Interest Rate Roundup

Tuesday, September 30, 2008

Will FDIC deposit insurance limits rise? And will mark to market accounting be suspended?

These seem to be the latest angles of attack for the government, which is wrestling with how to amend or replace the bailout bill. From a New York Times item:

"As they worked to make the government bailout plan more palatable, Senators John McCain and Barack Obama on Tuesday both proposed raising the federal insurance limit to $250,000 in an effort to help small businesses and restore public confidence in the American financial system.

"The presidential candidates discussed the idea in separate telephone calls with President Bush on Tuesday, aides said, as they began working to build support for the $700 billion economic package that failed on Monday in the House. Their tones – so far, at least, more measured from one day earlier – underscored the complicated politics at work for both men.

“Given the progress we have made, I believe we are unlikely to succeed if we start from scratch or reopen negotiations about the core elements of the agreement,” Mr. Obama said in a statement. “But in order to pass this plan, we must do more.”

Reuters is also reporting that the FDIC will soon formally request authority to insure deposits above the current $100,000 threshold.

As for mark to market accounting, here is an argument for suspending it. Here is an argument against doing so. Meanwhile, a recent survey from the CFA Institute shows that its members largely oppose (73% against) eliminating the accounting standard.

The thing that I have a hard time with: Those in favor of suspending the standard say that today's prices are "fire sale" prices. They say it's forced selling that is driving the value of these assets down, and that they are really worth a lot more.

I say: Says who? How do we KNOW the intrinsic value is higher -- or that prices will be higher, later if banks are just allowed to hold to maturity? If home prices keep falling, the economy deteriorates, and so on, the value of these assets could just keep slumping.

Even if prices eventually recover, my other point would be "So what!" The price of something -- any good, asset, service, or what have you -- is what you can sell it for at any given time. Period. I bet GM would love to sell its Hummers for $200,000 each today based on the idea that gas prices will be lower down the road, and therefore the "real, intrinsic value" of its gas guzzlers is higher than what people are paying today. But it can't. The price is what it is.

Or here's another example: For the first year/year and a half of the housing market downturn, sales volume started dropping sharply and for-sale inventories started surging, but home prices really didn't decline. Ignorant observers said: "Look, there's no downturn. Prices are still up!"

But what was really happening? Sellers were clinging to unrealistic views of the long-term, intrinsic value of their homes. They were saying: "I'm right. The market is wrong. I'm not going to GIVE my house away." They refused to mark their homes to market. Result: The housing downturn was prolonged.

Now, thankfully, that attitude has been tossed out the window. Sellers ARE coming to grips with reality. They are marking their homes to market. And you know what? It's helping to clear the backlog of inventory in certain hard-hit markets. I think what we have here isn't a case of they're being NO market for this paper, and therefore artificially low "marks." It's that sellers and policymakers don't want to acknowledge just how far the market value of these assets has fallen.

UPDATE: SEC guidance on MTM accounting is now online. MTM accounting is not being suspended. Instead, the SEC is giving companies more latitude when it comes to determining fair value of certain assets.

Chicago PMI dips, home prices fall further, confidence pops

While the credit crisis is grabbing all the air time and ink, we shouldn't completely ignore the flow of economic data. The latest news there:

* The Chicago Purchasing Managers Index slipped to 56.7 in September from 57.9 in August. That was slightly better than the Bloomberg consensus forecast of 53. The new orders subindex dropped to 53.9 from 60.2 (bad), while the employment subindex rose to 49.1 from 39.2 (good). The production subindex also ramped up to 71.4 from 63.4.

* The latest S&P/Case-Shiller figures (PDF link) show home prices falling 0.88% between June and July. That's better than the 2%+ readings we were seeing at the beginning of this year, but the largest monthly decline since April. Home prices in 20 top metropolitan areas fell 16.4% from a year earlier, up from the 15.9% decline reported for June. The hardest-hit markets are the same as before (Las Vegas at -29.9%, Phoenix at -29.3%, Miami at -28.3% and so on).

* Meanwhile, the Conference Board's consumer confidence index climbed to 59.8 in September from 58.5 in August. That was better than the 55 reading economists were expecting. The expectations index rose to 60.5 from 54.1, while the present situation index slumped to 58.5 from 65.

I doubt these numbers will continue to hold up, given what has happened in the stock and credit markets over the past few days. Incidentally, a subindex that takes the "jobs plentiful" reading and subtracts the "jobs hard to get" reading came in at -20.6 vs. -18.2 in August. So the underlying jobs market appears to be deteriorating. Also, the percentage of people who said they planned to buy cars (4.9% vs. 5.2% in August) and homes (2.1% vs. 3.4%) declined.

LIBOR off the charts


Banks are still hesitant to lend to each other, as the latest LIBOR fixings make abundantly clear. The chart above shows overnight, U.S. dollar LIBOR rates, which shot up from 2.31% on Friday to 2.57% yesterday and a whopping 6.88% this morning. Three-month (4.05%) and six-month LIBOR (3.98%) are also on the rise and well above the federal funds rate target (2%).

Monday, September 29, 2008

Stock market crashes

No, I don't think that's hyperbole. The Dow Jones Industrial Average finished down 777 points, the biggest point loss in history. The previous record was -721.56 set in the immediate aftermath of the 9/11 terrorist attacks. The Standard & Poor's 500 shed 102.90, or roughly 8.5%. That was the worst percentage decline since the October 1987 crash. The Nasdaq Composite lost almost 200 points, or 9.1%.

Bailout bill vote fails

Wow. Initial bailout bill vote failed 228 "against" vs. 205 "for." More from the New York Times:

"In a moment of historic drama in the Capitol and on Wall Street, the House of Representatives voted on Monday to reject a $700 billion rescue of the financial industry.

"The vote against the measure was 228 to 205. Supporters vowed to try to bring the rescue package up for consideration again as soon as possible.

"Stock markets plunged sharply at midday as it appeared that the measure would go down to defeat.

"House leaders pushing for the package kept the voting period open for some 40 minutes past the allotted time, trying to convert “no” votes to “yes” votes by pointing to damage being done to the markets, but to no avail.

"Supporters of the bill had argued that it was necessary to avoid a collapse of the economic system, a calamity that would drag down not just Wall Street investment houses but possibly the savings and portfolios of millions of Americans. Opponents said the bill was cobbled together in too much haste and might amount to throwing good money from taxpayers after bad investments from Wall Street gamblers.

"Should the measure somehow clear the House on a second try, the Senate is expected to vote later in the week. The Jewish holidays and potential procedural obstacles made a vote before Wednesday virtually impossible, but Senate vote-counters predicted that there was enough support in the chamber for the measure to pass. President Bush has urged passage and spent much of the morning telephoning wavering Republicans to plead for their support."

Citigroup taking over Wachovia's banking operations with government assistance

From the FDIC a few minutes ago:

"Citigroup Inc. will acquire the banking operations of Wachovia Corporation; Charlotte, North Carolina, in a transaction facilitated by the Federal Deposit Insurance Corporation and concurred with by the Board of Governors of the Federal Reserve and the Secretary of the Treasury in consultation with the President. All depositors are fully protected and there is expected to be no cost to the Deposit Insurance Fund. Wachovia did not fail; rather, it is to be acquired by Citigroup Inc. on an open bank basis with assistance from the FDIC.

"For Wachovia customers, today's action will ensure seamless continuity of service from their bank and full protection for all of their deposits." said FDIC Chairman Sheila C. Bair. "There will be no interruption in services and bank customers should expect business as usual."

"Citigroup Inc. will acquire the bulk of Wachovia's assets and liabilities, including five depository institutions and assume senior and subordinated debt of Wachovia Corp. Wachovia Corporation will continue to own AG Edwards and Evergreen. The FDIC has entered into a loss sharing arrangement on a pre-identified pool of loans. Under the agreement, Citigroup Inc. will absorb up to $42 billion of losses on a $312 billion pool of loans. The FDIC will absorb losses beyond that. Citigroup has granted the FDIC $12 billion in preferred stock and warrants to compensate the FDIC for bearing this risk.

