Financial, Real Estate, Stock Markets Trends and Current Affairs

Accordign to Plender in the Financial Times, the role of the Fed is to play market maker of last resort if there are no efficient markets. The argument can be made that the markets are efficient and the MBS and derivative securities written on top of the asset bubble are, when the bubble pops, the trash that the market is pricing them to be. Nonetheless, it truly appears that Bernanke's Fed is using a for profit LLC ran by Blackstone to sell off assets from Bear Stearns under financing from the Fed. They are orderly and sytematically dismantling the illiquid Bear Stearns portfolio, and consequently trying to make a market. I am very curious to see who buys these and for how much. I wouldn't hold my breath waiting for the tax payers to get their $29 billion dollars used to finance these securities back, that's for sure.

On a related noted, I don't think many banks are holding their breath either...

Hoarding by banks stokes fears on credit crisis

Central banks’ efforts to ease strains in the money markets are failing to stop financial institutions from hoarding cash, stoking fears that the recent respite in equity markets may not signal the end of the credit crisis.

Banks’ borrowing costs – a sign of their willingness to lend to each other – in the US, eurozone and the UK rose again even after the Federal Reserve’s unprecedented activity in lending to retail and investment banks against weaker than usual collateral and similar action in Europe.

Recent news bytes:

• Bloomberg: Treasuries rose and three-month bill rates plunged to to 0.56%,
  the lowest level in almost 50 years on speculation credit market losses
  will widen (e.g. ex-LTCM Meriwether's fund facing losses, Thornburg
  Mortgage Inc. may go bankrupt, Merrill suing monoliner over recalled
  $3.1bn CDO guarantee)
• RGE Montitor: Flight to quality trades:
  -
  The rate on the three-month Treasury bill, viewed by investors as a
  haven in times of trouble, dropped 32 basis points to 0.56% on Feb 19;
  - Capital preservation trade: buy Treasuries sell stocks;
  - TED spreads (= LIBOR- T-Bill) spiking upwards in all markets
  - 2-year swap spreads widening
• BNP:
  Signs of interbank lending stress and liquidity hoarding eased after
  Fed actions on March 16/17; spreads on the rise again in US, UK and
  Euro market. Interbank spread decomposition shows that crunch is driven
  by upward trending credit premium since 2008 instead of liquidity
  premium as was the case in H2 2007. Fed interventions ultimately can
  address liquidity, not credit concerns.
• Fed, BoE, ECB intervening in their respective markets
• Krugman:
  Flight to quality and cash hoarding lead to Treasury yields close to
  zero--> if there is no compensation for holding Treasury paper,
  investors prefer to hold cash--> normal monetary policy channel via
  buying and selling of Treasuries breaks down (i.e. liquidity trap). He also points out that TED spreads - between 3-month Libor and 3-month treasuries - are now
  back to where it was, saying that the results of the rate cut and the
  new liquidity measures must be disappointing to the Fed.
• Yves Smith
  at Naked Capitalism backs up my assertion that all attention has focused so far on US banks, but European banks are in at least as much trouble, citing research that some European banks have written off senior and
  mezzanine tranches of CDOs to a large extent, while others have not at
  all, quoting CreditSights, whose model indicates a shortfall in
  write-downs of over $3bn for Barclays, RBS and SocGen, and of over $6bn
  for UBS .

Lehman
has been in my bearish sites, but until now I have not put the
microscope on them. That will change very soon. I am also intensifying my
research on Morgan Stanley since I feel they carry the most credit
risk, leverage and level 3 asset concentrations (bullsh1t risk) on the
street. I will also start covering the borrow short buy long funds that have been going bust lately like TMA and Carlyle Capital which are still over $10 per share. I had a short position on KFN, which I unfortunately closed out a while back. I am looking into to going back in, although to do so would be a bet that they will be wiped out of existence since their share price has fallen so much thus far. They have the exact same problem Carlyle Capital has (had?).

I am very close to spreading out to the European and Asian banks. I know they are in serious trouble, it is just that I have but so much to dedicate in analytical resources and time. I hate running in blind. Anyone who has experise in any of these areas (or any other areas of interest), feel free to start a post, thread or user group - or contact me to share info and thoughts.

