal effectively with banks' misbehavior," says Charles Wyplosz, an economics professor at the Graduate Institute in Geneva. You have to look the devil in the eyes and the eyes are pretty frightening.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Decision To Let Firm Fail Marked A Turning Point In Crisis
By Carrick Mollenkamp and Mark Whitehouse, UK; Jon Hilsenrath And Ianthe Jeanne Dugan, UK | 29 September 2008
Two weeks ago, Wall Street titans and the government's most powerful economic stewards made a fateful choice: Rather than propping up another failing financial institution, they let 158-year-old Lehman Brothers Holdings Inc. collapse. Now, the consequences of that decision look more dire than almost anyone imagined.
AFP/Getty Images. A policeman tries to calm and direct customers crowding the entrance of a branch of Hong Kong's Bank of East Asia after rumors spread about BEA's exposure to assets linked to failed investment bank Lehman Brothers.Lehman's bankruptcy filing in the early hours of Monday, Sept. 15, sparked a chain reaction that sent credit markets into disarray. It accelerated the downward spiral of giant U.S. insurer American International Group Inc. and precipitated losses for everyone from Norwegian pensioners to investors in the Reserve Primary Fund, a U.S. money-market mutual fund that was supposed to be as safe as cash. Within days, the chaos enveloped even Wall Street pillars Goldman Sachs Group Inc. and Morgan Stanley. Alarmed U.S. officials rushed to unveil a more systemic solution to the crisis, leading to Sunday's agreement with congressional leaders on a $700 billion financial-markets bailout plan.
The genesis and aftermath of Lehman's downfall illustrate the difficult position policy makers are in as they grapple with a deepening financial crisis. They don't want to be seen as too willing to step in and save financial institutions that got into trouble by taking big risks. But in an age where markets, banks and investors are linked through a web of complex and opaque financial relationships, the pain of letting a large institution go has proved almost overwhelming.
In hindsight, some critics say the systemic crisis that has emerged since the Lehman collapse could have been avoided if the government had stepped in. Before Lehman, federal officials had dealt with a series of financial brushfires in a way designed to keep troubled institutions such as Fannie Mae, Freddie Mac and Bear Stearns Cos. in business. Judging them as too big to fail, officials committed billions of taxpayer dollars to prop them up. Not so Lehman.
"I don't understand why they didn't understand that the markets would be completely spooked by this failure," says Richard Portes, professor of economics at London Business School and president of the Centre for Economic Policy Research. Rather than showing the government's resolve, he says, letting Lehman fail only exacerbated the central problem that has afflicted markets since the financial crisis began more than a year ago: Nobody knows which financial firms will be able to make good on their debts.
To be sure, Lehman's downfall was largely of its own making. The firm bet heavily on investments in overheated real-estate markets, used large amounts of borrowed money to supercharge its returns, then was slower than others to recognize its losses and raise capital when its bets went wrong. The depth of the firm's woes made finding a willing buyer a difficult task, leaving officials with few viable options. Given the limited time and information available, many experts believe government officials made the best choices possible.
Struggle For Capital
As they watched Lehman struggle to raise capital, policy makers— including Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke and New York Fed President Timothy Geithner— mulled the question of whether they could let Lehman fail. On the one hand, they didn't want to come to the rescue because they were concerned about moral hazard, the idea that bailouts encourage irresponsible risk-taking, according to people familiar with the planning. They doubted Lehman had viable buyers and they thought the market and the Fed had had time to prepare to handle the fallout if a big institution collapsed.
Still, some Fed officials were leery of sending signals that the Fed was done working with Wall Street to stop the spreading crisis. Mr. Geithner, for one, had been telling others that the markets were still in for serious trouble. "If you don't do something, the outcome is going to be bad," Mr. Geithner told executives as they gathered to bargain over Lehman's fate at the New York Fed's downtown headquarters on Friday night, Sept. 12, according to a person in the meeting. At one point, officials raised with Wall Street bankers the possibility of a private-sector rescue fund, but the bankers either balked at the idea of bailing out a competitor or didn't have the extra funds needed, people familiar with the situation said.
Prepare The Markets
Over the weekend, as possible buyouts by Bank of America Corp. and U.K. bank Barclays PLC fell through, Fed officials focused on what needed to be done to prepare markets for what would be the largest bankruptcy in U.S. history. Lehman's total assets of more than $630 billion dwarf WorldCom's assets when the telecom company filed for bankruptcy in 2002 with assets of $104 billion. Officials were particularly concerned with two areas: the credit-default-swap market, where players buy and sell insurance against defaults on corporate and other bonds; and the so-called repo market, where Wall Street banks fund their investments by putting up securities as collateral for short-term loans.
The Fed had been pushing Wall Street firms for months to set up a new clearinghouse for credit-default swaps. The idea was to provide a more orderly settlement of trades in this opaque, diffuse market with a staggering $55 trillion in notional value, and, among other things, make the market less vulnerable if a major dealer failed. But that hadn't gotten off the ground. As a result, nobody knew exactly which firms had made trades with Lehman and for what amounts.
On Monday, those trades would be stuck in limbo. In a last-ditch effort to ease the problem, New York Fed staff worked with Lehman officials and the firm's major trading partners to figure out which firms were on opposite sides of trades with Lehman and cancel them out. If, for example, two of Lehman's trading partners had made opposite bets on the debt of General Motors Corp., they could cancel their trades with Lehman and face each other directly instead.
The Fed had also seen with the collapse of Bear Stearns how the repo market was prone to severe disruptions when lenders got skittish, a problem that threatened to cut off crucial funding to Wall Street banks. Because repo loans are made for periods of as little as a day, the funding can disappear suddenly— one reason the Fed set up an emergency facility to lend to securities firms in the wake of Bear Stearns's collapse. Fed officials worked furiously through Sunday to expand that facility, allowing banks to put up as collateral for loans a wider range of securities, including stocks.
On Sunday, after the Barclays deal fell through, the group began to "spray foam on the runway"— the term Mr. Geithner used to describe measures to cushion the blow. By that night, Fed officials recognized that their preparations might not cover all contingencies. Still, they expected the turbulence to settle down after a time, with the help of the expanded lending facilities they hurried Sunday to put in place. They also felt that financial institutions and markets had been given enough time to prepare for the shock of a large failure since the crisis consumed Bear Stearns in March.
But Lehman's bankruptcy, filed early Monday morning in federal bankruptcy court— case No. 08-13555— proved far more destabilizing, and spread much further, than many had expected. The bankruptcy immediately wiped out huge investments for Lehman shareholders and bondholders. Among the biggest was Norway's government pension fund, which invests the country's surplus oil revenue. As of the end of 2007, the most recent data available, the fund owned more than $800 million worth of Lehman bonds and stock. Lehman's demise has become a lightning rod for critics who have long questioned the way the government was investing the oil resources. A spokesman said the fund's management is "very concerned and monitoring the situation closely."
The government's decision to let Lehman go marked a turning point in the way investors assess risk. When the Fed stepped in to engineer the takeover of Bear Stearns by J.P. Morgan Chase & Co. in March, Bear's shareholders lost most of their investments, but bondholders came out well. In the financial hierarchy of risk, this wasn't surprising, since bondholders have more contractual rights to get their money back than equity holders. But it created a false impression among investors that the government would step in to rescue bondholders when the next bank ran into trouble. By letting Lehman fail, the government had suddenly disabused the market of that notion.
The reaction was most evident in the massive credit-default-swap market, where the cost of insurance against bond defaults shot up Monday in its largest one-day rise ever. In the U.S., the average cost of five-year insurance on $10 million in debt rose to $194,000 from $152,000 Friday, according to the Markit CDX index. When the cost of default insurance rises, that generates losses for sellers of insurance, such as banks, hedge funds and insurance companies. At the same time, those sellers must put up extra cash as collateral to guarantee they will be able to make good on their obligations. On Monday alone, sellers of insurance had to find some $140 billion to make such margin calls, estimates asset-management firm Bridgewater Associates.
As investors scrambled to get the cash, they were forced to sell whatever they could— a liquidation that hit financial markets around the world.
Cash Calls
The cash calls added to the problems of AIG, which was already teetering toward collapse as it sought to meet more than $14 billion in added collateral payments triggered by a downgrade in its credit rating. AIG was one of the biggest sellers in the default insurance market, with contracts outstanding on more than $400 billion in bonds. To make matters worse, actual trading in the CDS market declined to a trickle as players tried to assess how much of their money was tied up in Lehman. The bankruptcy meant that many hedge funds and banks that were on the profitable side of a trade with Lehman were now out of luck because they couldn't collect their money. Also, clients of Lehman's prime brokerage, which provides lending and trading services to hedge funds, would have to try to retrieve their money or their securities through the courts.
Autonomy Capital Research, a London-based hedge fund that was started in 2003 by former Lehman trader Robert Charles Gibbins, was among the Lehman clients who got caught. When Lehman filed for bankruptcy protection, it froze about $60 million of Autonomy's funds, according to a person close to the situation. That is about 2% of the $2.5 billion Autonomy manages. An official at Autonomy declined to comment.
Spooked that other securities firms could fail, hedge funds rushed to buy default insurance on the firms with which they did business. But sellers were hesitant, prompting something akin to what happens if every homeowner in a neighborhood tries to buy homeowners insurance at exactly the same time. The moves dramatically drove up the cost of insurance on Morgan Stanley and Goldman Sachs debt in what became a dangerous spiral of fear about those firms.
At the same time, hedge funds began pulling their money out of the two firms. Over the next few days, for example, Morgan Stanley would lose about 10% of the assets in its prime-brokerage business. "It was just mayhem," says Thomas Priore, the CEO of New York-based hedge fund Institutional Credit Partners LLC. People were paralyzed by fear of what could erupt.
Amid the uncertainty about how Lehman's bankruptcy would affect other financial institutions, rumors and confusion sparked wild swings in stock prices. On Tuesday, for example, a London-based analyst issued a report saying that Swiss banking giant UBS AG, already hurt by tens of billions of dollars in write-downs, might lose another $4 billion because of its exposure to Lehman. Shares in UBS fell 17% on the day. UBS subsequently said its exposure was no more than $300 million.
Rising concerns about the health of financial institutions quickly spread to the markets on which banks depend to borrow money. At around 7 a.m. Tuesday in New York, the market got its first jolt of how bad the day was going to be: In London, the British Bankers' Association reported a huge rise in the London interbank offered rate, a benchmark that is supposed to reflect banks' borrowing costs. In its sharpest spike ever, overnight dollar Libor had risen to 6.44% from 3.11%. But even at those rates, banks were balking at lending to one another.
Within a few hours, the markets had shifted their focus to the fate of Goldman Sachs and Morgan Stanley, which found themselves fighting to restore investors' flagging confidence. During an earnings presentation in which he answered one after another question about the firm's ability to borrow money, Goldman chief financial officer David Viniar made an admission: "We certainly did not anticipate exactly what happened to Lehman," he said.
Morgan Stanley's stock, meanwhile, plunged 28% in early trading as investors bet that it would be the next after Lehman to fall. At around 4 p.m., the firm decided to report its third-quarter earnings a day early, in the hope that the decent results would halt the stock decline. "I care that it could be contagion," Morgan Stanley chief financial officer Colm Kelleher said in a conference call with analysts. "You've got fear in the market."
Even as Morgan Stanley's call was taking place, the Lehman fallout cropped up in a different corner of finance: so-called money-market funds, widely seen as a safe alternative to bank deposits. Many of the funds had bought IOUs, known as commercial paper, which Lehman issued to borrow money for short periods. Now, though, the paper was worth only 20 cents on the dollar.
At around 5 p.m. New York time, a well-known money-market fund manager called The Reserve said that its main fund, the Reserve Primary Fund, owned Lehman debt with a face value of $785 million. The result, said The Reserve, a strongly conservative fund which had criticized its rivals for taking on too much risk in the commercial-paper market, was that its net asset value had fallen below $1 a share— the first time a money-market fund had "broken the buck" in 14 years. [[And the first time ever for retail clients!: normxxx]]
The trouble in the commercial-paper market presented a particularly serious threat to the broader economy. Companies all over the world depend on commercial paper for short-term borrowings, which they use for everything from paying salaries to buying raw materials. But as jittery money-market funds pulled out, the market all but froze.
On Wednesday, the freeze in lending markets triggered a dramatic turn of events in the U.K. Amid growing concerns about its heavy dependence on markets to fund its business, HBOS PLC, the UK's biggest mortgage lender, saw it share price plummet by 19%. The situation was a red flag for government officials, who suffered embarrassment earlier this year when they were forced to nationalize troubled mortgage lender Northern Rock PLC, which had become the target of the country's first bank run in more than a century.
Moving quickly, the government brokered an emergency sale of HBOS to UK bank Lloyds TSB Group PLC. In a sign of their desperation to make the deal happen, officials went so far as to amend the UK's antitrust rules, which could have prevented the merger. Together, HBOS and Lloyds control nearly a third of the UK mortgage market.
Back in New York, the situation at Morgan Stanley and Goldman Sachs was worsening rapidly. In the middle of the trading day, at about 2 p.m., Morgan Stanley CEO John Mack dispatched an email to employees: "What's happening out here? It's very clear to me— we're in the midst of a market controlled by fear and rumors." By the end of Wednesday, employees at Morgan Stanley and Goldman were shell-shocked. Morgan Stanley's shares had fallen 24% to $21.75 while Goldman, the largest investment bank by market value, fell 14% to $114.50.
By Thursday, Messrs. Paulson and Bernanke decided that the fallout presented too great a threat to the financial system and the economy. In the biggest government intervention in financial markets since the 1930s, they extended federal insurance to some $3.4 trillion in money-market funds and proposed a $700 billion plan to take bad assets off the balance sheets of banks. Three days later, Goldman Sachs and Morgan Stanley applied to the Fed to become commercial banks— a historic move that ended the tradition of lightly regulated Wall Street securities firms that take big risks in the pursuit of equally big returns.
To some, the government's decision to resort to a bailout represents a tacit admission: For all officials' desire to allow markets to punish the risk-taking that engendered the crisis, banks have the upper hand. "Lehman demonstrated that it's much harder than we thought to deal effectively with banks' misbehavior," says Charles Wyplosz, an economics professor at the Graduate Institute in Geneva. You have to look the devil in the eyes and the eyes are pretty frightening.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Saturday, September 27, 2008
Buffett's CDS "Time Bomb" Goes Off
Buffett's CDS "Time Bomb" Goes Off On Wall Street
By James B. Kelleher | 27 September 2008
CHICAGO (Reuters)— On Main Street, insurance protects people from the effects of catastrophes. But on Wall Street, specialized insurance known as a credit default swaps are turning a bad situation into a catastrophe. When historians write about the current crisis, much of the blame will go to the slump in the housing and mortgage markets, which triggered the losses, layoffs and liquidations sweeping the financial industry. But credit default swaps— complex derivatives originally designed to protect banks from deadbeat borrowers— are adding to the turmoil.
"This was supposedly a way to hedge risk," says Ellen Brown, the author of the book Web of Debt: The Shocking Truth About Our Money System and How We Can Break Free (Revised and Updated Paperback, 2008). "I'm sure their predictive models were right as far as the risk of the things they were insuring against. But what they didn't factor in was the risk that the sellers of this protection wouldn't pay ... That's what we're seeing now." Brown is hardly alone in her criticism of the derivatives. Five years ago, billionaire investor Warren Buffett called them a "time bomb" and "financial weapons of mass destruction" and directed the insurance arm of his Berkshire Hathaway Inc (BRKa.N) to exit the business.
Recent events suggest Buffett was right. The collapse of Bear Stearns. The fire sale of Merrill Lynch & Co Inc (MER.N). The meltdown at American International Group Inc (AIG.N). In each case, credit default swaps played a role in the fall of these financial giants. The latest victim is insurer AIG, which received an emergency $85 billion loan from the U.S. Federal Reserve late on Tuesday to stave off a bankruptcy.
Over the last three quarters, AIG suffered $18 billion of losses tied to guarantees it wrote on mortgage-linked derivatives. Its struggles intensified in recent weeks as losses in its own investments led to cuts in its credit ratings. Those cuts triggered clauses in the policies AIG had written that forced it to put up billions of dollars in extra collateral— billions it did not have and could not raise.
Easy Money
When the credit default market began back in the mid-1990s, the transactions were simpler, more transparent affairs. Not all the sellers were insurance companies like AIG— most were not. But the protection buyer usually knew the protection seller. As it grew— according to the industry's trade group, the credit default market grew to $46 trillion by the first half of 2007 from $631 billion in 2000— all that changed.
The 'over-the-counter' market grew up and some of the most active players became asset managers, including hedge fund managers, [[mostly unknown to the insured: normxxx]] who bought and sold the policies like any other investment. And in those deals, they sold protection as often as they bought it. But rarely set aside the reserves they would need if the obligation ever had to be paid.
In one notorious case, a small hedge fund agreed to insure UBS AG (UBSN.VX), the Swiss banking giant, from losses related to defaults on $1.3 billion of subprime mortgages for an annual premium of about $2 million. The trouble was, the hedge fund set up a subsidiary to stand behind the guarantee— and capitalized it with just $4.6 million. As long as the loans performed, the fund made a killing, raking in an annualized return of nearly 44 percent.
But in the summer of 2007, as home owners began to default, things got ugly. UBS demanded the hedge fund put up additional collateral. The fund balked. UBS sued. The dispute is hardly unique. Both Wachovia Corp (WB.N) and Citigroup Inc (C.N) are involved in similar litigation with firms that promised to step up and act like insurers— but were not actually insurers. "Insurance companies have armies of actuaries and deep pools of policyholders and the financial wherewithal to pay claims," says Mike Barry, a spokesman at the Insurance Information Institute.
"Sloppy"
Another problem: As hedge funds and others bought and sold these protection policies, they did not always get prior written consent from the people they were supposed to be insuring. Patrick Parkinson, the deputy director of the Fed's research and statistic arm, calls the practice "sloppy." As a result, some protection buyers had trouble figuring out who was standing behind the insurance they bought. And it put investors into webs of relationships they did not understand.
"This is the derivative nightmare that everyone has been warning about," says Peter Schiff, the president of Euro Pacific Capital at the author of Crash Proof: How to Profit From the Coming Economic Collapse. "They booked all these derivatives assuming bad things would never happen. It was like writing fire insurance, assuming no one is ever going to have a fire, only now they're turning around and watching as the whole town burns down."
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By James B. Kelleher | 27 September 2008
CHICAGO (Reuters)— On Main Street, insurance protects people from the effects of catastrophes. But on Wall Street, specialized insurance known as a credit default swaps are turning a bad situation into a catastrophe. When historians write about the current crisis, much of the blame will go to the slump in the housing and mortgage markets, which triggered the losses, layoffs and liquidations sweeping the financial industry. But credit default swaps— complex derivatives originally designed to protect banks from deadbeat borrowers— are adding to the turmoil.
"This was supposedly a way to hedge risk," says Ellen Brown, the author of the book Web of Debt: The Shocking Truth About Our Money System and How We Can Break Free (Revised and Updated Paperback, 2008). "I'm sure their predictive models were right as far as the risk of the things they were insuring against. But what they didn't factor in was the risk that the sellers of this protection wouldn't pay ... That's what we're seeing now." Brown is hardly alone in her criticism of the derivatives. Five years ago, billionaire investor Warren Buffett called them a "time bomb" and "financial weapons of mass destruction" and directed the insurance arm of his Berkshire Hathaway Inc (BRKa.N) to exit the business.
Recent events suggest Buffett was right. The collapse of Bear Stearns. The fire sale of Merrill Lynch & Co Inc (MER.N). The meltdown at American International Group Inc (AIG.N). In each case, credit default swaps played a role in the fall of these financial giants. The latest victim is insurer AIG, which received an emergency $85 billion loan from the U.S. Federal Reserve late on Tuesday to stave off a bankruptcy.
Over the last three quarters, AIG suffered $18 billion of losses tied to guarantees it wrote on mortgage-linked derivatives. Its struggles intensified in recent weeks as losses in its own investments led to cuts in its credit ratings. Those cuts triggered clauses in the policies AIG had written that forced it to put up billions of dollars in extra collateral— billions it did not have and could not raise.
Easy Money
When the credit default market began back in the mid-1990s, the transactions were simpler, more transparent affairs. Not all the sellers were insurance companies like AIG— most were not. But the protection buyer usually knew the protection seller. As it grew— according to the industry's trade group, the credit default market grew to $46 trillion by the first half of 2007 from $631 billion in 2000— all that changed.
The 'over-the-counter' market grew up and some of the most active players became asset managers, including hedge fund managers, [[mostly unknown to the insured: normxxx]] who bought and sold the policies like any other investment. And in those deals, they sold protection as often as they bought it. But rarely set aside the reserves they would need if the obligation ever had to be paid.
In one notorious case, a small hedge fund agreed to insure UBS AG (UBSN.VX), the Swiss banking giant, from losses related to defaults on $1.3 billion of subprime mortgages for an annual premium of about $2 million. The trouble was, the hedge fund set up a subsidiary to stand behind the guarantee— and capitalized it with just $4.6 million. As long as the loans performed, the fund made a killing, raking in an annualized return of nearly 44 percent.
But in the summer of 2007, as home owners began to default, things got ugly. UBS demanded the hedge fund put up additional collateral. The fund balked. UBS sued. The dispute is hardly unique. Both Wachovia Corp (WB.N) and Citigroup Inc (C.N) are involved in similar litigation with firms that promised to step up and act like insurers— but were not actually insurers. "Insurance companies have armies of actuaries and deep pools of policyholders and the financial wherewithal to pay claims," says Mike Barry, a spokesman at the Insurance Information Institute.
"Sloppy"
Another problem: As hedge funds and others bought and sold these protection policies, they did not always get prior written consent from the people they were supposed to be insuring. Patrick Parkinson, the deputy director of the Fed's research and statistic arm, calls the practice "sloppy." As a result, some protection buyers had trouble figuring out who was standing behind the insurance they bought. And it put investors into webs of relationships they did not understand.
"This is the derivative nightmare that everyone has been warning about," says Peter Schiff, the president of Euro Pacific Capital at the author of Crash Proof: How to Profit From the Coming Economic Collapse. "They booked all these derivatives assuming bad things would never happen. It was like writing fire insurance, assuming no one is ever going to have a fire, only now they're turning around and watching as the whole town burns down."
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Credit Default Swaps Explained
Credit Default Swaps Explained
By Dirk Van Dijk, CFA | 27 September 2008
At this point, it makes sense to explain just what a credit default swap, or CDS, is. They were the key reason for the demise of AIG (AIG), and for the fear that if they were not bailed out that the whole ball of wax would come unglued. Essentially it is an insurance policy, but an unregulated one (the State of N.Y. just recently said that it would (belatedly) start to regulate part of the market— can you say closing the barn door?).
If you buy a bond from, say, General Motors (GM), you are lending them money for a set interest rate for a specified length of time. You face two sets of risks in doing so. The first is that they go bankrupt and don't pay you back. The second is that interest rates rise and the bond falls in value (think of bond prices and interest rates as being on opposite sides of a see-saw).
With a CDS, you could go out and find someone who will insure against the default risk. For a given premium, the seller of the CDS will pay off on the GM bond if GM goes belly up. Now, if it was from a real insurance company, the insurance company would be regulated and would have to hold enough money in reserve to pay you off in case GM actually did go belly up. This is just like a Life Insurance company has to have enough cash on had to pay off on your policy in case you die.
However, since this is an unregulated market, someone can sell you a CDS and blow the money in Las Vegas. In that case, if GM did go belly up, you would just plain be out of luck. In the case of life insurance, there are strict limits on who can take out a policy on you. You can take out a policy on your own life, and on close family members.
In some circumstances you can take out a policy on your business partner, but beyond that there are not many people you can take out a policy on. You have to have what is called an insurable interest; you can't just wander the halls of the hospital looking for people who are unlikely to make it and take out life insurance policies on them. This is not true for the CDS market.
You are perfectly free to take out a "life insurance policy" on GM, GE, or any other firm that issues a bond, and you do not have to be holding the bond. You could even take out a "life insurance policy" on the 'toxic' garbage that Wall Street has been pumping out. This ability to buy insurance on things that you have no insurable interest in transformed this market into a huge casino. It is totally unregulated, and even the new steps by the New York State Insurance Commissioner, Eric Dinnallo, only covers the least egregious part of the market, where people actually have an insurable interest (i.e. hold the underlying bond).
Regulation of this market was specifically prohibited under the Commodity Futures Modernization Act of 2001. That provision was slipped into the bill in the dead of night by our old friend Senator Phil Gramm of Texas— now Vice Chairman of UBS (UBS). People use this market to bet on the credit worthiness of companies, and often hedge funds will hold both long and short positions on the same underlying credit. (NOTE: figures are made up here, not a reflection of the actual creditworthiness of any real company.) For example, the hedge fund might make a bet that it is worthwhile to get $200,000 up front and be on the hook for $10 million if GXX defaults sometime in the next five years.
Then after a few months, GXX raises a bunch of capital which significantly strengthens its balance sheet and lowers the risk of default, so it can make a bet with someone else who would now be willing to take just $100,000 to bet that GXX will not go belly up within then next five years. The hedge fund could have a perfectly matched book, so in theory they were totally indifferent if GXX survives or not. However, suppose that the person who they made the bet with goes bankrupt themselves and can't pay up. That hedge fund might then have a hard time paying its counter party. This is where the fear of "cascading cross defaults" comes in.
All this is to say that the CDS market has seen more growth than practically any market in the history of mankind. It is currently at over $62 TRILLION, up from under $1 Trillion a decade ago. It would not take a very big percentage of that market to fail to leave a very big mark on the world financial system. When the dust settles from all the current mess, bringing this market under control has to be high on the agenda.
I would suggest that the contracts be standardized and that they be traded on an exchange, where the exchange itself acts as the counter-party for each trade (this is how the commodity exchanges work). It might also make sense to require that any party buying a CDS have an insurable interest in the underlying bond (i.e. that they are using it to hedge, not speculate).
This however, is work for the next Congress and Administration. First, we have to put out the fire with a well crafted and responsible bailout bill to prevent these cascading cross defaults from occurring. The original Paulson proposal was not well crafted, yet Congress doesn't appear likely to make significant improvements to the bill.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Dirk Van Dijk, CFA | 27 September 2008
At this point, it makes sense to explain just what a credit default swap, or CDS, is. They were the key reason for the demise of AIG (AIG), and for the fear that if they were not bailed out that the whole ball of wax would come unglued. Essentially it is an insurance policy, but an unregulated one (the State of N.Y. just recently said that it would (belatedly) start to regulate part of the market— can you say closing the barn door?).
If you buy a bond from, say, General Motors (GM), you are lending them money for a set interest rate for a specified length of time. You face two sets of risks in doing so. The first is that they go bankrupt and don't pay you back. The second is that interest rates rise and the bond falls in value (think of bond prices and interest rates as being on opposite sides of a see-saw).
With a CDS, you could go out and find someone who will insure against the default risk. For a given premium, the seller of the CDS will pay off on the GM bond if GM goes belly up. Now, if it was from a real insurance company, the insurance company would be regulated and would have to hold enough money in reserve to pay you off in case GM actually did go belly up. This is just like a Life Insurance company has to have enough cash on had to pay off on your policy in case you die.
However, since this is an unregulated market, someone can sell you a CDS and blow the money in Las Vegas. In that case, if GM did go belly up, you would just plain be out of luck. In the case of life insurance, there are strict limits on who can take out a policy on you. You can take out a policy on your own life, and on close family members.
In some circumstances you can take out a policy on your business partner, but beyond that there are not many people you can take out a policy on. You have to have what is called an insurable interest; you can't just wander the halls of the hospital looking for people who are unlikely to make it and take out life insurance policies on them. This is not true for the CDS market.
You are perfectly free to take out a "life insurance policy" on GM, GE, or any other firm that issues a bond, and you do not have to be holding the bond. You could even take out a "life insurance policy" on the 'toxic' garbage that Wall Street has been pumping out. This ability to buy insurance on things that you have no insurable interest in transformed this market into a huge casino. It is totally unregulated, and even the new steps by the New York State Insurance Commissioner, Eric Dinnallo, only covers the least egregious part of the market, where people actually have an insurable interest (i.e. hold the underlying bond).
Regulation of this market was specifically prohibited under the Commodity Futures Modernization Act of 2001. That provision was slipped into the bill in the dead of night by our old friend Senator Phil Gramm of Texas— now Vice Chairman of UBS (UBS). People use this market to bet on the credit worthiness of companies, and often hedge funds will hold both long and short positions on the same underlying credit. (NOTE: figures are made up here, not a reflection of the actual creditworthiness of any real company.) For example, the hedge fund might make a bet that it is worthwhile to get $200,000 up front and be on the hook for $10 million if GXX defaults sometime in the next five years.
Then after a few months, GXX raises a bunch of capital which significantly strengthens its balance sheet and lowers the risk of default, so it can make a bet with someone else who would now be willing to take just $100,000 to bet that GXX will not go belly up within then next five years. The hedge fund could have a perfectly matched book, so in theory they were totally indifferent if GXX survives or not. However, suppose that the person who they made the bet with goes bankrupt themselves and can't pay up. That hedge fund might then have a hard time paying its counter party. This is where the fear of "cascading cross defaults" comes in.
All this is to say that the CDS market has seen more growth than practically any market in the history of mankind. It is currently at over $62 TRILLION, up from under $1 Trillion a decade ago. It would not take a very big percentage of that market to fail to leave a very big mark on the world financial system. When the dust settles from all the current mess, bringing this market under control has to be high on the agenda.
I would suggest that the contracts be standardized and that they be traded on an exchange, where the exchange itself acts as the counter-party for each trade (this is how the commodity exchanges work). It might also make sense to require that any party buying a CDS have an insurable interest in the underlying bond (i.e. that they are using it to hedge, not speculate).
This however, is work for the next Congress and Administration. First, we have to put out the fire with a well crafted and responsible bailout bill to prevent these cascading cross defaults from occurring. The original Paulson proposal was not well crafted, yet Congress doesn't appear likely to make significant improvements to the bill.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Japanese Go Bargain-Hunting
Japanese Go Bargain-Hunting On Wall Street
By Blaine Harden | 24 September 2008
TOKYO, Sept. 24— Major Japanese banks and investment houses, fat with cash and apparently largely free of toxic investments, are spotting opportunity in the global financial mess and snapping up substantial holdings on Wall Street. With U.S. financial institutions still desperate for capital, analysts here say more major purchases are likely in coming days and weeks as the financial crisis churns on. Nomura Holdings, Japan's largest brokerage house, announced Tuesday it would buy for an undisclosed sum the 2,500-person European and Middle Eastern operation of the failed Lehman Brothers investment bank— one day after it had picked up Lehman's Asia-Pacific franchise, employer of about 3,000 people, for $190 million. Lehman filed for bankruptcy protection last week.
This is a once-in-a-generation opportunity, Kenichi Watanabe, chief executive of Nomura, said in a statement. He added that "our ability to capitalize on this opportunity in spite of such volatile markets reflects our financial strength." Although Nomura has lost money in the past two quarters, it had assets of about $263 billion as of March 31, making the purchases relatively small.
Japan's largest bank, Mitsubishi UFJ spent about $10 billion in August to buy the remaining shares of California's second-largest bank, UnionBanCal. Meanwhile, Sumitomo Mitsui Financial Group, Japan's third-largest bank, is planning a possible investment in Goldman Sachs, the Kyodo news agency reported Wednesday, citing unnamed sources. Japan's chance to buy up investment talent that its banks and brokerage firms have long coveted is, in part, a function of turmoil on Wall Street, where investment firms are desperate to cover bad wagers on subprime mortgages and other failed speculation.
It is also the culmination of the slow, stolid recovery of banks and other financial institutions from Japan's market meltdown in the 1990s. "We didn't take part in the good growth of the worldwide economy in the 1990s and now we are not getting hit by the downward trend," said Oki Matsumoto, chief executive officer of Monex Group, one of Japan's largest online brokers. "Japan has huge reserves of capital. We are much safer than any other country."
Banks and brokerage houses here spent nearly two decades rebuilding, selling off bad debt and devouring each other in mergers. These mergers, as several weaker banks were digested by stronger rivals, account for the alphabet-soup names of banks like Mitsubishi UFJ. Banks here have also changed their credit culture. Before they lent money on the basis of assets, much as U.S. lenders still do. Now, many banks here analyze the cash flow of their clients before they extend large amounts of credit.
"They spent the last 18 years going to hell and then coming back," said Ken Courtis, former vice chairman of Goldman Sachs in East Asia. "It is now the U.S. banks and investment firms that are on the hellish road toward the bottom." As Japanese banks recovered over the past five years, their cash reserves grew at an astonishing rate, owing to the peculiarities of this country's investing culture and its continuing economic problems.
There are about $15 trillion in personal financial assets in Japan, about $8 trillion of which are on deposit in banks. Banks are stuffed with money from an aging population whose consumer spending has been declining for years. Supermarket and department store sales have declined for 11 consecutive years, while sales of new cars of all brands peaked 18 years ago and have been falling ever since.
In the past two years, millions of elderly Japanese have grown alarmed about the security of their government pensions. The government announced early last year that more than 50 million pension records had been misfiled. The problem has not yet been sorted out, and it has led to people stuffing even more savings into banks.
As important to the capacity of banks here to accumulate capital: The cost of keeping someone's money in Japan is close to zero. Most depositors receive less than 1 percent interest on their savings. The central bank in Japan keeps interest rates extraordinarily low (0.5 percent for overnight loans to banks).
In large measure, low interest rates are a function of the country's huge public debt burden. At 182 percent of the Japan's gross domestic product, it is the most onerous in the world. The government acquired much of this debt in the 1990s, when it bailed out troubled banks. If interest rates were allowed to rise substantially, Japan's ability to service this debt could be threatened.
Finally, cash-flush banks in Japan have few local opportunities for profit. The economy is contracting and a recession is likely. Export-dependent companies such as Toyota report flat or declining worldwide sales, and foreign direct investment in Japan is by far the lowest among the world's major economies.
As Watanabe, the president of Nomura, made clear Monday: Opportunities are mostly elsewhere. "It will significantly extend our reach in Asia," he said, referring to the purchase of Lehman's regional operation. We see immediate strategic benefits, delivering the scale and scope to realize our vision to be a world-class investment bank.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Blaine Harden | 24 September 2008
TOKYO, Sept. 24— Major Japanese banks and investment houses, fat with cash and apparently largely free of toxic investments, are spotting opportunity in the global financial mess and snapping up substantial holdings on Wall Street. With U.S. financial institutions still desperate for capital, analysts here say more major purchases are likely in coming days and weeks as the financial crisis churns on. Nomura Holdings, Japan's largest brokerage house, announced Tuesday it would buy for an undisclosed sum the 2,500-person European and Middle Eastern operation of the failed Lehman Brothers investment bank— one day after it had picked up Lehman's Asia-Pacific franchise, employer of about 3,000 people, for $190 million. Lehman filed for bankruptcy protection last week.
This is a once-in-a-generation opportunity, Kenichi Watanabe, chief executive of Nomura, said in a statement. He added that "our ability to capitalize on this opportunity in spite of such volatile markets reflects our financial strength." Although Nomura has lost money in the past two quarters, it had assets of about $263 billion as of March 31, making the purchases relatively small.
Japan's largest bank, Mitsubishi UFJ spent about $10 billion in August to buy the remaining shares of California's second-largest bank, UnionBanCal. Meanwhile, Sumitomo Mitsui Financial Group, Japan's third-largest bank, is planning a possible investment in Goldman Sachs, the Kyodo news agency reported Wednesday, citing unnamed sources. Japan's chance to buy up investment talent that its banks and brokerage firms have long coveted is, in part, a function of turmoil on Wall Street, where investment firms are desperate to cover bad wagers on subprime mortgages and other failed speculation.
It is also the culmination of the slow, stolid recovery of banks and other financial institutions from Japan's market meltdown in the 1990s. "We didn't take part in the good growth of the worldwide economy in the 1990s and now we are not getting hit by the downward trend," said Oki Matsumoto, chief executive officer of Monex Group, one of Japan's largest online brokers. "Japan has huge reserves of capital. We are much safer than any other country."
Banks and brokerage houses here spent nearly two decades rebuilding, selling off bad debt and devouring each other in mergers. These mergers, as several weaker banks were digested by stronger rivals, account for the alphabet-soup names of banks like Mitsubishi UFJ. Banks here have also changed their credit culture. Before they lent money on the basis of assets, much as U.S. lenders still do. Now, many banks here analyze the cash flow of their clients before they extend large amounts of credit.
"They spent the last 18 years going to hell and then coming back," said Ken Courtis, former vice chairman of Goldman Sachs in East Asia. "It is now the U.S. banks and investment firms that are on the hellish road toward the bottom." As Japanese banks recovered over the past five years, their cash reserves grew at an astonishing rate, owing to the peculiarities of this country's investing culture and its continuing economic problems.
There are about $15 trillion in personal financial assets in Japan, about $8 trillion of which are on deposit in banks. Banks are stuffed with money from an aging population whose consumer spending has been declining for years. Supermarket and department store sales have declined for 11 consecutive years, while sales of new cars of all brands peaked 18 years ago and have been falling ever since.
In the past two years, millions of elderly Japanese have grown alarmed about the security of their government pensions. The government announced early last year that more than 50 million pension records had been misfiled. The problem has not yet been sorted out, and it has led to people stuffing even more savings into banks.
As important to the capacity of banks here to accumulate capital: The cost of keeping someone's money in Japan is close to zero. Most depositors receive less than 1 percent interest on their savings. The central bank in Japan keeps interest rates extraordinarily low (0.5 percent for overnight loans to banks).
In large measure, low interest rates are a function of the country's huge public debt burden. At 182 percent of the Japan's gross domestic product, it is the most onerous in the world. The government acquired much of this debt in the 1990s, when it bailed out troubled banks. If interest rates were allowed to rise substantially, Japan's ability to service this debt could be threatened.
Finally, cash-flush banks in Japan have few local opportunities for profit. The economy is contracting and a recession is likely. Export-dependent companies such as Toyota report flat or declining worldwide sales, and foreign direct investment in Japan is by far the lowest among the world's major economies.
As Watanabe, the president of Nomura, made clear Monday: Opportunities are mostly elsewhere. "It will significantly extend our reach in Asia," he said, referring to the purchase of Lehman's regional operation. We see immediate strategic benefits, delivering the scale and scope to realize our vision to be a world-class investment bank.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Japanese Go Bargain-Hunting
Japanese Go Bargain-Hunting On Wall Street
By Blaine Harden | 24 September 2008
TOKYO, Sept. 24— Major Japanese banks and investment houses, fat with cash and apparently largely free of toxic investments, are spotting opportunity in the global financial mess and snapping up substantial holdings on Wall Street. With U.S. financial institutions still desperate for capital, analysts here say more major purchases are likely in coming days and weeks as the financial crisis churns on. Nomura Holdings, Japan's largest brokerage house, announced Tuesday it would buy for an undisclosed sum the 2,500-person European and Middle Eastern operation of the failed Lehman Brothers investment bank— one day after it had picked up Lehman's Asia-Pacific franchise, employer of about 3,000 people, for $190 million. Lehman filed for bankruptcy protection last week.
"This is a once-in-a-generation opportunity," Kenichi Watanabe, chief executive of Nomura, said in a statement. He added that "our ability to capitalize on this opportunity in spite of such volatile markets reflects our financial strength." Although Nomura has lost money in the past two quarters, it had assets of about $263 billion as of March 31, making the purchases relatively small.
Japan's largest bank, Mitsubishi UFJ spent about $10 billion in August to buy the remaining shares of California's second-largest bank, UnionBanCal. Meanwhile, Sumitomo Mitsui Financial Group, Japan's third-largest bank, is planning a possible investment in Goldman Sachs, the Kyodo news agency reported Wednesday, citing unnamed sources. Japan's chance to buy up investment talent that its banks and brokerage firms have long coveted is, in part, a function of turmoil on Wall Street, where investment firms are desperate to cover bad wagers on subprime mortgages and other failed speculation.
It is also the culmination of the slow, stolid recovery of banks and other financial institutions from Japan's market meltdown in the 1990s. "We didn't take part in the good growth of the worldwide economy in the 1990s and now we are not getting hit by the downward trend," said Oki Matsumoto, chief executive officer of Monex Group, one of Japan's largest online brokers. "Japan has huge reserves of capital. We are much safer than any other country."
Banks and brokerage houses here spent nearly two decades rebuilding, selling off bad debt and devouring each other in mergers. These mergers, as several weaker banks were digested by stronger rivals, account for the alphabet-soup names of banks like Mitsubishi UFJ. Banks here have also changed their credit culture. Before they lent money on the basis of assets, much as U.S. lenders still do. Now, many banks here analyze the cash flow of their clients before they extend large amounts of credit.
"They spent the last 18 years going to hell and then coming back," said Ken Courtis, former vice chairman of Goldman Sachs in East Asia. "It is now the U.S. banks and investment firms that are on the hellish road toward the bottom." As Japanese banks recovered over the past five years, their cash reserves grew at an astonishing rate, owing to the peculiarities of this country's investing culture and its continuing economic problems.
There are about $15 trillion in personal financial assets in Japan, about $8 trillion of which are on deposit in banks. Banks are stuffed with money from an aging population whose consumer spending has been declining for years. Supermarket and department store sales have declined for 11 consecutive years, while sales of new cars of all brands peaked 18 years ago and have been falling ever since.
In the past two years, millions of elderly Japanese have grown alarmed about the security of their government pensions. The government announced early last year that more than 50 million pension records had been misfiled. The problem has not yet been sorted out, and it has led to people stuffing even more savings into banks.
As important to the capacity of banks here to accumulate capital: The cost of keeping someone's money in Japan is close to zero. Most depositors receive less than 1 percent interest on their savings. The central bank in Japan keeps interest rates extraordinarily low (0.5 percent for overnight loans to banks).
In large measure, low interest rates are a function of the country's huge public debt burden. At 182 percent of the Japan's gross domestic product, it is the most onerous in the world. The government acquired much of this debt in the 1990s, when it bailed out troubled banks. If interest rates were allowed to rise substantially, Japan's ability to service this debt could be threatened.
Finally, cash-flush banks in Japan have few local opportunities for profit. The economy is contracting and a recession is likely. Export-dependent companies such as Toyota report flat or declining worldwide sales, and foreign direct investment in Japan is by far the lowest among the world's major economies.
As Watanabe, the president of Nomura, made clear Monday: Opportunities are mostly elsewhere. "It will significantly extend our reach in Asia," he said, referring to the purchase of Lehman's regional operation. "We see immediate strategic benefits, delivering the scale and scope to realize our vision to be a world-class investment bank."
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Blaine Harden | 24 September 2008
TOKYO, Sept. 24— Major Japanese banks and investment houses, fat with cash and apparently largely free of toxic investments, are spotting opportunity in the global financial mess and snapping up substantial holdings on Wall Street. With U.S. financial institutions still desperate for capital, analysts here say more major purchases are likely in coming days and weeks as the financial crisis churns on. Nomura Holdings, Japan's largest brokerage house, announced Tuesday it would buy for an undisclosed sum the 2,500-person European and Middle Eastern operation of the failed Lehman Brothers investment bank— one day after it had picked up Lehman's Asia-Pacific franchise, employer of about 3,000 people, for $190 million. Lehman filed for bankruptcy protection last week.
"This is a once-in-a-generation opportunity," Kenichi Watanabe, chief executive of Nomura, said in a statement. He added that "our ability to capitalize on this opportunity in spite of such volatile markets reflects our financial strength." Although Nomura has lost money in the past two quarters, it had assets of about $263 billion as of March 31, making the purchases relatively small.
Japan's largest bank, Mitsubishi UFJ spent about $10 billion in August to buy the remaining shares of California's second-largest bank, UnionBanCal. Meanwhile, Sumitomo Mitsui Financial Group, Japan's third-largest bank, is planning a possible investment in Goldman Sachs, the Kyodo news agency reported Wednesday, citing unnamed sources. Japan's chance to buy up investment talent that its banks and brokerage firms have long coveted is, in part, a function of turmoil on Wall Street, where investment firms are desperate to cover bad wagers on subprime mortgages and other failed speculation.
It is also the culmination of the slow, stolid recovery of banks and other financial institutions from Japan's market meltdown in the 1990s. "We didn't take part in the good growth of the worldwide economy in the 1990s and now we are not getting hit by the downward trend," said Oki Matsumoto, chief executive officer of Monex Group, one of Japan's largest online brokers. "Japan has huge reserves of capital. We are much safer than any other country."
Banks and brokerage houses here spent nearly two decades rebuilding, selling off bad debt and devouring each other in mergers. These mergers, as several weaker banks were digested by stronger rivals, account for the alphabet-soup names of banks like Mitsubishi UFJ. Banks here have also changed their credit culture. Before they lent money on the basis of assets, much as U.S. lenders still do. Now, many banks here analyze the cash flow of their clients before they extend large amounts of credit.
"They spent the last 18 years going to hell and then coming back," said Ken Courtis, former vice chairman of Goldman Sachs in East Asia. "It is now the U.S. banks and investment firms that are on the hellish road toward the bottom." As Japanese banks recovered over the past five years, their cash reserves grew at an astonishing rate, owing to the peculiarities of this country's investing culture and its continuing economic problems.
There are about $15 trillion in personal financial assets in Japan, about $8 trillion of which are on deposit in banks. Banks are stuffed with money from an aging population whose consumer spending has been declining for years. Supermarket and department store sales have declined for 11 consecutive years, while sales of new cars of all brands peaked 18 years ago and have been falling ever since.
In the past two years, millions of elderly Japanese have grown alarmed about the security of their government pensions. The government announced early last year that more than 50 million pension records had been misfiled. The problem has not yet been sorted out, and it has led to people stuffing even more savings into banks.
As important to the capacity of banks here to accumulate capital: The cost of keeping someone's money in Japan is close to zero. Most depositors receive less than 1 percent interest on their savings. The central bank in Japan keeps interest rates extraordinarily low (0.5 percent for overnight loans to banks).
In large measure, low interest rates are a function of the country's huge public debt burden. At 182 percent of the Japan's gross domestic product, it is the most onerous in the world. The government acquired much of this debt in the 1990s, when it bailed out troubled banks. If interest rates were allowed to rise substantially, Japan's ability to service this debt could be threatened.