"In consultation with the President, the Secretary of the Treasury on the recommendation of the Federal Reserve and FDIC determined that open bank assistance was necessary to avoid serious adverse effects on economic conditions and financial stability.

"On the whole, the commercial banking system in the United States remains well capitalized. This morning's decision was made under extraordinary circumstances with significant consultation among the regulators and Treasury," Bair said. "This action was necessary to maintain confidence in the banking industry given current financial market conditions."

UPDATE: More details coming out from Citigroup on the nature of the transaction...

"Wachovia will remain a public company and retain its asset management, retail brokerage, and certain select parts of its wealth management businesses, including the Evergreen and Wachovia Securities franchises. Going forward, Wachovia expects to have adequate capital to support its remaining businesses, an appropriate allocation of tangible equity, and certain tax assets that will be recognized immediately.

"Under the terms of the agreement-in-principle, Citi will pay Wachovia approximately $2.16 billion in stock and assume Wachovia senior and subordinated debt, totaling approximately $53 billion.

"Citi will acquire more than $700 billion of assets of Wachovia’s banking subsidiaries, and related liabilities. The Federal Deposit Insurance Corporation (FDIC) has agreed to provide loss protection in connection with approximately $312 billion of mortgage-related and other Wachovia assets. Citi is responsible for the first $30 billion of losses on this portfolio, and expects to record these expected losses under purchase accounting upon closing of the transaction. Citi is also responsible for the next $12 billion in losses up to a maximum of $4 billion per year for the next three years. Citi has also agreed to issue to the FDIC preferred stock and warrants with a combined value of approximately $12 billion. The FDIC has agreed to be responsible for any further losses on this portfolio.

"The transaction, which has been approved by the Boards of Directors of both companies, is subject to: approval by Wachovia’s shareholders; to the occurrence of the closing by December 31, 2008; definitive documentation; regulatory approvals; and other customary closing conditions.

"The deal is expected to be accretive to Citi’s earnings from year one excluding a total of $3.7 billion in pre-tax restructuring charges for severance over the next four years, and expected to be fully accretive in 2010.

"Citi expects to raise $10 billion in common equity in connection with this transaction and reduce its quarterly dividend to 16 cents per share, effective immediately, to maintain the company’s strong capital position. On a pro forma basis for the second quarter ended June 30, 2008, Citi’s Tier 1 capital ratio is expected to be 8.8% assuming completion of the transaction."

Sunday, September 28, 2008

Bailout bill ready for a vote

Looks like both sides of the aisle hammered out a compromise bill over the weekend. You can read a draft of the plan here. Or, if you don't feel like reading all 100+ pages, here's a quick summary from the Washington Post:

"The bill gives Paulson the entire $700 billion that he sought, but not all at once: He has $250 billion immediately to begin purchase of the troubled assets. He can get an additional $100 billion on the president's authority, and the final $350 billion if the president submits a written report to Congress requesting the sum. Lawmakers will have 15 days to deny the request.

"According to the bill, the secretary must report to Congress and give a detailed accounting of purchases for every $50 billion in troubled assets he purchases.

"The bill establishes a Financial Stability Oversight Board that would include the chairman of the Federal Reserve, the Treasury secretary, the director of the Federal Home Finance Agency, the chairman of the Securities and Exchange Commission and the secretary of housing and urban development.

"The bill also requires federal entities that hold mortgages and mortgage-backed securities to develop plans to minimize foreclosures.

"The bill raises the U.S. debt ceiling from $10 trillion to $11.3 trillion.

"If, five years from now, the government has not recouped its money, the president must submit a report to Congress proposing ways to make up the shortfall from the financial industry."

Incidentally, the bill also has a couple of other provisions related to mark-to-market accounting and and the Fed paying interest on required reserves. Per the Wall Street Journal:

"A summary of the legislation also indicates that the Securities and Exchange Commission will be given the authority to suspend mark to market accounting rules if the agency deems it necessary. And the legislation authorizes the Federal Reserve to start paying interest on the regulatory reserves it requires financial firms to hold for capital adequacy reasons in 2008, rather than in three years' time as it is currently scheduled to do."

Friday, September 26, 2008

Everybody's working all this weekend (in Washington, anyway)

I've been quiet on the posting front because I don't know what else to say at this point. I believe it's highly likely there will be some form of bailout plan released over the weekend. The real question is whether it will "work" -- in terms of curing the credit market and the economy. I'm somewhat skeptical on those fronts, though I'll reserve my judgment until I see what actually comes out of Washington.

Why am I skeptical?

First, this bailout may help some banks avoid some additional losses, but it won't help all banks do so. Depending on what the government pays for these crummy assets going forward, the plan could actually cause even MORE losses. And let's say the government does agree to pay above-market prices for assets. Market players aren't stupid. They know the "real" prices are likely lower. So confidence in the balance sheets of the very banks the plan is supposed to support could become a real issue.

Plus, the sheer magnitude of bad debt out there is enormous. Even if the government buys some bad paper, plenty more loans will still sour, plenty more banks will see earnings tank, and more banks will likely fail.

Second, the bailout package won't magically make lenders take on huge risks again. After all, they've been burned badly in the past year. I don't think we'll see the ridiculously easy residential mortgage, commercial mortgage, auto loan, credit card, and leveraged buyout lending that we saw from 2002 through 2007 for a long, long time. I'm talking years, not months or quarters.

Third, the cost of this bailout could be gigantic. Even before this latest proposal, the U.S. had committed up to hundreds of billions of dollars to various rescues. That includes more than $25 billion to bail out Bear Stearns, $100 billion each for Fannie and Freddie, and $85 billion for AIG. Treasury has also floated the idea of spending billions more to backstop money market funds (the ultimate cost is unknown). Not to be left out, the auto industry looks like it's getting its own $25-billion bailout in the form of government-supported low interest loans.

And of course, the latest package has an initial price tag of up to $700 billion. All told, we're looking at more than $1 TRILLION in bailouts — and it's not like we have all that money sitting in a bank somewhere. We're a nation that spends much more than it earns, and borrows the rest.

The White House was ALREADY projecting that the 2009 federal deficit would be $482 billion. Now, with the additional bailouts announced and proposed, we could be looking at tacking another $1 trillion — or more — onto that number. This would push the budget deficit so far into the red, we'll all be swimming in crimson ink.

To fund those deficits, we're going to have to borrow a huge amount of money. The Treasury just held a record $34 billion sale of 2-year Treasury Notes. That was followed by a $24 billion sale of 5-year Notes, the biggest such sale in more than five years. Those numbers will only go higher with time. This is why Congress is talking about raising the federal debt ceiling to $11.3 TRILLION.

All the additional bond supply will likely drive bond prices lower and interest rates higher. Indeed, 10-year Treasury Note yields have already climbed from a low of 3.39% to 3.85%. That will blunt the impact of the bailout by driving financing costs higher on all loans whose rates are benchmarked to Treasuries.

Lastly, this crisis long ago stopped being just a financial one. This bailout bill won't prevent the "real" economy from sliding into recession. Witness the poor news on the durable goods and employment front this week. With all the money we're spending on the bailout bill, what funding does that leave for other potentially helpful government efforts, like stimulus packages?

Anyway, it will be an interesting weekend and fascinating Monday. Rest up!

Thursday, September 25, 2008

Wamu fails, bailout plan update

Here's a quick update from the Wall Street Journal web site regarding Washington Mutual:

"J.P. Morgan Chase & Co. was expected to announce as early as Thursday night a deal to acquire the bulk of Washington Mutual Inc.'s operations in a deal that would mark the end of independence for what once was the largest U.S. thrift.

"Federal regulators have been heavily involved in orchestrating the transaction, which comes as WaMu was besieged by a mountain of bad mortgage loans. WaMu, of Seattle, has been scrambling to find a solution and put itself on the auction block last week. A number of interested parties have been studying WaMu's books, but the bank didn't receive any offers.

"While the exact structure of the transaction wasn't immediately known, J.P. Morgan is expected to acquire Washington Mutual's deposits and branches, as well as other operations.

"The deal isn't expected to result in any hit to the bank-insurance fund, which would be a huge relief given that some analysts worried that a failure of the thrift could cost more than $20 billion."

