Category: Economy

Level 3 Asset Bingo

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Here is an interesting commentary on the rather dubious nature of some of the assets on wall street.

Here’s Rule No. 1 from Wall Street’s public-relations playbook: If the company you run has big losses on hard-to-value assets, scream your head off about the accounting rules.

And what if the squishy values result in huge gains instead, as they have in the not-so-distant past? Rule No. 2: Stay mum about it for as long as the rules allow.

Basically he is noting that the various brokerages are booking a lot of profits on level 3 assets, but level three assets have no regular market to independently determine value, so we are back to smoke and mirror.

Go read, if you dare.

Economics Update

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The dollar is doing better now, $1.5613:€1.0000, as I type this, which is about 3% stronger than when it was above $1.60.

I put down most of the movement over the past week to people betting on what the Fed will do in interest rates, and the consensus that it will not cut.

Oil, however, just went up again, as did gasoline, because of reports of a pipeline attack in Nigeria. The reality is that supplies are so tight that even a minor disruption causes a minor panic.

The New York Times has discovered that the housing crisis has moved to tony Greenwich, CT. And so they cover it with wringing hands, because it interests their readers.

For the rest of us, the fact that the mosts states are having financial meltdowns, and many are near broke, because of falling tax revenues, are a matter of greater concern.

Also, Consumer confidence is at a 26 year low. That’s as in 1982, when we were at 10% unemployment, and so consumers are scaling way back on spending.

In a sign of the apocalypse, Moody’s is downgrading some more of the Alt-A mortgage backed slop. Who knew that a ratings firm would actually do its job.

It’s been a busy day for AMBAC, the monoline insurer, with a report that it may need to seek more capital after posting a $1.66 billion dollar loss for the quarter. Further confirming this report is the fact that their interim CEO is saying that there are no liquidity issues and that its ratings are solid.

S&P is back stopping Ambac on this explicitly stating that the loss will not lead to a downgrade.

Of course if the ratings agencies, or for that matter the financial markets, were at all honest, most the monoliners would already be rated as junk.

Must Read On Bond Ratings and Mortgage Crisis

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Roger Lowenstein is a very concise analysis of just how what Atrios and I call the “Big Sh%$pile”* got the high ratings from Moodys necessary for the debt to be resold.

I think that it explains the process in a clear and concise way, though I think that he is far too easy on Moodys.

The process involved is inherently corrupt, since the issuers get to choose their ratings agency.

I would argue that much of this was covered in “Best PowerPoint Ever“, which makes it rather more clear just how corrupt this game was.

*Only the distinguished gentleman from Philadelphia does not mask out the last two letters of the word “Sh%$”

Economics Update

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Unemployment claims fell again, note my standard caveat about noisy measures though.

Note also that new-home sales are unbelievably grim. An 8.5% drop month to month is falling off a cliff, but this is following the numbers being revised downward for the month of February.

If that doesn’t scare you, there is a Credit Suisse research report that suggests that there will be 6.5 million foreclosures by 2012:

The foreclosures could put 12.7 percent of all residential borrowers out of their homes, Credit Suisse analysts, led by Rod Dubitsky, said in the report. That compares with a foreclosure rate of 2.04 percent in the last quarter of 2007, they said, citing Mortgage Bankers Association data.

That is one out of 8 residential borrowers.

That’s too bearish for even me, and I’m the biggest bear out there.

In terms of non-residential real estate measures, we have the Architecture Billings Index (ABI) dropping to its lowest level ever, suggesting that commercial real estate’s about to tank too, and orders for durable goods, items expected to last 3 or more years, fell 0.3% from February, worse than expected.

The drop in unemployment claims triggered a drop in treasuries and a strengthening of the dollar, because it makes it less likely that the Fed will cut rates at its next meeting.

Truth be told, the Fed cutting rates won’t do much anyway, as is shown by mortgage rates continued upward path.

The Fed has lowered rates below the effective inflation rate, and so their rates have decoupled from the commercial rates.

Insurer Problems on a Much Smaller, and Much Larger Scale

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This is about health insurance, and obviously these policies, whose payouts typically max out at less than a million dollars, are smaller than the monoliner’s policies, but this is the tip of the iceberg.

UnitedHealth Group is taking a major hit because fewer and fewer employers can afford to buy its product.

The healthcare crisis is real and ongoing, and we are going 90mph towards a brick wall.

Food Crisis Update

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I guess the part of the story we expect is this:

The rising prices are “threatening to plunge more than 100 million people on every continent into hunger,” Josette Sheeran, executive director of the United Nations’ World Food Program, said on the agency’s Web site Tuesday.

