Category: bubble

Krugman On Difference Between Illiquidity and Insolvency

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Once again, Paul Krugman demonstrates why the New York Times pays him to write.

He clearly and concisely describes why the current problem is insolvency, and not illiquidity.

He then goes on to explain just why the Fed really cannot fix this. If you have a run on a sound bank, an quick loan to infuse of cash works, because it gives everyone time to get their heads screwed on straight again, but if a bank is busted, a loan, no matter how large cannot help.

Basically, it means that the Fed, which after all only loans money, and sets up rules for short term loans, cannot help.

Go read his article.

The last line, which is a note from the editor, that “David Brooks is off today,” is also a bit of an unintentional hoot.

David Brooks is a bit off every day.

Your Daily Economic Update

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First, you have calculated risk reporting that the discount rate spread has jumped to near record levels:

This is the spread between high and low quality short term (30 days) commercial paper. Even the bad stuff is supposed to be pretty much a sure thing, and the spread between the two is big, indicating a very high fear level.

It’s worse than when the big sh$@pile started to collapse in August.

It’s worse than when the Twin Towers DID collapse on 911.

People are scared, and getting people UNscared will be a very difficult thing.

Then there is the fact that the Producer Price Index took the biggest one-month jump in 34 years, 3.2% in a month, or 45% a year.

The economists will tell you to look at the core rate, but I live in a non core world, as do you.

Florida says $9B can’t be pulled from fund — OrlandoSentinel.com

Remember when I wrote about a Florida money market fund for local governments that froze its accounts because of a run on the account due to its investments in the big sh#$pile?

They are finally releasing some funds to the local governments, but only ¼ of what was deposited.

Citigroup to lay off as many as 32,000 employees.

On the Fed Shoveling Currency Out The Door

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Yesterday, the Fed cut rates, and the market screamed in anguish, because it was not enough.

Well today, the Federal Reserve, and other nations’ central banks, came up with a scheme to deal with the credit freeze that is a result of what amounts to widespread insolvency in the financial markets (here, here, here, here), and here).

Basically, they are flooding the market with currency by lending out large sums of money on the basis of illiquid worthless securities.

Quotes from some of the articles cited above:

You will note that it allows the lending of up to 85 percent of the face value of AAA-rated collateralized mortgage obligations, if there is no observable market value.

…

So much for discouraging future risk taking.

…

The most prominent sign of that is that the Libor, a benchmark for many dollar-loans between banks especially in Europe, has shot up as much as 0.8 percentage points above the federal funds rate. The gap is normally less than 0.2 points. A high Libor rate raises banks’ costs of funds and thus the rates they charge borrowers. In addition, many U.S. homeowners have adjustable rate mortgages with linked to Libor.

…

“Clearly, the Fed is feeling its way in the dark here,” said Ian Shepherdson, chief U.S. economist at High Frequency Economics.

(Emphasis mine)

Nouriel Roubini says that this is, “Too Little Too Late To Address the Fundamental Problems of the Financial System.”

I tend to agree with Dr. Roubini, but he’s a bear, as I have been, for the past few years.

Honestly, I think that what is going on here is the beginning of a major devaluation of US currency, so people will be paying back loans in devalued dollars.

Basically, it’s using inflation to get out of the problem. It was done during the Great Depression, and the amount ov exotic and dishonest leverage in 1929 is far less than now.

Your Update on the Economy

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Let’s see, the Fed cut rates by 25 basis points, but the market wanted 50, so the Dow dropped 294.26 points.

The WSJ is saying that the U.S. mortgage crisis rivals the S&L meltdown.

While it’s nice that they take it seriously, the US Credit/Insolvency crisis is already worse than the S&L meltdown. Still, it’s a good read.


Own to rent cost ratio, the real estate equivalent of P/E:


The discount for the mortgage packages:

And while we are at it, how about MBIA, the world’s largest bond insurer, getting $1B infusion from private equity firm?

