Category: bubble

Good Point on the Credit Collapse: Actions Taken are Bailing Out Banks, Not Helping Economy

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John Cassidy at Portfolio.com details what amounts to an ongoing and growing program of bailouts for the banking industry.

There is, of course, the Fed Auctions of cash where worthless and near worthless securities are being used as collateral for loans, but there is more.

The Federal Home Loan Bank system, which actually dates from the Herbert Hoover administration, has been shoveling cash out the door, with an implicit federal guarantee. It’s government chartered, like Fannie and Freddie, which have now had their lending limits increased.

Cassidy’s recommendation, that the Federal Government buy distressed security at steep discounts, would be a good one, except that any discount would likely still be too much. The assets are illiquid, which means that they have next to no value right now.

The only way that we are getting out of this is by inflating our way out of this.

A lot of 401(k) and IRA accounts are going to be a lot worse off, but the alternative will look like 1932.

Economics Update

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Well, let’s start off with real estate:

First, we have an article asking whether the Federal reserve is refilling the housing bubble. Normally this would not merit comment, but look at the link. Look at the author. Look at the title. It’s Lawrence Yun, chief economist for the National Association of Realtors, and it has the word “bubble” in the title.

When the NAR is calling it a bubble, it’s a bubble.

We also have reports that people are defaulting on subprime loans before they reset, which implies that these people so overbought their houses, that they can’t even afford the “teaser” rates.

We also have single family home starts dropping to a 17 year low, though there has been a pickup in condo and apartment construction (not sure how much is the former, and how much is the latter).

We also have Mortgage applications plummeting 22%, as rates rise in the face of the fed cuts, because no one trust to lend anymore.

The fed is “pushing on a string”.

Finally, we are starting to see Foreclosure tourism, with bus tours of foreclosed homes becoming a regular event in Florida.

It’s an attempt by some realtors and speculators to get the market moving again. Isn’t gonna happen.

In terms of more personal finance, we have an explosion of people tapping their 401(k) accounts for living expenses.

Yep, those private accounts to replace social security sound like such a good idea. As I’ve said before, it’s like eating your seed corn, which is what these folks are doing.

On a more general macroeconomic note, inflation is up, with the CPI rising 4.3% in 2007, and prices rising at a 5% annual rate in January.

On top of all this, the Federal Reserve has cut its forecast for economic growth.

Considering the fact that the official CPI understates inflation, we are probably closer to an 8% inflation rate (prices doubling every 9 years), so I’m calling stagflation, which seems a no brainer, even without oil hitting another record, with it peaking at trading at $101.32/bbl and closing at $100.74/bbl….No…wait….that’s two records.

In terms of the financial establishment recognizing that the problems are far deeper and broader than previously understood, we have Martin Wolf of the financial times saying that, “America’s economy risks mother of all meltdowns“, and we have Portfolio.com wondering if the basic model used to evaluate the complex instruments in the big sh$#pile, or more generally, the prices of options, the Black Scholes Pricing Model, is simply inaccurate, which would render their prices unknown. It’s literally look at the chicken entrails to figure out the prices time.

Basically, the model falls apart, and has always fallen apart:

Good theory. The glitch was discovered only after the fact: When a market is crashing and no one is willing to buy, it’s impossible to sell short. If too many investors are trying to unload stocks as a market falls, they create the very disaster they are seeking to avoid. Their desire to sell drives the market lower, triggering an even greater desire to sell and, ultimately, sending the market into a bottomless free fall. That’s what happened on October 19, 1987, when the sweet logic of Black-Scholes was shown to be irrelevant in the real world of crashes and panics. Even the biggest portfolio insurance firm, Leland O’Brien Rubinstein Associates (co-founded and run by the same finance professors who invented portfolio insurance), tried to sell as the market crashed and couldn’t.

This is what has happened with investment banks and leveraged loans, where they have been left holding the bag on $197 billion in loans to people like private equity buyout specialists that they cannot resell.

In the ever popular world of the bond insurers collapsing, we have Moody’s predicting a $7-$10 billion hit for banks as a result, though I would add at least one zero to that total.