Foreign starvation, hand wringing over biofuels, etc.

Nothing to worry about here, we’re Americans…right???

WRONG

We are seeing severe shortages of rye flour, with no domestic supplies being available around July, and there are currently only 27 days wheat supply.

Additionally, we are seeing panic buying, which is forcing big box retailers to restrict bulk purchases of rice, so that they don’t run out.

We already have hunger in the US, just look at our overburdened food pantries, and it is going to get worse.

View From North of the Border

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Murray Dobbin has an interesting perspective on the “harmonization” and “integration” of Canada with the US, Americanize Me? No Thanks. He thinks that it’s ill advised, and his first example is quite illustrative:

Now we find out that despite recommendations from the Canadian Pediatric Society and the Canadian Cancer Society that Health Canada dramatically increase the recommended daily does of Vitamin D, the federal agency refuses to do so. Why? Because it is committed to “harmonizing” Canadian nutrition standards with those in the United States.

The interesting thing about Vitamin D is that there are two sources for this, diet, and sunlight, as the human body manufactures it when the skin is exposed to ultraviolet.*

Given the specifics of Canada, further north, less sunlight, the idea that they would need more dietary D is abundantly clear.

More generally, he finds America as a government completely dysfunctional†, America as a society paranoid morass generally bereft of morality†, and America as an economy as an “emerging economic basket case on pace to self destruct.”†

It’s a good read, particularly for Canadians who need to deal with Stephen Harper style boneheads.

*It’s why we have white people in the world. The layer in the skin that manufactures vitamin is beneath the pigment layer, so paler people make more Vitamin D for a given amount of sunlight, so in light starved regions, it favors the pale.
†I Agree

Economics Update

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Today, since they’ve been off the update for a while, I’d like to welcome back a monoliner insurer, specifically AMBAC which lost even more money than forecast, $3.6 billion.

However, they are looking to turning things around. Specifically, they have their “lawyers and forensic experts”looking at 17 big money losing contracts, targeting (it appears) Bear Stearns and First Franklin. The max losses were originally seen at 10-12%, and now they are staring down the barrels of over 80%, so they may have a good case.

We’ll be seeing a lot more of this, and insurers won’t be paying out in the near term without this sort of teardown of the contract and investment looking for evidence of deception of some sort.

In related news, bondholders recovery on bankruptcy has plunged, with B+ bonds going from around 42¢ on the dollar to less than 10¢.

This is not a liquidity crisis. It is an insolvency crisis.

The Fed, however, is still treating this as a liquidity crisis, because there is no cure for an insolvency crisis but the dissolution of the entities involved, and it will auction another $75 billion in Treasuries in exchange for pieces of the big sh%$pile.

Speaking of the sh%$pile Moody’s just downgraded 1,923 residential mortgage backed securities in the past to days.

It’s likely to get worse. Robert Shiller, who is one of the creators of Case-Shiller housing index, believes that house prices will fall more than 30% from their high, and likens this to the slump associated with the Great Depression.

In terms of the more general economy, we have UPS saying that it’s seeing a dramatic slowing in the U.S. economy, and in its business, and Target’s write offs on its credit card sales are soaring. They are at an annualized rate of 8.1% for March (ouch) up from a rate of 6.8% in February (ouch x2).

In currency, we already know about the Dollar cracking the $1.60 barrier, but now we are seeing a price hike driven by this, with Airbus raising prices on its planes.

We’re going to see a lot more currency driven inflation.

Economics Update

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It’s official, we’re in a recession, because Bush is denying that we are in a recession – Apr. 22, 2008.

For more direct evidence of a recession, we have American drivers cutting back on driving and gasoline usage. When Americans stop driving, it means that the recession is here…big time.

In energy, oil broke $119/bbl, $110/bbl now appears to be the new $100/bbl

Across the border, Canadian Central Bank cut rates by 50 basis points, but even so, the Canadian dollar is still above parity with the US dollar, but they are definitely seeing the fallout from the US downturn.

In other currency matters, the dollar weakened to above $1.60:€1.00, though it’s now about $1.5992.

At the beginning of the year, it was $1.48 or so.

In things related to banking and real estate, we have to start with the elephant in the room, that GSEs Fannie Mae and Freddie Mac are looking increasingly at risk, and a potential bailout would run to over $1 trillion, which might threaten the US government’s AAA rating.

Generally, bank profits are tanking, so it should come as no surprise that banks are retrenching.

Notably, Bank of America will be ending subprime operations, and tightening generally on mortgage standards, which makes it hard to understand why it’s buying Countrywide.

Citi needs more capital, so it’s offerring $6.2 billion in hybrid bonds, at 8.4%, with an A2 rating.