Finally, cash-flush banks in Japan have few local opportunities for profit. The economy is contracting and a recession is likely. Export-dependent companies such as Toyota report flat or declining worldwide sales, and foreign direct investment in Japan is by far the lowest among the world's major economies.
As Watanabe, the president of Nomura, made clear Monday: Opportunities are mostly elsewhere. "It will significantly extend our reach in Asia," he said, referring to the purchase of Lehman's regional operation. "We see immediate strategic benefits, delivering the scale and scope to realize our vision to be a world-class investment bank."
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Wednesday, September 24, 2008
500 Trades From A Meltdown
Almost Armageddon: Markets Were 500 Trades From A Meltdown
By Michael Gray | 24 September 2008
Click Here, or on the image, to see a larger, undistorted image.
The market was 500 trades away from Armageddon on Thursday, traders inside two large custodial banks tell The Post. Had the Treasury and Fed not quickly stepped into the fray that morning with a quick $105 billion injection of liquidity, the Dow could have collapsed to the 8,300-level— a 22 percent decline!— while the clang of the opening bell was still echoing around the cavernous exchange floor. According to traders, who spoke on the condition of anonymity, money market funds were inundated with $500 billion in sell orders prior to the opening. The total money-market capitalization was roughly $4 trillion that morning.
The panicked selling was directly linked to the seizing up of the credit markets— including a $52 billion constriction in commercial paper— and the rumors of additional money market funds "breaking the buck," or dropping below $1 net asset value. The Fed's dramatic $105 billion liquidity injection on Thursday (pre-market) was just enough to keep key institutional accounts from following through on the sell orders and starting a stampede of cash that could have brought large tracts of the US economy to a halt.
While many depositors treat money market accounts as fancy savings accounts, they are different. Banks buy a variety of short-term debt, including commercial paper, with the assets. It is an important distinction because banks use the $1.7 trillion commercial-paper market to fund their credit card operations and car finance companies use it to move autos. Without commercial paper, "factories would have to shut down, people would lose their jobs and there would be an effect on the real economy," Paul Schott Stevens, of the Investment Company Institute, told the Wall Street Journal.
Cracks started to show in money market accounts late Tuesday when shares in one fund, the Reserve Primary Fund— which touted itself as super safe— fell below the golden $1 a share level. It had purchased what it thought was safe Lehman bonds, never dreaming they could default— which they did 24 hours earlier when the 158-year-old investment bank filed Chapter 11. By Wednesday, banks sensed a run on their accounts. They started stockpiling cash in anticipation of withdrawals.
Banks, which usually keep an average of $2 billion in excess reserves earmarked for withdrawals, pumped that up to an astounding $90 billion by Wednesday, Lou Crandall, chief economist at Wrighton ICAP, told The Journal. And for good reason. By the close of business on Wednesday, $144.5 billion— a record— had been withdrawn. How much money was taken out of money market funds the prior week? Roughly $7.1 billion, according to AMG Data Services.
By Thursday, that level, fed by the incredible volume of sell orders pouring in from institutional investors like pension funds and sovereign funds, had grown to $100 billion. It was still not enough to stem the tidal wave. The banks knew something drastic had to be done. So did Paulson. The injection of capital into the market was followed up by calls from Treasury Secretary Hank Paulson to major money market players like Bank of New York Mellon and State Street in Boston informing them that federal money was in the market and they should tell their clients the Feds would be back with a plan to stem the constriction in the credit market.
Paulson knew the $105 billion injection was not a real solution. A broader, more radical answer was needed. Hours after Paulson made his round of calls to calm the industry, word leaked out that an added $1 trillion bailout of banks was being readied. Investors cheered. At about 3 p.m., news of the plans was filtering up and down Wall Street, fueling a 700-point advance in the Dow Jones industrial average through 4 p.m. Friday. By that time, Paulson had announced the plan. It included insurance on money market accounts, a move that started in quiet Thursday morning, when the former Goldman Sachs executive saved the country from a paralyzing meltdown.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Michael Gray | 24 September 2008
Click Here, or on the image, to see a larger, undistorted image.
The market was 500 trades away from Armageddon on Thursday, traders inside two large custodial banks tell The Post. Had the Treasury and Fed not quickly stepped into the fray that morning with a quick $105 billion injection of liquidity, the Dow could have collapsed to the 8,300-level— a 22 percent decline!— while the clang of the opening bell was still echoing around the cavernous exchange floor. According to traders, who spoke on the condition of anonymity, money market funds were inundated with $500 billion in sell orders prior to the opening. The total money-market capitalization was roughly $4 trillion that morning.
The panicked selling was directly linked to the seizing up of the credit markets— including a $52 billion constriction in commercial paper— and the rumors of additional money market funds "breaking the buck," or dropping below $1 net asset value. The Fed's dramatic $105 billion liquidity injection on Thursday (pre-market) was just enough to keep key institutional accounts from following through on the sell orders and starting a stampede of cash that could have brought large tracts of the US economy to a halt.
While many depositors treat money market accounts as fancy savings accounts, they are different. Banks buy a variety of short-term debt, including commercial paper, with the assets. It is an important distinction because banks use the $1.7 trillion commercial-paper market to fund their credit card operations and car finance companies use it to move autos. Without commercial paper, "factories would have to shut down, people would lose their jobs and there would be an effect on the real economy," Paul Schott Stevens, of the Investment Company Institute, told the Wall Street Journal.
Cracks started to show in money market accounts late Tuesday when shares in one fund, the Reserve Primary Fund— which touted itself as super safe— fell below the golden $1 a share level. It had purchased what it thought was safe Lehman bonds, never dreaming they could default— which they did 24 hours earlier when the 158-year-old investment bank filed Chapter 11. By Wednesday, banks sensed a run on their accounts. They started stockpiling cash in anticipation of withdrawals.
Banks, which usually keep an average of $2 billion in excess reserves earmarked for withdrawals, pumped that up to an astounding $90 billion by Wednesday, Lou Crandall, chief economist at Wrighton ICAP, told The Journal. And for good reason. By the close of business on Wednesday, $144.5 billion— a record— had been withdrawn. How much money was taken out of money market funds the prior week? Roughly $7.1 billion, according to AMG Data Services.
By Thursday, that level, fed by the incredible volume of sell orders pouring in from institutional investors like pension funds and sovereign funds, had grown to $100 billion. It was still not enough to stem the tidal wave. The banks knew something drastic had to be done. So did Paulson. The injection of capital into the market was followed up by calls from Treasury Secretary Hank Paulson to major money market players like Bank of New York Mellon and State Street in Boston informing them that federal money was in the market and they should tell their clients the Feds would be back with a plan to stem the constriction in the credit market.
Paulson knew the $105 billion injection was not a real solution. A broader, more radical answer was needed. Hours after Paulson made his round of calls to calm the industry, word leaked out that an added $1 trillion bailout of banks was being readied. Investors cheered. At about 3 p.m., news of the plans was filtering up and down Wall Street, fueling a 700-point advance in the Dow Jones industrial average through 4 p.m. Friday. By that time, Paulson had announced the plan. It included insurance on money market accounts, a move that started in quiet Thursday morning, when the former Goldman Sachs executive saved the country from a paralyzing meltdown.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Let HP & BB Buy Some Of This Crap!
Let Paulson And Bernanke Buy Some Of This Crap
By Brady Willett, Fallstreet.com | 24 September 2008
The Treasury Secretary Paulson and Fed Chairman Bernanke bailout plan calls for $700 billion in taxpayer funds to be used to purchase assets that will in all likelihood be worth considerably less in the future. As for the contention that the assets to be purchased could be worth more in the future than prices paid today, if there was any validity to this speculation the bailout plan in question would not be required as the assets in question would have already found more than one ready buyer.
Before continuing the above point needs to be stressed. To be sure, there are willing and able distressed assets investors roaming the markets (i.e. Buffett took a position in Goldman yesterday). However, what these investors have concluded is that a lot of mortgage based securities are toxic in that they can not be accurately priced by any conceivable buy-and-hold model and/or that they are still being too richly valued by their owners.
Even to suggest that the Treasury is going to be able to employ someone able to successfully accomplish what many well healed foreign and domestic distressed interests have not— is shameful. In other words, the bailout plan, at best, is an attempt to make a market based upon the grand speculation that such an action will 'unfreeze' markets and not prove overly detrimental to the taxpayer. [[With all of the miscreants magically 'cleansed' and 'born again', and ready to start in all over again.: normxxx]]
With that out of the way, the sad truth is that Paulson and Bernanke have come to the crossroads of common sense. They both know that the free market alternative, while preferable, would see many more massive blow-ups in the future than we have already had and that following their current policies of 'selective' rescues would simply compel the need for still more bailouts [[as the dominoes fall… : normxxx]]. So, rather than further disgrace the sanctity of 'free market idealism' and watch investor confidence crumble with the day-by-day, largely ad hoc bailout proceedings, they instead opted for the Mother Of All Bailouts. In this regard, they are trying to act à la Greenspan, or in a ‘preemptive’ manner.
"I have never been a proponent of intervention… There is no way to stabilize the markets and deal with [this] situation other than through government intervention." Paulson.
But while the preemptive action plan is understandable and perhaps even necessary, temporarily, to restore functionality in the financial mess that is the U.S. markets, that Bernanke and Paulson took turns trying to spin the bailout in an optimistic light yesterday is ridiculous. The $700 billion bailout is a desperate plan that could fail miserably, permanently damage the U.S.’s financial standing, and leave the U.S. taxpayer holding the bag. The way Paulson and Bernanke talk you would think that taxpayers should be lining up to donate more than $700 billion.
When Life Hands You Lemons Try To Make Lemonade
When asked by Sen. Jon Tester yesterday if the $700 billion bailout ‘could potentially affect the credit rating of the U.S. Treasury’, Paulson avoided the question, adding that the $700 billion wasn’t necessarily an expenditure. Astonishingly, Mr. Paulson also said "This is all about the American taxpayer. That is all we care about…" Buying junk with taxpayer dollars shows that you care about taxpayers? Setting an artificial price for toxic assets is not expenditure?
"This is not expenditure." Paulson.
"This is not expenditure." Bernanke.
The initial Paulson/Bernanke bailout plan was all of three pages long and was franticly cooked-up as the markets were collapsing. It reads like it was put together by a bunch of tyrannical toddlers playing with crayons. Are we really to believe given the circumstances that this plan represents an opportunity and not an expenditure for U.S. taxpayers?
"This is not an expenditure of $700 billion. This is a purchase of assets, and if auctions are done properly, evaluations are done properly, the American taxpayer will get a good value for his or her money." Bernanke.
Good value? Well Mr. Bernanke, if buying the garbage stinking up the American financial system is such an opportunity why don’t you partake in this adventure with some of your own capital? (I am quite sure the public would not mind if a few 'Chinese walls' were broken down to allow Hank and Ben to invest some of their own funds in this scheme.) Why not call the new plan ‘Opportunity USA’, get the 'best minds' in the industry to run the entity, and entice Greenspan, Bush, Gross, and other proponents of the plan to invest some of their own funds. After all, under such a scenario it is not inconceivable that taxpayers dollars would start voluntarily rolling in to also invest.
But alas, the chain of events to create ‘Opportunity USA’ is exactly how the free market works, and the free market has already spoken and told us that the crap to be so graciously purchased by the U.S. taxpayer is indeed— CRAP.
Unable To Make Lemonade? Try To Hike Up The Price of Lemons.
By Bernanke and Paulson’s own admission the plan in question would 'not be successful' if assets were purchased at ‘fire-sale’ prices. [[Indeed, there must be enough there to 'pay off' those erstwhile 'captains of industry' and their 'golden parachutes'!: normxxx]] I am sure that taxpayers (the investor’s fronting this endeavor) would think much differently. Which brings us to the crux of the situation: you can not protect the financial system and the taxpayer at the same time. You focus on one— in this case the ‘system’— at the expense of the other.
"Just as when you sell a painting at Sotheby’s, nobody knows what its worth until the auction is over. Then people know what its worth. I think the same thing here…" Bernanke.
Some of the securities auctions this year have been canceled, others have been devoid of buyers, and still others generated bids for pennies on the dollar. But pay no attention to these other auctions, because apparently it takes Bernanke, Paulson, and $700 billion to tell us what many securities are really worth.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Brady Willett, Fallstreet.com | 24 September 2008
The Treasury Secretary Paulson and Fed Chairman Bernanke bailout plan calls for $700 billion in taxpayer funds to be used to purchase assets that will in all likelihood be worth considerably less in the future. As for the contention that the assets to be purchased could be worth more in the future than prices paid today, if there was any validity to this speculation the bailout plan in question would not be required as the assets in question would have already found more than one ready buyer.
Before continuing the above point needs to be stressed. To be sure, there are willing and able distressed assets investors roaming the markets (i.e. Buffett took a position in Goldman yesterday). However, what these investors have concluded is that a lot of mortgage based securities are toxic in that they can not be accurately priced by any conceivable buy-and-hold model and/or that they are still being too richly valued by their owners.
Even to suggest that the Treasury is going to be able to employ someone able to successfully accomplish what many well healed foreign and domestic distressed interests have not— is shameful. In other words, the bailout plan, at best, is an attempt to make a market based upon the grand speculation that such an action will 'unfreeze' markets and not prove overly detrimental to the taxpayer. [[With all of the miscreants magically 'cleansed' and 'born again', and ready to start in all over again.: normxxx]]
With that out of the way, the sad truth is that Paulson and Bernanke have come to the crossroads of common sense. They both know that the free market alternative, while preferable, would see many more massive blow-ups in the future than we have already had and that following their current policies of 'selective' rescues would simply compel the need for still more bailouts [[as the dominoes fall… : normxxx]]. So, rather than further disgrace the sanctity of 'free market idealism' and watch investor confidence crumble with the day-by-day, largely ad hoc bailout proceedings, they instead opted for the Mother Of All Bailouts. In this regard, they are trying to act à la Greenspan, or in a ‘preemptive’ manner.
"I have never been a proponent of intervention… There is no way to stabilize the markets and deal with [this] situation other than through government intervention." Paulson.
But while the preemptive action plan is understandable and perhaps even necessary, temporarily, to restore functionality in the financial mess that is the U.S. markets, that Bernanke and Paulson took turns trying to spin the bailout in an optimistic light yesterday is ridiculous. The $700 billion bailout is a desperate plan that could fail miserably, permanently damage the U.S.’s financial standing, and leave the U.S. taxpayer holding the bag. The way Paulson and Bernanke talk you would think that taxpayers should be lining up to donate more than $700 billion.
When Life Hands You Lemons Try To Make Lemonade
When asked by Sen. Jon Tester yesterday if the $700 billion bailout ‘could potentially affect the credit rating of the U.S. Treasury’, Paulson avoided the question, adding that the $700 billion wasn’t necessarily an expenditure. Astonishingly, Mr. Paulson also said "This is all about the American taxpayer. That is all we care about…" Buying junk with taxpayer dollars shows that you care about taxpayers? Setting an artificial price for toxic assets is not expenditure?
"This is not expenditure." Paulson.
"This is not expenditure." Bernanke.
The initial Paulson/Bernanke bailout plan was all of three pages long and was franticly cooked-up as the markets were collapsing. It reads like it was put together by a bunch of tyrannical toddlers playing with crayons. Are we really to believe given the circumstances that this plan represents an opportunity and not an expenditure for U.S. taxpayers?
"This is not an expenditure of $700 billion. This is a purchase of assets, and if auctions are done properly, evaluations are done properly, the American taxpayer will get a good value for his or her money." Bernanke.
Good value? Well Mr. Bernanke, if buying the garbage stinking up the American financial system is such an opportunity why don’t you partake in this adventure with some of your own capital? (I am quite sure the public would not mind if a few 'Chinese walls' were broken down to allow Hank and Ben to invest some of their own funds in this scheme.) Why not call the new plan ‘Opportunity USA’, get the 'best minds' in the industry to run the entity, and entice Greenspan, Bush, Gross, and other proponents of the plan to invest some of their own funds. After all, under such a scenario it is not inconceivable that taxpayers dollars would start voluntarily rolling in to also invest.
But alas, the chain of events to create ‘Opportunity USA’ is exactly how the free market works, and the free market has already spoken and told us that the crap to be so graciously purchased by the U.S. taxpayer is indeed— CRAP.
Unable To Make Lemonade? Try To Hike Up The Price of Lemons.
By Bernanke and Paulson’s own admission the plan in question would 'not be successful' if assets were purchased at ‘fire-sale’ prices. [[Indeed, there must be enough there to 'pay off' those erstwhile 'captains of industry' and their 'golden parachutes'!: normxxx]] I am sure that taxpayers (the investor’s fronting this endeavor) would think much differently. Which brings us to the crux of the situation: you can not protect the financial system and the taxpayer at the same time. You focus on one— in this case the ‘system’— at the expense of the other.
"Just as when you sell a painting at Sotheby’s, nobody knows what its worth until the auction is over. Then people know what its worth. I think the same thing here…" Bernanke.
Some of the securities auctions this year have been canceled, others have been devoid of buyers, and still others generated bids for pennies on the dollar. But pay no attention to these other auctions, because apparently it takes Bernanke, Paulson, and $700 billion to tell us what many securities are really worth.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Tuesday, September 23, 2008
US Dollar To Be Major Casualty
Us Dollar Set To Be Major Casualty Of Hank Paulson's Bailout
By Edmund Conway, Telegraph.co.uk | 22 September 2008
Whether or not tomorrow’s accounts of today’s turmoil prove David Owen of Dresdner Kleinwort right; whether or not this is the beginning of the end of the dollar’s pre-eminence in the world’s central banks and foreign exchanges, the economic landscape has undoubtedly changed forever. The US taxpayer bail-out of America’s banking sector is an event whose significance will reverberate for many years. What it means for free markets, for the way Western economies are run, for the prosperity of the world economy, must remain to be seen.
But as investors scrambled to make sense of last week’s events, already one conclusion was all but irrefutable— the US dollar will have to take another major fall. The dollar rally that began in July and pushed the pound’s value against the greenback significantly lower has come to an abrupt end as markets face up to the fact that the currency will have to absorb the effects of a sudden shocking increase in America’s budget deficit.
When Treasury Secretary Hank Paulson announced that the world’s biggest economy was about to embark on the world’s biggest bail-out for its financial sector, the first concern economists had was about the long-term prospects for the nation’s finances and its currency. Might the dollar now be vulnerable to a run? In the longer term, might this signal the beginning of the end for the dollar’s status as the world’s reserve currency?
The US Treasury was already planning to borrow $438bn (£237bn) next year to shore up its budget deficit. That could now rise to $1 trillion or more after the cost of the $700bn mortgage rescue fund is taken into account. Budget deficits of that kind are usually enough to scare many foreign investors away, and indeed the dollar slumped 1.1 cents to $1.8441 against the pound yesterday, and in late trading was down almost two cents against the euro at $1.46880.
Ironically, despite the pound’s comparative strength against the dollar— having risen from just above $1.75 in the past few weeks— it remains extremely weak against other world currencies, due to investors’ fears about the UK’s own home-grown problems. "The magic trillion-dollar deficit is within sight," says Simon Derrick, of Bank of New York Mellon, "The combination of the fiscal position and loose monetary policy is likely to be significantly dollar-negative. With an expanding supply of US paper they might want to hold something else as their safe haven, which might mean other currencies and might just as easily mean commodities such as gold."
When a government opens the spending taps and [resorts to seemingly limitless borrowing], investors invariably take flight, fearing that assets denominated in those currencies will lose their value as inflation rises and the currency weakens. However, with the Treasury still reluctant to spell out precisely how the rescue package, modelled on the late 1980s’ Resolution Trust Corporation, will work, analysts are still unclear about how far the dollar has to fall.
It is likewise still unknown precisely what effect the quasi-nationalisation of Fannie Mae and Freddie Mac will have for the nation’s finances, though the implications will again almost certainly be negative. According to Mr Derrick, "the sums have changed so quickly on the fiscal side within the space of two weeks, and clearly the outlook for the US economy relative to where people were forecasting before Freddie and Fannie. Investors will also have a radically different outlook for the future."
The biggest question, however, is whether the reserve managers in central banks in China and elsewhere will treat this as a justification for selling off some of their massive mountain of dollar-denominated investments. If this were to happen, it could cause a catastrophic drop in the US currency, potentially compromising its status as the world’s reserve currency. However, with the euro area facing its own economic and financial crises, it looks unlikely to be able to step into the breach. This helps explain the leap yesterday in gold and oil prices as investors seek to buy tangible commodities in place of currencies that may easily be devalued in the coming years.
What was perhaps even more worrying for investors was an item in the small print of Hank Paulson’s rescue plan. It said that, separate to the $700bn markets rescue package, the US Treasury would plunder the Exchange Stabilisation Fund— the US currency reserves, established in the 1930s— in order to pay for an insurance scheme for the money markets. "The Treasury has committed the nation’s FX reserves to supporting the money market industry," said Chris Turner, head of foreign exchange strategy at ING. "That suggests to us that the dollar has fallen well down the list of the administration’s priorities— a worrying development for foreign investors in the US."
The fund’s cash is being funnelled into a new scheme designed to protect money market mutual funds, which mirrors the Federal Deposit Insurance scheme for consumers’ bank savings. "What worries us is that the US Treasury has committed the nation’s FX reserves at a time when the dollar is exceptionally vulnerable," said Mr Turner.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Edmund Conway, Telegraph.co.uk | 22 September 2008
|
Whether or not tomorrow’s accounts of today’s turmoil prove David Owen of Dresdner Kleinwort right; whether or not this is the beginning of the end of the dollar’s pre-eminence in the world’s central banks and foreign exchanges, the economic landscape has undoubtedly changed forever. The US taxpayer bail-out of America’s banking sector is an event whose significance will reverberate for many years. What it means for free markets, for the way Western economies are run, for the prosperity of the world economy, must remain to be seen.
But as investors scrambled to make sense of last week’s events, already one conclusion was all but irrefutable— the US dollar will have to take another major fall. The dollar rally that began in July and pushed the pound’s value against the greenback significantly lower has come to an abrupt end as markets face up to the fact that the currency will have to absorb the effects of a sudden shocking increase in America’s budget deficit.
When Treasury Secretary Hank Paulson announced that the world’s biggest economy was about to embark on the world’s biggest bail-out for its financial sector, the first concern economists had was about the long-term prospects for the nation’s finances and its currency. Might the dollar now be vulnerable to a run? In the longer term, might this signal the beginning of the end for the dollar’s status as the world’s reserve currency?
The US Treasury was already planning to borrow $438bn (£237bn) next year to shore up its budget deficit. That could now rise to $1 trillion or more after the cost of the $700bn mortgage rescue fund is taken into account. Budget deficits of that kind are usually enough to scare many foreign investors away, and indeed the dollar slumped 1.1 cents to $1.8441 against the pound yesterday, and in late trading was down almost two cents against the euro at $1.46880.
Ironically, despite the pound’s comparative strength against the dollar— having risen from just above $1.75 in the past few weeks— it remains extremely weak against other world currencies, due to investors’ fears about the UK’s own home-grown problems. "The magic trillion-dollar deficit is within sight," says Simon Derrick, of Bank of New York Mellon, "The combination of the fiscal position and loose monetary policy is likely to be significantly dollar-negative. With an expanding supply of US paper they might want to hold something else as their safe haven, which might mean other currencies and might just as easily mean commodities such as gold."
When a government opens the spending taps and [resorts to seemingly limitless borrowing], investors invariably take flight, fearing that assets denominated in those currencies will lose their value as inflation rises and the currency weakens. However, with the Treasury still reluctant to spell out precisely how the rescue package, modelled on the late 1980s’ Resolution Trust Corporation, will work, analysts are still unclear about how far the dollar has to fall.
It is likewise still unknown precisely what effect the quasi-nationalisation of Fannie Mae and Freddie Mac will have for the nation’s finances, though the implications will again almost certainly be negative. According to Mr Derrick, "the sums have changed so quickly on the fiscal side within the space of two weeks, and clearly the outlook for the US economy relative to where people were forecasting before Freddie and Fannie. Investors will also have a radically different outlook for the future."
The biggest question, however, is whether the reserve managers in central banks in China and elsewhere will treat this as a justification for selling off some of their massive mountain of dollar-denominated investments. If this were to happen, it could cause a catastrophic drop in the US currency, potentially compromising its status as the world’s reserve currency. However, with the euro area facing its own economic and financial crises, it looks unlikely to be able to step into the breach. This helps explain the leap yesterday in gold and oil prices as investors seek to buy tangible commodities in place of currencies that may easily be devalued in the coming years.
What was perhaps even more worrying for investors was an item in the small print of Hank Paulson’s rescue plan. It said that, separate to the $700bn markets rescue package, the US Treasury would plunder the Exchange Stabilisation Fund— the US currency reserves, established in the 1930s— in order to pay for an insurance scheme for the money markets. "The Treasury has committed the nation’s FX reserves to supporting the money market industry," said Chris Turner, head of foreign exchange strategy at ING. "That suggests to us that the dollar has fallen well down the list of the administration’s priorities— a worrying development for foreign investors in the US."
The fund’s cash is being funnelled into a new scheme designed to protect money market mutual funds, which mirrors the Federal Deposit Insurance scheme for consumers’ bank savings. "What worries us is that the US Treasury has committed the nation’s FX reserves at a time when the dollar is exceptionally vulnerable," said Mr Turner.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Friday, September 19, 2008
Govt Trading Ban Could Have Unintended Results
By Marcy Gordon and Stevenson Jacobs | 19 September 2008
WASHINGTON— The government's unprecedented move Friday to ban people from betting against financial stocks might be a salve for the market's turmoil but could also carry serious unintended consequences. In a bid to shore up investor confidence in the face of the spiraling market crisis, the Securities and Exchange Commission temporarily banned all short-selling in the shares of 799 financial companies. Short selling is a time-honored method for profiting when a stock drops.
The ban took effect immediately Friday and extends through Oct. 2. The SEC said it might extend the ban— so that it would last for as many as 30 calendar days in total— if it deems that necessary. That window could be enough time to calm the roiling financial markets, with the Bush administration's massive new programs to buy up Wall Street's toxic debt possibly starting to have a salutary effect by then. The short-selling ban is "kind of a time-out," said John Coffee, a professor of securities law at Columbia University. "In a time of crisis, the dangers of doing too little are far greater than the dangers of doing too much."
But on Wall Street, professional short-sellers said they were being unfairly targeted by the SEC's prohibition. And some analysts warned of possible negative consequences, maintaining that banning short-selling could actually distort— not stabilize— edgy markets. Indeed, hours after the new ban was announced, some of its details appeared to be a work in progress. The SEC said its staff was recommending exemptions from the ban for the trades market professionals make to hedge their investments in stock options or futures.
"I don't think it's going to accomplish what they're after," said Jeff Tjornehoj, senior analyst at fund research firm Lipper Inc. Without short sellers, he said, investors will have a harder time gauging the true value of a stock. "Most people want to be in a stock for the long run and want to see prices go up. Short sellers are useful for throwing water in their face and saying, 'Oh yeah? Think about this,'" Tjornehoj said. As a result, restricting the practice could artificially inflate the value of some stocks, opening the door for a big downward correction later.
"Without offering a flip-side to the price-discovery mechanism, I think there's a pressure built up in stock prices that only gets relieved in a great cataclysm," he said. Short selling involves borrowing a company's shares, selling them, and then buying them to return them to the lender later, when the stock falls. The short-seller pockets the difference in price. Although the practice can make markets more efficient and bring in more capital, the government argues that it has widened the scope of the recent financial crisis and contributed to the collapsing values of investment and commercial bank stocks in particular.
Government officials on both sides of the Atlantic have been denouncing hedge funds and other short sellers they say have swarmed over the limp bodies of venerable investment banks and other big companies. New York Attorney General Andrew Cuomo likened them to "looters after a hurricane," and his office is investigating a possible conspiracy among short-sellers to spread negative rumors to pound down companies' stock prices. The turmoil in recent weeks has swallowed some of the most storied names on Wall Street. Three of its five major investment banks— Bear Stearns, Lehman Brothers and Merrill Lynch— have either gone out of business or been driven into the arms of another bank. Many contend that short-selling played a key role in forcing the collapse of these institutions.
SEC Chairman Christopher Cox, who with Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke had met with lawmakers at the Capitol Thursday night, acknowledged that such extraordinary measures would not be necessary in a well-functioning market and said they are only temporary. Cox said Friday his agency "is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets." He said the temporary ban "will restore equilibrium to markets."
The SEC also imposed a new requirement, also temporary, for investment managers to publicly report their new short sales of stocks. And the agency eased restrictions on the ability of companies to buy back their own shares, also through Oct. 2, another move aimed at helping restore liquidity to the distressed and volatile market. Over the summer, the SEC imposed a 30-day emergency ban on "naked" short selling— where sellers don't actually borrow the shares they sell— in the stocks of mortgage finance giants Fannie Mae and Freddie Mac and 17 large investment banks. But Friday's ban expanded to all short selling, not just the more aggressive naked variety, and to a much wider universe of companies.
The 799 companies covered by the SEC ban are an A-to-Z of the nation's financial institutions, including the powerhouse investment banks such as Goldman Sachs Group Inc. and Morgan Stanley and commercial banks running the gamut from Bank of America Corp. to Cape Fear Bank Corp. SLM Corp., which is known as Sallie Mae and is the biggest U.S. student lender is on the list, as are Charles Schwab Corp., Berkshire Hathaway Inc. and Principal Financial Group Inc.
Washington Mutual Inc., the nation's largest thrift, which has lost billions from subprime mortgage exposure and seen its shares plunge in recent weeks, also is on the SEC list. So is the NYSE Euronext, the biggest stock exchange, and foreign financial companies whose stock is traded on U.S. exchanges, such as Lloyds TSB Group PLC of Britain and China Life Insurance Co. Ltd. However, investors still have ways to place bearish bets: by trading in options that turn profitable when a stock drops. Jim Chanos, a prominent short seller and president of a $7 billion hedge fund, Kynikos Associates, called short-selling a "vital investment strategy" and said banning the practice "will not enhance long-term market integrity."
He argued that investment banks' bad bets on risky assets— not predatory short-sellers— were the true cause of the steep declines in the stock price of financial firms. "Far from being the cause of the crisis, many short sellers were warning months and years ago about problems in this area," Chanos said in a statement. The new SEC ban also touched smaller investors. Two popular funds that specialize in short selling and are traded on stock exchanges— ProShares' Short Financials and UltraShort Financials— were temporarily halted Friday due to the ban. Trading resumed later in the day, but ProShares said it has suspended creating new shares in the funds until further notice.
ProShares Chairman Michael Sapir called the ban "extraordinary" and said it remains to be seen whether it has the intended effect of calming the markets.
I don't think anyone sees the action today as a long-term solution, Sapir said. "It's a way to calm things down, but it isn't consistent with a free and open market." The SEC's ban came in concert with Britain's Financial Services Authority, which announced a similar ban there Thursday. Some British politicians had claimed that short-selling was partly responsible for HBOS PLC's abrupt takeover by banking rival Lloyds TSB PLC on Thursday. The ban there was met with a similar reaction as the SEC move— a mix of relief and skepticism.
"Banning short selling is just a part of a solution," said Nic Clarke, banking analyst at Charles Stanley Stockbrokers. "We view this as a side issue. It doesn't stop the underlying reason for the credit crunch and it doesn't get to the heart of the problem."
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Marcy Gordon and Stevenson Jacobs | 19 September 2008
AP Photo | |
| Senate Majority Leader Harry Reid, D-Nev., speaks to reporters after members of Congress met with SEC Chairman Chris Cox, 3rd left, and Treasury Secretary Henry Paulson, fourth from left, Speaker Nancy Pelosi, D-Calif., and Federal Reserve Board Chairman Ben Bernanke, right. Congressional leaders met with financial leaders late into the evening Thursday, Sept. 18, 2008 on Capitol Hill in Washington. |  |
WASHINGTON— The government's unprecedented move Friday to ban people from betting against financial stocks might be a salve for the market's turmoil but could also carry serious unintended consequences. In a bid to shore up investor confidence in the face of the spiraling market crisis, the Securities and Exchange Commission temporarily banned all short-selling in the shares of 799 financial companies. Short selling is a time-honored method for profiting when a stock drops.
The ban took effect immediately Friday and extends through Oct. 2. The SEC said it might extend the ban— so that it would last for as many as 30 calendar days in total— if it deems that necessary. That window could be enough time to calm the roiling financial markets, with the Bush administration's massive new programs to buy up Wall Street's toxic debt possibly starting to have a salutary effect by then. The short-selling ban is "kind of a time-out," said John Coffee, a professor of securities law at Columbia University. "In a time of crisis, the dangers of doing too little are far greater than the dangers of doing too much."
But on Wall Street, professional short-sellers said they were being unfairly targeted by the SEC's prohibition. And some analysts warned of possible negative consequences, maintaining that banning short-selling could actually distort— not stabilize— edgy markets. Indeed, hours after the new ban was announced, some of its details appeared to be a work in progress. The SEC said its staff was recommending exemptions from the ban for the trades market professionals make to hedge their investments in stock options or futures.
"I don't think it's going to accomplish what they're after," said Jeff Tjornehoj, senior analyst at fund research firm Lipper Inc. Without short sellers, he said, investors will have a harder time gauging the true value of a stock. "Most people want to be in a stock for the long run and want to see prices go up. Short sellers are useful for throwing water in their face and saying, 'Oh yeah? Think about this,'" Tjornehoj said. As a result, restricting the practice could artificially inflate the value of some stocks, opening the door for a big downward correction later.
"Without offering a flip-side to the price-discovery mechanism, I think there's a pressure built up in stock prices that only gets relieved in a great cataclysm," he said. Short selling involves borrowing a company's shares, selling them, and then buying them to return them to the lender later, when the stock falls. The short-seller pockets the difference in price. Although the practice can make markets more efficient and bring in more capital, the government argues that it has widened the scope of the recent financial crisis and contributed to the collapsing values of investment and commercial bank stocks in particular.
Government officials on both sides of the Atlantic have been denouncing hedge funds and other short sellers they say have swarmed over the limp bodies of venerable investment banks and other big companies. New York Attorney General Andrew Cuomo likened them to "looters after a hurricane," and his office is investigating a possible conspiracy among short-sellers to spread negative rumors to pound down companies' stock prices. The turmoil in recent weeks has swallowed some of the most storied names on Wall Street. Three of its five major investment banks— Bear Stearns, Lehman Brothers and Merrill Lynch— have either gone out of business or been driven into the arms of another bank. Many contend that short-selling played a key role in forcing the collapse of these institutions.
SEC Chairman Christopher Cox, who with Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke had met with lawmakers at the Capitol Thursday night, acknowledged that such extraordinary measures would not be necessary in a well-functioning market and said they are only temporary. Cox said Friday his agency "is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets." He said the temporary ban "will restore equilibrium to markets."
The SEC also imposed a new requirement, also temporary, for investment managers to publicly report their new short sales of stocks. And the agency eased restrictions on the ability of companies to buy back their own shares, also through Oct. 2, another move aimed at helping restore liquidity to the distressed and volatile market. Over the summer, the SEC imposed a 30-day emergency ban on "naked" short selling— where sellers don't actually borrow the shares they sell— in the stocks of mortgage finance giants Fannie Mae and Freddie Mac and 17 large investment banks. But Friday's ban expanded to all short selling, not just the more aggressive naked variety, and to a much wider universe of companies.
The 799 companies covered by the SEC ban are an A-to-Z of the nation's financial institutions, including the powerhouse investment banks such as Goldman Sachs Group Inc. and Morgan Stanley and commercial banks running the gamut from Bank of America Corp. to Cape Fear Bank Corp. SLM Corp., which is known as Sallie Mae and is the biggest U.S. student lender is on the list, as are Charles Schwab Corp., Berkshire Hathaway Inc. and Principal Financial Group Inc.
Washington Mutual Inc., the nation's largest thrift, which has lost billions from subprime mortgage exposure and seen its shares plunge in recent weeks, also is on the SEC list. So is the NYSE Euronext, the biggest stock exchange, and foreign financial companies whose stock is traded on U.S. exchanges, such as Lloyds TSB Group PLC of Britain and China Life Insurance Co. Ltd. However, investors still have ways to place bearish bets: by trading in options that turn profitable when a stock drops. Jim Chanos, a prominent short seller and president of a $7 billion hedge fund, Kynikos Associates, called short-selling a "vital investment strategy" and said banning the practice "will not enhance long-term market integrity."
He argued that investment banks' bad bets on risky assets— not predatory short-sellers— were the true cause of the steep declines in the stock price of financial firms. "Far from being the cause of the crisis, many short sellers were warning months and years ago about problems in this area," Chanos said in a statement. The new SEC ban also touched smaller investors. Two popular funds that specialize in short selling and are traded on stock exchanges— ProShares' Short Financials and UltraShort Financials— were temporarily halted Friday due to the ban. Trading resumed later in the day, but ProShares said it has suspended creating new shares in the funds until further notice.
ProShares Chairman Michael Sapir called the ban "extraordinary" and said it remains to be seen whether it has the intended effect of calming the markets.
I don't think anyone sees the action today as a long-term solution, Sapir said. "It's a way to calm things down, but it isn't consistent with a free and open market." The SEC's ban came in concert with Britain's Financial Services Authority, which announced a similar ban there Thursday. Some British politicians had claimed that short-selling was partly responsible for HBOS PLC's abrupt takeover by banking rival Lloyds TSB PLC on Thursday. The ban there was met with a similar reaction as the SEC move— a mix of relief and skepticism.
"Banning short selling is just a part of a solution," said Nic Clarke, banking analyst at Charles Stanley Stockbrokers. "We view this as a side issue. It doesn't stop the underlying reason for the credit crunch and it doesn't get to the heart of the problem."
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Congress to the Res Cue!?!
Washington News: Officials, Congress Crafting Mortgage Debt Remedy
Click here for a link to complete article:
By
| 19 September 2008
The Financial Times reports, "A breakthrough agreement to create a giant US government-sponsored vehicle to take on toxic assets in the financial system looked possible on Thursday night as" Secretary Paulson, Federal Reserve chairman Ben Bernanke "and top lawmakers convened a dramatic meeting to discuss the financial crisis." The Treasury Department "said the meeting discussed a 'comprehensive approach to address the illiquid assets on bank balance sheets that are at the underlying source of the current stresses in our financial institutions and financial markets.'"
The New York Times reports the group of officials meeting with Hill leaders "included Christopher Cox, the chairman of the Securities and Exchange Commission." Congressional participants included Speaker Nancy Pelosi, Senate Majority Leader Harry Reid, Minority Leader Mitch McConnell, Sens Christopher J. Dodd and Richard C. Shelby of Alabama, House Minority Leader John A. Boehner of Ohio and Rep. Barney Frank.
The Washington Post reports, "Congressional leaders gave bipartisan support to the administration's efforts after" the meeting last night. According to "a participant in the meeting who spoke on condition of anonymity," Paulson and Bernanke "presented a 'chilling' picture of the state of the financial system," and "lawmakers were told that the consequences would be grave if they failed to pass legislation by the end of next week."
AFP reports, "In a brief news conference on Capitol Hill, Paulson, flanked by participants," said, "I think we saw the best of the United States of America in the speaker's office tonight. This country is able to come together and do things quickly when it needs to be done for the good of the American people." The AP reports Pelosi "said any potential action must protect taxpayers who are already on the hook for potentially billions of dollars in bailouts to financial firms taken down by the financial crisis."
The Wall Street Journal notes President George Bush met with Paulson, Cox and Bernanke "for 45 minutes Thursday to discuss 'the serious conditions in our financial markets,'" according to White House spokesman Tony Fratto. The "sweeping series of programs" under consideration "would represent perhaps the biggest intervention in financial markets since the 1930s."
The Christian Science Monitor reports, "Washington's response to the credit crisis so far has seemed to rely on daily improvisation. Perhaps it now needs something more organized: a new US government resale agency that would absorb and then dispose of the assets of damaged firms."
The Politico says "the discussions this week have sometimes been confused by comparisons to the Resolution Trust Corp. created to address the savings and loan crisis in the late 80s and early 90s." Sen. Charles Schumer "took the Senate floor Thursday to propose an alternative modeled on a Depression-era entity designed not to buy up bad assets but to invest in companies to give them needed capital to work their way out of debt." USA Today, Los Angeles Times and Washington Times also report on the talks.
Dems May Want Stimulus In Return Meanwhile, the New York Times reports, "Democrats, having their own desire for a second round of economic aid for struggling Americans, see the administration's request as a way to win White House approval of new spending to help stimulate the economy in exchange for support for the Treasury request." Democrats also "say they will push for relief for homeowners faced with foreclosure in return for supporting any broad bailout of struggling financial institutions."
On ABC World News, George Stephanopoulos said,"The Speaker of the House and other Democrats are also going to push that as part of the price for agreeing to a program like this, there is a second stimulus package that will include funding for unemployment, food stamps, home heating assistance, direct aid to taxpayers and consumers."
Media Downplays 410-Point Dow Rebound
The Dow Jones Industrial Average rebounded on Thursday on word that Treasury Secretary Henry Paulson was working to create an entity like the Resolution Trust Corporation to unwind the subprime mortgage crisis. ABC World News reported, "The market had its biggest one day rally since October 2002." Bloomberg News notes the S&P "advanced 50.12 points to 1,206.51, recovering most of yesterday's 4.7 percent tumble. The Dow surged 410.03, or 3.9 percent, to 11,019.69," and "the Nasdaq Composite Index jumped 100.25, or 4.8 percent, to 2,199.1."
Most media reports, however, caution that yesterday's Wall Street rally does not mean the crisis affecting the financial system is closer to being over. The New York Times says investors were "heartened by signs that the government is taking more drastic steps to tamp down problems plaguing the financial markets," but the market gains were "by no means a sign that the crisis on Wall Street had turned a corner."
The Washington Post titles its front-page story "Despite Late Surge, Markets Still Show Signs of Instability," and the Wall Street Journal says that "despite Thursday's late burst of buying activity, few participants are willing to call an end to the volatility and the generally bearish tone that has been the hallmark of trading this week." The Los Angeles Times and Financial Times ran similar stories.
M O R E. . .
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Click here for a link to complete article:
By
| 19 September 2008The Financial Times reports, "A breakthrough agreement to create a giant US government-sponsored vehicle to take on toxic assets in the financial system looked possible on Thursday night as" Secretary Paulson, Federal Reserve chairman Ben Bernanke "and top lawmakers convened a dramatic meeting to discuss the financial crisis." The Treasury Department "said the meeting discussed a 'comprehensive approach to address the illiquid assets on bank balance sheets that are at the underlying source of the current stresses in our financial institutions and financial markets.'"
The New York Times reports the group of officials meeting with Hill leaders "included Christopher Cox, the chairman of the Securities and Exchange Commission." Congressional participants included Speaker Nancy Pelosi, Senate Majority Leader Harry Reid, Minority Leader Mitch McConnell, Sens Christopher J. Dodd and Richard C. Shelby of Alabama, House Minority Leader John A. Boehner of Ohio and Rep. Barney Frank.
The Washington Post reports, "Congressional leaders gave bipartisan support to the administration's efforts after" the meeting last night. According to "a participant in the meeting who spoke on condition of anonymity," Paulson and Bernanke "presented a 'chilling' picture of the state of the financial system," and "lawmakers were told that the consequences would be grave if they failed to pass legislation by the end of next week."
AFP reports, "In a brief news conference on Capitol Hill, Paulson, flanked by participants," said, "I think we saw the best of the United States of America in the speaker's office tonight. This country is able to come together and do things quickly when it needs to be done for the good of the American people." The AP reports Pelosi "said any potential action must protect taxpayers who are already on the hook for potentially billions of dollars in bailouts to financial firms taken down by the financial crisis."
The Wall Street Journal notes President George Bush met with Paulson, Cox and Bernanke "for 45 minutes Thursday to discuss 'the serious conditions in our financial markets,'" according to White House spokesman Tony Fratto. The "sweeping series of programs" under consideration "would represent perhaps the biggest intervention in financial markets since the 1930s."
The Christian Science Monitor reports, "Washington's response to the credit crisis so far has seemed to rely on daily improvisation. Perhaps it now needs something more organized: a new US government resale agency that would absorb and then dispose of the assets of damaged firms."
The Politico says "the discussions this week have sometimes been confused by comparisons to the Resolution Trust Corp. created to address the savings and loan crisis in the late 80s and early 90s." Sen. Charles Schumer "took the Senate floor Thursday to propose an alternative modeled on a Depression-era entity designed not to buy up bad assets but to invest in companies to give them needed capital to work their way out of debt." USA Today, Los Angeles Times and Washington Times also report on the talks.
Dems May Want Stimulus In Return Meanwhile, the New York Times reports, "Democrats, having their own desire for a second round of economic aid for struggling Americans, see the administration's request as a way to win White House approval of new spending to help stimulate the economy in exchange for support for the Treasury request." Democrats also "say they will push for relief for homeowners faced with foreclosure in return for supporting any broad bailout of struggling financial institutions."
On ABC World News, George Stephanopoulos said,"The Speaker of the House and other Democrats are also going to push that as part of the price for agreeing to a program like this, there is a second stimulus package that will include funding for unemployment, food stamps, home heating assistance, direct aid to taxpayers and consumers."
Media Downplays 410-Point Dow Rebound
The Dow Jones Industrial Average rebounded on Thursday on word that Treasury Secretary Henry Paulson was working to create an entity like the Resolution Trust Corporation to unwind the subprime mortgage crisis. ABC World News reported, "The market had its biggest one day rally since October 2002." Bloomberg News notes the S&P "advanced 50.12 points to 1,206.51, recovering most of yesterday's 4.7 percent tumble. The Dow surged 410.03, or 3.9 percent, to 11,019.69," and "the Nasdaq Composite Index jumped 100.25, or 4.8 percent, to 2,199.1."
Most media reports, however, caution that yesterday's Wall Street rally does not mean the crisis affecting the financial system is closer to being over. The New York Times says investors were "heartened by signs that the government is taking more drastic steps to tamp down problems plaguing the financial markets," but the market gains were "by no means a sign that the crisis on Wall Street had turned a corner."
The Washington Post titles its front-page story "Despite Late Surge, Markets Still Show Signs of Instability," and the Wall Street Journal says that "despite Thursday's late burst of buying activity, few participants are willing to call an end to the volatility and the generally bearish tone that has been the hallmark of trading this week." The Los Angeles Times and Financial Times ran similar stories.