As a result, a unit of private equity firm KKR cannot refinance, and has delayed repaying loans as a result.

Compounding this is the fact that the proposals to split the insurance companies into separate Municipal bond insurance and sh&^pile insurance is making it much more difficult for them to raise the capital they need to stay afloat.

Economics Update

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It appears that US banks have borrowed massive amounts of money from the Federal Reserve, over $50 billion, using assets that have very little value in the market right now. They get money for shovels of the big sh&#pile

Credit Suisse will be writing down $2.8 billion because of “pricing errors” of assets (also here), and has suspended the traders involved.

Errors, my ass. If these were “errors” as opposed to fraud and/or bad systems, the net would be closer to $0.

The Forthcoming “Jingle Mail” Tsunami: 10 to 15 Million Households Likely to Walk Away from their Homes/Mortgages Leading to a Systemic Banking Crisis

It is now expected that the U.K. government will keep British home mortgage giant Northern Rock nationalized for years, in order to avoid a massive exposure to the taxpayer.

In the increasingly dire world of insurance, we have predictions that bond insurer splits may lead to an explosion of lawsuits, as the separation valuable (municipal) side and the insolvent (big sh$%pile) side involves a lot of loss for the holders of non-municipal paper. Additionally, MBIA’s CEO has stepped down, and has been replaced by his predecessor.


Deck chairs, Titanic.

In the lawsuit category, we have investor activists calling for more accountability in management, which is generally a prelude to shareholder suits and the like.

Finally, we have inflation in China hitting an 11-year high, 7.8%. It’s likely that this will drive interest rates up in China, placing downward pressure on the US dollar.

And if that doesn’t make you think that it will soon be raining brokers in Wall Street, Noriel Roubini is predicting between 10 and 15 million home owners simply walking away from their homes, because they will be underwater with their mortgages, and cannot afford their resetting mortgages.

O’Malley Issues Emergency Foreclosure Regulations – washingtonpost.com

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Maryland Governor Martin O’Malley (I still love saying that) is instituting emergency regulations for mortgages and mortgage loan companies, see here and here.

First, they are requiring loan servicers to give advance notice to the state, so that state agencies might be able to help.

Additionally, it looks like administrative action may be taken against what appears to be one of the bad actors in this, Ocwen Financial Corp., which appears to have no one answering the phones.

Economics Update

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After not receiving what they considered to be adequate bids, Britain is nationalizing Northern Rock Bank, which was one of the top home mortgage providers in the UK. The bids received, “failed to meet the government’s criteria for protecting taxpayers.”

I think that we will see more of this in the UK, which is suffering from the Anglo-Saxon contagion much as its American counterparts are. We won’t in the US, substituting instead ruinous (for the taxpayer at least) bailouts, because the American body politic will not accept this solution.

In a related note, it appears that there is a lucrative business developing aiding banks in finding people who have skipped out on mortgages. With the costs of foreclosures typically nearing $100K, it makes sense to find and cut a deal with these people, but they leave without providing a forwarding address.

From September 2005 to August 2007, 53 percent of the loans backed by Freddie Mac that went into foreclosure involved borrowers who could not be reached.

As an insight as to just how bad this has gotten, some lenders are allying with ACORN, an organization with a mission that is seriously at odds with those of banks, to find the mortgage holders.

In much higher finance, we have signs of trouble in credit default swaps, a complex derivative whose market is estimated to be twice that of the stock market.

These instruments are largely unregulated, to the degree that the exact size of the market is not known.

Basically, it’s an agreement between two parties. One pays the other a fee, and if something bad happens, such as a default, the second party pays off the default.

How flaky and unregulated is this market?

But during the credit market upheaval in August, 14 percent of trades in these contracts were unconfirmed, meaning one of the parties in the resale transaction was unidentified in trade documents and remained unknown 30 days later. In December, that number stood at 13 percent. Because these trades are unregulated, there is no requirement that all parties to a contract be told when it is sold.

One out of 7 people did not know who owed them money.