UPDATE: More details should come out at 9:15 this evening, when JPMorgan is scheduled to hold a conference call on the matter, per the New York Times.

Meanwhile, some resistance from Republicans, including Senator Richard Shelby of Alabama appears to be throwing a wrench in the bailout plan works temporarily. From the New York Times:

"The status of a rescue plan for the nation’s financial system was in doubt, at least for the moment, on Thursday as lawmakers emerged from a White House meeting with President Bush to say that negotiations have a ways to go.

“My hope is that we can get a deal,” said Senator Christopher J. Dodd, chairman of the Senate Banking Committee, hours after House and Senate negotiators had announced that an accord was at hand. It had also been President Bush’s hope that an agreement could be announced after the late-afternoon meeting.

"Looking tired and annoyed, Mr. Dodd complained that late complications were making the episode sound more like “a rescue plan for John McCain,” the Republican presidential candidate, than one for the country’s financial system.

"It does no good, Mr. Dodd said, “to be distracted for two or three hours by political theater.”

"The senator was apparently alluding to a growing revolt by conservative House Republicans against the proposed $700 billion rescue, and the fact that Senator McCain has not yet endorsed the plan, whose concept runs contrary to the policy positions he has taken for years."

UPDATE2: The FDIC and JPMorgan have more on Wamu. Here is the FDIC release. The release refers to the OTS "closing" Wamu, which would likely make this the biggest bank failure in the history of the country.

New home sales plunge 11.5% in August


The latest new home sales figures were just released by Census. Here's a breakdown of the numbers ...

* Sales collapsed 11.5% to a seasonally adjusted annual rate of 460,000 in August. That was much worse than the average forecast, which called for a 1% decline to 510,000 units. Sales were down 34.5% from the year-earlier 702,000.

* Regionally, sales plunged 31.9% in the Northeast and 36.1% in the West. Sales fell 2.1% in the South, but climbed 7.2% in the Midwest.

* The supply of homes for sale continues to decline -- by 4.4% to 408,000 units in August from 427,000 in July. However, on a months supply at current sales pace basis, inventory rose to 10.9 months from 10.3 months in July. The cycle high was 11.2 months in March.

* Median home prices fell 5.5% to $221,900 in August from $234,900 in July. They fell 6.2% from a year earlier.

New housing sales took a header in August as mortgage market tightness and economic weakness hit home. We haven't seen sales this low since January 1991. Exclude that one month and you'd have to go all the way back to August 1982 to find a worse month for the new home market.

The "good" news, if there is any here, is that the supply of homes for sale continues to fall. We have seen builders cut back aggressively on construction plans and activity, and that will eventually restore some balance to the supply/demand equation. Unfortunately, the existing home market is still larded up with inventory. So the housing market overall will likely continue to struggle, with prices under pressure through 2009.

Orders, claims figures show "real" economy slumping

It seems like some form of bailout bill is all but a done deal at this point, though we're still waiting on the details. In the meantime, the "real" economy (as opposed to the financial one) is showing signs of slumping fast.

Durable goods orders plunged 4.5% in August – more than double the 1.9% decline that economists were expecting. A key measure of business spending, non-defense capital goods orders excluding aircraft, tanked 2%. That was the largest decline since January 2007.

Meanwhile, initial jobless claims soared to 493,000, the highest since the period right after the 9/11 terrorist attacks. Some of that gain stemmed from Hurricanes Ike and Gustav. But the trend higher is clear, and a sign of real economic weakness. Continuing claims ramped up to 3.542 million, the highest level in five years.

Wednesday, September 24, 2008

Biggest Chevrolet dealer turning out the lights

In yet another sign of how the spreading credit crunch is impacting the "real" economy, the biggest Chevrolet dealership in the world (and 13th largest dealership group in the U.S., according to Automotive News) is reportedly shutting down today. The firm had 2007 revenue of $2.13 billion. Here's more from the Orlando Sentinel ...

"Bill Heard Chevrolet of Sanford closed its doors at the end of business Wednesday, part of a shutdown of all 13 of the Georgia-based Bill Heard Enterprises dealerships nationwide.

"Whether the store will reopen under new management, or by Chevrolet itself, remains to be seen.

"According to a statement from Bill Heard Enterprises about 2,700 employees will be affected by the closings.

"The company blamed "rising fuel prices, a product portfolio of mostly heavy trucks and sport utility vehicles, economic recession, unfavorable local market conditions for vehicle sales, the crisis in the banking and financing sectors, and other factors all combined to create a business environment in which the company simply did not have the resources needed to continue to operate.''

"Susan Garontakos, GM's manager of dealer communications in Detroit, said that Chevrolet has no ownership stake in the Bill Heard operation, and she had no knowledge of whether the Sanford dealership will remain open. GM does have the option, she says, of essentially running the dealership for a "brief" period of time while a new owner is sought.

"Meanwhile, Garontakos stressed that Bill Heard Chevrolet customers will be taken care of, if not by that dealership, then by nearby stores. Still, customers who have ongoing transactions with Bill Heard must deal with that company, as "our dealers are independent businesses, and General Motors is not directly part of that process."

"Heard's 13-dealership network includes the store in Sanford and one in Tampa, as well as dealerships in Nevada, Texas, Tennessee, Alabama and the comany's home state of Georgia. Heard, bileld as "Mr. Big Volume," shut its Chevrolet dealership in Scottsdale, Arizona earlier this month."

August existing home sales slump 2.2%

The National Association of Realtors just released August existing home sales figures. Here's what the numbers showed ...

* Sales fell 2.2% to a seasonally adjusted annual rate of 4.91 million in August from 5.02 million in July (previously reported as 5 million). That was worse than the average forecast of 4.94 million home sales. Sales were down 10.7% from the year-earlier reading of 5.5 million.

* Regionally, sales dropped 6.6% in the Northeast from a month earlier. They also fell 5.3% in the West. Sales inched up 0.5% in the South and 0.9% in the Midwest. By property type, single-family sales dropped 1.4% and condo sales tanked 8.2%.

* The supply of homes for sale fell 7% to 4.255 million units in August from 4.575 million in July. Inventories were also down from 4.383 million a year earlier. On a months supply at current sales pace basis, inventory slipped to 10.4 months from 10.9 months in July. That was up from 9.6 months in August 2007.

* Median home prices dropped 3.4% to $203,100 in August from $210,300 in July. They fell 9.5% from $224,400 a year earlier, the biggest drop on record and the 12th month in a row of price declines.

The housing market continued to spin its wheels in August. Sales hovered around the 5 million unit mark for another month. Home prices fell from year ago levels for the 12th month in a row. And the supply of homes for sale held in the low 4-million unit area, well above the long-term average and close to July's record.

That being said, the rate of deterioration in home sales is easing and the absolute number of homes for sale may be close to topping out. Sales have actually started picking up in select markets -- especially the hardest-hit ones, where prices have plunged the most. That's a sign that the market works. Government assistance programs can help around the edges. But time and price are the real cures for the housing market slump. Or stated another way, lower home prices are part of the SOLUTION, not the problem.

LIBOR surging ... Buffett taking a bite out of Goldman ... Fed raining Mo' Money on the world

You know what's wrong with today's market? It's just too boring. There's nothing to write about and nothing to watch. Wake me up when something happens. (Just kidding, by the way)

A few things that caught my eye this morning:

* LIBOR rates are surging in the money market again. 1-month LIBOR rates jumped 22 basis points to 3.43%, while 6-month LIBOR surged 24 bps to 3.70%, according to the British Bankers Association. That's the highest since January and not so good news for those with ARM adjustments coming due. Many ARMs (and corporate loans, for that matter) use LIBOR rates as the benchmark to which their rates reset.

* Goldman Sachs is catching a bid this morning on news it's raising $5 billion from Warren Buffett's Berkshire Hathaway investment firm. Buffett is purchasing perpetual preferred shares yielding 10%, and getting warrants to buy another $5 billion in common shares at $115. Goldman also sold 40.65 million comon shares at $123 this morning, good for $5 billion total.

