Welcome back the spectre of the monoline downgrade.
And we have a new milestone. SCA became the first of the AAA-badged bond insurers to have its rating slashed to below investment grade. ACA, which succumbed to junk status some months ago, was never rated top notch to start with.
Fitch, of course, was the one doing the downgrading. It cut the financial-strength rating of SCA’s subsidiary XLCA from A to BB, citing an updated assessment of the company’s capital position as well as the “material erosion in SCA’s franchise value and competitive business position.”
The agency now expected losses on SCA’s subprime CDOs to fall between $3bn and $4bn, compared to the company’s resources to cover losses of $4.2bn at the turn of the year. The company, which suspended the writing of new business earlier this month, has said it won’t resume normal operations until it has regained a rating of at least AA, and preferably AAA.
But the signs are not good. Fitch reckons that the insurer would need to raise as much as $5.9bn to regain a triple-A badge.
SCA was swiftly joined in the downgrade camp by FGIC, cut to BBB by Fitch from AA. It is short of between $5.1bn and $5.3bn in capital, compared to levels required for an AAA rating. The insurer has ceased writing new business, as it fights to bring its capital levels back above the regulatory minimum under New York insurance law.
The return of monoline woes may be bad news for Merrill, which has previously taken a sizeable hit from the downgrade of ACA. A legal spat which kicked off between the bank and XLCA last week raises the prospect of further writedowns on exposure to CDOs, after CDS contracts were terminated by XLCA.
Here, courtesy of Bank of America, is a ready-reckoner to remind us of the various monoline woes (though not yet updated for Fitch’s latest on FGIC).
- Secretary Paulson: Treasury will soon release a Blueprint for Regulatory Reform--> any regular access to the discount window by securities firms/non-banks should involve the same type of regulation and supervision. However: it would be premature to jump to the conclusion that all broker-dealers or other potentially important financial firms in our system today should have permanent access to the Fed's liquidity facility; this is a temporary emergency situation.
- Wolf: Remember Friday March 14 2008: it was the day the dream of global free- market capitalism died.Implication: there will have to be far greater regulation of complex financial institutions.
- NYT: New Democratic proposals would subject Wall Street firms to the kind of strict oversight that banks have had for decades in exchange for new privilege of being able to borrow from the Fed's discount window ($28.8bn in first few days, excl. $30bn BS loan to JPMorgan)
- Barney Frank: Congress should consider creating a single regulator — or giving the Federal Reserve greater powers — to oversee all financial markets and intervene when necessary. Today, supervisory framework too fragmented.
- Frank: Regulators should re-examine capital reserves, risk-management practices and consumer protection without regard to whether companies were commercial banks, investment banks or nonbank mortgage lenders.
- Both President Bush and Mr. Paulson remain philosophically opposed to restrictions and requirements that might hamper economic activity--> major overhaul unlikely this year.
- Bernanke: 3 principal public policy objectives: financial stability, investor protection, and market integrity. Challenges: Complexity, illiquidity, leverage
--> central banks and other regulators should resist the temptation to devise ad hoc rules for each new type of financial instrument or institution. Rather develop common, principles-based policy responses that can be applied consistently across the financial sector to meet clearly defined objectives.
- Roubini: It would be a most dangerous step to expand the lender of last resort support of the central bank to most non-bank financial institutions beyond the few systemically important ones, even to all securities firms: risks of additional fiscal bailout costs of insolvent securities firms would be serious.
- Economist: Deposit-taking banks should keep their government guarantee, whereas banks that want to live like hedge funds should learn to die like them too.
- Krugman, Lex: Banking crisis of the 1930s showed that unregulated, unsupervised financial markets can all too easily suffer catastrophic failure--> reintroduce variant of Glass-Steagal separating banking and securities business and was repealed in 1999.
- SIPC: customers of a failed brokerage firm receive all non-negotiable securities - such as stocks or bonds -- that are already registered in their names. At the same time, funds from the SIPC reserve are available to satisfy the remaining claims of each customer up to a maximum of $500,000. This figure includes a maximum of $100,000 on claims for cash.
As I have repeated ad nauseum - it's not a liquidity problem, it is a solvency problem. No matter how much money you put into the system, the banks know that there a lot of dead bodies buried in the back yard. That's why they won't lend to each other. If I were a bank with a bunch of bubble top trash on my balance sheet at 30x leverage, and I know I hired the same guys from the same B schools, using the same algorithms, theories and trading tactics, involved in the same profit centers as the rest of the industry - I wouldn't trust the next guy either.
From Bloomberg :
The cost of borrowing in euros and pounds rose to the highest since last year after central bank offers of emergency cash failed to ease money-market tensions as the end of the quarter approached.
The three-month London interbank offered rate, or Libor, for euros increased 1 basis point to 4.73 percent, the highest level since Dec. 27, the British Bankers' Association said today. The comparable pound rate climbed above 6 percent for the first time this year.
``Money markets have seized up again and by some measures the funding crisis is more acute then ever before,'' Christoph Rieger, a fixed-income strategist in Frankfurt at Dresdner Kleinwort, wrote in a note to clients today.
The European Central Bank said today it's ready to inject more cash into money markets to ease a lending crisis that's threatening to undermine economic growth. The Swiss National Bank offered three-month funds today to promote lending. Financial institutions are hoarding cash after more than $200 billion of losses linked to U.S. subprime mortgages.
The ECB and the Federal Reserve this week provided extra emergency funds in a bid to stem surging money-market rates. The Bank of England injected 13.6 billion pounds ($27 billion) of additional cash today.
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.
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
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
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 .
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.
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.