Category: Finance

Economics Update

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It turns out that banks are closing the barn door after the cow has gone, and they are tightening credit standards…a lot.

In fact, it’s the worst since they started keeping records, as Paul Krugman notes, and he provides has a good graph of just how tight it has become:

He correctly calls it “grim”

Additionally, we have the Institute for Supply Management’s non-manufacturing index, which accounts for around 9/10 of the economy, dropping. See also here.

Krugman has another graph to illustrate this:

Economics Update

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In January, employers cut 17,000 jobs, the first cut in about 4 years.

Truth be told, the private sector has not been responsible for significant employment growth in this “tide that leaves ordinary people drowning” recovery anyway. It’s pretty much all been public sector jobs.

Additionally, you have 2007 having the worst performance since 2002, with factory orders for the year being only 1.4% above 2006, though the month to month numbers for November and December were relatively healthy.

In the increasingly inevitable meltdown of the monoliner bond insurance companies, private equity firms want no part of a bailout of the insurers, so banks are trying to go it alone (here and here).

Banks trying to bail out insurers, so that the banks won’t show huge losses or insolvency as a result of losses in the market.

So, you have broke insurers being bailed out by banks that are broke too?

This will all unwind, just like the 1929 crash, only the availability of computers, and computer models, means that the level of exposure of these institutions has multiplied many times.

In any case, it appears that the credit crunch is in the process of making large private equity deals more risky for investment banks, in this case, a take over of Harrah’s Entertainment by Apollo Management and Texas Pacific Group.

The banks are, “Having trouble selling on the leveraged buy-out debt to third parties. With the bulk of the debt remaining on their books, the banks are sitting on a sizeable loss.” No one wants to buy the funny paper no more.

For the UK, there is some good news, asthere are now competing bids for the Northern Rock bank, with Richard Branson and the board of Northern Rock competing, which implies that the UK taxpayers won’t take too bad a hit.

In a sign of the new world order, CitiGroup is no longer number one in the world in market capitalization, that honor now goes to the Industrial & Commercial Bank of China Ltd., China Construction Bank Corp. and Bank of China Ltd. (ICBC).

In fact, it’s number 7 on the list, after ICBC, Bank of America, HSBC Holdings, China Construction, Bank of China, and JPMorgan Chase.

And we now have indications that perhaps that trader was not so “rogue”, with Societe Generale in court defending itself against money laundering. It appears that they were laundering stolen checks through Israeli banks.

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.

Bankrupt Your Company, Get a Better Paying Job Somewhere Else

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The Times has a story that has got me thinking that all of Wall Street is one giant criminal conspiracy.

People keep falling up.

High (low) points cut and pasted from the article:

  • UNDER the stewardship of Dow Kim and Thomas G. Maheras, Merrill Lynch and Citigroup built positions in subprime-related securities that led to $34 billion in write-downs last year. The debacle cost chief executives their jobs and brought two of the world’s premier financial institutions to their knees.
  • Mr. Maheras, who left his job as co-president of Citigroup’s investment bank … has had serious discussions with several investment banks, including Bear Stearns, about taking on a top management position, people who have been briefed on the situation said. And he has also been approached by investment firms willing to back him to the tune of $1 billion or more if he decides to start his own hedge fund, these people said.
  • Mr. Kim, who until this spring was a co-president at Merrill Lynch with oversight of the firm’s trading and market operations, has been crisscrossing the globe in recent months raising money for his new hedge fund, Diamond Lake Capital.
  • Zoe Cruz, the Morgan Stanley co-president who was forced to leave her job after $10.8 billion in subprime losses, has been approached by investment banks, hedge funds and private equity funds about a senior management role.
  • John Meriwether. Ousted from Salomon Brothers in 1991 for his role in a bond trading scandal, he became a co-founder of Long Term Capital Management, the hedge fund that nearly collapsed in 1998, rattling markets worldwide. He has since founded a second fund, JWM Partners, with assets of around $3 billion.
    • So he was fired for corruption, and then he went on to found LTCM, which the Federal Reserve had to structure a bail out for, and he’s got another hedged fund?
  • More recently, Brian Hunter, the energy trader at Amaranth Advisors whose disastrous bets led to the disintegration of that $9 billion hedge fund, is now advising a private equity fund called Peak Ridge on starting a hedge fund. Howard A. Rubin, a trader at Merrill Lynch, who lost $377 million in 1987, quickly landed a job at Bear Stearns, where he had a successful career.