* Meanwhile, the Federal Reserve is setting up more swap lines with more foreign central banks. It will help rain $30 billion more dollars on the world to ease the global funding crisis. The new swap lines will be established in Australia, Denmark, Norway, and Sweden.

UPDATE: More chaos is evident in the credit markets this a.m. Yields on 3-month Treasury Bills, for instance, are plunging anew. They are down about 26 basis points to just 0.46%, BELOW the panic levels set last week (around 0.73%). Those swap spreads are also rising again, with 2-year swaps up around 142 bps this morning (vs. an intraday high of 157 on 9/18).

Tuesday, September 23, 2008

Bernanke, Paulson Senate testimony continues

I've been following the Senate Banking Committee testimony of Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson all day, so my posting has been minimal. But if you want to see their prepared statements, you can click here (Bernanke) and here (Paulson).

In general, Congress appears reluctant to just give Paulson the blank check he is looking for. There are also a lot of questions about the way the government will determine what to pay -- and how the prices it does pay will impact other institutions. I'm also hearing questions about why taxpayers aren't getting more for their money (i.e. warrants or some kind of vehicle for them to profit if bailout banks eventually recover).

Monday, September 22, 2008

Belated thoughts on the latest multi-billion dollar bailout scheme

Greetings everyone. There's a very simple reason I haven't been posting: I was away on vacation for a few days. And wouldn't you know it? The trip just happened to coincide with some of the most tumultuous times in financial market history. Rest assured I was keeping up with the news (I was in Boston, not Botswana, after all), just not taking extra time away from family and friends to blog about it.

So what are my thoughts on this gazillion dollar bailout of the financial system?

Well, if unfettered American capitalism wasn't already on its deathbed due to the earlier bailout efforts, it's lying on a cold slab somewhere now. For better or for worse, the government is now intimately involved in everything from the pricing of mortgage backed securities (via Treasury's plan to manipulate MBS yields by sopping up MBS in the open market) ... to the insurance business (via its bailout of AIG) ... to the pricing of certain financial stocks (via the ridiculous move by the SEC to ban shortselling -- but only for companies the government has deemed don't deserve to go down).

So much about this bailout package is unknown at this point, too. Will it truly end up costing U.S. taxpayers $700 billion? Or will they make out much better eventually if the government buys assets on the cheap, holds them for a long time, and then sells them at a profit once the crisis has passed? Speaking of buying on the cheap, how exactly will the government determine the price it pays? There are hazards in paying too little and in paying too much, as the New York Times notes today:

"Perhaps the biggest question about the Treasury’s acquisition plan is how the government will decide how much it is willing to pay for the loans and securities it acquires. Will the government drive a hard bargain and acquire assets for the lowest possible price to protect taxpayers against losses? Or will the Treasury Department, in the interest of jumpstarting the credit market, try to bolster large financial institutions like Citigroup and Washington Mutual by paying a slight premium to the markets’ valuation of these troubled assets? Over the weekend, Treasury said it might use “reverse” auctions in which financial institutions rather than the Treasury — as buyer — would submit bids."

What else might get tacked onto any bailout legislation? That's up in the air as well. Democrats are mulling several possible additions, including a provision that would allow bankruptcy judges to cram down mortgage loans and one that would restrict CEO pay. There is also talk of requiring banks that participate in the program to grant warrants or shares to the government. That would allow taxpayers to later recoup some of the cost of bailing the companies out now.

Finally, there's the biggest question of all to consider: How the heck is the government going to pay for all this? It's not like we're a surplus nation or anything. We're already running a large budget deficit. We've already committed vast resources to bailing out Fannie Mae, Freddie Mac, AIG, and Bear Stearns. And now, we're talking about adding as much as $700 billion more in bailout costs to the mix? No wonder Treasuries have gotten trashed in the past couple of days, and the dollar has fallen out of bed.

Bottom line: There are no easy answers at this stage, only a lot of unanswered questions.

Thursday, September 18, 2008

It's raining dollars, hallelujah

Global central banks are really opening the taps this morning, with the Federal Reserve raining dollars around the world via special agreements with other central banks in Europe and Asia. Obviously the effort is directed at the faltering credit and stock markets, with have been melting down this week. More details from Bloomberg:

"The Federal Reserve almost quadrupled the amount of dollars central banks can auction around the world to $247 billion in a fresh coordinated bid to ease financial markets facing their worst crisis since the 1920s.

"The Fed increased the amount of dollars that European Central Bank, Bank of Japan and other counterparts can offer from $67 billion ``to address the continued elevated pressures in U.S. dollar short-term funding markets.'' The Bank of England, the Bank of Canada and the Swiss National Bank also participated.

"Finance officials have struggled to restore confidence in markets this week as investors stockpiled money amid mounting concern more banks will follow Lehman Brothers Holdings Inc. into bankruptcy. The cost to hedge against losses on U.S. government debt climbed to a record yesterday, the U.K. government was forced to sponsor a rescue of mortgage lender HBOS Plc and Russia poured money into its banks.

"There's a complete lack of faith in the markets," said Jim O'Neill, chief economist at Goldman Sachs Group Inc. in London. "There's a lot of cash hoarding and people losing trust in banks, so the central banks are acting to relieve that. This might not be the last time they have to act."

"The rate on overnight dollar loans fell to about 2 percent as of 10:40 a.m. in London from around 5 percent before the announcement, according to Guillaume Baron, a fixed-income strategist who specializes in money markets for Societe Generale SA in Paris.

"The Fed will spray the dollars around the world via swap lines with other central banks who can then auction them in their own markets. The ECB, BOE and SNB offered at a total of $90 billion for one day today.

"Under the new arrangements, the ECB can now double its existing limit of dollars it gets from the Fed to $110 billion and Switzerland's central bank can offer $27 billion, an extra $15 billion. New swap facilities with the Bank of Japan, the Bank of England and the Bank of Canada amount to $60 billion, $40 billion and $10 billion, respectively. The arrangements are authorized until Jan. 30."

Wednesday, September 17, 2008

Credit market pandemonium


Not to incite panic or anything. But the credit markets are absolutely coming unglued this morning. A few examples:

* LIBOR rates are surging. For instance, three-month U.S. LIBOR jumped almost 19 basis points today after rising 6 bps yesterday. At 3.06%, it is well above the federal funds rate of 2%.

* The yield on the 3-month Treasury Bill is plunging -- to just 0.28% from 0.69% yesterday and 1% the day before that. This is the lowest T-Bill rates have been since at least 1954.

* A major U.S. money market fund -- Reserve Primary Fund -- "broke the buck." This is the oldest fund of its type, and shareholders yanked more than 60% of the fund's $64.8 billion in assets after losses on Lehman debt forced its net asset value below the $1 level.

* The TED spread - the difference between the yield on three-month Treasury bills and three-month LIBOR -- blew out to 280 basis points, the highest level since the 1987 stock market crash.

* 2-year swap spreads have exploded -- recently up 21 basis points to 128. This is the highest level since at least 1988 (the farthest back my data goes -- see chart above).

Housing starts tank ... AIG gets bailed ... mortgage apps soar

When it rains, it pours. And this week, it's like a monsoon out there. So much is going on, I'm struggling to keep up. So let me try to digest the biggest developments as I see them now ...

* Housing starts plunged another 6.2% in August, falling to 895,000 from 954,000 in July. That was far below the average forecast of 950,000 and the lowest level since January 1991. Single-family starts were down 1.9%, while multi-family starts tanked 15.1%. Starts overall are down 33.1% YOY.

Building permit issuance also fell sharply, by 8.9% to 854,000 units at a seasonally adjusted annual rate from 937,000. That too was below expectations for a reading of 927,000. Single family permits were off 5.1%, while multifamily permits were down 15%. Permit issuance is off 36.4% from a year earlier.

* American International Group -- AIG -- got its bailout after all. A quick recap from the New York Times on the deal:

"Fearing a financial crisis worldwide, the Federal Reserve reversed course on Tuesday and agreed to an $85 billion bailout that would give the government control of the troubled insurance giant American International Group.

"The decision, only two weeks after the Treasury took over the federally chartered mortgage finance companies Fannie Mae and Freddie Mac, is the most radical intervention in private business in the central bank’s history.