Hybrid bonds are….are….Ummm, a sort of hybrid between preferred stock and bonds…I’m confused, and they are described as “innovative”. I’ll try to get more information, but in the meantime, run away.

Finally, the Fed bailout of banks continues apace, reaching $360 billion with the sale yesterday.

Economics Update

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Current position of Dollar with Regard to Euro

The rebels in Nigeria’s delta region just bombed an oil pipeline, and in response, oil hit $117/bbl before settling at $116.69.

In addtion to lower levels of employment, hours worked by those still employed are also down, so there are fewer people doing less work to produce goods and services.

Both Citi and AT&T are announcing big layoffs because of losses (Citi), and “increased competitive pressure (AT&T).

It’s a recession already.

The Fed just auctioned off about $25 billion for non-magic beans, as a part of its ongoing Wall St. bailout.

Yesterdya, I talked about new home sales falling, today, it’s existing home sales falling 13%, but north of the Border in Canada, which has generally had a better regulated loan market.

Finally, a picture, courtesy of Paul Krugman showing the increase in the LIBOR-OIS spread since this all started:


The second image is actually a bit scarier, because it shows a longer time frame, and it shows that the spread is completely outside of historical norms.

Why We Are Screwed

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I’m not sure that there is a real “vision” for my blog, except to provide for the 5-6% of personal posts that I want to put in my eponymous newsletter.

That being said, I think that my most consistent vision, after being a fighting liberal, is that I am an economic bear, and a pro-regulation one at that.

Martin Hutchinson, writing in the Asia Times, manages to distill much of what is going on right now. He calls it The degradation of accounting.

Basically, it comes down to the fact that any number of people have a vested interest, at least in the short term, of not using accounting that reflects the situation out in meat space.

THE BEAR’S LAIR
The degradation of accounting
By Martin Hutchinson

Fair value accounting, by which debt and equity securities on a company’s balance sheet are “marked to market” – written up or down to their market price – has been hyped by accountants and regulators as the epitome of modern financial reporting, enabling investors to gain a completely true picture of their investment’s financial position.

Indeed, Gerald White of the Chartered Financial Analyst Institute, speaking at an American Enterprise Institute conference on Tuesday, believes it should be applied to all items on the balance sheet, not just financial instruments. There is just one problem: in the turbulence of the past nine months, it has completely failed to
work and has indeed shown itself to be pro-cyclical, encouraging economically foolish behavior in both up and down cycles.

He notes that this is a change from when he was in B-School in the 1970s, when frequently assets such as real estate were on the balance sheet at a value close to what they were in the 1920s.

While having undervalued assets on a balance sheet is an issue in the old system, it’s also clear that the current system of accounting is less accurate, and it is less accurate in a potentially catestrophic way:

The new accounting standard FAS157, propounded in September 2006 and coming into effect for fiscal years beginning in 2008, codifies this trend but does not materially alter it. Its most startling feature for a layman is that it allows companies to mark-to-market assets for which there is no market. Financial assets are divided into three “levels” according to their degree of marketability. Level 1 assets are those for which a ready market exists, Level 2 assets are those for which a market exists for comparable securities and Level 3 assets are those for which no market exists, which are to be valued by use of mathematical models.

(emphasis mine)

He makes the note that this is why we have an insolvency crisis, not just a liquidity crisis.

It will take 5 minutes to read, and you should send it to every financial regulator you know.

Economics Update

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Clickable Image

In terms of economic indicators, we have 4 today, one up, and three down.

FWIW, the Jobless claims are noisy, but overall the numbers are trending up, and the LEI typically does not mean anything until you get three in a row.

The Dollar hit a new low vs. the Euro, $1.5982:€.

As an aside, I spend a fair amount of time on currency, because I believe that it will be the final nail in the proverbial coffin, much like it was in the Asian and Argentine financial crises.

In banking, investment and otherwise, we have
Merrilly Lynch announcing a $6.5 billion write down and massive layoffs.

Across the pond, we have the Bank of England announcing that it had three times as many bids for its cash auction as it was offering, implying that credit is still pretty frozen, and the prospect of massive bank failures in Germany as a result of the subprime crisis, which truth be told extends well into the prime mortgages too.

Finally, in another sign of the apocalypse, my predictions regarding the countrywide sale, that Bank of America was throwing good money after bad, appear to be coming true, as , “Continued credit deterioration at Countrywide Financial Corp. could raise concern among investors about the final sale price of the mortgage lender to Bank of America Corp., a Lehman Brothers analyst said Thursday.”