M O R E. . .
|
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Thursday, September 18, 2008
20 Year 'Annual' Average (Each EoY From 1900)
This table was originally posted early in 1998!
|
Tuesday, September 16, 2008
Rummage-Sale Bargains?
Buffett, Greenberg May Find AIG Rummage-Sale Bargains
Click here for a link to complete article:
By Andrew Frye | 18 September 2008
Sept. 18 (Bloomberg)— Billionaire Warren Buffett and Maurice "Hank" Greenberg may find bargains as the U.S. government opens up American International Group Inc., the biggest U.S. insurer, for a rummage sale. AIG will probably sell assets to raise cash and repay the $85 billion loan it secured Sept. 16 from the Federal Reserve to stay in business. The insurance units are solvent, regulators said, because New York-based AIG was barred from tapping reserves at the subsidiaries even as $18 billion of losses tied to home loans drained capital from the holding company. [[So, those old, fuddy-duddy laws, and 'clueless' regulators would seem to have done some good, eh!?!: normxxx]]
Buffett, chairman of Berkshire Hathaway Inc., and Greenberg, who ran AIG for almost 40 years until 2005, may bump elbows with Allianz SE Chief Executive Officer Michael Diekmann and Munich Re's Nikolaus von Bomhard. Both told reporters this week they would consider bids for parts of AIG. "There's going to be widespread international interest in some of the areas where AIG has accumulated a dominant presence," said Frank Betz a partner at Warren, New Jersey-based Carret Zane Capital Management, which holds Berkshire shares. Buffett is probably "lurking in the shadows," looking for a deal, Betz said.
Insurers are buying U.S. property and casualty companies at the fastest rate in 10 years, announcing 33 deals worth $13.5 billion since Dec. 31, after profits rose in 2006 and 2007 on sales outside the U.S. and lower-than-average losses from Atlantic hurricanes. Buffett and CEOs including Prudential Financial Inc.'s John Strangfeld have said they'll be ready to make purchases when the credit crunch pushes rivals to sell assets at distressed prices.
New CEO
The government tapped former Allstate Corp. chief Edward Liddy to oversee the divestitures. Liddy replaces AIG CEO Robert Willumstad who took over in June and saw the company collapse before he could present a reorganization strategy, which was set to be unveiled Sept. 25. Liddy arrived yesterday and hadn't yet presented a plan, said spokesman Nicholas Ashooh. AIG may sell assets including the biggest commercial insurance business in the U.S. and "the best Asian insurance franchise in life and general insurance of any Western company," said David Havens, a credit analyst at UBS AG.
Investors led by Greenberg said hours before the federal loan announcement they might want to buy the insurer's subsidiaries. Greenberg, who controlled 11 percent of AIG's shares before the takeover, the largest block, has the ability to assemble "huge pools of capital" and will likely seek to bid for assets, Betz said.
Allianz, Private Equity
Diekmann and J.C. Flowers & Co., the private equity firm, submitted a joint bid to invest in AIG in the days preceding its collapse, two people with knowledge of the talks said. AIG rejected that offer. Munich-based Allianz says it will consider AIG assets that come up for sale. Munich Re, the world's biggest reinsurer, may pursue AIG's insurance business in Eastern Europe or its industrial protection unit, von Bomhard told German newspaper Handelsblatt. His comments were confirmed by a company spokesman.
"There's a lot of capacity" for acquisitions, Ziad Tadmoury, head of FM Insurance Co.'s business in France, said in an interview. European carriers "have got buying power," given the strength of the euro, Tadmoury said. Allstate, the largest publicly traded U.S. home and auto insurer, may consider bidding for aigdirect.com to expand its sales of car coverage over the Internet, said Stifel Nicolaus & Co. analyst Meyer Shields. Chubb Corp., Ace Ltd. or Allianz's Fireman's Fund Insurance unit could be interested in acquiring the AIG unit that sells coverage to individuals through independent agents, Shields said.
Allstate, Prudential
Allstate CEO Thomas Wilson said of potential takeovers on Sept. 4, "If you can get something attractive, you ought to do it." Spokesman Rich Halberg declined to comment on AIG. Prudential, the second-biggest U.S. life insurer, is "best positioned to make acquisitions," Morgan Stanley analyst Nigel Dally said yesterday in a research note. Newark, New Jersey-based Prudential and No. 1 MetLife Inc. may compete with Canadian and European carriers for AIG's life insurance assets, Dally said.
Prudential's Strangfeld anticipated in June, "there could be a phase, potentially, if another shoe drops," in which competitors seek cash by selling businesses. "It's an opportunity for our industry to deploy capital," he said. Buffett's Berkshire, which had about $30 billion in cash as of June 30, makes about half of its revenue from insurance and reinsurance.
Annuities, Reinsurance
"We would love to have a great business in any industry that we would understand," Buffett said at a news conference last year. "We would understand insurance." Buffett's spokeswoman didn't return a call seeking comment yesterday. Insurers, which have seen profits slip on declines in the value of holdings amid the subprime collapse and credit crisis, are now facing fresh losses on investments in AIG and bankrupt investment bank Lehman Brothers Holdings Inc.
This week, MetLife disclosed $800 million invested in AIG and Lehman debt, equity and derivatives, while Prudential said third-quarter earnings would be reduced by similar holdings. Units that may be sold include AIG's U.S. variable-annuity business, and a 59 percent stake in reinsurer Transatlantic Holdings Inc., according to Citigroup analyst Joshua Shanker. The Transatlantic stake is worth about $2.2 billion, based on yesterday's share price.
Aircraft Leasing
AIG's aircraft-leasing unit International Lease Finance Corp. may be bought by investors led by the unit's founder, Steven Udvar-Hazy, the Wall Street Journal reported yesterday, citing unnamed people. ILFC, which Willumstad had ruled out selling, could fetch $7 billion to $14 billion, said Bank of America Corp. analyst Alain Karaoglan. Udvar-Hazy and ILFC Chief Operating Officer John Plueger declined to comment, a secretary for Plueger said.
AIG may find bidders for life insurance businesses outside the U.S., where competitors including Hartford Financial Services Group Inc., MetLife, Prudential and Canada's Manulife Financial Corp. have been seeking customers. "When properties come up for sale around the world, it's very competitive," MetLife Chief Financial Officer William Wheeler said Sept. 10.
M O R E. . .
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Click here for a link to complete article:
By Andrew Frye | 18 September 2008
Sept. 18 (Bloomberg)— Billionaire Warren Buffett and Maurice "Hank" Greenberg may find bargains as the U.S. government opens up American International Group Inc., the biggest U.S. insurer, for a rummage sale. AIG will probably sell assets to raise cash and repay the $85 billion loan it secured Sept. 16 from the Federal Reserve to stay in business. The insurance units are solvent, regulators said, because New York-based AIG was barred from tapping reserves at the subsidiaries even as $18 billion of losses tied to home loans drained capital from the holding company. [[So, those old, fuddy-duddy laws, and 'clueless' regulators would seem to have done some good, eh!?!: normxxx]]
Buffett, chairman of Berkshire Hathaway Inc., and Greenberg, who ran AIG for almost 40 years until 2005, may bump elbows with Allianz SE Chief Executive Officer Michael Diekmann and Munich Re's Nikolaus von Bomhard. Both told reporters this week they would consider bids for parts of AIG. "There's going to be widespread international interest in some of the areas where AIG has accumulated a dominant presence," said Frank Betz a partner at Warren, New Jersey-based Carret Zane Capital Management, which holds Berkshire shares. Buffett is probably "lurking in the shadows," looking for a deal, Betz said.
Insurers are buying U.S. property and casualty companies at the fastest rate in 10 years, announcing 33 deals worth $13.5 billion since Dec. 31, after profits rose in 2006 and 2007 on sales outside the U.S. and lower-than-average losses from Atlantic hurricanes. Buffett and CEOs including Prudential Financial Inc.'s John Strangfeld have said they'll be ready to make purchases when the credit crunch pushes rivals to sell assets at distressed prices.
New CEO
The government tapped former Allstate Corp. chief Edward Liddy to oversee the divestitures. Liddy replaces AIG CEO Robert Willumstad who took over in June and saw the company collapse before he could present a reorganization strategy, which was set to be unveiled Sept. 25. Liddy arrived yesterday and hadn't yet presented a plan, said spokesman Nicholas Ashooh. AIG may sell assets including the biggest commercial insurance business in the U.S. and "the best Asian insurance franchise in life and general insurance of any Western company," said David Havens, a credit analyst at UBS AG.
Investors led by Greenberg said hours before the federal loan announcement they might want to buy the insurer's subsidiaries. Greenberg, who controlled 11 percent of AIG's shares before the takeover, the largest block, has the ability to assemble "huge pools of capital" and will likely seek to bid for assets, Betz said.
Allianz, Private Equity
Diekmann and J.C. Flowers & Co., the private equity firm, submitted a joint bid to invest in AIG in the days preceding its collapse, two people with knowledge of the talks said. AIG rejected that offer. Munich-based Allianz says it will consider AIG assets that come up for sale. Munich Re, the world's biggest reinsurer, may pursue AIG's insurance business in Eastern Europe or its industrial protection unit, von Bomhard told German newspaper Handelsblatt. His comments were confirmed by a company spokesman.
"There's a lot of capacity" for acquisitions, Ziad Tadmoury, head of FM Insurance Co.'s business in France, said in an interview. European carriers "have got buying power," given the strength of the euro, Tadmoury said. Allstate, the largest publicly traded U.S. home and auto insurer, may consider bidding for aigdirect.com to expand its sales of car coverage over the Internet, said Stifel Nicolaus & Co. analyst Meyer Shields. Chubb Corp., Ace Ltd. or Allianz's Fireman's Fund Insurance unit could be interested in acquiring the AIG unit that sells coverage to individuals through independent agents, Shields said.
Allstate, Prudential
Allstate CEO Thomas Wilson said of potential takeovers on Sept. 4, "If you can get something attractive, you ought to do it." Spokesman Rich Halberg declined to comment on AIG. Prudential, the second-biggest U.S. life insurer, is "best positioned to make acquisitions," Morgan Stanley analyst Nigel Dally said yesterday in a research note. Newark, New Jersey-based Prudential and No. 1 MetLife Inc. may compete with Canadian and European carriers for AIG's life insurance assets, Dally said.
Prudential's Strangfeld anticipated in June, "there could be a phase, potentially, if another shoe drops," in which competitors seek cash by selling businesses. "It's an opportunity for our industry to deploy capital," he said. Buffett's Berkshire, which had about $30 billion in cash as of June 30, makes about half of its revenue from insurance and reinsurance.
Annuities, Reinsurance
"We would love to have a great business in any industry that we would understand," Buffett said at a news conference last year. "We would understand insurance." Buffett's spokeswoman didn't return a call seeking comment yesterday. Insurers, which have seen profits slip on declines in the value of holdings amid the subprime collapse and credit crisis, are now facing fresh losses on investments in AIG and bankrupt investment bank Lehman Brothers Holdings Inc.
This week, MetLife disclosed $800 million invested in AIG and Lehman debt, equity and derivatives, while Prudential said third-quarter earnings would be reduced by similar holdings. Units that may be sold include AIG's U.S. variable-annuity business, and a 59 percent stake in reinsurer Transatlantic Holdings Inc., according to Citigroup analyst Joshua Shanker. The Transatlantic stake is worth about $2.2 billion, based on yesterday's share price.
Aircraft Leasing
AIG's aircraft-leasing unit International Lease Finance Corp. may be bought by investors led by the unit's founder, Steven Udvar-Hazy, the Wall Street Journal reported yesterday, citing unnamed people. ILFC, which Willumstad had ruled out selling, could fetch $7 billion to $14 billion, said Bank of America Corp. analyst Alain Karaoglan. Udvar-Hazy and ILFC Chief Operating Officer John Plueger declined to comment, a secretary for Plueger said.
AIG may find bidders for life insurance businesses outside the U.S., where competitors including Hartford Financial Services Group Inc., MetLife, Prudential and Canada's Manulife Financial Corp. have been seeking customers. "When properties come up for sale around the world, it's very competitive," MetLife Chief Financial Officer William Wheeler said Sept. 10.
M O R E. . .
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
'Nightmare On Wall Street'
'Nightmare On Wall Street'
From Economist.com | 15 September 2008
NEW YORK AND WASHINGTON,DC— A weekend of high drama reshapes American finance.
Even by the standards of the worst financial crisis for at least a generation, the events of Sunday September 14th and the day before were extraordinary. The weekend began with hopes that a deal could be struck, with or without government backing, to save Lehman Brothers, America’s fourth-largest investment bank. Early Monday morning Lehman filed for Chapter 11 bankruptcy protection. It has more than $613 billion of debt.
Other vulnerable financial giants scrambled to sell themselves or raise enough capital to stave off a similar fate. Merrill Lynch, the third-biggest investment bank, sold itself to Bank of America (BofA), an erstwhile Lehman suitor, in a $50 billion all-stock deal. American International Group (AIG) brought forward a potentially life-saving overhaul and went cap-in-hand to the Federal Reserve. But its shares also slumped on Monday.
The situation remains fluid, and investors stampeded towards the relative safety of American Treasury bonds. Stockmarkets tumbled around the world (though some Asian bourses were closed) and the oil price plummeted to well under $100 a barrel. The dollar fell sharply, and the yield on two-year Treasury notes fell below 2% on hopes the Federal Reserve would cut interest rates at a scheduled meeting on Tuesday. American stock futures were deep in the red too. Spreads on risky credit, already elevated, widened further.
With these developments the crisis is entering a new and extremely dangerous phase. If Lehman's assets are dumped in a liquidation, prices of like assets on other firms' books will also have to be marked down, eroding their capital bases. The government's refusal to help with a bail-out of Lehman will strip many firms of the benefit of being thought too big to fail, raising their borrowing costs. Lehman’s demise highlights the industry’s inability, or unwillingness, to rescue the sick, even when the consequences of inaction are potentially dire.
The biggest worry is the effect on derivatives markets, particularly the giant one for credit-default swaps. Lehman is a top-ten counterparty in CDSs, holding contracts with a notional value of almost $800 billion. On Sunday, banks called in their derivatives traders to assess their exposures to Lehman and work on mitigating risks. The Securities and Exchange Commission, Lehman’s main regulator, said it is working with the bank to protect clients and trading partners and to "maintain orderly markets".
Government officials believed they had persuaded a consortium of Wall Street firms to back a new vehicle that would take $40 billion-70 billion of dodgy assets off Lehman’s books, thereby facilitating a takeover of the remainder. But the deal died when the main suitors, BofA and Barclays, a British bank, walked away on Sunday afternoon. Both were unwilling to buy the firm, even shorn of the worst bits, without some sort of government backstop.
But Hank Paulson, the treasury secretary, decided to draw a line and refuse such help. After the Fed had bailed out Bear Stearns in March and the Treasury had taken over Fannie Mae and Freddie Mac last weekend, expectations were high that they would do the same for Lehman. And that was precisely the problem: it would have confirmed that the federal government stood behind all risk-taking in the financial system, creating moral hazard that would take years to undo and expanding taxpayers’ liability almost without limit. Conceivably, Congress could have denied Mr Paulson the money he needed even if he had been inclined to bail Lehman out.
This left Lehman with no option but to prepare for bankruptcy. Though the bank has access to a Fed lending facility, introduced after Bear’s takeover by JP Morgan Chase, the collapse of its share price left it unable to raise new equity and facing crippling downgrades from rating agencies. Moreover, rival firms that had continued to trade with it in recent weeks— at the urging of regulators— had begun to pull away in the past few days.
The inability to find a buyer is a huge blow to Lehman’s 25,000 employees, who own a third of the company’s now-worthless stock; in such a difficult environment, most will struggle to find work at other financial firms. It also makes for an ignominious end to the career of Dick Fuld, Lehman’s boss since 1994, who until last year was viewed as one of Wall Street’s smartest managers. Merrill’s rush to sell itself was motivated by fear that it might be next to be caught in the stampede.
Despite selling a big dollop of its most rotten assets recently, the market continued to question its viability. Its shares fell by 36% last week, and hedge funds had started to move their business elsewhere. Its boss, John Thain, concluded that it needed to strike a deal before markets reopened. It approached several firms, including BofA and Morgan Stanley, but only BofA felt able to conduct the necessary due diligence in time.
Not only has Mr Thain managed to shelter his firm from the storm, but he has also secured a price well above its closing price last Friday, $29 per share compared with $17. How he managed that in such an ugly market is not yet clear. Ken Lewis, BofA’s boss, is no fan of investment banking, but he is a consummate opportunist, and he has coveted Merrill’s formidable retail brokerage. Still, the deal carries risks.
It will be a logistical challenge, all the more so since BofA is in the middle of digesting Countrywide, a big mortgage lender. Commercial-bank takeovers of investment banks have a horrible history because of the stark cultural differences. And it is not clear if BofA has a clear picture of Merrill’s remaining troubled assets.
The takeover of Merrill leaves just two large independent investment banks in America, Morgan Stanley and Goldman Sachs. Both are in better shape than their erstwhile rivals. But this weekend’s events cast a shadow over the standalone model, with its reliance on leverage and skittish wholesale funding. Spreads on both banks' CDSs, which reflect investors views of the probability of default, soared on Monday.
Wall Street has company in its misery. Washington Mutual, a big thrift, is fighting for survival under a new boss. Even more worryingly, so is AIG, America’s largest insurer, thanks to a reckless foray into CDSs of mortgage-linked collateralised-debt obligations. Investors have fled, fearing the firm will need a lot more new capital than the $20 billion raised so far.
Prompted by the weekend bloodletting, AIG brought forward to Monday a restructuring that was to have been unveiled on September 25th. This was expected to include the sale of its aircraft-leasing arm and other businesses. It is also reported to be seeking a $40 billion in bridge loan from the Fed, to be repaid once the sales go through, in the hope that this will attract new capital, possibly from private-equity firms.
With Lehman left dangling, official attention is now turning to putting more safeguards in place to soften the coming shock to markets and the economy. The first step has been to encourage Lehman’s counterparties to get together and try to net out as many contracts as possible. On Sunday the Fed also expanded the list of collateral it will accept for loans at its discount window, to include even equities; and dealers may lend any investment-grade security, not just triple-A rated, to the Fed in exchange for Treasury bonds.
Markets are also pricing in some possibility that the Fed will cut its short-term interest rate target from 2% when it meets for a regularly scheduled meeting on Tuesday. That would be an abrupt turnaround from August, when officials figured their next move would be to raise rates, not lower them. In a sign of how bad things are, even straitened banks are stumping up cash to help the stabilisation efforts. On Sunday, a group of ten banks and securities firms set up a $70 billion loan facility that any of the founding members can tap if it finds itself short of cash.
Even if markets can be stabilised this week, the pain is far from over— and could yet spread. Worldwide credit-related losses by financial institutions now top $500 billion, of which only $350 billion of equity has been replenished. This $150 billion gap, leveraged 14.5 times (the average gearing for the industry), translates to a $2 trillion reduction in liquidity. Hence the severe shortage of credit and predictions of worse to come.
Indeed, most analysts think that the deleveraging still has far to go. Some question how much has taken place. Bianco Research notes that while the credit positions of the 20 largest banks have fallen by $300 billion, to $1.3 trillion, since the Fed started its special lending facilities, the same amount has been financed by the Fed itself through these windows. In other words, instead of deleveraging, the banks have just shifted a chunk of their risk to the central bank. As spectacular as this weekend was, more drama is on the way.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
From Economist.com | 15 September 2008
NEW YORK AND WASHINGTON,DC— A weekend of high drama reshapes American finance.Even by the standards of the worst financial crisis for at least a generation, the events of Sunday September 14th and the day before were extraordinary. The weekend began with hopes that a deal could be struck, with or without government backing, to save Lehman Brothers, America’s fourth-largest investment bank. Early Monday morning Lehman filed for Chapter 11 bankruptcy protection. It has more than $613 billion of debt.
Other vulnerable financial giants scrambled to sell themselves or raise enough capital to stave off a similar fate. Merrill Lynch, the third-biggest investment bank, sold itself to Bank of America (BofA), an erstwhile Lehman suitor, in a $50 billion all-stock deal. American International Group (AIG) brought forward a potentially life-saving overhaul and went cap-in-hand to the Federal Reserve. But its shares also slumped on Monday.
The situation remains fluid, and investors stampeded towards the relative safety of American Treasury bonds. Stockmarkets tumbled around the world (though some Asian bourses were closed) and the oil price plummeted to well under $100 a barrel. The dollar fell sharply, and the yield on two-year Treasury notes fell below 2% on hopes the Federal Reserve would cut interest rates at a scheduled meeting on Tuesday. American stock futures were deep in the red too. Spreads on risky credit, already elevated, widened further.
With these developments the crisis is entering a new and extremely dangerous phase. If Lehman's assets are dumped in a liquidation, prices of like assets on other firms' books will also have to be marked down, eroding their capital bases. The government's refusal to help with a bail-out of Lehman will strip many firms of the benefit of being thought too big to fail, raising their borrowing costs. Lehman’s demise highlights the industry’s inability, or unwillingness, to rescue the sick, even when the consequences of inaction are potentially dire.
The biggest worry is the effect on derivatives markets, particularly the giant one for credit-default swaps. Lehman is a top-ten counterparty in CDSs, holding contracts with a notional value of almost $800 billion. On Sunday, banks called in their derivatives traders to assess their exposures to Lehman and work on mitigating risks. The Securities and Exchange Commission, Lehman’s main regulator, said it is working with the bank to protect clients and trading partners and to "maintain orderly markets".
Government officials believed they had persuaded a consortium of Wall Street firms to back a new vehicle that would take $40 billion-70 billion of dodgy assets off Lehman’s books, thereby facilitating a takeover of the remainder. But the deal died when the main suitors, BofA and Barclays, a British bank, walked away on Sunday afternoon. Both were unwilling to buy the firm, even shorn of the worst bits, without some sort of government backstop.
But Hank Paulson, the treasury secretary, decided to draw a line and refuse such help. After the Fed had bailed out Bear Stearns in March and the Treasury had taken over Fannie Mae and Freddie Mac last weekend, expectations were high that they would do the same for Lehman. And that was precisely the problem: it would have confirmed that the federal government stood behind all risk-taking in the financial system, creating moral hazard that would take years to undo and expanding taxpayers’ liability almost without limit. Conceivably, Congress could have denied Mr Paulson the money he needed even if he had been inclined to bail Lehman out.
This left Lehman with no option but to prepare for bankruptcy. Though the bank has access to a Fed lending facility, introduced after Bear’s takeover by JP Morgan Chase, the collapse of its share price left it unable to raise new equity and facing crippling downgrades from rating agencies. Moreover, rival firms that had continued to trade with it in recent weeks— at the urging of regulators— had begun to pull away in the past few days.
The inability to find a buyer is a huge blow to Lehman’s 25,000 employees, who own a third of the company’s now-worthless stock; in such a difficult environment, most will struggle to find work at other financial firms. It also makes for an ignominious end to the career of Dick Fuld, Lehman’s boss since 1994, who until last year was viewed as one of Wall Street’s smartest managers. Merrill’s rush to sell itself was motivated by fear that it might be next to be caught in the stampede.
Despite selling a big dollop of its most rotten assets recently, the market continued to question its viability. Its shares fell by 36% last week, and hedge funds had started to move their business elsewhere. Its boss, John Thain, concluded that it needed to strike a deal before markets reopened. It approached several firms, including BofA and Morgan Stanley, but only BofA felt able to conduct the necessary due diligence in time.
Not only has Mr Thain managed to shelter his firm from the storm, but he has also secured a price well above its closing price last Friday, $29 per share compared with $17. How he managed that in such an ugly market is not yet clear. Ken Lewis, BofA’s boss, is no fan of investment banking, but he is a consummate opportunist, and he has coveted Merrill’s formidable retail brokerage. Still, the deal carries risks.
It will be a logistical challenge, all the more so since BofA is in the middle of digesting Countrywide, a big mortgage lender. Commercial-bank takeovers of investment banks have a horrible history because of the stark cultural differences. And it is not clear if BofA has a clear picture of Merrill’s remaining troubled assets.
The takeover of Merrill leaves just two large independent investment banks in America, Morgan Stanley and Goldman Sachs. Both are in better shape than their erstwhile rivals. But this weekend’s events cast a shadow over the standalone model, with its reliance on leverage and skittish wholesale funding. Spreads on both banks' CDSs, which reflect investors views of the probability of default, soared on Monday.
Wall Street has company in its misery. Washington Mutual, a big thrift, is fighting for survival under a new boss. Even more worryingly, so is AIG, America’s largest insurer, thanks to a reckless foray into CDSs of mortgage-linked collateralised-debt obligations. Investors have fled, fearing the firm will need a lot more new capital than the $20 billion raised so far.
Prompted by the weekend bloodletting, AIG brought forward to Monday a restructuring that was to have been unveiled on September 25th. This was expected to include the sale of its aircraft-leasing arm and other businesses. It is also reported to be seeking a $40 billion in bridge loan from the Fed, to be repaid once the sales go through, in the hope that this will attract new capital, possibly from private-equity firms.
With Lehman left dangling, official attention is now turning to putting more safeguards in place to soften the coming shock to markets and the economy. The first step has been to encourage Lehman’s counterparties to get together and try to net out as many contracts as possible. On Sunday the Fed also expanded the list of collateral it will accept for loans at its discount window, to include even equities; and dealers may lend any investment-grade security, not just triple-A rated, to the Fed in exchange for Treasury bonds.
Markets are also pricing in some possibility that the Fed will cut its short-term interest rate target from 2% when it meets for a regularly scheduled meeting on Tuesday. That would be an abrupt turnaround from August, when officials figured their next move would be to raise rates, not lower them. In a sign of how bad things are, even straitened banks are stumping up cash to help the stabilisation efforts. On Sunday, a group of ten banks and securities firms set up a $70 billion loan facility that any of the founding members can tap if it finds itself short of cash.
Even if markets can be stabilised this week, the pain is far from over— and could yet spread. Worldwide credit-related losses by financial institutions now top $500 billion, of which only $350 billion of equity has been replenished. This $150 billion gap, leveraged 14.5 times (the average gearing for the industry), translates to a $2 trillion reduction in liquidity. Hence the severe shortage of credit and predictions of worse to come.
Indeed, most analysts think that the deleveraging still has far to go. Some question how much has taken place. Bianco Research notes that while the credit positions of the 20 largest banks have fallen by $300 billion, to $1.3 trillion, since the Fed started its special lending facilities, the same amount has been financed by the Fed itself through these windows. In other words, instead of deleveraging, the banks have just shifted a chunk of their risk to the central bank. As spectacular as this weekend was, more drama is on the way.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
CBs Strain To Contain Market Crisis
Central Banks Strain To Contain Market Crisis
Click here for a link to complete article:
By Mark Felsenthal, Kerstin Gehmlich, and Chikako Mogi | 16 September 2008
Stocks extended their slide, with Europe's FTSEurofirst index hitting a three-year low at one stage as investors fretted over events on Wall Street, where Lehman Brothers, once thought 'too big to fail', filed for bankruptcy protection on Monday, and where another, even larger giant, insurer AIG, is seeking survival help. "It's clear that this financial market crisis is the worst worldwide in decades— and it is not over," Germany's finance minister, Peer Steinbrueck, told parliament. The Federal Reserve pumped in $50 billion into the markets on Tuesday, following up on the $70 billion it provided on Monday, and said it was ready to do more.
There was even market speculation that the Fed could reduce interest rates by as much as a half percentage point at a meeting it was holding on Tuesday. The European Central Bank injected 70 billion euros ($98.09 billion) into the money markets on Tuesday, after 30 billion the day before. Demand from banks for Tuesday's funds, a measure of how much other sources of liquidity are drying up, topped 100 billion. In Britain, the Bank of England injected 20 billion pounds ($35.21 billion), after five billion on Monday. Demand was three times the amount of extra liquidity offered on Tuesday.
Wheels Slowing
The cost of borrowing dollars 'overnight', as revealed by the LIBOR (London interbank offered rate) fixing, more than doubled to 6.43750 percent from 3.10625 percent on Monday, its highest since January 2001, the latest fixing by the British Banker's Association on Tuesday showed. "This is much worse than August last year," said one market source, referring to the day the credit crunch snowballed out of the United States, forcing central banks to launch emergency liquidity operations.
Asian central banks also rolled into action, with those of Japan, Australia and India flooding money markets with cash. The region's banks doled out $17 billion, following Monday's $70 billion Federal Reserve injection. The Bank of Japan made its biggest cash injection in almost six months— 1.5 trillion yen ($14.2 billion)— and the prime minister met top financial policy makers to discuss events. The rates at which banks lend to each other jumped in South Korea too, and in the financial hub of Hong Kong, while Asian stock markets, many of them closed for a holiday on Monday, tumbled and currencies whipsawed.
FED Cut?
The Bank of Japan is expected to leave its key interest rate unchanged at 0.5 percent on Wednesday. In contrast, markets were pricing in an almost 100 percent chance of a quarter-point cut in the U.S. benchmark rate, to 1.75 percent at a Fed meeting on Tuesday. And U.S. short-term interest rate futures showed about a one-in-three chance that the Fed would cut by half a percentage point, to 1.5 percent. "The U.S. central bank is facing a state of crisis in the financial markets from a perspective of solvency, liquidity and confidence," said Ashraf Laidi, chief FX strategist at CMC Markets US in New York.
U.S. markets appeared poised for another selloff on Tuesday after ratings agencies downgraded AIG's debt, complicating its battle for survival. Shockwaves from the Wall Street crisis prompted the Reserve Bank of Australia to pump nearly A$1.8 billion ($1.5 billion) into the banking system in its second injection in two days. The Reserve Bank of India added almost 60 billion rupees ($1.32 billion) through a refinance operation, its biggest injection in at least a month.
Hong Kong, South Korea, Taiwan, New Zealand and Indonesia all offered verbal reassurances, as did governments in Europe. Russia's central bank injected a record $14 billion on one-day funds while in Norway the central bank allotted $5 billion in one-week foreign exchange swaps, having earlier in the day suspended a new fixing for daily money market rates due to lack of liquidity. Paris, Berlin and Rome have all made statements saying banks on their own patches should see only 'limited damage' from events on the other side of the Atlantic.
Germany's Steinbrueck said one risk outside the financial sector was the extent to which banks would stop lending to firms and individuals, hitting the economy more generally. Eric Woerth, France's budget minister, said he believed the crisis remained primarily one for investors and the financial sector but not retail bank depositors, even if they too could suffer from banks being less willing to lend.
M O R E. . .
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Click here for a link to complete article:
By Mark Felsenthal, Kerstin Gehmlich, and Chikako Mogi | 16 September 2008
|
Stocks extended their slide, with Europe's FTSEurofirst index hitting a three-year low at one stage as investors fretted over events on Wall Street, where Lehman Brothers, once thought 'too big to fail', filed for bankruptcy protection on Monday, and where another, even larger giant, insurer AIG, is seeking survival help. "It's clear that this financial market crisis is the worst worldwide in decades— and it is not over," Germany's finance minister, Peer Steinbrueck, told parliament. The Federal Reserve pumped in $50 billion into the markets on Tuesday, following up on the $70 billion it provided on Monday, and said it was ready to do more.
There was even market speculation that the Fed could reduce interest rates by as much as a half percentage point at a meeting it was holding on Tuesday. The European Central Bank injected 70 billion euros ($98.09 billion) into the money markets on Tuesday, after 30 billion the day before. Demand from banks for Tuesday's funds, a measure of how much other sources of liquidity are drying up, topped 100 billion. In Britain, the Bank of England injected 20 billion pounds ($35.21 billion), after five billion on Monday. Demand was three times the amount of extra liquidity offered on Tuesday.
Wheels Slowing
The cost of borrowing dollars 'overnight', as revealed by the LIBOR (London interbank offered rate) fixing, more than doubled to 6.43750 percent from 3.10625 percent on Monday, its highest since January 2001, the latest fixing by the British Banker's Association on Tuesday showed. "This is much worse than August last year," said one market source, referring to the day the credit crunch snowballed out of the United States, forcing central banks to launch emergency liquidity operations.
Asian central banks also rolled into action, with those of Japan, Australia and India flooding money markets with cash. The region's banks doled out $17 billion, following Monday's $70 billion Federal Reserve injection. The Bank of Japan made its biggest cash injection in almost six months— 1.5 trillion yen ($14.2 billion)— and the prime minister met top financial policy makers to discuss events. The rates at which banks lend to each other jumped in South Korea too, and in the financial hub of Hong Kong, while Asian stock markets, many of them closed for a holiday on Monday, tumbled and currencies whipsawed.
FED Cut?
The Bank of Japan is expected to leave its key interest rate unchanged at 0.5 percent on Wednesday. In contrast, markets were pricing in an almost 100 percent chance of a quarter-point cut in the U.S. benchmark rate, to 1.75 percent at a Fed meeting on Tuesday. And U.S. short-term interest rate futures showed about a one-in-three chance that the Fed would cut by half a percentage point, to 1.5 percent. "The U.S. central bank is facing a state of crisis in the financial markets from a perspective of solvency, liquidity and confidence," said Ashraf Laidi, chief FX strategist at CMC Markets US in New York.
U.S. markets appeared poised for another selloff on Tuesday after ratings agencies downgraded AIG's debt, complicating its battle for survival. Shockwaves from the Wall Street crisis prompted the Reserve Bank of Australia to pump nearly A$1.8 billion ($1.5 billion) into the banking system in its second injection in two days. The Reserve Bank of India added almost 60 billion rupees ($1.32 billion) through a refinance operation, its biggest injection in at least a month.
Hong Kong, South Korea, Taiwan, New Zealand and Indonesia all offered verbal reassurances, as did governments in Europe. Russia's central bank injected a record $14 billion on one-day funds while in Norway the central bank allotted $5 billion in one-week foreign exchange swaps, having earlier in the day suspended a new fixing for daily money market rates due to lack of liquidity. Paris, Berlin and Rome have all made statements saying banks on their own patches should see only 'limited damage' from events on the other side of the Atlantic.
Germany's Steinbrueck said one risk outside the financial sector was the extent to which banks would stop lending to firms and individuals, hitting the economy more generally. Eric Woerth, France's budget minister, said he believed the crisis remained primarily one for investors and the financial sector but not retail bank depositors, even if they too could suffer from banks being less willing to lend.
|
M O R E. . .
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Sunday, September 14, 2008
Outside the Box: "Dead Men Walking"
Outside the Box
By John Mauldin | 25 August 2008
Last Friday's letter was about the fact that it is not just Freddie and Fannie. There are other problems. The Weekend Edition and today's Wall Street Journal are filled with stories about the problems with Freddie and Fannie. The assumption in so many quarters is that they will soon need government assistance. The only questions seem to be when and in what form? Can this wait until a new president is in place? Congress is leaving town soon. Can it wait until the lame duck session?
As I have been writing for well over a year, the credit crisis is going to be deeper and take longer to correct than the main stream media and economists think. Losses at banks are going to be much larger, and they are going to bleed for a long time. That means we are going to see more banks failing. Bennet Sedacca, whom I quoted in last week's letter, sent out a new letter this morning, providing a list of stocks he thinks may also be in trouble, his "Dead Men Walking" list. He also notes several banks that will be the beneficiaries of the crisis as they gobble up weak competitors.
Caveat: I am not a stock guy, and can't comment on any of the specifics of what Bennet writes about, but I thought it important for my readers to understand that this crisis is not going to be over when Freddie and Fannie are nationalized. There are still some whales out there left which are coming to the surface. Warning: this is not pleasant reading. (Bennet is the president of Atlantic Advisors in Winter Park, Florida.)
.
"Dead Men Walking"
By Bennet Sedacca | 25 August 2008
Dead Man Walking— Originally, a phrase in a poem by Thomas Hardy in 1909, but later in a work of non-fiction by Sister Helen Prejean, A Roman catholic nun and one of the Sisters of Saint Joseph of Medaille. Prejean later wrote 'Dead Man Walking', which became a hit movie in 1995. The title comes from the traditional exclamation "dead man walking, dead man walking here" used by prison guards as the condemned are led to their execution.
Death Row— A term that refers to the section of a prison that houses individuals awaiting execution. It is also used to refer to the state of awaiting execution, even in places where a special section does not exist. As of 2008, there were 3,263 prisoners awaiting execution in the United States.
The Last Mile— "I guess sometimes the past just catches up to you, whether you want it to or not. Usually death row is called 'The Last Mile'. We called ours 'The Green Mile'— the floor was the color of faded limes." — Tom Hanks as Paul Edgecomb in 'The Green Mile'.
Are There Corporations that are "Dead Men Walking"?
The title of this piece sums up how I feel about the current credit markets. When I first started in the industry in 1981 we were worried, but only about one company— the Chrysler Corporation. Prior to that, Continental Illinois was in the forefront. Later in my career, in 1998, it was Long Term Capital Management, the hedge fund founded by John Meriwether that captured our attention. Then we had Enron/WorldCom, and by early 2008 Bear Stearns became a worry and then a problem that needed 'fixing'.
All of these events were isolated, dealt with, often with either direct assistance from Uncle Sam or an effort coordinated by our benevolent/socialist government financial authorities. Markets would become unnerved, fear would grow, and then the Government would step in to make sure that the 'systemic risk' that had finally come to the surface didn't melt the entire planet.
But this is where it is "different this time". Not only is it different, I think it may be unprecedented in nature. When I look at my Bloomberg monitor each day that contains my 100 most important indices, companies, commodities, bonds, bond spreads, preferred shares, etc, I shudder. The reason I shudder is that my screen doesn't have just one "problem child". It looks like a screen that contains many "dead men walking".
The Failed Fannie Mae/Freddie Mac Experiment
I recently wrote a piece entitled The Tale of Two Markets, where I talked about the "Fannie Mae/Freddie Mac Experiment". That experiment has now clearly failed and a bailout/privatization/nationalization of Fannie and Freddie is now being planned. While I have been expecting nationalization for quite a while, I am intrigued along with my peers and colleagues as to why the bailout is taking so long to accomplish. This is where it gets interesting and dangerous from a systemic point of view. My hunch is that the reason for the delay is that the Treasury Department is "peeling back the onion" on Fannie/Freddie and finding out just how much of a mess the two of them are in.
At last count, Freddie had Level 3 Assets of $151 billion while Fannie had $65 billion, for a not-so-paltry sum of $216 billion. When Freddie announced their results a couple of quarters back, they disclosed that most of their Level 3 Assets were of the "sub-prime" variety (the type of assets that started the whole Credit Crisis in the first place). They are also littered with Alt-A mortgages and are leveraged to the hilt.
Just how bad is the news at Fannie/Freddie? On Friday morning [[several weeks ago; see date above: normxxx]], Moody's downgraded their outstanding preferred stock 5 notches from A1 to Baa3 (a slight gradation above junk) and their Bank Financial Strength Ratings (BSFR) to D+ from B— (one/half notch above D, which is reserved for companies in default). According to Moody's, "the downgrade of the BFSR reflects Moody's view that Fannie Mae and Freddie Mac's financial flexibility to manage potential volatility in its mortgage risk exposures is constricted.....in particular, given recent market movement, Moody's believe these companies currently have limited access to common and preferred equity capital at economically attractive terms." "Dead men walking" defined!
Moody's went on to say,
Let me put it this way. "We the people" are about to become owners in Fannie and Freddie, whether we like it or not. The capital markets have shut on them both as their stocks trade in the $2 - $5 range, down from the $70 - $80 level just a year ago. And the yield on the outstanding preferred shares hovers in the 18% - 23% range, quite the bargain if they keep paying, but also it is the market's way of saying "beware the value trap", as the preferred shares may pay another dividend or two, but that is likely about it.
When the Treasury peels back the onion, I believe they will find a hornet's nest. I think we will see an initial bailout of $100 billion or so, with 2/3-3/4 going to Fannie (as it is a larger organization). The scenario I foresee however, just as happened at Merrill Lynch, Lehman Brothers and Morgan Stanley, is that they came to the financing window expecting to have borrowed enough, but then find they have to keep coming back repeatedly until the buyers go away or until "We The People" have thrown at least $500 billion at Fannie/Freddie to get them back on their feet again. This will also likely take an Act of Congress to raise the Treasury's Debt ceiling quite dramatically.
I will now identify who might be the other "Dead Men Walking".
More Dead Men Walking— Is There a Pattern?
What strikes me the most about impaired companies, whether they are automakers, airline companies, banks, brokers or GSE's, is that they seem to sing the same tune, or have the same pattern of behavior. This is how I have attempted in the past to identify what would be in trouble in the future (whether that was just to avoid their stocks and bonds from the long side or to try to profit from their missteps on the short side). It is a pattern that is not terribly dissimilar from the emotion charts I like to focus on so much. In the graphic below, I will offer my "recipe for disaster" for a bank or brokerage firm. I would like this cycle to be called, "The Dead Man Walking Cycle".
The first tip-off or "tell" is when a company releases earnings or some sort of positive announcement and the stock falls. Another important tell is the credit spreads of the debt as the company begins to widen. Then, the company will usually announce that "all is well" and is so great that they will buy back stock and not "cut the common dividend". After this comes the "acceptance" phase and write-offs/write-downs are announced and then some Sovereign Wealth Fund or Private Equity firm will inject capital or that a company within the same group will buy a "strategic stake". After a brief pop in the stock and short covering rally, the stock begins to fall further and credit spreads begin to blow out and preferred shares get hammered. Then, uh-oh, more write-downs and more write-offs and yes, another capital raise and finally a dividend cut to 'preserve capital'.
Sound familiar yet...?
All of this goes on for quite some time, until your stock price is so low that you would have to issue so many shares in a secondary offering that you dilute your shareholder base until it is unrecognizable. With any new share offering, your credit, while still rated 'investment grade', trades like junk, and your preferred shares rise to double digit yields. Further, the former strategic buyers, Sovereign Wealth Funds and Private Equity firms have taken such a beating that there are no further buyers. Yet the write-downs and write-offs continue unmercifully as the economy slows and credit is all but cut off.
Eventually, dividends go to zero and you are a "Dead Man Walking". There are only a few things that can happen to the companies that are walking "The Green Mile". Either you make it to the electric chair (in the movie "The Green Mile" it was called "Old Sparky") and cease to exist or you are eventually forced into the arms of a better capitalized institution. Over time, I expect a bit of both but mostly of the latter.
Keep in mind that if too many are allowed into the arms of "Big Sparky", it [must] have a 'systemic' effect as all the institutions are now so totally intertwined, [that] when one group of institutions is forced to 'mark their bonds to market', others are forced to do the same, ending in an ugly daisy chain. I think the chain has now formed and that many are about to "walk the mile".
In the end, perhaps years from now, many banks and brokers will be merged into an international list of "good banks" or "Live Men Walking". Who are the Live Men Walking? They are likely Bank of America, Bank of New York, JP Morgan Chase, Northern Trust, State Street, US Bancorp, ABN Amro, Deutsche Bank, BNP Paribas, Royal Bank of Scotland, Barclays, Allianz and a few others. The following cycle is how the cycle goes from good bank to 'Dead Man Walking'.
Click Here, or on the image, to see a larger, undistorted image.
Who Are the Dead Men Walking?
Above, the cycle begins with denial, and ultimately ends up in despair. At first, the company denounces that anything is wrong, but Mr. Market has a way of sniffing out who is imitating Pinocchio. Ultimately, the company ends up in despair when they need/want to raise capital to just be able to function normally, but alas, they cannot because the window of opportunity to raise capital has shut.
Let's use Lehman Brothers as the poster child of this sort of behavior. I wrote a piece last week that singled out National City, Washington Mutual and Lehman Brothers. Before the credit crisis started, Lehman, at the time known for its savvy timing, suddenly came to market for $5 billion of long-term bonds when they didn't need capital-or did they know something was awry as I suspect? Last year, with the Credit Crisis in its infancy, Lehman announced a $100,000,000 stock buyback. The shares, as you would expect, popped on the news, but of course no stock was ever re-purchased. As the stock began to sell off again, they kept saying that capital was not needed.
Then, on June 9, 2008 they sold 143,000,000 shares at $28 per share. As hedge fund manager David Einhorn said, "They've raised billions of dollars they said they didn't need to replace losses they said they didn't have." In between was an enormous preferred stock deal— 75,900,000 shares at $25 per share at a rate of 7.95%. Those shares now change hands at $15 per share for a yield of 13.1%. Its pretty hard to turn a profit when your cost of capital is greater than 10%.
During this time, in January, the company actually raised its common dividend by 15% year-over-year. They have written off north of $8 billion since the Credit Crisis began and when they release earnings (or lack thereof) next month, estimates are for another round of $2 - $4 billion of write-downs. They have reportedly been trying to shop $40 billion of impaired real estate and they are mired in all sorts of Alt A, sub-prime, CMBS and CDOs and CLOs.
The best part is that they said they "shrank their balance sheet" when in fact they were sold to an "off balance sheet subsidiary" that they own part of. The bonds weren't sold, they were just "relocated". I sure wish I could do that when I make a mistake. And lets not forget that the Federal Reserve opened up the discount window to primary/dealers so that they could off-load a bunch of nuclear waste on to the Fed's balance sheet, which now looks like one big hedge fund in drag. And then the SEC temporarily changed short selling rules for 'the Group of 19' (the GSE's and Primary Dealers) for a few weeks, resulting in a short squeeze, but their shares still hobble along at recent lows.
On Friday, there was a rumor that the Korean Development Bank would buy Lehman, but again that turned out to be hogwash. And if they wanted to raise debt, like they say, "lotsa luck". Their bonds trade around +500 basis points to treasuries but my guess is that even if they could get a deal done, they would have to come in the 10+% range, again uneconomic.
So now we have the recipe and an example for "Dead Men Walking":
Now that we have identified the "poster child", let's find a few more... Or sadly, more than a few.
Zions Bancorp
Tried to issue a $200 million preferred stock offering at 9.5% but only was able to sell $47 million.
Their debt trades in the open market approximately 1,000 basis points above Treasuries, IF you can sell them, or 13 - 14%.
They are geographically in Utah, but spread out to Florida, Nevada and Arizona at the top of housing to take advantage of those 'great opportunities'.
They say they need $200-300 million capital. Good luck.
They maintained their common dividend.
KeyCorp
Preferred Stock trades at 13%.
Debt trades in the market at 10-11% dividend.
Cut dividend in half in July, still yields 6.5% even while they lose money.
Fifth Third Bank
There are no preferred issues outstanding.
Debt trades in 10-11% range if you can sell it.