"With time running out after A.I.G. failed to get a bank loan to avoid bankruptcy, Treasury Secretary Henry M. Paulson Jr. and the Fed chairman, Ben S. Bernanke, convened a meeting with House and Senate leaders on Capitol Hill about 6:30 p.m. Tuesday to explain the rescue plan. They emerged just after 7:30 p.m. with Mr. Paulson and Mr. Bernanke looking grim, but with top lawmakers initially expressing support for the plan. But the bailout is likely to prove controversial, because it effectively puts taxpayer money at risk while protecting bad investments made by A.I.G. and other institutions it does business with.

"What frightened Fed and Treasury officials was not simply the prospect of another giant corporate bankruptcy, but A.I.G.’s role as an enormous provider of esoteric financial insurance contracts to investors who bought complex debt securities. They effectively required A.I.G. to cover losses suffered by the buyers in the event the securities defaulted. It meant A.I.G. was potentially on the hook for billions of dollars’ worth of risky securities that were once considered safe."

* Mortgage applications are surging as rates come down. The strength is largely in refinance loan apps. They jumped 88% in the week ended September 12. The purchase index, by comparison, rose just 2.4%.

Tuesday, September 16, 2008

Fed leaves rates unchanged

Here is the statement ...

"The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

"Strains in financial markets have increased significantly and labor markets have weakened further. Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

"Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

"The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

"Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Ms. Cumming voted as the alternate for Timothy F. Geithner."

Housing market index rises in September

The latest read on the housing market was just released. I'm referring to the monthly figures from the National Association of Home Builders, which showed that in September ...

* The group's overall index climbed to 18 from 16 in August. The August reading was a record low for the index, which dates back to 1985.

* The sub-index measuring present home sales inched up to 17 from 16. The sub-index measuring expectations about future sales jumped to 30 from 24. Meanwhile, the sub-index measuring prospective buyer traffic climbed to 14 from 13.

* Regionally, the index rose in all four areas -- to 22 from 16 in the Northeast, to 15 from 13 in the Midwest, to 22 from 20 in the South and to 12 from 10 in the West.

The recent decline in mortgage rates, plus the government's efforts to stimulate housing demand and reduce foreclosure activity, have brightened spirits in the housing industry. However, the biggest improvement this month was in expectations for FUTURE sales. The subindices that measure buyer traffic and current sales were more muted, each rising by just a point. We'll have to see if the positive vibes about the future translate into actual, closed sales, what with the credit markets in disarray and unemployment on the rise.

Another wild day shaping up

What more can I say? The chaos continues. AIG is the area of biggest focus in the credit market, given the gigantic size of its portfolio and the risks it is facing. From Bloomberg:

"American International Group Inc.'s ratings cut drove the cost of default protection on Wall Street banks to a record on speculation the insurer needs more cash to back $441 billion of credit derivatives.

"AIG may have to post as much as $17 billion in collateral after the company was downgraded yesterday, UBS AG analysts said. The biggest U.S. insurer by assets is seeking as much as $75 billion in loans arranged by Goldman Sachs Group Inc. and JPMorgan Chase & Co. after posting $18 billion in losses over the past three quarters, according to two people familiar with the situation.

"If AIG goes under, there could be a domino effect,'' said Andrea Cicione, a credit strategist at BNP Paribas SA in London. "AIG is very connected to the financial system and it is very connected to the real economy.''

"Credit-default swaps on the Markit CDX North America Investment Grade Index jumped 25 basis points to a record 220, according to Phoenix Partners Group prices at 7:50 a.m. in New York.

"Sellers of protection on AIG demanded a record 49 percent upfront and 5 percent a year, according to Phoenix. That's up from 33 percent yesterday and means it costs $4.9 million in advance and $500,000 a year to protect $10 million in bonds for five years.

"Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A rise indicates a deterioration in the perception of credit quality; a decline signals the opposite."

Meanwhile, the U.S. Fed and other global central banks are injecting tens of billions of dollars in liquidity into their respective financial systems. Again from Bloomberg:

"The Federal Reserve added $50 billion in temporary reserves to the banking system when it arranged overnight repurchase agreements, or repos.

"The rate for overnight loans between banks had opened at 3.75 percent, above the Federal Reserve's targetrate, as American International Group Inc.'s credit rating cut increased banks' reluctance to lend. The rate dropped to the central bank's target of 2 percent after the cash injection.

"The Fed added $70 billion in reserves to the banking system yesterday, the most since the September 2001 terrorist attacks, to bring borrowing costs down after the bankruptcy of Leman Brothers Holdings Inc. triggered a hoarding of cash. Funds opened at 3.5 percent yesterday."

Speaking of the Fed, policymakers meet today. Given all the carnage out there, they could decide to cut interest rates -- in fact, a 25-basis point cut is currently all-but-priced in (in the futures market), with the possibility of a 50-point cut rising. The federal funds rate target is currently 2%, and has been there since late April.

Monday, September 15, 2008

Apres Lehman, le deluge

I am very busy at the "day job" -- as are many of you, I'm sure, given the market events. So I'll just keep it short and sweet (actually, not so sweet, given the news) ...

The fourth biggest broker in the U.S. – Lehman Brothers – has filed for bankruptcy. Merrill Lynch, the firm with almost 17,000 retail brokers and assets of almost $1 trillion, was forced into the arms of Bank of America. AIG, the biggest insurance firm in the country, is desperately seeking to shore up its finances. It’s reportedly planning to dump assets, raise capital, and asking the Federal Reserve for a $40 billion bridge loan.

The Fed is reacting by agreeing to take on all kinds of collateral in exchange for loans. It is also boosting the size of its TSLF auctions. Who knows what the rest of the day will bring. But in the early going, the Dow is off more than 300 points, 10-year yields are plunging 20 basis points, swap spreads are blowing out, and the VIX index is toying with the 30 level. Guess this post of mine from the other day was right on target.

The economic data out today, meanwhile, was not good. Industrial production dropped 1.1% in August, far worse than the 0.3% decline that economists were expecting. The Empire Manufacturing Index for September also came in worse than expected: -7.4 vs. a forecast of +1.

UPDATE: The Dow closed down 504 points. The S&P 500 plunged 4.6%, the worst day since right after the 9/11 attacks. The VIX soared almost six full points to 31.62. Long bond futures skyrocketed by 3 10/32 in price, while 2-year Treasury Note yields plunged a whopping 45 basis points to 1.75%.

Sunday, September 14, 2008

Monday market madness

Monday is shaping up to be one heck of a wild day in the markets. Get a load of these headlines from the WSJ site this evening:

For Lehman, Liquidation Seems the Most Likely Scenario
The fate of Lehman Brothers darkened as Barclays, the sole remaining bidder for the firm, told federal regulators that it was walking away from a transaction.

Bank of America, Merrill Lynch in Merger Talks
Bank of America and Merrill Lynch are in merger discussions. Much remains uncertain and conditions were fluid.

AIG Plans Restructuring
AIG plans to disclose a comprehensive restructuring early Monday that is likely to include the disposal of major assets, including its aircraft-leasing business.

Meanwhile, the Journal reports that a special Sunday trading session has been opened to allow credit default swap traders to transact business. An excerpt:

"As word that a Barclays deal was off filtered across Wall Street, credit derivative traders scrambled to unwind their outstanding contracts with Lehman and shift their positions to other banks. CDS traders at many Wall Street firms were told to come to work immediately.

"With many trading desks open, investors rushed to buy credit default swaps tied to other brokerages and corporations, sending the cost of protection on investment banks such as Goldman Sachs and others sharply higher. One senior trader said Bank of America is offering to face Lehman's counterparties in CDS trades, as long as the swaps don't reference Lehman's own debt.

"In a statement on Sunday, the International Swaps and Derivatives Association, a trade group whose members include many large dealers, said a "netting trading session" will take place between 2 p.m. and 4 p.m. on Sunday to allow Lehman's counterparties to offset their positions against each other.

