Sunday, 26 October 2008 02:00

Global Recession - an economic reality

Global Recession - an economic reality

Part 28 of Reggie Middleton on the Asset Securitization Crisis

The repercussions of the historical events that unfolded on Wall Street in September 2008 are being felt across the global financial system-banks and insurers across the Atlantic and Pacific are beginning to implode at an increasingly rapid pace, held together by the glue of their respective government bailout packages. The crisis, thought to be restricted to US markets, has spread to their European and Asian counterparts, freezing credit markets in the region - with the emerging markets on tap. It looks like the investment banking era on Wall Street has ended with Lehman Brothers going bankrupt, Merrill Lynch being sold off to Bank of America, Bear Stearns imploding over a weekend and the conversion of Goldman Sachs and Morgan Stanley to bank holding companies. Nearly each week sees a new bank filing for bankruptcy (TGIF, its not - OMGIFDICFA). The latest to join the list are Washington Mutual and Wachovia Corporation. Washington Mutual's banking assets were taken over by JP Morgan Chase for US$1.9 billion, while Citigroup made a US$2.2 billion bid for certain banking assets of Wachovia. The crisis has spread to Europe as reflected by the nationalization of Fortis Bank-the governments of Belgium, Luxembourg and the Netherlands provided €11.2 billion to bail out the bank. The FDIC Troubled Bank List grew from 90 to 117 in Q2 08, indicating that more banks could head toward bankruptcy. These developments completely shook the confidence in the banking system, as jittery depositors queued to withdraw their deposits. What has emerged is a credit crunch, making it increasingly difficult for borrowers (individual and corporate) to fund their requirements (see The Butterfly Effect and the The Butterfly is released!). As a result, economic activities are slowing down.

Recession: The United States

The US government is looking to stabilize the current financial crisis through a bailout package of US$700 billion;

The Asset Securitization Crisis Analysis road-map to date:

1. Intro:
The great housing bull run - creation of asset bubble, Declining
lending standards, lax underwriting activities increased the bubble - A
comparison with the same during the S&L crisis

2. Securitization - dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble - declining home prices and rising foreclosure

3. Counterparty risk analyses - counter-party failure will open up another Pandora's box (must read for anyone who is not a CDS specialist)

4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue

5. Municipal bond market and the securitization crisis - part I

6. Municipal bond market and the securitization crisis - part 2 (should be read by whoever is not a muni expert - this newsbyte may be worth reading as well)

7. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two

8. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux

9. More on the banking backdrop, we've never had so many loans!

10. As I see it, these 32 banks and thrifts are in deep doo-doo!

11. A little more on HELOCs, 2nd lien loans and rose colored glasses

12. Will Countywide cause the next shoe to drop?

13. Capital, Leverage and Loss in the Banking System

14. Doo-Doo bank drill down, part 1 - Wells Fargo

15. Doo-Doo Bank 32 drill down: Part 2 - Popular

16. Doo-Doo Bank 32 drill down: Part 3 - SunTrust Bank

17. The Anatomy of a Sick Bank!

18. Doo Doo Bank 32 Drill Down 1.5: Wells Fargo Bank

19. GE: The Uber Bank???

20. Sun Trust Forensic Analysis

21. Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street

22. Goldman Sachs Forensic Analysis

23. American Express: When the best of the best start with the shenanigans, what does that mean for the rest..

24. Part one of three of my opinion of HSBC and the macro factors affecting it

25. The Big Bank Bust

26. Continued Deterioration in Global Lending, Government Intervention in Free Markets

27. The Butterfly is released!

however, despite the positive response from the US Senate, the crisis does not seem to be over yet. On September 30, 2008, LIBOR jumped 4.31 percentage points to an all time high of 6.88%, while Euribor rose to 5.05% as credit markets froze. If challenges related to availability of finance continue, economic activities would be severely impaired across both sides of the Atlantic. Note: both rates have started edging lower since this report was originally penned, but only at the behest of well over a trillion dollars of global central bank prodding.

The credit crunch is now beginning to impact the real economy by setting off a slowdown in economic activities. With credit drying up in the US, demand has fallen, adversely impacting industrial production in this region as well as the global manufacturing centers, ex. Southeast Asia. Consumer spending, which accounts for around 70% of the total demand in the US, is declining. Stricter lending practices followed by financial institutions triggered a decline in credit growth, which brought down consumption levels. Wholesale and retail sales are decreasing due to the slow growth in credit. The weakening demand is prompting manufacturing entities to cut down production. The resultant decline in profits is adversely affecting the margins of companies. Profitability is also affected by the rise in input costs due to the high inflation across the globe. In addition, with short-term financing getting increasingly difficult to obtain due to the credit fiasco, manufacturing/ industrial companies are in for tougher times.