I used to think that somehow or other, GW Bush’s history of failing upwards was the exception. It’s not. It’s the rule. Our financial markets are irredeemably corrupt.

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.

Bank’s Solution for the Credit Crunch: F$%k the Small Depositor

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Yep, they banks are looking at implementing new larger fees on holders of small accounts.

I guess that they need to stick it to the little guy because of all the money that they are losing on the high rollers that they gave exotic mortgage packages to.

Today, the average ATM fee is $1.78, while five years ago it cost a little more than a $1 to retrieve money from a bank with which you didn’t have an account.

In some areas, JP Morgan Chase, Bank of America and Wachovia fees have hit $3 for non-customers.

Bankers and the Sirius Cybernetics Corporation, the first up against the wall when the revolution comes.

Economics Update

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Profits are still tanking, we now have Commerce Bank and Harley Davidson way down, and I see Harley as a real bellwether of a recession.

When middle aged guys don’t feel secure enough to buy their toys, it’s game over.

And we have another insurance downgrade, this time Security Capital is downgraded by Fitch.

And we have Nobel winning economist Joseph Stiglitz warning that we may sliding into a 1930s type ‘liquidity trap’.

One of the Joys of the Internet: Finding People Smarter Than Me

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I don’t know his name, but the person known as “the Scanner” is one of them.

He has an ingenious proposal for dealing with the issue of bailing out financial institutions that are drowning in the “Big Sh%$pile”.

Here’s my proposal. I offer it at no charge to any member of Congress, presidential candidate or editorial writer willing to bear the calvary of getting the stink-eye next time at Harry Cipriani. If it becomes necessary to bail out the monoliners to prevent a depression, there will be terms. For once, the highly-paid beneficiaries of a taxpayer-financed bailout will not get off scot-free.

Congress shall specify that no bailout will take place unless and until (a) every bailed out monoliner and (b) every financial institution holding a bailed-out policy certifies that its employees have voluntarily agreed to accept a 25% federal income tax surcharge on every dollar earned above $200,000 for a period of 5 years. A young hotshot earning $300,000 would see $25,000 added to his tax bill. An elder pulling down $1 million would owe an extra $200,000. Since some of the biggest Wall Street multinationals are policyholders, and since this would apply to every one of their employees over $200,000, we could be talking about a lot of people and a lot of money. It could even go some way towards making the bailout pay for itself.

Politically, it’s a winner. Fiscally, it’s sound. It’s extraordinarily well-targeted to precisely the assholes who got us into this mess in the first place. John Edwards: Have your staff contact me through the comments box.

My only difference would be that I would go for a higher surcharge, perhaps something like 50%.

Signs of the Apocalypse: Financial Times Columnist Calls for Regulation of Bankers’ Pay

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Martin Wolf, a columnist and editor for the Financial Times, is calling for regulations regarding the remuneration of banking executives.

Basically, he sees the current pay structures of banking, with enormous bonuses for short term results, as being a major factor in the current banking/credit crisis.

Further, he sees banking as an industry with an amazing talent for, “privatising gains and socialising losses.”

He says, “My attitude to the banking industry is not a prejudice. It is a ‘postjudice’.”, or to be translated into more prosaic language, he learns from the mistakes he observes, and prior behavior colors his attitude towards the industry.

It is the nature of limited liability businesses to create conflicts of interest – between management and shareholders, between management and other employees, between the business and customers and between the business and regulators. Yet the conflicts of interest created by large financial institutions are far harder to manage than in any other industry.