"The purpose of this session is to reduce risk associated with a potential Lehman Brothers Holdings Inc. bankruptcy filing," it said, adding that trades conducted during this period "are contingent on a bankruptcy filing on or before 11.59 p.m. New York time" today. If no filing takes place, the trades will be canceled, ISDA said."

In early Globex trading, by the way, the S&P futures are down about 38 points though anything can change between now and the New York open tomorrow.

UPDATE: The New York Times is reporting that Lehman will be filing for bankruptcy protection.

Saturday, September 13, 2008

Whither Lehman?

It will be an interesting weekend on the financial front to say the least as the world awaits news on the fate of Lehman Brothers. A noteworhty tidbit: Federal officials are telling Wall Street not to expect any government support for a takeover of all or part of the investment bank. Good for them. Market players created this mess; they should figure out how to solve it. Of course, if push comes to shove, we'll have to see whether the government stands its ground. Here's an update on the situation from the Washington Post this morning:

"Senior federal officials met last night with leading Wall Street executives to discuss the potential sale of ailing investment bank Lehman Brothers and review how an acquisition could affect those doing business with the firm, according to sources familiar with the discussions.

"Attending the emergency session at the Federal Reserve Bank of New York were Treasury Secretary Henry M. Paulson Jr., Securities and Exchange Commission Chairman Christopher Cox and New York Fed President Timothy F. Geithner, federal officials confirmed. They were joined by chief executives including John Thain of Merrill Lynch, John Mack of Morgan Stanley, Lloyd Blankfein of Goldman Sachs, Jamie Dimon of J.P. Morgan Chase and Vikram Pandit of Citigroup, sources said.

"An official of the New York Fed said the meeting had been called "to discuss recent market conditions," but declined to offer further details. Other sources said the discussions centered on a wide range of issues that would arise for Lehman's trading partners and other business associates if a rescue were launched. The sources spoke on condition of anonymity because of the sensitivity of the negotiations.

"Financial problems at the nation's fourth-largest investment bank have eroded shareholder confidence, sending Lehman scrambling to find a buyer. One major stumbling block has been the role that the government might play in such a deal.

"Federal Reserve and Treasury Department officials have pressed for a privately funded solution, while suitors for Lehman have insisted on a government guarantee that they would be protected against any losses arising from toxic assets on the bank's books, according to sources."

Friday, September 12, 2008

Retail sales weak, PPI down, confidence up

On the economic front this morning, the Producer Price Index dropped 0.9% in August, versus expectations for a decline of 0.5%. The core PPI was up 0.2% on the month, in line with forecasts. The overall PPI was up 9.6% from a year ago, down from a 9.8% rise in July. The core PPI rose 3.6%, compared with a 3.5% YOY rise one month prior. This was expected considering the decline we saw in energy prices last month.

August retail sales were the bigger story, and they were generally disappointing. Overall sales fell 0.3% against forecasts for a 0.2% gain. Strip out autos and you got a 0.7% decline, compared with expectations for a 0.2% drop. Even if you strip out both autos AND gas, you still get a poor reading: -0.4%. Food and beverage spending (+0.7%) showed some strength, as did sporting goods (+0.5%). But spending on general merchandise was down (-0.2%), as was spending on clothing (-0.3%), building materials (-2.2%), and electronics (-1.3%)

On the other hand, the University of Michigan's consumer sentiment index brightened in August -- to 73.1 from 63 (and against forecasts of 64.1). Personally, I don't find the sentiment index very useful. It seems to just move up and down with the stock market (and more recently, gas prices).

Relying on the generosity of foreign creditors

You know what's wrong with being deeply in hock to someone? To some degree, they own you. You rely on the kindness and generosity of that creditor to keep funding your excesses. So it's not exactly heartwarming to learn that our Treasury has reportedly been reduced to lobbying foreign debtholders not to dump our Fannie and Freddie securities. From Marketwatch this morning:

"Seeking to head off any unloading of Fannie Mae and Freddie Mac bonds by Japanese investors, the U.S. Treasury Department is taking the unusual step of directly contacting Japanese financial institutions about the plan to rescue the mortgage giants, according to a published report.

"Because a massive unloading of Fannie Mae holdings could hamper the U.S. government's efforts to shore up the mortgage firms' finances, the Treasury Department is effectively asking investors to refrain from doing so, Japanese business daily Nikkei said on its Website in a report dated Friday.

"According to sources familiar with the matter, Treasury Undersecretary for International Affairs David McCormick on Thursday phoned senior executives at major Japanese banks as well as the Life Insurance Association of Japan to explain Washington's plans for Fannie Mae and Freddie Mac, the report said.

"McCormick is believed to have reiterated plans announced Sunday, including seizure of both mortgage giants and the government's intention to infuse funds if necessary. During the phone calls, he is also said to have urged Japanese institutions to continue investing with confidence in Fannie Mae and Freddie Mac."

And let's be clear: The timing of the bailout of Fannie Mae and Freddie Mac was likely tied to the recent skittishness among foreign investors toward their debt. As the New York Times noted back in July ...

"For more than a decade, Fannie Mae and Freddie Mac, the housing giants that make the American mortgage market run, have attracted overseas investors with a simple pitch: the securities they issue are just as good as the United States government’s, and they usually pay better.

"The marketing plan worked. About one-fifth of securities issued by Fannie, Freddie and a handful of much smaller quasi-governmental agencies, some $1.5 trillion worth, were held by foreign investors at the end of March. One out of 10 American mortgages is, in effect, in the hands of institutions and governments outside the United States.

"Now that the two companies are at risk, how their rescue is handled will ultimately test the world’s faith in American markets. It could also influence the level of interest rates and weigh on the strength of the dollar for years to come, analysts say.

“No less than the international perception of the credit quality of the U.S. government is at stake,” said Richard Hofmann, an analyst with CreditSights, an independent research house with offices in London and New York."

Thursday, September 11, 2008

Bailouts, bailouts everywhere

It's another day of fun and excitement in the markets, with everything from bonds to stocks to currencies trading all over the map. I want to step back from the trees for a minute, though, and share my thoughts on the forest -- the big-picture trend toward "bailouts, bailouts everywhere." Some of you may agree with my stance. Some of you may disagree. But it is what it is. Here goes ...

Back in August, I asked the question: “When is enough, enough?” I wrote:

It seems like every week we get another borrower bailout initiative.

Or another multi-billion dollar package of legislation.

Or another whiz-bang Federal Reserve program that keeps U.S. banks and brokers on the dole for a few more months.

Or more recently, a blatantly transparent attempt by the Securities and Exchange Commission to squeeze short-sellers and drive stock prices higher ... but only for a select group of 19 financial companies.

And things have only gotten dicier since then! The number of companies and executives lining up at the Fed’s doorstep ... or the Treasury’s ... or the Congress’ ... looking for bailouts gets longer every day.

The U.S. auto industry, for example, is panhandling in D.C. for $50 billion or more in federally subsidized loans to revamp their factories and product lines to produce more fuel-efficient cars.

Several banks are essentially living off the Fed, with borrowing at the discount window surging to an average of $19 billion per day in the week ended September 3. That’s the highest in U.S. history and a huge increase from $1.1 billion a year ago.

And of course, we just saw Treasury bailout Fannie Mae and Freddie Mac. According to the terms of the deal ...

* The government will place the two Government Sponsored Enterprises into conservatorship, essentially taking them over.

* Common and preferred share dividends will be eliminated, and the government will buy a new class of preferred shares. This has left the original shares with little value.

* The senior and subordinated debt securities of Fannie and Freddie will be backed.

* The Treasury is going to open another secured, short-term funding facility that will be accessible to Fannie, Freddie, and the 12 Federal Home Loan Banks that support various private banking activities.

* The Treasury has also announced plans to buy mortgage backed securities in the open market. This is an attempt to manipulate the market in such a way as to drive down consumer mortgage rates.

Now here’s the thing: With each new bailout, we the American taxpayers are told, this is in the best interest of the country. And with each bailout, we’re told these bailouts are necessary to save the financial system.

Heck, if you think I’ve been bearish about the prospects for the financial industry, get a load of what Fed Chairman Bernanke had to say a few weeks ago about what would have happened if the Fed had let Bear Stearns collapse...