Economics Update: Real Estate Edition

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Swiss banking giant UBS is looking at a $26.6 billion exposure to toxic mortgates, in addition to whatever hit that they might take on subprime, so these are A and alt-A mortgages. It reported a loss of $11 billion in Q4.

In the Dallas-Ft. Worth Metroplex, foreclosure postings are up 27%, effecting 13,000+ residences, an all time record. The scary quote is, “Out of the homes posted, at least 20 percent are underwater and probably more” .

And everyone’s favorite subprime whipping boy, Countrywide Financial, has had delinquencies rise to 7.47%. That’s about one out of every 14 loans that is delinquent, which is clearly unsustainable.

If banks had to consider this rate of delinquencies as a normal cost of business, mortgage rates would probably be in excess of 12% just to break even.

It now looks like Royal Bank of Scotland is the latest institution in line to see significant losses from mortgage backed securities.

Economics Update: Insurance Edition

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Bond insurer FGIC has asked regulators to break it up into two separate divisions/a>, one which insures minicipal bonds, and the other that insures the structured finance deals (aka the big sh$#pile).

This is likely a reflection of their dire position following Moody’s down grade of them from AAA to A3.

UBS is saying that banks are at risk of an additional $203 billion in losses from the bond insurance crisis.

Economics Update

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Note that this has been, for whatever reason, a busy news day, so this does not include news related to real estate or to the bond insurance crisis. Those will be posted later.

We have downward pressure on the dollar, because additional Fed rate cuts are anticipated.

Basically, the thought is that Fed rate cuts lead to lower interest rates, which make the dollar less attractive, because rates of return are less.

If I had the money, I would bet against this, because, as the latest rate cuts have showed, the Fed can no longer move rates down. We are in a Japan style liquidity trap.

We also have a type of investment that I have never heard of before, auction rate securities, which were sold as being as liquid as cash. They work by regularly re-auctioning the securities on a fairly frequent basis, allowing for people to sell easily, and for the rates to adjust to suit market conditions.

These are now becoming increasingly illiquid, with thousands of auctions failing, and Goldman Sachs refusing to let investors withdraw money from their investments when auctions fail to attract buyers.

UBS has notified its 8200 US brokers that it will not support these securities if the auction fails either.

FWIW, Paul Krugman has a very good editorial, even by his own ordinarily high standards, describing what is going wrong, and the consequences of this failure in terms that a layman like me can understand.

Related is the news that Citigroup is suspending withdrawals from its CSO Partners hedge fund.

In terms of the real economy, as opposed to high finance, we have the New York Federal reserve reporting that its Empire State Manufacturing Index fell nearly 21 points, from +9.03 in January to -11.72 in February. It was expected to fall, but only to +5.75.

The Financial Times is reporting that banks are being advised to walk away from the private equity deals that they are funding, because the penalties are far lower than the potential losses.

This would stop private equity buyouts in their tracks.

Economics Update

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Well, we have Bernanke and Paulson acknowledging that the economy is in trouble, but denying that there will be a recession in 2008.

The thing is, we are already in a recession. Let’s seem consumer spending is flat, with a false increase being driven by increasing food and fuel prices, and the growth rate is less than the real inflation rate.

In bond insurance, we have NY governor Elliot Spitzer saying that the Monolininers have 4-5 business days to recapitalize, or they will lose their AAA ratings, and regulators will have to, “have to step in and separate bond insurers’ municipal businesses from their more troubled structured finance units”.

Bet that offer from Warren Buffet does not look so awful now.

In mortgage loans, banks are lobbying hard to put off their bad investment choices on the US tax payers, which is not surprising, considering that house prices took their biggest quarterly drop ever, a national median price drop of 5.8% in Q4 of 2007.

Annually, that comes to about 23%/year.

The credit crisis is extending further, with delinqencies in assets backed by auto loans surging.

The Trade deficit fell in 2007, for the first time since the 2001 recession.

Economics Update

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The Michigan Higher Education Student Loan Authority will stop making loans under the Michigan Alternative Student Loan, because it cannot raise money in the capital markets to lend out. You can see their notice here

Student loans are about as safe as it gets. You cannot discharge them through bankruptcy, and they are very safe, but no one is willing to buy the paper, both because the bond insurers are basically belly up, and because no one trusts anything.