Cut dividend by 75%.
Washington Mutual
No preferred outstanding except convertible preferred.
Debt trades in the 20-25% range.
Cut the dividend to $0.01 per share in April.
Has admitted they will lose money for the next several years.
National City
Preferred stock trades at 13-15%.
Sold a huge amount of shares at $5 per share in April.
Cut dividend to $0.01 per share in April.
Regions Financial
Preferred Stock Trading at 10%.
Debt trades in the 10-11% range, if you can sell it.
Cut dividend by 75% in June.
Needs to raise $2 billion, according to Sanford Bernstein.
General Motor/GMAC
Preferred stock trades in 18% area.
Short-term debt trades in 25-30% range.
Long-term debt trades in 17% range.
Eliminated common dividend in July.
Ford/Ford Motor Credit Co
Preferred stock trades in 16-17% range.
Long term debt trades in the 18-20% range.
Eliminated common dividend in September.
Wachovia
Issued a $3.5 billion "hybrid security" in February that now trades at 11%.
S&P has stated they cannot issue any more hybrids.
Sold 92,000,000 shars of a preferred stock in December at 8% that now trades $18 or 11%.
Cut common dividend twice since February to $.05 a share or 90%.
Debt trades at 9.5-10.5%.
CitiGroup
Who are in the "Limping but Not (Yet) 'Dead Man Walking' Crowd"?
These companies would include those that may be 'too big to fail', have enough quality assets to sell, a franchise that is worth something to an acquirer or could just be broken up into pieces.
They include:
Summary— This is NOT Shaping Up to be a Pretty Couple of Years
I am certain that I have missed a bunch of names on the "Dead man Walking List", but the pattern is rather easy to discern. As I stated early on, when we have one or two firms in trouble, we can deal with it. But when we add rising unemployment, the explosive debt growth of recent years, and 'non-performing' assets to many hobbled financial institutions with trillions of dollars of exposure, it is hard not to be concerned. For this reason, we remain cautious towards credit, expect a hard sell-off in stocks into 2010, consolidation in the financial services industry and some pain, like it or not. I am just not sure where the capital will come from to bail everyone out simultaneously. And even if the capital showed up, it would likely come at a cost that is uneconomic and would likely be dilutive for many years to come.
It is why we expect much lower than consensus earnings across the board and lower stock prices ahead. In the meantime, we sit with our historically cheap GNMA's at the widest spreads in 20 years and continue to add to that position. In the meantime we position our portfolios so that if we are wrong, the most we can lose is opportunity, not precious capital.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By John Mauldin | 25 August 2008
Last Friday's letter was about the fact that it is not just Freddie and Fannie. There are other problems. The Weekend Edition and today's Wall Street Journal are filled with stories about the problems with Freddie and Fannie. The assumption in so many quarters is that they will soon need government assistance. The only questions seem to be when and in what form? Can this wait until a new president is in place? Congress is leaving town soon. Can it wait until the lame duck session?
As I have been writing for well over a year, the credit crisis is going to be deeper and take longer to correct than the main stream media and economists think. Losses at banks are going to be much larger, and they are going to bleed for a long time. That means we are going to see more banks failing. Bennet Sedacca, whom I quoted in last week's letter, sent out a new letter this morning, providing a list of stocks he thinks may also be in trouble, his "Dead Men Walking" list. He also notes several banks that will be the beneficiaries of the crisis as they gobble up weak competitors.
Caveat: I am not a stock guy, and can't comment on any of the specifics of what Bennet writes about, but I thought it important for my readers to understand that this crisis is not going to be over when Freddie and Fannie are nationalized. There are still some whales out there left which are coming to the surface. Warning: this is not pleasant reading. (Bennet is the president of Atlantic Advisors in Winter Park, Florida.)
.
"Dead Men Walking"
By Bennet Sedacca | 25 August 2008
Dead Man Walking— Originally, a phrase in a poem by Thomas Hardy in 1909, but later in a work of non-fiction by Sister Helen Prejean, A Roman catholic nun and one of the Sisters of Saint Joseph of Medaille. Prejean later wrote 'Dead Man Walking', which became a hit movie in 1995. The title comes from the traditional exclamation "dead man walking, dead man walking here" used by prison guards as the condemned are led to their execution.
Death Row— A term that refers to the section of a prison that houses individuals awaiting execution. It is also used to refer to the state of awaiting execution, even in places where a special section does not exist. As of 2008, there were 3,263 prisoners awaiting execution in the United States.
The Last Mile— "I guess sometimes the past just catches up to you, whether you want it to or not. Usually death row is called 'The Last Mile'. We called ours 'The Green Mile'— the floor was the color of faded limes." — Tom Hanks as Paul Edgecomb in 'The Green Mile'.
Are There Corporations that are "Dead Men Walking"?
The title of this piece sums up how I feel about the current credit markets. When I first started in the industry in 1981 we were worried, but only about one company— the Chrysler Corporation. Prior to that, Continental Illinois was in the forefront. Later in my career, in 1998, it was Long Term Capital Management, the hedge fund founded by John Meriwether that captured our attention. Then we had Enron/WorldCom, and by early 2008 Bear Stearns became a worry and then a problem that needed 'fixing'.
All of these events were isolated, dealt with, often with either direct assistance from Uncle Sam or an effort coordinated by our benevolent/socialist government financial authorities. Markets would become unnerved, fear would grow, and then the Government would step in to make sure that the 'systemic risk' that had finally come to the surface didn't melt the entire planet.
But this is where it is "different this time". Not only is it different, I think it may be unprecedented in nature. When I look at my Bloomberg monitor each day that contains my 100 most important indices, companies, commodities, bonds, bond spreads, preferred shares, etc, I shudder. The reason I shudder is that my screen doesn't have just one "problem child". It looks like a screen that contains many "dead men walking".
The Failed Fannie Mae/Freddie Mac Experiment
I recently wrote a piece entitled The Tale of Two Markets, where I talked about the "Fannie Mae/Freddie Mac Experiment". That experiment has now clearly failed and a bailout/privatization/nationalization of Fannie and Freddie is now being planned. While I have been expecting nationalization for quite a while, I am intrigued along with my peers and colleagues as to why the bailout is taking so long to accomplish. This is where it gets interesting and dangerous from a systemic point of view. My hunch is that the reason for the delay is that the Treasury Department is "peeling back the onion" on Fannie/Freddie and finding out just how much of a mess the two of them are in.
At last count, Freddie had Level 3 Assets of $151 billion while Fannie had $65 billion, for a not-so-paltry sum of $216 billion. When Freddie announced their results a couple of quarters back, they disclosed that most of their Level 3 Assets were of the "sub-prime" variety (the type of assets that started the whole Credit Crisis in the first place). They are also littered with Alt-A mortgages and are leveraged to the hilt.
Just how bad is the news at Fannie/Freddie? On Friday morning [[several weeks ago; see date above: normxxx]], Moody's downgraded their outstanding preferred stock 5 notches from A1 to Baa3 (a slight gradation above junk) and their Bank Financial Strength Ratings (BSFR) to D+ from B— (one/half notch above D, which is reserved for companies in default). According to Moody's, "the downgrade of the BFSR reflects Moody's view that Fannie Mae and Freddie Mac's financial flexibility to manage potential volatility in its mortgage risk exposures is constricted.....in particular, given recent market movement, Moody's believe these companies currently have limited access to common and preferred equity capital at economically attractive terms." "Dead men walking" defined!
Moody's went on to say,
|
Let me put it this way. "We the people" are about to become owners in Fannie and Freddie, whether we like it or not. The capital markets have shut on them both as their stocks trade in the $2 - $5 range, down from the $70 - $80 level just a year ago. And the yield on the outstanding preferred shares hovers in the 18% - 23% range, quite the bargain if they keep paying, but also it is the market's way of saying "beware the value trap", as the preferred shares may pay another dividend or two, but that is likely about it.
When the Treasury peels back the onion, I believe they will find a hornet's nest. I think we will see an initial bailout of $100 billion or so, with 2/3-3/4 going to Fannie (as it is a larger organization). The scenario I foresee however, just as happened at Merrill Lynch, Lehman Brothers and Morgan Stanley, is that they came to the financing window expecting to have borrowed enough, but then find they have to keep coming back repeatedly until the buyers go away or until "We The People" have thrown at least $500 billion at Fannie/Freddie to get them back on their feet again. This will also likely take an Act of Congress to raise the Treasury's Debt ceiling quite dramatically.
I will now identify who might be the other "Dead Men Walking".
More Dead Men Walking— Is There a Pattern?
What strikes me the most about impaired companies, whether they are automakers, airline companies, banks, brokers or GSE's, is that they seem to sing the same tune, or have the same pattern of behavior. This is how I have attempted in the past to identify what would be in trouble in the future (whether that was just to avoid their stocks and bonds from the long side or to try to profit from their missteps on the short side). It is a pattern that is not terribly dissimilar from the emotion charts I like to focus on so much. In the graphic below, I will offer my "recipe for disaster" for a bank or brokerage firm. I would like this cycle to be called, "The Dead Man Walking Cycle".
The first tip-off or "tell" is when a company releases earnings or some sort of positive announcement and the stock falls. Another important tell is the credit spreads of the debt as the company begins to widen. Then, the company will usually announce that "all is well" and is so great that they will buy back stock and not "cut the common dividend". After this comes the "acceptance" phase and write-offs/write-downs are announced and then some Sovereign Wealth Fund or Private Equity firm will inject capital or that a company within the same group will buy a "strategic stake". After a brief pop in the stock and short covering rally, the stock begins to fall further and credit spreads begin to blow out and preferred shares get hammered. Then, uh-oh, more write-downs and more write-offs and yes, another capital raise and finally a dividend cut to 'preserve capital'.
Sound familiar yet...?
All of this goes on for quite some time, until your stock price is so low that you would have to issue so many shares in a secondary offering that you dilute your shareholder base until it is unrecognizable. With any new share offering, your credit, while still rated 'investment grade', trades like junk, and your preferred shares rise to double digit yields. Further, the former strategic buyers, Sovereign Wealth Funds and Private Equity firms have taken such a beating that there are no further buyers. Yet the write-downs and write-offs continue unmercifully as the economy slows and credit is all but cut off.
Eventually, dividends go to zero and you are a "Dead Man Walking". There are only a few things that can happen to the companies that are walking "The Green Mile". Either you make it to the electric chair (in the movie "The Green Mile" it was called "Old Sparky") and cease to exist or you are eventually forced into the arms of a better capitalized institution. Over time, I expect a bit of both but mostly of the latter.
Keep in mind that if too many are allowed into the arms of "Big Sparky", it [must] have a 'systemic' effect as all the institutions are now so totally intertwined, [that] when one group of institutions is forced to 'mark their bonds to market', others are forced to do the same, ending in an ugly daisy chain. I think the chain has now formed and that many are about to "walk the mile".
In the end, perhaps years from now, many banks and brokers will be merged into an international list of "good banks" or "Live Men Walking". Who are the Live Men Walking? They are likely Bank of America, Bank of New York, JP Morgan Chase, Northern Trust, State Street, US Bancorp, ABN Amro, Deutsche Bank, BNP Paribas, Royal Bank of Scotland, Barclays, Allianz and a few others. The following cycle is how the cycle goes from good bank to 'Dead Man Walking'.
The "Dead Man Walking" Cycle
Click Here, or on the image, to see a larger, undistorted image.
Who Are the Dead Men Walking?
Above, the cycle begins with denial, and ultimately ends up in despair. At first, the company denounces that anything is wrong, but Mr. Market has a way of sniffing out who is imitating Pinocchio. Ultimately, the company ends up in despair when they need/want to raise capital to just be able to function normally, but alas, they cannot because the window of opportunity to raise capital has shut.
Let's use Lehman Brothers as the poster child of this sort of behavior. I wrote a piece last week that singled out National City, Washington Mutual and Lehman Brothers. Before the credit crisis started, Lehman, at the time known for its savvy timing, suddenly came to market for $5 billion of long-term bonds when they didn't need capital-or did they know something was awry as I suspect? Last year, with the Credit Crisis in its infancy, Lehman announced a $100,000,000 stock buyback. The shares, as you would expect, popped on the news, but of course no stock was ever re-purchased. As the stock began to sell off again, they kept saying that capital was not needed.
Then, on June 9, 2008 they sold 143,000,000 shares at $28 per share. As hedge fund manager David Einhorn said, "They've raised billions of dollars they said they didn't need to replace losses they said they didn't have." In between was an enormous preferred stock deal— 75,900,000 shares at $25 per share at a rate of 7.95%. Those shares now change hands at $15 per share for a yield of 13.1%. Its pretty hard to turn a profit when your cost of capital is greater than 10%.
During this time, in January, the company actually raised its common dividend by 15% year-over-year. They have written off north of $8 billion since the Credit Crisis began and when they release earnings (or lack thereof) next month, estimates are for another round of $2 - $4 billion of write-downs. They have reportedly been trying to shop $40 billion of impaired real estate and they are mired in all sorts of Alt A, sub-prime, CMBS and CDOs and CLOs.
The best part is that they said they "shrank their balance sheet" when in fact they were sold to an "off balance sheet subsidiary" that they own part of. The bonds weren't sold, they were just "relocated". I sure wish I could do that when I make a mistake. And lets not forget that the Federal Reserve opened up the discount window to primary/dealers so that they could off-load a bunch of nuclear waste on to the Fed's balance sheet, which now looks like one big hedge fund in drag. And then the SEC temporarily changed short selling rules for 'the Group of 19' (the GSE's and Primary Dealers) for a few weeks, resulting in a short squeeze, but their shares still hobble along at recent lows.
On Friday, there was a rumor that the Korean Development Bank would buy Lehman, but again that turned out to be hogwash. And if they wanted to raise debt, like they say, "lotsa luck". Their bonds trade around +500 basis points to treasuries but my guess is that even if they could get a deal done, they would have to come in the 10+% range, again uneconomic.
So now we have the recipe and an example for "Dead Men Walking":
- Common stock too low to issue new shares.
- Preferred stock yield too high to issue new shares economically.
- Issuing debt is uneconomic.
- More write-offs coming in days to come.
- Business trends are awful.
- Denial.
Now that we have identified the "poster child", let's find a few more... Or sadly, more than a few.
Zions Bancorp
- Equity has traded down from $75 to $25.
KeyCorp
- Common Stock has traded down from $40 to $11.
Fifth Third Bank
- Equity has traded down from $60 to $14.
Washington Mutual
- Equity has traded from $40 to $3.
National City
- Equity has traded from $40 to $5.
Regions Financial
- Equity down from $40 to $8.
General Motor/GMAC
- Equity has traded from $80 to $10.
Ford/Ford Motor Credit Co
- Equity has traded from $60 to $4.
Wachovia
- Equity has traded from $60 to $14.
CitiGroup
- Equity has traded from 60 to 9.
- Preferred Stock trades in 12% range.
- Outstanding debt trades in 12-14% range.
- Cut common dividend by 66%.
- Sold 91,000,000 shares of common at $11 in April 2008.
Who are in the "Limping but Not (Yet) 'Dead Man Walking' Crowd"?
These companies would include those that may be 'too big to fail', have enough quality assets to sell, a franchise that is worth something to an acquirer or could just be broken up into pieces.
They include:
- Citi
- Merrill Lynch
- Morgan Stanley
- Suntrust
- Legg Mason
- Capital One
- AIG
- MetLife
- Prudential
Summary— This is NOT Shaping Up to be a Pretty Couple of Years
I am certain that I have missed a bunch of names on the "Dead man Walking List", but the pattern is rather easy to discern. As I stated early on, when we have one or two firms in trouble, we can deal with it. But when we add rising unemployment, the explosive debt growth of recent years, and 'non-performing' assets to many hobbled financial institutions with trillions of dollars of exposure, it is hard not to be concerned. For this reason, we remain cautious towards credit, expect a hard sell-off in stocks into 2010, consolidation in the financial services industry and some pain, like it or not. I am just not sure where the capital will come from to bail everyone out simultaneously. And even if the capital showed up, it would likely come at a cost that is uneconomic and would likely be dilutive for many years to come.
It is why we expect much lower than consensus earnings across the board and lower stock prices ahead. In the meantime, we sit with our historically cheap GNMA's at the widest spreads in 20 years and continue to add to that position. In the meantime we position our portfolios so that if we are wrong, the most we can lose is opportunity, not precious capital.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Housing: Are We At The Bottom?
Housing: Are We At The Bottom?
By John Maulden | 14 September 2008
The short answer is no, but let's look at the data from one of the most knowledgeable sources on that topic. John Burns of John Burns Real Estate Consulting consults with over 2000 of the largest banks and homebuilders in the country (his client list is a who's who of banks, builders, and hedge funds). He has a reputation for solid research and pulling no punches.
Some of his hedge fund clients were the ones you read about who made billions. (He wishes he had negotiated a percentage!) He is deeply involved in analyzing trends in the housing market. Click for his web site. He has graciously sent me the executive summary of his latest posting (a 27-page executive summary) that we will be looking at for the next few pages.
Let's start with a quote from John at the beginning of his report: "The prospects for the U.S. housing market have changed for the worse. It has become increasingly clear that the U.S. economy is on the brink of recession, as overall job growth has slowed to zero and retailers are reporting abysmal results. New home sales, traffic and pricing are all heading down according to the results of our survey of over 300 builder executives.
Resale [existing home] sales are starting to plateau in some markets, but pricing continues to fall as distressed sales dominate the market. The new housing bill will help in some ways, but will first serve a devastating blow to homebuilders, with the elimination of seller-funded down payment assistance, which "accounts for 17% of new home demand, by one estimate."
How far along are we? Burns thinks that home prices will drop by 22%, 12% of which has already occurred. His analysis differs from that of the Case-Shiller Indices, which suggests a much steeper decline [[and a much lower bottom, eg, 35% to 50%, from the peak: normxxx]]. Note in the graph below that the Case-Shiller Index shows home prices rising more than does Burns' work. Part of it is different methodology and part of it is that the CS index focuses on major markets and Burns' work is more broadly based.
Click Here, or on the image, to see a larger, undistorted image.
However you slice it, there has been a lot of pain. Shiller's work shows home prices in the areas he measures to be down about 17%. He said last week that he does not think it unlikely that we will see home prices drop by as much as 30%, or about the same as during the Depression of the '30s. Burns sees less of a drop, but from not as high a point, so they both end up close to the same end point. [[Anyway you slice it, both indicate we are only halfway through the drop in housing prices!: normxxx]]
The graph above shows Burns' projection for the next few years. He thinks it will be 2011 before housing prices begin to turn back up on a nationwide basis, with national prices continuing to fall into 2010. That will not sit well with the pundits who keep telling us each month that we have seen the bottom.
Click Here, or on the image, to see a larger, undistorted image.
For the difference in his numbers with Case-Shiller, he offers the following explanation: "The Case-Shiller national number, which is a 'paired sales' analysis, showed much more price appreciation than other indices based on median prices. We suspect that there was a shift in the mix of homes sold to lower priced homes in 2006 due to subprime lending, which depressed the median value and showed large percent increases in the paired sales index."
Sales volumes are suffering and will continue to suffer.
Click Here, or on the image, to see a larger, undistorted image.
On a more optimistic note, he thinks new home prices, which started to correct much earlier than existing home prices, should bottom out in 2009, although some particularly overbuilt areas will suffer longer. [He thinks w]e are actually close to a bottom in new home construction, and we will be back to 900,000 new homes by 2012. That is a far cry from the 1.68 million in 2005, but it is also a more sustainable number.
There is a problem though, and that is that the recently enacted housing bill eliminated seller-funded down payments, and this was 17% of new home sales. Watch for a rise in the number of new homes sold in September, as the new law does not take effect until October. Home builders will be telling people to buy now before this ability to help with the down payment goes away. But cheerleaders on TV will be telling us the market has turned. They won't be saying that in November.
Alt-A Is The New Subprime
By now, everyone in the world is aware of how bad the subprime mortgage business was. But now it is time to get ready to hear the same tale, told again, about Alt-A mortgages. These are mortgages made to borrowers with better credit scores than subprime borrowers, but who 'could not' or 'decided not' to document their income. One estimate is that 70% of Alt-A borrowers may have [[grossly?: normxxx]] exaggerated their incomes (Wholesale Access). More than half of those were people who exaggerated their incomes by 50% or more! (Mortgage Asset Research Institute)
How much are we talking about? Around 3 million US borrowers have Alt-A mortgages totaling $1 trillion, compared with $855 billion of subprime loans outstanding. $400 billion of that was sold in 2006. Almost 16% of securitized Alt-A loans issued since January 2006 are at least 60 days late. Many of these loans (around $270 billion) were interest-only or with a low teaser rate, and the resets were at 3- and 5-year lengths.
These are called Option ARMs. That means starting next year we are going to see another wave of mortgages resetting to new rates. And it is no modest increase. Rates can jump 4% - 8% or more from teaser rates. Some Option ARMs are resetting at 12.25%. That can double a payment.
Wachovia and Washington Mutual were big sellers of Alt-A loans, and had $122 billion and $53 billion, respectively, on their books at the end of the second quarter. Is it any wonder their stocks are under pressure? That is why it is so hard to quantify how many more write-offs there will be. You [can't] write down a mortgage until it starts to develop problems. These problems may not show up for a few years. I continue to stress I do not want to own a financial stock that has exposure to mortgage paper.
Write-downs are going to continue to come for a long, long time. This means there will be a steady wave of foreclosures for the next two years in communities all over the US. As long as these homes keep coming onto the market, they are going to exert downward pressure on prices. Foreclosure sales are up by 109% from this time last year.
3.5 Million Unemployed And Counting
The number of people receiving unemployment benefits jumped to 3.525 million, the highest level since 2003. My friend, Chief Economist John Silvia at Wachovia forecasts that unemployment will rise to 6.7% in 2009 (from 5.5% today) and above 7% in 2010. Given the inability of US consumers to borrow against their homes, and with rising unemployment, is it any wonder that consumer spending data released this morning showed retail sales dropping 0.3% in August, for the second month in a row (July was down 0.5%)? Excluding automobiles, sales dropped 0.7% in August, the most this year.
Look at this chart from Greg Weldon. As he notes, retail sales are posting their worst reading since the last recession.
Click Here, or on the image, to see a larger, undistorted image.
Prices at the wholesale level actually fell. Silvia thinks the Consumer Price Index will be in the neighborhood of 2%. Right now, a lot of people think that sounds crazy; but I agree. First, remember that CPI measures changes from 12 months ago. As an example, look at the oil price chart below. Starting next spring, unless energy prices rise a lot, we are going to see year-over-year comparisons for energy prices that will be negative. If oil drops to $80, which it very well could, that would have the affect of decreasing inflation next summer, by a significant amount.
And given that Europe and Japan are well into a recession, and emerging markets have reduced demand because of high prices, thinking that oil in the short term could be lower is not unreasonable. (Long-term I think oil will go MUCH higher, but that is another story.) A 40% reduction in gas prices from their peak is not out of the question. That would impact inflation by pulling it down.
You can make the same case for a lot of commodities and some of the food complex as well. Year-over-year comparisons are going to start to look good in a few quarters. In absolute terms, looking back a few years, it will still feel like inflation, but the numbers don't have feelings.
With Europe and Great Britain central banks likely to cut rates, the dollar is going to get stronger (as predicted here long ago). That will also help hold inflation down. Consumer spending is going to continue to be under pressure, which will not be good for stocks, which means that those facing retirement are going to have to save more and spend less.
I think this time next year we will start to see stories about DEflation. I know, call me crazy, but given that we have seen two major bubbles burst in the last year (housing and credit), it is not out of the realm of reason. It is what SHOULD happen. Bursting bubbles are by definition DEflationary events.
Within a very few quarters the Fed will hardly be under pressure to raise rates, especially with rising unemployment and what is clearly an economy on the ropes. [[We are already seeing the leading edge of a bust in retail sales.: normxxx]] Further, the banks need lower rates in order to re-liquify. Home buyers will need lower rates as well. I think, as I have written for a long time, that the Fed is [[at least: normxxx]] on hold for a very long time. And I am not sanguine that the next move will be a rate hike. This time next year when inflation is seen as yesterday's problem and unemployment is rising, the drums will be pounding for a rate cut. We live in interesting times.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By John Maulden | 14 September 2008
The short answer is no, but let's look at the data from one of the most knowledgeable sources on that topic. John Burns of John Burns Real Estate Consulting consults with over 2000 of the largest banks and homebuilders in the country (his client list is a who's who of banks, builders, and hedge funds). He has a reputation for solid research and pulling no punches.
Some of his hedge fund clients were the ones you read about who made billions. (He wishes he had negotiated a percentage!) He is deeply involved in analyzing trends in the housing market. Click for his web site. He has graciously sent me the executive summary of his latest posting (a 27-page executive summary) that we will be looking at for the next few pages.
Let's start with a quote from John at the beginning of his report: "The prospects for the U.S. housing market have changed for the worse. It has become increasingly clear that the U.S. economy is on the brink of recession, as overall job growth has slowed to zero and retailers are reporting abysmal results. New home sales, traffic and pricing are all heading down according to the results of our survey of over 300 builder executives.
Resale [existing home] sales are starting to plateau in some markets, but pricing continues to fall as distressed sales dominate the market. The new housing bill will help in some ways, but will first serve a devastating blow to homebuilders, with the elimination of seller-funded down payment assistance, which "accounts for 17% of new home demand, by one estimate."
How far along are we? Burns thinks that home prices will drop by 22%, 12% of which has already occurred. His analysis differs from that of the Case-Shiller Indices, which suggests a much steeper decline [[and a much lower bottom, eg, 35% to 50%, from the peak: normxxx]]. Note in the graph below that the Case-Shiller Index shows home prices rising more than does Burns' work. Part of it is different methodology and part of it is that the CS index focuses on major markets and Burns' work is more broadly based.
Click Here, or on the image, to see a larger, undistorted image.
However you slice it, there has been a lot of pain. Shiller's work shows home prices in the areas he measures to be down about 17%. He said last week that he does not think it unlikely that we will see home prices drop by as much as 30%, or about the same as during the Depression of the '30s. Burns sees less of a drop, but from not as high a point, so they both end up close to the same end point. [[Anyway you slice it, both indicate we are only halfway through the drop in housing prices!: normxxx]]
The graph above shows Burns' projection for the next few years. He thinks it will be 2011 before housing prices begin to turn back up on a nationwide basis, with national prices continuing to fall into 2010. That will not sit well with the pundits who keep telling us each month that we have seen the bottom.
Click Here, or on the image, to see a larger, undistorted image.
For the difference in his numbers with Case-Shiller, he offers the following explanation: "The Case-Shiller national number, which is a 'paired sales' analysis, showed much more price appreciation than other indices based on median prices. We suspect that there was a shift in the mix of homes sold to lower priced homes in 2006 due to subprime lending, which depressed the median value and showed large percent increases in the paired sales index."
Sales volumes are suffering and will continue to suffer.
|
Click Here, or on the image, to see a larger, undistorted image.
On a more optimistic note, he thinks new home prices, which started to correct much earlier than existing home prices, should bottom out in 2009, although some particularly overbuilt areas will suffer longer. [He thinks w]e are actually close to a bottom in new home construction, and we will be back to 900,000 new homes by 2012. That is a far cry from the 1.68 million in 2005, but it is also a more sustainable number.
There is a problem though, and that is that the recently enacted housing bill eliminated seller-funded down payments, and this was 17% of new home sales. Watch for a rise in the number of new homes sold in September, as the new law does not take effect until October. Home builders will be telling people to buy now before this ability to help with the down payment goes away. But cheerleaders on TV will be telling us the market has turned. They won't be saying that in November.
Alt-A Is The New Subprime
By now, everyone in the world is aware of how bad the subprime mortgage business was. But now it is time to get ready to hear the same tale, told again, about Alt-A mortgages. These are mortgages made to borrowers with better credit scores than subprime borrowers, but who 'could not' or 'decided not' to document their income. One estimate is that 70% of Alt-A borrowers may have [[grossly?: normxxx]] exaggerated their incomes (Wholesale Access). More than half of those were people who exaggerated their incomes by 50% or more! (Mortgage Asset Research Institute)
How much are we talking about? Around 3 million US borrowers have Alt-A mortgages totaling $1 trillion, compared with $855 billion of subprime loans outstanding. $400 billion of that was sold in 2006. Almost 16% of securitized Alt-A loans issued since January 2006 are at least 60 days late. Many of these loans (around $270 billion) were interest-only or with a low teaser rate, and the resets were at 3- and 5-year lengths.
These are called Option ARMs. That means starting next year we are going to see another wave of mortgages resetting to new rates. And it is no modest increase. Rates can jump 4% - 8% or more from teaser rates. Some Option ARMs are resetting at 12.25%. That can double a payment.
Wachovia and Washington Mutual were big sellers of Alt-A loans, and had $122 billion and $53 billion, respectively, on their books at the end of the second quarter. Is it any wonder their stocks are under pressure? That is why it is so hard to quantify how many more write-offs there will be. You [can't] write down a mortgage until it starts to develop problems. These problems may not show up for a few years. I continue to stress I do not want to own a financial stock that has exposure to mortgage paper.
Write-downs are going to continue to come for a long, long time. This means there will be a steady wave of foreclosures for the next two years in communities all over the US. As long as these homes keep coming onto the market, they are going to exert downward pressure on prices. Foreclosure sales are up by 109% from this time last year.
3.5 Million Unemployed And Counting
The number of people receiving unemployment benefits jumped to 3.525 million, the highest level since 2003. My friend, Chief Economist John Silvia at Wachovia forecasts that unemployment will rise to 6.7% in 2009 (from 5.5% today) and above 7% in 2010. Given the inability of US consumers to borrow against their homes, and with rising unemployment, is it any wonder that consumer spending data released this morning showed retail sales dropping 0.3% in August, for the second month in a row (July was down 0.5%)? Excluding automobiles, sales dropped 0.7% in August, the most this year.
Look at this chart from Greg Weldon. As he notes, retail sales are posting their worst reading since the last recession.
Click Here, or on the image, to see a larger, undistorted image.
Prices at the wholesale level actually fell. Silvia thinks the Consumer Price Index will be in the neighborhood of 2%. Right now, a lot of people think that sounds crazy; but I agree. First, remember that CPI measures changes from 12 months ago. As an example, look at the oil price chart below. Starting next spring, unless energy prices rise a lot, we are going to see year-over-year comparisons for energy prices that will be negative. If oil drops to $80, which it very well could, that would have the affect of decreasing inflation next summer, by a significant amount.
And given that Europe and Japan are well into a recession, and emerging markets have reduced demand because of high prices, thinking that oil in the short term could be lower is not unreasonable. (Long-term I think oil will go MUCH higher, but that is another story.) A 40% reduction in gas prices from their peak is not out of the question. That would impact inflation by pulling it down.
You can make the same case for a lot of commodities and some of the food complex as well. Year-over-year comparisons are going to start to look good in a few quarters. In absolute terms, looking back a few years, it will still feel like inflation, but the numbers don't have feelings.
With Europe and Great Britain central banks likely to cut rates, the dollar is going to get stronger (as predicted here long ago). That will also help hold inflation down. Consumer spending is going to continue to be under pressure, which will not be good for stocks, which means that those facing retirement are going to have to save more and spend less.
I think this time next year we will start to see stories about DEflation. I know, call me crazy, but given that we have seen two major bubbles burst in the last year (housing and credit), it is not out of the realm of reason. It is what SHOULD happen. Bursting bubbles are by definition DEflationary events.
Within a very few quarters the Fed will hardly be under pressure to raise rates, especially with rising unemployment and what is clearly an economy on the ropes. [[We are already seeing the leading edge of a bust in retail sales.: normxxx]] Further, the banks need lower rates in order to re-liquify. Home buyers will need lower rates as well. I think, as I have written for a long time, that the Fed is [[at least: normxxx]] on hold for a very long time. And I am not sanguine that the next move will be a rate hike. This time next year when inflation is seen as yesterday's problem and unemployment is rising, the drums will be pounding for a rate cut. We live in interesting times.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Saturday, September 13, 2008
If Lehman Collapses...
If Lehman Collapses Expect A Run On All Of The Other Broker Dealers
And The Collapse Of The The Shadow Banking System
By Nouriel Roubini | 14 September 2008
It is now clear that we are again— as we were in mid— March at the time of the Bear Stearns collapse— an epsilon away from a generalized run on most of the shadow banking system, especially the other major independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley, Goldman Sachs). If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal), you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, i.e. JP Morgan and Citigroup).
Then this run would lead to a massive systemic meltdown of the financial system. That is the reason why the Fed has convened in emergency meetings the heads of all major Wall Street firms on Friday and again today to convince them not to pull the plug on Lehman and maintain their exposure to this distressed broker dealer. This 'bail-in' of investors is the opposite of a bailout of investors such as the one that was done in the case of Bear Stearns and Fannie and Freddie. It is thus akin to the bail-in of investors that was done in the case of LTCM in the summer of 1998 and the bail-in of the interbank creditors of Korean banks in the winter of 1997.
In 2004 I wrote an entire book with Brad Setser titled "Bailouts versus Bailins: Responding to Financial Crises in Emerging Markets" that discusses those policy tradeoffs in financial crises where you have runs on the liquid liabilities of either illiquid and/or insolvent countries. Those were the international equivalent of the banks runs and financial crises that we are now seeing in the cases of Bear Stearns, Lehman and Fannie and Freddie. Since government bailouts put at risk public money and create moral hazard Treasury and the Fed decided that they need to draw a line somewhere after the bailouts of Bear Stearns creditors, of Fannie and Freddie and all the other actions aimed at backstopping the financial system.
These actions have included the creation of the TAF, TSLF, PDCF, the use of the FHLBs to provide liquidity to distressed mortgage lenders, the provision of Treasury liquidity to the FHLBs, the outright purchase of agency MBS by the Treasury, the swapping of two thirds of the safe Treasuries of the Fed for toxic illiquid securities of banks and non banks, etc. So after having created the mother of all moral hazards with their actions (including the biggest bailout of all, i.e. the rescue of Fannie and Freddie), the Fed and Treasury are now playing a chicken game with the financial system. Tim Geithner told the heads of all the major Wall Street firms clearly, that if they pull the plug on Lehman and Lehman collapses they are next in line for a run on their institutions.
So if a buyer for Lehman is not found (or even if it is found and the counterparty lines are still pulled) not only Lehman will collapse but the run will extend to all of the other major broker dealers and banks that are the counterparties of Lehman. The Fed may delude itself in thinking— as its stress models suggest— that the systemic risk of a collapse of Lehman are less serious than those of Bear Stearns: after all Lehman is less involved into CDSs than Bear was and now both Lehman and the other major broker dealers have access to the discount window with the PDCF. A collapse of Lehman will instead have as much of a systemic effect as the collapse of Bear for many reasons: Lehman is larger than Bear was; Lehman is a major player in a variety of key financial markets; all the other major Wall Street institutions are interconnected with Lehman in dozens of different types of counterparty activities; the PDCF support of the Fed is neither unlimited nor unconditional, i.e. investors cannot assume that Lehman or any other broker dealer can borrow unlimited amounts with no conditions from the discount window.
Thus, a collapse of Lehman would trigger a panic and a potential run on all sort of other broker dealers and also on other distressed financial institutions like banks (WaMu) and insurance companies (AIG) and smaller member of the shadow financial system (distressed and highly leveraged hedge funds, etc.). The reason why Lehman is having a hard time to find a buyer is that it is most likely insolvent. If you had to mark to market the value of its illiquid and toxic assets (the $40 billion of commercial real estate assets, its remaining residential MBS and CDOs, its holdings of real estate private equity funds), Lehman is most likely insolvent (i.e. has negative net worth with liabilities well above its impaired assets).
So leaving aside the potential and now dubious value of its franchise (an option to the value of a much slimmed down financial institution) no financial institution should be paying even a single penny to buy an insolvent firm. That is why all the potential suitors of Lehman (such as Bank of America and others) are waiting for the government to provide another sleazy Bear Stearns deal where the government would buy at higher than market value the toxic assets of Lehman (the commercial real estate assets for example) so as to make the net worth of the remaining institution positive and worth buying. But such action— borderline illegal in the case of Bear as pointed out by Paul Volcker— would be a scandal in the case of Lehman and severely exacerbate the moral hazard problem.
But here lies the conundrum of this Lehman crisis: no one seems to want to buy for a positive price Lehman unless there is a public subsidy (taking off their toxic assets off the firms’ balance sheet). The government cannot afford to provide the subsidy as the moral hazard problems are becoming severe. But then if on Monday no deal is done Lehman collapses and goes into Chapter 11 court and you have the beginning of a systemic financial meltdown as the run on the other broker dealers will start. Thus, what Fed and Treasury are trying to do this weekend is another 1998 LTCM bailin or Korea 1997 bailin, i.e. trying to convince all the major institutions to either support a purchase of Lehman or maintain their exposure to Lehman if no buyers are found or put capital into a bad bank that would take the toxic assets off Lehman's balance sheet.
Can this bail-in work? It is not clear as there is a major collective action problem: you can’t only convince half a dozen major Wall Street firms to maintain their exposure to Lehman or fork new money to support a bad bank full of junky toxic waste. You need also to convince all the other counterparties of Lehman (including the hedge funds and the other broker dealers and banks) not to roll off their claims and credit to Lehman. This is a much more messy collective action problem and coordination game than in the case of LTCM and Korea where the number of involved counterparties was more limited (less than 20 in each case).
Paulson and Bernanke and Geithner (the troika managing this financial crisis) have all made public statements in the last few month to the necessity of finding an orderly way to close down— rather than bailout— a major and systemically important non bank financial institutions: the embarrassment and losses for the Fed that the bailout of the creditors of Bear led made it paramount to avoid another Bear like bailout. That is why they are now playing tough with Lehman and its creditors. But in this game of chicken the Fed and the Treasury may end up being the ones to blink. Faced with the risk of a generalized run on the other broker dealers they may decide that again greasing a deal for the purchase of Lehman may be less costly and less risky than testing whether the system can work out an orderly resolution in the event of a collapse of Lehman (something that is highly uncertain).
Even in the case of the Bank of America purchase of Countrywide such public subsidy was significant (the FHLB of Atlanta lent to Countrywide over $50 billion and Bank of America has most likely received plenty of tacit forbearance from the Fed to support its takeover of an insolvent Countrywide). So implicitly or explicitly the Fed and the Treasury may decide— however reckless and moral hazard laden that choice may be— to provide some explicit or implicit subsidy to a private purchase of Lehman. The trouble is that, in spite of all public statements regarding the need to provide an orderly demise of large broker dealers, the Fed and the Treasury have done nothing to create such insolvency regime for such broker dealers. The only option for Lehman— if a buyer is not found— will be the one of ending up in Chapter 11 and triggering massive losses for its counterparties that will in turn trigger a run on such counterparties [[ie, the dominos will fall! : normxxx]].
In February of 2008 I predicted— in my "12 Steps to a Financial Disaster"— that one or two major broker dealers would go bankrupt. A month later Bear Stearns went bust and the collapse of the other ones were avoided for a time by the most radical change in monetary policy since the Great Depression, i.e. the creation of the PDCF that extended the lender of last resort (LOLR) role of the Fed to non-bank systemically important broker dealers (i.e. all of the bank and non bank primary dealers of the Fed). I next argued in June that such action would not prevent a run on other broker dealers such as Lehman, as to avoid a run you need both deposit insurance and unlimited and unconditional access to the Fed LOLR support. I also discussed why Lehman was next in line for a collapse and why the PDCF could not prevent a run on Lehman.
I also argued in follow-up pieces that, in a matter of two years, no one of the remaining independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley and Goldman Sachs) would survive as:
1. their business model is now severely impaired (securitization is moribund);
2. they will need to be regulated like banks, given the PDCF support, and thus have lower leverage, higher liquidity and more capital of a kind that will erode their profitability; and
3. their severe maturity mismatch— borrowing very short term and liquid, leveraging a lot, and lending and investing in much more long term and illiquid ways— makes them very fragile and vulnerable— in the absence of deposit insurance and in the presence of only limited LOLR support by a central bank— to bank like runs that are destructive even of illiquid but otherwise solvent institutions.
Thus all such broker dealers need to merge with larger financial institutions that have a commercial banking arm and thus access to stable and insured deposits and to true LOLR Fed support. That process of unraveling of independent broker dealers started with Bear Stearns; now it is moved to Lehman; tomorrow Merrill Lynch will be on line; and Morgan Stanley and Goldman Sachs will be next. No one of them can or will survive as independent entities. So, the Fed and Treasury should advise them all to start finding a large international partner (international as almost no domestic partner is now sound to take them over) and merge with such partner before we get another Bear or Lehman disaster.
The step by step, ad hoc and non-holistic approach of Fed and Treasury to crisis management has been a failure so far, as plugging and filling one hole at the time is useless when the entire system of levies is collapsing in the perfect financial storm of the century. A much more radical, holistic and systemic approach to crisis management is now necessary. What we are facing now is the beginning of the unraveling and collapse of the entire shadow financial system, a system of institutions (broker dealers, hedge funds, private equity funds, SIVs, conduits, etc.) that look like banks (as they borrow short, are highly leveraged and lend and invest long and in illiquid ways) and thus are highly vulnerable to bank like runs; but unlike banks they are not properly regulated and supervised, they don’t have access to deposit insurance and don’t have access to the lender of last resort support of the central bank (with now only a small group of them having access to the limited and conditional and thus fragile support of the Fed).
So no wonder that this shadow banking system is now collapsing. The entire conduits/SIV system has already collapsed with the roll-off of their ABCP financing; next is the collapse of the broker dealers (Bear, Lehman and soon enough the other ones) that rely mostly on unstable overnight repos and other very short term funding for their financing; next will be hundreds of poorly managed hedge funds that will face a tsunami of redemptions; and, finally, runs on money market funds that are not supported by a large financial institution; runs on other, smaller members of the shadow banking system; and runs on highly leveraged and distressed private equity funds, cannot be ruled out. [[And who knows where it will stop!?!: normxxx]]
This is indeed the most severe financial crisis since the Great Depression and occurring at a time when the US is falling into a now severe consumer led recession. The vicious interaction between a systemic financial and banking crisis and a severe economic contraction will get much worse before there is any bottom to it. We are only in the third inning of a nine innings economic and financial crisis. And the only light at the end of the tunnel is the one of the onrushing train.
==============
Late Breaking News: Lehman Set For Three - Way Break Up (Sunday Express)
LONDON (Reuters) - Bank of America , Barclays and Goldman Sachs are expected to agree a deal as early as Sunday to buy stricken U.S. investment bank Lehman Brothers, Britain's Sunday Express reported. The newspaper, without citing sources, said Bank of America would acquire the bulk of Lehman Brothers, including its mortgage assets. Barclays, Britain's third-biggest bank, would take a smaller parcel including Lehman's asset management and fixed income businesses, while Goldman would take the rest, it said.
Barclays declined to comment. Goldman, Bank of America and Lehman Brothers could not immediately be reached. The Sunday Express said the success of the plan depended on U.S. Treasury Secretary Hank Paulson hammering out a deal to get funding from Wall Street's financial institutions.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
And The Collapse Of The The Shadow Banking System
By Nouriel Roubini | 14 September 2008
It is now clear that we are again— as we were in mid— March at the time of the Bear Stearns collapse— an epsilon away from a generalized run on most of the shadow banking system, especially the other major independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley, Goldman Sachs). If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal), you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, i.e. JP Morgan and Citigroup).
Then this run would lead to a massive systemic meltdown of the financial system. That is the reason why the Fed has convened in emergency meetings the heads of all major Wall Street firms on Friday and again today to convince them not to pull the plug on Lehman and maintain their exposure to this distressed broker dealer. This 'bail-in' of investors is the opposite of a bailout of investors such as the one that was done in the case of Bear Stearns and Fannie and Freddie. It is thus akin to the bail-in of investors that was done in the case of LTCM in the summer of 1998 and the bail-in of the interbank creditors of Korean banks in the winter of 1997.
In 2004 I wrote an entire book with Brad Setser titled "Bailouts versus Bailins: Responding to Financial Crises in Emerging Markets" that discusses those policy tradeoffs in financial crises where you have runs on the liquid liabilities of either illiquid and/or insolvent countries. Those were the international equivalent of the banks runs and financial crises that we are now seeing in the cases of Bear Stearns, Lehman and Fannie and Freddie. Since government bailouts put at risk public money and create moral hazard Treasury and the Fed decided that they need to draw a line somewhere after the bailouts of Bear Stearns creditors, of Fannie and Freddie and all the other actions aimed at backstopping the financial system.
These actions have included the creation of the TAF, TSLF, PDCF, the use of the FHLBs to provide liquidity to distressed mortgage lenders, the provision of Treasury liquidity to the FHLBs, the outright purchase of agency MBS by the Treasury, the swapping of two thirds of the safe Treasuries of the Fed for toxic illiquid securities of banks and non banks, etc. So after having created the mother of all moral hazards with their actions (including the biggest bailout of all, i.e. the rescue of Fannie and Freddie), the Fed and Treasury are now playing a chicken game with the financial system. Tim Geithner told the heads of all the major Wall Street firms clearly, that if they pull the plug on Lehman and Lehman collapses they are next in line for a run on their institutions.
So if a buyer for Lehman is not found (or even if it is found and the counterparty lines are still pulled) not only Lehman will collapse but the run will extend to all of the other major broker dealers and banks that are the counterparties of Lehman. The Fed may delude itself in thinking— as its stress models suggest— that the systemic risk of a collapse of Lehman are less serious than those of Bear Stearns: after all Lehman is less involved into CDSs than Bear was and now both Lehman and the other major broker dealers have access to the discount window with the PDCF. A collapse of Lehman will instead have as much of a systemic effect as the collapse of Bear for many reasons: Lehman is larger than Bear was; Lehman is a major player in a variety of key financial markets; all the other major Wall Street institutions are interconnected with Lehman in dozens of different types of counterparty activities; the PDCF support of the Fed is neither unlimited nor unconditional, i.e. investors cannot assume that Lehman or any other broker dealer can borrow unlimited amounts with no conditions from the discount window.
Thus, a collapse of Lehman would trigger a panic and a potential run on all sort of other broker dealers and also on other distressed financial institutions like banks (WaMu) and insurance companies (AIG) and smaller member of the shadow financial system (distressed and highly leveraged hedge funds, etc.). The reason why Lehman is having a hard time to find a buyer is that it is most likely insolvent. If you had to mark to market the value of its illiquid and toxic assets (the $40 billion of commercial real estate assets, its remaining residential MBS and CDOs, its holdings of real estate private equity funds), Lehman is most likely insolvent (i.e. has negative net worth with liabilities well above its impaired assets).