The decline in economic activities across the globe has pushed economies worldwide to the brink of a recession. Growth in the global GDP, expected to increase 2.7% in 2008 (compared to the earlier forecast of 3.3% in January 2008), would largely be driven by the estimated GDP growth of over 6.5% in emerging countries. Taking into consideration the deepening financial crisis and the impact of the rising inflation on the economy, the World Bank revised its US GDP growth estimate for 2008 to 1.1% from 1.9%. As the credit crisis widened, players in the banking sector lost confidence-financial institutions were not willing to lend to one another. While this dried up liquidity in the banking system, it led to an increase in effective interest rates.

Fears over rising defaults in mortgage loans spreading to other asset categories forced banks to adopt stricter lending practices. Also, financial institutions focusing on deleveraging their balance sheet due to the crisis is restricting credit growth. Consumer demand and overall growth in the economy will undoubtedly take a beating due to these reasons. The consistently high prices of commodities have increased the cost of production, thus forcing companies to cut costs. The glimpse of softening commodity prices comes at the cost of a perceived and actual significant slowing of the economy. Consequently, unemployment, which has already touched a record level, could rise further in either case.

Recession: The Eurozone

The credit crunch has spread across the Euro zone as reflected by the increase in writedowns in this region. The nationalization of Bradford & Bingley, the eight-largest mortgage lender in the UK, dealt the most severe blow. The impact of the credit crisis on the manufacturing/real sector could severely cripple the prospects of economic growth in the near term. The 2008 growth forecast for the Euro zone was revised to 1.7% from the earlier projection of 2.8%. Countries such as Germany, France and Italy are on the brink of recession, as their GDP fell 0.5%, 0.3% and 0.3%, respectively, in 2Q 08. The mounting losses of financial institutions coupled with the slowdown in manufacturing activities could force the economy into a recession.

Recession: Japan

Japan's GDP is expected to grow at 1.4% in 2008, down from the earlier estimate of 2%. Economic growth in Japan has been driven by net exports, which contribute around 42% to the GDP. The decrease in exports, particularly to the US, is likely to severely affect the GDP. Due to lower exports to the US, the country's GDP (annualized) declined 3% in 2Q 08; this represented the most severe decline in seven years. Industrial production decreased 3.5% m-o-m in August 2008, as Japan's three largest automakers, Toyota Motor Corp, Honda Motor Co, and Nissan Motor Co, cut down domestic production. The unemployment rate rose to 4.2% in August 2008 from 4.0% in July 2008, implying the highest rise in unemployment in two years. The increase in unemployment is expected to have a direct impact on aggregate demand, which is likely to decrease in the coming quarters. The increase in unemployment and slowdown in economic growth dented consumer spending, which fell 4.0% y-o-y in August 2008. Any decline in consumer spending is likely to lower demand in the domestic market.

US Metrics

The Chicago Fed National Activity Index (CFNAI) measures the overall economic activity, such as production and income, employment, unemployment, personal consumption, sales, orders, and inventories, in the US as well as the inflationary pressure. The index slipped to the lowest level since 2001 (-1.59 in August 2008 from -0.93 in July 2008). The index has been in the negative territory since August 2007, which indicates that the economy is growing way below its potential. With the widening of the crisis and a greater number of financial institutions filing for bankruptcy, economic activities across all the spheres are likely to be affected, pushing the US economy closer to a recession.

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Source: Bloomberg

US housing prices yet to bottom out

The housing crisis, which started in 2007, has spiraled into a widespread credit crisis, with the continuous decline in house prices and increase in default on loans and rising foreclosures. The increase in US banks' exposure to subprime mortgages to 20% in 2005 from 5% in 1994 was the impetus behind the housing crisis, but far from the root cause, which I identify as the asset securitization crisis. However, the housing bubble burst in July 2007 due to higher interest rates resulting in defaults by the subprime borrowers, followed by Alt-A and low documentation borrowers and eventually prime borrowers who were allowed to either overextend or purchase property with inflated values. The rise in foreclosures led to an increase in housing inventories as demand declined. Lack of demand and large supply of houses brought down prices. The S&P Case Shiller Home Prices Index, which covers housing prices in 20 cities, fell more than 19.5% until July 2008 from the high in July 2006. Prices continued to decline, falling 16.3% y-o-y in July 2008 (down 0.9% m-o-m). Considering the sustained decline in home prices coupled with rising unemployment and a drastically slowing economy, problems in the US housing market seem far from over, and as a matter of debate may even be just beginning; the slowdown in the economy is likely to continue, going forward.