In a similar vein, though more directly related to the bursting housing bubble, Freddie Mac cut nearly in half the size of its REMIC (Real Estate Mortgage Investment Conduits) issue, because it cannot find buyers.

And in the useful congressional hearings area, i.e. not Roger Clemens and steroids, we have hearings on the collapse of the bond insurers.

In another sign of a slowing economy, media company Belo corporation is showing a loss.

Part of this may be the fact that, and I speak from experience having experienced their flagship Dallas Morning News, that Belo is to journalism what Osama bin Laden is to wet t-shirt contests. When you have a crappy product, you get hammered.

Economics Update

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Chancellor of the exchequer, Alistair Darling has stated at a G-7 forum that the credit crunch will be a “prolonged adjustment”.

Auditors for AIG, the world’s largest insurer is showing “material weakness” ovalues some of its complex financial instruments, specifically its, “credit-default swap portfolio”, see here and here.

Basically, it needs to write down more of its holdings in the big sh^%pile.

In related news, credit-default swaps are becoming more expensive across the markets, which reflects the standard risk/return equation. People find these riskier, so they are demanding higher yields.

In real estate, experts are saying that home prices will drop for 2 more years. I think that it will be 5+ years, at least adjusted for investment.

A Morgan Stanley analyst has stated the obvious, that Fannie Mae will be seeing a lot mroe defaults on its loans.

In personal finance, credit card companies are jacking up rates of credit worthy customers. It appears that they are looking for cash flow to offset losses in various financial derivatives and the mortgage market.

Rupert Murdoch Dow Jones is ajusting the Dow Jones Industrial Average, with Bank of America and Chevron replacing Honeywell and Altria.

This really does not mean much, after all the Dow is not really a good metric anyway, Honeywell has become too small, and with the spinoff of Kraft, Altria is pretty much just tobacco. Nothing to see here, move along.

Finally, I recommend that you check out this examination of the US financial position compared to meltdowns in 5 other counties. It’s kind of grim, as these charts show:
The Big Picture | 5 Historical Economic Crises and the U.S. look at pics”/>


Economics Update

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The Fed Bank of Philidelphia president is making noise about how inflation is poised fore a comeback, which bummed out stock traders.

It looks like the current economic situation is leading bankers to screw their small customers. Of course, were the economic situation reversed, it would be used by bankers to screw their small customers.

At least, there is symmetry.

Foreclosures: Las Vegas is the foreclosure capital of the US. This appears not to be from the economic downturn, it’s a prosperous area, but rather from exotic mortgages.

In a blaze of recognizing the bloody obvious, the NAR is now saying that they expect home prices to decline in 2008.

If you look at regional downturns, we are looking at 5-10 years before a rebound.

The director of the Office of Federal Housing Enterprise Oversight (OFHEO), which regulates Fannie Mae and Freddie Mac, is warning that the GSEs are taking on too much risky debt. He is saying that, “reducing risks in the market, but concentrating mortgage risks on themselves.”

I think that he is suggesting that without tighter regulation, the suggestion of allowing Fannie and Freddie to take on larger mortgages is a very bad idea.

Overseas, the Bank of England cut its benchmark 25 basis points to 5.25%, while the European Central Bank holds kept its rate steady at 4%. The UK appears to be in a real-estate driven downturn, while most of Europe (Spain excepted) did not experience the same sort of speculative real estate bubble.

On Jobs, new applicants for unemployment fell by 22K last week, but the total number of people collecting unemployment continues to rise. (the former is a far noisier number).

In retail, January sales posted their worst performance since records were kept, with same store sales rising only 0.5%, which is a significant drop when inflation is factored in.

And finally, a cartoon for your amusement:

Illiquid

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Illiquid sounds like a mile word.

It sounds like maybe the markets are thirsty.

It’s actually MUCH worse than that.

It means that a buyer cannot be found for your asset, so for the time being at least, it is worthless.

