Monday, March 31, 2008

Slow Motion Train Wreck

How long the Fed can keep the train on the tracks remains to be seen but I agree with Sedacca that it might not be too long. Capital impairments are simply too high, and the combination of rising unemployment, imploding commercial real estate, and homeowners walking away will be too much for lenders to handle. One or more major banks and broker dealers in addition to Bear Stearns will not survive the coming train wreck.
Citigroup, Merrill, Morgan Stanley, Lehman?

Monday, March 24, 2008

Existing Home Sales & Supply

Existing-home sales – including single-family, townhomes, condominiums and co-ops – rose 2.9 percent to a seasonally adjusted annual rate (1) of 5.03 million units in February from a pace of 4.89 million in January, but remain 23.8 percent below the 6.60 million-unit level in February 2007. The sales pace has been in a fairly narrow range since last September.

The national median existing-home price for all housing types was $195,900 in February, down 8.2 percent from a year earlier when the median was $213,500.

Also in the NAR sales report is the following:

Home prices within metropolitan areas are more telling. The most recent data shows roughly half of the metro areas in the U.S. with price increases, with healthy gains in markets such as Oklahoma City and Trenton, N.J.

What is conveniently left out of this bit of optimistic drivel is that the "most recent data" is from the third quarter of 2007, before all the bad stuff started happening. Some time ago, the NAR cited these statistics and they claimed price increases in two-thirds of metro areas - that was for data through June of 2007.

Look for these claims to disappear as soon as the fourth quarter data is available.

Saturday, March 22, 2008

S&P Flags Goldman, Lehman

Standard & Poor's, in a continuing sign of loss of confidence in investment banks' profitability, Friday put Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc. on negative outlook, lowering them from stable.

Although S&P didn't change the senior-debt ratings from AA-minus for Goldman and A-plus for Lehman Brothers, it brought its view of the likelihood of a precipitous decline in profits at the Wall Street firms during the next two years to the same negative levels it previously assigned to Merrill Lynch & Co. and Morgan Stanley.

The changes in the ratings outlooks are appropriate despite the fact that recent actions by the Federal Reserve have instilled confidence in the capital markets, S&P added.

"We believe that negative rating outlooks are broadly appropriate for the independent securities firms, reflecting the potential for a more substantial decline in profitability from capital-market activities," S&P said in a report whose principal authors are managing director Scott Sprinzen and analyst Diane Hinton. "Our current expectation is that net revenues could decline 20%-30% year-on-year" after write-downs.

Thursday, March 20, 2008

The Fed becomes a Subprime Lender

The Federal Reserve may be a central bank with special rights and obligations, but in the end it, too, is a bank and has to be very careful who it lends to and what kind of collateral it accepts in exchange.

From a bank analyst perspective, during the last few months the Fed has become increasingly more lax in its lending practices. It is financing highly leveraged investment banks and brokers and accepting a wide range of illiquid securities as collateral, particularly MBSs.

As of March 12, 2008 the Fed had almost $891 billion in assets, of which $660 billion were in Treasury bills and notes and $170 billion in an assortment of repos, the TAF facility, etc. The most recently announced programs like the TSLF ($200 billion), the open-ended discount window facility for investment banks/brokers and the $30 billion loan to Morgan (i.e. Bear's toxic assets) are not shown yet.

Like any other bank, the Fed does not have an unlimited amount of money to lend - all it has is about $660 billion in Treasuries that it can exchange for other, less marketable securities (and it has already announced programs for a big part of that). In contrast, US home mortgages alone amount to $10.5 trillion; if things keep unraveling, the Fed's balance sheet will prove very small for the role it has now chosen for itself.

As for the liability side, the Fed has issued about $781 billion of its own Federal Reserve Notes, i.e. dollars. Our currency is thus increasingly going to be backed by lower quality, riskier assets that no one else wishes to buy or lend against, instead of Treasurys. In effect, Mr. Bernanke is betting the farm on a quick real estate/mortgage turnaround and a very shallow recession. Worse still, instead of charging a higher interest rate for the loans made against the riskier collateral, the Fed keeps cutting rates.

Let's summarize: riskier borrowers, low quality collateral concentrated on real estate, questionable appraisals for market prices and "low, low rates". Is the Fed turning itself into a sub-prime lender? If I were a bank examiner, I would want to have a quiet word with Mr. Chairman about his lending practices.