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Source: Bloomberg

Increase in housing inventories with decline in housing starts

After the dot com bubble burst in 2001, construction activities were on an upswing due to the easy availability of loans - a result of the Great Global Macro Experiment. This factor led to a huge spike in the supply of houses. When the Fed rate rose from 2.25% in December 2004 to 5.25% in June 2006, the demand for houses declined. Furthermore, as subprime borrowers were unable to repay the increased installment, the rate of foreclosures increased. Higher construction activities and increased foreclosures added to the inventories. The demand-supply mismatch led to a decrease in home prices. The housing inventory rose 7.2% y-o-y in 2Q 08, further boosting supply. Considering the massive supply of houses, prices are expected to decline further. As a result, the problems of financial institutions with derivative inventories based upon housing could increase. Demand is likely to remain low as stricter lending practices and decline in creditworthy borrowers have led to a considerable increase in the "effective" affordability of homes, despite any drop in nominal prices.

The increase in inventories and decline in home prices discouraged construction activities, triggering a decline in housing starts. After falling 29.6% in July 2008, housing starts declined 6.2% y-o-y in August. The decline in housing starts would facilitate the selling of inventories, which is likely to resolve the demand-supply mismatch. NAHB President Sandy Dunn opines that decrease in new home construction would lead to the recovery of the US housing market, a statement which I believe to be an oversimplification. The huge supply of houses forced the market to reduce the number of permits requested for construction, thus reducing the revenue stream to municipalities who bloated their budgets based on the heady times (see "Municipal bond market and the securitization crisis - part I"and "Municipal bond market and the securitization crisis - part 2" - should be read by whoever is not a muni expert - this newsbyte may be worth reading as well). Stability in home prices would help steady the housing market. However, despite market manipulating efforts by local authorities and the federal government, house prices continue to decline with demand continuing to slacken save for the thirst for foreclosed homes, which actually detracts from the organic sales of conventional home sellers (builders, investors, and owner/occupants). With the sales paces failing to pick up as the economy faces the worst financial crisis in many decades, a continued drag is all but guaranteed. Although the Fed targeted and effective rate declined to 2% in September 2008 from 5.25% in June 2006, the mortgage lending rate remained high, providing no respite to homeowners.

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Source: US Census Bureau & NAHB

Mortgage foreclosure and delinquency

The rise in foreclosure of real estate mortgages coupled with the decrease in real estate prices has widened the losses for financial institutions. The foreclosure of all loans increased from 0.58% in 2Q 07 to 0.99% in 1Q 08. In addition, delinquencies rose at an alarming rate from 4.84% in 2Q 07 to 6.35% in 1Q 08. The entire economy has been adversely affected by increasing foreclosures and rise in risk levels following high delinquency.

The rate of foreclosures related to subprime loans was the highest due to the inability of homeowners to repay the borrowed loans. Subprime loans-related foreclosures increased to 4.1% in 1Q 08 from 2.4% in 2Q 07. In addition, the delinquency on subprime loans, radically high at 13.8% in 2Q 07, further increased to 18.8% in 1Q 08. Foreclosure and delinquency rates related to loans provided to creditworthy customers (prime loans) also rose. The foreclosure rate more than doubled to 0.54% in 1Q 08 from 0.25% in 2Q 07. The delinquency rate also increased to 3.7% from 2.6%. The growth in foreclosures prompted banks to adopt stricter lending practices, which hampered the growth in credit as well as the economy.

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Source: S&P & Bloomberg

Housing prices decline in UK

The unprecedented increase in housing prices in the UK led to a sharp increase in housing loans backed by lax underwriting practices. The UK Nationwide House Prices Index fell for the fifth month consecutively; it plunged 10.5% y-o-y in August 2008 after falling 8.1% in July 2008. Considering the increase in foreclosures and delinquencies, and decline in housing prices, the UK housing market appears far from stable and is likely to fall further in the coming months.

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Source: Bloomberg

Spain and France

Housing prices in Spain and France grew at a decreasing pace over the last few quarters. In Spain, the house prices increased 2.4% in 2Q 08, much slower than the 10.8% growth recorded in 2Q 06. The sharp decline in growth indicates increase in supply and decline in demand in the housing market. In France, the index rose 4.3% in 1Q 08 after rising 12.9% y-o-y in 2Q 06. Considering the slowdown in Spain, where the GDP grew 0.1% in 2Q 08, and France, which in fact recorded a 0.3% decline in the GDP, housing price appreciation rates are likely to turn negative in a fragile economy.