The Naked Capitalism Blog
alleges the collateral pledged by prime brokers to the Fed via commercial
banks will be valued by the commercial banks. Since they often hold the
same collateral, this facility may induce them not to write down their
own assets and put on excessive valuations. One way to counter this is to try to identify the classes of assets and put our own gross marks on them. This is what I did with GGP and the monolines. It may not be the most accurate in some cases. GGP is quite accurate in my opinion due to ample supporting data and proven robust modeling, the monolines were educated guesses just like everyone else's opinion on valuation. What makes the monoline situation believable is that you can be off by a whopping 25% and still see how they are in trouble because the losses x leverage x macro trend is not very ambiguous.

...and for those who haven't read the popular Money Trap article, click here,

From aroung the web:

• S&P (via Bloomberg): S&P 500 at its most volatile in 70 years. Index has advanced or declined 1% or more on 28 days this year - 52% of trading sessions so far, the highest proportion since 1938
• BNP: Current level of risk aversion is higher than during the 80/82, 90/91 and 2001 recessions (NBER definition) as well as during financial shocks like 1987's Black Monday and 1998's LTCM collapse
• VIX has been volatile this week, dropping to 25 on Fed cuts Mar 18, then headed above 32 the following day and now back below 30 again
• Merrill Lynch Fund Managers Survey: Risk aversion highest since 9/11 2001. A net 41% of fund managers are overweight cash
• DBS: Credit risk premia remain high
• Jan 22: VIX jumps to 37.57, highest since Oct 2002 and back at Aug 16 2007 level; iTraxx Crosssover credit derivatives index hits all-time high 532bps
• Feb 20: iTraxx Crossover Index at all-time high 614bps. Markit CDX North America Investment-Grade Index jumped to all-time high 167.25bps.
• Feb 8: Markit LCDX Series 9 index of U.S. loan credit-default swaps hit record low 91.45bps, indicating worst sentiment since trade began Oct 2007
• VIX more than doubled in 2007 compared to 2006
• Drivers of higher risk aversion: repricing of risk in credit mkts, concern with financial sector impact and spillovers from credit crisis
• Historical perspective: VIX at 40 in 2002
• Standard: Volatility to continue in 2008

From RGE Monitor:

• McCormick: March 20: Surging demand for U.S. Treasuries is causing failures to deliver or receive government debt in the $6.3 trillion a day market for borrowing and lending to climb to the highest level in almost four years.
• SF Fed: a large share of securities firms' assets are reverse repurchase transactions with other market participants. The primary liquidity risk facing securities firms is the risk that sources of funding will become unavailable, thereby forcing a firm to wind down its operations and liquidate asset portfolio. To mitigate this risk, securities firms hold liquid securities and attempt to diversify their funding sources.
• March 20: Fed expands collateral for $200bn 'Treasury Swap' facility (TSLF) to include bundled mortgage debt (i.e. AAA RMBS) and securities linked to commercial real- estate loans i.e. AAA CMBS (originally only federal agency debt, federal agency MBS, and non-agency AAA/Aaa-rated private-label residential MBS). First $75bn auction to be held on March 27.
• Failures, an indication of scarcity, surged to $1.795 trillion in the week ended March 5, the highest since May 2004, and up from $374 billion the prior week. They have averaged $493.4 billion a week this year, compared with $359.6 billion over the last five years and $168.8 billion back through July 1990.
• Alea: We have seen negative repo rates before on (possibly squeezed) notes and treasuries but I don’t recall ever seeing that on T-bills. Quote 3 month T-bill repo: -0.20% also 4 year notes around -0.25%
• NY Fed: Surges in fails sometimes result from operational disruptions, but often reflect market participants' insufficient incentive to avoid failing.
• Krugman: The flight to safety has driven the yield on three-month Treasuries down to 0.55%. Meanwhile, three-month LIBOR — the rate at which banks lend to each other — is up slightly, so that the difference, the TED spread is back close to its earlier peaks--> companies/households not benefitting from rate cuts as their debt is priced off LIBOR

Not only did they add that much liqudity, they expanded the eligible collateral to include CMBS. It appears that the I banking system was in more trouble than we were led to believe. Now, those companies with high levels of ineligible collateral will still have many of the same problems as last week. In addition, the Fed can swap for treasuries all it wants, no one will want to buy these structured and MBS securities. Too many people know what's behind them and what level in the boom-bust cycle they were written on.

