- BNP, FT: Central banks’ efforts to ease
strains in the money markets are failing to stop financial institutions
from hoarding cash. LIBOR - T-Bill spreads near crisis highs in UK, EU,
U.S. despite renewed liquidity auctions against weaker than usual
- Krugman: unprecedented credit and market risk on Fed balance sheet--> $400bn are still small compared to the problem.
11: New Term Securities Lending Facility (TSLF): Federal Reserve to
lend up to $200b in treasury securities for 28 day period in exchange
for debt including federal agency debt, federal agency
residential-mortgage-backed securities (MBS), and non-agency
AAA/Aaa-rated private-label residential MBS as well as AAA CMBS.
Surplus banks with market power may strategically underprovide lending
thereby inducing excessive and inefficient sales of bank-specific
assets. Central Banks can ameliorate this inefficiency by targeted
lending to affected banks or, if no info available, by readiness to
make some loss-making loans.
Betting the Bank , from Paul Krugman:
years ago, an academic economist named Ben Bernanke co-authored a
technical paper that could have been titled “Things the Federal Reserve
Might Try if It’s Desperate” — although that may not have been obvious
from its actual title, “Monetary Policy Alternatives at the Zero Bound:
An Empirical Investigation.”
Today, the Fed is indeed
desperate, and Mr. Bernanke, as its chairman, is putting some of the
paper’s suggestions into effect. Unfortunately, however, the Bernanke
Fed’s actions — even though they’re unprecedented in their scope —
probably won’t be enough to halt the economy’s downward spiral.
if I’m right about that, there’s another implication: the ugly
economics of the financial crisis will soon create some ugly politics,
To understand what’s going on, you have to know a bit about how monetary policy usually operates.
Fed’s economic power rests on the fact that it’s the only institution
with the right to add to the “monetary base”: pieces of green paper
bearing portraits of dead presidents, plus deposits that private banks
hold at the Fed and can convert into green paper at will.
the Fed is worried about the state of the economy, it basically
responds by printing more of that green paper, and using it to buy
bonds from banks. The banks then use the green paper to make more
loans, which causes businesses and households to spend more, and the
This process can be almost magical in its
effects: a committee in Washington gives some technical instructions to
a trading desk in New York, and just like that, the economy creates
millions of jobs.
But sometimes the magic doesn’t work. And this is one of those times.
days, it’s rare to get through a week without hearing about another
financial disaster. Some of this is unavoidable: there’s nothing Mr.
Bernanke can or should do to prevent people who bet on ever-rising
house prices from losing money. But the Fed is trying to contain the
damage from the collapse of the housing bubble, keeping it from causing
a deep recession or wrecking financial markets that had nothing to do
So Mr. Bernanke and his colleagues have been
doing the usual thing: printing up green paper and using it to buy
bonds. Unfortunately, the policy isn’t having much effect on the things
that matter. Interest rates on government bonds are down — but
financial chaos has made banks unwilling to take risks, and it’s
getting harder, not easier, for businesses to borrow money.
a result, the Fed’s attempt to avert a recession has almost certainly
failed. And each new piece of economic data — like the news that retail
sales fell last month — adds to fears that the recession will be both
deep and long.
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...
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.
Comments from a blog member - I would like to hear my constituency's opinion on this:
One of the banks that I have been following in the recent months is ICICI bank. The stock peaked around $71 on Jan 10th and is down to around $36 of late. From what I can observe, Indian market took off just around the time MER was making margin calls on BSC (last July-August) mostly due to foreign money flows. (Smart money got in early and setup rising expectations). Of late ICICI has revealed derivative losses and may be there is more to come. And this has shown up in the near 50% drop in the stock over a 10 week period. (By the time CNBC started touting "Emerging market safe havens" smart money was already getting out). Lot of common people in India are getting hurt in the process and are learning a hard lesson. On the ground in Indian real estate is beyond bubble territory, people buying multiple homes as investment at the height of the bubble, but there are signs of sentiment turning negative. For the service industry the Rupee appreciation along with US downturn is becoming a serious problem. Although service export industry is a net positive, it can only employ a very small slice of the population. Despite all this India may not be as dependent on exports as China and has a reasonably mature/strong domestic market.
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.
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.
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.
- 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)
My blog has been quite popular as of late,
most likely because it may appear to some that I have a crystal ball.