This is not about someone finding a deal. It’s about a private equity firm keeping MBIA alive while they offload their piece of the big sh&%pile on some other idiot.

Also, Washington Mutual is closing offices and laying off more than 3000 employees, including a friend of mine, because of mortgage and credit problems.

Also, Freddie Mac is looking at $5.5-$12 billion in additional losses. That’s in addition to the $4.5 billion that it’s already lost this year.

At the rate this is going, it will be raining Katz and Hutton on Wall Street.

Watch out for jumping finance professionals.

Construction Loans Heading the Way of Subprime Loans

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This is not good:

Like Subprime Mortgages, Some Construction Loans Are Delinquent

Like Subprime Mortgages, Some Construction Loans Are Delinquent
By FLOYD NORRIS

BANKS across the United States, particularly the smaller ones, have become dependent on construction lending just as that area of the economy is weakening and the number of bad loans is growing.

Figures compiled by the Federal Deposit Insurance Corporation and released last week show that both midsize and small banks had construction loans outstanding that were greater than their total capital. A decade ago, such loans were equal to only a third of capital for those banks.

For most of this decade, that was a good strategy. Construction loans proved to be very profitable, particularly for smaller banks as competition from larger banks and securities markets eroded their position in areas like mortgage lending and credit card issuance.

Now, however, more than 3 percent of all construction loans are classified as being nonperforming, or have borrowers that are behind on their payments. That is the highest proportion in a decade.

…

The smaller banks have eschewed many of the riskier practices of the larger national operations, but it looks like they are going to get bitten by the turndown too.

Real Estate Update

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existing household real estate assets declined $67 Billion in the 3rd quarter. That’s about $200 for every man, woman, and child in the US.

You can see this in declining home equity percentages over time (there are more graphs at the link):

While we’re at it, Morgan Stanley analysts are saying that home prices could be falling for at least the next three years.

.…
The property derivatives market seems to be suggesting that we are in a very different environment, on the heels of market events that could force a housing recession like none ever imagined or experienced,” Morgan Stanley analysts said.

“The fundamental argument for going long housing is that history has never seen such extended periods of house price declines,” Morgan Stanley said. “We think that such arguments have limited credibility because of limited periods of data and over-reliance on analysis using national level data.”

While home price declines for three years or longer have not occurred in recent years on a national level, regional data demonstrates that unusual price increases often lead to sustained corrections, the report said.

….

And then we have Standard and Poors sayint that the mortgage relief program might cause downgrades on some of the related bonds.

Honestly though, I don’t see how the action will make things much worse:

.…

The share of all home loans with payments more than 30 days late, including prime and fixed-rate loans, rose to a seasonally adjusted 5.59 percent, the highest since 1986, according to a report today from the Washington-based bankers trade group. New foreclosures hit an all-time high for the second consecutive quarter in a survey that goes back to 1972.

….

Steven Pearlstein Explains the Credit Crunch

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He does not get into the why this crunch has happened, short form is that you had regulators who allowed investment banks to use fairy dust and call it innovation, but its a very good picture regarding what forces are in motion now, and where they are likely to lead.

His OP/Ed is aptly titled It’s Not 1929, but It’s the Biggest Mess Since:

….

The financial giants that originated, packaged, rated and insured all those subprime mortgages were the same ones, run by the same executives, with the same fee incentives, using the same financial technologies and risk-management systems, who originated, packaged, rated and insured home-equity loans, commercial real estate loans, credit card loans and loans to finance corporate buyouts.

It is highly unlikely that these organizations did a significantly better job with those other lines of business than they did with mortgages. But the extent of those misjudgments will be revealed only once the economy has slowed, as it surely will.

At the center of this still-unfolding disaster is the Collateralized Debt Obligation, or CDO. CDOs are not new — they were at the center of a boom and bust in manufacturing housing loans in the early 2000s. But in the past several years, the CDO market has exploded, fueling not only a mortgage boom but expansion of all manner of credit. By one estimate, the face value of outstanding CDOs is nearly $2 trillion.