So leaving aside the potential and now dubious value of its franchise (an option to the value of a much slimmed down financial institution) no financial institution should be paying even a single penny to buy an insolvent firm. That is why all the potential suitors of Lehman (such as Bank of America and others) are waiting for the government to provide another sleazy Bear Stearns deal where the government would buy at higher than market value the toxic assets of Lehman (the commercial real estate assets for example) so as to make the net worth of the remaining institution positive and worth buying. But such action— borderline illegal in the case of Bear as pointed out by Paul Volcker— would be a scandal in the case of Lehman and severely exacerbate the moral hazard problem.
But here lies the conundrum of this Lehman crisis: no one seems to want to buy for a positive price Lehman unless there is a public subsidy (taking off their toxic assets off the firms’ balance sheet). The government cannot afford to provide the subsidy as the moral hazard problems are becoming severe. But then if on Monday no deal is done Lehman collapses and goes into Chapter 11 court and you have the beginning of a systemic financial meltdown as the run on the other broker dealers will start. Thus, what Fed and Treasury are trying to do this weekend is another 1998 LTCM bailin or Korea 1997 bailin, i.e. trying to convince all the major institutions to either support a purchase of Lehman or maintain their exposure to Lehman if no buyers are found or put capital into a bad bank that would take the toxic assets off Lehman's balance sheet.
Can this bail-in work? It is not clear as there is a major collective action problem: you can’t only convince half a dozen major Wall Street firms to maintain their exposure to Lehman or fork new money to support a bad bank full of junky toxic waste. You need also to convince all the other counterparties of Lehman (including the hedge funds and the other broker dealers and banks) not to roll off their claims and credit to Lehman. This is a much more messy collective action problem and coordination game than in the case of LTCM and Korea where the number of involved counterparties was more limited (less than 20 in each case).
Paulson and Bernanke and Geithner (the troika managing this financial crisis) have all made public statements in the last few month to the necessity of finding an orderly way to close down— rather than bailout— a major and systemically important non bank financial institutions: the embarrassment and losses for the Fed that the bailout of the creditors of Bear led made it paramount to avoid another Bear like bailout. That is why they are now playing tough with Lehman and its creditors. But in this game of chicken the Fed and the Treasury may end up being the ones to blink. Faced with the risk of a generalized run on the other broker dealers they may decide that again greasing a deal for the purchase of Lehman may be less costly and less risky than testing whether the system can work out an orderly resolution in the event of a collapse of Lehman (something that is highly uncertain).
Even in the case of the Bank of America purchase of Countrywide such public subsidy was significant (the FHLB of Atlanta lent to Countrywide over $50 billion and Bank of America has most likely received plenty of tacit forbearance from the Fed to support its takeover of an insolvent Countrywide). So implicitly or explicitly the Fed and the Treasury may decide— however reckless and moral hazard laden that choice may be— to provide some explicit or implicit subsidy to a private purchase of Lehman. The trouble is that, in spite of all public statements regarding the need to provide an orderly demise of large broker dealers, the Fed and the Treasury have done nothing to create such insolvency regime for such broker dealers. The only option for Lehman— if a buyer is not found— will be the one of ending up in Chapter 11 and triggering massive losses for its counterparties that will in turn trigger a run on such counterparties [[ie, the dominos will fall! : normxxx]].
In February of 2008 I predicted— in my "12 Steps to a Financial Disaster"— that one or two major broker dealers would go bankrupt. A month later Bear Stearns went bust and the collapse of the other ones were avoided for a time by the most radical change in monetary policy since the Great Depression, i.e. the creation of the PDCF that extended the lender of last resort (LOLR) role of the Fed to non-bank systemically important broker dealers (i.e. all of the bank and non bank primary dealers of the Fed). I next argued in June that such action would not prevent a run on other broker dealers such as Lehman, as to avoid a run you need both deposit insurance and unlimited and unconditional access to the Fed LOLR support. I also discussed why Lehman was next in line for a collapse and why the PDCF could not prevent a run on Lehman.
I also argued in follow-up pieces that, in a matter of two years, no one of the remaining independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley and Goldman Sachs) would survive as:
1. their business model is now severely impaired (securitization is moribund);
2. they will need to be regulated like banks, given the PDCF support, and thus have lower leverage, higher liquidity and more capital of a kind that will erode their profitability; and
3. their severe maturity mismatch— borrowing very short term and liquid, leveraging a lot, and lending and investing in much more long term and illiquid ways— makes them very fragile and vulnerable— in the absence of deposit insurance and in the presence of only limited LOLR support by a central bank— to bank like runs that are destructive even of illiquid but otherwise solvent institutions.
Thus all such broker dealers need to merge with larger financial institutions that have a commercial banking arm and thus access to stable and insured deposits and to true LOLR Fed support. That process of unraveling of independent broker dealers started with Bear Stearns; now it is moved to Lehman; tomorrow Merrill Lynch will be on line; and Morgan Stanley and Goldman Sachs will be next. No one of them can or will survive as independent entities. So, the Fed and Treasury should advise them all to start finding a large international partner (international as almost no domestic partner is now sound to take them over) and merge with such partner before we get another Bear or Lehman disaster.
The step by step, ad hoc and non-holistic approach of Fed and Treasury to crisis management has been a failure so far, as plugging and filling one hole at the time is useless when the entire system of levies is collapsing in the perfect financial storm of the century. A much more radical, holistic and systemic approach to crisis management is now necessary. What we are facing now is the beginning of the unraveling and collapse of the entire shadow financial system, a system of institutions (broker dealers, hedge funds, private equity funds, SIVs, conduits, etc.) that look like banks (as they borrow short, are highly leveraged and lend and invest long and in illiquid ways) and thus are highly vulnerable to bank like runs; but unlike banks they are not properly regulated and supervised, they don’t have access to deposit insurance and don’t have access to the lender of last resort support of the central bank (with now only a small group of them having access to the limited and conditional and thus fragile support of the Fed).
So no wonder that this shadow banking system is now collapsing. The entire conduits/SIV system has already collapsed with the roll-off of their ABCP financing; next is the collapse of the broker dealers (Bear, Lehman and soon enough the other ones) that rely mostly on unstable overnight repos and other very short term funding for their financing; next will be hundreds of poorly managed hedge funds that will face a tsunami of redemptions; and, finally, runs on money market funds that are not supported by a large financial institution; runs on other, smaller members of the shadow banking system; and runs on highly leveraged and distressed private equity funds, cannot be ruled out. [[And who knows where it will stop!?!: normxxx]]
This is indeed the most severe financial crisis since the Great Depression and occurring at a time when the US is falling into a now severe consumer led recession. The vicious interaction between a systemic financial and banking crisis and a severe economic contraction will get much worse before there is any bottom to it. We are only in the third inning of a nine innings economic and financial crisis. And the only light at the end of the tunnel is the one of the onrushing train.
==============
Late Breaking News: Lehman Set For Three - Way Break Up (Sunday Express)
LONDON (Reuters) - Bank of America , Barclays and Goldman Sachs are expected to agree a deal as early as Sunday to buy stricken U.S. investment bank Lehman Brothers, Britain's Sunday Express reported. The newspaper, without citing sources, said Bank of America would acquire the bulk of Lehman Brothers, including its mortgage assets. Barclays, Britain's third-biggest bank, would take a smaller parcel including Lehman's asset management and fixed income businesses, while Goldman would take the rest, it said.
Barclays declined to comment. Goldman, Bank of America and Lehman Brothers could not immediately be reached. The Sunday Express said the success of the plan depended on U.S. Treasury Secretary Hank Paulson hammering out a deal to get funding from Wall Street's financial institutions.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Another Bull Goes Bearish
Another Bull Goes Over To The Bears
Peter Eliades Now Says Dow Could Drop Below 9,000
By Peter Brimelow, Marketwatch | 13 September 2008
The year has been a grim grind, for investors and for investment letters alike. As of the end of August, just 19 letters of some 180 followed by the Hulbert Financial Digest had made money in 2008. Even the ultraconservative Growth Stock Outlook, which has finished in the black every year for more than two decades, is slightly (0.8%) under water YTD (but don't count it out yet). See June 5 column.
Let's look on the bright side— except that it's dark. Year to date, Peter Eliades' Stockmarket Cycles is up 13.0% by Hulbert Financial Digest count, vs. about negative 10% for the dividend-reinvested Dow Jones Wilshire 5000. That's the second-best performance, after Forbes Special Situation Survey. See Aug. 18 column. Over the past three years, Stockmarket Cycles has achieved a 4.53% annualized gain, slightly (10.1%) above the 4.16% annualized gain of the total return DJ-Wilshire 5000.
But over the past 10 years, Stockmarket Cycles has significantly underperformed the market according to Hulbert, gaining 1.81% annualized vs. some 5.66% annualized for the total return DJW. It's one of those letters that has odd periodic streaks of success— what Mark Hulbert calls a "hot hand." It's irritating to statisticians, but can be deeply interesting to investors, if they're in at the beginning. See Aug. 4 column. And, arguably, editor Eliades' hand is hot right now.
Eliades' methods are equally irritating to statisticians. He claims to distinguish multiple patterns of cycles in the stock market, complex overlapping rhythms of the sort that naturally appeal to the professional musician he once was. In his monthly letter dated Sept. 5, however, Eliades argues that simple technical analysis explains the situation:
Eliades says his "preliminary projection" for the Dow Jones Industrial Average is a decline to at least 8,847, and to 918 - 976 on the S&P 500. More recently, he commented: "The Dow would have to move below 10,790 at some time this week in order to confirm nominal four-year downside projections." But Wednesday he had his mutual fund switchers buy a leveraged bearish play: Rydex Dynamic: Tm 500 (RYTPX).
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Peter Eliades Now Says Dow Could Drop Below 9,000
By Peter Brimelow, Marketwatch | 13 September 2008
|
The year has been a grim grind, for investors and for investment letters alike. As of the end of August, just 19 letters of some 180 followed by the Hulbert Financial Digest had made money in 2008. Even the ultraconservative Growth Stock Outlook, which has finished in the black every year for more than two decades, is slightly (0.8%) under water YTD (but don't count it out yet). See June 5 column.
Let's look on the bright side— except that it's dark. Year to date, Peter Eliades' Stockmarket Cycles is up 13.0% by Hulbert Financial Digest count, vs. about negative 10% for the dividend-reinvested Dow Jones Wilshire 5000. That's the second-best performance, after Forbes Special Situation Survey. See Aug. 18 column. Over the past three years, Stockmarket Cycles has achieved a 4.53% annualized gain, slightly (10.1%) above the 4.16% annualized gain of the total return DJ-Wilshire 5000.
But over the past 10 years, Stockmarket Cycles has significantly underperformed the market according to Hulbert, gaining 1.81% annualized vs. some 5.66% annualized for the total return DJW. It's one of those letters that has odd periodic streaks of success— what Mark Hulbert calls a "hot hand." It's irritating to statisticians, but can be deeply interesting to investors, if they're in at the beginning. See Aug. 4 column. And, arguably, editor Eliades' hand is hot right now.
Eliades' methods are equally irritating to statisticians. He claims to distinguish multiple patterns of cycles in the stock market, complex overlapping rhythms of the sort that naturally appeal to the professional musician he once was. In his monthly letter dated Sept. 5, however, Eliades argues that simple technical analysis explains the situation:
|
Eliades says his "preliminary projection" for the Dow Jones Industrial Average is a decline to at least 8,847, and to 918 - 976 on the S&P 500. More recently, he commented: "The Dow would have to move below 10,790 at some time this week in order to confirm nominal four-year downside projections." But Wednesday he had his mutual fund switchers buy a leveraged bearish play: Rydex Dynamic: Tm 500 (RYTPX).
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Friday, September 12, 2008
Welcome To September
Kaeppel's Corner: Welcome To September
By Jay Kaeppel, Optionetics.com | 10 September 2008
Investors of a certain age— ouch, was that a new ache or pain I just felt?— well remember the Crash of 1987 when the Dow lost 22% in a single day. While that was a devastating event for many, the long term results were somewhat mitigated by the fact that the Dow essentially bottomed out that day and resumed a longer-term uptrend shortly thereafter. Other market "crashes"— for now roughly defined as a sharp sudden decline in the stock market contained within a given month— include 1978, 1979, 1989, 1997, 1998.
So clearly the month of October is not to be trusted. Nevertheless, over the long run, the month October— crashes and all— has been a day in the park compared to September [[especially since October often marks the bottom of the Autumnal downdraft, whereas September often marks its beginning.: normxxx]]. Under the category of "a picture is worth a thousand words", Chart 1 displays the growth— or more accurately, the destruction— of $1,000 invested in the Dow only during the month of September every year since 1900. The results speak for themselves. $1,000 invested only during September since 1900 would today be worth just $259. This represents a staggering loss of -74.1%. To put this in better perspective, this loss occurred within the context of an overall gain in excess of +16,700% by the Dow. How’s that for "underperformance"?
Chart 1— $1,000 invested in the Dow only during the month of September 1900 to present
Fortunately for me (or unfortunately as the case may be), as a lifelong "statistics geek" as well as a lifelong Cubs fan, I’m pretty used to looking at "ugly" numbers. Below are some of the "unhappy totals" regarding the performance numbers for the Dow during the month of September over the past 108 years.
So clearly the month of September has not been "happy time" for stock investors over the past century. But hey, just like the Cubs, any month (or team) can have a bad century now and then. September 2008 opened with a loss of -2.8% in the first four trading days. At the very least you have to respect consistency. So at this point for stock investors it’s kind of like the same situation experienced by lifelong Cubs fans when the Cubs are in first place in early September. It’s hard to know whether to stand up and cheer or to curl up in a ball and say "tell me when it’s over", possibly peeking out of one eye once in a while.
For now simply consider how an investor (okay, admittedly one with a crystal ball who could have foreseen in January 1900 that September would be a disaster for stocks over the next 108 years) might have fared if he or she had simply skipped the month of September every year since then. Chart 2 displays the growth of $1,000 invested in the Dow on a buy-and-hold basis since 1900 as well as the growth of $1,000 invested in the Dow at all times except the month of September during the same time frame. As you can see, by once again applying the theory of "addition by subtraction", sitting out the month of September would have improved an investor’s performance exponentially.
Chart 2— Buy and hold and Buy and hold minus September
By 9/5/2008, $1,000 invested in the Dow on a buy and hold basis would have been worth $168,458. Had an investor simply moved into cash at the end of August each year and then back into stocks at the end of September, that same $1,000 would have grown to $650,110, a gain of about 3.9 times as much as could have been gained by simply buying and holding.
Summary
Please remember that the implication here is not that the month of September is absolutely, positively guaranteed to decline each and every year. In fact, far from it as 45 of the past 108 years have witnessed a September gain in stock prices— let’s call it a "September surprise." Still, investors should clearly be cautious. On the brighter side, if the major market averages retest their yearly lows during the month of September and are able to hold, we might ultimately look back at September as a buying opportunity.
So please remember (now and always) that "being cautious" and "sticking one’s head in the sand" are two very different things.
To search for previous articles written by Jay Kaeppel, please click here.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Jay Kaeppel, Optionetics.com | 10 September 2008
|
Investors of a certain age— ouch, was that a new ache or pain I just felt?— well remember the Crash of 1987 when the Dow lost 22% in a single day. While that was a devastating event for many, the long term results were somewhat mitigated by the fact that the Dow essentially bottomed out that day and resumed a longer-term uptrend shortly thereafter. Other market "crashes"— for now roughly defined as a sharp sudden decline in the stock market contained within a given month— include 1978, 1979, 1989, 1997, 1998.
So clearly the month of October is not to be trusted. Nevertheless, over the long run, the month October— crashes and all— has been a day in the park compared to September [[especially since October often marks the bottom of the Autumnal downdraft, whereas September often marks its beginning.: normxxx]]. Under the category of "a picture is worth a thousand words", Chart 1 displays the growth— or more accurately, the destruction— of $1,000 invested in the Dow only during the month of September every year since 1900. The results speak for themselves. $1,000 invested only during September since 1900 would today be worth just $259. This represents a staggering loss of -74.1%. To put this in better perspective, this loss occurred within the context of an overall gain in excess of +16,700% by the Dow. How’s that for "underperformance"?
Chart 1— $1,000 invested in the Dow only during the month of September 1900 to presentFortunately for me (or unfortunately as the case may be), as a lifelong "statistics geek" as well as a lifelong Cubs fan, I’m pretty used to looking at "ugly" numbers. Below are some of the "unhappy totals" regarding the performance numbers for the Dow during the month of September over the past 108 years.
- The average daily gain during the month of September was (-0.000492%).
- The average daily gain during all other trading days was +0.000307%.
- The annualized rate of return during the month of September was (-11.7%).
- The annualized rate of return during all other trading days was +8.0%.
- The Dow posted a gain during 45 of 108 months of September, or 42% of the time.
So clearly the month of September has not been "happy time" for stock investors over the past century. But hey, just like the Cubs, any month (or team) can have a bad century now and then. September 2008 opened with a loss of -2.8% in the first four trading days. At the very least you have to respect consistency. So at this point for stock investors it’s kind of like the same situation experienced by lifelong Cubs fans when the Cubs are in first place in early September. It’s hard to know whether to stand up and cheer or to curl up in a ball and say "tell me when it’s over", possibly peeking out of one eye once in a while.
For now simply consider how an investor (okay, admittedly one with a crystal ball who could have foreseen in January 1900 that September would be a disaster for stocks over the next 108 years) might have fared if he or she had simply skipped the month of September every year since then. Chart 2 displays the growth of $1,000 invested in the Dow on a buy-and-hold basis since 1900 as well as the growth of $1,000 invested in the Dow at all times except the month of September during the same time frame. As you can see, by once again applying the theory of "addition by subtraction", sitting out the month of September would have improved an investor’s performance exponentially.
Chart 2— Buy and hold and Buy and hold minus September
By 9/5/2008, $1,000 invested in the Dow on a buy and hold basis would have been worth $168,458. Had an investor simply moved into cash at the end of August each year and then back into stocks at the end of September, that same $1,000 would have grown to $650,110, a gain of about 3.9 times as much as could have been gained by simply buying and holding.
Summary
Please remember that the implication here is not that the month of September is absolutely, positively guaranteed to decline each and every year. In fact, far from it as 45 of the past 108 years have witnessed a September gain in stock prices— let’s call it a "September surprise." Still, investors should clearly be cautious. On the brighter side, if the major market averages retest their yearly lows during the month of September and are able to hold, we might ultimately look back at September as a buying opportunity.
So please remember (now and always) that "being cautious" and "sticking one’s head in the sand" are two very different things.
To search for previous articles written by Jay Kaeppel, please click here.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Best- And Worst-Case Scenarios
The Economy: Best- And Worst-Case Scenarios
Will The Fannie Mae/Freddie Mac Bailout Work? It Pays To Imagine The Possibilities
Click here for a link to complete article:
By Peter Coy, Businessweek | 12 September 2008
Related Items
Browse the BusinessWeek Archive
Virtuous Circle
Vicious Circle
O.K., we've finally wrapped our minds around the impossible: On Sunday, Sept. 7, in the name of preventing a financial meltdown, the 'conservative' [['incompetently opportunistic' would be the better adjectives: normxxx]] Bush Administration announced that it was seizing control of two of the nation's biggest and highest-rated (until recently) financial institutions, the mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE). In short, pigs can fly, and hell really can freeze over. So maybe it's time to expand our sense of the possible and ask what other shockers are in store. Will the 13-month-old credit crunch get even worse and drag down the entire global economy? Or are punch-drunk Americans due for an even bigger shock, namely some good news for a change?
The financial markets are grappling with just those issues— and gyrating between euphoria and panic. Stocks climbed on Sept. 8, the first trading day after Treasury Secretary Henry M. Paulson Jr. announced that he was placing Fannie and Freddie under federal conservatorship. The Standard & Poor's 500-stock index rose 2%.
But the very next day, fears that venerable investment bank Lehman Brothers (LEH) might go under dragged the S&P 500 down 3.4%. In highly uncertain times like these, scenario-spinning can be an excellent tool for making sense of conflicting data. It won't guide you straight to the right answer, but it will get you thinking about the right questions to ask. [[And place some bounds around the problem.: normxxx]]
For a best case, imagine a virtuous circle of events that starts with a favorable market reaction to Paulson's putsch. Paulson promised to replenish the companies' capital by purchasing up to $100 billion in senior preferred shares in each, as needed, to make sure they retain a positive net worth. He also set up a secured lending facility that they can draw on if their private funding sources get too costly. And he said Treasury itself will try to make mortgage loans more available and affordable by buying Fannie and Freddie mortgage-backed securities, starting with a token $5 billion but possibly going far higher.
Paulson's move made a big impression in foreign markets, which have been nervously eyeing the condition of American banks. On Sept. 10, at a conference in Germany titled "Banks in Upheaval," Deutsche Bank (DB) CEO Josef Ackermann argued that "we are in a period of stabilization in credit markets and in stock markets, although they still remain nervous." Ackermann added: "We believe that what we see is the beginning of the end of the crisis." [[I've lost count, but I believe this is at least the eighth or ninth 'definitive' "…beginning of the end of the crisis.": normxxx]]
At the very least, Paulson's unprecedented move defuses one [[more?: normxxx]] ticking time bomb. It decreases the chance that either Fannie or Freddie will default on its debts or credit guarantees, which was the [[just one: normxxx]] doomsday scenario for global financial markets. Together, the two companies have about $1.7 trillion in outstanding corporate debt. In addition, they have guaranteed repayment on $3.7 trillion worth of mortgage-backed securities they've issued.
Those securities are held by risk-averse investors such as banks, pension funds, and central banks around the world. Asian central bankers, in particular, had pressed the Treasury Dept. for action in the weeks before the takeover. Technically, Treasury is not guaranteeing the twins' obligations, but the chance that it would tolerate a default has dropped from small to near zero.
As investors get comfortable with Treasury's terms, the hope is they will settle for lower yields on the mortgage-backed securities Fannie and Freddie package and insure. Indeed, yields on the companies' mortgage-backed securities fell the day after the announcement by about 0.4 percentage points. National average rates on 30-year, fixed-rate mortgages fell by an equal amount between the Friday before the announcement and the Wednesday after, to about 5.7%, according to daily surveys by Bankrate (RATE). Unclogging Fannie and Freddie's pipeline could finally make effective the easy-money policies of the Federal Reserve, which has cut the federal funds rate by 3.25 percentage points since the start of the crisis, to a stimulative 2%.
If mortgage rates keep moving lower, it should help some people refinance to avoid foreclosure while spurring sales by lowering the financial hurdle for people to buy homes. "I think this is a correct move. I think it will stabilize housing," says David Kelly, chief market strategist for JPMorgan Funds (JPM). Stabilizing the housing market would be a confidence booster for the entire economy and the financial system.
John Paulson of Paulson & Co., a $35 billion hedge fund that made a killing in 2007 betting against the U.S. subprime sector, told clients in a conference call days before the Treasury announcement that he's finally ready to make some tactical investments in financial firms that have gotten especially cheap, even though he thinks prices in the overall sector still have further to fall as foreclosures mount. His toe-dipping was first reported by the Financial Times.
If the housing market stopped sinking, or even rose, consumers might also spend more liberally, which would then boost employment and induce even more spending— the classic virtuous circle. One optimist, James W. Paulsen (not to be confused with either Henry or John), chief investment officer of Minneapolis-based Wells Capital Management, notes that the 94% of the economy that's not housing or autos has grown over 5% over the past year, while the 6% consisting of housing and autos has shrunk 20%. The implication (says James W. Paulsen): "A quicker-than-expected turnaround is possible, since it would not require a broad-based recovery, but rather only a cessation of the collapse in two industries."
Signs of health in the U.S. economy would reduce the risk of a panicky pullout by foreign investors, ensuring that inflowing capital would help finance spending by American households and businesses [[ and maybe postpone Armageddon by a few more years: normxxx]]. In fact, the dollar rose after the Treasury announcement, adding to a gain of 10% against six major currencies since mid-July.
The Nightmare
So we're golden, right? Well, maybe not. In the vicious-circle scenario, Treasury's intervention ends up being a replay of Japan's ill-fated effort to prop up crippled banks in the 1990s. Increasing the availability of credit delays— but does not prevent— the full price decline needed to clear out the daunting overhang of nearly 4.7 million unsold existing homes as of July.
As the lender of last resort, the government throws good money after bad, first on housing and then on airlines, automakers, and other supplicants. All this against an undeniable backdrop of huge, rising federal deficits: The Congressional Budget Office predicted this month that the federal budget deficit would remain above $400 billion annually from 2008 through 2010, up from about $160 billion in 2007. [[And that was without calculating in the $Trillion bailouts.: normxxx]]
In the nightmare scenario, this descent into quasi-socialism [[ie, for the rich and foreigners: normxxx]] balloons the national debt and finally wrecks foreign investors' faith in the US economy. That's the vision sketched out by ultra-bears like Peter Schiff, president of Euro Pacific Capital, a brokerage in Darien, Conn. Schiff is passionate on the topic: "The dollar is going to go through the floor, interest rates are going to spike up, and we're going to have a complete financial meltdown. It's going to be the worst-case scenario."
A different school of pessimists says the housing market actually does need a big adrenaline shot from the government. But they say it's unlikely to get one from either a McCain or an Obama Administration because the risk to taxpayers from a much bigger commitment to housing would be deemed too great. The only real beneficiaries of the takeover are the holders of Fannie and Freddie securities, who are bailed out of their bad investment choices, says Robert I. Kessler, CEO of Kessler Cos., a Denver investment firm. Says Kessler: "It's a great thing for the big banks. I don't see any benefit whatsoever to consumers."
Specifically, the Fan-Fred takeover does nothing to help homeowners who can't refinance a home loan because their property has been assessed for less than they owe. It also may not be enough to draw in buyers, who are focused more on the risk of declining home values than on the upside of a slightly lower mortgage rate. "I've sat in open houses, and you just can't get people to make an offer," says Edward Cudahy Spalding, a real estate broker in Fort Lauderdale. "You've got to reinflate values in the housing market. I don't know how you do that."
Without more relief for homeowners and consumers, the housing-led recession is likely to deepen. In this vicious-circle scenario, the housing slump depresses consumer spending, leading to job cuts and thus forcing even more foreclosures and bigger spending reductions— in other words, the mirror image of the virtuous circle. Vulnerable sectors include finance; nonresidential construction, which tends to follow homebuilding downward with a lag; and retail, which has so far lost only a modest number of jobs nationally relative to the size of the sector.
Away from Wall Street, the mood is glum. Douglas S. Bartlett, owner of Bartlett Manufacturing, a maker of printed-circuit boards in Cary, Ill., says competition from China has forced him to cut employment nearly two-thirds since 2000, to 87. He hasn't felt any reprieve from the dollar's recent depreciation against China's currency.
Says Bartlett: "Fortunately for us, there's been enough of our competitors going out of business that we're able to pick up their work." In Sacramento, restaurateur Ali Mackani was forced to shut down his fashionable Restaurant 55 Degrees shortly after Labor Day because of slower-than-expected commercial and residential development in the area, which he had been counting on to produce customers.
Today's business failures ripple across the economy, triggering yet more failures. And when the financial system is crippled by losses, the hoped-for V-shaped recovery can flatten out into a wide-bottomed U, says Dan North, chief economist of Euler Hermes ACI, a North American unit of Germany's Allianz Group (AZ) that insures accounts receivable. North says that because of business failures, the number of insurance claims processed by his company was up 80% in the first six months of 2008 compared with a year earlier.
Hedge Your Bets
It's easy to imagine either scenario unfolding, good or bad. And really, that's the whole point. Blind conviction has not served us well. On the one hand, the credit crunch has embarrassed optimists, like Federal Housing Finance Agency Director James B. Lockhart III, who averred on Mar. 19 that Fannie and Freddie "will continue to be safe and sound" and called the idea of a bailout "nonsense." In his new book, The Subprime Solution, Yale University economist Robert J. Shiller says regulators suffered from an "inability to believe that there could ever be a housing crisis of the proportions we are seeing today".
On the other hand, it would [[probably: normxxx]] be equally wrong to assume the worst and get into a defensive crouch, as some investors have done. Prices of some derivative securities are so low that they seem to factor in a complete collapse of the U.S. economy. And yet investors who smell a profit opportunity in those assets are holding back because they worry that their prices could go even lower before rebounding. Ricardo Caballero, a Massachusetts Institute of Technology economist, wrote in the Bank of France's Financial Stability Review in February that "in today's market, uncertainty has led every player to make decisions based on imagined worst-case scenarios".
What to do? Whether you're inclined toward the virtuous circle or the vicious one, hedge your bets. Because, as the Fan/Fred takeover shows, just about anything can happen.
M O R E. . .
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Will The Fannie Mae/Freddie Mac Bailout Work? It Pays To Imagine The Possibilities
Click here for a link to complete article:
By Peter Coy, Businessweek | 12 September 2008
Related Items
Browse the BusinessWeek Archive
Virtuous Circle
Vicious Circle
O.K., we've finally wrapped our minds around the impossible: On Sunday, Sept. 7, in the name of preventing a financial meltdown, the 'conservative' [['incompetently opportunistic' would be the better adjectives: normxxx]] Bush Administration announced that it was seizing control of two of the nation's biggest and highest-rated (until recently) financial institutions, the mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE). In short, pigs can fly, and hell really can freeze over. So maybe it's time to expand our sense of the possible and ask what other shockers are in store. Will the 13-month-old credit crunch get even worse and drag down the entire global economy? Or are punch-drunk Americans due for an even bigger shock, namely some good news for a change?
The financial markets are grappling with just those issues— and gyrating between euphoria and panic. Stocks climbed on Sept. 8, the first trading day after Treasury Secretary Henry M. Paulson Jr. announced that he was placing Fannie and Freddie under federal conservatorship. The Standard & Poor's 500-stock index rose 2%.
But the very next day, fears that venerable investment bank Lehman Brothers (LEH) might go under dragged the S&P 500 down 3.4%. In highly uncertain times like these, scenario-spinning can be an excellent tool for making sense of conflicting data. It won't guide you straight to the right answer, but it will get you thinking about the right questions to ask. [[And place some bounds around the problem.: normxxx]]
For a best case, imagine a virtuous circle of events that starts with a favorable market reaction to Paulson's putsch. Paulson promised to replenish the companies' capital by purchasing up to $100 billion in senior preferred shares in each, as needed, to make sure they retain a positive net worth. He also set up a secured lending facility that they can draw on if their private funding sources get too costly. And he said Treasury itself will try to make mortgage loans more available and affordable by buying Fannie and Freddie mortgage-backed securities, starting with a token $5 billion but possibly going far higher.
Paulson's move made a big impression in foreign markets, which have been nervously eyeing the condition of American banks. On Sept. 10, at a conference in Germany titled "Banks in Upheaval," Deutsche Bank (DB) CEO Josef Ackermann argued that "we are in a period of stabilization in credit markets and in stock markets, although they still remain nervous." Ackermann added: "We believe that what we see is the beginning of the end of the crisis." [[I've lost count, but I believe this is at least the eighth or ninth 'definitive' "…beginning of the end of the crisis.": normxxx]]
At the very least, Paulson's unprecedented move defuses one [[more?: normxxx]] ticking time bomb. It decreases the chance that either Fannie or Freddie will default on its debts or credit guarantees, which was the [[just one: normxxx]] doomsday scenario for global financial markets. Together, the two companies have about $1.7 trillion in outstanding corporate debt. In addition, they have guaranteed repayment on $3.7 trillion worth of mortgage-backed securities they've issued.
Those securities are held by risk-averse investors such as banks, pension funds, and central banks around the world. Asian central bankers, in particular, had pressed the Treasury Dept. for action in the weeks before the takeover. Technically, Treasury is not guaranteeing the twins' obligations, but the chance that it would tolerate a default has dropped from small to near zero.
As investors get comfortable with Treasury's terms, the hope is they will settle for lower yields on the mortgage-backed securities Fannie and Freddie package and insure. Indeed, yields on the companies' mortgage-backed securities fell the day after the announcement by about 0.4 percentage points. National average rates on 30-year, fixed-rate mortgages fell by an equal amount between the Friday before the announcement and the Wednesday after, to about 5.7%, according to daily surveys by Bankrate (RATE). Unclogging Fannie and Freddie's pipeline could finally make effective the easy-money policies of the Federal Reserve, which has cut the federal funds rate by 3.25 percentage points since the start of the crisis, to a stimulative 2%.
If mortgage rates keep moving lower, it should help some people refinance to avoid foreclosure while spurring sales by lowering the financial hurdle for people to buy homes. "I think this is a correct move. I think it will stabilize housing," says David Kelly, chief market strategist for JPMorgan Funds (JPM). Stabilizing the housing market would be a confidence booster for the entire economy and the financial system.
John Paulson of Paulson & Co., a $35 billion hedge fund that made a killing in 2007 betting against the U.S. subprime sector, told clients in a conference call days before the Treasury announcement that he's finally ready to make some tactical investments in financial firms that have gotten especially cheap, even though he thinks prices in the overall sector still have further to fall as foreclosures mount. His toe-dipping was first reported by the Financial Times.
If the housing market stopped sinking, or even rose, consumers might also spend more liberally, which would then boost employment and induce even more spending— the classic virtuous circle. One optimist, James W. Paulsen (not to be confused with either Henry or John), chief investment officer of Minneapolis-based Wells Capital Management, notes that the 94% of the economy that's not housing or autos has grown over 5% over the past year, while the 6% consisting of housing and autos has shrunk 20%. The implication (says James W. Paulsen): "A quicker-than-expected turnaround is possible, since it would not require a broad-based recovery, but rather only a cessation of the collapse in two industries."
Signs of health in the U.S. economy would reduce the risk of a panicky pullout by foreign investors, ensuring that inflowing capital would help finance spending by American households and businesses [[ and maybe postpone Armageddon by a few more years: normxxx]]. In fact, the dollar rose after the Treasury announcement, adding to a gain of 10% against six major currencies since mid-July.
The Nightmare
So we're golden, right? Well, maybe not. In the vicious-circle scenario, Treasury's intervention ends up being a replay of Japan's ill-fated effort to prop up crippled banks in the 1990s. Increasing the availability of credit delays— but does not prevent— the full price decline needed to clear out the daunting overhang of nearly 4.7 million unsold existing homes as of July.
As the lender of last resort, the government throws good money after bad, first on housing and then on airlines, automakers, and other supplicants. All this against an undeniable backdrop of huge, rising federal deficits: The Congressional Budget Office predicted this month that the federal budget deficit would remain above $400 billion annually from 2008 through 2010, up from about $160 billion in 2007. [[And that was without calculating in the $Trillion bailouts.: normxxx]]
In the nightmare scenario, this descent into quasi-socialism [[ie, for the rich and foreigners: normxxx]] balloons the national debt and finally wrecks foreign investors' faith in the US economy. That's the vision sketched out by ultra-bears like Peter Schiff, president of Euro Pacific Capital, a brokerage in Darien, Conn. Schiff is passionate on the topic: "The dollar is going to go through the floor, interest rates are going to spike up, and we're going to have a complete financial meltdown. It's going to be the worst-case scenario."
A different school of pessimists says the housing market actually does need a big adrenaline shot from the government. But they say it's unlikely to get one from either a McCain or an Obama Administration because the risk to taxpayers from a much bigger commitment to housing would be deemed too great. The only real beneficiaries of the takeover are the holders of Fannie and Freddie securities, who are bailed out of their bad investment choices, says Robert I. Kessler, CEO of Kessler Cos., a Denver investment firm. Says Kessler: "It's a great thing for the big banks. I don't see any benefit whatsoever to consumers."
Specifically, the Fan-Fred takeover does nothing to help homeowners who can't refinance a home loan because their property has been assessed for less than they owe. It also may not be enough to draw in buyers, who are focused more on the risk of declining home values than on the upside of a slightly lower mortgage rate. "I've sat in open houses, and you just can't get people to make an offer," says Edward Cudahy Spalding, a real estate broker in Fort Lauderdale. "You've got to reinflate values in the housing market. I don't know how you do that."
Without more relief for homeowners and consumers, the housing-led recession is likely to deepen. In this vicious-circle scenario, the housing slump depresses consumer spending, leading to job cuts and thus forcing even more foreclosures and bigger spending reductions— in other words, the mirror image of the virtuous circle. Vulnerable sectors include finance; nonresidential construction, which tends to follow homebuilding downward with a lag; and retail, which has so far lost only a modest number of jobs nationally relative to the size of the sector.
Away from Wall Street, the mood is glum. Douglas S. Bartlett, owner of Bartlett Manufacturing, a maker of printed-circuit boards in Cary, Ill., says competition from China has forced him to cut employment nearly two-thirds since 2000, to 87. He hasn't felt any reprieve from the dollar's recent depreciation against China's currency.
Says Bartlett: "Fortunately for us, there's been enough of our competitors going out of business that we're able to pick up their work." In Sacramento, restaurateur Ali Mackani was forced to shut down his fashionable Restaurant 55 Degrees shortly after Labor Day because of slower-than-expected commercial and residential development in the area, which he had been counting on to produce customers.
Today's business failures ripple across the economy, triggering yet more failures. And when the financial system is crippled by losses, the hoped-for V-shaped recovery can flatten out into a wide-bottomed U, says Dan North, chief economist of Euler Hermes ACI, a North American unit of Germany's Allianz Group (AZ) that insures accounts receivable. North says that because of business failures, the number of insurance claims processed by his company was up 80% in the first six months of 2008 compared with a year earlier.
Hedge Your Bets
It's easy to imagine either scenario unfolding, good or bad. And really, that's the whole point. Blind conviction has not served us well. On the one hand, the credit crunch has embarrassed optimists, like Federal Housing Finance Agency Director James B. Lockhart III, who averred on Mar. 19 that Fannie and Freddie "will continue to be safe and sound" and called the idea of a bailout "nonsense." In his new book, The Subprime Solution, Yale University economist Robert J. Shiller says regulators suffered from an "inability to believe that there could ever be a housing crisis of the proportions we are seeing today".
On the other hand, it would [[probably: normxxx]] be equally wrong to assume the worst and get into a defensive crouch, as some investors have done. Prices of some derivative securities are so low that they seem to factor in a complete collapse of the U.S. economy. And yet investors who smell a profit opportunity in those assets are holding back because they worry that their prices could go even lower before rebounding. Ricardo Caballero, a Massachusetts Institute of Technology economist, wrote in the Bank of France's Financial Stability Review in February that "in today's market, uncertainty has led every player to make decisions based on imagined worst-case scenarios".
What to do? Whether you're inclined toward the virtuous circle or the vicious one, hedge your bets. Because, as the Fan/Fred takeover shows, just about anything can happen.
M O R E. . .
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Thursday, September 11, 2008
Strategy: INflation Or DEflation?
Strategy: How To Tell Whether To Prepare For INflation Or DEflation.
Extraordinary Measures Today, A Financial Funeral Tomorrow.
By Kurt Kasun | 11 September 2008
The problem is that the government has made the problem worse. In the present instance, this first began with the surprising and unprecedented 75-basis point cut in August 07— followed with other extraordinary actions taken in January, March, July, and September of this year. I can't wait to see what they have up their sleeves for the next debacle. Ed Sullivan would say "we are in for a really big show." They better think up something fast because they are up against a multi-decade extended market that is now headed down after just having reached a major double top:
Look out below. You could make the case that the S&P 500 will decline all the way back to 500 before being rescued by technical support.
After the moves to restructure Fannie/Freddie, it should be clear to all, that there are no limits to which the government officials will go to prevent a collapse (and for politicians to keep their jobs). The only reasonable conclusion is that we will one day arrive at a point where government action is not enough, and when it does, the magnitude of the collapse will be far worse than what it would have been if we allowed it to occur earlier. We need to let this beast die as I wrote in "It's Always Darkest Before the Dawn...of a Depression."
We have strayed too far off course and there will be no avoidance of catastrophe at this point. We are just too far extended now. The decision to save Freddie and Fannie was totally expected. The third and final leg on our path to collapse (first initiated by the creation of the Federal Reserve in 1913) was set in motion by our total abandonment of the gold standard in 1971 and is now only months, if not weeks away.
Nixon gets the blame, but he was merely reflecting the collective will (or "non-will") of the American people to exercise a little sacrifice and discipline and pay our national and international debts. The price we will pay the piper will be catastrophic as a result. We became the most gluttonous nation in the history of the world. The image of that fat guy who ate so much that he exploded in that Monty Python movie comes to mind when I look for an analogy.
Many have written that our children will be paying for the extravagance of the baby-boomers for the rest of their lives. I disagree. I now think that we are close to a reckoning event that will impose austerity, economic pain and suffering on the vast majority of Americans. This will be difficult to endure and could last a while. The US Government and consumers will be forced to make major adjustments. Lifestyle changes will be revolutionary.
But on the positive side, it could restore some of the bedrock principles this country was founded, built, and thrived upon (thrift over profligacy, savings over consumption, and discipline over excess). This will hopefully place us back onto the path of responsibility and sustained growth. We should be able to refresh anew after the cleansing process which expunges the huge multi-year debt overhang. This will be painful and most government officials will fight it tooth and nail, pandering to the masses to prop up the current system, now clearly doomed to failure.
This backdrop will prove to be treacherous for investors. I think we are now embarking in a period that will see financial convulsions between inflation and deflation. Battling between the two and trying to position for the correct scenario will rip most portfolios apart. If you are positioned for one while the other occurs, it destroys your capital base, leaving an investor with less to try to take advantage of the next swing.
Since last August (2007), the correct bet was on the inflation trade. That trade changed on dime on July 15. Many incorrectly interpreted the dollar strengthening and rebound in deeply oversold sectors as a return a bull market for US equities. Wrong! This was a reversal of a very crowded trade as the winds of deflation began to displace inflationary forces. The reversal of the long commodities/short the dollar (and equities which benefit) was swift and brutal and continues today.
Because the jig is up and the end game/ reckoning has now begun, the only question that remains is will it end in fire (inflation/hyper-inflation) or ice (deflation). I like the recent quotes from the prescient old-timer Harry Schultz (from Peter Brimelow at CBS Marketwatch) to explain: "Fed maneuver room approximately gone. Any $US injection big enough to avert a depression triggers runaway inflation. If not big enough: depression. US on knife-edge. Gold helps you either way."
If Bush bails them [financial institutions] all out, the die would be cast for inflation unseen in the West since 1923 Germany. If no bail: "Hello, 1929." In order to determine which scenario to position your portfolio for, I like to turn to the US Dollar for clues. The "80-level", a multi-decade support level violated a year ago, should now offer firm resistance for any further dollar strengthening as it rises to 80 once again. Look at the chart below:
As the dollar rose from under 71 (the end of March) to over 79 (now) over the summer we saw an across-the-board selloff in commodities and emerging market equities and a mini-counter-trend rally in the stinky US sectors (tech, financials, consumer discretionary) where investors had previously been losing their shirts. Government bonds also rallied indicating that this was a period in which you should have been invested for deflation. We are now approaching an important test for the US dollar is it approaches 80 again. The dollar has rallied up to 80 over the last couple of weeks (not quite shown on the chart above).
If the dollar does in fact rally above 80, then I think that the deflation trade will accelerate further and takedown US equities, this time in a major whiff of asset deflation which takes down almost all asset classes except US treasuries. If it continues unabated it will result in a major deflationary depression. Gold will eventually rise in value amidst the chaos and removal of the paper currencies, but not until after first declining significantly.
If, on the other hand, the US dollar begins to decline back below the 74-73-level, I think that investors will need to consider repositioning for the inflation trade. While the dollar stays in the 75-80 range we can expect big gyrations, but little real movement or investment direction. In the inflationary environment, your best investment choices are energy and precious metals.
If the dollar does move above 80, I view it highly likely that at some point before a deflationary depression occurs, governments and politicians around the world will massively debase their currencies and enact ultra-expansionary fiscal and monetary policies in order to fight it. Therefore, anyone with a one-way bet on deflation could be wiped out if we experience one or two highly-inflationary periods along the way.
Planning for the unavoidable collapse of this beast of a fiat financial system we must now confront, the "Financial Funeral" is thus fraught with danger as you try to navigate between seemingly wild and capricious swings between inflation and deflation. The only bet sure to fail is that the government actions will succeed in preventing the Financial Funeral from ever occurring.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Extraordinary Measures Today, A Financial Funeral Tomorrow.
By Kurt Kasun | 11 September 2008
|
|
The problem is that the government has made the problem worse. In the present instance, this first began with the surprising and unprecedented 75-basis point cut in August 07— followed with other extraordinary actions taken in January, March, July, and September of this year. I can't wait to see what they have up their sleeves for the next debacle. Ed Sullivan would say "we are in for a really big show." They better think up something fast because they are up against a multi-decade extended market that is now headed down after just having reached a major double top:
Look out below. You could make the case that the S&P 500 will decline all the way back to 500 before being rescued by technical support.
After the moves to restructure Fannie/Freddie, it should be clear to all, that there are no limits to which the government officials will go to prevent a collapse (and for politicians to keep their jobs). The only reasonable conclusion is that we will one day arrive at a point where government action is not enough, and when it does, the magnitude of the collapse will be far worse than what it would have been if we allowed it to occur earlier. We need to let this beast die as I wrote in "It's Always Darkest Before the Dawn...of a Depression."
We have strayed too far off course and there will be no avoidance of catastrophe at this point. We are just too far extended now. The decision to save Freddie and Fannie was totally expected. The third and final leg on our path to collapse (first initiated by the creation of the Federal Reserve in 1913) was set in motion by our total abandonment of the gold standard in 1971 and is now only months, if not weeks away.
Nixon gets the blame, but he was merely reflecting the collective will (or "non-will") of the American people to exercise a little sacrifice and discipline and pay our national and international debts. The price we will pay the piper will be catastrophic as a result. We became the most gluttonous nation in the history of the world. The image of that fat guy who ate so much that he exploded in that Monty Python movie comes to mind when I look for an analogy.
Many have written that our children will be paying for the extravagance of the baby-boomers for the rest of their lives. I disagree. I now think that we are close to a reckoning event that will impose austerity, economic pain and suffering on the vast majority of Americans. This will be difficult to endure and could last a while. The US Government and consumers will be forced to make major adjustments. Lifestyle changes will be revolutionary.