That is so for three fundamental reasons: first, these are virtually the only businesses able to devastate entire economies; second, in no other industry is uncertainty so pervasive; and, finally, in no other industry is it as hard for outsiders to judge the quality of decision-making, at least in the short run. This industry is, in consequence, exceptional in the extent of both regulation and subsidisation. Yet this combination can hardly be deemed a success. The present crisis in the world’s most sophisticated financial system demonstrates that.

Basically, he is saying that these institutions are immature and short sighted in outlook, but they possess the ability to destroy the output of the most of the rest of society, and so they need aggressive regulation.

Word up.

Economics Update

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According to “reliable sources”, Ben Bernanke thinks that the downturn will be very severe, and that’s why there was the very large, unscheduled rate cuts.

Additionally, as reported by Calculated risk the market is expecting another 50 basis point rate cut at the regular meeting next week.

This would leave the Fed at a 3% discount rate, and I think that beyond that point, they are pushing on a string. Monetary controls of the economy are pretty much at their limits now.

In the real estate world, Merrill Lynch is saying that nationwide U.S. home prices could decline 25% to 30% over the next three years.

I think that they are optimistic.

Then we have student loan giant Sallie Mae reporting a $1.6 billion quarterly loss, which raises the obvious question, “How the hell do you lose money on GSLs?” These are government guaranteed loans, and the fact that borrowing costs have shot up so much that they cannot profit on them is …ominous.

There are indications that Bank of America’s deal to buy Countrywide may be getting into trouble. At least that what the market is saying, literally. BoA is offering the equivalent of $7.1058, but Countrywide is trading at $5.54.

This spread is a measure of the market’s opinion that the deal won’t actually be consummated, this spread implies that “there is roughly a 77.9 percent consensus among Wall Street’s risk arb desks and their hedge fund brethren that the deal goes through at the agreed upon terms. That also means that more than 22 percent of risk arbitrageurs don’t think the deal will go through”.

You also have Capital One taking a major earnings hit, both from the closing of its GreenPoint Mortgage arm, and from higher credit card losses.

Finally, you have talks between New York Insurance Superintendent Eric Dinallo and major US banks about a bailout of bond insurers. There is an implication that there will be some sort of government involvement, if not outright government sponsorship of such a bailout.

Economics Update: OMFG Edition

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First, of course, the Fed cut it’s Federal Funds Rate by 75 basis points, the biggest cut since 1984, and it did so a week before its regular meeting, which it hasn’t done since 911.

The US markets recovered after the rate cut, but still they were down by over 1% for the day.

I think that Paul Krugman’s analysis of this is accurate, Bernanke used to be the head of his department at Princeton, so I would assume that he knows him pretty well.

Basically, Bernanke is concerned about the Japanese slow down of the 1990s, when monetary tools simply stopped working:

What was so disturbing about Japan was the way monetary policy became ineffective; by the later 1990s the short-term interest rate was up against the ZLB — the “zero lower bound.” This is alternatively known as the “liquidity trap.” And once you’re there, conventional monetary policy can do no more, because interest rates can’t go below zero.

There was a lot of discussion of various unconventional monetary things you could do. But the best answer was not to get there in the first place. A 2004 paper co-authored by Bernanke argued that the ZLB could and should be avoided by “maintaining a sufficient inflation buffer and easing preemptively as necessary”.

In terms of corporate profits, Bank of America took a major hit, with profits dropping 95% as a result of $5 billion dollar writedown, and its, “tier 1 capital ratio – a key measure of its ability to absorb losses – stood at 6.87 percent at the end of the year, down from 8.22 percent in the previous quarter, due to its purchase of LaSalle Bank and lower net income during the second half of last year.”

Wachovia took an 89% hit on profits, “due to a $1.7 billion reduction in the value of certain portfolios and $1.5 billion set aside to cover bad loans”.