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Source: Bloomberg

Fallout of the credit crisis - Problems in financial sector spill over to manufacturing

The global asset securitization crisis, which emerged in 2007 led by widespread foreclosures in the mortgage market and decline in housing prices, has reached calamitous proportions. Snowballing into a widespread credit crisis, it has swallowed major financial institutions across the world. The massive exposure of banks in the CDS market and defaults in this segment paved way for the Federal Reserve-backed sale of Bear Stearns to JP Morgan in March 2008. This move was aimed at saving the overall economy from a widespread recession and injecting confidence in the banking system. However, within six months Lehman Brothers filed for bankruptcy, while Merrill Lynch was bought by Bank of America. Furthermore, the Federal Reserve bailed out AIG, which being counterparty to the Lehman CDS agreement, was driven to near bankruptcy; the Fed provided a loan of US$85 billion for a 79.9% stake in AIG. Even this, it appears, was insufficient to save AIG for the CEO is alleging there may be additional need for capital. I do not think that gaping capital hole that is AIG is a standalone phenomenon and we have identified other insurers at similar risk. Indeed, Treasury Secretary Paulson has confirmed our suspicions by the consideration of adding insurers to the "bank" bailout fund.

Widespread writedowns and increased provisioning for mortgage-backed securities (as financial institutions resort to stricter lending practices) are squeezing liquidity from the global credit market and the banking system. Though the respective central banks of both the developed and emerging global economies tried to pump money into the financial system at regular intervals to increase liquidity, the problem has assumed truly epidemic proportions. The fall of some of the biggest investment banks on Wall Street led to loss of confidence in the banking system, as liquidity dried up. The credit crisis spread to the manufacturing sector, leading to a slowdown in demand that forced companies to reduce capacity utilization. The pressure on manufacturing companies has increased with the rise in cost of production due to higher input prices and cost of borrowing. In chapter 27 of the Asset Securitization, the "Butterfly Effect", we delved into this occurrence in detail, as well as provided 4 forensic reports of manufacturers at extreme risk.

The fallout of the credit crisis has created problems for the manufacturing sector. First, the decline in the credit creating capacity of financial institutions has pushed the interest rate higher, thereby increasing the cost of borrowing for manufacturing companies. The increase in the 3-month London Inter Bank Offer Rate (LIBOR) to 4.05% as of September 30, 2008, from 2.81% as of September 1, 2008, would make borrowing even more expensive. Second, the increase in default on corporate bonds has dented confidence and increased risk aversion, thereby sending the interest rate higher. The slowdown in the US manufacturing sector is reflected in the movement of the manufacturing output index, which declined 3.6% y-o-y to 110.3 in August 2008. As demand weakened, manufacturers cut down on capacity utilization, bringing down the factory utilization rate to 76.6% in August from the high of 78.5% in March 2008. The decline in output and goods necessitated cost cutting measures, including job-cuts. Nearly 61,000 employees lost their jobs in the manufacturing sector in August 2008. As a result, demand could come down further. The motor vehicles group was the worst hit, as it declined 11.9% m-o-m sequentially to 78.7 in August 2008.

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Source: Federal Reserve

The credit crisis also rattled the Euro area, especially the manufacturing sector. Industrial production declined 1.2% y-o-y in June 2008. Italy was the worst hit-the index declined 5.8% y-o-y and 2% m-o-m to 88.3 in July 2008. France and Germany declined 5% and 3%, respectively, during the same period. The credit crisis and manufacturing slowdown forced ECB to reduce the GDP forecast for 2008 to 1.3% in September from 1.7% earlier. UK's production index declined 1.9% y-o-y in July 2008 after declining 1.6% in May and 1.7% in June. The weakness in the industrial sector is likely to continue; according to the Confederation of British Industry (CBI), production declined to -16% in September 2008, the lowest level since 2002. This reflects the potential for further slowdown in the coming quarters. In a CBI survey, 36% of respondents said they expect output to decline in the coming quarter; 44% said they expect the order book balance to shrink, indicating a further decline in output and job losses.

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Source: Economagic

The credit turmoil hurt the industrial sector as well. Higher input costs (backed by the hike in commodity prices) increased cost of production. The worsening health of financial institutions due to huge writedowns also increased interest rates and (consequently) the cost of borrowing. Many companies are finding it difficult to sustain growth as the increased cost of production and borrowing cannot be fully passed on to consumers. Lower consumer spending due to poor credit growth reduced aggregate demand. In such a scenario, many companies are likely to default on corporate bonds, particularly those that binged on "subprime" corporate debt, ala PIK notes, covenant-lite loans and leveraged loans - many of which are due to rollover in the next 24 months, into one of the weakest credit markets in this country's history. Shoddy credit ratings have translated to an unprecedented increase in the yield on corporate bonds, increasing risk associated with these assets. Factors such as higher interest rates, decreased sales and higher cost of borrowing weighed on companies' stability. Over a period of one year, the yield increased 105 basis points to 7.85 as of September 25, 2008. The higher bond yield would increase risk associated with these assets. As of May 2008, 28 entities had defaulted on corporate bonds worth US$18.4 billion.

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Source: Bloomberg

Higher defaults to dent credit growth

The credit crisis knocked the wind out of Wall Street. Goldman Sachs and Morgan Stanley, the two investment banks still standing, were converted to bank holdings companies so as to reduce risk. Bankruptcies in the banking and financial sector increased due to huge losses on mortgage-backed securities. Over the last year, 86 financial institutions filed for bankruptcies.