From Bloomberg :

The Federal Reserve, in its first extension of credit to non-banks since the Great Depression, lent $28.8 billion as of yesterday to the biggest securities firms to try to stabilize capital markets.

In a separate announcement, the Fed expanded collateral eligible for its first auction of Treasuries March 27 to include bundled mortgage debt and securities linked to commercial real- estate loans. The value of the sale was set at $75 billion, part of a $200 billion facility unveiled last week... The recipients of the Fed's credit are getting cash and Treasury notes in exchange for securities tied to mortgages and other distressed debt...

The central bank's Primary Dealer Credit Facility, announced March 16, allows Wall Street banks to borrow money overnight at a 2.5 percent interest rate, the same charged to commercial banks. The Fed bypassed its own emergency-lending policies and used broader authority in the Federal Reserve Act to give both kinds of companies the same borrowing costs.

Six Months

The central bank said the loans will be available for at least six months. The Fed's decision to be lender of last resort to the 20 primary dealers of government debt came two days after the Fed provided emergency financing to Bear Stearns through JPMorgan.

The Fed's weekly balance sheet released today showed other credit extensions, including loans to facilitate JPMorgan's purchase of Bear Stearns, averaged $5.5 billion a day for the week ended yesterday. The balance ended at zero, according to the Fed's weekly balance sheet.

The zero balance on the Bear Stearns loans signals that the Fed has yet to extend the $30 billion in financing to JPMorgan in exchange for collateral that includes ``less liquid'' Bear assets. The $5.5 billion daily average of the JPMorgan-Bear Stearns loan indicates that a March 14 bridge loan, assuming it was paid off three days later, totaled about $13 billion.

`Show Some Leadership'

Morgan Stanley and Goldman Sachs Group Inc. said yesterday that they borrowed to ``test'' the new lending facility. Lehman Brothers Holdings Inc. Chief Financial Officer Erin Callan said in a Bloomberg Television interview that the firm was using the lending window to ``show some leadership.'' The Fed report today showed that the lending averaged $13.4 billion in the week ended yesterday...

In the Term Securities Lending Facility, the New York Fed bank today altered its plans so it will accept the expanded collateral list, which includes residential mortgage-backed securities, in the first weekly auction instead of the second.

The new eligible collateral for the TSLF includes agency collateralized-mortgage obligations and AAA/Aaa-rated commercial mortgage-backed securities, in addition to similarly rated private-label residential mortgage-backed securities and any collateral normally eligible for Fed open-market operations...

The Fed scheduled the second auction for April 3 and said the central bank's Open Markets Desk will announce the size and the eligible collateral the prior day.

• March 19: Lehman, Goldman, Morgan Stanley tap dealer's discount window: "no stigma attached, just alternative source of financing"
• March 16: Federal Reserve Board: Federal Reserve Bank of New York authorized to create a discount window-like lending facility for 20 primary dealers. Credit extended may be collateralized by a broad range of investment-grade debt securities. Interest rate charged same as discount rate at 3.25%. Maximum maturity of primary credit loans extended to 90 days from 30.
• March 11: Term Securities Lending Facility (TSLF): Federal Reserve will lend up to $200 billion of Treasury securities to primary dealers secured for a term of 28 days (rather than overnight, as in the existing program) by a pledge of other securities, including federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS. Securities will be made available through an auction process.
• March 11: Federal Open Market Committee has authorized increases in its existing temporary reciprocal currency arrangements (swap lines) with the European Central Bank (ECB) and the Swiss National Bank (SNB). These arrangements will now provide dollars in amounts of up to $30 billion (from 10) and $6 billion (from 2) to the ECB and the SNB.
• March 7: Fed initiates a series of term repurchase transactions that are expected to cumulate to $100 billion. These transactions will be conducted as 28-day term repurchase (RP) agreements in which primary dealers may elect to deliver as collateral Treasuries, agency debt, or agency mortgage-backed securities (same collateral as in conventional open market operations). Size will be increased if conditions warrant.
• December 17: Term Auction Facility (TAF): Federal Reserve auctions now $50bn (20 in the beginning) in 28-day credit twice a month. Minimum bid rate is the OIS 1m rate. Collateral and margin requirement accepted are the same that are accepted by the discount window (i.e. including AAA-rated asset-backed securities)