More real estate and derivatives.

And while we are on the topic of real estate and derivatives, bond insurer Ambac is looking for a buyer. If they take monopoly money, I’m game, but only if it’s less than one whole game.

Otherwise, the deal just does not make financial sense.

Of course, the one thing that we can be sure of is that if George W. Bush speaks, the market will tank, so, of course, they are talking again, and saying that they are looking at increasing the stimulus package beyond the $150 billion originally proposed.

My guess is that there is a “Bush Ranger” out there who wants a special tax break just for him.

Of course, we are already beginning to see the allocation of blame, aka “blamestorming”, with EU Economic and Monetary Affairs Commissioner Joaquin Almunia saying that this problem is a result of excessive US trade deficit…..Ummmm…Well Duh!!!!…Though that whole deregulation of markets thing isn’t working either.

And on the housing front, California loan defaults reach have reached a 15-year high in Q4 2007, up 114% from the same time in 2006. Foreclosures are up 421.2% from 2006.

No Good Comes of Treating Insolvency as Illiquidity

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As the good doctor Roubini says, there is a difference between an illiquidity crisis, and an insolvency crisis.

A corollary is that dealing with insolvency as illiquidity simply throws good money after bad*, and the extensions that are being granted to ACA Bond Holdings to “unwind” its credit swaps, is an attempt to deal with insolvency as illiquidity.

ACA has lost 97% of its market cap over the past year, it’s been downgraded to CCC last month (12 steps all at once), and it’s currently being run by its regulator, the Maryland Insurance Administration, which, “extended an agreement that waives collateral requirements, policy claims and termination rights until Feb. 19, the New York-based company said in a statement on Business Wire late yesterday.”

It’s hit an ice berg, and it’s going down. Delaying this in the hope of finding stupid investors is going to help no one in the long term.

*To quote Roubini on the difference, “But the current market turmoil is much worse than the liquidity crisis experienced by the US and the global economy in the 1998 LTCM episode. Let me explain why. Economists distinguish between liquidity crises and insolvency/debt crises. An agent (household, firm, financial corporation, country) can experience distress either because it is illiquid or because it is insolvent; of course insolvent agents are – in most cases – also illiquid, i.e. they cannot roll over their debts. Illiquidity occurs when the agent is solvent – i.e. it could pay its debts over time as long as such debts can be refinanced or rolled over – but he/she experiences a sudden liquidity crisis, i.e. its creditors are unwilling to roll over or refinance its claims. An insolvent debtor does not only face a liquidity problem (large amounts of debts coming to maturity, little stock of liquid reserves and no ability to refinance). It is also insolvent as it could not pay its claim over time even if there was no liquidity problem; thus, debt crises are more severe than illiquidity crises as they imply that the debtor is insolvent, i.e. bankrupt, and its debt claims will be defaulted and reduced. In emerging market crises of the last decade, we had liquidity crises (i.e. a solvent but illiquid sovereign) in Mexico, Korea, Brazil, Turkey; we had debt/insolvency crises (a sovereign that was both illiquid and insolvent) in Russia, Ecuador, Argentina.”†

†You have to just love this, footnotes almost twice as long as my post.

To Err Is Human, but It Requires an MBA To Create Total Clusterfu$% . . .

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I probably should include this in my standard economics update, but Barry Ritholtz’s line (my title) is too good not to give top billing.

He is talking about something called “Counter-Party Risk“, which is the risk that an issuer might default on a payment or go into liquidation. Also known as counter party risk.

Basically, he is continuing his ongoing riff on what will happen if monoline insurers go belly up, as increasingly seems likely.

He expects there to be a lot more “down” there, as do I. There is a lot of leverage, out there. For an MBA, it’s called leverage, for the rest of us, it’s called “being in debt up to our eyeballs”.

In describing the monoliners, MR. Ritholtz is right:

That situation was obviously intolerable. So they brought in the financial engineers. Hey, we should be issuing insurance on Credit Default Swaps (CDS) — the premiums are much much bigger than boring old munis!