But on the positive side, it could restore some of the bedrock principles this country was founded, built, and thrived upon (thrift over profligacy, savings over consumption, and discipline over excess). This will hopefully place us back onto the path of responsibility and sustained growth. We should be able to refresh anew after the cleansing process which expunges the huge multi-year debt overhang. This will be painful and most government officials will fight it tooth and nail, pandering to the masses to prop up the current system, now clearly doomed to failure.
This backdrop will prove to be treacherous for investors. I think we are now embarking in a period that will see financial convulsions between inflation and deflation. Battling between the two and trying to position for the correct scenario will rip most portfolios apart. If you are positioned for one while the other occurs, it destroys your capital base, leaving an investor with less to try to take advantage of the next swing.
Since last August (2007), the correct bet was on the inflation trade. That trade changed on dime on July 15. Many incorrectly interpreted the dollar strengthening and rebound in deeply oversold sectors as a return a bull market for US equities. Wrong! This was a reversal of a very crowded trade as the winds of deflation began to displace inflationary forces. The reversal of the long commodities/short the dollar (and equities which benefit) was swift and brutal and continues today.
Because the jig is up and the end game/ reckoning has now begun, the only question that remains is will it end in fire (inflation/hyper-inflation) or ice (deflation). I like the recent quotes from the prescient old-timer Harry Schultz (from Peter Brimelow at CBS Marketwatch) to explain: "Fed maneuver room approximately gone. Any $US injection big enough to avert a depression triggers runaway inflation. If not big enough: depression. US on knife-edge. Gold helps you either way."
If Bush bails them [financial institutions] all out, the die would be cast for inflation unseen in the West since 1923 Germany. If no bail: "Hello, 1929." In order to determine which scenario to position your portfolio for, I like to turn to the US Dollar for clues. The "80-level", a multi-decade support level violated a year ago, should now offer firm resistance for any further dollar strengthening as it rises to 80 once again. Look at the chart below:
As the dollar rose from under 71 (the end of March) to over 79 (now) over the summer we saw an across-the-board selloff in commodities and emerging market equities and a mini-counter-trend rally in the stinky US sectors (tech, financials, consumer discretionary) where investors had previously been losing their shirts. Government bonds also rallied indicating that this was a period in which you should have been invested for deflation. We are now approaching an important test for the US dollar is it approaches 80 again. The dollar has rallied up to 80 over the last couple of weeks (not quite shown on the chart above).
If the dollar does in fact rally above 80, then I think that the deflation trade will accelerate further and takedown US equities, this time in a major whiff of asset deflation which takes down almost all asset classes except US treasuries. If it continues unabated it will result in a major deflationary depression. Gold will eventually rise in value amidst the chaos and removal of the paper currencies, but not until after first declining significantly.
If, on the other hand, the US dollar begins to decline back below the 74-73-level, I think that investors will need to consider repositioning for the inflation trade. While the dollar stays in the 75-80 range we can expect big gyrations, but little real movement or investment direction. In the inflationary environment, your best investment choices are energy and precious metals.
If the dollar does move above 80, I view it highly likely that at some point before a deflationary depression occurs, governments and politicians around the world will massively debase their currencies and enact ultra-expansionary fiscal and monetary policies in order to fight it. Therefore, anyone with a one-way bet on deflation could be wiped out if we experience one or two highly-inflationary periods along the way.
Planning for the unavoidable collapse of this beast of a fiat financial system we must now confront, the "Financial Funeral" is thus fraught with danger as you try to navigate between seemingly wild and capricious swings between inflation and deflation. The only bet sure to fail is that the government actions will succeed in preventing the Financial Funeral from ever occurring.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Last Ditch
Last Ditch
By James Howard Kunstler, Author Of The Long Emergency | 9 September 2008
Kunstler.com
Why do the big deals always happen over the weekends? So the big boyz in government and finance can take off their neckties when they bargain with each other? So the markets will be closed and unable to register a response one way or another? So the shrinking fraction of the US public that pays attention to anything besides Nascar and pornography won't catch the news Saturday evening? This weekend's big deal was the US government taking over the "government sponsored enterprises" (GSEs)
Fannie Mae and Freddie Mac that guarantee trillions of dollars in mortgages. The "guarantee" is supposedly accomplished by converting bundles of mortgages from the banks and loan companies that originate them (that make the contracts with the buyers of houses) into bonds that can be sold downstream. Risk was theoretically dispersed among the holders of these bonds. This all seemed to work during the long stable period when our cheap oil economy was chugging along, and house prices maintained a consistent relationship with incomes, and people paid their mortgages dependably. The whole system ran like a reliable machine— like a Chrysler slant-six engine!
Until the cheap oil age came to an end. Then, all parts of the system shook apart. It was the end of cheap oil that catalyzed the housing collapse and, by extension, the current huge financial crisis. But the run up to it was like a bounce off a high diving board into an empty pool. The bounce came around 2001 when it became apparent that the US standard-of-living could not be maintained on incomes in a post-cheap-oil economy. The trauma of 9/11 prompted a new and utterly insane consensus to form that the US standard of living could be switched over from income to massive debt.
All the normal brakes against irresponsible lending and borrowing came off— embodied in Alan Greenspan's absurd statement that it was a good time to assume an adjustable rate mortgage when interest rates were at a historic low— meaning they could only be adjusted upwards. Why hold Greenspan responsible? Because he was at the apex of the authority vested with establishing norms, and he shoved our behavior into the realm of the recklessly abnormal, and he should have known better.
The public went along with it because "free money" and high living are fun. Their behavior was reinforced by other authorities— for instance, President Bush, who told Americans to go shopping after the 9/11 attacks. (They went shopping with credit cards.) Things really wobbled in 2005— which was, coincidentally, the year of all-time world-wide peak conventional oil production— with hurricanes Katrina and Rita ripping through the Gulf of Mexico oil rigs as a dramatic highlight. (It was also the year that The Long Emergency was published.)
Since then, the US economy and the financial part of it that became a nine hundred pound tail wagging a thirty-pound dog, has been held together with baling wire, duct tape, and band-aids. All the debt run up by all parties— home-owners, credit-card holders, business, banks, hedge funds, government— is not being paid back reliably, and all the leveraged arrangements that depend on it being paid back are coming apart. Thus, capital disappears. The wealth of a nation disappears. All that remains is the pretense that we are still a wealthy society.
Fannie and Freddie are near the center of this black hole of debt. So far, the black hole has been "papered over" by the old stage magician's trick of diverting the audience's attention. The systemic wound that Bear Stearns represented, was covered up with a band-aid applied by the Federal Reserve's exchange of loans for worthless securities. In fact, the capital of Bear Stearns actually did disappear— a mere residue of it, a few cents on the dollar, was shifted to JP Morgan as payment for taking the wrapper off the band-aid. But, basically, the money is gone— all gone.
Now, the same thing has happened with Fannie and Freddie, except that the scale is an order of magnitude greater. This time, the US Treasury Department is assuming worthless paper and paying out much larger loans to enterprises that are functionally bankrupt. The exact nature of the government's chartered "sponsorship" has always been ambiguous.
Professional opinion has generally held that government backing was implied rather than explicit— but that's a ridiculous internal contradiction that went unchallenged for decades as Fannie and Freddie's Ponzi-style operation lumbered on (and their executives made off with obscene payouts). Now the government's role has suddenly been made 'explicit'. It will probably only make things worse, since the enterprises are too big and over-scaled to work under any circumstances, let alone insolvency.
One thing this points to is a truth that is uniformly overlooked by kibitzers: that what we developed over the past decade in America was not an "information economy" or a "consumer economy" but a "suburban sprawl building economy", meaning an economy dedicated to building a living arrangement with no future. The climax of the sprawl building economy occurred in absolute lockstep with the climax of peak oil.
You can date it virtually to the month— May, 2005. After that, the future asserted itself and all the financial expectations bound up with sprawl-building went up in a vapor— including the value of mortgages on suburban houses. Everything that followed has been an attempt to cover up this basic reality: that the way we live in America can't continue.
The reason our energy debate is so hollow and idiotic is because we can't face this basic reality. The fantasy-du-jour among both political parties is that we can become "energy independent." By this they mean we can keep on living the way we do by means other than [cheap] oil. This is just not true. We have to make profound changes in everything we do from the way we inhabit the landscape to the way we produce our food. Lately, the only change we've shown any interest in is changing what our cars run on. But that is not going to rescue us, not even a little. Our inability to talk about anything else except cars will drag us down into poverty and turmoil.
The housing market is not coming back. Ever. Not in the form that we knew it in the last few decades— or even since WWII. The suburban project is over. That version of the American Dream is over. We'll be a lot better off if we put aside dreaming altogether for a while and start focusing on reality instead— that part of the day when we're awake and capable of actually doing things. We've got a lot to face and a lot to do.
The government takeover of Fannie and Freddie is just another papering-over of our fundamental problem— that until we embark on new ways of being a nation, of living differently and working differently on different things, the other nations of the world will not have confidence in us, or the paper we issue, and we will not really have confidence in ourselves.
I have believed all along— and said as much in The Long Emergency— that we would not get through this crisis without passing through a period of hardship. We're entering it now. Even if the stock markets shoot up five hundred points today on the basis of the Fannie-Freddie deal (and the mistaken belief that our troubles are over), we are only at the beginning of a very painful workout. Personally, I think we're in for financial carnage before the election. The Fannie-Freddie deal may be the place where the wheels really come off.
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By James Howard Kunstler, Author Of The Long Emergency | 9 September 2008
Kunstler.com
Why do the big deals always happen over the weekends? So the big boyz in government and finance can take off their neckties when they bargain with each other? So the markets will be closed and unable to register a response one way or another? So the shrinking fraction of the US public that pays attention to anything besides Nascar and pornography won't catch the news Saturday evening? This weekend's big deal was the US government taking over the "government sponsored enterprises" (GSEs)
Fannie Mae and Freddie Mac that guarantee trillions of dollars in mortgages. The "guarantee" is supposedly accomplished by converting bundles of mortgages from the banks and loan companies that originate them (that make the contracts with the buyers of houses) into bonds that can be sold downstream. Risk was theoretically dispersed among the holders of these bonds. This all seemed to work during the long stable period when our cheap oil economy was chugging along, and house prices maintained a consistent relationship with incomes, and people paid their mortgages dependably. The whole system ran like a reliable machine— like a Chrysler slant-six engine!
Until the cheap oil age came to an end. Then, all parts of the system shook apart. It was the end of cheap oil that catalyzed the housing collapse and, by extension, the current huge financial crisis. But the run up to it was like a bounce off a high diving board into an empty pool. The bounce came around 2001 when it became apparent that the US standard-of-living could not be maintained on incomes in a post-cheap-oil economy. The trauma of 9/11 prompted a new and utterly insane consensus to form that the US standard of living could be switched over from income to massive debt.
All the normal brakes against irresponsible lending and borrowing came off— embodied in Alan Greenspan's absurd statement that it was a good time to assume an adjustable rate mortgage when interest rates were at a historic low— meaning they could only be adjusted upwards. Why hold Greenspan responsible? Because he was at the apex of the authority vested with establishing norms, and he shoved our behavior into the realm of the recklessly abnormal, and he should have known better.
The public went along with it because "free money" and high living are fun. Their behavior was reinforced by other authorities— for instance, President Bush, who told Americans to go shopping after the 9/11 attacks. (They went shopping with credit cards.) Things really wobbled in 2005— which was, coincidentally, the year of all-time world-wide peak conventional oil production— with hurricanes Katrina and Rita ripping through the Gulf of Mexico oil rigs as a dramatic highlight. (It was also the year that The Long Emergency was published.)
Since then, the US economy and the financial part of it that became a nine hundred pound tail wagging a thirty-pound dog, has been held together with baling wire, duct tape, and band-aids. All the debt run up by all parties— home-owners, credit-card holders, business, banks, hedge funds, government— is not being paid back reliably, and all the leveraged arrangements that depend on it being paid back are coming apart. Thus, capital disappears. The wealth of a nation disappears. All that remains is the pretense that we are still a wealthy society.
Fannie and Freddie are near the center of this black hole of debt. So far, the black hole has been "papered over" by the old stage magician's trick of diverting the audience's attention. The systemic wound that Bear Stearns represented, was covered up with a band-aid applied by the Federal Reserve's exchange of loans for worthless securities. In fact, the capital of Bear Stearns actually did disappear— a mere residue of it, a few cents on the dollar, was shifted to JP Morgan as payment for taking the wrapper off the band-aid. But, basically, the money is gone— all gone.
Now, the same thing has happened with Fannie and Freddie, except that the scale is an order of magnitude greater. This time, the US Treasury Department is assuming worthless paper and paying out much larger loans to enterprises that are functionally bankrupt. The exact nature of the government's chartered "sponsorship" has always been ambiguous.
Professional opinion has generally held that government backing was implied rather than explicit— but that's a ridiculous internal contradiction that went unchallenged for decades as Fannie and Freddie's Ponzi-style operation lumbered on (and their executives made off with obscene payouts). Now the government's role has suddenly been made 'explicit'. It will probably only make things worse, since the enterprises are too big and over-scaled to work under any circumstances, let alone insolvency.
One thing this points to is a truth that is uniformly overlooked by kibitzers: that what we developed over the past decade in America was not an "information economy" or a "consumer economy" but a "suburban sprawl building economy", meaning an economy dedicated to building a living arrangement with no future. The climax of the sprawl building economy occurred in absolute lockstep with the climax of peak oil.
You can date it virtually to the month— May, 2005. After that, the future asserted itself and all the financial expectations bound up with sprawl-building went up in a vapor— including the value of mortgages on suburban houses. Everything that followed has been an attempt to cover up this basic reality: that the way we live in America can't continue.
The reason our energy debate is so hollow and idiotic is because we can't face this basic reality. The fantasy-du-jour among both political parties is that we can become "energy independent." By this they mean we can keep on living the way we do by means other than [cheap] oil. This is just not true. We have to make profound changes in everything we do from the way we inhabit the landscape to the way we produce our food. Lately, the only change we've shown any interest in is changing what our cars run on. But that is not going to rescue us, not even a little. Our inability to talk about anything else except cars will drag us down into poverty and turmoil.
The housing market is not coming back. Ever. Not in the form that we knew it in the last few decades— or even since WWII. The suburban project is over. That version of the American Dream is over. We'll be a lot better off if we put aside dreaming altogether for a while and start focusing on reality instead— that part of the day when we're awake and capable of actually doing things. We've got a lot to face and a lot to do.
The government takeover of Fannie and Freddie is just another papering-over of our fundamental problem— that until we embark on new ways of being a nation, of living differently and working differently on different things, the other nations of the world will not have confidence in us, or the paper we issue, and we will not really have confidence in ourselves.
I have believed all along— and said as much in The Long Emergency— that we would not get through this crisis without passing through a period of hardship. We're entering it now. Even if the stock markets shoot up five hundred points today on the basis of the Fannie-Freddie deal (and the mistaken belief that our troubles are over), we are only at the beginning of a very painful workout. Personally, I think we're in for financial carnage before the election. The Fannie-Freddie deal may be the place where the wheels really come off.
|
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Very Modest Good News
Very Modest Good News
By Dr. Marc Faber | 11 August 2008
I can see some— albeit very modest— improvement for the US stock market. For one, it appears that the slowdown and problems in other economies, such as the UK (a disaster waiting to happen), Italy, Spain, and Ireland, [[and Chindia and the Far East: normxxx]] are even greater than in the US. Also, since numerous emerging stock markets have underperformed the US this year, some money is likely to be repatriated from countries such as India and China, where stock markets are down approximately 40% year-to-date. We should also consider that, as Joachim Fels noted, "Fifty of the 190 or so countries in the world now have inflation running at double-digit rates. Almost all of these are EM economies." In my opinion, some emerging economies— contrary to expectations— could therefore be hit even harder than the US. So, the good news here is that the "bad news" is even worse in some other countries than in the US (though this may be hard to believe).
The media and some market commentators who were "bullish" until late June have noticed recently that we are in a bear market, probably because the major indices are down roughly 20% from their peak [[although now they are calling a "bottom" for this bear market: normxxx]]. This is a remarkable achievement in the annals of forecasting and market timing! How many stocks had to drop by between 50% and 99% before the media and some "bulls" who have continued to talk about another upward wave in stock prices being 'just around the corner', which would supposedly lift the indices to new highs, finally accepted that we are now in a bear market?
Don't forget that when stock market indices made new highs seven months ago, the media and most advisers were exuberantly optimistic— although most stocks were then already in downtrends. Moreover, sentiment figures (bulls versus bears) among individual investors and investment advisers are now heavily tilted towards the bearish side. Whenever sentiment has been this negative in the past, the odds favoured at least a short term rally. Still, I need to warn our readers that since sentiment remained so extremely optimistic between 2003 and 2007 while the stock market rose, it is just possible that sentiment will remain extremely negative for a long time while the market continues to decline.
The third improvement I have noticed is that, from a technical point of view, the market has become "quite" (though not extremely) oversold. But again, I need to warn here that the market would now be oversold in the context of a bull market— not in the context of a bear market, during which the oversold condition could last for a very long time. I suppose that Ambac was already oversold at US$70, and where did it eventually bottom at? Moreover, at major turning points, markets can quickly reach oversold or overbought conditions and then work out these conditions without large corrections. Let me explain.
In the summer of 1982, US equities had become extremely depressed; they were no higher than in 1964, and in real terms were down by more than 70% from their 1966 "real" high. The Dow bottomed out at 769 on August 9 and, if I recall correctly, the stock market took off on August 18. By September 22, the Dow had reached 951 (up more than 20% from the August low). The two most overbought conditions I have seen up to that time had occurred at the end of August 1982, and then again on September 22. But, thereafter, the market continued to rise: to 1296 in November 1983, to 2746 at the August 1987 peak, and to the recent high of 14,198 on October 12, 2007.
So, I wish to stress that overbought and oversold conditions must always be put in the context of both the primary trend— up or down— and the phase of the bull or bear market in which they show up. Overbought conditions at the beginning of an uptrend, and oversold conditions at the beginning of a downtrend, are meaningless from a longer-term perspective! If we are indeed in a bear market, which is my view— and has been since the summer of 2007, the current oversold position is relevant only from a very short-term point of view.
The fourth improvement I see is that some previously strong stocks and groups such as US Steel (X), Cleveland-Cliffs (CLF), IBM, and the oil sector, as well as the Nasdaq and some of its leaders such as Research in Motion (RIMM), Apple (AAPL), etc, are beginning to turn down. For the market leaders to collapse is an important precondition for a major low. But again, we need to understand that it will take much longer, and far lower prices, before the very strong stocks and sectors (mostly energy-related and materials) that have so far defied the bear market in financial stocks reach a major low.
Since I fully expect the financial crisis to spread into the real economy, I would sell those sectors and stocks that have so far defied the weakness in financial stocks. Another potentially good piece of news is that the current expansionary monetary policies make the stronger companies in an industry relatively stronger than their weaker competitors, which would then be reflected in strongly diverging stock performances. The weak company stocks could decline so much as to make them, at some point, attractive merger and acquisitions candidates for the financially stronger companies. Industry consolidation would in this scenario accelerate and lead to stronger pricing power (and inflation).
The last potentially good bit of news is that oil and other commodity prices may have reached an intermediate top. Should oil prices decline by, say, 20% to 40%, this fact will certainly be broadcasted by the media— as well as by ignorant cheerleaders and people who still don't regard commodities as an asset class— as great news for the stock market! A relief rally would likely follow. But wait a minute: why would oil prices and other commodities decline meaningfully?
Because of a lack of affordability and a weak economy around the world— not just in the US! This would lead to declining demand for raw materials and likely lower prices. (Supplies are unlikely to increase significantly, but they could be cut as a result of war, civil strife, or concerted action by the producers.) However, a weak economy or economic contraction around the world would be unlikely to be favourable for equities and corporate profits.
I need to make one more comment with respect to oil prices and commodities. It is not a strong US dollar that will lead to declining oil prices, as some commentators argue. What will bring about lower oil prices is a collapse of consumer spending in the US and elsewhere in the world. If US consumption collapses, the US trade and current account deficit will be halved and will lead to a drying up of global liquidity.
I have discussed this relationship many times in the past and have clearly shown the relationship between the growth rate in Foreign Official US Dollar Reserves and the US dollar. Declining US consumption will be positive for the US dollar and will certainly bring down commodity prices because of lower demand (at least temporarily). But if you really think that such an outcome will be good for stocks, then dream on!
Finally, since the bull market in commodities began, there has been a body of people who have maintained that commodities are not an asset class. Some have even gone as far as to compare gold to washing machines. But consider the following: my dogs and my books are an asset for me, but maybe not to someone else. My dogs protect my house and my books. My books give me pleasure and— so I hope— some modest knowledge. But my dogs would be a liability to someone else if he lived in a secure condo building. (If there is such a thing as a secure condo building!)
Also, my books would be useless to an illiterate person, since he would not be in a position to read them. A high-calibre mathematician is likely to be an asset for James Simons of Renaissance fame, but a huge liability in a rescue mission on Mount Everest. Water may be a huge asset if you are lost in the middle of the desert, but it is not an asset when you are standing in the rain without an umbrella and waiting for a date to arrive. So, the first point to understand is that anything can be an asset for somebody at some time, and not an asset for somebody else at some other time. Normally, cigarettes are not considered to be an asset, but in prisoners' camps during wars, in wartime in general, and in times of hyperinflation, they are an asset— in fact, they replace cash banknotes.
Now, if someone defines an asset class as something that provides a cash flow, commodities may by this definition not be an asset. However, what if asset markets such as equities, bonds, and cash (T-bills) provide a negative return in real terms (inflation adjusted)? The moment when money loses its purchasing power because real interest rates are negative, and because we need to deal with people like Mr. Bernanke, assets such as raw land, commodities, art and collectibles do become a store of value and, therefore, represent a desirable asset class.
All I wish to say is that the term "asset class" is extremely difficult to define, and that at different times and in different situations certain things and certain skills become an asset, whereas on other occasions they are useless. But one thing all my readers should clearly understand: when the last ship leaves the port as the enemy approaches, the captain of that ship will accept one kilogram of gold from you to buy your passage. I doubt that he will accept CDOs, derivative contracts, bonds or, for that matter, stock certificates of Fannie Mae or Freddie Mac. (Maybe by then the captain won't even accept US dollars, because their value could decline precipitously during the voyage.) I may add that, in the financial sector, the last ship may be about to leave.
In sum, I believe that in the next few years the returns from equities will be disappointing (short-term rallies aside), which could cause other asset classes (especially industrial commodities) also to come under pressure. When I look around, I find it hard to identify any asset that is particularly attractive at this point. Therefore, in the absence of anything that promises far superior returns, I am still happy to accumulate physical gold. In democracies, where the leadership is afraid to ask for sacrifices from its citizens and with money printers at central banks, gold would seem to be the only sound currency.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Dr. Marc Faber | 11 August 2008
I can see some— albeit very modest— improvement for the US stock market. For one, it appears that the slowdown and problems in other economies, such as the UK (a disaster waiting to happen), Italy, Spain, and Ireland, [[and Chindia and the Far East: normxxx]] are even greater than in the US. Also, since numerous emerging stock markets have underperformed the US this year, some money is likely to be repatriated from countries such as India and China, where stock markets are down approximately 40% year-to-date. We should also consider that, as Joachim Fels noted, "Fifty of the 190 or so countries in the world now have inflation running at double-digit rates. Almost all of these are EM economies." In my opinion, some emerging economies— contrary to expectations— could therefore be hit even harder than the US. So, the good news here is that the "bad news" is even worse in some other countries than in the US (though this may be hard to believe).
The media and some market commentators who were "bullish" until late June have noticed recently that we are in a bear market, probably because the major indices are down roughly 20% from their peak [[although now they are calling a "bottom" for this bear market: normxxx]]. This is a remarkable achievement in the annals of forecasting and market timing! How many stocks had to drop by between 50% and 99% before the media and some "bulls" who have continued to talk about another upward wave in stock prices being 'just around the corner', which would supposedly lift the indices to new highs, finally accepted that we are now in a bear market?
Don't forget that when stock market indices made new highs seven months ago, the media and most advisers were exuberantly optimistic— although most stocks were then already in downtrends. Moreover, sentiment figures (bulls versus bears) among individual investors and investment advisers are now heavily tilted towards the bearish side. Whenever sentiment has been this negative in the past, the odds favoured at least a short term rally. Still, I need to warn our readers that since sentiment remained so extremely optimistic between 2003 and 2007 while the stock market rose, it is just possible that sentiment will remain extremely negative for a long time while the market continues to decline.
The third improvement I have noticed is that, from a technical point of view, the market has become "quite" (though not extremely) oversold. But again, I need to warn here that the market would now be oversold in the context of a bull market— not in the context of a bear market, during which the oversold condition could last for a very long time. I suppose that Ambac was already oversold at US$70, and where did it eventually bottom at? Moreover, at major turning points, markets can quickly reach oversold or overbought conditions and then work out these conditions without large corrections. Let me explain.
In the summer of 1982, US equities had become extremely depressed; they were no higher than in 1964, and in real terms were down by more than 70% from their 1966 "real" high. The Dow bottomed out at 769 on August 9 and, if I recall correctly, the stock market took off on August 18. By September 22, the Dow had reached 951 (up more than 20% from the August low). The two most overbought conditions I have seen up to that time had occurred at the end of August 1982, and then again on September 22. But, thereafter, the market continued to rise: to 1296 in November 1983, to 2746 at the August 1987 peak, and to the recent high of 14,198 on October 12, 2007.
So, I wish to stress that overbought and oversold conditions must always be put in the context of both the primary trend— up or down— and the phase of the bull or bear market in which they show up. Overbought conditions at the beginning of an uptrend, and oversold conditions at the beginning of a downtrend, are meaningless from a longer-term perspective! If we are indeed in a bear market, which is my view— and has been since the summer of 2007, the current oversold position is relevant only from a very short-term point of view.
The fourth improvement I see is that some previously strong stocks and groups such as US Steel (X), Cleveland-Cliffs (CLF), IBM, and the oil sector, as well as the Nasdaq and some of its leaders such as Research in Motion (RIMM), Apple (AAPL), etc, are beginning to turn down. For the market leaders to collapse is an important precondition for a major low. But again, we need to understand that it will take much longer, and far lower prices, before the very strong stocks and sectors (mostly energy-related and materials) that have so far defied the bear market in financial stocks reach a major low.
Since I fully expect the financial crisis to spread into the real economy, I would sell those sectors and stocks that have so far defied the weakness in financial stocks. Another potentially good piece of news is that the current expansionary monetary policies make the stronger companies in an industry relatively stronger than their weaker competitors, which would then be reflected in strongly diverging stock performances. The weak company stocks could decline so much as to make them, at some point, attractive merger and acquisitions candidates for the financially stronger companies. Industry consolidation would in this scenario accelerate and lead to stronger pricing power (and inflation).
The last potentially good bit of news is that oil and other commodity prices may have reached an intermediate top. Should oil prices decline by, say, 20% to 40%, this fact will certainly be broadcasted by the media— as well as by ignorant cheerleaders and people who still don't regard commodities as an asset class— as great news for the stock market! A relief rally would likely follow. But wait a minute: why would oil prices and other commodities decline meaningfully?
Because of a lack of affordability and a weak economy around the world— not just in the US! This would lead to declining demand for raw materials and likely lower prices. (Supplies are unlikely to increase significantly, but they could be cut as a result of war, civil strife, or concerted action by the producers.) However, a weak economy or economic contraction around the world would be unlikely to be favourable for equities and corporate profits.
I need to make one more comment with respect to oil prices and commodities. It is not a strong US dollar that will lead to declining oil prices, as some commentators argue. What will bring about lower oil prices is a collapse of consumer spending in the US and elsewhere in the world. If US consumption collapses, the US trade and current account deficit will be halved and will lead to a drying up of global liquidity.
I have discussed this relationship many times in the past and have clearly shown the relationship between the growth rate in Foreign Official US Dollar Reserves and the US dollar. Declining US consumption will be positive for the US dollar and will certainly bring down commodity prices because of lower demand (at least temporarily). But if you really think that such an outcome will be good for stocks, then dream on!
Finally, since the bull market in commodities began, there has been a body of people who have maintained that commodities are not an asset class. Some have even gone as far as to compare gold to washing machines. But consider the following: my dogs and my books are an asset for me, but maybe not to someone else. My dogs protect my house and my books. My books give me pleasure and— so I hope— some modest knowledge. But my dogs would be a liability to someone else if he lived in a secure condo building. (If there is such a thing as a secure condo building!)
Also, my books would be useless to an illiterate person, since he would not be in a position to read them. A high-calibre mathematician is likely to be an asset for James Simons of Renaissance fame, but a huge liability in a rescue mission on Mount Everest. Water may be a huge asset if you are lost in the middle of the desert, but it is not an asset when you are standing in the rain without an umbrella and waiting for a date to arrive. So, the first point to understand is that anything can be an asset for somebody at some time, and not an asset for somebody else at some other time. Normally, cigarettes are not considered to be an asset, but in prisoners' camps during wars, in wartime in general, and in times of hyperinflation, they are an asset— in fact, they replace cash banknotes.
Now, if someone defines an asset class as something that provides a cash flow, commodities may by this definition not be an asset. However, what if asset markets such as equities, bonds, and cash (T-bills) provide a negative return in real terms (inflation adjusted)? The moment when money loses its purchasing power because real interest rates are negative, and because we need to deal with people like Mr. Bernanke, assets such as raw land, commodities, art and collectibles do become a store of value and, therefore, represent a desirable asset class.
All I wish to say is that the term "asset class" is extremely difficult to define, and that at different times and in different situations certain things and certain skills become an asset, whereas on other occasions they are useless. But one thing all my readers should clearly understand: when the last ship leaves the port as the enemy approaches, the captain of that ship will accept one kilogram of gold from you to buy your passage. I doubt that he will accept CDOs, derivative contracts, bonds or, for that matter, stock certificates of Fannie Mae or Freddie Mac. (Maybe by then the captain won't even accept US dollars, because their value could decline precipitously during the voyage.) I may add that, in the financial sector, the last ship may be about to leave.
In sum, I believe that in the next few years the returns from equities will be disappointing (short-term rallies aside), which could cause other asset classes (especially industrial commodities) also to come under pressure. When I look around, I find it hard to identify any asset that is particularly attractive at this point. Therefore, in the absence of anything that promises far superior returns, I am still happy to accumulate physical gold. In democracies, where the leadership is afraid to ask for sacrifices from its citizens and with money printers at central banks, gold would seem to be the only sound currency.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Dollar Rescue?
US, Europe, Japan Planned March Dollar Rescue
By Reuters | 27 August 2008
NEW YORK, Aug 27 (Reuters)— The United States, Europe and Japan had planned to intervene and rescue a weak U.S. dollar in March, business newspaper Nikkei reported on Wednesday. Officials from the U.S. Treasury Department, Japan's Finance Ministry, and the European Central Bank reportedly drew up a currency contingency plan to be undertaken over the March 15-16 weekend, Nikkei reported, citing sources familiar with the situation. The monetary officials also agreed on a framework for coordinating dollar-buying intervention, the report said.
The officials did not specify an exchange rate for initiating the dollar rescue plan, but in the event of a free-fall, they all agreed to aggressively buy the greenback and sell yen and euros, according to Nikkei. Under the intervention framework, Japan was to supply the yen necessary for the underlying currency swaps. The plan also called for using a previously established swap mechanism between the United States and Europe.
No coordinated intervention took place, however, as the dollar began recovering shortly after U.S. authorities brokered the buyout of Bear Stearns by JPMorgan Chase & Co. As measured by the U.S. dollar index, the currency hit bottom on March 17, the first market day following the Bear Stearns deal announcement. It retested those lows in April and again in July, but is now nearly 9 percent stronger against the basket of major currencies included in the index.
A U.S. Treasury spokeswoman declined to comment on the report. The Federal Reserve also declined to comment. A spokeswoman for the ECB said she had no immediate comment, but said the central bank would talk about the situation in the morning. Overall, analysts said that even though a rescue plan never took place, the fact that global monetary officials showed concern for a weak dollar was significant. "If anything, the fact that officials recognized the concern about the dollar's decline seems somewhat supportive for the dollar as maybe benign neglect was not so neglectful," said Marc Chandler, head of global FX strategy at Brown Brothers Harriman in New York.
"At the end of the day, however, President Bush is still set to be the first American president since at least the break-up of Bretton Woods that has not authorized intervention in the FX market, and given the recent price action the distinction looks relatively safe." The United States, Europe and Japan have not intervened together in the currency market since September 2000. Japan's last intervention was in March 2004. (Reporting by Gertrude Chavez-Dreyfuss; Editing by Leslie Adler)
Meanwhile, foreign central banks are buying U.S. dollar-denominated bonds at a furious pace. Why? No one seems to know. But holdings of U.S. Treasury securities have increased at a 34% annualized pace over the last three months. And, it looks like a dollar rebound is firmly in play, thanks to tighter credit conditions in the U.S.(?)
From a fundamental perspective, something has changed: For the first time in 20 years, the supply of credit around the world is drying up. Consider the availability of credit in the United States. Mortgage lending, the engine of our economy for the last 10 years, has ground almost to a halt. You cannot get a cheap mortgage anymore, and you can only get a mortgage if you've got an unblemished credit history.
That's a radical change from only two years ago. Likewise, all U.S. banks have tightened their lending standards across the board and have moved rates higher. While the Federal Reserve has been making credit available to troubled investment banks, the size of its overall balance sheet has barely grown at all— up only 2.1% in the last 12 months.
The Fed can't permit the money supply to grow while it has interest rates set so low. The resulting inflation would be catastrophic. So... even though credit is cheap to banks, it is also very tight for the first time in two decades [[and dear for the 'rest of us'— who were scarcely responsible for this fiasco: normxxx]].
It should not be any surprise that the USD may find broad support and even open intervention. In 10 years USD Reserves have risen nearly 500%. The world is flooded in US Dollars and yet economies are suffering. It should not surprise anybody that inflation has set in— I also do not realistically see the Central Banks throttling their money growth.
If an unforeseen event should occur and drive out holders of the US Dollar, this would cause a large drop in the US Dollar value. The fact that the share of official reserves being held in dollars has remained broadly constant, while the dollar has seen a large depreciation, implies that central banks have been large buyers of dollars. There is thus still fundamental support for the dollar from official reserve flows, which is acting to curb some of the depreciative pressures from the general economic fundamentals. That the dollars reserve share has not seen a marked fall is naturally positive and the dollar would likely have fallen even further in recent years had it not been for these fundamental flows.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Reuters | 27 August 2008
NEW YORK, Aug 27 (Reuters)— The United States, Europe and Japan had planned to intervene and rescue a weak U.S. dollar in March, business newspaper Nikkei reported on Wednesday. Officials from the U.S. Treasury Department, Japan's Finance Ministry, and the European Central Bank reportedly drew up a currency contingency plan to be undertaken over the March 15-16 weekend, Nikkei reported, citing sources familiar with the situation. The monetary officials also agreed on a framework for coordinating dollar-buying intervention, the report said.
The officials did not specify an exchange rate for initiating the dollar rescue plan, but in the event of a free-fall, they all agreed to aggressively buy the greenback and sell yen and euros, according to Nikkei. Under the intervention framework, Japan was to supply the yen necessary for the underlying currency swaps. The plan also called for using a previously established swap mechanism between the United States and Europe.
No coordinated intervention took place, however, as the dollar began recovering shortly after U.S. authorities brokered the buyout of Bear Stearns by JPMorgan Chase & Co. As measured by the U.S. dollar index, the currency hit bottom on March 17, the first market day following the Bear Stearns deal announcement. It retested those lows in April and again in July, but is now nearly 9 percent stronger against the basket of major currencies included in the index.
A U.S. Treasury spokeswoman declined to comment on the report. The Federal Reserve also declined to comment. A spokeswoman for the ECB said she had no immediate comment, but said the central bank would talk about the situation in the morning. Overall, analysts said that even though a rescue plan never took place, the fact that global monetary officials showed concern for a weak dollar was significant. "If anything, the fact that officials recognized the concern about the dollar's decline seems somewhat supportive for the dollar as maybe benign neglect was not so neglectful," said Marc Chandler, head of global FX strategy at Brown Brothers Harriman in New York.
"At the end of the day, however, President Bush is still set to be the first American president since at least the break-up of Bretton Woods that has not authorized intervention in the FX market, and given the recent price action the distinction looks relatively safe." The United States, Europe and Japan have not intervened together in the currency market since September 2000. Japan's last intervention was in March 2004. (Reporting by Gertrude Chavez-Dreyfuss; Editing by Leslie Adler)
Meanwhile, foreign central banks are buying U.S. dollar-denominated bonds at a furious pace. Why? No one seems to know. But holdings of U.S. Treasury securities have increased at a 34% annualized pace over the last three months. And, it looks like a dollar rebound is firmly in play, thanks to tighter credit conditions in the U.S.(?)
From a fundamental perspective, something has changed: For the first time in 20 years, the supply of credit around the world is drying up. Consider the availability of credit in the United States. Mortgage lending, the engine of our economy for the last 10 years, has ground almost to a halt. You cannot get a cheap mortgage anymore, and you can only get a mortgage if you've got an unblemished credit history.
That's a radical change from only two years ago. Likewise, all U.S. banks have tightened their lending standards across the board and have moved rates higher. While the Federal Reserve has been making credit available to troubled investment banks, the size of its overall balance sheet has barely grown at all— up only 2.1% in the last 12 months.
The Fed can't permit the money supply to grow while it has interest rates set so low. The resulting inflation would be catastrophic. So... even though credit is cheap to banks, it is also very tight for the first time in two decades [[and dear for the 'rest of us'— who were scarcely responsible for this fiasco: normxxx]].
It should not be any surprise that the USD may find broad support and even open intervention. In 10 years USD Reserves have risen nearly 500%. The world is flooded in US Dollars and yet economies are suffering. It should not surprise anybody that inflation has set in— I also do not realistically see the Central Banks throttling their money growth.
If an unforeseen event should occur and drive out holders of the US Dollar, this would cause a large drop in the US Dollar value. The fact that the share of official reserves being held in dollars has remained broadly constant, while the dollar has seen a large depreciation, implies that central banks have been large buyers of dollars. There is thus still fundamental support for the dollar from official reserve flows, which is acting to curb some of the depreciative pressures from the general economic fundamentals. That the dollars reserve share has not seen a marked fall is naturally positive and the dollar would likely have fallen even further in recent years had it not been for these fundamental flows.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
A Decade Of Slow Growth
A Decade Of Slow Growth:
Why The United States Will Face A Decade Of Economic Stagnation And Face A L Shaped Recession.
By Dr. Housing Bubble | 8 September 2008
Given the recent positive reading for GDP, some are now doubting that we will even face a recession. This of course is a misnomer and most average Americans realize that our country finds itself in a very tenuous situation. It is very easy to brush off the current talk of economic malaise as simply another business cycle unwinding yet this time there are many fundamental circumstances that simply make this situation a very unique beast.
As baby boomers reach retirement age it could not have happened at a worse time. The economy is on the brink of recession and we are going to face the largest entitlement program drain on our system ever. Social Security was never devised as a retirement or pension program but a large portion of our elderly depend on this income.
There is a baby-boomer age-wave theory proposed by economist Harry Dent that views a peak in the US stock market at 2007 and 2009. His prediction is based on observations that consumer spending peaks at or near age 50. With many boomers starting to retire in the upcoming years the age-wave theory predicts a slow down in the economy.
Generally speaking there are 76 million people that were born between 1946 and 1964. With that said, 2011 will be the first year that the first baby boomers will hit the 65 year age mark [[they've already hit the 62 year, early retirement, mark this year: normxxx]] and the beginning of a long-term trend that will become more reliant on entitlement programs. This is happening just as the largest United States housing bubble is popping. With residential housing prices peaking at nearly $24 trillion only to see about $5 trillion of that disappear in a few short years, the economy is facing constraints at the worst possible times.
We are also seeing consumer inflation pick up in gas, groceries, and healthcare at a time when many boomers are going to be stuck on a fixed income. While prices go up, their monthly payment is fixed. In the following article, we are going to examine 10 very crucial areas in our economy that practically guarantee that for the next decade, we are going to see slow to negative growth in our economy. We’ll examine housing, entitlement programs, and income to try to arrive at a forecast for the next decade.
Factor 1— New Homes Sold
Click Here, or on the image, to see a larger, undistorted image.
Examine the above chart for a minute. Never in our nation’s history have we seen such an epic boom in new homes being sold. For the past decade, much of our economic prosperity was intertwined with the fate of housing. In fact, there have been recent estimates that housing related industries accounted for 30 to 40 percent of job growth since 2000. The peak was reached in the second half of 2005.
At this time homes were flying off of the shelves like the latest hit album and financing was ample to feed this flame [[indeed, it was a prime source of oxygen: normxxx]]. Keep in mind the above chart is for new homes. Thus we can assume that builders were privy to this information and more than willingly participated in an epic housing construction boom to meet this new home demand. Much of the creative financing including the $500 billion in currently outstanding option ARM mortgages helped fuel this run up.
This pace was simply unrealistic since the growth in population was not keeping up. In fact, demographic trends would have pointed to another conclusion. That is, many baby boomers now with empty nests would be selling their homes and downsizing and organically there would be a natural jump in housing inventory on the market [[especially since the "baby bust" followed the boomer generation: normxxx]]. Instead, we had a decade long boom in new home construction that will now contend with the onslaught of baby boomer homes that will hit the market in the next decade.
Factor 2— New Housing Units Started
Click Here, or on the image, to see a larger, undistorted image.
Given the above, builders were quick to catch onto this once in a lifetime trend. Yet what you’ll notice is that new home sales peaked in the second half of 2005 while new housing starts peaked in the summer of 2006. This lag was partly because many builders came late to the game and over estimated the actual demand in the market [[eg, greed: normxxx]]. What they failed to grasp was that much, if not most, of the market was a Ponzi scheme based on pure speculation. This was similar to 1920s Florida real estate except this engulfed numerous metropolitan areas across the nation. States like California, Florida, Nevada, and Arizona are now feeling the brunt of this correction.
The new housing starts and new homes that have been built assure us that we will have plenty of housing for the entire next decade. Even though many are now pointing to the decline in housing construction as a sign that we will move inventory off the market in the next few years, they fail to examine the baby-boomer age-wave theory and fail to realize that many boomers will be selling their homes in the upcoming years which will once again push inventory up. The birth rate has also massively declined since the time of the baby boomers. Take a look at the below chart:
Click Here, or on the image, to see a larger, undistorted image.
*Source: Profutures.com
So the trend is unmistakably for smaller families which of course means that many people do not need bigger places which is ironic given the average size of a home has increased over this time not for necessity, but for other reasons.
Factor 3— Construction Spending
Click Here, or on the image, to see a larger, undistorted image.
It would logically follow that construction spending has now declined as well. Construction spending peaked with new housing starts in 2006. Since then, it has been steadily declining. Given the nature of construction, much of the unemployment in this industry has hurt many other areas. These are generally high paying jobs but also include much of the shadow economy of employment.
Recent data on remittances to Latin America show a major decrease in money being sent back home that nearly parallels the peak in construction spending and contraction. In addition, trucks are a big part of the industry. Construction bodes well for this industry but it has been hit with a one-two punch. First, the industry has contracted but then high fuel costs have also hurt the recreational truck buyer. That is, those that buy not because they need a truck but because they want a truck.
Construction employs a large number of people and this pull back is only going to fuel even higher unemployment which we are already seeing. The idea being postulated that we’ll see this pick up soon is somewhat unfounded. Just as we start clearing the current glut of new housing, which is 2 to 4 years away, we should be seeing a natural organic selling of baby boomer homes.
Not to be macabre, but James Love of BoomerDeathCounter.com states that a Baby Boomer will die every 49.5 seconds in the USA during the year 2008. This number will increase simply because of aging and the natural life process and this will add still more inventory to the overall housing market. In this same vein, boomers will start relying much more heavily on an already over burdened healthcare system. These reasons practically ensure that we will see a decade long contraction in construction as it pertains to residential housing.
Factor 4— Household Debt and Liabilities
Click Here, or on the image, to see a larger, undistorted image.
It is hard to believe that there is nearly $14 trillion in household debt in the United States. This trumps our nationwide GDP. As I discussed in a previous article as to why the United States will not see a second half recovery, this amount of debt is putting a pinch on the bottom line of many households. A large amount of this debt, approximately $11 trillion, is mortgage debt. But, as the price of housing continues to fall, the amount of debt does not diminish.
That is the challenge that we are facing. Much of the foreclosures that we are seeing are an economically vicious way of reconciling the balance sheet of America. That is, no lender is going to willingly modify a loan by -$200,000, but if an owner cannot make the payment due to the larger economic forces, the lender will get the property back, and will have to contend in the open market with everyone else— including other lenders in a like position— so the house will only 'clear' at the much lower price.
The amount of debt is simply staggering. Debt in itself is not bad, but when you have this much on the balance sheets of American households, what has occurred is that many have already spent today their anticipated future earnings of the next decade [[which may not even arrive as planned: normxxx]]. In a consumerist economy where nearly 70 percent of our economy is based on spending, people are going to be forced to pay off debt instead of consuming. And this can be seen in the following chart.
Factor 5— Household debt as a Percent of Disposable Income
Click Here, or on the image, to see a larger, undistorted image.
Since 1980 even with ups and downs in our economy, the percent of a household’s disposal income toward debt payments has steadily increased. Money that can be used to go out and have a nice dinner is now diverted to paying the monthly minimum on your American Express card. This is an increasingly serious problem. This can only go on for so long and given that the household debt has gone from $5 trillion in the mid '90s to the current $14 trillion is simply amazing. Much of this debt increase was due to the epic housing bubble. Never in the history of this country has household debt surpassed GDP until now.
You may be asking, if approximately $11 of the $14 trillion is mortgage debt, what is the rest? The bulk of the remaining $3 trillion is largely unsecured consumer debt. In fact, credit card companies and auto lenders are now starting to see a large increase in defaults and late payments on these items. Why? Well the economy is grinding to a halt and if you lose your job or have a pay cut, all of a sudden that portion of your 'disposable' income that is going to service current debt (that hasn’t much decreased, but can increase greatly with increased, 'punitive' interest rates and penalties) can easily exceed what's available. It becomes a vicious cycle and that is why the debt trap is so deadly.