Did I Say $45 Trillion? Me bad. $62 Trillion

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Yep, the numbers for Credit Default Swaps are far higher than I had previously noted. It’s $62.2 Trillion, up from $34.5 trillion a year ago, and up from my earlier number of $45 trillion.

By way of reference, world GDP is listed at $65.82 Trillion.

So we have something near the entire economic capacity of the Earth in complex instruments which may be worth nothing, and no one really knows what they are worth.

Paul Calello, head of investment banking at Credit Suisse, will tell the Isda meeting that the banking sector must accept that regulators will become more involved in the CDS market and other areas of derivatives in the future.

In particular, bankers and other financiers must now work with regulators to make the infrastructure more robust, since the crisis has exposed some serious potential weaknesses.

“There will be new regulation and there should be; voluntary efforts are not enough,” Mr Callelo will say. “We cannot expect ‘business as usual’.”

But Alan “Bubbles” Greenspan said that, “The use of a growing array of derivatives and the related application of more sophisticated methods for measuring and managing risk are key factors underpinning the enhanced resilience of our largest financial intermediaries.”

And as we all know Alan “Bubbles” Greenspan, acolyte of Ayn Rand, and poster child for sex without partners, is never wrong.*

*I know cheap shot, fish in a barrel. But I’m a cheap shot, fish in a barrel kind of guy.

OK, This One is Really Bad News if True

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OK, for a while now, I have been talking about how the increasing TED and other spreads indicate that the credit market has not unfrozen.

It now appears that at least one of these numbers, the LIBOR, the London inter-bank offered rate, may actually have been significantly understated, meaning that the spread is higher, which means that people are more timid about lending money than has been previously reported (H/t Paul Krugman)

There are now indications that some banks may be under-reporting both the interest rates on the loans that they are paying, because it would be seen as financial weakness, which might lead to downgrades, and possibly a run on the institution.

Questions about Libor were raised as far back as November, at a Bank of England meeting in which United Kingdom banks, the firms that process bank trades and central bank officials discussed the recent financial turmoil. According to minutes of the meeting, “several group members thought that Libor fixings had been lower than actual traded interbank rates through the period of stress.” In a recent report, two economists at the Bank for International Settlements, a sort of central bank for central bankers, also expressed concerns that banks might report inaccurate rate quotes.

It’s of interest to more than the markets. LIBOR is also what many adjustable rate mortgages use as a benchmark to set their rates.

The financial system really does seem on the verge of collapse. We are getting to the point where there is absolutely no reliable data upon which one can make a decision, whether it is an individual investor, or the Federal Reserve.

Oops! Wholesale Prices Surge

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Wholesale prices rose by 1.1% in March, analysts had been predicting .4%, and over the past year, it has been 6.9% (I’m not doing the core rate bull sh@# for a 1 year reading, that’s enough time to smooth out the noise)

This means that there is more pressure to raise rates:

  • Lower interest rates make it cheaper to accumulate stock piles of raw materials and keep them off the market.
  • Inflation fears drive the dollar down.
  • Low interest rates drive the dollar down.

I don’t expect any interest rate increases in the next couple of months, but we might have seen the end of rate cuts, which have pretty much stopped working anyway.

Fannie and Freddie at Risk?

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Standard and Poors is warning that the GSEs are facing increasing risks as the housing crisis deepens, and so they might at some future time have to downgrade them.

Being the 2nd and 3rd largest borrowers in the world, they are firmly in the “too big to fail” camp, the regulators have reduced the reserve capital requirements for the GSEs (also here), and Congress making noise about increasing their lending limits*, I’m not particularly confident in Fannie Mae and Freddie Mac remaining particularly solvent.

*Shoot me now, I’m agreeing with some puke economist from the Heritage Foundation.

Economics Update

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Real estate is still trending worse. We have the New York Times writing about how the troubles have gone global.*

We also are now seeing discounts up to 60% on the last sale price in bank auctions on properties in South Florida.

And it won’t get better soon, because when pollsters ask about buying a home, respondents reply, “What??? buy a house now??? Are you out of your bloody mind???“.

Energy prices are surging, with oil closing at a new all time high, $111.76/bbl.

Also, it looks like Wachovia is hemorrhaging, and so is cutting dividends and planning to offer stock for much needed capital.

*As an aside, I’m not surprised that Ireland is in this select group. The “Celtic Tiger” has always seemed to me to be closer to Thailand and Indonesia than the rest of the EU with its prosperity being almost completely driven by low wages and real estate, and Spain is a close second on this. This is not to say that they will become 3rd world countries, but that they both may end up far closer to EU members like Poland, Slovakia, Hungary, and Croatia than they had previously imagined.†
†Mass flows of speculative capital always produce a nasty hangover.