And if I were a shareholder or creditor of the Federal Reserve Bank (remember what its liabilities are), I would be worried. As, indeed, so many already are - they are those who are exchanging their dollars for other currencies and commodities.

Tuesday, March 18, 2008

Foreign investors veto Fed rescue

Asian, Mid East and European investors stood aside at last week's auction of 10-year US Treasury notes. "It was a disaster," said Ray Attrill from 4castweb. "We may be close to the point where the uglier consequences of benign neglect towards the currency are revealed."

The share of foreign buyers ("indirect bidders") plummeted to 5.8pc, from an average 25pc over the last eight weeks. On the Richter Scale of unfolding dramas, this matches the death of Bear Stearns.

Goldman & Lehman Earnings

Those were not good earnings. Those were horrid earnings. However, the end of the world that many were expecting did not come. It's hard to say for sure but the realization the world is not ending today is likely what's behind this rally. The Fed's rate cut today that everyone is yapping about on CNBC likely has nothing to do with it.

Lehman may not be Bear Stearns but it is still leveraged 30.7 to 1. Citigroup and many financials are hugely leveraged as well. Eventually the market will have to face a deleveraging of those assets. Huge additional writeoffs are coming. Furthermore, many homebuilders are going to go bankrupt and today does not change that. But that is not today's business.

Today's business is simple: The much anticipated end of world did not come. Looking forward however, the underlying economic fundamentals have not changed.

Wednesday, March 12, 2008

Are the Fed & Financial Institutions Runing Low on Ammo as Projected Losses Escalate?

Housing Value = $20 Trillion

Outstanding Mortgages = $11 Trillion

Fannie Mae & Freddie Mac Share = $1.5 Trillion portfolio + $3.4 Trillion guaranteed

Household Equity = $9 Trillion ($3 Trillion > 30% decline)

Estimated Loss on All Credit = $1 to $2.7 Trillion

Capital of All Banks, Savings,
      Credit Unions, Hedge Funds, GSEs
= $1.7 Trillion

Fed Capital Remaining = $400 Billion

The Fed's Swap Meet

In an attempt to restore liquidity the Fed came up with a new facility called the Term Securities Lending Facility (TSLF). This program allows primary dealers to exchange a total of $200 billion mortgage backed securities (MBS) for treasuries. The period is 28 days instead of the traditional overnight lending. Why $200 billion? Because primary dealers hold $139.7 billion agency securities and $60.2 billion mortgage-backed securities. Minyanville cited Tony Crescenzi at Miller Tabak for those numbers early Tuesday.

Unlike the Term Auction Facility (TAF), which swaps cash for MBS and therefore requires sterilization so as not to affect the target funds rate, the TSLF is simply a swap of one instrument for another. It is not printing, and it injects no cash into the system even though there are misleading headlines such as this one bandied about by MarketWatch: Fed turns on the spigot of money again.

Lee Adler in Bandaid on a Ruptured Jugular explains what the Fed is up to with the TSLF.

The Primary Dealers are heavily short Treasuries at all times. They are heavily long all other debt securities simultaneously. The level of securities lending in recent months is unprecedented in all of human history, by an order of magnitude of 10.

Securities lent by Fed to Primary Dealers

The Fed is now responding to the pressure of the imminent collapse of the Primary Dealers and major banks worldwide, because not only are the PDs heavily short the stuff that is going up, Treasuries, they are heavily long the stuff that is going down, which is all other debt securities.

This is the worst of all possible worlds and the Fed’s action is like putting a bandaid on a ruptured jugular vein.
Lord only knows why primary dealers were short treasuries when interest rates were falling and the Fed was cutting rates, but that is what was happening.

What happens after 28 day is pretty clear. The swap will be rolled over and over and over until the mortgage backed security market stabilizes. This could be a year from now, or perhaps 10. That may sound ridiculous but it's essentially what happened in Japan. It's also part of the Zombification process I described in The Great Pretender.

This may temporarily stop a further squeeze against dealers who are short treasuries and long MBS, but it is will not do much of anything to restore a bid in the MBS market. Nor will it cure the massive leverage problems at many of the primary dealers and banks.