It’s like being marooned on a desert island with a pirate chest full of gold doubloons. Technically, you are rich, but you still have no shelter, food or water, and you die all the same.

The Collateralized Debt Obligation (CDO)market is very nearly illiquid, according to Ross Heller of JPMorgan Securities, who is saying, “We’re definitely in a period of very low liquidity at the moment, which has actually been dropping precipitously in the last few weeks.”

Desert Island time.

I’m beginning to wonder if a Honda full of silver is over optimistic, and that instead we should fill it with canned goods and ammunition.

Economics Update

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First-time jobless claims skyrocket to 375 thousand. Last week was 306 thousand, so it’s about a 20% increase, and well over the consensus estimate of 320 thousand first time claims, though week to week data points are always noisy.

That being said, Consumer spending slowing in December, up only 0.2% from November is a lot less noisy, and at least as scary. First, 0.2% is a drop in real dollars, and second, this was December, the height of greed and excess season.

And in the “another day, another downgrade department”, S&P is looking at downgrading about $500 billion more in mortgage related securities.

We are not near the bottom.

Economics Update

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The Fed cuts rates by 50 basis points.
The discount rate is now at or below the inflation rate, well below the inflation rate using real world inflation.

There are no longer any monetary tools to use that will work, it has to be fiscal (spending), because any lower, and the Fed is paying people to borrow money.

Still, it makes sense, as GDP growth in the 4th quarter was only at a .6% rate annual rate. When you consider the fact that inflation is (at least) 3%, this means that real GDP is falling at more than a 2% rate.

The dollar has fallen currently at $1.4761:€1.0000, and $1.0003:$1.0000 CDN, so the Canadian dollar is above unity again.

And the credit crunch is spreading all over the world, the Swiss bank UBS AG has reported its biggest loss ever, in US real-estate related issues.

We also have Morgan Stanley using some serious weasel words to not call its write downs a loss, when it, “reclassified $7 billion of funded assets and $279 million in unfunded assets from Level 2 to Level 3.”

Of course, the fact that the FBI has dropped some subpoenas on their asses isn’t good news eithr.

Lever 3 assets are ones in which buyers are not easy to find, and it’s rapidly getting to the point where the buyers are getting harder to find than straight Republicans.

It looks like the bond insurers will be downgraded below AAA, which in addition to closing off a lot of their business, and making it harder to raise capital, will likely force investment banks towrite down $70 billion more.

Economics Update

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Economic schizophrenia, Consumer Confidence Falls, But Durable Orders Jump. Mr. Benanke is not sleeping well tonight.

Home ownership rate has biggest drop ever. A 1.1% drop in the percentage of occupied homes.

Everyone’s favorite not-so-whiz kid, Jerome Kerviel, is claiming that his superiors at French Bank Societe Generale knew of his activities, but took no action because it pumped up its profit numbers.

The First Bank Failure of 2008, the Douglass National Bank of Kansas City, Missouri.

The FBI has initiated investigations of 14 firms regarding subprime irregularities. Kind of makes the FBI sound like Metamucil.

They did not identify the companies. But the probes reached across the industry to include developers, subprime lenders, companies that securitized loans and investment banks that held them, said Neil Power, head of the FBI’s economic crimes unit.

Contrywide: $422 million Q4, and 1/3 of its sub-prime mortgages are delinquent. Well I got this prediction right.

Economics Update

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New home sales plummet. New home sales were down 26% from 2006, the biggest drop ever, surpassing the 23% decline posted of 1980.

Regulators opposes oppose increasing the GSE’s lending limit, with the director of OFHEO, James Lockhart saying, “We are very disappointed in the proposal to increase the conforming loan limit as we believe it is a mistake to do so in the absence of comprehensive GSE regulatory reform.”

I agree, the solution to too many people hanging themselves is not more rope.

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CBS News reporter Steve Croft has an interesting report on the mess on 60 minutes (click to view, but there is a 30 second ad at the beginning). Too narrow in scope, the big sh$%pile is about more than subprime.

European hedge funds are suspending redemptions.