“Although not an extraordinarily large company by many metrics, Bear Stearns was deeply involved in a number of critical markets, including (as I have noted) markets for short-term secured funding as well as those for over-the-counter (OTC) derivatives. One of our concerns was that the infrastructures of those markets and the risk- and liquidity-management practices of market participants would not be adequate to deal in an orderly way with the collapse of a major counterparty.

“With financial conditions already quite fragile, the sudden, unanticipated failure of Bear Stearns would have led to a sharp unwinding of positions in those markets that could have severely shaken the confidence of market participants. The company’s failure could also have cast doubt on the financial conditions of some of Bear Stearns’s many counterparties or of companies with similar businesses and funding practices, impairing the ability of those firms to meet their funding needs or to carry out normal transactions.

“As more firms lost access to funding, the vicious circle of forced selling, increased volatility, and higher haircuts and margin calls that was already well advanced at the time would likely have intensified. The broader economy could hardly have remained immune from such severe financial disruptions.”

I happen to agree with him. But how come the shareholders of Bear ended up getting $10 out of the deal? How come the bondholders didn’t get a big haircut?

More importantly, we have no idea what the Bear bailout will ultimately cost. The same goes for the Fannie Mae and Freddie Mac bailout. There literally is no precise, accurate estimate of the cost to taxpayers now or in the future.

There are three more important questions people should be asking too:

1) If these firms truly are “Too Big to Fail,” how in the heck did the government let them get that way?

2) Where the heck were the regulators when these chowderheads were piling up so much counterparty risk on derivatives and complex securities, that their failures would force the government’s hand?

3) Why were they allowed to make tens of billions of dollars financing crummy subprime mortgages ... loan huge amounts of money against overpriced commercial real estate ... take on gigantic risk financing stupid leverage buyouts ... during the boom times, then come crying to the Fed and Treasury when things head south?

It’s enough to make your head spin.

I have another problem with all of these bailouts, too: If you keep weak institutions alive on the dole (by allowing them to keep swapping crummy assets to the Fed for Treasuries ... allowing them to keep rolling over short-term loans at the Fed to ensure liquidity, if not solvency ... and so on), you just make it harder for the stronger institutions to do business.

What do I mean? Go to Bankrate.com when you have a minute and look up rates on Certificates of Deposit. Or look at the ads in your local newspaper. Who is offering the highest rates? Generally speaking, it’s the banks that are in the most trouble.

Bankrate showed a 1-year CD from Washington Mutual paying an Annual Percentage Yield of 5% today. Washington Mutual is loaded down with bad mortgage debt. Stock market investors are so concerned, in fact, that they have driven WM shares down 86% year-to-date to around $2. Its main bank subsidiary has a “D+” Financial Strength Rating from TheStreet.com — fairly low on the A to F scale.

Next in line is Corus Bank of Chicago, offering a 4.6% APY. This institution was a huge lender to condominium developers and converters. It has significant exposure to the markets that experienced the biggest real estate bubbles — Florida, California, Las Vegas, and so on. Corus merits a “D” rating from TheStreet.com.

Troubled banks like these are paying so much for consumer deposits because other avenues of fundraising have been shut down. The problem is, as they offer higher and higher yields, it siphons deposits from other institutions that pay less. That forces even healthy banks to pay more for money, pressuring THEIR profitability.

In other words, it’s bad enough that propping up weak institutions sends a bad message to the market — namely, that you can take huge risks during the good times and keep all that profit, then get bailed out during the bad. It also carries other unintended consequences.

Speaking of unintended consequences, the Fannie Mae and Freddie Mac bailout allows Treasury to directly intervene in the Mortgage Backed Securities market. It can buy up however many MBS it wants, whenever it wants, with the goal of driving down mortgage rates. Trading in the MBS market determines how much you and I pay for mortgages; when MBS yields go down, so do the mortgage rates we pay.

That part of the Fannie and Freddie bailout program incited a big rally in MBS. Thirty-year fixed rates have dropped about a half a percentage point as a result. Sounds good, right?

But here’s the thing: I have never, ever seen such direct manipulation of a freely traded market by the government. You literally have the government saying: “Private investors have it ‘wrong.’ They don’t know how MBS should be priced. We do. And we’re going to manipulate this market as we see fit.”

What kind of precedent is this setting? What does it say about our supposedly “free” markets — you know, the ones we keep being told are the envy of the world? And not to sound all “tin foil hat” here, but what if one day Secretary Paulson woke up and said, “You know what? Stocks are too cheap. Let’s buy some S&P futures!” Is that really the direction we want to be headed in?

I said a long time ago my fear was that we’d end up in a Japan-like situation — facing a long, drawn out period of economic weakness. I got some pushback there. People argued that we were different ... that America dealt with its economic problems quickly ... that we wouldn’t just prop up so-called “zombie” companies for quarters or years on end, and instead let them fail. That, in turn, would let the stronger companies survive and thrive.

But look at what has happened in the past year and ask yourself: “Is that really true any more?”

I think a case can be made that we’re sacrificing the long-term principles (free markets, unfettered capitalism) that make America great just to avoid short-term pain. I also think you can make an argument that all these moves by the Fed, the Treasury, and Congress could be prolonging the crisis, rather than solving it.

So I really hope the politicians in Washington ... the big-wigs on Wall Street ... and the policymakers at the Fed and in Congress do some soul searching here. I really hope they start thinking more about the long term. And frankly, I really hope they just start letting some weaker companies fail, so that the rest of America can get back to business.

Wednesday, September 10, 2008

Warren Buffett reportedly exiting the bank deposit insurance business

I've been pretty busy, so I didn't get a chance to blog on this story in the Wall Street Journal from earlier today. But it appears Warren Buffett isn't exactly bullish on the outlook for bank safety. I say that because he is reportedly getting out of the business of covering deposits that exceed the FDIC's insurance limit. More details:

"Warren Buffett's Berkshire Hathaway Inc. has told one of its subsidiaries to stop insuring bank deposits above the amount guaranteed by the federal government, dealing a fresh blow to the financial-services industry as it tries to assuage anxious customers.

"The subsidiary, Kansas Bankers Surety Co., is notifying about 1,500 banks in more than 30 states that it will no longer offer a program called "bank deposit guaranty bonds." KBS is an 18-employee subsidiary of Berkshire Hathaway, according to the parent firm's 2007 annual report. It is one of a handful of firms that offer such insurance, a big selling point for banks trying to attract wealthy customers.

"Two people briefed on the matter said the order was made Monday by Mr. Buffett, Berkshire Hathaway's chief executive. Chuck Towle, a senior vice president at KBS, declined to comment on why his firm was leaving the business. "We have decided to do so," he said. "We'll work with each individual bank and work it out with them."

"Mr. Towle wouldn't confirm or deny Mr. Buffett's involvement, calling it "strictly rumor." Mr. Buffett declined to comment.

"Eleven banks have failed this year. Seven have fallen since July 11, a concentration not seen since the savings-and-loan crisis of the late 1980s and early 1990s. The Federal Deposit Insurance Corp. backs deposits of as much as $100,000 on most accounts or $250,000 on some retirement accounts.

"That Mr. Buffett is withdrawing from this insurance market is an indicator of how many in the industry are worried about future bank failures."

Speaking of the markets...

VIX CHART

LONG BOND FUTURES CHART

Speaking of the markets, have any of you juxtaposed a price chart of, say, the long bond futures against the VIX, the CBOE's SPX Volatility Index? Now I don't usually make stock predictions or anything like that on this blog. But it sure looks to me like the patterns are similar, but with the bonds "leading."

In other words, it looks possible to me that volatility could spike in the coming weeks, playing "catch up" to the bonds (which are trading around their panic levels from earlier this year). And of course, volatility spikes are usually accompanied by sharp stock market declines. Just some food for thought.

On the positive side of things, the initial Large Hadron Collider experiment apparently did not create a black hole that would swallow the earth. So we do have something to be thankful for this fine morning.