Financial institutions also had to cope up with higher net charge-offs to loans, which increased to 1.16% in 1H 08 from 0.49% in FY 05. Charge-offs for real estate loans, constituting 60.0% of total loans and leases, increased to 0.94% in 1H 08 from 0.05% in FY 05. As loan defaults increased, the decreasing credit capacity of banks negatively impacted credit growth. Consequently, financial institutions experienced a squeeze from both sides-the default rate increased on one hand, while the fall in real estate prices increased MTM losses on the other.

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Source: FDIC

Among real estate loans, category 1-4 Family Residential (RHS) loans constituted 58.4% of total real estate loans; charge-offs increased to 1.16% in 1H 08 from 0.06% in FY 05. The Home Equity category had the highest charge-offs (1.79% in 1H 08 from 0.09% in FY 05).

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Source: FDIC

With the unemployment rate rising to 6.1% in August 2008, charge-offs related to personal loans as well as loans related to credit cards are likely to increase further. Credit card charge-offs increased to 5.12% in 1H 08 from 4.74% in FY 05, while loans to individuals increased to 3.18% from 2.72% during the same period. Credit card defaults are likely to increase in tandem with jobless claims. The higher default rate could impede credit growth by forcing financial institutions to reduce lending. This has the potential to send the entire economy on a tailspin.

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Source: FDIC

The higher cost of production and higher interest rates negatively impacted the commercial & industrial sector as the charge-off on loans provided to them began to increase. The charge-off more than doubled to 0.82% in 2Q 08 from 0.39% in 1Q 07.

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Source: FDIC

According to Moody's Investors Service, the global speculative-grade default rate will rise to 5% by the end of 2008 from 1.5% in April 2008. With the default rate increasing, companies are expected to experience greater refinancing risk, which could dampen economic growth. With sales declining due to a reduction in aggregate demand, many companies are reporting negative free cash flow. This has only served to increase the default risk. With large banks and investment banks filing for bankruptcies, the default rate is likely to increase at a rapid pace. The overall increase in the corporate default rate will dampen the credit ratings of companies.

Declining consumer spending to dent aggregate demand

The fall of Lehman Brothers, the sale of Merrill Lynch to Bank of America, and the nationalization of AIG in September 2008 indicated that the financial crisis was far from over. Washington Mutual and Wachovia, the sixth largest bank in the US, are the latest casualties. The worsening credit crisis had a direct impact on consumer spending as credit growth declined due to stricter lending practices and higher interest rate. The credit crisis has also increased the unemployment rate as companies look to cut costs. The decline in consumer demand due to slower credit growth and higher unemployment rate dented aggregate demand.

The GDP growth rate decelerated due to a decline in domestic consumption, net exports and domestic investment. In the scenario of rising interest rates, domestic consumption is likely to decline as evidenced in the slowdown in consumer credit growth and its impact on retail sales. Retail sales fell for the second consecutive month in August-sales declined 0.3% y-o-y; analysts were expecting a 0.3% rise. Retail sales had declined 0.5% in July. The slowdown in consumer spending due to poor credit growth is likely to dent aggregate demand. While total consumer credit outstanding has risen, the slowdown is evident in annual growth terms. Consumer credit growth declined to 5.6% y-o-y in June 2008 from 6.0% in October 2007. As growth in consumer credit decelerates, overall demand is expected to decrease further.

The Commerce Department revised the consumer spending growth forecast for 2Q 08 to 1.2% from 1.7% earlier. Lower consumer spending could significantly dent demand. We expect the lower consumer spending due to poor credit growth to dent aggregate demand in the coming quarters. Disposal income in the US declined 1.1% m-o-m to US$10,767 in July 2008. This is also likely to hurt demand. The decline in per capital disposal income has the potential to dent aggregate demand and constrain economic growth.

Rising unemployment could negatively impact consumer spending. We expect aggregate demand to decrease as jobless claims increase. The US unemployment rate stood at 6.1% in August; the Financial Forecast Center expects it to rise to 7.1% in April 2009. This could hurt demand further.

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Source: Federal Reserve

The fallout of the credit crisis has been even more severe in the UK. With mortgage related losses and provision for bad assets rising, credit lending has diminished significantly. Household final consumption expenditure declined 5% q-o-q sequentially in 1Q 08. With jobless claims rising, domestic retail sales also declined a significant 3.9% m-o-m sequentially in June 2008. Expenses related to restaurants and hotels declined 10.2% q-o-q sequentially in 1Q 08. As the credit crisis widens, we expect consumer spending to decrease further as highlighted by the fall in household and restaurant and hotels expenditure. The sharp decline in consumer spending has negatively impacted aggregate demand.