….

Those are scary numbers, but he goes on to explain why we are in trouble:

….

In the simple version, each investor owned a small percentage of the entire package and got the same yield as all the other investors. Then someone figured out that you could do a bigger business by selling them off in tranches corresponding to different levels of credit risk. Under this arrangement, if any of the mortgages in the pool defaulted, the riskiest tranche would absorb all the losses until its entire investment was wiped out, followed by the next riskiest and the next.

With these tranches, mortgage debt could be divided among classes of investors. The riskiest tranches — those with the lowest credit ratings — were sold to hedge funds and junk bond funds whose investors wanted the higher yields that went with the higher risk. The safest ones, offering lower yields and Treasury-like AAA ratings, were snapped up by risk-averse pension funds and money market funds. The least sought-after tranches were those in the middle, the “mezzanine” tranches, which offered middling yields for supposedly moderate risks.

Stick with me now, because this is where it gets interesting. For it is at this point that the banks got the bright idea of buying up a bunch of mezzanine tranches from various pools. Then, using fancy computer models, they convinced themselves and the rating agencies that by repeating the same “tranching” process, they could use these mezzanine-rated assets to create a new set of securities — some of them junk, some mezzanine, but the bulk of them with the AAA ratings more investors desired.

It was a marvelous piece of financial alchemy, one that made Wall Street banks and the ratings agencies billions of dollars in fees. And because so much borrowed money was used — in buying the original mortgages, buying the tranches for the CDOs and then in buying the tranches of the CDOs — the whole thing was so highly leveraged that the returns, at least on paper, were very attractive. No wonder they were snatched up by British hedge funds, German savings banks, oil-rich Norwegian villages and Florida pension funds.

What we know now, of course, is that the investment banks and ratings agencies underestimated the risk that mortgage defaults would rise so dramatically that even AAA investments could lose their value.

….

As part of the unwinding process, the rating agencies are in the midst of a massive and embarrassing downgrading process that will force many banks, pension funds and money market funds to sell their CDO holdings into a market so bereft of buyers that, in one recent transaction, a desperate E-Trade was able to get only 27 cents on the dollar for its highly rated portfolio.

Meanwhile, banks that are forced to hold on to their CDO assets will be required to set aside much more of their own capital as a financial cushion. That will sharply reduce the money they have available for making new loans.

And it doesn’t stop there. CDO losses now threaten the AAA ratings of a number of insurance companies that bought CDO paper or insured against CDO losses. And because some of those insurers also have provided insurance to investors in tax-exempt bonds, states and municipalities have decided to pull back on new bond offerings because investors have become skittish.

If all this sounds like a financial house of cards, that’s because it is. And it is about to come crashing down, with serious consequences not only for banks and investors but for the economy as a whole.

That’s not just my opinion. It’s why banks are husbanding their cash and why the outstanding stock of bank loans and commercial paper is shrinking dramatically.

…..

This may not be 1929. But it’s a good bet that it’s way more serious than the junk bond crisis of 1987, the S&L crisis of 1990 or the bursting of the tech bubble in 2001.

What’s the Deal With the So-Called Mortgage Bailout

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To paraphrase Atrios:

To qualify:

  • have an income and live in their homes
  • are currently making their payments on time
  • would default if their interest went up
  • ARM mortgage has to have been taken between 1/05 and 7/7
  • Has a rate reset between 1/8-1/10

The following rules you out:

  • have missed payment
  • can afford mortgage rate increase
  • don’t have an income
  • own homes which are worth less than their mortgage

So, if you are poor, you are more likely to have missed a payment, and more likely not to have put anything down, and so be under water. As Duncan Black puts it:

I became increasingly skeptical that such a broad-based bailout would be workable for various reasons, but as is usually the case with anything the Bush administration gets involved in, they aren’t even really trying.