Any time you hear words to that effect, you know you are dealing with an idiot of the highest magnitude. Those are the equivalent to “Give me a match, I want to see if there is any gas in the tank.”

The monolines are not in trouble because Municipalities are defaulting on bond payments. (That’s waaaay in the future). The problem is they wrote insurance — taking in that fat premiums — without properly understanding the risk.

….

I’ve said it before, and I’ll repeat it again: To err is human, but it requires an MBA to create total clusterfu#@ . . .

My analogy, that like those people on American Idol whose friends have told them that they can sing. Is nowhere near as clear or as lyrical.

Are Brokers and Financial Professionals Like American Idol Contestants?

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Michael Lewis asks, “What’s odd about the subprime crash is Goldman Sachs Group Inc. A single firm took a position contrary to the rest of Wall Street. Giant Wall Street firms are designed for many things, but not, typically, to express highly idiosyncratic views in the market.”

Basically, what happened was that in 2006, some smart guys at Goldman, as they did at other places, went to senior management, and said that they thought that the Subprime market was soft, and that they should short it.

This probably a bit of advice that any number of brokerages got over that time, but how they handled it was different.

As opposed to reviewing the data, coming to a decision, and issuing guidance to the subprime traders based on that decision, Goldman Sachs has some different management structures. They

The only difference between Goldman and everyone else was that Goldman had, in effect, an entirely separate enterprise, sitting on top of the firm, with the power to reverse the judgment of its own supposed experts in various markets. They were able to do this, apparently, without ever saying a word about it to their own traders. Instead of telling the fools trading subprime mortgages that they are wrong, and that they should unwind their positions, they simply offset their trades.”

Rolling Heads

All across Wall Street risk managers are being fired, reassigned or hovering under a cloud of contempt and suspicion. Heads must roll, and after the CEO, these guys are the most plausible to guillotine.

But at the same time it’s pretty clear that a lot of these so-called risk managers never really had the power to manage risk. They had to consider the feelings, for example, of the guys who ran subprime mortgages. Morgan Stanley conceded as much when it said recently it was considering changing things around so that the risk manager reported to the CFO, rather than the heads of individual businesses.

But at Goldman there were two intelligences at work: one, the ordinary Wall Street intelligence, which was allowed to get itself in trouble, just as at every other Wall Street firm; the other, more like an extremely smart hedge fund that made its living off the idiocy of big Wall Street firms, including its own people.

(emphasis mine)
There is a frightening corollary to this, that the experts operating in high finance are less like dispassionate experts than they are like those people on American Idol whose friends have told them that they can sing.

Accusations of Inappropriate Pressure by WaMu on Appraisers

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I am so not shocked that Jeniffer Wertz is claiming that claiming she was blacklisted last year for providing a housing market forecast that was too gloomy.

In the lawsuit, which was filed a week ago, Wertz says she completed appraisals on two houses in May and then quickly got a call from a WaMu sales manager demanding she change her outlook to “stable” so a loan could be approved.

The WaMu sales manager also demanded Wertz change her appraisal process to produce higher prices for the properties she was evaluating, according to Wertz’s lawyer Stephen Danz. The higher an appraisal comes out, the more likely it is a home loan will get approved.

When Wertz refused to comply, she claims the sales manager threatened to block her from doing future appraisal work for the bank. A month later, Wertz’s suit says, a third-party appraisal request assigner told her WaMu would no longer accept her work.

I have no doubt that this is true, and that this was endemic in the lending industry among most, if not all of the major players.

Andrew Cuomo is alleging that WaMu’s pressure on “title company First American and its appraisal unit, eAppraiseIT” is why they were basically falsifying appriasals, and The Securities and Exchange Commission and the Office of Thrift Supervision has opened an investigation.

I think that it will be more difficult to find a major lender who did not do this than to find one who did.