The tightening credit outlay has dented aggregate demand across the world. Domestic demand in Europe declined 2% y-o-y in June 2008 due to lower consumer spending. As the credit crisis spreads, we expect banks to tighten lending measures. This would negatively impact consumer demand.

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Source: Bloomberg

The Asset Securitization Crisis Analysis road-map to date:

1. Intro: The great housing bull run - creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble - A comparison with the same during the S&L crisis

2. Securitization - dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble - declining home prices and rising foreclosure

3. Counterparty risk analyses - counter-party failure will open up another Pandora's box (must read for anyone who is not a CDS specialist)

4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue

5. Municipal bond market and the securitization crisis - part I

6. Municipal bond market and the securitization crisis - part 2 (should be read by whoever is not a muni expert - this newsbyte may be worth reading as well)

7. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two

8. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux

9. More on the banking backdrop, we've never had so many loans!

10. As I see it, these 32 banks and thrifts are in deep doo-doo!

11. A little more on HELOCs, 2nd lien loans and rose colored glasses

12. Will Countywide cause the next shoe to drop?

13. Capital, Leverage and Loss in the Banking System

14. Doo-Doo bank drill down, part 1 - Wells Fargo

15. Doo-Doo Bank 32 drill down: Part 2 - Popular

16. Doo-Doo Bank 32 drill down: Part 3 - SunTrust Bank

17. The Anatomy of a Sick Bank!

18. Doo Doo Bank 32 Drill Down 1.5: Wells Fargo Bank

19. GE: The Uber Bank???

20. Sun Trust Forensic Analysis

21. Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street

22. Goldman Sachs Forensic Analysis

23. American Express: When the best of the best start with the shenanigans, what does that mean for the rest..

24. Part one of three of my opinion of HSBC and the macro factors affecting it

25. The Big Bank Bust

26. Continued Deterioration in Global Lending, Government Intervention in Free Markets

27. The Butterfly is released!

Last modified on Sunday, 26 October 2008 02:00

13 comments

  • Comment Link KeedaBentak Thursday, 28 November 2013 01:41 posted by KeedaBentak

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  • Comment Link Andrew Watson Sunday, 02 November 2008 12:28 posted by Andrew Watson

    I am leaning toward stagflation as being highly probable in the next two years. Everybody keeps talking about all this deleveraging well that argument doesn't entirely make sense.
    Alot of the assets getting unwound from the global banking system are illiquid. Thus, money supply is largely going one way at the moment.
    Of course I am the farthest thing from an economist. I simply cannot make sense of the argument that there is more deflation probability than inflation. If somebody can elaborate and what is the major liquid deleveraging going on in more detail?

    The quantity theory of money has the following simplified ratio: M x V = P x Q ... Left side is supposed to equal the right side. With money supply and velocity (increase in volume) way up over the last 6 years. This simply shows pricing - interest rates will be going up to match off.

    Within this theory can also be explained the potential mid-term weakness in the US dollar. I can't see China & Middle East continuing to buy into US treasury issues at super low interest rates. They already have more than enough US cash for trade and monetary policy. The idea that everybody will continue to back US currency because it's in the best interest doesn't completely add up.

    My end conclusion is that the foreign governments that have been buying 70% of US treasuries over the past couple years. Will simply want higher returns (interest rates).

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  • Comment Link Phil V Monday, 27 October 2008 18:41 posted by Phil V

    I suggest you travel a bit and think critically when you return home.

    As badly run the US is, most other places are just an iota short of bedlam.:D:D:D

    Also, it seems that the G20 meeting will reach some sort of consensus to return to status quo ante crisis.

    The reasons why are below: mainly, 10's of millions unemployed chinese...

    http://piaohaoreport.sampasite.com/china-financial-markets/blog/Bring-on-the-new-financial-order.htm

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  • Comment Link Reggie Middleton Monday, 27 October 2008 18:26 posted by Reggie Middleton

    In regards to all of the "Death of the Dominant Dollar" conspiracy theories, I simply query, what currency has the depth, breadth, strength and liquidity to replace the dollar? A basket of currencies is simply a fight waiting to happen (you that joke, "I went to a fight and a hockey game broker out").

    Not only will the US not loses its hegemony through the dollar and it's financial capital status, I think it may actually be strengthened.

    As for the Euro, I actually think there is a 30% chance it may break up due to the heterogeneous stresses being applied to the member countries' economies receiving a homogeneous balm (favoring one nation the most - Germany), through a tunnel visioned central banking system that is not as nearly as creative and responsive as out own - and I think our CB made a few grave errors.