Here's an interesting paragraph from the MarketWatch article reference earlier: "Counting the currency swaps with the foreign central banks, the Fed has now committed more than half of its combined securities and loan portfolio of $832 billion, Lou Crandall, chief economist for Wrightson ICAP noted. 'The Fed won't have run completely out of ammunition after these operations, but it is reaching deeper into its balance sheet than before."

The Fed is simply too small an actor, relative to the global banking system, to have enough impact. Consider: one analyst observed that with its new programs (the new $100 billion repo facility and the $200 billion Treasuries-for-MBS facility), the Fed had just creates a $300 billion bank overnight. True enough, but consider: Citigroup's balance sheet has $2.2 trillion in assets. Steve Waldman estimates that the Fed can take deploy another $300 to $400 billion to similar operations. It can take one more big shot at this problem (ex monetary moves, which Hamilton deems ineffective) before it has used up all its powder. Source

Bernanke's intent is to buy the dealers time, but it really can't work. Those securities will not be worth more tomorrow than they are today. For now, a MBS fire sale was averted, but it can't be put off forever.

The ongoing tsunami of housing related bankruptcies and foreclosures will seal the fate. Meanwhile the zombification of banks continues.

Tuesday, March 11, 2008

$1 Trillion is the New Size 6!

"On March 7, Goldman Sachs economists published an even higher estimate of mortgage-related losses, at $500bn, along with $656bn in other losses, for a total of $1,156bn. The mainstream has caught up."

Unfortunately we have gotten to the point that we need to pray that the Fed can rescue the economy and financial markets. But as argued here last summer the problems in the financial markets are not just of illiquidity that Fed policy can address; they are rather of credit and insolvency that no amount of monetary easing and liquidity injections can ease.

Indeed, the reason why the agency debt and agency MBS securities spreads have sharply widened relative to Treasury has only partly to do with illiquidity; it has much more to do with the fact that Fannie and Freddie have already experienced massive losses on their portfolios of mortgage related assets and that these losses will significantly increase in the months to come. That repricing of AAA agency debt and agency MBS is a fundamental credit repricing, not just driven by illiquidity in these markets.

And now the Fed radically shifting the compositions of its almost $900 billion of assets from safe Treasuries into up to $400 billion of mortgage related securities is dangerous and a active form of manipulation of the credit spreads on these instruments. Why to fight a repricing of these agency spread that is fundamentally driven by the expected losses that the GSEs face? The last time the Fed tried to manipulate long term interest rates was during the Operation Twist program in the 1950s. The fact that the Fed has effectively gone back to trying to actively affect the yields on longer term (agency) bonds is a sign of how desperate the markets are now and how desperate the Fed has become in trying to avoid a financial meltdown that looks more likely by the day.

Wednesday, March 5, 2008

Ambac - No Rescue, No Split, No Sale, No Bailout, No Backstop, No $3 billion

Ambac Financial Group, Inc. (NYSE:ABK) (Ambac) today announced that it has commenced a public offering for at least $1 billion worth of shares of its common stock, par value $0.01 per share ("Common Stock"). Ambac has also granted the underwriters in that public offering a 30-day option to purchase from Ambac additional shares of Common Stock to cover over-allotments, if any.

In addition, Ambac announced that it has concurrently commenced a public offering of Equity Units, with a stated amount of $50 per unit for a total stated amount of $500 million. Ambac has also granted the underwriters a 30-day option to purchase additional Equity Units to cover over-allotments, if any. Source
[Y]ou can imagine my surprise when the stock was halted today. WSJ Marketbeat announced "Ambac Bailout Imminent! Maybe! Possibly!"

Then we learn that the deal was dead, and that Ambac needs to raise $1.5 billion dollars. Thus, all of those rumors and CNBC appear to have been patently false. Source
``This wasn't what the market was hoping for,'' said Robert Haines, an analyst at CreditSights Inc., a bond research firm in New York. ``There's no bailout. It's just a capital raise, and there's no guarantee they'll get it done.'' Source
Today's announcement by Ambac, that it will raise $1.5 billion in equity and equity units, came as a shocker. It had been leaked more than a week ago that the bond insurer planned to raise a total of $3 billion, $2.5 billion of it in equity backstopped by the eight banks previously involved in bailout talks, and $500 million in debt. Now the deal is only $1.5 billion in equity, no mention of debt, and apparently no bank backstop either.