From RGE Monitor:

• FT: Financial Stability Forum urges prompt writedowns and warned that the full impact of the credit squeeze had yet to be felt. Banks wrote down $140bn by Q4 ($84bn in U.S., about $40bn in Europe) subprime securities so far, finance ministers expect $400bn. Half of it expected in U.S., other half rest of world.
• Fitch: Basel II rules allow easier clean break with off-balance sheet vehicles.
• SIFMA: Outstanding volume for the European securitization market stood at €1.32 trillion, as of 30 September 2007. Euro-denominated CDO market volume 2004-2007= €285.4bn (around $410bn)
• WSJ: EU banks reported to be exposed to monoliners via popular 'negative basis trades' in past few years (arbitrage opportunity technically due to oversupply when CDS spread (i.e. cost to buy protection) on a single name is smaller than the bond yield--> buy both bond and protection from monoliner and cash in the risk-free spread difference.)
  --> 6 banks out of 8 planning monoline rescue were European; expected losses in $20-140bn range
• European banks also reported to be exposed to commercial real estate loans/CMBS and leveraged loans stemming from buy-out boom. These markets are turning now and additional writedowns are expected ($100-200bn)
• UK, Spain, Ireland financial sector additionally exposed to domestic housing bust--> Spanish banks e.g. less exposed to U.S. subprime fallout and off-balance sheet SIVs but draws heavily on ECB lending facility which delays actual writedowns on unviable collateral. I have warned members of this blog about this several times.
  

From RGEMonitor.com:

• Bloomberg: Treasuries rose and three-month bill rates plunged to to 0.56%, the lowest level in almost 50 years on speculation credit market losses will widen (e.g. ex-LTCM Meriwether's fund facing losses, Thornburg Mortgage Inc. may go bankrupt)
• Flight to quality trades:
  - The rate on the three-month Treasury bill, viewed by investors as a haven in times of trouble, dropped 32 basis points to 0.56% on Feb 19;
  - Capital preservation trade: buy Treasuries sell stocks;
  - TED spreads (= LIBOR- T-Bill) spiking upwards in all markets
• BNP: Signs of interbank lending stress and liquidity hoarding eased after Fed actions on March 16/17; spreads on the rise again in US, UK and Euro market. Interbank spread decomposition shows that crunch is driven by upward trending credit premium since 2008 instead of liquidity premium as was the case in H2 2007. Fed interventions ultimately can address liquidity, not credit concerns.
• Fed, BoE, ECB intervening in their respective markets (see all measures below)
• Krugman: Flight to quality and cash hoarding lead to Treasury yields close to zero--> if there is no compensation for holding Treasury paper, investors prefer to hold cash--> normal monetary policy channel via buying and selling of Treasuries breaks down (i.e. liquidity trap)

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...

From the WSJ:

Stocks were unable to
hold onto Tuesday’s 400-plus point rally in the Dow industrials and
attendant rallies in other indexes, and steadily marched lower through
the afternoon, until news of a lawsuit filed by Merrill Lynch against a
unit of bond insurer Security Capital Assurance, alleging the company
is trying to avoid obligations of up to $3.1 billion under seven credit default swaps.
Merrill’s own CDS widened on the news, moving to 250 basis points from
210 basis points, according to Phoenix Partners Group, and the stock
market dove, with the Dow giving back a good lot of the previous day’s
massive rally.

I stated several
times in the comments that the CDS market may very well lead us into
the next serious leg down. Many of the guys who wrote these either
don't have the cash to pay up or are wrapped up in hedges using CDS
which will easily get @#$@ed up once one leg of the hedge falls.