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  • Comment Link sdmtgbanker Monday, 27 October 2008 17:59 posted by sdmtgbanker

    Reggie,

    You have any thoughts on the recent development of the Fri meeting between EU and Asian countries, and their apparent agreement on an undisclosed Global/IMF solution to be presented at the Nov. 15th meeting in Washington of the G20? It appears to me that they used this forum to decide on a unified course of action in the glaring absence of a North/South American presence. Some of their comments also seemed to point to currency implications in addition to the regulatory, repair, and reform agenda.

    I'm guessing that they may try and lessen the role of the dollar in world markets. Maybe a biforcated system of Yuan/Euro/Dollar? I don't believe that they could realistically expect the Euro or Yuan alone could eventually supplant the role of the dollar in world markets... and I don't believe EU and Asia would EVER be able to jointly agree as to one currency or the other as being better. But I do think, that "they think" they are way too reliant on the US and the dollar under the current system.

    Do you think the dollar dependancy play gets unwound in the near/mid future? It also appears that given the Kuwait banking situation, that the % rate derivatives are now also in jeopardy as to counterparty risk. With the shear size of that market and the volatile swings in currencies as of late..... I'm wondering if that is not the real "Boogey Man" in the closet" Credit derivatives may just be the appetizer... with % rate swaps the main course.

    It's scary world in which we play these days.

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  • Comment Link a b Monday, 27 October 2008 02:15 posted by a b

    From article above:

    "And despite what you hear from so-called gurus, the buck is the world reserve currency; a status that is not in jeopardy."

    Just accept that on faith and everything seems fine.
    And house prices always go up.

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  • Comment Link Phil V Monday, 27 October 2008 01:44 posted by Phil V

    http://blogs.cfr.org/setser/2008/10/26/the-case-for-a-bigger-imf/#comments

    please see comments...

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  • Comment Link Phil V Monday, 27 October 2008 00:35 posted by Phil V

    see below:

    http://derivativedribble.wordpress.com/

    p.s: inflationary vs carry-trade resumption: big diference: reflation = end of shit hitting fan. inflation =, i presume, $2000 gold.

    considering some drone in the sell-side "forecasted" 150 oil and 1500 gold to move some equities, i think it's safe to say that inflation like that isn't in the cards.

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  • Comment Link I Irongate Sunday, 26 October 2008 21:44 posted by I Irongate

    re; gjk313's question. i would have thought that once the delevering is over that we need to put the inflation trade back on since there is so much liquidity being thrown at the problems. BUT after reading this article below... I am not so sure anymore. It is a lengthly article but well worth the read.

    Burning Question: Won't This All Be Inflationary?
    by Jack Crooks
    Oct. 25, 2008


    It's a popular notion when the financial winds are blowing unfavorably:

    Money is being printed uncontrollably ... inflation is the only option ... fiat currencies are doomed.

    The thing is, if you're buying into this idea, you're mostly perpetuating a misconception. Actually, inflation isn't as simple and certain as it's cracked up to be.

    Until the global economy recently got tossed on its rear end, prices were rising in most every part of the world. The focus, of course, was on the cost of energy, food and various other raw materials. Central banks in a position to stand firm on monetary policy did so at all costs. Inflation was the real threat.

    But did that idea get turned around in the blink of an eye or what?

    Prices for natural resources have collapsed and continue lower still. Economies, developed and emerging, are feeling the pain of a U.S.-led slowdown. Global capital flow is shifting direction and composition. In other words, money is escaping risky assets and making a beeline to safer U.S.-dollar based assets and cash.

    The majority is starting to agree that deflationary forces are becoming strong. And at times when recession spans much of the globe, any upward pressure on prices nearly vanishes.

    But even those joining the deflation camp now have no idea what to expect in the future. They see all the money being pumped into the system and feel as though that seals the deal on a nasty wave of inflation not far down the road.

    To That I Say, "Not So Fast"

    Simply printing money can be the cause of inflation, but that is not always the case in a sophisticated economy where money and credit combine to produce wealth. Money must be spent, or make it down into the real economy where real people buy real stuff, otherwise it won't do the trick for those harboring inflation expectations — i.e. it does not provide economic stimulus in the form of rising prices. The best recent example of this comes from Japan.

    When the stock market bubble burst in Japan back in 1989, then the real estate bubble burst a couple of years later, the Bank of Japan pumped massive amounts of yen into the financial system. In fact, the bank pushed interest rates to zero in Japan. If it was all about money, then Japan should have experienced runaway inflation. But the money pumped into the system never made it to the real economy because, even at zero percent interest rates, no banks wanted to lend and few showed up to borrow.

    Why? Japanese banks had a massive amount of bad debts on their books. And they were using the Bank of Japan in providing liquidity to save themselves first and worry about lending later. Japanese consumers, after being crushed by the stock market crash and watching real estate investments crumble, weren't interested in borrowing anything at any rate. And many had no collateral left to borrow even if they wanted to. Does any of this sound eerily familiar?