As Kevin Drum puts it:

The lower your income, the more likely you are to have missed a payment already, and the lower your income the more likely you are to have been sold a no-down loan that’s already left you underwater due to falling housing prices. Net result: no help for low-income folks.

Like Atrios, I’ve become increasingly unsure that any kind of broad-based bailout plan can work — or work well, in any case — but if you’re going to do it everyone ought to have a shot at getting help. Bush’s plan, conversely, pretty transparently doesn’t care about anyone with a modest income. Not part of his base, I guess.

My assesment is less charitable. He does not want to do anything but score political points.

MBIA, Largest Bond Insurer, Risking Moody’s Downgrade

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Moody’s has said that MBIA is, “‘somewhat likely’ to face a shortage of capital that threatens its AAA credit rating.”

If their credit rating slips, then the bonds that they insure will have to be re-rated….House of cards.

The loss of MBIA’s top ranking would cast doubt over the ratings of $652 billion of state, municipal and structured finance bonds that the company guarantees. MBIA is among at least eight bond insurers seeking to ward off potential credit-rating downgrades by Moody’s, Fitch Ratings and Standard & Poor’s. The insurers guarantee $2.4 trillion of debt and downgrades could cause losses of $200 billion, according to Bloomberg data.

Banks That Purchase Loans May Be Liable for Original Lender Misdeeds

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When I originally came across this story, it was just a glitch in foreclosures. Cleveland federal judge Christopher Boyko tossed 14 foreclosures without prejudice, because the plaintiffs could not show that they owned the loans.

Basically, the title on the loans was never changed, they just put it in the transfer contract.

I figured, this isn’t a big deal…It just means that before foreclosing, the banks have to do some paperwork, so amidst a sea of financial ice-bergs, this is a spring rain.

Well, once again, I am wrong.

It appears that the methods used to pool loans into CDOs and similar instruments may also mean that the organizations holding the CDOs are legally liable for any unethical or illegal tactics used whenever the loans were first made.

The problem stems from a shortcut that many players in the fast-moving securitization business have used in recent years. Normally, when a loan is sold, a simple document is prepared showing that the debt and any collateral attached to it has been transferred to the purchaser. That piece of paper is called an assignment. But in buying up thousands of mortgages at a time, Wall Street commonly skips this step, which requires separate paperwork for each loan. Instead, the industry customarily relies on a lengthy contract, known as a pooling-and-servicing agreement (PSA) to spell out arrangements for all of the loans in a pool. But, as some recent court rulings indicate, a PSA may not be good enough when it comes time to foreclose.

…

There also could be a more troubling consequence for investors, says Kathleen C. Engel, a professor at Cleveland-Marshall College of Law. Players in the secondary market for mortgages rely on an obscure but critical legal theory–known as the “holder in due course” doctrine–to insulate themselves from problems with the underlying loans.

Under the doctrine, a homeowner who believes that a lender deceived him about the terms of a loan can’t press such claims against the purchaser of a mortgage, such as a mortgage-backed securities trust. The holder-in-due-course doctrine protects pension funds and the like from having to worry about any misbehavior by home lenders–and thereby greases the wheels for the whole mortgage-securities market. But it’s a different story if, as appears to be common practice, the trust waits to complete paperwork transferring a loan until after it goes into default. In that case, the holder-in-due-course protection evaporates, and anybody who tries to foreclose could face defenses from the borrower that he or she was lied to when seeking a loan.

Ouch!

Florida Pension Investments in Big Sh#@ Pile

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Well, a few days ago, it was the short term money market type funds for local Florida governments and school boards, and today, it’s the state of Florida’s pension fund.

More Structured Investment Vehicles (SIV), more downgrades, more losses.

I think that what has been going on for the past 18-24 months is that the investment banks have realized that the stuff is illiquid (economist speak for worthless), so they fobbed it off on a lot of people with more money than brains, state pension and similar funds.

Given that the level of leverage and complexity is greater than in 1929, the consequences of the collapse might be a lot worse than in 1929. This is not just subprime….It’s almost everything out there.