My last 5 or so warnings have resulted in 50 point or so price drops in
the shares of the companies in questions. Let me be both modest and
honest. I am not that smart and do not have a crystal ball. There is a
simple premise behind all of this that allows me to understand what is
going on, but this premise does not get any press play and is not
harped on by the analyst community. Many major players in our financial system are simply insolvent.
Plain and simple. The liquidity issues that you see are simply a result
of that insolvency, not a cause. When you lever up on assets at the top
of a bubble and that bubble pops, you become insolvent, delevered or
not. If forced to delever, the balance sheet insolvency now becomes an
income statement insolvency as the cash outflow outstrips the cash
inflows, but it all stems from the original balance sheet insolvency -
not the other way around.
Borrowing more money, no matter what the
terms, will not aide you in your dilemma. That is, of course, unless
you can borrow large amounts of that money quickly on non-recourse
terms. But that is not really borrowing money, it is someone giving you
money with the option to pay it back.
It is the equivalent of a straight bailout, isn't it? That is what just
happened last weekend, which leads me to the next paragraph...
I have been alleging that many investment banks, monoline insurers, home builders and commercial banks are effectively insolvent. Nouriel Roubinin wrote an accurate piece on the topic.
Between that and the the five or six major analytical pieces that I put
together, I believe a pattern emerges (please take note of the dates
the pieces were written and the share prices at the time of the post).
I believe the pattern is indisputable. You could have made a fortune on
the short side of these analyses, and you could have lost a fortune on
the long side, just ask the employess and shareholders of Bear Stearns,
Ambac, MBIA, Lennar, etc. My condolences go out to the rank and file
employees of all of these companies whose savings have been lost in the
share price devalution. Hopefully, there is a lesson to be learned
Are the Mortgage Insurers in Serious Trouble? 9/3/2007
A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton -11/13/2007
Tie-in to the Halloween Story11/21/2007
Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion in Equity 11/29/2007
- Follow up to the Ambac Analysis 12/4/2007
More on Commercial Real Estate
More on Residential Real Estate
Banks, Brokers, & Bullsh1+ part 1
- Banks, Brokers, & Bullsh1+ part 2
- Money Panic
- Bear Fight
- The Breaking of the Bear
- The Riskiest Bank on the Street
- Here comes the CRE Bust (Quip on Lehman Brothers)
- Is Lehman a Lemming in Disguise (from a conributing individual investor)
- Liquidity vs Insolvency
- Bear Stearns Bear Market, Revisited
More on Investment Banks
As you can see, the path was not impossible to determine as
practically all of these companies shared the same catalyst to their
downfall - excessive leverage at the top of an asset and credit cycle
bubble. Now, the Fed is attempting to lend directly to institutions
that it has no jursidiction over. If I am not mistaken, the Fed's
balance sheet is only good for $400 billion dollars or so. There are a
lot of potential "runs on the non-bank" coming down the pike, enought
to drain the coffers. This is an ingenious, albeit very risky endeavor.
Moral hazard abounds. I know the Fed believes that they have nixed the
moral hazard argument in the butt by wiping out the Bear Stearns
shareholders, but this is an imperfect argument. The shareholders have
to approve this $2 buyout deal, and $2 is low enough to risk a battle
with the Fed and their agents. This is a major flaw in the plan that I
see as coming back to bite the markets. If this happens when the next
shoe drops, I can see the Fed getting overwhelmed.
As an investor and analytical pundit, I will be looking for the next
shoe to drop, which I believe I have found. I will keep you posted.
JP Morgan bought Bear Stearns for $230 something million, about 7%
of its closing price Friday, and about 2% of what it was trading for 2
weeks ago. On top of it, this was an all stock deal with the government
funding more tha 100% of it (the Fed will be financing $30 billion of
non-liquid BSC securities, the back stop that I said would happen).
put this into perspective (I'm a NYer, so I am quite familiar with the
landscape), the BSC headquarters is worth at LEAST $1 to $2 billion.
Between the clearing infrastructure, asset management, structured
product assets and real estate, there is at least a $1.5 billion
immediate gain here. How much that will be offset by litigation risk is
an unknown. The CEO got up on CNBC and clearly told the world that BSC
had no problems. Lawyers must be getting a boners in real time.
will admit to a big mistake that I made. I hedged my gains at $35
Friday to lock in the profts. Those calls are literally worthless now.
