Financial, Real Estate, Stock Markets Trends and Current Affairs

Excerpts from Roubini's most recent blog post.
Many have witnessed my espousing the very same viewpoints here. I don't
always agree with the man, but he is salient and intelligent and he is
definitely on point with this post:

... Let me now
flesh out how the crisis is becoming more severe and increasing the
risk of the mother of all financial meltdowns…

First note that in
spite of the most radical change in Fed policy since the Great
Depression – i.e. the extension of the Fed’s lender of last resort
support to non bank primary dealers and the announced swap of up to
$400 bn of safe Treasuries for toxic agency and private label MBS again
make available also to non bank primary dealers – the panic in money
markets and interbank markets is now seriously worsening: today the
yield on 3 month Treasuries plunged to 0.56, a level not seen since the
1950s; the TED spread (the difference between dollar Libor and 3 month
T-bills) increased 32 basis points to 1.98 percentage points; swap
spreads widened again; while the VIX spiked to a level close to 30;
even off-the-run long dated Treasuries are becoming illiquid (as in the
1998 LTCM crisis). The situation in money markets is scary as there is
a generalized flight to safety with investors avoiding everything but
the most liquid and safe government bonds.

In the meanwhile the
liquidity and credit crunch in the agency debt and MBS market is
worsening in spite of all the Fed recent easing actions and in spite of
the Fed decision to swap Treasuries for hundreds of billions of agency
and private label MBS: the difference in yields for Fannie Mae's
current-coupon, 30-year fixed-rate mortgage bonds and 10- year
government notes widened again both yesterday and today. So the radical
decision of the Fed to prop the agency and non-agency MBS market with
$400 bn of swaps has done very little to affect the liquidity and
spreads of these markets. This is no wonder as Fannie and Freddie are –
on a mark to market basis – effectively insolvent and the widening in
their debt and MBS spreads reflect the worsening credit outlook for
their assets, not just a situation of illiquidity.

These
extreme dislocations in money markets and credit markets are
slaughtering a variety of highly leveraged hedge funds and other funds
that deluded themselves that high leverage could provide high returns:
after the Carlyle Capital Corp, the Endeavour fund lost 25% of its value on wrong JBG “box trade” bets while the bond fund of Meriwether (of LTCM infamy) lost 24%
on the crash in credit markets. Martin Wolf correctly pointed out today
in his FT column that many hedge funds – run by mediocre managers – can
make money for a while only following highly leveraged and risky
strategies. These strategies are being smashed in this period of market
turmoil and volatility. So, expect the bloodbath among hedge funds
triggered by the market turmoil, the liquidity crunch and the forced
deleveraging that margin calls trigger to worsen in the weeks ahead.
And with spreads on even “safe” AAA agency and private label debt and
MBS being so wide expect another round of massive writedowns that will
lead to the bankruptcies of a wide range of leveraged institutions
(hedge funds, broker dealers and other members of the shadow financial
system).

Today we are facing a massive margin call on highly
leveraged US capital markets and a massive de-leveraging of the
financial system following fire sales of marked to market assets in
vastly illiquid money markets, credit markets and derivatives markets.
We are thus close to the last steps of my 12 Steps to a Financial Disaster.
Each of these 12 steps is now underway and the only question is not
whether such steps will take place but rather how severe they will be
and how big the losses will be. We are now observing – with the Bear
Stearns episode as well as with the collapse of the SIVs, the losses on
money market funds and the collapse of hedge funds and highly leveraged
funds – the beginning of a generalized run on the shadow financial
system...

The Fed response to this run has been to provide the
Bear Stearns bailout and provide both liquidity and swap of illiquid
and toxic assets for safe Treasuries to the non-bank primary dealers.
But these radical and risky actions of the Fed - as the collateral for
this lending is now toxic – are not achieving their goals: in the short
run the risk of a run on a Lehman may have been reduced; but what is
happening in the money markets and in the agency markets shows that the
Fed can only affect partially liquidity premia, not credit premia; and
spreads are widening for a wide range of money markets and credit
markets because of widening credit spreads driven by sharply rising
counterparty risk.

The lack of trust of financial institutions
in their counterparties is surging in spite of all the Fed actions as
panic is setting in money markets and credit markets. Thus, providing
access to a dozen broker dealers who are primary dealers does nothing
to ease the credit risk and liquidity/rollover risk of thousands of US
and global institutions that are part of the shadow financial system.
In a mark to market world many of these highly leveraged institutions –
including large broker dealers other than Bear Stearns – are
effectively bankrupt and no Fed action can rescue them. And the run on the shadow financial system has barely started.

Thus
the piecemeal approach to crisis management taken by the Fed, the
Treasury and other financial authorities is going to fail miserably. A
severe recession and a severe financial crisis cannot be avoided at
this point. Only much more radical government action will limit the
financial meltdown and start to put a floor on the financial markets
collapse. This government intervention would not be aimed to prevent
the necessary adjustment of asset prices; it would be aimed at ensuring
that the necessary adjustment is not disorderly...

Claiming the
Bear Stearns was not bailed out because the current shareholders got
only $2 per share is disingenuous: this was a massive bailout as the
Fed put $30 billion of cheap credits in the pot: without this massive
financial support not only the shareholders would have been wiped out
100% as they deserved to (rather than keeping the option value that the
government support will recover in due time the value of their shares);
but also many of the creditors of Bear Stearns would have experienced
massive losses as Bear was insolvent and unable to pay such creditors
with its impaired assets. Instead the $30 bn Fed support represents a
major subsidy for JPMorgan and a major bailout of Bear’s creditors.
Effectively the Fed has taken on its balance sheet the entire credit
risk of $30 of toxic securities held by Bear Stearns. So, this Fed
bail out is an explicit case of using the disastrous Japanese model of
a “convoy system” (healthier banks taking over zombie banks with the
help of lots of public money) that led to a decade of economic and
financial stagnation.

A market solution to this crisis does not
exist; those who believe in such markets solutions are deluding
themselves as markets left alone will melt down and enter into the
mother of all meltdowns, margin calls, cascading collapse of asset
prices, massive credit crunch and liquidity seizure and severe economic
recession.

Of course the price adjustment in overpriced asset
prices should not and cannot be avoided: home prices will have to fall
at least 30%; equities will need to sharply correct in a bear market;
risk spreads will have to widen sharply; many institutions will go
bankrupt as they should. But what we risk today is a systemic financial
meltdown where negative feedback loops lead asset prices to collapse
much more than justified even by the much lower fundamental value of
such assets...