Lehman news is out this morning -- now we see how the market reacts

Lehman Brothers preannounced earnings (actually, big losses) this morning. Here is the press release, which details how the firm wants to spin off commercial real estate assets, how it's slashing its dividend, and how it's looking to sell a majority stake in its asset management arm. Also, here is some press coverage from Bloomberg and Reuters. Now we see how the market reacts. In pre-market trading, bonds and stocks have been all over the map -- both up and down.

Tuesday, September 09, 2008

Lehman weakness hits the market

Of all the stuff going on right now in the market, the glaring thing that jumps out at me is the sharp decline in both common and preferred shares of Lehman Brothers, as well as a widening out in its credit default swaps. The catalyst appears to be reports that talks with Korea Development Bank for an investment/buyout have ended.

Pending home sales drop 3.2% in July

We just got the latest news on pending home sales, this time for July. Here's what the figures showed:

* Pending sales dropped 3.2% in July. That was more than twice as bad as the 1.5% decline that economists were looking for, though June's reading was revised up to +5.8% from +5.3%.

* The pending home sales index, at 86.5, is down 6.8% from its year-earlier reading of 92.8. The cycle low was 83 in March.

* Geographically, pendings fell 7.5% in the Northeast and 10.6% in the West. Sales were unchanged in the South and up 2.8% in the Midwest.

The latest National Association of Realtors figures show that pending home sales remain weak, though the pace of deterioration from year-ago levels has eased. That seems to be the message from a number of indicators, including the S&P/Case-Shiller monthly data on home prices.

What about the outlook? I believe we will continue to see a weak market through 2009, though it will be more of a "slow bleed" downturn than a fresh, sharp collapse. Key catalysts: Rising unemployment, still-high levels of existing home inventory, and ongoing uncertainty in the credit markets (though it's an open question as to whether that turmoil eases in the wake of the massive government bailout of Fannie Mae and Freddie Mac).

Monday, September 08, 2008

Did he really just say that?

I highlighted Pimco fund manager Bill Gross' comments last week in which he essentially begged for an even more aggressive government bailout. We now all know that within 48 hours, the biggest bailout in U.S. history was announced.

What we also know is that as part of the bailout, the government is directly manipulating ... er ... intervening in the mortgage backed securities market to drive prices up and yields down. Who will pay for it? The Treasury, and by extension, us taxpayers. Of course, we're told that by playing hedge fund (borrowing at cheap Treasury rates and buying at dear MBS yields), this won't actually cost taxpayers anything. The Treasury will probably make money. Or at least, that's the plan.

Anyway, back to Pimco. Before publicly urging the government to bail out the housing and mortgage markets -- and going on CNBC to underscore that message -- Mr. Gross (and his investment team) positioned Pimco's Total Return Fund with 61% of its holdings in mortgage backed securities as of June 30 (per this Bloomberg story). Those MBS holdings would naturally rise in a bailout scenario, especially one like we ended up getting. And indeed, they have. Mr. Gross didn't stop there, however. He just went on CNBC again and basically spelled out his investment thesis as follows: You want to buy MBS now and then sell them back to the Treasury later, hopefully at a higher price.

So in a nutshell -- a huge bond fund manager buys up paper that would benefit from a taxpayer-funded government bailout ... goes public with an aggressive "we need a bailout out now" pitch ... gets his wish ... and then openly admits that he wants to make money by dumping that paper back to the Treasury (read: taxpayers). Or in other words, he wants U.S. taxpayers to basically help his bond fund make money. Nice work if you can get it.

There's is some other interesting reading on the Fannie/Freddie situation at other sites today, including this piece from Minyanville and this one at Housing Wire.

More thoughts on the bailout and post-bailout action

Hey, did you hear that Fannie Mae and Freddie Mac got a government bailout? Thought so. Now it's time to assess the fallout. Some notable details:

* Fannie Mae and Freddie Mac common shareholders are getting crushed. Fannie Mae is down more than 83% as I write to a buck and change. Freddie Mac broke the buck at one point, setting an intraday low of 88 cents (vs. a Friday close of $5.10). The preferreds aren't having a good day either. You know those Fannie Mae 8 3/4% preferreds sold in May at a par value of $50? They're going for about $2.20 right now, off 87% on the day. Oops.

* At the same time, Fannie and Freddie debt spreads are collapsing. Case in point: The spread on Fannie Mae 10-year paper vs. 10-year Treasuries is down about 23 basis points to around 52 bps. That's a huge decline on par with what we saw post-Bear Stearns. What about the mortgage backed securities market? Well, rates on current coupon 30-year Fannie Mae MBS are down around 29 bps. It's reasonable to expect fixed-rate mortgages to decline into the mid-to-high 5s from the low-to-mid 6s.

* The dollar was initially sold off hard on the news. But it rallied back in the early morning hours. U.S. Treasuries initially tanked, with the long bond futures getting all the way down to the 118 area (from 119 30/32 on Friday). But bond futures are now down only about 10/32. 10-year Treasury yields are only up about 1.5 basis points (after being up about 15 bps in the early going).

* Stocks loved the news, with the Dow Jones Industrial Average up about 300 points in the early going. But it has since pared some of those gains. Part of the problem? Other financial institutions that have been concerning investors aren't having a good day. Shares of Lehman Brothers are down about 17% as I write, while shares of Washington Mutual have given up early gains. Washington Mutual, for its part, jettisoned its CEO and announced a memorandum of understanding with its regulator, the Office of Thrift Supervision. You can read more here and here.

Now that that's out of the way, the obvious question is "What do I think about what happened?" I understand why some kind of bailout was probably necessary. I understand why it happened. And I'm pleased to see that some "pain" was meted out -- to common and preferred shareholders and Fannie and Freddie executives. That's what should happen when taxpayer money is being committed to rescue financially troubled firms.

But this whole "let's buy MBS to drive down mortgage rates" component of the plan really smells. Yes, it's well intentioned. But you know what they say about the road to hell and all that. Essentially, we will now have the Treasury Department deciding when and if mortgage bonds are too cheap ... and when it judges that they are, it will use taxpayer money to manipulate the market until prices are "right." Huh?

Not to get all tin-foil-hat here, but what kind of precedent does that set? What if the auto lenders ... or the commercial real estate guys ... start to make a stink about how spreads on ABS and CMBS are too high, and how that's hurting the ability of consumers to buy cars or developers to finance commercial projects? Could the Treasury be authorized to jump in and buy ABS and CMBS to drive spreads lower?

Or how about the stock market? Higher stock prices make everyone richer right? So why shouldn't the government borrow money at low Treasury rates and buy higher-yielding stocks or just S&P futures? That's "good" right?

As I said a couple weeks ago:

"This is the problem with bailouts. You do it for someone, you have to do it for everyone."

Sunday, September 07, 2008

The unprecedented bailout of Fannie Mae and Freddie Mac is official

Details of the unprecedented bailout of the GSEs have been released by Treasury. Full details and links can be accessed here.

Here too is coverage from the Wall Street Journal:

"U.S. federal regulators outlined their takeover of Fannie Mae and Freddie Mac Sunday morning, including control of the firms by their regulator and a Treasury Department purchase of the firms' senior preferred stock.

"The plan, outlined jointly by the Treasury Department and Federal Housing Finance Agency, also includes a plan for the Treasury to purchase mortgage-backed securities from the firms in the open market, and a lending facility through the Treasury from its general fund held at the Federal Reserve Bank of New York.

"Treasury Secretary Henry Paulson said the two firms are "critical to turning the corner on housing" and that the plan should promote stability in the secondary mortgage market and lower the cost of funding.

"Through the four actions we have taken today, FHFA and Treasury have acted on the responsibilities we have to protect the stability of the financial markets, including the mortgage market, and to protect the taxpayer to the maximum extent possible," Mr. Paulson said.

"Mr. Paulson acknowledged that the radical proposal does pose risks for U.S. taxpayers, giving the U.S. government a "large stake in the future value of these entities."

Of all the components of this plan, the idea of Treasury purchasing MBS in the open market is the most striking. Our government is now officially in the business of deciding whether MBS pricing is "correct" or not, and intervening at will to manipulate pricing in the MBS market. For good intentions, of course (the desire to lower mortgage rates). But this is one heck of a scary precedent.


 
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