I shouldn't be complaining since my gains as of this post are averaging
over 800% on this trade, it was the largest position in my portfolio,
and that was after taking profits last week. Just thought I would be
honest and let everyone know that I am far from perfect, thus as I have
said so often, no one should be taking anything I say as investment
Now, as for Monday's trading.... I am not a trader, and
I believe in medium to long term investment horizons, but there is a
LOT of opportunity to be had here. Lehman is probably going to get a
drubbing. Morgan Stanley is being overlooked by the Street. Citibank
will get no love. I already covered on WaMu, with all of the
opportunities abound, I don't believe that I should be trying to dabble
below $10 when I have ridden shares down from last year in the $30's.
fear Goldman will be seeing a lot of devaluation. Don't forget the
companies that we have covered earlier in the blog. There financing is
damn near gone. GGP, the builders, etc.
The Fed is working hard
to help the country. That is undeniable. They have cut rates, extended
financing directly to non-banks, cut more rates - but, and as I
thought, the markets are ignoring these actions and driving financials
down and commodities up.
Lehmans asset make up will make it a
target in US trading. I will probably attempt to expand my position and
will be willing to pay premiums. My small position is quite profitable
already. I will attempt to expand the financials on my list in
aggregate, and MS (who is my 2nd largest position in the financials)
will be expanded as well.
The most acute contagion from
the liquidity disease afflicting Bear Stearns today appears to be
festering at Lehman Brothers, which joins fellow brokerages in
reporting earnings next week. New jitters about Lehman's financial
health came in the form of news in its credit default swaps, which
reportedly widened by 65 basis points this morning in the immediate
wake of the Bear Stearns news. The development sent implied volatility
in Lehman Brothers options more than 76% higher to 113.8%, with heavy
put buying in the March contract at strikes 35, 40 and 45 as the mad
rush for protection against further downside drama in its share price
appears more or less unmitigated.
My posistion in
Lehman is very light because I have been too stingy to overpay for the
options and did not go in with a naked short. Yet, I noticed that many
of the puts were trading below their theoretical value. Interesting!
Remember, at least according to Bear Stearns, this is how the run on the bank started. Rumor spawned into reality. There is reason for rumor at both banks though since they are numbers 1 and 2 on the street in MBS underwriting and neither are true banks in the sense that they cannot go to the Fed's discount window for access to capital. If the put action piles up on Lehman, I can see this daisy chain effect happening when no one will want to stand as their counterparty either and their CDS spreads get blown out.
If it happens to MS, there will be a big problem due to the amound of inherent counterparty risk and leverage that they sport.
Stories from RGE Monitor and around the net related to Banks, Brokers, & Bullsh1+ part 2:
- Carlyle Capital Corp (CCC) defaults on about $16.6 billion of AAA agency debt as widening spreads led to huge losses and margin calls on position leveraged 32 times. Lenders seizing all of its assets--> Carlyle Group's only material financial exposure to CCC is through a $150 million unsecured subordinated revolving credit agreement with CCC.
- Sudden Debt, FT: Almost all structured finance transactions are based on unfunded margin debt--> Margin debt cannot be "restructured" with falling asset prices.
- Brunnermeier/Pedersen (Princeton/NYU), BIS: Under certain conditions, margins are destabilizing and market liquidity and funding liquidity are mutually reinforcing, leading to liquidity spirals.
- Whalen (IRA), Joseph Mason: With prime brokers and hedge funds there is no such thing as a "true sale" or complete risk transfer because the hedge fund has little capital and the prime broker, as a result, ultimately bears all the risk. Same as securitized assets landing back on balance sheet without capital to account for them.
- InvestorsInsight: Hedge Funds are net sellers of credit protection in CDS market, like insurers. Seides: hedge funds sell 32% of all CDS ($14.5 trillion) with only about $2.5 trillion in net assets under management--> watch counterparty risk.
- S&P via FT Alphaville 75% of loans to junk-rated U.S. companies provided by HF/non-banks (about $400bn)--> worst asset class performance in Q4.
- Peloton hedge fund run by former Goldman Sachs partners is liquidating $1.8bn ABS fund that produced 87% gain in 2007. Potential $9bn asset fire sale.
Strategy: go short subprime paper, go long prime rated paper--> as of Jan 2008 however spreads on both low and prime rated assets widened due to deleveraging (=reverse leveraged bets on good assets). Margin calls triggered decision to unwind.
- FT Alphaville: January 08 worst month for hedge funds since August 1998 LTCM episode--> average fund tracked by the HFRX index lost more than 2% in January, with event-driven funds, which include activists, the worst hit with a 3.39% loss. Equity long-short funds with net long exposure down too.