If the banks were unwilling to offer even a mere backstop, it suggests that Ambac wasn't able to provide satisfactory information about its prospects, confirming the critics' case.

The fact that the equity-raising is so far below the earlier plan is a bad sign for Ambac's ability to maintain its AAA. This is at most a short-term stay of execution unless the housing market miraculously improves. Needless to say, the share price beat a hasty retreat. Source

Sunday, March 2, 2008

In Parts of U.S., Foreclosures Top Sales

Mortgage foreclosure notices are going out so fast that in some states the number of new foreclosure proceedings each month is greater than the number of homes sold that month.

Saturday, March 1, 2008

Why the Fed has no other Alternative but to print Money

So why is the US Fed so concerned about deflation that Mr.Bernanke even suggested dropping US dollar bills from a helicopter in order to combat it? There is one condition under which deflation is a disaster and this is when total U.S. credit market debt is high as a percentage of the economy.

At the end of 2006, it stood at 336.4%.
Prepare to be shocked.
The US is insolvent. There is simply no way for our national bills to be paid under current levels of taxation and promised benefits. Our federal [debts] alone now total more than 400% of GDP. [W]e find that the official debt stands at $8.507 trillion or 65% of (nominal) GDP but when we add in our “off balance sheet” items [for social insurance] the national debt stands at $53 trillion or 403% of GDP. See table 4, page 10, of the 2006 annual report.

That is the conclusion of a recent Treasury/OMB report entitled Financial Report of the United States Government that was quietly slipped out on a Friday (12/15/06), deep in the holiday season, with little fanfare. Source 2007 Report
1. There is no way to ‘grow out of this problem. What really jumps out is that the US financial position has deteriorated by over $22 trillion in only 4 years and $4.5 trillion in the last 12 months (see table above, from page 10 of the report). The problem did not ‘get better’ as a result of the excellent economic growth over the past 3 years but rather got worse and is apparently accelerating to the downside.

2. The future will be defined by lowered standards of living. As Lawrence Kotlikoff pointed out in his paper titled “Is the US Bankrupt?” posted to the St. Louis Federal Reserve website, the insolvency of the US will minimally require some combination of lowered entitlement payouts and higher taxes. Both of those represent less money in the taxpayer’s pockets and, last time I checked, less money meant a lower standard of living.

The Gokhale and Smetters measure of the fiscal gap is a stunning $65.9 trillion! This figure is more than five times U.S. GDP and almost twice the size of national wealth. One way to wrap one’s head around $65.9 trillion is to ask what fiscal adjustments are needed to eliminate this red hole. The answers are terrifying. One solution is an immediate and permanent doubling of personal and corporate income taxes. Another is an immediate and permanent two-thirds cut in Social Security and Medicare benefits. A third alternative, were it feasible, would be to immediately and permanently cut all federal discretionary spending by 143 percent.

3. Every government facing this position has opted to “print its way out of trouble”. Of course, it is impossible to print our way out of this particular pickle because printing money is inflationary and therefore a ‘hidden tax’ on everyone. Consider, what’s the difference between having half of your money directly taken (taxed) by the government and having half of its value disappear due to inflation? Nothing. Except that the former is political suicide while the second is conveniently never discussed by the US financial mainstream press (for some reason) and therefore goes undetected by a majority of people as the thoroughly predictable outcome of deficit spending. All printing can realistically accomplish is the preservation of some DC jobs and the decimation of the middle and lower classes.

There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.
~ Ludwig Von Mises (1881-1973)

Markets Fall on Drumbeat of Grim Reports

“You can almost draw it out in a diagram,” said Bernard Baumohl, managing director at the Economic Outlook Group in Princeton, N.J. “With home prices going down, consumers cut back on spending. If consumers cut back on spending, the economy weakens further. If the economy weakens further, fewer people are able to afford mortgages so home foreclosures increase.”

In January, 23.4 percent of outstanding subprime mortgages were either 60 days’ delinquent, in foreclosure or had already had the home repossessed, up 9 percent from December, according to Rod Dubitsky and other analysts at Credit Suisse. He noted that in California, which is suffering more than most states, mortgage companies are holding 10 times the number of foreclosed homes as they were at the start of last year, because more borrowers are falling behind and it is taking longer to sell homes given the glut of properties on the market.