Factor 6— U.S. Banking Facing Major Issues
Click Here, or on the image, to see a larger, undistorted image.
I remember seeing the above chart at the FDIC a few months ago. It had one bank in the 'list'. I had to wonder, why in the world would you put in a drop down menu if you only had one bank on the list? Clearly the FDIC already knew that the United States banking system was going to be facing major long term problems. With the failure of Indymac bank the FDIC initially estimated that the cost would be from $4 to $8 billion. Their initial insurance fund is at $53 billion. Now, recent revisions tell us that the cost will be more like $8.9 billion. With this one bank failure, the FDIC will burn through 16.7 percent of their fund.
They have come out with a recent report that revised the March 2008 number of troubled banks from 90 to 117, an increase of 30 percent in one quarter. In fact, FDIC Chairwoman Shelia Bair is now mentioning that the FDIC may need to seek assistance from the U.S. Treasury (aka, the bank of you and me). Given that U.S. banks have over $6 trillion in deposits, you would think that a mere $53 billion (much of it eaten up at Indymac) would do little to cover even a slight amount of the overall funds. If, as we are expecting, systemic problems arise, we can expect this number to balloon.
Yet why is this going to put the breaks on the economy for the next decade? Banks are now becoming more prudent since much of the money being lent is now their own which puts them on the hook. The "give money to anyone with a pulse model" is finished. I used to get about 20 pieces of mail a week for new credit cards. Now it has dwindled down to about 4 or 5 a week. Now that banks actually have to verify income and ability to pay, it turns out that many Americans do not qualify for loans.
Many areas now require 10, 15, or even 20 percent down to purchase a home. One reader sent me an article from Florida where in some heavily hit areas, lenders are requiring 40 percent down. In California where the median home price is $318,000, that means buyers would need to put down $31,800 or $63,600 plus closing costs. As we are quickly finding out, not many people have this amount of 'ready' money. Even a 5 percent down payment put a large crimp in the market. No money down was a large part of the market.
Given the problems in U.S. banks, many are tightening lending at a time when most people actually need money. Banks do not stay in business doling out charity. As the adage goes, a good borrower is someone who does not need the money. Unfortunately, many people now need the money yet banks are afraid to play with their own money.
Factor 7— Income Inequality
Click Here, or on the image, to see a larger, undistorted image.
*Source: Wikipedia
Even given our decade long housing and credit boom where homeownership soared to record highs, the inequality in wealth in our country has never been so pronounced. People have just learned a quick lesson that debt does not equal wealth. Having items that make you appear wealthy does not mean that you actually have a healthy balance sheet. Look at the above chart.
Only 17.8 percent of United States households make over $100,000 per year. We’ve already highlighted before using a detailed budget that $100,000 does not get you that far anymore especially in areas like California. Indeed, some politicians would have you believe that $5 million is the threshold for middle class— yet only 0.12 percent of American households make over $1.6 million a year.
In the United States only 146,000 households have incomes over $1,500,000, while there are only 11,000 households that make more than $5,500,000. 82.2 percent of all households make under $100,000 per year. Maybe they are betting that you will acquiesce on the tired old line of "no new taxes" instead of looking at who would get the real tax breaks. I think given how divergent this is, we should look more closely at both McCain’s and Obama’s tax proposals:
Click Here, or on the image, to see a larger, undistorted image.
*Source: Washington Post
Things are rarely so clear cut. When you have many of the hedge fund managers and heads of financial institutions making $10 million a year providing products that have actually harmed our economy, there is something seriously wrong. On the Main Street of America, financial innovations which once sounded like a new tonic now is redolent of snake oil. Just as in the Great Depression, Wall Street and its bankers, once seen as the new captains of industry, will be paraded on Capitol Hill and in the courts to be reviled for the damage they have caused.
Things had gotten totally out of control, but this Ponzi scheme is now coming to a painful close. Keep in mind that if we are to be punished for this decade long bubble, and implement and enforce regulations to prevent recurrences, we are going to have to pay the piper dearly. This means living within our means. Can Americans do that for a decade to retool their economy for the long future?
Sadly when we continue to hear gimmicks about fixing 'bucket' issues, it tells us that many Americans only care about the one step that is immediately in front of them. It is time to dig into the data and see the facts for what they are. "No new taxes" is a tired line that can only lead to the death of our economy.
Factor 8— Government Spending
Click Here, or on the image, to see a larger, undistorted image.
*Source: Perotcharts.com
Now we need to come full circle and look at the entitlement programs. For years we have talked about fixing Social Security and Medicare but haven’t done a single thing about it. Guess what? That day has now come. Whether people want to deal with this or not we now have no choice. We spent $1.45 trillion in mandatory spending items including Social Security, Medicare, and Medicaid in 2007. 53% of the $2.73 trillion Federal Budget is based on these fixed items.
Another troubling line item is the $237 billion in interest that we pay each year on debt. The U.S. is simply reflecting the poor management of budgets like U.S. households. Discretionary spending is somewhat of a misleading label. Many items such as the military and defense really are not discretionary since these will not go anywhere. When it comes down to it, only a small amount is left to 'debate' about.
The rest is never even touched by politicians since it is like a third rail in politics. For many of the younger generations, we look at these items and wonder if we will ever even see one Social Security check even though we are putting in more and more money into this fund. Take a look at this chart:
You can see how quickly payroll tax rates have increased over the last few decades. Yet you need to remember that there is currently a cap on this at $102,000. Remember the inequality charts above? What this means is those with the highest incomes pay the least in percentage terms into this fund. 82.2 percent of the population pay every nickel on the above rates into this fund.
Now to be upfront I don’t think simply lifting the cap is going to solve the stunning amount we have to confront. There has to be a shift in how this will work. When Social Security was created, the life expectancy of people wasn’t as high as it is now. It was never crafted as a retirement or pension system yet many Americans now rely on Social Security as a primary source of their retirement income. We are going to have to make some hard choices here. What will that be? Either raise the tax rate or let many folks go without these funds.
That is the flipside of the political equation. Many "no tax" folks are quick to say don’t ever raise taxes yet fail to follow their logical conclusion. Then what then of the 76 million baby boomers that will be retiring in the next few years? That of course is the harder question. In addition, bad fiscal policy by government causing consumer inflation is a hidden tax but many people don’t understand how inflation even works so this is a good way to tax the public.
There is a great book by Christopher Buckley called Boomsday that examines this exact issue. It is a humorous look at this impending entitlement debacle and explores the possibility of generational politics emerging as a major issue. Currently everyone is for Social Security. But how is that going to play out in the future for younger generations if they realize they won’t see any of that money and become a bigger and more powerful voting bloc? This is going to be a major issue and we need to get ready for this.
And what of the 401(k) idea? Well given how the stock market is currently going, you may be happy with a 5 percent return on a guaranteed investment. If the above trends hold, how horrible of a crosswind to see both a sinking stock market when baby boomers will start drawing on their accounts.
Factor 9— The Explosion of Entitlement Programs
Click Here, or on the image, to see a larger, undistorted image.
*Source: Perotcharts.com
Here is how this oncoming tsunami looks. Currently we spend about 8 percent on Social Security, Medicare, and Medicaid. This is going to explode and if we hit a severe recession, these estimates are going to go higher since we’ll have a lower GDP. In addition, the $9.6 trillion in national debt (which will now go over $10 trillion with Fannie Mae and Freddie Mac and the FDIC) has a large portion of entitlement IOUs given by the United States government. That is, the money that people currently pay into the tax system are being used right now for other government spending including current entitlement outflows.
Remember that lock box talk? Now you know why it was so important but people rather make fun of things they don’t understand. Now it is time to pay up. Keep in mind that these tax receipts are viewed by the government as an income stream only second to the actual income taxes paid. At this rate, there is going to be some serious negotiations for the next decade and either way, this is going to put a clamp on our economic growth for the next decade.
Factor 10— Booming Foreclosures
Click Here, or on the image, to see a larger, undistorted image.
The immediate problems of course are with the housing market. Long viewed as the most stable of all investments, housing is no longer a solid rock. This long held belief is being shattered and if housing isn’t safe then what is? Stocks? No. Commodities? Not always. So where do people put their money? Aside from all the bottom callers trying to look for the proverbial housing bottom we are really very far away from seeing a bottom in housing.
They are like a dog chasing its own tail. Once we reach the bottom then what? That is the ultimate reality check. Do they somehow think that we are going to hit the bottom and rebound like this past bubble we just had? No chance. If anything, we’ll be back to seeing housing as a boring and dry investment as it should be seen.
If you look at the above chart monthly foreclosure filings are still at record levels. Before we can acknowledge a bottom we first have to define what a bottom is. If we are looking at prices, nationwide it looks like we will hit a bottom in the second half of 2009 or early 2010. If we look at states like California, we won’t see a bottom in price until May of 2011. If we are defining a 'bottom' as a low in sales, we may already be reaching that point, yet most people associate a bottom with price so given that definition, we are not even close to a bottom as highlighted by the above foreclosure trend.
Keep in mind, that in California nearly half of all sales were foreclosures. These sales by definition are problematic and are thus pushing prices lower. Nationwide foreclosures are making up a large portion of all sales. This will keep prices low. Until the above chart starts declining, then we can realistically talk about a bottom. Until then, it is merely mincing data with sales numbers and minor bumps in the larger trend.
By looking at multiple facets of the economy it is very likely that we will see a L shape recession like Japan did in the 1990s and which it battling with even today. I know many people will argue that we are very different, yet given the housing bubble, our boomer population, and credit contraction, I just don’t see how we avoid a similar fate. People partied this decade in anticipation of the next decade’s prosperity. But now, it is time to pay the check.
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Real US Housing Losses Are $6 Trillion
By Daniel R. Amerman, CFA | 8 September 2008
Overview
Actual losses in the US real estate market are much higher than what you have been reading in the newspapers recently. Using a combination of official government statistics and the most widely used index of housing values, we will demonstrate that the US real estate market has lost a total of $6 trillion in value in the last two years. We will show that an average house that was worth about $226,000 in 2006 is, once you adjust for inflation, down to a real value of only about $160,000.
To put what a $6 trillion loss is into perspective, we will show that when all factors are taken into account, the two year drop in US real estate values is equivalent to wiping out the entire retirement savings of all 78 million Baby Boomers, and annual housing losses are close to the annual GDP of China. We will close by talking about how this national disaster creates major personal profit opportunities for people who can learn to look beyond the false number of nominal dollars and into the reality of how wealth is rapidly redistributed during times of economic turmoil.
Four Steps To Finding Total Real Estate Losses
To understand the full extent of US real estate value losses requires a four step process: 1) Find the average loss in dollar terms for single family homes; 2) Find the decline in the value of a dollar during the same period; 3) Combine the fall in housing values with the fall in the value of the dollar to find the real housing loss, not in dollars, but in purchasing power, or what a dollar will buy for you; and 4) Determine the loss for the US economy as a whole.
Step 1: Average Loss Per Home (Simple Dollars)
The widely quoted S&P/Case-Shiller Home Price Index reached its maximum value during the month of June, 2006 at a level of 226.29 (10— City Composite). Two years later, by June of 2008, the index had reached a level of 180.38. The fall of 45.91 in index value means a 20.29% decline in the average value of a home in the cities measured. This decline is illustrated in the graph below:
Step 2: Decline In The Value Of A Dollar
The most common measure of the decline in the value of a dollar is the Consumer Price Index (CPI). Unfortunately, it is growing increasingly difficult to find consumers who believe the CPI accurately reflects the prices they are paying in such crucial areas as energy, food or medical care. (This disbelief is particularly strong among those living on a fixed income.) Indeed, when inflation is measured using the same statistical methods of past decades, it is above 10%, according to John Williams of Shadowstats.com.
Therefore, for this analysis, we will compromise between the official rate of inflation, and a widespread belief in higher actual rates of inflation, by using a different official government inflation index, that of the Producer Price Index (PPI), which measures wholesale inflation. (To the extent that wholesale inflation tends to lead retail inflation, the two indexes should be converging anyway before too long.) The Producer Price Index in June of 2008 set a 27 year record with a 9.2% twelve month rate of inflation. The last time inflation was this high was the same year that Treasury yields exceeded 15%, and 30 year mortgage rates exceeded 16%. We are in the midst of an extraordinarily rapid destruction of the value of a dollar.
This is shown in the graph below, which illustrates monthly changes in the value of a dollar over the last two years, based upon monthly changes in the PPI. As shown, by June of 2008, a dollar would only buy what 88.7 cents would have purchased in 2006.
Step 3: Adjust Housing Decline For Loss In Value Of Dollar
There is a basic problem with the 20% decline in the dollar value of single family homes over the last two years, and that is that those dollars themselves are worth less than they were two years ago. So, if we want to look at the real value of homes, then we need to adjust our home values for inflation. For dollars themselves aren’t what matter— it is what you can buy with those dollars. The chart below shows what happens when we combine the 20% decline in the real estate index with the 11% decline in the value of the dollar.
As you can see by following the June 2007 line, twelve months after the real estate peak, the index value of the average house was down 9 points, or 4.0%. However, the value of the dollar had also fallen 3.2% during that time, so that by December a dollar would only buy what 96.8 cents would have bought in June. When we combine the two, with 4% fewer dollars and each of those dollars being worth 3.2% less, then on a real (purchasing power adjusted basis) the average homeowner lost 7.0% of the value of their home during that year, as can be seen in the rightmost column. In other words, real homeowner losses were 75% greater than what was widely reported.
As we go forward to December of2007, eighteen months after the peak, the decline in the value of the housing market was really starting to pick up, with a loss in the index of 26 points, or 11.3%. Unfortunately, the rate of inflation was also beginning to pick up, and the dollar had fallen 5% over the eighteen months, meaning a dollar would only buy what 95 cents did in June of 2006. So a house is worth 88.7 cents on the dollar, but the dollar itself is only worth 95 cents, and when we combine the two, the real value of the average house fell 15.7%. This was about 40% greater than what was widely reported.
By the time we reach June of 2008, then as shown above, the real estate index was down to 180.38, a full 20% decline. The dollar was down to 88.7 cents, as it had lost 11.3% of it’s value. When we combine the two, we say that a average $226,290 house in 2006 only has a market value of $180,380 by June of 2008, and when we also include that a 2008 dollar is only worth 88.7 cents— then the real value of our house is not $180,380, but $159,920.
When we adjust for inflation, a house that was worth $226,000 in 2006, is down to a real value of only $160,000 in 2008. Which means the real dollar loss is not $45,910— but $66,250. Thus, the real percentage loss is not 20%— but 30%. The real loss in homeowner wealth has been a full 50% greater than what is being widely reported in the media.
Step Four: Add Up Losses For All Us Households
How big of a blow is a 30% decline in housing values to the US economy and national wealth? For the answer to that, we will turn to the Federal Reserve. As of 2006, Federal Reserve statistics show that total household real estate assets were $19.8 trillion (Statistical release Z.1 (Flow of Funds), table B.100( Household Balance sheet), line 4). So, we start with $19.8 trillion and multiply times the 29.3% real two year decline in home values that is in the bottom right hand corner of the chart.
$20 trillion in 2006 real estate, times 30% inflation-adjusted real estate losses between 2006 and 2008, is a $6 trillion dollar loss in homeowner wealth (rounded numbers). What is $6 trillion? Numbers that large are difficult to grasp, but 6 trillion is equal to 6 million, times 1 million. So a six trillion dollar loss is equal to six million people each having a million dollars, and each having their entire net worth wiped out. Six million millionaires, each losing every penny.
Another way of viewing $6 trillion is that as of 2006, it was equal to the sum of Baby Boomer retirement account investments, as well as pension investments dedicated to funding Boomer retirements (a detailed methodology for the $6 trillion in 2006 figure can be found in my previous research report "Adding Up $44 Trillion In Boomer Wealth Expectations"). A $6 trillion drop in value is equal to wiping out 100% of the retirement savings accounts and pension investment values for all 78 million US Baby Boomers between ages 44 and 62.
For additional perspective on the value of $6 trillion, the Chinese economy reached a GDP of $3.4 trillion in 2007, according to the Chinese news agency Xinhua. That means that over the last two years, the US housing market has been losing value at a rate almost equal to the size of the entire Chinese economy, the economic juggernaut that is currently driving much of the growth of the global economy.
(The Purchasing Power Parity (PPP) measure of the Chinese economy at $7 trillion for 2007 (as calculated in the CIA Factbook) is a much better measure than a GDP that is based upon blatantly manipulated currency values, but using such currency values as if a (non-existent) fair market had established them is the norm for financial reporting, so we’ll use it here. Even if we use the PPP, the loss in wealth compared to the Chinese economy is still extraordinary.)
Yet another way of looking at the size of $6 trillion is to compare it to the source of much of the plunge in value for real estate, which is the subprime mortgage securities market. The subprime debacle, which has shaken the global financial system and ravaged four of the strongest financial institutions in the US (Fannie, Freddie, MBIA and AMBAC), took place in a $1.2 trillion market. The two year loss in US housing values is five times the size of the total subprime mortgage securities market. As can readily be seen below, the two year collapse in US housing values is a financial disaster of epic proportions.
(Note that the $6 trillion loss shown does not reconcile with Federal Reserve real estate values for 2008, which show total real estate asset values of $19.7 trillion as of the first quarter, meaning essentially no fall in real estate values. Curiously enough, the official government statistics seem to do a remarkably good job of rising fast with rising real estate values, yet, don’t seem to reflect bad news at all. Much like some of the most interesting inflation numbers that the government has been using lately to claim that the economy is still growing fast, as measured by the GDP. More on this subject can be found in my article "Inflation Index Manipulation: Theft By Statistics".)
Personal Implications & Taking Actions
Let’s think for a moment about recent financial history. How about the collective "wisdom" of the markets pushing the NASDAQ to 5,000— and then 80% of that value quickly imploding as the NASDQ fell to 1,000. Then there is this most recent episode, where it appears the collective brilliance of the markets ran up a little $6 trillion (and still counting) pricing mistake. Just a little rounding error, twice the size of the economy of China. Now, let’s think about the safety of your retirement and other investment assets.
When you direct your IRA and 401 plans, when you plan your retirement income, what is your source of safety for your stock and bond investments? In the financial profession, your ultimate source of safety is what is known as the "Efficient Market Hypothesis", which just basically says that the awesome wisdom and intelligence of the markets makes sure that all securities are always fairly priced.
Given what we’ve seen just in the last decade— how confident are you about this collective brilliance of the markets? Confident enough to risk every penny of your retirement savings? Yet, you must invest and invest well— or inflation will eat your savings, and you will be impoverished anyway. So, what do you do?
A place to start is to think very seriously about reducing your ownership of financial assets. If you are investing for retirement and your portfolio of stocks and bonds gets taken down by broad market developments similar to what has already happened with real estate and tech stocks just in the last seven years, then you may never have the chance to replace retirement savings. There is a powerful, powerful case for moving a substantial portion of your assets into tangible assets. Good examples of tangible assets include gold, silver, commodities, farmland and energy— and yes, real estate. Not at the peak of a bubble, but at the right time and the right price.
The next thing you should do is very seriously think about is whether crisis leads to opportunity, in ways that go well beyond a simple strategy of only buying tangible assets. As a prominent recent example, John Paulson saw the crisis that was coming in subprime mortgages, researched and educated himself on this area (which had not been his field of expertise), and he turned the crisis into a $3-$4 billion personal payday in 2007. If you're not a hedge fund manager like Paulson, you may not have the tools that he used to turn a market crisis into personal billions. That’s OK, because Paulson didn’t start with the tools either. He started with educating himself, learning about a new area, until he came up with a novel way to profit from disaster. A method that wasn’t in the financial textbooks, and that he didn’t find by reading a financial columnist in the paper.
You have more tools than you may think, some of which may surprise you. Tools which can give you the opportunity to turn financial disaster into personal net worth. There are ways you can use those tools to turn the $6 trillion fall in real estate values in combination with the destruction of the US dollar into perhaps the greatest real wealth-building opportunity of your life, on a long-term and tax-advantaged basis.
But, if you want this to happen— then education is the essential first step. You are going to have to not just understand, but to master some of the financial forces and methods in play here. You will have to learn how to turn the destruction of paper wealth into real wealth. With Turning Inflation Into Wealth being the first key step. My best wishes to you for turning this challenge into an extraordinary personal opportunity.
Do you know how to Turn Inflation Into Wealth? To position yourself so that inflation will redistribute real wealth to you, and the higher the rate of inflation— the more your after-inflation net worth grows? Do you know how to achieve these gains on a long-term and tax-advantaged basis? Do you know how to potentially triple your after-tax and after-inflation returns through Reversing The Inflation Tax? So that instead of paying real taxes on illusionary income, you are paying illusionary taxes on real increases in net worth? These are among the many topics covered in the free "Turning Inflation Into Wealth" Mini-Course. Starting simple, this course delivers a series of 10-15 minute readings, with each reading building on the knowledge and information contained in previous readings. More information on the course is available at http://InflationIntoWealth.com
Contact Information:
Daniel R. Amerman, Cfa
Website: http://InflationIntoWealth.com/
ߧ
Normxxx
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Why The United States Will Face A Decade Of Economic Stagnation And Face A L Shaped Recession.
By Dr. Housing Bubble | 8 September 2008
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Given the recent positive reading for GDP, some are now doubting that we will even face a recession. This of course is a misnomer and most average Americans realize that our country finds itself in a very tenuous situation. It is very easy to brush off the current talk of economic malaise as simply another business cycle unwinding yet this time there are many fundamental circumstances that simply make this situation a very unique beast.
As baby boomers reach retirement age it could not have happened at a worse time. The economy is on the brink of recession and we are going to face the largest entitlement program drain on our system ever. Social Security was never devised as a retirement or pension program but a large portion of our elderly depend on this income.
There is a baby-boomer age-wave theory proposed by economist Harry Dent that views a peak in the US stock market at 2007 and 2009. His prediction is based on observations that consumer spending peaks at or near age 50. With many boomers starting to retire in the upcoming years the age-wave theory predicts a slow down in the economy.
Generally speaking there are 76 million people that were born between 1946 and 1964. With that said, 2011 will be the first year that the first baby boomers will hit the 65 year age mark [[they've already hit the 62 year, early retirement, mark this year: normxxx]] and the beginning of a long-term trend that will become more reliant on entitlement programs. This is happening just as the largest United States housing bubble is popping. With residential housing prices peaking at nearly $24 trillion only to see about $5 trillion of that disappear in a few short years, the economy is facing constraints at the worst possible times.
We are also seeing consumer inflation pick up in gas, groceries, and healthcare at a time when many boomers are going to be stuck on a fixed income. While prices go up, their monthly payment is fixed. In the following article, we are going to examine 10 very crucial areas in our economy that practically guarantee that for the next decade, we are going to see slow to negative growth in our economy. We’ll examine housing, entitlement programs, and income to try to arrive at a forecast for the next decade.
Factor 1— New Homes Sold
Click Here, or on the image, to see a larger, undistorted image.
Examine the above chart for a minute. Never in our nation’s history have we seen such an epic boom in new homes being sold. For the past decade, much of our economic prosperity was intertwined with the fate of housing. In fact, there have been recent estimates that housing related industries accounted for 30 to 40 percent of job growth since 2000. The peak was reached in the second half of 2005.
At this time homes were flying off of the shelves like the latest hit album and financing was ample to feed this flame [[indeed, it was a prime source of oxygen: normxxx]]. Keep in mind the above chart is for new homes. Thus we can assume that builders were privy to this information and more than willingly participated in an epic housing construction boom to meet this new home demand. Much of the creative financing including the $500 billion in currently outstanding option ARM mortgages helped fuel this run up.
This pace was simply unrealistic since the growth in population was not keeping up. In fact, demographic trends would have pointed to another conclusion. That is, many baby boomers now with empty nests would be selling their homes and downsizing and organically there would be a natural jump in housing inventory on the market [[especially since the "baby bust" followed the boomer generation: normxxx]]. Instead, we had a decade long boom in new home construction that will now contend with the onslaught of baby boomer homes that will hit the market in the next decade.
Factor 2— New Housing Units Started
Click Here, or on the image, to see a larger, undistorted image.
Given the above, builders were quick to catch onto this once in a lifetime trend. Yet what you’ll notice is that new home sales peaked in the second half of 2005 while new housing starts peaked in the summer of 2006. This lag was partly because many builders came late to the game and over estimated the actual demand in the market [[eg, greed: normxxx]]. What they failed to grasp was that much, if not most, of the market was a Ponzi scheme based on pure speculation. This was similar to 1920s Florida real estate except this engulfed numerous metropolitan areas across the nation. States like California, Florida, Nevada, and Arizona are now feeling the brunt of this correction.
The new housing starts and new homes that have been built assure us that we will have plenty of housing for the entire next decade. Even though many are now pointing to the decline in housing construction as a sign that we will move inventory off the market in the next few years, they fail to examine the baby-boomer age-wave theory and fail to realize that many boomers will be selling their homes in the upcoming years which will once again push inventory up. The birth rate has also massively declined since the time of the baby boomers. Take a look at the below chart:
Click Here, or on the image, to see a larger, undistorted image.
*Source: Profutures.com
So the trend is unmistakably for smaller families which of course means that many people do not need bigger places which is ironic given the average size of a home has increased over this time not for necessity, but for other reasons.
Factor 3— Construction Spending
Click Here, or on the image, to see a larger, undistorted image.
It would logically follow that construction spending has now declined as well. Construction spending peaked with new housing starts in 2006. Since then, it has been steadily declining. Given the nature of construction, much of the unemployment in this industry has hurt many other areas. These are generally high paying jobs but also include much of the shadow economy of employment.
Recent data on remittances to Latin America show a major decrease in money being sent back home that nearly parallels the peak in construction spending and contraction. In addition, trucks are a big part of the industry. Construction bodes well for this industry but it has been hit with a one-two punch. First, the industry has contracted but then high fuel costs have also hurt the recreational truck buyer. That is, those that buy not because they need a truck but because they want a truck.
Construction employs a large number of people and this pull back is only going to fuel even higher unemployment which we are already seeing. The idea being postulated that we’ll see this pick up soon is somewhat unfounded. Just as we start clearing the current glut of new housing, which is 2 to 4 years away, we should be seeing a natural organic selling of baby boomer homes.
Not to be macabre, but James Love of BoomerDeathCounter.com states that a Baby Boomer will die every 49.5 seconds in the USA during the year 2008. This number will increase simply because of aging and the natural life process and this will add still more inventory to the overall housing market. In this same vein, boomers will start relying much more heavily on an already over burdened healthcare system. These reasons practically ensure that we will see a decade long contraction in construction as it pertains to residential housing.
Factor 4— Household Debt and Liabilities
Click Here, or on the image, to see a larger, undistorted image.
It is hard to believe that there is nearly $14 trillion in household debt in the United States. This trumps our nationwide GDP. As I discussed in a previous article as to why the United States will not see a second half recovery, this amount of debt is putting a pinch on the bottom line of many households. A large amount of this debt, approximately $11 trillion, is mortgage debt. But, as the price of housing continues to fall, the amount of debt does not diminish.
That is the challenge that we are facing. Much of the foreclosures that we are seeing are an economically vicious way of reconciling the balance sheet of America. That is, no lender is going to willingly modify a loan by -$200,000, but if an owner cannot make the payment due to the larger economic forces, the lender will get the property back, and will have to contend in the open market with everyone else— including other lenders in a like position— so the house will only 'clear' at the much lower price.
The amount of debt is simply staggering. Debt in itself is not bad, but when you have this much on the balance sheets of American households, what has occurred is that many have already spent today their anticipated future earnings of the next decade [[which may not even arrive as planned: normxxx]]. In a consumerist economy where nearly 70 percent of our economy is based on spending, people are going to be forced to pay off debt instead of consuming. And this can be seen in the following chart.
Factor 5— Household debt as a Percent of Disposable Income
Click Here, or on the image, to see a larger, undistorted image.
Since 1980 even with ups and downs in our economy, the percent of a household’s disposal income toward debt payments has steadily increased. Money that can be used to go out and have a nice dinner is now diverted to paying the monthly minimum on your American Express card. This is an increasingly serious problem. This can only go on for so long and given that the household debt has gone from $5 trillion in the mid '90s to the current $14 trillion is simply amazing. Much of this debt increase was due to the epic housing bubble. Never in the history of this country has household debt surpassed GDP until now.
You may be asking, if approximately $11 of the $14 trillion is mortgage debt, what is the rest? The bulk of the remaining $3 trillion is largely unsecured consumer debt. In fact, credit card companies and auto lenders are now starting to see a large increase in defaults and late payments on these items. Why? Well the economy is grinding to a halt and if you lose your job or have a pay cut, all of a sudden that portion of your 'disposable' income that is going to service current debt (that hasn’t much decreased, but can increase greatly with increased, 'punitive' interest rates and penalties) can easily exceed what's available. It becomes a vicious cycle and that is why the debt trap is so deadly.
Factor 6— U.S. Banking Facing Major Issues
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I remember seeing the above chart at the FDIC a few months ago. It had one bank in the 'list'. I had to wonder, why in the world would you put in a drop down menu if you only had one bank on the list? Clearly the FDIC already knew that the United States banking system was going to be facing major long term problems. With the failure of Indymac bank the FDIC initially estimated that the cost would be from $4 to $8 billion. Their initial insurance fund is at $53 billion. Now, recent revisions tell us that the cost will be more like $8.9 billion. With this one bank failure, the FDIC will burn through 16.7 percent of their fund.
They have come out with a recent report that revised the March 2008 number of troubled banks from 90 to 117, an increase of 30 percent in one quarter. In fact, FDIC Chairwoman Shelia Bair is now mentioning that the FDIC may need to seek assistance from the U.S. Treasury (aka, the bank of you and me). Given that U.S. banks have over $6 trillion in deposits, you would think that a mere $53 billion (much of it eaten up at Indymac) would do little to cover even a slight amount of the overall funds. If, as we are expecting, systemic problems arise, we can expect this number to balloon.
Yet why is this going to put the breaks on the economy for the next decade? Banks are now becoming more prudent since much of the money being lent is now their own which puts them on the hook. The "give money to anyone with a pulse model" is finished. I used to get about 20 pieces of mail a week for new credit cards. Now it has dwindled down to about 4 or 5 a week. Now that banks actually have to verify income and ability to pay, it turns out that many Americans do not qualify for loans.
Many areas now require 10, 15, or even 20 percent down to purchase a home. One reader sent me an article from Florida where in some heavily hit areas, lenders are requiring 40 percent down. In California where the median home price is $318,000, that means buyers would need to put down $31,800 or $63,600 plus closing costs. As we are quickly finding out, not many people have this amount of 'ready' money. Even a 5 percent down payment put a large crimp in the market. No money down was a large part of the market.
Given the problems in U.S. banks, many are tightening lending at a time when most people actually need money. Banks do not stay in business doling out charity. As the adage goes, a good borrower is someone who does not need the money. Unfortunately, many people now need the money yet banks are afraid to play with their own money.
Factor 7— Income Inequality
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*Source: Wikipedia
Even given our decade long housing and credit boom where homeownership soared to record highs, the inequality in wealth in our country has never been so pronounced. People have just learned a quick lesson that debt does not equal wealth. Having items that make you appear wealthy does not mean that you actually have a healthy balance sheet. Look at the above chart.
Only 17.8 percent of United States households make over $100,000 per year. We’ve already highlighted before using a detailed budget that $100,000 does not get you that far anymore especially in areas like California. Indeed, some politicians would have you believe that $5 million is the threshold for middle class— yet only 0.12 percent of American households make over $1.6 million a year.
In the United States only 146,000 households have incomes over $1,500,000, while there are only 11,000 households that make more than $5,500,000. 82.2 percent of all households make under $100,000 per year. Maybe they are betting that you will acquiesce on the tired old line of "no new taxes" instead of looking at who would get the real tax breaks. I think given how divergent this is, we should look more closely at both McCain’s and Obama’s tax proposals:
Click Here, or on the image, to see a larger, undistorted image.
*Source: Washington Post
Things are rarely so clear cut. When you have many of the hedge fund managers and heads of financial institutions making $10 million a year providing products that have actually harmed our economy, there is something seriously wrong. On the Main Street of America, financial innovations which once sounded like a new tonic now is redolent of snake oil. Just as in the Great Depression, Wall Street and its bankers, once seen as the new captains of industry, will be paraded on Capitol Hill and in the courts to be reviled for the damage they have caused.
Things had gotten totally out of control, but this Ponzi scheme is now coming to a painful close. Keep in mind that if we are to be punished for this decade long bubble, and implement and enforce regulations to prevent recurrences, we are going to have to pay the piper dearly. This means living within our means. Can Americans do that for a decade to retool their economy for the long future?
Sadly when we continue to hear gimmicks about fixing 'bucket' issues, it tells us that many Americans only care about the one step that is immediately in front of them. It is time to dig into the data and see the facts for what they are. "No new taxes" is a tired line that can only lead to the death of our economy.
Factor 8— Government Spending
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*Source: Perotcharts.com
Now we need to come full circle and look at the entitlement programs. For years we have talked about fixing Social Security and Medicare but haven’t done a single thing about it. Guess what? That day has now come. Whether people want to deal with this or not we now have no choice. We spent $1.45 trillion in mandatory spending items including Social Security, Medicare, and Medicaid in 2007. 53% of the $2.73 trillion Federal Budget is based on these fixed items.
Another troubling line item is the $237 billion in interest that we pay each year on debt. The U.S. is simply reflecting the poor management of budgets like U.S. households. Discretionary spending is somewhat of a misleading label. Many items such as the military and defense really are not discretionary since these will not go anywhere. When it comes down to it, only a small amount is left to 'debate' about.
The rest is never even touched by politicians since it is like a third rail in politics. For many of the younger generations, we look at these items and wonder if we will ever even see one Social Security check even though we are putting in more and more money into this fund. Take a look at this chart:
You can see how quickly payroll tax rates have increased over the last few decades. Yet you need to remember that there is currently a cap on this at $102,000. Remember the inequality charts above? What this means is those with the highest incomes pay the least in percentage terms into this fund. 82.2 percent of the population pay every nickel on the above rates into this fund.
Now to be upfront I don’t think simply lifting the cap is going to solve the stunning amount we have to confront. There has to be a shift in how this will work. When Social Security was created, the life expectancy of people wasn’t as high as it is now. It was never crafted as a retirement or pension system yet many Americans now rely on Social Security as a primary source of their retirement income. We are going to have to make some hard choices here. What will that be? Either raise the tax rate or let many folks go without these funds.
That is the flipside of the political equation. Many "no tax" folks are quick to say don’t ever raise taxes yet fail to follow their logical conclusion. Then what then of the 76 million baby boomers that will be retiring in the next few years? That of course is the harder question. In addition, bad fiscal policy by government causing consumer inflation is a hidden tax but many people don’t understand how inflation even works so this is a good way to tax the public.
There is a great book by Christopher Buckley called Boomsday that examines this exact issue. It is a humorous look at this impending entitlement debacle and explores the possibility of generational politics emerging as a major issue. Currently everyone is for Social Security. But how is that going to play out in the future for younger generations if they realize they won’t see any of that money and become a bigger and more powerful voting bloc? This is going to be a major issue and we need to get ready for this.
And what of the 401(k) idea? Well given how the stock market is currently going, you may be happy with a 5 percent return on a guaranteed investment. If the above trends hold, how horrible of a crosswind to see both a sinking stock market when baby boomers will start drawing on their accounts.
Factor 9— The Explosion of Entitlement Programs
Click Here, or on the image, to see a larger, undistorted image.
*Source: Perotcharts.com
Here is how this oncoming tsunami looks. Currently we spend about 8 percent on Social Security, Medicare, and Medicaid. This is going to explode and if we hit a severe recession, these estimates are going to go higher since we’ll have a lower GDP. In addition, the $9.6 trillion in national debt (which will now go over $10 trillion with Fannie Mae and Freddie Mac and the FDIC) has a large portion of entitlement IOUs given by the United States government. That is, the money that people currently pay into the tax system are being used right now for other government spending including current entitlement outflows.
Remember that lock box talk? Now you know why it was so important but people rather make fun of things they don’t understand. Now it is time to pay up. Keep in mind that these tax receipts are viewed by the government as an income stream only second to the actual income taxes paid. At this rate, there is going to be some serious negotiations for the next decade and either way, this is going to put a clamp on our economic growth for the next decade.
Factor 10— Booming Foreclosures
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The immediate problems of course are with the housing market. Long viewed as the most stable of all investments, housing is no longer a solid rock. This long held belief is being shattered and if housing isn’t safe then what is? Stocks? No. Commodities? Not always. So where do people put their money? Aside from all the bottom callers trying to look for the proverbial housing bottom we are really very far away from seeing a bottom in housing.
They are like a dog chasing its own tail. Once we reach the bottom then what? That is the ultimate reality check. Do they somehow think that we are going to hit the bottom and rebound like this past bubble we just had? No chance. If anything, we’ll be back to seeing housing as a boring and dry investment as it should be seen.
If you look at the above chart monthly foreclosure filings are still at record levels. Before we can acknowledge a bottom we first have to define what a bottom is. If we are looking at prices, nationwide it looks like we will hit a bottom in the second half of 2009 or early 2010. If we look at states like California, we won’t see a bottom in price until May of 2011. If we are defining a 'bottom' as a low in sales, we may already be reaching that point, yet most people associate a bottom with price so given that definition, we are not even close to a bottom as highlighted by the above foreclosure trend.
Keep in mind, that in California nearly half of all sales were foreclosures. These sales by definition are problematic and are thus pushing prices lower. Nationwide foreclosures are making up a large portion of all sales. This will keep prices low. Until the above chart starts declining, then we can realistically talk about a bottom. Until then, it is merely mincing data with sales numbers and minor bumps in the larger trend.
By looking at multiple facets of the economy it is very likely that we will see a L shape recession like Japan did in the 1990s and which it battling with even today. I know many people will argue that we are very different, yet given the housing bubble, our boomer population, and credit contraction, I just don’t see how we avoid a similar fate. People partied this decade in anticipation of the next decade’s prosperity. But now, it is time to pay the check.
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Real US Housing Losses Are $6 Trillion
By Daniel R. Amerman, CFA | 8 September 2008
Overview
Actual losses in the US real estate market are much higher than what you have been reading in the newspapers recently. Using a combination of official government statistics and the most widely used index of housing values, we will demonstrate that the US real estate market has lost a total of $6 trillion in value in the last two years. We will show that an average house that was worth about $226,000 in 2006 is, once you adjust for inflation, down to a real value of only about $160,000.
To put what a $6 trillion loss is into perspective, we will show that when all factors are taken into account, the two year drop in US real estate values is equivalent to wiping out the entire retirement savings of all 78 million Baby Boomers, and annual housing losses are close to the annual GDP of China. We will close by talking about how this national disaster creates major personal profit opportunities for people who can learn to look beyond the false number of nominal dollars and into the reality of how wealth is rapidly redistributed during times of economic turmoil.
Four Steps To Finding Total Real Estate Losses
To understand the full extent of US real estate value losses requires a four step process: 1) Find the average loss in dollar terms for single family homes; 2) Find the decline in the value of a dollar during the same period; 3) Combine the fall in housing values with the fall in the value of the dollar to find the real housing loss, not in dollars, but in purchasing power, or what a dollar will buy for you; and 4) Determine the loss for the US economy as a whole.
Step 1: Average Loss Per Home (Simple Dollars)
The widely quoted S&P/Case-Shiller Home Price Index reached its maximum value during the month of June, 2006 at a level of 226.29 (10— City Composite). Two years later, by June of 2008, the index had reached a level of 180.38. The fall of 45.91 in index value means a 20.29% decline in the average value of a home in the cities measured. This decline is illustrated in the graph below:
Step 2: Decline In The Value Of A Dollar
The most common measure of the decline in the value of a dollar is the Consumer Price Index (CPI). Unfortunately, it is growing increasingly difficult to find consumers who believe the CPI accurately reflects the prices they are paying in such crucial areas as energy, food or medical care. (This disbelief is particularly strong among those living on a fixed income.) Indeed, when inflation is measured using the same statistical methods of past decades, it is above 10%, according to John Williams of Shadowstats.com.
Therefore, for this analysis, we will compromise between the official rate of inflation, and a widespread belief in higher actual rates of inflation, by using a different official government inflation index, that of the Producer Price Index (PPI), which measures wholesale inflation. (To the extent that wholesale inflation tends to lead retail inflation, the two indexes should be converging anyway before too long.) The Producer Price Index in June of 2008 set a 27 year record with a 9.2% twelve month rate of inflation. The last time inflation was this high was the same year that Treasury yields exceeded 15%, and 30 year mortgage rates exceeded 16%. We are in the midst of an extraordinarily rapid destruction of the value of a dollar.
This is shown in the graph below, which illustrates monthly changes in the value of a dollar over the last two years, based upon monthly changes in the PPI. As shown, by June of 2008, a dollar would only buy what 88.7 cents would have purchased in 2006.
Step 3: Adjust Housing Decline For Loss In Value Of Dollar
There is a basic problem with the 20% decline in the dollar value of single family homes over the last two years, and that is that those dollars themselves are worth less than they were two years ago. So, if we want to look at the real value of homes, then we need to adjust our home values for inflation. For dollars themselves aren’t what matter— it is what you can buy with those dollars. The chart below shows what happens when we combine the 20% decline in the real estate index with the 11% decline in the value of the dollar.
As you can see by following the June 2007 line, twelve months after the real estate peak, the index value of the average house was down 9 points, or 4.0%. However, the value of the dollar had also fallen 3.2% during that time, so that by December a dollar would only buy what 96.8 cents would have bought in June. When we combine the two, with 4% fewer dollars and each of those dollars being worth 3.2% less, then on a real (purchasing power adjusted basis) the average homeowner lost 7.0% of the value of their home during that year, as can be seen in the rightmost column. In other words, real homeowner losses were 75% greater than what was widely reported.
As we go forward to December of2007, eighteen months after the peak, the decline in the value of the housing market was really starting to pick up, with a loss in the index of 26 points, or 11.3%. Unfortunately, the rate of inflation was also beginning to pick up, and the dollar had fallen 5% over the eighteen months, meaning a dollar would only buy what 95 cents did in June of 2006. So a house is worth 88.7 cents on the dollar, but the dollar itself is only worth 95 cents, and when we combine the two, the real value of the average house fell 15.7%. This was about 40% greater than what was widely reported.
By the time we reach June of 2008, then as shown above, the real estate index was down to 180.38, a full 20% decline. The dollar was down to 88.7 cents, as it had lost 11.3% of it’s value. When we combine the two, we say that a average $226,290 house in 2006 only has a market value of $180,380 by June of 2008, and when we also include that a 2008 dollar is only worth 88.7 cents— then the real value of our house is not $180,380, but $159,920.
When we adjust for inflation, a house that was worth $226,000 in 2006, is down to a real value of only $160,000 in 2008. Which means the real dollar loss is not $45,910— but $66,250. Thus, the real percentage loss is not 20%— but 30%. The real loss in homeowner wealth has been a full 50% greater than what is being widely reported in the media.
Step Four: Add Up Losses For All Us Households
How big of a blow is a 30% decline in housing values to the US economy and national wealth? For the answer to that, we will turn to the Federal Reserve. As of 2006, Federal Reserve statistics show that total household real estate assets were $19.8 trillion (Statistical release Z.1 (Flow of Funds), table B.100( Household Balance sheet), line 4). So, we start with $19.8 trillion and multiply times the 29.3% real two year decline in home values that is in the bottom right hand corner of the chart.
$20 trillion in 2006 real estate, times 30% inflation-adjusted real estate losses between 2006 and 2008, is a $6 trillion dollar loss in homeowner wealth (rounded numbers). What is $6 trillion? Numbers that large are difficult to grasp, but 6 trillion is equal to 6 million, times 1 million. So a six trillion dollar loss is equal to six million people each having a million dollars, and each having their entire net worth wiped out. Six million millionaires, each losing every penny.
Another way of viewing $6 trillion is that as of 2006, it was equal to the sum of Baby Boomer retirement account investments, as well as pension investments dedicated to funding Boomer retirements (a detailed methodology for the $6 trillion in 2006 figure can be found in my previous research report "Adding Up $44 Trillion In Boomer Wealth Expectations"). A $6 trillion drop in value is equal to wiping out 100% of the retirement savings accounts and pension investment values for all 78 million US Baby Boomers between ages 44 and 62.
For additional perspective on the value of $6 trillion, the Chinese economy reached a GDP of $3.4 trillion in 2007, according to the Chinese news agency Xinhua. That means that over the last two years, the US housing market has been losing value at a rate almost equal to the size of the entire Chinese economy, the economic juggernaut that is currently driving much of the growth of the global economy.
(The Purchasing Power Parity (PPP) measure of the Chinese economy at $7 trillion for 2007 (as calculated in the CIA Factbook) is a much better measure than a GDP that is based upon blatantly manipulated currency values, but using such currency values as if a (non-existent) fair market had established them is the norm for financial reporting, so we’ll use it here. Even if we use the PPP, the loss in wealth compared to the Chinese economy is still extraordinary.)
Yet another way of looking at the size of $6 trillion is to compare it to the source of much of the plunge in value for real estate, which is the subprime mortgage securities market. The subprime debacle, which has shaken the global financial system and ravaged four of the strongest financial institutions in the US (Fannie, Freddie, MBIA and AMBAC), took place in a $1.2 trillion market. The two year loss in US housing values is five times the size of the total subprime mortgage securities market. As can readily be seen below, the two year collapse in US housing values is a financial disaster of epic proportions.
(Note that the $6 trillion loss shown does not reconcile with Federal Reserve real estate values for 2008, which show total real estate asset values of $19.7 trillion as of the first quarter, meaning essentially no fall in real estate values. Curiously enough, the official government statistics seem to do a remarkably good job of rising fast with rising real estate values, yet, don’t seem to reflect bad news at all. Much like some of the most interesting inflation numbers that the government has been using lately to claim that the economy is still growing fast, as measured by the GDP. More on this subject can be found in my article "Inflation Index Manipulation: Theft By Statistics".)
Personal Implications & Taking Actions
Let’s think for a moment about recent financial history. How about the collective "wisdom" of the markets pushing the NASDAQ to 5,000— and then 80% of that value quickly imploding as the NASDQ fell to 1,000. Then there is this most recent episode, where it appears the collective brilliance of the markets ran up a little $6 trillion (and still counting) pricing mistake. Just a little rounding error, twice the size of the economy of China. Now, let’s think about the safety of your retirement and other investment assets.