    There was a major sentiment shift in Japan when the bubbles broke. Despite all the money the Bank of Japan continued to pour into the system, and no matter how much fiscal stimulus the government provided, real people shunned borrowing, lending, and investing.


    When the Japanese stock market burst, fiscal stimulus packages failed to boost borrowing, lending or investing. Sound familiar?
    The bottom line: Japan became locked in the bear hug of 14-year long deflation. Many believed they finally emerged from this grip, thanks to a positive 1% print in the Japanese consumer price index. But the credit crunch that is morphing into a threat to the global financial system, is pulling Japan back into the vortex of deflation. In the final analysis, all that money didn't matter.

    Sayonara, Conventional Wisdom

    This example proves that despite the best efforts of government officials to eliminate the business cycle and fight against the forces of the market, they usually end up prolonging the problem. Had Japan allowed for a huge wave of bankruptcies, effectively clearing the deck of all the dead wood and debris, they would likely have shortened this deflationary period considerably and set the stage for the strong, well-managed companies to prosper.

    This is a critical point, because if we think of a world with unlimited resources, it is the most efficient use of those resources that provides healthy growth for the entire system. It is why poorly managed institutions that waste resources should be allowed to fail, and the best managed allowed to profit without being hampered by competition that otherwise wouldn't exist if it weren't for the best intentions of government.

    The question is, will the weight of all this money become inflationary at some point?

    The answer is maybe. We are in the midst of a major global debt implosion. Writing off bad loans is deflationary because resources (money and credit) that could otherwise be used to create real value in the economy in the form of loans to businesses and entrepreneurs, are basically poured down the rat hole of past malinvestment.

    The question of when inflation returns may be more social or psychological than anything purely quantitative. Until real people are willing to borrow and lend again, in what we consider a rational risk-taking approach, it is unlikely monetary stimulus will do anything than allow the economy to muddle through at best.

    So inflation returns when sentiment shifts back to a world with a healthy risk appetite. The two key sentiment and wealth drivers for most investors in the developed world is their house and their investments for retirement — both have been ravaged and continue to be. It means a return of healthy risk appetite may be further down the road than is now expected.


    Writing off bad loans is deflationary because resources that could create real value in the economy are poured down the drain of past malinvestment.
    What Does This Mean for the Dollar?

    My long-term view has been, and continues to be, that the U.S. dollar has entered a multi-year bull market. That view is only validated in this environment.

    The U.S. dollar is the raw material, or fuel, for risky asset investing around the globe. When people want to target higher returns, they move money offshore to the periphery, to emerging and developing markets of the world that grow the fastest when money and credit are abundant. Thus, think of the dollar as greasing the wheels of financial markets around the globe.

    And despite what you hear from so-called gurus, the buck is the world reserve currency; a status that is not in jeopardy. Thus, as sentiment concerning risk taking continues to spiral lower and lower, more and more funds flow back from the periphery to the center where capital markets are deepest. U.S. capital markets are the deepest by far. It's why you see U.S. Treasuries rallying as big pools of money run to hide. So in this deflationary, risk-adverse world, the U.S. dollar is king once again.


    There is one chart I think best expresses this reality. It is the commodities index divided by the U.S. dollar index.

    When global growth is humming and money is flowing, investors want to be involved in emerging and developing economies that benefit mightily from commodities demand.

    As you can see on the chart, that sentiment has run its course and is diminishing fast — and that's very bullish for the dollar.

    Best wishes,

    Jack

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  • Comment Link gabe krawzak Sunday, 26 October 2008 20:40 posted by gabe krawzak

    This may not be the place to be asking this question but I know there are some knowledgeable folks using this blog so I thought I'd inquire. From reading this blog and others as well I understand that many hedge funds are closing shop and have been selling and will continue selling through the rest of the year. I'm interested in any opinions as to where that $ will be invested in the future. If the "golden age" of hedgefunds is over for now, doesn't the investment capital have to go somewhere? Also, I'm very fortunate to have found this blog because if I did not I'm certain that I would have relied on much of the "professional" Wall St. research I receive and would have bought many of the companies discussed in this blog rather than sold and in doing so I saved myself from major portfolio damage. For anyone that has not subscribed, a membership is likely the best investment you may ever make.

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  • Comment Link Jeffrey Hurley Sunday, 26 October 2008 20:13 posted by Jeffrey Hurley

    Appreciate your analysis you are doing excellent work. Thanks.

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  • Comment Link Phil V Sunday, 26 October 2008 12:25 posted by Phil V

    best i've seen:

    http://elainemeinelsupkis.typepad.com/money_matters/2008/10/elaine-meinel-supkis-------------east-asian-countries-to-create-80-billion-fund-to-deal-with-financial-crisis-leaders-from.html

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  • Comment Link a Sunday, 26 October 2008 11:50 posted by a

    that was for free,,,thx

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