Some People in the Subprime Loan Trap Qualified for Better Loans

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This is what an unregulated lending market gets you, people with good credit steered toward sub prime loans because the lenders made more money that way.

According to the WSJ article, 55% of all sub prime loan borrowers were qualified for prime loans.

The brokers make big bucks over this.

This is a legacy of Republithug philosophy….The idea that, unfettered by regulation, sophisticated players will be honest.

Krugman Nails the Root Cause of the Liquididy/Insolvency Crisis

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Basically, he sees the cause as being the free market fundamentalism that is practiced by regulators, brokers, and politicians. I wholeheartedly agree.

This time, market players seem truly horrified — because they’ve suddenly realized that they don’t understand the complex financial system they created.

This is, of course, a symptom, not the cause, but he does see the cause too.

How did things get so opaque? The answer is “financial innovation” — two words that should, from now on, strike fear into investors’ hearts.

O.K., to be fair, some kinds of financial innovation are good. I don’t want to go back to the days when checking accounts didn’t pay interest and you couldn’t withdraw cash on weekends.

But the innovations of recent years — the alphabet soup of C.D.O.’s and S.I.V.’s, R.M.B.S. and A.B.C.P. — were sold on false pretenses. They were promoted as ways to spread risk, making investment safer. What they did instead — aside from making their creators a lot of money, which they didn’t have to repay when it all went bust — was to spread confusion, luring investors into taking on more risk than they realized.

Why was this allowed to happen? At a deep level, I believe that the problem was ideological: policy makers, committed to the view that the market is always right, simply ignored the warning signs. We know, in particular, that Alan Greenspan brushed aside warnings from Edward Gramlich, who was a member of the Federal Reserve Board, about a potential subprime crisis.

(emphasis mine)

So, when does he get his Nobel?

Go and read the whole thing

People are Starting to Get It About Alan “Bubbles” Greenspan

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Patrick Artus, chief economist of Natixis SA and one of France’s most listened-to pundits says that “very bad” Fed chairman. A quote from his interview:

Artus: Yes. Greenspan was an arsonist and a fireman combined. He derived all his glory from his reaction to the savings-and- loans crisis, to the collapse of Long-Term Capital Management LP, and to Sept. 11, 2001. But LTCM and the savings-and-loans crisis were his doing. He absolutely failed to see where the malfunctions in the U.S. economy were.

Greenspan came up with a phrase, “irrational exuberance,” in 1997, but he didn’t do anything about it.

According to the article, Stiglitz is similarly down on Greenspan.

State Money Market Fund in Montana Now in Trouble

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I get the sense that the serious of complex investmentsts that Atrios calls “The Big Sh@$pile” were aggressively dumped off on a lot of states and municipalities over the past few years, because it now appears that
Montana’s Short Term Investment Pool, another money market like investment. And again, there appears to be a run on this.

We’ve got the same thing going on in King County, WA (Seattle).

But here is the scary quote:

Montana has completed a thorough review of its subprime exposures. Less than 1% of the underlying assets of its SIVs are subprime, South said, with the rest being bank debt and prime and commercial mortgages.

“It’s not a subprime issue anymore, it’s an asset-backed commercial paper issue now,” South added.

Translated into English, this means that the entire us investment system is now unsafe.

90% Plunge in the US Dollar Forecast

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So says Trends Research Institute Director Gerald Celente, he is forecasting a 90% plunge and Gold being at $2,000.00/ounce.

Personally, based on nothing more than my gut, I would say that this is unreasonable, I don’t see it dropping more than 50% long term $3.00=€1.00, with an overshoot to somewhere around $5.00=€1.00 at the height of the speculative frenzy.

Still, this guy did, “forecast the subprime mortgage financial crisis and the dollar’s decline a year ago and gold’s current rise in May”, though so were a lot of other people.

However, I agree that, “the subprime mortgage meltdown was just the first “small, high-risk segment of the market” to collapse”.