When you direct your IRA and 401 plans, when you plan your retirement income, what is your source of safety for your stock and bond investments? In the financial profession, your ultimate source of safety is what is known as the "Efficient Market Hypothesis", which just basically says that the awesome wisdom and intelligence of the markets makes sure that all securities are always fairly priced.
Given what we’ve seen just in the last decade— how confident are you about this collective brilliance of the markets? Confident enough to risk every penny of your retirement savings? Yet, you must invest and invest well— or inflation will eat your savings, and you will be impoverished anyway. So, what do you do?
A place to start is to think very seriously about reducing your ownership of financial assets. If you are investing for retirement and your portfolio of stocks and bonds gets taken down by broad market developments similar to what has already happened with real estate and tech stocks just in the last seven years, then you may never have the chance to replace retirement savings. There is a powerful, powerful case for moving a substantial portion of your assets into tangible assets. Good examples of tangible assets include gold, silver, commodities, farmland and energy— and yes, real estate. Not at the peak of a bubble, but at the right time and the right price.
The next thing you should do is very seriously think about is whether crisis leads to opportunity, in ways that go well beyond a simple strategy of only buying tangible assets. As a prominent recent example, John Paulson saw the crisis that was coming in subprime mortgages, researched and educated himself on this area (which had not been his field of expertise), and he turned the crisis into a $3-$4 billion personal payday in 2007. If you're not a hedge fund manager like Paulson, you may not have the tools that he used to turn a market crisis into personal billions. That’s OK, because Paulson didn’t start with the tools either. He started with educating himself, learning about a new area, until he came up with a novel way to profit from disaster. A method that wasn’t in the financial textbooks, and that he didn’t find by reading a financial columnist in the paper.
You have more tools than you may think, some of which may surprise you. Tools which can give you the opportunity to turn financial disaster into personal net worth. There are ways you can use those tools to turn the $6 trillion fall in real estate values in combination with the destruction of the US dollar into perhaps the greatest real wealth-building opportunity of your life, on a long-term and tax-advantaged basis.
But, if you want this to happen— then education is the essential first step. You are going to have to not just understand, but to master some of the financial forces and methods in play here. You will have to learn how to turn the destruction of paper wealth into real wealth. With Turning Inflation Into Wealth being the first key step. My best wishes to you for turning this challenge into an extraordinary personal opportunity.
Do you know how to Turn Inflation Into Wealth? To position yourself so that inflation will redistribute real wealth to you, and the higher the rate of inflation— the more your after-inflation net worth grows? Do you know how to achieve these gains on a long-term and tax-advantaged basis? Do you know how to potentially triple your after-tax and after-inflation returns through Reversing The Inflation Tax? So that instead of paying real taxes on illusionary income, you are paying illusionary taxes on real increases in net worth? These are among the many topics covered in the free "Turning Inflation Into Wealth" Mini-Course. Starting simple, this course delivers a series of 10-15 minute readings, with each reading building on the knowledge and information contained in previous readings. More information on the course is available at http://InflationIntoWealth.com
Contact Information:
Daniel R. Amerman, Cfa
Website: http://InflationIntoWealth.com/
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Normxxx
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Wednesday, September 10, 2008
Mortgage Mess Falls To Regulator
Mortgage Giants' Mess Falls To Their Regulator
By David S. Hilzenrath and Zachary A. Goldfarb, WP | 11 September 2008
With the government's seizure of Fannie Mae and Freddie Mac on Sunday, the federal regulator who oversaw the mortgage giants during their long descent is now in charge of restoring them to financial health. In the months before the takeover, James B. Lockhart III repeatedly assured investors that the mortgage giants were financially sound. In March, he even called fears about a government bailout "nonsense" as he reduced the financial cushion they were required to maintain. He eventually came to a different conclusion, deciding the companies were in perilous shape and would pose a major risk to financial markets if the government did not intervene. In an interview, Lockhart said he was "obviously wrong" about his assessment in March.
As the director of the newly created Federal Housing Finance Agency (FHFA), he now finds himself in full control of the companies and facing many of the same challenges that brought Fannie Mae and Freddie Mac down— along with a few new ones. Fannie Mae and Freddie Mac were chartered by the government to keep money flowing to the mortgage market, but they also had a duty to shareholders to maximize profits. Lockhart said it is now Fannie Mae and Freddie Mac's first priority to support the battered mortgage market, which he said might include loosening standards for mortgages the companies fund. The companies had pulled back on more risky lending when the housing market collapsed.
"They may look at targeted changes that might allow more people to get more mortgages," Lockhart said. If the companies' losses mount, "we know the U.S. government will be there" to cover them, he said. [[How many $trillions!?!: normxxx]] Lockhart also must find new incentives for employees who have watched the value of their Fannie Mae and Freddie Mac stock fall more than 98 percent over the past year and may be tempted to look elsewhere. Lockhart said he would seek to retain employees, potentially offering special bonuses. "I want to make sure there is an incentive for these people to stay," he said.
Lockhart said he would work with the new chief executives he appointed to run the companies. Richard S. Carnell, a law professor at Fordham University and a former senior Treasury official, said there was a "tension" between Lockhart's goals of providing a boost to the mortgage markets and maintaining the companies' health. "They got into problems by guaranteeing mortgages where the credit quality of the loans was too weak," he said. "The more careful they are [in expanding lending], the more it constrains the macroeconomic and housing market goals."
Lockhart faces other sensitive questions. He must decide whether to write off tens of billions of dollars of troubled assets on the companies' books, potentially increasing the near-term cost of the government bailout, or whether to defer the reckoning. Then there are the golden parachutes. The ousted chief executives, Daniel H. Mudd of Fannie Mae and Richard F. Syron of Freddie Mac, have the potential to leave with multimillion-dollar severance packages. Prominent lawmakers are calling on Lockhart to severely scale back the size of those packages.
"Under no circumstances should the executives of these institutions earn a windfall at a time when the U.S. Treasury has taken unprecedented steps to rescue these companies with taxpayer resources," Illinois Sen. Barack Obama, the Democratic presidential nominee, wrote in a letter to Lockhart and Treasury Secretary Henry M. Paulson Jr. this week. The campaign of Sen. John McCain (Ariz.), the Republican nominee, did not respond to a request to provide the candidate's view on the compensation question. The regulator said the issue of compensation was "under review."
Lockhart, 62, is a former Navy submariner and veteran of the financial-services industry. He has been friends with President Bush since they attended Andover prep school, Yale University and Harvard Business School. [[Ah-h-h; another 'w' "chum.": normxxx]] He worked for the Social Security Administration and the Pension Benefit Guarantee Corp. before signing on as Fannie and Freddie's chief regulator in 2006. His arrival at what was then known as the Office of Federal Housing Enterprise Oversight came as the companies were still recovering from separate accounting scandals. Lockhart spent much of his time warning that he lacked the tools of other regulators and urging Congress to create a new, more powerful overseer for the companies.
Lockhart began his tenure at OFHEO aggressively. He issued a scathing report on past accounting problems at Fannie Mae. Later, he accused former Fannie Mae executives such as Franklin D. Raines of manipulating earnings to maximize bonuses. He also imposed limits on the volume of mortgages the companies could hold. But this year, Lockhart turned from confrontation to accommodation. [[So, within a year, he and his agency had been copted by F&F!: normxxx]] The housing market meltdown was making the government more dependent on Fannie Mae and Freddie Mac, and the firms were "making progress" toward fixing long-standing internal weaknesses.
He settled the claim against Raines on terms that required Raines to pay nothing out of pocket. He issued a report raising questions about the kind of accounting that enabled Freddie Mac to boost its bottom line by $1 billion— but he didn't force the company to change that accounting. In addition, Lockhart authorized the companies to expand their portfolios of mortgage investments and then reduced the amount of financial cushion— known as capital— they were required to have to protect them against insolvency. In return, the companies promised to raise more capital, but Freddie Mac never did.
The agency "had to strike an appropriate balance between the objective of enabling Fannie Mae and Freddie Mac to perform their mission during a period of weakness in housing and mortgage markets, and the objective of limiting the risk the enterprises pose to taxpayers and the financial system," Lockhart said in a May speech. Doing so, he added, was "quite a challenge." In July, as panicked investors dumped stock in the two companies, Lockhart declared that their capital levels were "well in excess" of federal requirements. "At a very difficult time in the market, the enterprises have the flexibility and sound operations needed to support their mission." [[If he was in the private sector, he could go to jail for that; as it is, he can't even be sued.: normxxx]]
In late July, Congress created a more powerful agency to replace OFHEO, and Lockhart was named to head it. In recent weeks, FHFA examiners, working with the Federal Reserve and other agencies, concluded that the underlying economics of Fannie Mae and Freddie Mac were precarious. "The issues were pervasive" with the companies' ability to stay solvent and manage risk in doubt, Lockhart said in the interview. Without taking them over, he said, "they could have caused a significant systemic event" in the world markets.
In separate meetings Friday at his agency's headquarters near the White House, he and Paulson told the heads of Fannie Mae and Freddie Mac they should consent to being taken over by the government— and signaled that if they did not, the government would do it, according to people familiar with the matter who spoke anonymously because the talks were private. In the interview, Lockhart said he was surprised by how fast the companies ran into severe trouble. "No one projected how bad this market was going to get," he said. "We thought with the ability to raise capital in a significant amount they could weather this storm. But what happened, of course, is the storm got worse and worse." [[As was perfectly predictable by anyone but a fool!: normxxx]]
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Normxxx
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By David S. Hilzenrath and Zachary A. Goldfarb, WP | 11 September 2008
|
With the government's seizure of Fannie Mae and Freddie Mac on Sunday, the federal regulator who oversaw the mortgage giants during their long descent is now in charge of restoring them to financial health. In the months before the takeover, James B. Lockhart III repeatedly assured investors that the mortgage giants were financially sound. In March, he even called fears about a government bailout "nonsense" as he reduced the financial cushion they were required to maintain. He eventually came to a different conclusion, deciding the companies were in perilous shape and would pose a major risk to financial markets if the government did not intervene. In an interview, Lockhart said he was "obviously wrong" about his assessment in March.
As the director of the newly created Federal Housing Finance Agency (FHFA), he now finds himself in full control of the companies and facing many of the same challenges that brought Fannie Mae and Freddie Mac down— along with a few new ones. Fannie Mae and Freddie Mac were chartered by the government to keep money flowing to the mortgage market, but they also had a duty to shareholders to maximize profits. Lockhart said it is now Fannie Mae and Freddie Mac's first priority to support the battered mortgage market, which he said might include loosening standards for mortgages the companies fund. The companies had pulled back on more risky lending when the housing market collapsed.
"They may look at targeted changes that might allow more people to get more mortgages," Lockhart said. If the companies' losses mount, "we know the U.S. government will be there" to cover them, he said. [[How many $trillions!?!: normxxx]] Lockhart also must find new incentives for employees who have watched the value of their Fannie Mae and Freddie Mac stock fall more than 98 percent over the past year and may be tempted to look elsewhere. Lockhart said he would seek to retain employees, potentially offering special bonuses. "I want to make sure there is an incentive for these people to stay," he said.
Lockhart said he would work with the new chief executives he appointed to run the companies. Richard S. Carnell, a law professor at Fordham University and a former senior Treasury official, said there was a "tension" between Lockhart's goals of providing a boost to the mortgage markets and maintaining the companies' health. "They got into problems by guaranteeing mortgages where the credit quality of the loans was too weak," he said. "The more careful they are [in expanding lending], the more it constrains the macroeconomic and housing market goals."
Lockhart faces other sensitive questions. He must decide whether to write off tens of billions of dollars of troubled assets on the companies' books, potentially increasing the near-term cost of the government bailout, or whether to defer the reckoning. Then there are the golden parachutes. The ousted chief executives, Daniel H. Mudd of Fannie Mae and Richard F. Syron of Freddie Mac, have the potential to leave with multimillion-dollar severance packages. Prominent lawmakers are calling on Lockhart to severely scale back the size of those packages.
"Under no circumstances should the executives of these institutions earn a windfall at a time when the U.S. Treasury has taken unprecedented steps to rescue these companies with taxpayer resources," Illinois Sen. Barack Obama, the Democratic presidential nominee, wrote in a letter to Lockhart and Treasury Secretary Henry M. Paulson Jr. this week. The campaign of Sen. John McCain (Ariz.), the Republican nominee, did not respond to a request to provide the candidate's view on the compensation question. The regulator said the issue of compensation was "under review."
Lockhart, 62, is a former Navy submariner and veteran of the financial-services industry. He has been friends with President Bush since they attended Andover prep school, Yale University and Harvard Business School. [[Ah-h-h; another 'w' "chum.": normxxx]] He worked for the Social Security Administration and the Pension Benefit Guarantee Corp. before signing on as Fannie and Freddie's chief regulator in 2006. His arrival at what was then known as the Office of Federal Housing Enterprise Oversight came as the companies were still recovering from separate accounting scandals. Lockhart spent much of his time warning that he lacked the tools of other regulators and urging Congress to create a new, more powerful overseer for the companies.
Lockhart began his tenure at OFHEO aggressively. He issued a scathing report on past accounting problems at Fannie Mae. Later, he accused former Fannie Mae executives such as Franklin D. Raines of manipulating earnings to maximize bonuses. He also imposed limits on the volume of mortgages the companies could hold. But this year, Lockhart turned from confrontation to accommodation. [[So, within a year, he and his agency had been copted by F&F!: normxxx]] The housing market meltdown was making the government more dependent on Fannie Mae and Freddie Mac, and the firms were "making progress" toward fixing long-standing internal weaknesses.
He settled the claim against Raines on terms that required Raines to pay nothing out of pocket. He issued a report raising questions about the kind of accounting that enabled Freddie Mac to boost its bottom line by $1 billion— but he didn't force the company to change that accounting. In addition, Lockhart authorized the companies to expand their portfolios of mortgage investments and then reduced the amount of financial cushion— known as capital— they were required to have to protect them against insolvency. In return, the companies promised to raise more capital, but Freddie Mac never did.
The agency "had to strike an appropriate balance between the objective of enabling Fannie Mae and Freddie Mac to perform their mission during a period of weakness in housing and mortgage markets, and the objective of limiting the risk the enterprises pose to taxpayers and the financial system," Lockhart said in a May speech. Doing so, he added, was "quite a challenge." In July, as panicked investors dumped stock in the two companies, Lockhart declared that their capital levels were "well in excess" of federal requirements. "At a very difficult time in the market, the enterprises have the flexibility and sound operations needed to support their mission." [[If he was in the private sector, he could go to jail for that; as it is, he can't even be sued.: normxxx]]
In late July, Congress created a more powerful agency to replace OFHEO, and Lockhart was named to head it. In recent weeks, FHFA examiners, working with the Federal Reserve and other agencies, concluded that the underlying economics of Fannie Mae and Freddie Mac were precarious. "The issues were pervasive" with the companies' ability to stay solvent and manage risk in doubt, Lockhart said in the interview. Without taking them over, he said, "they could have caused a significant systemic event" in the world markets.
In separate meetings Friday at his agency's headquarters near the White House, he and Paulson told the heads of Fannie Mae and Freddie Mac they should consent to being taken over by the government— and signaled that if they did not, the government would do it, according to people familiar with the matter who spoke anonymously because the talks were private. In the interview, Lockhart said he was surprised by how fast the companies ran into severe trouble. "No one projected how bad this market was going to get," he said. "We thought with the ability to raise capital in a significant amount they could weather this storm. But what happened, of course, is the storm got worse and worse." [[As was perfectly predictable by anyone but a fool!: normxxx]]
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Tuesday, September 9, 2008
Best Quotes Of August 2008
Best Quotes Of August 2008
By John Rubino | 4 September 2008
Gene Arensberg, Resource Investor
Everyone can look at the data and form their own conclusions. But when silver is in short physical supply, commanding injuriously high premiums and difficult to locate; when investors are piling into the silver ETF in droves, a 40% silver price plunge is not only not warranted, it smells.
It is difficult to imagine a legitimate reason that two U.S. banks could quickly and systematically amass a net short position on the COMEX which amounts to over a quarter of the entire action on that bourse. It will not be surprising at all if we learn that these two U.S. banks are taken to task by regulators for their actions. It will be even less surprising to learn that they have become the target of multi-billion dollar class action lawsuits by hungry lawyers representing silver investors everywhere.
Futures markets are supposed to answer the actual physical markets, not the other way around. In other words, futures markets are supposed to be a place where producers or large holders of a commodity can lay off price risk to speculators and thereby hedge against unforeseen adverse movements in the price of the commodity. Futures markets are definitely not supposed to be a place where a couple of well connected and well funded entities can bully the market with their own heavy handed trading.
If silver really was just taken down by a couple of very big U.S. banks to irrationally low levels, it won’t be long before the laws of supply and demand reassert themselves. Got silver?
Frank Barbera, Gold Stock Technician
Even more to that point, we wonder at what point does an institution such as the Fed lose its credibility? At what point does an institution become irrelevant? The answer to that question is when events have taken on a life of their own, and when their words no longer have any real impact. We have fortunately not reached this point yet, but for all appearances seem to be heading in this direction at a rapid pace. The socialization of financial market bad debts has forced the Fed to act as the lender of last resort, placing its own balance sheet on the line for the ineptitudes which were sewn over so many years of the Greenspan Fed. How dare Mr. Greenspan comment on perils of the current collapse when he was the chief architect of the events now unfolding each and every week.
Bob Chapman, International Forecaster
Why should gold go down if the dollar goes up? If the dollar goes up substantially, that means the euro is going down substantially, so gold should be exploding in the Euro Zone. If anything, a weaker euro should be more supportive of gold than a weaker dollar as there are just as many euros out there as there are dollars now, and because the people of Europe are far more attuned to the uses and purposes of precious metals than are their US counterparts. We sure hope the people in the Euro Zone loaded up on precious metals, which are now skyrocketing in their currency as the euro has gone from 1.60 dollars to less than 1.50 dollars in rather rapid succession. All fiat currencies will continue to lose against gold, including the dollar, so it is time to load up on the bargains you have been so graciously gifted with by your evil government and the Wall Street fraudsters!!!
Another scheme that financial companies have employed during the crisis is to regularly reclassify assets from Level 2 to Level 3 and vice versa. Level 3 assets have no market whatsoever, so values have to be 'estimated from models', ie, 'guessed'. Level 2 assets are ‘marked by model according to tangible data’. Ergo if you have a 'beneficial' model you move assets from Level 3 to Level 2 to generate better marks and earnings.
Which leads us to JP Morgan— For most of the US financial crisis the media and pundits hailed JP Morgan as having a ‘fortress-like balance sheet’ even though it has over $80 trillion of derivatives. JP Morgan CEO Jamie Dimon has been portrayed as the Financial Wizard of Oz.
So for the past several months most investors and people assumed that JP Morgan somehow managed to avoid all the crappy paper and ancillary problems that plague the industry. One group that thought otherwise averred that the Bear Stearns bailout was engineered to help JP Morgan obfuscate its problems and borrow massively from the Fed without public concern.
But the revelation of a relatively miniscule $1.5B write-down has destroyed the illusion of JP Morgan’s imperviousness to the financial mess. This has led analysts, investors, and just wise guys to re-examine JPM.
One disconcerting JPM fundamental is the amount of its Level 2 assets. An astute money manager alerted us that, "The market is obsessed with Level 3 assets levels but forgot to notice that of JPM's total $1.775 trillion in assets, $1.575 trillion are Level 2 or mark to model. The whole loan, MBS and Level 2 are what presents the real danger when the raters finally get there."
Gary Dorsch, Global Money Trends
Trading in foreign currencies is akin to judging a reverse beauty contest and, suddenly, the US-dollar's was looking a little less ugly than its peers.
Ambrose Evans-Prichard, Telegraph UK
My guess is that political protest will mark the next phase of this drama. Almost half a million people have lost their jobs in Spain alone over the last year. At some point, the feeling of national impotence in the face of monetary rule from Frankfurt will erupt into popular fury. The ECB will swallow its pride and opt for a weak euro policy, or face its own destruction.
What we are about to see is a race to the bottom by the world's major currencies as each tries to devalue against others in a beggar-thy-neighbor policy to shore up exports, or, indeed, simply because they have to cut rates frantically to stave off the consequences of debt-deleveraging and the risk of an outright [DEflation]. When that happens— if it is not already happening— it will become abundantly clear that the both pillars of the global monetary system [the dollar and the euro] are unstable, [hugely] infested with the dry rot of excess debt.
Gold bugs, you ain't seen nothing yet. Gold at $800 looks like a bargain in the new world currency disorder.
Bill Fleckenstein, Fleckenstein Capital
In any case, if we saw (as it appeared) heavy selling or short-selling in the futures market while demand for gold in the physical world was rising, that historically would be a very bullish development.
What does seem quite clear is that some portion of gold's weakness has been a function of the dollar's strength. The dollar's violent rally owes to folks' beliefs that the economy is improving in the U.S., that the Federal Reserve intends to raise interest rates and that the rest of the world economy is slowing down. [[At least that last is true! : normxxx]]
The rest of the world may in fact be slowing down. But our economy is not about to get better, and the Fed is not about to tighten rates. Just the thought of the Fed increasing rates is laughable.
Eric Janszen, Itulip
The current recession is more serious than all previous recessions since the early 1980s. This time inflation, unemployment, and a credit crunch are cutting into demand. Demand, in the economic sense, is the combined desire of consumers to spend and the availability of the cash they need to act on that desire. Recessions with declining demand tend to be self-reinforcing as falling demand leads to further falling consumption, leading businesses to reduce labor costs by laying off employees, leading to still further falling incomes and still further reductions in demand.
Another unusual aspect of this recession is that traditional Keynesian techniques to stimulate demand by expanding credit through interest rates cuts is hobbled by a moribund housing market; housing has for decades been the primary mechanism for transmitting interest cuts to consumers by reducing a household's primary interest expense, their mortgage. The freed up money acts much like tax cut. Now, however, [long term] interest rates are rising, especially for those homeowners who took Greenspan's advice in 2005 and took out an adjustable rate mortgage when fixed rate mortgages were already at 40 year lows, and rapidly tightening lending standards are further cutting off home mortgage refinancing for millions.
Finally, a weak dollar since 2001 means "oil prices drive up the cost of everything that requires oil to grow, be dug up, blown, packed, scrubbed, crushed, shaken, warmed, cooled, pickled, packaged, processed, or moved— that is, everything on God’s green earth including your own hair and the hot water you used to wash it this morning." The only way to reduce that impact short term is to use less oil. A recession will help, as long as the dollar doesn't fall faster than oil demand.
Jack Lifton, Resource Investor
As the 2008 political season nears its quadrennial crescendo and rock stars and war heroes are vying to be selected for the most militarily powerful job in the world it would seem that no one, certainly no politician, is willing to admit that America’s world economic-leadership is eroding at an almost perceptible daily rate. Candidates, and office holders, remind us that each of the U.S. Navy’s 12 carrier battle-groups is, by itself, more powerful than any other single nation’s entire navy! Yet they fail to mention that we cannot build armoured ships or vehicles, small arms, artillery, armour piercing ammunition, missile guidance, night vision equipment, computers, displays, or, believe it or not, nuclear propulsion systems, or aircraft of any kind, civilian or military, without minor metals, such as the rare earths. Most of which we are now, 100%, dependent on nations unfriendly to America, which, notwithstanding their being unfriendly, already practice resource nationalism. Some of them, such as China, have already openly begun to restrict the export— or use for items of export— of key industrial minor metals, in order to safeguard their own sufficiency in these materials.
Bob Moriarty, 321gold
Homestake [Gold] Mining declined about 21% from the crash in late October 1929 through the end of that year, but through the entire decade of the 1930s Homestake was the highest gaining stock on the New York Stock Exchange. So, it’s entirely possible the market could crash and gold stocks go up. At some point in time, people are going to recognize the precious metals stocks, not all metal stocks, are the safest place to be.
Doug Noland, Prudent Bear
It is not the nature of dislocated markets to let fundamentals get in the way of price movement. Markets, after all, live on fear and greed. Sinking energy prices and a short squeeze ignited U.S. stocks this week. And surging stock prices always entice the optimistic viewpoint, with many viewing runs in stocks and the dollar as confirmation that the worst of the financial and economic crisis is behind us. The bursting of the so-called Energy/Commodities Bubble is also viewed in positive light.
Yet if the key dynamic is instead a Bursting Leveraged Speculating Community Bubble, entirely different dynamics are now in play. Enormous short positions have built up, the vast majority as part of "market neutral," "quant" and myriad risk hedging strategies. If today’s dislocation develops into a significant unwind of these positions, the market immediately then becomes vulnerable to a disorderly "melt-up" followed almost inevitably by a sharp reversal and disorderly decline. The unwind of bearish speculations and hedges would be a most problematic market development, unleashing a final bout of speculative excess and disorder that would set the stage for a major market crisis.
It is now clear that many within the leveraged speculating community have suffered huge losses over the past few weeks. For a "community" that was already suffering a difficult year, blowups in the popular energy, commodities and short dollar trades were a decisive backbreaker. Huge rallies in heavily shorted stocks and sectors have added further pain. One can now expect major redemptions at quarter and year-ends, a dynamic that likely ensures recent near-chaotic market conditions become the norm for awhile.
Jim Puplava, Financial Sense
The US Mint has suspended the production of US Eagles. I was told by one dealer this morning, checking with him, they’re telling people delivery dates for silver Eagles won’t be till January, February of next year. One dealer I was talking to said that they can’t even get the plates— so what they were doing is they were ordering thousand ounce bars and they were melting the bars down to make one ounce coins because most people are buying either silver rounds— and I was told delivery dates right now are two months out. So this is August, probably late October. That’s how scarce it is.
So, the other thing is get your physical metals because there is a gross discrepancy and divergence between trying to drive down the paper market price of silver. One dealer told me in July his sales were up four fold last year; and this month alone, his sales are up eight fold. One dealer was telling me today that he had never seen anything like this in his lifetime. On this Friday I just bought a ton of silver and I’ve been told it’s going to take two months to take delivery on that ton. And if the price goes lower, I’ll buy another ton. I’ve got a couple of dealers who store my bullion for me until it’s shipped overseas.
James Quinn, Wharton School, University Of Pennsylvania
We have outsourced our savings to the emerging economies, along with our manufacturing jobs. The Chinese are saving the money we’ve paid them for flat screen TVs and the Middle Eastern countries are saving the money we’ve paid them for oil. You need savings in order to increase investment. The emerging markets are making the vast majority of the investments in the world.
While the U.S. endlessly debates drilling and construction of nuclear plants (none built in U.S. since 1987) and oil refineries (none built in U.S. since 1977), China brought four oil refineries online in 2008 and plans to build 30 nuclear reactors in the next twelve years. The Asian Century has begun, but the U.S. has tried to keep up by using debt. It will not work. If anything, this has accelerated the shift of power to Asia.
Nouriel Roubini, RGE Monitor
Barron's: Unfortunately for the rest of us, you have a pretty good track record. How much more misery lies ahead?
Roubini: We are [only] in the second inning of a severe, protracted recession, which started in the first quarter of this year and is going to last at least 18 months, through the middle of next year. [[I would bet on the end of 2009— or even sometime in 2010! : normxxx]] A systemic banking crisis will go on for awhile, with hundreds of banks going belly up. The taxpayer's bill is going to be huge. I estimate this financial crisis will lead to credit losses of at least $1 trillion and most likely closer to $2 trillion. When I made this analysis in February everybody thought I was a lunatic.
But a few weeks later the International Monetary Fund came out with an estimate of $945 billion, Goldman Sachs (GS) estimated $1.1 trillion and UBS (UBS) $1 trillion. Hedge-fund manager John Paulson recently estimated the losses would be $1.3 trillion, and late last month Bridgewater Associates came up with an estimate of $1.6 trillion. So, at this point $1 trillion isn't a ceiling, it's a floor. And the banks, as I've said, have written down only about $300 billion of subprime debt. I think $2 trillion is too high, but the number will definitely be huge.
Franklin Sanders, Money Changer
Either this is the greatest silver and gold buying opportunity of all time, or the end of [the] bull market.
But it is NOT the end of a bull market. Time alone argues that. A bull market runs 10 - 20 years, and this one has run only 7, since 2001. Those who think silver & gold have fallen with the "bursting of the commodity bubble" completely misunderstand what drives them in the first place. Silver & gold are not commodities; they are money. [[Silver acts as both; usually as a commodity when gold is quiescent, but as "the poor man's money" when gold takes off.: normxxx]] When investors pile into silver & gold, it's not any commodity bubble forcing them there, but monetary demand. They aren't buying metals because they think all the Indian ladies are going to be wearing two nose rings instead of one this season, or that the American bourgeoisie will suddenly begin stockpiling sterling silver forks again.
They are buying metals because— listen to this, get it straight once & forever— they distrust fiat central bank currencies (or if you prefer, national currencies). The dollar is trash, the yen is trash, the euro is trash; all are equally insolvent, equally unbacked by anything except a politician's or central banker's promise, which is hardly as good as that of a madame at a bordello.
The dollar is rising? So, why? Did it suddenly become better, acquire more gold backing, solve its chronic balance of payments deficit last night? Come on. Did the euro get worse overnight? The yen? How much worse could they get? You are seeing competitive devaluations, but, at least this time, all very much worked out collegially in advance by the central bankers. Fundamentally meaningless.
What is NOT meaningless is that the Great Alternative Currencies, silver & gold, have long been advancing against ALL national currencies. All markets swing like pendulums, too far one way, then too far the other. Silver & gold prices became overbought— a lot of people short dollars were long silver & gold. The dollar rallied, oil & commodities fell, sucking down silver & gold money. Look at the numbers. Even with gold down to $787.50 today, that's only a 21.5% correction, while always more volatile silver is down 37.4%. Friends, these are perfectly normal, not outlandish, corrections. Sober up.
Julian D. W. Phillips, Gold Forecaster
The huge gap between the value of gold and the value of money must narrow. Whether it is through the rise in the value of gold and silver or through the fall of the value of money dictates the future of the financial system. Either way, gold and silver will prove to be the safe-haven it has been since money was part of man’s world. And the second half of this year is likely to be as dramatic as the first half but with a golden or silver sheen to it.
Steve Saville, Speculative Investor
Many people will be asking the question: why is the US$ rallying when its fundamentals are so terrible? From our perspective, however, a more reasonable question is: why has it taken so long for the US$ to rally against the euro given that the US$ is extremely under-valued relative to the euro and the euro's fundamentals are just as bad? [[Or, worse.: normxxx]]
The answer, we think, is that the currency market has believed that the US Federal Reserve would be as 'easy' as it needed to be to help the banking system through its crisis, while the ECB would continue to focus on minimizing currency depreciation. We think the market was/is right to believe that the Fed will do whatever it takes to maintain the solvency of the major banks, but traders now appear to be coming around to the view that the ECB will also be loosening the monetary reins. Take away the interest-rate 'prop' and the euro suddenly becomes free to fall under the weight of its own over-valuation.
Mike Shedlock, Mish’s Global Economic Trend Anal
By John Rubino | 4 September 2008
Gene Arensberg, Resource Investor
Everyone can look at the data and form their own conclusions. But when silver is in short physical supply, commanding injuriously high premiums and difficult to locate; when investors are piling into the silver ETF in droves, a 40% silver price plunge is not only not warranted, it smells.
It is difficult to imagine a legitimate reason that two U.S. banks could quickly and systematically amass a net short position on the COMEX which amounts to over a quarter of the entire action on that bourse. It will not be surprising at all if we learn that these two U.S. banks are taken to task by regulators for their actions. It will be even less surprising to learn that they have become the target of multi-billion dollar class action lawsuits by hungry lawyers representing silver investors everywhere.
Futures markets are supposed to answer the actual physical markets, not the other way around. In other words, futures markets are supposed to be a place where producers or large holders of a commodity can lay off price risk to speculators and thereby hedge against unforeseen adverse movements in the price of the commodity. Futures markets are definitely not supposed to be a place where a couple of well connected and well funded entities can bully the market with their own heavy handed trading.
If silver really was just taken down by a couple of very big U.S. banks to irrationally low levels, it won’t be long before the laws of supply and demand reassert themselves. Got silver?
Frank Barbera, Gold Stock Technician
Even more to that point, we wonder at what point does an institution such as the Fed lose its credibility? At what point does an institution become irrelevant? The answer to that question is when events have taken on a life of their own, and when their words no longer have any real impact. We have fortunately not reached this point yet, but for all appearances seem to be heading in this direction at a rapid pace. The socialization of financial market bad debts has forced the Fed to act as the lender of last resort, placing its own balance sheet on the line for the ineptitudes which were sewn over so many years of the Greenspan Fed. How dare Mr. Greenspan comment on perils of the current collapse when he was the chief architect of the events now unfolding each and every week.
Bob Chapman, International Forecaster
Why should gold go down if the dollar goes up? If the dollar goes up substantially, that means the euro is going down substantially, so gold should be exploding in the Euro Zone. If anything, a weaker euro should be more supportive of gold than a weaker dollar as there are just as many euros out there as there are dollars now, and because the people of Europe are far more attuned to the uses and purposes of precious metals than are their US counterparts. We sure hope the people in the Euro Zone loaded up on precious metals, which are now skyrocketing in their currency as the euro has gone from 1.60 dollars to less than 1.50 dollars in rather rapid succession. All fiat currencies will continue to lose against gold, including the dollar, so it is time to load up on the bargains you have been so graciously gifted with by your evil government and the Wall Street fraudsters!!!
Another scheme that financial companies have employed during the crisis is to regularly reclassify assets from Level 2 to Level 3 and vice versa. Level 3 assets have no market whatsoever, so values have to be 'estimated from models', ie, 'guessed'. Level 2 assets are ‘marked by model according to tangible data’. Ergo if you have a 'beneficial' model you move assets from Level 3 to Level 2 to generate better marks and earnings.
Which leads us to JP Morgan— For most of the US financial crisis the media and pundits hailed JP Morgan as having a ‘fortress-like balance sheet’ even though it has over $80 trillion of derivatives. JP Morgan CEO Jamie Dimon has been portrayed as the Financial Wizard of Oz.
So for the past several months most investors and people assumed that JP Morgan somehow managed to avoid all the crappy paper and ancillary problems that plague the industry. One group that thought otherwise averred that the Bear Stearns bailout was engineered to help JP Morgan obfuscate its problems and borrow massively from the Fed without public concern.
But the revelation of a relatively miniscule $1.5B write-down has destroyed the illusion of JP Morgan’s imperviousness to the financial mess. This has led analysts, investors, and just wise guys to re-examine JPM.
One disconcerting JPM fundamental is the amount of its Level 2 assets. An astute money manager alerted us that, "The market is obsessed with Level 3 assets levels but forgot to notice that of JPM's total $1.775 trillion in assets, $1.575 trillion are Level 2 or mark to model. The whole loan, MBS and Level 2 are what presents the real danger when the raters finally get there."
Gary Dorsch, Global Money Trends
Trading in foreign currencies is akin to judging a reverse beauty contest and, suddenly, the US-dollar's was looking a little less ugly than its peers.
Ambrose Evans-Prichard, Telegraph UK
My guess is that political protest will mark the next phase of this drama. Almost half a million people have lost their jobs in Spain alone over the last year. At some point, the feeling of national impotence in the face of monetary rule from Frankfurt will erupt into popular fury. The ECB will swallow its pride and opt for a weak euro policy, or face its own destruction.
What we are about to see is a race to the bottom by the world's major currencies as each tries to devalue against others in a beggar-thy-neighbor policy to shore up exports, or, indeed, simply because they have to cut rates frantically to stave off the consequences of debt-deleveraging and the risk of an outright [DEflation]. When that happens— if it is not already happening— it will become abundantly clear that the both pillars of the global monetary system [the dollar and the euro] are unstable, [hugely] infested with the dry rot of excess debt.
Gold bugs, you ain't seen nothing yet. Gold at $800 looks like a bargain in the new world currency disorder.
Bill Fleckenstein, Fleckenstein Capital
In any case, if we saw (as it appeared) heavy selling or short-selling in the futures market while demand for gold in the physical world was rising, that historically would be a very bullish development.
What does seem quite clear is that some portion of gold's weakness has been a function of the dollar's strength. The dollar's violent rally owes to folks' beliefs that the economy is improving in the U.S., that the Federal Reserve intends to raise interest rates and that the rest of the world economy is slowing down. [[At least that last is true! : normxxx]]
The rest of the world may in fact be slowing down. But our economy is not about to get better, and the Fed is not about to tighten rates. Just the thought of the Fed increasing rates is laughable.
Eric Janszen, Itulip
The current recession is more serious than all previous recessions since the early 1980s. This time inflation, unemployment, and a credit crunch are cutting into demand. Demand, in the economic sense, is the combined desire of consumers to spend and the availability of the cash they need to act on that desire. Recessions with declining demand tend to be self-reinforcing as falling demand leads to further falling consumption, leading businesses to reduce labor costs by laying off employees, leading to still further falling incomes and still further reductions in demand.
Another unusual aspect of this recession is that traditional Keynesian techniques to stimulate demand by expanding credit through interest rates cuts is hobbled by a moribund housing market; housing has for decades been the primary mechanism for transmitting interest cuts to consumers by reducing a household's primary interest expense, their mortgage. The freed up money acts much like tax cut. Now, however, [long term] interest rates are rising, especially for those homeowners who took Greenspan's advice in 2005 and took out an adjustable rate mortgage when fixed rate mortgages were already at 40 year lows, and rapidly tightening lending standards are further cutting off home mortgage refinancing for millions.
Finally, a weak dollar since 2001 means "oil prices drive up the cost of everything that requires oil to grow, be dug up, blown, packed, scrubbed, crushed, shaken, warmed, cooled, pickled, packaged, processed, or moved— that is, everything on God’s green earth including your own hair and the hot water you used to wash it this morning." The only way to reduce that impact short term is to use less oil. A recession will help, as long as the dollar doesn't fall faster than oil demand.
Jack Lifton, Resource Investor
As the 2008 political season nears its quadrennial crescendo and rock stars and war heroes are vying to be selected for the most militarily powerful job in the world it would seem that no one, certainly no politician, is willing to admit that America’s world economic-leadership is eroding at an almost perceptible daily rate. Candidates, and office holders, remind us that each of the U.S. Navy’s 12 carrier battle-groups is, by itself, more powerful than any other single nation’s entire navy! Yet they fail to mention that we cannot build armoured ships or vehicles, small arms, artillery, armour piercing ammunition, missile guidance, night vision equipment, computers, displays, or, believe it or not, nuclear propulsion systems, or aircraft of any kind, civilian or military, without minor metals, such as the rare earths. Most of which we are now, 100%, dependent on nations unfriendly to America, which, notwithstanding their being unfriendly, already practice resource nationalism. Some of them, such as China, have already openly begun to restrict the export— or use for items of export— of key industrial minor metals, in order to safeguard their own sufficiency in these materials.
Bob Moriarty, 321gold
Homestake [Gold] Mining declined about 21% from the crash in late October 1929 through the end of that year, but through the entire decade of the 1930s Homestake was the highest gaining stock on the New York Stock Exchange. So, it’s entirely possible the market could crash and gold stocks go up. At some point in time, people are going to recognize the precious metals stocks, not all metal stocks, are the safest place to be.
Doug Noland, Prudent Bear
It is not the nature of dislocated markets to let fundamentals get in the way of price movement. Markets, after all, live on fear and greed. Sinking energy prices and a short squeeze ignited U.S. stocks this week. And surging stock prices always entice the optimistic viewpoint, with many viewing runs in stocks and the dollar as confirmation that the worst of the financial and economic crisis is behind us. The bursting of the so-called Energy/Commodities Bubble is also viewed in positive light.
Yet if the key dynamic is instead a Bursting Leveraged Speculating Community Bubble, entirely different dynamics are now in play. Enormous short positions have built up, the vast majority as part of "market neutral," "quant" and myriad risk hedging strategies. If today’s dislocation develops into a significant unwind of these positions, the market immediately then becomes vulnerable to a disorderly "melt-up" followed almost inevitably by a sharp reversal and disorderly decline. The unwind of bearish speculations and hedges would be a most problematic market development, unleashing a final bout of speculative excess and disorder that would set the stage for a major market crisis.
It is now clear that many within the leveraged speculating community have suffered huge losses over the past few weeks. For a "community" that was already suffering a difficult year, blowups in the popular energy, commodities and short dollar trades were a decisive backbreaker. Huge rallies in heavily shorted stocks and sectors have added further pain. One can now expect major redemptions at quarter and year-ends, a dynamic that likely ensures recent near-chaotic market conditions become the norm for awhile.
Jim Puplava, Financial Sense
The US Mint has suspended the production of US Eagles. I was told by one dealer this morning, checking with him, they’re telling people delivery dates for silver Eagles won’t be till January, February of next year. One dealer I was talking to said that they can’t even get the plates— so what they were doing is they were ordering thousand ounce bars and they were melting the bars down to make one ounce coins because most people are buying either silver rounds— and I was told delivery dates right now are two months out. So this is August, probably late October. That’s how scarce it is.
So, the other thing is get your physical metals because there is a gross discrepancy and divergence between trying to drive down the paper market price of silver. One dealer told me in July his sales were up four fold last year; and this month alone, his sales are up eight fold. One dealer was telling me today that he had never seen anything like this in his lifetime. On this Friday I just bought a ton of silver and I’ve been told it’s going to take two months to take delivery on that ton. And if the price goes lower, I’ll buy another ton. I’ve got a couple of dealers who store my bullion for me until it’s shipped overseas.
James Quinn, Wharton School, University Of Pennsylvania
We have outsourced our savings to the emerging economies, along with our manufacturing jobs. The Chinese are saving the money we’ve paid them for flat screen TVs and the Middle Eastern countries are saving the money we’ve paid them for oil. You need savings in order to increase investment. The emerging markets are making the vast majority of the investments in the world.
While the U.S. endlessly debates drilling and construction of nuclear plants (none built in U.S. since 1987) and oil refineries (none built in U.S. since 1977), China brought four oil refineries online in 2008 and plans to build 30 nuclear reactors in the next twelve years. The Asian Century has begun, but the U.S. has tried to keep up by using debt. It will not work. If anything, this has accelerated the shift of power to Asia.
Nouriel Roubini, RGE Monitor
Barron's: Unfortunately for the rest of us, you have a pretty good track record. How much more misery lies ahead?
Roubini: We are [only] in the second inning of a severe, protracted recession, which started in the first quarter of this year and is going to last at least 18 months, through the middle of next year. [[I would bet on the end of 2009— or even sometime in 2010! : normxxx]] A systemic banking crisis will go on for awhile, with hundreds of banks going belly up. The taxpayer's bill is going to be huge. I estimate this financial crisis will lead to credit losses of at least $1 trillion and most likely closer to $2 trillion. When I made this analysis in February everybody thought I was a lunatic.
But a few weeks later the International Monetary Fund came out with an estimate of $945 billion, Goldman Sachs (GS) estimated $1.1 trillion and UBS (UBS) $1 trillion. Hedge-fund manager John Paulson recently estimated the losses would be $1.3 trillion, and late last month Bridgewater Associates came up with an estimate of $1.6 trillion. So, at this point $1 trillion isn't a ceiling, it's a floor. And the banks, as I've said, have written down only about $300 billion of subprime debt. I think $2 trillion is too high, but the number will definitely be huge.
Franklin Sanders, Money Changer
Either this is the greatest silver and gold buying opportunity of all time, or the end of [the] bull market.
But it is NOT the end of a bull market. Time alone argues that. A bull market runs 10 - 20 years, and this one has run only 7, since 2001. Those who think silver & gold have fallen with the "bursting of the commodity bubble" completely misunderstand what drives them in the first place. Silver & gold are not commodities; they are money. [[Silver acts as both; usually as a commodity when gold is quiescent, but as "the poor man's money" when gold takes off.: normxxx]] When investors pile into silver & gold, it's not any commodity bubble forcing them there, but monetary demand. They aren't buying metals because they think all the Indian ladies are going to be wearing two nose rings instead of one this season, or that the American bourgeoisie will suddenly begin stockpiling sterling silver forks again.
They are buying metals because— listen to this, get it straight once & forever— they distrust fiat central bank currencies (or if you prefer, national currencies). The dollar is trash, the yen is trash, the euro is trash; all are equally insolvent, equally unbacked by anything except a politician's or central banker's promise, which is hardly as good as that of a madame at a bordello.
The dollar is rising? So, why? Did it suddenly become better, acquire more gold backing, solve its chronic balance of payments deficit last night? Come on. Did the euro get worse overnight? The yen? How much worse could they get? You are seeing competitive devaluations, but, at least this time, all very much worked out collegially in advance by the central bankers. Fundamentally meaningless.
What is NOT meaningless is that the Great Alternative Currencies, silver & gold, have long been advancing against ALL national currencies. All markets swing like pendulums, too far one way, then too far the other. Silver & gold prices became overbought— a lot of people short dollars were long silver & gold. The dollar rallied, oil & commodities fell, sucking down silver & gold money. Look at the numbers. Even with gold down to $787.50 today, that's only a 21.5% correction, while always more volatile silver is down 37.4%. Friends, these are perfectly normal, not outlandish, corrections. Sober up.Julian D. W. Phillips, Gold Forecaster
The huge gap between the value of gold and the value of money must narrow. Whether it is through the rise in the value of gold and silver or through the fall of the value of money dictates the future of the financial system. Either way, gold and silver will prove to be the safe-haven it has been since money was part of man’s world. And the second half of this year is likely to be as dramatic as the first half but with a golden or silver sheen to it.
Steve Saville, Speculative Investor
Many people will be asking the question: why is the US$ rallying when its fundamentals are so terrible? From our perspective, however, a more reasonable question is: why has it taken so long for the US$ to rally against the euro given that the US$ is extremely under-valued relative to the euro and the euro's fundamentals are just as bad? [[Or, worse.: normxxx]]
The answer, we think, is that the currency market has believed that the US Federal Reserve would be as 'easy' as it needed to be to help the banking system through its crisis, while the ECB would continue to focus on minimizing currency depreciation. We think the market was/is right to believe that the Fed will do whatever it takes to maintain the solvency of the major banks, but traders now appear to be coming around to the view that the ECB will also be loosening the monetary reins. Take away the interest-rate 'prop' and the euro suddenly becomes free to fall under the weight of its own over-valuation.
Mike Shedlock, Mish’s Global Economic Trend Anal